Fighting a rising tide. Image source:  Encana Corporation.

For years, Encana Corporation (OVV 2.78%) has attempted a difficult transition: moving away from natural gas to become primarily an oil producer. 

Since 2013, oil has grown from 5% of its production to nearly 20%. However, despite its best efforts, natural gas still comprises over 70% of its total output. Because oil generally has better market conditions, and, based on Encana's cost of production, comes with higher profit margins, company management is focused on moving away from natural gas as quickly as possible.

Will Encana succeed in transforming its business? 

Follow the spending

Oil should inevitably increase its share of company output based on two factors: concentrated capital spending and asset sales.

This year, management reduced its capital budget by 55% with spending now focused on just four core areas: Eagle Ford, Permian Basin, Montney, and Duvernay. Because those properties are largely oil-producing, Encana's output should slowly shift away from natural gas. By 2018, natural gas will likely comprise less than 50% of production, down from 82% in 2014.

Last month, Reuters reported that Encana is "exploring the sale of more non-core assets in the United States and Canada that could be worth about $1 billion." The company already sold $2.8 billion in assets last year, but sources now say that it's open to offers on every one of its non-core assets. Any additional asset sales will likely be focused on natural-gas properties, boosting Encana's oil exposure.

Oil has better economics

At $50 a barrel, most of Encana's major projects would generate attractive returns. Its four primary assets are projected to have 30% returns at $50/barrel oil and $3/MMBtu natural gas. Oil and liquid production already increased 36% in the final quarter of last year; higher oil production should result in a higher share price.

Financially, Encana should have no problem continuing to afford its evolution. Last year the company generated $400 million in capital and operating efficiencies, beyond the initial target of $375 million. Cost savings helped Encana reduce debt by roughly 30%, or $2 billion. Management believes it can achieve another $550 million in savings this year. Over 75% of long-term debt isn't due until at least 2030, and no debt matures until 2019. It also still has access to $4.5 billion in fully committed, unsecured, revolving credit facilities.

With no significant debt maturities over the next few years, a renewed line of credit, and permanent cost savings taking hold, Encana should have no issues surviving another dip in energy prices. Meanwhile, asset sales and streamlined spending could transform Encana into an oil producer fairly quickly, resulting in a more profitable business. As long as energy prices rebound over the long term, the company may be setting itself up for a massive turnaround.

The stakes are rising

A new report from the U.S. Geological Survey this month revealed yet another possible headwind for natural gas. 

According to new estimates, western Colorado potentially has 40 times more natural gas than previously thought. If true, that would make it the second-largest source of reserves in the U.S., behind only the Marcellus shale region. In 2003 the Mancos shale formation was estimated to hold 1.6 trillion cubic feet of natural gas. The new estimates now call for an incredible 66.3 trillion cubic feet.

"We reassessed the Mancos Shale in the Piceance Basin as part of a broader effort to reassess priority onshore U.S. continuous oil and gas accumulations," said the organization. "In the last decade, new drilling in the Mancos Shale provided additional geologic data and required a revision of our previous assessment of technically recoverable, undiscovered oil and gas."

It's likely that other regions have similar disparities in their reported natural-gas supplies. For Encana, the shift toward oil has never been more imperative.