If oil and gas prices remain strong, Standard & Poor’s Ratings Services (S&P) expects domestic producers’ capital budgets to “gently” rise this year, which will lead to modest increases in aggregate production. As the year progresses, S&P also expects merger and acquisition activity to increase, with companies able to use their strong cash flows and “largely undrawn bank facilities” to fund acquisitions.
Major integrated companies appear to be reinvesting “only 30-40% of their domestic cash flow in the United States,” and “have made strategic decisions to allow their shallow-water and onshore natural gas production to deplete to redeploy capital to international (mainly oil) projects.” Unlike earlier cycles, “companies have been reluctant to incur debt to finance their drilling programs,” but if prices remain strong, S&P expects the capital budgets to modestly rise, which will also slightly increase aggregate oil and gas production.
According to a 57-page report published Thursday, the global oil and gas industry continued to strengthen their bottom lines in the first quarter on increased cash flow from high commodity prices. Energy companies were able to continue debt repayment and other balance-sheet strengthening with their “still-moderate financial policies,” according to “First Quarter 2004 Global Oil and Gas Ratings Roundup.”
“Another plus for the industry is a red-hot high-yield market that has enabled companies to raise new debt or refinance at extraordinarily low rates — thus likely improving their viability for years to come,” analysts said. “However, operational performance and corporate governance/accounting issues remain of high concern, underscored by negative reserve revisions at three companies.
S&P said “blemishes remain” for exploration and production companies. “…it is unclear that producers are investing enough to grow production materially — and this follows a year in which the domestic gas production (excluding acquisitions) of rated producers appears to have declined. The lack of production response to a strong increase in drilling is largely a result of capital allocation to smaller onshore properties…and a preference to invest in long lead-time deepwater projects versus the Outer Continental Shelf.”
Natural gas inventories “appear adequate to prevent immediate price spikes,” but S&P noted that “rising prices could resume later this year depending on summer weather, the pace of U.S. economic growth and oil price strength. The supply constraints of North American natural gas have been well documented; low supplies are likely to persist for the near term as North American producers at best are likely to achieve only very moderate (1-2%) production growth in 2004, with the most significant portion occurring in the middle to end of the year.”
Production growth in gas supplies, “coupled with an increase in liquefied natural gas (LNG) imports, is likely to cause a severe price decline; unlike 2003, when inventories were replenished at a record pace at a $5 gas price, weather may not be as mild and industrial consumption appears to be increasing. Given price increases in many heavy industries, a higher natural gas price than last year may be needed to discourage U.S. industrial demand.”
Longer term, S&P analysts expect “only modest incremental supplies to U.S. markets from conventional and new sources (i.e., LNG, Arctic gas) until 2006 when additional LNG receiving terminals and tankers are likely to enter service.”
For more information on the report, visit www.standardandpoors.com.
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