Standard & Poor's Ratings Services expects generally favorable rating trends to persist in the U.S. oil and gas sector this year, noting that upgrades have outpaced downgrades in the sector by nearly six to one through the first half.

"Robust hydrocarbon prices and improved operating performance-particularly by companies in the service sector-are the key drivers of positive ratings activity," says Standard & Poor's credit analyst Ben Tsocanos.

He notes that price volatility is more pronounced on the upside, which also helps to provide a beneficial operating climate for the sector. However, from a credit-quality standpoint, several factors continue to limit improvement for ratings in the near term.

"Operating costs remain high across all sectors of the industry," Tsocanos says. "Moreover, share-repurchase activity continues to reach levels that would have been hard to imagine just a year ago."

In addition, energy companies are relying on large levels of debt financing for their corporate acquisitions. A good example of this is the recently announced Transocean and GlobalSantaFe merger and recapitalization.

"The combined entity plans to pay $15 billion in debt-financed cash distributions to Transocean and GlobalSantaFe shareholders," he notes. "So although the operating environment is very supportive of ratings improvement, companies are largely managing their businesses to their current ratings."

These factors aside, Tsocanos expects ongoing strength in profitability and generally low debt levels to support a relatively benign credit environment for the oilfield-service sector in the near to intermediate term.

He notes the U.S. land-rig count has remained healthy, recently up 9% year over year. Some 1,700 rigs were active in mid-July, according to Baker Hughes.

Meanwhile, Tsocanos' outlook for growth in international oilfield-service markets, particularly the Middle East and Russia, remains bright, "given continued strength in upstream capital spending by major and national oil companies, high oil prices and sustained international rig-count growth-up 12% year over year."

In the offshore market, dayrates and rig utilization for marine contract-drilling providers also remain at robust levels-and revenue backlog is at historical highs for most contractors, the analyst points out.

The only offshore market not doing well: the Gulf of Mexico jackup market. "Dayrates in the Gulf shallow-water market have declined relative to 2006 highs, and jackup units continue to leave for international markets with better contract terms."

The analyst adds that near- to intermediate-term prospects for oilfield-equipment providers, such as Grant Prideco, National Oilwell Varco and Cameron International, remain favorable, given their strong margins, high equipment orders and backlogs.

Within the E&P sector, Tsocanos says year-to-date credit trends have been generally favorable. "Crude oil prices continue to edge up-driven by a tight supply-and-demand balance and geopolitical turmoil-and are testing all-time highs."

And although natural gas prices have fallen recently, Henry Hub prices still averaged $7.52 per million Btu for second-quarter 2007 compared with $6.50 in the same quarter a year earlier, he notes.

At these commodity prices, "almost all oil-focused North American producers are generating strong returns while most natural gas-focused operators are realizing acceptable returns-with the possible exception of those companies with significant exposure to the Rockies where price differentials were particularly severe in the second quarter."

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