Forest Oil (FST)

TOP CONTRIBUTORS

Alexander Kowalsky

Thomas Shyr

As one of the largest independent oil and gas companies in America, the Forest Oil Corporation (NYSE: FST) has been a major player in the oil and natural gas industry since its inception in 1916. Prior to 2003, the company was heavily involved in offshore exploration, but this strategy proved unprofitable as production and reserves were lacking. A management change and a shift in focus have reinvigorated Forest, and the firm has been able to enjoy successful growth through acquisitions.

Forest seeks to augment efficiency by implementing secondary recovery techniques to increase production from wells that are considered depleted. Through a technique called water flooding, increased quantities of oil are forced to the surface by injecting water into oil-bearing rock formations.^[1] Forest conducts business operations in the United States, Canada and International markets. The firm has consolidated recently, selling its offshore Gulf of Mexico operations and its Alaskan operations, in order to focus on its core land-based operations in North America.

Forest's focus on land-based drilling may limit its growth, as it won't capitalize on the recent industry wide surge in demand for offshore deepwater drilling. However, the company’s focus on onshore operations has allowed the company to cut costs and led to gains in production and reserves, and these low-risk properties promise stable, long-term growth. Stability in the balance sheet is important for Forest, as it has had struggles in the past with its high leverage and can't afford to borrow capital to fund expensive exploration projects.

Company Overview

In March 2006, Forest Oil completed the sale of its offshore Gulf of Mexico operations, a move that positioned Forest to begin to transform into an exclusively onshore oil and gas company. During this period Forest encountered substantial revenue losses, but operating expenses also declined because the company shed the burden of expensive offshore operations. In June 2007 the firm acquired Houston Exploration, a move that boosted its onshore production almost 60%, and to finance the acquisition and cut costs further the company sold its Alaskan operations. Without risky offshore operations Forest can concentrate on growing production from its five major assets - Houston Exploration, Cotton Valley, and Katy fields in Texas, Buffalo Wallow in the U.S. Mid-Continent, and Wild River field in Canada.

Business Segments

In 2009, FST earned a total of $768 million in total revenues. This was a drastic decline from its 2008 total revenues of $1.65 billion. However, despite the huge dropoff in revenues, FST was actually able to reduce its net loss. Between 2008 and 2009, FST's net loss declined from $1.03 billion in 2008 to $923 million in 2009.^[2]

Trends and Forces

Production Has Increased Due to the Acquisition of Houston Exploration

Though expensive, the $1.5 billion dollar acquisition positioned Forest to expand its asset-base and has boosted production by 60%. This acquisition has allowed Forest to rebound after a revenue decline and will continue to be a source of significant growth in the next few years.

Forest Faces Intense Competition in Acquiring New Oil and Natural Gas Properties

With many larger companies with greater resources interested in acquiring promising new onshore properties, Forest may encounter difficulty capitalizing on acquisition opportunities. Forest stands to lose if they are squeezed out of these opportunities because their growth is exceedingly dependent on acquisitions. Moreover, there are many uncertainties inherent in determining productive potential in prospective properties. Forest's success could take a big hit if one of its acquisitions turns out to be a bust.

Forest Depends on Volatile Gas and Oil Prices to Sustain Growth

High market prices for gas and oil are at the core of Forest's success. The company's bottom line and margins generally benefit from increases in the prices of these commodities, since operating expenses remain more or less fixed due to the company's focus on drilling. In addition to favorable market conditions the global economic cycle has been heavily impacted by the economic growth of developing nations and their rising demand for energy. As industrialized countries continue to increase their demand for energy drilling companies such as Forest are poised to benefit from increases in the demand for energy because the day-rates of drilling rigs are precipitated by cost increases of oil and gas.

Forest Limits Deepwater Oil Exploration

Forest's limited involvement in the offshore drilling market may keep the company from growing at the same rate with competing companies that are pursuing deepwater oil exploration. Traditional oil producing basins have matured, particularly on land, and oil exploration and production companies have started to look for new reserves in challenging, deepwater environments. The recent increases of oil and gas costs have enabled offshore drilling contractors to engage in deepwater oil exploration that was once too expensive to pursue. The prospect of oil exploration and production is more economically feasible than ever due to substantial returns companies are enjoying because of higher energy costs. The price may be right to pursue more risky deepwater drilling, but Forest intends to "play it safe" and avoid investing too much in offshore drilling activity.

Emerging Markets in Hybrid and Alternative Energy Technology May Compete with Forest in the Long Term

Rising oil prices have led both consumers and companies to seek out alternative sources of energy and invest in renewable energy such as nuclear, solar, wind, biofuels, and ethanol. As the global consumer demand shifts toward renewable energy sources due to recent environmental concerns over climate change, this change in consumer consciousness may adversely affect the oil and gas industry. With the advent of hybrid and fuel cell vehicles and the cost of gasoline becoming dangerously close to $4 per gallon, consumers have become less inclined to purchase gas guzzling SUV’s opposed to more fuel-efficient cars. As a result oil and gas companies stand to lose if the industry encounters a sudden decrease in demand.

Competition

Each year competition within the oil and gas industry becomes more intense. With a limited number of resource basins and an increasing number of players, the competition for promising acquisitions has become intense because most of these companies rely on acquisitions to sustain economic growth. Forest could encounter significant trouble with acquiring new resource basins because the company is in the process of exiting the offshore industry in order to re-structure its business model to better accommodate onshore operations. Forest has done well among its competitors and the purchase of Houston Exploration has not only stimulated production but also more than doubles potential drilling locations that are projected to drive long-term growth.

Some of FST's major competitors include Denbury Resources, Inc. (Holding Company) (DNR), EOG Resources (EOG), Quicksilver Resources (KWK), Noble Energy (NBL), and Newfield Exploration Company (NFX).

Footnotes

1. ↑ Forest Oil Corporate Website
2. ↑ FST 10-K 2009 Item 6 Pg. 35