Encana in Gas Supply Deal

Canada’s largest natural gas producer Encana Corporation ( ECA - Analyst Report ) entered into an agreement with steel maker Nucor Corporation ( NUE - Analyst Report ) for the supply of natural gas. Nucor expects delivery of low cost natural gas for more than 20 years for its mills and other operations in the US.

Encana will operate the wells and will drill in areas with confirmed reserves. Nucor or EnCana may defer drilling if U.S. domestic gas prices drop below a predetermined level.

Prior to this deal, both the companies signed an agreement in 2010. The producing wells from that agreement surpassed Nucor’s expectation by more than 60%.

Total cost of the operation will be shared by both the companies. It is anticipated that Nucor will put in about $542 million in the next three years and $3.64 billion over the long term.

The deal will keep Nucor in a competitive position with respect to natural gas price for its direct reduced iron (DRI) facility in Convent, Louisiana. It is expected that this facility will commence operations in mid 2013.

The drilling and production work of this deal focuses on Encana's Piceance Basin assets in northwest Colorado. Last year, Piceance assets produced 446 million cubic feet equivalent of natural gas per day.

We are maintaining our long-term Neutral recommendation on Encana supported by a Zacks #3 Rank, which translates into a short-term Hold rating. The company is one of the largest natural gas companies in North America with a diverse/high quality portfolio of natural gas assets spread over Canada and the U.S. This provides the company with a huge inventory of reserves and a resource base capable of robust production growth.

However, the current unfavorable macro backdrop is expected to continue to offset the positives, at least in the near term. Other areas of concern are Encana’s extensive natural gas exposure, which raises its sensitivity to gas price fluctuations, compared to its more diversified independent peers with higher oil production.