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WIKI ANALYSIS
El Paso Corporation (EP) is a natural gas company involved in oil and natural gas production and natural gas transportation. EP owns the largest interstate gas pipeline system in the U.S., and is responsible for transporting a quarter of all the natural gas used in the country every day.[1] In its oil and natural gas production and exploration segment El Paso holds 2.9 trillion cubic feet equivalent in proved reserves.[2]
El Paso had financial problems in the early part of the decade that forced it to restructure its entire business. The company had been expanding its operations, and in the process accumulated a large debt balance. It began struggling to meet debt service (interest plus principal) payments and had difficulty refinancing. To pay down its debt and consolidate its businesses, EP began selling off assets and business segments.[3] Since 2005 EP has sold $16.0B in assets, disposing of its power plants and power trading portfolio, and has focused on its core businesses: interstate pipelines and petroleum production.[4]
EP's pipeline segment is subject to regulation by the Federal Energy Regulatory Commission (FERC), because the company's pipelines cross state borders. FERC caps EP's pipeline rates, but also guarantees that the company earns a steady return. This constant income stream lets EP pay out a relatively constant dividend, $0.16 a year since 2003, and allows the company to fund debt service during periods of expansion, giving EP more debt capacity than companies focused on only exploration and production.
Business Financials
EP operates two separate business segments, pipelines and exploration and production. In 2007 pipelines accounted for 52% of EP's revenue (58% of EBIT due to lower operating costs) and exploration and production accounted for 48% of revenue (41% of EBIT).[5]
- Pipelines: EP transports natural gas from primary gas producing regions to major U.S. consumer markets, specifically the Northeast, Southeast, Southwest, Gulf Coast and California. EP owns directly or through subsidiaries 42,000 miles of interstate pipeline, making it America's largest owner and operator of interstate pipeline systems.[6] EP transmits a quarter of all natural gas consumed in the U.S. every day.[7] EP's pipeline segment is regulated by the federal government; the FERC sets the rates that EP can charge to transport gas on its pipeline system and which expansion projects the company can undertake. The rates EP can charge on its system are typically determined by calculating the company's incremental cost of transporting gas on its pipeline system, then adding in a "reasonable" return on its invested capital.[8] This leads to income stability but little ability to increase rates during a period of peak demand. Because rates are fixed, to increase revenues and net income on its pipelines EP instead focuses on increasing its market share and total volumes transported.
- Exploration and Production: El Paso explores for and develops natural gas, oil and natural gas liquids in the United States, Brazil and Egypt.[9] As of December 31st, 2007 it held an estimated 2.9 trillion cubic feet in U.S. proved reserves of natural gas equivalents.[10] During 2007, the company produced 792 million cubic feet of natural gas equivalents every day.[11] To compare, BP (BP) (the nation's top producer of natural gas producing 3.5% of the country's daily output), produced 3.5 billion cubic feet of natural gas per day. Revenues at El Paso´s exploration and production segment are dependent upon the price of oil and natural gas, and the company's success in finding and developing oil and natural gas reserves.
Data on the companies scale of operations for the last three years is presented below.
| 2007 | 2006 | 2005 | |
|---|---|---|---|
| U.S. Onshore | 374 | 345 | 300 |
| Texas Gulf Coast | 213 | 187 | 211 |
| Gulf of Mexico and South Louisiana | 191 | 174 | 179 |
| Brazil | 14 | 24 | 53 |
| Total Throughput On Pipeline Segment (BBtu per day) | 18,131 | 17,012 | 16,070 |
As of December 31, 2007 approximately 15% or $1.9B of EP's debt was variable interest rate debt.[13] If general economic conditions were to cause interest rates to rise, EP would see increases in its debt service payments, decreasing the company's cash flow available for distribution to shareholders. In addition to lowering income, a change in interest rates would also affect EP's stock price. Because of government regulation, revenue and income in the company´s pipeline segment is relatively stable. These stable revenues have historically led El Paso to pay consistent dividends, at $.04 per quarter since 2003.[14]
With its repositioning completed in 2007, EP began focusing on expanding its exploration and production and pipeline segments. The company entered 2007 with $2.0B in contracted expansion projects and by year end they had increased that number to 4.0B while investing $566M.[15] Because the company receives predictable, regulated earnings from its pipeline segment, it can use those earnings to fund large debt service payments and increase its rate of expansion in its more variable exploration and production segment. Expansion projects the company started in 2007 include increasing its pipeline system in Florida and acquiring a liquid natural gas import facility in Mississippi.[16] A map of the company's pipeline system and producing basins is below. EP is focusing its expansion on areas where it already has operations, attempting to use its established infrastructure to lower cost and give the company a competitive advantage.
