The senior executive bonuses for this year are gone, some of the long-term executive incentives have been eliminated, capital spending has been reduced even more, and up to $2 billion more in assets will be sold. As El Paso Corp.’s chairman noted, the interstate pipeline leader is not reacting, but rather responding to what shareholders and the marketplace now demand. “We are doing what management is supposed to do,” explained CEO William Wise on Thursday. “We are all sharing the pain.”

Noting that its balance sheet was “strong and improving,” with “solid” liquidity that will prepare the company for “any market events,” Wise presided over a second-quarter earnings conference call with confidence that El Paso will grow stronger with more fiscal responsibility and fewer frills. “We have throttled back to live within our means,” he said. “Beginning in 2003, we intend to fund our capital expenditures with operating cash flow from our core businesses,” which he said were its pipelines, exploration and production and field services.

To do that, the company is crossing off another $900 million in its capital spending budget, reducing it to $3 billion through 2002. Most of the cutbacks will be in new exploration and production activities that were scheduled through 2003. More properties also will be put up for sale, with between $1.5 billion and $2 billion of non-strategic production, pipeline and power assets added to the list.

Since December, El Paso has completed approximately $2.5 billion of equity financing, and has announced or completed $2.5 billion of asset sales. Before Thursday’s announcements, the company had already trimmed $300 million from its costs. Parent company expenses in all areas have been significantly reduced, said Wise, and like all of its energy merchant peers, El Paso has reduced its energy trading operations and personnel.

With liquidity able to handle any situation, Wise said that as of July 31, the company reported $5.8 billion in total available liquidity, comprised of $1.8 billion of cash on hand, an available $3 billion, 364-day revolving credit line, and a $1 billion multiple-year bank revolver. For the remainder of this year, El Paso has debt maturities totaling approximately $490 million. Another $1.7 billion comes due in 2003.

For the third time this year, El Paso also revised its earnings estimates through 2003. Core earnings estimates this year will fall between $2.05 and $2.15 per diluted share, and in 2003 it expects to earn between $1.80 and $2.00. In late May, the company revised an earlier forecast, cutting its earnings guidance to $2.60 to $2.75 a share for 2002, and 2003 earnings of $2.75 to $2.90 a share.

The new estimates assume a Nymex natural gas price of $3.36/Mcf for the second half of this year, and $3.82/Mcf for 2003. The earnings estimates also reflect expected lower natural gas and liquids production in 2003, that will follow with the spending reductions, asset sales and reduced expectations with its trading operations.

“There are very important messages here, if you don’t take away anything else,” declared Wise. “We are operating in a difficult business environment. Given the credit environment, with capital markets uneasy, it is very prudent to be operating from the point of view of balance sheet and capital objectives.”

Ralph Eads, CEO of El Paso’s Merchant Energy Group, said there now was a “new energy trading environment,” in place, and “in the last 60 days, the energy trading industry has undergone more fundamental change.” With “substantially less liquidity,” El Paso’s merchant business has slashed its earnings forecast from trading, expecting $150 million a year versus $400 million through 2003.

Eads said the forecast for merchant trading had been based upon 2000 and 2001 earnings, and “they were not representative of the current environment.” He does expect merchant earnings to “return to profitability in the third quarter” because of the company’s storage and pipeline assets, however. “We have a positive feeling now that we are going forward against new lower expectations.”

Standard & Poor’s Ratings Service affirmed El Paso’s credit ratings late Thursday, noting the company “has strengthened itself remarkably well since the bankruptcy of Enron Corp. by lowering its business risk, reducing debt, issuing equity, and improving its liquidity. El Paso’s decisive actions and the progression of its initiatives, such as multiple equity issuances and a growing pool of asset sale proceeds, at a time when many of its peers still have yet to complete their equity and asset sales exemplifies why El Paso’s rating has held up in a storm of credit uncertainty in 2002.”

These actions, along with the company’s large asset base, strong market presence, and quick actions to repeatedly stay ahead of the credit curve are sufficient for current ratings,” said S&P. However, it notched the company’s outlook to “negative” from “stable” because of “the extreme turmoil in the energy sector has caused a decline in credit quality for many top industry participants and a fundamental change in the energy trading and marketing industry, all of which has forced El Paso to take many actions that have ultimately impacted cash flow to the point where it is pressuring current ratings.”

