Embattled El Paso Corp. reported Friday it closed out the third quarter in the red, and will begin winding down its ailing energy trading business in an effort to resuscitate the company. The Houston-based company said exiting trading could take up to two years, and would result in an as-yet undetermined number of lay-offs.

The energy giant posted a net loss of $69 million, or minus 12 cents per diluted share, for the third quarter compared to earnings of $211 million, or 41 cents per diluted share, for the year-earlier period. The results included a loss of $36 million for the company’s discontinued coal operations, a charge of $22 million on asset sales and $193 million in non-recurring charges and income from discontinued operations.

El Paso’s per-share performance for the quarter was substantially below Wall Street’s consensus of 27 cents/share for the company, as reported by the research firm Thomson Financial First Call. The company’s stock continued to take a beating in the wake of the earnings’ report, falling by $1.34/share to trade at $7.86 late Friday.

Despite the third-quarter drubbing, El Paso reported it was financially healthier on a year-to-date basis, with a net income of $269 million, or 49 cents per diluted share, for the nine-month period, compared to a loss of $282 million, or minus 56 cents per diluted share, for the same period in 2001.

“While overall earnings were hurt by weak trading and refining results, our core businesses of pipelines, production, midstream and power produced strong earnings and cash flow in a difficult quarter,” said El Paso Chairman William A. Wise. “Our core businesses alone generated third-quarter earnings per share of approximately $0.33 after deducting 100% of our financing and corporate/other expenses. We are moving aggressively to rationalize our weaker businesses and are announcing today a plan to exit energy trading.”

Wise estimated the actual winding down of the energy business will take 18 to 24 months. The company would not say how many trading employees would be affected by the move, although The Houston Chronicle reported El Paso plans to lay off about 200 workers. “We’re evaluating that. We’re still in the developmental stages of our plan to exit that business,” an El Paso spokesman told NGI. The planned cutbacks would be in addition to the 300 traders El Paso began laying off in late May (See NGI, June 3)

As a first step, El Paso said it plans to liquidate its trading portfolio, which has a net asset value of $968 million, and separate the credit and balance demands of trading from the rest of the corporation by transferring the bulk of the portfolio to a new subsidiary, Travis Energy Services LLC. It said it has asked the major credit rating agencies to rate Travis Energy separately, and is seeking an investment-grade rating for Travis.

El Paso said it expects to finance the liquidation of Travis Energy’s trading portfolio by obtaining credit facilities valued at approximately $600 million. The company noted it currently is actively negotiating with lenders to provide the funding, and intends to pledge the cash flow from liquidating its trading portfolio and 50% stakes in Citrus Corp., which owns Florida Gas Transmission, and Great Lakes Gas Transmission as collateral for the $600 million in credit. The company’s decision to withdraw from energy trading will result in an after-tax charge of $400-$600 million in the fourth quarter, it noted.

The response of the credit rating agencies to El Paso’s plans to exit trading “has been very positive,” Wise told industry analysts during a conference call Friday.

The company reported its energy trading operations contributed $336 million less during the third quarter than in the comparable period last year, largely due to the credit concerns in the market and the new prohibition against mark-to-market accounting of certain energy contracts. Without the accounting change, trading would have posted an additional $96 million in earnings during the quarter, El Paso said.

El Paso deferred its revised earnings and cash flow guidance for the year and 2003 for six weeks, saying it first had to complete its annual budget process and a review of the impact of the new accounting rules on energy contracts. Wall Street analysts have projected average earnings of $1.96/share for the company in 2002, but El Paso will be hard-pressed to meet the target.

The company put its available cash liquidity at $4.5 billion, including $1.3 billion of immediately available cash, a $3 billion, 364-day bank revolver and a $1 billion multiple-year bank revolver.

On a segment basis, El Paso’s pipeline group saw earnings before interest and taxes (EBIT) rise 11% to $302 million in the third quarter from $274 million for the comparable period in 2001. The company credited the increase to its expansions, reactivation of the Elba Island liquefied natural gas (LNG) facility, lower operating expenses and a $14 million favorable resolution of a processing issue. It noted that all of its pipelines had solid increases in throughput during the quarter, with the exception of El Paso Natural Gas, which experienced an 11% decline due to a sharp reduction in gas demand from California power generation plants this year.

Despite a drop in production, El Paso’s production operations had an EBIT of $179 million for the third quarter, up from $169 million for the same period a year ago. The 2001 results were negatively affected by a $135 million ceiling test charge and a $3 million merger-related charge, the company noted. Third-quarter production fell 14% from 2001 levels due to the sale of about 1 Tcf of natural gas equivalent proved reserves during the first nine months, as well as the loss of some wells in South Texas and shut-in production due to Hurricane Isadore.

