Moody's revises Forest Oil outlook to stable

Wed Feb 11, 2009 3:49pm GMT

  (The following statement was released by the rating agency)

  Approximately $1.8 billion of debt securities affected

  Feb 11 - Moody's Investors Service assigned a B1 (LGD 5; 73%) rating to Forest Oil's (FST.N) (FST) pending $350 million 5-year senior unsecured notes and affirmed its existing Ba3 Corporate Family, Ba3 probability of default, and B1 (LGD 5; 73%) senior unsecured note ratings. The note ratings are assigned under Moody's Loss Given Default notching methodology. The Speculative Grade Liquidity rating was lowered to SGL-3 from SGL-2. Net proceeds along with working capital will repay a like amount of outstandings under FST's first secured borrowing base revolver.

The rating outlook is moved to stable from positive. This reflects the low likelihood that FST could reduce leverage sufficiently under current down-cycle conditions to warrant an upgrade. While FST intends to contain capital spending to within cash flow, cash flow will have also funded a material first half 2009 rise in working capital. FST has been paying for substantial previously ordered drilling pipe at a time when accounts payable are sharply contracting as it lays off third party drilling rigs. FST's rig count will decline from 45 active rigs to 20.

Liquidity is adequate for the next four quarters. It appears that FST will be able to maintain $300 million to $400 million of undrawn borrowing availability under its approximately $1.7 billion pro-forma borrowing base. The borrowing base will be reduced from $1.8 billion due to the note offering in a ratio of 0.3 times the amount of the offering. When and if asset market conditions improve, FST intends to divest another $450 million to $750 million in non-strategic assets to reduce debt.

However, the reduced SGL rating reflects a potentially tight bank revolver leverage covenant in first quarter 2010. If natural gas prices do not recover sufficiently as the year progresses to boost second half 2008 EBITDA above levels currently expected for first half 2009, trailing twelve month EBITDA would appear insufficient to keep Debt/EBITDA below the 3.5x bank covenant.

The ratings are supported by seasoned leadership with a history in onshore exploitation, supportive hedges on approximately 50% of 2009 production, diversified reserves and large diversified drilling inventory, the 2008 reduction in unit cash costs, sufficient margin coverage of cash costs and reserve replacement costs to withstand weak prices for a reasonable period of time without adding to leverage, and an adequate capital and liquidity structure to ride out the down-cycle.

Reserve replacement visibility is reasonably good. In the development category, FST has a base of two large, one medium, and two comparatively small core areas for low risk drilling and exploitation. In early stage plays, in formations of already proven sector productivity, FST has considerable growth off the current base; FST has reported a strong horizontal well test in the Haynesville Shale and significant prospective acreage in its Barnett Shale and Greater Vermejo/Haley programs.

The ratings are restrained by significant leverage for the ratings and little chance leverage could be materially reduced from operating cash flow alone, FST's medium reserve and production scale for the ratings (although the onshore strategy has moved to a lower operating risk profile), a reduced 2009 production trend due to reduced capital spending, a high 37% of reserves in the proven undeveloped category with attendant heavy capital requirements and drilling, and a need to see FST mount sustained drilling success with its properties acquired during 2008.

Over the last several years, FST has made major portfolio transformations involving proportionately major acquisitions and divestitures as the firm moved away from its historic roots in short-lived Gulf of Mexico reserves towards longer-lived onshore properties. During 2008, FST acquired mid-continent reserves for cash and stock for a total of $873 million, followed by the divestiture of Rocky Mountain properties for $200 million cash.

However, FST's move into the capital extensive resource plays, that are price sensitive and where economical success or failure can take years to materialize, could result in carrying leverage that prevents FST from being upgraded in the foreseeable future. The company will be funding heavy development capital spending for several years. FST has announced a major reduction in capital spending for 2009 until natural gas prices recover.

Moody's believes that FST's 2008 reserve replacement costs were acceptable given sector cost conditions during the year and the fact that the resulting year-end reserve additions had to qualify under sharply lower oil and gas prices. That positive point is tempered, however, by the fact that this was achieved partially through an material increase in the proportion of higher risk and largely unfunded proven undeveloped reserves.

FST's leverage on reserves has increased by approximately 10% since mid-2008 and Moody's believes that leverage will need to decline in order to solidify the ratings. The company's plan to reduce debt after its 2008 acquisitions by selling assets was cut short by the sharp contraction in the asset market as 2008 progressed.

Moody's last rating action for FST was May 19, 2008, at which time we assigned ratings to its new note senior note offering, affirmed existing ratings, and moved the rating outlook to positive from stable. The principal methodology used in rating FST was the Global Exploration and Production (E&P) rating methodology which can be found at www.moodys.com in the Credit Policy &Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating FST can also be found in the Credit Policy & Methodologies directory.

Forest Oil is an independent oil and gas exploration and production company headquartered in Denver, Colorado.

 (New York Ratings Team)