Forest Oil Corp., Denver, (NYSE: FST) has delivered some anticipated bad news, but it was worse than expected. The company chopped its offshore Alaskan reserves some 86%, or a fifth of its year-end 2002 estimate. And the Denver-based independent added another warning: It may chop more. However, the company proactively bought as many U.S. reserves during 2003 as it has lost on paper in Alaska, softening the blow to its net asset value upon the revision news. Shares, which had been trading at around $29 in early January, fell upon the news but did not spiral, closing at $25.30 on announcement day and improving slightly the following day. The investment community expected a cut, but the size of the downgrade took at least one analyst by surprise. The slice was "nearly twice the size of our previous 25 million-bbl. estimate," says Lloyd Byrne, an E&P analyst with Morgan Stanley. Forest reduced its estimate of Redoubt Shoal Field, Cook Inlet, Alaska, proved reserves by 49 million bbl., of which 36 million were categorized as proved undeveloped. The new estimate of Forest's proved oil reserves from the field is 8 million bbl. During a conference call with Forest management, one analyst noted that a long-term process-the way the company looked at reserves-led to the recent massive write-down at Royal Dutch/Shell, and asked if Forest faced a similar situation. Craig Clark, Forest president and chief executive, said that was not the case with Forest. Production results in 2003 from Redoubt Shoal, which began flowing in December 2002, were lower than expected, prompting Forest management to order new estimates of what is recoverable from the field. Data from wells drilled in 2003 were reflecting significantly lower oil in place than 2002 estimates, lower overall recovery efficiencies and economic cutoffs. Both of the Alaska reserve estimates came from independent engineers. The field currently produces from three wells at combined rates between 1,500 and 2,000 bbl. per day. The #1 well needs repairs, and the company plans to selectively stimulate its #7 horizontal well. Forest made additional downward revisions in its estimated proved reserves for other properties as well. These additional cuts total as much as 143 billion cu. ft. equivalent-or about 24 million BOE-due to recent production performance and to revised field-development plans. Since Forest took the additional 143-billion-cu.-ft. cut, it expects year-end 2003 proved reserves, including its more than 300 billion cu. ft. equivalent of acquisitions in 2003, would be approximately 1.3 trillion cu. ft. equivalent versus 1.56 billion cu. ft. equivalent at year-end 2002. Without the acquisitions, the year-end 2003 figure could have been approximately 1 trillion cu. ft. equivalent, or a 36% loss. Clark said, "We are extremely disappointed with the results at Redoubt Shoal. However, our strategy is clear." The company is aiming for cost reduction, reduced frontier exploration exposure, more acquisitions and improvements in its balance sheet. "We expect to continue the implementation of this strategy in 2004," Clark said. Forest is planning to sell the balance of its international exploration program, according to Glenn Mizenko, director of business development. "We'll be looking for someone to either come in and take it off our hands or partner [with us]," he told fellow business-development professionals at a recent Society of Petroleum Engineers-Gulf Coast Section program in Houston. Forest has already moved out of Australia, Thailand and Indonesia. Remaining are gas-exploration operations offshore South Africa and in Gabon, Romania, Germany and Italy. The decision in fourth-quarter 2003 to shift capital away from frontier exploration led to a non-cash, pre-tax impairment expense of $15- to $20 million. Its $370 million of asset purchases in 2003 have been in the U.S.-in the Gulf of Mexico, along the Gulf Coast and in the Permian Basin. "We'll be doing a lot less internationally," Mizenko said at the SPE-GCS program. The domestic strategy is counter to that of many independents that are trying to grow-even counter to that of most major oil companies. While U.S. reserves are mature, opportunities abroad are seen as having the greatest potential to offer large rewards. "I would have thought anybody investing in North America would have realized there is more [drain on] cash than [there are] opportunities, finding and development costs are going up [and] the decline rate is getting faster," says an executive with a major oil company. "It continues to surprise me that companies continue to focus their efforts on North America. I know commodity prices are high, but it's getting more and more expensive to produce them-and probably at a faster rate than commodity prices are going up." Byrne said Forest's domestic purchases are a first step in a multi-step process of a "lengthy/challenging turnaround," a strategy most analysts have applauded. In its acquisitions program, Mizenko said, "we are trying to position ourselves to do a deal of any size." It wants more reserves onshore the U.S. Some 60% of Forest's current production is from the Gulf of Mexico. "We'd like to balance that out," he said, but the company would make another Gulf purchase if it were a good opportunity, like the one it recently made from Unocal Corp., El Segundo, Calif. It would also like to grow its Canadian business, "but that's a very competitive market," he said. Standard & Poor's Ratings Services is concerned about Forest's focus on U.S. reserves, particularly in the Gulf of Mexico and its "growing reliance on acquisitions to fuel reserve growth." S&P moved its outlook on Forest's debt in September from positive to stable upon the news of a possible revision of the Alaska reserves. At press time, S&P was considering a negative outlook. As for its bank debt, Forest's $575-million borrowing base will be redetermined based on the new proved reserves estimate sometime later this year. Forest's debt on June 30, 2003, was approximately $746 million, and it has since grown due to some $370 million of asset purchases that were funded in part with debt. The rumor in the upstream A&D community is that all of Forest is for sale. What would it cost? The market was valuing Forest at press time at about $1.64 per thousand cu. ft. equivalent of proved reserves, based on a roughly $25.50 stock price, debt of at least $750 million and 1.3 trillion cu. ft. equivalent of proved reserves. No revisions are expected on properties acquired in 2003, according to Forest. Company-wide production, currently 400- to 420 million cu. ft. equivalent per day, is not expected to change, it added.

Comments