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 SEPTEMBER 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 November 12,
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 September 30, 2004, and for the
quarters and nine months ended September 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 Annual Report on 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. In addition, 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

El Paso is a significant potential source of liquidity to us. We
participate in El Paso's cash management program whereby, 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 and as of September 30, 2004, we had a cash advance receivable from El Paso
of $796 million, $674 million of which is classified as a non-current asset in
our balance sheet because we do not anticipate settlement on this amount within
the next twelve months. We believe that our cash flows from operating activities
along with the current note receivables from El Paso under the 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 would still be required to repay affiliated company
payables, if demanded. 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.

During 2004, El Paso restated its historical financial statements to
reflect the accounting impact of revisions to its natural gas and oil reserve
estimates and for changes in the manner in which it accounted for certain
derivative contracts, primarily those related to the hedging of its natural gas
production. El Paso believes the restatement of its historical financial
statements would have constituted events of default under its revolving credit
facility, under which we are eligible to borrow, 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. During 2004, El Paso received a
series of waivers on its revolving credit facility and these other financing
transactions to address these issues. These waivers continue to be in effect. El
Paso also received an extension of time from various lenders until November 30,
2004 to file its second quarter 2004 Form 10-Q which it expects to meet. If El
Paso is unable to file its second quarter 2004 Form 10-Q by that date and is not
able to negotiate an additional extension of the filing deadline, its revolving
credit facility and various other financings could be accelerated. As part of
obtaining the waivers, El Paso amended various provisions of the revolving
credit facility, including provisions related to events of default and
limitations on the ability of El Paso, as well as its subsidiaries, to prepay
debt

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that matures after June 30, 2005. Although we are a party to El Paso's revolving
credit facility, we do not have any borrowings or letters of credit outstanding
under that facility. See Note 3 below for a further discussion of the revolving
credit facility and the potential refinancing of this facility.

Based upon a review of the covenants contained in our long-term debt
agreements, we believe that a default on El Paso's revolving credit facility
would not result in an event of default under our debt agreements.

El Paso's ownership in us and our ownership in Mojave Pipeline Company
(Mojave) serve as collateral under El Paso's 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 4.

3. CREDIT FACILITIES

Letters of Credit

As of September 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.

Other Financing Arrangements

El Paso maintains a revolving credit facility, with a $1.5 billion letter
of credit sublimit, which matures on June 30, 2005. The 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 revolving credit facility. El Paso liquidated a portion of
the collateral that supported the revolving credit facility, which reduced the
overall borrowing availability from $3 billion to $2.5 billion in October 2004.
We are only liable for amounts we directly borrow under the revolving credit
facility. As of September 30, 2004, there were no borrowings and $1.1 billion in
letters of credit were issued under the revolving credit facility, none of which
were issued on our behalf. See Note 2 for a discussion regarding El Paso's
waivers on the revolving credit facility.

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

El Paso is in the process of negotiating the refinancing of this facility
as the combination of a three year revolving credit facility and a five year
term loan and currently expects to be successful in this refinancing by December
31, 2004.

Under the 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

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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 6.

4. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

Western Energy Settlement. In June 2004, our Master Settlement Agreement
(MSA), along with other separate settlement agreements, became effective with a
number of public and private claimants, including the states of California,
Washington, Oregon and Nevada to resolve the principal litigation, claims, and
regulatory proceedings arising out of the sale or delivery of natural gas and/or
electricity to the western United States (the Western Energy Settlement or WES).
As part of the Western Energy Settlement, we admitted no wrongdoing but agreed,
among other things, to make various cash payments as described below.

We also entered into a Joint Settlement Agreement, or JSA, 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, 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.

