UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

Commission File Number 1-14365

 

 

 

 

El Paso Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

Telephone Number: (713) 420-2600

Internet Website: www.elpaso.com

 

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 þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ           Accelerated filer o          Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock, par value $3 per share. Shares outstanding on October 31, 2006: 705,389,577

 

 

EL PASO CORPORATION

 

TABLE OF CONTENTS

 

 

 

Below is a list of terms that are common to our industry and used throughout this document:

 

 

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”, “the company” or “El Paso”, we are describing El Paso Corporation and/or our subsidiaries.

 

EL PASO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per common share amounts)
(Unaudited)

 

 

See accompanying notes.

EL PASO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except share amounts)
(Unaudited)

 

 

See accompanying notes.

EL PASO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except for share amounts)
(Unaudited)

 

 

See accompanying notes.

EL PASO CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)

 

See accompanying notes.

EL PASO CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In millions)

(Unaudited)

 

 

See accompanying notes.

EL PASO CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Basis of Presentation

 

We prepared this Quarterly Report on Form 10-Q under the rules and regulations of the United States Securities and Exchange Commission (SEC). Because this is an interim period filing presented using a condensed format, it does not include all of the disclosures required by United States generally accepted accounting principles. You should read this Quarterly Report on Form 10-Q along with our Current Report on Form 8-K dated May 12, 2006, which updated the financial information originally presented in our 2005 Form 10-K to reclassify our Macae power facility in Brazil as a discontinued operation, and which contains a summary of our significant accounting policies and other disclosures. The financial statements as of September 30, 2006, and for the quarters and nine months ended September 30, 2006 and 2005, are unaudited. We derived the condensed consolidated balance sheet as of December 31, 2005, from the audited balance sheet filed in our Current Report on Form 8-K dated May 12, 2006. In our opinion, we have made all adjustments which are of a normal, recurring nature to fairly present our interim period results. Due to the seasonal nature of our businesses, information for interim periods may not be indicative of our results of operations for the entire year. Additionally, our financial statements for prior periods include reclassifications that were made to conform to the current period presentation. Those reclassifications did not impact our reported net income or stockholders’ equity.

 

Significant Accounting Policies

 

Our significant accounting policies are discussed in our Current Report on Form 8-K dated May 12, 2006. The information below provides updating information, disclosures where these policies have changed and required interim disclosures with respect to those policies.

 

Stock-Based Compensation.  In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment. This standard and its related interpretations amend previous stock-based compensation guidance and require companies to measure all employee stock-based compensation awards at fair value on the date they are granted to employees and recognize compensation cost in their financial statements over the requisite service period. Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R) for stock-based compensation awards granted on or after that date and for unvested awards outstanding at that date using the modified prospective application method. Under this method, prior period results were not restated. Prior to January 1, 2006, we accounted for these plans using the intrinsic value method under the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations, and did not record compensation expense on stock options that were granted at the market value of the stock on the date of grant. The adoption of SFAS No. 123(R) did not result in a significant cumulative effect to our financial statements. For additional information on our stock-based compensation awards, see Note 13.

 

Accounting for Pipeline Integrity Costs.  As of January 1, 2006, we adopted an accounting release issued by the Federal Energy Regulatory Commission (FERC) that requires us to expense certain costs our interstate pipelines incur related to their pipeline integrity programs. Prior to adoption, we capitalized these costs as part of our property, plant and equipment. During the quarter and nine months ended September 30, 2006, we expensed approximately $7 million and $14 million as a result of the adoption of this accounting release, which was approximately $0.01 per basic and fully diluted share for both the quarter and nine month periods ended September 30, 2006. We anticipate we will expense additional costs of approximately $7 million for the remainder of the year.

New Accounting Pronouncements Issued But Not Yet Adopted

 

Accounting for Uncertainty in Income Taxes.  In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes. FIN No. 48 clarifies SFAS No. 109, Accounting for Income Taxes, and requires us to evaluate our tax positions for all jurisdictions and all years where the statute of limitations has not expired. FIN No. 48 requires companies to meet a “more-likely-than-not” threshold (i.e. greater than a 50 percent likelihood of a tax position being sustained under examination) prior to recording a benefit for their tax positions. Additionally, for tax positions meeting this “more-likely-than-not” threshold, the amount of benefit is limited to the largest benefit that has a greater than 50 percent probability of being realized upon ultimate settlement. The cumulative effect of applying the provisions of the new interpretation will be recorded as an adjustment to the beginning balance of retained earnings, or other components of stockholders’ equity, as appropriate, in the period of adoption. We will adopt the provisions of this interpretation effective January 1, 2007, and are currently evaluating the impact that this interpretation will have on our financial statements.

 

Accounting for Pension and Other Postretirement Benefits.  In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an Amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS No. 158 requires companies to record an asset or liability for their pension and other postretirement benefit plans based on their funded or unfunded status. The standard also requires any deferred amounts related to unrealized gains and losses or changes in actuarial assumptions be recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity, until those gains and losses are realized. These deferred amounts were previously included in our pension and other postretirement assets in our balance sheets, and their reclassification to stockholders’ equity will not impact our pension expense included in our income statements. Finally, the standard requires companies to measure their pension and postretirement obligations as of their year end balance sheet date beginning in 2008.

