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

DBRS has today maintained the Unsecured Senior Notes and Medium-Term Notes & Debentures of EnCana Corporation (EnCana or the Company) and Unsecured Long-Term Notes of EnCana Holdings Finance Corporation (Finance) Under Review with Developing Implications, which was initiated on May 12, 2008 (see separate press release). Concurrently, DBRS has confirmed EnCana’s Commercial Paper rating at R-1 (low) with a Stable trend based on DBRS’s expectation that the Company’s committed liquidity will remain strong.

The rating actions follow EnCana’s announcement that its Board of Directors has unanimously approved a proposal (the Transaction) to spin off its Integrated Oil and Canadian Plains divisions into a new entity, Cenovus Energy Inc. (Cenovus). The Transaction would result in two energy companies going forward: (1) a pure play natural gas company (post-Transaction EnCana), with a North American portfolio of early life, diversified natural gas resource plays fairly equally split between Canada and the United States in major gas basins in the Canadian Foothills, the Rockies and Texas; and (2) an integrated oil company (Cenovus) with enhanced oil recovery oil sands properties in western Canada and interests in two refineries in the United States through its joint venture with ConocoPhillips (COP), supported by mature oil and gas properties in western Canada (primarily in Alberta and Saskatchewan). Of EnCana’s current production and proved reserves at year-end 2008, approximately two-thirds would remain with post-Transaction EnCana and Cenovus would own one-third. The Transaction was originally proposed in May 2008 (the May 2008 Proposal) and postponed in October 2008 due to unfavourable financial market conditions. The Transaction is anticipated to close November 30, 2009, subject to court, regulatory and shareholder approvals and is not expected to be taxable from a corporate and shareholder perspective. The restructuring of the Canadian businesses would increase 2009 cash taxes by approximately $700 million. This would be partly offset by related tax benefits of about $500 million in 2010. The go-forward expenses of the Transaction are expected to be less than $200 million on an after-tax basis.

DBRS does not currently expect the Transaction to result in downgrades to EnCana’s long-term ratings (which would apply to post-Transaction EnCana, along with the confirmed R-1 (low) Commercial Paper rating) if the Transaction proceeds as expected and as outlined by the Company. However, given the weakened natural gas market conditions since the postponement of the May 2008 Proposal, DBRS expects post-Transaction EnCana to manage well within the targeted credit metric ranges detailed below, and to expedite remedial measures, if required, to bring these metrics in line with DBRS’s expectations in order to maintain the current ratings.

The Company has stated that post-Transaction EnCana and Cenovus will each initially pursue the same financial strategy and use the same credit metric targets as EnCana currently employs, and that each entity will be appropriately capitalized for their respective business models and growth strategies. The metric targets include a debt-to-capitalization ratio of 30% to 40% and a debt-to-EBITDA ratio of one to two times. DBRS expects post-Transaction EnCana to manage within the lower half of these ranges in order to maintain the current ratings. The Company also expects that the initial combined dividends of the two companies will approximate EnCana’s current dividend of $1.60 per share annually.

Steps have been taken since the May 2008 Proposal to reduce EnCana’s debt load by approximately $2 billion, from about $10.2 billion pre-announcement in 2008 to about $8.2 billion as of August 31, 2009. This was accomplished largely through the suspension of its substantial share repurchase program and through asset divestitures to provide additional cash inflow, resulting in stronger credit metrics than when the spin-off was originally proposed. DBRS expects initial pro forma net debt-to-capitalization (on a DBRS-defined basis) for each entity to remain close to EnCana’s level of 26% as of June 30, 2009 (32% as of March 31, 2008 at the May 2008 Proposal) and is to be maintained in the low 30% range in order to maintain the current ratings. Post-Transaction EnCana’s debt-to-cash flow could exceed two times on a temporary basis should the current low natural gas prices persist throughout 2010. DBRS expects this ratio to improve thereafter as production ramp-up occurs and natural gas prices rise to more sustainable levels. Cenovus would be paying approximately $3.5 billion in cash at closing to EnCana to acquire its Integrated Oil and Canadian Plains divisions. Cenovus has obtained a committed and fully underwritten $3 billion non-revolving 364-day bridge financing facility to partially fund the amount to be paid to EnCana. In addition, Cenovus has obtained a committed and fully underwritten CAD 1.5 billion three-year revolving credit facility and a CAD 500 million 364-day revolving credit facility.

