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El Paso's Stewart Says E&P Unit 'Very Close' to Stabilizing

El Paso Corp.'s Lisa Stewart, who took over the company's faltering exploration and production (E&P) business last year, said last week it was "far too early to declare victory," but she's confident that by the end of this year, the company's oil and natural gas production will be 8% above last year's output and begin to show sustainable grow in 2006.

Stewart, an Apache Corp. E&P veteran, took over El Paso's nonregulated operations Feb. 1, 2004 just days before the company announced it would take a $1 billion charge on reserves revisions, which were cut by 41% following an independent audit (see NGI, Feb. 23, 2004).

Nineteen months later, El Paso's E&P unit is "very close to being there, but I'm not sure people are looking for us to be flat, but rather for us to grow," said Stewart. "Our fourth quarter volumes will look very good because of things in the Gulf of Mexico. But I'm not going to declare victory until victory is in our grasp, and it will be determined by your perception of us."

CEO Doug Foshee, who presided over a conference call with Stewart and other members of his management team Tuesday, noted "declaring victory is not the right term. We'll have more confidence when we hit a production target and when we report 2005 reserves. I think, internally, we have already declared victory in the onshore and in the Gulf of Mexico. I absolutely believe in the team in place in the Texas Gulf Coast.

"At the same time, we only have a couple of data points that are tangible that we can report to you, so we are bruised about where we should have been in hindsight, and we're afraid to step out on [a] limb," he added. "To some extent, we are caught in a little bit of a volume trap, but that is not the only measure of success. The other measures are looking quite good."

Faced with a daunting task of revamping the company's devastated E&P unit, Stewart went to work last year, replacing employees, recommending asset sales, and recommending acquisitions, including Medicine Bow Energy Corp. last month (see NGI, July 25, 2005). So far, the work appears to be paying off. E&P still isn't hitting the targets that it set for itself last year, but the forecast is expected to change within the next few months.

"E&P has missed its production targets set for this year, and I don't want to minimize that," Foshee said. "But I don't want to overshadow what Lisa Stewart has done with value creation."

What has changed within El Paso's E&P business, said Foshee, is "we are now spending our capital wisely. We understand every element of risk in our production profile across the board. Things are improving. Two important measures of value creation are reserves growth and reserves additions, and [finding and development] F&D costs. We are showing improvement in both areas."

Production in the second quarter was lower than a year earlier, 784 MMcfe/d versus 804 MMcfe/d, but Stewart noted there had been unexpected shortfalls from the E&P operations in Brazil as well as in the Gulf of Mexico (GOM). So far this year, El Paso's production is averaging 775 MMcfe/d, about 3% below its stated target set late last year.

Still, Stewart said there are reasons for optimism, especially from onshore and offshore operations. "Our onshore production is showing great growth." In the Raton Basin, output is up 10 MMcfe/d, or 16% higher than a year ago, while in the Arkoma, volumes are up 5 MMcfe/d, or 36% higher. In the Rocky Mountains, output has grown 48% from a year ago, up 10 MMcfe/d.

In the GOM, output declined on workovers and completions. However, the "drilling success was not reflected." That will show up in the future as two deep shelf discoveries are set to ramp up in the fourth quarter. There also is a backlog of "significant 2006 inventory," she said.

The next big turnaround in the E&P unit will be within the Texas Gulf Coast operations, where output has fallen consistently from a year ago, when it was 307 MMcfe/d, versus 253 MMcfe/d in 2Q2005. While the coastal production accounted for 35% of El Paso's production in 2004, Stewart said it will drop to 26% by the end of this year.

"We have had a lack of drilling success" on the Gulf Coast, Stewart said, which led to a turnover in management. "We are bringing in new members with fresh ideas," and El Paso is "taking the appropriate corrective action to rebuild credibility in 2006."

El Paso now anticipates exiting 2005 at a production rate of 860-900 MMcfe/d. "We have proven we can grow onshore organically, and I believe we can turn around the Texas onshore," said Stewart. "I believe we're on track to turn around the production company by yearend."

Also last week, massive charges on international power assets and the impact of mark-to-market accounting on marketing operations led El Paso to report a second quarter loss of $238 million (minus 38 cents/share) compared with a profit of $5 million (1 cent) from the same period a year ago. The company also reported in its Form 10-Q that it received an order in June from the Securities and Exchange Commission (SEC) requesting additional documents and information related to the United Nations' Oil for Food Program, which governed sales of Iraqi oil.

El Paso originally received a request for information regarding The Coastal Corp.'s participation in the Oil for Food program in September 2004 from the grand jury of the U.S. District Court for the Southern District of New York (see NGI, Nov. 29, 2004). El Paso acquired Coastal in January 2001.

"We have also received informal requests for information and documents from the United States Senate's Permanent Subcommittee of Investigations and the House of Representatives International Relations Committee related to Coastal's purchases of Iraqi crude under the Oil for Food Program," El Paso said in its filing. "We are cooperating with the U.S. Attorney's, the SEC's, the Senate subcommittee's, and the House committee's investigations of this matter."

In the second quarter, El Paso's biggest losses were within the nonregulated power segment, which lost $381 million before interest and tax, compared with a profit of $102 million a year earlier. The loss included a $294 million impairment at its Macae plant in Brazil, $11 million in impairments on its Central American power assets, and $34 million in asset impairments in Asia.

Overall, El Paso's five earnings segments -- pipelines, production, field services, marketing and trading and power, reported earnings before interest and taxes (EBIT) of $613 million. The pipelines, production and field services segments contributed $1.259 billion of combined EBIT, partially offset by losses of $215 million within its marketing and trading segment and $431 million in the Power segment.

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