During the past five years El Paso has been selling underperforming assets including its power trading portfolio and state regulated utility companies. This simplified its business model to focus on just two main businesses, pipelines and exploration and production. Because of liquidity problems facing the company in 2003, EP used the proceeds of its asset sales to repay debt. It entered 2007 with a stable capital structure and little refinancing risk; no more than 10% of its total debt matures in any one year until 2012.[18] The company's decreased debt balance helped to bring up operating income; interest expense decreased from $1.3B in 2005 to $1.0B in 2007 and is drop even further in 2008 due to debt repayments in 2007.[19] However, El Paso still suffers from some remnants of its previous liquidity problems. It retains below investment grade debt ratings from Moody's and Standard and Poors.[20] Low debt ratings have a number of negative effects. Many institutional investors will only invest in investment grade companies, decreasing the company´s access to capital. Low debt ratings also increase EP's cost of debt capital. These factors have the potential to slow El Paso´s growth in coming years.
The graph below illustrates EP's transformation over the past five years. The company´s revenues dropped sharply in 2003 and 2004 as the company sold(state regulated utilities and a power trading portfolio), becoming smaller and more focused. Revenues began to rise in 2005 as it started to expand its portfolio of pipelines and production facilities. Operating income jumped during this period, as the company sold all but its most profitable assets and focused on increasing operating efficiency in its core production and pipeline businesses. This caused similar increases in operating income as a percentage of revenue.
Trends and Forces
Fluctuating Natural Gas Prices Affect Demand
The price of natural gas has undergone wide fluctuations in the past five years. The price declined slightly in the past two years, down 5% from a record high in 2005.[22] However, the price is still up 43% since 2002.[23] These price fluctuations affect demand for natural gas as other fuels become cheaper substitutes, especially among facilities with the capacity to switch to other types of fuels. For example many electrical power companies, who consumed 32% of all natural gas produced in 2007, switch to coal power during periods of high natural gas prices.[24] The price of coal has risen slower than the price of natural gas, and provides cheaper power during periods of high gas prices.[25] Many industrial users, who used 31% of natural gas produced in 2007, also have built in fuel switching capacities. [26] While residential and commercial users usually have no built in switching capacity many still conserve energy during periods of high gas prices. A reduction in demand for natural gas results in a loss of revenues at both of El Paso´s business segments. In its pipeline segment, decreased consumer demand leads to decreased volumes. Because pipelines earn fees based on volumes transported, decreased demand leads to falling revenues and net income. Similarly, diminishing demand for natural gas leads to decreased customer demand at El Paso´s Exploration and Production segment, which can counteract increased prices and lead to decreased total revenues.
The United States is Switching Towards Eco-Friendly Energy Sources, Which Has A Mixed Effect On Demand For Natural Gas
Increasing environmental concern has a direct affect on the demand for natural gas. In the long run, increasing consumer concern over Global Climate Change will decrease the demand for natural gas. Already increasing environmental consciousness has led both consumers and electric companies to seek out and invest in renewable energy sources such as nuclear, solar, and wind power to heat homes and generate electricity.[27] To date, 24 states have adopted renewable portfolio standards, which require power companies to purchase some of their electricity from renewable sources.[28] The percentages range from 4.5%-25% and phase in over a number of years, becoming fully implemented between 2009 in Massachusetts and 2025 in Utah.[29] As residential customers and electric power plants switch to other forms of energy, the demand for natural gas will fall. However, these renewable sources of energy are not yet developed enough to provide for the majority of energy uses in the United States. In the short run natural gas is one of the cleanest burning fuels in widespread use today.[30] Many electric companies are switching to natural gas as a cleaner alternative to coal and oil power plants.[31] Until renewable energy sources are better developed, environmentalism in the U.S. will actually lead to an increase in short-term demand for natural gas.
