( EP) foray into the rough-and-tumble of energy trading skidded out Wednesday when the company said it will cut half its trading staff and concentrate on its old business of selling gas.
The move reflects a growing lack of tolerance in the capital markets for the extreme volatility of energy trading and is, to some degree, a blueprint for other companies trying to extricate themselves from a sometimes brutal line of business. The step was a costly one for El Paso: Along with the layoffs the company was also forced to lower earnings guidance for the second time this year. Its shares plunged $8.26, or 23.4%, to $27.01 and are off 39% so far this year.
El Paso hopes to reap $150 million of cost savings from the staff reductions. In addition, it wants to limit investment in its trading portfolio to no more than $1 billion and limit future noncash mark-to-market income to 5% of total earnings.
"By limiting our investment in trading and its demand on corporate credit and liquidity, this plan allows El Paso to utilize its strengthened balance sheet and credit profile to take advantage of significant growth opportunities in the natural gas arena," said William Wise, El Paso's CEO, in a statement.
The news comes as energy traders are under increased scrutiny. On Tuesday,
CEO resigned, while
CEO stepped down Friday. The
Securities and Exchange Commission
is investigating both firms for "round-trip" trading -- or selling power and instantly repurchasing it at the same price to inflate volume.
Though not under the same microscope, El Paso, like other energy traders, needs to improve its credit quality. (Standard & Poor's cut its rating on
to two notches above junk status on Tuesday.) To do that, the company said it would issue $1.5 billion of equity and sell its San Juan, N.M., natural gas assets to El Paso Energy Partners, a limited partnership in which it has a 30% stake, for $800 million.
Additionally, El Paso said it would narrow activity to the "most attractive businesses," which are its natural gas assets.
"The credit rating agencies are looking for stability in cash flow," said Anne Falgout, an analyst at Johnson Rice. "Trading activity does not give these companies that."
Before El Paso's plan was put in place, trading and marketing -- which are loosely defined as the company's nonasset-based businesses -- made up about 18% of total EBIT, or earnings before income taxes. Now, trading is expected to be approximately 11% of the company's EBIT in 2002.
"Two years ago, El Paso saw that there was money to be made in power trading," said Louis Gagliardi, an analyst at John S. Herold, an independent oil and gas research firm. "Now, they have decided to get back to their roots as a natural gas provider and fix their balance sheet."
But as a result, investors should not expect the 15% year-over-year growth rate of the past. "Investors will have to accept the company is going to grow at a slower rate," said Gagliardi.
Nevertheless, the problem may be less acute for El Paso than it is for other energy traders.
In Dynegy's first quarter, 68% of its gross profit came from asset-generated businesses, while 32% of it came from customer risk-management activity, which includes the company's trading operations.
On a call Tuesday, Dynegy said 80% of 2002 cash flow should come from asset businesses -- calling it "a solid foundation for sustainable growth." That level of volatility is about what El Paso started with before Wednesday.