Financial performance within the U.S. upstream oil and natural gas sector looks positive in 2005, driven by high crude and gas prices, according to a new outlook report by Fitch Rating.

“Upstream producers should again generate significant free cash, providing management greater flexibility to increase capital budgets, further strengthen balance sheets, and/or return excess cash to shareholders,” according to the report.

Among other things, Fitch analysts expect overall capital spending to increase over 2004 levels, driven by increased costs in oil field services and higher steel prices. Capital budget increases also will be driven by organic growth capital, because many North American independents still have a sizable portfolio of drilling prospects from acquisitions completed over the past couple years.

The “super-majors,” said analysts, will be disciplined in their capital spending, continuing to return most excess cash to shareholders, mostly in the form of stock repurchases.

“Heightened speculation over global crude oil supplies, combined with robust demand, will continue to drive prices in 2005,” the report said. “The U.S. election and Venezuelan referendum removed some uncertainty from the crude markets, although lingering concerns remain over continued sabotage of the Iraqi oil infrastructure and production issues in both Norway and Nigeria.”

And, despite the lingering effects of Hurricane Ivan on Gulf of Mexico production, domestic natural gas inventories are full going into the winter season. Next year, Fitch expects that weather and the price of oil will continue to dictate the strength of natural gas prices.

Fitch’s outlook for the oil services industry is also positive, because of expectations for increased capital budgets for independent producers and national oil companies. However, the ratings agency again is taking a cautious approach for the refining sector. “Although refineries continue to generate substantial free cash flow, the sector also has a history of significant downturns and acquisitions financed principally with debt. Fitch expects a choppy stream of transactions to occur, albeit at a lower pace than recent years due to the limited number of buyers.”

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