Despite a lukewarm economic recovery and a higher risk of recession, the credit quality for the U.S. oil and gas sector should remain relatively stable in 2012, according to an industry report card by Standard & Poor’s (S&P).

“We believe that a weak but gradually improving economy will support strong oil prices plus marginally higher prices for natural gas, which accounts for 30% of U.S. industrial energy usage, though supply will set the direction of gas prices,” said credit analyst Thomas Watters.

S&P’s 2012 baseline forecast for West Texas Intermediate (WTI) oil of $98.50/bbl “bodes well for exploration and production (E&P) companies with a focus on oil, as well as for oilfield services and contract drilling companies.”

Higher oil prices will benefit E&Ps focused on natural gas liquids (NGL) as well as oilfield and contract drillers, which will achieve “very strong financial performance in our view,” he said. “In addition, we expect E&P companies to spend slightly more in 2012 versus 2011, thus helping oilfield service companies and drillers maintain recent healthy ratios and earnings.”

S&P’s base-case economic forecast is calling for a “mildly positive but weak recovery” through the coming year. “The U.S. economy should skirt a double dip recession but the odds of that occurring have increased to 40%.” The ratings agency’s downside case assumes gross domestic product (GDP) contraction of 0.4% in 2012.

“We believe E&P companies will continue to focus on drilling in basins rich in higher-priced oil and NGLs, such as propane and butane, in light of weak natural gas prices,” wrote Watters. “Relatively high oil prices reflect supply-demand issues as well as a weak U.S. dollar.”

S&P still views oil prices as “more resilient” than gas prices. “Yet we also believe that a prolonged recession in the U.S. or Europe could push prices much lower than the $85/bbl for WTI as of Oct. 10. Were that to happen, we think, E&P companies, with their relatively strong balance sheets, could compensate by cutting capital expenditures somewhat.”

In step with recent energy analysts’ reports, S&P expects gas prices to remain weak “over the next few quarters” on abundant supplies.

“Prices could rise, however, as producers reach completion on their held-by-production leases in the next few years and face less attractive hedging opportunities,” said Watters. The “one-year forward curve is currently under $5/Mcf, which would reduce producers’ incentive to drill.”

However, drilling for NGLs in the North American onshore “could add to the high natural gas supply as could a backlog of drilled but not yet completed gas wells. Together, these factors could keep prices down. We thus view companies that have a relatively small scale and high concentrations of natural gas assets as most vulnerable to weaker credit quality in the next 12 months.”

For oilfield services operators, demand remains robust but offshore contract drilling prospects are limited, noted S&P.

“We expect overall demand for onshore drilling and related oilfield services to remain solid entering 2012, but susceptible to a downturn in the U.S. economy,” said Watters. “Onshore drilling and oilfield service providers will likely continue to perform well over the next few quarters, as oil producers continue to demand more complex equipment and additional [hydraulic] fracturing capacity in order to drill service-intensive wells.”

Offshore contract drillers may face challenges.

“We expect deepwater offshore drilling companies to experience lower demand” in part because about half of the new floating rigs scheduled for delivery in the next two years is uncontracted, said Watters. The new rigs may displace lower-specification rigs, which in turn could reduce older rig utilization and contract rates.

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