Many segments of the US economy have been forced to scale back their economic expectations for 2008 amid growing concerns about the lingering impact of the subprime mortgage crisis and the resulting credit crunch. The oil and gas industry will not be exempt from this development.

The credit crisis is already being felt in energy project finance markets and will continue to be a factor this year, says Rutherford “Bo” Poats, executive vice president of energy finance advisor Pace. The power sector is seeing a “signifi cant slowdown” in energy project finance, especially for large projects. Despite a booming midstream gas and upstream oil market, Pace expects capital markets to be “challenged” and capital sources to “remain tight.”

The market for capital is expected to remain highly selective, driven by stricter project quality requirements and adjusted default-risk pricing within credit committees. Banks positioned to underwrite projects will be in strong demand, and standards for bank group syndications will be more rigorous in the near term, says Poats.

He added that the most immediate impact of the credit crunch is being felt by hedge funds that had taken large positions in energy assets. The impact on sub-investment-grade projects led many funds and banks to freeze investment activity in late summer. Sub-investment-grade loans are now returning, but at conservative pricing levels.

Some economists believe the current housing slump ( the US Commerce Dept. reported Jan. 17 that new home construction in 2007 slowed to its lowest level in 27 years) will push the economy into another recession. The steep drop in housing starts is blamed on the credit crunch and rising mortgage defaults, which have made loans harder to obtain.

Many large financial institutions have lost billions of dollars in the meltdown of sub-prime mortgages, and they are simply not prepared to take further risks. Lenders who have for the last few years almost ignored risk, now fear it everywhere and are increasing their scrutiny of projects and raising interest rates.

As this issue of OGFJ goes to press, Federal Reserve Chairman Ben Bernanke was testifying before the House Budget Committee. He forecasts slower growth in 2008, but not a recession.

He warned that, “Further sharp increases in crude oil prices have put renewed upward pressure on inflation, and may impose further restraint on economic activity.”

After his speech, one industry analyst noted the tight spot the Fed is in: “It’s hard to combat deflation in housing and infl ation in commodities spurred by a falling dollar at the same time.”

Pace’s Poats is a little more optimistic than most observers. He says that credit terms will continue to tighten, and deals will need to be cleaner with large equity commitments at the table. However, he concludes, the need for energy project investment will create a robust supply of financing opportunities, which will help correct the market, especially if the economy can avoid a significant downturn in 2008.

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Don Stowers
Editor-OGFJ

Energy industry feeling credit crunch

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