 

We will adopt the recognition and disclosure provisions of this standard effective December 31, 2006 and currently anticipate the adoption will result in a reduction of our pension and other postretirement assets included in other non-current assets of approximately $600 million, a reduction of our non-current deferred tax and other liabilities of approximately $200 million, and a decrease in our stockholders’ equity (in accumulated other comprehensive income(loss)) of approximately $400 million. SFAS No. 158 will also require us to change the measurement date for our pension and other postretirement benefit plans from September 30, the date we currently use, to December 31 beginning in 2008.

 

Fair Value Measurements.  In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which provides guidance on measuring the fair value of assets and liabilities in the financial statements. We will be required to adopt the provisions of this standard no later than 2008, and are currently evaluating the impact, if any, that it will have on our financial statements.

 

Evaluation of Prior Period Misstatements in Current Financial Statements. In September 2006, the staff of the SEC released Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements.  SAB No. 108 provides guidance on how to evaluate the impact of financial statement misstatements from prior periods that have been identified in the current year. We will adopt the provisions of SAB No. 108 in the fourth quarter of 2006, and do not anticipate that it will have a material impact on our financial statements.

 

 

In August 2005, we acquired Medicine Bow Energy Corporation, a privately held energy company, for total cash consideration of $853 million. Medicine Bow owns a 43.1 percent interest in Four Star Oil & Gas Company, an unconsolidated affiliate. Our proportionate share of the operating results associated with Four Star are reflected as earnings from unconsolidated affiliates in our financial statements.

 

We reflected Medicine Bow’s results of operations in our income statement beginning September 1, 2005. The following summary of unaudited pro forma consolidated results of operations for the quarter and nine months ended September 30, 2005 reflect the combination of our historical income statements with Medicine Bow, adjusted for certain effects of the acquisition and related funding. These pro forma results are prepared as if the acquisition had

occurred on January 1, 2005 and are not necessarily indicative of the operating results that would have occurred had the acquisition been consummated at that date, nor are they necessarily indicative of future operating results.

 

 

 

Sales of Assets and Investments

 

During the nine months ended September 30, we completed the sale of a number of assets and investments. The following table summarizes the proceeds from these sales:

 

 

 

 

The following table summarizes the significant assets sold during the nine months ended September 30:

 

 

In October 2006, we also sold our interests in a power facility in Indonesia, two domestic power facilities and a cost basis investment for total proceeds of approximately $90 million. In addition, we also have agreements to sell additional assets for total proceeds of approximately $100 million, including a pipeline lateral located in the northeastern United States, certain Brazilian natural gas and oil properties and interests in our remaining Asian and Central American power assets.

 

Discontinued Operations

 

Under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we classify assets to be disposed of as held for sale or, if appropriate, discontinued operations when they have received appropriate approvals by our management or Board of Directors and when they meet other criteria. Cash flows from our discontinued businesses are reflected as discontinued operating, investing, and financing activities in our statement of cash flows. To the extent these operations do not maintain separate cash balances, we reflect the net cash flows generated from these businesses as a contribution to our continuing operations in cash from continuing financing activities. The following is a description of our discontinued operations and summarized results of these operations for the quarters and nine months ended September 30, 2006 and 2005.

 

Macae and Other International Power Operations.  In the first quarter of 2006, our Board of Directors approved the sale of our interest in the Macae power facility in Brazil to Petrobras. The sale was completed in April 2006 and we received $358 million and repaid approximately $229 million of Macae’s project debt. During 2005, our Board of Directors approved the sale of our Asian and Central American power asset portfolio, which included our consolidated interests in the Nejapa, CEBU and East Asia Utilities power plants. We completed the sale of our CEBU and East Asia Utilities power plants in July 2006 for approximately $6 million. As of September 30, 2006, our only remaining power asset in discontinued operations is our Nejapa power plant which we expect to sell within the next six months. For a further discussion of our international power operations, see Note 15.

 

South Louisiana Gathering and Processing Operations.  During the second quarter of 2005, our Board of Directors approved the sale of our south Louisiana gathering and processing assets, which were part of our historical Field Services segment. In the fourth quarter of 2005, we completed the sale of these assets.

 

International Natural Gas and Oil Production Operations.  In 2004 and 2005, we sold our Canadian and certain other international natural gas and oil production operations.

 

Petroleum Markets.  We completed the sale of these historical operations in 2005.

 

 

Assets and liabilities of discontinued operations relate to our international power operations. As of September 30, 2006 and December 31, 2005, we had total assets of approximately $34 million and $583 million classified as discontinued operations. As of September 30, 2006 and December 31, 2005, total liabilities classified as discontinued operations were approximately $33 million and $422 million.

 

Under the full cost method of accounting for natural gas and oil properties, we perform quarterly ceiling tests, on an after-tax basis, to evaluate whether the carrying value of these properties exceeds the present value of future net revenues, discounted at 10 percent, plus the lower of cost or fair market value of unproved properties. Our ceiling test assessments utilize period-end natural gas and oil prices adjusted for oilfield or gas gathering hub and wellhead price differences as appropriate. Additionally, we include the impact of financial instruments designated as hedges on our natural gas and oil production in our ceiling test calculation to determine whether or not we would recognize a ceiling test charge.

