El Paso Corp. has arranged a $500-million drilling joint venture with drilling company Nabors Industries Ltd. and investment banker Lehman Brothers. The deal will result in $350 million more exploration and exploitation capex spending by El Paso during the next nine to 12 months than El Paso had budgeted. Lehman will contribute $250 million for a 50% net profits interest; Nabors, $100 million for 20%. El Paso will contribute $150 million. Upon pay-out, the net profits interests will convert to an overriding royalty interest in the wells for the remainder of their production. Credit Lyonnais analyst Gordon Howald says, "This is somewhat of a shift in strategy from what prior El Paso management had initially leaned toward for El Paso, which was not farm-outs, but rather a partial monetization of its E&P division via an [initial public offering]. It was the dissident shareholders that had put forth this proposal, which we saw as a major difference between the two plans." Banc of America Securities oilfield-services analyst James K. Wicklund says Nabors has a large amount of cash. Using it to get more rigs put to work, and investing cash at potentially higher returns than alternative investments, is very positive, he says. The deal covers onshore drilling only. Wicklund expects an offshore deal will be announced too. Howald said, "We believe that this is an attractive option for El Paso as it preserves access to these assets long-term, which provides the opportunity to either IPO or further develop these assets in the future as a means of creating long-term shareholder value. An IPO is attractive only if El Paso finds itself in need of a further liquidity cushion near-term." Wicklund says, "The deal essentially affords El Paso the ability to continue exploration." Wicklund likes the deal from a Nabors perspective. And Howald likes it from an El Paso perspective-in the long term. However, short-term, "we believe this supports our concern that El Paso will not be able to have its cake and eat it too, as it relates to its E&P program, and that production levels, net to El Paso, will not live up to investor expectations in [the second half and next year]," Howald says. Howald adds that El Paso's Brazilian E&P assets could be put up for sale in the future. It will take a lot more time for the company to better understand these assets, time that the company may not have, he says. -Jodi Wetuski
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