Once the spin-off of El Paso Corp.'s exploration and production (E&P) business is completed, the yet-to-be-named independent producer will be formidable competition in some of the prolific unconventional natural gas and oil plays in the United States, CEO Doug Foshee said.

The decision to jettison the E&P operations was announced Tuesday as the centerpiece of the Houston-based company's annual analyst meeting (see Daily GPI, May 25a).

"This is a big deal for us," Foshee told analysts. The spin-off wasn't a complete surprise, but the timing was.

In recent quarterly conference calls Foshee has hinted that spinning off the E&P unit would increase intrinsic shareholder value (see Daily GPI, Jan. 28; April 17, 2008). He told analysts that jettisoning the E&P operations would give the corporation running room to focus exclusively on its domestic natural gas pipeline business, which is the largest interstate system in the country, as well as midstream operations and the limited partner stakes it holds in El Paso Pipeline Partners LP (see Daily GPI, May 25b).

With the balance sheet improving at a faster clip than expected and an $8 billion pipeline construction backlog scheduled to be completed this year, now seemed to be the right time to announce the plan, Foshee added.

El Paso's E&P business today is concentrated in four core programs in the United States that lean toward oil; it also has leaseholds in Egypt and Brazil. The domestic operations fall into one of three divisions, said E&P chief Brent Smolik, who will become CEO of the new company.

Smolik, formerly president of ConocoPhillips Canada, took over as president of El Paso's E&P business in November 2006 (see Daily GPI, Oct. 17, 2006).

The stand-alone E&P likely would compare in size to Newfield Exploration Co. or Petrohawk Energy Corp., both onshore shale players, Foshee told analysts. However, the "most visible indicators" of the company's E&P business is the current drilling inventory, Smolik said. "We have well over 10 years of drilling inventory in just four core programs."

The core domestic plays and estimated number of future drilling locations are:

"We're only spending in one gas play," Smolik said of the Haynesville. "We achieve returns even at current natural gas prices," or even if they fall below $4/Mcf. In addition, the company still has drilling rights in several small onshore unconventional gas fields that include two coalbed methane (CBM) plays: the Pierre Field in the Raton Basin and the Black Warrior Basin of Alabama.

The gas plays won't be developed until prices are higher, Smolik explained.

"We're not investing much today [in the CBM plays], but the acreage is largely held by production. We can keep the options available as gas prices recover."

Oil prices dictated a move to the unconventional oil holdings, which El Paso was able to obtain over the past few years at pre-hoopla prices. The company first picked up about 40,000 net acres in the gassy Haynesville Shale in 2007, and then took that know-how to the Eagle Ford in late 2009 (see Daily GPI, Nov. 5, 2009).

Less than two months later the Altamont oil field in Utah was added to the portfolio after El Paso snapped up Rockies-based Flying J. Inc. for $103.5 million (see Daily GPI, Dec. 24, 2009). Leasing in the Wolfcamp began in 2010.

It wasn't too long ago that El Paso put out the word that it was hunting for a joint venture partner to help fund drilling in the Eagle Ford. However, a more positive business environment and stronger oil prices led management to rethink its decision (see Shale Daily, April 15). Without a partner, said Foshee, El Paso will be able to retain higher working interests in the South Texas wells that it already had planned to drill.

Oil will represent about two-thirds of the E&P company's future value, a plan that has been in place for more than a year, Smolik said. He noted that El Paso ended 2007 weighted about 38% to oil; by the end of 2010 it was 48% oil-weighted.

The E&P business ended 2010 with 8 Tcfe in net risked resources, a huge jump from the end of 2007, when it had about 3.7 Tcfe. About 4.3 Tcfe of the reserves are unconventional, with 2.2 Tcfe considered "conventional, high-risk" reserves, and 1.3 Tcfe classified as proved undeveloped.

The "Haynesville, Eagle Ford and Wolfcamp have driven significant growth," said Smolik.

As to whether acquisitions are planned, Smolik said the company will "invest in places where we have competency and sell those that don't work. We're always looking for new opportunities to add." But it has to fit within the company's "culture," he said, and efficiency is job No. 1. "The new additions must compete with the current inventory."

In 2010 El Paso's E&P unit drilled 154 gross wells and had about 13 rigs running on average. It completed 142 gross wells with 1,178 total hydraulically fractured stages. Net production at year's end was 629 MMcfe/d.

To ensure that the E&P business splits from the parent in good fashion, El Paso announced a $300 million increase to its capital spending plan for 2011, which now will total $1.6 billion. Most of the new funds will target onshore shales, and of the shale assets it currently holds, the Eagle Ford will take the bulk of the spending, said Smolik.

The corporation should be able to achieve an "investment-grade balance sheet" by the time of the spinoff, which is scheduled later this year, Foshee said. The separation is to be completed through a tax-free spin-off, which can be completed in a shorter amount of time -- and with a higher benefit to shareholders -- than an initial public offering (IPO).

"We analyzed a whole host of transactions," he said. "We didn't go with the partial IPO because we didn't see burdening the company with more debt. We're highly confident what El Paso Corp.'s cash flow will be going forward." Still the separation isn't set in stone; the company noted that the planned separation is subject to "market, regulatory, tax, final approval by the company's board of directors and other customary conditions."

Foshee would remain as chairman and CEO of El Paso Corp. and would become the nonexecutive chairman of the E&P company. Dane Whitehead was named CFO of the proposed E&P company. The E&P company would be headquartered in Houston in the same building as the corporation, said Foshee.

Most of the financial analysts who cover El Paso appeared to see the split as positive for the corporation. E&P operations inherently are more risky and volatile.

BMO Capital Markets analyst Carl Kirst and his team put a value on the E&P operations at $8/share based on $8.4 billion in enterprise value.

Even though El Paso "has made tremendous strides in high-grading the asset base, inventory and overall execution, we believe it will still take time for pure-play energy investors to get comfortable enough such that the E&P-spin company trades at a notable premium out of the gate," said the BMO team.