SOUTHERN 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 MARCH 31, 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 1-2745

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

DELAWARE 63-0196650
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)

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

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 May 14, 2004:
1,000

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SOUTHERN 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
Mcf = thousand cubic feet
MMcf = million cubic feet
Tcfe = trillion cubic feet equivalent

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 Southern
Natural Gas Company and/or our subsidiaries.

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PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHERN NATURAL GAS COMPANY

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

See accompanying notes.

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SOUTHERN NATURAL GAS COMPANY

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

See accompanying notes.

2

SOUTHERN NATURAL GAS COMPANY

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

See accompanying notes.

3

SOUTHERN NATURAL GAS COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

We are a 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 March 31, 2004 and for the quarters ended March 31, 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

On May 3, 2004, El Paso announced that the results of its internal
investigation confirmed that its historical financial statements should be
restated to reflect its 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 and various other financings; specifically
under the provisions of these arrangements related to representations and
warranties on the accuracy of its historical financial statements and on El
Paso's debt to total capitalization ratio. El Paso has received waivers on its
$3 billion revolving credit facility and these other financing transactions to
address these issues, and these waivers continue to be effective. These waivers
require that El Paso issue its December 31, 2003 financial statements by June
15, 2004. Otherwise, El Paso would need to obtain additional waivers to avoid an
event of default. Based upon a review of our financing transactions, we do not
believe that a default on El Paso's $3 billion revolving credit facility
constitutes an event of default on our 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 and
consistently provided cash to El Paso under this program, and as of March 31,
2004, we had a cash advance receivable from El Paso of $135 million, classified
as a non-current asset in our balance sheet. 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 entire amounts owed to us. In that
event, we could be required to write-off some amount of these advances, which
could have a material impact on our stockholder's equity. Furthermore, we would
still be required to repay affiliated company payables. Write-downs that cause
our debt to EBITDA (as defined in our agreements) ratio to exceed 6 to 1 could
prohibit us from incurring additional debt. However, this non-cash equity
reduction would not result in an event of default under our existing debt
securities.

Our equity investment in Bear Creek Storage Company (Bear Creek) serves as
collateral under El Paso's revolving credit facility and other of El Paso's
financing transactions. If El Paso's lenders under this facility or those other
financing transactions were to exercise their rights to this collateral, our
investment could be liquidated. However, this liquidation would not constitute
an event of default under our existing debt agreements.

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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 that
state that should we incur an event of default under which borrowings in excess
of $10 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. ACCOUNTING FOR HEDGING ACTIVITIES

As of March 31, 2004 and December 31, 2003, our equity interest in the
value of Citrus Corp.'s (Citrus) cash flow hedges included in accumulated other
comprehensive income was an unrealized loss of $8 million, net of income taxes.
This amount will be reclassified to earnings over the term of Citrus'
outstanding debt. We estimate that $1 million of this unrealized loss will be
reclassified from accumulated other comprehensive loss over the next twelve
months. For the quarters ended March 31, 2004, and 2003, no ineffectiveness was
recorded in earnings on these cash flow hedges.

4. CREDIT FACILITIES

El Paso maintains a $3 billion revolving credit facility, with a $1.5
billion letter of credit sublimit, which matures on June 30, 2005. We are not a
borrower under El Paso's $3 billion revolving credit facility; however, El
Paso's equity in several of its subsidiaries, including our equity in Bear
Creek, collateralizes the $3 billion revolving credit facility and other
financing arrangements including leases, letters of credit and other facilities.
See Note 2 for a discussion regarding El Paso's waivers on the $3 billion
revolving credit facility.

Under our indentures, 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 6 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

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.

