-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RkphyPU0ShawpScrAEeyZcloyx+A+AwGyOaIp68khXX/EVDzOpDalnwRCY/9mrKz Zf/HvmRlgpeDIp71WYok8A== 0000950129-01-502485.txt : 20010814 0000950129-01-502485.hdr.sgml : 20010814 ACCESSION NUMBER: 0000950129-01-502485 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EL PASO CGP CO CENTRAL INDEX KEY: 0000021267 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION [4922] IRS NUMBER: 741734212 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-07176 FILM NUMBER: 1705239 BUSINESS ADDRESS: STREET 1: EL PASO BUILDING STREET 2: 1001 LOUISIANA STREET CITY: HOUSTON STATE: TX ZIP: 77095 BUSINESS PHONE: 7134202131 MAIL ADDRESS: STREET 1: 1001 LOUISIANA STREET CITY: HOUSTON STATE: TX ZIP: 77095 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: COASTAL STATES GAS CORP DATE OF NAME CHANGE: 19800113 10-Q 1 h88256e10-q.txt EL PASO CGP COMPANY - 6/30/01 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 1-7176 --------------------- EL PASO CGP COMPANY (Exact Name of Registrant as Specified in its Charter) DELAWARE 74-1734212 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) EL PASO BUILDING 1001 LOUISIANA STREET HOUSTON, TEXAS 77002 (Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (713) 420-2600 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, par value $1.00 per share. Shares outstanding on August 6, 2001: 1,000 EL PASO CGP COMPANY MEETS THE CONDITIONS OF GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS REPORT WITH A REDUCED DISCLOSURE FORMAT AS PERMITTED BY SUCH INSTRUCTION. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. EL PASO CGP COMPANY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN MILLIONS) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------- ----------------- 2001 2000 2001 2000 ------- ------ ------- ------- Operating revenues....................................... $5,866 $5,965 $13,728 $11,882 ------ ------ ------- ------- Operating expenses Cost of natural gas and other products................. 4,898 5,189 11,679 10,309 Operation and maintenance.............................. 549 348 931 687 Merger-related costs and asset impairments............. 217 3 984 7 Depreciation, depletion, and amortization.............. 193 156 357 304 Taxes, other than income taxes......................... 57 42 125 78 ------ ------ ------- ------- 5,914 5,738 14,076 11,385 ------ ------ ------- ------- Operating income (loss).................................. (48) 227 (348) 497 ------ ------ ------- ------- Other income Earnings from unconsolidated affiliates................ 44 68 105 132 Other, net............................................. 59 26 71 67 ------ ------ ------- ------- 103 94 176 199 ------ ------ ------- ------- Income (loss) before interest, income taxes, and other charges................................................ 55 321 (172) 696 ------ ------ ------- ------- Non-affiliated interest and debt expense................. 112 121 236 234 Affiliated interest expense, net......................... 18 -- 22 -- Minority interest........................................ 12 15 26 30 Income taxes............................................. (19) 57 (51) 131 ------ ------ ------- ------- 123 193 233 395 ------ ------ ------- ------- Income (loss) before extraordinary items................. (68) 128 (405) 301 Extraordinary items, net of income taxes................. 3 -- (7) -- ------ ------ ------- ------- Net income (loss)........................................ $ (65) $ 128 $ (412) $ 301 ====== ====== ======= =======
See accompanying notes. 1 3 EL PASO CGP COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
JUNE 30, DECEMBER 31, 2001 2000 -------- ------------ ASSETS Current assets Cash and cash equivalents................................. $ 181 $ 53 Accounts and notes receivable, net Customers.............................................. 2,004 2,549 Affiliates............................................. 726 34 Other.................................................. 644 473 Inventory................................................. 864 1,203 Assets from price risk management activities.............. 249 544 Other..................................................... 377 223 ------- ------- Total current assets.............................. 5,045 5,079 ------- ------- Property, plant, and equipment, at cost Pipelines................................................. 6,203 6,092 Refining, crude oil, and chemical facilities.............. 2,008 2,338 Power facilities.......................................... 250 237 Natural gas and oil properties, at full cost.............. 6,119 5,100 Gathering and processing systems.......................... 350 340 Other..................................................... 601 744 ------- ------- 15,531 14,851 Less accumulated depreciation, depletion, and amortization........................................... 4,609 4,248 ------- ------- Total property, plant, and equipment, net......... 10,922 10,603 ------- ------- Other assets Intangible assets......................................... 461 464 Investments in unconsolidated affiliates.................. 1,726 1,596 Assets from price risk management activities.............. 399 138 Other..................................................... 932 989 ------- ------- 3,518 3,187 ------- ------- Total assets...................................... $19,485 $18,869 ======= =======
See accompanying notes. 2 4 EL PASO CGP COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS -- (CONTINUED) (IN MILLIONS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
JUNE 30, DECEMBER 31, 2001 2000 -------- ------------ LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities Accounts and notes payable Trade.................................................. $ 2,017 $ 1,804 Affiliates............................................. 1,905 13 Other.................................................. 795 1,552 Short-term borrowings (including current maturities of long-term debt)........................................ 423 945 Liabilities from price risk management activities......... -- 546 Other..................................................... 759 348 ------- ------- Total current liabilities......................... 5,899 5,208 ------- ------- Long-term debt, less current maturities..................... 4,855 5,296 ------- ------- Other Liabilities from price risk management activities......... -- 113 Deferred income taxes..................................... 1,867 1,957 Other..................................................... 1,433 994 ------- ------- 3,300 3,064 ------- ------- Commitments and contingencies Securities of subsidiaries Company-obligated preferred securities of consolidated trusts................................................. 300 300 Minority interests........................................ 445 451 ------- ------- 745 751 ------- ------- Stockholder's equity Cumulative preferred stock, no shares outstanding in 2001; with aggregate liquidation preference of $7.3 million at December 31, 2000................................... -- -- Class A common stock, no shares outstanding in 2001; par value 33 1/3c, 311,377 shares issued in 2000........... -- -- Common stock, par value $1 per share, 1,000 shares authorized and issued in 2001; par value 33 1/3c per share, 219,604,836 shares issued in 2000............... -- 73 Additional paid-in capital................................ 1,264 1,044 Retained earnings......................................... 3,161 3,573 Accumulated other comprehensive income.................... 261 (8) Treasury stock (at cost) no shares in 2001 and 4,394,651 shares in 2000......................................... -- (132) ------- ------- Total stockholder's equity........................ 4,686 4,550 ------- ------- Total liabilities and stockholder's equity........ $19,485 $18,869 ======= =======
See accompanying notes. 3 5 EL PASO CGP COMPANY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ---------------- 2001 2000 ----- ------- Cash flows from operating activities Net income (loss)......................................... $(412) $ 301 Adjustments to reconcile net income (loss) to net cash from operating activities Depreciation, depletion, and amortization.............. 357 304 Deferred income tax expense............................ 30 99 Extraordinary items.................................... 6 -- Undistributed earnings of unconsolidated affiliates.... (57) (52) Non-cash portion of merger-related costs and asset impairments........................................... 855 -- Other.................................................. 200 -- Working capital changes, net of non-cash transactions..... (395) (544) Other..................................................... (236) (8) ----- ------- Net cash provided by operating activities......... 348 100 ----- ------- Cash flow from investing activities Purchases of property, plant, and equipment............... (970) (1,057) Additions to investments.................................. (188) (125) Net proceeds from the sale of assets...................... 199 4 Proceeds from the sale of investments..................... 128 111 Repayment of notes receivable from unconsolidated affiliates............................................. 158 -- Other..................................................... 2 1 ----- ------- Net cash used in investing activities............. (671) (1,066) ----- ------- Cash flow from financing activities Net borrowings (repayments) of commercial paper and short-term notes....................................... (795) 308 Payments to retire long-term debt......................... (266) (274) Net proceeds from the issuance of long-term debt.......... 47 969 Issuances of common stock................................. 2 12 Dividends paid............................................ (13) (27) Change in affiliated advances payable..................... 1,472 -- Other..................................................... 4 -- ----- ------- Net cash provided by financing activities......... 451 988 ----- ------- Increase in cash and cash equivalents....................... 128 22 Cash and cash equivalents Beginning of period....................................... 53 44 ----- ------- End of period............................................. $ 181 $ 66 ===== =======
