10-K 1 h23806e10vk.txt CITGO PETROLEUM CORP.- DECEMBER 31, 2004 ================================================================================ United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 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 1-14380 CITGO PETROLEUM CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 73-1173881 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1293 ELDRIDGE PARKWAY, HOUSTON, TEXAS 77077 (Address of principal executive office) (Zip Code) (832) 486-4000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: NONE 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 [ ] The registrant meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K and is therefore omitting (i) the information otherwise required by Item 601 of Regulation S-K relating to a list of subsidiaries of the registrant as permitted by General Instruction (I)(2)(b), (ii) certain information otherwise required by Item 10 of Form 10-K relating to directors and executive officers as permitted by General Instruction (I)(2)(c), (iii) certain information otherwise required by Item 11 of Form 10-K relating to executive compensation as permitted by General Instruction (I)(2)(c) and (iv) certain information otherwise required by Item 12 of Form 10-K relating to security ownership of certain beneficial owners and management as permitted by General Instruction (I)(2)(c). Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act): Yes [ ] No [X] Aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2004: NONE Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. COMMON STOCK, $1.00 PAR VALUE 1,000 ----------------------------- ---------------------------------- (Class) (outstanding at February 28, 2005) DOCUMENTS INCORPORATED BY REFERENCE: None ================================================================================ CITGO PETROLEUM CORPORATION ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 TABLE OF CONTENTS
PAGE FACTORS AFFECTING FORWARD LOOKING STATEMENTS.................................................. 1 PART I. Items 1. and 2. Business and Properties....................................................... 2 Item 3. Legal Proceedings................................................................... 16 Item 4. Submission of Matters to a Vote of Security Holders................................. 17 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 18 Item 6. Selected Financial Data............................................................. 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 20 Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................... 37 Item 8. Financial Statements and Supplementary Data......................................... 41 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................................................................... 42 Item 9A. Controls and Procedures............................................................. 42 Item 9B. Other Information................................................................... 42 PART III. Item 10. Directors and Executive Officers of the Registrant.................................. 43 Item 11. Executive Compensation.............................................................. 43 Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 43 Item 13. Certain Relationships and Related Transactions...................................... 44 Item 14. Principal Accountant Fees and Services.............................................. 45 PART IV. Item 15. Exhibits and Financial Statement Schedules.......................................... 46
FACTORS AFFECTING FORWARD LOOKING STATEMENTS Except for the historical information contained in this Report, certain of the matters discussed in this Report may be deemed to be "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Specifically, all statements under the caption "Items 1 and 2 - Business and Properties" and "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" pertaining to capital expenditures and investments related to environmental compliance, strategic planning, purchasing patterns of refined products and capital resources available to CITGO (as defined herein) are forward looking statements. Words such as "anticipate," "estimate," "expect," "project," "believe" and similar expressions generally identify a forward-looking statement. We caution readers that these forward looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from the results that are projected, expressed or implied. Some of those risks and uncertainties include: - the availability and cost of crude oil, feedstocks, blending components and refined products, which can affect our ability to operate our refineries and our costs; - accidents, interruptions in transportation, inclement weather and other events that cause unscheduled shutdowns or otherwise adversely affect our refineries, pipelines or equipment, or those of our suppliers or customers; - prices or demand for CITGO products, which are influenced by general economic activity, weather patterns (including seasonal fluctuations), prices of alternative fuels, energy conservation efforts and actions by competitors; - environmental and other regulatory requirements, which affect the content of our products and our operations, operating costs and capital expenditure requirements; - costs and uncertainties associated with technological change and implementation; - inflation: and - continued access to capital markets and commercial bank financing on favorable terms, which can affect our ability to finance capital improvements, our costs and our flexibility. CITGO purchases approximately one-half of its crude oil requirements from Petroleos de Venezuela, S.A. (as defined herein), its ultimate parent corporation, under long-term supply agreements and spot purchases. The table on page 8 shows the history of deliveries of crude oil from PDVSA over the past three years and can be compared to contract volume deliveries shown on page 9. Readers are cautioned not to place undue reliance on these forward looking statements, which apply only as of the date of this Report. CITGO disclaims any duty to publicly release any revision to these forward looking statements to reflect events or circumstances after the date of this Report. WHERE TO FIND MORE INFORMATION The public may read and copy any reports or other information that we file with the SEC at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These documents are also available to the public from commercial document retrieval services, the web site maintained by the SEC at http://www.sec.gov and our web site at http://www.citgo.com. Copies may be obtained from our web site free of charge. 1 PART I ITEMS 1. AND 2. BUSINESS AND PROPERTIES OVERVIEW CITGO Petroleum Corporation ("CITGO" or the "Company") is a direct wholly owned operating subsidiary of PDV America, Inc. ("PDV America"), a wholly owned subsidiary of PDV Holding, Inc. ("PDV Holding"). The Company's ultimate parent is Petroleos de Venezuela, S.A. ("PDVSA", which may also be used herein to refer to one or more of its subsidiaries), the national oil company of the Bolivarian Republic of Venezuela. CITGO and its subsidiaries are engaged in the refining, marketing and transportation of petroleum products including gasoline, diesel fuel, jet fuel, petrochemicals, lubricants, asphalt and refined waxes, mainly within the continental United States east of the Rocky Mountains. The Company operates as a single segment. (See Consolidated Financial Statements of CITGO in Item 15a). CITGO's transportation fuel customers include CITGO branded wholesale marketers, convenience stores and airlines located mainly east of the Rocky Mountains. Asphalt is generally marketed to independent paving contractors on the East and Gulf Coasts and in the Midwest of the United States. Lubricants are sold principally in the United States to independent marketers, mass marketers and industrial customers. Petrochemical feedstocks and industrial products are sold to various manufacturers and industrial companies throughout the United States. Petroleum coke is sold primarily in international markets. CITGO also sells lubricants, gasoline and distillates in various Latin American markets including Puerto Rico, Brazil, Ecuador and Mexico. COMPETITIVE NATURE OF THE PETROLEUM REFINING BUSINESS The petroleum refining industry is cyclical and highly volatile, reflecting capital intensity with high fixed and low variable costs. Petroleum industry operations and profitability are influenced by a large number of factors, over some of which individual petroleum refining and marketing companies have little control. Governmental regulations and policies, particularly in the areas of taxation, energy and the environment, have a significant impact on how companies conduct their operations and formulate their products. Demand for crude oil and its products is largely driven by the condition of local and worldwide economies, although weather patterns and taxation relative to other energy sources also play significant parts. Generally, U.S. refiners compete for sales on the basis of price, brand image and, in some areas, product quality. 2 REFINING CITGO's aggregate net interest in rated crude oil refining capacity is 865 thousand barrels per day ("MBPD"). The following table shows the capacity of each refinery in which CITGO holds an interest and CITGO's share of such capacity as of December 31, 2004. CITGO REFINING CAPACITY
TOTAL NET RATED CITGO SOLOMON CRUDE OWNERSHIP PROCESS CITGO REFINING IN REFINING COMPLEXITY OWNER INTEREST CAPACITY CAPACITY RATING ----- -------- -------- ----------- ---------- (%) (MBPD) (MBPD) LOCATION Lake Charles, LA CITGO 100 320 320 18.2 Corpus Christi, TX CITGO 100 157 157 16.5 Lemont, IL CITGO 100 167 167 11.7 Paulsboro, NJ CITGO 100 84 84 - Savannah, GA CITGO 100 28 28 - ----- --- CITGO Wholly owned 756 756 Houston, TX LYONDELL-CITGO 41 265 109 15.5 ----- --- Total Rated Crude Refining Capacity 1,021 865 ===== ===
The Lake Charles, Corpus Christi and Lemont refineries and the Houston refinery each have the capability to process large volumes of heavy crude oil into a flexible slate of refined products. They have Solomon Process Complexity Ratings of 18.2, 16.5, 11.7 and 15.5, respectively, as compared to an average of 14.0 for U.S. refineries in the most recently available Solomon Associates, Inc. survey. The rating is an industry measure of a refinery's ability to produce higher value products from a lower value feedstock, with a higher rating indicating a greater capability to produce such products from such feedstocks. 3 The following table shows CITGO's aggregate interest in refining capacity, refinery input, and product yield for the three years ended December 31, 2004. CITGO REFINERY PRODUCTION (1)
YEAR ENDED DECEMBER 31, --------------------------------------------------- 2004 2003 2002 --------------- ------------ ------------ (MBPD, EXCEPT AS OTHERWISE INDICATED) RATED REFINING CRUDE CAPACITY AT YEAR END 865 865 865 Refinery Input Crude oil 796 84% 801 84% 674 84% Other feedstocks 155 16% 152 16% 131 16% --- --- --- --- --- --- Total 951 100% 953 100% 805 100% === === === === === === Product Yield Light fuels Gasoline 404 42% 414 43% 379 46% Jet fuel 71 7% 75 8% 76 9% Diesel/#2 fuel 188 20% 193 20% 153 19% Asp halt 52 5% 43 4% 16 2% Petrochemicals and industrial products 246 26% 241 25% 194 24% --- --- --- --- --- --- Total 961 100% 966 100% 818 100% === === === === === === UTILIZATION OF RATED CRUDE REFINING CAPACITY 92% 93% 78%
---------- (1) Includes 41.25% of the Houston refinery production. CITGO produces its light fuels and petrochemicals primarily through its Lake Charles, Corpus Christi and Lemont refineries. Asphalt refining operations are carried out through CITGO's Paulsboro and Savannah refineries. 4 Lake Charles, Louisiana Refinery. This refinery has a rated refining capacity of 320 MBPD and is capable of processing large volumes of heavy crude oil into a flexible slate of refined products, including significant quantities of high-octane unleaded gasoline and reformulated gasoline. The following table shows the rated refining capacity, refinery input and product yield at the Lake Charles refinery for the three years ended December 31, 2004. LAKE CHARLES REFINERY PRODUCTION
YEAR ENDED DECEMBER 31, -------------------------------------------- 2004 2003 2002 ----------- ----------- ------------ (MBPD, EXCEPT AS OTHERWISE INDICATED) RATED REFINING CRUDE CAPACITY AT YEAR END 320 320 320 Refinery Input Crude oil 309 88% 313 85% 320 92% Other feedstocks 42 12% 56 15% 28 8% --- --- --- --- --- --- Total 351 100% 369 100% 348 100% === === === === === === Product Yield Light fuels Gasoline 177 49% 179 47% 184 51% Jet fuel 64 18% 67 18% 68 19% Diesel/#2 fuel 53 15% 55 15% 45 13% Petrochemicals and industrial products 64 18% 77 20% 60 17% --- --- --- --- --- --- Total 358 100% 378 100% 357 100% === === === === === === Utilization of Rated Crude Refining Capacity 97% 98% 100%
A project to increase the crude oil distillation capacity of the Lake Charles refinery by 105 MBPD was completed in February 2005. The Lake Charles refinery's Gulf Coast location provides it with access to crude oil deliveries from multiple sources; imported crude oil and feedstock supplies are delivered by ship directly to the Lake Charles refinery, while domestic crude oil supplies are delivered by pipeline and barge. In addition, the refinery is connected by pipelines to the Louisiana Offshore Oil Port and to terminal facilities in the Houston area through which it can receive crude oil deliveries. For delivery of refined products, the refinery is connected through the Lake Charles Pipeline directly to the Colonial and Explorer Pipelines, which are the major refined product pipelines supplying the northeast and midwest regions of the United States, respectively. The refinery also uses adjacent terminals and docks, which provide access for ocean tankers and barges to load refined products for shipment. The Lake Charles refinery's main petrochemical products are propylene, benzene and mixed xylenes. Industrial products include sulphur, residual fuels and petroleum coke. 5 Corpus Christi, Texas Refinery. The Corpus Christi refinery processes heavy crude oil into a flexible slate of refined products. This refinery complex consists of the East and West Plants, located within five miles of each other. The following table shows rated refining capacity, refinery input and product yield at the Corpus Christi refinery for the three years ended December 31, 2004. CORPUS CHRISTI REFINERY PRODUCTION
YEAR ENDED DECEMBER 31, -------------------------------------------- 2004 2003 2002 ----------- ----------- ---------- (MBPD, EXCEPT AS OTHERWISE INDICATED) RATED REFINING CRUDE CAPACITY AT YEAR END 157 157 157 Refinery Input Crude oil 138 66% 154 71% 154 73% Other feedstocks 71 34% 62 29% 57 27% --- --- --- --- --- --- Total 209 100% 216 100% 211 100% === === === === === === Product Yield Light fuels Gasoline 86 42% 95 44% 93 44% Diesel/#2 fuel 56 27% 60 28% 59 28% Petrochemicals and industrial products 65 31% 60 28% 58 28% --- --- --- --- --- --- Total 207 100% 215 100% 210 100% === === === === === === Utilization of Rated Crude Refining Capacity 88% 98% 98%
CITGO operates the West Plant under a sublease agreement (the "Sublease") from Anadarko Petroleum Corporation ("Anadarko"). The basic term of the Sublease ended on January 1, 2004, but CITGO renewed the lease for a two year term and may continue to renew the Sublease for successive renewal terms through January 31, 2011. CITGO has the right to purchase the West Plant from Anadarko at the end of the basic term, the end of any renewal term, or on January 31, 2011 at a nominal price. (See Consolidated Financial Statements of CITGO - Note 13 in Item 15a). The Corpus Christi refinery's main petrochemical products include cumene, cyclohexane, and aromatics (including benzene, toluene and xylenes). These products are used in the manufacture of plastic and building materials. 6 Lemont, Illinois Refinery. The Lemont refinery produces a flexible slate of refined products from a crude slate which includes approximately 50% heavy Canadian crude oil. The following table shows the rated refining capacity, refinery input and product yield at the Lemont refinery for the three years ended December 31, 2004. LEMONT REFINERY PRODUCTION
YEAR ENDED DECEMBER 31, -------------------------------------------- 2004 2003 2002 ----------- ----------- ---------- (MBPD, EXCEPT AS OTHERWISE INDICATED) RATED REFINING CRUDE CAPACITY AT YEAR END 167 167 167 Refinery Input Crude oil 160 89% 162 92% 69 73% Other feedstocks 20 11% 15 8% 25 27% --- --- --- --- --- --- Total 180 100% 177 100% 94 100% === === === === === === Product Yield Light fuels Gasoline 94 53% 92 52% 54 59% Diesel/#2 fuel 40 22% 43 25% 16 17% Petrochemicals and industrial products 44 25% 41 23% 22 24% --- --- --- --- --- --- Total 178 100% 176 100% 92 100% === === === === === === Utilization of Rated Refining Crude Capacity 96% 97% 41%
Petrochemical products at the Lemont refinery include benzene, toluene and xylenes, plus a range of ten different aliphatic solvents. In August 2001, a fire occurred at the crude oil distillation unit of the Lemont refinery. A new crude unit was operational in May 2002. See Consolidated Financial Statements of CITGO - Note 15 in Item 15a for further information. 7 LYONDELL-CITGO Refining LP. Subsidiaries of CITGO and Lyondell Chemical Company ("Lyondell") are partners in LYONDELL-CITGO Refining LP ("LYONDELL-CITGO"), which owns and operates a 265 MBPD refinery previously owned by Lyondell and located on the ship channel in Houston, Texas. At December 31, 2004, CITGO's investment in LYONDELL-CITGO was $410 million. In addition, at December 31, 2004, CITGO held a note receivable from LYONDELL-CITGO in the approximate amount of $35 million. (See Consolidated Financial Statements of CITGO -- Note 3 in Item 15a). A substantial amount of the crude oil processed by this refinery is supplied by PDVSA under a long-term crude oil supply agreement that expires in the year 2017. For the years ended December 31, 2004 and 2002, LYONDELL-CITGO constituted a significant investment for CITGO as defined under SEC regulations. As such, the financial statements for LYONDELL-CITGO are included in this annual report. See separate financial statements for LYONDELL-CITGO in Item 15a. CRUDE OIL AND REFINED PRODUCT PURCHASES CITGO owns no crude oil reserves or production facilities, and must therefore rely on purchases of crude oil and feedstocks for its refinery operations. Crude oil is CITGO's primary raw material. CITGO buys and sells crude oil to facilitate procurement and delivery of a desired type or grade of crude oil to a desired location to supply our refineries, not as an independent business activity to generate profit. CITGO believes that reflecting the net result of this activity in cost of sales is an appropriate reflection of the nature of these transactions as efforts undertaken to acquire raw material. In addition, because CITGO's refinery operations do not produce sufficient refined products to meet the demands of its marketers, CITGO purchases refined products, primarily gasoline, from other refiners, including a number of affiliated companies. (See "Item 13. Certain Relationships and Related Transactions"). Crude Oil Purchases. The following chart shows CITGO's net purchases of crude oil for the three years ended December 31, 2004: CITGO CRUDE OIL PURCHASES
LAKE CHARLES, LA CORPUS CHRISTI, TX LEMONT, IL PAULSBORO, NJ SAVANNAH, GA ------------------ ------------------ ------------------- ------------------ ----------------- 2004 2003 2002 2004 2003 2002 2004 2003 2002 2004 2003 2002 2004 2003 2002 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- (MBPD) (MBPD) (MBPD) (MBPD) (MBPD) SUPPLIERS PDVSA (2) 155 139 125 115 134 126 - 3 11 51 39 36 26 21 22 Other sources 155 178 190 24 20 29 160 158 62 1 2 7 - - - --- --- --- --- --- --- --- --- -- -- -- -- -- -- -- Total (1) 310 317 315 139 154 155 160 161 73 52 41 43 26 21 22 === === === === === === === === == == == == == == ==
(1) Total crude oil purchases do not equal crude oil refinery inputs because of changes in inventory. (2) Includes total of contract volume and volume purchased on a spot basis. Contract volumes for each refinery are shown in the table on page 9. PDVSA works very closely with CITGO to assure total volume commitments are met. 8 CITGO's largest single supplier of crude oil is PDVSA. CITGO has entered into long-term crude oil supply agreements with PDVSA with respect to the crude oil requirements for each of CITGO's Lake Charles, Corpus Christi, Paulsboro and Savannah refineries. The following table shows the base and incremental volumes of crude oil contracted for delivery and the volumes of crude oil actually delivered under these contracts in the three years ended December 31, 2004. CITGO CRUDE OIL SUPPLY CONTRACTS WITH PDVSA
