El Paso Corp. stock took a pummeling on Wall Street last week after the company lowered its earnings projections for 2002 and 2003 to accommodate a major cutback in its energy trading work force and other streamlining actions. The Houston-based energy giant plans to slash its trading staff, primarily the power side, by 50% in an attempt to ease the concerns of investors and credit rating agencies. The expected cost savings/proceeds from this and other moves, such as debt reduction and asset sales, will be channeled to El Paso’s core natural gas businesses — exploration and production (E&P), liquefied natural gas (LNG), and its midstream and pipelines facilities.

The El Paso Merchant Energy operation remains a “very strong” business, but the market conditions for trading going forward are vastly different, El Paso Chairman William Wise told institutional investors in New York City last Wednesday. There has been an “almost total reversal” during the past six months in the growth in energy trading and the pace of electricity deregulation, agreed El Paso Merchant Energy President Ralph Eads. “We think the opportunities…in the gas business continue to be attractive for us, where we believe we have a leading position. But the power business is somewhat more problematic” due to “uncertainty” in the market, he said. As a result, El Paso is “de-emphasizing” the power trading end of its business.

El Paso will cut a total of 300 traders, said spokeswoman Norma Dunn, adding that about 110-130 traders had been notified already. Further staff reductions are planned for corporate services, such as information technology, human resources and accounting. In addition, El Paso’s Pipeline, Field Services and Production segments have been instructed to review their cost structures, and “we will see head-count reductions there” before the end of summer, she noted. These actions are expected to result in $300 million in cost savings for the company.

El Paso’s plan “obviously has the effect of reducing earnings and [to] some degree reducing growth rate, but we think what we get back for that is a substantial reduction in business risk and a real enhancement of the credit profile of the company,” Eads said.

El Paso cut its projected range for pro forma earnings per share to $2.60-$2.75 in 2002, and to $2.75-$2.90 in 2003, due to lower earnings anticipated from Merchant Energy related to the downsizing of the trading staff, and a decline in margins at the company’s Aruba refinery. El Paso officials warned analysts that the second-quarter results for trading and marketing will be “very weak” partly because of the cuts in its trading staff. Also, Eads said that $120 million in trading transactions, which were booked during the second quarter, will not be recognized as earnings because of a change in the way the company now reports its earnings.

However, Wise vowed that El Paso’s earnings picture will change. “I think that we can…tell you that we’ll be on the double-digit earnings growth track” within the next five years. On the credit front, these new changes will “absolutely cement” a solid investment grade rating for El Paso going forward, he said.

Meanwhile on Wall Street, El Paso’s stock took a bashing after the company disclosed its scaled-back earnings projections and business plans, falling at one point last week to $24.40, setting a new 52-week low for the company’s stock. The company’s stock began to regain some strength Friday, rising to $25.77 a share in mid-day trading. The 52-week high for El Paso shares is $60.90.

Moody’s Investors Service appeared to be one of the few supporters of El Paso’s game plan. It responded by confirming its rating of Baa2 for $15 billion of senior unsecured debt for the corporation and its subsidiaries, with a stable outlook. Moody’s said it believed the steps announced by El Paso were “positive,” although it acknowledged there was “execution risk.” El Paso “has the ability to make significant near-term progress, since many elements of the plan are within [its] control,” the ratings agency noted. It said it will “closely monitor” El Paso’s progress, and will “assess [the] medium-term financial implications in more detail” at a later time.

“We believe that our trading business has grown into a business that is too large for [the] credit available within the El Paso corporation balance sheet,” Wise told investors. “The value that we get in our stock from our earnings out of the trading business is very unquantifiable, and there’s a very good argument with the increasingly large doses of mark-to-market earnings that we are actually getting negative value on our stock as a result of our trading business.” He noted an “important objective” of the company was to limit its mark-to-market earnings to 5% or less of its total earnings stream.

“We’re going to draw a circle around the trading business, and we’re going to limit our call on credit…and our investment in that business,” he noted. On top of the cost savings from staff reductions, Wise estimated that capital investment in El Paso’s trading activities will be cut to $1 billion. Under the company’s plan, Merchant Energy will include three divisions — Power, Petroleum and LNG, and Energy Trading. “We will move directionally toward separation” of these businesses.

In anticipation of the cut in trading staff, Wise said the company has “quietly” been shrinking its trading book from $1 billion to about $800 million. He noted El Paso plans to “zero in on the highest value part” of the energy trading business in the future.

As part of its efforts to reposition the company and improve its credit, Wise said the company also will issue “sooner rather than later” $1.5 billion of equity securities, and sell its San Juan Basin natural gas gathering assets to El Paso Energy Partners for an estimated $800 million. Negotiations currently are under way, he noted. The $1.5 billion in securities are at the center of El Paso’s plan to cut more than $2 billion in overall company debt.

With the savings from staff reductions and other actions, El Paso intends to take advantage of the “tremendous opportunities in our core natural gas businesses,” said Wise. Specifically, it will increase capital expenditures for its E&P business to $2.3 billion in both 2002 and 2003, and expand its LNG operations. Currently, he noted that El Paso has about 20-25% of LNG market share, and intends to capture an “ever-increasing share” of it. In addition, the company is “very aggressively pursuing” its pipeline and midstream operations.

“We’ve got, we think, the best E&P [operation]” in the business, noted Wise, adding that it “is just knocking the socks off” of its competitors. In addition, the company’s LNG strategy “is maturing,” he said. It had a “terrific first part of this year.”

Wise also indicated that El Paso will hedge less of its gas production in the future. “We are below 50% going forward. That is what you should expect, somewhere below 50% of our 12-month rolling forward production [to be] hedged,” he said. “We don’t think we were getting any value in our stock by hedging our production,” he noted, “so we’re exposing ourselves more to the commodity going forward.”

Overall, “we have reduced [our] net capital expenditures to $3 billion. And we’re going to continue on that even with the $2.3 billion of capex that we’re putting into E&P in 2002,” according to Wise.

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