El Paso Corp.’s credit ratings teeter on the edge of junk status after a downgrade by Standard & Poor’s Ratings Services on Tuesday. S&P said El Paso remains on CreditWatch with negative implications and could fall deep into junk levels if FERC sides with an administrative law judge in concluding that the company manipulated the California natural gas market.

Ratings on El Paso Corp. were cut to ‘BBB’ from ‘BBB+’ The ratings on the company’s senior unsecured debt were cut to ‘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 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.”

S&P 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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