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<SEC-DOCUMENT>0000950129-03-001717.txt : 20030331
<SEC-HEADER>0000950129-03-001717.hdr.sgml : 20030331
<ACCEPTANCE-DATETIME>20030331113146
ACCESSION NUMBER: 0000950129-03-001717
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 23
CONFORMED PERIOD OF REPORT: 20021231
FILED AS OF DATE: 20030331
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: EL PASO CORP/DE
CENTRAL INDEX KEY: 0001066107
STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION [4922]
IRS NUMBER: 760568816
STATE OF INCORPORATION: DE
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-14365
FILM NUMBER: 03628003
BUSINESS ADDRESS:
STREET 1: 1001 LOUISIANA ST, SUITE 2955A
STREET 2: EL PASO BLDG
CITY: HOUSTON
STATE: TX
ZIP: 77002
BUSINESS PHONE: 7134202600
MAIL ADDRESS:
STREET 1: 1001 LOUISIANA ST
STREET 2: SUITE 2955A
CITY: HOUSTON
STATE: TX
ZIP: 77002
FORMER COMPANY:
FORMER CONFORMED NAME: EL PASO ENERGY CORP/DE
DATE OF NAME CHANGE: 19980716
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>h01594e10vk.txt
<DESCRIPTION>EL PASO CORPORATION - DECEMBER 31, 2002
<TEXT>
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
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 1-14365
EL PASO CORPORATION
(FORMERLY EL PASO ENERGY CORPORATION)
(Exact Name of Registrant as Specified in Its Charter)
<Table>
<S> <C>
DELAWARE 76-0568816
(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)
</Table>
TELEPHONE NUMBER: (713) 420-2600
INTERNET WEBSITE: WWW.ELPASO.COM
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<Table>
<Caption>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
<S> <C>
Common Stock, par value $3 per share New York Stock Exchange
Pacific Exchange
</Table>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ].
STATE THE AGGREGATE MARKET VALUE OF THE VOTING AND NON-VOTING COMMON EQUITY
HELD BY NON-AFFILIATES OF THE REGISTRANT.
Aggregate market value of the voting stock (which consists solely of shares
of common stock) held by non-affiliates of the registrant as of June 28, 2002,
computed by reference to the closing sale price of the registrant's common stock
on the New York Stock Exchange on such date: $12,055,450,292.
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE.
Common Stock, par value $3 per share. Shares outstanding on March 27, 2003:
599,435,088
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: Portions of our definitive Proxy Statement for the 2003 Annual
Meeting of Stockholders, to be filed not later than 120 days after the end of
the fiscal year covered by this report, are incorporated by reference into Part
III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
EL PASO CORPORATION
TABLE OF CONTENTS
<Table>
<Caption>
CAPTION PAGE
------- ----
<S> <C> <C>
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 28
Item 3. Legal Proceedings........................................... 29
Item 4. Submission of Matters to a Vote of Security Holders......... 29
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 30
Item 6. Selected Financial Data..................................... 32
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 33
Risk Factors and Cautionary Statement for Purposes of the
"Safe Harbor" Provisions
of the Private Securities Litigation Reform Act of 1995... 76
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 83
Item 8. Financial Statements and Supplementary Data................. 85
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 185
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 185
Item 11. Executive Compensation...................................... 185
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 185
Item 13. Certain Relationships and Related Transactions.............. 185
Item 14. Controls and Procedures..................................... 185
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 187
Signatures.................................................. 195
Certifications.............................................. 197
</Table>
- ---------------
Below is a list of terms that are common to our industry and used
throughout this document:
<Table>
<S> <C>
/d = per day
Bbl = barrels
BBtu = billion British thermal units
= billion British thermal unit
BBtue equivalents
Bcf = billion cubic feet
Bcfe = billion cubic feet of gas equivalents
MBbls = thousand barrels
Mcf = thousand cubic feet
Mcfe = thousand cubic feet of gas equivalents
Mgal = thousand gallons
MMBbls = million barrels
MMBtu = million British thermal units
MMcf = million cubic feet
MMcfe = million cubic feet of gas equivalents
MMDth = million dekatherm
MTons = thousand tons
MW = megawatt
MWh = megawatt hours
MMWh = thousand megawatt hours
Tcfe = trillion cubic feet of gas equivalents
</Table>
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 of oil is equal to six Mcf of
natural gas. Also, when we refer to cubic feet measurements, all measurements
are at a pressure of 14.73 pounds per square inch.
When we refer to "us", "we", "our", "ours", or "El Paso", we are describing
El Paso Corporation and/or our subsidiaries.
i
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
We are an energy company originally founded in 1928 in El Paso, Texas. For
many years, we served as a regional pipeline company conducting business mainly
in the western United States. Since 1996, we have grown into an international
energy company whose operations extend from natural gas production and
extraction to power generation. Our growth during this period has been
accomplished through several significant acquisitions and internal growth
initiatives, each of which has expanded our competitive abilities in energy
markets in the United States and abroad. Some of the significant highlights
during this period were:
<Table>
<Caption>
YEAR TRANSACTION IMPACT
- ---- ----------- ------
<S> <C> <C>
1996 Acquisition of the energy businesses of Expanded our U.S. interstate pipeline
Tenneco Inc. system from coast to coast and signaled our
entry into the international energy market.
1998 Acquisition of DeepTech International, Inc. Expanded our U.S. onshore and offshore
gathering capabilities. Established us as
the general partner for El Paso Energy
Partners, L.P.
1999 Merger with Sonat Inc. Expanded our pipeline operations into the
southeast portion of the U.S. and signaled
our entrance into the exploration and
production business.
2001 Merger with The Coastal Corporation Placed us as a top tier participant in
every aspect of the wholesale energy
marketplace.
</Table>
Since the fourth quarter of 2001, our industry and business have been
adversely impacted by a number of industry changing events, including:
- The bankruptcy of Enron Corp.;
- The decline in the energy trading industry;
- Credit ratings downgrades of us and other industry participants by
Moody's and Standard & Poor's to "below investment grade" status, and
we remain on negative outlook; and
- Regulatory and political pressure arising out of the western energy
crisis of 2000 and 2001.
Beginning in December 2001 and continuing throughout 2002 and the first
quarter of 2003, we responded to these industry developments by focusing on
activities that would enhance our liquidity and strengthen our capital
structure. These activities involved:
- selling marginally performing assets and businesses that were not core to
our fundamental base business of natural gas and pipelines;
- exiting complex areas that require higher credit support, such as energy
trading, and focusing instead on core cash generating businesses; and
- pursuing resolution of regulatory and litigation matters, which led to a
March 2003 agreement in principle to settle our primary exposure to the
western energy crisis (Western Energy Settlement).
In February 2003 we announced what we refer to as our 2003 Operational and
Financial Plan. This plan is based upon five key principles:
- Preserving and enhancing the value of our core businesses;
- Exiting non-core businesses quickly, but prudently;
- Strengthening and simplifying our balance sheet while maximizing
liquidity;
1
<PAGE>
- Aggressively pursuing additional cost reductions; and
- Continuing to work diligently to resolve litigation and regulatory
matters.
Our ongoing critical areas of focus are:
- Pipelines: Protecting and enhancing asset value in our natural gas
transportation business through continuous efficiency gains and prudent
and necessary capital spending.
- Production: Developing production opportunities in North America that
maximize volumes produced and minimize costs, thereby optimizing cash
flow per unit produced.
- Field Services: Optimizing stable cash flows from our investment in El
Paso Energy Partners, L.P.
- Global Power: Enhancing cash flows from existing projects, while selling
non-strategic power generation facilities.
We will also continue to focus on winding down our non-core businesses
including energy trading and petroleum markets as well as other capital
intensive businesses such as liquefied natural gas (LNG) operations.
SEGMENTS
Our operations are segregated into four primary business segments:
Pipelines, Production, Field Services and Merchant Energy. These segments are
strategic business units that provide a variety of energy products and services.
We manage each segment separately, and each segment requires different
technology and marketing strategies. As future developments in our businesses
occur, and as we carry out our ongoing strategy and plans, we will continue to
assess the appropriateness of our business segments. For the operating results
and identifiable assets by segment, you should see Part II, Item 8, Financial
Statements and Supplementary Data, Note 24, which is incorporated herein by
reference.
Our Pipelines segment owns or has interests in approximately 60,000 miles
of interstate natural gas pipelines in the U.S. and internationally. In the
U.S., our systems connect the nation's principal natural gas supply regions to
the five largest consuming regions in the U.S.: the Gulf Coast, California, the
Northeast, the Midwest and the Southeast. These pipelines represent one of the
largest integrated coast-to-coast mainline natural gas transmission systems in
the U.S. Our U.S. pipeline systems also own or have interests in approximately
440 Bcf of storage capacity used to provide a variety of services to our
customers and own and operate an LNG terminal at Elba Island, Georgia. Our
international pipeline operations include access between our U.S. based systems
and Canada and Mexico as well as interests in three operating natural gas
transmission systems in Australia.
Our Production segment conducts our natural gas and oil exploration and
production activities. Domestically, we lease approximately 4 million net acres
in 16 states, including Louisiana, Oklahoma, Texas and Utah, and in the Gulf of
Mexico. We also have exploration and production rights in Australia, Bolivia,
Brazil, Canada, Hungary, Indonesia and Turkey. During 2002, daily equivalent
natural gas production exceeded 1.6 Bcfe/d, and our reserves at December 31,
2002, were approximately 5.2 Tcfe.
Our Field Services segment conducts our midstream activities. As part of
our plan to strengthen our capital structure and enhance our liquidity, we
completed a number of asset sales during 2002, including the sale of our San
Juan Basin gathering, treating and processing assets and our Texas and New
Mexico midstream assets, including the intrastate natural gas pipeline system we
acquired from Pacific Gas & Electric in 2000, to El Paso Energy Partners. El
Paso Energy Partners is a publicly traded master limited partnership for which
our subsidiary serves as general partner. As a result of asset sales to the
partnership and others during 2002, our remaining Field Services assets consist
of 23 processing plants and related gathering facilities located in the south
Texas, Louisiana, Mid-Continent and Rocky Mountain regions, as well as our
interests in El Paso Energy Partners. The partnership provides natural gas,
natural gas liquids (NGL) and oil gathering, transportation, processing,
fractionation, storage and other related services.
2
<PAGE>
Our Merchant Energy segment consists of three primary divisions: global
power, petroleum and energy trading. We are a significant owner of electric
generating capacity and own or have interests in 88 power plants in 18
countries. We operate three refineries that have the capacity to process
approximately 438 MBbls of crude oil per day and produce a variety of petroleum
products. We also produce agricultural and industrial chemicals at four
facilities in the U.S. and one in Canada. On February 5, 2003, we announced our
intent to sell our remaining petroleum and chemicals assets, except for our
Aruba refinery, as well as reduce our involvement in the LNG business. On
November 8, 2002, we announced our plan to exit the energy trading business and
pursue an orderly liquidation of our trading portfolio as a result of
diminishing business opportunities and higher capital costs for this activity.
During 2002 and the first part of 2003, we also completed or announced several
asset sales including the sale of our coal mining assets and operations,
petroleum assets and interests in power projects.
PIPELINES SEGMENT
Our Pipelines segment provides natural gas transmission, storage, gathering
and related services in the U.S. and internationally. We conduct our activities
primarily through seven wholly owned and seven partially owned interstate
transmission systems along with six underground natural gas storage entities and
an LNG terminalling facility. The tables below detail our wholly owned and
partially owned interstate transmission systems:
Wholly Owned Interstate Transmission Systems
<Table>
<Caption>
AS OF DECEMBER 31, 2002
------------------------------ AVERAGE THROUGHPUT(1)
TRANSMISSION SUPPLY AND MILES OF DESIGN STORAGE ------------------------
SYSTEM MARKET REGION PIPELINE CAPACITY CAPACITY 2002 2001 2000
------------ ------------- -------- -------- -------- ----- -------- -----
(MMCF/D) (BCF) (BBTU/D)
<S> <C> <C> <C> <C> <C> <C> <C>
Tennessee Gas Extends from Louisiana, the Gulf of 14,200 6,487 97 4,596 4,405 4,354
Pipeline (TGP) Mexico and south Texas to the
northeast section of the U.S.,
including the metropolitan areas of
New York City and Boston.
ANR Pipeline (ANR) Extends from Louisiana, Oklahoma, 10,600 6,450 207 3,691 3,776 3,807
Texas and the Gulf of Mexico to the
midwestern and northeastern regions
of the U.S., including the
metropolitan areas of Detroit,
Chicago and Milwaukee.
El Paso Natural Gas Extends from the San Juan, Permian 10,600 5,330(2) -- 3,799 4,253 3,937
(EPNG) and Anadarko Basins to California,
which is EPNG's single largest
market, as well as markets in
Arizona, Nevada, New Mexico,
Oklahoma, Texas and northern Mexico.
Southern Natural Gas Extends from Texas, Louisiana, 8,000 2,963 60 2,020 1,877 2,132
(SNG) Mississippi, Alabama and the Gulf of
Mexico to Louisiana, Mississippi,
Alabama, Florida, Georgia, South
Carolina and Tennessee, including the
metropolitan areas of Atlanta and
Birmingham.
</Table>
- ---------------
(1) Includes throughput transported on behalf of affiliates.
(2) This capacity is comprised of 4,530 MMcf/d of west-flow capacity (which
includes 230 MMcf/d added by our Line 2000 expansion project) and 800 MMcf/d
of east-end delivery capacity.
3
<PAGE>
<Table>
<Caption>
AS OF DECEMBER 31, 2002
------------------------------ AVERAGE THROUGHPUT(1)
TRANSMISSION SUPPLY AND MILES OF DESIGN STORAGE ------------------------
SYSTEM MARKET REGION PIPELINE CAPACITY CAPACITY 2002 2001 2000
------------ ------------- -------- -------- -------- ----- -------- -----
(MMCF/D) (BCF) (BBTU/D)
<S> <C> <C> <C> <C> <C> <C> <C>
Colorado Interstate Extends from most production areas in 4,000 3,100 29 1,563 1,448 1,383
Gas (CIG) the Rocky Mountain region and the
Anadarko Basin to the front range of
the Rocky Mountains and multiple
interconnects with pipeline systems
transporting gas to the Midwest, the
Southwest, California and the Pacific
Northwest.
Wyoming Interstate Extends from western Wyoming and the 600 1,860 -- 1,194 1,017 832
(WIC) Powder River Basin to various
pipeline interconnections near
Cheyenne, Wyoming.
Mojave Pipeline (MPC) Connects with the EPNG and 400 400 -- 266 283 407
Transwestern transmission systems at
Topock, Arizona, and the Kern River
Gas Transmission Company transmission
system in California, and extends to
customers in the vicinity of
Bakersfield, California.
</Table>
- ---------------
(1) Includes throughput transported on behalf of affiliates.
Partially Owned Interstate Transmission Systems
<Table>
<Caption>
AS OF DECEMBER 31, 2002
----------------------------------
TRANSMISSION SUPPLY AND OWNERSHIP MILES OF DESIGN
SYSTEM MARKET REGION INTEREST PIPELINE CAPACITY(1)
------------ ------------- --------- -------- -----------
(PERCENT) (MMCF/D)
<S> <C> <C> <C> <C>
Florida Gas Transmission Extends from south Texas to Florida. 50 4,804 1,950
Alliance Pipeline(2) Extends from western Canada to Chicago. 2 2,345 1,537
Great Lakes Gas Extends from the Manitoba-Minnesota border to the 50 2,115 2,895
Transmission Michigan-Ontario border at St. Clair, Michigan.
Dampier-to-Bunbury Extends from Dampier to Bunbury in western 33 1,152 570
pipeline system Australia.
Moomba-to-Adelaide Extends from Moomba to Adelaide in southern 33 685 383
pipeline system Australia.
Ballera-to-Wallumbilla Extends from Ballera to Wallumbilla in 33 470 115
pipeline system southwestern Queensland, Australia.
Portland Natural Gas Extends from the Canadian border near Pittsburg, 30(3) 294 214
Transmission New Hampshire to Dracut, Massachusetts.
<Caption>
AVERAGE
THROUGHPUT(1)
TRANSMISSION ---------------------
SYSTEM 2002 2001 2000
------------ ----- ----- -----
(BBTU/D)
<S> <C> <C> <C>
Florida Gas Transmission 2,004 1,616 1,524
Alliance Pipeline(2) 1,476 1,479 105
Great Lakes Gas 2,378 2,224 2,477
Transmission
Dampier-to-Bunbury 573 555 523
pipeline system
Moomba-to-Adelaide 271 261 231
pipeline system
Ballera-to-Wallumbilla 72 71 71
pipeline system
Portland Natural Gas 144 123 110
Transmission
</Table>
- ---------------
(1) Volumes represent the systems' total design capacity and average throughput
and are not adjusted for our ownership interest.
(2) The Alliance pipeline project commenced operations in the fourth quarter of
2000. We sold 12.3 percent of our equity interest in the system during the
fourth quarter of 2002, and the remaining 2.1 percent equity interest in the
first quarter of 2003.
(3) Our ownership interest increased from 19 percent to 30 percent effective
June 2001.
4
<PAGE>
In addition to the storage capacity on our transmission systems, we own or
have interests in the following natural gas storage entities:
Underground Natural Gas Storage Entities
<Table>
<Caption>
AS OF DECEMBER 31, 2002
-----------------------
OWNERSHIP STORAGE
STORAGE ENTITY INTEREST CAPACITY(1) LOCATION
- -------------- --------- ----------- --------
(PERCENT) (BCF)
<S> <C> <C> <C>
Bear Creek Storage.......................................... 100 58 Louisiana
ANR Storage................................................. 100 56 Michigan
Blue Lake Gas Storage....................................... 75 47 Michigan
Eaton Rapids Gas Storage.................................... 50 13 Michigan
Steuben Gas Storage......................................... 50 6 New York
Young Gas Storage........................................... 48 6 Colorado
</Table>
- ---------------
(1) Includes a total of 139 Bcf contracted to affiliates. Storage capacity is
under long-term contracts and is not adjusted for our ownership interest.
In addition to our operations of natural gas pipeline systems and storage
facilities, we own an LNG receiving terminal located on Elba Island, near
Savannah, Georgia. The facility is capable of achieving a peak send-out of 675
MMcf/d and a base load send-out of 446 MMcf/d. The terminal was placed in
service and began receiving deliveries in December 2001. The capacity at the
terminal is currently contracted to our affiliate, El Paso Merchant Energy,
under a contract that extends through 2023. In September 2001, we announced
plans to expand the peak send out capacity of the Elba Island facility by 540
MMcf/d and the base load send out by 360 MMcf/d (for a total peak send out
capacity once completed of 1,215 MMcf/d and a base load send out of 806 MMcf/d).
The expansion will cost approximately $145 million and has a planned in-service
date of late 2005.
We have a number of transmission system expansion projects that have been
approved by the Federal Energy Regulatory Commission (FERC) as follows:
<Table>
<Caption>
TRANSMISSION ANTICIPATED
SYSTEM PROJECT CAPACITY DESCRIPTION(1) COMPLETION DATE
- ------------ ------- -------- -------------- ---------------
(MMCF/D)
<S> <C> <C> <C> <C>
TGP CanEast 127 Extend TGP's mainline system through a April 2003
combination of lease capacity and facilities
modifications, to the Leidy Hub.
TGP South Texas 312 Construct pipeline, compression and border September 2003
Expansion crossing facilities to fuel four electric power
generation plants in the Northern Mexico
Municipalities of Rio Bravo and Valle Hermoso,
State of Tamaulipas.
ANR Westleg Wisconsin 218 To increase capacity of ANR's existing system November 2004
Expansion by looping the Madison lateral and by enlarging
the Beloit lateral through abandonment and
replacement.
SNG South System I (Phase 196 Installation of compression and pipeline June 2003
2) looping to increase firm transportation
capacity along SNG's south mainline in Alabama,
Georgia and South Carolina.
SNG South System II 330 Installation of compression and pipeline June 2003,
looping to increase firm transportation November 2003
capacity along SNG's south mainline to Alabama, and May 2004
Georgia and South Carolina.
SNG North System II 33 Installation of compression and additional June 2003
pipeline looping to increase capacity along
SNG's north mainline in Alabama.
CIG Valley Line 92 Installation of additional natural gas December 2003
compression and air blending facilities to
expand the deliverability of the Front Range
system.
</Table>
- ---------------
(1) Pipeline looping is the installation of a pipeline, parallel to an existing
pipeline, with tie-ins at several points along the existing pipeline.
Looping increases the transmission system's capacity.
5
<PAGE>
Our transportation, storage and related services (transportation services)
revenues consist of reservation and usage revenues. In 2002, approximately 87
percent of our transportation services revenues were attributable to a capacity
reservation or a demand charge paid by firm customers. These firm customers are
obligated to pay a monthly demand charge, regardless of the amount of natural
gas they transport or store, for the term of their contracts. The remaining 13
percent of our transportation services revenue was attributable to usage
charges, based largely on the volumes of gas actually transported or stored on
our pipeline systems.
Regulatory Environment
Our interstate natural gas transmission systems and storage operations are
regulated by the FERC under the Natural Gas Act of 1938 and the Natural Gas
Policy Act of 1978. Each of our pipeline systems and storage facilities operates
under FERC-approved tariffs that establish rates, terms and conditions for
services to our customers. Generally, the FERC's authority extends to:
- rates and charges for natural gas transportation, storage, terminalling
and related services;
- certification and construction of new facilities;
- extension or abandonment of facilities;
- maintenance of accounts and records;
- relationships between pipeline and marketing affiliates;
- terms and conditions of service;
- depreciation and amortization policies;
- acquisition and disposition of facilities; and
- initiation and discontinuation of services.
The fees or rates established under our tariffs are a function of our costs
of providing services to our customers, including a reasonable return on our
invested capital. Consequently, our financial results have historically been
relatively stable. However, these results can be subject to volatility due to
factors such as weather, changes in natural gas prices and market conditions,
regulatory actions, competition and the creditworthiness of our customers.
In Canada, our pipeline activities are regulated by the National Energy
Board. Similar to the FERC, the National Energy Board governs tariffs and rates,
and the construction and operation of natural gas pipelines in Canada. In
Australia, various regional and national agencies regulate the tariffs, rates
and operating activities of natural gas pipelines.
Our interstate pipeline systems are also subject to federal, state and
local pipeline and LNG plant safety and environmental statutes and regulations.
Our systems have ongoing programs designed to keep our facilities in compliance
with pipeline safety and environmental requirements. We believe that our systems
are in material compliance with the applicable requirements.
A discussion of significant rate and regulatory matters is included in Part
II, Item 8, Financial Statements and Supplementary Data, Note 20, and is
incorporated herein by reference.
6
<PAGE>
Markets and Competition
The following table details our markets and competition on each of our
wholly owned pipeline systems as of December 31, 2002:
<Table>
<Caption>
TRANSMISSION
SYSTEM CUSTOMER INFORMATION(1) CONTRACT INFORMATION COMPETITION
- ------------ ---------------------------- ------------------------------- -------------------------------------
<S> <C> <C> <C>
TGP Approximately 434 firm and Approximately 436 firm TGP faces strong competition in the
interruptible customers contracts Northeast, Appalachian, Midwest and
Contracted capacity: 93% Southeast market areas. It competes
Major Customers: Weighted average remaining with other interstate and intrastate
None of which individually contract term of approximately pipelines for deliveries to
represents more than 10 five years multiple-connection customers who can
percent of revenues take deliveries at multiple
connection points. Natural gas
delivered on the TGP system competes
with alternative energy sources such
as electricity, hydroelectric power,
coal and fuel oil. It also competes
with pipelines and local distribution
companies to deliver increased
quantities of natural gas to our
market areas. In addition, TGP
competes with pipelines and gathering
systems for connection to new supply
sources in Texas, the Gulf of Mexico
and at the Canadian border.
ANR Approximately 238 firm and Approximately 643 firm In the Midwest markets, ANR competes
interruptible customers contracts with other interstate and intrastate
Contracted capacity: 98% pipeline companies and local
Weighted average remaining distribution companies in the
Major Customer: contract term of approximately transportation and storage of natural
We Energies four years gas. In the Northeast markets, ANR
(1,138 BBtu/d) competes with other interstate
Contract terms expire in pipelines serving electric generation
2003-2010. and local distribution companies.
Also, Wisconsin Gas, which operates
under the name We Energies, is a
sponsor of Guardian Pipeline, which
was placed in service in December
2002. Guardian will serve a portion
of We Energies transportation
requirements and will compete
directly with ANR.
EPNG Approximately 230 firm and Approximately 180 firm EPNG faces competition from other
interruptible customers contracts pipelines that deliver natural gas to
Contracted capacity:(2) California and the southwestern U.S.,
Weighted average remaining as well as alternative energy sources
contract term of approximately that generate electricity such as
Major Customer: five years hydroelectric power, nuclear, coal
Southern California Gas and fuel oil.
Company
(1,235 BBtu/d)
(95 BBtu/d) Contract term expires in 2006.
Contract terms expire in
2004-2007.
SNG Approximately 260 firm Approximately 170 firm Competition is strong in a number of
and interruptible contracts SNG's key markets. SNG's three
customers Contracted capacity: 100% largest customers are able to obtain
Weighted average remaining a significant portion of their
contract term of approximately natural gas requirements through
Major Customers: five years transportation from other pipelines.
Atlanta Gas Light Also, SNG competes with several
Company (959 BBtu/d) pipelines for the transportation
Alabama Gas Corporation business of many of its other
(394 BBtu/d) Scana Contract terms expire in customers.
Resources Inc. (253 2005-2007.
BBtu/d)
Contract terms expire in
2005-2008.
Contract terms expire in
2003-2017.
</Table>
- ---------------
(1)Includes natural gas producers, marketers, end-users and other natural gas
transmission, distribution and electric generation companies.
(2)A discussion of significant rate and regulatory matters regarding EPNG's
capacity is included in Part II, Item 8, Financial Statements and
Supplementary Data, Note 20.
7
<PAGE>
<Table>
<Caption>
TRANSMISSION
SYSTEM CUSTOMER INFORMATION(1) CONTRACT INFORMATION COMPETITION
- ------------ ---------------------------- ------------------------------- -------------------------------------
<S> <C> <C> <C>
CIG Approximately 125 firm Approximately 170 firm CIG serves two major markets, the
and interruptible contracts "on-system" market, consisting of
customers Contracted capacity: 100% utilities and other customers located
Weighted average remaining along the front range of the Rocky
contract term of approximately Mountains in Colorado and Wyoming,
Major Customer: seven years and the "off- system" market,
Public Service Company of consisting of the transportation of
Colorado (1,095 BBtu/d) Rocky Mountain production from
(462 BBtu/d) multiple supply basins to
Contract term expires in 2007. interconnections with other pipelines
Contract terms expire bound for the Midwest, the Southwest,
2008-2025. California and the Pacific Northwest.
Competition for the on-system market
consists of local production from the
Denver-Julesburg basin, an intrastate
pipeline, and long-haul shippers who
elect to sell into this market rather
than the off-system market.
Competition for the off-system market
consists of other interstate
pipelines that are directly connected
to CIG's supply sources and transport
these volumes to markets in the West,
Northwest, Southwest and Midwest.
WIC Approximately 43 firm Approximately 47 firm contracts WIC competes with eight interstate
and interruptible Contracted capacity: 100% pipelines and one intrastate pipeline
customers Weighted average remaining for its mainline supply. The
contract term of approximately Overthrust supply basin, which
six years historically supplies the WIC
mainline, has been declining and
Major Customers: there has been increased competition
Williams Energy Marketing from the pipelines serving the West
and Trading (340 and Northwest market areas for this
BBtu/d) Contract terms expire in gas supply. To replace these volumes,
Western Gas Resources 2003-2013. WIC is pursuing access to new supply
(272 BBtu/d) sources. Additionally, WIC's one Bcf
Colorado Interstate Gas Contract terms expire in expandable Medicine Bow lateral is
Company 2003-2013. the primary source of transportation
(247 BBtu/d) for increasing volumes of Powder
CMS Field Services River Basin supply. Currently there
(234 BBtu/d) Contract terms expire in are two other interstate pipelines
2003-2007. that transport limited volumes out of
this basin. Upon the approval and
Contract terms expire in construction of the new Cheyenne
2004-2013. Plain project(2), WIC will have an
increased outlet to mid-continent
markets.
MPC Approximately 35 firm and Eight firm contracts MPC faces competition from other
interruptible customers Contracted capacity: 98% pipelines that deliver natural gas to
Weighted average remaining California and the southwestern U.S.
contract term of approximately as well as alternative energy sources
four years that generate electricity such as
Major Customers: hydroelectric power, nuclear, coal
Texaco Natural Gas Inc. and fuel oil.
(185 BBtu/d) Contract term expires in 2007.
Burlington Resources
Trading Inc.
(76 BBtu/d) Contract term expires in 2007.
Los Angeles Department
of Water and Power
(50 BBtu/d) Contract term expires in 2007.
</Table>
- ---------------
(1)Includes natural gas producers, marketers, end-users and other natural gas
transmission, distribution and electric generation companies.
(2)The Cheyenne Plain project is a new 30-inch diameter pipeline proposed by us
to transport natural gas from the Cheyenne hub to the confluence of several
pipelines near Greensburg, Kansas. This pipeline is anticipated to be in
service in mid-2005 depending on the timing of regulatory approval.
8
<PAGE>
Electric power generation is one of the fastest growing demand sectors of
the natural gas market. The potential consequences of proposed and ongoing
restructuring and deregulation of the electric power industry are currently
unclear. Restructuring and deregulation benefit the natural gas industry by
creating more demand for natural gas turbine generated electric power, but this
effect is offset, in varying degrees, by increased generation efficiency and
more effective use of surplus electric capacity as a result of open market
access. In addition, in several regions of the country, new capacity additions
have exceeded load growth and transmission capabilities out of those regions.
This will result in lower growth in the gas demand in those regions associated
with new power generation facilities.
Imported LNG is one of the fastest growing supply sectors of the natural
gas market. Terminals and other regasification facilities can serve as important
sources of supply for pipelines, enhancing the delivery capabilities and
operational flexibility and complementing traditional supply and market areas.
These LNG delivery systems also may compete with pipelines for transportation of
gas into market areas.
As our pipeline contracts expire, our ability to extend our existing
contracts or re-market expiring contracted capacity is dependent on the
competitive alternatives, the regulatory environment at the federal, state and
local levels and market supply and demand factors at the relevant dates these
contracts are extended or expire. The duration of new or re-negotiated contracts
will be affected by current prices, competitive conditions and judgments
concerning future market trends and volatility. Subject to regulatory
constraints, we attempt to re-contract or re-market our capacity at the maximum
rates allowed under our tariffs, although we, at times, discount these rates to
remain competitive. The level of discount varies for each of our pipeline
systems.
As a result of the rating agencies downgrading the credit rating of several
members of the energy sector, including energy trading companies, and placing
them on negative credit watch, the creditworthiness of some customers has
deteriorated. We have taken actions to mitigate our exposure by requesting these
companies provide us with letters of credit or prepayments as permitted by our
tariffs. Our tariffs permit us to request additional credit assurance from our
shippers equal to the cost of performing transportation services for various
periods as specified in each tariff. If these companies experience financial
difficulties, or file for Chapter 11 bankruptcy protection, and our contracts
are not assumed by other counterparties, or if the capacity is unavailable for
resale, it could have a material adverse effect on our financial position,
operating results or cash flows.
PRODUCTION SEGMENT
Our Production segment is engaged in the exploration for, and the
acquisition, development and production of natural gas, oil and natural gas
liquids, primarily in North America. In the U.S., we have onshore and coal seam
operations and properties in 16 states and offshore operations and properties in
federal and state waters in the Gulf of Mexico. Internationally, we have
exploration and production rights in Australia, Bolivia, Brazil, Canada,
Hungary, Indonesia and Turkey.
Strategically, Production emphasizes disciplined investment criteria and
manages its existing production portfolio to maximize volumes and minimize
costs. It employs geophysical technology and seismic data processing to identify
economic hydrocarbon reserves. Production's deep drilling capabilities and
hydraulic fracturing technology allow it to optimize production with high-rate
completions at competitive reserve replacement costs. Production maintains an
active drilling program that capitalizes on its land and seismic holdings. It
also acquires production properties subject to acceptable investment return
criteria.
Natural Gas and Oil Reserves
The table below details Production's proved reserves at December 31, 2002.
Information in this table is based on the reserve report dated January 1, 2003,
prepared internally by Production and reviewed by Huddleston & Co., Inc. This
information is consistent with estimates of reserves filed with other federal
agencies except for differences of less than five percent resulting from actual
production, acquisitions, property sales, necessary reserve revisions and
additions to reflect actual experience. These reserves include 465,783
9
<PAGE>
MMcfe of production delivery commitments under financing arrangements that
extend through 2042. The financing arrangement supported by these reserves
matures in 2006. Total proved reserves on the fields with this dedicated
production were 919,265 MMcfe. In addition, the table excludes the following
equity interests: Production's interest in UnoPaso (Pescada in Brazil); Merchant
Energy's interests in Sengkang in Indonesia, CAPSA and CAPEX in Argentina and
Aguaytia in Peru; and Field Services' interest in El Paso Energy Partners.
Combined proved natural gas reserves balances for these equity interests were
435,713 MMcf, liquids reserves were 39,693 MBbls and natural gas equivalents
were 673,871 MMcfe, all net to our ownership interests.
<Table>
<Caption>
NET PROVED RESERVES(1)
------------------------------------
NATURAL GAS LIQUIDS(2) TOTAL
----------- ---------- ---------
(MMCF) (MBBLS) (MMCFE)
<S> <C> <C> <C>
United States
Producing...................................... 2,235,877 50,712 2,540,145
Non-Producing.................................. 448,303 20,094 568,868
Undeveloped.................................... 1,528,726 45,923 1,804,267
--------- ------- ---------
Total proved.............................. 4,212,906 116,729 4,913,280
========= ======= =========
Canada
Producing...................................... 89,144 4,213 114,422
Non-Producing.................................. 14,555 233 15,953
Undeveloped.................................... 26,701 1,694 36,865
--------- ------- ---------
Total proved.............................. 130,400 6,140 167,240
========= ======= =========
Other Countries(3)
Producing...................................... -- -- --
Non-Producing.................................. -- -- --
Undeveloped.................................... 76,032 12,652 151,944
--------- ------- ---------
Total proved.............................. 76,032 12,652 151,944
========= ======= =========
Worldwide
Producing...................................... 2,325,021 54,925 2,654,567
Non-Producing.................................. 462,858 20,327 584,821
Undeveloped.................................... 1,631,459 60,269 1,993,076
--------- ------- ---------
Total proved.............................. 4,419,338 135,521 5,232,464
========= ======= =========
</Table>
- ---------------
(1) Net proved reserves exclude royalties and interests owned by others and
reflects contractual arrangements and royalty obligations in effect at the
time of the estimate.
(2) Includes oil, condensate and natural gas liquids.
(3) Includes international operations in Brazil, Hungary and Indonesia.
During 2002, as a result of our efforts to enhance our liquidity position,
we sold reserves totaling 1.8 Tcfe to various third parties. The reserves sold
were primarily located in Colorado, Texas, Utah and western Canada.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond Production's control.
The reserve data represents only estimates. Reservoir engineering is a
subjective process of estimating underground accumulations of natural gas and
oil that cannot be measured in an exact manner. The accuracy of any reserve
estimate is a function of the quality of available data and of engineering and
geological interpretations and judgment. As a result, estimates of different
engineers often vary. Estimates are subject to revision based upon a number of
factors, including reservoir performance, prices, economic conditions and
government restrictions. In addition, results of drilling, testing and
production subsequent to the date of an estimate may justify revision of that
estimate. Reserve estimates are often different from the quantities of natural
gas and oil that are ultimately recovered. The meaningfulness of reserve
estimates is highly dependent on the accuracy of the assumptions on which they
were based. In general, the volume of production from natural gas and oil
properties owned by Production declines as reserves are depleted. Except to the
extent Production conducts successful exploration and development activities or
acquires additional properties containing proved reserves, or both, the proved
reserves of Production will decline as reserves are
10
<PAGE>
produced. For further discussion of our reserves, see Part II, Item 8, Financial
Statements and Supplementary Data, Note 28.
Wells and Acreage
The following table details Production's gross and net interest in
developed and undeveloped onshore, offshore, coal seam and international acreage
at December 31, 2002. Any acreage in which Production's interest is limited to
owned royalty, overriding royalty and other similar interests is excluded.
<Table>
<Caption>
DEVELOPED UNDEVELOPED TOTAL
--------------------- ----------------------- -----------------------
GROSS(1) NET(2) GROSS(1) NET(2) GROSS(1) NET(2)
--------- --------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
United States
Onshore............. 1,142,805 445,427 1,278,683 928,135 2,421,488 1,373,562
Offshore............ 626,705 407,121 1,026,358 952,736 1,653,063 1,359,857
Coal Seam........... 217,412 119,674 1,204,020 781,462 1,421,432 901,136
--------- --------- ---------- ---------- ---------- ----------
Total.......... 1,986,922 972,222 3,509,061 2,662,333 5,495,983 3,634,555
--------- --------- ---------- ---------- ---------- ----------
International
Australia........... -- -- 1,770,364 677,350 1,770,364 677,350
Bolivia............. -- -- 154,840 19,355 154,840 19,355
Brazil.............. -- -- 6,757,164 4,690,446 6,757,164 4,690,446
Canada.............. 338,971 174,533 881,353 698,905 1,220,324 873,438
Hungary............. -- -- 568,100 568,100 568,100 568,100
Indonesia........... -- -- 1,213,170 378,397 1,213,170 378,397
Turkey.............. -- -- 4,047,508 2,023,754 4,047,508 2,023,754
--------- --------- ---------- ---------- ---------- ----------
Total............. 338,971 174,533 15,392,499 9,056,307 15,731,470 9,230,840
--------- --------- ---------- ---------- ---------- ----------
Worldwide Total... 2,325,893 1,146,755 18,901,560 11,718,640 21,227,453 12,865,395
========= ========= ========== ========== ========== ==========
</Table>
- ---------------
(1) Gross interest reflects the total acreage we participated in, regardless of
our ownership interests in the acreage.
(2) Net interest is the aggregate of the fractional working interest that we
have in our gross acreage.
The U.S. domestic net developed acreage is concentrated primarily in the
Gulf of Mexico (42 percent), Oklahoma (15 percent), Utah (14 percent), Texas (12
percent), and Louisiana (10 percent). Approximately 20 percent, 21 percent and
12 percent of our total U.S. net undeveloped acreage is held under leases that
have minimum remaining primary terms expiring in 2003, 2004 and 2005. During
2002, we sold approximately 421,316 net developed and 887,391 net undeveloped
acres primarily in Colorado, Texas, Utah and western Canada as a result of our
efforts to enhance our liquidity position.
11
<PAGE>
The following table details Production's working interests in onshore,
offshore, coal seam and international natural gas and oil wells at December 31,
2002:
<Table>
<Caption>
PRODUCTIVE PRODUCTIVE TOTAL NUMBER OF
NATURAL GAS WELLS OIL WELLS PRODUCTIVE WELLS WELLS BEING DRILLED
----------------- ----------------- ----------------- -------------------
GROSS(1) NET(2) GROSS(1) NET(2) GROSS(1) NET(2) GROSS(1) NET(2)
-------- ------ -------- ------ -------- ------ --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
United States
Onshore........... 1,937 1,502 335 257 2,272 1,759 47 36
Offshore.......... 386 167 93 36 479 203 11 9
Coal Seam......... 1,756 1,001 -- -- 1,756 1,001 6 4
----- ----- --- --- ----- ----- -- --
Total........ 4,079 2,670 428 293 4,507 2,963 64 49
----- ----- --- --- ----- ----- -- --
International
Canada............ 267 170 135 77 402 247 6 5
Other............. 1 1 -- -- 1 1 -- --
----- ----- --- --- ----- ----- -- --
Total........ 268 171 135 77 403 248 6 5
----- ----- --- --- ----- ----- -- --
Worldwide
Total........ 4,347 2,841 563 370 4,910 3,211 70 54
===== ===== === === ===== ===== == ==
</Table>
- ---------------
(1) Gross interest reflects the total number of wells we participated in,
regardless of our ownership interests in the wells.
(2) Net interest is the aggregate of the fractional working interest that we
have in our gross wells.
During 2002, as a result of our efforts to enhance our liquidity position,
we sold approximately 2,055 net wells located primarily in Colorado, Texas, Utah
and western Canada.
The following table details Production's exploratory and development wells
drilled during the years 2000 through 2002:
<Table>
<Caption>
NET EXPLORATORY NET DEVELOPMENT
WELLS DRILLED WELLS DRILLED
------------------ ------------------
2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
United States
Productive.................................... 15 17 16 523 449 424
Dry........................................... 10 8 17 9 23 18
-- -- -- --- --- ---
Total.................................... 25 25 33 532 472 442
-- -- -- --- --- ---
Canada
Productive.................................... 18 21 3 5 38 10
Dry........................................... 27 35 3 1 3 1
-- -- -- --- --- ---
Total.................................... 45 56 6 6 41 11
-- -- -- --- --- ---
Other Countries(1)
Productive.................................... 1 -- -- -- -- --
Dry........................................... 1 9 1 -- 1 --
-- -- -- --- --- ---
Total.................................... 2 9 1 -- 1 --
-- -- -- --- --- ---
Worldwide
Productive.................................... 34 38 19 528 487 434
Dry........................................... 38 52 21 10 27 19
-- -- -- --- --- ---
Total.................................... 72 90 40 538 514 453
-- -- -- --- --- ---
</Table>
- ---------------
(1) Includes international operations in Australia, Brazil, Hungary, Turkey and
Indonesia.
