DBRS Confirms EnCana Commercial Paper Rating, Maintains Long-Term Ratings Under Review – Developing

DBRS has today confirmed the Commercial Paper (CP) rating of EnCana Corporation (EnCana or the Company) at R-1 (low) with a Stable trend and maintained the long-term rating of EnCana and EnCana Holdings Finance Corporation (Finance) at A (low) – Under Review with Developing Implications. Finance’s rating is based on the guarantee of EnCana. The Under Review status was initiated on May 12, 2008, following the Company’s announced proposed spin-off into an integrated oil and a gas-focused company (Cenovus Energy Inc. (Cenovus) and new EnCana (GasCo), collectively Newcos), each with comparable size and scope to its peers. The spin-off was postponed in October 2008 and could be protracted due to the challenging global financial and economic conditions and sharply declining commodity prices (closing was originally anticipated in early 2009 subject to regulatory and shareholder approvals). In the interim, DBRS expects that EnCana will continue to perform satisfactorily, despite the current environment, due to its low cost structure, substantial hedges in place, operational strengths and reasonable financial profile. The Company maintains strong liquidity with minimal refinancing needs within the next two years. A combination of these factors has led to the confirmation of the CP rating with a Stable trend. However, production growth has typically been supported by aggressive capex, which could be relatively inflexible in the oil sands and downstream areas over the next couple of years as expansions are underway.

The ratings reflect EnCana’s effort to improve its capital structure prior to the potential spin-off by using free cash flow to modestly reduce debt through 2008. It has also suspended its previously substantial share buyback program, with no plans to resume, while its spin-off plans remain in place. Debt-to-capital of 28% at year end 2008 is on plan with debt-to-EBITDA improved to 0.82 times (versus 34% and 0.92 times at March 31, 2008 before the proposed spin-off). Liquidity is strong through a CAD$4.5 billion multi-year credit facility to 2012 and a $600 million subsidiary line, with no material debt maturities until 2011. Based on the Company’s 2009 guidance and current gas prices, free cash flow is expected (10% of operating cash flow targeted) as about 50% of total planned volumes are covered by favourable hedging arrangements (at an average price of $9.13/mcf). DBRS expects a stable financial profile with debt-to-capital and debt-to-EBITDA at the lower end and the middle range of the Company’s managed range of 30% to 40% and 1 to 2 times, respectively.

The Company’s key strength remains its ability to grow production and replace reserves (188% on a three-year average basis) mostly through the drill bit, despite substantial divestitures. It also retains a vast inventory of unconventional natural gas and oil sands resources, which are more predictable with relatively low exploration risk, potentially providing approximately 40,000 development drilling locations, or more than 10-year drilling inventory. The Company reported 11.6 years proved reserve life, and no technical pricing revisions to its 2008 proved reserves, despite the sharp drop in commodity prices at year end. However, reserve replacement costs ($14.15/boe on a three-year average basis), while among the lowest in the industry, have increased substantially in the past year. Further, the Company’s continued strong operating performance has been supported by aggressive capital spending relative to operating cash flow (average of near 90%). The scaled back capex, projected at $6.1 billion in 2009 ($7.1 billion in 2008), will likely see a temporary pause in volume growth versus an average 5% growth to 2011 previously targeted. Oil sands will play a bigger role in driving growth through its 50/50 partnerships (Venture) with ConocoPhillips (COP) started in early 2007, which provides a cost effective downstream solution. If the proposed split were not to proceed, it should also pave the way for a more integrated operation with a more balanced product mix. In-situ oil sands production is expected to reach 200,000 b/d (EnCana’s share) by 2015, which together with other crude volumes, could represent over one-third of current production (18% in 2008).

The Company’s continued focus on the more predictable unconventional natural gas in North America and in-situ oil sands through the Venture should bode well for its fairly stable credit profile in the medium term, barring any significant acquisitions funded by debt, or resumption of share repurchases. Many of the Company’s projects are scaleable, which should facilitate continued capital discipline, should markets deteriorate further in the near term. The Company is also unique in its consistent hedging program (typically 50% hedged on current production and up to 25% for the following two year), providing a measure of stability in earnings and cash flow.

DBRS believes that EnCana’s strengthened capital structure could help to partly offset the modestly negative impact on the business risk of the proposed Newcos. GasCo’s performance will reflect the increased natural gas weighted operations (94% pro forma versus 83% currently for EnCana), resulting in concentration risk and greater exposure to volatile natural gas prices. While recognizing EnCana’s ability to manage sizable capital programs, GasCo was previously expected to pursue an aggressive capital expenditure program to achieve its growth targets, which could resume should commodity prices and market improve. Cenovus will face the challenges of its own aggressive capital program, compounded by the limited flexibility of oil sands and refining investments and a shorter reserve life for its gas assets.

DBRS believes that the proposed spin-off may not result in a ratings downgrade, if the transaction proceeds as expected in a more normalized commodity pricing, economic and credit climate, including a recovery in the downstream sector. DBRS’s review will focus on the satisfactory resolution of the following issues: (1) The Company will continue to reduce net debt levels prior to transaction closing to improve the credit profiles of the respective new entities. (2) Satisfactory allocation of assets and debt and the resulting entities will maintain financial profiles and capital structure consistent with EnCana’s current credit metric targets mentioned above. (3) DBRS’s expectation and management’s commitment that future capital investment programs, share repurchases and other related activities will be managed within the context of current target metrics and other key financial principles, such as consistent hedging policies remaining in place. (4) Liquidity arrangements commensurate with capital growth requirements will be arranged to facilitate execution upon transaction closing. (5) Legal, tax, contractual and regulatory matters will be satisfactorily resolved.

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

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

This is a Corporate rating.