Doug Foshee

For Doug Foshee and the shareholders of El Paso Corp., persistence is par for the course. When Foshee joined El Paso in 2003 as president and chief executive officer, the beleaguered company was struggling after a tough proxy fight, big losses and the post-Enron meltdown of the energy sector. Since then, he has made numerous strategic changes, cut the employee head count by almost two-thirds and sold noncore assets and businesses. By 2006, Foshee was declaring El Paso’s makeover complete, and he was looking forward to focused growth.

In May 2009, he was also named chairman—just as the energy sector was reeling once more, this time from the dramatic downdraft caused by the Great Recession and the hurricanes of 2008. With capital markets in disarray, Foshee chose to pare the dividend, sell more assets, cut costs and issue debt to fund significant growth capital.

Now, after showing a smaller loss in 2009 than in 2008, El Paso is back on track. It is even more tightly focused on the E&P side, and is benefiting from a growing Haynesville shale program—and leveraging that expertise into the Eagle Ford shale, which could have more potential than its Haynesville acreage.

Foshee notes that in 2009, the E&P side delivered its strongest operating performance since he joined the company. Fourth-quarter production was 742 million cubic feet equivalent per day and unit operating costs were down.

In addition, El Paso has the biggest backlog of projects in the pipeline business, including the $3-billion Ruby Pipeline, which will move natural gas from Rocky Mountain basins to northern California. And at press time, the company had just placed in service an expansion of its Elba Island liquefied natural gas receiving terminal near Savannah, Georgia, and the new Elba Express Pipeline. These represent roughly $900 million of capital investment.

Before joining El Paso, Foshee was executive vice president and chief operating officer for Halliburton Co. and before that, chairman, president and CEO of Nuevo Energy Co. He also spent seven years in commercial banking, primarily as an energy lender. He is currently on the board of the Houston branch of the Federal Reserve Bank, Dallas, and serves on numerous civic and charitable boards in Houston.

Oil and Gas Investor talked recently with Foshee about the company’s latest prospects for growth.

Investor: When you joined El Paso six and a half years ago, it was not in good shape. You have been constantly tightening the bolts and screws ever since. Do you feel you are pretty much done? Is this transition to unconventional resources the final move?

Foshee: Back when I joined in 2003, our story was really about survival. We had a lot of debt, morale was terrible and we were in 22 businesses. But now, we’ve shed half the debt, and we’re only trying to be good at two things: pipelines and E&P. We can show a three-year trend of improvement in the E&P business and now we’re in the top quartile. Our pipeline business has the biggest backlog in the industry.

Our execution has become much more tight and predictable.

For the whole company, we expect an earnings impact of 15% CAGR (compound annual growth rate) from 2010 to 2012, and that is underpinned with significant price protection of a $6.40 floor for 80% of our 2010 domestic gas production, and a $6 floor for 2011 production.

Investor: How did you manage this?

Foshee: We’re coming off one of our best years ever; operationally it was the best since I joined in 2003. I’m very proud of the way we managed through a very difficult year. We did $3.8 billion worth of financings between fourth-quarter ’08 and fourth-quarter ’09, and we ended the year with $1.8 billion of liquidity—and that’s after a $100-million bolt-on acquisition in the Altamont oil field in Utah.

On the pipeline side, we completed four growth projects on time and on budget, and we secured a 50% partner for the Ruby Pipeline, bringing in Global Infrastructure Partners. This is a 675-mile line from the Rockies to the West Coast. It’s a $3-billion project, so it was critical to get a partner. And we just added a new pipeline project in the Marcellus. Most of that capital will be spent in 2013, which fits perfectly from a capital standpoint. As our pipeline capital spending begins to roll over from its peak in 2011, we go free-cash-flow positive in 2012.

Investor: And on the E&P side?

Foshee: Clearly it was the best year the E&P company has ever had. We can abandon talk about rebuilding E&P, which was maybe the most significant challenge since I’ve been here. Brent Smolik and his team have done a great job of improving the portfolio. It’s now more onshore, it’s more unconventional, it’s more repeatable. We’ve gotten our domestic lifting costs down to 70 cents an Mcfe (thousand cubic feet equivalent), which we think is top-quartile.

Investor: Those shale plays don’t hurt.

Foshee: We are transitioning to a new production profile in the shales that is much lower on the risk curve and more important, on the cost curve.

We added the Haynesville shale, a new core area for us, with 42,000 net acres, and 75% to 80% of that is in the heart of the field in DeSoto Parish. We began 2009 with virtually no production there and exited the year at 110 million cubic feet a day, net. We’re completing our wells for $7.5 million, plus or minus, and our cycle time, as measured by days from spud date to first production, is the most efficient in the industry.

Investor: What EURs are you seeing in the Haynesville?

Foshee: We have estimated 6.5 to 7.5 Bcf (billion cubic feet) a well in the core, and in the noncore areas, 5 to 6 Bcf. Most recently we drilled a well that had an IP in a noncore area that might stretch that estimate. In the Haynes­ville, we’re not drilling to hold leases. Virtually all of it is HBP (held by production) and came to us via our acquisition of proved properties in 2005, ’06 and ’07. So we are drilling on the economics…our Haynesville wells are economic at the lower end of the Lower 48 cost curve.

Investor: And now you’re gearing up in the Eagle Ford.

Foshee: In the Eagle Ford, we have built a 138,000-net-acre position that is still growing. We had our first successful well at year-end and it flowed 8 million a day, and we are completing our second one.

It’s still in its early days but it’s quite exciting.

South Texas is a very important legacy area for us, not only because of our E&P business, but also because we own a major pipeline right through the heart of it, Tennessee Gas Pipeline.

In the great land grab from 2004 to 2008, or 2009, we began to hear about all these shales, but for much of that time, we were not aggressive in building big acreage positions. The Eagle Ford is one of the first shales we got into and we did that early, because it’s in a legacy area for us. We built a big acreage position at low cost.

Our design is to take the learnings from the Haynesville, where we took our drilling costs from $12 million to $7 million, and initial production rates of 5 million a day up to sometimes more than 20 million a day, and bring them to the Eagle Ford. We have just added a second rig.

Investor: Any opportunities for a partner to come in with you?

Foshee: We are early days in the Eagle Ford and we believe very strongly in it, that it’s an important new supply basin that’s down at the lower end of the cost curve. We are always interested in partnerships if they can add to the EP stock price.

Investor: You have 6,000 drilling locations or about 10 years of activity at your current pace, so are you looking at any joint ventures to speed that up?

Foshee: While we are interested in growth, we are cognizant we have an advantage in that the E&P business sits in a broader corporation with the pipelines that have lots of stable cash flow. We don’t want to do anything in E&P that would degrade our overall performance—there’s a point at which increasing activity levels begin to tax your performance, so that’s the tradeoff we’re constantly evaluating.

We would look at joint ventures and the potential for sell-downs. We are always mindful of opportunities.

Investor: How would you compare the Haynesville to the Eagle Ford, and which will get more of the 2010 budget?

Foshee: In 2010, we will deploy more capital in the Haynesville. But that could change down the road if we have more success in the Eagle Ford. Half of our drillbit budget for the year is Haynesville, Eagle Ford and Altamont, our oil play in the Uintah Basin.

The difference between our Haynesville and Eagle Ford programs is the maturity of the plays and pace of development we’re in. We’re in more of a manufacturing phase in the Haynesville…it’s delineated, we know what we have. We have more than 20 wells, operated and nonoperated. We are up to a five-rig program and are trying to cut costs and optimize our completion techniques.

In the Eagle Ford, there’s lots of activity to monitor. We are completing a second well and just added a second rig. There is every reason to think the Eagle Ford could have a meaningful impact on Lower 48 supply.

Investor What about your Marcellus activity?

Foshee In the Marcellus, a couple of things have happened for us: we previously announced the Line 300 expansion on behalf of EQT, and we signed up an exciting project to support Chesapeake and Statoil’s desire to get their gas to Northeast markets, with a $400-million expansion, supported by 20-year contracts. Most of that capital will get spent in 2013.

Investor: When does Ruby break ground?

Foshee: We are on track for our original projections. We expect to be on the ground in the late spring or early summer. We have more than enough commitments for the $1.5-billion project financing, which looks to be the marquee project-finance deal this year.

Investor: How long will it take to build Ruby?

Foshee: Less than a year.

Investor: Has the price per mile increased?

Foshee: The cost to build an interstate pipeline is about a third steel and 30% to 40% is the construction itself, and the balance is things we do ourselves like obtaining rights-of-way, permitting, design and engineering and so on. Pipeline construction was at a peak in 2007 and early 2008 but prices have moved back our way versus a year or two ago. It’s still very competitive. Plus, all of our steel prices are locked in so we know what a third of our cost is going to be.

Investor: Do you have any concerns that the California market is depressed and so, there is less need for that Rockies gas?

Foshee: No, because 1.1 Bcf a day out of 1.3 is fully sold under 10-year or longer contracts, so the vast majority of the revenue from Ruby is locked in for a decade. Something like more than 60% of the electricity on the western side of the U.S. comes from Canadian gas sources, which are on the decline, so there is a replacement aspect to it.

Our view is, as you see more output from the Marcellus, the Haynesville, and the Fayetteville, that gas will want to go to the Eastern Seaboard, so that incentivizes Rockies gas to head west.

Investor: Are you worried we’ll over do it with these shales?

Foshee The honest answer is, it’s too early to tell. It depends on the gas-price environment we’re in. If we’re at the low end of people’s expectations, you’re going to have substitution—the most cost-effective shales will push out drilling in more traditional production areas. At the right price, you should have both.

Investor: Do conventional gas assets now become noncore?

Foshee: No, I don’t think that’s the case. We look at our profile and it has changed dramatically in the past 36 months, with the Haynesville, Eagle Ford, and Altamont. We have to ask ourselves if we have properties in our portfolio that are still economic, are they going to compete for capital? If not, they belong in someone else’s hands.

Investor What sorts of things keep you up at night?

Foshee: We always worry about project execution. This is a big execution year for us, particularly on the pipeline side, where we are going to be deploying $2.9 billion of our shareholders’ money. But we think this is an area where we can really differentiate ourselves—last year we put four projects in service on time and on budget. And in March, our Elba Island expansion and Elba Express Pipeline, which together cost almost $1 billion, both went into service on time and on budget.

On the E&P side, it’s still about execution. In 2009 we had the metrics to back up what we said we’d do. We are a top-quartile performer now, but we have to prove it again in 2010, as we move through the year.

We are still an industry faced with this demographic issue in that the average age of our workers continues to go up. We think a lot about what we can do about that; a big part of our vision is to be the place to work, because we want to compete for intellectual talent.

Investor: What does the market misunderstand about you?

Foshee: After our December 2009 analyst day, we got some comments that said, “We believe in the El Paso story, but it is really a 2011 story.” We don’t think that’s the case. That’s not a good investment thesis. In 2010’s first quarter we got commitments for the Ruby financing and we expect FERC approval soon. We did an equity offering in our MLP (master limited partnership), El Paso Pipeline Partners, which will likely lead to a drop down from El Paso, and we also announced a $300-million asset sale.

We went on stream at Elba and Elba Express—a lot of progress already. Later in the year we’ll be under construction with Ruby, which will have a big impact on us once it is in service. We are moving forward.