Sharp Price Drops Pressuring Some Oil & Gas Company Debt

Some weaker oil and gas companies could face difficulty funding their operations as a result of the sharp and swift decline in oil prices, according to Fitch Ratings.

The sharp drop in hydrocarbon prices at year-end 2008 may have a significantly negative impact on proven oil & gas reserve bookings under existing accounting rules, leading to increased debt/boe (barrel of oil equivalent) metrics across the sector, Fitch says in Lower Oil Prices to Pressure Debt/Reserve Metrics in 2009.

Firms with significant reserves booked under Production Sharing Contracts ((PSCs))- predominantly integrated oil companies and larger independents- may see a partial offset to this as these contracts are generally structured to increase bookings under a low oil price environment and decrease bookings under a high-priced environment, Fitch says.

Currently, Securities and Exchange Commission (SEC) oil & gas disclosure rules require that firms test the economic viability of reserves based on year-end hydrocarbon prices. Although the SEC recently approved a major overhaul of these rules, including a move to 12-month average pricing instead of year-end pricing for the reserves test, these changes will not be effective for the 2008 fiscal year.

“From a ratings perspective, the impact of price-based negative reserve revisions may be muted insofar as they stem from a particular accounting rule which is in the process of being changed. In addition, it is important to note that Fitch evaluates the creditworthiness of the upstream sector throughout the cycle. However, with that said, Fitch expects that the range of negative reserve revision information will also communicate important information about an individual company’s relative asset quality.”

Fitch also notes that while negative price-based reserve revisions are not expected to affect the liquidity of most investment grade issuers, those companies whose revolvers are linked to the size and/or value of their reserves via a borrowing base could be negatively affected by downwards reserve revisions in the form of reduced borrowing capacity, which in turn may limit their ability to fund operations.