See accompanying notes. 4 6 EL PASO CGP COMPANY CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME AND CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (IN MILLIONS) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------- ---------------- COMPREHENSIVE INCOME (LOSS) 2001 2000 2001 2000 - --------------------------- ----- ---- ------ ----- Net income (loss).......................................... $ (65) $128 $(412) $301 Foreign currency translation adjustments................. 8 -- 2 (6) Unrealized net gains (losses) from cash flow hedging activity Cumulative-effect transition adjustment (net of tax of $248)............................................... -- -- (459) -- Reclassification of initial cumulative-effect transition adjustment at original value (net of tax of $40 and $189).................................... 72 -- 348 -- Additional reclassification adjustments for changes in initial value to settlement date (net of tax of $25 and $77)............................................ (46) -- (142) -- Unrealized mark-to-market gains arising during period (net of tax of $219 and $281)....................... 410 -- 520 -- ----- ---- ----- ---- Comprehensive income (loss)................................ $ 379 $128 $(143) $295 ===== ==== ===== ====
ACCUMULATED OTHER COMPREHENSIVE INCOME 2001 2000 - -------------------------------------- ----- ---- Beginning balances as of December 31, 2000 and 1999......... $ (8) $ -- Foreign currency translation adjustments.................. 2 (6) Unrealized net gains (losses) from cash flow hedging activity Cumulative-effect transition adjustment, net of taxes................................................. (459) -- Reclassification of initial cumulative-effect transition adjustment at original value, net of taxes................................................. 348 -- Additional reclassification adjustments for changes in initial value to settlement date, net of taxes........ (142) -- Unrealized mark-to-market gains arising during period, net of taxes.......................................... 520 -- ----- ---- Balance as of June 30,...................................... $ 261 $ (6) ===== ====
See accompanying notes. 5 7 EL PASO CGP COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION Our 2000 Annual Report on Form 10-K includes a summary of our significant accounting policies and other disclosures. You should read it in conjunction with this Quarterly Report on Form 10-Q. The financial statements as of June 30, 2001, and for the quarters and six months ended June 30, 2001 and 2000, are unaudited. The balance sheet as of December 31, 2000, is derived from the audited balance sheet included in our Annual Report on Form 10-K. These financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission and do not include all disclosures required by accounting principles generally accepted in the United States. In our opinion, we have made all adjustments, all of which are of a normal, recurring nature (except for merger-related costs and asset impairments discussed in Note 3 and changes in accounting estimates discussed in Note 4), to fairly present our interim period results. Information for interim periods may not necessarily indicate the results of operations for the entire year due to the seasonal nature of our businesses. The prior period information also includes reclassifications which were made to conform to the current period presentation. These reclassifications have no effect on our reported net income or stockholder's equity. Our accounting policies are consistent with those discussed in our Form 10-K, except as discussed below. You should refer to the Form 10-K for a further discussion of those policies. Accounting for Price Risk Management Activities Our business activities expose us to a variety of risks, including commodity price risk, interest rate risk, and foreign currency risk. Our corporate risk management group identifies risks associated with our businesses and determines which risks we want to manage and which types of instruments we should use to manage those risks. With the adoption of Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivatives and Hedging Activities, we now record all derivative instruments on the balance sheet at their fair value. These instruments consist of two types, those derivatives entered into and held to mitigate, or hedge a particular risk, and those that are entered into and held for purposes other than risk mitigation, such as those in our trading activities. Those instruments that do not qualify as hedges are recorded at their fair value with changes in fair value reported in current period earnings. For those instruments entered into to hedge risk, and which qualify as hedges under SFAS No. 133, the appropriate accounting treatment depends on each instrument's intended use and how it is designated. Derivative instruments that qualify as hedges may be designated as: - hedges of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedges); - hedges of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedges); - foreign currency fair value or cash flow hedges (foreign currency hedges); or - hedges of a net investment in a foreign operation (net investment hedges). In addition to its designation, a hedge must be effective. To be effective, the value of the derivative or its resulting cash flows must substantially offset changes in the value or cash flows of the item being hedged. If it is determined that the hedge is no longer effective, hedge accounting is discontinued prospectively. Hedge accounting is also discontinued when: - the derivative instrument expires or is sold, terminated, or exercised; 6 8 - it is no longer possible that the forecasted transaction will occur; - the hedged firm commitment no longer meets the definition of a firm commitment; or - management determines that the designation of the derivative instrument as a hedge is no longer appropriate. At the time we enter into a hedge, we formally document relationships between the hedging instrument and the hedged item. This documentation includes: - the nature of the risk being hedged; - our risk management objectives and strategies for undertaking the hedging activity; - a description of the hedged item and the derivative instrument used to hedge the item; - a description of how effectiveness is tested at the inception of the hedge; and - how effectiveness will be tested on an ongoing basis. When hedge accounting is discontinued, the derivative instrument continues to be carried on the balance sheet at its fair value. However, any further changes in its fair value are recognized in current period earnings. Accounting for the item that was being hedged differs depending on how the hedge was originally designated. Our accounting policies for derivative instruments used in our business that qualify as hedges are discussed below:
IMPACT OF THE DISCONTINUATION OF HEDGE TYPE OF HEDGE ACCOUNTING TREATMENT ACCOUNTING ON ITEM BEING HEDGED - ------------- -------------------- -------------------------------------- Fair value Changes in the fair value of the When hedge accounting is discontinued, derivative and changes in the fair the hedged asset or liability is no value of the related asset or longer adjusted for changes in fair liability attributable to the value. When hedge accounting is hedged risk are recorded in current discontinued because the hedged item period earnings, generally as a no longer meets the definition of a component of revenue in the case of firm commitment, any asset or a sale or as a component of the liability that was recorded related to cost of products in the case of a the firm commitment is removed from purchase. the balance sheet and recognized in current period earnings. Cash flow Changes in the fair value of the When hedge accounting is discontinued derivative are recorded in other because it is unlikely that the comprehensive income for the forecasted transaction will occur, portion of the change in value of gains or losses that were accumulated the derivative that is effective. in other comprehensive income related The ineffective portion of the to the forecasted transaction will be derivative is recorded in earnings recognized immediately in earnings. in the current period. When a cash flow hedge is Classification in the income de-designated, but the forecasted statement of the ineffective transaction is still probable, the portion is based on the income accumulated amounts remain in other classification of the item being comprehensive income until the hedged. forecasted transaction occurs. At that time, the accumulated amounts are recognized in earnings. Foreign currency Changes in the fair value of the If hedge accounting is discontinued, derivative are recorded in current accounting for the hedged item depends period earnings if it qualifies as on whether the hedge is a fair value a fair value hedge, or in other hedge or a cash flow hedge, and comprehensive income if it follows the accounting discussed qualifies as a cash flow hedge. above.