The information above should not be considered indicative of future
drilling performance, nor should it be assumed that there is any correlation
between the number of productive wells drilled and the amount of natural gas and
oil that may ultimately be recovered.
12
<PAGE>
Net Production, Sales Prices, Transportation and Production Costs
The following tables detail Production's net production volumes, average
sales prices received, average transportation costs, average production costs
and production taxes associated with the sale of natural gas and oil for each of
the three years ended December 31:
<Table>
<Caption>
2002 2001 2000
------ ------ ------
<S> <C> <C> <C>
Net Production Volumes
United States
Natural Gas (Bcf)..................................... 470 552 516
Oil, Condensate and Liquids (MMBbls).................. 17 13 12
Total (Bcfe)..................................... 569 634 586
Canada
Natural Gas (Bcf)..................................... 17 13 1
Oil, Condensate and Liquids (MMBbls).................. 1 1 --
Total (Bcfe)..................................... 23 17 1
Worldwide
Natural Gas (Bcf)..................................... 487 565 517
Oil, Condensate and Liquids (MMBbls).................. 18 14 12
Total (Bcfe)..................................... 592 651 587
Natural Gas Average Sales Price (per Mcf)(1)
United States
Price excluding hedges................................ $ 3.19 $ 4.26 $ 3.97
Price including hedges................................ $ 3.64 $ 3.57 $ 2.73
Canada
Price excluding hedges................................ $ 2.85 $ 2.86 $ 4.27
Price including hedges................................ $ 2.84 $ 2.85 $ 4.27
Worldwide
Price excluding hedges................................ $ 3.16 $ 4.23 $ 3.97
Price including hedges................................ $ 3.61 $ 3.56 $ 2.73
Oil, Condensate, and Liquids Average Sales Price (per
Bbl)(1)
United States
Price excluding hedges................................ $21.38 $23.08 $28.39
Price including hedges................................ $21.28 $22.39 $21.97
Canada
Price excluding hedges................................ $21.56 $17.68 $ --
Price including hedges................................ $21.55 $18.52 $ --
Worldwide
Price excluding hedges................................ $21.39 $22.87 $28.39
Price including hedges................................ $21.30 $22.24 $21.97
</Table>
- ---------------
(1) Prices are stated before transportation costs.
13
<PAGE>
<Table>
<Caption>
2002 2001 2000
------ ------ ------
<S> <C> <C> <C>
Average Transportation Cost (per Mcfe)
United States
Natural gas........................................... $ 0.18 $ 0.11 $ 0.11
Oil, condensate and liquids........................... $ 0.97 $ 0.57 $ 0.15
Canada
Natural gas........................................... $ 0.19 $ 0.17 $ 0.17
Oil, condensate and liquids........................... $ 0.39 $ 0.26 $ --
Worldwide
Natural gas........................................... $ 0.18 $ 0.12 $ 0.11
Oil, condensate and liquids........................... $ 0.93 $ 0.56 $ 0.15
Average Production Cost and Production Taxes (per Mcfe)(1)
United States
Average Production Cost............................... $ 0.50 $ 0.51 $ 0.41
Average Production Taxes.............................. $ 0.08 $ 0.14 $ 0.12
Canada
Average Production Cost............................... $ 0.80 $ 0.74 $ 0.66
Worldwide
Average Production Cost............................... $ 0.51 $ 0.52 $ 0.41
Average Production Taxes.............................. $ 0.08 $ 0.14 $ 0.12
</Table>
- ---------------
(1) Production costs include direct lifting costs (labor, repairs and
maintenance, materials and supplies) and the administrative costs of field
offices, insurance and property and severance taxes.
Acquisition, Development and Exploration Expenditures
The following table details information regarding Production's costs
incurred in its development, exploration and acquisition activities for each of
the three years ended December 31:
<Table>
<Caption>
2002 2001 2000
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
United States
Acquisition Costs:
Proved.............................................. $ 362 $ 91 $ 201
Unproved............................................ 29 44 171
Development Costs..................................... 1,520 1,529 1,229
Exploration Costs:
Delay Rentals....................................... 7 14 12
Seismic Acquisition and Reprocessing................ 35 37 64
Drilling............................................ 204 126 214
------ ------ ------
Total............................................ $2,157 $1,841 $1,891
====== ====== ======
Canada
Acquisition Costs:
Proved.............................................. $ 6 $ 232 $ 3
Unproved............................................ 7 16 6
Development Costs..................................... 80 105 69
Exploration Costs:
Seismic Acquisition and Reprocessing................ 21 10 10
Drilling............................................ 49 9 32
------ ------ ------
Total............................................ $ 163 $ 372 $ 120
====== ====== ======
</Table>
14
<PAGE>
<Table>
<Caption>
2002 2001 2000
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Other Countries(1)
Acquisition Costs:
Proved.............................................. $ -- $ -- $ --
Unproved............................................ 10 26 --
Development Costs..................................... 3 14 --
Exploration Costs:
Seismic Acquisition and Reprocessing................ 34 6 18
Drilling............................................ 24 97 17
------ ------ ------
Total............................................ $ 71 $ 143 $ 35
====== ====== ======
Worldwide
Acquisition Costs:
Proved.............................................. $ 368 $ 323 $ 204
Unproved............................................ 46 86 177
Development Costs..................................... 1,603 1,648 1,298
Exploration Costs:
Delay Rentals....................................... 7 14 12
Seismic Acquisition and Reprocessing................ 90 53 92
Drilling............................................ 277 232 263
------ ------ ------
Total............................................ $2,391 $2,356 $2,046
====== ====== ======
</Table>
- ---------------
(1) Includes international operations in Australia, Brazil, Hungary, Indonesia
and Turkey.
The table below details approximate amounts spent to develop proved
undeveloped reserves that were included in our reserve report as of January 1 of
each year:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Cost to Develop Proved Undeveloped Reserves (IN MILLIONS)
<S> <C> <C> <C>
United States............................................... $482 $559 $286
Canada...................................................... 11 17 24
---- ---- ----
Total..................................................... $493 $576 $310
==== ==== ====
</Table>
Regulatory and Operating Environment
Production's natural gas and oil activities are regulated at the federal,
state and local levels, as well as internationally by the countries around the
world in which Production does business. These regulations include, but are not
limited to, the drilling and spacing of wells, conservation, forced pooling and
protection of correlative rights among interest owners. Production is also
subject to governmental safety regulations in the jurisdictions in which it
operates.
Production's domestic operations under federal natural gas and oil leases
are regulated by the statutes and regulations of the U.S. Department of the
Interior that currently impose liability upon lessees for the cost of
environmental impacts resulting from their operations. Royalty obligations on
all federal leases are regulated by the Minerals Management Service, which has
promulgated valuation guidelines for the payment of royalties by producers.
Production's international operations are subject to environmental regulations
administered by foreign governments, which include political subdivisions and
international organizations. These domestic and international laws and
regulations relating to the protection of the environment affect Production's
natural gas and oil operations through their effect on the construction and
operation of facilities, drilling operations, production or the delay or
prevention of future offshore lease sales. We believe that our operations are in
material compliance with the applicable requirements. In addition, we maintain
insurance on behalf of Production for sudden and accidental spills and oil
pollution liability.
15
<PAGE>
Production's business has operating risks normally associated with the
exploration for and production of natural gas and oil, including blowouts,
cratering, pollution and fires, each of which could result in damage to life or
property. Offshore operations may encounter usual marine perils, including
hurricanes and other adverse weather conditions, governmental regulations and
interruption or termination by governmental authorities based on environmental
and other considerations. Customary with industry practices, we maintain
insurance coverage on behalf of Production with respect to potential losses
resulting from these operating hazards.
Markets and Competition
Our Production segment primarily sells its natural gas to third parties
through our Merchant Energy segment at spot market prices. As a result of our
plan to exit the energy trading business announced in November 2002, our
Production segment is currently evaluating how it will sell its production in
the future. Alternatives being considered include whether to cancel its
agreement with Merchant Energy and assume responsibility for natural gas sales
to third parties or enter into new marketing agreements with third parties
engaged in the marketing of natural gas. Production sells its natural gas
liquids at market prices under monthly or long-term contracts and its oil
production at posted prices, subject to adjustments for gravity and
transportation. Production also engages in hedging activities on its natural gas
and oil production to stabilize its cash flows and reduce the risk of downward
commodity price movements on sales of its production. This is achieved primarily
through natural gas and oil swaps. Under our hedging program, we may hedge up to
50 percent of our anticipated production for a rolling 12-month forward period.
The natural gas and oil business is highly competitive in the search for
and acquisition of additional reserves and in the sale of natural gas, oil and
natural gas liquids. Production's competitors include major and intermediate
sized natural gas and oil companies, independent natural gas and oil operations
and individual producers or operators with varying scopes of operations and
financial resources. Competitive factors include price, contract terms and
quality of service. Ultimately, our future success in the production business
will be dependent on our ability to find or acquire additional reserves at costs
that allow us to remain competitive.
FIELD SERVICES SEGMENT
Our Field Services segment provides customers with wellhead-to-mainline
services, including natural gas gathering, products extraction, fractionation,
dehydration, purification, compression and transportation of natural gas and
NGL. It also provides well-ties and real-time information services, including
electronic wellhead gas flow measurement.
Field Services' assets include natural gas gathering and NGL pipelines,
treating, processing and fractionation facilities, in the south Texas,
Louisiana, Mid-Continent and Rocky Mountain regions.
El Paso Energy Partners Company, a subsidiary in our Field Services segment
serves as the sole general partner of El Paso Energy Partners. We currently own
26.5 percent, or 11,674,245 of the partnership's common units and the one
percent general partner interest. The remaining 73.5 percent of the common units
of the limited partnership are owned by public unit holders (including small
amounts owned by the general partner's management and employees), none of which
exceeds a 10 percent ownership interest. Field Services also owns all 125,392 of
the outstanding Series B preference units and all 10,937,500 of the outstanding
Series C units issued in November 2002, which are non-voting. Our overall voting
interest in El Paso Energy Partners is 26.5 percent.
As the general partner, Field Services manages the partnership's daily
operations. Employees of Field Services perform all of the limited partnership's
administrative and operational activities under a general and administrative
services agreement or, in some cases, separate operational agreements. El Paso
Energy Partners contributes to our income through our general partner interest
and our ownership of common and preference units. We do not have any loans to or
from El Paso Energy Partners. In addition, we have not provided any guarantees,
either monetary or performance, on behalf of or for the benefit of El Paso
Energy Partners nor do we have any other liabilities other than those arising in
the normal course of business or those arising out of our role as the general
partner in El Paso Energy Partners.
16
<PAGE>
El Paso Energy Partners provides a capital-efficient means of expanding our
midstream business, and through our general partner relationship, we have used
the partnership as our primary means of growth of our midstream natural gas
business. El Paso Energy Partners manages a balanced, diversified portfolio of
interests and assets related to the midstream energy sector, which includes:
- offshore oil and natural gas pipelines, platforms, processing facilities
and other energy infrastructure in the Gulf of Mexico, primarily offshore
Louisiana and Texas;
- onshore natural gas pipelines and processing facilities in Alabama,
Colorado, Louisiana, Mississippi, New Mexico and Texas;
- onshore NGL pipelines and fractionation facilities in Texas; and
- onshore natural gas and NGL storage facilities in Mississippi, Louisiana
and Texas.
We enter into transactions with El Paso Energy Partners in the normal
course of business for the purchase of natural gas and for services such as
transportation and fractionation, storage, processing and other types of
operational services. For a further discussion of these activities and the
impact of El Paso Energy Partners on our Field Services operations, see Part II,
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following tables provide information on Field Services' natural gas
gathering and transportation facilities, its processing facilities and the
facilities of its equity method investees:
<Table>
<Caption>
AS OF DECEMBER 31, 2002
----------------------- AVERAGE THROUGHPUT
MILES OF THROUGHPUT ------------------------
GATHERING & TREATING PIPELINE CAPACITY 2002 2001 2000
- -------------------- -------- ------------ ------ ------ ------
(MMCFE/D) (BBTUE/D)
<S> <C> <C> <C> <C> <C>
El Paso Field Services........................ 4,048 1,563 3,023(1) 6,109(2) 3,868
El Paso Energy Partners(3).................... 15,764 10,345 6,686(1) 1,946 1,714
</Table>
<Table>
<Caption>
AS OF
DECEMBER 31,
2002 AVERAGE NATURAL GAS
------------ AVERAGE INLET VOLUME LIQUIDS SALES
INLET ------------------------- --------------------------
PROCESSING PLANTS CAPACITY 2002 2001 2000 2002 2001 2000
- ----------------- ------------ ----- --------- ----- ------ -------- ------
(MMCFE/D) (BBTUE/D) (MGAL/D)
<S> <C> <C> <C> <C> <C> <C> <C>
El Paso Field Services... 4,911 3,920 4,360 2,930 6,635(1) 7,122(2) 4,664
El Paso Energy
Partners(3)............ 950 729 -- -- 266 -- --
</Table>
- ---------------
(1) During 2002, we sold a number of assets to El Paso Energy Partners including
gathering and processing assets in the San Juan Basin of New Mexico and our
Texas midstream assets, most of which we acquired in December 2000.
(2) The increase in activity from 2000 to 2001 is a result of our acquisition of
PG&E's Texas Midstream operations in December 2000.
(3) All volumetric information for El Paso Energy Partners reflects 100 percent
of El Paso Energy Partners' interest. Mileage and volumetric information
have not been reduced to reflect our net ownership.
Regulatory Environment
Some of Field Services' operations are subject to regulation by the FERC in
accordance with the Natural Gas Act of 1938 and the Natural Gas Policy Act of
1978. Each entity subject to the FERC's regulation operates under separate FERC
approved tariffs with established rates, terms and conditions of service.
Some of Field Services' operations are also subject to regulation by the
Railroad Commission of Texas under the Texas Utilities Code and the Common
Purchaser Act of the Texas Natural Resources Code. Field Services files the
appropriate rate tariffs and operates under the applicable rules and regulations
of the Railroad Commission.
17
<PAGE>
In addition, some of Field Services' operations, owned directly or through
equity investments, are subject to the Natural Gas Pipeline Safety Act of 1968,
the Hazardous Liquid Pipeline Safety Act and various environmental statutes and
regulations. Each of the pipelines has continuing programs designed to keep the
facilities in compliance with pipeline safety and environmental requirements,
and Field Services believes that these systems are in material compliance with
the applicable requirements.
Markets and Competition
Field Services competes with major interstate and intrastate pipeline
companies in transporting natural gas and NGL. Field Services also competes with
major integrated energy companies, independent natural gas gathering and
processing companies, natural gas marketers and oil and natural gas producers in
gathering and processing natural gas and NGL. Competition for throughput and
natural gas supplies is based on a number of factors, including price,
efficiency of facilities, gathering system line pressures, availability of
facilities near drilling activity, service and access to favorable downstream
markets.
MERCHANT ENERGY SEGMENT
Our Merchant Energy segment consists of three primary divisions: global
power, petroleum and energy trading.
Global Power
Our global power division includes the ownership and operation of domestic
and international power generation facilities. Our commercial focus in the power
generation business has been to either develop projects in which new long-term
power purchase agreements allow for an acceptable return on capital, or to
acquire projects with existing attractive power purchase agreements. Under this
strategy, we have become a significant U.S.-based independent power generator
and currently own or have interests in 88 power plants in 18 countries. These
plants represent 20,665 gross megawatts of generating capacity, 72 percent of
which is sold under power purchase or tolling agreements with terms in excess of
five years. Of these facilities, 60 percent are natural gas fired, 11 percent
are geothermal and the remaining 29 percent use coal or NGL as fuel or are
hydroelectric plants. As part of our 2003 Operational and Financial Plan, we
have announced the planned sales of some of these power generation assets. Most
of our power plants are partially owned by us through either a direct equity
investment or through our unconsolidated affiliates, Chaparral Investors, L.L.C.
(Chaparral) and Gemstone. As of December 31, 2002, we had a direct investment in
the following power plants:
<Table>
<Caption>
EL PASO
GROSS OWNERSHIP
PROJECT MEGAWATTS(1) INTEREST
- ------- ------------ ---------
(PERCENT)
<S> <C> <C>
Aguaytia Energy............................................. 155 24
Bastrop Company, LLC........................................ 534 50
Berkshire Power Company L.L.C.(2)........................... 261 25
CAPSA/CAPEX................................................. 650 27
CDECCA(2)................................................... 62 50
CE Generation(3)............................................ 823 50
Costanera................................................... 2,302 12
Eagle Point Cogeneration Partnership(2)..................... 233 84
East Asia Power............................................. 236 46
EGE Fortuna................................................. 300 25
EGE Itabo................................................... 513 25
Enfield Power............................................... 378 25
Fauji Kabirwala............................................. 157 42
</Table>
- ---------------
(1) Gross megawatts represent tested generating capacity of these facilities.
(2) Chaparral also owns an interest in these projects.
(3) These projects were sold in 2003.
18
<PAGE>
<Table>
<Caption>
EL PASO
GROSS OWNERSHIP
PROJECT MEGAWATTS(1) INTEREST
- ------- ------------ ---------
(PERCENT)
<S> <C> <C>
Habibullah Power............................................ 136 50
Kladno Power(2)............................................. 365 18
Korea Independent Energy Corporation........................ 1,720 50
Manaus(3)................................................... 238 100
MASSPOWER(4)................................................ 270 18
Meizhou Wan Generating...................................... 734 25
Mid-Georgia Cogeneration.................................... 308 50
Midland Cogeneration Venture................................ 1,575 44
Milford Power Company(4)(5)................................. 540 25
Nejapa Power................................................ 144 87
PPN......................................................... 325 26
Rio Negro(3)................................................ 158 100
Saba Power Company.......................................... 128 93
Sengkang.................................................... 135 48
Other projects.............................................. 1,271 various
------
Total............................................. 14,651
======
</Table>
- ---------------
(1) Gross megawatts represent tested generating capacity of these facilities.
(2) These projects were sold in 2003.
(3) Gemstone also owns an interest in these projects.
(4) Chaparral also owns an interest in these projects.
(5) This plant is under construction.
We conduct a significant portion of our domestic power activity through our
investment in Chaparral. At December 31, 2002, we owned 20 percent of Chaparral,
and Limestone Electron Trust (Limestone), an unrelated party capitalized by
private equity and debt, owned the remaining 80 percent. Limestone is controlled
by investment affiliates of Credit Suisse First Boston Corporation. In March
2003, we notified Limestone that we will exercise our right under the
partnership agreements to acquire all of the outstanding third party equity in
Limestone. On March 17, 2003, we contributed $1 billion to Limestone in exchange
for a non-controlling interest. Limestone used the proceeds from the
contribution to pay off $1 billion of the Limestone notes that matured on that
date. Following our additional investment of $1 billion in Limestone, our
effective ownership of Chaparral increased to approximately 90 percent, but
neither our rights nor the rights of Limestone to participate in the operating
decisions of Chaparral changed. As a result, we continue to account for our
investment in Chaparral as an equity investment. We will consolidate Chaparral
upon the purchase of the remaining third party equity interest in Limestone,
which we expect to occur in May 2003.
Chaparral was formed during 1999 to obtain low-cost financing to fund the
growth of our unregulated domestic power generation and related businesses.
During 2002, Chaparral's primary focus was on restructuring power contracts. A
power contract restructuring is accomplished typically by amending an
above-market power contract that requires delivery of power from a dedicated
power plant and replacing it with low-cost power obtained from the market.
Chaparral also operates power plants whose contracts have been previously
restructured on a merchant basis, which means that these plants operate and sell
power to the wholesale market in periods where power prices are high enough that
it is economical to do so. Through Chaparral, we have investments in 34 U.S.
power generation facilities with a total generating capacity of approximately
5,592 gross megawatts. Most of Chaparral's plants provide power under long-term
contracts. We serve as the manager of Chaparral under a management agreement
that expires in 2006, and we were paid a management fee for the services we
performed under this agreement through the end of 2002. This fee was based on
how well we performed as the manager of Chaparral, and was determined by
evaluating the present value of the portfolio of power assets held by Chaparral.
Our management fee is subject to the approval of our joint venture partner
annually. In 2002, the management fee was $205 million consisting of a $185
million performance fee plus a $20 million annual cost reimbursement. We will
not earn a fee from Chaparral in 2003.
19
<PAGE>
As of December 31, 2002, Chaparral owned or had interests in the following
power plants:
<Table>
<Caption>
CHAPARRAL
GROSS OWNERSHIP
PROJECT MEGAWATTS(1) INTEREST
- ------- ------------ ---------
(PERCENT)
<S> <C> <C>
Berkshire Power Company L.L.C.(2)........................... 261 31
Cambria Cogen Company, G.P.................................. 80 100
CDECCA(2)................................................... 62 50
Dartmouth Power Associates, L.P. ........................... 68 100
Eagle Point Cogeneration Partnership(2)..................... 233 16
East Coast Power L.L.C.(3) ................................. 1,131 82
El Paso Golden Power, L.L.C.(3)............................. 435 32
Front Range(4).............................................. 500 50
Juniper Generation, L.L.C.(3)............................... 682 25
Linden 6 Expansion.......................................... 169 99
MASSPOWER(2)................................................ 270 33
Milford Power Company(2)(4)................................. 540 70
Nevada Cogeneration Associates #1........................... 85 50
Newark Bay Cogeneration Partnership L.P. ................... 147 100
Orlando CoGen Limited, L.P. ................................ 115 50
Pawtucket Power Associates L.P. ............................ 69 100
Prime Energy Limited Partnership............................ 52 50
San Joaquin CoGen L.L.C. ................................... 48 100
Vandolah.................................................... 645 100
------
Total............................................. 5,592
======
</Table>
- ---------------
(1) Gross megawatts represent the tested generating capacity of these
facilities.
(2) We also own a direct interest in these projects.
(3) These project companies own interests in multiple plants.
(4) These plants are under construction.
Internationally, our focus has been on building and acquiring energy
infrastructure in developed economies, and to a lesser degree in selected
emerging markets. Our primary areas of focus historically have included Brazil,
Europe and Asia. We principally conduct our Brazilian development activities
within an investment that we refer to as Gemstone. We own approximately 50
percent of Gemstone, and Gemstone Investors, an unrelated party capitalized by
private equity (Rabobank International) and debt, owns the remaining 50 percent.
Gemstone Investor Limited also indirectly purchased preferred interests in two
of our consolidated power projects in Brazil. The Gemstone structure owns or has
interests in five Brazilian power generation facilities with a total generating
capacity of approximately 2,184 gross megawatts. We serve as the manager of
Gemstone under a management agreement that expires in 2004, under which we are
paid a fee that reimburses us for the cost to provide the management services,
which cannot exceed $2 million on an annual basis. Our activities as manager of
Gemstone include:
- management of the operations and commercial activities of the facilities;
- project financings, sales and acquisitions; and
- daily administration activities of accounting, tax, legal and treasury
functions.
20
<PAGE>
As of December 31, 2002, Gemstone owned or had interests in the following
power plants:
<Table>
<Caption>
GEMSTONE
GROSS OWNERSHIP
PROJECT MEGAWATTS(1) INTEREST
- ------- ------------ ---------
<S> <C> <C>
Macae....................................................... 895 100%
Porto Velho(2).............................................. 409 50%
Araucaria................................................... 484 60%
Rio Negro................................................... 158 (3)
Manaus...................................................... 238 (3)
-----
Total............................................. 2,184
=====
</Table>
- ---------------
(1) Gross megawatts represent the tested generating capacity of these
facilities.
(2) The second phase of this project is under construction.
(3) These are consolidated power projects in which Gemstone owns a preferred
ownership interest.
Rabobank International, the third party investor in Gemstone, has the right
to remove us as manager of Gemstone. In January 2003, Rabobank notified us that
it planned to remove us as manager. We retained our management rights by
agreeing to purchase Rabobank's $50 million of equity in Gemstone on or before
April 17, 2003. We will consolidate Gemstone, its related power plants and its
debt on the purchase date, unless we replace Rabobank with another partner.
For a further discussion of both Chaparral's and Gemstone's activities, see
Part II, Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations and Part II, Item 8, Financial Statements and
Supplementary Data, Note 26.
Detailed below are our power generation projects, by region (segregated by
those that are consolidated and those that are not) as of December 31, 2002:
<Table>
<Caption>
CONSOLIDATED POWER PROJECTS
- --------------------------- NUMBER OF GROSS NET
REGION PROJECT STATUS FACILITIES MEGAWATTS(1) MEGAWATTS(2)
- ------ -------------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
North America
East Coast Operational................ 4 429 429
South America Operational................ 2 396 396
Asia Operational................ 2 108 95
Central America Operational................ 1 144 125
Europe Operational................ 1 69 35
-- ----- -----
Total...................................... 10 1,146 1,080
== ===== =====
</Table>
- ---------------
(1) Gross megawatts represent the tested generating capacity of these
facilities.
(2) Net megawatts represent our net ownership in the facilities.
21
<PAGE>
<Table>
<Caption>
UNCONSOLIDATED POWER PROJECTS
- ----------------------------- NUMBER OF GROSS NET
REGION PROJECT STATUS FACILITIES MEGAWATTS(1) MEGAWATTS(2)
- ------ -------------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
North America
East Coast Operational................ 20 4,050 2,891
Under Construction......... 1 540 513
Central Operational................ 3 2,309 1,052
Under Construction......... 1 500 250
West Coast Operational................ 25 1,363 514
South America Operational................ 6 4,698 1,780
Under Construction......... 1 197 99
Asia Operational................ 13 4,023 1,842
Central America Operational................ 5 1,046 294
Under Construction......... 1 50 11
Europe Operational................ 2 743 159
--- ------ -----
Total...................................... 78 19,519 9,405
=== ====== =====
</Table>
- ---------------
(1) Gross megawatts represent the tested generating capacity of these
facilities.
(2) Net megawatts represent our net ownership in the facilities.
Petroleum
In February 2003, we announced our intent to sell substantially all of our
petroleum business (with the exception of our Aruba refinery) since it is not
core to our primary natural gas business. In addition, we also announced our
intent to minimize our involvement in a developing LNG business because the
significant capital and credit requirements associated with this business were
in excess of our current financial capacity.
Our existing petroleum division: (i) owns or has interests in four crude
oil refineries and five chemical production facilities; (ii) has petroleum
terminalling and related marketing operations; and (iii) has blending and
packaging operations that produce and distribute a variety of lubricants and
automotive related products. Of the four refineries we own, we operate three of
them. The three refineries we operate have a throughput capability of
approximately 438 MBbls of crude oil per day to produce a variety of gasolines,
diesel fuels, asphalt, industrial fuels and other products. Our chemical
facilities have a production capability of 3,800 tons per day and produce
various industrial and agricultural products.
In 2002, our refineries operated at 64 percent of their average combined
capacity, at 70 percent in 2001 and at 93 percent in 2000. The aggregate sales
volumes at our wholly owned refineries were approximately 110 MMBbls in 2002,
131 MMBbls in 2001 and 182 MMBbls in 2000. Of our total refinery sales in 2002,
38 percent was gasoline, 41 percent was middle distillates, such as jet fuel,
diesel fuel and home heating oil, and 21 percent was heavy industrial fuels and
other products.
The following table presents average daily throughput and storage capacity
at our wholly owned refineries at December 31:
<Table>
<Caption>
AVERAGE AT DECEMBER 31,
DAILY 2002
THROUGHPUT -------------------
------------------ DAILY STORAGE
REFINERY LOCATION 2002 2001 2000 CAPACITY CAPACITY
- -------- -------- ---- ---- ---- -------- --------
(IN MBBLS)
<S> <C> <C> <C> <C> <C> <C>
Aruba Aruba.......................... 146 178 229 280 15,320
Eagle Point Westville, New Jersey.......... 127 118 143 140 8,492
Corpus
Christi(1) Corpus Christi, Texas.......... -- 38 99 -- --
Mobile Mobile, Alabama................ 9 10 12 18 600
--- --- --- --- -------
Total....................................... 282 344 483 438 24,412
=== === === === =======
</Table>
- ---------------
(1) In June 2001, we leased our Corpus Christi refinery to Valero Energy
Corporation for 20 years. In February 2003, Valero exercised its option to
purchase the plant and related assets. These volumes only reflect those
produced prior to our lease of the facilities.
22
<PAGE>
Our chemical plants produce agricultural fertilizers, gasoline additives
and other industrial products from facilities in Nevada, Oregon and Wyoming. The
following table presents sales volumes from our wholly owned chemical facilities
in the U.S. for each of the three years ended December 31:
<Table>
<Caption>
2002 2001 2000
----- ----- -----
(MTONS)
<S> <C> <C> <C>
Industrial.................................................. 512 492 547
Agricultural................................................ 380 378 389
Gasoline additives.......................................... 199 173 214
----- ----- -----
Total............................................. 1,091 1,043 1,150
===== ===== =====
</Table>
Since January 2003, we have sold the majority of our interests in our
Florida petroleum terminals, our tug and barge operations, our leasehold crude
business and asphalt operations and all of our interests in the Corpus Christi
refinery. We expect to sell the rest of the assets associated with our petroleum
business in 2003, with the exception of the Aruba refinery.
Our LNG business contracts for LNG terminalling and regasification
capacity, coordinates short and long-term LNG supply deliveries and, prior to
our announced intent to minimize our involvement in this business, was
developing an international LNG supply, marketing and infrastructure business.
As of December 31, 2002, our LNG business had contracted for 163 Bcf per year of
LNG regasification capacity at the Elba Island location in Georgia, which is
contracted through 2023.
We have contracted for 103 Bcf per year of LNG supplies at market sensitive
prices, under the terms of a long-term Caribbean supply agreement. Initial
deliveries under this agreement are scheduled to commence in June 2003. In May
2002, we received final approval from the Norwegian and United States
governments for an LNG purchase and sale agreement signed in October 2001 with
Snohvit, which is a consortium of natural gas production companies led by
Statoil ASA. In the fourth quarter of 2002, we completed a sale of our position
in the LNG purchase and sale agreement and an assignment of our capacity rights
at the Cove Point LNG regasification facility to Statoil for $210 million.
During 2001 and 2002, we contracted to charter four LNG tankers, with an
option to charter a fifth ship, to transport LNG from supply areas to domestic
and international market centers. In February 2003, following our announced plan
to minimize our involvement in the LNG business, we entered into various
agreements with the ship owners under which all four of the ship charters and
our option for chartering the fifth ship were cancelled in consideration of
payments by us totaling $24 million. On two of the ship charters, the ship
owners assumed responsibility for the charter of those vessels, and we paid $20
million for the capital costs associated with fitting those two ships with
regasification capabilities. In connection with transferring the chartering
responsibilities back to the ship owners, we agreed to provide letters of
credit, fully collateralized by cash, equal to $120 million that could be drawn
on by the ship owners. These letters of credit are intended to cover additional
capital costs and any shortfalls in the rates at which they are able to charter
the vessels, compared to the rates provided for in the original charter
agreements, as adjusted for capital costs we have already paid. In the event
that the ship owners are able to charter the ships at rates in excess of the
original rates, as adjusted, we will share in the benefits. We also retained
rights to charter some of the vessels for our use in potential future LNG
activities. In connection with these transactions, our future exposure to the
ship arrangements is limited to $120 million. We also transferred our interest
in our Baja LNG development project to an unaffiliated third party in connection
with these transactions. We are exploring our options with respect to the
remainder of our LNG business, including the sales of assets and supply and
sales contracts, and participating in joint ventures that would use our Energy
Bridge technology (technology which uses regasification capability on board the
LNG transport ships in combination with or instead of using land-based
facilities).
Energy Trading
At the beginning of 2002, we were one of the largest energy marketers in
North America. Our trading activities included providing both short and
long-term supplies of energy commodities to a broad range of
23
<PAGE>
wholesale customers worldwide. We traded natural gas, power, crude oil, other
energy commodities and related financial instruments in North America and Europe
and provided pricing and valuation analysis for the entire Merchant Energy
segment. Detailed below is our marketed and traded energy commodity sales
volumes that were settled during each of the three years ended December 31:
<Table>
<S> <C> <C> <C>
Volumes 2002 2001 2000
------- ------- -------
Physical
Natural gas (BBtu/d)............................... 11,879 9,230 7,768
Power (MMWh)....................................... 469,477 217,387 115,303
Financial settlements (BBtue/d)....................... 188,467 143,095 98,630
</Table>
Due to deterioration of the energy trading environment, we decided in
November 2002 to exit the energy trading business and pursue an orderly
liquidation of our trading portfolio. We anticipate this liquidation will
continue through 2004. Our liquidation strategy is intended to:
- maximize cash flow from the trading portfolio;
- reduce our risk in an uncertain environment; and
- avoid inefficient sales of the portfolio in the current distressed
environment.
We will execute this strategy in several ways, including:
- negotiating early settlements pursuant to contractual terms with
counterparties;
- actively pursuing the sales of transactions or the entire portfolio with
third parties;
- matching and transferring offsetting positions with different
counterparties;
- transferring activities to other El Paso segments or divisions; and
- liquidating through scheduled settlements.
In late 2002, we began actively liquidating our trading portfolio. As of
December 31, 2002, we had approximately 40,000 transactions to be settled in the
future. Included in our portfolio at that time was approximately 4.4 Bcf/d of
natural gas transportation capacity and natural gas storage rights of
approximately 125 Bcf. As of December 31, 2002, we had contracted to sell 2.1
Bcf/d of this transportation capacity and 70 Bcf of those gas storage rights.
Additionally, in the first quarter of 2003, we sold our European natural gas
trading portfolio and completed the liquidation of all of our open trading
positions in Europe. We are continuing to work with numerous counterparties to
liquidate the remainder of our portfolio through 2004.
Historically, our energy trading division purchased a significant portion
of the Production segment's natural gas production and a smaller amount of the
Field Services segment's natural gas and NGL volumes, as well as power generated
from the global power division's merchant power plants. These purchases
comprised approximately 20 percent and 1 percent of the energy trading
division's 2002 natural gas and power volumes included in the above table. With
our announcement that we will exit the trading business, these affiliated
activities are being evaluated to determine if they should be assumed by the
individual segment or whether each segment will separately contract for those
services with third parties that are actively engaged in that business.
Regulatory Environment
Merchant Energy's domestic power generation activities are regulated by the
FERC under the Federal Power Act with respect to its rates, terms and conditions
of service. In addition, exports of electricity outside of the U.S. must be
approved by the Department of Energy. Merchant Energy's cogeneration power
production activities are regulated by the FERC under the Public Utility
Regulatory Policies Act (PURPA) with respect to rates, procurement and provision
of services and operating standards. Its power generation and refining, chemical
and petroleum activities are also subject to federal, state and local
environmental regulations. We believe that our operations are in material
compliance with the applicable requirements.
24
<PAGE>
Merchant Energy's foreign operations are regulated by numerous governmental
agencies in the countries in which these projects are located. Many of the
countries in which Merchant Energy conducts and will conduct business have
recently developed or are developing new regulatory and legal structures to
accommodate private and foreign-owned businesses. These regulatory and legal
structures and their interpretation and application by administrative agencies
are relatively new and sometimes limited. Many detailed rules and procedures are
yet to be issued, and we expect that the interpretation of existing rules in
these jurisdictions will evolve over time. We believe that our operations are in
material compliance with all environmental laws and regulations in the
applicable foreign jurisdictions.
Markets and Competition
During 2002, Merchant Energy's activities served over 2,200 suppliers and
3,800 customers around the world.
Merchant Energy's businesses operate in a highly competitive environment.
Its primary competitors include:
- affiliates of major oil and natural gas producers;
- multi-national energy infrastructure companies;
- large domestic and foreign utility companies;
- affiliates of large local distribution companies;
- affiliates of other interstate and intrastate pipelines;
- independent energy marketers and power producers with varying scopes of
operations and financial resources; and
- independent refining and chemical companies.
Merchant Energy competes on the basis of price, operating efficiency,
technological advances, experience in the marketplace and counterparty credit.
Each market served by Merchant Energy is influenced directly or indirectly by
energy market economics.
Many of Merchant Energy's power generation facilities sell power pursuant
to long-term agreements with investor-owned utilities in the U.S. The terms of
its power purchase agreements for its facilities are such that Merchant Energy's
revenues from these facilities are not significantly impacted by competition
from other sources of generation. The power generation industry is rapidly
evolving and regulatory initiatives have been adopted at the federal and state
level aimed at increasing competition in the power generation business. As a
result, it is likely that when the power purchase agreements expire, these
facilities will be required to compete in a significantly different market in
which operating efficiency and other economic factors will determine success.
Merchant Energy is likely to face intense competition from generation companies
as well as from the wholesale power markets.
As a part of our strategy to exit the energy trading business, we will seek
to sell a portion or all of our trading price risk management assets and
liabilities to other energy marketers or financial institutions which engage in
energy trading activities. With the deterioration of the profitability and
credit standing of entities in the energy trading business, many industry
participants have announced their decision to exit the energy trading business.
We may face competition for limited resources in liquidating our trading price
risk management assets and liabilities from these other energy trading
companies, and this competition may impact the amounts we will be able to
realize through our liquidation efforts.
CORPORATE AND OTHER OPERATIONS
Through our corporate group, we perform management, legal, accounting,
financial, tax, consulting, administrative and other services for our operating
business segments. The costs of providing these services are
25
<PAGE>
allocated to our business segments. Our telecommunications business and
discontinued operations, including coal and retail, are also included in
Corporate and Other Operations.
Telecommunications
Our on-going telecommunication business, which we conduct through our
subsidiary, El Paso Global Networks, focuses on providing Texas-based metro
transport services and collocation and cross-connect services in Chicago. Our
Texas-based metro transport services business provides bandwidth transport
services to wholesale and commercial customers in Austin, San Antonio, Dallas,
Ft. Worth and Houston. Our collocation and cross-connect services are available
through space we lease in Lakeside Technology Center, a Chicago-based
telecommunications facility. This facility provides space for telecommunication
carriers that is designed for their unique equipment needs and provides access
to multiple network connections of various telecommunication carriers.
Regulatory Environment
The passage of the 1996 Telecommunications Act created a legal framework
for competitive telecommunications companies to provide local, analog and
digital communications services in competition with the traditional telephone
companies. The 1996 Telecommunications Act eliminated a substantial barrier to
entry for competitive telecommunications companies by enabling them to leverage
the existing infrastructure built by the traditional telephone companies rather
than constructing a competing infrastructure at significant and uneconomic cost.
A critical aspect of our Texas-based metro business is our interconnection
agreement with SBC Communications Inc. (SBC). We have pending arbitration
proceedings in Texas relating to the various terms of our new interconnection
arrangements. Although we have received a favorable decision from an
administrative law judge (ALJ) that supports the requirements needed in our
current business plan, the Public Utility Commission of Texas (PUC) is reviewing
the new language of the interconnection arrangement and is having ongoing
proceedings to determine the rates, charges and terms, and conditions for
collocation and unbundled network elements. Unbundled network elements are the
various portions of a traditional telephone company's network that a competitive
telecommunications company can lease for purposes of building a facilities-based
competitive network, including end loops, central office collocation space, and
interoffice transport. The interconnection agreement is ultimately subject to
PUC, Federal Communications Commission (FCC) and judicial oversight. These
government authorities may modify the terms of the interconnection agreements in
a way that significantly disadvantages our business.
The FCC has commenced a rulemaking proceeding as part of its triennial
review of its unbundling rules. In this proceeding, the FCC has undertaken a
reexamination of its unbundling rules. These rules provide the legal means by
which we obtain access to collocation, interoffice transport, and other
unbundled network elements that are vital to our business plan and our ability
to serve current and future customers. In particular, we rely on unbundled
network elements, leased from SBC pursuant to FCC rules, in order to reach
customers. Should the FCC decide to change its rules to limit our access to such
elements, our ability to provide our Texas-based metro services could be
significantly impacted. Additionally, legislative changes, either from Congress
or the Texas legislature, may occur, which could also limit our access to
unbundled network elements and significantly impact our business.
Markets and Competition
The markets for wholesale and commercial telecommunication services are
intensely competitive, and we expect that these markets will continue to be
competitive in the future. In the Texas markets, SBC offers similar services to
ours and represents competition in all of our target service areas.
Not many competitive telecommunications companies offer services using a
business strategy similar to ours. However, some competitive telecommunications
companies have adopted the same or modified versions of our interconnection
agreement, and other companies may continue to do so in the future. As a result,
some of these competitors offer similar services and are likely to do so in the
future.
26
<PAGE>
ENVIRONMENTAL
A description of our environmental activities is included in Part II, Item
8, Financial Statements and Supplementary Data, Note 20, and is incorporated
herein by reference.
EMPLOYEES
As of March 26, 2003, we had approximately 11,855 full-time employees, of
which 900 are subject to collective bargaining arrangements.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers as of March 28, 2003, are listed below. Prior to
August 1, 1998, all references to El Paso refer to positions held with El Paso
Natural Gas Company.
<Table>
<Caption>
OFFICER
NAME OFFICE SINCE AGE
---- ------ ------- ----
<S> <C> <C> <C>
Ronald L. Kuehn, Jr. ...... Chairman and Chief Executive Officer of El 2003 67
Paso
H. Brent Austin............ President and Chief Operating Officer of El 1992 48
Paso
D. Dwight Scott............ Executive Vice President and Chief Financial 2002 39
Officer of El Paso
John W. Somerhalder II..... Executive Vice President of El Paso and 1990 47
President of El Paso's Pipeline Group
Peggy A. Heeg.............. Executive Vice President and General Counsel 1997 43
of El Paso
Robert W. Baker............ Executive Vice President of El Paso and 1996 46
President of El Paso Global Power
Greg G. Jenkins............ Executive Vice President of El Paso 1996 45
David E. Zerhusen.......... Executive Vice President of El Paso 2000 47
Rodney D. Erskine.......... President of El Paso Production 2001 58
Robert G. Phillips......... President of El Paso Field Services 1995 48
Clark C. Smith............. President of El Paso's Trading Group 2000 48
</Table>
Mr. Kuehn has been Chairman of the Board and Chief Executive Officer since
March 2003. From September 2002 to March 2003, Mr. Kuehn was the Lead Director
of El Paso. From January 2001 to March 2003, he was a business consultant. Mr.
