DBRS Changes Trends on Encana Corporation to Negative from Stable

DBRS has today changed the trends of all ratings of Encana Corporation (Encana or the Company) and Encana Holdings Finance Corp. to Negative from Stable. The rating action reflects DBRS’s concern that the continued challenging natural gas market environment may lead Encana’s credit risk profile to deteriorate to a level that is no longer consistent with the current rating categories.

A recovery of the natural gas market fundamentals is expected to take longer than DBRS originally anticipated when DBRS confirmed the ratings following the closing of the spinoff of Encana’s Integrated Oil and Canadian Plains divisions into a new entity, Cenovus Energy Inc., on November 30, 2009 and most recently on February 10, 2011. The outlook for natural gas in North America remains negative, largely due to excess supply created by continued strong production growth in shale gas supplies and, to a lesser extent, a weak economy.

While Encana intends to increase liquids production to improve profitability, DBRS believes that it would take several years to generate meaningful net free cash flow from the liquids-rich gas developments given that many of these projects are in the early stages, including Duvernay, Niobrara and Collingwood. Encana is materially more susceptible to the volatility of natural gas prices than its peers, which possess more balanced oil and gas production profiles. Natural gas has accounted for approximately 96% of the Company’s total product mix since the spinoff.

Encana’s operating cash flow for the last 12 months ending September 30, 2011 (LTM), declined to $4,050 million from $4,353 million in 2010 despite good production volume growth (3.44%) and improved operating efficiency. The decline was predominately caused by continued weakness in realized natural gas prices ($5.03 per thousand cubic feet (mcf) in 9 months ending September 30, 2011 (9M 2011) versus $5.48 per mcf in 2010 and $7.03 per mcf in 2009). Operating cash flow in LTM was not adequate to fully fund capital expenditures and dividends, resulting in a free cash flow deficit of $1,553 million. Weaker operating cash flow and higher debt combined have deteriorated credit metrics over the past two years.

On February 10, 2011, DBRS confirmed Encana’s A (low) rating with a Stable trend and stated that DBRS expected the Company to maintain (1) its debt-to-capital ratio within the 30% to 35% range (34.3% as at September 30, 2011), (2) its debt-to-EBITDA within the 1.0 times to 1.5 times level (2.1 times in LTM ) and (3) a similar range for debt-to-cash flow of 1.0 times to 1.5 times (2.1 times in LTM).

Although DBRS recognizes the low gas price environment, Encana has exceeded the DBRS ranges for the debt-to-EBITDA and debt-to-cash flow ratios since the spin off. These ratios could weaken further, particularly from 2013 as above-market hedging positions roll off significantly, despite significant recently completed and pending asset sales and joint venture activities. The majority of total above-market hedging positions are expected to be rolled off within the next 12 months ($1.2 billion of total $1.5 billion as at September 30, 2011). In the absence of a recovery in natural gas prices, Encana will likely have to rely heavily on proceeds from asset divestitures and/or joint ventures to mitigate weak cash flow challenges.

A lack of material improvement in cash flow generation capability could warrant a downgrade to the ratings in the near future.

Note:
All figures are in U.S. dollars unless otherwise noted.

The Unsecured Long-Term Notes of Encana Holdings Finance Corp. are guaranteed by Encana Corporation.

The applicable methodology is Rating Oil and Gas Companies, which can be found on our website under Methodologies.