During the fourth quarter of 2002, we recorded a $412 million pretax charge
related to the Western Energy Settlement. During 2003, we recorded an additional
pretax benefit of $20 million and a pretax charge of $126 million for the
quarter and nine months ended September 30, 2003, based upon reaching definitive
settlement agreements in June 2003, and as a result of additional changes in the
value of our obligation under the WES to provide proceeds from the issuance of
El Paso common stock to the settling parties. Once the settlement became
effective in June 2004, El Paso released to the WES parties $516 million of
previously escrowed funds, including $73 million of proceeds from the issuance
of El Paso's common stock which were contributed to us by El Paso in January
2004. We also paid an additional $22 million, the total of which satisfied our
$538 million obligation under the WES. The release of funds by El Paso on our
behalf from the escrow account is reflected as an increase in our cash flows
from investing activities. The release of funds to satisfy our WES liability has
been reflected as a reduction of our cash flow from operating activities.

El Paso Marketing L.P. (EPM), formerly El Paso Merchant Energy, L.P., our
affiliate, and El Paso were obligated to pay a total of $1,027 million (on an
undiscounted basis) under these settlement agreements. As of September 30, 2004,
El Paso and EPM have either made payments or granted contractual price discounts
of approximately $97 million, net of a $12 million discount for prepayment of a
portion of its 20 year cash installment obligation. El Paso's remaining
obligation consists of an $855 million settlement obligation, which will be paid
in installments over the next 20 years, and EPM's $63 million in contractual
price discounts

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that will be realized over the remaining 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 EPM 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 EPM fail to
pay these amounts.

Sierra Pacific Resources and Nevada Power Company v. El Paso et al. In
April 2003, Sierra Pacific Resources and Nevada Power Company filed a suit in
U.S. District Court for the District of Nevada against us, our affiliates and
unrelated third parties. The allegations are 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. These motions to dismiss are
scheduled to be heard in November 2004. Our costs and legal exposure related to
this lawsuit are not currently determinable.

IMC Chemicals v. El Paso Merchant Energy L.P., et al. In January 2003, IMC
Chemicals filed a lawsuit in California state court against us and our
affiliates. The suit arose out of a gas supply contract between IMC Chemicals
(IMCC) and EPM and sought to void the Gas Purchase Agreement between IMCC and
EPM for gas purchases until December 2003. IMCC contended that EPM 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. EPM 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
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. We are also in settlement negotiations with the
State of Arizona. Our costs and legal exposure related to this lawsuit are not
currently determinable.

Phelps Dodge vs. EPNG. In February 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 U.S. District Court for the District of Arizona.
Plaintiffs have filed a motion to remand the matter to state court which we have
opposed. Oral argument on the remand issue is scheduled for December 2004. 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.

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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 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
pre-accident inspections contributed to the accident by not identifying
deficiencies in our internal corrosion control program.

In November 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. In April 2004, we and
El Paso received a new federal grand jury subpoena requesting additional
documents. We have responded fully 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, in
November 2002, seeking additional sums based upon their interpretation of
earlier settlement agreements. This matter has been settled and dismissed. In
addition, a lawsuit entitled Baldonado et al. v. EPNG was filed in June 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. The appeals
court initially issued a notice dismissing all claims. This decision was
appealed and the appeals court has agreed to hear this matter. Briefs will be
filed by the end of the year. 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.

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 post judgment
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 in
April 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

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heating content claim. 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. In
September 2004, the court granted several motions made by Burlington, but denied
Burlington's motion to preclude interest payments on any amounts found to be
owing to plaintiffs. As a result, the plaintiff's damage claims have been
reduced but remain substantial. It is anticipated that this matter will be
scheduled for trial during 2005. 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 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
September 30, 2004, we had accrued approximately $3 million for our 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 September
30, 2004, we had accrued approximately $28 million for expected remediation
costs and associated onsite, offsite and groundwater technical studies and for
related environmental legal costs. Our accrual was based on the most likely
outcome that can be reasonably estimated; however, our exposure could be as high
as $56 million. Below is a reconciliation of our accrued liability as of
September 30, 2004 (in millions):

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

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For the remainder of 2004, we estimate that our total remediation
expenditures will be approximately $2 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 September
30, 2004, we have estimated our share of the remediation costs at these sites to
be between $12 million and $19 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.

