Liquidity, previous hedging, low debt, declining costs and capital-spending discipline are among the key features of a strongly positioned E&P, says Jeff Morrison, associate director, corporate and government ratings, with Standard & Poor's debt-rating service. Another key feature may be the E&P’s use of asset sales to further bolster the balance sheet, he adds.

Morrison is among panelists in a webinar “Seeing Through To Solutions: The Economic Downturn's Impact On The Energy Industry” hosted by OilandGasInvestor.com and Allegro, a provider of energy risk-management solutions. The recording of the webinar is now available at https://www.oilandgasinvestor.com/webinar/200812_dpsmarquis.

The attributes Morrison cites are mitigating factors against declining commodity prices, reduced access to debt or equity capital, upcoming borrowing-base redeterminations, covenant violations and overspending cash flow.

“Cash-flow adequacy is an area in this market we are certainly focusing on now,” Morrison says. Among the 44 E&Ps whose credit quality S&P rates, one is rated “A” and 30 are rated “BB” through “B-,” or generally in the high-yield category. S&P’s analysts have issued 15 negative high-yield E&P rating actions so far this year, he adds.

“Liquidity is something we’re really placing a premium on right now.”

Greg Kerley, executive vice president and chief financial officer for Houston-based Southwestern Energy Co., presents Southwestern’s current financials as a baseline example of a strongly positioned E&P. “We are a bit of an anomaly in that we don’t have borrowing-base redeterminations…through 2012,” Kerley says. Its $1-billion credit facility is unsecured, and is undrawn.

The Fayetteville-shale-focused producer has some $200 million of cash on hand. Its $600 million of senior notes are at 7.5% and are not due until 2018. Its year-end 2008 debt-to-total-capitalization ratio is expected to be some 23%. The company has put no new production hedges in place, and the remaining hedges—approximately 48% of its 2009 production—is at an average floor of $8.48 per thousand cubic feet, he says.

In terms of costs, it operates some 90% of its production, thus it is able to control spending, up and down, he adds.

Michael D. Bodino, director of research and senior E&P analyst for the SMH Capital institutional equity research group, acknowledges Southwestern as an exception to the generally reduced profile of the E&P industry.

Investors looking for clues to the best-positioned E&Ps in a total-downturn marketplace can find some answers in sighting the red flags, he suggests. “There are a number of companies that are precariously positioned. Watch for the following warning signs that keep us up at night.”

-- Spending more than cash flow or having to make a sizeable investment to convert a project to cash flow. These E&Ps may still be drawing down a borrowing base. “Those that have to borrow give us the most concern into this downturn.”

-- No dry powder.

-- Poor project economics. These E&Ps may be continuing to pursue projects with mediocre or poor rates of return.

-- High debt-to-cap and high debt-to-EBITDA.

-- Difficult capital structures and/or unpalatable terms in bond indentures or bank covenants.

-- High G&A as a percentage of revenue.

-- High F&D costs and poor investment returns.

-- Positioning in the wrong basins, e.g. the Rockies or Gulf of Mexico. “Gulf of Mexico companies need 70% to 80% of cash flow to replace reserves.”

-- A short reserve life, which is a higher risk in a period of declining commodity prices.

-- A high percentage of PUDs (proved, undeveloped reserves). “You start getting an aging-of-PUDs issue where you can’t develop them in a period of time in which they are valuable.”

-- Long acreage and short capital. “Don’t be fooled,” he warns.

-- Negative growth rates, as shrinking companies typically mean shrinking capital and smaller valuations.

Solutions include refinancing; monetizations, including VPPs and farm-outs and joint ventures; strict cost management (“Any dollar saved is a day longer that you stay in business”), and at worse: merger or sale. “I certainly expect to see more M&A activity this year,” he says.

Bodino cites several solutions in his presentation, which is available along with the archived webinar, and adds, “The silver lining? The average (commodity-price) down-cycle since 1970 has lasted an average of 18 months…The next upturn begins again in earnest in 2018.”

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, Oil and Gas Investor This Week, OilandGasInvestor.com, A-Dcenter.com; ndarbonne@hartenergy.com