Shares of El Paso Corp. (NYSE: EP) dropped 18% on news the company would slash its year-end 2003 proved reserve estimate 41% and take a $1-billion impairment charge. Analysts questioned whether the company will be forced to sell any of its core assets to support its balance sheet, and how it will be able to attract the third-party capital it desires to bolster its slim E&P spending plan this year. "The level of this impairment is simply unprecedented," says Gordon Howald, an analyst with Credit Lyonnais Securities. El Paso sliced 1.8 trillion cu. ft. of gas equivalent off its proved reserve inventory, leaving it with 2.6 trillion, following an independent audit by Ryder Scott-a firm with a reputation for conservative evaluations. The affected areas include South Texas (803 billion cu. ft. equivalent), coalbed-methane properties (511 billion), the Gulf of Mexico (392 billion) and Brazil (37 billion). The reasons given for the revisions were widespread. On the coalbed-methane properties in Colorado's Raton Basin, for example, reserves were originally booked based on 160-acre well spacing, but production performance indicates that 80-acre spacing will be needed to drain the field. El Paso does not yet have approvals to drill the additional wells. In Brazil, the lack of a signed gas-sales agreement for the Camamu Basin meant that the reserves there needed to be recategorized as probable, rather than proven. John Olson, an analyst with Sanders Morris Harris, asked El Paso executives during a conference call whether all of the affected reserves were moved into the probable category, as were the Brazilian reserves, or whether any of them had vanished altogether. Executives were vague with their answer, saying they were still in the process of categorizing their nonproved reserves, and that even more reasons for the revisions may surface. They promised more detail in the second quarter, when their review would be complete. Howald, for one, is troubled by the vagueness. "How can a company be comfortable with its revisions if it is not comfortable with the means used to arrive at its revisions?" he asks. He also said he expects the impairment charge to be more than $1 billion. That figure was arrived at using a $6 Henry Hub gas price. At the time of the announcement, the Henry Hub price was $5.43. "With natural gas prices...likely to remain below $6 as we move through 2004, further impairments are likely," he says. Tucked into the press release about the revisions was some bad news concerning El Paso's widely touted drilling agreement with Lehman Brothers and Nabors Industries Ltd. (Amex: NBR). The $230-million CGP drilling package-which included properties in South Texas, North Louisiana, the upper Gulf Coast and offshore Gulf of Mexico-has not met expectations. Lehman Brothers has pulled out of that package, and El Paso expects Nabors to do the same. The two partners will continue to invest in the $270-million EPPH package, which includes properties in South Texas, the upper Gulf Coast and the Gulf of Mexico. Doug Foshee, president and chief executive of El Paso, has touted these funding arrangements as one way to help boost production, while at the same time cutting its E&P spending. The company plans to reduce E&P outlays from $1.4 billion in 2003 to $850 million in 2004, while growing production from an estimated 850- to 950 million cu. ft. of gas equivalent in 2004 to 1 billion in 2006. Howald says it might be difficult for the company to find partners going forward. "Something about this development doesn't sit well with us-at the very least, the contract terms with future partners would have to be even more favorable to its partners than even the Lehman/Nabors deal," he says. "Why would any partner want to be associated with this situation, particularly given the possibility [or likelihood] of an SEC inquiry, unless the return potential to them was extraordinary?" Moody's Investors Service placed under review for possible downgrade the ratings of El Paso Corp. and its subsidiaries. It also downgraded El Paso Production Holding's senior unsecured note and senior implied ratings. Standard & Poor's Ratings Services lowered its corporate credit rating on the company to Single B-Minus from Single B. The outlook remains negative. -Jodi Wetuski