El Paso Corp. sees some “risk” in natural gas prices over the next two to three years, and while capital markets have improved, the company’s not yet convinced that it’s a long-term recovery, CEO Doug Foshee said Thursday.

“So our strategy given those two premises hasn’t changed,” Foshee told financial analysts during a quarterly earnings conference call.

With close to $1 billion of pipeline projects coming online over the next 12 months, “job one for us as a company is to complete our pipeline backlog on time and on budget,” the CEO said. “Right now we anticipate that being on time and on budget.”

Because of the commodity price environment, and “in spite of our substantial hedge position,” El Paso also will move cautiously on the exploration and production (E&P) side, he said. “We will be spending and focusing only on our most economic areas,” which today are the Haynesville Shale, where the company has around 40,000 net acres, and the Altamont oilfield.

Net profit fell 59% in 2Q2009 from a year ago on weak gas prices, but adjusted earnings beat Wall Street estimates. The company earned $79 million net (11 cents/share) in the period, compared with $191 million net (25 cents) in 2Q2008. Excluding one-time items, adjusted earnings totaled 25 cents/share, which was 4 cents above the Street’s average.

“El Paso generated good financial results in a difficult environment, and I am particularly pleased with the operational progress that we have made in recent months,” said Foshee.

“In our pipeline business, we secured a partner for our Ruby Pipeline project and brought two projects into service — both on time and on budget,” Foshee said. Private equity Global Infrastructure Partners will partner on Ruby, the company said last month (see Daily GPI, July 28).

The Pipeline Group earned $327 million in the quarter, compared with $295 million a year earlier. The group’s results benefited from several expansion projects that went into service in 2008, including the Kanda Lateral project, the Medicine Bow expansion and the High Plains Pipeline.

Increased reservation revenues on the El Paso Natural Gas system, new contracts on its Rocky Mountain region systems and additional capacity sold in different regions of the Tennessee Gas Pipeline system, also propped up quarterly earnings, said Jim Yardley, who runs the pipeline unit.

Throughput of 17,929 billion Btu/d in 2Q2009 was essentially flat from the year-ago period “as volumes from recent expansions were offset by weaker demand due to slower economic conditions,” said Yardley. “While the pipelines experience fluctuations in throughput, there is no material impact to near-term financial results because a significant portion of revenues are derived from demand charges under long-term contracts.”

El Paso’s domestic E&P business, which has turned its sights to the Haynesville Shale, also “held up very well,” said Foshee, “even though we have reduced our drilling rig activity by roughly 70% since the third quarter of 2008.”

The E&P business reported $61 million in earnings for 2Q2009, versus $304 million in the same period of 2008. The decrease followed lower realized commodity prices and lower production volumes, which were partially offset by lower cash operating costs, mark-to-market gains associated with derivative hedging contracts and lower debt expenses, said Brent Smolik, who helms exploration for the company.

A sharp drop in drilling activity because of lower gas prices led to a decline in quarterly volumes, which averaged 777 MMcfe/d in the period, compared with 2Q2008’s 833 MMcfe/d. Total per-unit cash operating costs decreased to an average of $1.68/Mcfe, from $2.01/Mcfe in 2Q2008.

“No question that we’re operating in a difficult environment, but we’ve got very clear priorities for the E&P company,” said Smolik. “In this part of the cycle…E&P investment opportunities are limited, which is why we’re content to spend less and generate more free cash flow.

“In the meantime, our teams are busy preparing for the future,” Smolik said. The E&P team is “continuously developing new ideas…and our inventory of drill projects is up nicely from the beginning of the year.” In addition, Smolik hinted of more news to come: El Paso is “pursuing some interesting opportunities beyond the Haynesville that we aren’t ready to talk about today.”

To protect the company’s balance sheet and to fund its growth projects, CFO Mark Leland told analysts, “we’ve done more hedging over the next 30 months than we have historically done. We have about 70% of our 2009 domestic gas production floor at just over $9/MMBtu.”

For 2010, El Paso has gas positions that provide an average floor price of $6.41/MMBtu on 175 trillion Btu and an average ceiling price of $7.24/MMBtu on 112.5 trillion Btu. And into 2011 hedges are in place to provide an average floor price of $6.00/MMBtu and an average ceiling price of $8.66/MMBtu on 136 trillion Btu.

“All of these positions look good in today’s forward strip, and if we’re wrong on price we have plenty of upside…” Leland said.

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