Kuehn served as non-executive Chairman of the Board of El Paso from October 1999
to December 2000. Mr. Kuehn served as President and Chief Executive Officer of
Sonat Inc. from June 1984 until his retirement in October 1999. He was Chairman
of the Board of Sonat Inc. from April 1986 until his retirement. He is a
director of AmSouth Bancorporation, Praxair, Inc. and The Dun & Bradstreet
Corporation.
Mr. Austin has been President and Chief Operating Officer of El Paso since
October 2002. He was an Executive Vice President of El Paso from May 1995 to
September 2002 and was Chief Financial Officer of El Paso from April 1992 to
September 2002. Prior to that period, he served in various positions with
Burlington Resources Inc. and Burlington Northern Inc.
Mr. Scott has been Executive Vice President and Chief Financial Officer of
El Paso since October 2002. Mr. Scott served as Senior Vice President of Finance
and Planning for El Paso from July 2002 to September 2002. He has held various
other positions within El Paso since October 2000. Prior to that time, he served
as a managing director in the energy investment banking practice of Donaldson,
Lufkin and Jenrette.
Mr. Somerhalder has been an Executive Vice President of El Paso since April
2000, and President of our Pipelines segment since January 2001. He has been
Chairman of the Board of TGP, EPNG and SNG since
27
<PAGE>
January 2000. He was President of TGP from December 1996 to January 2000,
President of El Paso Energy Resources Company from April 1996 to December 1996
and Senior Vice President of El Paso from August 1992 to April 1996.
Ms. Heeg has been Executive Vice President and General Counsel of El Paso
since January 2002. She was Senior Vice President and Deputy General Counsel
from April 2001 to December 2001 and Vice President and Associate General
Counsel for regulated pipelines from 1997 to 2001. Ms. Heeg has held various
positions in the legal department of Tenneco Energy and El Paso since 1989.
Mr. Baker has been Executive Vice President of El Paso and President of El
Paso Global Power since February 2003. He was Senior Vice President and Deputy
General Counsel of El Paso from January 2002 to February 2003. Prior to that
time he held various positions in the legal department of Tenneco Energy and El
Paso since 1983.
Mr. Jenkins has been Executive Vice President of El Paso since January
2002. He was President of El Paso Global Networks from August 2000 to January
2002. He was President of El Paso Merchant Energy from December 1996 to August
2000. He was Senior Vice President and General Manager of Entergy Corp. from May
1996 to December 1996. Prior to that period, he was President and Chief
Executive Officer of Hadson Gas Services Company.
Mr. Zerhusen has been Executive Vice President of El Paso since November
2002. He was Senior Vice President and Deputy General Counsel of El Paso from
April 2001 to November 2002. Prior to joining El Paso, Mr. Zerhusen served as
Vice President of Law for Tenneco Europe in London and held various positions
with Tenneco in Houston. Prior to that time, he was a litigation partner with
the law firm of Jenner and Block.
Mr. Erskine has been President of El Paso Production since our merger with
Coastal in January 2001. He was Senior Vice President of Coastal from August
1997. He has held various positions with Coastal Oil & Gas Corporation, a
subsidiary of Coastal, since 1994.
Mr. Phillips has been President of El Paso Field Services since June 1997.
He was President of El Paso Energy Resources Company from December 1996 to June
1997, President of Field Services from April 1996 to December 1996 and was
Senior Vice President of El Paso from September 1995 to April 1996. Prior to
that period, Mr. Phillips was Chief Executive Officer of Eastex Energy, Inc. Mr.
Phillips is the Chairman of the Board of Directors of El Paso Energy Partners
Company, the general partner of El Paso Energy Partners, L.P.
Mr. Smith has been President of El Paso's Trading Group since January 2003.
He was President of El Paso Merchant Energy North America from August 2000 to
January 2003. He served as President and CEO of Engage Energy Inc. since 1997.
Prior to that period, he held the position of President and CEO of Coastal Gas
Marketing Company and held several positions with Enron Corp.
Executive officers hold offices until their successors are elected and
qualified, subject to their earlier removal. Each of these elected officers also
hold officer and/or director positions with our affiliated entities.
AVAILABLE INFORMATION
Our website is http://www.elpaso.com. We make available, free of charge on
or through our website, our annual, quarterly and current reports, and any
amendments to those reports, as soon as is reasonably possible after these
reports are filed with the Securities and Exchange Commission (SEC). Information
contained on our website is not part of this report.
ITEM 2. PROPERTIES
A description of our properties is included in Item 1, Business, and is
incorporated herein by reference.
We believe that we have satisfactory title to the properties owned and used
in our businesses, subject to liens for taxes not yet payable, liens incident to
minor encumbrances, liens for credit arrangements and easements and restrictions
that do not materially detract from the value of these properties, our interests
in
28
<PAGE>
these properties, or the use of these properties in our businesses. We believe
that our properties are adequate and suitable for the conduct of our business in
the future.
ITEM 3. LEGAL PROCEEDINGS
A description of our legal proceedings is included in Part II, Item 8,
Financial Statements and Supplementary Data, Note 20, and is incorporated herein
by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
29
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange and the Pacific
Exchange under the symbol EP. As of March 27, 2003, we had 52,489 stockholders
of record, which does not include beneficial owners whose shares are held by a
clearing agency, such as a broker or bank.
The following table reflects the quarterly high and low sales prices for
our common stock based on the daily composite listing of stock transactions for
the New York Stock Exchange and the cash dividends we declared in each quarter:
<Table>
<Caption>
HIGH LOW DIVIDENDS
------ ------ ---------
(PER SHARE)
<S> <C> <C> <C>
2002
Fourth Quarter......................................... $11.91 $ 4.39 $ 0.2175
Third Quarter.......................................... 21.07 5.30 0.2175
Second Quarter......................................... 46.80 18.88 0.2175
First Quarter.......................................... 46.89 31.70 0.2175
2001
Fourth Quarter......................................... $54.05 $36.00 $ 0.2125
Third Quarter.......................................... 54.48 38.00 0.2125
Second Quarter......................................... 71.10 49.90 0.2125
First Quarter.......................................... 75.30 57.25 0.2125
</Table>
In February 2003, our Board of Directors declared a quarterly dividend of
$0.04 per share of common stock, payable on April 7, 2003, to stockholders of
record on March 7, 2003. Future dividends will be dependent upon business
conditions, earnings, our cash requirements and other relevant factors.
We have an odd-lot stock sales program available to stockholders who own
fewer than 100 shares of our common stock. This voluntary program offers these
stockholders a convenient method to sell all of their odd-lot shares at one time
without incurring any brokerage costs. We also have a dividend reinvestment and
common stock purchase plan available to all of our common stockholders of
record. This voluntary plan provides our stockholders a convenient and
economical means of increasing their holdings in our common stock. Neither the
odd-lot program nor the dividend reinvestment and common stock purchase plan
have a termination date; however, we may suspend either at any time. You should
direct your inquiries to Fleet National Bank, our exchange agent at
1-877-453-1503.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information concerning our equity compensation
plans as of December 31, 2002. The table is divided into two categories: plans
that have been approved by stockholders and equity compensation plans that have
not been approved by stockholders. The table includes (a) the number of
securities to be issued upon exercise of options, warrants and rights
outstanding under the equity
30
<PAGE>
compensation plans, (b) the weighted-average exercise price of all outstanding
options, warrants and rights and (c) additional shares available for future
grants under all of our equity compensation plans.
<Table>
<Caption>
NUMBER OF
NUMBER OF SECURITIES WEIGHTED-AVERAGE SECURITIES REMAINING
TO BE ISSUED UPON EXERCISE PRICE OF AVAILABLE FOR
EXERCISE OF OUTSTANDING FUTURE ISSUANCE
OUTSTANDING OPTIONS, OPTIONS, WARRANTS UNDER EQUITY
PLAN CATEGORY WARRANTS AND RIGHTS(1) AND RIGHTS COMPENSATION PLANS
- ------------- ----------------------- ------------------- --------------------
<S> <C> <C> <C>
Equity compensation plans approved by
stockholders.......................... 7,820,635 $40.904 7,087,410(2)
Equity compensation plans not approved
by stockholders....................... 32,107,007 $52.562 19,775,268(3)
---------- ----------
Total................................... 39,927,642 26,862,678
========== ==========
</Table>
- ---------------
(1) Amounts do not include 3,279,772 shares with a weighted-average exercise
price of $35.788 per share which we assumed under the Executive Award Plan
of Sonat Inc. as a result of the merger with Sonat in October 1999. The
Executive Award Plan of Sonat Inc. has been terminated and no future awards
can be made under it.
(2) Amount includes 2,831,050 shares available for future issuance under the
Employee Stock Purchase Plan.
(3) Amount includes 69,250 shares available for future awards granted under the
Restricted Stock Award Plan for Management Employees.
Non-Stockholder Approved Plans
The following is a discussion of the plans that have not been approved by
our stockholders:
Strategic Stock Plan. This plan provides for the grant of stock options,
stock appreciation rights, limited stock appreciation rights and shares of
restricted common stock to non-employee members of our Board of Directors,
officers and key employees primarily in connection with our strategic
acquisitions. As the plan administrator, we determine which employees are
eligible to participate, the amount of any grant and the terms and conditions
(not otherwise specified in the plan) of the grant. If a change in control, as
it is defined in the plan, occurs: (1) all outstanding stock options become
fully exercisable (2) stock appreciation rights and limited stock appreciation
rights become immediately exercisable; and (3) all restrictions placed on awards
of restricted common stock automatically lapse.
Restricted Stock Award Plan for Management Employees. The plan provides
for the granting of restricted shares of our common stock to our management
employees (other than executive officers and directors) for specific
accomplishments beyond that which are normally expected and which will have a
significant and measurable impact on our long-term profitability. As the plan
administrator, we designate which employees are eligible to participate, the
amount of any grant and the terms and conditions (not otherwise specified in the
plan) of the grant.
Omnibus Plan for Management Employees. This plan provides for the grant of
stock options, stock appreciation rights, limited stock appreciation rights and
shares of restricted common stock to our salaried employees (other than
employees covered by a collective bargaining agreement). If a change in control,
as it is defined in the plan, occurs: (1) all outstanding stock options become
fully exercisable; (2) stock appreciation rights and limited stock appreciation
rights become immediately exercisable; and (3) all restrictions placed on awards
of restricted common stock automatically lapse.
For a further discussion of these plans, as well as plans that have been
approved by our stockholders, see our proxy statement for the 2003 Annual
Meeting of Stockholders, which has been incorporated by reference into this Form
10-K.
31
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(IN MILLIONS, EXCEPT PER COMMON SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Operating Results Data:
Operating revenues............................... $12,194 $13,649 $19,271 $13,318 $13,399
Income (loss) from continuing operations before
preferred stock dividends(1).................. (1,289) 72 1,237 251 176
Income (loss) from continuing operations
available to common stockholders(1)........... (1,289) 72 1,237 251 170
Basic earnings (loss) per common share from
continuing operations......................... $ (2.30) $ 0.14 $ 2.50 $ 0.51 $ 0.35
Diluted earnings (loss) per common share from
continuing operations......................... $ (2.30) $ 0.14 $ 2.43 $ 0.51 $ 0.34
Cash dividends declared per common share(2)...... $ 0.87 $ 0.85 $ 0.82 $ 0.80 $ 0.76
Basic average common shares outstanding.......... 560 505 494.... 490 487
Diluted average common shares outstanding........ 560 516 513 497 495
</Table>
<Table>
<Caption>
AS OF DECEMBER 31,
-----------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Financial Position Data:
Total assets..................................... $46,224 $48,546 $46,903 $32,090 $26,759
Long-term financing obligations.................. 16,106 12,891 11,603 10,021 7,691
Non-current notes payable to affiliates.......... 201 368 343 -- --
Securities of subsidiaries....................... 3,420 4,013 3,707 2,444 999
Stockholders' equity............................. 8,377 9,356 8,119 6,884 6,913
</Table>
- ---------------
(1) In March 2003, we entered into an agreement in principle to settle claims
associated with the western energy crisis of 2000 and 2001. We also incurred
losses related to impairments of assets and equity investments and incurred
restructuring charges related to industry changes. We also incurred a
ceiling test charge on our full cost natural gas and oil properties. During
2001, we merged with The Coastal Corporation and incurred costs and asset
impairments related to this merger. In 1999, we incurred $557 million of
merger charges primarily related to our merger with Sonat, Inc. and incurred
$352 million of ceiling test charges. In 1998, we incurred $1,035 million of
ceiling test charges. For a further discussion of events affecting
comparability of our results in 2002, 2001 and 2000, See Item 8, Financial
Statements and Supplementary Data, Notes 2, 4, 5, 6 and 7.
(2) Cash dividends declared per share of common stock represent the historical
dividends declared by El Paso for all periods presented.
32
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Our Management's Discussion and Analysis includes forward-looking
statements that are subject to risks and uncertainties. Actual results may
differ substantially from the statements we make in this section due to a number
of factors that are discussed beginning on page 76.
OVERVIEW
We are an energy company whose operations encompass natural gas and oil
production; gathering, processing and interstate and intrastate transmission of
natural gas; power generation; petroleum refining; and energy trading. Our
business is divided into four distinct business segments: Pipelines, Production,
Field Services and Merchant Energy.
During the last five years, we experienced substantial growth from mergers
and acquisitions, and organic growth of our marketing and trading and global
power businesses. Growth through mergers and acquisitions has included
significant transactions, such as our DeepTech International acquisition in
1998, Sonat merger in 1999, and the Coastal merger in 2001. These transactions,
the growth of trading and power activities and the capital needs of our other
businesses required substantial financial resources. During this five-year
period, we frequently accessed the capital markets to fund our growth through a
wide variety of financings.
During 2002, we experienced dramatic changes in our industry as well as in
the financial markets on which we rely, and we continue to operate in a very
challenging environment. In response to industry events, the credit rating
agencies, including Moody's and Standard & Poor's, re-evaluated the ratings of
companies involved in energy trading activities. As a result, the ratings of
many of the largest participants in the energy trading industry, including us,
were downgraded to below investment grade. Several experienced significant
financial distress. Also impacting us was a preliminary decision reached by a
FERC ALJ that one of our subsidiaries withheld pipeline capacity from the
California market during 2000 and 2001. Reacting to the changes in the market,
our leverage and a preliminary decision related to our California matters,
Moody's and Standard & Poor's initiated a series of ratings actions lowering our
senior unsecured debt rating to Caa1 and B (both "below investment grade"
ratings), and we remain on negative outlook.
Several negative outcomes resulted from these downgrades. First, cash
generated in 2002 from the sales of assets, which had originally been identified
for debt reductions, was instead: required to be posted as additional cash
collateral in connection with our commercial trading activities; paid to satisfy
financial guarantees; and used to retire other arrangements. Additionally, our
access to capital markets and commercial paper markets became much more
restricted because of our lower credit ratings. Finally, the credit downgrades
resulted in the net cash generated by assets and businesses that collateralize
two of our minority interest financing arrangements being largely unavailable to
us for general corporate purposes. Instead, we were required to use this cash to
redeem preferred securities issued in connection with those arrangements and for
the operation of those assets and businesses. In March 2003, we issued a $1.2
billion two-year term loan. The proceeds were used to retire the outstanding
amounts under the Trinity River preferred interest financing arrangement,
partially freeing up these cash usage restrictions. For a further discussion of
this redemption, see Item 8, Financial Statements and Supplementary Data, Note
19.
Since the fourth quarter of 2001, we have taken several steps to address
the issues affecting us, and we have made significant progress in our plans to
meet the demands on our liquidity and to strengthen our capital structure.
Some of our more significant accomplishments include:
- The sale of over $2.5 billion of equity or equity-linked securities;
- The completion or execution of contracts for the sale of over $5.5
billion of non-core assets and investments;
33
<PAGE>
- The removal of rating triggers from over $4 billion of our investment and
financing programs, which, because of our credit rating downgrades, would
have resulted in the issuance of our stock or the liquidation of assets,
the proceeds from which would have been used to repay those arrangements;
- The issuance of $700 million in senior unsecured notes at Southern
Natural Gas Company ($400 million) and ANR Pipeline Company ($300
million);
- The completion in March 2003 of a new $1.2 billion term loan, which
enabled the retirement of our Trinity River preferred interest financing
arrangement and eliminated the cash restrictions and accelerated
amortization of that arrangement;
- The establishment of an exit strategy for our trading business, including
the planned orderly liquidation of our existing trading portfolio;
- The substantial reduction of our credit exposure to our LNG business;
- The repayment of over $1.9 billion of financial obligations, including
Electron and Trinity River; and
- The achievement of the Western Energy Settlement in March 2003, which was
designed to resolve our principal exposure relating to the western energy
crisis while minimizing the impact on our current liquidity.
On February 5, 2003, we announced our 2003 Operational and Financial Plan.
This plan is based on five key principles:
- Preserve and enhance the value of our core businesses;
- Exit non-core businesses quickly but prudently;
- Strengthen and simplify the balance sheet while maximizing liquidity;
- Aggressively pursue additional cost reductions; and
- Continue to work diligently to resolve litigation and regulatory matters.
In the following sections of our Management's Discussion and Analysis, we
address these events and our outlook in greater detail. In the section entitled
Liquidity and Capital Resources, we discuss the impact of changes in our credit
standing and our current liquidity, including our ability to generate cash from
operations and capital market transactions. In the section entitled Off-Balance
Sheet Arrangements and Contractual Obligations, we discuss the various financing
and contractual arrangements in which we are involved that commit us under
guarantees and other commercial and contractual obligations. In Results of
Operations, we analyze operating results for each of our business segments and
identify unusual and infrequent events that have impacted and, in some cases,
may continue to impact, the operations of our business segments.
Our discussions of Liquidity and Capital Resources, Off-Balance Sheet
Arrangements and Contractual Obligations and Results of Operations are based on
our consolidated financial statements, which have been prepared through the
application of accounting principles that are generally accepted in the U.S. The
preparation of our financial statements reflect the selection and application of
accounting policies, many of which require us to use assumptions, estimates and
judgments that involve complex processes. Actual results can, and often do,
differ from these estimates. Beginning on page 70 is a discussion of our
Critical Accounting Policies, which discuss those policies that are significant
to our financial position and operating results that are presented in our
financial statements. You should also read our significant accounting policies
in Item 8, Financial Statements and Supplementary Data, Note 1, to understand
all of the policies that impact our financial presentation included in this
discussion and analysis and in the presentation of our financial statements as a
whole.
34
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Overview of Current Liquidity
We rely on cash generated from our internal operations as our primary
source of liquidity, as well as available credit facilities, bank financings,
asset sales and the issuance of long-term debt, preferred securities and equity
securities. From time to time, we have also used structured financings sometimes
referred to as off-balance sheet arrangements. We expect that our future funding
for working capital needs, capital expenditures, long-term debt repayments,
dividends and other financing activities will continue to be provided from some
or all of these sources. Each of these sources are impacted by factors that
influence the overall amount of cash generated by us and the capital available
to us. For example, cash generated by our business operations may be impacted by
changes in commodity prices or demands for our commodities or services due to
weather patterns, competition from other providers or alternative energy
sources. Collateral demands or recovery of collateral posted are impacted by
natural gas prices, hedging levels and our credit quality and that of our
counterparties. Liquidity generated by future asset sales may depend on the
overall economic conditions of the industry served by these assets, the
condition and location of the assets and the number of interested buyers. In
addition, our credit ratings or general market conditions can restrict our
ability to access capital markets, which can have a significant impact on our
liquidity.
The following tables, which reflect our available liquidity at the
beginning of the year and estimated sources and uses of liquidity throughout
2003, indicate the adequacy of our liquidity to meet our immediate needs.
At the beginning of 2003, our available liquidity was as follows (in
billions):
<Table>
<S> <C>
Sources
Available cash............................................ $1.1
Availability under 364-day bank facility(1)............... 1.5
Availability under multi-year bank facility(1)(2)......... 0.5
----
Net available liquidity..................................... $3.1
====
</Table>
- ---------------
(1) Our 364-day bank facility matures in May 2003, with amounts outstanding
at that time becoming due in May 2004, and our multi-year bank facility
matures in August 2003.
(2) An additional $0.5 billion was drawn in February 2003.
Other sources of cash we expect for 2003 include (in billions):
<Table>
<S> <C>
Cash flow from operating activities before working capital
and non-working capital changes........................... $2.1 - $2.4
Return of working capital................................... 0.3
Debt issuances(1)........................................... 3.1
Other financings............................................ 0.4
Asset sales(2).............................................. 3.1 - 3.3
-----------
Total.................................................. $9.0 - $9.5
===========
</Table>
- ---------------
(1) Issuances of $1.9 billion occurred in March 2003.
(2) As of March 31, 2003, we have completed or executed contracts for the
sale of over $1.7 billion of non-core assets and investments.
35
<PAGE>
For 2003, our anticipated cash needs include (in billions):
<Table>
<S> <C>
Debt repayments............................................. $3.0
Minority interest redemptions(1)............................ 1.6
Other financing obligations(2).............................. 1.2
Maintenance capital......................................... 1.8
Discretionary capital....................................... 0.7
Dividends................................................... 0.2
----
Anticipated cash needs................................. $8.5
====
</Table>
- ---------------
(1) Includes redemption of Trinity River preferred interest of $980 million that
occurred in the first quarter of 2003.
(2) Includes repayment of Limestone notes of $1 billion that occurred in March
2003 and the purchase of Limestone's equity for $175 million that is
expected to occur in May 2003.
Our anticipated requirements may change significantly, and our analysis is
intended to provide you with an understanding of our cash needs, both required
and discretionary, to better understand our liquidity outlook. The factors that
could impact our outlook are identified beginning on page 76.
Overview of Cash Flow Activities for 2002
For the years ended December 31, 2002 and 2001, our cash flows are
summarized as follows:
<Table>
<Caption>
2002 2001
------- -------
(IN MILLIONS)
<S> <C> <C>
Cash flows from operating activities
Net income (loss)......................................... $(1,467) $ 93
Non-cash income adjustments............................... 3,516 2,320
------- -------
Cash flows before working capital and non-working
capital changes....................................... 2,049 2,413
Working capital changes................................... (1,436) 1,914
Non-working capital changes and other..................... (177) (207)
------- -------
Cash flows from operating activities................... 436 4,120
------- -------
Cash flows from investing activities........................ (1,255) (5,023)
------- -------
Cash flows from financing activities........................ 1,272 1,300
------- -------
Change in cash......................................... $ 453 $ 397
======= =======
</Table>
During the year ended December 31, 2002, our cash and cash equivalents
increased by approximately $0.5 billion to approximately $1.6 billion. We
generated a substantial amount of cash from various sources, including cash
flows from our principal operations, sales of assets and financing transactions,
including long-term debt and equity securities issuances. We also used a major
portion of that cash to fund our capital expenditures, to repay maturing
financial obligations and to meet the increased demand for cash collateral as a
result of our credit downgrade.
In summary, we generated cash from our principal business operations
(before working capital demands and other changes) of $2.0 billion. We also
raised $5.4 billion of cash through the issuance of debt and equity securities
and borrowings under our revolving credit facility. Cash proceeds from the sale
of assets and investments amounted to approximately $2.9 billion. With the cash
we received from these sources, we invested approximately $4.0 billion in our
property, plant and equipment and equity investments and we paid $2.8 billion on
maturing long-term debt and other obligations. Additionally we paid $0.5 billion
in dividends and $0.9 billion to redeem minority and preferred interests. We
also met net working capital and other demands of $1.6 billion primarily for
margin payments related to our energy trading activities, hedging activities on
our natural gas production and other collateral requirements. A more detailed
analysis of our cash flows from operating, investing and financing activities
follows.
36
<PAGE>
Cash From Operating Activities
We generated almost $2.0 billion in cash from operations in 2002 before
working capital and other changes, as compared to $2.4 billion in 2001. Net cash
provided by operating activities was $0.4 billion for the year ended December
31, 2002, compared to net cash provided by operating activities of $4.1 billion
for the same period in 2001.
Margin call requirements and trading activities have been a volatile
source, or use, of working capital for us, and are the primary reasons for the
significant differences in our 2002 operating cash flows compared to 2001. Where
we had substantial net cash outflows for margins in 2002 of $0.9 billion, we had
net cash inflows in 2001 for margins of almost $0.3 billion. Operating cash
flows in 2002 also reflected significantly lower cash inflows from settlements
of trading positions of $0.3 billion compared to $1.5 billion in 2001.
Our margin positions are significantly impacted by two factors: credit and
commodity prices. Following our downgrade, credit extended to us by our
counterparties was lowered requiring us to post additional margins. Many of our
counterparties also posted letters of credit with us requiring us to return
their margin deposits. In addition, the impact on our operating cash flows from
changes in commodity prices depends on whether our hedged prices are above or
below market prices. For most of 2001, our hedged prices were above market,
which resulted in margins being deposited with us. When our hedged prices go
below market, as they did in 2002, we are required to make margin deposits.
However, the margin deposits will be recovered when we sell the underlying
commodities and settle the positions or when natural gas prices decrease. At
December 31, 2002, we held $0.1 billion of cash and $0.4 billion of letters of
credit as collateral from third parties related to our price risk management
activities and have provided $1.0 billion of cash and $0.2 billion letters of
credit to third parties related to those activities.
Cash From Investing Activities
Net cash used in our investing activities was $1.3 billion for the year
ended December 31, 2002. Our investing activities consisted primarily of capital
expenditures and equity investments of $4.0 billion offset by net proceeds from
sale of assets and investments and cash received for repayment of notes
receivable of $2.9 billion. Our capital expenditures and equity investments
included the following (in billions):
<Table>
<S> <C>
Production exploration, development and acquisition
expenditures.............................................. $2.2
Pipeline expansion, maintenance and integrity projects...... 0.9
Investments in and net advances to unconsolidated
affiliates................................................ 0.3
Other (primarily petroleum and power projects).............. 0.6
----
Total capital expenditures and equity
investments....................................... $4.0
====
</Table>
Cash received from our investing activities includes $2.9 billion from the
sale of assets and investments. Our asset sales proceeds are primarily
attributable to the sale of natural gas and oil properties in Texas, Colorado,
Utah and western Canada for $1.3 billion, the sales of Texas and New Mexico
midstream assets for $0.5 billion and San Juan assets of $0.4 billion to El Paso
Energy Partners and the sale of other power, petroleum and processing assets of
$0.7 billion.
Cash From Financing Activities
Net cash provided by our financing activities was $1.3 billion for the year
ended December 31, 2002. Cash provided from our financing activities included
the net proceeds from the issuance of long-term debt of $4.3 billion, including
$0.8 billion of nonrecourse debt issued in connection with our Utility Contract
Funding, L.L.C. (UCF) power contract restructuring and $0.6 million associated
with an equity security units issuance. Additionally, we issued $1.0 billion of
common stock. We also received net proceeds under our commercial paper and
short-term credit facilities of $0.2 billion. Cash used by our financing
activities included payments made to retire third party long-term debt and other
financing obligations of $2.3 billion. We also redeemed $700 million of
preferred securities previously issued by our subsidiaries and made other
minority interest payments of $161 million, primarily to Chaparral which holds a
16 percent minority interest in the UCF
37
<PAGE>
project. Further, we repaid $513 million of notes payable to affiliates and paid
dividends of $470 million. Also, during the year ended December 31, 2002, El
Paso Tennessee Pipeline Co., our subsidiary, paid dividends of approximately $25
million on our Series A cumulative preferred stock that accrues at a rate of
8 1/4% per year (2.0625% per quarter).
A summary of our significant borrowing and repayment activities during 2002
and 2003 is presented below. These amounts do not include borrowings or
repayments on our short-term financing instruments with an original maturity of
three months or less, which are referred to above under cash from financing
activities.
Issuances
<Table>
<Caption>
NET
COMPANY INTEREST RATE PRINCIPAL PROCEEDS(1) DUE DATE
------- ------------- --------- ----------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C>
2002
El Paso......................... 6.14%-7.875% $2,707(2) $2,580 2007-2032
SNG............................. 8.00% 300 297 2032
EPNG............................ 8.375% 300 297 2032
TGP............................. 8.375% 240 238 2032
Mohawk River Funding IV(3)...... 7.75% 92 90 2008
Utility Contract Funding(3)..... 7.944% 829 792 2016
------ ------
Total................... $4,468 $4,294
====== ======
2003
ANR............................. 8.875% $ 300 $ 288 2010
SNG............................. 8.875% 400 385 2010
EPC(4).......................... LIBOR+4.25% 1,200 1,179 2004-2005
------ ------
Total................... $1,900 $1,852
====== ======
</Table>
- ---------------
(1) Net proceeds were primarily used to repay maturing long-term debt,
short-term borrowings, for repayment of intercompany borrowings, to meet
capital requirements of the borrower, to redeem preferred interests in
consolidated subsidiaries and for general corporate purposes.
(2) Includes $82 million change in value on our E500 million Euro notes from May
2002 to December 2002 due to a change in the Euro to U.S. dollar foreign
currency exchange rate.
(3) These notes are collateralized solely by the cash flows and contracts of
these consolidated subsidiaries, and are non-recourse to our other
consolidated subsidiaries. The Mohawk River Funding IV financing relates to
our Capitol District Energy Center Cogeneration Associates power
restructuring transaction, and the Utility Contract Funding financing
relates to our Eagle Point Cogeneration power restructuring transaction.
(4) We have collateralized this term loan with natural gas and oil reserves of
approximately 2.3 Tcfe. The minimum LIBOR rate is 3.5%.
38
<PAGE>
Retirements
<Table>
<Caption>
NET
COMPANY INTEREST >RATE PRINCIPAL PAYMENTS DUE DATE
------- -------------- --------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
2002
El Paso................................ 6.75%-8.78% $ 109 $ 89(1) 2002-2011
El Paso CGP............................ 6.20%-8.125% 720 284(2) 2002-2004
El Paso CGP............................ Variable 1,262 1,262 2002-2028
El Paso Tennessee...................... 7.88% 12 12 2002
SNG.................................... 7.85%-8.625% 200 200 2002
EPNG................................... 7.75% 215 215 2002
El Paso Oil and Gas Resources.......... Variable 215 216 2002-2005
Other.................................. Various 51 50 2002
------ ------
Total........................... $2,784 $2,328
====== ======
2003
El Paso CGP............................ 4.49% $ 240 $ 240 2004
Other.................................. Various 47 47 2003
------ ------
Total........................... $ 287 $ 287
====== ======
</Table>
- ---------------
(1) We bought back $109 million of our bonds in the open market during the
second half of the year for $89 million. We anticipate we will continue to
repurchase debt, subject to available liquidity and ongoing market
opportunities.
(2) Includes exchange of $435 million of senior debentures for common stock as
discussed below.
In June 2002, we issued 51.8 million shares of our common stock at a public
offering price of $19.95 per share. Net proceeds from the offering were
approximately $1 billion and were used to repay short-term borrowings and other
financing obligations and for general corporate purposes.
In June 2002, we issued 11.5 million, 9% equity security units. Equity
security units consist of two securities: (i) a purchase contract on which we
pay quarterly contract adjustment payments at an annual rate of 2.86% and that
requires its holder to buy our common stock to be settled on August 16, 2005,
and (ii) a senior note due August 16, 2007, with a principal amount of $50 per
unit, and on which we pay quarterly interest payments at an annual rate of 6.14%
beginning August 16, 2002. The senior notes we issued had a total principal
value of $575 million and are pledged to secure the holders' obligation to
purchase shares of our common stock under the purchase contracts.
When the purchase contracts are settled in 2005, we will issue common
stock. At that time, the proceeds will be allocated between common stock and
additional paid-in capital. The number of common shares issued will depend on
the prior consecutive 20-trading day average closing price of our common stock
determined on the third trading day immediately prior to the stock purchase
date. We will issue a minimum of approximately 24 million shares and up to a
maximum of 28.8 million shares on the settlement date, depending on our average
stock price. We recorded approximately $43 million of other non-current
liabilities to reflect the present value of the quarterly contract adjustment
payments that we are required to make on these units at an annual rate of 2.86%
of the stated amount of $50 per purchase contract with an offsetting reduction
in additional paid-in capital. The quarterly contract adjustment payments are
allocated between the liability recognized at the date of issuance and
additional paid-in capital based on a constant rate over the term of the
purchase contracts.
Fees and expenses incurred in connection with the equity security units
offering were allocated between the senior notes and the purchase contracts
based on their respective fair values on the issuance date. The amount allocated
to the senior notes is recognized as interest expense over the term of the
senior notes. The amount allocated to the purchase contracts is recorded as
additional paid-in capital.
In August 2002, we issued 12,184,444 shares of common stock to satisfy
purchase contract obligations under our FELINE PRIDES(sm) program. In return for
the issuance of the stock, we received approximately
39
<PAGE>
$25 million in cash from the maturity of a zero coupon bond and the return of
$435 million of our existing 6.625% senior debentures due August 2004 that were
issued in 1999. The zero coupon bond and the senior debentures had been held as
collateral for the purchase contract obligations. The $25 million received from
the maturity of the zero coupon bond was used to retire additional senior
debentures. Total debt reduction from the issuance of the common stock was
approximately $460 million.
Credit Facilities
We have historically used commercial paper programs to manage our
short-term cash requirements. Under our programs we could borrow up to $3
billion through a combination of individual corporate, TGP and EPNG commercial
paper programs of $1 billion each. However, as a result of our credit downgrade,
we are not currently issuing commercial paper to meet our liquidity needs.
In May 2002, we renewed our existing $3 billion 364-day revolving credit
and competitive advance facility. EPNG and TGP are also designated borrowers
under this facility and, as such, are jointly and severally liable for any
amounts outstanding. This facility matures in May 2003 and provides that amounts
outstanding on that date are not due until May 2004. We also maintain a 3-year,
$1 billion, revolving credit and competitive advance facility under which we can
conduct short-term borrowings and other commercial credit transactions. In June
2002, we amended this facility to permit us to issue up to $500 million in
letters of credit and to adjust pricing terms. This facility matures in August
2003. Our subsidiaries, El Paso CGP Company (formerly Coastal), EPNG and TGP,
are designated borrowers under the facility and, as such, are jointly and
severally liable for any amounts outstanding. The interest rate under both of
these facilities varies based on our senior unsecured debt rating, and as of
December 31, 2002, borrowings under the facility have a rate of LIBOR plus 1.00%
plus a 0.25% utilization fee. At December 31, 2002, we had $1.5 billion
outstanding under the $3 billion facility and issued approximately $456 million
letters of credit under the $1 billion facility. In February 2003, we borrowed
$500 million under the $1 billion facility.
We are currently negotiating an amendment to our $3 billion 364-day
revolving credit facility. If we are successful in negotiating this amendment,
we expect the terms and conditions of the amended revolving credit facility to
include an extension of the maturity date, an increase in the unused commitment
fee and margin, collateral to support the financing, and new and amended
financial ratios and covenants. It is expected that ANR, TGP and EPNG would also
be borrowers under this facility. We are also currently negotiating an amendment
to our $1 billion multi-year facility, which we expect to be conformed to the
amended $3 billion 364-day revolver, except for the commitment amount, the
identity of lenders and the maturity.
The availability of borrowings under our credit and borrowing agreements is
subject to specified conditions, which we currently meet. These conditions
include compliance with the financial covenants and ratios required by such
agreements, absence of default under such agreements, and continued accuracy of
the representations and warranties contained in such agreements.
Restrictive Covenants. We and our subsidiaries have entered into debt
instruments and guaranty agreements that contain covenants such as restrictions
on debt levels, restrictions on liens securing debt and guarantees, restrictions
on mergers and on the sales of assets, capitalization requirements, dividend
restrictions and cross-payment default and cross-acceleration provisions. A
breach of any of these covenants could result in acceleration of our debt and
other financial obligations and that of our subsidiaries. Under our revolving
credit facilities, the significant debt covenants and cross defaults are:
(a) the ratio of consolidated debt and guarantees to capitalization
(excluding certain project financing and securitization programs and
other miscellaneous items as defined in the agreement) cannot exceed 70
percent;
(b) the consolidated debt and guarantees (other than excluded items) of our
subsidiaries cannot exceed the greater of $600 million or 10 percent of
our consolidated net worth;
40
<PAGE>
(c) we or our principal subsidiaries cannot permit liens on the equity
interest in our principal subsidiaries or create liens on assets
material to our consolidated operations securing debt and guarantees
(other than excluded items) exceeding the greater of $300 million or 10
percent of our consolidated net worth, subject to certain permitted
exceptions; and
(d) the occurrence of an event of default for any non-payment of principal,
interest or premium with respect to debt (other than excluded items) in
an aggregate principal amount of $200 million or more; or the
occurrence of any other event of default with respect to such debt that
results in the acceleration thereof.
We were in compliance with the above covenants as of the date of this
filing, including our ratio of debt to capitalization (as defined in our credit
facilities), which was 63.2% at December 31, 2002.
We have also issued various guarantees securing financial obligations of
our subsidiaries and unconsolidated affiliates with similar covenants as in the
above credit facilities.
With respect to guarantees issued by our subsidiaries, the most significant
debt covenant, in addition to the covenants discussed above, is that El Paso CGP
must maintain a minimum net worth of $1.2 billion. If breached, the amounts
guaranteed by the guaranty agreements could be accelerated. The guaranty
agreements also maintain a $30 million cross-acceleration provision. El Paso
CGP's net worth at December 31, 2002, was $4.3 billion.
In addition, three of our subsidiaries have indentures associated with
their public debt that contain $5 million cross-acceleration provisions. These
cross-acceleration provisions generally state that if an event of default occurs
that exceeds $5 million, then amounts outstanding for the securities that
contain these indentures also become due and payable.
Available Capacity Under Shelf Registration Statements
In February 2002, we filed a new shelf registration statement with the SEC
that allows us to issue up to $3 billion in securities. Under this registration
statement, we can issue a combination of debt, equity and other instruments,
including trust preferred securities of two wholly owned trusts, El Paso Capital
Trust II and El Paso Capital Trust III. If we issue securities from these
trusts, we will be required to issue full and unconditional guarantees on these
securities. As of December 31, 2002, we had $818 million remaining capacity
under this shelf registration statement.
Letters of Credit
We enter into letters of credit in the ordinary course of our operating
activities. As of December 31, 2002, we had outstanding letters of credit of
approximately $852 million versus $465 million as of December 31, 2001. The
increase is primarily due to the issuance of letters of credit in connection
with the management of our trading activities. At December 31, 2002, $456
million of our outstanding letters of credit were supported by our revolving
credit facility.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
In the course of our business activities, we enter into a variety of
financing arrangements and contractual obligations. The following discusses
first those contingent obligations, often referred to as off-balance sheet
arrangements, that are not part of the consolidated obligations reflected in our
financial statements. Second, we present aggregated information on our
contractual cash obligations, some of which are reflected in our financial
statements, such as short and long-term debt, and others, such as operating
leases and capital commitments, which are not reflected in our financial
statements.
41
<PAGE>
OFF-BALANCE SHEET ARRANGEMENTS
The following table summarizes our off-balance sheet arrangements by date
of expiration as of December 31, 2002. These commitments are discussed in
further detail below:
<Table>
<Caption>
TOTAL
AMOUNTS
OFF-BALANCE SHEET ARRANGEMENTS COMMITTED
------------------------------ -------------
(IN MILLIONS)
<S> <C>
Credit facilities........................................... $ 300
Guarantees.................................................. 2,508
Residual value guarantees................................... 570
------
Total.................................................. $3,378
======
</Table>
Credit Facilities
We have a credit facility with Gemstone that allows Gemstone to borrow up
to $300 million from us at a variable interest rate, which was 6.8% at December
31, 2002. Gemstone owed us $25 million under this facility as of December 31,
2002, and did not utilize this facility in 2001. We earned less than $1 million
of interest income from this facility in 2002 and 2001.
Guarantees
We are involved in various joint ventures and other ownership arrangements
that sometimes require additional financial support that results in the issuance
of financial and performance guarantees. In a financial guarantee, we are
obligated to make payments if the guaranteed party fails to make payments under,
or violates the terms of, the financial arrangement. In a performance guarantee,
we provide assurance that the guaranteed party will execute on the terms of the
contract. If they do not, we are required to perform on their behalf. For
example, if the guaranteed party is required to deliver natural gas to a third
party and then fails to do so, we would be required to either deliver that
natural gas or make payments to the third party equal to the difference between
the contract price and the market value of the natural gas.
As of December 31, 2002, we had approximately $2.5 billion of both
financial and performance guarantees outstanding. Of this amount, approximately
$1.0 billion relates to our Chaparral investment and $950 million relates to our
Gemstone investment, both of which are discussed below. The remaining $558
million relates to other global power equity investments, including some of the
projects under Chaparral and Gemstone, and pipeline and petroleum activities.
Chaparral. We entered into the Chaparral investment (also referred to as
Electron) in 1999 to expand our domestic power generation business. At the time
Chaparral was formed, we were interested in participating in the deregulation of
the power industry that was occurring across the U.S. Our objective was to
acquire a number of nonregulated power plants that were built because of PURPA.
