EL PASO NATURAL GAS CO - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-2700

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EL PASO NATURAL GAS COMPANY
(Exact Name of Registrant as Specified in its Charter)

DELAWARE 74-0608280
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)

EL PASO BUILDING
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
(Address of Principal Executive Offices) (Zip Code)

Telephone Number: (713) 420-2600

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 [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

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 $1 per share. Shares outstanding on August 13,
2004: 1,000

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EL PASO NATURAL GAS COMPANY

TABLE OF CONTENTS

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

/d = per day
BBtu = billion British thermal units
Bcf = billion cubic feet
MMcf = million cubic feet

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" or "ours", we are describing El Paso
Natural Gas Company and/or our subsidiaries.

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PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EL PASO NATURAL GAS COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
(UNAUDITED)

See accompanying notes.

1

EL PASO NATURAL GAS COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)

See accompanying notes.

2

EL PASO NATURAL GAS COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)

See accompanying notes.

3

EL PASO NATURAL GAS COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

We are an indirect wholly owned subsidiary of El Paso Corporation (El
Paso). We prepared this Quarterly Report on Form 10-Q under the rules and
regulations of the United States Securities and Exchange Commission. Because
this is an interim period filing presented using a condensed format, it does not
include all of the disclosures required by generally accepted accounting
principles. You should read it along with our 2003 Annual Report on Form 10-K,
which includes a summary of our significant accounting policies and other
disclosures. The financial statements as of June 30, 2004, and for the quarters
and six months ended June 30, 2004 and 2003, are unaudited. We derived the
balance sheet as of December 31, 2003, from the audited balance sheet filed in
our 2003 Form 10-K. 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 business, information for interim periods may not be
indicative of our results of operations for the entire year. Prior period
information presented in these financial statements includes reclassifications
which were made to conform to the current period presentation. These
reclassifications had no effect on our previously reported net income or
stockholder's equity.

Our accounting policies are consistent with those discussed in our 2003
Form 10-K.

2. LIQUIDITY

In May 2004, El Paso announced that the results of an independent
investigation confirmed that its historical financial statements should be
restated to reflect previously announced revisions to its natural gas and oil
reserve estimates. El Paso believes that a material restatement of its financial
statements would have constituted an event of default under its $3 billion
revolving credit facility, under which we are eligible to borrow (see Note 4),
and various other financings; specifically under the provisions of those
agreements related to representations and warranties on the accuracy of its
historical financial statements and on El Paso's debt to total capitalization
ratio. Beginning in March 2004, El Paso received a series of waivers on its $3
billion revolving credit facility and these other financing transactions to
address these issues. In August 2004, El Paso announced that its financial
statements would likely be further restated for an issue related to the manner
in which it historically accounted for hedges of its natural gas production. To
address the issues relating to the further restatement, on August 6, 2004, El
Paso received a third waiver on its $3 billion revolving credit facility which
waived any defaults related to representations and warranties of the accuracy of
its historical financial statements, amended its debt to capitalization ratio,
extended the filing deadline for its December 31, 2003 annual financial
statements until September 30, 2004, and extended the filing deadline for its
March 31, 2004 and June 30, 2004 quarterly financial statements until November
30, 2004. The August waiver to the $3 billion revolving credit facility also
placed restrictions on the voluntary prepayment of El Paso's and its
subsidiaries debt that matures after June 30, 2005, amended one of the defined
event of default provisions and also provided that if El Paso or any of its
significant subsidiaries receives or is required to provide a notice of default
on any other debt or guaranty of debt that in the aggregate exceeds $100
million, El Paso will have 29 days to file its financial statements (not to go
beyond September 30, 2004, in the case of its December 31, 2003 financial
statements, and November 30, 2004, in the case of its March 31, 2004 and June
30, 2004 financial statements). If El Paso does not file its financial
statements by these required dates, El Paso would need to obtain additional
waivers to avoid an event of default. Although we are a party to El Paso's $3
billion revolving credit facility, we do not have any borrowings or letters of
credit outstanding under that facility. Based upon a review of our financing
transactions, we believe that a default on El Paso's $3 billion revolving credit
facility would not constitute an event of default on our other debt agreements.

El Paso is a significant potential source of liquidity to us. We
participate in El Paso's cash management program. Under this program, depending
on whether we have short-term cash surpluses or requirements, we either provide
cash to El Paso or El Paso provides cash to us. We have historically provided
cash to El Paso under this program, and as of June 30, 2004, we had a cash
advance receivable from El Paso of $741 million,

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$688 million of which is classified as a non-current asset in our balance sheet.
The remaining $53 million is classified as a current asset. Based on our current
estimates of cash flows and cash flow needs under our current capital
expenditure plan, we believe we will need to seek repayment of this portion of
the advance in the next year. If El Paso were unable to meet its liquidity
needs, we would not have access to this source of liquidity and there is no
assurance that El Paso could repay the amounts owed to us. In that event, we
could be required to write-off some or all of these advances, which could have a
material impact on our stockholder's equity and we would still be required to
repay affiliated company payables. Although increases in our debt to EBITDA (as
defined in our agreements) ratio that cause the ratio to exceed 5 to 1 could
prohibit us from incurring additional debt, the equity reduction that would
result if we wrote off these receivables would not result in an event of default
under our existing debt agreements.

El Paso's ownership in us and our ownership in Mojave Pipeline Company
(Mojave) serve as collateral under El Paso's $3 billion revolving credit
facility and other of El Paso's financing transactions. If El Paso's lenders
under these facilities were to exercise their rights to this collateral, our
ownership could change and our ownership interests in Mojave could be
liquidated. However, this change of control and liquidation would not constitute
an event of default under our existing debt agreements.

If, as a result of the events described above, El Paso were subject to
voluntary or involuntary bankruptcy proceedings, El Paso and its other
subsidiaries and their creditors could attempt to make claims against us,
including claims to substantively consolidate our assets and liabilities with
those of El Paso and its other subsidiaries. We believe that claims to
substantively consolidate us with El Paso and/or its other subsidiaries would be
without merit. However, there is no assurance that El Paso and/or its other
subsidiaries or their creditors would not advance such a claim in a bankruptcy
proceeding. If we were to be substantively consolidated in a bankruptcy
proceeding with El Paso and/or its other subsidiaries, there could be a material
adverse effect on our financial condition and our liquidity.

For a discussion of our obligations under the Western Energy Settlement
agreement that could have an impact on our liquidity, see Note 5.