7 9 Because our business activities encompass all aspects of the wholesale energy marketplace, including the production, gathering, processing, treating, transmission, refining, and the purchase and sale of highly liquid energy commodities, our normal business contracts may qualify as derivative instruments under the provisions of SFAS No. 133. As a result, we evaluate each of our commercial contracts to see if derivative accounting is appropriate. Contracts that meet the criteria of a derivative are then evaluated to determine whether they qualify as a "normal purchase" or a "normal sale" as those terms are defined in SFAS No. 133. If they qualify as normal purchases and normal sales, we may exclude them from SFAS No. 133 treatment. We also evaluate our contracts for "embedded" derivatives. Embedded derivatives have terms that are not clearly and closely related to the terms of the contract in which they are included. If embedded derivatives exist, they are accounted for separately from the host contract as derivatives, with changes in their fair value recorded in current period earnings. 2. MERGER WITH EL PASO CORPORATION In January 2001, we became a wholly owned subsidiary of El Paso Corporation through our merger with a wholly owned El Paso subsidiary. In the merger, holders of our common stock and Class A common stock received 1.23 shares of El Paso common stock on a tax-free basis for each outstanding common share; holders of our Series A and Series B convertible preferred stock received 9.133 shares of El Paso common stock on a tax-free basis for each outstanding convertible share; and holders of our Series C convertible preferred stock received 17.98 shares of El Paso common stock on a tax-free basis for each outstanding convertible preferred share. In addition, holders of our outstanding stock options received shares of El Paso common stock based on the fair value of these options on the date of the merger. As a result of the merger, El Paso owns 100 percent of our common equity. Under a Federal Trade Commission (FTC) order related to the merger, we sold our Gulfstream pipeline project, our 50 percent interest in the Stingray and U-T Offshore pipeline systems, and our investments in the Empire State and Iroquois pipeline systems. For the quarter and six months ended June 30, 2001, net proceeds from these sales were approximately $40 million and $184 million, and we recognized extraordinary net gain (loss) of approximately $3 million and $(7) million, net of income tax expense of approximately $2 million and $1 million. We do not anticipate the impact from these sales to be material to our ongoing financial position, operating results, or cash flows. 3. MERGER-RELATED COSTS AND ASSET IMPAIRMENTS During the quarter and six months ended June 30, we incurred merger-related costs associated with our merger with El Paso and asset impairments as follows:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------- ---------------- 2001 2000 2001 2000 ---- ---- ----- ----- (IN MILLIONS) Merger-related costs................................. $208 $ 3 $975 $ 7 Asset impairments.................................... 9 -- 9 -- ---- --- ---- --- $217 $ 3 $984 $ 7 ==== === ==== ===
8 10 Merger-Related Costs Our merger-related costs consisted of the following:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------- ---------------- 2001 2000 2001 2000 ----- ----- ----- ----- (IN MILLIONS) Employee severance, retention, and transition costs.............................................. $ 7 $-- $585 $-- Business and operational integration costs........... 141 -- 155 -- Merger-related asset impairments..................... 19 -- 153 -- Other................................................ 41 3 82 7 ---- --- ---- --- $208 $ 3 $975 $ 7 ==== === ==== ===
Employee severance, retention, and transition costs include direct payments to, and benefit costs for, severed employees and early retirees that occurred as a result of the merger-related workforce reduction and consolidation. Following the merger, we completed an employee restructuring across all of our operating segments, resulting in the reduction of approximately 3,200 full-time positions through a combination of early retirements and terminations. Employee severance costs include actual severance payments and costs for pension and post-retirement benefits settled and curtailed under existing benefit plans as a result of this restructuring. Retention charges include payments to employees who were retained following the merger and payments to employees to satisfy contractual obligations. Transition costs relate to costs to relocate employees and costs for severed and retired employees arising after their severance date to transition their jobs into the ongoing workforce. Substantially all of the costs accrued in connection with these activities had been paid as of June 30, 2001. Also included in employee severance, retention, and transition costs for the six months ended June 30, 2001, was a charge of $278 million resulting from the issuance of approximately 4 million shares of El Paso common stock in exchange for the fair value of our employees' stock options. Business and operational integration costs include charges to consolidate facilities and operations of our business segments, such as lease related charges, and incremental fees under software and seismic license agreements. Merger-related asset impairments relate to write-offs or write-downs of capitalized costs for duplicate systems, redundant facilities, and assets whose value was impaired as a result of decisions on the strategic direction of our combined operations following our merger. These charges occurred primarily in our Merchant Energy segment, and all of these assets continue to be held for use. Other costs include investment banking, legal, accounting, consulting, and other advisory fees incurred to obtain federal and state regulatory approvals, and take other actions necessary to complete our merger. Asset Impairments During the quarter ended June 30, 2001, we incurred an asset impairment charge of approximately $9 million resulting from the unrecoverability of capitalized costs of Merchant Energy's Corpus Christi refinery. In June 2001, we entered into a 20-year agreement related to our Corpus Christi refinery that qualified as a sales-type capital lease. 4. CHANGES IN ACCOUNTING ESTIMATES Included in our operation and maintenance costs for the quarter and six months ended June 30, 2001, are approximately $204 million in costs related to changes in our estimates of environmental remediation liabilities and the usability of spare parts inventory in our worldwide operations. Both charges arose as a result of an ongoing evaluation of our operating standards and plans following our merger with El Paso and our combined operating strategy. These changes in estimates reduced net income before extraordinary items and net income by approximately $136 million. 9 11 5. ACCOUNTING FOR HEDGING ACTIVITIES On January 1, 2001, we adopted the provisions of SFAS No. 133, and recorded a cumulative-effect adjustment of $459 million, net of income taxes, in accumulated other comprehensive income to recognize the fair value of all derivatives designated as cash flow hedging instruments. The majority of the initial charge related to hedging forecasted sales of natural gas for 2001 and 2002. During the quarter and six months ended June 30, 2001, $72 million and $348 million, net of income taxes, of this initial transition adjustment was reclassified to earnings as a result of hedged sales and purchases during the periods, and an additional $107 million of this adjustment will be reclassified by the end of 2001. A discussion of our hedging activities is as follows: Fair Value Hedges. We have crude oil and refined products inventories that change in value daily due to changes in the commodity markets. We use futures and swaps to protect the value of these inventories. For the quarter and six months ended June 30, 2001, the financial statement impact of our hedges of the fair value of these inventories was immaterial. Cash Flow Hedges. A majority of our commodity sales and purchases are at spot market or forward market prices. We use futures, forward contracts, and swaps to limit our exposure to fluctuations in the commodity markets and allow for a fixed cash flow stream from these activities. As of June 30, 2001, the value of cash flow hedges included in accumulated other comprehensive income was an unrealized gain of $267 million, net of income taxes. Of this amount, we estimate that $145 million will be reclassified from accumulated other comprehensive income over the next 12 months. Reclassifications occur upon physical delivery of the hedged commodity and the corresponding expiration of the hedge. The maximum term of our cash flow hedges is 2 years; however, most of our cash flow hedges expire within the next 12 months. For the quarter and six months ended June 30, 2001, no ineffectiveness was recorded in our earnings on our cash flow hedges. Our other comprehensive income also includes our proportionate share of amounts recorded in other comprehensive income by our unconsolidated affiliates who use derivatives as cash flow hedges. 6. PROPERTY, PLANT, AND EQUIPMENT In June 2001, we entered into a 20-year agreement related to our Corpus Christi refinery with Valero Energy Corporation that qualified as a sales-type capital lease. The net investment of the lease at June 30, 2001, discounted using a rate of 7.5%, consisted of the following:
JUNE 30, 2001 -------- (IN MILLIONS) Minimum lease payments...................................... $288 Estimated residual value.................................... 91 ---- Net investment.................................... $379 ====
At June 30, 2001, the undiscounted minimum lease payments are as follows: $14 million in 2001; $19 million in 2002; $37 million in 2003; and $43 million per year thereafter. 7. INVENTORY Our inventory consisted of the following:
JUNE 30, DECEMBER 31, 2001 2000 -------- ------------ (IN MILLIONS) Refined products, crude oil, and chemicals.................. $737 $1,011 Coal, materials and supplies, and other..................... 127 156 Natural gas in storage...................................... -- 36 ---- ------ Total............................................. $864 $1,203 ==== ======
10 12 8. DEBT AND OTHER CREDIT FACILITIES At December 31, 2000, our weighted average interest rate on short-term borrowings was 7.15%. We had the following short-term borrowings, including current maturities of long-term debt:
JUNE 30, DECEMBER 31, 2001 2000 -------- ------------ (IN MILLIONS) Notes payable............................................... $ -- $343 Notes payable from affiliates............................... 8 -- Commercial paper............................................ -- 455 Current maturities of long-term debt........................ 415 147 ---- ---- $423 $945 ==== ====
In January 2001, we terminated approximately $1.5 billion in revolving credit facilities and became a designated borrower under El Paso's 364-day and 3-year revolving credit and competitive advance facilities. The interest rate on these facilities varies and was LIBOR plus 50 basis points on June 30, 2001. No amounts were outstanding under these facilities as of June 30, 2001. In June 2001, El Paso replaced its $2 billion, 364-day revolving credit facility, and we are no longer a designated borrower under its new facility. In addition to the items discussed above, during the six months ended June 30, 2001, we issued $45 million of long-term debt and retired approximately $84 million aggregate principal amount of 10.0% notes. 9. COMMITMENTS AND CONTINGENCIES Legal Proceedings In May 1999, we were named as defendants in a suit filed in the 319th Judicial District Court, Nueces County, Texas by an individual employed by one of our contractors (Rolando Lopez and Rosanna Barton v. Coastal Refining & Marketing, Inc. and The Coastal Corporation). The suit sought damages for injuries sustained at the time of an explosion at one of our refining plants, and was settled in August 2000 for a total payment of $7 million, of which $5 million was covered by insurance. Three of our refinery employees intervened in the suit and sought damages for injuries sustained in the explosion. Those claims were tried in August 2000, resulting in a $122 million verdict, for which there is insurance coverage. In 1997, a number of our subsidiaries were named defendants in actions brought by Jack Grynberg on behalf of the U.S. Government under the False Claims Act. Generally, these complaints allege an industry-wide conspiracy to under report the heating value as well as the volumes of the natural gas produced from federal and Native American lands, which deprived the U.S. Government of royalties. These matters have been consolidated for pretrial purposes (In re: Natural Gas Royalties Qui Tam Litigation, U.S. District Court for the District of Wyoming). In May 2001, the court denied the defendants' motions to dismiss. A number of our subsidiaries were named defendants in Quinque Operating Company, et al v. Gas Pipelines and Their Predecessors, et al, filed in 1999 in the District Court of Stevens County, Kansas. This class action complaint alleges that the defendants mismeasured natural gas volumes and heating content of natural gas on non-federal and non-Native American lands. The Quinque complaint was transferred to the same court handling the Grynberg complaint and has now been sent back to Kansas State Court for further proceedings. In October 1992, several property owners in McAllen, Texas, filed suit in the 93rd Judicial District Court, Hidalgo County, Texas, against, among others, one of our subsidiaries (Timely Adventures, Inc. et al, v. Phillips Properties, Inc., et al and Garza v. Coastal Mart, Inc.). The suit sought damages for the alleged diminution of property value and damages related to the exposure to hazardous chemicals arising from the operation of service stations and storage facilities. In July 2000, the trial court entered a judgment for approximately $1.2 million in actual damages for property diminution and approximately $100 million in punitive damages. The judgment is being appealed. 11 13 We are also a named defendant in numerous lawsuits and a named party in numerous governmental proceedings arising in the ordinary course of our business. While the outcome of the matters discussed above cannot be predicted with certainty, we do not expect the ultimate resolution of these matters will have a material adverse effect on our financial position, operating results, or cash flows. Environmental We are subject to extensive federal, state, and local laws and regulations governing environmental quality and pollution control. These laws and regulations require us to remove or remedy the effect on the environment of the disposal or release of specified substances at current and former operating sites. As of June 30, 2001, we had a reserve of approximately $181 million for expected remediation costs. In addition, we expect to make capital expenditures for environmental matters of approximately $141 million in the aggregate for the years 2001 through 2006. These expenditures primarily relate to compliance with clean air regulations. From March to October 2000, our Eagle Point Oil Company received several Administrative Order Notices of Civil Administrative Penalty Assessment from the New Jersey Department of Environmental Protection. All of the assessments are related to similar alleged noncompliances with the New Jersey Air Pollution Control Act pertaining to occurrences of air pollution from the second quarter 1998 through the third quarter 2000 by Eagle Point's refinery in Westville, New Jersey. The New Jersey Department of Environmental Protection has assessed penalties totaling approximately $1 million for these alleged violations. Eagle Point has requested an administrative hearing on all issues raised by the assessments and, concurrently, is in negotiations to settle these assessments. We have been designated and have received notice that we could be designated, or have been asked for information to determine whether we could be designated, as a Potentially Responsible Party (PRP) with respect to 24 active sites under CERCLA or state equivalents. We have sought to resolve our liability as a PRP at these CERCLA sites, as appropriate, through indemnification by third parties and/or settlements which provide for payment of our allocable share of remediation costs. As of June 30, 2001, we have estimated our share of the remediation costs at these sites to be between approximately $5 million and $6 million and have provided reserves that we believe are adequate for such costs. Since the cleanup costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, and because in some cases we have asserted a defense to any liability, our estimates could change. Moreover, liability under the federal CERCLA statute is joint and several, meaning that we could be required to pay in excess of our pro rata share of remediation costs. Our understanding of the financial strength of other PRPs has been considered, where appropriate, in the determination of our estimated liabilities. We presently believe that the costs associated with these CERCLA sites will not have a material adverse effect on our financial position, operating results, or cash flows. In Michigan, where we have extensive operations, the Michigan Environmental Response Act requires individuals, including corporations, who have caused contamination to remediate the contamination to regulatory standards. Owners or operators of contaminated property who did not cause the contamination are not required to remediate the contamination, but must exercise due care in their use of the property so that the contamination is not exacerbated and the property does not pose a threat to human health. We estimate that our costs to comply with the Michigan regulations will be approximately $21 million, which will be expended over a period of several years and for which appropriate reserves have been made. It is possible that new information or future developments could require us to reassess our potential exposure related to environmental matters. We may incur significant costs and liabilities in order to comply with existing environmental laws and regulations. It is also possible that other developments, such as increasingly strict environmental laws and regulations and claims for damages to property, employees, other persons and the environment resulting from our current or past operations, could result in substantial costs and liabilities in the future. As this information becomes available, or other relevant developments occur, we will adjust our accrual amounts accordingly. While there are still uncertainties relating to the ultimate costs we 12 14 may incur, based upon our evaluation and experience to date, we believe the recorded reserves are adequate. For further discussion of specific environmental matters, see Legal Proceedings above. 10. SEGMENT INFORMATION We segregate our business activities into four distinct operating segments: Pipelines, Merchant Energy, Production, and Field Services. These segments are strategic business units that provide a variety of energy products and services. They are managed separately as each business unit requires different technology and marketing strategies. We measure segment performance using earnings before interest expense and income taxes (EBIT). At the beginning of 2001, we aligned our segments to conform with El Paso's segments. All periods presented have been restated for these changes. The following are our results as of and for the periods ended June 30:
