Fitch Ratings' outlook for US and EMEA oil and gas industry issuers remains strong due to the impact of high commodity prices and a tight supply/demand balance. However, Fitch notes that significant challenges face the industry in the form of cost inflation (including high drilling costs), commodity price volatility, and for majors, resource access and reserve replacement issues.

While oil prices were pushed dramatically higher in the second half of the year, Fitch believes that much of the current run-up is not supported by market fundamentals. Fitch is maintaining a stable outlook on each of the major industry segments (upstream, drilling and services, and refining) despite robust market conditions.

As a result of strong balance sheets, Fitch expects to see excess cash flows continue to be directed toward shareholder-friendly activities, growth-oriented capital expenditures, and acquisitions. The slant towards shareholder friendly activities may be especially pronounced for majors, which face unique significant challenges to replace reserves in the current environment.

Fitch anticipates that oil prices will moderate from historical highs in 2008 although this trend is likely to be marked by continued volatility due to geopolitical uncertainty, weather, and the financial markets' appetite for commodity exposure. Fitch's 2008 price deck is $70/bbl for crude oil (NYMEX-WTI) and $7.00/Mcf for natural gas (U.S. Henry Hub), falling to $60/barrel and $5.50/Mcf in 2009 and finally tailing off to $40/barrel and $4.50/Mcf over the longer-term. Fitch's price deck represents a significant decline from current market prices for oil; however, it's important to recall that oil prices averaged only $26/barrel as recently as 2001-2002, while 2005's record natural gas prices in the U.S. were largely hurricane-driven.

While Fitch's price deck is used primarily for modeling and rating purposes (and is therefore intended to have a more conservative slant), it also represents Fitch's belief that prices will ultimately revert to more historical levels driven by fundamental supply and demand forces.

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