Finally, we have cross-acceleration provisions in our long-term debt
agreements that state that should we incur an event of default under which
borrowings in excess of $25 million are accelerated, our long-term debt could
also be accelerated. The acceleration of our long-term debt would adversely
affect our liquidity position and, in turn, our financial condition.

3. WESTERN ENERGY SETTLEMENT

In the fourth quarter of 2002, we reached preliminary settlement to resolve
the principal litigation and claims relating to the sale or delivery of natural
gas and/or electricity to or in the Western United States. In the second quarter
of 2003, the preliminary settlement was finalized and in June 2004, we received
final approval of the settlement. Prior to final approval, El Paso had
established an escrow account for certain amounts related to the settlement. As
of December 31, 2003, $443 million had been deposited by us into this account
and an additional $73 million was deposited in January 2004. Upon final approval
of the settlement in June, these amounts were released by El Paso to the Western
Energy Settlement parties. We also paid an additional $22 million, the total of
which satisfied our $538 million obligation under this settlement. Release of
funds by El Paso on our behalf from the escrow account are reflected as an
increase in our cash flows from investing activities. The release of funds to
satisfy our Western Energy Settlement liability has been reflected as a
reduction of our cash flow from operating activities. See Note 5 for a further
discussion of the Western Energy Settlement.

4. CREDIT FACILITIES

Letters of Credit

As of June 30, 2004 we had $1 million of outstanding letters of credit on
behalf of various unconsolidated affiliates, which are subsidiaries of El Paso.
These letters of credit will mature in April 2005.

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Other Financing Arrangements

El Paso maintains a $3 billion revolving credit facility, with a $1.5
billion letter of credit sublimit, which matures on June 30, 2005. The $3
billion revolving credit facility has a borrowing cost of LIBOR plus 350 basis
points, letter of credit fees of 350 basis points and a commitment fee of 75
basis points on the unused portion of the facility. We, along with El Paso and
our affiliates, ANR Pipeline Company, Tennessee Gas Pipeline Company and
Colorado Interstate Gas Company, are borrowers under the $3 billion revolving
credit facility. We are only liable for amounts we directly borrow under the $3
billion revolving credit facility. As of June 30, 2004, $600 million was
outstanding and $1.1 billion in letters of credit were issued under the $3
billion revolving credit facility, none of which was borrowed by or issued on
our behalf. During the fourth quarter of 2003 and the first quarter of 2004, El
Paso liquidated a portion of the collateral that supported the $3 billion
revolving credit facility, which reduced the borrowing availability by $42
million. See Note 2 for a discussion regarding El Paso's waivers on the
$3 billion revolving credit facility.

El Paso's equity in several of its subsidiaries, including its equity in us
and our equity in Mojave, collateralizes the $3 billion revolving credit
facility and $303 million of other financing arrangements including leases,
letters of credit and other credit facilities.

Under the $3 billion revolving credit facility and other financing
agreements, we are subject to a number of restrictions and covenants. The most
restrictive of these include (i) limitations on the incurrence of additional
debt, based on a ratio of debt to EBITDA (as defined in the agreements), the
most restrictive of which shall not exceed 5 to 1; (ii) limitations on the use
of proceeds from borrowings; (iii) limitations, in some cases, on transactions
with our affiliates; (iv) limitations on the incurrence of liens; (v) potential
limitations on our ability to declare and pay dividends; and (vi) potential
limitations on our ability to participate in El Paso's cash management program
discussed in Note 7.

5. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

Western Energy Settlement. In June 2003, El Paso announced that it had
executed a Master Settlement Agreement, or MSA, to resolve the principal
litigation relating to the sale or delivery of natural gas and/or electricity to
or in the Western United States. The MSA became effective in June 2004. The MSA,
along with additional separate settlement agreements, settle California lawsuits
in state court, the California Public Utilities Commission (CPUC) proceeding at
the Federal Energy Regulatory Commission (FERC), and the California Attorney
General investigation discussed herein. Parties to the settlement agreements
include private class action litigants in California; the governor and
lieutenant governor of California; the attorneys general of California,
Washington, Oregon and Nevada; the CPUC; the California Electricity Oversight
Board; the California Department of Water Resources; Pacific Gas and Electric
Company (PG&E), Southern California Edison Company, five California
municipalities and six non-class private plaintiffs.

As a party to the settlement agreements, we bear a portion of the costs and
obligations of the settlements, as discussed more fully below. In the
agreements, we agreed to the following:

- We admitted to no wrongdoing;

- We released approximately $344 million for the benefit of the parties to
the definitive settlement agreements; and

- We paid amounts equal to the proceeds of $195 million from the issuance
of approximately 26.4 million shares by El Paso of El Paso common stock
on behalf of the settling parties. In this transaction, El Paso sold its
common stock and provided the proceeds from the issuance to us through an
equity contribution to satisfy this obligation.

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The MSA is in addition to a Joint Settlement Agreement, or JSA, announced
earlier in June 2003 where we agreed to provide structural relief to the
settling parties. In the JSA, we agreed to do the following:

- Subject to the conditions in the settlement, (1) make 3.29 Bcf/d of
primary firm pipeline capacity on our system available to California
delivery points during a five year period from the date of settlement,
but only if shippers sign firm contracts for 3.29 Bcf/d of capacity with
California delivery points; (2) maintain facilities sufficient to
physically deliver 3.29 Bcf/d to the California delivery points; and (3)
not add any firm incremental load to our system that would prevent us
from satisfying our obligation to provide this capacity;

- Construct a new 320 MMcf/d, Line 2000 Power-up expansion project, and
forgo recovery of the cost of service of this expansion until our next
rate case before the FERC;

- Clarify the rights of Northern California shippers to recall some of our
system capacity (Block II capacity) to serve markets in PG&E's service
area; and

- With limited exceptions, bar any of our affiliated companies from
obtaining additional firm capacity on our pipeline system during a five
year period from the effective date of the settlement.

In June 2003, in anticipation of the execution of the MSA, El Paso, the
CPUC, PG&E, Southern California Edison Company, and the City of Los Angeles
filed the JSA described above with the FERC in resolution of the CPUC complaint
proceeding discussed below under Rates and Regulatory Matters. In November 2003,
the FERC approved the JSA with minor modifications. Our east of California
shippers filed requests for rehearing which were denied by the FERC in March
2004. Certain shippers have appealed the FERC's ruling to the U.S. Court of
Appeals for the District of Columbia.