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Key. We were named as a defendant in Randall Key v. LDI Contractors, Inc.,
et al., filed in 2002 in the Circuit Court of Jefferson County, Alabama. The
plaintiff, an employee of a contractor, suffered paralysis as a result of a
coupling failure during a pipeline repressurization in May 2002. The plaintiff
is seeking compensatory and punitive damages against us and two other
defendants. We are pursuing contribution and indemnity from the codefendants and
their insurers. The matter is set for trial in October 2004. Our costs and legal
exposure related to this lawsuit and claims are not currently determinable.

Royalty Claim. In five contract settlements reached in the late 1980s with
Elf Aquitaine (Elf) pertaining to the pricing of gas produced from certain
federal offshore blocks, we indemnified Elf against royalty claims that
potentially could have been asserted by the Minerals Management Service (MMS).
Following its settlements with us, Elf received demands from MMS for royalty
payments related to the settlements. With our approval, Elf protested the
demands for over a decade while trying to reach a settlement with the MMS. Elf,
which is now Total E&P USA (Total), has recently advised us that it is now
renewing efforts to settle claims by the MMS for excess royalties attributable
to price reductions that we achieved in the gas contract settlements in the late
1980s. Total has informed us that the MMS is claiming $10.2 million in
royalties, including $7.3 million of interest, for the five settlements with us
and that Total is proposing to make a settlement offer to MMS. If Total cannot
resolve these claims administratively with MMS, then an appeal can be taken to
the federal courts. We have the right under a pre-existing settlement with our
customers to recover through a surcharge payable by our customers a portion of
the amount ultimately paid to MMS under the royalty indemnity with Total.

In addition to the above matters, we and our subsidiaries and affiliates
are named defendant 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 to 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 March
31, 2004, we had accrued $1 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 March 31,
2004, we had accrued approximately $2 million for expected remediation costs and
associated onsite, offsite and groundwater technical studies. Our accrual was
based on the most likely outcome that can be reasonably estimated. Below is a
reconciliation of our environmental remediation liabilities as of March 31, 2004
(in millions):

Balance as of January 1, 2004............................... $ 3
Payments for remediation activities......................... (1)
---
Balance as of March 31, 2004................................ $ 2
===

In addition, we expect to make capital expenditures for environmental
matters of approximately $9 million in the aggregate for the years 2004 through
2006, excluding Toca Air Permit Violation discussed below. These expenditures
primarily relate to compliance with clean air regulations. 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.

Toca Air Permit Violation. In June 2003, we notified the Louisiana
Department of Environmental Quality (LDEQ) that we had discovered possible
compliance issues with respect to operations at our Toca Compressor Station. In
response to a request from the LDEQ, we submitted a report in September 2003

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documenting that there had been unpermitted emissions from nine condensate
storage tanks and a tank truck loading station. In December 2003, the LDEQ
issued an order requiring us to correct the existing operating permit and
achieve compliance with federal and state laws and regulations. Our Toca
Compressor Station will invest an estimated $6 million to upgrade the station's
environmental controls by 2005. We filed a revised permit application and a plan
for compliance with the LDEQ in January 2004. The LDEQ has indicated that it
will assess a penalty of $66,000 to resolve this matter.

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 one active site 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 March 31, 2004, we
have made no accruals related to this site. 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 estimate 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 our estimates.

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

There are several 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 Matters

Atlanta Gas Light. The majority of our contracts for firm transportation
service with our largest customer, Atlanta Gas Light Company (AGL), were due to
expire in 2005. On January 15, 2004, we and AGL executed a Letter of Intent
(LOI) pursuant to which AGL agreed to extend its firm transportation service
contracts with us for 926,534 Mcf/d for a weighted average term of 6.5 years
between 2008 and 2015 in exchange for the sale by us to AGL of approximately 250
miles of certain pipeline facilities and 8 measurement facilities in the
metropolitan Atlanta area at a transfer price of approximately $33 million. We
and AGL reached an agreement on terms for the contract extensions and facility
sales and executed the definitive agreements to implement the transactions on
April 14, 2004, subject to the Federal Energy Regulatory Commission (FERC)
approval and the approval of the Georgia Public Service Commission. We are
preparing the FERC application which is anticipated to be filed on or about May
18, 2004.

