Capital markets don't lie. Oh, the stories they will tell in the coming months. At press time, the Federal Open Market Committee announced a new federal-funds target rate of 4.75%, a full 50 basis points lower than the rate the FOMC had held for more than a year-staggeringly, and impossibly, since June 2006.

Key here is that 4.75 is the "target" rate. To achieve it, billions of dollars will be thrown at capital markets to make lower-risk cash cheaper (and try to keep variable-interest-rate mortgages afloat), keeping money circulating in the economy.

The Fed had trouble in mid-August at holding its 5.25 target. How many billions will it take to hit 4.75? Is the Fed hurdle over-lofty? With all the triple-A credit of U.S. Treasuries behind it, it will achieve 4.75, but at what price?

Japan dropped its target rate to 0% for years, and it was ineffective; at 0%, the alternative to jump-starting an economy is to give money away. When the FOMC hit 1% several years ago, after 9/11, it too flirted dangerously with inefficacy.

That the FOMC, knowing the challenge of holding 5.25, is targeting 4.75 is revealing into its sense of the danger lurking in the U.S. economy. It has been more than 20 years since U.S. capital markets have run amuck to the point of requiring years of careful, intuitive reprogramming. This will be Bernanke's first critical test, just as Greenspan had his in 1987.

What does the credit-market turmoil mean to capitalizing the upstream energy industry? Already, Oil and Gas Investor has seen it affect new energy issues. This summer, companion newsletter Oil and Gas Investor This Week had been reporting weekly on six or so announcements of large upstream M&A deals and MLP plans. In mid-August, big deal-making went silent. Investment bankers went on holiday. Trading in the new Quicksilver midstream MLP units was soft. Quantum Resources Management put its MLP plan aside and is waiting it out.

The business is back now, but not as strong. Since Labor Day, Encore Energy Partners-the newest upstream MLP-priced its IPO, raising some $190 million instead of the expected $250 million. Exco Resources is nearing pricing the IPO of its MLP, and others are in the queue.

Producers may have to leave some money on the table they could have expected just a few months ago, particularly due to softer natural gas prices. Meanwhile, watch for a small group of falling E&P companies, those overleveraged as capital providers expect stretch debt to be less accessible to these for a while.

Successful asset buyers will be those with much dry powder.

Capital markets did lie at one time, but the upstream energy industry is more finely tuned today to hiccups in capital access and the cost of capital. Hedging, in particular, has put the business on a real-time capital-cost schedule. And, it's been good for the industry. In the 1980s, it was four years before producers and investors began to concede they were chasing a bottom-seeking, commodity-price spiral-a plummet that wasn't fully defined for yet two more years, in 1987.

Today, upstream capital markets are correcting themselves on a dime. Most revealing of this is that Chesapeake Energy Corp. has gone quiet in 2007 on the acquisition scene, and instead is shutting in production and looking to offer some assets for sale (or lease). Possibly the most highly financially engineered U.S. producer, Chesapeake won't buy if it can't hedge production at profitable oil and gas prices. That it's been quiet for most of 2007 speaks volumes as to what it considers profitable prices.

Meanwhile, healthy producers will enjoy debt capital keyed to a 4.75% Fed funds rate. Let the savings begin!



P.S. For more commentary on the upstream industry, capital and M&A, see this new blog: OilandGasInvestor.com/Nissa.

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