Independent oil and gas exploration and production companies (E&Ps) still face increasing challenges to reinvest “substantial” capital every year as they seek new reserves to replace current production, according to Moody’s Investors Service. However, analysts because technical and geological risks remain high in mature basins and the deepwater, analysts expect more consolidation, especially among independents.

“The companies face constant pressure to replace production and grow their reserve base,” said John Cassidy, a senior credit analyst. “We believe this challenge will become even more difficult, which is why we place a fair amount of emphasis on the need for financial flexibility and a relatively strong balance sheet in order to be considered an investment grade company.”

By carefully examining an E&P’s sources of replacement and associated costs, analysts can highlight the effectiveness of a company’s drilling efforts and success over time, said Cassidy. “In general, it continues to be very difficult for independent E&Ps to consistently replace 100% of production exclusively through the drillbit at competitive costs. As a result, we expect further consolidation in the industry, more churning of assets, and an increasing reliance on technology because large new discoveries in mature basins in North America are not likely to occur.”

In all, Moody’s rates 17 investment-grade E&P companies, most of which have ratings in the investment-grade “Baa” category and stable rating outlooks. In total, they have approximately $50 billion in rated debt outstanding. Moody’s evaluates an independent E&P’s financial leverage by assessing the amount of adjusted debt relative to the underlying proved developed reserve base and relative to gross cash flow. The analysis generally starts with an overall assessment of the industry and concludes with a company-specific analysis that emphasizes reserves and production, financial leverage, and total full-cycle costs.

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