Focusing on oil and natural gas liquids (NGL) has paid off for small exploration and production (E&P) companies, according to Moody's Investors Service, as they are expected to gain from rapid production and reserve growth.

"Because of recent technological advances, smaller E&P companies that have large positions in newly productive, unconventional resource plays are expected to show rapid reserve and production growth over the next few years," said Moody's Stuart Miller, a senior analyst. "In addition, companies that have a high percentage of their production comprised of oil or natural gas liquids are expected to benefit from increased cash flow and greater liquidity. We believe that smaller, speculative-grade companies are disproportionately, and positively, affected by these developments."

Horizontal drilling and multi-stage hydraulic fracturing are again given the credit for the improving outlook in the energy patch. Companies that have been successful in applying these new drilling and completion techniques have lowered their finding and development costs, improved their risked return on investment, and enjoyed significant reserve and production growth, according to Moody's. "Future drilling results and production levels can now be predicted with greater certainty over large acreage positions, due to the improved performance of wells drilled using this new technology," said Moody's.

Over the next few years, many small E&P companies with a high proportion of oil and NGLs in their production streams are expected by Moody's to report improving operating cash flow levels, higher capital budgets, declining leverage metrics, and better liquidity. Conversely, companies with a high proportion of their production made up of dry natural gas are expected to be more at risk on a relative basis, Moody's said.

Dry natural gas-focused companies may be forced to scale-back capital budgets and slow growth, the ratings agency warned. "In more extreme cases, natural gas E&P companies may be forced to sell or monetize assets to manage their leverage ratios."

Moody's identified a group of speculative-grade E&P companies that are poised to benefit the most from the technological advances, or from sustained high oil prices. The firm placed 23 speculative-grade companies on review for upgrade: Alta Mesa Holdings LP (B2), Antero Resources LLC (B2), Baytex Energy Corp. (B1), Berry Petroleum Co. (B1), Chaparral Energy Inc. (B3), Clayton Williams Energy Inc. (B3), Concho Resources Inc. (Ba3), Carrizo Oil & Gas Inc. (B2), Energy XXI Gulf Coast Inc. (B3), Harvest Operations Corp. (Ba2), Hilcorp Energy I LP (Ba3), Laredo Petroleum Inc. (B3) MEG Energy Corp. (B1), Oasis Petroleum Inc. (B3), PDC Energy (B2), RAAM Global Energy Co. (Caa1), Rosetta Resources Inc. (B2), SandRidge Energy Inc. (B2), Sheridan Production Partners (B2), Stone Energy Corp. (B3), Swift Energy Co. (B2), Unit Corp. (B1) and W&T Offshore Inc. (B3)

The companies placed on review for upgrade either have a more oily mix to their production streams or a large inventory of drilling locations in unconventional reservoirs, Moody's said. "And while E&P companies of all sizes may benefit from the positive industry trends, the smaller and more weakly rated companies are expected to benefit the most, resulting in an improving risk profile."