 

Our net capitalized natural gas and oil property costs did not exceed the capitalization ceiling based on a subsequent recovery of prices from those levels that existed at September 30, 2006. Based on SEC guidelines, we considered the recovery of commodity prices subsequent to the balance sheet date to determine whether we were required to record a ceiling test charge as of September 30, 2006. As of October 26, 2006, natural gas prices had recovered to approximately $7.92/MMbtu from $4.18/MMbtu at September 30 and crude oil prices, which have less impact on us, decreased slightly from $62.91/Bbl at September 30. Using the October 26, 2006 prices, the present value of future net revenues exceeded the carrying value of our properties and we were not required to record a ceiling test charge for our domestic full cost pool. Had we utilized prices as of September 30, 2006, capitalized costs in our domestic full cost pool would have exceeded the present value of future net revenues, on an after-tax basis, by approximately $221 million. For purposes of this calculation, hedges of natural gas production as of September 30, 2006, increased the net present value of future net revenues on an after-tax basis by approximately $318 million.

 

 

Our loss on long-lived assets consists of realized gains and losses on sales and impairments of long-lived assets. During the nine months ended September 30, 2006, our loss on long-lived assets of $15 million was due primarily to our decision to discontinue the development of several pipeline expansion projects due to changing market conditions. During the nine months ended September 30, 2005, our net loss on long-lived assets of $10 million was primarily due to a $15 million impairment recorded by our Power segment on several power turbines, partially offset by a gain of $9 million in our Pipelines segment on the sale of facilities located in the southeastern United States.

 

 

Income taxes included in our income from continuing operations for the periods ended September 30 were as follows:

 

We compute our quarterly income taxes using a method based on applying an anticipated annual effective tax rate to our year-to-date income or loss, except for significant unusual or infrequently occurring items. Significant tax items, which may include the conclusion of income tax audits, are recorded in the period that the specific item occurs.

 

In 2006, the IRS audits of The Coastal Corporation’s 1998-2000 tax years and El Paso’s 2001 and 2002 tax years were concluded. During 2006, our overall effective tax rate on continuing operations was lower than the statutory rate of 35 percent primarily due to conclusion of these audits which resulted in the reduction of tax contingencies and the reinstatement of certain tax credits. Also, the rate was impacted by net tax amounts recognized on certain foreign investments. The totals of these amounts were $105 million and $163 million for the quarter and nine months ended September 30, 2006.

 

During the nine months ended September 30, 2005, our overall effective tax rate on continuing operations was different than the statutory rate of 35 percent primarily due to a reduction in our liabilities for tax contingencies as a result of an IRS settlement for the 1995-1997 income tax returns for The Coastal Corporation.

Other Tax Matters.  The IRS is currently auditing El Paso’s 2003 and 2004 tax years. We have recorded liabilities for tax contingencies associated with these audits, as well as for proceedings and examinations with other taxing authorities, which we believe are adequate. As these matters are finalized, we may be required to adjust our liability which could significantly increase or decrease our income tax expense and effective income tax rates in future periods.

 

 

We calculated basic and diluted earnings per common share as follows:

 

 

We exclude potentially dilutive securities from the determination of diluted earnings per share (as well as their related income statement impacts) when their impact on income from continuing operations per common share is antidilutive. These potentially dilutive securities consist of our employee stock options, restricted stock, convertible preferred stock, trust preferred securities, and zero coupon convertible debentures (which were paid off in April 2006). During the quarter and nine months ended September 30, 2006, certain employee stock options and our remaining trust preferred securities were antidilutive. Additionally, during the nine month period in 2006 our zero coupon convertible debentures were antidilutive. In 2005, we incurred losses from continuing operations and accordingly excluded all potentially dilutive securities from the determination of diluted earnings per share as their impact on income (loss) per common share was antidilutive. For a discussion of our capital stock activity in 2006, our stock-based compensation arrangements, and other instruments noted above, see Notes 12 and 13 as well as our Current Report on Form 8-K dated May 12, 2006.

 

 

The following table summarizes the carrying value of the derivatives used in our price risk management activities as of September 30, 2006 and December 31, 2005. In the table, derivatives designated as hedges consist of instruments used to hedge our natural gas and oil production. Other commodity-based derivative contracts relate to derivative contracts that are not designated as hedges. Finally, interest rate and foreign currency hedging derivatives consist of swaps that are designed to hedge our interest rate and currency risks on long-term debt.

 

Our derivative contracts are recorded in our financial statements at fair value. The best indication of fair value is quoted market prices. However, when quoted market prices are not available, we estimate the fair value of those derivative contracts utilizing commodity pricing data either obtained or derived from information provided by a third party pricing service. During the third quarter of 2006, we changed this third party pricing source. The impact of this change was not material to our results for the period.