QUARTER ENDED JUNE 30, 2001 ----------------------------------------------------------------- MERCHANT FIELD PIPELINES ENERGY PRODUCTION SERVICES OTHER(1) TOTAL --------- -------- ---------- -------- -------- ------- (IN MILLIONS) Revenues from external customers.......... $ 231 $4,709 $ 565 $244 $ 117 $ 5,866 Intersegment revenues..................... 21 121 (99) 14 (57) -- Merger-related costs and asset impairments............................. 132 19 -- 4 62 217 Operating income (loss)................... (54) (107) 261 18 (166) (48) EBIT...................................... (29) (42) 264 19 (157) 55 Segment assets............................ 5,173 6,104 6,351 620 1,237 19,485
QUARTER ENDED JUNE 30, 2000 ----------------------------------------------------------------- MERCHANT FIELD PIPELINES ENERGY PRODUCTION SERVICES OTHER(1) TOTAL --------- -------- ---------- -------- -------- ------- (IN MILLIONS) Revenues from external customers.......... $ 195 $ 5,070 $ 262 $136 $ 302 $ 5,965 Intersegment revenues..................... 6 (23) 16 11 (10) -- Merger-related costs and asset impairments............................. -- -- -- -- 3 3 Operating income (loss)................... 79 13 122 16 (3) 227 EBIT...................................... 105 82 117 22 (5) 321 Segment assets............................ 5,191 5,888 3,651 447 1,277 16,454
SIX MONTHS ENDED JUNE 30, 2001 ----------------------------------------------------------------- MERCHANT FIELD PIPELINES ENERGY PRODUCTION SERVICES OTHER(1) TOTAL --------- -------- ---------- -------- -------- ------- (IN MILLIONS) Revenues from external customers.......... $ 542 $11,325 $1,001 $566 $ 294 $13,728 Intersegment revenues..................... 34 308 (111) 45 (276) -- Merger-related costs and asset impairments............................. 211 155 61 5 552 984 Operating income (loss)................... 6 (129) 411 42 (678) (348) EBIT...................................... 61 (15) 411 43 (672) (172) Segment assets............................ 5,173 6,104 6,351 620 1,237 19,485
SIX MONTHS ENDED JUNE 30, 2000 ----------------------------------------------------------------- MERCHANT FIELD PIPELINES ENERGY PRODUCTION SERVICES OTHER(1) TOTAL --------- -------- ---------- -------- -------- ------- (IN MILLIONS) Revenues from external customers.......... $465 $10,110 $ 491 $239 $ 577 $11,882 Intersegment revenues..................... 28 140 28 18 (214) -- Merger-related costs and asset impairments............................. -- -- -- -- 7 7 Operating income (loss)................... 216 30 224 39 (12) 497 EBIT...................................... 271 150 216 53 6 696 Segment assets............................ 5,191 5,888 3,651 447 1,277 16,454
- --------------- (1) Includes Corporate and eliminations as well as retail operations. 13 15 11. INVESTMENTS IN UNCONSOLIDATED AFFILIATES We hold investments in various affiliates which we account for using the equity method of accounting. Summarized financial information for our proportionate share of these investments is as follows:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------- ---------------- 2001 2000 2001 2000 ----- ------- ----- ------- (IN MILLIONS) Operating results data Revenues and other income.................... $ 659 $ 2,321 $ 902 $ 3,300 Costs and expenses........................... (613) (2,255) (782) (3,158) Income from continuing operations............ 46 66 120 142 Net income................................... 44 68 105 132
12. TRANSACTIONS WITH RELATED PARTIES During 2000, El Paso formed Clydesdale Associates, L.P., a limited partnership, and several other legal entities, for the purpose of generating funds for El Paso to invest in capital projects and other assets. The proceeds are collateralized by various assets of El Paso and, effective June 2001, by the net assets of our wholly owned subsidiary, Colorado Interstate Gas Company, which had a net asset value of $702 million as of June 30, 2001. After our merger, we began to participate in El Paso's cash management program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing total borrowing from outside sources. We had borrowed $991 million at June 30, 2001, at a market rate of interest which was 4.2%. At June 30, 2001, we had accounts receivable from other related parties of $726 million and $34 million at December 31, 2000. In addition, we had accounts and notes payable to other related parties of $914 million at June 30, 2001, versus $13 million at December 31, 2000. These balances were incurred in the normal course of business. 13. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED Business Combinations In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations. This statement requires that all transactions that fit the definition of a business combination be accounted for using the purchase method and prohibits the use of the pooling of interests method for all business combinations initiated after June 30, 2001. This statement also establishes specific criteria for the recognition of intangible assets separately from goodwill and requires unallocated negative goodwill to be written off immediately as an extraordinary item. This standard will have an impact on any business combination we undertake in the future. We are currently evaluating the effects of this pronouncement on our historical financial statements. Goodwill and Other Intangible Assets In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. This statement requires that goodwill no longer be amortized but intermittently tested for impairment at least on an annual basis. Other intangible assets are to be amortized over their useful life and reviewed for impairment in accordance with the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. An intangible asset with an indefinite useful life can no longer be amortized until its useful life becomes determinable. This statement has various effective dates, the most significant of which is January 1, 2002. We are currently evaluating the effects of this pronouncement. 14 16 Accounting for Asset Retirement Obligations In July 2001, the FASB approved for issuance SFAS No. 143, Accounting for Asset Retirement Obligations. This statement requires companies to record a liability relating to the retirement and removal of assets used in their business. The liability is discounted to the present value, and the related asset value is increased by the amount of the resulting liability. Over the life of the asset, the liability will be accreted to its future value and eventually extinguished when the asset is taken out of service. The provisions of this statement are effective for fiscal years beginning after June 15, 2002. We are currently evaluating the effects of this pronouncement. 15 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(1) The information contained in Item 2 updates, and you should read it in conjunction with, information disclosed in Part II, Items 7, 7A, and 8, in our Annual Report on Form 10-K for the year ended December 31, 2000, in addition to the financial statements and notes presented in Item 1, Financial Statements, of this Quarterly Report on Form 10-Q. RECENT DEVELOPMENTS Merger with El Paso Corporation In January 2001, we merged with El Paso. El Paso accounted for the merger as a pooling of interests and converted each share of our common stock and Class A common stock on a tax-free basis into 1.23 shares of El Paso common stock. El Paso also exchanged our outstanding convertible preferred stock with its common stock on the same basis as if the preferred stock had been converted into our common stock immediately prior to the merger. El Paso issued a total of approximately 271 million shares, including 4 million shares issued to holders of our stock options. Merger-Related Costs, Asset Impairments, and Other Charges During the quarters and six months ended June 30, 2001 and 2000, we incurred charges that had a significant impact on our results of operations, financial position, and cash flows, and that are not expected to continue. These charges include those related to our merger with El Paso, asset impairments, and other charges as follows:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------- ----------------- 2001 2000 2001 2000 ---- ---- ------- ----- (IN MILLIONS) Merger-related costs...................................... $208 $ 3 $ 975 $ 7 Asset impairments......................................... 9 -- 9 -- ---- --- ------ --- Total merger-related costs and asset impairments................................... 217 3 984 7 ---- --- ------ --- Other charges............................................. 204 -- 204 -- ---- --- ------ --- $421 $ 3 $1,188 $ 7 ==== === ====== ===
Merger-related costs include employee severance, retention, and transition charges; write-offs and write-downs of assets; charges to consolidate operations; contract termination charges; and other charges. Although we expect to incur additional merger-related charges during the remainder of 2001, we do not expect the level of charges to be as high as those incurred during the first and second quarters of 2001. - --------------- (1) Below is a list of terms that are common to our industry and used throughout our Management's Discussion and Analysis: /d = per day MBbls = thousand barrels Bbl = barrel MMBtu = million British thermal units BBtu = billion British thermal units Mcf = thousand cubic feet BBtue = billion British thermal unit equivalents MTons = thousand tons Bcf = billion cubic feet MMWh = thousand megawatt hours Btu = British thermal unit