VOLUMES OF CRUDE OIL PURCHASED CONTRACT CRUDE FOR THE YEAR ENDED OIL VOLUME DECEMBER 31, CONTRACT -------------------- ---------------------- EXPIRATION BASE INCREMENTAL(1) 2004 2003 2002 DATE ---- -------------- ---- ---- ---- ---------- (MBPD) (MBPD) (YEAR) LOCATION Lake Charles, LA (2) 120 70 122 123 109 2006 Corpus Christi, TX (2) 130 - 129 134 114 2012 Paulsboro, NJ (2) 30 - 29 29 27 2010 Savannah, GA (2) 12 - 11 12 12 2013
---------- (1) The supply agreement for the Lake Charles refinery gives PDVSA the right to sell to CITGO incremental volumes up to the maximum amount specified in the table, subject to certain restrictions relating to the type of crude oil to be supplied, refining capacity and other operational considerations at the refinery. (2) Volumes purchased as shown on this table do not equal purchases from PDVSA (shown in the previous table) as a result of transfers between refineries of contract crude purchases included here and spot purchases from PDVSA which are included in the previous table. These crude oil supply agreements require PDVSA to supply minimum quantities of crude oil and other feedstocks to CITGO for a fixed period. The supply agreements differ somewhat for each refinery but generally incorporate formula prices based on the market value of a slate of refined products deemed to be produced from each particular grade of crude oil or feedstock, less (i) specified deemed refining costs; (ii) specified actual costs, including transportation charges, actual cost of natural gas and electricity, import duties and taxes; and (iii) a deemed margin, which varies according to the grade of crude oil or feedstock delivered. Under each supply agreement, deemed margins and deemed costs are adjusted periodically by a formula primarily based on the rate of inflation. Because deemed operating costs and the slate of refined products deemed to be produced for a given barrel of crude oil or other feedstock do not necessarily reflect the actual costs and yields in any period, the actual refining margin earned by CITGO under the various supply agreements will vary depending on, among other things, the efficiency with which CITGO conducts its operations during such period. These crude supply agreements contain force majeure provisions which excuse the performance by either party of its obligations under the agreement under specified circumstances. The price we pay for crude oil purchased under these crude oil supply agreements is not directly related to the market price of any other crude oil. Thus there are periods in which the price paid for crude oil purchased under those agreements may be higher or lower than the price that might have been paid in the spot market. PDVSA and we have been evaluating possible changes to certain terms and conditions of these supply agreements, including the price mechanisms, volumes and term. If PDVSA and we determine to pursue those changes and we are able to successfully negotiate any related amendments to the supply agreements, the effectiveness of those amendments may require the consent of some of the holders of our outstanding debt. 9 Refined Product Purchases. The marketing and sale of refined petroleum products represents CITGO's revenue generating activity. The demand for those products in CITGO's market areas exceeds the capacity of its refineries to produce them so it purchases significant quantities of refined products from affiliated and non-affiliated suppliers. CITGO must have the right refined products in the right locations and in the right quantities in order to satisfy customer supply arrangements and market requirements. Thus, CITGO purchases and sells refined products of various grades in various locations from other suppliers. Sales of refined products are reported as revenue upon transfer of title to the buyer. Purchases of refined product are treated as acquisitions, a component of cost of sales, upon transfer of title to CITGO. The following table shows CITGO's purchases of refined products for the three years ended December 31, 2004. CITGO REFINED PRODUCT PURCHASES
YEAR ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 ---- ---- ---- (MBPD) LIGHT FUELS Gasoline 573 636 689 Jet fuel 86 83 61 Diesel/ #2 fuel 235 246 239 --- --- --- Total 894 965 989 === === ===
As of December 31, 2004, CITGO purchased substantially all of the gasoline, diesel/ #2 fuel, and jet fuel produced at the LYONDELL-CITGO refinery under a contract which extends through the year 2017. LYONDELL-CITGO was a major supplier in 2004 providing CITGO with 113 MBPD of gasoline, 95 MBPD of diesel/#2 fuel, and 17 MBPD of jet fuel. See "--Refining--LYONDELL-CITGO Refining LP". In October 1998, PDVSA V.I., Inc., an affiliate of PDVSA, acquired a 50% equity interest in HOVENSA, L.L.C. ("HOVENSA"), a joint venture that owns and operates a refinery in St. Croix, U.S. Virgin Islands. Under the related product sales agreement, CITGO acquired approximately 128 MBPD of refined products from the refinery during 2004, approximately one-half of which was gasoline. 10 MARKETING CITGO's major products are light fuels (including gasoline, jet fuel, and diesel fuel), industrial products and petrochemicals, asphalt, lubricants and waxes. The following table shows revenues and volumes of each of these product categories for the three years ended December 31, 2004. CITGO REFINED PRODUCT SALES REVENUES AND VOLUMES
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------------------- ----------------------------- 2004 2003 2002 2004 2003 2002 --------- ---------- ---------- ------ ------ ------ ($ IN MILLIONS) (GALLONS IN MILLIONS) LIGHT FUELS Gasoline $ 17,597 $ 14,320 $ 11,758 14,194 15,257 15,026 Jet fuel 2,707 1,951 1,402 2,318 2,315 2,003 Diesel / #2 fuel 6,590 5,287 3,462 5,854 6,238 5,031 ASPHALT 971 711 597 1,300 990 902 PETROCHEMICALS AND INDUSTRIAL PRODUCTS 3,369 2,272 1,485 2,865 2,643 2,190 LUBRICANTS AND WAXES 684 598 561 280 261 261 --------- ---------- ---------- ------ ------ ------ Total $ 31,918 $ 25,139 $ 19,265 26,811 27,704 25,413 ========= ========== ========== ====== ====== ======
Light Fuels. Gasoline sales accounted for 55% of CITGO's refined product sales revenue in 2004, 57% in 2003, and 61% in 2002. CITGO supplies CITGO branded gasoline to approximately 14,000 independently owned and operated CITGO branded retail outlets located throughout the United States, primarily east of the Rocky Mountains. CITGO purchases gasoline to supply this marketing network, as the gasoline production from the Lake Charles, Corpus Christi and Lemont refineries was only equivalent to approximately 54%, 57% and 54% of the volume of CITGO branded gasoline sold in 2004, 2003 and 2002, respectively. Purchases of gasoline from CITGO's affiliates, PDVSA, LYONDELL-CITGO and Hovensa, provide 32%, 36% and 32% of the volume of CITGO branded gasoline sold in 2004, 2003 and 2002, respectively. See "--Crude Oil and Refined Product Purchases -- Refined Product Purchases". CITGO's strategy is to enhance the value of the CITGO brand by delivering quality products and services to the consumer through a large network of independently owned and operated CITGO branded retail locations. This enhancement is accomplished through a commitment to quality, dependability and excellent customer service to its independent marketers, which constitute CITGO's primary distribution channel. Sales to independent branded marketers typically are made under contracts that range from three to seven years. Sales to 7-Eleven(TM) convenience stores are made under a contract that extends through August 31, 2006. Under this contract, CITGO arranges all transportation and delivery of motor fuels and handles all product ordering. CITGO markets jet fuel directly to airline customers at 20 airports, including such major hub cities as Chicago, Dallas/Fort Worth, Miami, and New York. CITGO's delivery of light fuels to its customers is accomplished in part through 52 refined product terminals located throughout CITGO's primary market territory. Of these terminals, 42 are wholly-owned by CITGO and 10 are jointly owned. Eleven of CITGO's product terminals have waterborne docking facilities, which greatly enhance the flexibility of CITGO's logistical system. Refined product terminals owned or operated by CITGO provide a total storage capacity of approximately 21 million barrels. Also, CITGO has active exchange relationships with over 300 other refined product terminals, providing flexibility and timely response capability to meet distribution needs. 11 Petrochemicals and Industrial Products. CITGO sells petrochemicals in bulk to a variety of U.S. manufacturers as raw material for finished goods. The majority of CITGO's cumene production is sold to Mount Vernon Phenol Plant Partnership, a joint venture phenol production plant in which CITGO and General Electric Company are partners. This plant produces phenol and acetone for sale primarily to the principal partner in the phenol plant for the production of plastics. Sulphur is sold to the U.S. and international fertilizer industries; cycle oils are sold for feedstock processing and blending; natural gas liquids are sold to the U.S. fuel and petrochemical industry; petroleum coke is sold primarily in international markets, through TCP Petcoke Corporation, a joint venture, for use as kiln and boiler fuel; and residual fuel blendstocks are sold to a variety of fuel oil blenders. Asphalt. CITGO asphalt is generally marketed to independent paving contractors on the East and Gulf Coasts and in the Midwest of the United States for use in the construction and resurfacing of roadways. CITGO delivers asphalt through three wholly-owned terminals and twenty-three leased terminals. Demand for asphalt is seasonal and peaks in the summer months. Lubricants and Waxes. CITGO markets many different types, grades and container sizes of lubricants and wax products, with the bulk of sales consisting of automotive oil and lubricants and industrial lubricants. Other major lubricant products include 2-cycle engine oil and automatic transmission fluid. INTERNATIONAL OPERATIONS CITGO, through its wholly-owned subsidiary, CITGO International, Inc., sells lubricants, gasoline and distillates in various Latin American markets including Puerto Rico, Brazil, Ecuador and Mexico. PIPELINE OPERATIONS CITGO owns and operates a crude oil pipeline and three products pipeline systems. CITGO also has equity interests in three crude oil pipeline companies and six refined product pipeline companies. CITGO's pipeline interests provide it with access to substantial refinery feedstocks and reliable transportation to refined product markets, as well as cash flows from dividends. One of the refined product pipelines in which CITGO has an interest, Colonial Pipeline, is the largest refined product pipeline in the United States, transporting refined products from the Gulf Coast to the mid-Atlantic and eastern seaboard states. CITGO has a 15.8 percent ownership interest in Colonial Pipeline. EMPLOYEES CITGO and its subsidiaries have a total of approximately 4,000 employees, approximately 1,500 of whom are covered by union contracts. Most of the union employees are employed in refining operations. The remaining union employees are located primarily at a lubricant plant and various refined product terminals. All our union contracts will expire between November 2005 and July 2006. 12 ENVIRONMENT AND SAFETY Environment CITGO is subject to the federal Clean Air Act ("CAA") which includes the New Source Review ("NSR") program as well as the Title V air permitting program; the federal Clean Water Act which includes the National Pollution Discharge Elimination System program; the Toxic Substances Control Act; and the federal Resource Conservation and Recovery Act and their equivalent state programs. CITGO is required to obtain permits under all of these programs and believes it is in material compliance with the terms of these permits. CITGO does not have any material Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") liability because the former owners of many of CITGO's assets have by explicit contractual language assumed all or the material portion of CERCLA obligations related to those assets. This includes the Lake Charles refinery and the Lemont refinery. The U.S. refining industry is required to comply with increasingly stringent product specifications under the 1990 Clean Air Act Amendments for reformulated gasoline and low sulfur gasoline and diesel fuel that require additional capital and operating expenditures, and alters significantly the U.S. refining industry and the return realized on refinery investments. In addition, CITGO is subject to various other federal, state and local environmental laws and regulations that may require CITGO to take additional compliance actions and also actions to remediate the effects on the environment of prior disposal or release of petroleum, hazardous substances and other waste and/or pay for natural resource damages. Maintaining compliance with environmental laws and regulations could require significant capital expenditures and additional operating costs. Also, numerous other factors affect the Company's plans with respect to environmental compliance and related expenditures. CITGO's accounting policy establishes environmental reserves as probable site restoration and remediation obligations become reasonably capable of estimation. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, to the extent required, will be made as more refined information becomes available. CITGO believes the amounts provided in its consolidated financial statements, as prescribed by generally accepted accounting principles, are adequate in light of probable and estimable liabilities and obligations. However, there can be no assurance that the actual amounts required to discharge alleged liabilities and obligations and to comply with applicable laws and regulations will not exceed amounts provided for or will not have a material adverse affect on CITGO's consolidated results of operations, financial condition and cash flows. In 1992, CITGO reached an agreement with the Louisiana Department of Environmental Quality ("LDEQ") to cease usage of certain surface impoundments at the Lake Charles refinery by 1994. A mutually acceptable closure plan was filed with the LDEQ in 1993. The remediation commenced in December 1993. CITGO is complying with a June 2002 LDEQ administrative order about the development and implementation of a corrective action or closure plan. CITGO and the former owner of the refinery are participating in the closure and sharing the related costs based on estimated contributions of waste and ownership periods. CITGO's Corpus Christi, Texas refinery and current and former employees are being investigated by state and federal agencies for alleged criminal violations of federal environmental statutes and regulations, including the CAA and the Migratory Bird Act. CITGO is cooperating with the investigation. CITGO believes that it has defenses to any such charges. At this time, CITGO cannot predict the outcome of or the amount or range of any potential loss that would ensue from any such charges. In June 1999, CITGO and numerous other industrial companies received notice from the United States Environmental Protection Agency ("U.S. EPA") that the U.S. EPA believes these companies have 13 contributed to contamination in the Calcasieu Estuary, near Lake Charles, Louisiana and are potentially responsible parties ("PRPs") under CERCLA. The U.S. EPA made a demand for payment of its past investigation costs from CITGO and other PRPs and since 1999 has been conducting a remedial investigation/feasibility study ("RI/FS") under its CERCLA authority. While CITGO disagrees with many of the U.S. EPA's earlier allegations and conclusions, CITGO and other industrial companies signed in December 2003, a Cooperative Agreement with the LDEQ on issues relative to the Bayou D'Inde tributary section of the Calcasieu Estuary, and the companies are proceeding with a Feasibility Study Work Plan. CITGO will continue to deal separately with the LDEQ on issues relative to its refinery operations on another section of the Calcasieu Estuary. The Company still intends to contest this matter if necessary. In January and July 2001, CITGO received notices of violation ("NOVs") from the U.S. EPA alleging violations of the CAA. The NOVs are an outgrowth of an industry-wide and multi-industry U.S. EPA enforcement initiative alleging that many refineries, electric utilities and other industrial sources modified air emission sources. Without admitting any violation CITGO reached a settlement with the United States and the states of Louisiana, Illinois, New Jersey, and Georgia. A Consent Decree was approved in the District court for the Southern District of Texas in January 2005. The Consent Decree requires the implementation of control equipment at CITGO's refineries and a Supplemental Environment Project at CITGO's Corpus Christi, Texas refinery. CITGO estimates that the costs of the settlement could range up to $325 million which includes a civil penalty of $3.6 million, split between the U.S. EPA and the states. CITGO accrued for the civil penalty during 2003 and paid it in February 2005. The capital costs will be incurred over a period of time, primarily between 2004 and 2009. In June 1999, an NOV was issued by the U.S. EPA alleging violations of the National Emission Standards for Hazardous Air Pollutants regulations covering benzene emissions from wastewater treatment operations at CITGO's Lemont, Illinois refinery. This matter has been consolidated with the matters described in the previous paragraph. In June 2002, a Consolidated Compliance Order and Notice of Potential Penalty was issued by the LDEQ alleging violations of the Louisiana air quality regulations at CITGO's Lake Charles, Louisiana refinery during 2001. The majority of the alleged violations related to the leak detection and repair program. This matter has been consolidated with the matters described in the previous paragraph related to the U.S. EPA's enforcement initiative. In October 2004, the New Jersey Land Trust voted to reject the donation by CITGO of a conservation easement covering the 365 acre Petty's Island, which is located in the Delaware River in Pennsauken, New Jersey and owned by CITGO. Petty's Island contains a CITGO closed petroleum terminal and other industrial facilities, but it is also the habitat for the bald eagle and other wildlife. The City of Pennsauken through a private developer wants to condemn Petty's Island through eminent domain and to redevelop Petty's Island into residential and commercial uses. The granting of the conservation easement would have mitigated the amount of remediation that CITGO would have to perform on Petty's Island. The ultimate outcome cannot be determined at this time. At December 31, 2004, CITGO's balance sheet included an environmental accrual of $65 million compared with $63 million at December 31, 2003. Results of operations reflect an increase in the accrual during 2004 due primarily to a revision of the Company's estimated share of costs related to two sites indicating higher costs offset in part, by spending on environmental projects. CITGO estimates that an additional loss of $33 million is reasonably possible in connection with environmental matters. Various regulatory authorities have the right to conduct, and from time to time do conduct, environmental compliance audits or inspections of CITGO and its subsidiaries' facilities and operations. Those compliance audits or inspections have the potential to reveal matters that those authorities believe represent non-compliance in one or more respects with regulatory requirements and for which those authorities may seek corrective actions and/or penalties in an administrative or judicial proceeding. Based 14 upon current information, CITGO does not believe that any such prior compliance audit or inspection or any resulting proceeding will have a material adverse effect on its future business and operating results, other than matters described above. Conditions which require additional expenditures may exist with respect to CITGO's various sites including, but not limited to, its operating refinery complexes, former refinery sites, service stations and crude oil and petroleum product storage terminals. Based on currently available information, CITGO cannot determine the amount of any such future expenditures. Increasingly stringent environmental regulatory provisions and obligations periodically require additional capital expenditures. During 2004, CITGO spent approximately $113 million for environmental and regulatory capital improvements in its operations. Management currently estimates that CITGO will spend approximately $1.1 billion for environmental and regulatory capital projects over the five-year period 2005-2009.