El Paso Merchant Energy, L.P. (EPME), our affiliate, and El Paso are also
parties to the MSA and the separate settlement agreements, and were obligated to
pay a total of $1,027 million (on an undiscounted basis) under these settlement
agreements. In June 2004, El Paso made payments of approximately $14 million,
which were net of a $12 million discount for prepayment of a portion of its 20
year cash installment obligation, satisfying $26 million of its obligation, and
EPME released approximately $50 million. The remaining obligation consists of El
Paso's $876 million settlement obligation, which will be paid in installments
over the next 20 years, and EPME's $75 million in contractual price discounts
that will be realized over the remaining 18 month life of an existing power
contract with one of the settling parties. The long-term payment obligation is a
direct obligation of El Paso and EPME and will be supported by collateral posted
by El Paso's affiliates in amounts specified by the settlement agreements. We
have guaranteed the payment of these obligations in the event El Paso and EPME
fail to pay these amounts.

Other Energy Market Lawsuits. In April 2003, Sierra Pacific Resources and
Nevada Power Company filed a suit against us. The allegations were similar to
those in the California cases. In January 2004, the Court dismissed the lawsuit.
In April 2004, the Court reaffirmed its previous order dismissing the
plaintiffs' complaint with prejudice, but also granted the plaintiffs 45 days to
amend their complaint. Plaintiffs have filed an amended complaint in district
court, and we have filed a new motion to dismiss, as have other defendants. Our
costs and legal exposure related to this lawsuit are not currently determinable.

In January 2003, a lawsuit titled IMC Chemicals v. EPME, et al. was filed
in California state court against us and our affiliates. The suit arose out of a
gas supply contract between IMC Chemicals (IMCC) and EPME and sought to void the
Gas Purchase Agreement between IMCC and EPME for gas purchases until December
2003. IMCC contended that EPME and its affiliates manipulated market prices for
natural gas and, as part of that manipulation, induced IMCC to enter into the
contract. In furtherance of its attempt to void the contract, IMCC repeated the
allegations and claims of the California lawsuits described above. EPME intends
to enforce the terms of the contract and has filed a counterclaim for contract
damages in excess of $5 million. IMCC's claim is undeterminable but appears to
be in excess of $20 million. Our costs and legal exposure related to this
lawsuit are not currently determinable.

State of Arizona v. El Paso et. al. In March 2003, the State of Arizona
sued us, our affiliates and other unrelated entities on behalf of Arizona
consumers. The suit alleges that the defendants conspired to artificially

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inflate prices of natural gas and electricity during 2000 and 2001. Making
allegations similar to those alleged in the California cases, the suit seeks
relief similar to the California cases, but under Arizona antitrust and consumer
fraud statutes. We have filed motions to dismiss this matter which are scheduled
to be heard in state court. Our costs and legal exposure related to this lawsuit
are not currently determinable.

Phelps Dodge vs. EPNG. On February 3, 2004, one of our customers, Phelps
Dodge, and a number of its affiliates filed a lawsuit against us in the state
court of Arizona. Plaintiffs claim we violated Arizona anti-trust statutes and
allege that during 2000-2001, we unlawfully manipulated and inflated gas prices.
We removed this lawsuit to the US District Court for the District of Arizona.
Plaintiffs have filed a motion to return the matter to state court which we have
opposed. Our costs and legal exposure related to this lawsuit are not currently
determinable.

Shareholder Class Action Suit. In November 2002, we were named as a
defendant in a shareholder derivative suit titled Marilyn Clark v. Byron
Allumbaugh, David A. Arledge, John M. Bissell, Juan Carlos Braniff, James F.
Gibbons, Anthony W. Hall, Ronald L. Kuehn, J. Carleton MacNeil, Thomas McDade,
Malcolm Wallop, William Wise, Joe B. Wyatt, El Paso Natural Gas Company and El
Paso Merchant Energy Company filed in state court in Houston. This shareholder
derivative suit generally alleges that manipulation of California gas supply and
gas prices exposed our parent, El Paso, to claims of antitrust conspiracy, FERC
penalties and erosion of share value. The plaintiffs have not asked for any
relief with regard to us. Our costs and legal exposure related to this
proceeding are not currently determinable.

Carlsbad. In August 2000, a main transmission line owned and operated by
us ruptured at the crossing of the Pecos River near Carlsbad, New Mexico. Twelve
individuals at the site were fatally injured. As a result, the U.S. Department
of Transportation's Office of Pipeline Safety issued a Notice of Probable
Violation and Proposed Civil Penalty to us proposing a fine of $2.5 million. We
have fully accrued for these fines. In October 2001, we filed a response with
the Office of Pipeline Safety disputing each of the alleged violations. In
December 2003, the matter was referred to the Department of Justice.

After a public hearing conducted by the National Transportation Safety
Board (NTSB) on its investigation of the Carlsbad rupture, the NTSB published
its final report in April 2003. The NTSB stated that it had determined that the
probable cause of the August 19, 2000 rupture was a significant reduction in
pipe wall thickness due to severe internal corrosion, which occurred because our
corrosion control program "failed to prevent, detect, or control internal
corrosion" in the pipeline. The NTSB also determined that ineffective federal
preaccident inspections contributed to the accident by not identifying
deficiencies in our internal corrosion control program.

On November 1, 2002, we received a federal grand jury subpoena for
documents relating to the rupture and we cooperated fully in responding to the
subpoena. That subpoena has since expired. In December 2003 and January 2004,
eight current and former employees were served with testimonial subpoenas issued
by the grand jury. Six individuals testified in March 2004. On April 2, 2004, we
and El Paso received a new federal grand jury subpoena requesting additional
documents. We are cooperating fully in responding to this subpoena. Two
additional employees testified before the grand jury in June 2004.

A number of personal injury and wrongful death lawsuits were filed against
us in connection with the rupture and have been settled. The settlement payments
were fully covered by insurance. In connection with the settlement of the cases,
we contributed $10 million to a charitable foundation as a memorial to the
families involved. The contribution was not covered by insurance.

Parties to four of the settled lawsuits have since filed an additional
lawsuit titled Diane Heady et al. v. EPEC and EPNG in Harris County, Texas, on
November 20, 2002, seeking additional sums based upon their interpretation of
earlier settlement agreements. A settlement agreement has been signed resolving
all issues with these parties and the case has been dismissed. In addition, a
lawsuit entitled Baldonado et al. v. EPNG was filed on June 30, 2003, in state
court in Eddy County, New Mexico, on behalf of 23 firemen and EMS personnel who
responded to the fire and who allegedly have suffered psychological trauma. This
case was dismissed by the trial court. It has been appealed. Our costs and legal
exposure related to the Baldonado lawsuit are currently not determinable,
however, we believe these matters will be fully covered by insurance.

