TOW­ER­ING AM­BI­TIONS

En­cana was once a made-in-Canada suc­cess story that seemed des­tined to de­fine the very best of the coun­try’s en­ergy sec­tor. How did it all go so wrong?

Alberta Oil - - FRONT PAGE - © al­ber­taoil­magazine.com

A se­ries of badly-timed de­ci­sions brought En­cana down from the heights of Canada’s en­ergy sec­tor. Is it too late to re­verse its for­tunes?

CAL­GARY’S BOW TOWER,

with its sleek criss-cross­ing de­sign and its curvy glass con­tours, stands in sharp con­trast to the city’s oth­er­wise drab sky­line. The build­ing rises up from Cen­tre Street to a height of 236 me­ters, mak­ing it Canada’s tallest build­ing out­side of Toronto—and, for now, eas­ily Cal­gary’s tallest. The top suite of the Bow, which serves as the head­quar­ters for En­cana, has an air of ex­trav­a­gance, with ex­ec­u­tive suites that over­look a sky-lit atrium pop­u­lated with modern fur­nish­ings, a lav­ish au­di­to­rium and a multi-story win­dow that over­looks the city.

THE BOW SERVES AS A

sort of mon­u­ment to the com­pany’s tow­er­ing am­bi­tions to be Canada’s most suc­cess­ful in­ter­na­tional en­ergy com­pany. By the time in­dus­try leg­end Gwyn Mor­gan re­tired as CEO of En­cana at the end of 2005—one year be­fore it un­veiled plans for the op­u­lent Bow build­ing—ev­ery­thing was in place for a con­tin­ued suc­cess story. The in­de­pen­dent com­pany’s gas re­serves had grown by al­most a quar­ter the year be­fore. Cash flow was up by 57 per­cent. The com­pany had off­loaded 740,000 net acres of North Sea as­sets to Nexen for $2.1 bil­lion in De­cem­ber 2004, adding to its al­ready en­vi­able war chest. Randy Eres­man, Mor­gan’s long-time right-hand man, was el­e­vated to CEO. There was no rea­son for the dom­i­nant com­pany to go any­where but up.

Fast for­ward to to­day. En­cana’s share price reached a low of $4.15 in Fe­bru­ary 2016, mark­ing an 82 per­cent drop from five years ear­lier. The com­pany posted a net loss of US$5.1 bil­lion in 2015, com­pared to a profit of US$3.4 bil­lion the year be­fore (it was dinged with $4.1 bil­lion worth of im­pair­ment charges). It cut 20 per­cent of its staff over that year, and slashed an­other 20 per­cent in the first quar­ter of 2016. Those re­duc­tions were in line with in­dus­try-wide cost cuts fol­low­ing the plum­met in oil prices that be­gan mid2014, but for En­cana the pain had been go­ing on for years. A badly-timed ex­pan­sion into nat­u­ral gas lead­ing up to the spinoff of Cen­ovus En­ergy in 2009 was caus­ing En­cana to buckle un­der a swelling pile of debt. By 2012 it had posted its worst-ever an­nual earn­ings re­sults, which in­cluded a US$2.79 bil­lion net loss due to write­downs on some of its nat­u­ral gas as­sets.

In 2013, En­cana brought in Doug Sut­tles, the BP vet who headed up the Deep­wa­ter Hori­zon dis­as­ter re­sponse, to im­ple­ment a rapid pivot back to liq­uids. But in an al­most tragi­comic turn of events, his shift to­ward liq­uids ex­posed the com­pany to the even­tual plunge in oil prices, with ex­pen­sive pur­chases in the Ea­gle Ford and Per­mian oc­cur­ring al­most im­me­di­ately be­fore the down­turn. De­spite suc­cesses, like the com­pany’s abil­ity to cut its per-well costs in some of its main as­sets, or the lu­cra­tive PrairieSky Roy­alty IPO in 2014, En­cana has not man­aged to es­cape its past trou­bles. All of this raises ques­tions about the com­pany that used to be Canada’s fore­most en­ergy firm: What can En­cana do to re­verse its for­tunes—and, more to the point, how did it all go so wrong?

THE HIS­TO­RIES OF THE AL­BERTA EN­ERGY

Com­pany (AEC) and PanCana­dian Pe­tro­leum—the two com­pa­nies that merged in 2002 to cre­ate En­cana—are mag­nif­i­cent in scope. To­gether they span 125 years and in­volve every­one from Canada’s first Prime Min­is­ter, John A. Macdonald, to for­mer Al­ber­tan pre­miers Peter Lougheed and Ralph Klein.