 

 

 

 

 

We had the following long-term and short-term borrowings and other financing obligations:

 

 

 

 

As of September 30, 2006, we have approximately $600 million of debt that is redeemable by holders in the first half of 2007, which is prior to its stated maturity date. As a result, we have classified these amounts as current liabilities in our balance sheet. Additionally, a number of debt obligations are callable by us prior to their stated maturity date. Based on September 30, 2006 balances, approximately $9 billion of debt obligations are callable by us in 2006, an additional $300 million is callable by us in 2007, and an additional $1.2 billion is callable by us in 2008 and thereafter. To the extent we decide to redeem any of this debt, certain obligations will require us to pay a make whole premium.

Long-Term Financing Obligations

 

From January 1, 2006 through September 30, 2006, we had the following changes in our long-term and short-term financing obligations:

 

 

 

 

Prior to their redemption in 2006, we recorded accretion expense on our zero coupon debentures, which increased the principal balance of long-term debt each period. During the nine months ended September 30, 2006 and 2005, the accretion recorded in interest expense was $4 million and $19 million. During the nine months ended September 30, 2006 and 2005, we redeemed $615 million and $236 million of our zero coupon convertible debentures, of which $110 million and $34 million represented increased principal due to the accretion of interest on the debentures. We account for these redemptions as financing activities in our statement of cash flows.

 

Credit Facilities and Letters of Credit

 

Available Capacity Under Credit Agreements.  As of September 30, 2006, we had available capacity under our credit agreements of approximately $1 billion. Of this amount, $375 million is related to the $500 million revolving credit agreement of our subsidiary, El Paso Exploration & Production Company (EPEP), and the remainder is available under our $1.75 billion credit agreement and our unsecured revolving credit facility. In May 2006, our $400 million credit facility matured unutilized.

 

Credit Agreement Restructuring.  In July 2006, we restructured our $3 billion credit agreement. As part of this restructuring, we entered into a new $1.75 billion credit agreement, consisting of a $1.25 billion three-year revolving credit facility and a $500 million five-year deposit letter of credit facility. In conjunction with the restructuring, we recorded a third quarter charge of approximately $17 million associated with unamortized financing costs on the previous credit agreement. Our subsidiaries Colorado Interstate Gas Company (CIG), El Paso Natural Gas Company (EPNG) and Tennessee Gas Pipeline Company (TGP) are eligible borrowers under the new agreement. Additionally, El Paso and certain of its subsidiaries have guaranteed the $1.75 billion credit agreement, which is collateralized by our stock ownership in CIG, EPNG, and TGP.

 

Under the $1.25 billion revolving credit facility which matures in July 2009, we can borrow funds at LIBOR plus 1.75% or issue letters of credit at 1.75% plus a fee of 0.15% of the amount issued. We pay an annual commitment fee of 0.375% on any unused capacity under the revolving credit facility. The terms of the $500 million deposit letter of credit facility provide for the ability to issue letters of credit or borrow amounts as revolving loans

which mature in July 2011. We pay LIBOR plus 2.00% on any amounts borrowed under the deposit facility, 2.15% on letters of credit, and 2.10% on unused capacity.

 

Under the new $1.75 billion credit agreement, the primary changes to our restrictive covenants as compared to our former $3 billion credit agreement were as follows:

 

 

 

In addition, we remain restricted from placing liens on the equity of ANR Pipeline Company (ANR); however, we no longer have a restriction on the early retirement of debt with maturities beyond July 2009.

 

Unsecured revolving credit facility.  In July 2006, we also entered into a $500 million unsecured revolving credit facility that matures in July 2011 with a third party and a third party trust that provides for both borrowings and issuing letters of credit. We are required to pay fixed facility fees at a rate of 2.3% on the total committed amount of the facility. In addition, we will pay interest on any borrowings at a rate comprised of either LIBOR or a base rate.

 

Letters of Credit.  As of September 30, 2006, we had total outstanding letters of credit of approximately $1.6 billion. Approximately $1.1 billion of letters of credit were issued under the $1.75 billion credit agreement, and substantially all of the remaining letters of credit were issued under the $500 million unsecured revolving credit facility.

 

 

Legal Proceedings

 

Shareholder/ Derivative/ ERISA Litigation

 

Shareholder Litigation.  Twenty-eight purported shareholder class action lawsuits have been pending since 2002 and are consolidated in federal court in Houston, Texas. The consolidated lawsuit alleges violations of federal securities laws against us and several of our current and former officers and directors. In November 2006, the parties executed a definitive settlement agreement in which the parties agreed to settle these class action lawsuits, subject to final court approval. Under the terms of the settlement, El Paso and its insurers will pay a total of $273 million to the plaintiffs. El Paso will contribute approximately $48 million and its insurers will contribute approximately $225 million. An additional $12 million will be separately contributed by a third party under the terms of the settlement.

 

Derivative Litigation.  Three shareholder derivative actions were filed, including two in federal court in Houston and one in state court in Houston. These cases generally alleged the same claims pled in the consolidated shareholder litigation. All of these cases have now been either settled or dismissed. In the settlement of the state court action, the settlement involved the payment of approximately $17 million which was fully funded by our insurers, of which approximately $12 million will be used to fund the settlement of the shareholder litigation.