The company said the realized price for gas dropped to $3.21/Mcf during the third quarter from $3.46/Mcf a year ago, while the realized price for oil, condensate and liquids rose to $22.19 per barrel from $21.62. It noted it has hedged approximately 50% of its expected gas production for the fourth quarter of this year at the New York Mercantile Exchange (Nymex) price of $4.15/Mcf, 38% of expected 2003 production at the Nymex price of $2.70/Mcf, and 13% of expected 2004 production at the Nymex price of $2.70/Mcf. It said it expects the realized price for gas to be 35-40 cents less than the Nymex per Mcf price due to transportation costs and regional price differentials.

El Paso’s Field Services’ operations posted a third-quarter loss of $11 million, down from $43 million in EBIT for the comparable period a year ago, due mostly to a $48 million loss on an asset sale. It noted that gathering and transportation rates improved during the quarter as a result of the sale of Field Services’ Texas intrastate gas transmission system to El Paso Energy Partners. However, gathering and transportation volumes fell significantly to 2,209 BBtu/d from 6,177 BBtu/d during the third quarter of 2001. In addition, processing volumes dropped to 3,883 BBtu/d during the third quarter of this year from 4,551 BBtu/d a year ago.

The Merchant Energy Group saw a third-quarter loss of $171 million compared with an EBIT of $253 million for the comparable period in 2001, reflecting lower income from trading and petroleum refining activities, as well as the change in the rules for mark-to-market accounting of certain energy contracts.

A major drag on the corporation’s overall earnings has been a high-profile complaint case pending at the Federal Energy Regulatory Commission, where an agency judge found that El Paso Natural Gas withheld substantial amounts of transportation capacity from California during the state’s energy crisis to ratchet up gas prices. FERC has scheduled oral arguments for Dec. 2 so both sides — El Paso and the California Public Utilities Commission — can argue the merits of the case before the full Commission.

Asked if he will personally argue El Paso’s case, Wise said, “I think that that’s still being discussed, but that’s not likely.” He assured analysts that “no matter” how FERC decides the case, it will be headed for the U.S. Court of Appeals in the District of Columbia.

In an effort to turn El Paso around, Wise said the company has “announced or completed” $3.6 billion of asset sales so far this year, and expects to exceed its target of $4 billion by the end of the year. Just last week, El Paso agreed to sell 600 Bcfe of natural gas reserves in the Uintah Basin, with current output of about 80 MMcf/d, and a Utah natural gas gathering system to Denver-based independent producer,Westport Resources Corp., for $502 million. The transaction is expected to close next month.

El Paso Production Co., El Paso Field Services and other affiliates will sell substantially all of their natural gas assets in the Uintah Basin of northeastern Utah, including interests in the Natural Buttes and Ouray Fields. The assets include interests in about 1,070 wells (800 of which are operated by the company) on 240,000 net leasehold acres. Current net daily production from these wells is 80 MMcfe/d, with additional upside drilling potential.

Also included were 240 miles of gathering pipelines with a capacity of about 200 MMcf/d and a current throughput averaging 150 MMcf/d. Gas gathered through the system is delivered to Colorado Interstate Gas (CIG) pipeline, another El Paso subsidiary. Westport Resources plans to fund the transaction initially with debt and is currently evaluating additional financing options, including the sale of assets, securing a partner for a portion of the acquisition and issuance of equity or other capital markets transactions.

For El Paso, the deal is only the latest sale in a string of transactions. The company recently sold substantially all of Coastal Coal’s reserves at its Kingwood operation in West Virginia, and at Virginia Iron, Coal and Coke in Virginia and its land business based in Hazard, KY, to an affiliate of Natural Resource Partners LP (NRP) for $69 million. Coastal Coal, an El Paso subsidiary, is based in Roanoke, VA.

The deal includes mineral rights to 120 millions tons of coal reserves. Natural Resource CEO Corbin J. Robertson Jr. said it was the company’s first acquisition since becoming a publicly held partnership.

El Paso also sold its LNG capacity at the Cove Point, MD terminal and LNG supply in northern Norway to Statoil for $250 million, and last week El Paso Merchant Energy Group sold a 213 MW gas-fired power plant in Brush, CO, to a subsidiary of MDU Resources Group. It also completed the sale of the 300 MW ManChief gas-fired power plant, also in Brush, CO, to TransCanada PipeLines for $127 million.

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