PanCana­dian was es­tab­lished in 1971 af­ter a merger be­tween Cen­tral-Del Rio Oils and Cana­dian Pa­cific Oil and Gas Com­pany, which was then a sub­sidiary of Cana­dian Pa­cific Rail­way. Lougheed cre­ated AEC, which be­gan as a pub­lic en­ter­prise, two years later. In 1993, Klein pri­va­tized the prov­ince’s re­main­ing 36 per­cent stake in AEC, paving the way for the mas­sive 2002 merger.

Gwyn Mor­gan, who joined AEC in 1975 as an en­gi­neer, be­came AEC’s CEO in 1994, one year af­ter its pri­va­ti­za­tion. Words com­monly used to de­scribe Mor­gan as leader of the newly formed com­pany in­cluded “larger-than-life,” “vi­sion­ary” and “dy­namic.” He has been known to tell sto­ries about his mod­est up­bring­ing in ru­ral Al­berta, where he grew up in a farm­house be­fore quickly ris­ing through the ranks of Canada’s en­ergy in­dus­try. Over his ten­ure at the com­pany, he mor­phed into one of the en­ergy sec­tor’s most con­tentious fig­ures. De­pend­ing on whom you ask, Mor­gan is ei­ther one of the in­dus­try’s most savvy and dis­cern­ing busi­ness lead­ers, or the head of a com­pany with some­times brash busi­ness oper­a­tions and a check­ered his­tory.

De­spite de­trac­tors, there is no doubt that the growth of En­cana un­der Mor­gan’s lead­er­ship was sub­stan­tial. In 1995, the year af­ter he be­came CEO, AEC ac­quired Con­west Ex­plo­ration Com­pany for $1.1 bil­lion, adding ex­cel­lent West Peace River Arch as­sets in Al­berta to the com­pany’s al­ready strong prop­er­ties in Suffield and Ogston. The move boosted AEC’s share value by 22 per­cent to a mar­ket cap of $2.2

bil­lion, mak­ing it one of the coun­try’s largest oil and gas com­pa­nies.

AEC ex­panded rapidly in the fol­low­ing years, with ac­qui­si­tions in Wy­oming’s Jonah gas fields in 2000 and Colorado’s Piceance basin in 2001 (around the same time, PanCana­dian was in­vest­ing in EOR devel­op­ments in Wey­burn and SAGD devel­op­ments in Christina Lake). Gas prices were on the rise, and AEC grew its net in­come sev­en­fold from the fourth quar­ter of 1999 to the fourth quar­ter of 2000, ris­ing from $69.2 mil­lion to $306 mil­lion.

There was also a co­in­cid­ing ap­petite for Cana­dian oil south of the bor­der. In re­sponse to the U.S. quest for en­ergy in­de­pen­dence, which in­ten­si­fied fol­low­ing the 9/11 at­tacks, U.S. com­pa­nies, flush with cash, started scoop­ing up Cana­dian mid-sized firms. In 2001, there were 104 merg­ers and ac­qui­si­tions in the Cana­dian oil patch, which to­taled $27 bil­lion in value. Well-cap­i­tal­ized U.S. pro­duc­ers made up the ma­jor­ity of buy­ers. It was the next year that PanCana­dian and AEC merged to cre­ate the $27 bil­lion be­he­moth un­der its new En­cana logo.

BUT MOR­GAN’S TEN­URE ALSO HAD ITS

darker side, and in­cluded sev­eral spats with lo­cal stake­hold­ers over its oper­a­tions. First came the spar­ring with Wiebo Lud­wig, the fun­da­men­tal­ist-Chris­tian pa­tri­arch who caused mil­lions of dol­lars’ worth of dam­ages in re­sponse to al­leged tres­pass­ing and sour gas leaks that he claimed En­cana was re­spon­si­ble for. In 1998, the RCMP al­legedly staged a bomb­ing of an En­cana-owned shed near Lud­wig’s prop­erty, with the per­mis­sion of the com­pany, in at­tempt to gather in­for­ma­tion to feed its in­ves­ti­ga­tion. The Crown later ad­mit­ted the al­le­ga­tions were true. Lud­wig was also ar­rested in 2010 for al­le­ga­tions of five sep­a­rate pipe­line bomb­ings be­tween late 2008 and early 2009, but was re­leased with­out charges.