A 2007 Court Ruling Will Likely Increase Rates El Paso Can Charge Customers Of Its Pipeline Segment
EP's pipeline segment is regulated by the FERC, which sets the rates it can charge its customers.[32] Pipeline regulation is a double edged sword, it guarantees a minimum level of company income but also caps potential net income growth. The FERC determines the rates EP can charge its pipeline customers by examining the pipeline’s operating costs then adding what it determines as a reasonable return on invested capital. That reasonable return on capital has historically been determined by the FERC using a group of proxy companies which included local natural gas distribution companies.[33] Pipeline companies argued that local distribution companies do not face the same risk or competition as interstate pipeline companies so their return on equity is lower to reflect that decreased risk. In 2007 the D.C. Court of Appeals ruled that if the FERC continued using local companies as proxies it would have to revise its return on equity upward to reflect those company’s decreased risk.[34] This is likely to increase the rates EP can charge pipeline customers, increasing the segment's revenues.
Demand for Natural Gas is Dependent on the Weather, Creating the Risk of Unfavorable Weather Conditions and Seasonality in El Paso´s Revenues
Demand for natural gas is highest during the coldest months of winter when it is used to heat homes.[35] Due to the shift towards natural gas for generating electricity, demand for natural gas is also high during the summer months when people are using large amounts of electricity to cool their homes.[36] Demand for natural gas drops sharply during the spring and fall.[37] This seasonal shift in demand creates seasonality in EP's revenues. The affect is more pronounced in the company's pipeline segment. In its exploration and production segment EP has the capacity to store some of the gas it produces during the slow spring and fall seasons to sell during the summer and winter, so its production can remain relatively constant throughout the year.[38] However, revenues at its pipeline segment decline during the spring and fall as producers transport less gas to accommodate low consumer demand. The weather can also impact annual revenues. If a winter or summer is longer and more severe than usual customers will demand more natural gas, increasing revenues. The opposite is also true. If the winter and summer seasons are short and temperate customers will demand less gas, decreasing the company´s revenues.
Competition
El Paso competes with a number of other exploration and production and pipeline companies. In the exploration and production segment the company competes to purchase reserves, find new sources of oil and natural gas, and produce more output. This is a large space, however, and El Paso has no control over the prices in the market. In this market the company competes as a price taker, selling at spot prices in the market. In the pipelines segment, EP competes with other companies for market share and long term gas transportation contracts. Though it has government rate caps for natural gas transmission, it sometimes lowers its rate below these caps to maintain competitive within the market. Because it has the largest pipeline system of any of its competitors, EP is the exclusive interstate pipeline operator in many of its markets.
EP is by far the largest pipeline operator in its group of competitors, and has the second most proved reserves of natural gas equivalents. However, its revenues and market cap are in the middle of its group of competitors. The reason is that EP operates fewer business segments than any of its competitors. In addition to being involved in natural gas production and transportation its competitors are also involved in such businesses as intrastate natural gas distribution, natural gas processing and electrical utilities. Though large in the segment's in which it operates, EP operates in fewer areas so is, overall, smaller than many competitors.
