Encana starts to turn the ship around
Also: are we on the verge of $75 oil?
When he was younger, Max Fawcett wanted to make a mint in the markets. Now as the managing editor of Alberta Venture he gets to write about them. Close enough, right? He can be reached at email@example.com
by Max Fawcett
Last year, newish CEO Doug Suttles announced that Encana (TSE:ECA) would be refocusing its efforts on five core areas. And earlier this week, he made an important step in that direction, selling off the company’s Jonah assets – not one of those five core areas – for US$1.8 billion. Meanwhile, it’s also in the process of trying to find a buyer for its Bighorn assets, which FirstEnergy thinks could be worth an additional $2 billion. That’s potentially $4 billion in dry powder for the company.
What will it do with the windfall? According to FirstEnergy, the company discussed five options at its East Coast Energy conference in New York a few weeks ago. First, it could retire some of its debt, which stood at US$7.1 billion at year’s end. It could buy back more shares, and given that its current market cap sits at around US$16 billion “the potential size of a share buyback program could be enormous,” FirstEnergy said. Third, it could make some bolt-on acquisitions near its five core areas. Fourth, it could identify a sixth key area and expand accordingly, although that seems unlikely given the direction the company is moving under Suttles’s leadership. And finally, it could increase its capex spending, although FirstEnergy thinks that’s even more unlikely. “Encana would not look to deviate from its current plans to keep capex in line with expected cash flows,” it said.
Meanwhile, investors (and, presumably, oil company executives) are talking about the recent cover story for Barron’s, which heralded the imminent arrival of $75 oil. “Citigroup’s head of global commodity research, Edward Morse, believes the combination of flattening consumption and rising production should mean that ‘the $90-a-barrel floor on the world oil price over the past few years will become a $90 ceiling,’” the authors of the Barron’s story write. “Within a new trading range with a $90 ceiling, Morse sees an average of $75 as plausible.”
Why? Demand substitution, mostly. Their thesis is based on two assumptions: that the supply of oil will continue to rise due to the ongoing exploitation of shale, offshore and other unconventional sources, while the demand for it may start to erode more quickly as the traditional pricing relationship between natural gas and oil remains broken. “Transportation accounts for nearly half of the oil the world consumes each year, and trucks alone use nearly one of every nine barrels consumed,” they write. “Also ripe for natural-gas substitution is the consumption of oil for industrial uses – accounting for more than one in five barrels consumed – and for electricity generation, which still accounts for one in 18 barrels consumed worldwide. Moreover, when mixed with petroleum, fuels that can be made from natural gas, like ethanol and methanol, can help meet ever-more-stringent Corporate Average Fuel Economy, or CAFE standards, being mandated over the next several years. Taken together, these trends should be more than enough to cause global consumption of oil to slow its growth over the next several years and then flatten out.” Given that most energy companies in Alberta are pricing in substantially higher expected oil prices, they may be in for a nasty surprise. That is, of course, if Morse is actually right.