Amerada Hess’ declining production, low reserve replacement and burdensome cost structure, which is among the highest in the industry, prompted Moody’s Investors Service to downgrade the company’s debt to junk status Friday.

Moody’s cut Hess’ long-term debt and commercial paper ratings to Ba1 and Not Prime from Baa3 and Prime-3, respectively. The ratings affect about $4 billion in debt and conclude a review started last fall. Moody’s also assigned a Ba1 senior implied rating to the company with a stable outlook.

Moody’s said the downgrades reflect its “concern that the execution risk and time frame required to show a material improvement in Amerada Hess’s production profile, coupled with a high embedded cost structure, will make it difficult for the company to maintain operational and reserve leverage metrics in line with its higher rated peer group companies.”

The outlook is stable because the company continues to produce solid cash flow from its mature exploration and production and downstream operations. Hess also has focused its attention on debt reduction and liquidity, Moody’s added.

“Amerada Hess’s oil and gas production have declined over the past two years as a result of natural declines in its mature U.S. and North Sea fields, asset sales to reconfigure the reserve portfolio, and other factors such as revised production strategies in the Ceiba field in Equatorial Guinea,” Moody’s noted. “The production declines also show the effects of an extended period of low internal reserve replacement. Moreover, inherently high cost fields with high decline characteristics, steep reserve acquisition costs, and resulting high fixed charges have resulted in the elevated unit cash production costs and high finding and development costs.”

Moody’s said Hess’ leveraged full cycle production costs currently exceed $23/boe and its debt per proved developed reserves is about $6 per barrel. These conditions “burden it with the highest cost structure among its most directly comparable exploration and production peer companies.”

Hess expects its production to stabilize this year around 325,000 boe/d and then to grow in the next few years as new core development projects start to add production to offset declines from its mature reserves.

Moody’s said it recognizes that the company is in the “early stages of an upstream turnaround” and execution of that turnaround, as well as efforts to reduce costs, should “lead to a gradual improvement in its cost structure.”

However, its reserve replacement and development programs are “subject to political, geological, execution, timing, and operational uncertainties, and such potential risks will be especially germane to Amerada Hess’s significant growth platforms such as Equatorial Guinea, Thailand/Malaysia and the deepwater Gulf of Mexico.”

Moreover, the rating agency believes that the next few years will be critical to establishing a more focused exploration program and adding reserves.

“A stable rating outlook gives recognition to the prudent measures management has taken to bolster its balance sheet and liquidity during a period of high committed capital spending for exploration and development,” Moody’s said. “These steps include recent debt reduction from asset sales and the leverage and liquidity benefits of a mandatorily convertible preferred share offering in December 2003, as well as a hedging program that will help stabilize cash flow available for capital spending.”

The outlook also reflects expected improvements in cost structure. The company’s ability to regain an investment grade rating will depend on its financial and operational progress.

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