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Grynberg. In 1997, we and a number of our affiliates were named defendants
in actions brought by Jack Grynberg on behalf of the U.S. Government under the
False Claims Act. Generally, 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, which deprived the U.S.
Government of royalties. The plaintiff in this case seeks royalties that he
contends the government should have received had the volume and heating value
been differently measured, analyzed, calculated and reported, together with
interest, treble damages, civil penalties, expenses and future injunctive relief
to require the defendants to adopt allegedly appropriate gas measurement
practices. No monetary relief has been specified in this case. These matters
have been consolidated for pretrial purposes (In re: Natural Gas Royalties Qui
Tam Litigation, U.S. District Court for the District of Wyoming, filed June
1997). Discovery is proceeding. Our costs and legal exposure related to these
lawsuits and claims are not currently determinable.

Will Price (formerly Quinque). We and a number of our affiliates are named
defendants in Will Price et al. v. Gas Pipelines and Their Predecessors, et al.,
filed in 1999 in the District Court of Stevens County, Kansas. Plaintiffs allege
that the defendants mismeasured natural gas volumes and heating content of
natural gas on non-federal and non-Native American lands and seek to recover
royalties that they contend they should have received had the volume and heating
value of natural gas produced from their properties been differently measured,
analyzed, calculated and reported, together with prejudgment and postjudgment
interest, punitive damages, treble damages, attorneys' fees, costs and expenses,
and future injunctive relief to require the defendants to adopt allegedly
appropriate gas measurement practices. No monetary relief has been specified in
this case. Plaintiffs' motion for class certification of a nationwide class of
natural gas working interest owners and natural gas royalty owners was denied on
April 10, 2003. Plaintiffs were granted leave to file a Fourth Amended Petition,
which narrows the proposed class to royalty owners in wells in Kansas, Wyoming
and Colorado, and removes claims as to heating content. A second class action
has since been filed as to the heating content claims. Our costs and legal
exposure related to these lawsuits and claims are not currently determinable.

Bank of America. We are a named defendant, with Burlington Resources,
Inc., in two class action lawsuits styled as 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, State
of Oklahoma and subsequently consolidated by the court. Plaintiffs contend that
defendants (i) underpaid royalties from 1983 to the present on natural gas
produced from specified wells in Oklahoma (ii) took improper deductions and
conducted improper transactions with affiliated companies and (iii) failed to
pay or delayed the payment of royalties on certain gas sold from these wells.
The plaintiffs seek an accounting and damages for alleged royalty underpayments,
plus interest from the time such amounts were allegedly due, as well as punitive
damages. The plaintiffs have filed expert reports alleging damages in excess of
$1 billion. While Burlington accepted our tender of defense in 1997, and had
been defending the matter since that time, it has recently asserted contractual
claims for indemnity against us. We believe we have substantial defenses to the
plaintiffs' claims as well as to the claims for indemnity. The court has
certified the plaintiff classes of royalty and overriding royalty interest
owners, and the parties are proceeding with discovery. In March 2004, the court
dismissed all claims brought on behalf of the class of overriding royalty
interest owners, but denied defendant's other motions for summary judgment. It
is anticipated that this matter will be scheduled for trial during 2004. A third
action, styled Bank of America, et al v. El Paso Natural Gas and Burlington
Resources Oil & Gas Company, 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. Defendants succeeded in transferring this action
to Washita County where it is pending before the same judge as the consolidated
1997 class action lawsuits. A class has not been certified. We believe we have
substantial defenses to the plaintiffs' claims as well as to the claims for
indemnity. Our costs and legal exposure related to these lawsuits and claims are
not currently determinable.

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.

For each of our outstanding legal matters, we evaluate the merits of the
case, our exposure in the matter, possible legal or settlement strategies and
the likelihood of an unfavorable outcome. If we determine that an

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unfavorable outcome is probable and can be estimated, we establish the necessary
accruals. 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 current reserves are adequate.
As of June 30, 2004, we had accrued approximately $3 million for all outstanding
legal 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 June 30,
2004, we had accrued approximately $30 million for expected remediation costs
and associated onsite, offsite and groundwater technical studies and for related
environmental legal costs. Our accrual at June 30, 2004, was based on the
probability of the most likely outcome that can be reasonably estimated;
however, our exposure could be as high as $58 million. Below is a reconciliation
of our accrued liability as of June 30, 2004 (in millions):

Balance as of January 1, 2004............................... $ 28
Additions / adjustments for remediation activities.......... 2
----
Balance as of June 30, 2004................................. $ 30
====

For the remainder of 2004, we estimate that our total remediation
expenditures will be approximately $3 million, which primarily will be expended
under government directed clean-up plans. In addition, we expect to make capital
expenditures for environmental matters of approximately $1 million in the
aggregate for the years 2004 through 2008. These expenditures primarily relate
to compliance with clean air regulations.

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 three 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 June 30,
2004, we have estimated our share of the remediation costs at these sites to be
between $13 million and $20 million. Since the clean-up costs are estimates and
are subject to revision as more information becomes available about the extent
of remediation required, and because 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. Reserves for these matters are included in the
environmental reserve discussed above.

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 and regulations and claims for
damages to property, employees, other persons and the environment 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 relating to the ultimate costs we may incur,
based upon our evaluation and experience to date, we believe our reserves are
adequate.

Rates and Regulatory Matters

CPUC Complaint Proceeding. In April 2000, the CPUC filed a complaint under
Section 5 of the Natural Gas Act (NGA) with the FERC alleging that our sale of
approximately 1.2 Bcf/d of capacity to our affiliate, EPME, raised issues of
market power and violation of the FERC's marketing affiliate regulations and

10

asked that the contracts be voided. In the spring and summer of 2001, two
hearings were held before an Administrative Law Judge (ALJ) to address the
market power issue and the affiliate issue. On November 19, 2003, in approving
the JSA, which is part of the Western Energy Settlement, the FERC also vacated
both of the ALJ's Initial Decisions. That decision was upheld by the FERC in an
order issued March 30, 2004. Certain shippers appealed both FERC orders on this
matter to the U.S. Court of Appeals for the District of Columbia.