New Mexico Ambient Air Quality Standards. In October 2004, the State of
New Mexico's Environmental Department proposed a new rule which would impose an
eight-hour ambient air quality standard on all New Mexico industrial facilities
that are currently under the federal Title 5 program. We have filed a notice of
intent to provide testimony in opposition to this rule at an upcoming hearing
but we are working with the state and industry to explore a negotiated
alternative to the proposed rule that could reduce compliance costs and help
achieve some of the Department's goals. The outcome of this proceeding is not
determinable at this time. If the rule were to become effective as proposed, we
estimate that compliance efforts could cost us between $33 million to $96
million over a six to seven year period.

State of Arizona Chromium Review. The State of Arizona's Department of
Environmental Quality has requested information from us regarding the historical
use of chromium in our operations. We responded fully to the request. We are
working with the State of Arizona on this matter and will be undertaking a
review of our facilities in Arizona and on the tribal lands in Arizona and New
Mexico to determine if there are any issues concerning the usage of chromium.
Our costs related to this matter are not currently determinable.

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

Accounting for Pipeline Assessment Costs. In November 2004, the FERC
issued an industry-wide Proposed Accounting Release that, if enacted as written,
will disallow the capitalization of certain costs that are part of our pipeline
integrity program. The accounting release is proposed to be effective January
2005 following a period of public comment on the release. We are currently
reviewing the release and have not determined what impact this release will have
on our consolidated financial statements.

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
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. In

10

November 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 a rehearing order issued in March 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 in September 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 in April 2004 with the District of Columbia Circuit.
The appeal has now been fully briefed by the parties. Oral arguments were heard
by the court in October 2004. 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 customer and 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.
In June 2003, the FERC issued an order approving our certificate application. In
November 2003, the FERC denied pending requests for rehearing on its June order
approving the Power-up. Phase I of the project was placed in service in February
2004, adding 120 MMcf/d of compression to our system and Phase II was placed in
service in April 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.

CPUC's OIR Proceeding. The California Public Utility Commission (CPUC)
initiated an Order Instituting Rulemaking (OIR) in Docket No. R04-01-025
addressing the state's utilities' energy supply plans

11

for the period of 2006 and beyond. The proceeding is broken into two phases,
with the first focusing on issues that need to be addressed more immediately
such as interstate capacity and utility access to liquified natural gas
supplies. In September 2004, the CPUC issued its decision on these Phase I
issues that is generally favorable to us. However, it authorizes the California
utilities to issue notices of termination of their contracts with us to permit
them to negotiate reduced contract levels and diversify their supply portfolios.
This means, for instance, that our largest customer, Southern California Gas
Company has CPUC's permission to terminate its contract to transport over 1.2
Bcf/day of gas on our system. Such notice would be due by the end of February
2005. Depending upon the actions of the California utilities, we could have
substantial quantities of capacity to remarket in 2006. The outcome of this
process is not determinable at this time.

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, the results are uncertain. 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. In August 2004, the CFTC announced they
had completed the investigation and found no evidence of wrongdoing.

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 $22 million at September 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.

12

5. RETIREMENT BENEFITS

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

6. 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 September 30, 2004 and December 31,
2003, we had advanced to El Paso $796 million and $779 million. The interest
rate at September 30, 2004 was 2.7% and at December 31, 2003 was 2.8%. These
receivables are due upon demand; however, as of September 30, 2004 and December
31, 2003, we have classified $674 million and $779 million of these advances as
non-current notes receivable from affiliates because we do not anticipate
settlement of these amounts within the next twelve months. See Note 2 for a
discussion regarding our participation in the program and the collectibility of
these receivables.

At September 30, 2004 and December 31, 2003, we had other accounts
receivable from affiliates of $8 million and $4 million. In addition, we had
accounts payable to affiliates of $16 million and $13 million at September 30,
2004 and December 31, 2003. These balances arose in the normal course of
business. We also received $6 million in deposits related to our transportation
contracts with EPM which are included in our balance sheet as current
liabilities as of September 30, 2004 and December 31, 2003.

