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El Paso Slices Dividend, Cuts Costs to Prepare for 2010

El Paso Corp. is cutting its dividend, selling assets and reducing internal costs to fund the launch of nearly $1 billion in natural gas pipeline projects and pay for about $1 billion of exploration and production (E&P) projects in 2010, CEO Doug Foshee told financial analysts last week.

Ahead of its 3Q2009 earnings report, El Paso late Tuesday announced that it planned to slash its quarterly dividend to 1 cent from 5 cents to save $112 million annually and said it would sell $300-500 million of assets in the coming year. Another $150 million in annual savings were found internally, including workplace reductions.

In a conference call Wednesday Foshee answered several questions about the reasoning behind the dividend reduction. Many companies early this year cut their dividends to preserve cash, and Foshee said El Paso was doing the same thing as it prepared for what is expected to be a costly 2010.

"It should come as no surprise to our shareholders that 2010 is a year when we will outspend the cash flow generating capabilities of the company," said Foshee. "So the question really is, what's the most prudent way to fund that? We made some really difficult decisions internally...and we also made the decision that spending the marginal dollar on investing in our business versus a higher dividend made sense."

The Houston-based company plans to reduce internal costs and improve cost efficiencies by "leveraging a consolidated supply chain organization," said the CEO. The reason, Foshee explained, is to keep debt to a minimum.

Next year will be a "big capital spending year for us in the pipeline business...combined with plus or minus $1 billion in capital spending in E&P," he said. "You won't see any debt reduction from us in 2010, so our ability to significantly delever the balance sheet starts to come into play post-2010. As we get into that arena where the growth capital has largely been spent, of the current backlog in the pipeline business, then we begin to have new sets of opportunities that could be changing the company long term, and decisions to make about the trade-off between debt reductions and dividend increases..."

Pipeline projects overseen by El Paso that are scheduled to begin construction or begin expansion in the coming year are:

"We hope in the eyes of our investors that we made hard decisions about internal ways to generate that cash flow first, and, in fact, we're going to take more costs out of the business internally, significantly more than we're asking our investors to allow us to keep in the form of a dividend," Foshee said.

With the "best set of organic growth opportunities that we've ever had," the CEO said, "we think these opportunities offer greater long-term rewards to our investors at that time margin than the after-tax returns on a larger dividend. We didn't make this choice easily or without considerable discussion and debate at the management team and the board level. And the reductions in our own internal costs are meant to show that we're willing to take out internal costs that far exceed what we're asking our shareholders to allow us to retain..."

Separately the reductions announced are "not needle movers," Foshee admitted. "Cumulatively the actions that we've taken are really important to put us in a position to be able to fund existing growth opportunities in both of our core businesses that we know generate attractive rates of return, even at low commodity prices, and be able to go into 2010 with a confidence we can fund that, no matter the circumstance."

More guidance is expected to be given by El Paso's management team at an analyst meeting in December.

Double-digit gains in natural gas pipeline profits failed to compensate for lower gas prices as El Paso's earnings fell to $67 million (23 cents/share) in 3Q2009 from $445 million (35 cents) in the year-ago period. Quarterly earnings in the Pipeline Group rose 17% from a year ago to $326 million from $278 million. However, the E&P unit was pummeled by low gas prices; profits fell to $88 million from $532 million a year ago.

Foshee pointed to the "solid" progress by the pipeline business and steady but slower growth in E&P.

"We placed the Piceance Lateral Expansion project in service during the quarter -- on time and on budget, while at the same time advancing other projects in our committed backlog as well as new growth opportunities," Foshee said of the Pipeline Group's progress. "In E&P, we continued to generate excellent results from our Haynesville Shale program and have ramped up our activity level to five rigs. Importantly, we are transferring our Haynesville expertise to the Eagle Ford Shale, where we are off to a great start."

In the Pipeline Group, 3Q2009 results benefited from several expansion projects that went into service throughout 2008 and this year, including the Medicine Bow expansion, the High Plains Pipeline, the Carthage Expansion and the Totem Gas Storage project. Results were also favorably impacted by lower operating and maintenance costs and higher volumes and realized prices on operational sales of gas not used in operations.

Total throughput decreased slightly from a year ago to 17,757 billion Btu/d from 18,905 billion Btu/d because of "slower economic conditions," which were offset by incremental volumes from the recent expansions, El Paso said. Results also improved because El Paso was no longer impacted by lost natural gas and higher operations and maintenance costs that happened in the year-ago period following facility damage from hurricanes Ike and Gustav.

The E&P segment saw its earnings fall not only from lower gas prices but also because of lower production volumes, lower mark-to-market hedging gains and a $16 million impairment of casing and tubular goods inventory, which was partially offset by lower operating costs. E&P quarterly volumes averaged 732 MMcfe/d, down from 793 MMcfe/d in 3Q2008.

"Production was lower primarily due to a sharp drop in drilling activity in response to lower natural gas and oil prices," said E&P chief Brent Smolik. Total per-unit cash operating costs decreased to an average of $1.78/Mcfe in the period, compared with $1.89/Mcfe a year ago.

El Paso also announced that its first Eagle Ford Shale well in La Salle County, TX, recently was drilled with a 4,000-foot horizontal lateral and completed with a 16-stage fracture. The well is still cleaning up with volumes steadily increasing, said El Paso. The current flow rate is about 6.1 MMcfe/d with a flowing tubing pressure of 5,200 pounds per square inch.

Based on early exploration success, El Paso has almost doubled its lease position in the Eagle Ford Shale to 112,000 net acres. It plans to maintain a one-rig program there in the near term.

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