 

ERISA Class Action Suits.  In December 2002, a purported class action lawsuit entitled William H. Lewis, III v. El Paso Corporation, et al. was filed in the U.S. District Court for the Southern District of Texas alleging generally that our communication with participants in our Retirement Savings Plan included misrepresentations and omissions similar to those pled in the consolidated shareholder litigation that caused members of the class to hold and maintain investments in El Paso stock in violation of the Employee Retirement Income Security Act (ERISA). Formal discovery in this lawsuit is currently stayed.

There are insurance coverages applicable to each of these shareholder, derivative and ERISA lawsuits, subject to certain deductibles and co-pay obligations. We have established certain accruals for these matters, which we believe are adequate.

 

Cash Balance Plan Lawsuit.  In December 2004, a purported class action lawsuit entitled Tomlinson, et al. v. El Paso Corporation and El Paso Corporation Pension Plan was filed in U.S. District Court for Denver, Colorado. The lawsuit alleges various violations of ERISA and the Age Discrimination in Employment Act as a result of our change from a final average earnings formula pension plan to a cash balance pension plan. Our costs and legal exposure related to this lawsuit are not currently determinable.

 

Retiree Medical Benefits Matters.  We currently serve as the plan administrator for a medical benefits plan that covers a closed group of retirees of the Case Corporation who retired on or before June 30, 1994. Case was formerly a subsidiary of Tenneco, Inc. that was spun off prior to our acquisition of Tenneco in 1996. In connection with the Tenneco-Case Reorganization Agreement of 1994, Tenneco assumed the obligation to provide certain medical and prescription drug benefits to eligible retirees and their spouses. We assumed this obligation as a result of our merger with Tenneco. However, we believe that our liability for these benefits is limited to certain previously established maximums, or caps, and costs in excess of these maximums are assumed by plan participants. In 2002, we and Case were sued by individual retirees in federal court in Detroit, Michigan in an action entitled Yolton et al. v. El Paso Tennessee Pipeline Co. and Case Corporation. The suit alleges, among other things, that El Paso and Case violated ERISA and that they should be required to pay all amounts above the cap. Case further filed claims against El Paso asserting that El Paso is obligated to indemnify, defend and hold Case harmless for the amounts it would be required to pay. In separate rulings in 2004, the court ruled that, pending a trial on the merits, Case must pay the amounts incurred above the cap and that El Paso must reimburse Case for those payments. In January 2006, these rulings were upheld on appeal by the U.S. Court of Appeals for the 6th Circuit. We have filed for the review of these decisions with the United States Supreme Court, and if it is not granted we will proceed with a trial on the merits with regard to the issues of whether the cap is enforceable and what degree of benefits have actually vested. Until this is resolved, El Paso will indemnify Case for any payments Case makes above the cap, which are currently about $1.7 million per month. We continue to defend the action and have filed for approval by the trial court various amendments to the medical benefit plans which would allow us to deliver the benefits to plan participants in a more cost effective manner. Although it is uncertain what plan amendments will ultimately be approved, the approval of plan amendments could reduce our overall costs and, as a result, could reduce our recorded obligation. We have established an accrual for this matter which we believe is adequate.

 

Natural Gas Commodities Litigation.  Beginning in August 2003, several lawsuits have been filed against El Paso Marketing L.P. (EPM) that allege El Paso, EPM and other energy companies conspired to manipulate the price of natural gas by providing false price information to industry trade publications that published gas indices. The first cases have been consolidated in federal court in New York for all pre-trial purposes and are styled In re: Gas Commodity Litigation. In September 2005, the court certified the class to include all persons who purchased or sold NYMEX natural gas futures between January 1, 2000 and December 31, 2002. Other defendants in the case have negotiated tentative settlements with the plaintiffs that have been approved by the court. We have reached a tentative settlement with the plaintiffs subject to execution of definitive agreements and court approval.

 

The second set of cases, involving similar allegations on behalf of commercial and residential customers, were transferred to a multi-district litigation proceeding (MDL) in the U.S. District Court for Nevada, In re Western States Wholesale Natural Gas Antitrust Litigation, dismissed and have been appealed. The third set of cases also involve similar allegations on behalf of certain purchasers of natural gas. These include purported class action lawsuits styled Leggett et al. v. Duke Energy Corporation et al. (filed in Chancery Court of Tennessee in January 2005); Ever-Bloom Inc. v. AEP Energy Services Inc. et al. (filed in federal court for the Eastern District of California in June 2005); Farmland Industries, Inc. v. Oneok Inc. (filed in state court in Wyandotte County, Kansas in July 2005); Learjet, Inc. v. Oneok Inc. (filed in state court in Wyandotte County, Kansas in September 2005); Breckenridge, et al v. Oneok Inc., et al. (filed in state court in Denver County, Colorado in May 2006) and Missouri Public Service Commission v. El Paso Corporation et al (filed in the circuit court of Jackson County, Missouri at Kansas City in October 2006). The Leggett case was removed but then remanded to state court. The Breckenridge case has been removed and conditionally transferred to the MDL proceeding in federal district court in Nevada. The remaining three cases have all been transferred to the MDL proceeding. Similar motions to dismiss

have either been filed or are anticipated to be filed in these cases as well. Our costs and legal exposure related to these lawsuits and claims are not currently determinable.