Enron Bankruptcy. In December 2001, Enron Corp. (Enron) and a number of
its subsidiaries, including Enron North America Corp. (ENA), filed for Chapter
11 bankruptcy protection in the United States Bankruptcy Court for the Southern
District of New York. We had contracts with ENA for, among

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other things, the transportation of natural gas. Following the rejection of
these contracts by ENA, we filed a proof of claim totaling $1.9 million with the
Bankruptcy Court. We have fully reserved for the amounts due from ENA.

In addition, we own 50 percent of the outstanding stock of Citrus with
Enron owning the other 50 percent. El Paso and Enron are parties to a Capital
Stock Agreement that governs, among other things, the ownership of capital stock
in Citrus. The Capital Stock Agreement contains restrictions on the
transferability of the capital stock of Citrus. These restrictions include
rights of first refusal if either owner desires to sell its interest in Citrus.
Those shares must first be offered to the other stockholder before the shares
can be sold or transferred to a party other than a wholly-owned subsidiary.

On October 31, 2003, Enron filed a motion with the Bankruptcy Court seeking
approval to assign the Capital Stock Agreement to CrossCountry Energy Corp.,
which would acquire Enron's stock in Citrus and then be distributed to Enron's
creditors. We objected to the motion on the basis that (1) we must consent to
the assignment and (2) the assignment would effectively circumvent the
transferability restrictions under the Capital Stock Agreement, including our
right of first refusal. The Bankruptcy Court granted the motion to assign the
Capital Stock Agreement on December 1, 2003. By letter dated March 31, 2004,
Enron gave notice that this assignment would be effective on April 1, 2004. A
hearing is scheduled on Enron's Amended Plan of Reorganization on June 3, 2004.

Duke. On March 7, 2003, Citrus Trading Corporation (CTC), a direct
subsidiary of Citrus, filed suit against Duke Energy LNG Sales, Inc. (Duke)
titled Citrus Trading Corp. v. Duke Energy LNG Sales, Inc. in the District Court
of Harris County, Texas seeking damages for breach of a gas supply contract.

In April 2003, Duke: (i) sent CTC notice of termination of the gas supply
contract alleging failure of CTC to increase the amount of an outstanding letter
of credit backstopping its purchase obligations; (ii) filed an answer to CTC's
complaint stating among other reasons that CTC had triggered the early
termination and breached the gas supply contract; and (iii) removed the case to
federal court, based on the existence of foreign arbitration with its LNG
supplier, Sonatrading Amsterdam B.V. Sonatrading was alleged to have repudiated
its supply contract with Duke.

In May 2003, CTC: (i) notified Duke that it was in default under the gas
supply contract, demanding cover damages for alternate supplies obtained by CTC;
and (ii) filed a motion to remand the case back to state court. Subsequently,
CTC gave Duke notice of early termination of the gas supply contract.

In August 2003, Duke filed a third-party petition against Sonatrading. In
October 2003, CTC filed an amended complaint, alleging wrongful contract
termination and specifying damages of $185 million. Also in October 2003, Duke
filed various petitions claiming that Sonatrading's breach of contract resulted
in its being responsible for any damages the court may ultimately find Duke owes
to Citrus. In October 2003, the case was removed to federal court. In November
2003, pursuant to a judicial order, CTC filed an amended complaint against Duke.
On March 8, 2004, CTC sent a demand letter to PanEnergy Corp. (PanEnergy), the
holding company of Duke, insisting on a financial guarantee from PanEnergy of
the $185 million. On April 14, 2004, CTC filed an amended complaint and
counter-claim, joining PanEnergy to the proceeding. On April 21, 2004, Duke
filed an answer and an amended counter-claim joining Citrus. We do not expect
the ultimate resolution of this matter to have a material adverse effect on us.

