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 and Allegro, a provider of energy risk-management solutions. The recording of the webinar is now available at

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,,;