In January 2004, El Paso contributed to us $73 million in proceeds from the
issuance of its common stock. The proceeds were placed in escrow and released to
the Western Energy Settlement parties in June 2004. See Note 4 for further
discussion. In addition, we acquired assets from our affiliate with a net book
value of $6 million in the third quarter of 2004.

The following table shows revenues and charges from our affiliates for the
periods ended September 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 Annual Report on Form
10-K and the financial statements and notes presented in Item 1 of this
Quarterly Report on 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 EBIT to net income.

OPERATING RESULTS (EBIT)

Third Quarter 2004 Compared to Third Quarter 2003

The following factors contributed to our overall EBIT decrease of $31
million for the three months ended September 30, 2004 as compared to the same
period in 2003:

14

Nine Months Ended 2004 Compared to Nine Months Ended 2003

The following factors contributed to our overall EBIT increase of $113
million for the nine months ended September 30, 2004 as compared to the same
period in 2003:

Our risk sharing provisions, which provided revenue net of our sharing
obligations, expired at the end of 2003 and will continue to impact our
comparative EBIT, as reflected above, for the remainder of 2004. The impact of
the capacity obligation for former FR customers reflected above terminated with
the completion of Phases I and II of our Line 2000 Power-up project in 2004. As
a result, 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. See Note 4 for a further discussion of our
obligations to former FR customers.

In November 2004, the FERC issued an industry-wide Proposed Accounting
Release that, if enacted as written, will disallow the capitalization of certain
costs that are part of our pipeline integrity program. The accounting release is
proposed to be effective January 2005 following a period of public comment on
the release. We are currently reviewing the release and have not determined what
impact this release will have on our consolidated financial statements.

INTEREST AND DEBT EXPENSE

Three Months Ended 2004 Compared to Three Months Ended 2003

Interest and debt expense for the three months ended September 30, 2004,
was $2 million lower than the same period in 2003 primarily due to the
retirement of $200 million of 6.75% notes in November 2003.

Nine Months Ended 2004 Compared to Nine Months Ended 2003

Interest and debt expense for the nine months ended September 30, 2004, was
$3 million higher than the same period in 2003 primarily due to the issuance in
July 2003 of $355 million of 7.625% long-term notes, partially offset by the
retirement of $200 million of 6.725% notes in November 2003.

AFFILIATED INTEREST INCOME, NET

Nine Months Ended 2004 Compared to Nine Months Ended 2003

Affiliated interest income, net for the nine months ended September 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

15

El Paso of $996 million for the nine months of 2003 decreased to $769 million
for the same period in 2004. The average short-term interest rates increased
from 1.6% in 2003 to 2.5% during the same period in 2004.

INCOME TAXES

Our effective tax rate for the quarter and nine months ended September 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 quarter and nine
months ended September 30, 2004 was lower than the statutory rate of 35 percent
due to a state income tax adjustment related to the Western Energy Settlement
and an adjustment to consolidated deferred taxes related to the Mojave pipeline
system.

As of December 31, 2003, we maintained a valuation allowance on deferred
tax assets related to 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 this 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 September 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 an 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 as of
September 30, 2004, we had a cash advance receivable from El Paso of $796
million as a result of this program. These receivables are due upon demand;
however, as of September 30, 2004, $674 million of these receivables were
classified as a non-current asset in our balance sheet because we do not
anticipate settlement on this amount within the next twelve months. We believe
that cash flows from operating activities along with the current notes
receivable from El Paso under the 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 would still be required to repay affiliated company
payables if demanded. 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

16

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.

