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Rating Action:

Moody's Assigns First-Time Ratings to Gastar Exploration USA, Inc.

15 Nov 2007
Moody's Assigns First-Time Ratings to Gastar Exploration USA, Inc.

New York, November 15, 2007 -- Moody's Investors Service assigned first-time ratings to Gastar Exploration USA, Inc. (Gastar), a wholly owned subsidiary of Gastar Exploration Ltd. Moody's assigned a Caa2 Corporate Family Rating (CFR) and a Caa2 rating (LGD 3, 47%) to its proposed $100 million senior secured notes due 2012. Proceeds from the offering will be used primarily to repay existing indebtedness. The rating outlook is stable.

Gastar is an independent E&P company with properties located in East Texas, Wyoming, and Australia. Its domestic drilling activities are focused on exploiting drilling locations in the deep Bossier sands and Knowles Limestone formations of East Texas and in the Powder River Basin of Wyoming. Gastar's activities in Australia are focused on the development of over 7.0 million gross (2.9 million net acres) of coal bed methane rights in New South Wales and Victoria, Australia.

The rating reflects Gastar's very small size and scale relative to its rated E&P peers; a high concentration of risks in that its natural gas wells in the Hilltop area of East Texas are individually significant in terms of costs, reserves, and production; its still developing track record of drilling results; and its very high leverage relative to proved reserves.

Litigation risks also were considered in the rating. There are a number of claims presented by GeoStar, of which the most significant matter involves a "Look Back" provision included in the purchase and sale agreements (PSAs) relating to Gastar's acquisition of most of its East Texas properties in 2005. Gastar believes that GeoStar's assertions are without merit and that an independent reserve report submitted by GeoStar does not meet the requirements of the PSAs. GeoStar asserts that it is entitled to a Look Back payment of approximately 1.69 billion shares of Gastar stock, which if issued would constitute approximately 89% of Gastar's common equity. Until these issues are resolved, it may be difficult for Gastar to raise capital through the sale of equity. Other claims made by GeoStar could result in cash payments of $5-$10 million.

Supporting the rating is the high potential associated with Gastar's acreage in the Hilltop area as demonstrated by the performance of recent wells and the activities of other players in the area; its experienced management team; and the observation that this offering is not being undertaken to fund its drilling program. Gastar had cash on the balance sheet of $82 million as of September 30, 2007, most which came from the sale of undeveloped acreage in May 2007 for $66.8 million. Gastar's Australian assets are more prospective in nature and currently do not provide much support for the ratings, although production is planned on PEL 238 next year and its partner, Eastern Star Gas Limited which operates and has a 65% interest, has an equity market capitalization of approximately $286 million (as of November 5, 2007).

In terms of proved reserves and production, Gastar is the smallest E&P company that Moody's rates. As of June 30, 2007, Gastar has total proved reserves of 36.4 Bcfe (6.1 MMBoe), of which 67.6% are proved developed (PD). In contrast, Caa2-rated Dune Energy and Baseline Oil & Gas have pro forma total proved reserves of 141.1 Bcfe (23.6 MMBoe) as of December 31, 2006 and 67.7 Bcfe (11.2 MMBoe) as of May 31, 2007, respectively. Gastar's average daily production is approximately 20 MMcfe/d, or roughly 7.3 Bcfe (1.2 MMBoe) on an annualized basis.

Gastar's three-year average F&D costs through the end of 2006 are very high reflecting a learning curve associated with the drilling of its Bossier wells. Recent results are more encouraging with wells such as the Donelson #3 in the deep Bossier sands with an EUR of 10.9 gross Bcfe (5.5 net Bcfe) and a D&C cost of $12.6 million gross ($8.4 million net) and the Lone Oak Ranch (LOR) #4 in the Knowles Limestone with a pre-simulation EUR of 1.8 gross Bcfe (0.7 net Bcfe) and a D&C cost of $6.8 million gross ($3.4 million net). The Donelson #3 well was included in the June 30, 2007 reserve report along with four PUD locations in the Hilltop area with estimated proved reserves of 9.2 Bcfe net. The LOR #4 was not included in the June 30, 2007 reserve report given that it was not completed until after that date. Depending on results from two wells currently drilling in the area expected to reach TD by year-end (the Wildman #3, an offset to the Donelson #3; and the LOR #3, an offset to the LOR #4) additional proved reserves may be booked.

Gastar's leverage is very high with pro forma debt/PD reserves of $32.46/Boe as of September 30, 2007 (using PD reserves as of June 30, 2007). Debt/PDP reserves is over $53/Boe. Debt plus future development costs/total proved reserves is approximately $28.26/Boe as of September 30, 2007. In contrast, looking at eight other Caa-rated E&P companies not including Gastar, debt/PD reserves ranges from a low of $9/Boe to a high of slightly above $25/Boe. Gastar's cash margin after interest is low and currently running about break-even reflecting weak price realizations (weighed down by spot prices received on its Powder River Basin production) and high G&A and interest burdens relative to production. Price realizations from Gastar's production in the Rockies, which accounts for about 25% of its current production, should improve next year as costless collars at favorable prices (at CIG) have been put in place.

Moody's also assigned an SGL-3 rating to Gastar reflecting adequate liquidity for the next 12 months. Pro forma for the notes offering, Gastar will have approximately $101 million in cash which is more than adequate to fund planned capex for the next 12 months (planned capex for 2008 is $65 million). Moody's expects that Gastar's cash flow from operations will be breakeven or slightly positive or negative, depending on commodity prices and production from planned wells. Concurrent with the closing of the notes offering, Gastar expects to enter into a revolving credit facility which will have an initial borrowing base of $25 million. Financial covenants are expected to include a minimum current ratio of 1 to 1 and a maximum net debt to EBITDA of 5 to 1. While Gastar is not expected to draw on the revolver over the next 12 months, it is possible that compliance with the leverage covenant could get tight toward the end of next year.

Gastar Exploration USA, Inc. is headquartered in Houston, Texas.

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

New York
Michael Doss
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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