In 1999, AEC bought up Pa­calta Re­sources and its oper­a­tions in Ecuador for $748 mil­lion, in­clud­ing $274 mil­lion in debt. At the time, Mor­gan de­scribed the op­por­tu­nity as pro­vid­ing “a solid plat­form for prof­itable growth in South Amer­ica.” The com­pany’s oper­a­tions there ap­peared to be in good order, par­tic­u­larly con­sid­er­ing En­cana’s 36 per­cent stake in the Oleo­duc­tos de Cru­dos Pe­sa­dos (or heavy crude oil pipe­line), which would even­tu­ally trans­port 450,000 b/d of oil from north­ern Ecuador to Colombian sea­ports.

But in the years fol­low­ing the ac­qui­si­tion, oil vol­umes in the pipe­line were flow­ing well be­low ca­pac­ity. The le­git­i­macy of En­cana’s ac­qui­si­tion was be­ing ques­tioned by lo­cals, who be­gan to protest the per­ceived lack of com­pen­sa­tion to res­i­dents in the Ama­zon basin, as well as claims that oper­a­tions were caus­ing en­vi­ron­men­tal dis­tur­bance.

Toby Heaps, CEO and co-founder of Cor­po­rate Knights, vis­ited Ecuador in 2003 and found the pipe­line project “scored very poorly” when the In­ter­na­tional Code of Ethics for Cana­dian Busi­ness was ap­plied to it. He re­calls that En­cana didn’t re­spond well to such find­ings, at­tempt­ing to “ex­plain away the con­tro­versy” by ap­peal­ing to the fact the project was a joint ven­ture. In Septem­ber 2005—a month af­ter pro­test­ers sab­o­taged a pipe­line owned by En­cana in the Orel­lana prov­ince—the com­pany sold all its Ecuador as­sets to An­des Pe­tro­leum Com­pany, a joint ven­ture be­tween Sinopec and CNPC, for $1.42 bil­lion.

Mean­while, Mor­gan was head­ing nu­mer­ous other deals, in­clud­ing the sale of its 13.75 per­cent stake in Syn­crude to Cana­dian Oil Sands in Fe­bru­ary and June of 2003 ($1 bil­lion in two sep­a­rate trans­ac­tions), the $2.7 bil­lion ac­qui­si­tion of Colorado’s Tom Brown in May of 2004, and the of­fload­ing of its mas­sive Gulf of Mex­ico as­sets to Sta­toil in May of 2005. Years later, then un­der the di­rec­tion of Randy Eres­man, En­cana suf­fered an­other rep­u­ta­tional set­back in its U.S. oper­a­tions. In 2012 Reuters un­cov­ered ev­i­dence sug­gest­ing that some ex­ec­u­tives at En­cana had con­spired with ex­ec­u­tives at Ch­e­sa­peake En­ergy, in­clud­ing Ch­e­sa­peake CEO Aubrey McClen­don, to keep prices ar­ti­fi­cially low in Michi­gan’s Colling­wood Shale re­gion dur­ing a rush of land sales in 2010. Both com­pa­nies were charged with sep­a­rate an­titrust vi­o­la­tions in 2014 fol­low­ing a lengthy in­ves­ti­ga­tion by a state pros­e­cu­tor, though both com­pa­nies de­nied any wrong­do­ing. En­cana agreed to a US$5 mil­lion set­tle­ment two months later.

AF­TER A TUR­BU­LENT YET LARGELY

suc­cess­ful ten­ure, Mor­gan stepped down as CEO in 2005. He was re­placed by Eres­man, who had joined AEC in 1980. Sherri Bril­lon, the ex­ec­u­tive vice-pres­i­dent and CFO of En­cana, notes that “it was much slower for Randy [Eres­man] to emerge as an ex­ter­nal kind of voice of the com­pany” com­pared to Mor­gan, who was “much more vis­i­ble.” But the some­what in­tro­verted Eres­man nonethe­less di­verged from Mor­gan on the oper­a­tions front, com­mit­ting the com­pany to a fu­ture heav­ily weighted by nat­u­ral gas plays. By 2007, the com­pany was pro­duc­ing 3.5 bcf/d. No one—and, it seemed, par­tic­u­larly not Eres­man—was pre­pared for the crash in nat­u­ral gas prices that came in 2008.

En­cana’s net earn­ings plum­meted from $3.59 bil­lion in 2008 to $1.9 bil­lion in 2009 as nat­u­ral gas prices lan­guished. Such a drop de­layed the Cen­ovus spinoff which had been in the works for two or three years—a rain check which Bril­lon now says was “with­out ques­tion the right call” (the cor­po­rate re­or­ga­ni­za­tion re­ceived 99 per­cent share­holder sup­port on Novem­ber 25, 2009). Cen­ovus took the com­pany’s heavy oil as­sets with it, mak­ing En­cana in­creas­ingly vul­ner­a­ble to the drop.