2005 2006 2007 2008 2009 TOTAL ------- ------- ------- ------- ------- ------- (IN MILLIONS) Tier 2 gasoline (1) $ 59 $ 54 $ - $ - $ - $ 113 Ultra low sulfur diesel (2) 47 121 45 120 225 558 Other environmental (3) 155 146 42 77 27 447 ------- ------- ------- ------- ------- ------- Total regulatory/environmental $ 261 $ 321 $ 87 $ 197 $ 252 $ 1,118 ======= ======= ======= ======= ======= =======
---------- (1) In February 2000, the EPA promulgated the Tier 2 Motor Vehicle Emission Standards Final Rule for all passenger vehicles, establishing standards for sulfur content in gasoline. These regulations mandate that the average sulfur content of gasoline for highway use produced at any refinery not exceed 30 parts per million during any calendar year by January 1, 2006, with a phase-in beginning January 1, 2004. In order to comply with these regulations, CITGO is installing additional hydroprocessing facilities at its refineries. (Hydroprocessing facilities remove sulfur from oil by means of a chemical reaction which occurs when the oil is mixed with hydrogen, heated and processed over a catalyst.) (2) Spending on Ultra Low Sulfur Diesel ("ULSD") assumes the EPA will require ULSD for on-road diesel in 2006 and ULSD for off-road diesel use in 2010. The ULSD program will require CITGO to make additional capital investments at its refineries. The estimates shown here are based on the installation of traditional hydroprocessing facilities. These regulations are not final and spending could be reduced if certain alternative regulatory schemes proposed by EPA are adopted. CITGO continues to evaluate new technological innovations which may reduce the required investment. (3) Other environmental spending assumes approximately $289 million in spending to comply with New Source Review standards under the Clean Air Act. These estimates may vary due to a variety of factors. See "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources". See also "Factors Affecting Forward Looking Statements". Safety Due to the nature of petroleum refining and distribution, CITGO is subject to stringent federal and state occupational health and safety laws and regulations. We strive to achieve excellent safety and health performance. We believe that safety is tied directly to productivity in our facilities and financial results. We maintain comprehensive safety management systems including policies, procedures, recordkeeping, internal reviews, training, incident reviews and corrective actions. We track not only accidents, but also "near miss" events and conditions, equipment malfunctions, first aid events and medical treatments. Each employee in 15 CITGO's facilities has a role in maintaining safe work conditions and has the authority to stop unsafe acts or unsafe conditions. ITEM 3. LEGAL PROCEEDINGS Various lawsuits and claims arising in the ordinary course of business are pending against the Company. The Company records accruals for potential losses when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to the Company, and in amounts greater than the Company's accruals, then such determinations could have a material adverse effect on the Company's results of operations in a given reporting period. The most significant lawsuits and claims are discussed below. In September 2002, a Texas court ordered CITGO to pay property owners and their attorneys approximately $6 million based on an alleged settlement of class action property damage claims as a result of alleged air, soil and groundwater contamination from emissions released from CITGO's Corpus Christi, Texas refinery. CITGO has appealed the ruling to the Texas Court of Appeals. CITGO, along with most of the other major oil companies, is a defendant in a number of federal and state lawsuits alleging contamination of private and public water supplies by methyl tertiary butyl ether ("MTBE"), a gasoline additive. In general, the plaintiffs claim that MTBE renders the water not potable. In addition to compensatory and punitive damages, plaintiffs seek injunctive relief to abate the contamination. CITGO intends to defend all of the MTBE lawsuits vigorously. CITGO's MTBE litigation can be divided into two categories--pre and post-September 30, 2003 litigation. Of the pre-September 30, 2003 cases, CITGO is defending itself in Madison County, Illinois state court and in a New York county state court. As of early October 2004, settlements in principle had been reached in both Madison County, Illinois cases and one of the cases has been settled subsequent to year-end. There will be no effect on results of operations because the accrual for these cases was adequate. The post-September 30, 2003 cases were filed after new federal legislation was proposed that would have precluded plaintiffs from filing lawsuits based on the theory that gasoline with MTBE is a defective product. These approximately 72 cases, the majority of which were filed by municipal authorities, were removed to federal court and at the defendants' request consolidated in Multi-District Litigation ("MDL") 1358. On March 16, 2004, the judge in MDL 1358 denied the plaintiffs' motion to remand the cases to state court. Subsequently, the judge denied the plaintiffs' motion to certify her rulings on the remand motion for an interlocutory appeal. It is not possible to estimate the loss or range of loss, if any, related to these cases. Claims have been made against CITGO in approximately 350 asbestos lawsuits pending in state and federal courts. These cases, most of which involve multiple defendants, are brought by former employees or contractor employees seeking damages for asbestos related illnesses allegedly caused, at least in part, from exposure at refineries owned or operated by CITGO in Lake Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois. In many of these cases, the plaintiffs' alleged exposure occurred over a period of years extending back to a time before CITGO owned or operated the premises at issue. CITGO does not believe that the resolution of these cases will have a material adverse effect on its financial condition or results of operations. In 2001, Miami-Dade County sued seventeen defendants for the costs of remediation of pollution rising from jet fuel operations during the past decades at the Miami International Airport ("the Airport"). Although not a defendant in this case, CITGO along with approximately 250 other former jet fuel operators at the Airport has received a payment demand from Miami-Dade County for the remediation costs for alleged pollution occurring while CITGO had jet fuel operations at the Airport. CITGO is exploring settlement discussions with Miami-Dade County. CITGO is contesting the amount of damages that Miami-Dade County claims are attributed CITGO's jet fuel operations at the Airport and will vigorously defend itself should no settlement be reached. CITGO does not believe that the resolution of this matter will have a material adverse effect on its financial condition or results of operations. 16 At December 31, 2004, CITGO's balance sheet included an accrual for lawsuits and claims of $24 million compared with $27 million at December 31, 2003. CITGO estimates that an additional loss of $35 million is reasonably possible in connection with such lawsuits and claims. In mid-March 2005, representatives of a special commission of the Venezuelan National Assembly (the "VNA Commission") visited CITGO's Houston, Texas offices for the purpose of interviewing several CITGO employees as part of an investigation that the VNA Commission had been charged with conducting. CITGO has not received any direct statements from the VNA Commission describing the scope of their investigation. CITGO understands from the interviewed employees that the questions were directed at the rationale for, and analysis underlying, note financings that CITGO completed in 2003 and 2004, the relocation of its corporate headquarters to Houston, Texas, and several minor transactions. The questions did not identify any unlawful or unrecorded activities, and CITGO is not aware of any such activities. CITGO is cooperating with the VNA Commission's investigation. Shortly following the VNA Commission's visit, a CITGO employee sent a memorandum to both CITGO's auditors and the SEC referencing the VNA Commission's investigation and other matters. CITGO is not aware of any improper activities, but has engaged counsel to investigate the employee's allegations. See also "ITEMS 1. and 2. Business and Properties -- Environment and Safety" for information regarding various enforcement actions. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The registrant meets the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K and is therefore omitting the information otherwise required by Item 4 of Form 10-K relating to submission of matters to a vote of security holders as permitted by General Instructions (I)(2)(c). 17 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market The Company's common stock is not traded on any market. All of the Company's common stock is held by PDV America. Dividends On December 10, 2004, CITGO made a $400 million dividend payment to PDV America. See Consolidated Financial Statements of CITGO - Note 9 in Item 15a for a description of restrictions applicable to dividend payments by CITGO. 18 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth certain selected historical consolidated financial and operating data of CITGO as of the end of and for each of the five years in the period ended December 31, 2004. The following table should be read in conjunction with the consolidated financial statements of CITGO as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, included in "Item 8. Financial Statements and Supplementary Data".
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------ 2004 2003 2002 2001 2000 ----------- ---------- ---------- ---------- ---------- (DOLLARS IN MILLIONS) INCOME STATEMENT DATA Net sales and sales to affiliates $ 32,028 $ 25,216 $ 19,358 $ 19,601 $ 22,157 Equity in earnings of affiliates 242 118 101 109 59 Other income (including insurance recoveries) 7 162 387 (5) (26) Net revenues 32,277 25,496 19,846 19,705 22,190 Income before cumulative effect of change in accounting principle 625 439 180 392 312 Net income 625 439 180 405 312 Other comprehensive income (loss) (4) 4 (22) (1) 1 Comprehensive income 621 443 158 404 313 Ratio of Earnings to Fixed Charges (1) 4.23 x 5.53 x 3.66 x 7.08 x 5.62 x BALANCE SHEET DATA Total assets $ 7,644 $ 7,273 $ 6,987 $ 6,509 $ 6,806 Long-term debt (excluding current portion)(2) 1,164 1,468 1,134 1,351 1,087 Total debt (3) 1,180 1,502 1,347 1,479 1,199 Shareholder's equity 2,722 2,501 2,559 2,401 2,476
---------- (1) For the purpose of calculating the ratio of earnings to fixed charges, "earnings" consist of income before income taxes and cumulative effect of accounting changes plus fixed charges (excluding capitalized interest), amortization of previously capitalized interest and certain adjustments to equity in income of affiliates. "Fixed charges" include interest expense, capitalized interest, amortization of debt issuance costs and a portion of operating lease rent expense deemed to be representative of interest. Interest expense in 2004 includes one-time prepayment premiums for the early retirement of the senior secured term loan and the tender of the 11-3/8% senior notes. (2) Includes long-term debt to third parties and capital lease obligations. (3) Includes short-term bank loans, current portion of capital lease obligations and long-term debt, long-term debt and capital lease obligations. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXECUTIVE SUMMARY CITGO is in the refining and marketing business. We refine crude oil and other feedstocks into a variety of products which include gasoline, diesel, fuel oil, and jet fuel, petrochemicals and industrial products, lubricants and waxes, and asphalt. Products are transported from our refineries primarily by pipeline and barge and then through terminals to our customers. These products are sold to wholesale marketers, convenience stores, airlines, end-users and to other manufacturers as feedstock. We sell more of these products than we refine and as a result, we supplement our own production with purchases from others. We evaluate our operating performance by attention to the utilization rates of the refinery equipment, the yield of products from the crude oil input and the cost of other key components such as natural gas and electricity. We evaluate our financial performance by focusing on gross margin, i.e., the sales price of the products above the cost of crude, on products sold. We evaluate the performance of our specialty products such as petrochemicals and lubricants against the alternate use value of the hydrocarbons used to produce these products. In most cases, this alternate use value relates to the price of gasoline. CITGO's financial results are a function of making full use of its refining capacity, maintaining margins on the products it sells, operating its facilities in a safe manner and maintaining strong cost control wherever possible. We assess our financial condition by various liquidity measures including interest coverage, debt coverage, debt-to-capitalization, return on capital employed and available borrowing capacity. CITGO's primary opportunities currently are based on enhancing our revenues through increasing our crude oil refining capacity, expanding the processing capacity of other refinery equipment and increasing the sales volume of fuels and asphalt and through reduction of expenses. Changes in environmental regulations present the most difficult challenges to CITGO management for the intermediate term. The regulations include site specific measures as well as more stringent product specifications. Site specific changes are aimed at reducing emission from CITGO facilities such as refineries, pipelines, terminals and other industrial facilities. On the product front, Tier II Gasoline, Ultra Low Sulfur Diesel, and the switch from MTBE to ethanol for oxygen addition for Reformulated Gasoline required by certain states are all examples of changes in fuels regulations. In addition, Group II and III Lube base oils and high performance asphalts are being required by the market place over the next 4 to 6 years. As stated above, some of these changes are being mandated by federal and state regulatory agencies, others are the indirect result of regulations, but ultimately our customers will require all these products plus possibly others not currently defined. The challenges to being able to supply this new generation of products include: planning and executing multi-million dollar capital projects; financing these projects; and adjusting operating practices and procedures to assure reliable, high quality supplies to our customers. All this must be done without impacting our profit and efficiency improvement initiatives. CITGO has taken a systems approach to addressing the need for new quality products. Capital projects at our refineries have been scheduled over several years, taking advantage of flexibility written into the regulations, to avoid extreme capital spending spikes which could create financing difficulties. CITGO continues to evaluate technology improvements, and believes that by staggering our implementation of new quality fuels production capabilities, we will benefit from technology improvements over time. We have estimated we will spend $1.1 billion in regulatory capital between 2005 and 2009, of which, approximately 70% is aimed at producing new quality products. This estimate is based on the cost of current technology. We believe our systems approach to this challenge increases the likelihood that we may reduce this cost. 20 The refined products business is inherently volatile, and the primary business risk for any company engaged in the business is a sudden and radical movement in market prices. CITGO's supply and distribution of feedstocks and acquired and produced refinery products results in a significant number of marine chartered movements. Regulations and limited vessel availability may from time to time cause fluctuations in transportation expenses. These expenses are typical of our industry but can be a large portion of overall manufacturing expenditures. Another major risk in the refined products business is operational risk, that is the risk of mechanical failure at any operating asset used to serve customers. A final area of risk is political risk. In the short term, geopolitical actions could upset the availability or price of crude oil or products creating market upsets. Over the longer term, changes in laws or regulations could radically increase the cost of being in the refined products business. CITGO operates to minimize our exposure to volatility in the refined products market place by avoiding significant inventory positions or forward price commitments. Operating risk is first addressed at CITGO by sound and stringent operating practices and procedures. However, in addition to striving for operational excellence, CITGO carries significant levels of property damage and business interruption insurance. Political risk is almost impossible to totally avoid. However, CITGO's large and diverse refining and distribution system provides the flexibility to react to crude and product shortages should they occur. CITGO's refineries are complex and flexible enough to process almost any type of crude oil traded on the world market. CITGO can compete for supply with any U.S based refiner. And while Lemont currently processes primarily Canadian crude, it can be and periodically is supplied from the U.S. mid-continent or the Gulf Coast as dictated by economics. CITGO also operates product terminals with import capability in New York Harbor, Miami-Fort Lauderdale, Tampa, Boston and a number of other locations if it becomes necessary to further supplement refinery production with increased product imports. Risk associated with increased regulation can only be addressed on an issue specific basis. CITGO is active in several industry and state specific associations to monitor statutory and regulatory trends which might affect the business. The refined products business continues to be very competitive. Industry analysts predict demand growth at 1% to 2% per year in the U.S. market and approximately double these numbers for the world market over the next 5 to 10 years. This forecasted demand growth creates opportunities for U.S. refineries which are currently operating at near capacity throughput. While this growth trend would appear to be positive for refining and marketing companies, the industry has always exhibited strong competitive tendencies, and recent corporate consolidations have resulted in cost reduction synergies and economies of scale which translated to competitive pricing in the market place. As noted above, the production of lower sulfur content fuels and higher quality lubricant base stocks and asphalts is definitely a trend for the future. The high capital requirements associated with facilities equipped to produce these products may lead to further consolidation of refining capacity into the hands of financially strong companies. CITGO will continue to monitor these trends and will take advantage of economic opportunities as they occur. Major uncertainties for CITGO generally coincide with market and political risks. While CITGO can only make educated guesses about the future of the refined products market and political actions which might affect it, the Company can prepare itself for potential contingencies. By maintaining an adequate level of financial liquidity, by assuring that its refineries and distribution assets are flexible and have multiple sources of supply and by monitoring and analyzing the market on a continuous basis, CITGO believes it is prepared to adjust to most market contingencies in ways that will not have a significant negative impact on its performance or future. 