Systemwide Capacity Allocation Proceeding. In July 2001, several of our
customers filed complaints against us at the FERC claiming that we had failed to
provide appropriate service on our pipeline. As a result of the FERC's many
orders in these proceedings; (i) full requirements (FR) shippers under Rate
Schedule FT-1 were required to convert from full requirements to contract demand
service on September 1, 2003; (ii) firm customers were assigned specific receipt
point rights in lieu of systemwide receipt point rights; (iii) reservation
charges will be credited to all firm customers if we fail to schedule confirmed
volumes except in cases of force majeure; in such force majeure cases, the
reservation charge credits will be limited to the return and associated tax
portion of our reservation rate; (iv) no new firm contracts can be executed
unless we can demonstrate there is adequate capacity on the system available to
provide the service; (v) capacity turned-back to us from contracts that
terminated or expired from May 31, 2002 to May 1, 2003, could not be remarketed
because it was included in the volumes allocated to the FR shippers; and (vi) a
backhaul service was established from our California delivery points for
existing and new shippers. We also received certificate authority to add
compression to our Line 2000 Power-up project to increase our system capacity by
320 MMcf/d without receiving cost coverage for the expansion until our next rate
case (in January 2006).

On July 9, 2003, the FERC found that we had not violated our certificates,
our contractual obligations, including our obligations under the 1996 Rate
Settlement (discussed below), or our tariff provisions as a result of the
capacity allocations that have occurred on the system since the 1996 Rate
Settlement. In addition, the FERC found we had correctly stated the capacity
that is available on a firm basis for allocation among our shippers and that we
had properly allocated that capacity.

On July 18, 2003, the FR shippers filed an appeal of the July 9 order with
the D.C. Circuit (Arizona Corporation Comm'n, et al. v. FERC, No. 03-1206) and
subsequently sought a stay of the FERC's orders. The stay was denied by the
court. Other parties have filed appeals of the FERC's orders some of which have
been consolidated. Southwest Gas Corporation, another customer of ours, filed an
appeal of these FERC Orders on April 1, 2004 with the District of Columbia
Circuit. The appeal has now been fully briefed by the parties. The final outcome
of these appeals cannot be predicted with certainty.

Rate Settlement. Our current rate settlement establishes our base rates
through December 31, 2005. The settlement has certain requirements applicable to
the Post-Settlement Period. These requirements include a provision which limits
the rates to be charged to a portion of our contracted portfolio to a level
equal to the inflation-escalated rate from the 1996 rate settlement. We are
currently reviewing the definition and applicability of this future capped-rate
requirement given, among other things, the contract changes required by the
capacity allocation proceeding discussed above. We have the right to increase or
decrease our base rates if changes in laws or regulations result in increased or
decreased costs in excess of $10 million a year. Our settlement included both
risk and revenue sharing provisions which expired at the end of 2003. We
refunded $12 million in the first quarter of 2004 related to these expiring
provisions.

Line 2000 Power-up Project. In October 2002, pursuant to the FERC's orders
in the systemwide capacity allocation proceeding, we filed with the FERC for a
certificate of public convenience and necessity to add compression to our Line
2000 project to increase the capacity of that line by an additional 320 MMcf/d.
On June 4, 2003, the FERC issued an order approving our certificate application.
On November 14, 2003, the FERC denied pending requests for rehearing on its June
4 order approving the Power-up. Phase I of the project was placed in service on
February 27, 2004, adding 120 MMcf/d of compression to our system and Phase II
was placed in service on April 30, 2004, adding an additional 100 MMcf/d of
capacity to our system. Phase III was placed in service in mid-June 2004, adding
an additional 100 MMcf/d of capacity to our system.

11

There are other regulatory rules and orders in various stages of adoption,
review and/or implementation, none of which we believe will have a material
impact on us.

While the outcome of our outstanding rates and regulatory matters cannot be
predicted with certainty, based on current information, we do not expect the
ultimate resolution of these matters to have a material adverse effect on our
financial position, operating results or cash flows. However, it is possible
that new information or future developments could require us to reassess our
potential exposure related to these matters, which could have a material effect
on our results of operations, our financial position, and our cash flows.

Other

Enron Bankruptcy. In December 2001, Enron Corp. (Enron) and a number of
its subsidiaries, including Enron North America Corp. and Enron Power Marketing,
Inc., filed for Chapter 11 bankruptcy protection in the United States Bankruptcy
Court for the Southern District of New York. Enron North America had
transportation contracts on our system. The transportation contracts have now
been rejected and we have filed a proof of claim in the amount of approximately
$128 million, which included $18 million for amounts due for services provided
through the date the contracts were rejected and $110 million for damage claims
arising from the rejection of its transportation contracts. We anticipate that
Enron will vigorously oppose these claims. Given the uncertainties of the
Bankruptcy Court, we have fully reserved for all amounts due from Enron through
the date the contracts were rejected, and we have not recognized any amounts
under these contracts since the rejection date.

CFTC Investigation. In April 2004, we elected to voluntarily cooperate
with the Commodity Futures Trading Commission (CFTC) in connection with the
CFTC's industry-wide investigation of activities affecting the price of natural
gas in the fall of 2003. Specifically, we provided information relating to
storage reports provided to the Energy Information Administration for the period
of October 2003 through December 2003.

Copper Eagle Gas Storage. In August 2003, we purchased Copper Eagle Gas
Storage, L.L.C., which is developing a natural gas storage facility, for
approximately $12 million. We also purchased land for approximately $9 million
in order to further develop the project. The storage facility is located in
Arizona near an Air Force base. In April 2004, the Arizona state legislature
signed a bill into law that would prevent the development of natural gas storage
facilities in areas around an active military base. We are considering whether
to challenge the statute on grounds it violates the U.S. Constitution and/or is
pre-empted under the Natural Gas Act. We do not believe our investment in this
project, which totaled $23 million at June 30, 2004, is impaired at this time.
However, further developments could impact this assessment.

While the outcome of these matters cannot be predicted with certainty,
based on current information, we do not expect the ultimate resolution of these
matters to have a material adverse effect on our financial position, operating
results or cash flows. However, it is possible that new information or future
developments could require us to reassess our potential exposure related to
these matters, which could have a material effect on our results of operations,
our financial position, and our cash flows.