CFTC Investigation. In April 2004, ANR Storage Company and Blue Lake Gas
Storage Company, our affiliates, received subpoenas from the Commodity Futures
Trading Commission (CFTC) in connection with the CFTC's investigation of
activities affecting the price of natural gas in the fall of 2003. Specifically,
the CFTC requested the companies to provide information, on behalf of themselves
and their affiliates, relating to storage reports provided to the Energy
Information Administration for the period October 2003 through December 2003. It
is our understanding that the CFTC is conducting an industry-wide investigation.
We are cooperating with the CFTC's investigation and have provided requested
information for the relevant time period regarding our storage operations at
Bear Creek and Muldon Field.

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

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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.

6. RETIREMENT BENEFITS

The components of our postretirement benefit costs for the quarters ended
March 31 are as follows:

7. INVESTMENTS IN UNCONSOLIDATED AFFILIATES AND TRANSACTIONS WITH AFFILIATES

Investments in Unconsolidated Affiliates

Our investments in unconsolidated affiliates consist of our equity
ownership interests in Citrus and Bear Creek. Summarized income statement
information of our proportionate share of our unconsolidated affiliates for the
quarters ended March 31 are as follows:

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(1) The difference between our proportionate share of our equity investments'
net income and our earnings from unconsolidated affiliates reflected in our
income statement is due primarily to timing differences between the
estimated and actual equity earnings from our investments.

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 March 31, 2004 and December 31,
2003, we had advanced to El Paso $135 million and $153 million. The market rate
of interest at March 31, 2004 was 2.5% and at December 31, 2003 was 2.8%. These
receivables are due upon demand; however, as of March 31, 2004 and December 31,
2003, we have classified these advances as non-current notes receivables 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.

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We had accounts payable to affiliates of $8 million at March 31, 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
quarters ended March 31:

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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. Our business consists of consolidated
operations as well as investments in unconsolidated affiliates. 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
both our consolidated business and our unconsolidated investments 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 quarters ended March 31:

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(1) Throughput volumes include volumes associated with our proportionate share
of our 50 percent equity interest in Citrus and billable transportation
throughput volumes for storage injection.

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OPERATING RESULTS (EBIT)

The following factors contributed to our overall EBIT reduction to $75
million for the three months ended March 31, 2004 from $80 million for the three
months ended March 31, 2003:

INTEREST AND DEBT EXPENSE

Interest and debt expense for the quarter ended March 31, 2004, was $7
million higher than the same period in 2003 primarily due to the issuance in
March 2003 of $400 million senior unsecured notes with an annual interest rate
of 8.875%.

AFFILIATED INTEREST INCOME

Affiliated interest income for the quarter ended March 31, 2004, was $1
million lower than the same period in 2003 due to higher interest rates on
average advances to El Paso under its cash management program, offset by lower
average balances of these advances. The average advance balance for the first
quarter of 2003 was $452 million and decreased to $141 million during the same
period in 2004. The average short-term interest rate for the first quarter
increased from 1.4% in 2003 to 2.7% during the same period in 2004.

INCOME TAXES

Our effective tax rates were different than the statutory rate of 35
percent, primarily due to the effect of state income taxes, offset by the tax
effect of earnings from unconsolidated affiliates where we anticipate receiving
dividends.

EXPANSION PROJECTS

In the third quarter of 2002, the FERC approved our South System II project
and related compressor facilities. This expansion has a design capacity of 330
MMcf/d. Construction will be completed in three phases. Phase I was placed in
service in September 2003 and Phase IA was placed in service in November 2003.
The targeted in service date for Phase II is May 2004. The South System II
project will increase our firm transportation capacity along our south mainline
to Alabama, Georgia and South Carolina. Current cost estimates are approximately
$242 million, and current expenditures as of March 31, 2004 are approximately
$226 million.

