Credit costs put EnCana breakup in doubt

October 11, 2008 CALGARY -- EnCana Corp. is revisiting plans to split into two companies, as Canada's largest energy company struggles to get favourable financing terms for its two offspring.

EnCana executives are out canvassing banks this month, attempting to nail down terms on loan packages that will support the two units that will be born from a breakup of the parent. Bankers working on new terms for $9.9-billion in debt say the rising costs of loans due to new interest rates and covenants, along with a lack of lenders, will likely force a delay in the bust-up, which was scheduled to play out early in 2009. Talks with banks are playing out against brutal credit markets, and sources say EnCana executives are growing increasingly concerned that the two smaller energy plays will end up facing a much higher cost of capital than the single large entity that generated $2.9-billion of cash in the most recent quarter.

EnCana announced plans in May to morph into natural gas and oil sands plays. Borrowing costs are a major challenge for the oil sands unit, recently christened Cenovus Energy Inc., which needs a whole new balance sheet and must shoulder project financing and other loans as it brings oil sands properties online. The natural gas side of the business will keep the EnCana name.

EnCana spokesman Alan Boras said yesterday that the company “continues to work towards our announced plan, but recognizes the unprecedented conditions in credit markets. We will act in the best interests of shareholders.”

Corporate debt has become harder to obtain at the same time energy stocks have skidded, in line with falling oil and gas prices. EnCana boasted a $71-billion market capitalization in June, just after it announced the bust-up. It is now a $35-billion company.

“If they choose to delay the split, it would simply be a reflection of what's happened in credit markets, not the underlying wisdom of the strategy,” said one banker who works with EnCana.

There is a tight timeline for a decision. Oil company executives expect to hear back from potential lenders to the two units by the end of the month, and expect to make a decision once they understand the cost of the new loan package.

“If the costs of raising capital are higher for the parts of the company than as a whole, then the split doesn't make sense,” said Philip Skolnick, an analyst at Genuity Capital Markets. “It could make it easier for the [oil sands company] to get taken out. … They're very attractive assets.”

He added that if EnCana does cancel or postpone its plans, that would mean other companies wouldn't follow its lead and split themselves up either. Canada's other major integrated firms, such as Husky Energy Inc. and Petro-Canada, are believed to be watching EnCana's actions closely to work out whether a similar split could pump up their valuation.

One Calgary-based investment banker argued that EnCana should stick with its current structure, which allows the company to fund much of its oil sands projects through existing cash flow from its natural gas operations. The banker said Cenovus will effectively be making oil sands development contingent on the generosity of capital markets. “Unless you have ways of producing cash flow in this market, you're a dead duck,” he said. “There are obvious benefits of being a large cash-flowing business right now.”

If EnCana can get loans on attractive terms, it would lay out its planned financial structure for shareholders as part of a “plan of arrangement” on the restructuring that is scheduled to be mailed by mid-November. EnCana shareholders are expected to vote on the bust-up in mid-December.

EnCana's two companies would each still rank among the country's largest energy plays and are expected to begin trading independently early in 2009.

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