El Paso Corp. swung to a profit in the second quarter, led by a stronger-than-expected performance from its core natural gas pipeline division and from gains on price risk investments. The Houston-based company reported quarterly net income of $141 million (21 cents/diluted share), well ahead of its losses of $246 million (minus 38 cents) for the same period a year ago and 3 cents above Wall Street estimates.

When El Paso unveiled its profits last week, investors appeared unenthused, sending shares slightly lower. Natexis Bleichroeder energy analyst Gordon Howald attributed some of the company’s stock decline to profit taking: El Paso shares have risen 35% since mid-April. Howald also noted that El Paso’s 2Q earnings were “certainly priced for outstanding results, and that’s not what we got. We got good — within expectations. But when you’re up 35% in three months, you’d better exceed expectations.”

In the quarter, El Paso’s Pipeline unit’s profit rose to $335 million from $309 million a year earlier. The segment’s reported earnings increase came primarily from the expiration of discounted rates to some El Paso Natural Gas (EPNG) customers, the implementation of new rates at EPNG, increased revenues from various interruptible services, and the contribution of pipeline expansion projects, including the Cheyenne Plains pipeline, the Piceance Basin expansion on the Wyoming Interstate Co. system, and the Elba Island liquefied natural gas terminal expansion. Offsetting these positive factors were unreimbursed insurance costs related to last year’s hurricanes and favorable contract restructurings and settlements on the ANR Pipeline system in 2Q2005.

El Paso reported a decline in its other core business unit, Exploration and Production (E&P), which fell to $163 million from $176 million in 2Q2005. The E&P segment’s consolidated production volumes averaged 719 MMcfe/d, excluding unconsolidated affiliate volumes of 66 MMcfe/d, compared with 784 MMcfe/d a year ago.

Quarterly production losses were attributed to higher costs, specifically the ongoing problems in the Gulf of Mexico (GOM) related to the hurricanes. Between 12 and 13 MMcf/d of natural gas remains shut in from 2005 hurricanes Ivan, Katrina and Rita, which is about half of the 21 MMcf/d that El Paso shut in immediately after the storms, CEO Doug Foshee said. El Paso also incurred an additional $8 million in uninsured hurricane losses.

Still, outgoing E&P Chief Lisa Stewart said El Paso should hit the low end of its targeted average overall oil and gas production this year, which is forecast at between 825-850 MMcfe/d. Stewart announced her resignation last week, effective Sept. 1, to take a position with Warburg Pincus (see NGI, Aug. 7). Until a new E&P chief is named, Foshee said he will oversee the business.

Noting the strong teams assembled within the business units, Foshee said El Paso was “doing well with the things we can control.” He also expressed enthusiasm for the earnings to date.

“El Paso’s second quarter results are another step toward the delivery of our 2006 goals,” said Foshee. “Our pipeline and E&P businesses both delivered solid results, and we are on track to reduce our year-end 2006 debt, net of cash, to $14 billion. More importantly, our pipeline and E&P businesses have solid growth trajectories that point to further improvement in 2007.”

The realized price for natural gas (net of transportation costs) in 2Q2006, including the impact of hedges, was $5.86/Mcf, compared with $5.96 in 2Q2005. Oil, condensate and natural gas liquids (NGL) realized prices, including the impact of hedges, were $59.84/bbl, up 43%, compared with the same period in 2005. Total per-unit cash costs increased to an average of $1.86/Mcfe, compared with $1.52 in 2Q2005, primarily due to higher production taxes as a result of lower tax credits received in 2006 and higher maintenance, repair and workover costs.

During the conference call, analysts quizzed management about the status of El Paso’s proposed Continental Connector, which held a binding open season earlier this year (see NGI, May 29). The system would connect the company’s Rocky Mountain pipelines, including Colorado Interstate, Wyoming Interstate and Cheyenne Plains, with its three lines in the eastern half of the United States: ANR Pipeline, Tennessee Gas Pipeline and Southern Natural Gas.

El Paso is “still not at the point of making any formal announcements” about the massive pipe system’s plans, said Foshee. However, several “large, potential shippers” are interested in the system, especially producers working in the prolific Barnett Shale of Texas. “We’ll provide more information about the negotiations in the third quarter,” he said.

Quarterly results included $27 million (2 cents/diluted share) of noncash, mark-to-market, pre-tax gains on derivatives intended to hedge the price risk of natural gas and oil production. In 2Q2005, price risk management derivatives generated a $12 million mark-to-market pre-tax loss. Results in 2005 were also impacted by impairments, net of gains on the sale of assets and investments, of $88 million driven primarily by the Power segment and $29 million of restructuring costs in 2005.

For the first six months, El Paso reported net income of $487 million (70 cents/diluted share), up from a net loss of $140 million (minus 19 cents) for the first half of 2005. Results for the first six months of 2006 included $189 million (17 cents/diluted share) of noncash, mark-to-market, pre-tax gains on derivatives, compared with the same period in 2005, when price risk management derivatives generated a $118 million mark-to-market pre-tax loss. Additionally, results for the first half of 2005 were impacted by net gains on the sale of assets and investments of $17 million, driven primarily by gains associated with the sale of the company’s remaining interest in Enterprise Products Partners LP, offset by impairments on certain power assets. Also, 2005 results were impacted by a $59 million charge for the early payoff of the western energy settlement and $30 million of restructuring costs.

At the end of the quarter, El Paso’s debt, net of cash, was $14.4 billion, a $1.7 billion reduction from Dec. 31, 2005. Gross debt was $16.2 billion on June 30, a $2.0 billion reduction from year-end 2005. Net debt and gross debt at Dec. 31, 2005 include $225 million of debt that was repaid in 2Q2006 upon the sale of El Paso’s Macae power plant. During the first six months, El Paso closed $854 million of asset sales as a part of its debt reduction program. In addition, $160 million of asset sales have either closed or are in various stages of completion.

In related news, El Paso said in a regulatory filing last week that it will record a noncash mark-to-market loss in 3Q2006 on natural gas supply agreements with the Michigan-based Midland Cogeneration Venture power plant. Based on the estimated value of these contracts at June 30, the loss would be about $135 million, El Paso said. El Paso sold its 44% interest in the gas-fired power plant on Aug. 3 to GSO Capital Partners and Rockland Capital Energy Investments and will have a pre-tax gain from the sale of $13 million in quarter.

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