Encana (NYSE: ECA) worked tirelessly during the oil market downturn to reposition its business so it could thrive at lower oil prices. Those efforts are starting to pay off, as indicated by the blowout results the company reported in the second quarter, when it noted that it was well ahead of the pace needed to achieve the goals of its five-year plan.
That momentum should provide a boost to the company's third-quarter results, which it will unveil on Wednesday morning. Here are three things investors should keep an eye on in that report to see if Encana's still on track.
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Look for liquids production to continue growing
In the second quarter, Encana reported that production from its core assets rose 3.9% to 246,500 barrels of oil equivalent per day (BOE/D), which put it on pace to increase output from those assets by 25% to 30% by year-end. Furthermore, the company noted that higher-margin liquids production jumped 14% to 100,200 barrels per day (BPD). Given the company's momentum, the odds are excellent that Encana's output increased in the third quarter.
That said, it's possible that production didn't rise as much as it could have due to the impact Hurricane Harvey had on the Eagle Ford Shale of south Texas, which is one of Encana's core assets. Rivals Marathon Oil (NYSE: MRO) and EOG Resources (NYSE: EOG) already noted that the storm hurt production, which is worth pointing out since both are major producers in Karnes County, Texas, where Encana operates. In Marathon's case, Harvey forced the temporary shutdown of 1,500 wells across the region, which kept its production from the play roughly flat with the second quarter. Meanwhile, EOG Resources noted that Harvey knocked 15,000 BPD offline during the quarter, which caused oil production to come in below the low end of its guidance range. However, despite that impact, Marathon and EOG Resources trounced earnings expectations, and both remain on pace to meet their full-year production growth targets. That seemed to be an industrywide trend, which suggests that Harvey didn't derail Encana's 2017 growth plans.
See if margins kept expanding
If Encana was able to overcome Harvey's impact, that should help it continue driving margins higher. Last quarter the company noted that its margin per barrel of oil equivalent increased 25% from the first quarter to $12.19 despite weaker oil prices. While that growth rate will be hard to maintain, there's reason to believe Encana boosted margins last quarter.
In addition to the likely benefit from an increase in higher-margin liquids production and the continued downward pressure on costs, Encana sold its Piceance natural gas assets during the quarter. Not only did that sale bring in $735 million in cash to strengthen its balance sheet, but it should significantly boost margins. That's because these assets primarily produce lower-margin natural gas that was further weighed down by a high-cost legacy transportation agreement. By jettisoning this asset, Encana's corporate margin should go up.
Keep an eye out for more innovation
Aside from driving down costs and reshuffling its portfolio, another key to Encana's turnaround has been innovation. That has enabled the company to get more oil and gas out of each well, which is improving drilling returns. As a result, Encana noted last quarter that it grew its premium return inventory to more than 11,000 locations, more than replacing all the wells it had drilled since October 2016, when it unveiled its five-year plan. These wells, which generate an after-tax rate of return of 35% at $50 oil, are what allow the company to grow at such a rapid pace at current oil prices. Given the importance of this inventory to Encana, investors would like to see it continue growing.
That's what happened in the second quarter, when Encana noted that a combination of factors had increased the estimated future recovery of oil and gas from its Permian Basin acreage by 20%. Because of that, the company can now drill 700 more premium return locations in that region than initially expected, partly because it can profitably drill new layers. EOG Resources reported a similar innovation-driven increase in the third quarter, noting that it has identified 555 drilling locations in the First Bone Spring layer of the Delaware Basin with premium return potential. As a result of that discovery, and another in Oklahoma, EOG now has about 8,000 premium return locations, though it's worth noting that it has a higher return hurdle of 30% at $40 oil for its inventory.
From the looks of things, Encana should report strong third-quarter results later this week, with production and margins both expected to improve, which should push earnings higher. That keeps the company on pace to deliver on the targets of its updated five-year plan, which would see it increase cash flow at a 25% compound annual rate through 2022 at less than the current oil price. That rapid growth rate has the potential to fuel significant returns for Encana investors.
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