 

Gas Measurement Cases.  A number of our subsidiaries were named defendants in actions that generally allege mismeasurement of natural gas volumes and/or heating content resulting in the underpayment of royalties. The first set of cases was filed in 1997 by an individual under the False Claims Act, which has been consolidated for pretrial purposes (In re: Natural Gas Royalties Qui Tam Litigation, U.S. District Court for the District of Wyoming.) These complaints allege an industry-wide conspiracy to underreport the heating value as well as the volumes of the natural gas produced from federal and Native American lands. In May 2005, a representative appointed by the court issued a recommendation to dismiss most of the actions. In October 2006, the U.S. District Judge issued an order dismissing all mismeasurement claims against all defendants.

 

Similar allegations were filed in a second action in 1999 in Will Price, et al. v. Gas Pipelines and Their Predecessors, et al., in the District Court of Stevens County, Kansas. The plaintiffs currently seek certification of a class of royalty owners in wells on non-federal and non-Native American lands in Kansas, Wyoming and Colorado. Motions for class certification have been briefed and argued in the proceedings and the parties are awaiting the court’s ruling. The plaintiff seeks an unspecified amount of monetary damages in the form of additional royalty payments (along with interest, expenses and punitive damages) and injunctive relief with regard to future gas measurement practices. Our costs and legal exposure related to this lawsuit and claim are not currently determinable.

 

Hurricane Litigation.  We have been named in three class action petitions for damages filed in the United States District Court for the Eastern District of Louisiana against all oil and natural gas pipeline and production companies that dredged pipeline canals, installed transmission lines or drilled for oil and natural gas in the marshes of coastal Louisiana. The lawsuits, George Barasich, et al. v. Columbia Gulf Transmission Company, et al., Charles Villa Jr., et al. v. Columbia Gulf Transmission Company, et al. (filed in 2005) and Henry and Hattie Bands et al. v. Columbia Gulf Transmission Company et al. (filed in August 2006) assert that the defendants caused erosion and land loss, which destroyed critical protection against hurricane surges and winds and was a substantial cause of the loss of life and destruction of property. The Barasich and Bands lawsuits allege damages associated with Hurricane Katrina. The Villa lawsuit alleges damages associated with Hurricanes Katrina and Rita. The court consolidated the Villa and Barasich cases and issued an order dismissing the cases for failure to state a claim on which relief could be granted. The Bands case was not consolidated at the time the Barasich and Villa dismissal order was issued and the defendants are seeking to have it dismissed on the same grounds. Our costs and legal exposure related to this lawsuit and claim are not currently determinable.

 

Bank of America.  We were a named defendant, along with Burlington Resources, Inc. (Burlington), in two class action lawsuits styled Bank of America, et al. v. El Paso Natural Gas Company, et al., and Deane W. Moore, et al. v. Burlington Northern, Inc., et al., each filed in 1997 in the District Court of Washita County, Oklahoma and subsequently consolidated by the court. The consolidated class action has been settled. Our settlement contribution was approximately $30 million plus interest, which had been fully accrued and was paid on August 1, 2006. A third action, styled Bank of America, et al. v. El Paso Natural Gas and Burlington Resources Oil and Gas Company, L.P., was filed in October 2003 in the District Court of Kiowa County, Oklahoma asserting similar claims as to specified shallow wells in Oklahoma, Texas and New Mexico. All the claims in this action have also been settled subject to court approval, after a fairness hearing scheduled for March 2007. We filed an action styled El Paso Natural Gas Company v. Burlington Resources, Inc. and Burlington Resources Oil and Gas Company, L.P. against Burlington in state court in Harris County, Texas relating to indemnity issues between Burlington and us. That action was stayed by agreement of the parties and settled in November 2005, subject to all the underlying class settlements being finalized and approved by the court.

 

MTBE.  In compliance with the 1990 amendments to the Clean Air Act, certain of our subsidiaries used the gasoline additive, methyl tertiary-butyl ether (MTBE) in some of their gasoline. Certain subsidiaries have also produced, bought, sold and distributed MTBE. A number of lawsuits have been filed throughout the U.S. regarding MTBE’s potential impact on water supplies. Some of our subsidiaries are among the defendants in 70 such lawsuits. These suits either have been or are in the process of being consolidated for pre-trial purposes in multi-district

litigation in the U.S. District Court for the Southern District of New York. The plaintiffs, certain state attorneys general, various water districts and a limited number of individual water customers seek remediation of their groundwater, prevention of future contamination, damages, punitive damages, attorney’s fees, court costs and, in one lawsuit, a request for medical monitoring. Among other allegations, plaintiffs assert that gasoline containing MTBE is a defective product and that defendant refiners are liable in proportion to their market share. The plaintiff states of California and New Hampshire have filed an appeal to the 2nd Circuit Court of Appeals challenging the removal of the cases from state to federal court. That appeal is pending. Our costs and legal exposure related to these lawsuits are not currently determinable.

 

Government Investigations and Inquiries

 

Reserve Revisions.  In March 2004, we received a subpoena from the SEC requesting documents relating to our December 31, 2003 natural gas and oil reserve revisions. We continue to cooperate with the SEC in its investigation related to such reserve revisions.

