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S&P: Oil/Gas Make High Prices into Ratings Gain

Unlike the U.S. industrial sector, particularly electric generation, which has struggled with high wholesale fuel commodity costs, oil and gas suppliers enjoyed more favorable credit ratings and profits in the first half of this year, carrying over the same momentum from all of 2007, according to a recent Standard & Poor's Ratings Services (S&P) report.

Concluding that most negative ratings activity took place in the refining sector, S&P said the U.S. oil and gas sector spawned 18 more rating upgrades, compared to four downgrades, in the first half of the year, and globally the same trend has emerged so far this year (29 upgrades and nine downgrades).

The report, "High Commodity Prices Pump Up the U.S. Oil and Gas Sector, but Refiners Feel the Squeeze," by New York City-based S&P Analyst Thomas Watters said the ratings agency expected the positive rating trend to continue in the second half of 2008, albeit at a slower pace. For the energy production and supply sector, S&P said, major factors affecting credit quality will continue to be a combination of national financial policy, limited free cash flow generation and mergers/acquisitions.

Noting that refining was hurt by a decline in gasoline demand caused by high prices, Watters nonetheless expects some improvement by refiners during the rest of the year, adding the caveat that "margin improvement will be restrained by the expectation of high oil prices continuing and softer demand for gasoline because of stratospheric gasoline prices and the general impact of a weak economy."

Earlier in April in another report, S&P opined that higher costs for oil, natural gas and electricity were being felt by consumers across the board as companies have been forced to pass on to customers the higher prices they pay for energy. In the chemicals and forest products industries, high energy commodity costs are reshaping company strategies, S&P said.

S&P stressed the lasting impact of the high energy prices in the industrial sector, particularly chemicals. "With the onset of increasingly elevated and volatile energy costs, almost all chemical companies have implemented strategies to mitigate this key issue, bringing renewed focus to customer pricing strategies, restructuring and strategic actions that will affect this industry for years to come," S&P said.

For natural gas wholesale prices, S&P said continued strong U.S. electricity demand -- along with increases in marginal costs -- will also have strong impact on the future prices. Shorter term those prices and the amount of price volatility will be impacted by a combination of the amount of cooling days this summer, the extensiveness of hurricanes and what S&P called "potential summer liquefied natural gas (LNG) imports."

"Financial policy, limited free cash flow generation and the mergers/acquisitions will still be a major factor in credit quality," the S&P report said. "Exploration and production companies, their coffers flush with cash and the ability to access debt capital markets, will continue to buy acreage or reserve positions. Also, we believe the drillers and drilling services companies are ripe for consolidation."

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