When we refer to natural gas and oil in "equivalents," we are doing so to compare quantities of oil with quantities of natural gas or to express these different commodities in a common unit. In calculating equivalents, we use a generally recognized standard in which one Bbl is equal to six Mcf of natural gas. Also, when we refer to cubic feet measurements, all measurements are at 14.73 pounds per square inch. 16 18 The asset impairment charge resulted from the unrecoverability of capitalized costs of Merchant Energy's Corpus Christi refinery. Other charges consist of changes in estimates of our environmental remediation obligations and the usability of spare parts inventories in our operations. These charges were necessitated by an ongoing evaluation of our operating standards and plans following our merger with El Paso. Each of these charges is discussed more fully in Item 1, Financial Statements, Notes 3 and 4. By segment, these charges were recorded as follows:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------- ---------------- 2001 2000 2001 2000 ---- ---- ------ ---- (IN MILLIONS) Merger-related costs, asset impairments, and other charges Pipelines..................................... $152 $-- $ 231 $-- Merchant Energy............................... 92 -- 228 -- Production.................................... 7 -- 68 -- Field Services................................ 5 -- 6 -- ---- -- ------ -- Segment total.............................. 256 -- 533 -- Corporate and other........................... 165 3 655 7 ---- -- ------ -- Consolidated total......................... $421 $3 $1,188 $7 ==== == ====== ==
RESULTS OF OPERATIONS For the quarter ended June 30, 2001, we had a net loss of $65 million versus net income of $128 million for the quarter ended June 30, 2000. The 2001 loss was a result of merger-related costs, asset impairments, and other charges totaling $421 million, or $329 million after taxes. In addition, we recorded net extraordinary gains totaling $3 million, net of income taxes, as a result of FTC ordered sales of our investments in the U-T Offshore and Iroquois pipeline systems. During the second quarter of 2000, merger-related costs were $3 million, or $2 million net of income taxes. Net income, excluding the effects of these charges and extraordinary items, would have been $261 million in 2001 versus $130 million in 2000. For the six months ended June 30, 2001, we had a net loss of $412 million versus net income of $301 million for the six months ended June 30, 2000. The 2001 loss was a result of merger-related costs, asset impairments, and other charges totaling $1,188 million, or $891 million after taxes. In addition, we recorded net extraordinary losses totaling $7 million, net of income taxes, as a result of FTC ordered sales of our Gulfstream pipeline project and our investments in the U-T Offshore and Iroquois pipeline systems. For the six months ended June 30, 2000, merger-related charges were $7 million, or $5 million net of income taxes. Net income, excluding the after-tax effects of these charges and extraordinary items, would have been $486 million in 2001 versus $306 million in 2000. SEGMENT RESULTS Our business activities are segregated into four segments: Pipelines, Merchant Energy, Production, and Field Services. These segments are strategic business units that offer a variety of different energy products and services and each requires different technology and marketing strategies. These segments have been restated to reflect the manner in which we are currently operating them, and all prior period information has been restated to reflect this segment presentation. The results presented in this analysis are not necessarily indicative of the results that would have been achieved had the revised business segment structure been in place during those periods. Operating revenues and expenses by segment include intersegment revenues and expenses which are eliminated in consolidation. Because changes in energy commodity prices have a similar impact on both our operating revenues and cost of products sold from period to period, we believe that gross 17 19 margin (revenue less cost of sales) provides a more accurate and meaningful basis for analyzing operating results for the trading and refining portions of Merchant Energy and the Field Services segment. For a further discussion of our individual segments, see Item 1, Financial Statements, Note 10. The segment results presented below include merger-related costs, asset impairments, and other charges as discussed above:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------- ----------------- 2001 2000 2001 2000 ----- ---- ------ ----- (IN MILLIONS) EARNINGS BEFORE INTEREST EXPENSE AND INCOME TAXES Pipelines............................................. $ (29) $105 $ 61 $271 Merchant Energy....................................... (42) 82 (15) 150 Production............................................ 264 117 411 216 Field Services........................................ 19 22 43 53 ----- ---- ----- ---- Segment total....................................... 212 326 500 690 ----- ---- ----- ---- Corporate and other, net.............................. (157) (5) (672) 6 ----- ---- ----- ---- Consolidated EBIT................................... $ 55 $321 $(172) $696 ===== ==== ===== ====
PIPELINES Our Pipelines segment operates our interstate pipeline businesses. Each pipeline system operates under a separate tariff that governs its operations and rates. Operating results for our pipeline systems have generally been stable because the majority of the revenues are based on fixed reservation charges. As a result, we expect changes in this aspect of our business to be primarily driven by regulatory actions and contractual events. Commodity or throughput-based revenues account for a smaller portion of our operating results. These revenues vary from period to period, and system to system, and are impacted by factors such as weather, operating efficiencies, competition from other pipelines, and fluctuations in natural gas prices. Results of operations of the Pipelines segment were as follows for the periods ended June 30:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------- ---------------- 2001 2000 2001 2000 ----- ----- ----- ----- (IN MILLIONS) Operating revenues.................................. $ 252 $ 201 $ 576 $ 493 Operating expenses.................................. (306) (122) (570) (277) Other income........................................ 25 26 55 55 ----- ----- ----- ----- EBIT.............................................. $ (29) $ 105 $ 61 $ 271 ===== ===== ===== =====
Second Quarter 2001 Compared to Second Quarter 2000 Operating revenues for the quarter ended June 30, 2001, were $51 million higher than the same period in 2000. The increase was due to completed system expansions and new transportation and storage contracts during 2001 and the impact of higher realized prices on sales of natural gas production and at the Dakota gasification facility. Also contributing to the increase were higher sales of excess natural gas during the second quarter of 2001. Operating expenses for the quarter ended June 30, 2001, were $184 million higher than the same period in 2000. The increase was primarily the result of merger-related costs, asset impairments, and other charges discussed above, along with the impact of higher natural gas prices on system fuel costs and gas purchases at the Dakota gasification facility. Also contributing to the increase were higher corporate allocations. 18 20 Six Months Ended 2001 Compared to Six Months Ended 2000 Operating revenues for the six months ended June 30, 2001, were $83 million higher than the same period in 2000. The increase was due to completed system expansions and new transportation and storage contracts during 2001 and the impact of higher realized prices on sales of natural gas production and at the Dakota gasification facility. Also contributing to the increase were higher sales of excess natural gas during the second quarter of 2001. Partially offsetting the increase was the sale of base gas in 2000, the expiration of revenue sharing agreements prior to 2001, and revised estimates of gas revenues in 2000. Operating expenses for the six months ended June 30, 2001, were $293 million higher than the same period in 2000. The increase was primarily the result of merger-related costs, asset impairments, and other charges discussed above, along with the impact of higher natural gas prices on system fuel costs and gas purchases at the Dakota gasification facility. Also contributing to the increase were higher corporate allocations. MERCHANT ENERGY Merchant Energy is involved in a wide range of activities in the wholesale energy market place, including petroleum trading and risk management and asset ownership of power plants, refineries and chemical facilities. Each market served by Merchant Energy is highly competitive and is influenced directly or indirectly by energy market economics. Prior to October 2000, we conducted our marketing and trading activities through Engage Energy US, L.P. and Engage Energy Canada, L.P., a joint venture between us and Westcoast Energy Inc., a Canadian natural gas company. During the fourth quarter of 2000, we terminated the Engage joint venture and assumed the U.S. portion of Engage. As a result, we consolidated the U.S. trading contracts. In February 2001, we transferred these contracts, which included Engage's marketing contracts and other assets to El Paso Merchant Energy, an affiliate and subsidiary of El Paso, in exchange for 22 percent of the shares of El Paso Merchant Energy, which had an estimated fair value of approximately $135 million. Below are Merchant Energy's operating results and an analysis of these results for the periods ended June 30:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- (IN MILLIONS, EXCEPT VOLUME AMOUNTS) Trading and refining gross margin............. $ 201 $ 234 $ 522 $ 417 Operating and other revenues.................. 87 94 181 180 Operating expenses............................ (395) (315) (832) (567) Other income.................................. 65 69 114 120 -------- -------- -------- -------- EBIT........................................ $ (42) $ 82 $ (15) $ 150 ======== ======== ======== ======== Volumes Physical Natural gas (BBtue/d).................... -- -- 3,457 -- Power (MMWh)............................. 71 84 192 168 Crude oil and refined products (MBbls)... 162,514 161,085 330,459 321,183 Coal (MTons)............................. 2,665 2,618 5,328 5,093