21 Financially, 2004 was an excellent year for CITGO as a result of a high utilization rate of refining capacity, excellent safety performance and favorable market conditions. As CITGO continues to emphasize the importance of efficient refinery operations and its commitment to safety and environmental stewardship, we will again take advantage of expected favorable market conditions in 2005. However, CITGO operates in an industry subject to volatility in earnings. Conditions can change quickly and results may differ markedly from management's expectations. For example, because CITGO does not produce any of the crude oil processed at its refineries, it is exposed to the risk of supply disruption or price spikes resulting from world events. A supply disruption could require CITGO to reduce its rate of crude oil processing and/or purchase higher priced crude oils and feedstocks. This would have a negative effect on profitability. In a similar manner, a spike in crude oil prices that was not quickly followed by a similar increase in product prices would reduce profitably. In addition, reactions to perceived credit risks by CITGO's suppliers and creditors can quickly affect the Company's liquidity should credit lines or payment terms be restricted. In February 2003, CITGO issued $550 million of 11-3/8% unsecured senior notes due in 2011 and CITGO closed on a three year, $200 million senior secured term loan. In July 2003, CITGO made a dividend payment of $500 million to its parent, PDV America. In June 2004, CITGO retired the $200 million senior secured term loan. In October 2004, CITGO issued $250 million of 6% unsecured senior notes due October 15, 2011. In connection with this transaction, CITGO repurchased approximately $540 million principal amount of its 11-3/8% senior notes due 2011 as part of a tender offer for such notes. In December 2004, CITGO made a dividend payment of $400 million to its parent, PDV America. CITGO has sufficient liquidity (defined as cash, available borrowing capacity and access to an accounts receivable sales facility) to maintain its current operations and to complete capital projects that are underway. Estimated capital expenditures for 2005 are approximately $515 million. Of this amount, $261 million is for regulatory projects, $162 million for strategic projects and $92 million is for maintenance projects. Liquidity at year end was approximately $553 million. Although CITGO has debt maturities during 2005 of approximately $11 million, it routinely evaluates financing opportunities that not only mature in 2005 but also future years. OVERVIEW The following discussion of the financial condition and results of operations of CITGO should be read in conjunction with the consolidated financial statements of CITGO included elsewhere herein. Petroleum refining industry operations and profitability are influenced by a large number of factors, some of which individual petroleum refining and marketing companies cannot control. Governmental regulations and policies, particularly in the areas of taxation, energy and the environment (as to which, see "ITEMS 1. and 2. Business and Properties - Environment and Safety"), have a significant impact on petroleum activities, regulating how companies conduct their operations and formulate their products. Demand for crude oil and refined products is largely driven by the condition of local and worldwide economies, although weather patterns and taxation relative to other energy sources also play a significant part. CITGO's consolidated operating results are affected by these industry-specific factors and by company-specific factors, such as the success of marketing programs and refinery operations. The earnings and cash flows of companies engaged in the refining and marketing business in the United States are primarily dependent upon producing and selling quantities of refined products at margins sufficient to cover fixed and variable costs. The refining and marketing business is characterized by high fixed costs resulting from the significant capital outlays associated with refineries, terminals and related facilities. This business is also characterized by substantial fluctuations in variable costs, particularly costs of crude oil, feedstocks and blending components, and in the prices realized for refined products. Crude oil and refined products are commodities whose price levels are determined by market forces beyond the control of CITGO. 22 In general, prices for refined products are influenced by the price of crude oil, feedstocks and blending components, inventory levels and consumer demand. Although an increase or decrease in the price for crude oil, feedstocks and blending components generally results in a corresponding increase or decrease in prices for refined products, inventory levels and consumer demand can create a lag in the realization of the corresponding increase or decrease in prices for refined products. The effect of changes in crude oil prices on CITGO's consolidated operating results therefore depends in part on how quickly refined product prices adjust to reflect these changes. Although the pricing formulas under CITGO's crude supply agreements with PDVSA are designed to provide a measure of stability to CITGO's refining margins, CITGO receives approximately 40% of its crude oil requirements under these agreements. Therefore, a substantial or prolonged increase in crude oil prices without a corresponding increase in refined product prices, or a substantial or prolonged decrease in refined product prices without a corresponding decrease in crude oil prices, or a substantial or prolonged decrease in demand for refined products could have a significant negative effect on CITGO's earnings and cash flows. CITGO also purchases significant volumes of refined products to supplement the production from its refineries to meet marketing demands and to resolve logistical issues. CITGO's earnings and cash flows are also affected by the cyclical nature of petrochemical prices. As a result of the factors described above, the earnings and cash flows of CITGO may experience substantial fluctuations. Inflation was not a significant factor in the operations of CITGO during the three years ended December 31, 2004. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with Generally Accepted Accounting Principles in the United States of America requires that management apply accounting policies and make estimates and assumptions that affect results of operations and the reported amounts of assets and liabilities. The following areas are those that management believes are important to the financial statements and which require significant judgment and estimation because of inherent uncertainty. Environmental Expenditures. The costs to comply with environmental regulations are significant. Environmental expenditures incurred currently that relate to present or future revenues are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations and that do not contribute to current or future revenue generation are expensed. The Company constantly monitors its compliance with environmental regulations and responds promptly to issues raised by regulatory agencies. Liabilities are recorded when environmental assessments and/or cleanups are probable and the costs can be reasonably estimated. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, to the extent required, may be made as more refined information becomes available. Litigation and Injury Claims. Various lawsuits and claims arising in the ordinary course of business are pending against the Company. The status of these lawsuits and claims are continually reviewed by external and internal legal counsel. These reviews provide the basis for which the Company determines whether or not to record accruals for potential losses. Accruals for losses are recorded when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to the Company, and in amounts greater than the Company's accruals, then such determinations could have a material adverse effect on the Company's results of operations in a given reporting period. Health Care Costs. The cost of providing health care to current employees and retired employees continues to increase at a significant rate. Historically, CITGO has absorbed the majority of these cost increases which reduce profitability and increase the Company's liability. There is no indication that the trend of increasing health care costs will be reversed in future periods. In 2003, federal legislation introduced a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of certain 23 retiree health care benefit plans. In May 2004, the FASB Staff issued FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003". The Staff Position permits a sponsor to report the effects of Medicare Reform prospectively in the third quarter of 2004 or retrospectively to the measurement date following enactment of the legislation. CITGO has chosen to use the retrospective method to reflect Medicare Reform as of January 1, 2004. The effect of this legislation at that date was to reduce the benefit obligation by approximately $40 million. The Company's liability for such health care costs is based on actuarial calculations that could be subject to significant revision as the underlying assumptions regarding future health care costs and interest rates change. Pensions. CITGO's pension cost and liability are based on actuarial calculations, which are dependent on assumptions concerning discount rates, expected rates of return on plan assets, employee turnover, estimated retirement dates, salary levels at retirement and mortality rates. In addition, differences between actual experience and the assumptions also affect the actuarial calculations. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may significantly affect the Company's future pension cost and liability. 24 RESULTS OF OPERATIONS -- 2004 COMPARED TO 2003
FOR THE YEAR ENDED INCREASE DECEMBER 31, (DECREASE) 2004 2003 FROM 2003 --------- ---------- --------------- (DOLLARS IN MILLIONS) Net sales $ 31,572 $ 24,829 $ 6,743 Sales to affiliates 456 387 69 --------- ---------- --------- 32,028 25,216 6,812 27% --------- ---------- --------- Equity in earnings of affiliates 242 118 124 Insurance recoveries - 146 (146) Other income (expense), net 7 16 (9) --------- ---------- --------- 32,277 25,496 6,781 27% --------- ---------- --------- Cost of sales and operating expenses 30,767 24,391 6,376 Selling, general and administrative expenses 328 296 32 Interest expense, excluding capital lease 255 120 135 Capital lease interest charge 4 5 (1) --------- ---------- --------- 31,354 24,812 6,542 26% --------- ---------- --------- Income before income taxes 923 684 239 Income taxes 298 245 53 --------- ---------- --------- Net income $ 625 $ 439 $ 186 42% ========= ========== ========= Gulf Coast 3/2/1 crack spread ($ per bbl)(1) $ 6.31 $ 4.46 $ 1.85 41% Average price per gallon of gasoline (2) $ 1.24 $ 0.94 $ 0.30 32% Average cost per barrel of crude oil (3) $ 35.37 $ 26.41 $ 8.96 34%
---------- (1) The Gulf Coast 3/2/1 crack spread is the value of two-thirds barrel of gasoline plus one-third barrel of distillate minus one barrel of crude (West Texas Intermediate or "WTI"). Heavy crude refiners also evaluate the light/heavy crude spread (WTI minus Maya). The sum of these benchmarks is the heavy crack spread. During 2004, the heavy crack spread was $17.82 per barrel versus $11.27 per barrel during 2003. The values used to calculate the Gulf Coast 3/2/1 crack spread and the heavy crack spread are obtained from Platts using an average of daily prices for the annual period ended December 31, 2004 and 2003 (excluding weekends and holidays). (2) The average price per gallon of gasoline is based on CITGO gasoline sales revenue divided by CITGO gasoline sales volume. See the "CITGO Sales Revenues and Volumes" table that follows. (3) The average cost per barrel of crude oil is based on CITGO's crude oil cost divided by CITGO refinery crude inputs. See the "CITGO Cost of Sales and Operating Expenses" table that follows. 25 Sales revenues and volumes. Sales increased $6.8 billion, or approximately 27%, in 2004 as compared to 2003. This increase was primarily due to an increase in average sales price of 31%. The following table summarizes the sources of our sales revenues and sales volumes for 2004, 2003 and 2002: CITGO SALES REVENUES AND VOLUMES
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------------------- ------------------------------- 2004 2003 2002 2004 2003 2002 --------- ----------- ---------- ------ ------ ------ (IN MILLIONS) (GALLONS IN MILLIONS) Gasoline $ 17,597 $ 14,320 $ 11,758 14,194 15,257 15,026 Jet fuel 2,707 1,951 1,402 2,318 2,315 2,003 Diesel / #2 fuel 6,590 5,287 3,462 5,854 6,238 5,031 Asphalt 971 711 597 1,300 990 902 Petrochemicals and industrial products 3,369 2,272 1,485 2,865 2,643 2,190 Lubricants and waxes 684 598 561 280 261 261 --------- ----------- ---------- ------ ------ ------ Total refined product sales $ 31,918 $ 25,139 $ 19,265 26,811 27,704 25,413 Other sales 110 77 93 - - - --------- ----------- ---------- ------ ------ ------ Total sales $ 32,028 $ 25,216 $ 19,358 26,811 27,704 25,413 ========= =========== ========== ====== ====== ======
Equity in earnings of affiliates. The table below shows the changes during 2004 compared to 2003 in the equity in earnings of affiliates. The increase in LYONDELL-CITGO's earnings in 2004 as compared to 2003 was due primarily to higher margins on crude oil refining and aromatics. LYONDELL-CITGO also benefited from higher crude processing rates in 2004 as compared to 2003.
FOR THE YEAR ENDED DECEMBER 31, INCREASE --------------------- (DECREASE) 2004 2003 OVER 2003 ------ ------- ---------- ($ in millions) LYONDELL-CITGO $ 197 $ 84 $ 113 Pipeline investments 39 36 3 Other 6 (2) 8 ------ ------- ------ Total $ 242 $ 118 $ 124 ====== ======= ======
26 Cost of sales and operating expenses. The following table summarizes our cost of sales and operating expenses for 2004, 2003 and 2002: CITGO COST OF SALES AND OPERATING EXPENSES
YEAR ENDED DECEMBER 31, 2004 2003 2002 ---------- --------- --------- ($ IN MILLIONS) Crude oil $ 8,883 $ 6,807 $ 5,098 Refined products 17,096 14,075 11,077 Intermediate feedstocks 2,697 1,657 1,489 Refining and manufacturing costs 1,509 1,307 1,233 Other operating costs and expenses and inventory changes 582 545 314 ---------- --------- --------- Total cost of sales and operating expenses $ 30,767 $ 24,391 $ 19,211 ========== ========= =========
We purchase refined products to supplement the production from our refineries in order to meet marketing demands and to optimize distribution. Refined product purchases represented 56% and 58% of total cost of sales and operating expenses for 2004 and 2003, respectively. Margins on purchased products, on average, are lower than margins on refinery produced products because refinery produced products benefit from the whole supply chain upgrade and purchased refined products do not. However, purchased products are not segregated from our produced products and margins may vary due to market conditions and other factors beyond our control. In the near term, other than normal refinery turnaround maintenance, we do not anticipate operational actions or market conditions which might cause a material change in anticipated purchased product requirements; however, there could be events beyond our control which impact the volume of refined products purchased. (See also "Factors Affecting Forward Looking Statements".) Gross margin. The gross margin for 2004 was $1.3 billion, or 3.9% of net sales, compared to $825 million or 3.3% of net sales, for 2003. The gross margin increased from 3.0 cents per gallon in 2003 to 4.7 cents per gallon in 2004 as a result of general market conditions and a high utilization rate of refining capacity. A change in the price of crude oil, feedstocks and blending products generally results in a corresponding change in the sales price of refined products. The impact of changes in crude oil and feedstock prices on our consolidated income before taxes depends, in part, on how quickly refined product prices are adjusted to reflect these changes in feedstock costs. Our 57% increase in gross margin for 2004 versus 2003 compares to the 58% increase in the industry heavy crack spread over the same period. Selling, general and administrative expenses. Selling, general and administrative expenses increased $32 million, or 11% from $296 million in 2003 to $328 million in 2004. The increase is primarily a result of the decision to relocate the corporate headquarters. Interest expense. Interest expense, including capital lease interest charge, increased $134 million in 2004 as compared to 2003. The increase in interest expense for 2004 is primarily attributable to prepayment premiums paid in connection with the early retirement of the $200 million senior secured term loan in the second quarter of 2004 and costs associated with a tender for the $550 million 11-3/8% senior notes in the fourth quarter of 2004, which resulted in the repurchase of approximately $543 million of such notes. Those prepayment premiums and tender costs are included in interest expense. Future years will reflect the lower amount of outstanding debt and the lower associated interest cost. 27 Income taxes. CITGO's provision for income taxes in 2004 was $298 million representing an effective tax rate of 32%. In 2003, CITGO's provision for income taxes was $245 million, representing an effective tax rate of 36%. The decrease in the effective tax rate in 2004 is attributable to the permanent tax difference related to the Medicare subsidy under the Medicare Prescription Drug, Improvement and Modernization Act of 2003, as well as an adjustment to the deferred state tax balance. RESULTS OF OPERATIONS -- 2003 COMPARED TO 2002
FOR THE YEAR ENDED INCREASE DECEMBER 31, (DECREASE) 2003 2002 FROM 2002 ---------- ---------- ----------------- (DOLLARS IN MILLIONS) Net sales $ 24,829 $ 19,081 $ 5,748 Sales to affiliates 387 277 110 ---------- ---------- --------- 25,216 19,358 5,858 30% ---------- ---------- --------- Equity in earnings of affiliates 118 101 17 Insurance recoveries 146 407 (261) Other income (expense), net 16 (20) 36 ---------- ---------- --------- 25,496 19,846 5,650 28% ---------- ---------- --------- Cost of sales and operating expenses 24,391 19,211 5,180 Selling, general and administrative expenses 296 285 11 Interest expense, excluding capital lease 120 67 53 Capital lease interest charge 5 7 (2) ---------- ---------- --------- 24,812 19,570 5,242 27% ---------- ---------- --------- Income before income taxes 684 276 408 Income taxes 245 96 149 ---------- ---------- --------- Net income $ 439 $ 180 $ 259 144% ========== ========== ========= Gulf Coast 3/2/1 crack spread ($ per bbl)(1) $ 4.46 $ 3.15 $ 1.31 42% Average price per gallon of gasoline (2) $ 0.94 $ 0.78 $ 0.16 21% Average cost per barrel of crude oil (3) $ 26.41 $ 23.01 $ 3.40 15%
---------- (1) The Gulf Coast 3/2/1 crack spread is the value of two-thirds barrel of gasoline plus one-third barrel of distillate minus one barrel of crude (West Texas Intermediate or "WTI"). Heavy crude refiners also evaluate the light/heavy crude spread (WTI minus Maya). The sum of these benchmarks is the heavy crack spread. During 2003, the heavy crack spread was $11.27 per barrel versus $8.37 per barrel during 2002. The values used to calculate the Gulf Coast 3/2/1 crack spread and the heavy crack spread are obtained from Platts using an average of daily prices for the annual period ended December 31, 2004 and 2003 (excluding weekends and holidays). (2) The average price per gallon of gasoline is based on CITGO gasoline sales revenue divided by CITGO gasoline sales volume. See the "CITGO Sales Revenues and Volumes" table that follows. (3) The average cost per barrel of crude oil is based on CITGO's crude oil cost divided by CITGO refinery crude inputs. See the preceding "CITGO Cost of Sales and Operating Expenses" table at page 27. Sales revenues and volumes. Sales increased $5.9 billion, representing a 30% increase from 2002 to 2003. This was due to an increase in average sales price of 19% and an increase in sales volume of 9%. The primary volume increase was in diesel/#2 fuel sales. We had an increase in refinery production of diesel/#2 fuel sales due primarily to the recovery of the Lemont, Illinois refinery, as well as increased availability of product from our related parties' refineries (See Item 13. Certain Relationships and Related Transactions). 28 This along with an increase in marketing demand led to an increase in sales of diesel/#2 fuel. (See CITGO Sales Revenues and Volumes table above.) Equity in earnings of affiliates. Equity in earnings of affiliates increased by approximately $17 million, or 17%, from $101 million in 2002 to $118 million in 2003. The increase was primarily attributable to an increase of $7 million from CITGO's investment in pipelines, an increase of $6 million from CITGO's investment in LYONDELL-CITGO and other earnings from affiliates of $4 million. Insurance recoveries. We recorded insurance recoveries of $146 million in 2003 compared to $407 million in 2002. The recoveries related primarily to a fire which occurred on August 14, 2001 at the Lemont refinery. These recoveries are, in part, reimbursements for expenses incurred in 2002 and 2001 to mitigate the effect of the fire on our earnings. We do not expect any additional insurance recoveries related to the Lemont fire. Other income (expense) net. Other income (expense) increased $36 million from $(20) million in 2002 to $16 million in 2003. The change relates primarily to miscellaneous income recorded during 2003 for the sale of use tax credits and a gain on the early retirement of debt. In contrast, during 2002, miscellaneous expenses were recorded primarily relating to the loss on the sale and retirement of assets. Cost of sales and operating expenses. Cost of sales and operating expenses increased by $5.2 billion, or 27%, from 2002 to 2003. The increase is due primarily to a 34% increase in crude oil purchases and a 27% increase in refined product purchases. The increase in crude oil purchases is due to an increase in crude oil prices and an increase in volumes purchased, which is due to the Lemont refinery's increased utilization during 2003. The increase in refined product purchases is due largely to the increase in refined product prices during 2003. (See CITGO Cost of Sales and Operating Expenses table above.) CITGO purchases refined products to supplement the production from its refineries to meet marketing demands and resolve logistical issues. The refined product purchases represented 58% of cost of sales for both 2003 and 2002. These refined product purchases included purchases from LYONDELL-CITGO and HOVENSA. CITGO estimates that margins on purchased products, on average, are lower than margins on produced products due to the fact that CITGO can only receive the marketing portion of the total margin received on the produced refined products. However, purchased products are not segregated from CITGO produced products and margins may vary due to market conditions and other factors beyond the Company's control. As such, it is difficult to measure the effects on profitability of changes in volumes of purchased products. In the near term, other than normal refinery turnaround maintenance, CITGO does not anticipate operational actions or market conditions which might cause a material change in anticipated purchased product requirements; however, there could be events beyond the control of CITGO which impact the volume of refined products purchased. (See also "Factors Affecting Forward Looking Statements".) Gross margin. The gross margin for 2003 was $825 million, or 3.3% of net sales, compared to $147 million or 0.8% of net sales, for 2002. The gross margin increased from 0.6 cents per gallon in 2002 to 3.0 cents per gallon in 2003 as a result of general market conditions and a high utilization rate of refining capacity. Selling, general and administrative expenses. Selling, general and administrative expenses increased $11 million, or 4% in 2003. The increase is primarily related to an increase in benefit costs, incentive compensation, and expenses related to an early retirement program. Interest expense. Interest expense increased by $52 million or 78% in 2003. This was due primarily to the net increase in the outstanding debt balance and higher overall interest rates resulting from the issuance of the $550 million senior notes and the closing of the $200 million secured term loan in February 2003. 29 Income taxes. CITGO's provision for income taxes in 2003 was $245 million, representing an effective tax rate of 36%. In 2002, CITGO's provision for income taxes was $96 million, representing an effective tax rate of 35%. LIQUIDITY AND CAPITAL RESOURCES The following summarizes cash flows during the years ended December 31, 2004 and 2003:
For the Year Ended December 31, --------------------- 2004 2003 --------- ------- ($ in millions) Net cash provided by/(used in): Operating activities $ 933 $ 995 Investing activities $ (382) $ (418) Financing activities $ (730) $ (408)
Cash Provided by Operating Activities Consolidated net cash provided by operating activities totaled approximately $933 million in 2004. Operating cash flows were derived primarily from net income of $625 million, depreciation and amortization of $375 million, distributions in excess of equity in earnings of affiliates of $67 million and changes in working capital of $(146) million. The change in working capital is primarily the result of increases in accounts receivable and due from affiliates and inventory offset, in part, by increases in accounts payable and current liabilities. The change in distributions in excess of equity in earnings of affiliates is primarily due to the cash distributions received in 2004 from LYONDELL-CITGO, of which approximately $15 million related to distributions which were payable to CITGO at December 31, 2003. Accounts receivable increased primarily due to the rising price of refined product prices in 2004 versus the price of products at the end of 2003. The increase in inventories is due to a build of 2.6 million barrels during 2004 related to operational needs and anticipated market demands for 2005. The increase in accounts payable was primarily attributable to the increase in prices of crude oil, feedstocks, and refined products in 2004 as compared to 2003. Cash Used in Investing Activities Net cash used in investing activities in 2004 totaled $382 million consisting primarily of capital expenditures of $341 million. These capital expenditures consisted of:
For the year ended December 31, 2004 ------------------ ($ in millions) Regulatory requirements $ 113 Maintenance capital projects 93 Strategic capital expenditures 135 -------- Total capital expenditures $ 341 ========
30 Cash Used in Financing Activities Net cash used in financing activities in 2004 totaled $730 million, consisting primarily of dividend payments of $400 million to PDV America; the payment of the $200 million senior secured term loan; and the redemption of $543 million of the 11-3/8% senior notes due 2011. These payments were offset by the proceeds from our 6% senior notes due in 2011 of $248 million and proceeds of $127 million from tax-exempt bonds. As of December 31, 2004, we had an aggregate of $1.1 billion of indebtedness outstanding that matures on various dates through the year 2033. As of December 31, 2004, our contractual commitments to make principal payments on this indebtedness were $11 million, $201 million and $62 million for 2005, 2006 and 2007, respectively. As of December 31, 2004, we have a $260 million, three year, unsecured revolving bank loan which matures in December 2005. There was no outstanding balance under this credit agreement at December 31, 2004. As of December 31, 2004, our other principal indebtedness consisted of (i) $248 million in 6% senior notes issued in 2004, (ii) $7 million in 11-3/8% senior notes issued in 2003, (iii) $150 million in 7-7/8% senior notes issued in 1996, (iv) $165 million in senior notes issued pursuant to a master shelf agreement with an insurance company, (v) $23 million in private placement senior notes issued in 1991, (vi) $459 million in obligations related to tax exempt bonds issued by various governmental units, and (vii) $80 million in obligations related to taxable bonds issued by various governmental units. (See Consolidated Financial Statements of CITGO - Note 9 in Item 15a.) As of December 31, 2004, capital resources available to us included cash on hand totaling $23 million generated by operations and other sources, and available borrowing capacity under our committed bank facilities of $255 million. On October 22, 2004, we issued $250 million aggregate principal amount of our 6% unsecured senior notes due October 15, 2011. On that date, we used the net proceeds from that note issue, together with cash on hand, to repurchase approximately $540 million aggregate principal amount of our 11-3/8% senior notes due 2011 that had been tendered to us in accordance with a tender offer we made for those notes. We also received the necessary consents of the holders of those notes to amend the indenture governing those notes to remove substantially all of the restrictive covenants and specified events of default. We recorded, as charges to interest expense in the fourth quarter of 2004, a $121.9 million tender premium, $10.6 million unamortized fees and $2.7 million unamortized discounts. However, this transaction will reduce annual interest expense by approximately $50 million and our weighted average cost of fixed rate borrowing was reduced from 8.8% to 6.7%. In addition, this transaction removes some and modifies other restrictive covenants provided for in the $550 million 11-3/8% senior notes. Our various debt instruments require maintenance of a specified minimum net worth and impose restrictions on its ability to: - incur additional debt unless it meets specified interest coverage and debt to capitalization ratios; - place liens on its property, subject to specified exceptions; - sell assets, subject to specified exceptions; - make restricted payments, including dividends, repurchases of capital stock and specified investments; and - merge, consolidate or transfer assets. Upon the occurrence of a change of control of our Company, as defined in the indenture governing our 6% senior notes due 2011, coupled with a rating decline on these notes, the holders of those notes have 31 the right to require us to repurchase them at a price equal to 101% of the principal amount plus accrued interest. In addition, our bank credit agreements and the reimbursement agreements governing various of the letters of credit issued to provide liquidity support for our tax-exempt bonds provide that, unless lenders holding two-thirds of the commitments there under otherwise agree, a change in control of our Company, as defined in those agreements, will constitute a default under those credit agreements. Various of our debt agreements, including the agreements governing the Private Placement Senior Notes and the Master Shelf Agreement Senior Notes and the reimbursement agreements relating to various letters of credit that provide liquidity support for our tax-exempt bonds, contain provisions requiring that we equally and ratably secure those instruments if we issue secured debt other than as permitted by those instruments. CITGO is in compliance with its obligations under its debt financing arrangements at December 31, 2004. Capital expenditure projected amounts for 2005 and 2006 through 2009 are as follows: CITGO ESTIMATED CAPITAL EXPENDITURES - 2005 THROUGH 2009
2006- 2005 2009 PROJECTED(1) PROJECTED TOTAL ------------ --------- -------- (IN MILLIONS) Strategic $ 162 $ 648 $ 810 Maintenance 92 393 485 Regulatory / Environmental 261 857 1,118 ------- --------- -------- Total $ 515 $ 1,898 $ 2,413 ======= ========= ========
---------- (1) These estimates may change as future regulatory events unfold. See "Factors Affecting Forward Looking Statements." 32 Estimated capital expenditures necessary to comply with the Clean Air Act and other environmental laws and regulations are summarized below. See "Factors Affecting Forward Looking Statements."
2005 2006 2007 2008 2009 TOTAL ------- -------- ------- ------- ------- -------- (IN MILLIONS) Tier 2 gasoline (1) $ 59 $ 54 $ - $ - $ - $ 113 Ultra low sulfur diesel (2) 47 121 45 120 225 558 Other environmental (3) 155 146 42 77 27 447 ------- -------- ------- ------- ------- -------- Total regulatory/environmental $ 261 $ 321 $ 87 $ 197 $ 252 $ 1,118 ======= ======== ======= ======= ======= ========
---------- (1) In February 2000, the EPA promulgated the Tier 2 Motor Vehicle Emission Standards Final Rule for all passenger vehicles, establishing standards for sulfur content in gasoline. These regulations mandate that the average sulfur content of gasoline for highway use produced at any refinery not exceed 30 parts per million during any calendar year by January 1, 2006, with a phase-in beginning January 1, 2004. In order to comply with these regulations, CITGO is installing additional hydroprocessing facilities at its refineries. (Hydroprocessing facilities remove sulfur from oil by means of a chemical reaction which occurs when the oil is mixed with hydrogen, heated and processed over a catalyst.) (2) Spending on Ultra Low Sulfur Diesel ("ULSD") assumes the EPA will require ULSD for on-road diesel in 2006 and ULSD for off-road diesel use in 2010. The ULSD program will require CITGO to make additional capital investments at its refineries. The estimates shown here are based on the installation of traditional hydroprocessing facilities. These regulations are not final and spending could be reduced if certain alternative regulatory schemes proposed by EPA are adopted. CITGO continues to evaluate new technological innovations which may reduce the required investment. (3) Other environmental spending assumes approximately $289 million in spending to comply with New Source Review standards under the Clean Air Act. We believe that we will have sufficient resources to carry out planned capital spending programs, including regulatory and environmental projects in the near term, and to meet currently anticipated future obligations and other planned expenditures as they arise. We periodically evaluate other sources of capital in the marketplace and anticipate that long-term capital requirements will be satisfied with current capital resources and future financing arrangements, including the issuance of debt securities. Our ability to obtain such financing will depend on numerous factors, including market conditions, compliance with existing debt covenants and the perceived creditworthiness of the Company at that time. See also "Factors Affecting Forward Looking Statements." CITGO is a member of the PDV Holding consolidated Federal income tax return. CITGO has a tax allocation agreement with PDV Holding, which is designed to provide PDV Holding with sufficient cash to pay its consolidated income tax liabilities. (See Consolidated Financial Statements of CITGO -- Note 1 and Note 4 in Item 15a). We have outstanding letters of credit that support taxable and tax-exempt bonds that were issued previously for our benefit. During 2003, we repurchased $90 million of taxable bonds and $165 million of tax-exempt bonds due to the non-renewal of these letters of credit. We have not repurchased any bonds in 2004. We have reissued the bonds that were repurchased during 2003 with replacement letters of credit in support or, alternatively, we have replaced these bonds with new bonds that do not require letter of credit support. As of December 31, 2004, we have $409 million of letters of credit outstanding that back or support bond issues that we have issued through governmental entities, which are subject to renewal during the year ending December 31, 2005. In August 2002, three of the Company's affiliates entered into agreements to advance excess cash to CITGO from time to time under demand notes. These notes provide for maximum amounts of $10 million from PDV Texas, Inc., $30 million from PDV America and $10 million from PDV Holding. At December 33 31, 2004, the amounts outstanding on these notes were $7 million, $14 million and $5 million from PDV Texas, PDV America and PDV Holding, respectively. There were no amounts outstanding on these notes at December 31, 2003. As of December 31, 2004, CITGO had an effective shelf registration with the SEC under which it could have publicly offered up to $400 million principal amount of debt securities. Due to CITGO's current credit ratings, the shelf registration statement is not presently available. Our unsecured debt ratings, as currently assessed by the three major debt rating agencies, are as follows: Moody's Investor's Services Ba2 Standard & Poor's Ratings Group BB Fitch Investors Services, Inc. BB CITGO's debt instruments do not contain any covenants that trigger increased costs or burdens as a result of a change in its securities ratings. However, certain of CITGO's guarantee agreements, which support approximately $33 million of PDV Texas, Inc., an affiliate, letters of credit, require CITGO to cash collateralize the applicable letters of credit upon a reduction of CITGO's credit rating below a stated level. CITGO believes that it has adequate liquidity from existing sources to support its operations for the foreseeable future. 34 CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following table summarizes future payments for CITGO's contractual obligations at December 31, 2004. CONTRACTUAL OBLIGATIONS AT DECEMBER 31, 2004
2005 2006 2007 2008 2009 THEREAFTER --------- ------- ------- -------- --------- ---------- ($ in millions) Long-term debt (1) $ 11 $ 201 $ 62 $ 45 $ 50 $ 763 Interest expense (2) 72 63 51 48 44 472 Capital lease obligations (3) 8 8 8 8 7 33 Operating leases (4) 100 61 32 21 6 25 Estimated crude purchase obligations (5) 3,641 3,003 1,960 1,964 1,960 4,074 Estimated product purchase obligations (6) 7,405 3,799 3,799 3,797 3,797 * Estimated capital project spending commitments 54 - - - - - Other commitments (7) 387 265 111 105 104 235 --------- ------- ------- -------- --------- --------- Total contractual cash obligations $ 11,678 $ 7,400 $ 6,023 $ 5,988 $ 5,968 $ 5,602 * ========= ======= ======= ======== ========= =========
---------- (1) Includes maturities of principal, but excludes interest payments. (2) Includes interest on fixed and variable rate debt. Variable rate debt was estimated using the all-in rate at December 31, 2004. (3) Includes amounts classified as interest. (4) Represents future minimum lease payments for noncancelable operating leases. (5) Represents an estimate of contractual crude oil purchase commitments which assure a portion of CITGO's supply requirements. These supply contracts specify minimum volumes to be purchased. Prices were estimated using actual prices paid in December 2004. (6) Represents an estimate of contractual refined product purchase commitments which assure a portion of CITGO's supply requirements. These supply contracts specify minimum volumes to be purchased. Prices were estimated using actual prices paid in December 2004 or December 2004 market prices as appropriate. (7) Represents an estimate of contractual commitments to purchase various commodities and services including hydrogen, electricity, steam, fuel gas and vessel freight service. * CITGO intends to continue purchasing a portion of its refined product supply from related parties. Such purchases currently amount to approximately $4 billion annually. (See Consolidated Financial Statements of CITGO--Notes 4, 9 and 13 in Item 15a). The following table summarizes CITGO's contingent commitments at December 31, 2004. OTHER COMMERCIAL COMMITMENTS AT DECEMBER 31, 2004
2005 2006 2007 2008 2009 THEREAFTER ---- ---- ---- ---- ---- ---------- ($ in millions) Letters of credit (1) $ 6 $ - $ - $ - $ - $ - Guarantees 39 1 - 10 - - Surety bonds 47 7 3 - - - ---- ---- ---- ---- ---- ---- Total commercial commitments $ 92 $ 8 $ 3 $ 10 $ - $ - ==== ==== ==== ==== ==== ====
---------- (1) The Company has outstanding letters of credit totaling approximately $415 million, which includes $409 million related to the Company's tax-exempt and taxable revenue bonds shown in the table of contractual obligations above. (See Consolidated Financial Statements of CITGO--Note 12 in Item 15a). 35 NEW ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46 defines variable interest entities and how an enterprise should assess its interests in a variable interest entity to decide whether to consolidate that entity. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), primarily to clarify the required accounting for investments in variable interest entities. This standard replaces FIN 46. For CITGO, which meets the definition of a nonpublic enterprise for purposes of applying FIN 46R, application is required immediately for variable interest entities created after December 31, 2003 and for variable interest entities in which an interest is acquired after that date, and to all entities that are subject to FIN 46R by January 1, 2005. The interpretation requires certain minimum disclosures with respect to variable interest entities in which an enterprise holds significant variable interest but which it does not consolidate. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The applicable provisions of FIN 46R had no impact on financial position or results of operations for the year ended December 31, 2004 and CITGO expects that the application of FIN 46R to interests currently held in other entities will not have a material impact on its financial position or results of operations in the future. 36 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction. CITGO has exposure to price fluctuations of crude oil and refined products as well as fluctuations in interest rates. To manage these exposures, management has defined certain benchmarks consistent with its preferred risk profile for the environment in which the Company operates and finances its assets. CITGO does not attempt to manage the price risk related to all of its inventories of crude oil and refined products. As a result, at December 31, 2004, CITGO was exposed to the risk of broad market price declines with respect to a substantial portion of its crude oil and refined product inventories. As of December 31, 2004 CITGO's total crude and refined products inventory was 49 million barrels. Aggregate commodity derivative positions entered into for price risk management purposes at that date totaled 1.4 million barrels. The following disclosures do not attempt to quantify the price risk associated with such commodity inventories. Commodity Instruments. CITGO balances its crude oil and petroleum product supply/demand and manages a portion of its price risk by entering into petroleum commodity derivatives. Generally, CITGO's risk management strategies qualified as hedges through December 31, 2000. Effective January 1, 2001, the Company's policy is to elect hedge accounting only under limited circumstances involving derivatives with initial terms of 90 days or greater and notional amounts of $25 million or greater. At December 31, 2004, none of the Company's commodity derivatives were accounted for as hedges. NON TRADING COMMODITY DERIVATIVES OPEN POSITIONS AT DECEMBER 31, 2004