By that point, Eres­man had an­nounced in­tent to dou­ble gas pro­duc­tion by 2015, and was pur­su­ing ag­gres­sive devel­op­ments in Wy­oming, Colorado’s Garfield County and the Hay­nesville Shale play in north­ern Louisiana. In 2012, he con­ducted two ma­jor deals, in­clud­ing a $2.9 bil­lion sale of its Cut­bank Ridge prop­er­ties in Bri­tish Columbia to Mit­subishi, and a $2.18 bil­lion sale of its stake in some Du­ver­nay as­sets to a sub­sidiary of PetroChina. But the lat­ter took a con­sid­er­able amount of work af­ter the ini­tial deal from Fe­bru­ary 2011—$5.4 bil­lion for a 50 per­cent stake— col­lapsed in June of that year, leav­ing Eres­man red-faced. At the time, CIBC an­a­lyst An­drew Pot­ter said in a note to in­vestors that the “fail­ure to close this trans­ac­tion will im­pact per­cep­tion of man­age­ment cred­i­bil­ity.” Bril­lon says that in ret­ro­spect, the com­pany should have con­tin­ued to mas­sage the ini­tial deal in­stead of an­nounc­ing it as a suc­cess: “Things were a lot more de­fined go­ing into that sec­ondary level of ne­go­ti­a­tions.”

Even with the PetroChina deal com­pleted, En­cana was in cri­sis. The bal­ance sheet was in ruins, and Eres­man re­tired on Jan­uary 11, 2013 with hardly any no­tice. Clay­ton Woitas, for­mer head of Re­nais­sance En­ergy, was ap­pointed in­terim CEO.

ERES­MAN’S EXIT MEANT THE COM­PANY HAD

to scour the land­scape for some­one who could right the com­pany’s path. Some 150 names were com­piled from around the world as a po­ten­tial re­place­ment for Eres­man, in­clud­ing Bril­lon and two other in­ter­nal can­di­dates. Sut­tles even­tu­ally re­ceived the nod. On the same day the ap­point­ment was made pub­lic, Sut­tles an­nounced the launch­ing of a new strat­egy re­view that would be for­mu­lated by “seven of their best and bright­est and fu­ture lead­ers in the com­pany,” and would be im­ple­mented in 2014.

Launch­ing the strat­egy was a gru­el­ing task. “We locked them in a win­dow­less con­fer­ence room, gave them in­cred­i­ble ac­cess to the or­ga­ni­za­tion and even brought in some out­side stim­u­lus—bankers and other folks—to give their own view of En­cana and share their own ideas,” Sut­tles says. “And then they worked es­sen­tially over a four-month pe­riod, did a great deal of as­sess­ment of En­cana and our strengths and our weak­nesses and the oil and gas in­dus­try and what op­por­tu­ni­ties would be out there and what is­sues to man­age.”

Bril­lon laughs when asked about the fol­low­ing months, de­scrib­ing the im­ple­men­ta­tion process as “a whirl­wind.” In ad­di­tion to the re­di­rect­ion of cap­i­tal from a sprawl­ing 28 as­sets down to four, the com­pany also un­der­went a com­plete struc­tural over­haul, with the con­sol­i­da­tion of de­part­ments and halv­ing of the ex­ec­u­tive team.

For his part, Sut­tles quickly got to work. The new CEO brought in aus­ter­ity mea­sures to help bal­ance its books, cut­ting 1,200 jobs in his first year at the com­pany, and cut­ting as­sets down to four plays—the Per­mian, Ea­gle Ford, Du­ver­nay and Mont­ney—from 28. “We had peo­ple in the or­ga­ni­za­tion work­ing on all 28,” Sut­tles re­calls. “In some ways, they were mea­sur­ing their suc­cess by how ef­fec­tive they were at at­tract­ing cap­i­tal. It was about get­ting peo­ple to un­der­stand that this com­pet­ing for cap­i­tal was not the def­i­ni­tion of suc­cess.”

In ad­di­tion, joint-ven­tures were sus­pended, a move Sut­tles says that, while not per­ma­nent, is in­tended to en­sure the com­pany re­mains ag­ile. PrairieSky Roy­alty, the com­pany that re­tained free­hold lands gifted by Canada’s first prime min­is­ter, was spun off in May 2014 for $1.46 bil­lion, with a sec­ondary of­fer­ing made in Septem­ber 2014 for $2.6 bil­lion. Two days af­ter the lat­ter deal, En­cana bought up the 30,000 boe/d Per­mian pro­ducer Athlon En­ergy for $5.93 bil­lion in cash, which added to the June 2014 pur­chase of Freeport-McMoRan’s 53,000 boe/d acreage in the Ea­gle Ford. De­spite crit­i­cism of the tim­ing, Sut­tles says that En­cana was both buy­ing and sell­ing as­sets at the same point in the price cy­cle, and that the tim­ing al­lowed the com­pany to pivot quickly and re­duce the risk of buy­ing and sell­ing “at the wrong points of the cy­cle.”

