El Paso Corp., which at the end of last week clinched a blockbuster deal to sell its exploration unit, on Monday said fourth quarter profits more than doubled. The natural gas pipeline franchise also reported a solid performance, lifted by rising volumes from the Marcellus Shale.

The company is preparing for a friendly takeover by Kinder Morgan Inc. (KMI), a deal expected to close by the end of June (see Daily GPI, Oct. 18, 2011). KMI had expressed no interest in the exploration and production (E&P) business, and late Friday that issue appeared to be put to rest.

A consortium of private equity investors led by Apollo Global Management LLC agreed to buy EP Energy for about $7.15 billion (see Daily GPI, Feb. 27). Apollo’s partners include Riverstone Holdings LLC and Access Industries Inc., which is led by industrialist Len Blavatnik. The KMI deal and the sale both are expected to close by the end of June.

With the company in the midst of transitioning it wasn’t able to hold a conference call or issue statements regarding negotiations. However, Apollo’s Josh Harris, senior managing director, said his company was acquiring “an impressive portfolio of valuable natural resource assets, a talented management team and a remarkable group of highly skilled employees. We look forward to building on El Paso’s impressive track record of success in partnership with Apollo’s natural resources expertise.”

The E&P business for years had been considered a drag on El Paso, whose forte is natural gas pipelines and midstream infrastructure. The company last May announced that it would spin off the unit to shareholders (see Daily GPI, May 25, 2011). And at that time, potential buyers began to express an interest in buying the business outright, sources told NGI. However, once KMI launched its takeover, the suitors began their pursuit in earnest.

According to the sources, Apollo was a leading contender for months; its pursuit was internally dubbed “Project Everest,” primarily because the private equity firm said from the start it intended to buy the entire package of E&P properties.

Apollo, with more than $75 billion in private equity funds invested across a core group of nine industries, is highly regarded. In 2009 one of Apollo’s units purchased Midland, TX-based Parallel Petroleum for around $495 million (see Daily GPI, Oct. 5, 2009). Parallel, among other things, had held a 35% stake in 34,500 acres of the Barnett Shale with leasehold partner Chesapeake Energy Corp. Chesapeake in early 2009 took over drilling and development commitments through 2016 to help its struggling partner (see Daily GPI, Feb. 18, 2009). Late last year Apollo sold Parallel for an estimated $780 million; Samsung C&T Corp., the trading arm of Samsung Group, agreed to purchase a 90% stake while Korea National Oil Corp. bought the remaining interest.

Meanwhile, Riverstone, an energy and power-focused private equity firm, has more than $18 billion of equity capital raised across seven investment funds and coinvestments. Riverstone participated in at least 24 energy-related transactions in 2011. Among other things, it provided about $900 million in equity to Legend Natural Gas IV LP to acquire Barnett Shale properties from Range Resources Inc. It also provided Legend almost $100 million to acquire South Texas property from Smith Production Inc. In early 2011 it invested in Three Rivers Natural Resource Holdings LLC, which significantly expanded its position in the Permian Basin.

Access is a privately held, U.S.-based industrial group with worldwide holdings. Access spans three key sectors: natural resources and chemicals; telecommunications and media; and real estate. Within its natural resources holdings Access has investments in LyondellBasell, TNK-BP UC Rusal and Boomerang Tube.

The private equity consortium plans to use around $3 billion in capital to back the EP Energy transaction and draw around $5.5 billion in financing arranged by seven banks, led by JPMorgan Chase and Citigroup.

Before it can complete the transaction, the companies may have to jump some legal hurdles.

Investment banker Goldman Sachs, which is part-owner of KMI, advised both KMI and El Paso about last year’s merger agreement. Some El Paso shareholders then filed a lawsuit claiming a conflict of interest by Goldman and said the sale should be reopened to other potential buyers. A judge in Delaware’s Court of Chancery has indicated that he plans to rule by early next week (March 6) on a request to block the merger vote (see Daily GPI, Feb. 23). And the Apollo-led leveraged buyout is contingent on closing the KMI merger.