NUMBER OF CONTRACT MARKET CONTRACTS VALUE VALUE (2) MATURITY ------------ ------- --------- COMMODITY DERIVATIVE DATE Long/(Short) Asset/(Liability) -------------------- -------------------------- -------- ------------ --------------------- ($ in millions) No Lead Gasoline (1) Futures Purchased 2005 600 $ 33.5 $ 31.1 Forward Purchase Contracts 2005 2,600 $ 90.9 $ 89.2 Forward Sale Contracts 2005 (1,864) $ (67.3) $ (64.6) Distillates (1) Futures Purchased 2005 1,885 $ 92.2 $ 96.0 Futures Purchased 2006 30 $ 1.4 $ 1.5 Futures Sold 2005 (700) $ (35.4) $ (33.7) Forward Purchase Contracts 2005 1,367 $ 57.9 $ 54.0 Forward Sale Contracts 2005 (2,457) $(122.3) $ (120.4) Forward Sale Contracts 2006 (17) $ (0.9) $ (0.8) Crude Oil (1) Forward Purchase Contracts 2005 446 $ 17.9 $ 17.4 Forward Sale Contracts 2005 (446) $ (18.7) $ (18.5)
---------- (1) 1,000 barrels per contract (2) Based on actively quoted prices. 37 NON TRADING COMMODITY DERIVATIVES OPEN POSITIONS AT DECEMBER 31, 2003
NUMBER OF CONTRACT MARKET CONTRACTS VALUE VALUE (2) MATURITY ------------ -------- --------- COMMODITY DERIVATIVE DATE Long/(Short) Asset/(Liability) -------------------- ----------------------------- -------- ------------ ---------------------- ($ in millions) No Lead Gasoline (1) Futures Purchased 2004 315 $ 12.2 $ 12.4 Futures Sold 2004 (396) $ (15.6) $ (15.6) Listed Call Options Purchased 2004 750 $ - $ 1.8 Listed Call Options Sold 2004 (750) $ - $ (1.2) Forward Purchase Contracts 2004 2,117 $ 80.2 $ 83.0 Forward Sale Contracts 2004 (1,842) $ (71.2) $ (73.3) Distillates (1) Futures Purchased 2004 2,211 $ 73.6 $ 82.7 Futures Purchased 2005 4 $ 0.1 $ 0.1 Futures Sold 2004 (400) $ (15.3) $ (15.4) OTC Call Options Purchased 2004 6 $ - $ - OTC Put Options Purchased 2004 6 $ - $ - OTC Call Options Sold 2004 (6) $ - $ - OTC Put Options Sold 2004 (6) $ - $ - Forward Purchase Contracts 2004 1,643 $ 60.5 $ 60.7 Forward Sale Contracts 2004 (1,273) $ (46.2) $ (46.8) Crude Oil (1) Futures Purchased 2004 100 $ 3.3 $ 3.3 Futures Sold 2004 (100) $ (3.3) $ (3.3) Forward Purchase Contracts 2004 1,287 $ 39.0 $ 39.4 Forward Sale Contracts 2004 (822) $ (27.0) $ (26.7)
---------- (1) 1,000 barrels per contract (2) Based on actively quoted prices. 38 Debt Related Instruments. CITGO has fixed and floating U.S. currency denominated debt. CITGO uses interest rate swaps to manage its debt portfolio and variable interest rate exposure with the objective of minimizing CITGO's long-term costs. At December 31, 2004 and 2003, CITGO's primary exposures were to LIBOR and floating rates on tax exempt bonds. For interest rate swaps, the table below presents notional amounts and interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contracts. NON TRADING INTEREST RATE DERIVATIVES OPEN POSITIONS AT DECEMBER 31, 2004 AND 2003
NOTIONAL FIXED PRINCIPAL VARIABLE RATE INDEX EXPIRATION DATE RATE PAID AMOUNT ------------------- --------------- --------- --------------- ($ in millions) J.J. Kenny February 2005 5.30% $ 12 J.J. Kenny February 2005 5.27% 15 J.J. Kenny February 2005 5.49% 15 --------------- $ 42 ===============
Changes in the fair value of these agreements are recorded in other income (expense). The fair value of the interest rate swap agreements in place at December 31, 2004, based on the estimated amount that we would receive or pay to terminate the agreements as of that date and taking into account current interest rates, was a loss of approximately $400 thousand, the offset of which is recorded in the balance sheet caption other current liabilities. 39 For debt obligations, the table below presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. DEBT OBLIGATIONS AT DECEMBER 31, 2004
EXPECTED EXPECTED FIXED AVERAGE FIXED VARIABLE AVERAGE VARIABLE MATURITIES RATE DEBT INTEREST RATE RATE DEBT INTEREST RATE ---------- --------------- ------------- --------------- ---------------- ($ in millions) ($ in millions) 2005 $ 11 9.30% $ - - 2006 201 8.10% - - 2007 50 8.94% 12 5.53% 2008 25 7.17% 20 5.73% 2009 50 7.22% - - Thereafter 403 6.77% 360 6.95% --------------- ---- --------------- ---- Total $ 740 7.36% $ 392 6.85% =============== ==== =============== ==== Fair Value $ 769 $ 392 =============== ===============
DEBT OBLIGATIONS AT DECEMBER 31, 2003
EXPECTED EXPECTED FIXED AVERAGE FIXED VARIABLE AVERAGE VARIABLE MATURITIES RATE DEBT INTEREST RATE RATE DEBT INTEREST RATE ---------- --------------- ------------- --------------- ---------------- ($ in millions) ($ in millions) 2004 $ 31 8.02% $ - - 2005 11 9.30% - - 2006 201 8.10% 200 7.17% 2007 50 8.94% - - 2008 25 7.17% 20 7.67% Thereafter 745 10.40% 190 8.04% --------------- ----- --------------- ---- Total $ 1,063 9.74% $ 410 7.60% =============== ===== =============== ==== Fair Value $ 1,195 $ 410 =============== ===============
40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Report of Independent Registered Public Accounting Firm are included in Item 15a of this report. QUARTERLY RESULTS OF OPERATIONS The following is a summary of the quarterly results of operations for the years ended December 31, 2004 and 2003:
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. ($ IN THOUSANDS) 2004 Sales $ 6,655,229 $ 8,065,182 $ 8,879,290 $ 8,427,947 ============= ============== ============== =============== Cost of sales and operating expenses, as previously reported $ 6,540,842 $ 7,734,801 $ 8,532,015 $ 7,974,766 Effect of Medicare subsidy (1) (7,525) (7,525) - - ------------- -------------- -------------- --------------- Cost of sales and operating expenses, as adjusted $ 6,533,317 $ 7,727,276 $ 8,532,015 $ 7,974,766 ============= ============== ============== =============== Gross margin, as previously reported $ 114,387 $ 330,381 $ 347,275 $ 453,181 Effect of Medicare subsidy (1) 7,525 7,525 - - ------------- -------------- -------------- --------------- Gross margin, as adjusted $ 121,912 $ 337,906 $ 347,275 $ 453,181 ============= ============== ============== =============== Net income, as previously reported $ 34,689 $ 172,096 $ 205,010 $ 194,693 Effect of Medicare subsidy (1) 7,482 11,033 - - ------------- -------------- -------------- --------------- Net income, as adjusted $ 42,171 $ 183,129 $ 205,010 $ 194,693 ============= ============== ============== ===============
(1) In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("Medicare Reform") was signed into law. Medicare Reform introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a non-taxable federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB Staff issued FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003". The Staff Position permits a sponsor to report the effects of Medicare Reform prospectively in the third quarter of 2004 or retrospectively to the measurement date following enactment of the legislation. CITGO has chosen to use the retrospective method to reflect Medicare Reform as of January 1, 2004. The first and second quarter financial information included herein has been adjusted to retrospectively reflect the effects of Medicare Reform in accordance with the Staff Position. The effect of this legislation at that date was to reduce the benefit obligation by approximately $40 million. The service cost and interest cost components of that reduction total approximately $3 million. Under CITGO's accounting policy for recognizing actuarial gains, net periodic benefit cost for the year ended December 31, 2004 has been reduced $40 million related to this actuarial gain.
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. ($ IN THOUSANDS) 2003 Sales $ 6,375,681 $ 6,021,068 $ 6,502,331 $ 6,317,280 ============== ============== ============== =============== Cost of sales and operating expenses $ 6,205,790 $ 5,811,233 $ 6,267,004 $ 6,106,916 ============== ============== ============== =============== Gross margin $ 169,891 $ 209,835 $ 235,327 $ 210,364 ============== ============== ============== =============== Net income $ 139,811 $ 108,709 $ 102,869 $ 87,385 ============== ============== ============== ===============
41 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES During the fourth quarter of 2004, the Company's management, including the principal executive officer and principal financial officer, evaluated the Company's disclosure controls and procedures related to the recording, processing, summarization and reporting of information in the Company's periodic reports that it files with the Securities and Exchange Commission ("SEC"). These disclosure controls and procedures have been designed to ensure that (a) material information relating to the Company, including its consolidated subsidiaries, is accumulated and made known to the Company's management, including these officers, by other employees of the Company and its subsidiaries as appropriate to allow timely decisions regarding required disclosure, and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Also, the Company does not control or manage certain of its unconsolidated entities and thus its access and ability to apply its disclosure controls and procedures to entities that it does not control or manage are more limited than is the case for the subsidiaries it controls and manages. Accordingly, as of December 31, 2004, these officers (principal executive officer and principal financial officer) concluded that the Company's disclosure controls and procedures were effective to accomplish their objectives. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. ITEM 9B. OTHER INFORMATION None. 42 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The registrant meets the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K and is therefore omitting the information otherwise required by Item 10 of Form 10-K relating to directors and executive officers as permitted by General Instruction (I)(2)(c). ITEM 11. EXECUTIVE COMPENSATION The registrant meets the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K and is therefore omitting the information otherwise required by Item 11 of Form 10-K relating to executive compensation as permitted by General Instruction (I)(2)(c). ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The registrant meets the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K and is therefore omitting the information otherwise required by Item 12 of Form 10-K relating to security ownership of certain beneficial owners and management as permitted by General Instruction (I)(2)(c). 43 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CITGO has entered into several transactions with PDVSA or affiliates of PDVSA, including crude oil and feedstock supply agreements, agreements for the purchase of refined products and transportation agreements. Under these agreements, CITGO purchased approximately $5.8 billion of crude oil, feedstocks and refined products at market related prices from PDVSA in 2004. At December 31, 2004, $429 million was included in CITGO's current payable to affiliates as a result of its transactions with PDVSA. Most of the crude oil and feedstocks purchased by CITGO from PDVSA are delivered on tankers owned by PDV Marina, S.A., a wholly-owned subsidiary of PDVSA. In 2004, 74% of the PDVSA contract crude oil delivered to the Lake Charles and Corpus Christi refineries was delivered on tankers operated by this PDVSA subsidiary. LYONDELL-CITGO owns and operates a 265 MBPD refinery in Houston, Texas. LYONDELL-CITGO was formed in 1993 by subsidiaries of CITGO and Lyondell ("the Owners"). The heavy crude oil processed by the Houston refinery is supplied by PDVSA under a long-term crude oil supply agreement through the year 2017. Under this agreement, LYONDELL-CITGO purchased approximately $2.6 billion of crude oil and feedstocks at market related prices from PDVSA in 2004. CITGO purchases substantially all of the gasoline, diesel and jet fuel produced at the Houston refinery under a long-term contract. (See Consolidated Financial Statements of CITGO -- Notes 3 and 4 in Item 15a). Various disputes exist between LYONDELL-CITGO and the Owners and their affiliates concerning the interpretation of these and other agreements between the parties relating to the operation of the refinery. CITGO's participation interest in LYONDELL-CITGO was approximately 41% at December 31, 2004, in accordance with agreements between the Owners concerning such interest. CITGO held a note receivable from LYONDELL-CITGO of $35 million at December 31, 2004. The note bears interest at market rates which were approximately 2.7% at December 31, 2004. Principal and interest are due January 1, 2008. CITGO accounts for its investment in LYONDELL-CITGO using the equity method of accounting and records its share of the net earnings of LYONDELL-CITGO based on allocations of income agreed to by the Owners. Cash distributions are allocated to the owners based on participation interest. In October 1998, PDVSA V.I., Inc., an affiliate of PDVSA, acquired a 50% equity interest in HOVENSA and has the right under a product sales agreement to assign periodically to CITGO, or other related parties, its option to purchase 50% of the refined products produced by HOVENSA (less a certain portion of such products that HOVENSA will market directly in the local and Caribbean markets). In addition, under the product sales agreement, the PDVSA affiliate has appointed CITGO as its agent in designating which of its affiliates shall from time to time take deliveries of the refined products available to it. The product sales agreement will be in effect for the life of the joint venture, subject to termination events based on default or mutual agreement (See Consolidated Financial Statements of CITGO -- Notes 2 and 4 in Item 15a). Pursuant to the above arrangement, CITGO acquired approximately 128 MBPD of refined products, approximately one-half of which was gasoline, and 34 MBPD of intermediates from the refinery during 2004. The refined product purchase agreements with LYONDELL-CITGO and HOVENSA incorporate various formula prices based on published market prices and other factors. Such purchases totaled $6.8 billion for 2004. At December 31, 2004, $183 million was included in payables to affiliates as a result of these transactions. CITGO had refined product, feedstock, crude oil and other product sales of $456 million to affiliates, including LYONDELL-CITGO and Mount Vernon Phenol Plant Partnership, in 2004. At December 31, 2004, $107 million was included in due from affiliates as a result of these and related transactions. 44 CITGO has guaranteed approximately $50 million of debt of certain affiliates, including $10 million related to NISCO and $33 million related to PDV Texas, Inc. (See Consolidated Financial Statements of CITGO -- Note 12 in Item 15a). Under a separate guarantee of rent agreement, PDVSA has guaranteed payment of rent, stipulated loss value and termination value due under the lease of the Corpus Christi Refinery West Plant facilities. (See Consolidated Financial Statements of CITGO -- Note 4 in Item 15a). In August 2002, three affiliates entered into agreements to advance excess cash to CITGO from time to time under demand notes for amounts of up to a maximum of $10 million with PDV Texas, Inc., $30 million with PDV America and $10 million with PDV Holding. The notes bear interest at rates equivalent to 30-day LIBOR plus 0.875% payable quarterly. At December 31, 2004, the amounts outstanding on these notes were $7 million, $14 million and $5 million from PDV Texas, PDV America and PDV Holding, respectively. The Company and PDV Holding are parties to a tax allocation agreement that is designed to provide PDV Holding with sufficient cash to pay its consolidated income tax liabilities. PDV Holding appointed CITGO as its agent to handle the payment of such liabilities on its behalf. As such, CITGO calculates the taxes due, allocates the payments among the members according to the agreement and bills each member accordingly. Each member records its amounts due or payable to CITGO in a related party payable account. At December 31, 2004, CITGO had net related party receivables related to federal income taxes of $28 million. ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES The following table presents fees for professional audit services rendered for the audit of the Company's financial statements for the years ended December 31, 2004 and 2003, respectively, and fees billed for other services rendered during the same periods.
2004 2003 --------- ------- (000s omitted) Audit fees $ 2,718 $ 1,899 Audit related fees (1) 244 450 Tax fees 132 127 All other fees 69 - --------- ------- Total $ 3,163 $ 2,476 ========= =======
---------- (1) Audit related fees in 2004 include approximately $139 thousand in fees related to CITGO's registration of $250 million 6% unsecured senior notes. Audit related fees in 2003 include approximately $360 thousand in fees related to CITGO's registration of $550 million 11-3/8% unsecured senior notes. CITGO has an audit committee of its board of directors. That committee, in accordance with their pre-approval policy, pre-approves each engagement of the independent accountants for any audit or non-audit services before the accountants are engaged to render those services. A committee member has been designated to represent the entire committee for purposes of approving any services not previously approved by the committee. Any services approved by the designated committee member are reported to the full committee at the next scheduled audit committee meeting. No de minimis exceptions to this approval process are allowed under the audit committee's pre-approval policy, and thus, none of the services described in the preceding table were approved pursuant to Rule 2-01(c)(7)(i)(C) of Regulation S-X. 45 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES a. CERTAIN DOCUMENTS FILED AS PART OF THIS REPORT (1) Financial Statements:
Page ---- CITGO Petroleum Corporation Report of Independent Registered Public Accounting Firm - KPMG LLP F-1 Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP F-2 Consolidated Balance Sheets at December 31, 2004 and 2003 F-3 Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2004, 2003 and 2002 F-4 Consolidated Statements of Shareholder's Equity for the years ended December 31, 2004, 2003 and 2002 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 F-6 Notes to Consolidated Financial Statements F-8 LYONDELL-CITGO Refining LP Report of Independent Registered Public Accounting Firm F-33 Statements of Income for the years ended December 31, 2004, 2003 and 2002 F-34 Balance Sheets at December 31, 2004 and 2003 F-35 Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 F-36 Statements of Partners' Capital for the years ended December 31, 2004, 2003 and 2002 F-37 Notes to Financial Statements F-38
(2) Exhibits: The Exhibit Index in part b. below lists the exhibits that are filed as part of, or incorporated by reference into, this report. 46 b. EXHIBITS
Exhibit Number Description ------ ----------- 3.1 Restated Certificate of Incorporation, as amended (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 3.1 filed with the Commission on April 4, 1996). 3.2 By-laws of CITGO Petroleum Corporation as amended on March 13, 2001 (incorporated by reference to Registrant's 2000 Form 10-K, File No. 1-14380, Exhibit 3.1(i) filed with the Commission on March 21, 2001). 4.1 Master Shelf Agreement (1994) by and between Prudential Insurance Company of America and CITGO Petroleum Corporation ($100,000,000), dated March 4, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.16 filed with the Commission on April 4, 1996). 4.2 Letter Agreement by and between the Company and Prudential Insurance Company of America, dated March 4, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.17(i) filed with the Commission on April 4, 1996). 4.3 Letter Amendment No. 1 to Master Shelf Agreement with Prudential Insurance Company of America, dated November 14, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.17(ii) filed with the Commission on April 4, 1996). 4.4 CITGO Senior Debt Securities (1991) Agreement (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.18 filed with the Commission on June 2, 1993). 4.5 Indenture, dated as of May 1, 1996, between CITGO Petroleum Corporation and the First National Bank of Chicago, relating to the 7-7/8% Senior Notes due 2006 of CITGO Petroleum Corporation, including the form of Senior Note (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 4.1 filed with the Commission on April 4, 1996). 4.6 Indenture, dated as of February 27, 2003, between CITGO Petroleum Corporation, as Issuer, and The Bank of New York, as Trustee, relating to the $550,000,000 11-3/8% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 4.2 filed with the Commission on March 24, 2003). 4.7 Supplemental Indenture dated as of October 20, 2004 between CITGO Petroleum Corporation, as Issuer, and The Bank of New York, as Trusted, relating to the $550,000,000 11-3/8% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's Form 8-K dated October 22, 2004, File No. 1-14380, Exhibit 4.1 filed with the Commission on October 28, 2004). 4.8 Indenture, dated as of October 22, 2004, between CITGO Petroleum Corporation, as Issuer, and J.P. Morgan Trust Company, National Association, as Trustee, relating to the $250,000,000 6% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's Registration Statement on Form S-4, File No. 333-122100, Exhibit 4.1 filed with the Commission on January 18, 2005). 10.1 Crude Supply Agreement between CITGO Petroleum Corporation and Petroleos de Venezuela, S.A., dated as of September 30, 1986 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.1 filed with the Commission on June 2, 1993).