12

6. RETIREMENT BENEFITS

The components of our postretirement benefit costs for the periods ended
June 30 are as follows:

7. TRANSACTIONS WITH AFFILIATES

We participate in El Paso's cash management program which matches
short-term cash surpluses and needs of participating affiliates, thus minimizing
total borrowings from outside sources. As of June 30, 2004 and December 31,
2003, we had advanced to El Paso $741 million and $779 million. The interest
rate at June 30, 2004 was 2.4% and at December 31, 2003 was 2.8%. These
receivables are due upon demand; however, as of June 30, 2004 and December 31,
2003, we have classified $688 million and $779 million of these advances as
non-current notes receivable from affiliates because we do not anticipate
settlement within the next twelve months. See Note 2 for a discussion regarding
our participation in and the collectibility of these receivables.

At June 30, 2004 and December 31, 2003, we had other accounts receivable
from affiliates of $11 million and $4 million. In addition, we had accounts
payable to affiliates of $15 million and $13 million at June 30, 2004 and
December 31, 2003. These balances arose in the normal course of business.

The following table shows revenues and charges from our affiliates for the
periods ended June 30:

13

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The information contained in Item 2 updates, and should be read in
conjunction with, the information disclosed in our 2003 Form 10-K and the
financial statements and notes presented in Item 1 of this Form 10-Q.

RESULTS OF OPERATIONS

Our management, as well as El Paso's management, uses earnings before
interest expense and income taxes (EBIT) to assess the operating results and
effectiveness of our business. We define EBIT as net income adjusted for (i)
items that do not impact our income from continuing operations, such as the
impact of accounting changes, (ii) income taxes, (iii) interest and debt expense
and (iv) affiliated interest income. We exclude interest and debt expense from
this measure so that our management can evaluate our operating results without
regard to our financing methods. We believe the discussion of our results of
operations based on EBIT is useful to our investors because it allows them to
more effectively evaluate the operating performance of our business using the
same performance measure analyzed internally by our management. EBIT may not be
comparable to measurements used by other companies. Additionally, EBIT should be
considered in conjunction with net income and other performance measures such as
operating income or operating cash flow.

The following is a reconciliation of our operating income to our EBIT and
our EBIT to our net income for the periods ended June 30:

14

OPERATING RESULTS (EBIT)

The following factors contributed to our overall EBIT increase of $156
million and $144 million for the three months and six months ended June 30, 2004
as compared to the same periods in 2003:

The impact of the termination of our risk sharing mechanism in December
2003, reflected above, will continue to impact our comparative EBIT for the
remainder of 2004. The impact of the 110 MMcf/d capacity obligation for former
FR customers reflected above terminated with the completion of Phases I, II and
III of our Line 2000 Power-up project in February, April and June of 2004. We
are now able to re-market this capacity; however, we must demonstrate that such
sales do not adversely impact our service to our firm customers and we are at
risk for portions that were turned back to us on a permanently released basis.

INTEREST AND DEBT EXPENSE

Below is the analysis of our interest expense for the periods ended June
30:

Interest and debt expense for the quarter and six months ended June 30,
2004, was $3 million and $5 million higher than the same periods in 2003
primarily due to the issuance in July 2003 of $355 million of 7.625% long-term
notes offset by a decrease in interest expense due to the retirement of $200
million of 6.75% notes in November 2003.

AFFILIATED INTEREST INCOME, NET

Second Quarter 2004 Compared to Second Quarter 2003

Affiliated interest income, net for the quarter ended June 30, 2004,
changed by less than a $1 million from the same period in 2003 despite having an
increase in short-term interest rates in 2004. The average advance balance due
from El Paso of $1 billion for the second quarter of 2003 decreased to $774
million in 2004. The average short-term interest rates for the second quarter
increased from 1.3% in 2003 to 2.3% in 2004.

15

Six Months Ended 2004 Compared to Six Months Ended 2003

Affiliated interest income, net for the six months ended June 30, 2004, was
$2 million higher than the same period in 2003 due to higher short-term interest
rates in 2004 partially offset by lower average advances to El Paso under our
cash management program in 2004. The average advance balance due from El Paso of
$998 million for the six months of 2003 decreased to $768 million in 2004. The
average short-term interest rates increased from 1.4% in 2003 to 2.5% in 2004.

INCOME TAXES

Our effective tax rate for the quarters ended June 30, 2004 and 2003 and
for the six months ended June 30, 2003, was higher than the statutory rate of 35
percent primarily due to the effect of state income taxes. The effective tax
rate for the six months ended June 30, 2004 was lower than the statutory rate of
35 percent due to a state income tax adjustment related to the Western Energy
Settlement.

As of December 31, 2003, we maintained a valuation allowance on deferred
tax assets related to our estimate of our ability to realize state tax benefits
from the deduction of the charge we took related to the Western Energy
Settlement. During the first quarter of 2004, we evaluated this allowance and
now believe, based on our current estimates, that these state tax benefits will
be fully realized. Consequently, we reversed our valuation allowance. Net of
federal taxes, this benefit totaled approximately $6 million. Our total tax
assets related to the Western Energy Settlement were $205 million as of June 30,
2004. Proposed tax legislation has been introduced in the U.S. Senate which
would disallow deductions for certain settlements made to or on behalf of
governmental entities. If enacted, this tax legislation could impact the
deductibility of the Western Energy Settlement and could result in a write-off
of some or all of the associated tax assets. In such event, our tax expense
would increase.

OTHER

In addition, approximately 1,567 MMcf/d of our capacity currently under
contract is subject to early termination in August 2006, provided shippers give
timely notice of their intent to terminate. If all of these rights were
exercised, the weighted average on the remaining contract terms would decrease
from approximately five years to approximately three years.

LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY

Our liquidity needs have historically been provided through cash flows from
operating activities and the use of El Paso's cash management program. Under El
Paso's cash management program, depending on whether we have short-term cash
surpluses or requirements, we either provide cash to El Paso or El Paso provides
cash to us. We have historically provided cash advances to El Paso, and we
reflect these net advances as investing activities in our statement of cash
flows. As of June 30, 2004, we had receivables from El Paso of $741 million as a
result of this program. These receivables are due upon demand; however, as of
June 30, 2004, $688 million of these receivables were classified as non-current
notes receivable from affiliates in our balance sheet. We do not anticipate
settlement on this amount within the next twelve months. We believe that cash
flows from operating activities along with $53 million of the receivables
classified as current notes receivable from the El Paso cash management program
will be adequate to meet our short-term capital and debt service requirements
for our existing operations.