 

Iraq Oil Sales.  Several government agencies and congressional committees have been reviewing and making formal and informal requests related to The Coastal Corporation’s and El Paso’s purchases of crude oil from Iraq under the United Nations’ Oil for Food Program. These agencies include a grand jury of the U.S. District Court for the Southern District of New York, the SEC and several congressional committees. In October 2005, a grand jury sitting in the Southern District of New York handed down an indictment against Oscar S. Wyatt, Jr., a former CEO and Chairman of Coastal. Also in October 2005, the Independent Inquiry Committee into the United Nations’ Oil for Food Program issued its final report. The report states that $201,877 in surcharges were paid with respect to a single contract entered into by our subsidiary, Coastal Petroleum NV (CPNV). The report lists Oscar Wyatt as the non-contractual beneficiary of the contract. The report indicates that the payments were made by two other individuals or entities and does not contend that CPNV paid that surcharge. We continue to cooperate with all government investigations into this matter and have commenced discussions with the DOJ and SEC in an attempt to resolve these investigations.

 

Other Government Investigations.  We also continue to provide information and cooperate with the inquiry or investigation of the U.S. Attorney and the SEC in response to requests for information regarding price reporting of transactional data to the energy trade press and the hedges of our natural gas production.

 

Other Contingencies

 

EPNG Rate Case.  In June 2005, EPNG filed a rate case with the FERC proposing an increase in revenues of 10.6 percent or $56 million annually over current tariff rates, new services and revisions to certain terms and conditions of existing services. On January 1, 2006, the rates became effective and are subject to refund. In March 2006, the FERC issued an order that generally approved our proposed new services, which were implemented on June 1, 2006. In April 2006, we solicited and received bids for certain new services and have entered into several contracts for new services. EPNG has made significant progress towards a tentative settlement with its customers. The outcome of this or any additional rate case cannot be predicted with certainty at this time.

 

CIG Rate Case.  In August 2006, the FERC approved a settlement reached with CIG’s customers to be effective October 1, 2006. The settlement establishes system-wide base rates through at least September 2010, but no later than September 2011, and establishes a sharing mechanism to encourage additional fuel savings.

 

Iraq Imports.  In December 2005, the Ministry of Oil for the State Oil Marketing Organization of Iraq (SOMO) sent an invoice to one of our subsidiaries with regard to shipments of crude oil that SOMO alleged were purchased and paid for by Coastal in 1990. The invoices request an additional $144 million of payments for such shipments, along with an allegation of an undefined amount of interest. The invoice appears to be associated with cargoes that Coastal had purchased just before the 1990 invasion of Kuwait by Iraq. We have requested additional information from SOMO to further assist in our evaluation of the invoice and the underlying facts. In addition, we are evaluating our legal defenses, including applicable statute of limitation periods.

 

Navajo Nation.  Approximately 900 looped pipeline miles of the north mainline of our EPNG pipeline system are located on lands held in trust by the United States for the benefit of the Navajo Nation. Our rights-of-way

on lands crossing the Navajo Nation expired in October 2005, and we entered into an interim agreement with the Navajo Nation to extend the use of our existing rights-of-way through the end of 2006. Negotiations on the terms of the long-term agreement are continuing. Although the Navajo Nation has at times demanded more than ten times the $2 million annual fee that existed prior to the execution of the interim agreement, EPNG continues to offer a combination of cash and non-cash consideration, including collaborative projects to benefit the Navajo Nation. In addition, EPNG continues to preserve other legal and regulatory alternatives, which include continuing to pursue our application with the Department of the Interior for renewal of our rights-of-way on Navajo Nation lands. EPNG also continues to press for public policy intervention by Congress in this area. The Energy Policy Act of 2005 commissioned a comprehensive study of energy infrastructure rights-of-way on tribal lands which is being prepared by the Department of Energy and the Department of Interior. We currently expect that the report will be submitted to Congress by the end of this year. It is uncertain whether our negotiation, public policy or litigation efforts will be successful, or if successful, what the ultimate cost will be of obtaining the rights-of-way or whether EPNG will be able to recover these costs in its rates.

 

In addition to the above matters, we and our subsidiaries and affiliates are named defendants in numerous lawsuits and governmental proceedings that arise in the ordinary course of our business. There are also other regulatory rules and orders in various stages of adoption, review and/or implementation. For each of our outstanding legal and other contingent matters, we evaluate the merits of the case, our exposure to the matter, possible legal or settlement strategies and the likelihood of an unfavorable outcome. If we determine that an unfavorable outcome is probable and can be estimated, we establish the necessary accruals. While the outcome of these matters, including those discussed above, cannot be predicted with certainty, and there are still uncertainties related to the costs we may incur, based upon our evaluation and experience to date, we believe we have established appropriate reserves for these matters. However, it is possible that new information or future developments could require us to reassess our potential exposure related to these matters and adjust our accruals accordingly, and these adjustments could be material. As of September 30, 2006, we had approximately $540 million accrued, net of related insurance receivables and restricted cash, for outstanding legal and other contingent matters.

