oftening commodity prices expose oil and gas producers to new enterprise values-and debt profiles. An onshore gas producer 60% weighted to debt at $9 gas could easily become 80% debt-heavy at $6 gas.

These dips in oil and gas prices create M&A opportunities for those carrying strong credit capacity and equity values. Target candidates are producers who become interested in exiting so as to not deal with the risk of trying, yet failing, to dig out of an upside-down profile, all the while losing momentum and value as an ongoing concern.

Other targets are unwilling sellers whose shareholders have been profiled by the asset-hunter as having a shallow threshold for commodity-price downside risk.

Many E&P equity analysts are projecting average oil and gas prices for 2007 that are profitable to most producers in most plays. Their optimism is no real leap of faith, nor comfort to shareholders, though, when the Nymex 12-month strip is equally confident.

Who are the M&A targets? Who are the potential buyers? These huddle up nicely when considering, for example, Standard & Poor's debt scores for the E&P companies it rates.

"U.S. oil and gas credit trends are likely to be more daunting in 2007 than in the past few years as weakening fundamentals, particularly for natural gas, result in a softening of prices," reports S&P credit analyst Andrew Watt. "...For 2007, (we) expect factors that influence crude oil and natural gas prices to have a significant impact on ratings activity and trends."

Among these factors are weather and gas in storage; growing E&P costs; reserve-replacement hurdles; political developments, such as the nationalism of assets abroad; and M&A activity. What could help is global economic growth.

"Assuming prices stay ($52 oil and under-$7 gas) or soften further, E&P companies' profit margins will be squeezed heading into 2007 and credit measures will deteriorate, particularly for those companies that are largely unhedged," Watt says. (At press time, near-month gas futures had improved to some $7.50.)

"A key question will be how willing companies are to scale back capital expenditures to be in line with internally generated cash flow. Poor organic reserve replacement and high finding and development costs could also pressure credit quality in the sector."

Trying to overcome the challenge of declining market conditions while attempting to reduce debt is Anadarko Petroleum Corp. It took a leap this past summer, when E&P equity values were already two months into a retreat, and made more than $20 billion of cash acquisitions-Kerr McGee Corp. and Western Gas Resources. Meanwhile, it has been selling other assets.

S&P credit analyst David Lundberg has a Stable rating on Anadarko's debt (BBB-). Issuing equity would reduce the debt but management does not prefer that option right now, he says.

How are the other large U.S.-based independents faring? Analyst Ben Tsocanos says Apache Corp. (A-) is achieving strong production growth organically and through acquisitions. The company has been noticeably absent in M&A deals in the past few years, as asset prices have climbed, except for large purchases in the Gulf of Mexico and a bolt-on in the Permian Basin.

Historically, Apache has correctly picked good buying seasons and good sitting-out seasons. When it reenters the market in a significant way, buying season is deemed by some as officially open. Yet, Apache has announced a $1-billion stock buyback plan, suggesting it still doesn't like current acquisition-market prices. When it does draw the rifle and dip into its dry powder, watch for an asset transaction, not a corporate deal-Apache has made extraordinarily few of the latter.

Likely to remain an active buyer is Chesapeake Energy Corp. (BB), whose leverage improved after selling $1 billion of stock in December, Lundberg says. Meanwhile, he adds, Devon Energy Corp.'s (BBB) momentum for a credit-rating upgrade "has cooled some" due to its aggressive capex plans and the weight of debt it took on when acquiring Barnett shale powerhouse Chief Oil & Gas last summer.

Currently a target of an aggressive shareholder, Pogo Producing Co. (BB) is "burdened by the challenges of integrating recent acquisitions, improving operational performance and managing high debt leverage," Tsocanos says. "We expect the company to be cash-flow negative in the near term...." Proceeds from divestments during this half should help improve Pogo's profile, he adds.

Also relatively absent at the M&A table this past year has been XTO Energy Inc. (BBB), which paid most of its 2006 capex bills with cash flow, Lundberg says. Like Apache, the company is well known for sniffing out a buying season, so watch for its signal.

Continued flat-to-lower oil and gas prices could have the effect of pushing some players out of the game. For details on U.S. E&P M&A transactions in second-half 2006, see our biannual list of deals in this issue.

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