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S&P: Capital Shortage to Stifle Buyers' Market

Supermajor and large independent producers generally enjoy strong liquidity positions, but tighter capital markets will crimp the purchasing power of smaller players at a time when some properties would likely become available at "distressed prices," Standard & Poor's Ratings Services (S&P) analyst Thomas Watters wrote in a recent note.

"The debt capital markets are effectively closed for speculative-grade issuers, and asset sales are becoming more difficult to execute," Watters wrote. "To make matters worse, unless prices improve from current levels, we expect that commercial banks could soon begin decreasing the borrowing bases that govern companies' senior secured revolving credit facilities by 15% to 20%."

Look for significant declines in asset sales and mergers as weaker industry conditions and credit market turmoil make financing more difficult to come by, S&P warned.

S&P is watching speculative grade-rated companies with a lot of bank debt and those that incur negative cash flow in pursuit of aggressive production growth. In the second half of 2008 S&P has revised the outlook downward for Berry Petroleum Co., placed Chaparral Energy Inc.'s ratings on CreditWatch with negative implications and lowered Gastar Exploration USA Inc.'s ratings, all due to liquidity concerns.

"The weakening global economy and credit market concerns continue to pummel crude oil and natural gas prices," Watters wrote. "In the case of natural gas, there are also concerns about excess North American supply.

"Without question, lower hydrocarbon prices will weigh heavily on the sector's credit quality, particularly when we consider that basis differentials remain so wide in the Rockies and the Midcontinent regions and that service costs have not declined much thus far. In addition, many of the drilling prospects in the U.S. are simply not economical."

S&P has lowered its 2009 pricing assumptions during the last six months to $55/bbl oil (West Texas Intermediate) from $80/bbl and $6/MMBtu gas (Henry Hub) from $8/MMBtu. "Many companies, particularly speculative grade-rated companies, have significantly hedged commodity prices in 2009, and some well beyond," Watters noted. "As a result, their cash flows will not decrease immediately."

Long-term assumptions remain $60/bbl and $6/MMBtu.

Despite the gloom, Watters noted that other industries are worse off in the liquidity department than oil and gas. "Most oil and gas companies have sufficient cushion under their asset-based borrowing facilities, and many companies refinanced debt before the credit crisis began, which extended maturities."

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