EnCana narrows focus

For EnCana (ECA-T, ECA-N) being big had its disadvantages.

The largest natural gas producer in North America announced on May 11 that it would separate its oil and gas division into two separate companies.

The move was immediately applauded by the market, as its shares moved up from their pre-announcement price of $86.52 to as high as $95.95.

“The real value we see in this transaction is that it really does create two best in class entities,” said UBS analyst Andrew Potter at a recent oil and gas conference, “and it forces the market into starting to realize more the real value in these two entities.”

Brian Ferguson, current chief financial officer of EnCana, and soon to be chief executive of the oilsands spin-out, says the move was the next step in a corporate strategy aimed at maximizing value by narrowing its focus.

That strategy began to be implemented back in 2003 when EnCana sold all of its reserves and production outside of North America.

Those sales raised $13 billion, some of which went towards repurchasing 13% of its shares outstanding while the rest went towards further establishing itself as the dominant natural gas company in North America.

Its a formula the company wants to repeat by allowing the new oil spin-out to focus on its sizable assets in the oilsands.

While the natural gas company will maintain the EnCana name, the oilsands are being called the integrated oil company.

Integrated because while the oilsands properties will make up the bulk of its assets, the company will also hold on to EnCana’s shallow gas projects in Alberta.

That means the split will occur along geographical lines as well, with the oil company focusing on Alberta, and the gas company working assets in B.C., the northwestern U.S. and Texas.

At a recent oil and gas conference in Texas, current EnCana chief financial officer and future chief executive of the integrated oil company, Brian Ferguson, touted the advantages of the spin-off in terms of market perception.

Ferguson said the move will make it easier for the market to value the two companies as much valuation on the Street is done by comparing to like-peers.

EnCana’s position as a large natural gas and oil producer meant it was lacking in such appropriate comparisons, and as a result, from the company’s point of view, both its oil and gas assets were undervalued.

“The gas company will get compared to the best companies in gas, and the integrated oil will get compared to the best company’s in the oilsands,” Ferguson said.

Current EnCana shareholders will get one share in each of the new companies for their current EnCana share.

EnCana expects the split to be implemented by early next year with each company expected to rank amongst the 20 largest companies in Canada.

And while EnCana’s meat-and-potatoes natural gas business has long been seen as a buffer to the increased risks on the costly oil sands side, the decision to put the oil sands on their own, speaks to a maturation of the projects.

The move also may silence those protesting against Alberta’s recently revised royalty regime.

One of the chief protesters was EnCana itself. Chief executive Randy Eresman was a vociferous opponent to the changes when meetings between industry and the province were underway last fall. Eresman said at the time that the company could pull $1 billion in capital spending if the higher royalties were instated.

They were, but rather than pull capital from the province, EnCana now says it will pour more money into it in the form of increased oil and natural gas drilling.

Oil prices north of US$130 per barrel have a way of soothing over frayed relations with the government.

And while packaging the natural gas projects in Alberta to the integrated oil company will mean that the remaining EnCana gas company will fall from its perch as the number one natural gas producer in North American, EnCana says its pipeline will get it back into the top spot within two years.

It is largely banking on production ramp up at its Amoruso field in East Texas to make those gains.

As for the Integrated oil sands company, production and refining is expected to bring in $2 billion a year in free cash flow that will in large part go towards expanding refineries in Illinois and Texas over the next two years. Those refineries are part of the company’s equally held joint venture with ConocoPhillips (COP-N).

EnCana itself was only created six years ago via a merger between PanCanadian Petroleum and Alberta Energy

PanCanadian was the product of Canadian Pacific’s significant land holdings in what is now the oilsands region. Pacific was granted the land by the federal government back when it was trying to encourage railroad construction.

Alberta Energy was also built on the back of government grants. Created by the provincial government in mid-1970s it was given crown mineral rights and various other business interests in the province, helping to make it the country’s biggest natural gas company.

And while both companies had oil assets, the new company focused on natural gas as oil assets were in the capital intensive oilsands, and oil prices were south of US$30.

How quickly things change.