El Paso Corp.’s quarterly earnings surged 190%, and in spite of the two Gulf Coast hurricanes that impacted operations in September, the pipeline group and the exploration and production (E&P) unit posted solid returns.

Net income rose to $445 million (63 cents/share) in 3Q2008 from $155 million (21 cents) in the same period of 2007. After adjusting for production-related hedges and other items, El Paso earned 35 cents/share, which was up from 22 cents in 3Q2007.

The natural gas pipeline unit earned $278 million, which included a $12 million loss from hurricanes Ike and Gustav. E&P earnings rose to $532 million — which was 129% higher than a year ago. E&P earnings included $214 million of mark-to-market gains on derivative contracts that were not designated as accounting hedges.

Production, including unconsolidated affiliate volumes, totaled 793 MMcfe/d, reflecting a production loss of 41 MMcfe/d because of the hurricanes and storms that impacted offshore operations.

“We had another solid quarter, with improved earnings in both the Pipeline Group and E&P,” said CEO Doug Foshee. “In addition, we placed three pipeline projects in-service, and we made continued progress on the Ruby Pipeline Project,” which would carry Rocky Mountain gas to West Coast markets. “On the E&P side, we completed our first two wells in the Haynesville Shale.”

However, to operate through the murky credit markets, El Paso slashed its capital spending for the last three months of the year and through 2009.

“For a lack of better description with regard to the current capital markets environment, as we say here in Texas, this ain’t our first rodeo,” Foshee said. “Recent events have conspired to hurt our share price and our investors. Just a few months ago we were trading at our six-year high, and just a few weeks ago, we were close to our five-year low.”

The “combination of a precipitous drop in oil and gas prices and the more recent closure for all practical purposes of the public capital market has caused us along with the rest of our industry to rethink prior plans,” Foshee said. “In our case these events have caused us to accelerate our normal planning process, which would have had us presenting a new long-range plan to our board in December.”

As El Paso management revised its spending plan through 2009, management wanted “to ensure our ability to fund our businesses in the worst of economic circumstances,” said the CEO. “Second, [we wanted to] preserve the growth attributable to our backlog of pipeline projects, which we believe is the best in the business. Third, preserve our ability to grow our E&P business longer term by not taking actions that impair the high quality inventory that [El Paso has] built over the last two years. And fourth, preserve the profitability that we worked so hard to create over the last five years by tightening our corporate belt.”

Foshee noted that “a significant amount of our revenue and profits come from a pipeline [business] that has very little exposure to commodity price links and because of the nature and duration of our contract is largely protected from near term changes in throughput.”

El Paso has “an $8 billion portfolio of pipeline projects that are 60- or 80-year kind of investments, in terms of the duration of those assets,” he explained. “And we do as a matter of corporate priority protect those and put those at sort of the highest part of the pecking order, from a capital allocation standpoint.

“And in addition to that, of course, we have made commitments to our customers. We have made commitments to contractors. We have made commitments to pipe companies, and those kinds of things. And by the way, we are very happy with that,” he said.

El Paso now has the flexibility “to respond to two things, one is the significant drop in commodity prices that hasn’t yet, but we believe will. lead to a commensurate drop in the cost of services related to our E&P business, and we have a portfolio in E&P that lends itself to be in flexible in since that we have very high working interest we operate of properties we have interest in. So, we can flex our E&P capital spend up and down to meet those market needs, which we think is a prudent thing to do, frankly whether or not we had an $8 billion pipeline backlog, but it is certainly prudent to do in that circumstance, and we can do it without sacrificing significant profitability because of the fact that so much of our earnings comes from a pipeline business, that doesn’t have throughput or near-term throughput, or commodity price volatility.”

In the E&P unit, El Paso placed 2009 hedge positions with a $9/MMBtu floor price on about 70% of its expected 2009 domestic gas output and on about 60% of expected 2009 domestic oil production hedged at $110/bbl. El Paso has “substantial flexibility in our E&P program, which allows us to reduce near-term capital spending and retain sufficient liquidity while not impacting long-term growth potential,” said Foshee.

“We expect that these actions will allow us to meet our debt maturities at mid-year 2009 without accessing capital markets should they not reopen even in an environment of lower commodity prices,” Foshee told analysts.

CFO Mark Leland explained that at the end of the last quarter, El Paso had $1.9 billion in liquidity, including $1.2 billion in cash and approximately $700 million available on its revolving credit facility.

“Supporting our liquidity we have $2.5 billion in revolving credit facilities that don’t mature until 2012,” Leland said. “We have a diverse group of 31 banks supporting our facilities. Only Lehman [Brothers, which filed for bankruptcy] has failed to fund and the potential impact of them not funding the future is about $27 million, and we are not including that $27million in our liquidity numbers.”

Through December, El Paso sliced off around $300 million from its previously set $3.8 billion capital spending plans for 2008. In 2009, the company will cut another $3 billion for the year, and under next year’s spending plans:

Based on its current and projected liquidity following scheduled May 2009 maturities, “our plan does not contemplate having to access the capital markets until the second half of 2009,” Leland said. “However, we will be ‘opportunistic’ in accessing the capital markets prior to that time.”

El Paso’s plan also includes the sale of around $150 million of noncore assets by the middle of next year. The company may consider taking on partners “on one or more pipeline expansion projects,” the CFO noted.

“The company has numerous additional alternatives to address potential liquidity challenges if access to capital markets remain restricted, any of the asset sales or partnering opportunities outlined…are delayed or not completed or there is a further decline in commodity prices,” Leland told analysts. If credit markets dry up, El Paso said it might consider more cuts to capital spending, using secured financings, selling more noncore assets or partnering in some of its growth projects.

“We believe that the current market actually plays to our strengths in a relative sense,” Foshee told analysts. “First, we have a track record of building infrastructure projects and bringing them in on time and on budget, and that continues to be borne out in our execution this year.

“Second, we have constructed a backlog of pipeline projects that allocates risks in a way that we think is both prudent and unique among our peers. Third, having an E&P business where virtually all of our capital spending is discretionary means that we can use this to our advantage in the near term, cutting back now and having a flexibility to continue to shape this capital spend, to both ensure our ability to fund the total company’s plans, and at the same time preserve the inventory in our E&P portfolio.”

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