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For Some Oil Companies, Writedowns Are Gushing

Oil and gas companies are writing down assets, which could cost some precious capital.

A steady stream of writedowns is gushing from oil and gas companies.

On Wednesday,

Union Pacific Resources

announced a $760 million fourth-quarter charge, including a writedown of its heavy-crude assets in Canada and Guatemala. That follows

Texaco's

(TX) - Get Report

announcement last week that it will post a special fourth-quarter charge of $350 million, including a $100 million writedown of oil and gas properties.

These are just the latest in a string of announcements from the likes of

Murphy Oil

(MUR) - Get Report

,

Pioneer Resources

(PXD) - Get Report

,

Gulf Canada Resources

(GOU)

and

Trans Texas Gas

(TTG)

.

As with everything else in the patch these days, low oil prices are to blame. The

Securities and Exchange Commission

requires oil companies to revalue their assets on a quarterly basis. And oil and gas properties are an oil company's primary assets, so lower prices mean lower asset values.

When companies cut asset values, assets are taken off the balance sheet for good. A company also may effectively cut its reserve levels because it figures it can no longer economically produce some of the oil at the lower prices.

Neither of those are good, but what's worse is what happens next.

Come February, after year-end oil- and gas-reserve reports have been completed, banks perform the annual or semiannual ritual of determining lending limits. And those limits are based on assets. So the asset cuts can mean less borrowing power. That's bad news (as if the sector needs more) for smaller companies that are already highly leveraged and whose primary access to capital is bank revolving credit lines. In addition, high-cost producers and companies with low-quality assets also might feel some pain.

"If you're at the top of your borrowing base and it narrows, it raises concern that there would not be adequate capital," says Steve Smith, an oil and gas analyst at

Dain Rauscher Wessels

in Houston.

Faced with the prospect of reduced capital, a company could be forced to sell properties, take on partners or cut drilling, Smith says. All are painful choices, and all could lower the rate at which the company's past year production is replaced.

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What does all this mean for investors? With oil prices hit harder than natural gas prices, heavy exposure to crude oil production is the first signal for writedown potential. Certain types of crude oil also are more expensive to produce than others, says Larry Nelms, a senior vice president at Denver's

Ryder Scott

, an engineering firm that prepares reserve reports. For instance, prices for oil produced in the Rocky Mountain region and California are much lower than the standard West Texas Intermediate benchmark. Look for production information, as well as the last published borrowing base figures, in SEC documents.

Here are a few companies to watch:

KCS Energy's

(KCS)

Rocky Mountain division was hit hard by the drop in oil prices. Prices fell as much as 45% from the year before. So in the second quarter, KCS took a $37.5 million writedown. Then, in December, KCS' borrowing base was reduced to $165 million from $175 million.

It's too soon to tell whether that base will fall further at the next re-evaluation in March. "It depends on what prices do," says Paul Samett, KCS' chief financial officer. It's also too soon to tell if the company will take a fourth-quarter writedown because the year-end reserve report is still in progress.

On Sept. 30, KCS had $29.6 million available under its credit facility -- that amount has stayed roughly the same even as its borrowing base was cut by $10 million since some debt has been paid off, Samett says.

Meanwhile, KCS is dealing with rising interest costs. For the nine months ended Sept. 30, interest expenses rose to $26.6 million from $15.1 million a year earlier. Its long-term debt to capital ratio stands at 81%, according to

First Call

.

Forcenergy

(FEN) - Get Report

Chief Financial Officer Russell Porter suspects the company will write down a portion of its reserves, though he has no estimate yet.

During 1998's second quarter, Forcenergy renegotiated certain aspects of its credit agreement. Its maximum loan amount was increased to $320 million from $200 million. Even if a new borrowing base is not determined, the maximum loan amount will be scaled down to $300 million on May 1 and to $275 million on Sept. 1.

Until a short time ago, Force was expecting to use the proceeds of a preferred stock sale to pay down debt. But the sale to private equity firms fell through in December. Forcenergy is in negotiations for a new agreement to sell $150 million in equity. According to SEC filings, Forcenergy's lenders were considering eliminating the limit on the maximum loan amount at the consummation of the equity sale.

The upshot is that it is going to take Force longer than expected to get the cash flow sufficient to replace and build its reserves, says Josh Gonze, an energy analyst at ratings service

Standard & Poor's

.

Force also has rising interest costs to worry about. Interest expense for the South Florida-based company has risen to an estimated $44.7 million in 1998 from $11.6 million in 1995. As of Sept. 30, it had only $24.3 million available under its credit line.

Comstock Resources

(CRK) - Get Report

has a borrowing base of $280 million, down from $290 million in 1997. On Sept. 30, it had $268 million outstanding. With just $2.5 million in cash as of Sept. 30, down from $14.5 million the year before, it may need to tap its credit line.

Comstock didn't return a call, but the company drilled three dry holes in the third quarter in the Gulf of Mexico, never a good sign.

Its long-term debt-to-capital ratio stands at 69%, according to First Call, and there's a minus sign in front of its working capital figure. At the end of September, its cash was $2.5 million, down from $14.5 million a year earlier.

The company's challenge, says Gonze at Standard & Poor's, will be to keep enough cash flow and maintain its borrowing capability in order to fund an expensive drilling program.

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