47 10.2 Supplemental Crude Supply Agreement dated as of September 30, 1986 between CITGO Petroleum Corporation and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.2 filed with the Commission on June 2, 1993). 10.3 Crude Oil and Feedstock Supply Agreement dated as of March 31, 1987 between Champlin Refining Company and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.3 filed with the Commission on June 2, 1993). 10.4 Supplemental Crude Oil and Feedstock Supply Agreement dated as of March 31, 1987 between Champlin Refining Company and Petroleos de Venezuela, S.A. (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.4 filed with the Commission on June 2, 1993). 10.5 Contract for the Purchase/Sale of Boscan Crude Oil dated as of June 2, 1993 between Tradecal, S.A. and CITGO Asphalt Refining Company (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.1 filed with the Commission on June 2, 1993). 10.6 Restated Contract for the Purchase/Sale of Heavy/Extra Heavy Crude Oil dated December 28, 1990 among Maraven, S.A., Lagoven, S.A. and Seaview Oil Company (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.6 filed with the Commission on June 2, 1993). 10.7 Sublease Agreement dated as of March 31, 1987 between Champlin Petroleum Company, Sublessor, and Champlin Refining Company, Sublessee (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.7 filed with the Commission on June 2, 1993). 10.8 Amended and Restated Limited Liability Company Regulations of LYONDELL-CITGO Refining Company, Ltd., dated July 1, 1993 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.9 filed with the Commission on June 2, 1993). 10.9 Contribution Agreement among Lyondell Petrochemical Company and LYONDELL-CITGO Refining Company, Ltd. and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.10 filed with the Commission on June 2, 1993). 10.10 Crude Oil Supply Agreement between LYONDELL-CITGO Refining Company, Ltd. and Lagoven, S.A. dated as of May 5, 1993 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.11 filed with the Commission on June 2, 1993). 10.11 Supplemental Supply Agreement dated as of May 5, 1993 between LYONDELL-CITGO Refining Company, Ltd. and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.12 filed with the Commission on June 2, 1993). 10.12 Tax Allocation Agreement dated as of June 24, 1993 among PDV America, Inc., VPHI Midwest, Inc., CITGO Petroleum Corporation and PDV USA, Inc., as amended (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.13 filed with the Commission on June 2, 1993). 10.13 Second Amendment to the Tax Allocation Agreement among PDV America, Inc., VPHI Midwest, Inc., CITGO Petroleum Corporation and PDV USA, Inc., dated as of January 1, 1997 (incorporated
48 by reference to Registrant's 2001 Form 10-K, File No. 1-14380, Exhibit 10.13(i) filed with the Commission on March 28, 2002). 10.14 Limited Partnership Agreement of LYONDELL-CITGO Refining LP, dated December 31, 1998 (incorporated by reference to the Registrant's 1998 Form 10-K, File No. 1-14380, Exhibit 10.24 filed with the Commission on March 17, 1999). 10.15 $260,000,000 Three-Year Credit Agreement dated as of December 11, 2002 among CITGO Petroleum Corporation, Bank of America, N.A., as Administrative Agent, JP Morgan Chase Bank, as Syndication Agent, Societe Generale, as Documentation Agent and the other lenders party thereto (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 10.22 filed with the Commission on March 24, 2003). 10.16 First Amendment to Three-Year Credit Agreement entered into January 29, 2003, but effective as of December 11, 2002, among CITGO Petroleum Corporation, Bank of America, N.A., as Administrative Agent and the other lenders party thereto (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 10.23 filed with the Commission on March 24, 2003). 10.17 Purchase and Sale Agreement dated as of February 28, 2003 between CITGO Petroleum Corporation and CITGO Funding Company, L.L.C. (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.23 filed with the Commission on March 30, 2004). 10.18 Amendment No. 1 dated as of November 26, 2003 to Purchase and Sale Agreement dated as of February 28, 2003 (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.24 filed with the Commission on March 30, 2004). 10.19 Receivables Purchase Agreement dated as of February 28, 2003 among CITGO Funding Company, L.L.C., CITGO Petroleum Corporation, Asset One Securitization, LLC and Societe Generale (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.25 filed with the Commission on March 30, 2004). 10.20 Amendment No. 1 dated as of November 26, 2003 to Receivables Purchase Agreement dated as of February 28, 2003 (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.26 filed with the Commission on March 30, 2004). 10.21 Amendment No. 2 dated as of November 24, 2004 to Receivables Purchase Agreement dated as of February 28, 2003. 12.1* Computation of Ratio of Earnings to Fixed Charges. 23.1* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.2* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.3* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.4* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.5* Consent of Independent Registered Public Accounting Firm of LYONDELL-CITGO Refining LP. 23.6* Consent of Independent Registered Public Accounting Firm of LYONDELL-CITGO Refining LP. 31.1* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Felix Rodriguez, President and Chief Executive Officer.
49 31.2* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Larry E. Krieg, Chief Financial Officer. 32.1* Certification Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Felix Rodriguez, President and Chief Executive Officer. 32.2* Certification Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Larry E. Krieg, Chief Financial Officer.
---------- * Filed Herewith 50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. CITGO PETROLEUM CORPORATION /s/ PAUL LARGESS ------------------------------------- Paul Largess Controller (Chief Accounting Officer) Date: March 30, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. Signatures Title Date By /s/ ALEJANDRO GRANADO Chairman of the Board March 30, 2005 ------------------------ and Director Alejandro Granado By /s/ JUAN CARLOS BOUE Director March 30, 2005 ----------------------- Juan Carlos Boue By /s/ EUDOMARIO CARRUYO Director March 30, 2005 ------------------------ Eudomario Carruyo By /s/ ASDRUBAL CHAVEZ Director March 30, 2005 ------------------------ Asdrubal Chavez By /s/ BERNARD MOMMER Director March 30, 2005 ------------------------ Bernard Mommer By /s/ FELIX RODRIGUEZ President, Chief Executive March 30, 2005 ------------------------ Officer and Director Felix Rodriguez By /s/ LARRY E. KRIEG Vice President Finance and March 30, 2005 ------------------------ Chief Financial Officer Larry E. Krieg 51 CITGO PETROLEUM CORPORATION Consolidated Financial Statements as of December 31, 2004 and 2003, and for Each of the Three Years in the Period Ended December 31, 2004, and Reports of Independent Registered Public Accounting Firms REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of CITGO Petroleum Corporation: We have audited the accompanying consolidated balance sheets of CITGO Petroleum Corporation and subsidiaries ("the Company") as of December 31, 2004 and 2003, and the related consolidated statements of income and comprehensive income, shareholder's equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of LYONDELL-CITGO Refining, LP ("LCR"), a 41.25 percent owned investee company. The Company's investment in LCR at December 31, 2004 and 2003 was $410 million and $455 million, respectively, and its equity in earnings of LCR was $197 million and $84 million for the years then ended, respectively. The financial statements of LCR were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for LCR, is based solely on the report of the other auditors. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of CITGO Petroleum Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Tulsa, Oklahoma March 3, 2005, except as to Note 17, which is as of March 30, 2005 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of CITGO Petroleum Corporation: We have audited the accompanying consolidated statements of income and comprehensive income, shareholder's equity and cash flows of CITGO Petroleum Corporation and subsidiaries for the year ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations, changes in shareholder's equity, and cash flows of CITGO Petroleum Corporation and subsidiaries for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Tulsa, Oklahoma February 14, 2003 F-2 CITGO PETROLEUM CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
DECEMBER 31, ----------------------------------- 2004 2003 -------------- -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 23,033 $ 202,008 Accounts receivable, net 1,292,751 1,060,333 Due from affiliates 106,514 71,336 Inventories 1,165,660 1,017,613 Prepaid expenses and other 77,696 28,003 -------------- -------------- Total current assets 2,665,654 2,379,293 PROPERTY, PLANT AND EQUIPMENT - Net 4,038,505 3,907,203 RESTRICTED CASH 2,315 6,886 INVESTMENTS IN AFFILIATES 580,647 647,649 OTHER ASSETS 356,551 332,462 -------------- -------------- $ 7,643,672 $ 7,273,493 ============== ============== LIABILITIES AND SHAREHOLDER'S EQUITY CURRENT LIABILITIES: Accounts payable $ 888,030 $ 766,331 Payables to affiliates 674,997 486,058 Taxes other than income 290,456 173,932 Other 251,451 255,953 Current portion of long-term debt 11,364 31,364 Current portion of capital lease obligation 4,404 2,336 -------------- -------------- Total current liabilities 2,120,702 1,715,974 LONG-TERM DEBT 1,120,527 1,442,100 CAPITAL LEASE OBLIGATION 43,755 25,969 POSTRETIREMENT BENEFITS OTHER THAN PENSIONS 359,707 319,911 OTHER NONCURRENT LIABILITIES 337,250 308,248 DEFERRED INCOME TAXES 939,299 959,807 COMMITMENTS AND CONTINGENCIES (Note 12) SHAREHOLDER'S EQUITY: Common stock - $1.00 par value, 1,000 shares authorized, issued and outstanding 1 1 Additional capital 1,659,698 1,659,698 Retained earnings 1,088,096 863,093 Accumulated other comprehensive loss (25,363) (21,308) -------------- -------------- Total shareholder's equity 2,722,432 2,501,484 -------------- -------------- $ 7,643,672 $ 7,273,493 ============== ==============
See notes to consolidated financial statements. F-3 CITGO PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2004 (DOLLARS IN THOUSANDS)
2004 2003 2002 REVENUES: Net sales (1) $ 31,571,937 $ 24,829,305 $ 19,080,845 Sales to affiliates 455,711 387,055 277,477 ----------------- -------------- ---------------- 32,027,648 25,216,360 19,358,322 Equity in earnings of affiliates 242,108 118,268 101,326 Insurance recoveries - 146,165 406,570 Other income (expense), net 7,319 14,965 (19,735) ----------------- -------------- ---------------- 32,277,075 25,495,758 19,846,483 ----------------- -------------- ---------------- COST OF SALES AND EXPENSES: Cost of sales and operating expenses (including purchases of $12,334,523, $9,109,938 and $6,779,798 from affiliates) (1) 30,767,374 24,390,943 19,211,316 Selling, general and administrative expenses 327,830 295,597 284,871 Interest expense, excluding capital lease 254,923 119,737 67,394 Capital lease interest charge 3,522 5,271 7,017 ----------------- -------------- ---------------- 31,353,649 24,811,548 19,570,598 ----------------- -------------- ---------------- INCOME BEFORE INCOME TAXES 923,426 684,210 275,885 INCOME TAXES 298,423 245,436 95,873 ----------------- -------------- ---------------- NET INCOME 625,003 438,774 180,012 OTHER COMPREHENSIVE INCOME (LOSS): Cash flow hedges: Reclassification adjustment for derivative losses included in net income, net of related income taxes of $177 in 2004, $172 in 2003 and $182 in 2002 315 304 310 Foreign currency translation gain (loss), net of related income taxes of $114 in 2004, $168 in 2003, and $(78) in 2002 211 302 (172) Minimum pension liability adjustment, net of related taxes of $(2,633) in 2004, $2,151 in 2003 and $(12,835) in 2002 (4,581) 3,741 (22,328) ----------------- -------------- ---------------- Total other comprehensive income (loss) (4,055) 4,347 (22,190) ----------------- -------------- ---------------- COMPREHENSIVE INCOME $ 620,948 $ 443,121 $ 157,822 ================= ============== ================
Supplemental information (billions of dollars) (1) Includes amounts related to buy/sell arrangements: Net sales $ 3.7 $ 3.9 * Cost of sales and operating expenses $ 3.7 $ 3.8 *
*Information is not available for 2002. See notes to consolidated financial statements. F-4 CITGO PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2004 (DOLLARS AND SHARES IN THOUSANDS)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) ------------------------------------------------ COMMON STOCK MINIMUM FOREIGN CASH TOTAL -------------- ADDITIONAL RETAINED PENSION CURRENCY FLOW SHAREHOLDER'S SHARES AMOUNT CAPITAL EARNINGS LIABILITY TRANSLATION HEDGES TOTAL EQUITY BALANCE, JANUARY 1, 2002 1 $ 1 $ 1,659,698 $ 745,102 $ (2,484) $ - $ (981) $ (3,465) $ 2,401,336 Net income - - - 180,012 - - - - 180,012 Other comprehensive (loss) income - - - - (22,328) (172) 310 (22,190) (22,190) -- ------ ----------- ----------- ----------- ----------- --------- ---------- ------------- BALANCE, DECEMBER 31, 2002 1 1 1,659,698 925,114 (24,812) (172) (671) (25,655) 2,559,158 Net income - - - 438,774 - - - - 438,774 Other comprehensive income - - - - 3,741 302 304 4,347 4,347 Dividends paid to parent, PDV America - - - (500,795) - - - - (500,795) -- ------ ----------- ----------- ----------- ----------- --------- ---------- ------------- BALANCE, DECEMBER 31, 2003 1 1 1,659,698 863,093 (21,071) 130 (367) (21,308) 2,501,484 Net income - - - 625,003 - - - - 625,003 Other comprehensive (loss) income - - - - (4,581) 211 315 (4,055) (4,055) Dividends paid to parent, PDV America - - - (400,000) - - - - (400,000) -- ------ ----------- ----------- ----------- ----------- --------- ---------- ------------- BALANCE, DECEMBER 31, 2004 1 $ 1 $ 1,659,698 $ 1,088,096 $ (25,652) $ 341 $ (52) $ (25,363) $ 2,722,432 == ====== =========== =========== =========== =========== ========= ========== =============
See notes to consolidated financial statements. F-5 CITGO PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2004 (DOLLARS IN THOUSANDS)
2004 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 625,003 $ 438,774 $ 180,012 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 375,213 333,626 298,686 Provision for losses on accounts receivable 12,415 15,066 17,458 Deferred income taxes (10,519) 159,791 37,642 Distributions in excess of equity in earnings of affiliates 67,146 100,071 22,313 Other adjustments 9,142 18,329 3,992 Changes in operating assets and liabilities: Accounts receivable and due from affiliates (291,141) (155,126) (40,009) Inventories (148,047) 73,302 18,431 Prepaid expenses and other current assets (49,248) 6,478 62,465 Accounts payable and other current liabilities 394,102 (68,508) 315,266 Other assets (121,114) (98,568) (128,466) Other liabilities 69,567 171,794 30,483 ----------- ----------- ------------ Total adjustments 307,516 556,255 638,261 ----------- ----------- ------------ Net cash provided by operating activities 932,519 995,029 818,273 ----------- ----------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (341,349) (413,704) (711,834) Proceeds from sales of property, plant and equipment 599 4,015 919 Decrease (increase) in restricted cash 4,571 16,600 (23,486) Investments in LYONDELL-CITGO Refining LP (30,690) (21,208) (32,000) Investments in and advances to other affiliates (14,882) (3,800) (22,484) ----------- ----------- ------------ Net cash used in investing activities (381,751) (418,097) (788,885) ----------- ----------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments of) proceeds from revolving bank loans - (279,300) (112,200) Proceeds from 6% senior notes due 2011 248,250 - - (Payments on) proceeds from 11-3/8% senior notes due 2011 (543,355) 546,590 - (Payments on) proceeds from senior secured term loan (200,000) 200,000 - Repurchase of senior notes due 2006 - (47,500) - Proceeds from (payments on) loans from affiliates 26,100 (39,000) 39,000 Payments on private placement senior notes (11,364) (11,364) (11,364) Payments of master shelf agreement notes (20,000) (50,000) (25,000) Proceeds from (payments on) taxable bonds 55,000 (90,000) (31,000) Proceeds from (payments on) tax-exempt bonds 126,805 (93,400) 68,502 Payments of capital lease obligations (4,131) (23,601) (20,358) Repayments of other debt - - (8,305) Dividends paid to parent, PDV America (400,000) (500,795) - Debt issuance costs (7,048) (19,579) - ----------- ----------- ------------ Net cash used in financing activities (729,743) (407,949) (100,725) ----------- ----------- ------------
(Continued) F-6 CITGO PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2004 (DOLLARS IN THOUSANDS)
2004 2003 2002 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS $ (178,975) $ 168,983 $ (71,337) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 202,008 33,025 104,362 ------------- -------------- -------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 23,033 $ 202,008 $ 33,025 ============= ============== ============== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest, net of amounts capitalized $ 271,851 $ 100,492 $ 72,970 ============= ============== ============== Income taxes, net of refunds of $441 in 2004 $45,794 in 2003 and $50,733 in 2002 $ 348,470 $ 110,965 $ (45,745) ============= ============== ============== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES: Investment in LYONDELL-CITGO Refining LP (Note 3) $ - $ (6,840) $ - ============= ============== ============== Assets received upon dissolution of a partnership $ 16,265 $ - $ - ============= ============== ============== SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES: Capital leases (Note 13) $ 22,740 $ - $ - ============= ============== ==============
