El Paso share prices were volatile last week fluctuating between the high $6s and $10/share, in response to a Standard and Poor’s downgrade and a New Mexico grand jury subpoena for documents in connection with a pipeline explosion on the El Paso Natural Gas South Mainline system that killed 12 members of two extended families in August 2000.

Despite EP’s continuing troubles, including its announcement Nov. 8 of a third quarter net loss of $69 million and plans to exit energy trading, Curt Launer of Credit Suisse First Boston still has an “Outperform” rating on El Paso stock. Launer has a 12-month target price on El Paso of $18/share apparently on the bet FERC will rule in the company’s favor in the California market manipulation case. “We believe that EP shares have been penalized by as much as $6 billion or $10 per share because of the FERC risk,” Launer said in a research note.

In spite of Launer’s optimism, S&P still has El Paso on CreditWatch with negative implications and said in its review last week that the company could fall deep into junk levels if FERC sides with an administrative law judge, who already concluded that the company manipulated the California natural gas market. In addition, shareholders also should expect a $400-600 million fourth quarter special charge because of the shutdown of energy trading, the company warned in its third quarter earnings report.

S&P ratings on El Paso Corp. were cut last week to ‘BBB’ from ‘BBB+.’ The ratings on the company’s senior unsecured debt were cut to one notch above junk at ‘BBB-‘ from BBB, and the company’s commercial paper rating was lowered to ‘A-3′ from A-2’.

S&P said its rating actions were in response to El Paso’s $17 billion in debt burden and the declining expectations from the company’s energy trading business. Cash flow from El Paso’s assets (pipeline, exploration and production, gathering and processing, and power) provides debt-service coverages more commensurate with the ‘BBB’ corporate credit rating, S&P said. “This is reflective of the company’s high debt balance, which has risen in recent years due to investments in myriad businesses.

“Of concern is the expectation that cash flow from the company’s trading and marketing unit will be minimal, if any, over the next few years due to an increasingly poor energy trading environment,” S&P said. “The company has also decided to seek to carve away its energy trading book into a new entity, Travis Energy Services LLC, in an effort to liquidate its positions. Standard & Poor’s expects to review El Paso’s plan to exit the trading arena and its potential effect on credit quality.”

While S&P said El Paso has strengthened itself “remarkably well” since Enron Corp.’s bankruptcy by lowering its risk, reducing debt, issuing equity, and improving liquidity, the “extreme turmoil in the energy sector has caused a decline in credit quality for many top industry participants and a fundamental change in the energy trading and marketing industry, all of which has forced El Paso to take many actions that have ultimately affected cash flow to the point where ratings have been affected.”

S&P also sees “sizable execution risk” in El Paso’s debt-reduction program, which is necessary to maintain the pace of the company’s attempt to improve its financial profile and maintain adequate liquidity. El Paso expects to sell $4 billion in assets in 2002, and $2 billion more in 2003. To date its asset sales have been quick and successful, S&P noted, but also “absolutely necessary to account for the company’s cash flow shortfall (expected at about $2.8 billion) less its capital spending ($3 billion) and dividend requirements ($500 million) in 2003.”

S&P added that El Paso’s future credit ratings also will depend upon the outcome of the ongoing investigation by FERC into market manipulation in California. A negative ruling by the Commission with fines for withholding capacity and exercising market power in California “could have a potentially dire effect because the company could then be exposed to a sizable, but unknown, amount of liabilities, as well as any potential fines and/or potential change in regulatory oversight,” S&P said. “This outcome would likely cause El Paso’s corporate credit rating to be lowered into the ‘BB’ category, or potentially lower, depending on the degree of exposure the company would face as well as the length of time it potentially would not have access to capital markets.”

El Paso also could face liabilities from the New Mexico grand jury investigation into the pipeline blast. The pipeline received the subpoena on Nov. 1, and intends to “cooperate fully” with the request for documents, the company said in its third quarter 10-Q filing submitted to the SEC. Twelve victims were killed while they were fishing and camping alongside the Pecos River near Carlsbad, NM, the site of the rupture and explosion on El Paso’s South Mainline system on Aug. 19, 2000. They were consumed in a blast and fireball that ripped open a 113-foot-long and 51-foot-deep trench, and left a mass of twisted metal (see Daily GPI, Aug. 22, 2000).

The NTSB still is investigating the cause of the fatal explosion and may release its final findings before the end of the year. In late June, the NTSB issued a series of factual reports that appeared to confirm federal investigators’ initial suspicions of substantial internal corrosion as the cause. It found “severe corrosion damage” on the bottom of the interior of the 1950s-vintage pipeline near the explosion site (see Daily GPI, June 21).

In June 2001, the Department of Transportation’s Office of Pipeline Safety (OPS) cited El Paso for several “probable violations” of the federal pipeline safety regulations in connection with the blast, and proposed a record fine of $2.5 million. El Paso has disputed the agency’s claims.

El Paso was hit with a number of multi-million-dollar personal injury and wrongful death lawsuits in the wake of the explosion. “All but one of these suits have been settled. The settlement payments have been fully covered by insurance,” it said in the SEC filing. The pipeline also said it has agreed to contribute $10 million to a “charitable foundation as a memorial to the families involved.”

Despite the myriad investigations and bleak outlook, S&P said last week that it believes El Paso’s liquidity position is “ample” to meet its obligations. Its liquidity is buoyed by a $4 billion credit facility backstopping minimal commercial paper borrowings, and cash and cash equivalents of $1.3 billion. Asset sale proceeds of nearly $4 billion are expected through 2003. S&P believes El Paso should have “no difficulty” in meeting debt maturities of about $240 million in 2002 and $1.7 billion in 2003. With the elimination of rating and stock price triggers on all but $300 million of the company’s financings, El Paso’s liquidity cushion is adequate.

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