With these plants and their related power contracts, there were opportunities to
improve existing income and cash flows by lowering the cost of power sold to the
regulated utility under the plant's power sales agreement. This was accomplished
by purchasing the power supplied to the utility from the wholesale power market,
rather than generating power at the plant. Consequently, Chaparral's investors,
and our shareholders would benefit from these improved economics. In
establishing this business, there were a number of objectives we hoped to
achieve, including:
- Portfolio management. Our goal was to establish an investment, not
unlike a mutual fund or other investment portfolio, that held a number of
assets, and on which we could earn a performance-based management fee
determined by the value we delivered to all investors. Furthermore, this
portfolio approach allowed us to reduce the volatility of earnings and
enhance the cash flows in this business.
- Flexibility and efficiency. Given the complexity of acquiring, managing
and renegotiating existing power contracts, we sought investors whose
business strategies were aligned with ours, to allow us maximum
flexibility and efficiency.
42
<PAGE>
- Liability segregation and separation of non-recourse financing and other
liabilities from our balance sheet. Many of the power projects in which
we would hold interests were funded through partnerships and non-recourse
project financings which, on average, had higher leverage in terms of
their debt to total equity. Had this business been developed on our
balance sheet, it could have negatively impacted our ratios and possibly
our credit ratings. Consequently, we did not want to reflect this higher
leverage in our overall capitalization given that the debt is
non-recourse to us. Furthermore, separation of these entities and their
related debt and other obligations more appropriately reflected the
nature of the recourse, which was solely to the projects.
Chaparral's corporate structure is a limited liability company that, at
December 31, 2002, was owned approximately 20 percent by us and approximately 80
percent by an unaffiliated investor, Limestone. Limestone is capitalized by
private equity contributions of $150 million from a group of unrelated financial
investors through Credit Suisse First Boston Corporation and $1 billion of
senior secured notes issued to institutional investors. Limestone is controlled
by subsidiaries or affiliates of Credit Suisse First Boston Corporation.
In March 2003, we notified Limestone that we will exercise our right under
the partnership agreements to purchase all of the outstanding third party equity
in Limestone on May 31, 2003, for $175 million. On March 31, 2003, we
contributed $1 billion to Limestone in exchange for a non-controlling interest.
Limestone used the proceeds from the contribution to pay off $1 billion of the
notes that matured on that date. With this note repayment, we cancelled our $1
billion guarantee related to our Chaparral investment. Following our additional
investment of $1 billion in Limestone, our effective ownership of Chaparral
increased to approximately 90 percent, but neither our rights nor the rights of
Limestone to participate in the operating decisions of Chaparral changed. As a
result, we continue to account for our investment in Chaparral under the equity
method. We will consolidate Chaparral upon the purchase of the remaining third
party equity interest in Limestone, which we expect to occur in May 2003. At
that time, we will record the acquired assets and liabilities at their fair
values. The fair value of assets and liabilities acquired will be impacted by
changes in the unregulated power industry as a whole, as well as by changes in
regional power prices in the U.S. Any excess of the proceeds paid over the fair
value of net assets acquired will be reflected as goodwill. Goodwill is not
subject to amortization but it will be tested for impairment. While we cannot
currently estimate the ultimate amount of goodwill that will be recorded, we
believe goodwill of up to $450 million may result. If goodwill were to be fully
impaired we would report a charge to earnings of approximately $300 million
after income taxes. If, on the other hand, the carrying amount of the acquired
assets and liabilities, when aggregated with our other power assets and
liabilities, is below the fair value of the reporting unit (reporting unit being
defined as the entire global power business), there would be no impairment of
goodwill.
As of December 31, 2002, Chaparral had $4.2 billion of total assets and
$1.8 billion of consolidated third party debt. Chaparral's debt is related to
specific assets it owns or has interests in, and is recourse solely to those
assets. Our equity investment in Chaparral at December 31, 2002 was $256
million, but we also had additional net receivables from Chaparral which totaled
$448 million, resulting in a total net investment in Chaparral of $704 million
at December 31, 2002.
For a further discussion of Chaparral and its activities, see Item 8,
Financial Statements and Supplementary Data, Note 26.
Gemstone. We entered into the Gemstone investment in 2001 to finance five
major power plants in Brazil. Gemstone was established to accomplish the
following objectives:
- Portfolio management. Like Chaparral, our goal was to establish an
investment portfolio that held a number of assets in which we participate
in the earnings of these equity investments. Unlike Chaparral's
performance-based management fee, however, our primary objective in this
investment was to have the flexibility to acquire or sell additional
assets into or out of the overall portfolio of projects.
- Flexibility and efficiency. Given the complexity of acquiring,
operationally managing and negotiating power contracts with foreign
governments, we sought investors whose interests were primarily financial
43
<PAGE>
(return driven), to allow us maximum flexibility and efficiency.
Furthermore, this allowed us to share risk in a foreign country and
partially mitigate our foreign investment risk.
Gemstone is a generic term used to describe several entities. The first is
the joint venture in which we have an equity investment named Diamond Power
Ventures, LLC (Diamond). Diamond is owned by us and Gemstone Investor. Gemstone
Investor is 100 percent owned by a subsidiary of Rabobank International, which,
in addition to its $50 million equity investment, issued $950 million of senior
secured notes to institutional investors. Gemstone Investor used the entire $1
billion to (a) invest up to $700 million in Diamond, and (b) purchase a $300
million preferred interest in a company called Topaz Power Ventures LLC (Topaz),
our consolidated subsidiary. Topaz indirectly owns and operates two Brazilian
power plants. We account for Gemstone Investor's preferred investment in Topaz
as minority interest. We do not consolidate Diamond, which owns three power
plants in Brazil.
Gemstone owns interests in five power generation facilities in Brazil with
a total power generation capacity of 2,184 megawatts. As of December 31, 2002,
Gemstone had total assets of $1.7 billion, including a $304 million investment
in Topaz, and $122 million in receivables from us. Our total investment in
Gemstone at December 31, 2002, was $663 million, excluding the payables of $304
million and minority interest of $122 million mentioned above.
Our consolidated subsidiary, Gemstone Administracao Ltda, serves as the
managing member of Diamond and provides management services to Diamond under a
fixed-fee administrative services agreement. The fixed fee reimburses us for
legal, accounting and general and administrative expenses incurred on behalf of
Diamond.
In January 2003, Rabobank notified us that they planned to remove us as
manager of Gemstone, in accordance with their rights under our partnership
agreements. We, in turn, notified Rabobank that we were exercising our right
under the partnership agreements to purchase all of Rabobank's $50 million of
equity in Gemstone. We will consolidate Gemstone upon the purchase of Rabobank's
equity in Gemstone by April 2003, unless we replace them with a new partner.
For a further discussion of Gemstone and its activities, see Item 8,
Financial Statements and Supplementary Data, Note 26.
Residual Value Guarantees
Under two of our operating leases, we have provided residual value
guarantees to the lessor. Under the leases, we can either choose to purchase the
asset at the end of the lease term for a specified amount, which is typically
equal to the outstanding loan amounts owed by the lessor, or we can choose to
assist in the sale of the leased asset to a third party. Should the asset not be
sold for a price that equals or exceeds the amount of the guarantee, we would be
obligated for the shortfall. The levels of our residual value guarantees range
from 86.2 percent to 89.9 percent of the original cost of the leased assets.
Accounting for these residual value guarantees will be impacted effective July
1, 2003, by our adoption of the new accounting rules on consolidations. For a
discussion of the accounting impact of these new rules, see New Accounting
Pronouncements Issued But Not Yet Adopted below.
As of December 31, 2002, we had purchase options and residual value
guarantees associated with operating leases for the following assets:
<Table>
<Caption>
PURCHASE RESIDUAL VALUE LEASE
ASSET DESCRIPTION OPTION GUARANTEE EXPIRATION
----------------- -------- -------------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
Lakeside Technology Center telecommunications
facility.......................................... $275 $237 2006
Facility at Aruba refinery.......................... 370 333 2006
</Table>
44
<PAGE>
CONTRACTUAL CASH OBLIGATIONS
The following table summarizes our contractual cash obligations as of
December 31, 2002, for each of the years presented.
<Table>
<Caption>
CONTRACTUAL CASH OBLIGATIONS 2003 2004 2005 2006 2007 THEREAFTER TOTAL
- ---------------------------- ------ ------ ------ ------ ------ ---------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
Long-term debt(1).............. $ 575 $ 586 $ 610 $1,234 $1,133 $12,590 $16,728
Preferred interests of
consolidated
subsidiaries(2).............. 400 900 380 950 -- 625 3,255
Western Energy Settlement(3)... 100 132 129 67 67 1,072 1,567
Operating leases(4)............ 174 147 113 89 56 265 844
Transportation and storage
capacity(5).................. 169 175 151 139 126 674 1,434
Commodity purchases(6)......... 4 3 3 3 3 20 36
Obligations to affiliates(7)... 189 10 12 6 -- 173 390
Other commitments and purchase
obligations(8)(9)............ 462 190 59 19 9 86 825
------ ------ ------ ------ ------ ------- -------
Total contractual cash
obligations............... $2,073 $2,143 $1,457 $2,507 $1,394 $15,505 $25,079
====== ====== ====== ====== ====== ======= =======
</Table>
- ---------------
(1) See Item 8, Financial Statements and Supplementary Data, Note 18.
(2) See Item 8, Financial Statements and Supplementary Data, Note 19.
(3) See Item 8, Financial Statements and Supplementary Data, Notes 2 and 20.
(4) We maintain operating leases in the ordinary course of our business
activities. These leases include those for office space and operating
facilities and office and operating equipment, and the terms of the
agreements vary from 2003 until 2053.
(5) Amounts include payments for firm access to natural gas transportation and
storage capacity.
(6) Amounts include purchase commitments for electricity that are not part of
our trading activities.
(7) Amounts include obligations of $252 million to Chaparral, $122 million to
Gemstone and $16 million to other affiliates. Our obligation to Chaparral
consists of $79 million of debt securities and $173 million of contingent
interest promissory notes. The debt securities are payable on demand and
carry a fixed interest rate of 7.443%. The contingent interest promissory
notes carry a variable interest rate not to exceed 12.75% and mature in 2019
through 2021. Our obligation to Gemstone consists of $122 million of debt
securities, which are payable on demand and carry a fixed interest rate of
5.25%.
(8) Amounts include primarily other purchase and capital commitments such as
maintenance contracts, engineering, procurement and construction costs.
(9) Other commitments exclude $2.5 billion associated with our LNG ship charter
agreement. These obligations were restructured in March 2003 and resulted in
issuance of letters of credit equal to $120 million, which was fully
collateralized by cash.
RESULTS OF OPERATIONS
We use earnings before interest and income taxes (EBIT) to assess the
operating results and effectiveness of our business segments. We define EBIT as
operating income, adjusted for earnings on equity investments, capitalized
returns on equity and other miscellaneous non-operating items. Items that are
not included in this measure are financing costs, including interest and debt
expense, income taxes, discontinued operations, extraordinary items and
cumulative effect of accounting changes. The following is a reconciliation
45
<PAGE>
of our operating results to EBIT and income (loss) from continuing operations
for the years ended December 31:
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Operating revenues.......................................... $ 12,194 $ 13,649 $ 19,271
Operating expenses.......................................... (12,266) (12,728) (16,856)
-------- -------- --------
Operating income (loss)................................... (72) 921 2,415
Earnings (losses) from unconsolidated affiliates............ (234) 450 428
Minority interest in consolidated subsidiaries.............. (58) (2) --
Other income................................................ 248 396 234
Other expenses.............................................. (109) (136) (57)
-------- -------- --------
EBIT...................................................... (225) 1,629 3,020
Interest and debt expense................................... (1,400) (1,156) (1,040)
Returns on preferred interests of consolidated
subsidiaries.............................................. (159) (217) (204)
Income taxes................................................ 495 (184) (539)
-------- -------- --------
Income (loss) from continuing operations.................. $ (1,289) $ 72 $ 1,237
======== ======== ========
</Table>
We believe EBIT is a useful measurement for our investors because it
provides information that can be used to evaluate the effectiveness of our
businesses and investments from an operational perspective, exclusive of the
costs to finance those activities and exclusive of income taxes, neither of
which are directly relevant to the efficiency of those operations. This
measurement may not be comparable to measurements used by other companies and
should not be used as a substitute for net income or other performance measures
such as operating cash flow.
OVERVIEW OF RESULTS OF OPERATIONS
Below are our results of operations (as measured by EBIT), by segment for
each of the years ended December 31. These results include the impacts of
restructuring and merger-related costs, asset impairments, and other charges
(including our estimated Western Energy Settlement) and gains on sales of
assets, which are discussed further in Item 8, Financial Statements and
Supplementary Data, Notes 2, 4, 5 and 26 See Item 8, Financial Statements and
Supplementary Data, Note 24, for a reconciliation of our operating results to
EBIT by segment.
<Table>
<Caption>
EBIT BY SEGMENT 2002 2001 2000
- --------------- ------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Pipelines................................................... $ 818 $ 1,038 $1,323
Production.................................................. 534 920 609
Field Services.............................................. 287 195 214
Merchant Energy............................................. (1,638) 904 930
------- ------- ------
Segment EBIT.............................................. 1 3,057 3,076
Corporate and other......................................... (226) (1,428) (56)
------- ------- ------
Consolidated EBIT from continuing operations.............. $ (225) $ 1,629 $3,020
======= ======= ======
</Table>
SEGMENT RESULTS
Our four segments: Pipelines, Production, Field Services and Merchant
Energy are strategic business units that offer a variety of different energy
products and services, each requires different technology and marketing
strategies. Below is a discussion and analysis of the operating results of each
of our business
46
<PAGE>
segments. These results include the impact of our significant acquisitions and
dispositions, the restructuring and merger-related costs, asset impairments and
other charges discussed above for all years presented.
PIPELINES
Our Pipelines segment consists of interstate natural gas transmission,
storage, gathering and related services in the U.S. and internationally. Our
interstate natural gas transportation systems face varying degrees of
competition from other pipelines, as well as from alternate energy sources used
to generate electricity, such as hydroelectric power, nuclear, coal and fuel
oil. In addition, some of our customers have shifted from a traditional
dependence solely on long-term contracts to a portfolio approach which balances
short-term opportunities with long-term commitments. The shift is due to changes
in market conditions and competition driven by state utility deregulation, local
distribution company mergers, new supply sources, volatility in natural gas
prices, demand for short-term capacity and new markets to supply power plants.
We are regulated by the FERC, which regulates the rates we can charge our
customers. These rates are a function of our costs of providing services to our
customers, and include a return on our invested capital. As a result, our
financial results have historically been relatively stable; however, they can be
subject to volatility due to factors such as weather, changes in natural gas
prices and market conditions, regulatory actions, competition and the
credit-worthiness of our customers. In addition, our ability to extend our
existing customer contracts or re-market expiring contracted capacity is
dependent on the competitive alternatives, the regulatory environment at the
federal, state and local levels and market supply and demand factors at the
relevant dates these contracts are extended or expire. The duration of new or
re-negotiated contracts will be affected by current prices, competitive
conditions and judgments concerning future market trends and volatility. Subject
to regulatory constraints, we attempt to re-contract or re-market our capacity
at the maximum rates allowed under our tariffs, although we, at times, discount
these rates to remain competitive. The level of discount varies for each of our
pipeline systems.
As discussed in Item 8, Financial Statements and Supplementary Data, Note
20 under the subheading Rates and Regulatory Matters, the FERC issued an order
related to the allocation of capacity on the EPNG system. This order required
EPNG to:
- give reservation charge credits prospectively to its firm shippers if it
fails to schedule the shippers' confirmed volumes (except in the case of
force majeure);
- refrain from entering into new firm contracts or remarketing turned back
capacity under contracts terminating or expiring after May 31, 2002; and
- add additional compression to its Line 2000 project increasing the
capacity by 320 MMcf/d without the opportunity to recover these costs in
its rates until its next rate case which will be effective January 1,
2006.
Our Pipelines segment's future results of operations will be impacted as a
result of the capacity allocation proceeding. The order prohibits EPNG from
remarketing approximately 471 MMDth/d of its capacity, of which approximately
200 MMDth/d was rejected by Enron Corp. in May 2002 in its bankruptcy
proceeding. The remaining 271 MMDth/d relates to capacity that EPNG is unable to
remarket from contracts that expired within the time frame specified under the
FERC's order. Prior to the rejection and expiration of the 471 MMDth/d
contracts, EPNG was earning approximately $3.5 million per month, net of revenue
credits, related to this capacity. EPNG has requested rehearing of the September
20 FERC order relating to this and other aspects of the order. This request for
rehearing is pending before the FERC.
In December 2001, Enron Corp. and a number of its subsidiaries, including
Enron North America Corp. and Enron Power Marketing, Inc., filed for Chapter 11
bankruptcy protection in the United States Bankruptcy Court for the Southern
District of New York. Enron's subsidiaries had transportation contracts on
several of our pipeline systems (including the EPNG contract discussed above).
All these transportation contracts have now been rejected, and our pipeline
subsidiaries have filed proofs of claim totaling approximately $137 million.
EPNG filed the largest proof of claim in the amount of approximately $128
million, which included
47
<PAGE>
$18 million for amounts due for services provided through the date the contracts
were rejected and $110 million for damage claims arising from the rejection of
its transportation contracts, which EPNG is prohibited from remarketing under
the capacity allocation orders discussed above. We have fully reserved for all
amounts due from Enron through the date the contracts were rejected, and we have
not recognized any revenues from these contracts since the rejection date.
In November 2002, we sold 12.3 percent of our 14.4 percent equity interest
in the Alliance pipeline system, and net proceeds were $141 million. We
completed the sale of our remaining equity interest in Alliance during the first
quarter of 2003. Income earned on our investment in Alliance for the year ended
December 31, 2002 and 2001, was approximately $21 million and $23 million.
Results of operations of the Pipelines segment were as follows for each of
the three years ended December 31:
<Table>
<Caption>
PIPELINES SEGMENT RESULTS 2002 2001 2000
- ------------------------- ------- ------- -------
(IN MILLIONS, EXCEPT VOLUME
AMOUNTS)
<S> <C> <C> <C>
Operating revenues.......................................... $ 2,605 $ 2,748 $ 2,741
Operating expenses.......................................... (1,815) (1,862) (1,591)
------- ------- -------
Operating income.......................................... 790 886 1,150
Other income................................................ 28 152 173
------- ------- -------
EBIT...................................................... $ 818 $ 1,038 $ 1,323
======= ======= =======
Throughput volumes (BBtu/d)(1)
TGP....................................................... 4,596 4,405 4,354
EPNG and MPC.............................................. 4,065 4,535 4,310
ANR....................................................... 3,691 3,776 3,807
CIG and WIC............................................... 2,644 2,341 2,106
SNG....................................................... 2,020 1,877 2,132
Equity investments (our ownership share).................. 2,731 2,470 2,315
------- ------- -------
Total throughput.................................. 19,747 19,404 19,024
======= ======= =======
</Table>
- ---------------
(1) Throughput volumes exclude those related to pipeline systems sold in
connection with Federal Trade Commission orders related to our Coastal and
Sonat mergers including the Midwestern Gas Transmission, East Tennessee
Natural Gas and Sea Robin systems; and the Destin, Empire State and Iroquois
pipeline investments. Throughput volumes exclude intrasegment activities.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Operating revenues for the year ended December 31, 2002, were $143 million
lower than in 2001. The decrease was due to lower natural gas and liquids sales
of $49 million resulting from lower prices in 2002 and $67 million due to the
impact of lower natural gas prices in 2002 on net natural gas recovered and used
in operations. Also contributing to the decrease were lower revenues of $49
million from natural gas sales and from gathering and processing activities due
to the sale of CIG's Panhandle field in July 2002, lower transportation revenues
of $49 million due to lower revenues from capacity sold under short-term
contracts and lower throughput due to lower electric generation demand and
milder winter weather in 2002. In addition, an $11 million decrease in operating
revenues was due to the favorable resolution of regulatory issues related to
natural gas purchase contracts in 2001, a $4 million decrease was due to lower
rates on the Mojave pipeline system as a result of a rate case settlement
effective October 2001, and a $6 million decrease due to the sale of our
Midwestern Gas Transmission system in April 2001. These decreases were partially
offset by $51 million of additional revenues due largely to transmission system
expansion projects placed in service in 2001 and 2002, $13 million due to a
larger portion of EPNG's capacity contracted at maximum tariff rates in 2002,
$32 million from the Elba Island LNG facility placed in service in December 2001
and $18 million from the favorable resolution of measurement issues at a
processing plant serving the TGP system in 2002.
48
<PAGE>
Operating expenses for the year ended December 31, 2002, were $47 million
lower than in 2001 primarily as a result of $41 million lower fuel and system
supply purchases costs resulting from lower natural gas volumes and prices in
2002, $22 million from the impact of price changes in natural gas imbalances,
$27 million due to lower employee benefit costs in 2002 due to cost efficiencies
following the merger with Coastal, lower amortization of goodwill of $18 million
due to the adoption of SFAS No. 142 in January 2002, $22 million decrease
related to the sale of CIG's Panhandle field in July 2002 and $27 million from
lower electricity, legal, environmental and overhead costs. Also contributing to
lower operating expenses was $11 million due to a gain on the sale of pipeline
expansion rights in February 2002. Offsetting these lower costs were charges of
$7 million to our reserve for bad debts in 2002 related to the bankruptcy of
Enron Corp., $10 million in contributions to a charitable foundation associated
with EPNG's pipeline rupture, $13 million of higher amortization of additional
acquisition costs assigned to a utility plant in 2002 and higher operating
expenses of $16 million due to the Elba Island LNG facility returning to service
in 2002. Also during 2002, we accrued $412 million for our Western Energy
Settlement, and in 2001 we had merger-related costs of $291 million in
connection with our Coastal merger. For a discussion of these charges, see Item
8, Financial Statements and Supplementary Data, Notes 2 and 4.
Other income for the year ended December 31, 2002, was $124 million lower
than in 2001 primarily due to a $153 million asset impairment charge associated
with our western Australia investment. Offsetting this charge was $11 million
due to the resolution of uncertainties associated with the sales of our
interests in the Empire State, Iroquois pipeline systems, and our Gulfstream
pipeline project in 2001 offset by lower equity earnings of $6 million on Empire
State and Iroquois pipeline systems due to the sale of our interests in 2001.
Also offsetting the lower income were higher equity earnings in 2002 of $16
million primarily due to higher equity earnings from our investment in Great
Lakes Gas Transmission.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Operating revenues for the year ended December 31, 2001, were $7 million
higher than in 2000. The increase was due to higher reservation revenues of $67
million on the EPNG system as a result of a larger portion of its capacity sold
at maximum tariff rates versus the same period in 2000 and the impact of
completed system expansions and new storage and transportation contracts during
2001 on CIG of $33 million. Also contributing to the increase were the impact of
higher natural gas prices in the first and second quarters on sales of
segment-owned production of $29 million, sales of excess natural gas and sales
under regulated natural gas sales contracts of $27 million, as well as higher
throughput from increased deliveries to California and other western states of
$6 million. These increases were partially offset by lower 2001 revenues of $44
million from contract remarketing in the TGP system in late 2000 and $42 million
from the impact of the sales of the Midwestern Gas Transmission system in April
2001, Crystal Gas Storage in September 2000 and the East Tennessee Natural Gas
and Sea Robin systems in the first quarter of 2000. Also partially offsetting
the increase were lower 2001 sales of $22 million related to base gas from
abandoned storage fields, the favorable resolution in 2000 of natural gas
price-related contingencies on CIG of $28 million, $11 million from lower
transportation revenues in 2001 on TGP as a result of higher proportion of
throughput earnings from short versus long hauls compared to 2000 and $6 million
from lower remarketed rates on seasonal turned-back capacity in 2001 as a result
of SNG's 2000 rate case settlement allowing some customers to partially reduce
their firm transportation capacity.
Operating expenses for the year ended December 31, 2001, were $271 million
higher than in 2000 primarily as a result of the merger-related and other
charges of $334 million in 2001 discussed previously. Also contributing to the
increase was the impact of higher natural gas prices in the first half of 2001
on natural gas purchase contracts of $12 million, higher purchase gas costs of
$8 million due to a natural gas imbalance revaluation in 2001 as a result of
falling gas prices during the second half of the year, increases to our reserve
for bad debts as a result of our exposure in connection with the bankruptcy of
Enron Corp., and a one-time favorable adjustment to depreciation expense during
the first quarter of 2000 of $10 million resulting from the FERC approval to
reactivate the Elba Island LNG facility. Also contributing to the increase was
the impact of gains in 2000 from the sales of non-pipeline assets of $8 million.
Partially offsetting the increase were lower operating and maintenance expenses
of $83 million due to cost efficiencies following the merger with Coastal
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<PAGE>
and reduced operating and lower depreciation expenses of $19 million due to the
sales of the Midwestern Gas Transmission system in April 2001, Crystal Gas
Storage in September 2000 and East Tennessee and Sea Robin in the first quarter
of 2000.
Other income for the year ended December 31, 2001, was $21 million lower
than in 2000 due to lower equity earnings of $13 million on our Australian
pipelines and Citrus Corp., which owns the Florida Gas Transmission System. Also
contributing to the decrease was the impact on equity earnings due to the sales
of our investments in the Empire State and Iroquois pipeline systems in 2001 of
$8 million and the sale of our one-third interest in Destin Pipeline Company in
2000 of $2 million. Partially offsetting the decrease was increased earnings
from our investment in the Alliance pipeline project of $9 million which
commenced operations in the fourth quarter of 2000.
PRODUCTION
The Production segment conducts our natural gas and oil exploration and
production activities. Our operating results are driven by a variety of factors
including the ability to locate and develop economic natural gas and oil
reserves, extract those reserves with minimal production costs, sell the
products at attractive prices and operate at the lowest total cost level
possible.
Production has historically engaged in hedging activities on its natural
gas and oil production to stabilize cash flows and reduce the risk of downward
commodity price movements on its sales. This is achieved primarily through
natural gas and oil swaps. In the past, our stated goal was to hedge
approximately 75 percent of our anticipated current year production,
approximately 50 percent of our anticipated succeeding year production and a
lesser percentage thereafter. As a component of our strategic repositioning plan
in May 2002, we modified this hedging strategy. Under our modified strategy, we
may hedge up to 50 percent of our anticipated production for a rolling 12-month
forward period. This modification of our hedging strategy will increase our
exposure to changes in commodity prices which could result in significant
volatility in our reported results of operations, financial position and cash
flows from period to period. As of December 31, 2002, we have hedged
approximately 215 million MMBtu's of our anticipated natural gas production for
2003 at a NYMEX Henry Hub price of $3.43 per MMBtu before regional price
differentials and transportation costs.
During 2002, we continued an active onshore and offshore development
drilling program to capitalize on our land and seismic holdings. This
development drilling was done to take advantage of our large inventory of
drilling prospects and to develop our proved undeveloped reserve base. We also
completed asset dispositions in Colorado, Utah, western Canada and Texas as part
of our balance sheet enhancement plan. Primarily due to our asset dispositions,
we have a lower reserve base at January 1, 2003 than we did at January 1, 2002.
See Item 8, Financial Statements and Supplementary Data, Note 28, for a
discussion of our natural gas and oil reserves. Since our depletion rate is
determined under the full cost method of accounting, a lower reserve base
coupled with additional capital expenditures in the full cost pool will result
in a higher depletion rate in future periods. For the first quarter of 2003, we
expect our domestic unit of production depletion rate to be approximately $1.59
per Mcfe.
We currently expect to reduce our total capital expenditures from
approximately $2.4 billion in 2002 to approximately $1.4 billion in 2003. We
continually evaluate our capital expenditure program and this estimate is
subject to change based on market conditions. We will continue to pursue
strategic acquisitions of production properties and the development of projects
subject to acceptable returns. In July 2002, we acquired natural gas properties
in the Raton Basin for approximately $140 million. These properties were
acquired to expand our interest in the current coal seam project in the area.
50
<PAGE>
Below are the operating results and analysis of these results for each of
the three years ended December 31:
<Table>
<Caption>
PRODUCTION SEGMENT RESULTS 2002 2001 2000
- -------------------------- ------------ ------------ ------------
(IN MILLIONS, EXCEPT VOLUMES AND PRICES)
<S> <C> <C> <C>
Operating Revenues:
Natural gas................................................. $ 1,758 $ 2,005 $ 1,412
Oil, condensate and liquids................................. 373 320 255
Other....................................................... (5) 22 19
-------- -------- --------
Total operating revenues.......................... 2,126 2,347 1,686
Transportation and net product costs........................ (113) (97) (78)
-------- -------- --------
Total operating margin............................ 2,013 2,250 1,608
Operating expenses(1)....................................... (1,484) (1,331) (995)
-------- -------- --------
Operating income.......................................... 529 919 613
Other income (loss)......................................... 5 1 (4)
-------- -------- --------
EBIT...................................................... $ 534 $ 920 $ 609
======== ======== ========
Volumes and Prices:
Natural gas
Volumes (MMcf)......................................... 486,923 564,740 516,917
======== ======== ========
Average realized prices with hedges ($/Mcf)(2)......... $ 3.61 $ 3.56 $ 2.73
======== ======== ========
Average realized prices without hedges ($/Mcf)(2)...... $ 3.16 $ 4.23 $ 3.97
======== ======== ========
Average transportation costs ($/Mcf)................... $ 0.18 $ 0.12 $ 0.11
======== ======== ========
Oil, condensate and liquids
Volumes (MBbls)........................................ 17,514 14,382 11,626
======== ======== ========
Average realized prices with hedges ($/Bbl)(2)......... $ 21.30 $ 22.24 $ 21.97
======== ======== ========
Average realized prices without hedges ($/Bbl)(2)...... $ 21.39 $ 22.87 $ 28.39
======== ======== ========
Average transportation costs ($/Bbl)................... $ 0.93 $ 0.56 $ 0.15
======== ======== ========
</Table>
- ---------------
(1) Includes production costs, depletion, depreciation and amortization, ceiling
test charges, merger-related costs, asset impairments, changes in accounting
estimates, corporate overhead, general and administrative expenses and
severance and other taxes.
(2) Prices are stated before transportation costs.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
For the year ended December 31, 2002 operating revenues were $221 million
lower than in 2001. A 14 percent decrease in natural gas volumes and a 25
percent decrease in natural gas prices before hedges and transportation costs
account for $848 million of the decrease in revenues, offset by a $599 million
favorable variance from natural gas hedging activity in 2002 when compared to
2001. The decline in natural gas volumes is primarily attributable to the sale
of properties in Colorado, Utah, and Texas. The decrease in operating revenues
is partially offset by a 22 percent increase in oil, condensate and liquids
volumes, net of a six percent decrease in their prices before hedges and
transportation costs, resulting in a $46 million increase in revenues. In
addition, oil hedging activity had a $7 million favorable variance in 2002 when
compared to 2001. Further decreasing operating revenues was a loss of $13
million in 2002 resulting from a mark-to-market adjustment of derivative
positions that no longer qualify as cash flow hedges. These hedges no longer
qualify for hedge accounting treatment since they were designated as hedges of
anticipated future production from natural gas and oil properties that were sold
in March 2002.
Transportation and net product costs for the year ended December 31, 2002,
were $16 million higher than in 2001 primarily due to a higher percentage of gas
volumes subject to transportation fees, offset by lower costs incurred to meet
minimum payment obligations under pipeline agreements.
51
<PAGE>
Operating expenses for the year ended December 31, 2002, were $153 million
higher than in 2001. Contributing to the increase in expenses were non-cash full
cost ceiling test charges totaling $269 million incurred in 2002 for our
Canadian full cost pool and other international properties, primarily in Brazil,
Turkey and Australia, offset by 2001 non-cash full cost ceiling test charges on
international properties totaling $135 million. The unit of production depletion
expense was higher by $93 million with $153 million due to higher depletion
rates in 2002, offset by a $60 million decrease resulting from lower production
volumes in 2002. The higher depletion rate resulted from higher capitalized
costs in the full cost pool and a lower reserve base. Also contributing to the
increase in 2002 expenses were increased oilfield service costs of $9 million
due primarily to higher labor, workovers and production processing fees, asset
impairments of $4 million and higher corporate overhead allocations of $34
million. Partially offsetting the increase in expenses were merger-related costs
of $63 million incurred in 2001 relating to our combined production operations
and $10 million for write-downs of materials and supplies recognized in 2001
resulting from the reduction in inventory values due to the implementation of
consistent operating standards, strategies and plans following the Coastal
merger. For a discussion of these merger-related costs and changes in accounting
estimates, see Item 8, Financial Statements and Supplementary Data, Notes 4 and
6. In addition, the increase in expenses was offset by $49 million of lower
severance and other taxes in 2002. The severance taxes decreased primarily
because of lower natural gas volumes and prices, and for tax credits taken in
2002 for qualified natural gas wells.
Other income for the year ended December 31, 2002, was $4 million higher
than in 2001 primarily due to higher earnings in 2002 from Pescada, an equity
investment in Brazil.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Operating revenues for the year ended December 31, 2001, were $661 million
higher than in 2000. A nine percent increase in natural gas volumes and a six
percent increase in natural gas prices before hedges and transportation costs,
account for $335 million of the increase in revenues. In addition, natural gas
hedging activity had a $261 million favorable impact in 2001 when compared to
2000. A 19 percent decrease in oil, condensate and liquids prices before hedges
and transportation costs, net of a 24 percent increase in oil, condensate and
liquids volumes, decreased revenues by $1 million. This decrease was offset by a
$66 million favorable impact from oil hedging activities in 2001 versus 2000.
Transportation and net product costs for the year ended December 31, 2001,
were $19 million higher than in 2000 primarily due to a higher percentage of gas
volumes subject to transportation fees and costs incurred to meet minimum
payments on pipeline agreements.
Operating expenses for the year ended December 31, 2001, were $336 million
higher than in 2000. Contributing to the increase were full cost ceiling test
charges of $135 million on international properties, higher depletion expense of
$80 million, with $64 million resulting from increased production and $16
million from higher depletion rates due to higher capitalized costs in the cost
pool. Also contributing to the higher expenses in 2001 were merger-related costs
of $63 million related to our combined production operations and $10 million for
write downs of materials and supplies resulting from the reduction in inventory
values due to the implementation of consistent operating standards, strategies
and plans following the Coastal merger. Also increasing expenses in 2001 were
higher oilfield service costs of $8 million and higher severance and other
production taxes of $40 million, resulting from higher production volumes and
higher natural gas prices.
FIELD SERVICES
Assets in our Field Services segment primarily consist of our investment in
El Paso Energy Partners and gathering and processing facilities in the south
Texas, Louisiana, Mid-Continent and Rocky Mountain regions.
As the general partner of El Paso Energy Partners, we manage the
partnership's day-to-day operations. In addition, we own through various
subsidiaries 26.5 percent of the partnership's common units, all of the Series B
preference units and all of the Series C units acquired for $350 million in
November 2002. We recognize earnings and receive cash from the partnership in
several ways, including through a share of the partnership's cash distributions
and through our ownership of limited, preferred and general partner interests.
52
<PAGE>
We are also reimbursed for costs we incur to provide various operational and
administrative services to the partnership. In addition, we are reimbursed for
other costs paid directly by us on the partnership's behalf. During 2002, we
were reimbursed approximately $59 million for expenses incurred on behalf of the
partnership. At December 31, 2002, our common units had a market value of $325
million, our preference units had a liquidation value of $158 million, and our
Series C units had a value of $351 million. During 2002, our earnings and cash
from El Paso Energy Partners were as follows:
<Table>
<Caption>
EARNINGS CASH
RECOGNIZED RECEIVED
---------- --------
(IN MILLIONS)
<S> <C> <C>
General partner's share of distributions.................... $ 42 $ 43
Proportionate share of income available to common unit
holders................................................... 10 30
Series B preference units................................... 15 --(1)
Series C units.............................................. 2 --(2)
------- -------
$ 69 $ 73
======= =======
</Table>
- ---------------
(1) The partnership is not obligated to pay distributions on these units until
2010.
(2) We received our first cash distributions in February 2003 for the Series C
units since we acquired these units in November 2002.
During 2000 through 2002, we entered into several asset sales transactions
with El Paso Energy Partners. Specific procedures have been instituted for
evaluating these transactions to ensure that they are in the best interests of
us and the partnership and are based on fair values. These procedures require
our Board of Directors to evaluate and approve, as appropriate, transactions
with the partnership. In addition, a special committee comprised of the general
partner's independent directors evaluates the transactions on the partnership's
behalf. This typically involves engaging an independent financial advisor to
assist with the evaluation and to opine on its fairness.
In 2000, we sold an intrastate pipeline system in Alabama and storage
facilities in Mississippi for $197 million, which included $170 million of
Series B preference units issued to us in exchange for the storage facilities.
During 2001, we also sold several assets to the partnership, including NGL
transportation and fractionation assets we acquired from PG&E and an investment
in Deepwater Holdings, an entity that owned several pipeline gathering systems
in the Gulf of Mexico. During 2001, the partnership also acquired rights to the
Chaco processing facility from its previous owners, and we leased this facility
under an agreement that expired in December 2002.
In 2002, as part of our plan to strengthen our capital structure and
enhance our liquidity, we entered into additional transactions to sell various
midstream assets to El Paso Energy Partners. In April 2002, we sold gathering
and processing assets, including the intrastate natural gas pipeline system we
acquired in our acquisition of PG&E's midstream operations in December 2000. We
also sold substantially all our natural gas gathering, processing and treating
assets in the San Juan Basin in November 2002. One of the San Juan Basin assets
included in this transaction was our remaining interests in the Chaco cryogenic
natural gas processing plant. As part of this transaction, we have an agreement
that requires us to repurchase the Chaco processing plant from El Paso Energy
Partners for $77 million in October 2021, and at that time, El Paso Energy
Partners has the right to lease the plant from us for a period of ten years with
the option to renew the lease annually thereafter. In addition to $416 million
of cash, we received approximately 11 million Series C units valued at $350
million. The Series C units represent a new class of the partnership's limited
partner interests and have no voting rights. Including the Series C units, our
limited partner ownership interest in El Paso Energy Partners has increased to
approximately 41 percent. For a discussion of our other transactions with El
Paso Energy Partners, see Item 8, Financial Statements and Supplementary Data,
Note 26.
In 2002, we also identified midstream assets to be sold to third parties as
part of our plan to strengthen our capital structure and enhance our liquidity.
We have also received interest from a number of parties interested in merging
with and/or purchasing all or a portion of our general partner interest in El
Paso Energy Partners. At this time, we cannot predict the outcome of these
discussions.
53
<PAGE>
In December 2002, we announced the sale of our gathering systems located in
Wyoming to Western Gas Resources, Inc. This transaction was completed in January
2003. In March 2003, we received approval from our Board of Directors to sell
our assets in the Mid-Continent and north Louisiana regions. Our Mid-Continent
assets primarily include our Greenwood, Hugoton, Keyes and Mocane natural gas
gathering systems, our Sturgis, Mocane and Lakin processing plants and our
processing arrangements at three additional processing plants. Our north
Louisiana assets primarily include our Dubach processing plant and Gulf States
interstate natural gas transmission system. We expect this sale to close before
the end of 2003. After this sale is completed, our remaining assets will consist
primarily of processing facilities in the south Texas, Louisiana and Rocky
Mountain regions. See Part II, Item 8, Financial Statements and Supplementary
Data, Note 3 for a discussion of our other asset sales to third parties during
2002.
As a result of our asset sales and the resulting decline in our gathering
and treating activities, we expect our future EBIT to decrease considerably.
However, we expect the increase in earnings from our interests in El Paso Energy
Partners to partially offset the anticipated decrease in EBIT.
We attempt to balance our earnings from our operating activities through a
combination of fixed-fee based and market-based services. A majority of our
gathering and transportation operations earn margins from fixed-fee-based
services. However, some of our operations earn margins from market-based rates.
Revenues from these market-based 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 return to the producer a Btu
equivalent amount of natural gas. Under our percentage-of-proceeds contracts and
make-whole contracts, we may have more sensitivity to price changes during
periods when natural gas and NGL prices are volatile.
We provide a variety of midstream services, including gathering and
transportation of natural gas, and processing and fractionation of natural gas,
NGL and natural gas derivative products, such as butane, ethane and propane.
Our operating results and an analysis of those results are as follows for
each of the three years ended December 31:
<Table>
<Caption>
FIELD SERVICES SEGMENT RESULTS 2002 2001 2000
- ------------------------------ -------- -------- --------
(IN MILLIONS, EXCEPT VOLUMES
AND PRICES)
<S> <C> <C> <C>
Gathering, transportation and processing gross margins...... $ 349 $ 561 $ 437
Operating expenses.......................................... (78) (437) (271)
------ ------ ------
Operating income.......................................... 271 124 166
Other income................................................ 16 71 48
------ ------ ------
EBIT...................................................... $ 287 $ 195 $ 214
====== ====== ======
Volumes and prices
Gathering and transportation
Volumes (BBtu/d)....................................... 3,023 6,109 3,868
====== ====== ======
Prices ($/MMBtu)....................................... $ 0.17 $ 0.14 $ 0.16
====== ====== ======
Processing
Volumes (inlet BBtu/d)................................. 3,920 4,360 2,930
====== ====== ======
Prices ($/MMBtu)....................................... $ 0.10 $ 0.15 $ 0.18
====== ====== ======
</Table>
54
<PAGE>
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Total gross margins for the year December 31, 2002, were $212 million lower
than in 2001. Margins decreased by approximately $134 million due to our sales
of midstream assets to El Paso Energy Partners in April 2002 and November 2002.