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In April 2003, the FERC approved our expansion of our Elba Island LNG
facility to increase the design sendout rate of the facility from 446 MMcf/d to
806 MMcf/d. Current cost estimates for the expansion are approximately $159
million, and current expenditures as of March 31, 2004 are approximately $31
million. Construction commenced in July 2003 with an in-service date expected to
be in February 2006.

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 March 31, 2004, we had receivables from El Paso of $135 million as
a result of this program. These receivables are due upon demand; however, we do
not anticipate settlement within the next twelve months. As of March 31, 2004,
these receivables were classified as non-current notes receivable from
affiliates in our balance sheet. As a result of announcements by El Paso related
to the restatement of its natural gas and oil reserves, our ability to recover
the amounts advanced under El Paso's cash management program could be impacted.

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 entire amounts owed to us. In that event, we could be required to
write-off some amount of these advances, which could have a material impact on
our stockholder's equity. Furthermore, we would still be required to repay
affiliated company payables. Write-downs that cause our debt to EBITDA (as
defined in our agreements) ratio to exceed 6 to 1 could prohibit us from
incurring additional debt. However, this non-cash equity reduction would not
result in an event of default under our existing debt agreements.

Our equity investment in Bear Creek serves as collateral under El Paso's
revolving credit facility and other of El Paso's financing transactions. If El
Paso's lenders under this facility or those other financing transactions were to
exercise their rights to this collateral, our investment could be liquidated.
However, this 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 that
state that should we incur an event of default under which borrowings in excess
of $10 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 quarters ended March 31 were as follows:

- ---------------

(1) Represents net proceeds from the issuance of $400 million of long-term debt
in March 2003, net of a dividend paid to our parent.

13

Cash Flows from Operating Activities

Net cash provided by operating activities was $30 million for the first
three months of 2004 versus $65 million in the same period of 2003. This
decrease was primarily due to higher interest payments of $14 million in 2004
resulting from additional long-term debt issued in 2003 and $10 million of
customer deposits returned in 2004. Also contributing to the decrease was an $8
million cash outflow for the replacement of stored gas. The remaining decrease
is due to various changes in assets and liabilities.

Cash Flows from Investing Activities

Net cash used in investing activities for the three months ended March 31,
2004 consisted of $47 million in capital expenditures, primarily for our
pipeline and LNG terminal expansions, offset by a $17 million reduction in
advances to our affiliate.

CAPITAL EXPENDITURES

Our capital expenditures for the quarter ended March 31, 2004 were
approximately $47 million. Under our current plan, we expect to spend $195
million during 2004 for capital expenditures, consisting of $125 million to
expand the capacity of our system and $70 million for maintenance capital. We
expect to fund our maintenance and expansion capital expenditures through a
combination of internally generated funds and/or by recovering amounts advanced
to El Paso under its cash management program, subject to the factors discussed
above.

COMMITMENTS AND CONTINGENCIES

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

14

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). These debt ratings will 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 March 31,
2004, we have net receivables of approximately $127 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 the results of its internal review of
its natural gas and oil reserves confirmed its previous assessment that the
financial statements for El Paso and its subsidiaries, El Paso CGP Company
(EPCGP) and El Paso Production Holding Company (EPPH), should be restated. At
this time, these financial statements have not been filed. Also, as a result of
its reduction in reserve estimates, several class action lawsuits have been
filed against El Paso and several of its subsidiaries, but not against us. The
reduction in reserve estimates has 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
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.

15

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).

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, 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.

Based on the controls evaluation, our principal executive officer and
principal financial officer have concluded that the disclosure controls are
effective. 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.

16

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. CHANGES IN 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.

b. Reports on Form 8-K

None.

17

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.

SOUTHERN NATURAL GAS COMPANY

Date: May 14, 2004 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board and Director
(Principal Executive Officer)

Date: May 14, 2004 /s/ GREG G. GRUBER
------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer, Treasurer
and Director
(Principal Financial and Accounting
Officer)

18

SOUTHERN 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.