Hoping for higher natural gas prices is not a strategy for El Paso Corp., CEO Doug Foshee said Friday. Instead, his company plans to use substantial hedges, a liquid balance sheet and flexible spending to guard against an uncertain future.

Even with a down economy and a plunge in gas prices, El Paso managed to maintain momentum and keep its financial position strong, Foshee told financial analysts during a conference call. “Both of our business units performed ahead of expectations for the quarter,” he said. The Houston-based company posted almost $1 billion in noncash losses in 1Q2009, but the company’s operational results sparked a stock rally on Friday, with its share price jumping almost 18% Friday, to close at $9.03, a gain of $1.36 in one of the New York Stock Exchange’s biggest rallies in months.

The investor enthusiasm came despite El Paso reporting a net loss of $978 million (minus $1.41/share), versus profit of $200 million (29 cents) in the year-ago period. Excluding $1.3 billion ($1.92) on the noncash charges related to the ceiling test of its exploration and production (E&P) assets, the company posted adjusted earnings of 47 cents/share — well above the 27 cents/share consensus forecast by Wall Street.

“We see two key drivers in the business today: natural gas prices and capital markets availability,” Foshee told analysts. “Almost every viable projection puts gas prices outside the normal range. “The U.S. market is oversupplied by over 4 Bcf/d. Activity levels have dropped at an unprecedented rate, but supply hasn’t yet responded.”As much as 9 Bcf/d between now and 2010 is set to come on line for liquefied natural gas liquefaction, and as much as 10,000 MW of new coal-fired power between now and 2011,” he said. “Industry demand now has recovered somewhat, largely due to fertilizer production. Overlaying this, is where the U.S. economy will go and more important, where the global economy is headed.”

Because of its vast U.S. gas pipeline system and E&P unit, “we have as good a handle on what’s going on in the gas markets as anybody,” said the CEO. “In the longer term, beyond 2011, evidence suggests there is a case for natural gas still really strong in the carbon-constrained world when emission comes into play…Natural gas is naturally advantaged…In the shorter term, our crystal ball is very fuzzy…We are predicting low gas prices for a sustained period of time, but the probability of lower gas prices going forward has risen in the last six months…This quarter we added to hedge our production prices materially for 2010 and 2011 very substantially to the proportion of what we expect to produce in 2010 in a constrained spending environment.”

How El Paso deals with gas prices and capital markets “is key to making our strategy work,” said Foshee. “That strategy is pretty simple. We have something very few of our competitors have in this environment: a clear path to long-term growth. We just have to execute it successfully. I don’t think hoping for natural gas to be higher is much of a strategy. We won’t spend incremental drilling dollars today on the hope of receiving $7 in a cash market because the market will contract in the second half of the year. There are too many risks…We plan to keep our balance sheet strong and able to fund our businesses…”

To ensure that it has some firepower, El Paso has put natural gas hedges in place through 2009 with an average floor price of $9.02/MMBtu on 120 trillion Btu, and an average ceiling price of $14.35/MMBtu on 96 trillion Btu. In addition, the company entered into fixed-price hedges on 1.5 million bbl of crude oil with an average price of $45/bbl. El Paso has around 1.35 million bbl of crude oil hedged at $45 through 2009.

El Paso also expanded its 2010 natural gas hedge position with an average floor price of $6.41/MMBtu on 175 trillion Btu and an average ceiling price of $7.24/MMBtu on 113 trillion Btu. The company established a 2011 natural gas hedge position, locking in 125 trillion Btu with an average floor price of $6/MMBtu and an average ceiling price of $8.62/MMBtu.

The gas pipeline unit realized a 4% increase in earnings in the quarter to $396 million from $381 million in 1Q2008, propelled by revenue from new projects. Incremental revenues came from several expansion projects that went into service in 2008 and higher capacity sales in the Rocky Mountain region and on the El Paso Natural Gas Pipeline and Tennessee Gas Pipeline systems. And despite a drop in gas demand from the industrial sector, total pipeline throughput rose to 19,704 billion Btu/d from 19,321 a year ago.

Among other things, El Paso made “significant progress to fund the backlog” of pipeline projects in the quarter and is close to securing a partner for its proposed Ruby Pipeline Project. The pipeline, which would carry gas supplies from the Rockies to West Coast markets, has come under fire by some energy analysts who question whether it’s viable. But company officials, for the second time in a week, reiterated their support (see Daily GPI, May 5).

“We’re in the late innings to select a Ruby partner, and I expect we’ll have news to report soon,” said Foshee.

On the ceiling test charges, El Paso’s E&P business lost $1.7 billion in the quarter, compared with profits of $242 million in 1Q2008. E&P gas volumes fell 10% from a year ago to 803 MMcfe/d from 886 MMcfe/d, but volumes were up 7% from 4Q2008.

“We’re in a totally different environment than we were a year ago,” E&P chief Brent Smolik told analysts.

Gas-weighted production grew 7% from 4Q2008, but Smolik noted that during the first three months of 2009, most of the shut-in output in the Gulf of Mexico was back on line. Otherwise, the E&P drilling operations have been scaled back. “We’re developing wells as efficiently as our peers, with a more intense focus on prices, which are down faster than costs.”

To make the E&P unit more efficient, El Paso reorganized its four operating areas to three by combining its Gulf Coast and Gulf of Mexico onshore and offshore operations, Smolik explained. The company did not detail if there were job losses associated with the combination.

El Paso’s E&P budget is flexible enough to expand its onshore drilling program, especially in the Haynesville Shale or the Cotton Valley trend, if gas prices take off, Smolik said. “We could be down to five or six rigs or as high as 15 this year, depending on costs” and gas prices. If gas prices fail to gain any strength, “we’ll continue to reduce our capital levels.”

Service costs “need to come down more to increase the rig count later this year,” Smolik said. “We are drilling only a fraction of our inventory, but we’re preserving the inventory while we throttle back the drilling program.”

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