In addition, processing margins decreased $58 million due to lower NGL prices in
2002, which primarily impacted our margins and volumes in the San Juan Basin,
south Louisiana, south Texas and Rocky Mountain regions. Higher processing costs
associated with a new processing arrangement at the Chaco processing facility
entered into in the fourth quarter of 2001 with El Paso Energy Partners and the
sale of the Dragon Trail processing plant in May 2002 also reduced our
processing margins by $18 million and $6 million. This processing agreement with
El Paso Energy Partners was terminated in November 2002 in connection with El
Paso Energy Partners' acquisition of our San Juan Basin assets. Lower natural
gas prices in the San Juan Basin in 2002 also resulted in a $22 million decrease
in our gathering and treating margins. Partially offsetting these decreases were
favorable resolutions of fuel, rate and volume matters of $13 million in the
first quarter of 2002, $8 million of unfavorable resolutions of fuel matters
which occurred in 2001 and $14 million due to higher realized transportation
rates and increased system efficiency related to the pipeline system acquired in
our acquisition of PG&E's midstream operation in December 2000. This pipeline
system was one of the assets sold to El Paso Energy Partners in April 2002.
Operating expenses for the year ended December 31, 2002, were $359 million
lower than in 2001. This decrease was primarily due to the sales of our San Juan
Basin assets, our Natural Buttes and Ouray gathering systems and our Dragon
Trail processing plant, resulting in a net gain of $245 million, lower operating
costs of $48 million and lower depreciation expense of $35 million. Also
contributing to the decrease was $46 million of merger-related costs in 2001,
which included payments to El Paso Energy Partners related to Federal Trade
Commission ordered sales of assets owned by the partnership, and a $9 million
increase in our estimated environmental remediation liabilities in 2001. In
addition, our 2002 cost reduction plan contributed $17 million to our lower
operating costs. Our depreciation expense was also lower by $9 million due to
the assets held for sale classification of the San Juan Basin assets in 2002 and
$9 million associated with lower amortization of goodwill due to the adoption of
SFAS No. 142 in January 2002 (see Item 8, Financial Statements and Supplementary
Data, Note 1). Partially offsetting these decreases was an impairment charge of
our north Louisiana facilities in the fourth quarter of 2002 of $66 million. We
believe that these facilities are likely to be sold before the end of their
estimated useful lives. For a further discussion of the asset sales and
merger-related costs, see Item 8, Financial Statements and Supplementary Data,
Notes 3 and 4.
Other income for the year ended December 31, 2002, was $55 million lower
than in 2001. The decrease was due to the losses on the sale in 2002 of our
investment in the Aux Sable NGL plant and our investment in the Blacks Fork
natural gas processing plant of $47 million and $3 million. Also contributing to
the decrease in other income for 2002 was a $13 million gain on the sale of our
investment in Deepwater Holdings in October 2001, a gain of $8 million recorded
in May 2001 from the sale of our 1.01 percent non-managing interest in El Paso
Energy Partners and $6 million of lower equity earnings from Deepwater Holdings
as a result of the sale of our interest to El Paso Energy Partners in October
2001. Offsetting these decreases were higher earnings of $22 million in 2002
from our interests in El Paso Energy Partners.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Total gross margins for the year ended December 31, 2001, was $124 million
higher than in 2000. An increase of $133 million was due to higher gathering and
processing volumes following our acquisition of PG&E's Texas Midstream
operations in December 2000. Higher volumes also increased our margin by $14
million as a result of our acquisition of the Indian Basin processing plant in
the second quarter of 2000 combined with an increase in Indian Basin's treating
capacity by 23 percent in 2001. The increase in margin was partially offset by
higher processing costs of $5 million associated with the new processing
arrangement with El Paso Energy Partners at the Chaco processing facility in the
fourth quarter of 2001. For the year ended December 31, 2001, lower average
gathering, treating and processing rates resulted in a reduction in total
margins of $17 million compared to 2000 due primarily to the different mix of
assets and contract terms resulting from the acquisition of PG&E's Texas
Midstream operations.
55
<PAGE>
Operating expenses for the year ended December 31, 2001, were $166 million
higher than in 2000. The increase was due to higher operating, depreciation and
other expenses of $117 million primarily resulting from the acquisition of
PG&E's Texas Midstream operations, as well as merger-related costs and other
charges of $45 million. For a discussion of merger-related costs, see Item 8,
Financial Statements and Supplementary Data, Note 4.
Other income for the year ended December 31, 2001, was $23 million higher
than in 2000. The increase was primarily due to increased earnings from El Paso
Energy Partners of $27 million and $13 million from a gain on the sale of our
interest in Deepwater Holdings in October 2001, partially offset by lower 2001
equity earnings from Deepwater Holdings of $3 million as a result of the sale.
The increase was also partially offset by equity investment losses of $7 million
from our Mobile Bay and Aux Sable liquids processing facilities due to lower
natural gas liquids prices and a decrease in equity earnings in other projects
of $8 million.
MERCHANT ENERGY
Our Merchant Energy segment consists of three primary divisions: global
power, petroleum and energy trading. In May 2002, we announced plans to limit
our energy trading and mitigate our exposure to working capital demands. Our
credit downgrades in the third and fourth quarter and a further deterioration of
the energy trading environment led to our decision in November 2002 to exit the
energy trading business and pursue an orderly liquidation of our trading
portfolio. We anticipate this liquidation may occur through 2004. Our
liquidation strategy is intended to maximize cash flow from the trading
portfolio and reduce our cash liquidity risk in an uncertain environment. Early
in 2003, we also announced our intent to reduce our involvement in the LNG
business and exit substantially all of our petroleum activities (excluding our
Aruba refinery).
Below are Merchant Energy's operating results and an analysis of those
results for each of the three years ended December 31:
<Table>
<Caption>
DIVISION TOTAL
------------------------------------------------- MERCHANT
ENERGY ENERGY
MERCHANT ENERGY SEGMENT RESULTS GLOBAL POWER PETROLEUM TRADING ELIMINATIONS SEGMENT
- ------------------------------- ------------ --------- ------- ------------ --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
2002
Gross margin............................... $ 1,139 $ 687 $ (862) $(49) $ 915
Operating expenses......................... (716) (906) (678) 49 (2,251)
------- ------- ------- ---- -------
Operating income (loss).................. 423 (219) (1,540) -- (1,336)
Other income (expense)..................... (429) 112 15 -- (302)
------- ------- ------- ---- -------
EBIT..................................... $ (6) $ (107) $(1,525) $ -- $(1,638)
======= ======= ======= ==== =======
2001
Gross margin............................... $ 421 $ 894 $ 604 $ -- $ 1,919
Operating expenses......................... (329) (1,055) (137) -- (1,521)
------- ------- ------- ---- -------
Operating income (loss).................. 92 (161) 467 -- 398
Other income............................... 369 111 26 -- 506
------- ------- ------- ---- -------
EBIT..................................... $ 461 $ (50) $ 493 $ -- $ 904
======= ======= ======= ==== =======
2000
Gross margin............................... $ 367 $ 895 $ 441 $ -- $ 1,703
Operating expenses......................... (271) (796) (64) -- (1,131)
------- ------- ------- ---- -------
Operating income......................... 96 99 377 -- 572
Other income............................... 298 39 21 -- 358
------- ------- ------- ---- -------
EBIT..................................... $ 394 $ 138 $ 398 $ -- $ 930
======= ======= ======= ==== =======
</Table>
56
<PAGE>
GLOBAL POWER
Our global power division includes the ownership and operation of domestic
and international power generating facilities. In most cases, we partially own
our power generating facilities and account for them using the equity method. We
conduct most of our domestic power business through Chaparral. Internationally,
we have invested in the Brazil power market through our equity investment in
Gemstone. For a further discussion of our Chaparral and Gemstone investments,
see Off-Balance Sheet Arrangements and Contractual Obligations above and Item 8,
Financial Statements and Supplementary Data, Note 26. We also have interests in
a number of other power facilities in Asia, Central America and Europe.
Power Contract Restructuring Activities. Many of our domestic power
plants, and the power plants owned by Chaparral, have long-term power sales
contracts with regulated utilities that were entered into under PURPA. The power
sold to the utility under these PURPA contracts is required to be delivered from
a specified power generation plant at power prices that are usually
significantly higher than the cost of power in the wholesale power market. Our
cost of generating power at these PURPA power plants is typically higher than
the cost we would incur by obtaining the power in the wholesale power market,
principally because the PURPA power plants are less efficient than newer power
generation facilities.
In the past, we have been successful at renegotiating or restructuring
these long-term power contracts. Typically, in a power contract restructuring,
the PURPA power sales contract is amended so that the power sold to the utility
does not have to be provided from the specific power plant. Because we have been
able to buy lower cost power in the wholesale power market, we had the ability
to reduce the cost paid by the utility, thereby inducing the utility to enter
into the power contract restructuring transaction. Following a contract
restructuring, the power plant operates on a merchant basis, which means that it
is no longer dedicated to one buyer and will operate only when power prices are
high enough to make operations economical. In addition, we may assume, and in
the case of Eagle Point Cogeneration we did assume, the business and economic
risks of supplying power to the utility to satisfy the delivery requirements
under the restructured power contract over its term. When we assume this risk,
we manage these obligations by entering into transactions to buy power from
third parties that mitigate our risk over the life of the contract. These
activities are reflected as part of our trading activities and reduce our
exposure to changes in power prices from period to period. Power contract
restructurings generally result in a higher rate of return on our investment in
our power generation business because we can deliver reliable power at lower
prices than our cost to generate power at these PURPA power plants. In addition,
we can use the restructured contracts as collateral to obtain financing at a
cost that is comparable to, or lower than, our existing financing costs.
During the last three years, we have successfully completed the
restructuring of a number of long-term power contracts held by unconsolidated
affiliates or, in some cases, held by us. As a result of our credit downgrades,
our decision to exit the energy trading business, and disruption in the capital
markets, it is unlikely we will pursue additional power contract restructurings
in the near term. For a further discussion of these activities, see Item 8,
Financial Statements and Supplementary Data, Note 13.
<Table>
<Caption>
GLOBAL POWER DIVISION RESULTS 2002 2001 2000
- ----------------------------- ------- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
Gross margin................................................ $ 1,139 $ 421 $ 367
Operating expenses.......................................... (716) (329) (271)
------- ----- -----
Operating income.......................................... 423 92 96
Other income (expense)...................................... (429) 369 298
------- ----- -----
EBIT................................................... $ (6) $ 461 $ 394
======= ===== =====
</Table>
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Gross margin consists of revenues from our power plants and the net results
from our power restructuring activities. The cost of fuel used in the power
generation process is included in operating expenses. For the year
57
<PAGE>
ended December 31, 2002, gross margin for the global power division was $718
million higher than in 2001. Gross margin from power contract restructurings
comprised $628 million of the increase. During 2002, we completed power contract
restructurings or contract terminations at our Eagle Point Cogeneration, Mount
Carmel and Nejapa power plants. The Eagle Point restructuring transaction,
completed in March 2002, was our most significant power contract restructuring
transaction and contributed $476 million to our net 2002 results.
The Eagle Point restructuring involved several steps and all revenues,
expenses, fees and impairments were reported in our 2002 gross margin. First, we
amended the existing PURPA power sales contract with Public Service Electric and
Gas (PSEG) to eliminate the requirement that power be delivered specifically
from the Eagle Point power plant. This amended contract has fixed prices with
stated increases over the 14-year term that range from $85 per MWh to $126 per
MWh. We entered into the amended power sales contract through a consolidated
subsidiary, UCF. UCF was created to hold and execute the restructured power
sales contract, to enter into a supply contract to meet the requirements of the
restructured agreement and to monetize the net cash flows of these contracts by
issuing debt. In keeping with its purpose, UCF entered into a power supply
agreement with our energy trading division (EPME) who usually participates in
our power restructuring activities by taking on the obligation to supply power.
The terms of the EPME power supply contract were identical to the amended power
sales contract, with the exception of price, which was set at $37 per MWh over
its 14-year term.
For credit enhancement purposes, in anticipation of the financing
transaction associated with the restructuring, UCF terminated the EPME supply
contract in the second quarter of 2002 and replaced it with a supply contract
with a Morgan Stanley affiliate. UCF entered into the Morgan Stanley contract
solely for the purpose of reducing the cost of debt UCF would issue. EPME
continued to supply power for the restructured transaction by entering into a
power supply agreement with the Morgan Stanley affiliate. As a result of the
steps we have taken in this transaction, we have replaced the high-cost of the
power generated from the Eagle Point plant, which had averaged over $75 per MWh,
with power that we purchased in the open market at an average cost of $31 per
MWh. We have also shifted the collection and credit risks to third parties over
the term of the restructured power sales agreement. The estimated improvement in
margins associated with this restructuring is approximately $136 million over
the life of the contracts.
The actions taken to restructure the contract required us to mark the
contract to its fair value. As a result, we recorded non-cash revenue
representing the estimated fair value of the derivative contract of
approximately $978 million. We also amended or terminated other ancillary
agreements associated with the cogeneration facility, such as gas supply and
transportation agreements, a steam contract and existing financing agreements.
We also paid $103 million to the utility to terminate the original PURPA
contract. Also included in our operating results for 2002 were a $98 million
non-cash charge to adjust the Eagle Point Cogeneration plant to fair value based
on its new status as a peaking merchant plant and a non-cash charge of $230
million to write off the book value of the original PURPA contract. The
transaction included closing and other costs of $21 million and the minority
interest owner's share of this transaction of $50 million. Total operating cash
flows from this transaction amounted to approximately $124 million of cash paid
to the utility to amend the original contract and other costs and total
financing cash flows included $829 million of proceeds from the issuance of
7.944% senior notes collateralized solely by the contracts and cash flows of
UCF.
The other two power restructuring transactions during 2002 were the Nejapa
and the Mount Carmel transactions. In 2002, an arbitration award panel approved
the termination of the power purchase agreement between Comision Ejecutiva
Hydroelectrica del Rio Lempa and the Nejapa Power Company, one of our
consolidated subsidiaries, in exchange for a cash payment of $90 million. We
recorded, as gross margin, a $90 million gain and also recorded $13 million in
other expense for the minority owner's share of this gain. We applied the
proceeds of the award to retire a portion of Nejapa's debt. The Mount Carmel
restructuring involved the termination of the existing PURPA power purchase
contract for a fee from the utility of $50 million. In addition, we recorded a
non-cash adjustment to reflect fair value of the Mount Carmel facility of $25
million, resulting in a total net benefit on the restructuring transaction of
$25 million.
58
<PAGE>
Due to increasing market power prices in 2002, the net increase in gross
margin from power contract restructurings of $628 million from our initial power
restructuring transactions was partially offset by a decrease in the fair value
of our restructured power contracts and related power supply contracts of $114
million from the initial gains through December 31, 2002. In addition to the net
increase in gross margin relating to restructuring activities discussed above,
gross margin increases of $147 million were realized from domestic and
international power facilities that were consolidated in the fourth quarter of
2001 and the first quarter of 2002, partially offset by decreased revenues from
the sale of the ManChief facility in 2001 to Chaparral. Also contributing to the
increase were higher management fees in 2002 of $42 million primarily from
Chaparral. Partially offsetting these increases were increased losses in other
investments of $22 million during 2002.
Operating expenses include the cost of fuel used in the power generation
processes, asset impairments and other costs we incur in operating and
maintaining our power plants. Operating expenses for the year ended December 31,
2002, were $387 million higher than in 2001 primarily as a result of asset
impairments that were recorded in 2002. In 2002, we wrote down our capitalized
turbine costs by $162 million as we reduced our capital expenditure plans
related to future power development as a result of our liquidity concerns, and
accordingly our ability and intent to use the turbines in international and
domestic power development projects changed. These reduced capital expenditure
plans also impacted our ability to fund future financial investments, resulting
in a $44 million impairment of goodwill by EnCap and Enerplus, our investment
management subsidiaries. Plant operation and maintenance expenses increased by
$156 million primarily resulting from the consolidation of international and
domestic power-related entities in the fourth quarter of 2001 and the first
quarter of 2002, and the expansion of our South America, Central America and
Mexico operations in 2002.
Other income for the year ended December 31, 2002, was $798 million lower
than in 2001 primarily due to higher write downs on our equity investments over
those that were recorded in 2001. Due to weak economic conditions in Argentina
in 2002, we recorded a $342 million impairment of our CAPSA/CAPEX equity
investment and Costanera cost investment. Also in 2002, we recorded a writedown
of our PPN equity investment in India of $41 million due to PPN's sole customer
failing to pay for power generated by the plant and significant difficulties
encountered with operating the plant, and a $17 million impairment of our
Milford equity investment where construction problems and disputes with our
contractors and lenders have further delayed completion of the plant. In
addition, we recognized a $74 million writedown of our CE Generation equity
investment in December 2002 resulting from the sale of the underlying power
plants, which was completed in the first quarter of 2003. The 2002 write downs
were partially offset by impairments of $74 million on our Fife and East Asia
equity investments in 2001. Contributing to the overall decrease was a decrease
in equity earnings from Chaparral of $136 million, from Enfield due to
unexpected plant shutdowns of $22 million, and from projects consolidated in the
fourth quarter of 2001 and first quarter of 2002 of $52 million. Other income
also decreased by $51 million due to the minority owner's interest in income of
projects consolidated by us in 2002, and a $22 million decrease in operating
lease income as a result of the consolidation of Nejapa in 2002. Other income
also decreased due to $75 million in fees earned for engineering, construction
management and other services for the Macae power project during 2001 that did
not recur in 2002 because the power plant became operational after it was
contributed to Gemstone in late 2001. These decreases were partially offset by
higher equity earnings of $107 million from Gemstone during 2002.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Gross margin for the year ended December 31, 2001, was $54 million higher
than in 2000. This increase was primarily due to an increase of $67 million in
management fees earned from Chaparral during 2001. Also contributing to the
increase were higher margins of $55 million from a Philippine power project that
was consolidated in the first quarter of 2001. Partially offsetting these
increases was a decrease of $61 million in margins associated with our West
Georgia facility, which we sold to Chaparral in the fourth quarter of 2000.
Operating expenses for the year ended December 31, 2001, were $58 million
higher than in 2000. This increase was primarily due to an increase in plant
operation and maintenance expenses of $100 million
59
<PAGE>
resulting from the consolidation of a Philippine power project in 2001 and
expansion of our operations in Mexico and Brazil during 2001. In addition, we
recorded $12 million in merger-related costs and other charges in 2001
associated with combining our operations with Coastal's operations. See Item 8,
Financial Statements and Supplementary Data, Notes 4 and 5, for a discussion of
these merger-related costs and asset impairments of our long-lived assets. These
increases were partially offset by lower costs of $33 million at our West
Georgia facility, which was sold in the fourth quarter of 2000.
Other income for the year ended December 31, 2001, was $71 million higher
than in 2000. This increase was primarily due to $75 million of fees earned for
engineering, construction management and other services related to the
development of the Macae power project in Brazil in 2001. Also contributing to
this increase was an increase in equity earnings from Chaparral of $80 million
during 2001 and from other equity investments of $28 million during 2001.
Partially offsetting these increases were an impairment of $74 million of our
Fife and East Asia equity investments in 2001 and gains of $36 million from the
sale of our interests in East Asia and Guatemalan power projects in 2000.
PETROLEUM
In addition to exiting our energy trading business, we announced in
February 2003 our intent to reduce our involvement in the LNG business and exit
substantially all of our petroleum businesses, except for our Aruba refinery. We
currently own or have interests in oil refineries, chemical production
facilities, petroleum terminalling and marketing operations, and blending and
packaging operations for lubricants and automotive products. Our refinery
operations are cyclical in nature and sensitive to movements in the price of
crude oil. During the last two years, we have operated in an environment where
the differences in the price of our crude oil input and the price we can realize
for the resulting products output has been so narrow that we have experienced
losses in our refinery operations. While the condition has improved during the
first quarter of 2003, our results in the future may continue to be volatile.
Also contributing to losses in 2002 and 2001 were operational difficulties
following a fire at our Aruba facility in 2001.
<Table>
<Caption>
PETROLEUM DIVISION RESULTS 2002 2001 2000
- -------------------------- ----- ------- -----
(IN MILLIONS)
<S> <C> <C> <C>
Gross margin................................................ $ 687 $ 894 $ 895
Operating expenses.......................................... (906) (1,055) (796)
----- ------- -----
Operating income (loss)................................ (219) (161) 99
Other income................................................ 112 111 39
----- ------- -----
EBIT................................................... $(107) $ (50) $ 138
===== ======= =====
</Table>
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Gross margin consists of revenues from our refineries and commodity trading
activities, less costs of the feedstocks used in the refining process and the
costs of commodities sold. For the year ended December 31, 2002, our gross
margin was $207 million lower than in 2001. This decrease was primarily due to a
$67 million decline in the fair value of our LNG supply contract derivatives in
2002 compared to a $86 million increase in the fair value of these contracts in
2001. Also contributing to this decrease was lower refining margins of $84
million resulting from lower throughput at our Aruba refinery. Also, we recorded
$57 million of insurance claims and recoveries in 2001 related to our refinery
losses associated primarily with a fire at our Aruba facility in April 2001, a
decrease of $143 million in marine revenues resulting from lower marine freight
rates and number of operating vessels and a decrease of $86 million associated
with the lease of our Corpus Christi refinery and related assets to Valero in
June 2001. These decreases were partially offset by increased refining margins
of $74 million at our Eagle Point refinery and a gain of $210 million from the
sale of a long-term LNG supply contract and capacity rights at a regasification
terminal to Snohvit during 2002.
Operating expenses for the year ended in December 31, 2002, were $149
million lower than in 2001. The decrease was primarily due to $244 million of
merger-related costs, asset impairments and other charges in
60
<PAGE>
2001 primarily associated with combining our operations with Coastal's
operations. See Item 8, Financial Statements and Supplementary Data, Notes 4 and
5 for a discussion of our merger-related costs and asset impairments. This
decrease was partially offset by a $91 million impairment of our MTBE chemical
processing plant in 2002 and a $7 million increase in operating costs associated
with the expansion of our LNG operations during 2002.
Other income for the year ended December 31, 2002, was $1 million higher
than in 2001. The increase was primarily due to $46 million of insurance claims
and recoveries from our insurers recorded in 2002 compared to $40 million, net
of writeoffs of damaged properties in 2001, primarily associated with the assets
destroyed in a fire at our Aruba facility in April 2001.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
For the year ended December 31, 2001, our gross margin was $1 million lower
than in 2000. The decreases from year to year were the result of a $105 million
decrease in margins in crude based refined products and lower margins and
throughput at the Eagle Point refinery as a result of decreased demand for jet
fuel following the events of September 11, 2001. Also contributing to the
decrease was a $48 million decrease in margins associated with the lease of our
Corpus Christi refinery and related assets to Valero in June 2001. Partially
offsetting these decreases was a $86 million increase in the fair value of our
LNG supply contract derivatives during 2001 compared to a $54 million decrease
in the fair value of these contracts in 2000, and $22 million of margins earned
on Coastal Liquid Partners, which was consolidated during early 2001. Also
offsetting these decreases were $57 million of insurance claims and recoveries
from our insurers on losses incurred related primarily to a fire at our Aruba
facility in April 2001. This fire was the primary reason for a 25 percent
decrease in output between 2000 and 2001 resulting in a $53 million reduction,
year over year, in refining margins.
Operating expenses for the year ended in December 31, 2001, were $259
million higher than in 2000. The increase was primarily due to $249 million of
merger-related costs, asset impairments and other charges in 2001 associated
with combining our operations with Coastal's operations. See Item 8, Financial
Statements and Supplementary Data, Notes 4 and 5 for a discussion of our
merger-related costs and asset impairments of our long-lived assets. Also
contributing to this increase was a $26 million increase in operating expenses
associated with our LNG business in 2001 and higher fuel costs of $29 million at
our refineries due to higher natural gas prices. These increases were partially
offset by lower operating expenses of $64 million resulting from the lease of
our Corpus Christi refinery and related assets to Valero in June 2001.
Other income for the year ended December 31, 2001, was $72 million higher
than in 2000. The increase was primarily the result of $77 million of insurance
claims and recoveries, net of writeoffs of damaged properties of $37 million,
from our insurers associated primarily with the assets destroyed in the Aruba
fire.
ENERGY TRADING
Our energy trading activities have historically included actively managing
the inherent risk across Merchant Energy's asset portfolios as well as providing
customers with risk management solutions involving natural gas, power, crude
oil, refined products, chemicals and coal. This division also conducted a
substantial energy trading business that executed proprietary trading strategies
and managed the segment's risk across multiple commodities and over seasonally
fluctuating energy demands using consistent methodologies. In November 2002 we
announced that we would exit the energy trading business due to the increasing
and volatile cash demands inherent in that business, which were magnified by our
credit downgrade. We are in the process of liquidating our trading price risk
management portfolio and anticipate that this effort will continue through 2004.
Our liquidation strategy is being executed in a variety of ways including:
- negotiating early settlements pursuant to contractual terms with our
counterparties;
- actively pursuing the sale of transactions or the entire portfolio to
third parties;
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- matching and transferring offsetting positions with different
counterparties;
- transferring transactions to other El Paso segments or divisions; and
- liquidating through scheduled settlements.
In late 2002, we began actively liquidating our trading portfolio. As of
December 31, 2002, we had approximately 40,000 transactions to be settled in the
future. Included in our portfolio at that time was approximately 4.4 Bcf/d of
natural gas transportation capacity and natural gas storage rights of
approximately 125 Bcf. As of December 31, 2002, we had contracted to sell 2.1
Bcf/d of that transportation capacity and 70 Bcf of those gas storage rights.
The sale resulted in a loss of approximately $25 million. Additionally, in the
first quarter of 2003, we sold our European natural gas trading portfolio and
completed the liquidations of all of our open trading positions in Europe. We
incurred a loss of approximately $4 million on this sale and liquidation. We are
continuing to work with numerous counterparties to liquidate the remainder of
our portfolio through 2004.
FAIR VALUE OF PRICE RISK MANAGEMENT CONTRACTS AS OF DECEMBER 31, 2002
The following table details the net estimated fair value of our energy
contracts (both trading and non-trading) by year of maturity and valuation
methodology as of December 31, 2002. We classify as trading activities those
price risk management activities that we enter into with the objective of
generating profits or benefiting from exposure to shifts or changes in market
prices. We classify all other derivative-related activities, including those
related to power restructuring activities, as non-trading price risk management
activities.
<Table>
<Caption>
MATURITY MATURITY MATURITY MATURITY MATURITY TOTAL
LESS THAN 1 TO 3 4 TO 5 6 TO 10 BEYOND FAIR
SOURCE OF FAIR VALUE 1 YEAR YEARS YEARS YEARS 10 YEARS VALUE
- -------------------- --------- -------- -------- -------- -------- -----
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Trading contracts
Exchange-traded positions(1)...... $ (16) $ (80) $ 3 $ 3 $ -- $(90)
Non-exchange traded
positions(2).................... 42 77 (12) (52) (24) 31
----- ----- ---- ---- ---- ----
Total trading contracts,
net........................ 26 (3) (9) (49) (24) (59)
----- ----- ---- ---- ---- ----
Non-trading contracts(3)
Non-exchange traded
positions(2).................... (148) (35) 122 329 191 459
----- ----- ---- ---- ---- ----
Total energy contracts............ $(122) $ (38) $113 $280 $167 $400
===== ===== ==== ==== ==== ====
</Table>
- ---------------
(1) Exchange-traded positions include positions that are traded on active
exchanges such as the New York Mercantile Exchange, International Petroleum
Exchange and London Clearinghouse.
(2) Non-exchange traded positions include positions based on exchange prices,
third party pricing data and valuation techniques that incorporate specific
contractual terms, statistical and simulation analysis and present value
concepts.
(3) Non-trading energy contracts include derivatives from our power contract
restructuring activities of $968 million and derivatives related to our
natural gas and oil producing activities of $(509) million. Earnings related
to the natural gas and oil producing activities are included in our
Production segment results.
The energy trading industry experienced dramatic changes during 2002,
especially in the fourth quarter. These changes included the credit downgrades
of many of the major industry participants and actions taken by most of the
major industry participants to reduce their trading activities or completely
exit the business. Because of our own actions to limit our trading activities
and exit the trading business, our accessibility to reliable forward market data
for purposes of estimating fair value was significantly limited in late 2002. As
a result, we obtained valuation assistance from a third party valuation
specialist in determining the fair value of our trading and non-trading price
risk management activities as of December 31, 2002. Based upon the specialist's
input, our estimates of fair value are based upon price curves derived from
actual prices observed in the market, pricing information supplied by the
specialist and independent pricing sources and models that rely on this forward
pricing information. These estimates also reflect factors for time value and
volatility
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<PAGE>
underlying the contracts, the potential impact of liquidating our position in an
orderly manner over a reasonable time under present market conditions, modeling
risk, credit risk of our counterparties and operational risks, as needed. We
have discontinued applying our ten-year liquidity valuation allowance that we
had instituted during the first quarter of 2002 in circumstances where there was
uncertainty related to our forward prices in less liquid markets. To the extent
that the forward market data received from the third party specialist indicates
value beyond ten years, we now include that value in the fair value of our
trading and non-trading price risk management activities.
The income impacts of both our trading and non-trading price risk
management activities are included in all divisions of our Merchant Energy
segment and our Production segment. A reconciliation of these trading and
non-trading activities for the years ended December 31, 2002 and 2001, is as
follows:
<Table>
<Caption>
TOTAL
COMMODITY
TRADING NON-TRADING BASED
------- ----------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
Fair value of contracts outstanding at December 31, 2000.... $ 2,200 $ -- $ 2,200
------- ------- -------
Cumulative effect of accounting change(1)................... -- (1,921) (1,921)
Fair value of contract settlements during the period........ (1,973) 744 (1,229)
Initial recorded value of new contracts..................... 160 -- 160
Change in fair value of contracts(2)........................ 680 1,636 2,316
Other(3).................................................... 228 -- 228
------- ------- -------
Net change in contracts outstanding during the period..... (905) 459 (446)
------- ------- -------
Fair value of contracts outstanding at December 31, 2001.... 1,295 459 1,754
------- ------- -------
Cumulative effect of accounting change...................... (343) -- (343)
Inventory-related reclassifications as a result of
accounting change......................................... (254) -- (254)
Fair value of contract settlements during the period........ (185) (274) (459)
Initial recorded value of new contracts(4).................. 84 991 1,075
Change in fair value of contracts........................... (635) (717) (1,352)
Other(3).................................................... (21) -- (21)
------- ------- -------
Net change in contracts outstanding during the period..... (1,354) -- (1,354)
------- ------- -------
Fair value of contracts outstanding at December 31, 2002.... $ (59) $ 459 $ 400
======= ======= =======
</Table>
- ---------------
(1) On January 1, 2001, we adopted SFAS No. 133 and recorded a cumulative effect
of accounting change of $1,921 million related to our hedging price risk
management activities.
(2) Includes a net loss of $109 million related to changes in the market values
of contracts transferred to our trading portfolio as a result of a change in
the manner in which these contracts were managed following the Coastal
merger.
(3) Includes option premiums and storage capacity transactions.
(4) The initial recorded value of new contracts for trading primarily comes from
completing our Snohvit LNG supply contract in the second quarter of 2002 and
for non-trading primarily comes from our Eagle Point Cogeneration
restructuring transaction completed in the first quarter of 2002. See the
discussion of these transactions under results of operations in our global
power and petroleum divisions.
(5) As a result of the discontinuance of our ten-year liquidity valuation
allowance, we have reversed $29 million which represents the remaining
balance of our initial valuation allowance of $61 million.
Our trading price risk management assets and liabilities changed
significantly in the fourth quarter of 2002 partly because we adopted EITF Issue
No. 02-3, Issues Related to Accounting for Contracts Involved in Energy Trading
and Risk Management Activities. The adoption of EITF Issue No. 02-3 had the
following impacts on our financial statements:
- We eliminated the mark-to-market value for contracts that do not meet the
definition of a derivative, including transportation, storage and other
contracts, which we reported as a cumulative effect of change in
accounting principle of $225 million;
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- We adjusted the carrying value of our natural gas inventory to its
weighted average cost and the value of inventory exchanges to their
expected settlement price assuming they had been accounted for under that
basis since their acquisition, which we reported as a cumulative effect
of change in accounting principle of $118 million; and
- We reclassified $254 million of our natural gas inventory and inventory
exchanges from price risk management assets to inventory and accounts
receivable and payable on our balance sheet.
Overall, the adoption of EITF Issue No. 02-3 reduced our net assets from
price risk management activities by approximately $597 million, lowered our
pre-tax net income by $343 million and lowered our net income by $222 million.
Those contracts for which the mark-to-market value was eliminated are now
accounted for under the accrual method of accounting.
The fair value of contract settlements during the period represents the
amounts of traded contracts settled in cash, through physical delivery of a
commodity or by a claim to cash as accounts receivable or payable. The initial
recorded value of new contracts includes the fair value of origination
transactions at the time the transaction is initiated.
The change in fair value of contracts during the year represents the change
in value of contracts from the beginning of the period, or the date of their
origination, until their settlement or, if not settled, until the end of the
period. One of the most significant factors affecting the declines in fair value
of our trading and non-trading price risk management activities was the decrease
in option value, especially in longer-dated and complex transactions. Despite
the commodity price volatility seen in the market over recent months, we are
finding that the remaining market participants are ascribing very little option
value to these types of transactions. Additionally, because of the significant
reductions in the creditworthiness of many of our counterparties, we were
required to adjust our valuation allowances. Because of these and other market
changes, particularly those experienced in the fourth quarter, we recognized a
loss in our petroleum and energy trading divisions due to changes in fair value
of $635 million in 2002.
In accordance with generally accepted accounting principles, we have
reflected our trading portfolio at estimated fair value, which is the amount at
which the contracts in our portfolio could be bought or sold in a current
transaction between willing buyers and sellers. However, the value we ultimately
receive in settlement of our trading activities may be less than our estimates.
As disclosed previously, we are actively liquidating our trading portfolio,
which included approximately 40,000 transactions as of December 31, 2002. We
believe the net realizable value of our trading portfolio may be less than their
currently estimated fair value. Our belief is based on recent transactions
completed at values below estimated fair value and bids received on transactions
that were also below their fair value. Additionally, because of the adoption of
EITF Issue No. 02-3, a portion of the transactions that we plan to liquidate are
accounted for under the accrual method and are not recorded on our balance
sheet. We believe that the amount we may ultimately realize from the liquidation
of our total portfolio (including our accrual-based portfolio) could result in
future losses of up to $200 million.
See Item 8, Financial Statements and Supplementary Data, Note 1 for our
revenue recognition policy related to these activities. The operating results of
our energy trading division are presented below:
<Table>
<Caption>
ENERGY TRADING DIVISION RESULTS 2002 2001 2000
- ------------------------------- ------- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
Gross margin................................................ $ (862) $ 604 $ 441
Operating expenses.......................................... (678) (137) (64)
------- ----- -----
Operating income (loss)................................ (1,540) 467 377
Other income................................................ 15 26 21
------- ----- -----
EBIT................................................... $(1,525) $ 493 $ 398
======= ===== =====
</Table>
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<PAGE>
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Gross margin consists of revenues from commodity trading and origination
activities less the costs of commodities sold, including changes in the fair
value of our energy trading portfolio. For the year ended December 31, 2002,
gross margin was $1.5 billion lower than in 2001. The decrease was due to a
combination of factors related to changes in the energy trading environment.
Approximately $1.3 billion of this decrease relates to a general market decline
in energy trading resulting from lower price volatility in the natural gas and
power markets and a generally weaker trading and credit environment in 2002.
Additionally, in the fourth quarter of 2002, many of the participants in the
trading industry, including us, publicly announced their intent to discontinue
or significantly reduce trading operations, which we believe, along with other
factors caused a further deterioration of the market valuations of trading and
marketing assets. The decrease in fair value of our trading and non-trading
price risk management activities was largely related to reduced option value,
with the remainder of the decrease resulting from the volatility of forward
prices and reductions in creditworthiness of our counterparties. The decline in
the energy trading environment caused us to reduce our trading and origination
operations which resulted in a decrease of $135 million in the gains from
transactions we originated in 2002 compared to 2001 primarily associated with
transportation, storage and gas supply contracts.
Operating expenses for the year ended December 31, 2002, were $541 million
higher than in 2001. This significant increase relates primarily to a charge of
$487 million related to our Western Energy Settlement and a charge of $20
million related to our Commodities Futures Trading Commission (CFTC) settlement.
See Item 8, Financial Statements and Supplementary Data, Note 2 for a
description of our Western Energy Settlement and Item 8, Financial Statements
and Supplementary Data, Note 20 for a description of our CFTC settlement. Adding
to this increase were additional costs of $5 million to expand our London
operations in early 2002 and an $18 million increase in staffing and
infrastructure costs in 2002. During 2003, we liquidated our European trading
assets and will close these offices.
Other income for the year ended December 31, 2002, was $11 million lower
than in 2001 primarily due lower interest rates and lower average outstanding
balances on our interest-bearing margin deposits and notes receivable during
2002.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
For the year ended December 31, 2001, gross margin was $163 million higher
than in 2000. The increase was due to higher trading margins in natural gas and
power as a result of increased trading volumes and price volatility, net of the
reserves established as a result of the bankruptcy of Enron Corp. in December
2001.
Operating expenses for the year ended December 31, 2001, were $73 million
higher than in 2000. The increase was partially the result of $27 million of
merger-related asset impairments in 2001. The remaining increase of $46 million
related to increased personnel costs to support increased origination activity
and expansion of our European operations in 2001 compared to 2000.
Other income for the year ended December 31, 2001, was $5 million higher
than in 2000. This increase was primarily due to a $16 million increase in other
income resulting from higher interest rates and higher average outstanding
balances on our interest-bearing margin deposits and notes receivable during
2001. These increases were offset by $11 million of equity earnings in 2000 no
longer being recorded upon termination of the Engage joint venture in October
2000.
CORPORATE AND OTHER EXPENSES, NET
Our Corporate and Other operations includes our general and administrative
activities, as well as the operations of our telecommunications and other
miscellaneous businesses. During 2001, there was a significant downturn in the
telecommunications market. As a result, we refocused our telecommunications
strategy and reduced our capital investment in this start-up business. Our
current business strategy involves primarily the development of wholesale
metropolitan transport services, primarily in Texas. At December 31, 2002, our
net investment in the telecommunications business was $388 million, which
includes $163 million of goodwill.
Our telecommunications business consists of Texas-based metro transport
services and collocation and cross-connect services. Our Texas-based metro
transport services business provides bandwidth transport
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<PAGE>
services to wholesale customers in Austin, San Antonio, Dallas, Ft. Worth and
Houston. There are several new initiatives aimed at expanding our market share
within existing markets. In 2003, we are expanding our business model to include
commercial customers through the launch of our channel partners program, which
utilizes third party entities as outside sales representatives in order to
market our existing products to commercial customers. We will also offer to both
wholesale and commercial customers additional products designed specifically to
leverage our existing asset infrastructure, including gigabit ethernet. We
provide a cost-effective service because of our ability to use parts of the
telecommunications infrastructure of SBC under our interconnection agreement
with them. We are currently involved in proceedings with SBC that could impact
our cost of using their infrastructure, and possibly our ability to use this
infrastructure in the future. For an additional discussion of this proceeding,
see Item 8, Financial Statements and Supplementary Data, Note 20 under the
subheading Southwestern Bell Proceeding. Because of the continuing decline in
the telecommunications industry, we evaluate the fair value of our Texas-based
assets, including our goodwill of $163 million, each quarter to determine if
they are impaired. As of December 31, 2002, these assets were not impaired. We
did, however, write off $15 million of right-of-way assets, primarily in the
Northeast, due to decisions not to construct along these rights-of-way or expand
the business into these market areas. There are a number of factors that could
impact the valuation of our Texas-based metro transport business in the future,
including a negative outcome of our SBC proceeding, judicial or legislative
changes affecting the current regulatory framework, a decline in our forecasted
demand for services in the areas we serve or a further decline in the
telecommunications industry impacting our ability to expand this business.
In December 2002, we decided to exit our long-haul and metro dark fiber
business because of the minimal contribution of the activities and the high cost
of maintaining it. Under these circumstances, the value of our inventory is
impaired and, accordingly, in the fourth quarter we reduced the carrying value
of our inventory by $153 million to $5 million. This is in addition to a third
quarter reduction of $8 million. The market value was determined by an
independent appraiser who evaluated the dark fiber value based on market
conditions existing in the fourth quarter of 2002 and recent liquidation values
for dark fiber. Our remaining $4 million of value is attributable to our route
from Houston, Texas to Los Angeles, California, which is the center of an
arbitration proceeding between us and Broadwing Communications Services. For a
further discussion of this matter, see Item 8, Financial Statements and
Supplementary Data, Note 20.
Our collocation and cross-connect services are available through our
Lakeside Technology Center, a Chicago-based telecommunications facility that
provides space for telecommunications carriers designed for their unique
equipment needs, as well as access to multiple network connections of various
telecommunications carriers. We operate this facility under an operating lease
that has a residual value guarantee of $237 million. In the second quarter of
2002, we reached a final settlement of a lease agreement at the facility with
Exodus Communications, Inc., who has now filed for bankruptcy. Although we
received some consideration, the settlement resulted in the termination of the
lease and the loss of a significant tenant at the facility. The building design,
which is beneficial for the heavy equipment, low staffing needs of a
telecommunications provider, also limits the alternative uses for the facility
putting pressure on the fair value of the building during this significant
downturn in the telecommunications industry. Consequently, we analyzed the fair
value of the building. Our analysis was completed in the third quarter of 2002,
and we estimated that the fair value of the building was $162 million, which is
significantly below the expected residual value originally anticipated and
guaranteed under our lease agreement and results in a contingent loss of $113
million. Consequently, we are amortizing this deficiency over the remaining
lease term. This resulted in a charge of $11 million in 2002, and will result in
a charge of $8 million for each remaining quarter through May 2006. Upon the
adoption of the new accounting pronouncement, Financial Accounting Standards
Board Interpretation (FIN) No. 46, in July 2003, we anticipate that we will
consolidate the lessor of this facility which will likely require an adjustment
to the fair value of the facility (see New Accounting Pronouncements Issued But
Not Yet Adopted below).