In addition to competing with other natural gas companies, EP's competes with suppliers of alternative fuels. The increasing consumer demand for alternative energy has led both companies and consumers to invest in renewable energy sources such as nuclear, solar, and wind power to heat homes and generate electricity. As the demand for these renewable sources of energy increases, the demand for the company´s natural gas and natural gas transportation services will fall.
| Company | Revenues (12/31/2007, $ in Millions) | Market Cap($ in Billions, 05/15/08) | Miles of Interstate Pipeline | Proved Reserves (Measured in Cubic Feet of Natural Gas Equivalents) |
| El Paso (EP) | $4,648.70[39] | $13.85[40] | 42,000[41] | 2.9 Trillion[42] |
| Williams Companies (WMB) | $10,558.00[43] | $21.62[44] | 14,200[45] | 3.7 Trillion[46] |
| Equitable Resources (EQT) | $1,361.41[47] | $8.80[48] | 3,200[49] | 2.7 Trillion[50] |
| Questar (STR) | $2,726.6[51] | $11.37[52] | 2,505[53] | 1.87 Trillion[54] |
| Kinder Morgan Energy Partners, L.P. (KMP) | $9,217.7[55] | $15.27[56] | 25,000[57] | 0.73 Trillion[58] |
References
- ↑ Company Website-About Us
- ↑ Reuters: Full Description: EP
- ↑ EP 2007 Form 10-K Page 98
- ↑ EP 2007 Form 10-K Page 98
- ↑ EP 2007 Form 10-K Page 44
- ↑ Reuters: Full Description: EP
- ↑ Company Website-About Us
- ↑ EP 2007 Form 10-K Page 3
- ↑ Reuters, Full Description: EP
- ↑ Reuters: Full Description: EP
- ↑ Reuters: Full Description: EP
- ↑ EP 2007 10-K Page 42 and 46
- ↑ EP 2007 Form 10-K
- ↑ Company Website-Dividend History
- ↑ EP Corp 2007 Summary Report
- ↑ EP Corp 2007 Summary Report
- ↑ EP Corp 2007 Summary Report
- ↑ EP 2007 Form 10-K Page 112
- ↑ EP 2007 Form 10-K Page 112
- ↑ EP 2007 Form 10-K Page 34
- ↑ Google Finance, Company Summary
- ↑ Energy Information Association, Natural Gas Price Summary
- ↑ Energy Information Association, Natural Gas Price Summary
- ↑ NaturalGas.Org, Factors Affecting Demand For Natural Gas
- ↑ National Coal Mining Association, Average Price of Electricity Used at Electrical Plants, 2002-2006
- ↑ NaturalGas.Org, Factors Affecting Demand For Natural Gas
- ↑ NaturalGas.Org, ¨Factors Affecting Natural Gas Demand¨
- ↑ U.S. Department Of Energy, Information Resources, ¨Factors Affecting Demand For Natural Gas¨
- ↑ U.S. Department Of Energy, Information Resources, ¨Factors Affecting Demand For Natural Gas¨
- ↑ U.S. DOE, Energy Facts:Sources of Power:Natural Gas
- ↑ Amber Esponosa, Minnesota Public Radio, April 23, 2008
- ↑ EP 2007 Form 10-K Page 49
- ↑ EP 2007 Form 10-K Page 33
- ↑ EP 2007 Form 10-K Page 33
- ↑ Natural Gas.Org, Factors Affecting Demand For Natural Gas
- ↑ Natural Gas.Org, Factors Affecting Demand For Natural Gas
- ↑ Natural Gas.Org, Factors Affecting Demand For Natural Gas
- ↑ Reuters: Full Description: EP
- ↑ Google Finance, Company Summary: EP
- ↑ Google Finance: Company Profile:EP
- ↑ Reuters: Full Description: EP
- ↑ Reuters: Full Description: EP
- ↑ Google Finance, Company Summary: WMB
- ↑ Google Finance, Company Summary:WMB
- ↑ Reuters: Company Profile: WMB
- ↑ WMB Company Website, About Us
- ↑ Google Finance: Company Summary: EQT
- ↑ Google Finance: Company Summary: EQT
- ↑ EQT 2007 Form 10-K Page 16
- ↑ EQT 2007 Annual Report Page 1
- ↑ Google Finance: Company Summary
- ↑ Google Finance: Company Summary: STR
- ↑ Reuters: Company Profile: STR
- ↑ Reuters: Company Profile: STR
- ↑ Google Finance: Company Summary: KMP
- ↑ Google Finance: Company Summary: KMP
- ↑ Google Finance: Company Summary: KMP
- ↑ KMP 2007 Form 10-K Page 206
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