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Rating Action:

MOODY'S ASSIGNS SGL-2 LIQUIDITY RATING TO FOREST OIL

22 Dec 2004
MOODY'S ASSIGNS SGL-2 LIQUIDITY RATING TO FOREST OIL

First Time Liquidity Rating

New York, December 22, 2004 -- Moody's assigned an SGL-2 liquidity rating for Forest Oil, Inc. (FST). This indicates that if, as now expected, quite volatile oil and natural gas prices remain above $37.50 per barrel and $5.75/mcf, respectively, FST would generate good-to-very good 2005 cash flow and back-up liquidity cover of expected gross interest expense ($58 million), debt maturities (none), budgeted capital spending ($350 million, excluding likely acquisitions), and common dividends (none). At such very strong prices and capital spending, FST has the capacity to repay all secured bank debt by mid-2005 and bank covenant cover would be good. Alternative liquidity is adequate.

However, cash flow cover falls to adequate levels if oil and gas prices correct to still historically high $30 per barrel and $5/mcf levels, respectively, and/or if, as is quite possible, $350 million proves not to be sustaining capital spending. These prices could be generous correction points if moderating demand and rising supply take command over historic oil and gas prices. The SGL-2 liquidity rating is also tempered by FST's ongoing relatively sizable acquisition program, particularly if not funded with equity or long-term notes.

We believe FST will have roughly $120 million of year-end 2004 bank debt and year-end 2004 total debt in the range of $820 million (excluding unamortized gains on monetizing interest rate swaps), down from $271 million and $1 billion, respectively, in third quarter 2004. After letters of credit, availability under FST's $500 million secured borrowing base would be approximately $375 million.

The senior implied and senior unsecured note ratings are Ba3. The rating outlook remains negative, though possibly improving, pending review of year-end 2004 reserve replacement costs, leverage, production trends, proven developed reserve levels, price outlook, and acquisition funding plan. Leverage is declining though possibly at the expense of gaining clearly stabilized organic production.

Considerably reduced reserve replacement costs are needed to stabilize the debt ratings and validate that $350 million of 2005 capital spending can stabilize production. That requires substantially reduced reserve replacement costs to in the range of $12/boe). Assuming: $12/boe reserve replacement costs; year-to-date average unit production and G&A costs; and $2/boe of interest expense, leveraged full-cycle costs would still be high at $24.50/boe. At FST's third quarter 2004 realized prices of $31.60/boe (well below market prices), unit cash flow cover of reserve replacement costs would be satisfactory but not strong considering historic up-cycle prices driving cash flow.

Current very strong natural gas prices are vulnerable to an average or warmer-than-normal winter given a very high 3.3 TCF of natural gas in storage and the significant support high natural gas prices gain from high but vulnerable oil prices. Furthermore, if FST has not substantially reduced reserve replacement costs, more than $350 million in capital spending or acquisitions would be needed to avoid production decline (from already reduced fourth quarter 2004 levels) to levels unacceptable to FST. If replacement costs fall only to a quite possible $13.50/boe, sustaining capital would be roughly $400 million. FST has little flexibility to reduce capital spending below $350 million unless reserve replacement costs improve to less than $12/boe.

Moody's flat 2005 production forecast, and sensitized 5% production decline, reflect the combined impact and challenge of: a fourth quarter 2004 reserve sale, the task of constantly offsetting FST's steep Gulf of Mexico production decline, a weak organic reserve replacement trend, and high reserve replacement costs. We anticipate roughly 7.3 mmboe to 7.4 mmboe in fourth quarter 2004 production, down roughly 4% from third quarter 2004 partly due to asset sales and partly due to production lost from hurricane damage. Absent 2005 acquisitions, we expect fairly flat 2005 production relative to fourth quarter 2004. If reserve replacement costs fall to the $12/boe range, $350 million of capital spending would achieve full reserve replacement.

Favorably, the SGL-2 rating, FST's ongoing secured and total debt reduction, and the lack of a rating notch between the senior note and senior implied ratings are related to each other, and may signal eventual ratings stabilization. When Moody's downgraded FST's senior implied rating from Ba2 to Ba3, Moody's also removed the rating notch between the senior notes and senior implied rating. This was in anticipation of quick reduction in the effective subordination of the notes with quick secured debt repayment aided by high oil and natural gas prices. FST is delivering on that expectation.

In light of FST's elevated full-cycle costs (especially high unit production and reserve replacement costs) and a relatively weak organic production trend, the SGL-2 rating largely reflects the multiple benefits of a record cash infusion driven by historically high, but volatile, oil and gas prices. The windfall infusion funds debt reduction, heavy capital spending for potential production and cash flow growth, boosts back-up liquidity, FST's elevated full-cycle costs, may partially fund acquisitions, and/or reduce the unit interest expense burden before the next significant price correction.

At market $37.50/bbl West Texas Intermediate (WTI) oil prices and $5.75/mcf Henry Hub natural gas prices, we expect roughly $650 million to $670 million of adjusted 2005 EBITDA (after $27 million of capitalized G&A expense). At $30/bbl WTI and $5/mcf Henry Hub, we expect 2005 EBITDA (after capitalized G&A) in the $530 million to $550 million range. If market oil prices averaged $41/bbl WTI, natural gas averaged $6.25/mcf Henry Hub, and production rose 5%, EBITDA could be in the [$720 million to $730 million] range, though we cannot extrapolate those elevated up-cycle prices into ratings.

Oil and gas producer cash flows are generated by destruction of prior years' capital investment in the creation of oil and gas reserves that must be replaced by constant major capital reinvestment. FST's free cash flow and liquidity is driven mostly by: (1) its embedded level of sustaining capital spending, driven by reserve replacement costs, production rate, and fairly short proven developed producing reserve life, (2) production times realized unit prices minus unit operating costs, (3) gross interest expense, and (4) whether it stretches liquidity with bank-funded acquisitions.

Forest Oil Corporation is headquartered in Denver, Colorado.

New York
John Diaz
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andrew Oram
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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