 

Environmental Matters

 

We are subject to federal, state and local laws and regulations governing environmental quality and pollution control. These laws and regulations require us to remove or remedy the effect on the environment of the disposal or release of specified substances at current and former operating sites. As of September 30, 2006, we have accrued approximately $362 million, which has not been reduced by $30 million for amounts to be paid directly under government sponsored programs. Our accrual includes approximately $351 million for expected remediation costs and associated onsite, offsite and groundwater technical studies and approximately $11 million for related environmental legal costs. Of the $362 million accrual, $66 million was reserved for facilities we currently operate and $296 million was reserved for non-operating sites (facilities that are shut down or have been sold) and Superfund sites.

 

Our reserve estimates range from approximately $362 million to approximately $582 million. Our accrual represents a combination of two estimation methodologies. First, where the most likely outcome can be reasonably estimated, that cost has been accrued ($60 million). Second, where the most likely outcome cannot be estimated, a range of costs is established ($302 million to $522 million) and if no one amount in that range is more likely than any other, the lower end of the expected range has been accrued. Our environmental remediation projects are in various stages of completion. Our recorded liabilities reflect our current estimates of amounts we will expend to remediate these sites. However, depending on the stage of completion or assessment, the ultimate extent of contamination or remediation required may not be known. As additional assessments occur or remediation efforts

continue, we may incur additional liabilities. By type of site, our reserves are based on the following estimates of reasonably possible outcomes:

 

 

Below is a reconciliation of our accrued liability from January 1, 2006 to September 30, 2006 (in millions):

 

 

For the remainder of 2006, we estimate that our total remediation expenditures will be approximately $20 million, most of which will be expended under government directed clean-up plans. In addition, we expect to make capital expenditures for environmental matters of approximately $77 million in the aggregate for the years 2006 through 2010. These expenditures primarily relate to compliance with clean air regulations.

 

Polychlorinated Biphenyls (PCB) Cost Recoveries.  Pursuant to a consent order executed with the United States EPA in May 1994, TGP has been conducting remediation activities at certain of its compressor stations associated with the presence of PCB and other hazardous materials. TGP has recovered a substantial portion of the environmental costs identified in its PCB remediation project through a surcharge to its customers. An agreement with TGP’s customers, approved by the FERC in November 1995, established the surcharge mechanism. The surcharge collection period is currently set to expire in June 2008 with further extensions subject to a filing with the FERC. As of September 30, 2006, TGP had pre-collected PCB costs of approximately $138 million. This pre-collected amount will be reduced by future eligible costs incurred for the remainder of the remediation project. To the extent actual eligible expenditures are less than the amounts pre-collected, TGP will refund to its customers the difference, plus carrying charges incurred up to the date of the refunds. TGP’s regulatory liability for estimated future refund obligations to its customers increased from approximately $110 million at December 31, 2005 to approximately $127 million as of September 30, 2006.

 

CERCLA Matters.  We have received notice that we could be designated, or have been asked for information to determine whether we could be designated, as a Potentially Responsible Party (PRP) with respect to 54 active sites under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) or state equivalents. We have sought to resolve our liability as a PRP at these sites through indemnification by third-parties and settlements, which provide for payment of our allocable share of remediation costs. As of September 30, 2006, we have estimated our share of the remediation costs at these sites to be between $37 million and $64 million. Because the clean-up costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, and in some cases we have asserted a defense to any liability, our estimates could change. Moreover, liability under the federal CERCLA statute is joint and several, meaning that we could be required to pay in excess of our pro rata share of remediation costs. Our understanding of the financial strength of other PRPs has been considered, where appropriate, in estimating our liabilities. Accruals for these issues are included in the previously indicated estimates for Superfund sites.

 

It is possible that new information or future developments could require us to reassess our potential exposure related to environmental matters. We may incur significant costs and liabilities in order to comply with existing environmental laws and regulations. It is also possible that other developments, such as increasingly strict environmental laws, regulations and orders of regulatory agencies, as well as claims for damages to property and the environment or injuries to employees and other persons resulting from our current or past operations, could result in substantial costs and liabilities in the future. As this information becomes available, or other relevant

developments occur, we will adjust our accrual amounts accordingly. While there are still uncertainties related to the ultimate costs we may incur, based upon our evaluation and experience to date, we believe our reserves are adequate.

 

Guarantees

 

We are involved in various joint ventures and other ownership arrangements that sometimes require additional financial support in the form of financial and performance guarantees. For a description of these commitments, see our Current Report on Form 8-K dated May 12, 2006. As of September 30, 2006, we had recorded obligations of $69 million related to our guarantees and indemnification arrangements. These arrangements had a total stated value of approximately $330 million, for which we are indemnified by third parties for $24 million. These amounts exclude guarantees for which we have issued related letters of credit discussed in Note 9. Included in the above stated value of $330 million is approximately $120 million associated with tax matters, related interest and other indemnifications arising out of the sale of our Macae power facility.

 

In addition to the exposures described above, a trial court has ruled, which was upheld on appeal, that we are required to indemnify a third party for benefits being paid to a closed group of retirees of one of our former subsidiaries. We have a liability of approximately $378 million associated with our estimated exposure under this matter as of September 30, 2006. For a further discussion of this matter, see Retiree Medical Benefits Matters above.

 

 

The components of net benefit cost for our pension and postretirement benefit plans for the periods ended September 30 are as follows: