El Paso cuts reserve estimate by 40%, takes $1 billion charge

Allen Baker

Petroleum News Contributing Writer

El Paso Corp. has made a dramatic cut in its reserve base, with proved reserves now totaling the equivalent of just 2.6 billion cubic feet, a reduction of 1.8 billion cubic feet, or 41 percent.

The announcement of the adjustment in yearend reserves came after the market closed on Feb. 17, and the stock of the debt-burdened company was pummeled the following day. The stock lost nearly 18 percent of its value as nearly 57 million shares — close to 10 percent of El Paso’s total — changed hands in a single day.

Investors were already wary of the reserve issue after a 20 percent downward adjustment by Royal Dutch Shell last month. ExxonMobil, on the other hand, announced Feb. 18 that its reserves grew by 1.7 billion barrels of oil equivalent, as the biggest oil company replaced 105 percent of its 2003 production.

Debt issues loom

Moody’s and Standard and Poor’s reduced debt ratings immediately. Standard and Poor’s cut El Paso’s rating to B-minus, the sixth-highest junk rating, and said more downgrades could be ahead.

“The negative outlook reflects the daunting obstacles El Paso faces through 2006, as it attempts to achieve its reorganization plan. Falling short on any of the plan’s components or further weakness in the company’s ability to produce operating cash flow from its core businesses could lead to lower ratings,” S&P said.

El Paso executives say they’re making progress on asset sales to improve the balance sheet, including a sale of its western Canadian properties, announced Feb. 16, to raise $346 million. All told, the company says it has announced or completed $2.9 billion in asset sales out of a goal of $3.3 billion to $3.9 billion.

Turnaround predicted

“Nobody’s happy about the outcome of our yearend reserves,” said Doug Foshee, the president and chief executive, in a teleconference with analysts. “It’s a big disappointment, to say the least. But it’s from this point that the turnaround of our E&P company will be measured.”

Foshee, who came to El Paso in September, noted that finding costs were about $3 per thousand cubic feet in 2003.

“That’s not something that gets anybody excited,” he noted.

And he didn’t mince words about El Paso’s execution:

“Please don’t confuse our recent performance in our core basins as representative of these basins,” Foshee said. “It’s not, as evidenced by the performance of our peers and competitors in these same basins. As we reorganize, get our cost structure in line, and get more discipline into the capital allocation process, you’ll see our performance in this area improve significantly. We’re tackling the issues in E&P head-on.”

Stewart, on the payroll as E&P head for just two weeks, wouldn’t say just what steps she planned to take to change the performance of the unit. But she did say that “the situation that we’re in is highly correctable.”

Big Texas revisions

“The quality of the Vicksburg pay varies from high permeability to low permeability zones,” said Stewart, the E&P executive. “In tighter rock, the drainage area is smaller than originally expected. In higher permeability areas, we have seen interference between wells.”

Expected reserves were also reduced due to performance issues, depletion concerns, and revised volumetric estimates, the company said. The adjustments were made after independent consultant Ryder Scott Co. L.P. was hired as the company’s third-party reservoir engineer last fall. Foshee, the president, said executives felt they “needed a fresh set of eyes on reserves.”

Reserves in the Gulf of Mexico were cut by 392 billion cubic feet of gas equivalent due to mechanical failures in producing well bores, as well as revised performance and geologic interpretations, Stewart said.

Coalbed methane down

In response to a question, Stewart said both contractual and regulatory issues prevented reduced well spacing at this point.

“In the Raton basin, it’s not just regulatory approval, but landowner approval. We need to get the landowner’s approval first,” she said. Regulators are likely to go along if the landowner agrees to the increased disturbance of the surface that would come with tighter spacing, she said. “But it’s not something we’ll do in the next month or so.”

A relatively small hit to reserves came in Brazil, where 37 billion cubic feet was taken off the books because El Paso doesn’t have a firm sales contract for its gas.

Internal review under way

El Paso’s near-term production won’t suffer due to the revisions, Foshee said. The company is still expecting production for 2004 to be in the range of 850 million to 950 million cubic feet of gas equivalent daily. January production averaged 960 million cubic feet of gas equivalent daily, though that includes about 57 million cubic feet daily from El Paso’s western Canadian assets, which are being sold to BG Group.

El Paso announced another disappointing development on the exploration front at the teleconference. The company entered joint drilling agreements in October with units of Nabors Industries Inc. and Lehman Brothers to finance an additional $350 million in drilling activity by two El Paso subsidiaries, with El Paso kicking in $150 million for 30 percent of the production.

Results from the El Paso CGP program did not meet expectations and Lehman Brothers, which had taken a 50 percent interest in both programs, has given notice of suspension there, Foshee said. Both investors are continuing to invest in the program at the El Paso Production subsidiary, he said.

One analyst asked Foshee what makes him think the rest of the company is on track when the returns for Lehman and Nabors “are marginal in this pricing environment.”

“We have a good asset base. There is nothing inherently wrong with the basins in which we operate,” Foshee replied. “We don’t think we need to do yeoman work to show significant improvement. ... But this is not an overnight change.”

El Paso sells Canadian holdings to UK-based BG Group for $346 million

Allen Baker

Petroleum News contributing writer

BG Group, based in the United Kingdom, is getting properties that produced an average of 57 million cubic feet daily over the course of last year, but BG executives say the unexplored part of the acreage in the Western Canada sedimentary basin is the big prize.

“The very large position of undeveloped oil and gas acreage provides significant opportunities for expansion ad development,” says Martin Houston, president of British Gas US Holdings LLC. “With a large inventory of identified prospects, the acquisition has enough opportunities to support a drilling campaign for many years.”

Substantial reserves

BG is a far-flung company with operations in 20 countries and is a major player in the liquefied natural gas business. The company has rights to all of the capacity at the Lake Charles, La., LNG import terminal, and in December bought El Paso’s capacity rights at the Elba Island LNG terminal in Georgia for $127 million.

That gives BG subsidiaries a capacity to import more than a billion cubic feet daily, about half of the existing regasification capacity for the U.S. market. Substantial expansions are also planned at Lake Charles.

BG is the second-largest owner of Atlantic LNG Company of Trinidad and Tobago, with 26 percent of the company that liquefies gas for transport. Its Dolphin field supplies the LNG plant and Trinidad’s domestic system.

The El Paso Canada transaction is expected to close next month. El Paso will retain some operations in Canada — the Caribou gas processing plant, capacity on the Alliance pipeline system, and interests in Nova Scotia.