If El Paso were unable to meet its liquidity needs, we would not have
access to this source of liquidity and there is no assurance that El Paso could
repay the amounts owed to us. In that event, we could be required to write-off
some or all of these advances, which could have a material impact on our
stockholder's equity and we

16

would still be required to repay affiliated company payables. Although increases
in our debt to EBITDA (as defined in our agreements) ratio that cause the ratio
to exceed 5 to 1 could prohibit us from incurring additional debt, the equity
reduction that would result if we wrote off these receivables would not result
in an event of default under our existing debt agreements.

El Paso's ownership in us and our ownership in Mojave serve as collateral
under El Paso's $3 billion revolving credit facility and other of El Paso's
financing transactions. If El Paso's lenders under these facilities were to
exercise their rights to this collateral, our ownership could change and our
ownership interests in Mojave could be liquidated. However, this change of
control and liquidation would not constitute an event of default under our
existing debt agreements.

If, as a result of the events described above, El Paso were subject to
voluntary or involuntary bankruptcy proceedings, El Paso and its other
subsidiaries and their creditors could attempt to make claims against us,
including claims to substantively consolidate our assets and liabilities with
those of El Paso and its other subsidiaries. We believe that claims to
substantively consolidate us with El Paso and/or its other subsidiaries would be
without merit. However, there is no assurance that El Paso and/or its other
subsidiaries or their creditors would not advance such a claim in a bankruptcy
proceeding. If we were to be substantively consolidated in a bankruptcy
proceeding with El Paso and/or its other subsidiaries, there could be a material
adverse effect on our financial condition and our liquidity.

Finally, we have cross-acceleration provisions in our long-term debt
agreements that state that should we incur an event of default under which
borrowings in excess of $25 million are accelerated, our long-term debt could
also be accelerated. The acceleration of our long-term debt would adversely
affect our liquidity position and, in turn, our financial condition.

Our cash flows for the six months ended June 30 were as follows:

Cash Flows from Operating Activities
Net cash used in operating activities was $480 million for the first six
months of 2004 versus $113 million provided in the same period of 2003. This
decrease is primarily due to fulfillment of our Western Energy Settlement
liability of $538 million and changes in assets and liabilities.

Cash Flows from Investing Activities
Net cash provided by investing activities was $406 million for the first
six months of 2004. In January 2004, we deposited $73 million into an escrow
account for the benefit of Western Energy Settlement parties; in June 2004, we
released $516 million out of the escrow account to the Western Energy Settlement
parties. This net change to restricted cash of $443 million was partially offset
by $76 million in capital expenditures and a decline in advances to affiliates.

Cash Flows from Financing Activities
Net cash provided by financing activities consisted of an equity
contribution of $73 million from El Paso, through our direct parent, related to
the sale of El Paso's common stock for the benefit of Western Energy Settlement
parties.

CAPITAL EXPENDITURES

Our capital expenditures for the six months ended June 30, 2004 were
approximately $76 million. Under our current plan, we expect to spend
approximately $210 million during 2004 for capital expenditures, consisting of
approximately $70 million to expand the capacity on our systems and $140 million
for maintenance capital. We expect to fund capital expenditures through a
combination of internally generated funds and/or by recovering amounts advanced
to El Paso under its cash management program.

17

COMMITMENTS AND CONTINGENCIES

See Item 1, Financial Statements, Note 5, which is incorporated herein by
reference.

18

RISK FACTORS AND CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, we caution that,
while we believe these assumptions or bases to be reasonable and to be made in
good faith, assumed facts or bases almost always vary from the actual results,
and the differences between assumed facts or bases and actual results can be
material, depending upon the circumstances. Where, in any forward-looking
statement, we or our management express an expectation or belief as to future
results, that expectation or belief is expressed in good faith and is believed
to have a reasonable basis. We cannot assure you, however, that the statement of
expectation or belief will result or be achieved or accomplished. The words
"believe," "expect," "estimate," "anticipate" and similar expressions will
generally identify forward-looking statements.

With this in mind, you should consider the risks discussed elsewhere in
this report and other documents we file with the Securities and Exchange
Commission from time to time, and the following important factors that could
cause actual results to differ materially from those expressed in any
forward-looking statement made by us or on our behalf.

OUR RELATIONSHIP WITH EL PASO AND ITS FINANCIAL CONDITION SUBJECTS US TO
POTENTIAL RISKS THAT ARE BEYOND OUR CONTROL.

Due to our relationship with El Paso, adverse developments or announcements
concerning El Paso could adversely affect our financial condition, even if we
have not suffered any similar development. The senior unsecured indebtedness of
El Paso is currently rated Caa1 by Moody's (with a negative outlook and under
review for a possible downgrade) and CCC+ by Standard & Poor's (with a negative
outlook), which are below investment grade ratings. Our senior unsecured
indebtedness is currently rated B1 by Moody's (with a negative outlook and under
review for a possible downgrade) and B- by Standard & Poor's (with a negative
outlook). Further downgrades of our credit ratings would increase our cost of
capital and collateral requirements, and could impede our access to capital
markets. As a result of its downgrades over the last two years, El Paso has
realized substantial demands on its liquidity. These downgrades are a result, at
least in part, of the outlook generally for the consolidated businesses of El
Paso and its needs for liquidity.

El Paso has a long-range plan that, among other things, defines its future
businesses, targets significant debt reduction and establishes financial goals.
An inability to meet these objectives could adversely affect El Paso's liquidity
position, and in turn affect our financial condition.

Pursuant to El Paso's cash management program, surplus cash is made
available to El Paso in exchange for an affiliated receivable. In addition, we
conduct commercial transactions with some of our affiliates. As of June 30,
2004, we have net receivables of approximately $737 million from El Paso and its
affiliates. El Paso provides cash management and other corporate services to us.
If El Paso is unable to meet its liquidity needs, there can be no assurance that
we will be able to access cash under the cash management program, or that our
affiliates would pay their obligations to us. However, we would still be
required to satisfy affiliated company payables. Our inability to recover any
intercompany receivables owed to us could adversely affect our ability to repay
our outstanding indebtedness. For a further discussion of these matters, see
Item 1, Financial Statements, Note 7.

