El Paso Corp. Is Thriving under Suspicion

Market manipulator. Poster child for California's energy woes. Member of the Texas cabal shaking down West Coast consumers. As the Golden State's energy debacle picked up speed this spring, El Paso Corp. (EPG) suddenly found itself cast in the role of Public Enemy No. 1. State and federal regulators are investigating charges that El Paso used its control of a key pipeline to sharply boost the price of natural gas flowing into the state. El Paso says it certainly didn't manipulate the market and blames higher prices on California's unique energy problems. Still, investors have reacted to the possibility of millions of dollars in fines--and now quickly falling natural gas prices--by knocking the company's stock down 33% this year.

All the headlines about legal troubles, however, are obscuring how well hard-charging Chief Executive William A. Wise, 56, has positioned El Paso in the rapidly mutating energy business. Ironically, El Paso was left holding the excess California pipeline capacity only because a big customer had decided in 1995 to dump it. That blow nearly sank El Paso and sent Wise off on a diversification strategy that has taken the company from a sleepy little regional outfit to one of the biggest players in the energy bonanza. Houston-based El Paso grew from $2.9 billion in revenues in 1995 to $21.9 billion in 2000, and will pass $50 billion this year. Its earnings of $652 million last year reversed a $255 million loss the year before.

In the process, El Paso has become North America's largest pipeline company and the nation's fourth-largest energy outfit, with a hand in everything from natural gas exploration and production, to wholesale power and gas trading, to power generation. It is also pushing to become a major player in the growing market for liquefied natural gas. On July 25, El Paso reported a 40% increase in second-quarter income, to $413 million, on sales of $13.4 billion. The stock price, however, remains in the doldrums, hovering around $48 a share. Falling prices have hurt much of the sector: Rival Enron Corp. is off 48% this year while Dynegy Inc. is down 23%.

Even if the company is forced to cough up a big fine--and no one is speculating how big that fine could be--many analysts and investors doubt that will crimp Wise's diversification push. "El Paso is the biggest and best-positioned [company] to take advantage of the nation's natural gas supply crunch," says Donald Coxe, chairman of Harris Investment Management Inc. in Chicago, which owns El Paso shares.

Wise really had no choice but to branch out. In the mid-'90s, Pacific Gas & Electric Corp. (PCG) and other utilities were paying millions of dollars for capacity they couldn't use because overbuilding had led to a huge pipeline glut. With the blessing of friendly state regulators, PG&E and others gave up their pipeline rights, with PG&E returning 1.14 billion cubic feet a day of capacity to El Paso. In one stroke, that erased $125 million of El Paso's annual revenue.

FRUGALITY AND LUCK. Wise worked quickly to put El Paso back on a firm footing. He slashed $100 million in costs, in part by laying off more than a third of El Paso's employees, freezing executives' pay, and taking no salary himself for three years. He also negotiated a $60 million settlement with PG&E and the other utilities for dumping the capacity. By last year, the situation had shifted 180 degrees. As demand jumped and California faced skyrocketing energy costs, that same pipeline space had become a precious commodity. And El Paso was in the driver's seat as the state's largest gas supplier. "That's what's so ironic now. The capacity that everybody's complaining about in California was basically the capacity that PG&E gave back," says H. Brent Austin, El Paso's chief financial officer.

More important, Wise, who declined to be interviewed, set out on an aggressive new strategy to diversify away from California--which had delivered 75% of El Paso's revenues before 1996. Wise had spent his entire career at El Paso, joining in 1970 out of the University of Colorado School of Law and taking over the CEO's post in 1990. His shopping spree began in 1996 when he scooped up Tenneco Inc.'s pipeline business. The $4 billion deal tripled El Paso's size and gave it the only coast-to-coast natural gas pipeline. In all, Wise has snapped up some $35 billion worth of acquisitions in five years, including his biggest, the $24 billion purchase in January of Coastal Corp. That substantially boosted El Paso's exploration and production operations, expanded its capacity to some 60,000 miles of pipeline nationwide, and added oil refining to the company's mix. Along the way, El Paso also has bought interests in some 44 natural gas-fired power plants across the country.

BALANCE OF POWER. Today, such nonregulated businesses as natural gas marketing and trading operations, exploration and production, and the power plants account for more than 60% of El Paso's earnings before interest and taxes, vs. 8% in 1996. Analysts say the new El Paso's "wellhead-to-wire" operations give it a big advantage over Enron, Dynegy, and other competitors at a time when the power industry is rapidly changing and clean-burning natural gas is growing in popularity. Meanwhile, its wide-reaching stable of assets means it doesn't have to rely on high natural gas prices, which have dropped roughly 70% nationwide since the beginning of the year.

But it's that very mutifaceted structure that may have landed El Paso in hot water in California. State regulators allege that the company's pipeline unit, El Paso Natural Gas, rigged a pipeline-capacity auction last year in favor of its energy-marketing affiliate, El Paso Merchant Energy Group. Regulators charge that the two wholly owned units passed secret information between them that helped the merchant group's bid. Federal hearings on this charge are to begin on Aug. 2. Ralph Eads III, the merchant group's president, counters that "the pipeline [unit] didn't have any say-so over whose bid it took, it just said whose bid was the highest. Our bid was the highest. There are [Federal Energy Regulatory Commission] rules that govern the behavior between our pipeline and our marketing affiliate. And we are very scrupulous in observing those rules."

In their second allegation, authorities claim that the company withheld pipeline capacity into California to jack up prices illegally; a judge's ruling is expected in October. Regulators note that spot prices for natural gas in Southern California spiked to more than double national spot rates. "A big reason for the increase in consumers' electricity bills is because El Paso manipulated prices at the California border," alleges Harvey Y. Morris, the state utilities commission attorney arguing the case before FERC.

Eads denies El Paso withheld capacity. Instead, the company blames the runup in natural gas prices in Southern California on an unusually hot summer last year and a cold winter this year, low reserves, rising electricity demand, and a now-inadequate pipeline system into the state. In any case, Eads says, El Paso didn't fully benefit from rising prices because the merchant group shipped 95% of its gas under fixed-price contracts as a hedge against a possible price drop. "As prices went up, we lost money," says Eads. "If we were smart enough to manipulate the market, we would have been smart enough not to have hedged."

Maybe so. Either way, given the company's smart transformation over the past five years, El Paso seems well-prepared to ride out whatever twists California has in store for it. By Stephanie Anderson Forest in Houston, with Christopher Palmeri in Los Angeles

The Good Business Issue
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