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Corporate and other net expenses for the year ended December 31, 2002, were
$1,202 million lower than in 2001. The decrease was primarily a result of $1,175
million in merger-related charges and asset
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impairments incurred in 2001, in connection with our merger with Coastal and
additional costs of $144 million incurred in 2001 related to increased estimates
of environmental remediation costs, legal obligations and reductions in the fair
value of spare parts inventories to reflect changes in usability of spare parts
inventories in our corporate operations based on an ongoing evaluation of our
operating standards and plans following the Coastal merger. For a discussion of
these costs, see Item 8, Financial Statements and Supplementary Data, Notes 4
and 6. Also contributing to the decrease was a reduction in telecommunication
expenses of $25 million in 2002 due to our 2001 telecommunication organizational
restructuring and losses of $34 million in 2001 on our retail gas stations,
substantially all of which were sold in 2001. In addition, in 2002, we recorded
a $21 million gain on the early extinguishment of debt. Partially offsetting the
decrease for the year ended December 31, 2002, were charges of $50 million for
severance payments related to our second quarter 2002 employee restructuring,
costs associated with the elimination of rating and stock-price triggers in the
second quarter of 2002 in our Gemstone and Chaparral investments and a $21
million decrease in pre-tax pension income as a result of a reduced expected
rate of return on our pension plan assets. In addition, in our telecommunication
operations, in 2002, we recorded a $153 million valuation adjustment of our dark
fiber inventory, a $15 million impairment of our right-of-way assets and a $11
million contingent loss on the Lakeside Technology Center facility, as discussed
above.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Corporate and Other expenses for the year ended December 31, 2001, were
$1,372 million higher than in 2000. The increase was primarily a result of
additional $1,082 million incurred in 2001 compared to 2000 of merger-related
costs and asset impairments incurred in 2001 in connection with our mergers with
Coastal and Sonat and additional costs of $144 million incurred in 2001 related
to increased estimates of environmental remediation costs, legal obligations and
usability of spare parts inventories and $39 million in lower margins due to the
sale of substantially all of our retail gas stations in 2001. Also contributing
to our higher costs were operating losses associated with our telecommunications
business during 2001 which were approximately $40 million.
INTEREST AND DEBT EXPENSE
Over the past three years, our interest and debt expense has increased as a
result of debt issued to finance the growth of our business segments. During
this period, our average debt balances have increased from approximately $10.8
billion in 2000 to $16 billion as of December 31, 2002. During this growth
period, we have raised funds in both domestic and international capital markets,
the majority of which was fixed rate debt. In the future, our ability to access
the capital markets and issue debt securities will be a function of market
conditions at that time and our credit ratings. Based on rating actions during
the latter part of 2002 and early 2003, we anticipate that the cost of future
debt issuances will be higher for us. Furthermore, since some of our debt
offerings have been in foreign markets, currency fluctuations can impact that
cost of our debt. For example, in 2002, as a result of a weaker U.S. dollar, we
incurred incremental interest costs of approximately $95 million on our Euro
denominated debt.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Interest and debt expense for the year ended December 31, 2002, was $244
million higher than in 2001. Below is an analysis of our interest expense during
the year ended December 31 (in millions):
<Table>
<Caption>
2002 2001 2000
------ ------ ------
<S> <C> <C> <C>
Long term debt, including current maturities............... $1,249 $ 952 $ 891
Commercial paper........................................... 42 98 90
Other interest............................................. 142 171 141
Less: Capitalized interest................................. (33) (65) (82)
------ ------ ------
Total interest expense.............................. $1,400 $1,156 $1,040
====== ====== ======
</Table>
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<PAGE>
Interest expense on long-term debt for the year ended December 31, 2002,
was $297 million higher than in 2001. The increase was due to a higher average
debt balance. During 2002, we issued long-term debt of approximately $4.4
billion that had an average interest rate of 7.9%. These issuances increased
interest on long-term debt by approximately $233 million. During the same year,
we retired approximately $1.6 billion of long-term debt that had an average
interest rate of 5.1%, resulting in a decrease to interest expense from these
retirements of approximately $36 million. In addition, we incurred $95 million
of interest expense in 2002 related to foreign currency losses on
Euro-denominated debt that was unhedged in 2002. The remaining increase was
primarily due to various debt issuances during 2001 that were outstanding for
the entire year in 2002.
Interest expense on commercial paper for the year ended December 31, 2002,
was $56 million lower than in 2001. The decrease was due to lower average
short-term interest rates on commercial paper activities and lower average
short-term borrowings in 2002. The average short-term interest rate, which is
based on daily ending rates, was 2.7% in 2002 versus 4.6% in 2001, and the
average commercial paper and other short-term debt balances, which were based on
daily ending balances, were approximately $963 million in 2002 versus $1.45
billion in 2001.
Other interest for the year ended December 31, 2002, was $29 million lower
than in 2001. The decrease was primarily due to a $23 million decrease in
interest resulting from retirement of our other financing obligations, an $8
million decrease in interest of receivable factoring, and an $8 million decrease
in interest due to termination of a marketing sales contract during 2002. These
decreases were partially offset by a $9 million increase in interest from the
debt securities issued to Gemstone in November 2001.
Capitalized interest for the year ended December 31, 2002, was $32 million
lower than in 2001 primarily due to the lower interest rates in 2002 than in
2001.
We expect to incur higher interest and debt expense on debt issuances in
2003 due to our credit downgrades below investment grade status.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Interest and debt expense for the year ended December 31, 2001, was $116
million higher than in 2000.
Interest expense on long-term debt for the year ended December 31, 2001,
was $61 million higher than in 2000. The increase was due to higher average debt
balance. During 2001, we issued long-term debt of approximately $4.1 billion
that had an average interest rate of 6.1%. These issuances increased interest on
long-term debt by approximately $125 million. During the same year, we retired
approximately $1.6 billion of long-term debt that had an average interest rate
of 6.8%, resulting in a decrease to interest expense from these retirements of
approximately $68 million. The remaining increase was primarily due to fourth
quarter 2000 debt issuances that were outstanding for the entire year in 2001.
Interest expense on commercial paper for the year ended December 31, 2001,
was $8 million higher than in 2000. The increase was due to the higher average
commercial paper balances. Average commercial paper and other short-term debt
balances, which were based on daily ending balances, were approximately $1.45
billion in 2001. This increase was offset by lower average rates on commercial
paper and other short-term borrowings during the year. The average interest
rate, which is based on daily ending rates, was 4.6% in 2001.
Other interest for the year ended December 31, 2001, was $30 million higher
than in 2000. The increase was primarily due to $9 million of interest expense
associated with a swap agreement and $11 million of interest expense associated
with other financing obligations.
Capitalized interest for the year ended December 31, 2001, was $17 million
lower than in 2000 due to the completion of the West Georgia facility during the
middle of 2000.
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MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES
Expense associated with minority interests of consolidated subsidiaries for
the year ended December 31, 2002, was $56 million higher than in 2001. This
increase was primarily due to 2002 income of the minority owners of Eagle Point
Cogeneration, Utility Contract Funding, CDECCA and Mohawk River Funding IV as a
result of our consolidation of these companies during 2002. These consolidations
contributed $38 million of the 2002 increase. An additional $13 million of the
increase related to the minority owner's share of the gain from the termination
of the Nejapa power purchase agreement.
RETURNS ON PREFERRED INTERESTS OF CONSOLIDATED SUBSIDIARIES
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Returns on preferred interests of consolidated subsidiaries for the year
ended December 31, 2002, were $58 million lower than in 2001, primarily due to
the redemptions of the preferred interests related to El Paso Oil & Gas
Resources, El Paso Oil & Gas Associates, Coastal Limited Ventures and Capital
Trust IV and the partial redemption of Clydesdale. The decrease was also due to
lower interest rates in 2002. Most of the preferred returns are based on
variable short-term rates, which were lower on average in 2002 than the same
periods in 2001. Partially offsetting these decreases were higher returns on
preferred interests issued as part of our Gemstone investment completed in
November 2001.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Returns on preferred interests of consolidated subsidiaries for the year
ended December 31, 2001, were $13 million higher than in 2000. Higher balances
in minority interests as a result of the issuance of additional preferred
interests in Clydesdale and Topaz (part of our Gemstone transaction) in 2001 and
a full year of costs on Clydesdale and Capital Trust IV, were significantly
offset by lower interest rates. Clydesdale and Capital Trust IV were formed in
May 2000.
For a further discussion of our borrowings and other financing activities
related to our consolidated subsidiaries, see Item 8, Financial Statements and
Supplementary Data, Note 19.
INCOME TAX EXPENSE
Income tax benefit for the year ended December 31, 2002, was $495 million
resulting in an effective tax rate of 28 percent. For the year ended December
31, 2001, income tax expense was $184 million, resulting in an effective tax
rate of 72 percent. Of this amount, $115 million related to non-deductible
merger charges and changes in our estimate of additional tax liabilities. The
majority of these estimated additional liabilities were paid in 2001 and are
being contested by us. The effective tax rate excluding these charges was 27
percent in 2001. For the year ended December 31, 2000, income tax expense was
$539 million, resulting in an effective tax rate of 30 percent. Differences in
our effective tax rates from the statutory tax rate of 35 percent in all years
were primarily a result of the following factors:
- state income taxes;
- earnings from unconsolidated affiliates where we anticipate receiving
dividends;
- non-deductible portion of merger-related costs and other tax adjustments
to provide for revised estimated liabilities;
- foreign income taxed at different rates;
- utilization of deferred credits on loss carryovers;
- non-deductible dividends on the preferred stock of a subsidiary;
- non-conventional fuel tax credits; and
- depreciation, depletion and amortization.
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For a reconciliation of the statutory rate of 35 percent to the effective
rates, see Item 8, Financial Statements and Supplementary Data, Note 9.
CONTINGENCIES
For a discussion of our contingencies, see Item 8, Financial Statements and
Supplementary Data, Note 20, incorporated herein by reference.
CRITICAL ACCOUNTING POLICIES
The selection and application of accounting policies is an important
process that has developed as our business activities have evolved and as the
accounting rules have developed. Accounting rules generally do not involve a
selection among alternatives, but involve an implementation and interpretation
of existing rules and the use of judgment to the specific set of circumstances
existing in our business. We make every effort to properly comply with all
applicable rules on or before their adoption, and we believe the proper
implementation and consistent application of the accounting rules is critical.
However, not all situations are specifically addressed in the accounting
literature. In these cases, we must use our best judgment to adopt a policy for
accounting for these situations. We accomplish this by analogizing to similar
situations and the accounting guidance governing them, and often consult with
our independent accountants about the appropriate interpretation and application
of these policies. The preparation of our financial statements requires the
selection and application of a number of accounting policies. For a discussion
of our significant accounting policies, see Item 8, Financial Statements and
Supplementary Data, Note 1. We have defined our critical accounting policies as
those significant accounting policies that involve critical accounting estimates
in the preparation of our financial statements.
We consider a critical accounting estimate to be an accounting estimate
recognized in the financial statements that requires us to make assumptions
about matters that may be highly uncertain at the time the estimate is made. We
believe that an accounting estimate is only considered a critical accounting
estimate if changes in those estimates are reasonably likely to occur or if we
reasonably could have selected a different estimate, and either of these
differences would have resulted in a material impact on our financial condition
or results of operations.
Estimates and assumptions about future events and their effects cannot be
determined with certainty. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. These estimates may change as new events occur and as additional
information is obtained. In addition, management is periodically faced with
uncertainties, the outcomes of which are not within our control and will not be
known for prolonged periods of time. We have discussed the development and
selection of the critical accounting policies and related disclosures with the
audit committee of the Board of Directors.
Our critical accounting policies include policies that are related to
specific business units, such as price risk management activities and accounting
for natural gas and oil producing activities, as well as broad policies that
include accounting for environmental reserves and pension and other post
retirement benefits. Each of these areas involves complex situations and a high
degree of judgment in both the application and interpretation of existing
literature and in the development of estimates that impact our financial
statements. These critical accounting policies have been identified for the
current year, and there may be additional critical accounting policies as and
when new accounting pronouncements are adopted. New accounting pronouncements
are discussed in the section below entitled New Accounting Pronouncements Issued
But Not Yet Adopted.
Price Risk Management Activities. We account for our price risk management
activities in accordance with the requirements of SFAS No. 133, which requires
that we determine the fair value of the derivative instruments we use and
reflect them in our balance sheet at their fair values. Changes in the fair
value from period to period of all derivative instruments, except cash flow
hedges, are recorded in our income statement. Changes in the fair value of
derivative instruments used to hedge our cash flows are generally recognized in
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our income statement when the hedge is settled. Over time, these methods will
derive similar results. However, from period to period, income under these
methods can differ significantly.
Some of our derivative instruments are traded on active exchanges such as
the New York Mercantile Exchange, while others are valued using exchange prices,
third party pricing data and valuation techniques that incorporate specific
contractual terms, statistical and simulation analysis and present value
concepts. One of the primary factors that can have an impact on our results each
period is the price assumptions used to value our derivative instruments.
Because of our actions to limit our trading activities and exit the trading
business, our accessibility to reliable forward market pricing data for purposes
of estimating fair value was significantly limited in late 2002. As a result, we
obtained valuation assistance from a third party valuation specialist in
determining the fair value of our trading and non-trading price risk management
activities as of December 31, 2002. Based upon the specialist's input, our
estimates of fair value are based upon price curves derived from actual prices
observed in the market, pricing information supplied by the specialist and
independent pricing sources and models that rely on this forward pricing
information. These estimates also reflect factors for time value and volatility
underlying the contracts, the potential impact of liquidating our position in an
orderly manner over a reasonable time under present market conditions, modeling
risk, credit risk of our counterparties and operational risks, as needed. We
have discontinued applying our ten-year liquidity valuation allowance that we
had instituted during the first quarter of 2002 in circumstances where there was
uncertainty related to our forward prices in less liquid markets. To the extent
that the forward market data received from the third party specialist indicates
value beyond ten years, we now include that value in the fair value of our
trading and non-trading price risk management activities.
The amounts we report in our financial statements change as these estimates
are revised to reflect actual results, changes in market conditions or other
factors, many of which are beyond our control.
Another factor that can impact our results each period is our ability to
estimate the level of correlation between future changes in the fair value of
the hedge instrument and the transaction being hedged, both at the time we enter
into the transaction and on an ongoing basis. By hedging risk, the derivative
instrument's value is intended to offset value changes in the item being hedged.
However, this is complicated in hedging energy commodities, because energy
commodity prices have qualitative and locational differences that can be
difficult to hedge effectively. Our estimates of fair value and our assessment
of correlation of our hedging derivatives are impacted by actual results and
changes in market conditions.
We evaluate the risk in our trading and non-trading price risk management
activities using a Value-at-Risk model to determine the maximum expected one-day
unfavorable impact on our financial performance due to normal market movement.
For a discussion of our methodology in calculating Value-at-Risk, please see
Item 7A, Quantitative and Qualitative Disclosures About Market Risk. We believe
that using this Value-at-Risk methodology captures many of the uncertainties
associated with the estimates in our trading and non-trading activities.
We have reflected our trading portfolio at estimated fair value which is
the amount at which the contracts in our portfolio could be bought or sold in a
current transaction between willing buyers and sellers. However, the value we
ultimately receive in settlement of our trading activities may be less than our
fair value estimates. As disclosed previously, we are actively liquidating our
trading portfolio, which include approximately 40,000 transactions as of
December 31, 2002. We believe the net realizable value of our trading portfolio
may be less than their currently estimated fair value. Our belief is based on
recent transactions completed at values below estimated fair value and bids
received on transactions that were also below their fair value. Additionally,
because of the adoption of EITF Issue No. 02-3, a portion of the transactions
that we plan to liquidate are accounted for under the accrual method and are not
recorded on our balance sheet. Should we have to pay counterparties to assume
these transactions, future losses will result. We believe that the amount we may
ultimately realize from the liquidation of our total portfolio (including our
accrual-based portfolio) could result in future losses up to $200 million.
Asset Impairments. The asset impairment accounting rules require us to
determine if an event has occurred indicating that a long-lived asset may be
impaired. In some cases, these events are clear. In most cases, however, a
clearly identifiable triggering event does not occur. Rather, a series of
individually
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insignificant events occur over time leading to an indication that an asset may
be impaired. This can be further complicated where we have investments in
foreign countries or where we have projects where we are not the operator. We
continually monitor our businesses and the market and business environments in
which we operate and make judgments and assessments about whether a triggering
event has occurred. If an event occurs, we make an estimate of our future cash
flows from these assets to determine if the asset is impaired. For investments,
we evaluate whether events and possible outcomes indicate that a decline in the
value of our investment has occurred that is other than temporary. The
impairment analysis generally involves an assessment of project level cash flows
that requires us to make projections and assumptions for many years into the
future for pricing, demand, competition, operating costs, legal and regulatory
issues and other factors and these variables can, and often do, differ from our
estimates. These changes can have either a positive or negative impact on our
estimates of impairment. In addition, further changes in the economic and
business environment can impact our original and ongoing assessments of
potential impairment.
Accounting for Environmental Reserves. We accrue for environmental
reserves when our assessments indicate that it is probable that a liability has
been incurred or an asset will not be recovered, and an amount can be reasonably
estimated. Estimates of our liabilities are based on currently available facts,
existing technology and presently enacted laws and regulations taking into
consideration the likely effects of inflation and other societal and economic
factors, and include estimates of associated onsite, offsite and groundwater
technical studies, and legal costs. These amounts also consider prior experience
in remediating contaminated sites, other companies' clean-up experience and data
released by the Environmental Protection Agency or other organizations. These
estimates are subject to revision in future periods based on actual costs or new
or changing circumstances and are included in our balance sheet in other current
and long-term liabilities at their undiscounted amounts. Actual results may
differ from our estimates, and our estimates can be, and often are, revised in
the future, either negatively or positively, depending upon actual outcomes or
changes in expectations based on the facts surrounding each exposure.
As of December 2002, we had accrued approximately $482 million for
environmental matters, including approximately $463 million for expected
remediation costs at current and former operating sites and associated onsite,
offsite and groundwater technical studies, and approximately $19 million for
related environmental legal costs, which we anticipate incurring through 2027.
Approximately $15 million of the accrual was related to discontinued coal mining
operations. The high end of our reserve estimates was approximately $620 million
and the low end was approximately $427 million, and our accrual at December 31,
2002 was based on the estimated most likely reasonable amount of liability. By
type of site, our reserves are based on the following estimates of reasonably
possible outcomes:
<Table>
<Caption>
DECEMBER 31,
2002
-------------
SITES LOW HIGH
- ----- ----- -----
(IN MILLIONS)
<S> <C> <C>
Operating................................................... $208 $287
Non-operating............................................... 193 286
Superfund................................................... 26 47
</Table>
Accounting for Natural Gas and Oil Producing Activities. We use the full
cost method to account for our natural gas and oil producing activities. Under
this accounting method, we capitalize substantially all of the costs incurred in
connection with the exploration, acquisition and development of natural gas and
oil reserves in full cost pools maintained by geographic areas, regardless of
whether reserves are actually located. This method differs from the successful
efforts method of accounting for these activities. The primary differences
between these two methods are the treatment of exploratory dry hole costs and
geological and geophysical costs and the recognition of gains or losses when
properties are sold. Exploratory dry hole costs include exploration, acquisition
and development costs on wells that do not yield measurable reserves. Under the
successful efforts method, these costs are generally expensed when the
determination is made that measurable reserves do not exist. Geological and
geophysical costs are also expensed under the successful efforts. Under the full
cost method, both dry hole costs and geological costs are capitalized into the
full cost
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pool. As a result, our financial statements will differ from companies that
apply the successful efforts method since we could potentially reflect a higher
level of capitalized costs as well as a higher depletion rate.
Under the full cost accounting method, we are required to conduct quarterly
impairment tests of our capitalized costs in each of our full cost pools. This
impairment test is referred to as a ceiling test. Our total capitalized costs,
net of related income tax effects, are limited to a ceiling based on the present
value of future net revenues using end of period spot prices, discounted at 10
percent, plus the lower of cost or fair market value of unproved properties, net
of related income tax effects. If these discounted revenues are not equal to or
greater than total capitalized costs, we are required to write-down our
capitalized costs to this level. The primary factors that could result in a
ceiling test write-down include lower prices, higher capitalized costs in the
full cost pool, a lower reserve base, and the impact of our hedging program.
The ceiling test calculation assumes that the price in effect on the last
day of the quarter is held constant over the life of the reserves. As a result
of this pricing assumption, the resulting value is not indicative of the true
fair value of the reserves. The prices of natural gas and oil are volatile and
change from period to period. We attempt to realize more determinable cash flows
through the use of hedges, but a decline in commodity prices can impact the
results of our ceiling test. Ceiling test charges due to fluctuating prices, as
opposed to reductions to the underlying reserve quantities, should not be
considered an absolute indicator of the value of the related reserves.
The process of estimating natural gas and oil reserves is very complex,
requiring significant decisions in the evaluation of all available geological,
geophysical, engineering and economic data. The data for a given field may also
change substantially over time as a result of numerous factors, including
additional development activity, evolving production history and a continual
reassessment of the viability of production under changing economic conditions.
As a result, material revisions to existing reserve estimates occur from time to
time. Although every reasonable effort is made to ensure that reserve estimates
reported represent the most accurate assessments possible, the subjective
decisions and variances in available data for various fields increases the
likelihood of significant changes in these estimates. Our reserve estimates
impact several financial calculations. If all other factors are held constant,
an increase in estimated proved reserves decreases our unit of production
depletion rate. Higher reserves can also reduce the likelihood of ceiling test
impairments. Estimated reserves are used to calculate projected future cash
flows from our natural gas and oil properties, which can often be used as
collateral to secure financing for our operations. For further discussion of our
reserves, see Part I, Item 1, Business, under Production segment and Item 8,
Financial Statements and Supplementary Data, Note 28.
Accounting for Pension and Other Postretirement Benefits
Our accruals related to our pension and other postretirement benefits are
based on actuarial calculations. In performing these calculations, our actuaries
must use assumptions, including those related to the return that we expect to
earn on our plan assets, discount rates used in calculating benefit obligations,
the rate at which we expect the compensation of our employees will increase over
the plan term, the cost of health care when benefits are provided under our
plans and other factors.
Actual results may differ from the assumptions included in these actuarial
calculations, and as a result our estimates associated with our pension and
other postretirement benefits can be, and often are, revised in the future, with
either a negative or positive effect on the costs we recognize and the accruals
we make. The following table shows the impact of a one percent change in our
primary assumptions used in our actuarial
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calculations associated with our pension and other postretirement benefits for
the year ended December 31, 2002 (in millions):
<Table>
<Caption>
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------------------- -------------------------------------
PROJECTED ACCUMULATED
NET BENEFIT BENEFIT NET BENEFIT POSTRETIREMENT
EXPENSE (INCOME) OBLIGATION EXPENSE (INCOME) BENEFIT OBLIGATION
---------------- ---------- ---------------- ------------------
<S> <C> <C> <C> <C>
One percent increase in:
Discount rates............... $ 1 $(186) $-- $(40)
Expected return on plan
assets.................... (30) -- (1) --
Rate of compensation
increase.................. 2 5 -- --
Health care cost trends...... -- -- 1 20
One percent decrease in:
Discount rates............... $ (2) $ 222 $-- $ 42
Expected return on plan
assets.................... 30 -- 1 --
Rate of compensation
increase.................. (1) (5) -- --
Health care cost trends...... -- -- (1) (19)
</Table>
Our estimates for our net benefit expense (income) are partially based on
the expected return on pension plan assets. We use a market-related value of
plan assets to determine the expected return on pension plan assets. In
determining the market-related value of plan assets, differences between
expected and actual asset returns are deferred and recognized over three years.
Due to recent losses in our pension plan assets, the fair value of plan assets
used to determine the 2002 net benefit expense (income) was less than the
market-related value of plan assets. If we used the fair value of our plan
assets instead of the market-related value of plan assets in determining the
expected return on pension plan assets, our net benefit income would have been
$51 million lower for the year ended December 31, 2002.
We have not recorded an additional pension liability for our primary
pension plan because the fair value of plan assets exceeded the accumulated
benefit obligation in that plan as of September 30, 2002, by approximately $130
million. Plan assets exceeded accumulated benefit obligations as of December 31,
2002, by a similar margin. If the accumulated benefit obligation exceeded plan
assets under this primary pension plan as of September 30, 2002, we would have
recorded a pre-tax additional pension liability of approximately $900 million
plus an amount equal to the excess of the accumulated benefit obligation over
plan assets of the primary pension plan. We would have also recorded an amount
equal to this additional pension liability to accumulated other comprehensive
loss, net of taxes, in our balance sheet.
For further details on these and our other significant accounting policies,
and the estimates, assumptions and judgments we use in applying these policies,
see Item 8, Financial Statements and Supplementary Data, Note 1.
NEW ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET ADOPTED
As of December 31, 2002, there were a number of accounting standards and
interpretations that had been issued, but not yet adopted by us. Below is a
discussion of the more significant standards that could impact us.
Accounting for Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, Accounting for Asset Retirement Obligations. This statement requires
companies to record a liability for the estimated retirement and removal costs
of long-lived assets used in their business. The liability is recorded at its
fair value, with a corresponding asset which is depreciated over the remaining
useful life of the long-lived asset to which the liability relates. An ongoing
expense will also be recognized for changes in the value of the liability as a
result of the passage of time. The provisions of SFAS No. 143 are effective for
fiscal years beginning after June 15, 2002. We expect that we will record a
charge as a cumulative effect of accounting change of approximately $23 million,
net of income taxes, upon our adoption of SFAS No. 143 on January 1, 2003. We
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also expect to record non-current retirement assets of $184 million and
non-current retirement liabilities of $214 million on January 1, 2003. Our
liability relates primarily to our obligations to plug abandoned wells in our
Production and Pipelines segments over the next one to 101 years.
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement will require us to recognize
costs associated with exit or disposal activities when they are incurred rather
than when we commit to an exit or disposal plan. Examples of costs covered by
this guidance include lease termination costs, employee severance costs
associated with a restructuring, discontinued operations, plant closings or
other exit or disposal activities. The statement is effective for fiscal years
beginning after December 31, 2002, and will impact any exit or disposal
activities we initiate after January 1, 2003.
Accounting for Guarantees
In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This interpretation requires that companies record a
liability for all guarantees issued after January 31, 2003, including financial,
performance and fair value guarantees. This liability is recorded at its fair
value upon issuance and does not affect any existing guarantees issued before
January 31, 2003. This standard also requires expanded disclosures on all
existing guarantees at December 31, 2002. We have included these required
disclosures in Item 8, Financial Statements and Supplementary Data, Note 20.
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51. This interpretation defines
a variable interest entity as a legal entity whose equity owners do not have
sufficient equity at risk and/or a controlling financial interest in the entity.
This standard requires that companies consolidate a variable interest entity if
it is allocated a majority of the entity's losses and/or returns, including fees
paid by the entity. The provisions of FIN No. 46 are effective for all variable
interest entities created after January 31, 2003, and are effective on July 1,
2003, for all variable interest entities created before January 31, 2003. We are
currently evaluating the effects of this pronouncement, but have reached several
tentative conclusions about the possible impact of this interpretation on us.
See Item 8, Financial Statements and Supplementary Data, Note 1, for a
discussion of the conclusions reached.
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RISK FACTORS AND 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 in good faith,
assumed facts or bases almost always vary from the actual results, and
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. All of our forward-looking
statements, whether written or oral, are expressly qualified by these cautionary
statements and any other cautionary statements that may accompany such
forward-looking statements. In addition, we disclaim any obligation to update
any forward-looking statements to reflect events or circumstances after the date
of this report.
With this in mind, you should consider the risks discussed elsewhere in
this report and other documents we file with the Commission from time to time
and the following important factors that could cause actual results to differ
materially from those expressed in any forward-looking statement made by us or
on our behalf.
WE HAVE SUBSTANTIAL DEBT. THE DOWNGRADES OF OUR CREDIT RATINGS TO BELOW
INVESTMENT GRADE HAVE SIGNIFICANTLY IMPACTED AND WILL CONTINUE TO SIGNIFICANTLY
IMPACT OUR LIQUIDITY.
We have substantial debt. As of December 31, 2002, we had total long-term
capital market debt, bank debt and other financing obligations of approximately
$16.7 billion, including approximately $8.5 billion of subsidiary debt. We also
have guarantees of approximately $2.5 billion and preferred interests of
consolidated subsidiaries of approximately $3.3 billion.
The ratings assigned to our outstanding senior unsecured indebtedness have
been downgraded to below investment grade, currently rated Caa1 by Moody's and B
by Standard & Poor's, and we remain on negative outlook at both agencies. These
ratings have increased and will increase our cost of capital and collateral
requirements, and could impede our access to capital markets. As a result of
these recent downgrades, we have realized substantial demands on our liquidity,
which demands have included:
- application of cash required to be withheld from our cash management
program in order to redeem preferred membership interests at one of our
minority interest financing structures; and
- cash collateral or margin requirements associated with contractual
commitments of our subsidiaries.
These downgrades may subject us to additional liquidity demands in the future.
These downgrades are a result, at least in part, of the outlook generally for
our consolidated businesses and our liquidity needs.
In order to meet our short-term liquidity needs, we have embarked on our
2003 Operational and Financial Plan that contemplates drawing all or part of our
availability under our existing bank facilities and consummating significant
asset sales. In addition, we may take additional steps, such as entering into
other financing activities, renegotiating our credit facilities and further
reducing capital expenditures, which should provide additional liquidity. There
can be no assurance that these actions will be consummated on favorable terms,
if at all, or that even if consummated, that such actions will be successful in
satisfying our liquidity needs. In the event our liquidity needs are not
satisfied, we could be forced to seek protection from our creditors in
bankruptcy. Such a development could materially adversely affect our financial
condition.
ONGOING LITIGATION AND INVESTIGATIONS COULD SIGNIFICANTLY ADVERSELY AFFECT OUR
BUSINESS.
On March 20, 2003, we entered into an agreement in principle (the Western
Energy Settlement) with various public and private claimants, including the
states of California, Washington, Oregon, and Nevada, to resolve the principal
litigation, claims, and regulatory proceedings against us and our subsidiaries
relating to
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the sale or delivery of natural gas and electricity from September 1996 to the
date of the Western Energy Settlement. For further information on these matters,
see Part II, Item 8, Financial Statements and Supplementary Data, Notes 2 and
20. If we are unable to negotiate definitive settlement agreements, or if the
settlement is not approved by the courts or the FERC, the proceedings and
litigation will continue.
Since July 2002, twelve purported shareholder class action suits alleging
violations of federal securities laws have been filed against us and several of
our officers. Eleven of these suits are now consolidated in federal court in
Houston before a single judge. The suits generally challenge the accuracy or
completeness of press releases and other public statements made during 2001 and
2002. The twelfth shareholder class action lawsuit was filed in federal court in
New York City in October 2002 challenging the accuracy or completeness of our
February 27, 2002 prospectus for an equity offering that was completed on June
21, 2002. It has since been dismissed, in light of similar claims being asserted
in the consolidated suits in Houston. Four shareholder derivative actions have
also been filed. One shareholder derivative lawsuit was filed in federal court
in Houston in August 2002. This derivative action generally alleges the same
claims as those made in the shareholder class action, has been consolidated with
the shareholder class actions pending in Houston and has been stayed. A second
shareholder derivative lawsuit was filed in Delaware State Court in October 2002
and generally alleges the same claims as those made in the consolidated
shareholder class action lawsuit. A third shareholder derivative suit was filed
in state court in Houston in March 2002, and a fourth shareholder derivative
suit was filed in state court in Houston in November 2002. The third and fourth
shareholder derivative suits both generally allege that manipulation of
California gas supply and gas prices exposed us to claims of antitrust
conspiracy, FERC penalties and erosion of share value. In December 2002, another
action was filed in federal court in Houston on behalf of participants in the El
Paso Corporation Retirement Savings Plan. At this time, our legal exposure
related to these lawsuits and claims is not determinable.
If we do not prevail in these cases (or any of the other litigation,
administrative or regulatory matters to which we are, or may be, a party
described in Item 8, Financial Statements and Supplementary Data, Note 20), and
if the remedy adopted in these cases substantially impairs our financial
position, the long-term adverse impact on our credit rating, liquidity and our
ability to raise capital to meet our ongoing and future investing and financing
needs could be substantial.
WE MAY NOT ACHIEVE ALL OF THE OBJECTIVES SET FORTH IN OUR 2003 OPERATIONAL AND
FINANCIAL PLAN IN A TIMELY MANNER OR AT ALL.
Our ability to achieve the stated objectives of our 2003 Operational and
Financial Plan, as well as the timing of their achievement, if at all, is
subject to factors beyond our control, including our ability to raise cash from
asset sales, which may be impacted by our ability to locate potential buyers in
a timely fashion and obtain a reasonable price or by competing assets sales
programs by our competitors. If we fail to timely achieve that plan, or if the
plan, even if achieved, fails to have the effects on our liquidity and financial
position that we anticipate, our liquidity or financial position could be
materially adversely affected.
OUR OBJECTIVES IN EXITING THE ENERGY TRADING BUSINESS AND THE PETROLEUM BUSINESS
MAY NOT BE ACHIEVED IN THE TIME PERIOD OR IN THE MANNER WE EXPECT, IF AT ALL.
In November 2002, we announced our intention to exit the energy trading
business and pursue an orderly liquidation of our trading portfolio. In February
2003, we announced our intention to sell our remaining petroleum assets,
excluding the Aruba refinery. If we are unable to achieve these objectives in
the time period or the manner that we expect, it could have a substantial
negative impact on our cash flows, liquidity and financial position. The ability
to achieve our goals in the liquidation of our trading portfolio is subject to
factors beyond our control, including, among others, liquidity constraints
experienced by the counterparties in our energy trading business, obtaining
maximum cash flow from our trading portfolio and isolating the credit and
liquidity needs of the energy trading business from the rest of our business.
Additionally, any amounts actually realized from the liquidation of the energy
trading business could be significantly less than the amounts we currently
expect from such liquidations. Ongoing losses from our trading business are
expected to be incurred as positions are liquidated. The ability to achieve our
goals in the sale of our petroleum assets is subject to
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factors beyond our control, including, among others, our ability to locate
potential buyers in a timely fashion and obtain a reasonable price, and
competing asset sales programs by our competitors.
THE PROXY CONTEST INITIATED BY SELIM ZILKHA TO REPLACE OUR BOARD OF DIRECTORS
COULD HAVE A MATERIAL ADVERSE EFFECT ON US.
On February 18, 2003, Selim Zilkha, one of our stockholders, announced his
intention to initiate a proxy solicitation to replace our entire board of
directors with his own nominees, and on March 11, 2003, Mr. Zilkha filed his
preliminary proxy statement to that effect with the SEC. This proxy contest may
be disruptive and may negatively impact our ability to achieve the stated
objectives of our 2003 Operational and Financial Plan. In addition, we may have
difficulty attracting and retaining key personnel until such proxy contest is
resolved. Therefore, this proxy contest, whether or not successful, could have a
material adverse effect on our liquidity and financial condition.
RESULTS OF INVESTIGATIONS INTO REPORTING OF TRADING INFORMATION COULD ADVERSELY
AFFECT OUR BUSINESS.
In response to an October 2002 data request from the FERC, we conducted an
investigation into the accuracy of information that employees of El Paso
Merchant Energy, our subsidiary, voluntarily reported to trade publications. As
a part of that investigation, we discovered that inaccurate information was
submitted to the trade publications. One of El Paso Merchant Energy's former
employees has been arrested and charged with knowingly submitting inaccurate
data to a trade publication. We have continued our policy of cooperation with
the office of the U.S. Attorney and the FERC and intend to take whatever
remedial steps are necessary to ensure that our operations are conducted with
integrity. However, these investigations are continuing, and there can be no
assurance that penalties or sanctions will not be imposed on us, which, in turn,
could adversely affect our business.
THE SUCCESS OF OUR PIPELINE AND FIELD SERVICES BUSINESSES DEPENDS ON FACTORS
BEYOND OUR CONTROL.
Most of the natural gas and natural gas liquids we transport, gather,
process and store are owned by third parties. As a result, the volume of natural
gas and natural gas liquids involved in these activities depends on the actions
of those third parties, and is beyond our control. Further, the following
factors, most of which are beyond our control, may unfavorably impact our
ability to maintain or increase current throughput, to renegotiate existing
contracts as they expire or to remarket unsubscribed capacity:
- future weather conditions, including those that favor alternative energy
sources;
- price competition;
- drilling activity and supply availability;
- expiration and/or turn back of significant capacity;
- service area competition;
- changes in regulation and action of regulatory bodies;
- credit risk of customer base;
- increased cost of capital; and
- natural gas and liquids prices.
THE REVENUES OF OUR PIPELINE BUSINESSES ARE GENERATED UNDER CONTRACTS THAT MUST
BE RENEGOTIATED PERIODICALLY.
Substantially all of our pipeline subsidiaries' revenues are generated
under contracts which expire periodically and must be renegotiated and extended
or replaced. We cannot assure that we will be able to extend or replace these
contracts when they expire or that the terms of any renegotiated contracts will
be as favorable as the existing contracts.
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<PAGE>
In particular, our ability to extend and/or replace contracts could be
adversely affected by factors we cannot control, including:
- the proposed construction by other companies of additional pipeline
capacity in markets served by our interstate pipelines;
- changes in state regulation of local distribution companies, which may
cause them to negotiate short-term contracts or turn back their capacity
when their contracts expire;
- reduced demand and market conditions;
- the availability of alternative energy sources or gas supply points; and
- regulatory actions.
If we are unable to renew, extend or replace these contracts or if we renew
them on less favorable terms, we may suffer a material reduction in our revenues
and earnings.
FLUCTUATIONS IN ENERGY COMMODITY PRICES COULD ADVERSELY AFFECT OUR PIPELINE AND
FIELD SERVICES BUSINESSES.
Revenues generated by our transmission, storage, gathering and processing
contracts depend on volumes and rates, both of which can be affected by the
prices of natural gas and natural gas liquids. Increased prices could result in
loss of load from our customers, such as power companies not dispatching gas
fired plants, industrial plant shutdown or load loss to competitive fuels and
local distribution companies' loss of customer base. The success of our
transmission, gathering and processing operations is subject to continued
development of additional oil and natural gas reserves and our ability to access
additional suppliers from interconnecting pipelines to offset the natural
decline from existing wells connected to our systems. A decline in energy prices
could precipitate a decrease in these development activities and could cause a
decrease in the volume of reserves available for transmission, gathering and
processing through our systems or facilities. Fluctuations in energy prices are
caused by a number of factors, including:
- regional, domestic and international supply and demand;
- availability and adequacy of transportation facilities;
- energy legislation;
- federal and state taxes, if any, on the sale or transportation of natural
gas and natural gas liquids;
- abundance of supplies of alternative energy sources; and
- political unrest among oil producing countries.
THE AGENCIES THAT REGULATE OUR PIPELINE BUSINESSES AND THEIR CUSTOMERS AFFECT
OUR PROFITABILITY.
Our pipeline businesses are regulated by the FERC, the U.S. Department of
Transportation, and various state and local regulatory agencies. Regulatory
actions taken by those agencies have the potential to adversely affect our
profitability. In particular, the FERC regulates the rates our pipelines are
permitted to charge their customers for their services. If our pipelines' tariff
rates were reduced in a future proceeding, if our pipelines' volume of business
under their currently permitted rates was decreased significantly, or if our
pipelines were required to substantially discount the rates for their services
because of competition, the profitability of our pipeline businesses could be
reduced.
Further, state agencies that regulate our pipelines' local distribution
company customers could impose requirements that could impact demand for our
pipelines' services.
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THE SUCCESS OF OUR NATURAL GAS AND OIL EXPLORATION AND PRODUCTION BUSINESSES IS
DEPENDENT ON FACTORS THAT ARE BEYOND OUR CONTROL.
The performance of our natural gas and oil exploration and production
businesses is dependent upon a number of factors that we cannot control. These
factors include:
- fluctuations in natural gas and crude oil prices including basis
differentials;
- the results of future drilling activity;
- our ability to identify and precisely locate prospective geologic
structures and to drill and successfully complete wells in those
structures in a timely manner;
- our ability to expand our leased land positions in desirable areas, which
often are subject to intensely competitive leasing conditions;
- increased competition in the search for and acquisition of reserves;
- risks incident to operations of natural gas and oil wells;
- future drilling, production and development costs, including drilling rig
rates and oil field services costs;
- future tax policies, rates, and drilling or production incentives by
state, federal, or foreign governments;
- increased federal or state regulations, including environmental
regulations, that limit or restrict the ability to drill natural gas or
oil wells, reduce operational flexibility, or increase capital and
operating costs;
- decreased demand for the use of natural gas and oil because of market
concerns about global warming or changes in governmental policies and
regulations due to climate change initiatives; and
- continued access to sufficient capital to fund drilling programs to
develop and replace a reserve base with rapid depletion characteristics.
ESTIMATES OF NATURAL GAS AND OIL RESERVES MAY CHANGE.
Actual production, revenues, taxes, development expenditures, and operating
expenses with respect to our reserves will likely vary from our estimates of
proved reserves of natural gas and oil, and those variances may be material. The
process of estimating natural gas and oil reserves is complex, requiring
significant decisions and assumptions in the evaluation of available geological,
geophysical, engineering, and economic data for each reservoir or deposit. As a
result, these estimates are inherently imprecise. Actual future production,
natural gas and oil prices, revenues, taxes, development expenditures, operating
expenses and quantities of recoverable natural gas and oil reserves may vary
substantially from our estimates. In addition, we may be required to revise the
reserve information, downward or upward, based on production history, results of
future exploration and development, prevailing natural gas and oil prices and
other factors, many of which are beyond our control.