Beyond the big deals, El Paso delivered a solid performance in the final three months of 2012. Net profits reached $185 million (24 cents/share) in 4Q2012, compared with $62 million (9 cents) in the year-ago period. After adjusting for the impacts of financial derivatives and other one-time charges, the company earned 28 cents in 4Q2011, versus 20 cents in 4Q2010. Net income in 2011, which was impacted by derivatives losses, fell to $141 million (18 cents/share), versus $721 million ($1.00) for 2010.

Throughput for the Pipeline Group, including equity investments, rose 8% in 4Q2011 from a year earlier, primarily because of higher Marcellus Shale volumes on Tennessee Gas Pipeline (TGP), as well as and several expansion projects that were placed into service, partially offset by declines on El Paso’s Rockies pipelines and El Paso Natural Gas. Around 90% of the Pipeline Group’s revenues are derived from fixed reservation charges.

In the last quarter of 2011 the TGP 300 Line expansion and the Gulf LNG (liquefied natural gas) regasification terminal were placed in-service, completing what had been an $8 billion project backlog in 2008.

“While TGP finished a major expansion in the Marcellus area with the 300 Line expansion, TGP is in various stages of permitting for four additional Marcellus expansion projects, totaling approximately $600 million of capital and 1.1 Bcf/d of new capacity,” El Paso noted. “The most significant of these projects is the TGP Northeast Upgrade Project, which will provide 620 MMcf/d of additional firm transportation service from receipt points in the Marcellus to an interconnect in New Jersey. The project, which is fully contracted, is expected to cost $400 million and, subject to regulatory approvals, is anticipated to be placed in-service in November 2013.”

The Pipeline Group earned $417 million in the final three months of 2011, compared with $439 million for the same period in 2010. The decline year/year was attributed to a lower allowance for equity funds used during construction and expansion projects placed into service, particularly the Ruby Pipeline, which runs from the Rocky Mountains to West Coast markets. The group’s earnings also were impacted by lower retained fuel volumes on the TGP system because of a fuel volume tracker implemented following a rate base settlement, as well as higher operating expenses.

El Paso’s E&P production volumes rose 11% in 4Q2011 from a year earlier to 880 MMcfe/d; the year-end production exit rate exceeded 900 MMcfe/d. Oil output was up by 50% year/year to 22,300 b/d.

The E&P segment’s quarterly profits totaled $92 million, compared with a loss of $27 million in 4Q2010. The improvement followed an $86 million, or 87%, increase in oil and condensate physical sales and a $10 million mark-to-market gain. Full-year production was up 7% from 2010 levels, to 838 MMcfe/d. El Paso finished the year at its forecasted capital budget of $1.6 billion and an average rig count of 13 rigs. Total per-unit cash operating costs decreased to an average of $1.76/Mcfe in 4Q2011, down from $1.84 in 4Q2010, mainly because of increased output volumes.

The gains came as the company moved toward more liquids production. In fact, in response to low natural gas prices, drilling activity in the Haynesville Shale has been reduced to one rig, and the company expects to release that rig once a well now being drilled is completed, the company said. El Paso is operating a total of nine rigs “with a continued focus on oil programs.”

The Eagle Ford Shale, the most active program with four rigs now operating in La Salle County, TX, had a net year-end exit rate of 14,073 boe/d from 64 wells, “as production constraints caused by limited natural gas takeaway have been eliminated with the completion of a natural gas gathering system by El Paso’s Midstream Group.” An additional hydraulic fracturing crew is to be added by the end of March; a fifth rig is expected later this year. Two rigs now are operating in the Altamont field, one is in the Wolfcamp Shale and one is operating in the South Louisiana Wilcox play.

Proved reserves jumped 19% year/year to 4 Tcfe fro 3.4 Tcfe. Total reserves of oil and condensate and natural gas liquids grew by almost 66% to 201 million bbl from 121 bbl. The reserve replacement ratio was 400%. Domestic reserve replacement costs, before acquisitions and price-related revisions, were $1.41/Mcfe. The company’s risked future drilling inventory at the end of 2011 was 9.7 Tcfe, up from 8.0 Tcfe in 2010. The risked future drilling inventory includes about 2 Tcfe of proved undeveloped reserves and 7.7 Tcfe of risked unproved resources.

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