Second Quarter 2001 Compared to Second Quarter 2000 Trading and refining gross margin consists of revenues from our refineries and commodity trading activities less the costs of the feedstocks used in the refining process and the costs of commodities sold. For the quarter ended June 30, 2001, trading and refining gross margin was $33 million lower than the same period in 2000. The decrease resulted from lower throughput at our refineries due to a fire at our Aruba facility in April 2001, which caused a cessation of operations for a period of approximately three weeks, lower chemical prices in the second quarter of 2001, and the lease of our Corpus Christi refinery to Valero in June 2001. 19 21 Operating and other revenues consist of revenues from consolidated domestic and international power generation facilities and coal operations. For the quarter ended June 30, 2001, operating and other revenues were $7 million lower than the same period in 2000. The decrease primarily resulted from a decrease in coal prices realized in the second quarter of 2001, partially offset by higher 2001 revenues on the Manchief power plant, which began operation in July 2000. Operating expenses for the quarter ended June 30, 2001, were $80 million higher than the same period in 2000. The increase was primarily a result of merger-related costs, asset impairments, and other charges discussed above. Other income for the quarter ended June 30, 2001, was $4 million lower than the same period in 2000. The decrease resulted from lower equity earnings on unconsolidated power and refining projects, lower management fees from foreign investments, and higher interest income in 2000. These decreases were partially offset by income from business interruption insurance proceeds related to the fire at our Aruba facility. Six Months Ended 2001 Compared to Six Months Ended 2000 For the six months ended June 30, 2001, trading and refining gross margin was $105 million higher than the same period in 2000. The increase resulted from increased refining gross margins in the first quarter largely due to higher prices received for refined products without a corresponding increase in feedstock prices. Also contributing to the increase was the margin on Engage's operations during January 2001 prior to the transfer of these contracts to El Paso Merchant Energy in February 2001. Operating and other revenues for the six months ended June 30, 2001, were $1 million higher than the same period in 2000. Higher revenues from the Manchief power plant, which began operating in July 2000 and other domestic power facilities were substantially offset by lower realized coal prices in 2001. Operating expenses for the six months ended June 30, 2001, were $265 million higher than the same period in 2000. The increase was primarily a result of merger-related costs, asset impairments, and other charges discussed above. Other income for the six months ended June 30, 2001, was $6 million lower than the same period in 2000. The decrease resulted from lower equity earnings on unconsolidated power and refining projects as well as a gain in the first quarter of 2000 on the sale of a Guatemala power plant. These decreases were partially offset by income from business interruption insurance proceeds related to the fire at our Aruba facility. PRODUCTION Production's operating results are driven by a variety of factors including its ability to locate and develop economic gas and oil reserves, extract those reserves with minimal production costs, sell the products at attractive prices, and operate at the lowest cost level possible. Production engages in hedging activities on its natural gas and oil production in order to stabilize cash flows and reduce the risk of downward commodity price movements on sales of its production. This is achieved through natural gas and oil swaps. We attempt to hedge approximately 75 percent of our anticipated current year production and approximately 50 percent of our anticipated succeeding year production. Production's hedged positions are closely monitored and evaluated in an effort to achieve its earnings objective and reduce 20 22 the risks associated with spot-market price volatility. Below are the operating results and analysis of these results for the periods ended June 30:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- --------------------- 2001 2000 2001 2000 -------- -------- --------- --------- (IN MILLIONS, EXCEPT VOLUMES AND PRICES) Natural gas................................................ $ 407 $ 235 $ 772 $ 436 Oil, condensate, and liquids............................... 52 40 107 77 Other...................................................... 7 3 11 6 ------ ------ ------ ------ Total operating revenues......................... 466 278 890 519 Operating expenses......................................... (205) (156) (479) (295) Other income (loss)........................................ 3 (5) -- (8) ------ ------ ------ ------ EBIT..................................................... $ 264 $ 117 $ 411 $ 216 ====== ====== ====== ====== Volumes and prices Natural gas Volumes (Bcf)......................................... 98 86 189 165 ====== ====== ====== ====== Average realized prices ($/Mcf)....................... $ 4.14 $ 2.72 $ 4.08 $ 2.63 ====== ====== ====== ====== Oil, condensate, and liquids Volumes (MBbls)....................................... 2,232 1,522 4,146 3,041 ====== ====== ====== ====== Average realized prices ($/Bbl)....................... $23.07 $26.41 $25.92 $25.22 ====== ====== ====== ======
Second Quarter 2001 Compared to Second Quarter 2000 For the quarter ended June 30, 2001, operating revenues were $188 million higher than the same period in 2000. The increase was the combined result of higher realized natural gas prices coupled with higher gas production. Realized natural gas sales prices were 52 percent higher than the same quarter of 2000, and natural gas production volumes rose during the second quarter of 2001 by 14 percent over the same period in 2000. Oil, condensate, and liquids production volumes were 47 percent higher than the same period in 2000, with realized average prices decreasing 13 percent. Operating expenses for the quarter ended June 30, 2001, were $49 million higher than the same period in 2000 as a result of higher oilfield services costs, higher severance and other production taxes in 2001, which are generally tied to natural gas and oil prices, and write-downs of materials and supplies caused by the ongoing evaluation of our operating standards and plans in our combined production operations. Also contributing to the increase was higher depletion expense in 2001 as a result of the increased production volumes and higher capitalized costs in the full cost pool, and higher costs under a production commitment with Alliance Pipeline, which commenced operations in the fourth quarter of 2000. Six Months Ended 2001 Compared to Six Months Ended 2000 Operating revenues for the six months ended June 30, 2001, were $371 million higher than the same period in 2000. The increase was the combined result of higher realized natural gas prices coupled with higher gas production. For the six months ended June 30, 2001, realized natural gas sales prices were 55 percent higher than the same period in 2000, and natural gas production volumes rose by 15 percent over the same period in 2000. Oil, condensate, and liquids production volumes were also 36 percent higher than the same period in 2000, with realized average prices slightly higher than 2000 levels. Operating expenses for the six months ended June 30, 2001, were $184 million higher than the same period in 2000 as a result of higher oilfield services costs, higher severance and other production taxes in 2001, which are generally tied to natural gas and oil prices, and merger-related costs and other charges related to our combined production operations. Also contributing to the increase was higher depletion expense in 2001 as a result of the increased production volumes and higher capitalized costs in the full cost pool, and higher costs 21 23 under a production commitment with Alliance Pipeline, which commenced operations in the fourth quarter of 2000. FIELD SERVICES Field Services provides a variety of services for the midstream component of our operations, including gathering and treating of natural gas, processing and fractionation of natural gas, natural gas liquids and natural gas derivative products, such as ethane, propane, and butane. Our gathering and treating operations earn margins substantially from fixed-fee based services; however, some of these operations earn margins from market-based rates. Revenues for these commodity rate services are the product of the market price, usually related to the monthly natural gas price index, and the volume gathered. Processing and fractionation operations earn a margin based on fixed-fee contracts, percentage-of-proceeds contracts, and make-whole contracts. Percentage-of-proceeds contracts allow us to retain a percentage of the product as a fee for processing or fractionation service. Make-whole contracts allow us to retain the extracted liquid products and to return to the producer a Btu equivalent amount of natural gas. Under its percentage-of-proceeds contracts and make-whole contracts, Field Services may have more sensitivity to price changes during periods when natural gas and natural gas liquids prices are volatile. Field Services' operating results and an analysis of those results are as follows for the periods ended June 30:
QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------ 2001 2000 2001 2000 ------- ------- ------- ------- (IN MILLIONS, EXCEPT VOLUMES AND PRICES) Gathering, treating, and processing margin.............. $ 44 $ 35 $ 85 $ 89 Operating expenses...................................... (26) (19) (43) (50) Other income............................................ 1 6 1 14 ------ ------ ------ ------ EBIT.................................................. $ 19 $ 22 $ 43 $ 53 ====== ====== ====== ====== Volumes and prices Gathering and treating Volumes (BBtu/d)................................... 1,033 985 984 964 ====== ====== ====== ====== Prices ($/MMBtu)................................... $ 0.13 $ 0.12 $ 0.13 $ 0.13 ====== ====== ====== ====== Processing Volumes (inlet BBtu/d)............................. 1,845 1,979 1,893 1,956 ====== ====== ====== ====== Prices ($/MMBtu)................................... $ 0.17 $ 0.16 $ 0.16 $ 0.17 ====== ====== ====== ======
Second Quarter 2001 Compared to Second Quarter 2000 Total gathering, treating, and processing margin for the quarter ended June 30, 2001, was $9 million higher than the same period in 2000. The increase was primarily due to higher profitability from the south Louisiana facilities in 2001, which processed gas to meet minimum pipeline specifications at a more profitable level than processing margins during 2000. Also contributing to the higher margin was the addition of the Caribou facility in 2001. Partially offsetting the increase were lower liquids prices in the Continental and Rocky Mountain regions. Operating expenses for the quarter ended June 30, 2001, were $7 million higher than the same period in 2000. The increase was primarily a result of merger-related costs arising from merging our operations with El Paso. Other income for the quarter ended June 30, 2001, was $5 million lower than the same period in 2000 as a result of equity investment losses from our Aux Sable liquids and Mobile Bay processing facilities. 22 24 Six Months Ended 2001 Compared to Six Months Ended 2000 Total gathering, treating, and processing margin for the six months ended June 30, 2001, was $4 million lower than the same period in 2000. The decrease was a result of lower liquids prices in the Continental and Rocky Mountain regions. Partially offsetting the decrease was higher profitability from the south Louisiana facilities in 2001, which processed gas to meet minimum pipeline specifications at a more profitable level than processing margins during 2000, and higher volumes as a result of higher natural gas and natural gas liquids prices related to percentage-of-proceeds contracts. Also contributing to the higher margin was the addition of the Caribou facility in 2001. Operating expenses were $7 million lower than the same period in 2000. Cost savings following the merger with El Paso were partially offset by merger-related costs in 2001. Other income was $13 million lower than the same period in 2000. Equity investment losses from our Aux Sable liquids and Mobile Bay processing facilities and gains in 2000 from the sale of assets contributed to the decrease. CORPORATE AND OTHER, NET Corporate expenses for the quarter and six months ended June 30, 2001, were $152 million and $678 million higher than the same periods in 2000. The increases were primarily a result of merger-related charges in connection with our January 2001 merger with El Paso. NON-AFFILIATED AND AFFILIATED INTEREST AND DEBT EXPENSE Total interest and debt expense for the quarter and six months ended June 30, 2001, was $9 million and $24 million higher than the same periods in 2000 primarily due to increased borrowings for ongoing capital projects and operating requirements. In the first quarter of 2001, all non-affiliated short-term borrowings, consisting of approximately $1 billion of commercial paper and short-term bank credit facilities, were retired and replaced with advances from El Paso. INCOME TAXES The income tax benefits for the quarter and six months ended June 30, 2001, were $19 million and $51 million, resulting in effective tax rates of 22 percent and 11 percent. Our effective tax rates were different than the statutory rate of 35 percent primarily due to the following: - the non-deductible portion of merger-related costs and, for the six months ended June 30, 2001, other tax adjustments to provide for revised estimated liabilities; - state income taxes; and - foreign income not taxed in the U.S., but taxed at foreign rates. The income tax expenses for the quarter and six months ended June 30, 2000, were $57 million and $131 million, resulting in effective tax rates of 31 percent and 30 percent. Our effective tax rates were different than the statutory tax rate of 35 percent primarily due to the following: - state income taxes and - foreign income not taxed in the U.S., but taxed at foreign rates. OTHER In August 2001, we completed the acquisition of Velvet Exploration Ltd., at a cost of approximately $230 million (approximately C$353 million). Velvet is a Canadian exploration and development company, with a majority of its properties located in the Foothills and Deep Basin areas of western Alberta Province. 23 25 COMMITMENTS AND CONTINGENCIES See Item 1, Financial Statements, Note 9, which is incorporated herein by reference. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED See Item 1, Financial Statements, Note 13, which is incorporated herein by reference. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report contains or incorporates by reference forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Where any forward-looking statement includes a statement of the assumptions or bases underlying the forward-looking statement, we caution that, while we believe these assumptions or bases to be reasonable and to be made in good faith, assumed facts or bases almost always vary from the actual results, and the differences between assumed facts or bases and actual results can be material, depending upon the circumstances. Where, in any forward-looking statement, we or our management express an expectation or belief as to future results, that expectation or belief is expressed in good faith and is believed to have a reasonable basis. We cannot assure you, however, that the statement of expectation or belief will result or be achieved or accomplished. The words "believe," "expect," "estimate," "anticipate" and similar expressions will generally identify forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This information updates, and you should read it in conjunction with, information disclosed in Part II, Item 7A in our Annual Report on Form 10-K for the year ended December 31, 2000, in addition to the information presented in Items 1 and 2 of this Quarterly Report on Form 10-Q. As a result of transferring Engage's contracts to El Paso Merchant Energy, we no longer conduct unregulated natural gas and power marketing and trading activities and are no longer exposed to the market risk associated with these activities. Except as discussed above, there are no material changes in market risk from those reported in our Annual Report on Form 10-K for the year ended December 31, 2000. 24 26 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Part I, Item 1, Financial Statements, Note 9, which is incorporated herein by reference. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits. None. Undertaking We hereby undertake, pursuant to Regulation S-K, Item 601(b), paragraph (4)(iii), to furnish to the U.S. Securities and Exchange Commission, upon request, all constituent instruments defining the rights of holders of our long-term debt and of our consolidated subsidiaries not filed herewith for the reason that the total amount of securities authorized under any of such instruments does not exceed 10 percent of our total consolidated assets. b. Reports on Form 8-K We filed a current report on Form 8-K, dated May 29, 2001, announcing the change in our certifying accountants. 25 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. EL PASO CGP COMPANY Date: August 10, 2001 /s/ H. BRENT AUSTIN ------------------------------------ H. Brent Austin Executive Vice President and Chief Financial Officer Date: August 10, 2001 /s/ JEFFREY I. BEASON ------------------------------------ Jeffrey I. Beason Senior Vice President and Controller (Chief Accounting Officer) 26 -----END PRIVACY-ENHANCED MESSAGE-----