THE SUCCESS OF OUR POWER GENERATION ACTIVITIES DEPENDS ON MANY FACTORS BEYOND
OUR CONTROL.
The success of our domestic and international power projects could be
adversely affected by factors beyond our control, including:
- alternative sources and supplies of energy becoming available due to new
technologies and interest in self generation and cogeneration;
- increases in the costs of generation, including increases in fuel costs;
- uncertain regulatory conditions resulting from the ongoing deregulation
of the electric industry in the U.S. and in foreign jurisdictions;
- our ability to negotiate successfully and enter into, restructure or
recontract advantageous long-term power purchase agreements;
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- the possibility of a reduction in the projected rate of growth in
electricity usage as a result of factors such as regional economic
conditions, excessive reserve margins and the implementation of
conservation programs;
- risks incidental to the operation and maintenance of power generation
facilities;
- the inability of customers to pay amounts owed under power purchase
agreements; and
- the increasing price volatility due to deregulation and changes in
commodity trading practices.
OUR USE OF DERIVATIVE FINANCIAL INSTRUMENTS COULD RESULT IN FINANCIAL LOSSES.
Some of our subsidiaries use futures, swaps and option contracts traded on
the New York Mercantile Exchange, over-the-counter options and price and basis
swaps with other natural gas merchants and financial institutions. We could
incur financial losses in the future as a result of volatility in the market
values of the energy commodities we trade, or if one of our counterparties fails
to perform under a contract. The valuation of these financial instruments
involve estimates. Changes in the assumptions underlying these estimates can
occur, changing our valuation of these instruments and potentially resulting in
financial losses. To the extent we hedge our commodity price exposure and
interest rate exposure, we forego the benefits we would otherwise experience if
commodity prices were to increase, or interest rates were to change. The use of
derivatives also requires the posting of cash collateral with our counterparties
which can impact our working capital when commodity prices or interest rates
change. For additional information concerning our derivative financial
instruments, see Item 7A, Quantitative and Qualitative Disclosures About Market
Risk and Item 8, Financial Statements and Supplementary Data, Note 13.
OUR FOREIGN OPERATIONS AND INVESTMENTS INVOLVE SPECIAL RISKS.
Our activities in areas outside the U.S. are subject to the risks inherent
in foreign operations, including:
- loss of revenue, property and equipment as a result of hazards such as
expropriation, nationalization, wars, insurrection and other political
risks;
- the effects of currency fluctuations and exchange controls, such as
devaluation of foreign currencies and other economic problems; and
- changes in laws, regulations and policies of foreign governments,
including those associated with changes in the governing parties.
COSTS OF ENVIRONMENTAL LIABILITIES, REGULATIONS AND LITIGATION COULD EXCEED OUR
ESTIMATES.
Our operations are subject to various environmental laws and regulations.
These laws and regulations obligate us to install and maintain pollution
controls and to clean up various sites at which regulated materials may have
been disposed of or released. Some of these sites have been designated Superfund
sites by the EPA under the Comprehensive Environmental Response, Compensation
and Liability Act. We are also party to legal proceedings involving
environmental matters pending in various courts and agencies.
It is not possible for us to estimate reliably the amount and timing of all
future expenditures related to environmental matters because of:
- the uncertainties in estimating clean up costs;
- the discovery of new sites or information;
- the uncertainty in quantifying liability under environmental laws that
impose joint and several liability on all potentially responsible
parties;
- the nature of environmental laws and regulations; and
- the possible introduction of future environmental laws and regulations.
Although we believe we have established appropriate reserves for
liabilities, including clean up costs, we could be required to set aside
additional reserves in the future due to these uncertainties. For additional
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information concerning our environmental matters, see Item 8, Financial
Statements and Supplementary Data, Note 20.
OUR OPERATIONS ARE SUBJECT TO OPERATIONAL HAZARDS AND UNINSURED RISKS.
Our operations are subject to the inherent risks normally associated with
those operations, including pipeline ruptures, explosions, pollution, release of
toxic substances, fires and adverse weather conditions, and other hazards, each
of which could result in damage to or destruction of our facilities or damages
to persons and property. In addition, our operations face possible risks
associated with acts of aggression on our domestic and foreign assets. If any of
these events were to occur, we could suffer substantial losses.
While we maintain insurance against many of these risks, our financial
condition and operations could be adversely affected if a significant event
occurs that is not fully covered by insurance.
TERRORIST ATTACKS AIMED AT OUR ENERGY OPERATIONS COULD ADVERSELY AFFECT OUR
BUSINESS.
On September 11, 2001, the U.S. was the target of terrorist attacks of
unprecedented scale. Since the September 11th attacks, the U.S. government has
issued warnings that energy assets, including our nation's pipeline
infrastructure, may be a future target of terrorist organizations. These
developments have subjected our energy operations to increased risks. Any future
terrorist attack on our facilities, those of our customers and, in some cases,
those of other energy companies, could have a material adverse effect on our
business.
A BREACH OF THE COVENANTS APPLICABLE TO OUR LONG-TERM DEBT AND OTHER FINANCIAL
OBLIGATIONS COULD ACCELERATE OUR LONG-TERM DEBT AND OTHER FINANCIAL OBLIGATIONS
AND THAT OF OUR SUBSIDIARIES.
Our long-term debt and other financial obligations contain restrictive
covenants and cross-acceleration provisions. A breach of any of these covenants
could accelerate our long-term debt and other financial obligations and that of
our subsidiaries. If this were to occur, we may not be able to repay such
long-term debt and other financing obligations upon such acceleration.
WE ARE SUBJECT TO FINANCING AND INTEREST RATE EXPOSURE RISKS.
Our future success depends on our ability to access capital markets and
obtain financing at cost effective rates. In addition, our recent downgrades and
current credit ratings have triggered higher cash requirements and operating
costs for our energy trading business, which we are in the process of exiting
pursuant to an orderly liquidation of our trading portfolio. Our ability to
access financial markets and obtain cost-effective rates in the future are
dependent on a number of factors, many of which we cannot control, including
changes in:
- our credit ratings;
- interest rates;
- the structured and commercial financial markets;
- market perceptions of us or the natural gas and energy industry;
- tax rates due to new tax laws; and
- our stock price.
WE WILL FACE COMPETITION FROM THIRD PARTIES TO PRODUCE, TRANSPORT, GATHER,
PROCESS, FRACTIONATE, STORE OR OTHERWISE HANDLE OIL, NATURAL GAS, NATURAL GAS
LIQUIDS AND OTHER PETROLEUM PRODUCTS.
The natural gas and oil business is highly competitive in the search for
and acquisition of reserves and in the gathering and marketing of natural gas
and oil production. Our competitors include the major oil companies, independent
oil and gas concerns, individual producers, gas marketers and major pipeline
companies, as well as participants in other industries supplying energy and fuel
to industrial, commercial and individual consumers. If we are unable to compete
effectively with services offered by other energy enterprises, our future
profitability may be negatively impacted.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments and energy related contracts to
manage market risks associated with energy commodities, interest rates and
foreign currency exchange rates. Our primary market risk exposures are those
related to changing commodity prices. Our market risks are monitored by a
corporate risk management committee to ensure compliance with the stated risk
management policies approved by the Audit Committee of our Board of Directors.
This committee operates independently from the business segments that create or
manage these risks.
COMMODITY PRICE RISK
We are exposed to a variety of market risks in the normal course of our
business activities. The nature of these market price risks varies based on our
segments. Our Production segment has price risks related to the natural gas and
oil it produces. Our Field Services segment has price risks related to the
natural gas liquids it retains in its processing operations. The global power
division of our Merchant Energy segment is exposed to price risks in both the
fuel it uses, primarily natural gas and coal, as well as the power it sells. The
petroleum division of our Merchant Energy segment is exposed to price risks in
both the feedstocks it uses, primarily crude oil and petroleum-based products,
as well as the refined products it sells. The energy trading division of our
Merchant Energy segment is exposed to market price risks inherent in its
contractual obligations to deliver or receive commodities and in the financial
instruments it uses for trading energy and energy-related commodities.
We attempt to mitigate price risk associated with both our energy trading
activities (included in our energy trading and petroleum divisions in Merchant
Energy) and non-trading activities (power and commodity hedging activities)
through the use of trading and non-trading financial instruments (including
forwards, swaps, options and futures). We measure risks from our commodity and
energy-related contracts on a daily basis using a Value-at-Risk model. This
model allows us to determine the maximum expected one-day unfavorable impact on
the fair values of those contracts due to normal market movements, and monitors
our risk in comparison to established thresholds. We use what is known as the
historical simulation technique for measuring Value-at-Risk. This technique
values positions in every iteration of the simulation and captures risk from all
types of financial positions. We also use other measures to monitor our risks on
a daily basis, including sensitivity analysis, stress testing, credit risk
management and other measures to monitor and measure risk exposure.
The following table presents our maximum expected one-day unfavorable
impact on the fair values of our commodity and energy-related contracts as
measured by Value-at-Risk based on a confidence level of 95 percent and a
one-day holding period. The high and low valuations represent the highest and
lowest of the month end values during 2002. The average valuation represents the
average of the 2002 month end values. Actual losses in fair value may exceed
those measured by Value-at-Risk:
<Table>
<Caption>
VALUE-AT-RISK
-------------------------------------
2002 2001
----------------------------- ----
YEAR YEAR
END HIGH LOW AVERAGE END
---- ---- --- ------- ----
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Trading Value-at-Risk.................................... $ 8 $23 $ 8 $16 $18
Non-trading Value-at-Risk................................ 8 10 4 7 15
Portfolio Value-at-Risk(1)............................... 11 22 9 16 17
</Table>
- ---------------
(1) Portfolio Value-at-Risk represents the combined Value-at-Risk for the
trading and non-trading commodity and energy-related contracts. The separate
calculation of Value-at-Risk for trading and non-trading commodity contracts
ignores the natural correlation that exists between traded and non-traded
commodity contracts and prices. As a result, the sum of the individually
determined values will be higher than the combined Value-at-Risk in most
instances. We manage our risks through a portfolio approach that balances
both trading and non-trading risks.
The $10 million decrease in trading Value-at-Risk during 2002 is
attributable to our efforts to limit and liquidate our trading activities during
2002. Our non-trading Value-at-Risk decreased by $7 million in 2002
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due to a reduction of our hedged volumes of future natural gas production during
2002. We reduced these hedged volumes to reduce the cash requirements of our
non-trading price risk management activities.
INTEREST RATE RISK
Many of our debt-related financial instruments and project financing
arrangements are sensitive to changes in interest rates. The table below shows
the maturity of the carrying amounts and related weighted average interest rates
on our interest-bearing securities, by expected maturity dates and the fair
values of those securities. As of December 31, 2002, the carrying amounts of
short-term borrowings are representative of fair values because of the
short-term maturity of these instruments. The fair value of the long-term
securities has been estimated based on quoted market prices for the same or
similar issues.
<Table>
<Caption>
DECEMBER 31, 2002 DECEMBER 31, 2001
-------------------------------------------------------------------------- ---------------------
EXPECTED FISCAL YEAR OF MATURITY OF CARRYING AMOUNTS
------------------------------------------------------------- CARRYING
2003 2004 2005 2006 2007 THEREAFTER TOTAL FAIR VALUE AMOUNTS FAIR VALUE
------ ---- ---- ------ ------ ---------- ------- ---------- -------- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES:
Short-term debt -- variable
rate....................... $1,500 -- -- -- -- -- $ 1,500 $ 1,500 $ 1,515 $ 1,515
Average interest
rate................. 2.7%
Long-term debt, including
current portion -- fixed
rate....................... $ 362 $331 $497 $1,120 $1,122 $12,469 $15,901 $11,488 $12,533 $12,007
Average interest
rate................. 7.8% 7.4% 8.5% 8.3% 7.7% 8.0%
Long-term debt, including
current portion-variable
rate....................... $ 213 $253 $113 $ 113 $ 9 $ 79 $ 780 $ 780 $ 2,082 $ 2,082
Average interest
rate................. 2.5% 4.4% 2.9% 2.7% 2.7% 6.1%
Notes payable to
unconsolidated
affiliates -- fixed
rate................... $ 189 $ 10 $ 12 $ 6 -- -- $ 216 $ 206 $ 515 $ 539
Average interest
rate................. 4.4% 7.3% 7.3% 7.3%
Notes payable to
unconsolidated
affiliates -- variable
rate................... -- -- -- -- -- $ 174 $ 174 $ 174 $ 357 $ 357
Average interest
rate................. 10.4%
COMPANY-OBLIGATED PREFERRED
SECURITIES:
El Paso Energy Capital Trust
I.......................... -- -- -- -- -- $ 325 $ 325 $ 118 $ 325 $ 370
Average interest
rate................. 4.8%
Coastal Finance I............ -- -- -- -- -- $ 300 $ 300 $ 160 $ 300 $ 378
Average fixed interest
rate................. 8.4%
</Table>
The fair value of our long-term securities was significantly impacted by a
series of ratings actions initiated by Moody's and Standard & Poor's that
lowered our unsecured debt rating to Caa1 and B (both "below investment grade"
ratings), and we remain on negative outlook. These rating actions decreased the
fair value of all of our fixed rate long-term securities during 2002.
FOREIGN CURRENCY EXCHANGE RATE RISK
Our exposure to foreign currency exchange rates relates primarily to
changes in foreign currency rates on our Euro-denominated debt obligations. We
have Euro-denominated debt with a principal amount of 1,050 million euros, or
$1,100 million at a Euro/USD spot exchange rate of 1.0492 as of December 31,
2002. 550 million euros and 500 million euros of this debt mature in 2006 and
2009. We have a foreign currency swap that converts 275 million euros of this
debt to U.S. dollars at a fixed rate of 0.9275. The remaining principal of 775
million euros is unhedged and is subject to foreign currency exchange risk. A
ten percent increase or decrease in the Euro/USD exchange rate would increase or
decrease the carrying value of our unhedged Euro-denominated debt by
approximately $81 million.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Below is an index to the financial statements and notes contained in Item
8, Financial Statements and Supplementary Data.
<Table>
<Caption>
PAGE
----
<S> <C>
Consolidated Statements of Income........................... 86
Consolidated Balance Sheets................................. 87
Consolidated Statements of Cash Flows....................... 89
Consolidated Statements of Stockholders' Equity............. 90
Consolidated Statements of Comprehensive Income............. 91
Notes to Consolidated Financial Statements.................. 92
1. Summary of Significant Events and Accounting
Policies............................................ 92
2. Western Energy Settlement............................ 105
3. Mergers and Divestitures............................. 106
4. Restructuring and Merger-Related Costs............... 109
5. Gain (Loss) on Long-Lived Assets..................... 111
6. Accounting Changes................................... 113
7. Ceiling Test Charges................................. 113
8. Other Income and Expenses............................ 114
9. Income Taxes......................................... 115
10. Discontinued Operations.............................. 117
11. Earnings Per Share................................... 118
12. Financial Instruments................................ 119
13. Price Risk Management Activities..................... 119
14. Inventory............................................ 125
15. Regulatory Assets and Liabilities.................... 126
16. Other Assets and Liabilities......................... 127
17. Property, Plant and Equipment........................ 128
18. Debt, Other Financing Obligations and Other Credit
Facilities.......................................... 129
19. Preferred Interests of Consolidated Subsidiaries..... 134
20. Commitments and Contingencies........................ 137
21. Retirement Benefits.................................. 153
22. Capital Stock........................................ 156
23. Stock-Based Compensation............................. 157
24. Segment Information.................................. 160
25. Supplemental Cash Flow Information................... 164
26. Investments in and Advances to Unconsolidated
Affiliates.......................................... 165
27. Supplemental Selected Quarterly Financial Information
(Unaudited)......................................... 173
28. Supplemental Natural Gas and Oil Operations
(Unaudited)......................................... 174
Report of Independent Accountants........................... 182
Schedule II -- Valuation and Qualifying Accounts............ 184
</Table>
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EL PASO CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER COMMON SHARE AMOUNTS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
<S> <C> <C> <C>
Operating revenues
Pipelines................................................. $ 2,605 $ 2,748 $ 2,741
Production................................................ 2,126 2,347 1,686
Field Services............................................ 2,029 2,553 1,439
Merchant Energy........................................... 5,590 6,075 13,000
Corporate and eliminations................................ (156) (74) 405
------- ------- -------
12,194 13,649 19,271
------- ------- -------
Operating expenses
Cost of products and services............................. 6,447 6,353 12,863
Operation and maintenance................................. 2,606 2,876 2,408
Restructuring and merger-related costs.................... 81 1,520 93
(Gain) loss on long-lived assets.......................... 282 183 (5)
Western Energy Settlement................................. 899 -- --
Ceiling test charges...................................... 269 135 --
Depreciation, depletion and amortization.................. 1,405 1,327 1,231
Taxes, other than income taxes............................ 277 334 266
------- ------- -------
12,266 12,728 16,856
------- ------- -------
Operating income (loss)..................................... (72) 921 2,415
Earnings (losses) from unconsolidated affiliates............ (234) 450 428
Minority interest in consolidated subsidiaries.............. (58) (2) --
Other income................................................ 248 396 234
Other expenses.............................................. (109) (136) (57)
Interest and debt expense................................... (1,400) (1,156) (1,040)
Returns on preferred interests of consolidated
subsidiaries.............................................. (159) (217) (204)
------- ------- -------
Income (loss) before income taxes........................... (1,784) 256 1,776
Income taxes................................................ (495) 184 539
------- ------- -------
Income (loss) from continuing operations before
extraordinary items and cumulative effect of accounting
changes................................................... (1,289) 72 1,237
Discontinued operations, net of income taxes................ (124) (5) (1)
Extraordinary items, net of income taxes.................... -- 26 70
Cumulative effect of accounting changes, net of income
taxes..................................................... (54) -- --
------- ------- -------
Net income (loss)........................................... $(1,467) $ 93 $ 1,306
======= ======= =======
Basic earnings per common share
Income (loss) from continuing operations before
extraordinary items and cumulative effect of accounting
changes................................................ $ (2.30) $ 0.14 $ 2.50
Discontinued operations, net of income taxes.............. (0.22) (0.01) --
Extraordinary items, net of income taxes.................. -- 0.05 0.14
Cumulative effect of accounting changes, net of income
taxes.................................................. (0.10) -- --
------- ------- -------
Net income (loss)......................................... $ (2.62) $ 0.18 $ 2.64
======= ======= =======
Diluted earnings per common share
Income (loss) from continuing operations before
extraordinary items and cumulative effect of accounting
changes................................................ $ (2.30) $ 0.14 $ 2.43
Discontinued operations, net of income taxes.............. (0.22) (0.01) --
Extraordinary items, net of income taxes.................. -- 0.05 0.14
Cumulative effect of accounting changes, net of income
taxes.................................................. (0.10) -- --
------- ------- -------
Net income (loss)......................................... $ (2.62) $ 0.18 $ 2.57
======= ======= =======
Basic average common shares outstanding..................... 560 505 494
======= ======= =======
Diluted average common shares outstanding................... 560 516 513
======= ======= =======
</Table>
See accompanying notes.
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EL PASO CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents................................. $ 1,591 $ 1,148
Accounts and notes receivable
Customer, net of allowance of $192 in 2002 and $130 in
2001.................................................. 5,315 5,138
Affiliates............................................. 798 934
Other.................................................. 464 649
Inventory................................................. 888 815
Assets from price risk management activities.............. 1,027 2,702
Margin and other deposits on energy trading activities.... 1,003 872
Other..................................................... 838 547
------- -------
Total current assets.............................. 11,924 12,805
------- -------
Property, plant and equipment, at cost
Pipelines................................................. 18,049 17,595
Natural gas and oil properties, at full cost.............. 14,940 14,466
Refining, crude oil and chemical facilities............... 2,556 2,524
Gathering and processing systems.......................... 1,101 2,628
Power facilities.......................................... 1,058 834
Other..................................................... 651 608
------- -------
38,355 38,655
Less accumulated depreciation, depletion and
amortization........................................... 14,745 14,250
------- -------
Total property, plant and equipment, net.......... 23,610 24,405
------- -------
Other assets
Investments in unconsolidated affiliates.................. 4,907 5,297
Assets from price risk management activities.............. 1,844 2,118
Intangible assets, net.................................... 1,370 1,425
Other..................................................... 2,569 2,496
------- -------
10,690 11,336
------- -------
Total assets...................................... $46,224 $48,546
======= =======
</Table>
See accompanying notes.
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EL PASO CORPORATION
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31,
-----------------
2002 2001
------- -------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable
Trade.................................................. $ 4,699 $ 4,939
Affiliates............................................. 29 26
Other.................................................. 777 959
Short-term financing obligations, including current
maturities............................................. 2,075 3,239
Notes payable to affiliates............................... 189 504
Liabilities from price risk management activities......... 1,073 1,868
Margin and other deposits from customers on energy trading
activities............................................. 123 1,147
Western Energy Settlement................................. 100 --
Other..................................................... 1,285 1,254
------- -------
Total current liabilities......................... 10,350 13,936
------- -------
Debt
Long-term financing obligations........................... 16,106 12,891
Notes payable to affiliates............................... 201 368
------- -------
16,307 13,259
------- -------
Other
Liabilities from price risk management activities......... 1,376 1,231
Deferred income taxes..................................... 3,576 4,388
Western Energy Settlement................................. 799 --
Other..................................................... 2,019 2,363
------- -------
7,770 7,982
------- -------
Commitments and contingencies
Securities of subsidiaries
Preferred interests of consolidated subsidiaries.......... 3,255 3,955
Minority interests of consolidated subsidiaries........... 165 58
------- -------
3,420 4,013
------- -------
Stockholders' equity
Common stock, par value $3 per share; authorized
1,500,000,000 shares and issued 605,298,466 shares in
2002; authorized 750,000,000 shares and issued
538,363,664 shares in 2001............................. 1,816 1,615
Additional paid-in capital................................ 4,444 3,130
Retained earnings......................................... 2,942 4,902
Accumulated other comprehensive income (loss)............. (529) 157
Treasury stock (at cost); 5,730,042 shares in 2002 and
7,628,799 shares in 2001............................... (201) (261)
Unamortized compensation.................................. (95) (187)
------- -------
Total stockholders' equity........................ 8,377 9,356
------- -------
Total liabilities and stockholders' equity........ $46,224 $48,546
======= =======
</Table>
See accompanying notes.
88
<PAGE>
EL PASO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------
2002 2001 2000
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss)......................................... $(1,467) $ 93 $ 1,306
Less loss from discontinued operations, net of income
taxes................................................... (124) (5) (1)
------- ------- -------
Net income (loss) from continuing operations.............. (1,343) 98 1,307
Adjustments to reconcile net income (loss) to net cash
from operating activities
Depreciation, depletion and amortization................ 1,405 1,327 1,231
Western Energy Settlement............................... 899 -- --
Ceiling test charges.................................... 269 135 --
Deferred income tax expense (benefit)................... (520) 200 612
Non-cash portion of merger-related costs and changes in
estimates............................................. -- 1,215 (21)
(Gain) loss on long-lived assets........................ 282 183 (5)
Undistributed equity (earnings) losses from
unconsolidated affiliates............................. 547 (40) (109)
Non-cash (gain) loss from trading and power
restructuring activities.............................. 48 (852) (443)
Other non-cash income items............................. 372 140 (63)
Working capital changes, net of non-cash transactions... (1,436) 1,914 (2,334)
Non-working capital changes and other................... (177) (207) (89)
------- ------- -------
Cash provided by continuing operations................ 346 4,113 86
Cash provided by discontinued operations.............. 90 7 13
------- ------- -------
Net cash provided by operating activities.......... 436 4,120 99
------- ------- -------
Cash flows from investing activities
Additions to property, plant and equipment................ (3,716) (4,023) (3,379)
Equity investments........................................ (299) (956) (1,492)
Cash paid for acquisitions, net of cash acquired.......... 45 (299) (524)
Net proceeds from the sale of assets...................... 2,554 548 787
Proceeds from the sale of investments..................... 391 354 354
Net change in restricted cash............................. (244) 3 24
Net change in notes receivable from unconsolidated
affiliates.............................................. 4 (606) 466
Other..................................................... 22 12 (1)
------- ------- -------
Cash used in continuing operations.................... (1,243) (4,967) (3,765)
Cash used in discontinued operations.................. (12) (56) (69)
------- ------- -------
Net cash used in investing activities.............. (1,255) (5,023) (3,834)
------- ------- -------
Cash flows from financing activities
Net short-term borrowings (repayments).................... 60 (786) 309
Net long-term borrowings.................................. 1,457 1,277 2,419
Net proceeds from issuance of preferred securities........ -- -- 293
Payments to minority interest holders..................... (161) -- --
Payments to preferred interest holders.................... (700) -- --
Issuances of common stock................................. 1,053 915 141
Dividends paid............................................ (470) (387) (243)
Proceeds from issuance of minority interests.............. 33 281 995
Contributions from (distributions to) discontinued
operations.............................................. 68 (43) (57)
------- ------- -------
Cash provided by continuing operations.................. 1,340 1,257 3,857
Cash provided by (used in) discontinued operations...... (68) 43 57
------- ------- -------
Net cash provided by financing activities.......... 1,272 1,300 3,914
------- ------- -------
Increase in cash and cash equivalents....................... 453 397 179
Less increase (decrease) in cash and cash equivalents
related to discontinued operations........................ 10 (6) 1
------- ------- -------
Increase in cash and cash equivalents from continuing
operations................................................ 443 403 178
Cash and cash equivalents
Beginning of period....................................... 1,148 745 567
------- ------- -------
End of period............................................. $ 1,591 $ 1,148 $ 745
======= ======= =======
</Table>
See accompanying notes.
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<PAGE>
EL PASO CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN MILLIONS)
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
---------------- ---------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------- ------ ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Common stock, $3.00 par:
Balance at beginning of year............. 538 $ 1,615 514 $ 1,541 507 $1,520
Compensation related issuances........... 2 5 3 10 6 18
Equity offering.......................... 52 155 20 61 -- --
Conversion of Coastal options............ -- -- 4 13 -- --
Conversion of FELINE PRIDES(SM).......... 12 37 -- -- -- --
Other.................................... 1 4 (3) (10) 1 3
--- ------- ---- ------- --- ------
Balance at end of year................ 605 1,816 538 1,615 514 1,541
--- ------- ---- ------- --- ------
Additional paid-in capital:
Balance at beginning of year............. 3,130 1,925 1,667
Compensation related issuances........... 57 188 171
Tax benefit of equity plans.............. 15 31 60
Equity offering.......................... 846 802 --
Retirement of Coastal treasury shares.... -- (132)
Conversion of Coastal options............ -- 265 --
Conversion of FELINE PRIDES(SM).......... 423 -- --
Other.................................... (27) 51 27
------- ------- ------
Balance at end of year................ 4,444 3,130 1,925
------- ------- ------
Retained earnings:
Balance at beginning of year............. 4,902 5,243 4,180
Net income (loss)........................ (1,467) 93 1,306
Dividends ($0.870, $0.850 and $0.824 per
share)................................ (493) (434) (243)
------- ------- ------
Balance at end of year................ 2,942 4,902 5,243
------- ------- ------
Accumulated other comprehensive income
(loss):
Balance at beginning of year............. 157 (65) (37)
Other comprehensive income (loss)........ (686) 222 (28)
------- ------- ------
Balance at end of year................ (529) 157 (65)
------- ------- ------
Treasury stock, at cost:
Balance at beginning of year............. (8) (261) (14) (400) (14) (405)
Compensation related issuances........... 3 79 1 11 -- 3
Retirement of Coastal treasury shares.... -- -- 5 132 -- --
Other.................................... (1) (19) -- (4) -- 2
--- ------- ---- ------- --- ------
Balance at end of year................ (6) (201) (8) (261) (14) (400)
--- ------- ---- ------- --- ------
Unamortized compensation:
Balance at beginning of year............. (187) (125) (41)
Issuance of new restricted stock......... (36) (144) (82)
Amortization of restricted stock......... 73 67 13
Market price changes on variable
restricted stock awards............... 40 11 (15)
Forfeitures of restricted stock.......... 15 4 --
------- ------- ------
Balance at end of year................ (95) (187) (125)
--- ------- ---- ------- --- ------
Total stockholders' equity................. 599 $ 8,377 530 $ 9,356 500 $8,119
=== ======= ==== ======= === ======
</Table>
See accompanying notes.
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<PAGE>
EL PASO CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN MILLIONS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------
2002 2001 2000
------- ------- ------
<S> <C> <C> <C>
Net income (loss)........................................... $(1,467) $ 93 $1,306
------- ------- ------
Foreign currency translation adjustments.................. (18) (33) (30)
Pension minimum liability accrual (net of income tax of
$20)................................................... (35) -- --
Net gains (losses) from cash flow hedging activities:
Cumulative-effect of transition adjustment (net of
income tax of $673).................................. -- (1,280) --
Unrealized mark-to-market gains (losses) arising during
period (net of income tax of $261 and $548 in 2002
and 2001)............................................ (459) 1,042 --
Reclassification adjustments for changes in initial
value to settlement date (net of income tax of $96
and $283 in 2002 and 2001)........................... (174) 494 --
Other..................................................... -- (1) 2
------- ------- ------
Other comprehensive income (loss).................... (686) 222 (28)
------- ------- ------
Comprehensive income (loss)................................. $(2,153) $ 315 $1,278
======= ======= ======
</Table>
See accompanying notes.
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<PAGE>
EL PASO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT EVENTS AND ACCOUNTING POLICIES
SIGNIFICANT EVENTS
Overview of Industry Developments
During 2002, we experienced dramatic changes in our industry as well as in
the financial markets on which we rely. In response to industry events, the
credit rating agencies, including Moody's and Standard & Poor's, re-evaluated
the ratings of companies involved in energy trading activities. As a result, the
ratings of many of the largest participants in the energy trading industry,
including us, were downgraded to below investment grade. Also impacting us was a
preliminary decision reached by a FERC administrative law judge (ALJ) that one
of our subsidiaries withheld pipeline capacity from the California market during
2000 and 2001. Reacting to the changes in the market, our leverage and a
preliminary decision by the FERC on our California matters, Moody's and Standard
& Poor's initiated a series of ratings actions lowering our senior unsecured
debt rating to Caa1 and B (both "below investment grade" ratings), and we remain
on negative outlook.
Several negative outcomes resulted from these downgrades. First, cash
generated in 2002 from the sales of assets, which had originally been identified
for debt reductions, was instead required to be posted as additional cash
collateral in connection with our commercial trading activities, paid to meet
financial guarantees and used to meet other arrangements. Additionally, our
access to capital markets and commercial paper markets became more restricted
because of our lower credit ratings. Finally, the credit downgrades have
resulted in the net cash generated by the assets in two of our minority interest
financing arrangements being largely unavailable to us for general corporate
purposes. Instead, we were required to use this cash to redeem preferred
securities issued in connection with those arrangements and for the operation of
the businesses that collateralize those arrangements. In March of 2003, we
redeemed the outstanding amounts under one of these financing arrangements,
partially freeing up these cash usage restrictions. For a further discussion of
this, see Note 19.
Liquidity Developments
We rely on cash generated from our operations as our primary source of
liquidity. We also expect to rely on borrowings under available credit
facilities, bank financings, asset sales and the issuance of long-term debt,
preferred and equity securities to provide liquidity as needed and for overall
flexibility. We believe that our future working capital needs, capital
expenditures, long-term debt repayments, dividends and other financing
activities will continue to be provided from some or all of these sources of
liquidity. Since the fourth quarter of 2001, we have taken a number of actions
to address our liquidity issues, and have made progress in our plans to meet the
demands on our liquidity and strengthen our capital structure.
Our accomplishments have included the sale of over $2.5 billion of equity
or equity-related securities, the completion or announcement of over $5.5
billion of asset sales, the removal of over $4 billion of rating triggers from
our investment and financing programs, which would have resulted in issuance of
common stock or the accelerated repayment of these obligations, and the
announcement of a plan to exit our trading business and minimize our involvement
in the LNG business. On February 5, 2003, we announced our 2003 Operational and
Financial Plan. This plan is based on five key principles:
- Preserving and enhancing the value of our core natural gas and pipeline
businesses;
- Exiting non-core businesses quickly, but prudently;
- Strengthening and simplifying our balance sheet, while maximizing
liquidity;
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<PAGE>
- Aggressively pursuing additional cost reductions; and
- Continuing to work diligently to resolve litigation and regulatory
matters.
Through March 2003, we have made further progress in accomplishing our
objectives under this plan, including (i) the finalization of a new $1.2 billion
term loan, which allowed us to retire our Trinity River preferred interest
financing arrangement and eliminate the cash restrictions and accelerated
amortization requirements of that arrangement (ii) the repayment of over $1.9
billion of financial obligations, including Electron and Trinity River, (iii)
the issuance of $700 million in bonds at two of our wholly owned subsidiaries
and (iv) the announcement of an agreement in principle to settle the principal
claims asserted against us in the western energy crisis of 2001.
We believe the accomplishment of this announced plan will enable us to
address our liquidity issues and simplify and improve our capital structure.
However, a number of factors could influence the timing and ultimate outcome of
our efforts.
SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our consolidated financial statements include the accounts of all
majority-owned, controlled subsidiaries after the elimination of all significant
intercompany accounts and transactions. Our financial statements for prior
periods include reclassifications that were made to conform to the current year
presentation. Those reclassifications did not impact our reported net income or
stockholders' equity.
Principles of Consolidation
We consolidate entities when we have the ability to control the operating
and financial decisions and policies of that entity. Where we can exert
significant influence over, but do not control, those policies and decisions, we
apply the equity method of accounting. We use the cost method of accounting
where we are unable to exert significant influence over the entity. The
determination of our ability to control or exert significant influence over an
entity involves the use of judgment of the extent of our control or influence
and that of the other equity owners or participants of the entity. Discussed
below as part of new accounting principles issued but not yet adopted is a
standard that, once effective, will impact our consolidation principles.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires the use of estimates and assumptions
that affect the amounts we report as assets, liabilities, revenues, and expenses
and our disclosures in these financial statements. Actual results can, and often
do, differ from those estimates.
Accounting for Regulated Operations
Our interstate natural gas systems and storage operations are subject to
the regulations and accounting procedures of the FERC in accordance with the
Natural Gas Act of 1938 and the Natural Gas Policy Act of 1978. Our interstate
systems, including TGP, EPNG, SNG and MPC, apply the provisions of Statement of
Financial Accounting Standards (SFAS) No. 71, Accounting for the Effects of
Certain Types of Regulation. ANR, CIG and WIC discontinued the application of
SFAS No. 71 in 1996. Accounting for regulated businesses that apply the
provisions of SFAS No. 71 differs from the accounting requirements for regulated
businesses that do not apply SFAS No. 71. Transactions that have been recorded
differently as a result of regulatory accounting requirements include the
capitalization of an equity return component on regulated capital projects,
employee related benefits, depreciation and other costs and taxes included in,
or expected to be included in, future rates.
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<PAGE>
Our application of SFAS No. 71 is based on the current regulatory
environment and our current tariff rates. Future regulatory developments and
rate cases could impact this accounting. Things that may influence our
assessment are:
- inability to recover cost increases due to rate caps and rate case
moratoriums;
- inability to recover capitalized costs, including an adequate return on
those costs through the ratemaking process and FERC proceedings;
- excess capacity;
- discounting rates in the markets we serve; and
- impacts of ongoing initiatives in, and deregulation of, the natural gas
industry.
We will continue to evaluate the application of regulatory accounting
principles based on on-going changes in the regulatory and economic environment.
Cash and Cash Equivalents
We consider short-term investments with an original maturity of less than
three months to be cash equivalents.
We maintain cash on deposit with banks and insurance companies that is
pledged for a particular use or restricted to support a potential liability. We
classify these balances as other current or non-current assets in our balance
sheet based on when we expect this cash to be used. As of December 31, 2002 and
2001, we reported $124 million and $17 million as other current assets and $212
million and $75 million as other non-current assets.
Allowance for Doubtful Accounts
We establish provisions for losses on accounts receivable and for natural
gas imbalances due from shippers and operators if we determine that we will not
collect all or part of the outstanding balance. We regularly review
collectibility and establish or adjust our allowance as necessary using the
specific identification method.
Inventory
Our inventory consists of refined products, crude oil and chemicals,
materials and supplies, natural gas in storage, coal and optic fiber. We also
hold power turbines in inventory. We classify inventory as current or
non-current based on whether it will be sold or used in the next twelve months.
We report non-current inventory as part of other non-current assets in our
balance sheets. We use the first-in, first-out and average cost methods to
account for our refined products, crude oil and chemicals inventories and the
average cost method to account for our other inventories. We value all inventory
at the lower of its cost or market value. On October 1, 2002, we adopted the
provisions of Emerging Issues Task Force (EITF) Issue No. 02-3, which required
us to reclassify all physical commodity inventory used in trading activities
from net assets from price risk management activities to inventory on our
balance sheet and to adjust this inventory to the lower of cost or market. See
Price Risk Management Activities below for a further discussion of this
accounting change.
Natural Gas and Oil Imbalances and Exchanges
Natural gas and oil imbalances occur when the actual amount of natural gas
or oil delivered from or received by a pipeline system, processing plant or
storage facility differs from the contractual amount scheduled to be delivered
or received. Natural gas exchange transactions involve receiving or delivering
natural gas inventory that will be made up in-kind. We value these imbalances
and exchanges due to or from shippers and operators at an appropriate market
index price. Imbalances and exchanges are settled in cash or made up in-kind,
subject to the contractual terms of settlement and tariffs.
Imbalances and exchanges due from others are reported in our balance sheet
as either accounts receivable from customers or accounts receivable from
unconsolidated affiliates. Imbalances and exchanges
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<PAGE>
owed to others are reported on the balance sheet as either trade accounts
payable or accounts payable to unconsolidated affiliates. In addition, all
imbalances and exchanges are classified as current or long-term depending on
when we expect to settle them. On October 1, 2002, we adopted the provisions of
EITF Issue No. 02-3, which required us to reclassify all natural gas exchanges
resulting from trading activities from net assets from price risk management
activities to accounts receivable and accounts payable on our balance sheet. See
Price Risk Management Activities below for a further discussion of this
accounting change.
Property, Plant and Equipment
Our property, plant and equipment is recorded at its original cost of
construction or, upon acquisition, at either the fair value of the assets
acquired or the cost to the entity that first placed the asset in service. We
capitalize direct costs, such as labor and materials, and indirect costs, such
as overhead, interest and in our regulated businesses that apply the provisions
of SFAS No. 71, an equity return component. We capitalize the major units of
property replacements or improvements and expense minor items. Included in our
pipeline property balances are additional acquisition costs, which represent the
excess purchase costs associated with purchase business combinations allocated
to our regulated interstate systems. These costs are amortized on a
straight-line basis, and we do not recover these excess costs in our rates.
The following table presents our property, plant and equipment by type,
depreciation method, remaining useful lives and depreciation rate:
<Table>
<Caption>
REMAINING
TYPE METHOD USEFUL LIVES RATES
- ----------------------------------------------------- ------------- ------------ ------------
(IN YEARS)
<S> <C> <C> <C>
Regulated interstate systems
SFAS No. 71(1)..................................... Composite 1-57 1% to 33%
Non-SFAS No. 71.................................... Straight-line 2-50 2% to 25%
Non-regulated systems
Transmission and storage facilities................ Straight-line 60 1% to 3%
Refining, crude oil and chemical facilities........ Straight-line 1-33 3% to 20%
Power facilities................................... Straight-line 3-26 2% to 33%
Gathering and processing systems................... Straight-line 1-40 3% to 40%
Transportation equipment........................... Straight-line 1-30 3% to 33%
Buildings and improvements......................... Straight-line 1-43 2% to 50%
Office and miscellaneous equipment................. Straight-line 1-20 4% to 50%
</Table>
- ---------------
(1) For our regulated interstate systems that apply SFAS No. 71, we use the
composite (group) method to depreciate property, plant and equipment. Under
this method, assets with similar useful lives and other characteristics are
grouped and depreciated as one asset. We apply the depreciation rate
approved in our tariff to the total cost of the group until its net book
value equals its salvage value. We re-evaluate depreciation rates each time
we redevelop our transportation rates when we file with the FERC for an
increase or decrease in rates.
When we retire regulated property, plant and equipment accounted for under
SFAS No. 71, we charge accumulated depreciation and amortization for the
original cost, plus the cost to remove, sell or dispose, less its salvage value.
We do not recognize a gain or loss unless we sell an entire operating unit. We
include gains or losses on dispositions of operating units in income. When we
retire regulated property, plant and equipment not accounted for under SFAS No.
71 and non-regulated properties, we reduce property, plant and equipment for its
original cost, less accumulated depreciation, and salvage value. Any remaining
gain or loss is recorded in income.
We capitalize a carrying cost on funds invested in our construction of
long-lived assets. This carrying cost consists of (i) an interest cost on the
investment financed by debt, which applies to both regulated and non-regulated
transmission businesses and (ii) a return on the investment financed by equity,
which only applies to regulated transmission businesses that apply SFAS No. 71.
The debt portion is calculated based on the average cost of debt. Interest cost
on debt amounts capitalized during the years ended December 31, 2002, 2001 and
2000, were $33 million, $65 million and $82 million. These amounts are included
as a reduction of interest expense in our income statements. The equity portion
is calculated using the most recent FERC approved equity rate of return. Equity
amounts capitalized during the years ended December 31, 2002, 2001
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<PAGE>
and 2000 were $8 million, $8 million and $2 million. These amounts are included
as other non-operating income on our income statement. Capitalized carrying cost
for debt and equity are reflected as an increase in the cost of the asset on our
balance sheet.
