?Given the drastic retrenchment in asset valuations, the tight credit markets, and the sharp correction in oil and natural gas prices, Mandeville, Louisiana-based Pritchard Capital Partners LLC downgraded several credit ratings of the 17 E&Ps in its coverage universe.

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The analysis and re-ratings are based on balance-sheet strength, bank debt covenants, hedging programs and growth prospects. Downgraded from Buy to Neutral are ATP Oil & Gas Corp., Crimson Exploration Inc., Energy Part?ners Ltd. and Petro Resources Corp.


“The near-term outlook of each of these companies is diminished by the lack of liquidity,” says Stephen Berman, senior research analyst at Pritchard. “We identified what we believe will be restrictive debt covenants in the year ahead for these companies.”


On the upside, the firm picked Petrohawk Energy Corp. as its top gas producer due to its “operational leadership, significant position in the Haynesville shale, strong 2009 hedging program and ample liquidity to fund future growth.” (Petrohawk chairman, president and chief executive Floyd Wilson has been named Oil and Gas Investor’s Executive of the Year in its sixth annual Excellence Awards program. For details, see the feature on Wilson in this issue.)


Other Pritchard top picks with Buy ratings include Encore Acquisition Co., W&T Offshore Inc., Arena Resources Inc., Gastar Exploration Ltd., PetroQuest Energy Inc., Penn Virginia Corp., GMX Resources Inc., Brigham Exploration Co., BPZ Resources Inc. and Vaalco Energy Inc.


“Each of these companies appears to have the necessary liquidity and/or asset base to continue to succeed in the current environment,” says Berman. “Although we still hold the belief that investment in the E&P industry is a long-term, winning play, we encourage investors to take a more selective approach when adding to or initiating new positions in the E&P space in 2009.”


Jeb Armstrong, New York-based analyst with Calyon Securities (USA) Inc., also reports debt-facility concerns. “Should commodity prices fall further or remain weak for an extended period, some E&P companies may face the possibility that the commitment amounts on their credit facilities could be reduced,” he says.


Bank groups will redetermine credit capacity, typically based on year-end reserves, in March. The borrowing base is usually determined by a formula that examines proved reserves, such as between 60% and 70% of PV-10 of proved, developed and producing (PDP) reserves, at December 31 oil and gas prices discounted 10%.


Due to those oil and gas prices, substantial negative PV-10-related revisions are expected and banks are likely to revise their estimation of collateral value, thus the amount they are willing to lend.


Armstrong advises hedging, which can strengthen the profile. “Since near-term cash flow is a major determinant, a company’s 2009 hedge position can mollify the impact of the near-term price swoon. In addition, E&P firms generally set the commitment amount of their credit facilities below their borrowing base, which itself is frequently not maximized.”


Also, E&Ps should be adding substantial reserves, thanks to robust drilling activity in 2008, he says. “E&P firms generally are in good financial shape right now.”


“With rare exception, E&P firms have committed themselves to keeping spending within cash flow in 2009. Excluding long-term rig contracts, companies have the flexibility to adjust spending quickly and should be able to stay a step ahead of any liquidity squeeze.”


Armstrong reports only two companies—ATP (Underperform) and Quicksilver Resources Inc. (Buy)—have debt-to-total-market-capitalization ratios above 50%, 2009 estimated interest-coverage ratios of less than 5.0, and 2009 estimated total debt-to-EBITDAX (earnings before interest, taxes, debt, amortization and exploration) ratios of more than 3.0.

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