Standard & Poor’s Ratings Services lowered El Paso Corp.’s credit ratings to ‘B+’ from ‘BB’ on Friday, ending a long and difficult week, that included a 42% collapse in El Paso’s stock price to $4.92/share on Friday from Monday’s open. Investors dumped the company’s stock after it announced that it would cut its dividend 82% to 16 cents annually, sell off another $2.9 billion in assets and exit the rapidly growing liquefied natural gas (LNG) business.

S&P credit analyst William Ferara said the rating action reflected “continued reductions in cash flow estimates, heightened refinancing risk, the inability to successfully meet debt reductions goals, and a deterioration in the company’s liquidity position.” The company has liquidity of $2.6 billion but only about $600 million is cash.

Meanwhile, it has $17 billion in debt. About $2.5 billion in borrowings need to be repayed this year and another $3.5 billion next year.

As a result, El Paso will sell $880 million in domestic power generation and contract assets and $1.1 billion in petroleum assets, excluding its Aruba refinery.

“Executing on planned asset sales (targeted at $2.9 billion in 2003) is crucial to meeting debt maturities and accounting for the continued shortfall in cash flow (expected at about $2.5 billion in 2003) versus capital spending ($2.6 billion) and dividend requirements ($200 million) in 2003,” S&P’s Ferara said.

The new focus for El Paso will be on pipelines, midstream gathering and processing, exploration and production and a much smaller core of power generation assets with long-term sales contracts, company officials said during a conference call with analysts. CEO William Wise also told an analyst that an initial public offering of stock from its E&P unit, formerly Sonat Inc., is a possibility.

El Paso expects to report losses for the fourth quarter of 2002 and the full year mainly resulting from a $600 million charge against 4Q earnings because of the shutdown of its energy trading business and a $450-700 million after-tax asset impairment charge related to its Western Australian pipeline investment, telecom dark fiber, turbine inventory, and other miscellaneous power and merchant assets.

The company said it expects ongoing earnings for 2002 to total $1 a share, well below the $1.31/share Wall Street forecast. And the massive charges against earnings are expected to continue in 2003. Company officials predicted a $300 million special charge in the second quarter of this year from having to pay down about $1 billion in Project Electron debt and continuing charges from the shut down of energy trading.

A dark cloud hangs over its decision to consolidate Project Electron’s generation assets and liabilities onto its balance sheet. The transfer of off balance sheet liabilities is reminiscent of similar moves that led to Enron’s downfall. El Paso officials said they plan to purchase all third party equity interest and consolidate all of the partnerships assets and liabilities. The assets will be consolidated at fair market value, which will result in a significant impairment.

“In a volatile industry, we have taken significant steps to reduce expenses, strengthen our balance sheet, enhance our liquidity position, and exit the energy trading business. We have moved aggressively to address many of the issues that affected our industry and our business, and we are confident that the company is headed in the right direction,” said Wise.

A total of 87% of El Paso’s 2003 capital budget will be spent on pipelines and exploration and production. Nevertheless, the E&P capital spending plan represents a 48% drop from the $2.5 billion last year. Although the company said it expects to maintain production, S&P said the lower spending will result in a lower cash flow.

El Paso plans to continue to be an active deep driller in the Gulf of Mexico. The production division was the most active driller in the United States in 2002, and since the Coastal merger in January 2001, the company’s prospect inventory has almost doubled. Its success has been attributed to the transfer of its South Texas deep-drilling expertise to the Gulf of Mexico, Canada, and Louisiana. The company’s 2003 E&P plan is focused on South Texas, coalbed methane and the deep-shelf play in the Gulf of Mexico.

Through its focus on core production operations, strong midstream performance with El Paso Energy Partners, and reduced and less risky power portfolio, El Paso hopes to keep its ship afloat in 2003. It is exiting the trading business and aggressively working to liquidate its remaining portfolio, but the affects of that move will last well into 2004, perhaps longer, company officials said.

Its dividend cut to 16 cents annually will provide a modest $425 million in annual cash flow and will reduce the company’s balance sheet leverage by more than 1.5% per year. Through cash flow from operations, the reduced capital program, lower common stock dividends, and proceeds from asset sales, El Paso expects to pay down $2.5 billion of debt and minority interest financings in 2003. The company has set a target of $150 million in cost reductions for 2003.

“Of paramount importance to the company’s ability to persevere in current conditions is renegotiating its credit facilities and regaining access to capital markets at the holding company level,” S&P said. “El Paso’s ability to refinance its obligations will most likely be delayed until the FERC’s ongoing investigation into market manipulation in California is resolved.” Absent such access, the company will be severely challenged to repay its borrowings.

S&P said its current ratings assume resolution of the FERC matter in a way that will be credit neutral. “Resolution in such a manner could be perceived as an important first step toward staunching negative investor sentiment and a key building block toward ratings stability.”

The negative outlook reflects significant hurdles the company has regarding regaining access to capital markets, halting the continued decline in cash flow, and resolving the FERC matter in a manner that is credit neutral to El Paso. Successful execution could lead to ratings stability and upward credit momentum.

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