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El Paso Adds 124 Bcfe of Proved Reserves with TX Purchases

El Paso Corp. last week paid $211 million for two Texas properties, including a private exploration and production company, that will add 124 Bcfe of proved reserves and 29 MMcfe/d of average net production. About 59% of the reserves are proved undeveloped.

With the new acquisitions, El Paso now expects its 2005 production capital budget to be approximately $900 million. The company will provide updated 2005 production volume guidance when it holds its annual analyst meeting on March 17.

Lisa Stewart, president of El Paso's non-regulated operations, said the acquisitions will strengthen the company's positions in South and East Texas. "We are adding a significant number of low-risk development locations to our inventory as well as properties that offer additional exploration upside. We also expect to achieve operating synergies as we integrate these properties into our operations."

In East Texas, El Paso signed an agreement to purchase a privately held producer for $179 million. The unnamed company has operations in Rusk and Shelby counties, and in the deal, El Paso will acquire 52 wells and associated gathering infrastructure. The transaction includes 20 MMcfe/d of production from the Cotton Valley and Travis Peak formations.

The East Texas acquisition, which is subject to the approval of the seller's shareholders, also includes six wells that are currently being drilled or completed, 77 proved undeveloped locations and additional potential development and exploration opportunities. El Paso will also acquire six additional wells that are currently being drilled or completed, 77 proved undeveloped locations, and significant additional potential development and exploration opportunities.

In South Texas, El Paso purchased assets in the Samano (Vicksburg) Field located in Starr and Hidalgo counties for approximately $32 million. The acquisition includes 26 wells that are producing approximately 9 MMcfe/d and the associated gathering system. El Paso already is the largest producer in the Samano Field and operates producing properties directly adjacent to these properties.

Following the announcement, Moody's Investors Service analysts affirmed the stable rating outlook of El Paso's production holding unit, pending a review of the company's 4Q2004 and year-end 2004 results.

"The acquisitions mark El Paso Holding Co.'s (EPPH) initial acquisitions since its 2003-2004 difficulties as EP works to stem production decline, replenish its drilling inventory, and add to existing regional holdings," said Moody's analysts. "On the other hand, a low 41% of acquired reserves is proven developed (PD) reserves and the acquisition package is expensive by historic standards as recent as 2003 and early 2004, and follow second half 2004 sector up-cycle acquisition price trends."

According to El Paso's internal estimates, the acquisitions include a "small 8.5 MMboe of PD reserves, 12.2 MMboe of proven undeveloped reserves (for a combined 20.7 MMboe of total proven reserves), and 3,333 boe of daily production. Combined, EPPH paid a very high $24.82/boe for the PD reserves."

Moody's noted that "substantial development capital spending (undisclosed at this point) will be needed to take the proven undeveloped reserves to production. Assuming that equates to $7/boe to $8/boe of proven undeveloped reserves (reasonable, if not conservative, in today's drilling and services market), the all-in cost of the acquisition would approximate $295 million to $310 million. Under that assumption, EPPH would be paying a high $14.25/boe to $15/boe for the acquired proven reserves."

The acquisitions "potentially may prove to be an important step" in the production unit's turnaround, however, they are not initially credit accretive. "Sustained post-acquisition drilling success on the proven undeveloped, probable, and possible drilling locations will be needed for the acquisition to drive credit accretion in the future."

Moody's said it is possible that El Paso's "B3" rating "could eventually be notched below the senior implied rating" if El Paso "executes a significant amount of acquisitions funded with secured debt. While Moody's views such activity to be central to EPPH's effort to regain momentum and moderate extremely high reserve replacement costs, the notes could face increasing and perhaps substantial effective subordination to secured debt."

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