Moody's Investors Service last week changed its rating outlook for Houston's EOG Resources Inc. to "negative" from "stable" because of the producer's plans to aggressively transform itself from a natural gas-weighted producer to one more weighted to natural gas liquids (NGL) and oil.

During a conference call earlier this month EOG CEO Mark Papa said in 2011 the company's North American production is expected to be 67% weighted to crude oil and NGLs, a huge reversal from 2007 when the company's oily output accounted for about 23% of total production (see NGI, Nov. 8).

EOG plans to finance the move to oil by selling $600 million to $1 billion of its gas-weighted North American producing and nonproducing assets; last week it sold Newfield Exploration Co. some Marcellus Shale acreage (see related story).

Moody's "change in outlook reflects EOG's shift in financial policy and the challenges stemming from its aggressive growth into oil and natural gas liquids plays," wrote senior analyst Gretchen French. "EOG has a long track record of strong organic operating performance and conservative financial leverage. However, its efforts to transform from a primarily natural gas-based company into a company with a more balanced profile between natural gas and liquids production is highly capital intensive and has pressured EOG's financial leverage metrics."

The ratings agency "recognizes the strategic benefits of EOG's production diversification strategy given the higher value of liquids relative to natural gas. Nevertheless, this diversification strategy is capital intensive and entails execution risk.

"Furthermore, secularly weak natural gas prices have resulted in EOG's cash flow generation and estimated proceeds from natural gas asset sales being below expectations. In addition, fracking [hydraulic fracturing] delays have delayed liquids production growth expectations. As such, EOG has raised its leverage limits from below 25% net debt/capital to the 30-35% range."

EOG's "A3" credit rating is among the highest of Moody's rated independent exploration and production companies, French noted. "Given EOG's smaller scale relative to its peers, maintenance of the 'A3' rating requires both robust capital productivity and very conservative financial leverage. EOG's leverage in 2010 has substantially increased from 2008 levels."

According to Moody's accounting, EOG's debt/daily production has risen to about $12,200/boe at the end of September from $7,400/boe for full-year 2008. Debt/proved developed (PD) reserves rose to $4.62/boe as of Sept. 30 from $2.22/boe on Dec. 31, 2008.

"Moody's notes that EOG is targeting material natural gas asset sales of approximately $1 billion for 2010 and over $1 billion targeted in 2011," French noted. "However, Moody's believes that asset sale proceeds will primarily be used to help fund cash flow shortfalls as a result of expected continued high levels of capital spending over the near to medium term. A significant portion of capital will be required to at least partially develop some oil and liquids rich gas targets to hold land leases over the next three years.

"If EOG's leverage continues to remain elevated (debt/daily production above $12,000/boe and debt/PD above $4.00/boe), the ratings could be lowered. Part of this process will also consider EOG's year-end 2010 capital productivity data and the company's 2011 capital plans." EOG's outlook also could stabilize if the company "is successful in returning financial leverage trending closer to its 2008 levels (debt/daily production less than $10,000/boe and debt/PD reserves under $3.00/boe)."

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