Threats to Encana's Turnaround

Threats to Encana's Turnaround

For all the excitement over North American energy production, threats to companies and their investors remain. There's money to be made and lost in this business, and investors need to examine these threats before putting their money into a stock. One company worth examining is Encana .

Encana represents a turnaround story. The company produced primarily natural gas, doing well until gas prices took a dive and took the stock with it in 2012. Since then, Encana named a new CEO, shook up the board, and pushed into oil and natural gas liquids. The company has its strengths and weaknesses, and certainly enjoys opportunities. In this article, I look at some threats Encana must overcome before completing its turnaround.

It's still a natural gas company
Encana traditionally produced natural gas. The company did well until the United States got in on the act in a big way and crushed gas prices like a bug. Encana responded by growing its oil and natural gas liquids business. This was a smart move; these commodities generate more profits than natural gas. The problem is, Encana still produces natural gas out the wazoo at a time when everyone else does, too.

According to the U.S. Energy Information Administration, natural gas production in the United States should remain at near record levels through 2014. Further, U.S. imports of natural gas will drop below 5% of overall gas consumption during this same time. This poses a problem for Canada since practically all of its dry natural gas exports go to the U.S. Liquefied natural gas exports are non-existent, though Encana and a few others look to export LNG in the future. The earliest exports are expected in 2015.

Most likely, natural gas prices will remain under pressure for the immediate future. Having come off the lows of June 2012, natural gas prices still remain below $4/MMBtu. Encana produces natural gas economically, but at these prices, natural gas won't be what it was as a revenue generator.

Takeaway problems
As mentioned earlier, exports of natural gas present an opportunity for Encana to grow its revenues. Exports to China, both in the form of natural gas and crude oil, could be a big market for the company. For natural gas, there are no export terminals. Several energy companies joined forces to build the Kitimat LNG export terminal on Canada's west coast. When completed, Encana will finally have a way to export its gas. It will also have to compete with Australia, Papua New Guinea, and perhaps even the United States for the Asian market.

Oil exports face a similar threat. The Asian market will likely pay more for Canadian crude oil than the U.S. market will, but the pipeline capacity to export this crude is limited. For that matter, export pipelines to the U.S. are also limited. These constraints hamper not only Encana's business but the Canadian economy as a whole.

These pipeline constraints are not for lack of trying. Enbridge operates the largest export pipeline network in Canada. All of its various pipelines feed into the United States. Enbridge will spend $26 billion on pipelines and other infrastructure projects through 2016 to help it meet demand. Kinder Morgan Energy Partners currently operates the only pipeline taking oil to the Canadian west coast. Its Trans Mountain pipeline moves 300,000 bbl/d, and Kinder Morgan wants to grow that. Specifically, it hopes to build a second pipeline on the existing right-of-way to expand its capacity to 850,000 bbl/d. Enbridge looks to compete with its own pipeline reaching to the deepwater port of Kitimat.

Much like the Keystone XL pipeline, these pipelines proposed by Enbridge and Kinder Morgan provoke resistance and opposition. Legitimate concerns regarding potential oil spills in British Columbia need to be addressed. Even if approval is granted, these oil pipelines won't become operational until 2017.

New board, new direction, but where is it going?
On Oct. 12, Encana CEO Doug Suttles announced a realignment of the company's senior management team. Suttles named two new executive vice presidents and released five other senior executives. According to the company, four of these five departing executives retired. The new board structure is meant to be simpler with clearer accountability for its members. Will it work? Good question.

The new leadership will take time to develop cohesion. The company's strategic review should be complete by year end. Will management be able to act decisively on the review? Encana and Suttles seem intent on streamlining the company. A well-functioning leadership team will help make that happen. A dysfunctional team won't.

Final Foolish thoughts
Flux, thy name is Encana. This past year saw a new CEO, a revamped board, and a major strategic review. Hopefully a more streamlined and focused company will emerge. Encana owns promising oil and liquids assets, but will the company focus on these more lucrative plays? Will it have sufficient take-away capacity to fully exploit its assets? Will the new management team coalesce and deliver the leadership necessary to make needed changes? Handling these threats while seizing its opportunities: That is the challenge facing Encana.

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Robert Zimmerman has no position in any stocks mentioned. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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