Will Forest Oil Strategy Pan Out?

We are maintaining our Hold recommendation on Forest Oil Corporation (FST - Analyst Report) shares ahead of the company’s second quarter results. The firm’s ramped up capital outlays are expected to drive organic production growth rate to about 15%, starting in the second quarter.

The company ended 2007 with 2.1Tcfe of proved reserves. Forest’s recent success in Canada’s Utica Shale bodes well for its long-term organic growth prospects. We are raising our estimates to reflect higher commodity prices and contribution from recent acquisitions.

High on the new management team’s priority list were the strategic shift towards an acquisition-exploitation business model, greater capital discipline and stronger cost controls. This model focuses on growth through acquisitions of lower-risk exploitation-oriented North American assets, while reducing exposure to higher-risk exploration activities.

The expansion of the capital budget this year from the originally announced $950 million to $1.2 billion is targeted at the core areas of Buffalo Wallow, Wild River, Arkoma Basin, East Texas and South Texas. Forest plans to fund this extended capital budget expansion by selling non-core properties.

But it is still too early to tell whether Forest Oil’s strategic shift to a low-risk acquisition/development/exploitation strategy and toward a longer-lived onshore asset base will pan out. Organic production growth and drill-bit reserve growth continue to remain weak areas. Even on the cost front, some of the momentum may have weakened due to the oilfield inflationary trends. A tentative commodity price environment is expected to negatively impact the company’s bottom-line.

Forest shares have performed strongly in the recent past. We are, however, still not convinced of the company’s ability to successfully emerge as a low-risk resource player. While the company’s long-term outlook has improved, we see better opportunities in this space elsewhere.

Read the full analyst report on FST