In May 2004, El Paso announced that an independent review of its natural
gas and oil reserves confirmed its previous assessment that the financial
statements of El Paso and certain of its subsidiaries should be restated. In
August 2004, El Paso announced it would likely be required to further restate
its financial statements for adjustments related to the manner in which it
historically accounted for hedges of its natural gas production. At this time,
El Paso's December 31, 2003 restated financial statements have not been filed,
nor has it filed quarterly reports for March 31, 2004 or June 30, 2004. Also, as
a result of its reserve revisions, several class action lawsuits have been filed
against El Paso and several of its subsidiaries, but not against us. The reserve
revisions have also become the subject of an SEC investigation and may become
the subject of separate inquiries by other governmental regulatory agencies.
These investigations and lawsuits may further

19

negatively impact El Paso's credit ratings and place further demands on its
liquidity. See Item 1, Financial Statements, Note 2 for a further discussion of
these matters.

As further discussed in Item 1, Financial Statements, Note 3 and Note 5, we
are a party to the Western Energy Settlement along with El Paso and EPME. We
have guaranteed the payment of El Paso's and EPME's settlement obligations in
the event El Paso and EPME fail to pay these amounts. If we were required to
satisfy El Paso's and EPME's settlement obligations, it would adversely affect
our liquidity position and financial condition.

A DEFAULT UNDER EL PASO'S $3 BILLION REVOLVING CREDIT FACILITY BY ANY PARTY
COULD ACCELERATE OUR FUTURE BORROWINGS, IF ANY, UNDER THE $3 BILLION REVOLVING
CREDIT FACILITY AND OUR LONG-TERM DEBT, WHICH COULD ADVERSELY AFFECT OUR
LIQUIDITY POSITION.

We are a party to El Paso's $3 billion revolving credit facility. We are
only liable, however, for our borrowings under the $3 billion revolving credit
facility, which were zero as of June 30, 2004. Under the $3 billion revolving
credit facility, a default by El Paso, or any other party, could result in the
acceleration of all outstanding borrowings under the $3 billion revolving credit
facility, including the borrowings of any non-defaulting party, and could
preclude us from borrowing under the $3 billion revolving credit facility in the
future. We believe El Paso's announced restatements of its prior period
financial statements would have constituted an event of default under the $3
billion revolving credit facility; however, El Paso received waivers of the
potential defaults on its $3 billion credit facility, which continue to be
effective. See Item 1, Financial Statements, Note 2, for additional information
regarding these matters. The acceleration of our future borrowings, if any,
under the $3 billion revolving credit facility, or the inability to borrow under
the $3 billion revolving credit facility, could adversely affect our liquidity
position and, in turn, our financial condition.

Furthermore, the indentures governing our long-term debt include
cross-acceleration provisions. Therefore, if we borrow $25 million or more under
the $3 billion revolving credit facility and such borrowings are accelerated for
any reason, including the default of another party, our long-term debt could
also be accelerated. The acceleration of our long-term debt could also adversely
affect our liquidity position and, in turn, our financial condition.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This information updates, and you should read it in conjunction with,
information disclosed in Part II, Item 7A in our Annual Report on Form 10-K for
the year ended December 31, 2003, in addition to the information presented in
Items 1 and 2 of this Quarterly Report on Form 10-Q.

There are no material changes in our quantitative and qualitative
disclosures about market risks from those reported in our Annual Report on Form
10-K for the year ended December 31, 2003.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures and the internal controls over financial reporting as of
the end of the period covered by this Quarterly Report pursuant to Rules 13a-15
and 15d-15 under the Securities Exchange Act of 1934 (Exchange Act). Based on
our controls evaluation, our principal executive officer and principal financial
officer have concluded that the disclosure controls are effective.

We strive to maintain disclosure controls and procedures and internal
controls over financial reporting that are designed to ensure that the
information required to be disclosed in our Exchange Act filings is recorded,
processed, summarized and reported within the required timeframes, and that this
information is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate, to
allow for timely decisions regarding required disclosure. In doing so, we
recognize that the effectiveness of our or any system of controls and procedures
is subject to limitations, including the exercise of judgment in the design,
implementation and evaluation of controls and procedures,

20

the assumptions used in identifying future events and the ability to completely
eliminate misconduct. As a result, there is no assurance that our or any
controls and procedures will prevent all errors and all fraud. By their nature,
controls and procedures can provide only reasonable assurance regarding our
control objectives.

We are currently documenting and reviewing our internal controls to ensure
compliance with Section 404 of the Sarbanes Oxley Act of 2002 by December 31,
2004. While we are not aware of any items at this time that constitute material
weaknesses, as that term is defined in Auditing Standards (AU) Section 325, we
are identifying areas where our processes can be improved, and are actively
working to implement those improvements. Furthermore, as we continue our
compliance review, we may identify additional matters which may need to be
reported or which may constitute material weaknesses in our internal controls
over financial reporting. Although we have identified deficiencies in our system
of internal controls over financial reporting, we do not believe these
deficiencies have had, or are reasonably likely to have, a material impact on
our financial statements. In addition, there have been no changes during the
period in our internal controls over financial reporting that would adversely
affect our ability to provide, with reasonable assurance, reliable information
required in our reports submitted under the Securities Exchange Act of 1934.

21

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Part I, Item 1, Financial Statements, Note 5, which is incorporated
herein by reference.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER
PURCHASES OF EQUITY SECURITIES

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a. Exhibits

Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*". All
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.

Undertaking

We hereby undertake, pursuant to Regulation S-K, Item 601(b),
paragraph (4)(iii), to furnish to the U.S. Securities and Exchange
Commission, upon request, all constituent instruments defining the rights
of holders of our long-term debt not filed herewith for the reason that the
total amount of securities authorized under any of such instruments does
not exceed 10 percent of our total consolidated assets.

22

b. Reports on Form 8-K

June 15, 2004............. Our parent company, El Paso
Corporation, announced that a
Master Settlement Agreement
related to the Western Energy
crisis became effective on June
11, 2004.

June 17, 2004............. Our parent company, El Paso
Corporation, announced that it
had received waivers on its $3
billion revolving credit
facility and certain other
financings.

August 10, 2004........... Our parent company, El Paso
Corporation, announced that it
had received waivers on its $3
billion revolving credit
facility and certain other
financings.

23

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

EL PASO NATURAL GAS COMPANY

Date: August 13, 2004 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board
and Director
(Principal Executive Officer)

Date: August 13, 2004 /s/ GREG G. GRUBER
------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer, Treasurer
and Director
(Principal Financial and Accounting
Officer)

24

EL PASO NATURAL GAS COMPANY

EXHIBIT INDEX

Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*". All
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.