Following its announcement to buy two Texas properties on Monday (see Daily GPI, Feb. 1), Moody’s Investors Service analysts affirmed the stable rating outlook of El Paso Corp.’s production holding unit, pending a review of the company’s 4Q2004 and year-end 2004 results.

“The acquisitions mark El Paso Holding Co.’s (EPPH) initial acquisitions since its 2003-2004 difficulties as EP works to stem production decline, replenish its drilling inventory, and add to existing regional holdings,” said Moody’s analysts. “On the other hand, a low 41% of acquired reserves is proven developed (PD) reserves and the acquisition package is expensive by historic standards as recent as 2003 and early 2004, and follow second half 2004 sector up-cycle acquisition price trends.”

According to El Paso’s internal estimates, the acquisitions include a “small 8.5 MMboe of PD reserves, 12.2 MMboe of proven undeveloped reserves (for a combined 20.7 MMboe of total proven reserves), and 3,333 boe of daily production. Combined, EPPH paid a very high $24.82/boe for the PD reserves.”

Moody’s noted that “substantial development capital spending (undisclosed at this point) will be needed to take the proven undeveloped reserves to production. Assuming that equates to $7/boe to $8/boe of proven undeveloped reserves (reasonable, if not conservative, in today’s drilling and services market), the all-in cost of the acquisition would approximate $295 million to $310 million. Under that assumption, EPPH would be paying a high $14.25/boe to $15/boe for the acquired proven reserves.”

Analysts said that the acquisitions “potentially may prove to be an important step” in the production unit’s turnaround, however, they are not initially credit accretive. “Sustained post-acquisition drilling success on the proven undeveloped, probable, and possible drilling locations will be needed for the acquisition to drive credit accretion in the future.”

The analysts noted that it is possible that El Paso’s “B3” rating “could eventually be notched below the senior implied rating” if El Paso “executes a significant amount of acquisitions funded with secured debt. While Moody’s views such activity to be central to EPPH’s effort to regain momentum and moderate extremely high reserve replacement costs, the notes could face increasing and perhaps substantial effective subordination to secured debt.”

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