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E&Ps will walk fine line between liquidity, default through 2017, S&P says

Despite a projected 40% cut in capital spending in 2016,after a 35% cut in 2015, oil and gas production volumes from U.S.-basedexploration and production and integrated oil companies will not to startfalling significantly until 2017, the credit analysts at Standard & Poor'sRatings Services said on April 13.

"Notwithstanding the dramatic spending reductions, oiland natural gas production is just beginning to decline," analysts CarinDehne-Kiley and Kevin Kwok said in a note. "After a nearly 5% year-over-yearoutput increase in 2015, we expect production to subside by 5% this year.However, we expect declines to accelerate in 2017."

When production does fall off steeply towards the end of2016 and into 2017, many E&Ps will be walking a fine line on liquidity,S&P said. With the stock market and bank loans off-limits, E&P's willhave to spend enough to keep the lights on while hoping for higher commodityprices to put some fat in their books, the credit rating agency said.

"While bringing capital spending more in line withdiscretionary cash flows can help companies support liquidity for a time,ultimately these companies will have to start spending again to grow productionin order to boost revenues and cash flows," S&P said.

S&P said its research was on a review of the nearly 95U.S. oil and gas E&Ps and integrated oil companies it currently rates.Roughly half that group has a high potential to default, S&P said.

"Liquidity has now moved to center stage for E&Pcompanies, with management teams looking for ways to hunker down and survivethe next 12 to 24 months until commodity prices (hopefully) recover,"S&P said. "After capital spending and dividend reductions, many of thetraditional means of boosting liquidity are no longer available to manycompanies."

Despite the spending cuts and moves towards short-termliquidity, S&P is not optimistic about the credit quality of U.S. oil andgas E&Ps in the short term.

"While lower spending will support near-term liquidity,lower production and commodity prices could mean deteriorating credit measuresfor the sector overall in 2016, leading to another wave of downgrades anddefaults," S&P said, noting it downgraded 45 of its covered companiesin 2015 and another 27 through the end of the first quarter of 2016.

"Because of constrained cash flows and tighterliquidity, we think companies will continue to sideline drilling and otherprojects, resulting in moderately decreased production this year but a potentiallysharper decline in 2017," S&P said.

S&P Ratings andS&P Global Market Intelligence are offerings of McGraw Hill Financial Inc.