If natural gas prices remain in the “up cycle” for the next 12 months, free cash flow will not only help XTO Energy Inc. reduce its debt, but it also will fund the Fort Worth producer’s aggressive acquisition plan, Moody’s Investors Service analysts said Friday.

Using its new liquidity system to rate the independent, Moody’s assigned an SGL-1 liquidity rating with a positive rating outlook to XTO. The SGL-1 rating is the best liquidity rating at Moody’s, which “reflects very good operating cash flow over the next 12 months of visible cash needs.” The company has no scheduled maturities, with budgeted capital spending to maintain production, discretionary capital spending and dividends.

“Assuming finding and development costs do not rise materially to consume expected free cash flow…XTO sustains a degree of growth capital spending and/or debt reduction,” said analysts. “The SGL-1 rating is principally vulnerable to XTO’s aggressive acquisition program, particularly if not suitably funded with equity, and if natural gas and oil prices fall below sensitized levels. The impact of leveraged acquisitions on the SGL-1 rating would amplify in environments of weaker prices.”

Currently, strong natural gas prices and cash flow are “vulnerable to the need for timely arrival of a normal-to-colder winter of 2003-2004, given the expectation of a normal 3 Tcf of U.S. natural gas in storage and the material support high natural gas prices derive from currently high but also vulnerable oil prices,” said analysts.

Analysts noted that overall, natural gas prices “could readily fall significantly below the $21/$3.50 sensitivity prices if the winter of 2003-2004 is warm to moderate and/or oil prices weaken substantially.” However, assuming 2004 benchmark prices of $24/bbl crude oil and $4.50/MMBtu gas, plus a 10% year-over-year combined production increase at XTO, earnings before interest and taxes could range between $875 million to $925 million.

“XTO displays a healthy balance between cash generating properties and cash absorbing development and exploration activity, as well as well-honed acquisition, exploitation, and funding skills,” said analysts. Also in its favor is the fact that it leases instead of buys a substantial proportion of the natural gas compression assets that boost production from low pressure natural gas well bores and inject that production into higher pressure natural gas gathering and transmission lines.

Moody’s noted “XTO’s reliance on one region, albeit the large multi-zone East Texas region, for 52% of natural gas production and for virtually all organic production growth,” adding that the region would receive 65% of the $450 million budgeted 2003 capital spending. “Thus, XTO’s 2003 and 2004 drillbit finding and development costs will be largely driven by its ability to avoid the inherent risk of deteriorating prospect quality as it continues to move across and within its core East Texas region and, in that regard, Moody’s will track initial production rates on new East Texas well bores over time.”

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