In a letter to employees last Monday, which was later filed with the Securities and Exchange Commission (SEC), El Paso Corp. Chairman William Wise attempted to dispel any fears that the energy giant was in danger of crumbling, assuring workers it had about $1.5 billion of readily available cash, a balance sheet and credit profile that were “strong and improving,” an investment grade credit rating, and “adequate financial resources” to meet all of the company’s obligations and to maintain “profitable operations” during the current crisis facing the industry. Although the company was tested with the rest of the merchant energy sector last week, El Paso weathered the storm better than many others.

“While it is difficult to watch our stock price decline and to read about negative news about our industry and sometimes about our company, we can all be proud of El Paso Corporation…,” Wise said. “I cannot tell you when [a] recovery will begin or how our stock will react to future events, but I can tell you we will continue to find, produce and transport natural gas to market every day.”

The day after Wise made those comments, El Paso’s accounting for results from restructured power contracts was in the headlines again in the Wall Street Journal and The New York Times, and investors avoided EP shares like the plague in reaction to the news. El Paso’s stock plummeted 23% to $10.40, only a day after UBS Warburg raised its stock rating on the company to “Strong Buy.”

The newspaper articles rehashed old news about, among other things, concerns related to the way El Paso managed off-balance sheet partnerships and booked future earnings up front from restructured long-term bulk power sales agreements. The concerns were raised recently by former Coastal Corp. CEO and large El Paso shareholder Oscar Wyatt, who sent letters about the issues to El Paso, the Securities and Exchange Commission and members of Congress.

Wyatt charged that the accounting used for certain transactions by El Paso’s Merchant Energy Group “discounted future earnings to report current earnings.” The strategy involved buying up power plants, renegotiating the sales agreements with utility companies based on power market purchases and hedging, and then reselling those securitized income streams, much like banks do with home mortgages. The sales enabled El Paso to book the entire earnings from multiyear agreements up front (mark-to-market). Meanwhile, the power plants were placed under a partnership structure that initially allowed the company to shield itself from the debt.

Wyatt questioned the use of a number of off-balance sheet partnerships to hide debt and other financial details. El Paso Corp. subsequently made an 8-K filing with the Securities and Exchange Commission in which CEO William Wise defended his company’s transactions and partnerships in a point-by-point rebuttal.

UBS Warburg analyst Ronald J. Barone defended the company last week in an equity notice saying the newspapers were digging up old news that really provided no smoking gun. Barone said the company engaged in “legitimate accounting” on Project Electron and other transactions. In addition is has decided to limit its mark-to-market activities to less than 10% of its annual recurring earnings going forward.

“With these [newspaper] articles now on the table, we believe EP shares have one less hurdle to pass,” Barone added, still maintaining his “Strong Buy” on the company, particularly after it lost 23% of its value on Tuesday. “Overall, we believe El Paso would be worth materially more if it was shut down today than where it is currently trading — 5.3x what we view as a highly realistic recurring 2003 projection (without liquidity concerns that could derail that projection).”

Standard and Poor’s (S&P) said it found nothing new in the newspaper reports and reaffirmed El Paso’s “BBB+/Stable/A2” credit ratings, despite the sharp downturn in its stock and in investor sentiment.

In a statement issued Tuesday, S&P said it identified “no fundamental change in the credit quality of El Paso given heightened uncertainty over ‘wash trades’ in the industry or negative press from outside shareholders.” S&P discussed El Paso’s accounting methods, but found nothing new that would impact credit ratings.

The potential negative impact from any off-balance sheet items could hinder El Paso’s credit protection measures, S&P admitted, “but not to a level that warrants a change in the company’s rating or outlook.”

“El Paso is expected to maintain its strengthened financial profile even if the current industry turmoil passes,” S&P said. El Paso’s debt leverage and funds to interest converge ratios “are more than adequate for current ratings.” S&P reiterated that El Paso’s liquidity also is adequate, with $4 billion of credit facility capacity supporting the ability to issue up to $3 billion of commercial paper. “With the elimination of rating and stock price triggers on all but $300 million of the company’s financings, and the declaration to limit working capital investment in its merchant energy group to $1 billion, S&P believes that El Paso has an ample liquidity cushion.”

S&P said it believes El Paso “will continue to maintain its strengthened financial profile and commitment to credit quality, and would further bolster itself, if necessary, to endure any additional credit concerns.” It also said it does not expect the ongoing cases at the Federal Energy Regulatory Commission to affect the parent company’s credit quality.

“El Paso’s multiple equity issuances and growing pool of asset sale proceeds at a time when many of its peers still have not yet completed their equity sales in the face of extremely depressed equity prices in the sector, and when many companies have either just identified the assets they will sell or have just started the sales process, exemplifies why El Paso’s rating has held up in a storm of credit uncertainty in 2002,” S&P said.

The company has completed or planned more than $3 billion in asset sales, raised or plans to raise a total of about $2.4 billion from equity issuances, downsized its trading operations, and reduced its costs by more than $300 million. Wise said the current value of El Paso’s energy assets is $48 billion.

Last week the company announced the pending sale of another package of assets. A total of $782 million in assets were to be sold to El Paso Energy Partners LP. The biggest piece was El Paso’s vast 6,000-mile natural gas gathering network which gathers 1.1 Bcf/d in the San Juan Basin in New Mexico. Other assets include the 60 MMcf/d Rattlesnake Treating Plant located in San Juan Basin, and a 50% interest in the 250 MMcf/d Coyote Gulch Treating facility in southern Colorado. Both plants extract carbon dioxide from local coal seam gas production.

In addition, El Paso Energy Partners will acquire an integrated set of NGL assets stretching from the Mexico border near McAllen, TX, to Houston, including more than 650 miles of pipelines with a capacity of 80,000 b/d, a 24,000 b/d NGL fractionator located in Houston, a truck loading terminal near McAllen, and 13.6 million barrels of underground NGL storage.

Included in the deal as well will be the Typhoon offshore oil and gas gathering pipelines that extend into the Gulf of Mexico Deepwater Trend to ChevronTexaco and BHP-Billiton’s Typhoon discovery in Green Canyon Block 237. The Typhoon oil pipeline currently gathers about 40,000 b/d of production, while the Typhoon gas pipeline gathers over 45 MMcf/d. The Typhoon gas gathering system will be eventually integrated into the partnership’s Marco Polo gas gathering system, which is to be built in 2003 to serve Anadarko Petroleum’s Marco Polo discovery located in Green Canyon Block 608. The transaction is subject to El Paso Energy Partners receiving Hart-Scott-Rodino antitrust approval and financing satisfactory to the partnership. It said it expects to close the deal during the fourth quarter of this year.

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