During 2004, El Paso restated its historical financial statements to
reflect the accounting impact of revisions to its natural gas and oil reserve
estimates and for changes in the manner in which it accounted for certain
derivative contracts, primarily those related to the hedging of its natural gas
production. El Paso believes the restatement of its historical financial
statements would have constituted events of default under its revolving credit
facility, under which we are eligible to borrow, 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. During 2004, El Paso received a
series of waivers on its revolving credit facility and these other financing
transactions to address these issues. These waivers continue to be in effect. El
Paso also received an extension of time from various lenders until November 30,
2004 to file its second quarter 2004 Form 10-Q which it expects to meet. If El
Paso is unable to file its second quarter 2004 Form 10-Q by that date and is not
able to negotiate an additional extension of the filing deadline, its revolving
credit facility and various other financings could be accelerated. As part of
obtaining the waivers, El Paso amended various provisions of the revolving
credit facility, including provisions related to events of default and
limitations on the ability of El Paso, as well as its subsidiaries, to prepay
debt that matures after June 30, 2005. Although we are a party to El Paso's
revolving credit facility, we do not have any borrowings or letters of credit
outstanding under that facility. See Item 1, Financial Statements, Note 3, for a
further discussion of the revolving credit facility and the potential
refinancing of this facility.

Based upon a review of the covenants contained in our long-term debt
agreements, we believe that a default on El Paso's revolving credit facility
would not result in an event of default under our debt agreements.

El Paso's ownership in us and our ownership in Mojave serve as collateral
under El Paso's 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.

Our cash flows for the nine months ended September 30 were as follows:

Cash Flows from Operating Activities

Net cash used in operating activities was $417 million for the first nine
months of 2004 versus $159 million provided in the same period of 2003. This
decrease is primarily due to the payment 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 $318 million for the first
nine 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 $103 million in capital expenditures and advances to affiliates of $17
million.

17

Cash Flows from Financing Activities

Net cash provided by financing activities consisted of an equity
contribution of $73 million from El Paso related to the sale of El Paso's common
stock for the benefit of the Western Energy Settlement parties.

CAPITAL EXPENDITURES

Our capital expenditures for the nine months ended September 30, 2004 were
approximately $103 million. We expect to spend approximately $76 million for the
remainder of 2004 consisting of approximately $3 million to expand the capacity
on our systems and $73 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.

COMMITMENTS AND CONTINGENCIES

See Item 1, Financial Statements, Note 4, which is incorporated herein by
reference.

18

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.

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

During 2003, we initiated a project to ensure compliance with Section 404
of the Sarbanes-Oxley Act of 2002 (SOX), which will apply to us at December 31,
2005. This project entailed a detailed review and documentation of the processes
that impact the preparation of our financial statements, an assessment of the
risks that could adversely affect the accurate and timely preparation of those
financial statements, and the identification of the controls in place to
mitigate the risks of untimely or inaccurate preparation of those financial
statements. Following the documentation of these processes, we initiated an
internal review or "walk-through" of these financial processes by the financial
management responsible for those processes to evaluate the design effectiveness
of the controls identified to mitigate the risk of material misstatements
occurring in our financial statements. We also initiated a detailed process to
evaluate the operating effectiveness of our controls over financial reporting.
This process involves testing the controls for effectiveness, including a review
and inspection of the documentary evidence supporting the operation of the
controls on which we are placing reliance. While we have identified areas where
our processes and internal controls can be improved, we have not identified any
deficiencies we believe, individually or in the aggregate, would constitute a
material weakness in our internal controls over financial reporting. As we
continue our SOX 404 compliance efforts, we may identify matters which may need
to be reported or which may constitute material weaknesses in our internal
controls over financial reporting.

We did not make any changes to our internal controls over financial
reporting during the quarter ended September 30, 2004, that have had a material
adverse effect or are reasonably likely to have a material adverse effect on our
internal controls over financial reporting. However, we have made changes to
improve our internal controls during the quarter ended September 30, 2004.

We also undertook a review of our overall disclosure controls and
procedures. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our principal
executive and financial officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. Based on
our evaluation, we have concluded that our disclosure controls and procedures
were effective at September 30, 2004.

19

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Part I, Item 1, Financial Statements, Note 4, which is incorporated
herein by reference.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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

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.

20

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: November 12, 2004 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board
and Director
(Principal Executive Officer)

Date: November 12, 2004 /s/ GREG G. GRUBER
------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer, Treasurer
and Director
(Principal Financial and Accounting
Officer)

21

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.