Encana is planning for natural gas-fuelled cars
But will that revolution happen in time to save the company that’s behind it?
by Max Fawcett
By the standards of Bay Street investment bankers and portfolio managers, the logic behind the deal was unimpeachable. In the fall of 2009, Encana was carved into two pure-play companies, one focused on natural gas and the other on oil. The company told its shareholders that by doing so, it would unlock the value that was being hidden in its combined operations, and they certainly seemed to agree. When the split was put to a vote, 99 per cent of Encana shareholders approved.
Photograph Colin Way
But the split left the company dependant on the price of natural gas for its success, and as anyone with a pulse and a portfolio knows only too well, they couldn’t have picked a worse time to do that. “By the time they ended up splitting,” says Michael Dunn, an analyst with FirstEnergy Capital who covers the company, “you’d already seen the best days for natural gas.” Dunn’s colleague Martin Molyneaux is confident that sub-$3 prices for natural gas won’t last forever, and the push to build LNG export terminals – there are 13 currently planned for construction – will give producers like Encana access to the global market. “You’ve never seen a protracted disparity between North American gas prices and global ones,” he says. “That can’t exist for a 10-year period. The economic prize is just too great.”
The problem for Encana is that it can’t afford to wait for those terminals to get built. The company’s hedges have already started to roll off, and in 2013 just 19 per cent of its production will be hedged at $5.24. By 2014 it will be completely exposed to the price of natural gas, and at current prices RBC Capital Markets estimates that it will face a cash shortfall in excess of $1 billion a year. It has a considerable portfolio of non-core assets that it can sell off to cover the shortfall between its operating revenues and its costs, but there is only so much furniture it can sell to pay the mortgage before the house is completely empty.
The job of saving Encana from the future belongs to Eric Marsh, the executive vice-president of Encana’s natural gas economy group as well as the senior vice-president of its U.S. division. He doesn’t dispute the fact that his company was caught a bit flat-footed by the whipsaw reversal in the price of natural gas, but he rejects the idea that Encana hasn’t done enough to respond to change. If anything, he says, the company has spent the last three years trying to lead that change, and it’s done that in part by playing the role of guinea pig in order to demonstrate the virtues of natural gas.
One of the first such measures the company took was switching its drilling rigs over to liquefied natural gas instead of diesel. “In areas where we operate, where we drill and complete natural gas wells, it makes a lot of sense for us to put LNG facilities in those areas and run our rigs on it and the trucks that serve our rigs,” Marsh says. “You build out from the areas in which you operate.” It didn’t hurt that the switch ended up producing savings for the company on its fuel costs that ranged from between $500,000 and $750,000 a year on a normal-sized rig to over a million dollars on its bigger ones.
In the same spirit, Encana committed to converting its fleet of 1,100 pickups and trucks to natural gas, with 290 of them already switched over. And in order to supply those vehicles it built seven compressed natural gas (CNG) fuelling stations, including one in Strathmore and another in Sierra, B.C. It has plans to build more of them in the near future, but in the interim decided to purchase six mobile fuelling vehicles to cover the gaps in their network.
The company has also been a vocal proponent of natural gas as an alternative feedstock for electricity generation. “We were one of the original members in America’s Natural Gas Association, where we worked hard on getting out the message that natural gas is a cleaner solution than the use of coal or diesel fuel,” Marsh says. Those efforts have started to pay dividends, as this past May, for the first time ever, more electricity was generated in the U.S. using natural gas than coal. That was a direct result of the decision by utilities across the U.S. to switch over to natural gas from coal in order to take advantage of the favourable price spreads between the two feedstocks. Marsh estimates that over the last five years the volume of natural gas being used to generate electricity in the U.S. has increased by seven billion cubic feet per day. “That’s quite a feat for natural gas.”
Marsh also says natural gas has an important role to play in backstopping the build-out of North America’s renewable energy sector. The two biggest downsides associated with solar and wind energy are their intermittency and their cost, but combining a solar plant in Arizona or a wind farm in Texas with cheap natural gas turbines addresses both of those shortcomings. “When the wind doesn’t blow and the sun isn’t shining, natural gas is there to provide that electricity for you,” Marsh says. “The combination of the two makes a lot of sense.”
Unfortunately for Encana, even with all the coal-to-gas switching that has taken place, the price of natural gas has barely budged. If it does start to move to the upside, utilities will simply switch back to cheaper coal in order to generate their electricity. And if that doesn’t put a damper on the price, the trillions of cubic feet of natural gas that are still in storage and the trillions more that have been taken off production but can be put back into it – and onto the market – with the turn of a valve will.
