El Paso Corp. strutted its stuff in the second quarter following a total body makeover that turned the once bloated and debt-ridden company into a buff earnings performer.

With higher-than-expected natural gas production and an edge from higher prices, the Houston-based company boasted an 11% jump in quarterly earnings with net profit of $156 million (22 cents/share), compared with $141 million (21 cents) in 2Q2006. Revenue rose 1% to $1.2 billion from $1.1 billion.

Excluding an 8-cent charge for debt repurchases, El Paso beat Wall Street's average forecasts by 2 cents.

CEO Doug Foshee, who presided over a conference call with energy analysts and investors last week, was understandably proud of the company's performance, which is the best since he took charge of the company four years ago (see NGI, July 21, 2003). The company is on track to meet all of its 2007 financial targets, and with "substantial natural gas price support for 2007, and more natural gas price support for 2008...more opportunities are on the horizon," he said.

"This quarter demonstrates El Paso's ability to turn opportunities into results," Foshee said. The company "continues to gain momentum," with the revamped exploration and production (E&P) unit "generating a significant increase in production and earnings, as well as establishing a clear path to reaching our full-year goals." He also praised El Paso's mainstay, the gas pipeline business, which "continues to grow as we develop our deep inventory of expansion projects, such as the Cypress pipeline project, which was completed in the second quarter, on time and on budget."

El Paso was in critical condition when Foshee, who had been COO of Halliburton, took over, but under his direction, the company has shed billions of prized and not-so-prized assets to good effect. The company sold its coveted ANR Pipeline earlier this year, but it also rid itself of cash-consuming power plants, refineries and under-performing domestic and international assets. The slimmer company is nourished by two high-protein partners: gas pipelines and E&P.

The results were enviable, with pipeline profit climbing 11% to $318 million from $286 million. Throughput rose 3%.

Foshee could offer few new details, but he reiterated that a planned initial public offering for a pipeline-oriented master limited partnership (MLP) is set to launch in the final quarter of the year. The MLP, as envisioned, will include the interest in "several" of the company's U.S. pipes.

Earnings were strong in the E&P unit, with profit rising to $235 million from $163 million on higher gas output and higher prices. El Paso's quarterly oil and gas output, excluding its unconsolidated affiliate volumes, averaged 786 MMcfe/d, compared with 719 MMcfe/d in 2Q2006. Production rose in all of El Paso's domestic exploration programs on successful drilling programs, acquisitions, recovery of hurricane shut-in volumes and the addition of several key Gulf of Mexico discoveries that were brought online.

Consolidated gas sales volumes topped 657 MMcf/d in the quarter, well ahead of 589 MMcf/d in 2Q2006. Including hedges, weighted realized gas prices averaged $7.67/Mcf, up from $6.08 a year ago.

However, higher workover activity, industry-wide cost inflation and lower severance tax credits sent total per-unit cash costs to an average of $1.92/Mcfe from $1.86.

El Paso also plans to slim down its E&P unit a bit more. It is high-grading its domestic E&P portfolio with plans to sell various assets that are mostly located in the Gulf of Mexico and South Texas by early next year. The coming sales don't mean El Paso is exiting either area, but the divestitures, to be done in "multiple packages," will help to focus on the most profitable properties, Foshee told analysts.

Based on year-to-date production, El Paso increased the low-end of its targeted 2007 average daily production range to 820-860 MMcfe/d, which would include 65-70 MMcfe/d from unconsolidated affiliate volumes.

El Paso also expanded its hedge position for 2008 to create an $8/MMBtu floor price and a $12/MMBtu ceiling price on 31 TBtu of anticipated gas production. El Paso also entered into fixed price swaps on 18 TBtu of anticipated gas production in 2008 at an average price of $8.24. In addition, the company entered into swaps to hedge the basis differential for El Paso's anticipated South Texas output and Rocky Mountain production in the Raton Basin.

Energy analysts who follow the company cautioned that continuing mild weather and a lack of storm disruptions could negatively impact El Paso's future results because more of its gas would remain in storage. The company also could be impacted by more restructuring charges, higher operating costs and fees from lawsuits it has completed this year.

Among other things, El Paso recently agreed to a $56 million settlement related to the California power crisis in 2000-2001, and it agreed to a $15.5 million penalty related to a New Mexico gas pipeline explosion in 2000. The company has spent almost $86 million so far to modify its pipe system to better monitor and remedy corrosion problems.

At least one energy analyst is unconcerned about the impact on El Paso after it received a "Wells notice" from the Securities and Exchange Commission in July regarding revisions to its natural gas and oil reserves in 2004 (see NGI, July 23).

"The company has likely already reserved for such issues and likely has available insurance," Calyon Securities USA Inc. analyst Gordon Howald wrote. "Therefore, we consider any potential impact as immaterial."

A.G. Edwards' Michael C. Heim was impressed with El Paso's (EP) results.

"Why did the CEO claim 'operationally, it was the best quarter in the four years I have been here'?," Heim asked. "EP has done a good job selling assets and reducing debt in recent years, but has struggled to demonstrate a fundamental improvement in operating results. It has consistently reported disappointing production volumes that forced management to reduce guidance. This quarter, EP reported volumes above expectation and raised the lower end of 2007 production..."

El Paso's stock price, hovering around $17 last week, was up almost 20% in the second quarter and is up almost 13% year-to-date. The average rating of 13 energy analysts evaluating the company is a "buy." Three analysts rate the company as a "strong buy," five rate it a "buy," and five rate it as a "hold."

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