Independent exploration and production (E&P) companies remain under pressure in the near term from an ongoing natural gas supply glut, which will pinch cash flow and returns in 2010, Moody’s Investors Service said in its annual outlook on the industry.

“We believe conditions in the E&P sector will continue to deteriorate somewhat over the next year — with the benefits of lower oilfield services costs being more than offset by continued natural gas oversupply and weak spot prices,” Moody’s analysts said in their annual outlook report on the independent E&P sector.

A drilling and services cost adjustment is under way, but “we do not believe this adjustment will match the lower gas price environment, particularly not in such higher-activity shale plays as the Haynesville and the Marcellus. E&Ps whose production is heavily oriented toward natural gas could have trouble maintaining production without outspending cash flow and increasing debt.”

Lower service costs, continued shale development and improved liquidity should enable many producers to maintain or even expand output going into 2010. In addition, more liquefied natural gas may be headed toward North American shores in the next year, Moody’s noted.

Combine all of those factors with uncompleted gas wells that could begin flowing in the next few months and “the oversupply situation could continue well into 2010,” said analysts. “Until we see more evidence of a healthier supply/demand balance for natural gas, our outlook for the E&P industry remains negative.”

Most E&Ps late last year reduced capital expenditure (capex) budgets for 2009 as commodity prices fell and the credit markets froze access to capital for corporate borrowers. At the time, many said they intended to “live within cash flow” and limit capital spending to avoid more debt and to preserve their liquidity.

However, even for the many that embraced less spending, “contractual drilling commitments and the sheer momentum of spending before commodity prices collapsed meant that it took several quarters to reduce capital spending to a level within cash flow,” the report noted. “This is why much of the decline in capex only occurred in the second half of 2009 — another reason production volume has held up so far this year among rated issuers.”

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