El Paso slashes its reserves estimates by 41%

Paula Dittrick
Senior Staff Writer

HOUSTON, Feb. 18 -- El Paso Corp. has reduced its estimated proven oil and natural gas reserves by 1.8 tcfe, or 41%, leaving the company with 2.64 tcfe as of Dec. 31, 2003. Of that total, 66% is proved developed reserves.

Previously, El Paso had told investors that it expected to make a "material negative revision," but the revision was bigger than some analysts had expected.

"Overall, the write-down represents a huge disappointment and worse than even the 'worse-case scenario' in our view," said Anatol Feygin, analyst with JP Morgan Securities Inc. of New York. Previously, he had expected a reserve write-down of as much as 1.1 tcfe.

The announcement marked the second major negative reserves revision this year. On Jan. 9, Royal Dutch/Shell Group announced that it overestimated its proved oil and natural gas reserves by 3.9 billion boe, or 20% (OGJ, Jan. 19, 2004, p. 28).

Analysts contacted by OGJ agreed that different issues are involved in the Shell revision vs. the El Paso revision.

El Paso details
Doug Foshee, El Paso president and CEO, made the announcement during a conference call after the markets had closed Tuesday. He called the reserves revision "another important step in the process of regaining our credibility in the marketplace."

El Paso expects to take a fourth quarter pretax ceiling-test charge of $1 billion; that is based on a Dec. 31, 2003, Henry Hub price of $6/MMbtu. Should the Henry Hub price that date prove to have been lower, an additional charge could be incurred—as much $1.5 billion if the price had been $1/MMbtu lower.

The company's January 2004 production averaged 960 MMcfed. Despite the reserves revision, El Paso maintained its production forecast of 850-950 MMcfed for 2004.

Foshee said the firm has hired a law firm, independent of El Paso, to examine the reasons for the "substantial" revision. After he became CEO in September 2003, El Paso hired Ryder Scott Co. LP as its reserves engineering consultant. Previously, that role had been filled by Huddleston & Co. Inc. of Houston. US Securities and Exchange Commission documents showed that El Paso changed its reserves engineer during fourth quarter 2003.

On Tuesday, El Paso executives outlined technical reasons for the revisions, which varied depending upon the location and the type of drilling involved in specific locations.

For instance, El Paso has reduced its coalbed methane reserves estimate by 511 bcfe, citing a "lack of contractual and regulatory approvals." Overall, the reserves revisions primarily are in South Texas and the Gulf of Mexico.

"We are committed to turning around our production business," Foshee said. "We are addressing the production issues head on. . . . I remain confident that we are on track to deliver the goals of our long-range plan."

Lisa A. Stewart, El Paso president of production and nonregulated operations, called the situation "very correctable." Formerly an executive vice-president with Apache Corp., Houston, Stewart started working for El Paso this month (OGJ Online, Feb. 13, 2004).

El Paso Chief Financial Officer D. Dwight Scott said El Paso uses the full-cost accounting method. Oil companies can use either full-cost accounting or successful-efforts accounting.

Analysts contacted by OGJ noted that El Paso is one of only a handful of large companies that still use full-cost accounting. Generally, small companies, particularly privately held firms, use full-cost accounting.

Analysts' reactions
Stuart Wagner, analyst with Petrie Parkman & Co. in Denver, said he doubts that the El Paso reserves revision will have "a huge impact" on the overall industry. "There are always revisions by various companies up and down every year."

In the case of El Paso, "the reserves are there but are not commercial any time soon," Wagner said.

In the case of Shell, more than half of the adjustment involved overestimates in Nigeria and the Gorgon fields development—linked to a proposed LNG export project—off Australia. The Shell revision involved gas sales contacts and development schedules that did not materialize as expected, he noted.

JP Morgan's Feygin said he found El Paso's disclosures surrounding the reserves writedown "to be inadequate, given the magnitude of the revision."

He said he expects additional details on the reasons behinds the revisions in the coming months. He expects the company's combined proved and probable reserves estimates will not have changed "as drastically" as have its proved reserves estimate. Meanwhile, he lowed his production estimates for El Paso for 2004-05.

In a Wednesday research note, Feygin noted that Stewart appears to be "still evaluating where capital on incremental projects may be sacrificed in order to improve E&P's lackluster returns. Ultimately, this may prove beneficial from a free cash-flow and returns perspective, but [it also] could mean lower production volumes going forward."

He said he has "incrementally less confidence in the company's ability to meet its targets going forward."

Standard & Poor's Ratings Services of New York Wednesday lowered its corporate credit rating on El Paso to "B-" from "B" to reflect the reserves write-down.

"The outlook remains negative," said S&P's credit analyst Todd Shipman, adding that, El Paso has about $24 billion in outstanding debt and other long-term obligations.

Although "there is no immediate cash flow effect related to this action, it does suggest that future production and likely cash flow will be weakened in 2005 and beyond. The negative outlook will continue until further progress on the company's long-range plan is accomplished," he continued.

In that plan, El Paso will exit several business lines over the next 3 years that will leave the company focused on two primary business activities by 2006: natural gas pipelines and exploration and production with an emphasis on natural gas production.