DBRS has maintained the Under Review – Developing status on EnCana’s long-term debt as the risk factors identified in its May 12, 2008, press release remain. Apart from the execution risk of the Transaction, DBRS recognizes the increased business risk and potentially weaker financial profiles in a weaker commodity pricing (especially for natural gas) and economic environment since the May 2008 Proposal. Other previously identified risk factors include the increased concentration risk of post-Transaction EnCana with respect to its natural gas operation (95% pro forma production compared with 83% currently for EnCana) and reduced economies of scale in the size and scope of each entity’s respective operations. While recognizing EnCana’s historic ability to manage sizable capital programs, post-Transaction EnCana is expected to pursue a substantial capital expenditure program (although considerably reduced in size compared with the May 2008 Proposal) to achieve its growth targets. These investments, as well as ongoing operations, would also reflect the escalation in industry-wide costs over the past several years, although this trend has started to reverse in recent quarters. Cenovus would face similar cost pressures and the challenges associated with its own substantial capital program, compounded by the limited flexibility of enhanced oil recovery oil sands properties and refining investments and a shorter reserve life for its natural gas assets compared with those of post-Transaction EnCana.

Offsetting aforementioned risk factors, post-Transaction EnCana’s ratings would continue to be supported by its operational expertise, continued capital discipline, one of the lowest cost structures relative to its peers and the benefits of its consistent and active hedging programs. EnCana currently has hedges covering about half of its production for the 2010 natural gas production year at slightly over $6 per thousand cubic feet (mcf) and 27,000 barrels per day (b/d) of expected 2010 crude oil production at an average fixed price of WTI $76.89 per barrel); these hedges would be split pro rata between post-Transaction EnCana and Cenovus. EnCana also reported minimal technical pricing revisions to its proved reserves at year-end 2008, despite the sharply lower year-end commodity prices, highlighting its conservative reserve booking practices and its relatively low cost base.

As noted above, DBRS does not expect the proposed spin-off will result in downgrades to EnCana’s long-term ratings (which would apply to post-Transaction EnCana, along with the confirmed R-1 (low) Commercial Paper rating), if the Transaction proceeds as expected, including the following key factors:

1. The Company continues to have satisfactory operating results and cash flows, and will use free cash flow to reduce debt levels prior to the Transaction’s closing to improve the initial credit profiles of the respective new entities.

2. Legal, tax, contractual and regulatory matters will be satisfactorily resolved.

3. Initial capital structures will be satisfactory so that the resulting entities will maintain financial profiles well within EnCana’s current credit metric targets.

4. 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 that other key financial principles such as hedging policies will remain in place.

5. Liquidity arrangements commensurate with capital growth requirements will be concluded at the Transaction’s closing.

DBRS’s review will focus on the satisfactory resolution of the issues mentioned above as well as other key items that could affect the financial and business profiles of the resulting entities.

DBRS notes that the Transaction would create two entities of critical mass in terms of size and scope comparable to its peers (representing a two-thirds and one-third split in production and reserves for post-Transaction EnCana and Cenovus, respectively). Cenovus would have pro forma production of approximately 248,000 barrels of oil equivalent per day (boe/d) and post-Transaction EnCana approximately 500,000 boe/d. Post-Transaction EnCana would remain the largest natural gas producer in Canada and would rank second in North America. The combination of high-growth assets and strong cash flow generating resources for each company should enable the respective management teams to focus on developing the underlying resource bases – enhanced oil recovery oil sands properties in the case of Cenovus and the eight key natural gas resource plays in post-Transaction EnCana. While both portfolios would require relatively high capital investments over the next few years, there would be minimal exploration risk for each entity compared with conventional crude oil and gas developments. The associated low cost structure and EnCana’s technological advantage should also mitigate some of the concerns associated with the heavily gas-weighted operation of post-Transaction EnCana. Cenovus would benefit from the joint venture with COP through the integration of its enhanced oil recovery oil sands properties and the downstream upgrading/refining operations, resulting in relatively low capital costs, currently estimated by DBRS at CAD 40,000 to CAD 50,000 per b/d of synthetic crude oil capacity, compared with the more than CAD 100,000 per b/d previously estimated for projects by other oil sands participants.

Notes:
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.

This is a Corporate rating.