That’s why Encana has shifted its focus to the transportation sector, the one area where the demand could match up with the supply of natural gas. The numbers say it all: there are approximately 75 billion cubic feet of natural gas produced every day in North America, and Marsh estimates that if every car and truck in the U.S. was switched to a natural gas engine, the demand from them could reach 70 billion cubic feet a day. “It’s a monstrous market,” he says, “so capturing 10 or 15 per cent of it would be a huge accomplishment for the natural gas industry.”
While it might be tempting to target the consumer market, Marsh knows that the current lack of infrastructure, along with the cost of retro-fitting existing vehicles and the time required to fill a vehicle with CNG (even so-called “fast fueller” stations take as long as 15 minutes to fill a Honda’s tank), make that virtually impossible. That’s why Encana has started by targeting commercial vehicles, the tens of thousands of rigs, barges, ships, buses and trucks that move goods across North America every day. Because of their size and the volume of fuel they use, Marsh is confident that the value proposition associated with switching to LNG can be made more clearly. For example, he says truckers can save anywhere from 25 to 35 per cent on their fuel costs by switching from diesel to natural gas, and that on higher mileage trucks the cost of converting the truck over to LNG pays for itself in a year or less.
Right now, there are approximately 800 Class-8 trucks (the biggest 18-wheelers) running on LNG, with 300 more already sold in 2012 and anywhere from 600 to 900 orders being processed by manufacturers. That’s a 25 per cent year-over-year increase in the number of trucks on the road that are using LNG, and Marsh thinks the momentum will continue to build as truckers get access to a wider range of LNG-fuelled vehicles. Right now, there are only two engine sizes – 8.9 litre and 14.9 litre – that someone looking to buy an LNG-compatible truck can choose from, but Encana’s efforts to convince engine manufacturers like Cummins, Westport and Peterbilt to expand their range of offerings has paid off. An 11.9-litre engine is set to be released in 2013, and Marsh says there are also plans to build two other LNG-compatible engine sizes by 2015. Meanwhile, the news that Shell is planning to invest more than $300 million to build as many as 100 of its own LNG fuelling stations across the U.S. won’t hurt the popularity of LNG as a commercial fuel source. “You’re starting to see it happen,” Marsh says. “The trucking industry will tell you that if they can get these kinds of savings, they’re going to do it.”
But the real tipping point will come when companies like Encana get access to the millions of cars and trucks that sit in driveways and garages across North America. Here, too, Encana is seeing some meaningful progress. Fiat, Ford, Volkswagen and Volvo have all put out cars that run on CNG, while GM, Ford and Dodge are all building so-called “bi-fuel” pickup trucks. “That was a huge accomplishment,” Marsh says, “because the reality is that people didn’t want to buy a conversion because of the warranty issues. We’re excited about the fact that you’re going to be buying natural gas vehicles right from the factory that are warrantied and completely emissions tested.” And while there is a spattering of compressed natural gas fuelling stations across the U.S., Marsh thinks the real future for CNG may lie in home-fuelling. “You’re going to have a gas appliance in your garage that’s going to fill your car,” he says. “When we get to that point, you’re going to see this thing tip even faster.”
The upside for Encana if that happens would be tremendous. There’s the fact that it would create a steady source of demand for natural gas, which can’t help but have a positive impact on the price of the commodity. But a robust market for natural gas as a fuel source would also give the company a permanent and profitable hedge against low natural gas prices. “Let’s just say we get to 2015 and the natural gas economy, whether it’s LNG or CNG, begins to take off,” Marsh says. “What’s really positive is that when natural gas prices are low, the profit you make selling it as a transportation fuel is quite high. What you’re really playing here is the spread between oil and natural gas. The wider the spread, the more profit you make.” He estimates that the company could earn a netback of anywhere from $4 to $8 per MCF under that scenario.
FirstEnergy’s Martin Molyneaux is cautious about the probability of widespread uptake of natural gas-fuelled vehicles in North America. “The leading nation in the world right now for compressed natural gas vehicles is India,” he says. “They’ve been at this for a decade, and they’ve put a small dent in things. It’s a very long process to get people off of gas and diesel.” But Marsh remains optimistic. “We’ve modelled it a number of ways,” Marsh says, “but realistically you begin to see the momentum build in three to four years.”
The key question – and an uncomfortable one, to be sure, for Encana – is whether the company will be around to see that happen. Encana recently announced that it was expanding its 2013 capital expenditure budget to drill for oil and liquids on some of its plays, and while that seems like a safe strategy – the market, after all, is currently paying far more for those than dry gas –the approximately 45,000 barrels per day that it will produce aren’t nearly enough to change the company’s direction. It is, for better or worse, a dry gas company, and its fortunes will depend in large part on a revolution it has tried to instigate but can’t ultimately control. Will North Americans embrace natural gas as an alternative fuel source? And will Encana be around in 10 years to see it happen?