Producers have stronger bottom lines than other sectors of the oil and gas industry, but high natural gas prices reflect falling U.S. production and the “hard time” exploration and production companies have to replace reserves of comparable or better quality at a competitive cost, said Moody’s Investors Service analysts. Moody’s analysts last week gave a “stable” rating to the entire sector, with the exception of oil refiners and wholesale marketing, which both carry a “negative” outlook.

“As a rule of thumb, an issuer would be hitting home runs if it can replace production with 50% of mid-cycle cash flow, showing high reinvestment productivity at good costs, ample cash flow for growth or debt reduction, and ample down-cycle cushion, but these issuers are the notable exceptions rather than the norm,” said Andrew Oram, Moody’s senior credit officer.

Technology has “impressively reduced some risks in E&P and made many challenging prospects quite economic,” but other components of risk are trending higher, Oram said. He cited increased reservoir depletion rates; rising proportions of proven but undeveloped reserves; political risk concentrations for some issuers; and the longer lead times, higher risk and higher front-end costs of several projects in the higher impact, less mature basins for some issuers. “When they apply, these factors can add to the interim or longer-term burdens on cash flow and capital structure,” said Oram.

For producers, spending will “gain modestly” in the second half of this year, and then will be stronger in 2003. Except for the North Sea, “notable strength” was forecast for offshore West Africa, offshore Mexico and offshore Asia Pacific. Offshore Brazil was “in balance,” said analysts.

Meanwhile, the drilling and oilfield services sector remains “stable” because of “generally stronger balance sheets than in the last downcycle, plus the benefits of greater industry consolidation,” noted Helen Calvelli, Moody’s senior credit officer. “Drillers’ U.S. cash margins mostly peaked in the third quarter of 2001 and are hurting now,” she said. “We don’t see step-changes in margins until utilization approaches or surpasses 90%. It may be later in 2003 before robust numbers are seen.”

Natural gas may trade widely in the $2.75-to-$4/Mcf range in 2003, assuming a “normal 2002/03 winter, with self-correcting moves above and below that range, and average $3 or a bit more for the year,” Calvelli added. “A warmer winter would probably subtract from that range while a particularly cold winter would probably add to the range.”

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