Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


Summary

  • Natural gas prices rose in 2013.
  • Encana reported a decline in proved natural gas reserves despite rising gas prices.
  • Encana's growing focus on crude oil plays reduced the value of its proved undeveloped gas reserves.

  • On February 13, 2014, Encana (“ECA”) reported fourth quarter and full-year 2013 operating results.  The company reported a per share net loss of $0.34 for the quarter and net income per share of $0.32 for the full year.  On an operating basis, excluding special items, ECA reported fourth quarter EPS of $0.31, compared to $0.40 in the 2012 fourth quarter.  For the year, ECA reported operating EPS of $1.09 in 2013, down from $1.35 in the prior year.

    The earnings announcement also included information on the ECA reserves which was confirmed at explained in greater detail in the company’s 40-F statement filed with the SEC.  As reflected in the Table below, the ECA reserves declined for the second straight year.  We will focus on the natural gas disclosures since 85% of the ECA total reserves asset base is composed of natural gas.  The Table shows that natural gas reserves of 12.8 tcf (trillion cubic feet) at the end of 2011 declined to 8.8 tcf by the end of 2012.  Last year, the natural gas reserves declined again to 7.8 tcf.   Many observers had  expected that rising natural gas prices in 2013 ( which averaged well above the comparable 2012 price average)  would enable ECA to report an improved reserves position.  As a Canadian company, ECA reports its reserves under both the Canadian and the US SEC rules.  The SEC rules look only at net reserves and must be based upon historical average prices. These historical prices are then used to estimate future revenues and reserves.  The Canadian protocol requires management to use projected prices.   The Table below is based on the SEC pricing rules.

    As noted on the 40-F statement, ECA used  natural gas prices of $4.12 for 2011; $2.76 for 2012; and $3.67 in 2013 (prices are per mcf).  As it became  clear during 2013, the average price for natural gas was going to be higher than the average price for 2012.  This supposition proved to be the case as the average price of $3.67 rose by 32.9% above the 2012 average price.   Based on the likelihood of this increase in the average natural gas price, many industry experts expected ECA to report an increase in its proved reserves of natural gas.   As we discussed  above, the ECA reserves actually decreased in 2013, from the end of 2012.



    The ECA Reserves Table, shown above, breaks down the various causes for the decline in the company’s natural gas reserves.  Production was not the culprit.   Production of natural gas was 1.01 tcf,  close to the 1.01 tcf produced in 2012, and well below the 1.2 tcf produced in 2011.  The primary reason for the decline in reserves was “Revisions” which the company explains in Note 4 to the Table.  Higher prices actually did add some 2.2 tcf to the company’s reserves, but this gain was more than offset by the decline of 2.87 tcf of the company’s proved undeveloped reserves. SEC rules only allow a company to include in its proved undeveloped total, the reserves that it has scheduled to develop within five years from the reserves disclosure date (in this case, the end of 2013.)   In fact, the ECA proved undeveloped reserves decreased from 3.17 tcf at the end of 2012,  to 2.48 tcf at the end of 2013.  ECA explains that it had changed its development plans during 2013, emphasizing more development of natural gas liquids and crude oil at the expense of natural gas development.  This change in development emphasis pushed a material portion of the proved undeveloped gas reserves beyond the five-year period and, therefore,  made them ineligible for inclusion in the SEC-defined proved reserves Table.   This ECA example is a stark reminder to investors that they cannot rely solely  on natural gas price movements when they attempt to predict an oil and gas company’s upcoming disclosures of oil and natural gas reserves.

    Tom Burnett is Director of Research at Wall Street Access.  He does not own Encana securities. Wall Street Access or its affiliates does not beneficially own 1% or more of the common equity securities of ECA.  In the past 12 months, Wall Street Access did not manage or co-manage a public offering of securities for ECA or receive compensation for these services.   Wall Street Access does not intend to receive compensation for investment banking services from ECA in the next three months.  Wall Street Access did make a market in ECA shares at the time this article was published.





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