Natural gas prices continue to be volatile, but most signs point to favorable rating trends for the U.S. oil and natural gas sector for the rest of this year and into 2008, according to an industry report card by Standard & Poor's (S&P).

In the report, "Top 50 Global Oil and Gas Companies Ride Demand Growth Toward $90 Oil," S&P credit analyst Andrew Wyatt said the global energy industry "has a generally favorable ratings outlook as solid demand trends support high hydrocarbon prices." Demand growth is "particularly strong in Asia and the Middle East," and low spare capacity in crude oil production is benefiting most upstream producers.

In the United States, "upgrades outpaced downgrades by nearly two to one through the first nine months of the year, driven by robust hydrocarbon prices and improved operating performance," said Wyatt. However, the analyst said "impediments to credit quality are growing...Turmoil in the credit markets and rising investor concerns about liquidity and underlying credit quality will limit some issuers' access to capital markets."

Gas price volatility also remains an issue for North American producers. "If relatively mild weather and an uneventful hurricane season persist, then natural gas storage levels could rise, further pressuring prices," said Wyatt. "This would dampen favorable operating conditions for natural gas producers and oilfield service providers, and ultimately hinder any further improvement in credit quality."

Rocky Mountain basis differentials are "notably pronounced, but the natural gas basis differential in the Rockies narrowed by 5% in 2006 from 2005," Wyatt said. "This was due to increased demand in the region during the second half of 2006 that offset the potentially widening effect of supply growth in the region as its pipeline grid operated at high utilization levels."

However, S&P noted that Rockies basis differentials "did significantly widen in first-half 2007, when they averaged about US$2.46/MMBtu. Continued supply growth in the Rockies will likely sustain the volatility in the region's price differentials until the Rockies Express Pipeline comes into service, probably in early 2008."

In Canada, gas prices have been influenced by regional supply and demand.

"North American natural gas prices continued to fluctuate throughout the past year and a half as weather-driven low demand and higher natural gas supplies kept storage levels above five-year averages. Moreover, the significant increase in liquefied natural gas (LNG) imports and stable production in the U.S. kept inventory levels in 2Q2007 about 120% higher than the five-year average for the period, despite production declines in Canada because of reduced drilling activity."

Financial policy and merger and acquisition activity also remain "major issues in credit quality" for North American producers, said S&P. Share repurchases, such as the recent $15 billion repurchase announced by Chevron Corp. "are on pace to surpass the nearly $50 billion made in the U.S. oil and gas sector in 2006."

A few key themes S&P said are emerging for the global energy sector into 2008 include:

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