DE­SPITE THE SEEM­INGLY DIS­AS­TROUS TIM­ING

of the deal, some an­a­lysts are sym­pa­thetic to Sut­tles’ de­ci­sion. “They came re­ally close to pick­ing the peak of WTI [in the Per­mian], and it went down­hill from there,” says Brook Pa­pau, man­ag­ing di­rec­tor at RS En­ergy Group. “But their un­der­stand­ing of the Per­mian over that time, and the well re­sults out of it, got bet­ter and bet­ter. So while oil was fall­ing, Per­mian names were flat. And so they prob­a­bly would have had to pay the ex­act same price six months later any­way.”

The com­pany has cer­tainly made the most of the new as­sets. By Novem­ber 2015, En­cana was post­ing a 36-per­cent in­crease in liq­uids from the year prior. In the first seven months fol­low­ing the ac­qui­si­tion, the com­pany had stripped 24 per­cent out of its op­er­at­ing costs, putting it into the top tier of drilling com­ple­tion costs and well pro­duc­tion per­for­mance. Michael McAl­lis­ter, the ex­ec­u­tive vice-pres­i­dent and COO of En­cana, cites a combo of fit-for­pur­pose rigs, real-time bit de­sign and ex­per­i­men­ta­tion with frack fluid rates and con­cen­tra­tions that al­lowed for the com­pany’s tech­ni­cal im­prove­ments.

David Meats, an eq­uity an­a­lyst at Morn­ingstar, says the cur­rent chal­lenge for the com­pany is that they have “an in­fi­nite port­fo­lio of high-qual­ity well lo­ca­tions that they can’t drill quickly enough to add value.” If prices were at 2014 lev­els, he es­ti­mates the com­pany would be do­ing three to four times the ac­tiv­ity it’s do­ing now. “It’s al­most like they’ve bit­ten off more than they can chew,” he says. “You can’t fault them for a strat­egy which made per­fect sense given prices at the time of the trans­ac­tions—but it was definitely bad tim­ing in 20/20 hind­sight.”

In March 2015, En­cana is­sued $1.25 bil­lion in eq­uity to raise funds. Bril­lon says the com­pany prob­a­bly could have is­sued eq­uity when it un­der­took the Athlon trans­ac­tion but felt the mar­ket was still open and the op­por­tu­nity to do an is­sue came for­ward (Cen­ovus col­lected $1.5 bil­lion in share sales the month prior). The money was used to help pay down around $1.6 bil­lion in debt.

In the months that fol­lowed, share prices con­tin­ued to plum­met, reach­ing a 13-year low in July 2015. Liq­uids pro­duc­tion had al­most dou­bled by that point com­pared to the year prior. En­cana off­loaded its Hay­nesville as­sets to GeoSouth­ern Pay­nesville for $850 mil­lion in Au­gust, and DJ Basin prop­er­ties to the Canada Pen­sion Plan In­vest­ment Board for $900 mil­lion. But val­ues have since plunged to all­time lows, sit­ting at about one-third of the price of Cen­ovus shares. Takeover talk has been resur­fac­ing in the fi­nan­cial bl­o­go­sphere. Given the in­cred­i­ble strength of its as­set base, there’s a case to be made that En­cana could be a tar­get (in April 2015, the Fi­nan­cial Post dubbed En­cana and Cen­ovus as “the hunted”). Meats doubts such a pos­si­bil­ity, say­ing that smaller firms are more likely to “roll over and dis­ap­pear first,” a trait which he dubs “a nat­u­ral de­fense mech­a­nism” for En­cana.

The com­pany’s fu­ture is com­pletely un­pre­dictable at this point, given the tight grip that multi-year lows in oil prices have put on all pro­duc­ers. But Bril­lon ul­ti­mately re­mains op­ti­mistic. “We’ve been through a lot of cy­cles,” she says. “We’ve con­fronted a lot of is­sues. It’s re­ally quite re­mark­able in my position that I’ve been able to look at a merger, a split, an IPO and a re­cast­ing of strat­egy as many times as I have. Lots of peo­ple don’t have that op­por­tu­nity once in their ca­reer to do one of those things. I guess we’ll keep it com­ing.” For now, the made-in-Canada en­ergy gi­ant has lit­tle other choice.

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