Asset Impairments
We apply the provisions of SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, to account for asset impairments. Under this
standard, we evaluate an asset for impairment when events or circumstances
indicate that a long-lived asset's carrying value may not be recovered. These
events include market declines, changes in the manner in which we intend to use
an asset or decisions to sell an asset and adverse changes in the legal or
business environment such as adverse actions by regulators. When we decide to
exit or sell a long-lived asset or group of assets, we adjust the carrying value
of these assets downward, if necessary, to the estimated sales price, less costs
to sell. We also reclassify the asset or assets as either held for sale or as
discontinued operations, depending on whether they have independently
determinable cash flows.
Natural Gas and Oil Properties
We use the full cost method to account for our natural gas and oil
properties. Under the full cost method, substantially all productive and
nonproductive costs incurred in connection with the acquisition, exploration and
development of natural gas and oil reserves are capitalized. These capitalized
amounts include the costs of all unproved properties, internal costs directly
related to acquisition, development and exploration activities and capitalized
interest.
We amortize these costs using the unit of production method over the life
of our proved reserves. Each quarter, we calculate the unit of production
depletion rate based on our estimated production and an estimate of proved
reserves. Capitalized costs associated with unproved properties are excluded
from amortizable costs until these properties are evaluated. Future development
costs and dismantlement, restoration and abandonment costs, net of estimated
salvage values, are included in costs subject to amortization.
Our capitalized costs, net of related income tax effects, are limited to a
ceiling based on the present value of future net revenues using end of period
spot prices discounted at 10 percent, plus the lower of cost or fair market
value of unproved properties, net of related income tax effects. If these
discounted revenues are not equal to or greater than total capitalized costs, we
are required to write-down our capitalized costs to this level. We perform this
ceiling test calculation each quarter. Any required write-downs are included in
our income statement as a ceiling test charge. Our ceiling test calculations
include the effects of derivative instruments we have designated as cash flow
hedges of our anticipated future natural gas and oil production.
We do not recognize a gain or loss on sales of our natural gas and oil
properties, unless those sales would significantly alter the relationship
between capitalized costs and proved reserves. We treat sales proceeds on
non-significant sales as an adjustment to the cost of our properties.
Planned Major Maintenance
Repair and maintenance costs are generally expensed as incurred, unless
they improve the operating efficiency or extend the useful life of an asset.
In our domestic refining business, repair and maintenance costs for planned
major maintenance activities are accrued as a liability in a systematic and
rational manner over the period of time until the planned major maintenance
activities occur. Any difference between the accrued liability and the actual
costs incurred in performing the maintenance activities are charged or credited
to expense at the time the maintenance occurs. At our international refineries,
the cost of each major maintenance activity is capitalized and amortized to
expense in a systematic and rational manner over the estimated period extending
to the next planned major maintenance activity. The types of costs we accrue in
conjunction with major maintenance at our refineries are outside contractor
costs, materials and supplies, company labor and other outside services. For our
domestic operations, we had accruals for major maintenance of $40 million and
$36 million at December 31, 2002 and 2001, and for
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<PAGE>
our international operations, we capitalized $75 million and $51 million for the
years ended December 31, 2002 and 2001.
Goodwill and Other Intangible Assets
Our intangible assets consist of goodwill resulting from acquisitions and
other intangible assets. We apply SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets to account for these intangibles.
Under these standards, we recognize goodwill separately from other intangible
assets. In addition, goodwill and intangibles that have indefinite lives are not
amortized. Also, goodwill and indefinite lived intangible assets are
periodically tested for impairment, at least annually, or whenever an event
occurs that indicates that an impairment may have occurred. We adopted these
standards on January 1, 2002 and stopped amortizing goodwill. We also recognized
a pretax and after-tax gain of $154 million related to the elimination of
negative goodwill. We reported this gain as a cumulative effect of an accounting
change in our income statement.
SFAS No. 142 requires that we perform impairment tests upon adoption of the
standard on January 1, 2002 and at least annually thereafter. The initial
impairment tests we performed as of January 1, 2002 indicated no impairment of
our goodwill. The impairment tests we performed as of December 31, 2002,
however, indicated a pre-tax impairment of our goodwill associated with our
Merchant Energy segment's financial services businesses, EnCap and Enerplus, of
$44 million. This impairment was recorded in 2002 and was the result of the
combined effects of weak financial services industry conditions and our decision
not to continue to invest capital in these financial services businesses. The
net carrying amounts of our goodwill as of January 1, 2002 and December 31, 2002
reported in net intangible assets in our balance sheets, and the changes in the
net carrying amounts of goodwill for the year ended December 31, 2002 for each
of our segments are as follows:
<Table>
<Caption>
FIELD MERCHANT CORPORATE &
PIPELINES PRODUCTION SERVICES ENERGY OTHER TOTAL
--------- ---------- -------- -------- ----------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Balances as of January 1, 2002..... $413 $61 $393 $ 89 $249 $1,205
Impairments........................ -- -- -- (44) -- (44)
Other changes...................... -- 1 9 -- (5) 5
---- --- ---- ---- ---- ------
Balances as of December 31, 2002... $413 $62 $402 $ 45 $244 $1,166
==== === ==== ==== ==== ======
</Table>
Our other intangible assets consist of customer lists, our general
partnership interest in El Paso Energy Partners, L.P. and other miscellaneous
intangible assets. We amortize all intangible assets on a straight-line basis
over their estimated useful life excluding our excess investment in our general
partnership interest in El Paso Energy Partners which has been determined to
have an indefinite life. The following are the gross carrying amounts and
accumulated amortization of our other intangible assets as of December 31:
<Table>
<Caption>
2002 2001
----- -----
(IN MILLIONS)
<S> <C> <C>
Intangible assets subject to amortization................... $ 52 $ 59
Accumulated amortization.................................... (29) (20)
---- ----
23 39
Intangible assets not subject to amortization............... 181 181
---- ----
$204 $220
==== ====
</Table>
Amortization expense of our intangible assets that were subject to
amortization was $9 million for the year ended December 31, 2002. For the year
ended December 31, 2001, amortization of all intangible assets, including
goodwill, was $55 million. Based on the current amount of intangible assets
subject to amortization, our estimated amortization expense is approximately $2
million for each of the next five years. These amounts may vary as a result of
future acquisitions, dispositions and any recorded impairments.
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<PAGE>
The following table presents our income from continuing operations before
extraordinary items and the cumulative effect of accounting changes, net income
and earnings per common share for the years ended December 31, 2001 and 2000, as
if goodwill and other indefinite-lived intangibles had not been amortized during
those periods, compared with those amounts reported for the year ended December
31, 2002:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------
2002 2001 2000
------- ----- ------
(IN MILLIONS, EXCEPT PER
COMMON SHARE AMOUNTS)
<S> <C> <C> <C>
Reported income (loss) from continuing operations before
extraordinary items and cumulative effect of accounting
changes(1)................................................ $(1,289) $ 72 $1,237
Amortization of goodwill and indefinite-lived intangibles... -- 35 44
------- ----- ------
Adjusted income (loss) from continuing operations before
extraordinary items and cumulative effect of accounting
changes................................................... $(1,289) $ 107 $1,281
======= ===== ======
Net income (loss):
Reported net income (loss).................................. $(1,467) $ 93 $1,306
Amortization of goodwill and indefinite-lived intangibles... -- 35 44
------- ----- ------
Adjusted net income (loss).................................. $(1,467) $ 128 $1,350
======= ===== ======
Basic earnings per common share:
Reported net income (loss).................................. $ (2.62) $0.18 $ 2.64
Amortization of goodwill and indefinite-lived intangibles... -- 0.07 0.09
------- ----- ------
Adjusted net income (loss).................................. $ (2.62) $0.25 $ 2.73
======= ===== ======
Diluted earnings per common share:
Reported net income (loss).................................. $ (2.62) $0.18 $ 2.57
Amortization of goodwill and indefinite-lived intangibles... -- 0.07 0.09
------- ----- ------
Adjusted net income (loss).................................. $ (2.62) $0.25 $ 2.66
======= ===== ======
</Table>
- ---------------
(1) Amounts include the reclassification of the results of our coal business as
discontinued operations.
Pension and Other Postretirement Benefits
We maintain several pension and other postretirement benefit plans. These
plans require us to make contributions to fund the benefits to be paid out under
the plans. These contributions are invested until the benefits are paid out to
plan participants. We record benefit expense in our income statement. This
benefit expense is a function of many factors including benefits earned during
the year by plan participants (which is a function of the employee's salary, the
level of benefits provided under the plan, actuarial assumptions, and the
passage of time), expected return on plan assets and recognition of certain
deferred gains and losses as well as plan amendments.
We compare the benefits earned, or the accumulated benefit obligation, to
the plan's fair value of assets on an annual basis. To the extent the plan's
accumulated benefit obligation exceeds the fair value of plan assets, we record
a minimum pension liability in our balance sheet equal to the difference in
these two amounts. We do not adjust this minimum liability if it is less than
the liability already accrued for the plan. If this difference is greater than
the pension liability recorded on our balance sheet, however, we record an
additional liability and an amount to other comprehensive loss, net of income
taxes, on our financial statements.
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Revenue Recognition
Our business segments provide a number of services and sell a variety of
products. Our revenue recognition policies by segment are as follows:
Pipelines revenues. Our Pipelines segment derives revenues primarily from
transportation and storage services and sales under gas sales contracts. For our
transportation and storage services, we recognize reservation revenues on firm
contracted capacity ratably over the contract period. For interruptible or
volumetric based services, we record revenues when we complete the delivery of
natural gas to the agreed upon delivery point and when natural gas is injected
or withdrawn from the storage facility. Revenues under natural gas sales
contracts are recognized when physical deliveries of commodities are made at the
agreed upon delivery point. Revenues in all services are generally based on the
thermal quantity of gas delivered or subscribed at a price specified in the
contract or tariff. We are subject to FERC regulations and, as a result,
revenues we collect may possibly be refunded in a final order of a pending or
future rate proceeding or as a result of a rate settlement. We have established
reserves for these potential refunds.
Production revenues. Our Production segment's revenues are derived
principally through physical sales of natural gas, oil and natural gas liquids
produced. Revenues from sales of these products are recorded upon the passage of
title using the sales method, net of any royalty interests or other profit
interests in the produced product. When actual natural gas sales volumes exceed
our entitled share of sales volumes, an overproduced imbalance occurs. To the
extent the overproduced imbalance exceeds our share of the remaining estimated
proved natural gas reserves for a given property, we record a liability. Costs
associated with the transportation and delivery of production are included in
cost of sales.
Field Services revenues. Our Field Services segment derives revenues
principally from gathering, transportation and processing services and through
the sale of commodities that are retained from providing these services. There
are two general types of service: fee-based and make-whole. For fee-based
services we recognize revenues at the time service is rendered based upon the
volume of gas gathered, treated or processed at the contracted fee. For
make-whole services, our fee consists of retainage of natural gas liquids and
other by-products that are a result of processing, and we recognize revenues on
these services at the time we sell these products, which generally coincides
with when we provide the service.
Merchant Energy revenues. Merchant Energy derives revenues from a number
of sources including physical sales of natural gas, power and petroleum, and
petroleum products. Revenues on these physical sales are recognized based on the
volumes delivered and the contracted or market price and are recognized at the
time the commodity is delivered to the specified delivery point. Revenues from
commodities sold as part of Merchant Energy's energy trading division are
reflected net of the cost of these sales. The energy trading division of
Merchant Energy also enters into derivative transactions which are recorded at
their fair value. See a discussion of our income recognition policies on
derivatives below under Price Risk Management Activities.
Corporate. Revenue producing activities in our corporate segment consist
principally of revenues from our telecommunications business. We recognize
revenues for our metro transport, collocation and cross-connect services in the
month that the services are actually used by the customer.
Environmental Costs and Other Contingencies
We record liabilities when our environmental assessments indicate that
remediation efforts are probable, and the costs can be reasonably estimated. We
recognize a current period expense for the liability when clean-up efforts do
not benefit future periods. We capitalize costs that benefit more than one
accounting period, except in instances where separate agreements or legal or
regulatory guidelines dictate otherwise. Estimates of our liabilities are based
on currently available facts, existing technology and presently enacted laws and
regulations taking into consideration the likely effects of inflation and other
societal and economic factors, and include estimates of associated legal costs.
These amounts also consider prior experience in remediating contaminated sites,
other companies' clean-up experience and data released by the EPA or other
organizations. These estimates are subject to revision in future periods based
on actual costs or new circumstances and are included in our balance sheet in
other current and long-term liabilities at their
99
<PAGE>
undiscounted amounts. We evaluate recoveries from insurance coverage or
government sponsored programs separately from our liability and, when recovery
is assured, we record and report an asset separately from the associated
liability in our financial statements.
We recognize liabilities for other contingencies when we have an exposure
that, when fully analyzed, indicates it is both probable that an asset has been
impaired or that a liability has been incurred and the amount of impairment or
loss can be reasonably estimated. Funds spent to remedy these contingencies are
charged against a reserve, if one exists, or expensed. When a range of probable
loss can be estimated, we accrue the most likely amount or at least the minimum
of the range of probable loss.
Price Risk Management Activities
We engage in price risk management activities to manage market risks
associated with commodities we purchase and sell, interest rates and foreign
currency exchange rates. These price risk management activities include trading
activities that we enter into with the objective of generating profits or from
exposure to shifts or changes in market prices, non-trading activities related
to our power investment, generation and power contract restructuring activities,
and other non-trading activities that involve hedging the market price risk
exposures on our assets, liabilities, contractual commitments and forecasted
transactions of each of our business segments. Our trading and non-trading price
risk management activities involve the use of a variety of derivative financial
instruments, including:
- exchange-traded futures contracts that involve cash settlements;
- forward contracts that involve cash settlements or physical delivery of a
commodity;
- swap contracts that require payments to (or receipts from) counterparties
based on the difference between a fixed and a variable price, or two
variable prices, for a commodity; and
- exchange-traded and over-the counter options.
We account for our trading and non-trading derivative instruments under
SFAS No. 133, Accounting for Derivatives and Hedging Activities. Under SFAS No.
133, all derivatives are reflected in our balance sheet at their fair value as
price risk management activities. We classify our price risk management
activities as either current or non-current assets or liabilities based on our
overall position by counterparty and their anticipated settlement date. Cash
inflows and outflows associated with the settlement of our price risk management
activities are recognized in operating cash flows, and any receivables and
payables resulting from these settlements are reported separately from price
risk management activities in our balance sheet as trade receivables and
payables. The accounting for revenues and expenses associated with our price
risk management activities varies based on whether those activities are trading
activities or non-trading activities. See Note 13 for a further description of
our price risk management activities.
During 2002, we adopted DIG Issue No. C-16, Scope Exceptions: Applying the
Normal Purchases and Sales Exception to Contracts that Combine a Forward
Contract and Purchased Option Contract. DIG Issue No. C-16 requires that if a
fixed-price fuel supply contract allows the buyer to purchase, at their option,
additional quantities at a fixed-price, the contract is a derivative that must
be recorded at its fair value. One of our unconsolidated affiliates, the Midland
Cogeneration Venture Limited Partnership, recognized a gain on one fuel supply
contract upon adoption of these new rules, and we recorded a gain of $14
million, net of income taxes, as a cumulative effect of an accounting change in
our income statement for our proportionate share of this gain.
During 2002, we also adopted the provisions of EITF Issue No. 02-3, Issues
Related to Accounting for Contracts Involved in Energy Trading and Risk
Management Activities. Prior to EITF Issue No. 02-3, we accounted for our
non-derivative trading instruments, such as contracts for transportation and
storage capacity and physical natural gas inventory and exchanges that were
actively traded as part of our trading business, at their fair value under EITF
Issue No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk
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<PAGE>
Management Activities. EITF Issue No. 02-3 rescinded EITF Issue No. 98-10 and
reached two general conclusions:
- Contracts which do not meet the definition of a derivative under SFAS No.
133 should not be marked to fair market value, and
- Revenues and costs associated with trading activities should be shown net
in the income statement, whether or not they are physically settled.
As a result of our adoption of EITF Issue No. 02-3, we adjusted the
carrying value of our non-derivative trading instruments (principally
transportation and storage capacity contracts) to zero and now account for them
using the accrual basis of accounting. We also adjusted the physical natural gas
inventory and exchanges used in our trading business to their actual cost (which
was lower than market) and expected settlement amounts and reclassified these
amounts to inventory and accounts receivable and payable on our balance sheet.
The adoption of EITF Issue No. 02-3 had the following impacts on our financial
statements:
- The elimination of the mark-to-market value for contracts that do not
meet the definition of a derivative ($225 million), which is reported as
a cumulative effect of change in accounting principle;
- An adjustment of the carrying value of our natural gas inventory to its
weighted average cost and the value of exchanges to their expected
settlement price assuming they had been accounted for under that basis
since their acquisition ($118 million), which is reported as a cumulative
effect of change in accounting principle; and
- A balance sheet reclassification of natural gas inventory and exchanges
from price risk management assets to inventory and accounts receivable
and payable ($254 million).
In total, we recorded a cumulative effect of an accounting change in our
income statement of $343 million ($222 million net of income taxes) from the
adoption of EITF Issue No. 02-3. We also began to report our trading activity on
a net basis (revenues net of the expenses of the physically settled purchases)
as a component of revenues effective July 1, 2002. We applied this guidance to
all prior periods, which had no impact on previously reported net income or
stockholders' equity. Revenues and costs for periods prior to the adoption of
EITF Issue No. 02-3 are revised as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
---------- ----------
(IN MILLIONS)
<S> <C> <C>
Gross operating revenues.................................... $ 57,138 $ 48,639
Costs reclassified.......................................... (43,489) (29,368)
-------- --------
Net operating revenues reported in the income
statements............................................. $ 13,649 $ 19,271
======== ========
</Table>
Income Taxes
We report current income taxes based on our taxable income, and we provide
for deferred income taxes to reflect estimated future tax payments and receipts.
Deferred taxes represent the tax impacts of differences between the financial
statement and tax bases of assets and liabilities and carryovers at each year
end. We account for tax credits under the flow-through method, which reduces the
provision for income taxes in the year the tax credits first become available.
We reduce deferred tax assets by a valuation allowance when, based on our
estimates, it is more likely than not that a portion of those assets will not be
realized in a future period. The estimates utilized in recognition of deferred
tax assets are subject to revision, either up or down, in future periods based
on new facts or circumstances.
We maintain a tax accrual policy to record both regular and alternative
minimum taxes for companies included in our consolidated federal income tax
return. The policy provides, among other things, that (i) each company in a
taxable income position will accrue a current expense equivalent to its federal
income tax, and (ii) each company in a tax loss position will accrue a benefit
to the extent its deductions, including general business credits, can be
utilized in the consolidated return. We pay all federal income taxes directly to
the IRS
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and, under a separate tax billing agreement, we may bill or refund our
subsidiaries for their portion of these income tax payments.
Foreign Currency Transactions and Translation
We record all currency transaction gains and losses in income. These gains
or losses are classified in our income statement based upon the nature of the
transaction that gives rise to the currency gain or loss. For sales and
purchases of commodities or goods, these gains or losses are included in
operating revenue or expense. For gains and losses arising through equity
investees, we record these gains or losses as equity earnings. For gains or
losses on foreign denominated debt, we include these gains or losses as a
component of interest expense. During 2002, the net currency gain recorded in
operating income was less than $1 million. Net currency losses recorded to
operating income in 2001 and 2000 were $13 million and less than $1 million. We
incurred currency losses in 2002 of approximately $95 million on our
euro-denominated debt which were included in interest expense. Gains and losses
were minimal on foreign denominated debt in 2001 and 2000. The U.S. dollar is
the functional currency for the majority of our foreign operations. For foreign
operations whose functional currency is deemed to be other than the U.S. dollar,
assets and liabilities are translated at year-end exchange rates and included as
a separate component of comprehensive income and stockholders' equity. The
cumulative currency translation loss recorded in accumulated other comprehensive
income was $115 million and $97 million at December 31, 2002 and 2001. Revenues
and expenses are translated at average exchange rates prevailing during the
year.
Treasury Stock
We account for treasury stock using the cost method and report it in our
balance sheet as a reduction to stockholders' equity. Treasury stock sold or
issued is valued on a first-in, first-out basis. Included in treasury stock at
December 31, 2002, and 2001, were approximately 1.7 million shares and 5.5
million shares of common stock held in a trust under our deferred compensation
programs.
Stock-Based Compensation
We apply the provisions of Accounting Principles Board Opinion No. 25 (APB
No. 25) and its related interpretations to account for our stock-based
compensation plans. We have both fixed and variable compensation plans, and we
account for these plans using fixed and variable accounting as appropriate.
Compensation expense for variable plans, including restricted stock grants, is
measured using the market price of the stock on the date the number of shares in
the grant becomes determinable. This measured expense is amortized into income
over the period of service in which the grant is earned. Our stock options are
issued under a fixed plan. Accordingly, compensation expense is not recognized
for stock options unless the options were granted at an exercise price lower
than market on the grant date. Had we accounted for our stock option grants
using SFAS No. 123 Accounting for Stock-Based Compensation, rather than the
provisions of APB No. 25, the income and per share impacts of stock-based
compensation on our financial statements of
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<PAGE>
stock-based compensation would have been different. The following shows the
impact on net income and earnings per share had we applied the provisions of
SFAS No. 123.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
--------- -------- --------
(IN MILLIONS, EXCEPT PER COMMON
SHARE AMOUNTS)
<S> <C> <C> <C>
Net income (loss), as reported............................ $(1,467) $ 93 $1,306
Deduct: Total stock-based employee compensation determined
under fair value based method for all awards, net of
related tax effects..................................... 143 157 43
------- ------ ------
Pro forma net income (loss)............................... $(1,610) $ (64) $1,263
======= ====== ======
Earnings (loss) per share:
Basic, as reported........................................ $ (2.62) $ 0.18 $ 2.64
======= ====== ======
Basic, pro forma.......................................... $ (2.88) $(0.13) $ 2.56
======= ====== ======
Diluted, as reported...................................... $ (2.62) $ 0.18 $ 2.57
======= ====== ======
Diluted, pro forma........................................ $ (2.88) $(0.12) $ 2.48
======= ====== ======
</Table>
Accounting for Debt Extinguishments
We apply the provisions of SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, to
account for debt extinguishments. Under SFAS No. 145, we are required to
evaluate any gains or losses incurred when we retire debt early to determine
whether they are extraordinary in nature or whether they should be included as
ordinary income from continuing operations in the income statement. In the third
quarter of 2002, we retired debt totaling $94 million, which resulted in a gain
of $21 million. Because we believe that we will continue to retire debt in the
near term, we reported these gains as income from continuing operations, as part
of other income.
New Accounting Pronouncements Issued But Not Yet Adopted
As of December 31, 2002, there were a number of accounting standards and
interpretations that had been issued but not yet adopted by us. Below is a
discussion of the more significant standards that could impact us.
Accounting for Asset Retirement Obligations. In June 2001, the Financial
Accounting Standards Board (FASB) issued SFAS No. 143, Accounting for Asset
Retirement Obligations. This statement requires companies to record a liability
for the estimated retirement and removal costs of long-lived assets used in
their business. The liability is recorded at its fair value, with a
corresponding asset which is depreciated over the remaining useful life of the
long-lived asset to which the liability relates. An ongoing expense will also be
recognized for changes in the value of the liability as a result of the passage
of time. The provisions of SFAS No. 143 are effective for fiscal years beginning
after June 15, 2002. We expect that we will record a charge as a cumulative
effect of accounting change of approximately $23 million, net of income taxes,
upon our adoption of SFAS No. 143 on January 1, 2003. We also expect to record
non-current retirement assets of $184 million and non-current retirement
liabilities of $214 million on January 1, 2003. Our liability relates primarily
to our obligations to plug abandoned wells in our Production and Pipelines
segments over the next one to 101 years.
Accounting for Costs Associated with Exit or Disposal Activities. In July
2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. This statement will require us to recognize costs
associated with exit or disposal activities when they are incurred rather than
when we commit to an exit or disposal plan. Examples of costs covered by this
guidance include lease termination costs, employee severance costs associated
with a restructuring, discontinued operations, plant closings or other exit or
disposal activities. The statement is effective for fiscal years beginning after
December 31, 2002, and will impact any exit or disposal activities we initiate
after January 1, 2003.
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<PAGE>
Accounting for Guarantees. In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45, Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This
interpretation requires that companies record a liability for all guarantees
issued after January 31, 2003, including financial, performance, and fair value
guarantees. This liability is recorded at its fair value upon issuance, and does
not affect any existing guarantees issued before January 31, 2003. This standard
also requires expanded disclosures on all existing guarantees at December 31,
2002. We have included these required disclosures in Note 20.
Consolidation of Variable Interest Entities. In January 2003, the FASB
issued FIN No. 46, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. This interpretation defines a variable interest
entity as a legal entity whose equity owners do not have sufficient equity at
risk and/or a controlling financial interest in the entity. This standard
requires that companies consolidate a variable interest entity if it is
allocated a majority of the entity's losses and/or returns, including fees paid
by the entity. The provisions of FIN No. 46 are effective for all variable
interest entities created after January 31, 2003, and are effective on July 1,
2003 for all variable interest entities created before January 31, 2003. We have
financial interests in several entities that we anticipate will be considered
variable interest entities. They fall into three categories:
- Operating leases with residual value guarantees;
- Consolidated subsidiaries with preferred interests held by third party
financial investors; and
- Equity investments.
Operating leases with residual value guarantees. We have two operating
leases where we provide a guarantee to the lessor for the residual value of the
facilities that we lease. These leases are for the following facilities:
- The Lakeside Technology Center, a telecommunications facility that
provides collocation and cross-connect services; and
- A facility at our Aruba refinery.
We believe we will consolidate the lessors under these arrangements on July
1, 2003 because (i) the equity investment by the third party investors (which
are banks), is less than 10 percent of the total capitalization of the company
that leases the facilities to us, and (ii) because we guarantee a significant
portion of the funds that were borrowed by the lessor to buy the facilities from
us. When we consolidate the lessors of these facilities, the assets owned by the
lessors and the debt that supports the assets will be consolidated in our
financial statements. In addition, these assets, once consolidated, will be
subject to impairment testing under SFAS No. 144. Based on our preliminary
analysis, we believe the impact on our financial statements will be as follows
(in millions):
<Table>
<S> <C>
Increase in total assets.................................... $625
Less: Impairments........................................... 113
----
Net increase in assets...................................... $512
Increase in long-term debt.................................. $625
</Table>
Consolidated subsidiaries with preferred interests held by third party
investors. We currently have interests in and consolidate several entities in
which third party investors hold preferred interests. The preferred interests
held by the third party investors are reflected in our balance sheet as
preferred securities in consolidated subsidiaries. The third party investors are
capitalized with three percent equity, which is held by banks in these
arrangements, and 97 percent debt. We believe we would consolidate these third
party investors under these arrangements because (i) the equity investment in
these third party investors is less than the specified 10 percent of total
capitalization of the investors and (ii) the rights of the third party investors
to expected residual returns from these arrangements is limited. When we
consolidate these third party investors, the minority interest that is currently
classified as preferred securities in consolidated subsidiaries will be
classified as long-term debt. Clydesdale and Coastal Securities Company Limited
are our consolidated
104
<PAGE>
subsidiaries that will be impacted by this standard. If we had not redeemed our
Trinity River financing arrangement in March 2003, it would also have been
impacted by this standard. We believe the impact on our financial statements
will be (in millions):
<Table>
<S> <C>
Decrease in preferred securities of consolidated
subsidiaries.............................................. $1,050
Increase in long-term debt.................................. $1,050
</Table>
For a further discussion of the consolidated subsidiaries potentially
impacted by this pronouncement, see Note 19.
Equity investments. We have equity investments in Chaparral and Gemstone.
These power investments involve a disproportionate allocation of income and
losses relative to the capital investments that are made by the equity holders.
To determine whether we would be required to consolidate these entities, we
evaluated the expected future losses of the entities, and how those losses would
be allocated to the owners. If we determined that we would be exposed to the
greatest level of the expected future losses, we would consolidate those
entities. Based on our analysis, we determined it is likely that we will
consolidate these investments because of our guarantee of the debt of the third
party investors which exposes us to a greater level of loss. However, we
anticipate that we will consolidate these investments prior to the effective
date of FIN No. 46 because we expect to purchase the third party investors'
interests in these investments. For a discussion of the equity investments we
hold, see Note 26.
2. WESTERN ENERGY SETTLEMENT
On March 20, 2003, we entered into an agreement in principle (Western
Energy Settlement) with various public and private claimants, including the
states of California, Washington, Oregon and Nevada, to resolve the principal
litigation, claims and regulatory proceedings against us and our subsidiaries
relating to the sale or delivery of natural gas and electricity from September
1996 to the date of the settlement. See Note 20 for a discussion of this matter.
The Western Energy Settlement resulted in a charge in the fourth quarter of
2002 of $899 million before tax and approximately $650 million after tax. These
amounts represent the present value of the components of the settlement
discounted at 10 percent. The settlement will include an initial payment of
cash, the issuance of our common stock and the payment of cash and delivery of
natural gas over a period of 20 years. The settlement will become payable
beginning with the execution of a definitive settlement agreement. Components of
the settlement were allocated among our Pipelines, Merchant Energy and Corporate
segments, based on the nature of the component and the segment's ability to
perform under the agreement. The components are as follows:
- a cash payment of $100 million to the settling parties;
- a $2 million cash payment from our officer bonus pool;
- the issuance of approximately 26.4 million shares of our common stock;
- the delivery to the California border of $45 million worth of natural gas
annually for 20 years, beginning in 2004;
- the reduction of the pricing of our long-term power supply contracts with
the California Department of Water Resources of $125 million over the
remaining term of those contracts, which run through the end of 2005;
- payment to the settling parties of $22 million a year in cash (or, at our
option, in cash and stock) for 20 years;
- for a period of five years, EPNG will make available at its California
delivery points, 3,290 MMcf/d of capacity on a primary delivery point
basis;
- for a period of five years, our affiliate will be subject to restrictions
in subscribing new capacity on the EPNG system; and
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<PAGE>
- no admission of wrongdoing.
The settlement is subject to review and approval by state courts and the
FERC.
The total obligation for the settlement is reflected in our balance sheet
at $0.9 billion, which represents the notional amount of approximately $1.7
billion, less a discount (at a rate of 10 percent) of approximately $0.8
billion. The components of the obligation for the settlement are as follows:
<Table>
<Caption>
(IN MILLIONS)
<S> <C>
Total Western Energy Settlement............................. $1,690
Discount at 10 percent...................................... (791)
------
Net present value at settlement............................. 899
Less: Current portion of obligation......................... 100
------
Non-current obligation for Western Energy Settlement........ $ 799
======
</Table>
The discount will be amortized to interest expense annually at an amount
based on a constant rate of interest (10 percent) applied to the declining
obligation balance. This amortization is expected to be approximately $47
million for 2003, after income taxes.
3. MERGERS AND DIVESTITURES
Coastal Merger
In January 2001, we merged with Coastal. We accounted for the transaction
as a pooling of interests and converted each share of Coastal's common stock and
Class A common stock on a tax-free basis into 1.23 shares of our common stock.
We also exchanged Coastal's outstanding convertible preferred stock for our
common stock on the same basis as if the preferred stock had been converted into
Coastal common stock immediately prior to the merger. In the merger, we issued
approximately 271 million shares of our common stock, including 4 million shares
in exchange for Coastal stock options. The following table presents the revenues
and net income for the previously separate companies and the combined amounts
presented in these audited combined financial statements for the year ended
December 31, 2000 (in millions). Several adjustments were made to conform the
accounting presentation of this financial information.
<Table>
<S> <C>
Revenues
El Paso................................................... $21,950
Coastal................................................... 18,014
Conforming reclassifications(1)........................... 8,951
-------
Combined(2)............................................... $48,915
=======
Extraordinary items, net of income taxes
El Paso................................................... $ 70
Coastal................................................... --
-------
Combined.................................................. $ 70
=======
Net income
El Paso................................................... $ 652
Coastal................................................... 654
-------
Combined.................................................. $ 1,306
=======
</Table>
- ---------------
(1) Conforming reclassifications primarily include a gross-up of revenues
associated with Coastal's physical petroleum marketing and trading
activities to be consistent with our method of reporting these revenues.
(2) Combined revenues do not take into account the adoption of a consensus
reached on EITF Issue No. 02-3, which requires us to report all physical
sales of energy commodities in our energy trading activities on a net basis
as a component of revenues. The impact of EITF Issue No. 02-3 on reported
2000 revenues was a reduction of these combined amounts by $29.4 billion.
These amounts also do not consider the reclassification of $276 million of
revenues related to coal mining properties, which were reclassified in our
financial statements as discontinued operations during 2002. See Notes 1 and
10 for further discussion of these matters.
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<PAGE>
Divestitures
During 2002 and into 2003, we have completed or announced a number of asset
sales in order to rationalize our business and address liquidity issues and
changing market conditions. These sales occurred in all of our business segments
as follows:
<Table>
<Caption>
PRETAX
SEGMENT PROCEEDS GAIN (LOSS) SIGNIFICANT ASSETS AND INVESTMENTS SOLD
- ------- -------- ----------- ---------------------------------------
(IN MILLIONS)
<S> <C> <C> <C>
Completed in 2002
Pipelines $ 303 $ 4 Natural gas and oil properties located in Texas, Kansas and
Oklahoma and their related contracts
12.3 percent equity interest in Alliance Pipeline and
related assets
Typhoon natural gas pipeline(3)
Production 1,297 --(1) Natural gas and oil properties located in:
East and south Texas
Colorado
Southeast Texas
Utah
Western Canada
Field Services 1,513 196 Texas and New Mexico midstream assets(2)
Dragon Trail processing plant
San Juan Basin gathering, treating and processing assets(3)
14.4 percent equity interest in Aux Sable NGL plant
Gathering facilities located in Utah
50 percent interest in Blacks Fork facility
Merchant Energy 161 (1) 50 percent equity interest in petroleum products terminal
NGL pipelines and fractionation facilities(3)
14.4 percent equity interest in Alliance Canada Marketing
L.P.
40 percent equity interest in Samalayuca Power II power
project in Mexico
Typhoon oil pipeline (3)
Corporate and 57 -- Coal reserves and properties in West Virginia, Virginia and
Other Kentucky(4)
------ ----
$3,331 $199
====== ====
</Table>
- ---------------
(1) We did not recognize gains or losses on these completed sales of natural gas
and oil properties because individually they did not significantly alter the
relationship between capitalized costs and proved reserves at the time they
were sold.
(2) Proceeds of $735 million consisted of $539 million in cash, common units of
El Paso Energy Partners with a fair value of $6 million and the
partnership's interest in the Prince tension leg platform including its nine
percent overriding royalty interest in the Prince production field with a
combined fair value of $190 million.
(3) Proceeds from these sales of $766 million consisted of $416 million in cash
and $350 million of Series C units, a new non-voting class of the limited
partnership interest in El Paso Energy Partners.
(4) During 2002, we recorded impairment charges of $185 million since the
carrying value was higher than our estimated net sales proceeds. These
properties are presented in our financial statements as discontinued
operations. See Note 10 for further discussion.
107
<PAGE>
<Table>
<Caption>
PRETAX SIGNIFICANT ASSETS AND
SEGMENT PROCEEDS GAIN (LOSS) INVESTMENTS SOLD
- ------- -------- ----------- ----------------------
(IN MILLIONS)
<S> <C> <C> <C>
Announced or Completed in 2003 (amounts are estimates)(1)
Pipelines $ 43 $ (1) Panhandle gathering system located in Texas
2.1 percent equity interest in Alliance pipeline and
related assets
Production 687 --(2) Natural gas and oil properties located in western Canada,
Oklahoma, New Mexico and offshore.
Field Services 35 -- Gathering systems located in Wyoming
Merchant Energy 813 69 50 percent equity interest in CE Generation L.L.C. power
investment (including the rights to a 50 percent interest
in a geothermal development project)(3)
Mt. Carmel power plant
Kladno power project
Corpus Christi refinery
Florida petroleum terminals and tug and barge operations(4)
Petroleum asphalt operations
Enerplus Global Energy Management Company
Corporate and 89 (8) Remaining coal reserves and properties in West Virginia,
Other Virginia and Kentucky(5)
Aircraft
------- -------
$ 1,667 $ 60
======= =======
</Table>
- ---------------
(1) Sales that have been announced, but not completed, are subject to customary
regulatory approvals and other conditions.
(2) We do not anticipate recognizing gains or losses on these sales of natural
gas and oil properties because individually they will not significantly
alter the relationship between capitalized costs and proved reserves at the
time they are sold.
(3) During 2002, we recorded impairment charges of $74 million resulting from an
expected sale of our ownership interests.
(4) The amount includes $25 million receivable.
(5) Proceeds of $59 million consisted of $35 million in cash and $24 million in
notes receivable.
In December 2002, we reclassified several of Field Services' small
gathering systems located in Wyoming and Merchant Energy's Florida petroleum
terminals and tug and barge operations to assets held for sale. We also
classified our petroleum asphalt operations and lease crude business as held for
sale. The total assets being sold had a net book value in property, plant and
equipment of approximately $134 million. We reclassified these assets as other
current assets as of December 31, 2002, since we plan to sell them in the next
twelve months.
Under a Federal Trade Commission order, as a result of our January 2001
merger with Coastal, we sold our Midwestern Gas Transmission system, 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 year ended December 31, 2001, net proceeds from these
sales were approximately $279 million, and we recognized extraordinary net gains
of approximately $26 million, net of income taxes of approximately $27 million.
During 2000, we sold East Tennessee Natural Gas Company, Sea Robin Pipeline
Company and our one-third interest in Destin Pipeline Company to comply with an
FTC order related to our merger with Sonat. Net proceeds from these sales were
approximately $616 million, and we recognized an extraordinary gain of $89
million, net of income taxes of $59 million. In December 2000, we sold our
interest in Oasis Pipeline Company to comply with an FTC order. We incurred a
loss on this transaction of approximately $19 million, net of income taxes of $9
million. We recorded the gains and losses on these sales as extraordinary items
in our income statement.
In February 2003, we announced we would exit non-core businesses, including
substantially all of our petroleum business (except our Aruba refinery). Since
making this announcement, we have been identifying
108
<PAGE>
potential buyers for our petroleum assets. At this time, we cannot determine the
amount of gain or loss, if any, that will be incurred. We will continue to
evaluate whether these assets will be treated for accounting purposes as assets
held for sale or possibly as discontinued operations.
4. RESTRUCTURING AND MERGER-RELATED COSTS
During each of the three years ended December 31, we incurred restructuring
costs, merger-related costs and asset impairment charges as follows:
<Table>
<Caption>
2002 2001 2000
---- ------ ----
(IN MILLIONS)
<S> <C> <C> <C>
Restructuring costs......................................... $81 $ -- $--
Merger-related costs........................................ -- 1,520 93
--- ------ ---
$81 $1,520 $93
=== ====== ===
</Table>
Restructuring Costs
Our restructuring costs were incurred in connection with organizational
restructurings in connection with our balance sheet and liquidity enhancement
actions taken in 2002. By segment, these charges were as follows:
<Table>
<Caption>
FIELD MERCHANT CORPORATE
PIPELINES SERVICES ENERGY AND OTHER TOTAL
--------- -------- -------- --------- -----
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Employee severance, retention and
transition costs.................... $ 1 $ 1 $28 $11 $41
Transaction costs...................... -- -- -- 40 40
--- --- --- --- ---
$ 1 $ 1 $28 $51 $81
=== === === === ===
</Table>
In December 2001, we announced a plan to strengthen our balance sheet,
reduce costs and focus our activities on our core natural gas businesses. During
2002, we completed an employee restructuring across all of our operating
segments which resulted in a reduction of approximately 772 full-time positions
through terminations. As a result of these actions, we incurred $41 million of
employee severance and termination costs, $30 million of which had been paid as
of December 31, 2002. We also incurred and paid fees of $40 million to eliminate
stock price and credit rating triggers related to our Chaparral and Gemstone
investments.
109
<PAGE>
Merger-Related Costs
During the years ended 2001 and 2000, we incurred merger-related costs in
connection with our merger with Coastal completed in January 2001 as follows:
<Table>
<Caption>
FIELD MERCHANT CORPORATE
PIPELINES PRODUCTION SERVICES ENERGY AND OTHER TOTAL
--------- ---------- -------- -------- --------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
2001
Employee severance,
retention and transition
costs................... $ 83 $ 7 $ 5 $18 $ 725 $ 838
Transaction costs.......... -- -- -- -- 70 70
Business and operational
integration costs....... 178 17 -- -- 188 383
Other...................... 30 23 41 26 109 229
---- --- --- --- ------ ------
$291 $47 $46 $44 $1,092 $1,520
==== === === === ====== ======
2000
Employee severance,
retention and transition
costs................... $ -- $-- $-- $-- $ 31 31
Transaction costs.......... -- -- -- -- 60 60
Other...................... -- -- -- -- 2 2
---- --- --- --- ------ ------
$ -- $-- $-- $-- $ 93 $ 93
==== === === === ====== ======
</Table>
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 our merger-related workforce reduction and consolidation. Following
the Coastal merger, we completed an employee restructuring across all of our
operating segments, resulting in the reduction of 3,285 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 these restructurings. Retention charges include payments to employees
who were retained following the mergers 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.
Employee severance, retention and transition costs for 2001 were
approximately $838 million, which included pension and post-retirement benefits
of $214 million which were accrued on the merger date and will be paid over the
applicable benefit periods of the terminated and retired employees. All other
costs were expensed as incurred and have been paid. Also included in the 2001
employee severance, retention and transition costs was a charge of $278 million
resulting from the issuance