The 12-month default rate for struggling exploration and production (E&P) companies, those rated "B2" or below, could more than double over the coming year, Moody's Investors Service said in a new report.

The default-forecasting model is estimating that the one-year portfolio-average baseline default rate for these companies would increase to 7.4% from 2.7%, according to the report, "Oil and Gas: The Bad, Ugly and Good," issued on Tuesday. Analysts ran the portfolio for 48 U.S.-based E&Ps rated B2 or lower, finding that the default rate rose rapidly from this past March to March 2016.

"With a gradual recovery in energy prices, the weaker oil and gas issuers are at a much greater risk of default," said Senior Vice President David Keisman. "The companies on the lower end of spec-grade ratings are the ones that should be most worried."

A gradual recovery in energy prices, rather than the rapid "V" pattern seen in 2008-2009, means that the credit profiles of weaker oil and gas issuers likely will deteriorate to levels that lead to more defaults. The model "has proven to be accurate, notably when forecasting the ultimate number of companies that defaulted off of the original Moody's B3 Negative and lower list," analysts noted.

The "bad" refers to low commodity prices have taken a toll across the industry, not just E&Ps. The "ugly" is reserved for the low-rated E&Ps that stand a chance of defaulting. For those producers, it could get even uglier.

"The three-year default-rate forecast for the portfolio increased during the same period from 12.0% to 18.9%," analysts reported. The model incorporates a number of variables including high yield spread over treasury. This spread is calculated from all rated high yield companies, not just the E&P firms in the portfolio that recently experienced wider spreads than the overall spread for noninvestment grade debt. In light of that, the forecast may actually underestimate the risk in this portfolio."

As of May 1, the oil and gas sector comprised 15% of Moody's companies rated "B3" or lower. That is the largest share for any sector included on the list of ratings across U.S. corporate sectors, said associate analyst Julia Chursin.

The percentage is nearly double the 8% of oil and gas companies that occupied the list of U.S. companies rated B3 negative or lower a year ago.

In contrast, analysts found some "good" news. At the end of April, more than 70% of U.S. E&Ps rated "B1" or below had maintained their ratings or had been upgraded since June 2014.

"The oil and gas industry is characterized by boom and bust cycles, and many U.S. E&P companies with experienced management teams have seen this game before," said Senior Vice President Pete Speer. "While these companies have successfully navigated the waters thus far, low oil prices will continue to pressure the industry-at-large and these companies' credit metrics."

Producers with higher ratings are keeping above the fray by reducing capital expenditures and operating only in areas that offer the best returns, Speer noted.

"In an industry characterized by boom and bust cycles, experienced management teams have seen this before," said the report. "However, if oil and natural gas prices remain low and do not recover in line with the Moody’s oil and gas team's current price assumptions, then more rating downgrades are likely to occur. Our expectation is that most U.S. E&P companies will have constructive dialogues with their senior secured lenders, despite the difficult pricing environment."

Moody's is assuming a West Texas Intermediate oil price of $50/bbl for 2015 and $60/bbl in 2016; Brent averages $55 for this year and $65 in 2016. Henry Hub gas prices are assumed to average $2.75/Mcf this year, climbing to $3.00 in 2016.

Companies with a "B" debt rating are considered speculative and subject to high credit risk, while "C" is the lowest class. "AAA" is the highest quality, with minimum credit risk.