Following the conference call, most analysts weighing in on the news seemed impressed with El Paso’s positive direction. UBS Warburg analyst Ron Barone said El Paso still “has one of the most expansive and highly attractive wellhead-to-burnertip asset portfolios in the sector (even after incremental sales announced today),” adding that the “portfolio would be worth more shut down and sold than where EP equity is trading today.”

Reiterating his “strong buy” rating, Barone called the company’s announcements “tough medicine,” but said, “We cannot complain about the nature of this strategy change within the context of the current turbulent industry environment, particularly management’s reduced emphasis / reliance on marketing & trading and its move to place less emphasis on E&P. Moreover, given that the majority of El Paso’s peers have substantially less financial flexibility — being forced to sell crown jewel assets — we believe management’s new strategy will yield an El Paso that is even more strongly positioned than where it is today. In short, unlike a Band-Aid solution, we view EP’s moves today as the once and for all cure.

“Beyond ‘shutdown’ value, ” said Barone, “we believe EP will emerge from this industry implosion as one of the most liquid and competitively strong players, capable of capitalizing on what should be significant long-term opportunities as the demand for natural gas continues to grow.”

Curt Launer, a Credit Suisse First Boston analyst, also rated El Paso a “strong buy.” With a target share price of $30 (El Paso has been trading around $14.00), Launer noted that El Paso was committed to its common share dividend adding that its current 6% yield “adds to valuation, the certification of financial statements provides credibility to the view that no additional write-offs are coming and the possible debt repurchase boosts capital access and credit statistics.”

Morningstar analyst Paul Larson was also positive, noting that “El Paso’s core pipeline business remains strong, and the company has made significant progress toward shoring up its balance sheet. Unlike many of its energy industry peers, El Paso does not have severe liquidity issues looming over it.”

For the second quarter of 2002, El Paso’s pro forma earnings were $234 million, or 44 cents per diluted share, down nearly half from the second quarter of 2001, when it reported earnings of 414 million, or 79 cents in the second quarter of 2001. The company had a quarterly loss of $45 million, or 8 cents per diluted share, but of that, $279 million, or 52 cents, was included for various non-recurring items.

The most significant non-recurring item was a pre-tax $234 million, or 29 cents, ceiling test charge, primarily for Canadian oil and natural gas properties. For the same period of 2001, El Paso reported a loss of $93 million, or 18 cents a share, which had included Coastal Corp. merger-related charges and other non-recurring items that totaled $507 million, or 97 cents a share. Second quarter earnings before interest and taxes (EBIT) totaled $698 million, compared with $957 million in 2001. Pro forma EBIT was $411 million, compared with $153 million last year.

Wise said that going forward, El Paso will add much more clarity and disclosure to its financial statements, beginning with the second quarter 10Q filing with the Securities and Exchange Commission. He added that he and CFO Brent Austin also will certify the company’s financial statements when the second quarter 10-Q is filed. “More disclosure will be one of the underlying principles going forward,” Wise said.

For the second quarter, the Pipeline Group EBIT rose 3% over the same quarter of 2001, following the reactivation of the Elba Island liquefied natural gas facility, new expansions, and the recontracting of 1.2 Bcf/d of capacity on the El Paso Natural Gas pipeline at full tariff rates.

El Paso Production Co.’s EBIT declined from 2001 levels following a 6% decline in total production, as well as higher per-unit depreciation, depletion and amortization costs. Since January, the company has sold assets with 1 Tcfe proved reserves, which amounts to approximately 15% of its total proved reserves at the beginning of 2002. The company has been able to offset much of the loss of production from these sales through a successful drilling program, especially in South Texas and the deep shelf play in the shallow Gulf of Mexico.

During the first six months, the company was successful on 276 out of 301 well completions for a 92% success rate, including a 97% success rate for domestic drilling. Excluding revisions and sales, the company has added 786 Bcfe of proved reserves this year at an average cost of approximately $1.00/Mcfe.

Field Services’ second quarter EBIT was below last year following the sale of its Texas intrastate natural gas transmission system to El Paso Energy Partners (EPN) and lower processing margins. El Paso expects to complete the sale of another $782 million of midstream assets to EPN by year’s end.

Similar to reports from other companies, El Paso’s Merchant Energy Group’s second quarter EBIT declined from 2001 levels because of lower income from trading and petroleum activities. Power income was up, mostly because of a buyout of a power contract at the company’s Nejapa project in El Salvador. “Trading profitability declined due to weaker market fundamentals and disorderly liquidation of industry participants’ positions in the trading arena,” the company said. Also, its petroleum operations were adversely affected by much lower refining margins, including continued historically low light/heavy crude differentials.

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