El Paso Corp. was one of the leading gainers on the New York Stock Exchange Tuesday after announcing it would spin off its exploration and production (E&P) business as a publicly traded company by the end of the year.

Once the proposed spinoff is completed, El Paso Corp. would be composed of El Paso's Pipeline Group, its Midstream Group and its general and limited partner interests in El Paso Pipeline Partners LP.

El Paso shares had risen 6.53% ($1.24) Tuesday to close at $20.22 after setting a new 52-week high intraday. Volume was five times more than normal.

"We believe that the creation of these two stand-alone public companies will result in significant and sustainable value creation," CEO Doug Foshee told financial analysts on Tuesday. He and his management team outlined the separation plans, as well as the corporation's strategy going forward.

"With the completion of what was an $8 billion pipeline backlog, the elevation of our E&P business to one of the top independent producers, outstanding leadership and employees in each of our businesses, and the accelerated improvement of our balance sheet, we are ready to take this important step," said the CEO.

The spinoff isn't a complete surprise. Foshee has talked publicly of restructuring El Paso for the past three years and has hinted previously that splitting off the E&P business would increase shareholder value (see Daily GPI, Jan. 28; April 17, 2008). However, the company had been expected to wait until at least 2012, when it was thought it would be able to regain an investment-grade rating.

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. Shareholders also have been restless about El Paso's inability to build value; earlier this month Jana Partners LLC, a hedge fund that has been instrumental in breaking up companies, confirmed that it had purchased more than 4% of El Paso stock (see Daily GPI, May 23).

As a separate company, the E&P business would compete with independent producers and allow investors to make decisions on each business separately. El Paso's exploration business today is concentrated in the U.S. onshore in four core programs that fall into one of three divisions, said E&P chief Brent Smolik, who will become CEO of the new company.

The "most visible indicators" of the strength of the E&P business is the drilling inventory, said Smolik. The core 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. "We have well over 10 years of drilling inventory in just four core programs." In addition, the company still has drilling rights in several small onshore U.S. gas fields that won't be developed until prices are higher, he said. "We're not investing much today, but the acreage is largely held by production. We can keep the options available as gas prices recover."

El Paso's current "drilling inventory is much more oily," said Smolik. Oil will represent about two-thirds of the E&P company's future value. El Paso ended 2007 weighted about 38% to oil; by the end of 2010 it had become 48% weighted to oil, he said.

The separation is to be completed through a tax-free spinoff, which can be completed in a shorter amount of time -- and with a higher benefit to shareholders -- than an initial public offering (IPO), Foshee told analysts.

"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 proposed spinoff follows one that is under way by Williams, which is similarly structured with U.S. gas pipelines and a domestic E&P business. Later this year Williams plans to launch a partial IPO (see Daily GPI, Feb. 17). Last year Questar Corp. spun off its E&P unit (see Daily GPI, June 15, 2010). And early this year Marathon Oil Corp.'s board of directors agreed to separate the upstream and downstream operations into two independent companies (see Daily GPI, Jan. 14).

El Paso's ability to create a new business has been an uphill climb. After the gas marketing sector went into meltdown after Enron Corp.'s bankruptcy in late 2001, El Paso had to sell off some of its most prized assets to remain viable (see Daily GPI, Aug. 25, 2003).

Foshee, who had been Halliburton's COO, came aboard in November 2003 and put El Paso on a diet and set the company on a path to pay off debt (see Daily GPI, Nov. 11, 2003). He faced what some might have considered insurmountable problems within the E&P unit, which had sold off assets to help the company avoid bankruptcy. In 3Q2003 the E&P unit reported a 42% drop in year/year earnings.

The E&P chief was booted from the company in short order (see Daily GPI, Nov. 17, 2003), but after it had to revise its proved reserves downward in early 2004 by 41%, many analysts thought it was only a question of time as to when El Paso would sell off the unit to focus on its substantial gas pipeline and midstream businesses (see Daily GPI, Feb. 19, 2004). However, by late 2005, with some small but significant acquisitions the makeover was considered nearly complete (see Daily GPI, Sept. 21, 2005).

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