El Paso Corp. reported a less-than-stellar third quarter earnings report last week, continuing a long-term plan to get debt levels in check without starving its remaining core businesses. CEO Doug Foshee stressed that the company is on track to divest $3.4 billion of assets by the end of this year, but said that going forward, “we won’t be able to sell our way to prosperity. We have to grow our core businesses.”

The company reported quarterly losses last week that were more than double those from the same period a year ago. Overall, El Paso reported a loss of $146 million (minus 24 cents/share), compared with a loss of $69 million (minus 12 cents) for the third quarter of 2002. Continuing operations lost $97 million (minus 16 cents/share), but excluding asset impairments and other items, the loss was $6 million (minus 1 cent), compared with adjusted earnings from continuing operations of $54 million (9 cents/share) a year ago. The loss fell 2 cents shy of Wall Street’s expectations, based on a Thomson First Call survey of 11 analysts.

Foshee, the former Halliburton operating chief who took over two months ago, said the Houston-based company is well ahead of its plan to reduce debt and improve liquidity, but he said there is still a lot of work ahead.

“We continued to show progress on debt reduction and liquidity in the quarter,” said Foshee. “In addition, we’re on track to meet our asset sales goal for the year. Unfortunately, a good quarter in the pipeline and midstream areas was offset by disappointing results in E&P as we continue to rationalize this business.

“My first two months at El Paso confirm my belief that while we have significant challenges still ahead, our people and our core assets will allow us to restore the long-term earnings power of the company and restore our balance sheet. I look forward to sharing in more detail later this year our plan for the future.”

However, several analysts were unimpressed with results, especially those within El Paso’s sagging exploration and production (E&P) unit, which reported a 42% drop in earnings for the quarter. The poor earnings may have spurred the resignation on Friday of Rodney D. Erskine, president of El Paso Production Co. Randy L. Bartley, the subsidiary’s COO, was named as interim president until a replacement is found. El Paso said it had initiated a search process that would consider internal and external candidates.

Erskine’s departure followed criticism from Curt Launer, an analyst with Credit Suisse First Boston (CSFB), who said “E&P results, primarily on lower production of natural gas and higher expenses were disappointing.”

Launer suggested that the company’s “need for ongoing debt reduction provides more impetus for a partial sale or spin-off scenario for the E&P unit.” CSFB noted that “with almost 25% or about 76 Bcf of ’04 production hedged at $2.65/Mcf and higher finding costs, we have reduced our outlook for E&P and continue to view the unit as a cash flow user in ’04. This scenario clearly limits El Paso’s ability to pay down debt and impedes El Paso’s balance sheet recovery plan.”

Credit Lyonnais Securities analyst Gordon Howald said the E&P decline was a “big issue and the fall-off in production is pretty dramatic. It doesn’t give me a tremendous amount of comfort for what they can achieve in that business in 2004.” And Moody’s Investors Service reduced its ratings outlook on El Paso to negative from stable, mostly because of the fall off in E&P. John Diaz, managing director of Moody’s Corporate Finance unit said El Paso’s “74% production concentration in very short-lived reserves, the nature of its development and exploration base, and its capital available for reinvestment in that base could be insufficient to sustain reserves, production and capital costs suitable for the ratings.”

Moody’s negative outlook won’t change, he said, until “sustainable production, proven developed reserves and total unit-full cycle costs can be reliably gauged.”

Growth of the remaining core businesses, particularly its reduced E&P segment, may be of particular concern to Foshee’s team. Operating income from E&P fell to $101 million, down from $179 million for the same period of 2002. Third quarter equivalent production dropped 32%, which El Paso blamed on the sale of nearly 1.6 Tcfe of proved reserves since a year ago, normal declines in base production and mechanical failures on some of its wells.

Natural gas sales volumes in the quarter totaled 80 Bcf, compared with 120 Bcf for the third quarter of 2002. Oil, condensate and liquids sales volumes totaled 2.891 billion bbl, compared with 3.986 billion bbl in last year’s third quarter. Total equivalent sales volumes were 97.77 Bcfe, compared with 144 Bcfe in 3Q02.

However, the company has taken a page from some of the smaller U.S. independent producers, and is shifting more of its E&P budget to coalbed methane (CBM) properties. CBM will account for 10% of El Paso’s total E&P budget in 2003, which is twice what it spent on CBM in 2002. In 2004, El Paso projects it again will double its CBM spending to 20% of the total E&P budget. As executives pointed out during a conference call Monday, CBM production is proving to be extremely predictable, stable income.

The Merchant Energy Group, another costly quarterly item, lost $37 million in the quarter, compared with an $83 million loss for the same period of 2002. Since early this year, the company has liquidated its European trading portfolio as well as its coal, currency and interest rate books. The merchant unit has cut its transportation capacity by 57%, while storage capacity has been trimmed by 84%. However, the cutbacks still weren’t enough to carry it out of the loss category.

Trading operations losses also hurt El Paso’s bottom line, with losses totaling $73 million , which was more than double the $33 million in losses from a year ago. El Paso blamed the losses on a decrease in fair value of derivative contracts and losses on accrual transactions, primarily related to transportation and storage demand charges not recovered during the quarter, $11 million of accretion for the western energy settlement, and $29 million of various expenses.

The LNG and “Other” category lost $8 million in the quarter, versus income of $20 million last year. The decrease, said El Paso, came from mark-to-market income from the execution of the Snohvit LNG supply contract in 2002 and mark-to-market losses on LNG supply contracts in 2003.

Going forward for Merchant Energy, El Paso projected that 70% of its forward trading contracts will roll off by the end of 2004. And the trading book will be 44% smaller by the end of 2003, and another 26% of the contracts also expire next year. The unit recovered $400 million in cash collateral during the third quarter, which brings total collateral down to $1.2 billion. Of that amount, $500 million is in cash.

Pipeline Group earnings were just under those from a year ago, with $301 million compared with $302 million. Losses were partially offset by completed system expansions and new transportation contracts, primarily on the Colorado Interstate Gas Co. and Southern Natural Gas Co. pipeline systems. Third quarter system throughput was down from 2002 levels as cooler summer weather and higher natural gas prices reduced demand.

Field Services reported $33 million in quarterly earnings, well ahead of last year’s $11 million loss. However, after adjusting for items, quarterly earnings were lower than a year ago because of the sale of midstream assets in the Mid Continent and northern Louisiana, offset by earnings from GulfTerra and reduced expenses.

As of Sept. 30, El Paso had $2.0 billion of available cash and lines of credit, consisting of $1.3 billion of readily available cash and $0.7 billion of lines of credit. The company also had $1.6 billion of total cash.

©Copyright 2003 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.