See notes to consolidated financial statements. (Concluded) F-7 CITGO PETROLEUM CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2004 1. SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS - CITGO Petroleum Corporation ("CITGO") is a subsidiary of PDV America, Inc. ("PDV America"), an indirect wholly owned subsidiary of Petroleos de Venezuela, S.A. ("PDVSA"), the national oil company of the Bolivarian Republic of Venezuela. CITGO manufactures or refines and markets transportation fuels as well as lubricants, refined waxes, petrochemicals, asphalt and other industrial products. CITGO owns and operates three crude oil refineries (Lake Charles, Louisiana, Corpus Christi, Texas, and Lemont, Illinois) and two asphalt refineries (Paulsboro, New Jersey, and Savannah, Georgia) with a combined aggregate rated crude oil refining capacity of 756 thousand barrels per day ("MBPD"). CITGO also owns a minority interest in LYONDELL-CITGO Refining LP, a limited partnership that owns and operates a refinery in Houston, Texas, with a rated crude oil refining capacity of 265 MBPD. CITGO's consolidated financial statements also include accounts relating to a lubricant and wax plant, pipelines, and equity interests in pipeline companies and petroleum storage terminals. CITGO's transportation fuel customers include CITGO branded wholesale marketers, convenience stores and airlines located mainly east of the Rocky Mountains. Asphalt is generally marketed to independent paving contractors on the East and Gulf Coasts and the Midwest of the United States. Lubricants are sold principally in the United States to independent marketers, mass marketers and industrial customers. Petrochemical feedstocks and industrial products are sold to various manufacturers and industrial companies throughout the United States. Petroleum coke is sold primarily in international markets. CITGO also sells lubricants, gasoline and distillates in various Latin American markets including Puerto Rico, Brazil, Ecuador and Mexico. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of CITGO and its subsidiaries (collectively referred to as the "Company"). All subsidiaries are wholly owned. All material intercompany transactions and accounts have been eliminated. The Company's investments in less than majority-owned affiliates are accounted for by the equity method. The excess of the carrying value of the investments over the equity in the underlying net assets of the affiliates is amortized on a straight-line basis over 40 years, which is based upon the estimated useful lives of the affiliates' assets. ESTIMATES, RISKS AND UNCERTAINTIES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CITGO's operations can be influenced by domestic and international political, legislative, regulatory and legal environments. In addition, significant changes in the prices or availability of crude oil and refined products could have a significant impact on CITGO's results of operations for any particular year. IMPAIRMENT OF LONG-LIVED ASSETS - The Company periodically evaluates the carrying value of long-lived assets to be held and used when events and circumstances warrant such a review. The carrying value of a F-8 long-lived asset is considered impaired when the separately identifiable anticipated undiscounted net cash flow from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated net cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for disposal costs. REVENUE RECOGNITION - Revenue is generated from the sale of refined petroleum products to bulk purchasers, wholesale purchasers and final consumers. CITGO's transportation fuel customers include CITGO branded wholesale marketers, convenience stores and airlines located mainly east of the Rocky Mountains. Asphalt is generally marketed to independent paving contractors on the East and Gulf Coasts and the Midwest of the United States. Lubricants are sold principally in the United States to independent marketers, mass marketers and industrial customers. Petrochemical feedstocks and industrial products are sold to various manufacturers and industrial companies throughout the United States. Petroleum coke is sold primarily in international markets. CITGO also sells lubricants, gasoline and distillates in various Latin American markets including Puerto Rico, Brazil, Ecuador and Mexico. Revenue recognition occurs at the point that title to the refined petroleum product is transferred to the customer. That transfer is determined from the delivery terms of the customer's contract. In the case of bulk purchasers, delivery and title transfer may occur while the refined petroleum products are in transit, if agreed by the purchaser; or may occur when the hydrocarbons are transferred into a storage facility at the direction of the purchaser. In the case of wholesale purchasers, delivery and title transfer generally occurs when the refined petroleum products are transferred from a storage facility to the transport truck. Direct sales to the final consumer make up an immaterial portion of revenue recognized by CITGO. SUPPLY AND MARKETING ACTIVITIES - The Company engages in the buying and selling of crude oil to supply its refineries. In order to obtain crude oil of a specific grade and quantity in a certain location, the Company may enter a contract to sell a different grade and quantity at a different location. In the event that the Company does not have the specified crude oil to satisfy its counterparty's needs, it must purchase that crude oil from a third party and sell it to the counterparty. The net results of this activity are recorded in cost of sales. The Company also engages in the buying and selling of refined products to facilitate the marketing of its refined products. The results of this activity are recorded in cost of sales and sales. In a typical refined product buy/sell transaction, the Company enters into a contract to buy a particular type of refined product at a specified location and date from a particular counterparty and simultaneously agrees to sell a particular type of refined product at a different location on the same or another specified date, generally with the same counterparty. The value of the purchased volume may not equal the value of the sold volume due to grade or quality differentials, location differentials or timing differences. The characteristics of the refined product buy/sell transactions include gross invoicing between the Company and its counterparties and cash settlement of the transactions. Nonperformance by one party to deliver does not relieve the other party of its obligation to perform. Both transactions require physical delivery of the product. The risks and rewards of ownership are evidenced by title transfer, assumption of risk of loss and credit risk. The Company believes that these refined product buy/sell transactions are monetary in nature and thus outside the scope of APB Opinion No. 29, "Accounting for Nonmonetary Transactions" (APB No. 29"). Additionally, the Company has evaluated Emerging Issues Task Force Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent", ("EITF No. 99-19") and, based on that evaluation believes that the recording of these transactions on a gross basis is appropriate. The Emerging Issues Task Force ("EITF") is currently considering Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty," ("EITF 04-13") which relates to transactions in which an entity sells inventory to another entity in the same line of business from which it also purchases inventory. The following questions have been raised regarding the accounting for these types of transactions and are expected to be addressed by the EITF: a) Under what circumstances should two or more transactions with the same counterparty (counterparties) be viewed as a single nonmonetary transaction within the scope of APB No. 29? b) If nonmonetary transactions within the scope of APB No. 29 involve inventory, are there any circumstances under which the transactions should be recognized at fair value? Depending on the EITF's conclusions on this issue, it is possible that net sales and cost of sales and expenses on the consolidated statement of income would both be reduced by the amount of refined product buy/sell transactions. The Company believes that the impact of such a reduction on net income would result from changes to LIFO inventory calculations and would not be material to the Company's consolidated financial statements. Refined product exchange transactions that do not involve the payment or receipt of cash are not accounted for as purchases or sales. Any resulting volumetric exchange balances are accounted for as inventory in accordance with the Company's last-in, first-out ("LIFO") inventory method. Exchanges that are settled through payment or receipt of cash are accounted for as purchases or sales. EXCISE TAXES - The Company collects excise taxes on sales of gasoline and other motor fuels. Excise taxes of approximately $3.8 billion, $3.5 billion, and $3.2 billion were collected from customers and paid to various governmental entities in 2004, 2003, and 2002, respectively. Excise taxes are not included in sales revenue. CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of highly liquid short-term investments and bank deposits with initial maturities of three months or less. INVENTORIES - Crude oil and refined product inventories are stated at the lower of cost or market and cost is determined using the LIFO method. Materials and supplies are valued using the average cost method. PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is reported at cost, less accumulated depreciation. Depreciation is based upon the estimated useful lives of the related assets using the straight-line method. Depreciable lives are generally as follows: buildings and leaseholds - 10 to 24 years; machinery and equipment - 5 to 24 years; and vehicles - 3 to 10 years. F-9 Upon disposal or retirement of property, plant and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized. The Company capitalizes interest on projects when construction entails major expenditures over extended time periods. Such interest is allocated to property, plant and equipment and amortized over the estimated useful lives of the related assets. Interest capitalized totaled $7 million, $9 million, and $4 million, during 2004, 2003, and 2002, respectively. RESTRICTED CASH - The Company has restricted cash consisting of highly liquid investments held in trust accounts in accordance with tax exempt revenue bonds due 2031. Funds are released solely for financing the qualified capital expenditures as defined in the bond agreement. COMMODITY AND INTEREST RATE DERIVATIVES - The Company uses futures, forwards, swaps and options primarily to reduce its exposure to market risk. The Company also enters into various interest rate swap agreements to manage its risk related to interest rate change on its debt. Fair values of derivatives are recorded in other current assets or other current liabilities, as applicable, and changes in the fair value of derivatives not designated in hedging relationships are recorded in income. The Company's policy is to elect hedge accounting only under limited circumstances involving derivatives with initial terms of 90 days or greater and notional amounts of $25 million or greater. REFINERY MAINTENANCE - Costs of major refinery turnaround maintenance are charged to operations over the estimated period between turnarounds. Turnaround periods range approximately from one to seven years. Unamortized costs are included in other assets. Amortization of refinery turnaround costs is included in depreciation and amortization expense. Amortization was $94 million, $88 million, and $75 million for 2004, 2003, and 2002, respectively. Ordinary maintenance is expensed as incurred. ENVIRONMENTAL EXPENDITURES - Environmental expenditures that relate to current or future revenues are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations and that do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or cleanups are probable and the costs can be reasonably estimated. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, to the extent required, may be made as more refined information becomes available. INCOME TAXES - The Company is included in the consolidated U.S. federal income tax return filed by PDV Holding, Inc., the direct parent of PDV America. The Company's current and deferred income tax expense has been computed on a stand-alone basis using an asset and liability approach. NEW ACCOUNTING STANDARDS - In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46 defines variable interest entities and how an enterprise should assess its interests in a variable interest entity to decide whether to consolidate that entity. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), primarily to clarify the required accounting for investments in variable interest entities. This standard replaces FIN 46. For CITGO, which meets the definition of a nonpublic enterprise for purposes of applying FIN 46R, application is required immediately for variable interest entities created after December 31, 2003 and for variable interest entities in which an interest is acquired after that date, and to all entities that are subject to FIN 46R by January 1, 2005. The interpretation requires certain minimum disclosures with respect to variable interest entities in which an enterprise holds significant variable interest but which it does not consolidate. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years F-10 with a cumulative-effect adjustment as of the beginning of the first year restated. The applicable provisions of FIN 46R had no impact on financial position or results of operations for the year ended December 31, 2004 and CITGO expects that the application of FIN 46R to interests currently held in other entities will not have a material impact on its financial position or results of operations in the future. 2. REFINERY AGREEMENTS An affiliate of PDVSA has a 50 percent equity interest in a joint venture that owns and operates a refinery in St. Croix, U.S. Virgin Islands ("HOVENSA") and has the right under a product sales agreement to assign periodically to CITGO, or other related parties, its option to purchase 50 percent of the refined products produced by HOVENSA (less a certain portion of such products that HOVENSA will market directly in the local and Caribbean markets). In addition, under the product sales agreement, the PDVSA affiliate has appointed CITGO as its agent in designating which of its affiliates shall from time to time take deliveries of the refined products available to it. The product sales agreement will be in effect for the life of the joint venture, subject to termination events based on default or mutual agreement (Note 4). Pursuant to the above arrangement, CITGO acquired approximately 162 MBPD, 149 MBPD, and 100 MBPD of refined products from HOVENSA during 2004, 2003, and 2002, respectively, approximately one-half of which was gasoline. 3. INVESTMENT IN LYONDELL-CITGO REFINING LP LYONDELL-CITGO Refining LP ("LYONDELL-CITGO") owns and operates a 265 MBPD refinery in Houston, Texas and is owned by subsidiaries of CITGO (41.25%) and Lyondell Chemical Company (58.75%) ("the Owners"). This refinery processes heavy crude oil supplied by PDVSA under a long-term supply contract that expires in 2017. CITGO purchases substantially all of the gasoline, diesel and jet fuel produced at the refinery under a long-term contract (Note 4). As of December 31, 2004 and 2003, CITGO has a note receivable from LYONDELL-CITGO of $35 million. The note bears interest at market rates, which were approximately 2.7 percent and 1.9 percent at December 31, 2004 and 2003. Principal and interest are due in January 1, 2008. Accordingly, the note and related accrued interest are included in the balance sheet caption other assets, noncurrent in the accompanying consolidated balance sheets. In addition, during 2003, CITGO converted $6.8 million of accrued interest related to this note to investments in LYONDELL-CITGO. F-11 CITGO accounts for its investment in LYONDELL-CITGO using the equity method of accounting and records its share of the net earnings of LYONDELL-CITGO based on allocations of income agreed to by the Owners which differ from participation interests. Cash distributions are allocated to the Owners based on participation interest. Information on CITGO's investment in LYONDELL-CITGO follows:
DECEMBER 31, -------------------------------------------- 2004 2003 2002 (000s OMITTED) Carrying value of investment $ 409,782 $ 454,679 $ 518,279 Notes receivable 35,278 35,278 35,278 Participation interest 41% 41% 41% Equity in net income $ 196,889 $ 83,503 $ 77,902 Cash distributions received 270,713 177,799 88,663 Summary of LYONDELL-CITGO's financial position: Current assets $ 359,000 $ 316,000 $ 357,000 Noncurrent assets 1,288,000 1,321,000 1,400,000 Current liabilities: Current portion of long-term debt 5,000 - - Distributions payable to partners 133,000 36,000 181,000 Other 450,000 350,000 333,000 Noncurrent liabilities (including debt of $443,000 at December 31, 2004 and $450,000 at 819,000 828,000 840,000 December 31, 2003 and 2002) Partners' capital 240,000 423,000 403,000 Summary of operating results: Revenue $ 5,603,000 $ 4,162,000 $ 3,392,000 Gross profit 575,000 320,000 299,000 Net income 500,000 228,000 213,000
On May 21, 2004, LYONDELL-CITGO closed on a three-year, $550 million credit facility to replace its expiring $520 million credit facility. The new credit facility is comprised of a $450 million senior secured term loan and a $100 million senior secured revolver, both with an interest rate of the London Interbank Offered Rate ("LIBOR") plus 2.5 percent. The facility is secured by substantially all of the assets of LYONDELL-CITGO and contains covenants that require LYONDELL-CITGO to maintain specified financial ratios. In September 2004, LYONDELL-CITGO obtained an amendment to the new facility which reduces the interest rate to LIBOR plus 2 percent and eases certain financial covenants, including the debt to total capitalization ratio. There was no outstanding balance under the working capital revolving credit facility at December 31, 2004. 4. RELATED PARTY TRANSACTIONS The Company purchases approximately one-half of the crude oil processed in its refineries from subsidiaries of PDVSA under long-term supply agreements and spot purchases. These supply agreements extend through the year 2006 for the Lake Charles refinery, 2010 for the Paulsboro refinery, 2012 for the Corpus Christi refinery and 2013 for the Savannah refinery. The Company purchased $5.8 billion, $4.2 billion, and $3.3 billion of crude oil, feedstocks and other products from wholly owned subsidiaries of PDVSA in 2004, 2003, and 2002, respectively, under these and other purchase agreements. At F-12 December 31, 2004 and 2003, $429 million and $335 million, respectively, were included in payables to affiliates as a result of these transactions. These crude oil supply agreements require PDVSA to supply minimum quantities of crude oil and other feedstocks to CITGO. The supply agreements differ somewhat for each refinery but generally incorporate formula prices based on the market value of a slate of refined products deemed to be produced from each particular grade of crude oil or feedstock, less (i) specified deemed refining costs; (ii) specified actual costs, including transportation charges, actual cost of natural gas and electricity, import duties and taxes; and (iii) a deemed margin, which varies according to the grade of crude oil or feedstock delivered. Under each supply agreement, deemed margins and deemed costs are adjusted periodically by a formula primarily based on the rate of inflation. Because deemed operating costs and the slate of refined products deemed to be produced for a given barrel of crude oil or other feedstock do not necessarily reflect the actual costs and yields in any period, the actual refining margin earned by CITGO under the various supply agreements will vary depending on, among other things, the efficiency with which CITGO conducts its operations during such period. The price CITGO pays for crude oil purchased under these crude oil supply agreements is not directly related to the market price of any other crude oil. Thus there are periods in which the price paid for crude oil purchased under those agreements may be higher or lower than the price that might have been paid in the spot market. The Company also purchases refined products from various other affiliates including LYONDELL-CITGO and HOVENSA, under long-term contracts. These agreements incorporate various formula prices based on published market prices and other factors. Such purchases totaled $6.8 billion, $4.9 billion, and $3.5 billion for 2004, 2003, and 2002, respectively. At December 31, 2004 and 2003, $183 million and $148 million, respectively, were included in payables to affiliates as a result of these transactions. The Company had refined product, feedstock, and other product sales to affiliates, primarily at market-related prices, of $456 million, $387 million, and $277 million in 2004, 2003, and 2002, respectively. At December 31, 2004 and 2003, $107 million and $71 million, respectively, was included in due from affiliates as a result of these and related transactions. Under a separate guarantee of rent agreement, PDVSA has guaranteed payment of rent, stipulated loss value and terminating value due under the lease of the Corpus Christi refinery facilities described in Note 13. The Company has also guaranteed debt of certain affiliates (Note 12). In August 2002, three affiliates entered into agreements to advance cash to CITGO from time to time under demand notes for amounts of up to a maximum of $10 million with PDV Texas, Inc. ("PDV Texas"), $30 million with PDV America and $10 million with PDV Holding, Inc. ("PDV Holding"). The notes bear interest at rates equivalent to 30-day LIBOR plus 0.875%, payable quarterly. At December 31, 2004, the amounts outstanding on these notes were $7 million, $14 million and $5 million from PDV Texas, PDV America and PDV Holding, respectively. There were no amounts outstanding on these notes at December 31, 2003. The Company and PDV Holding are parties to a tax allocation agreement that is designed to provide PDV Holding with sufficient cash to pay its consolidated income tax liabilities. PDV Holding appointed CITGO as its agent to handle the payment of such liabilities on its behalf. As such, CITGO calculates the taxes due, allocates the payments among the members according to the agreement and bills each member accordingly. Each member records its amounts due from or payable to CITGO in a related party payable account. At December 31, 2004 and 2003, CITGO had net related party receivables related to federal income taxes of $28 million and $35 million, respectively, which is included in due from affiliates. F-13 At December 31, 2004, CITGO has federal income tax prepayments of $39 million included in other current assets. At December 31, 2003, CITGO has federal income taxes payable of $5 million included in other current liabilities. 5. ACCOUNTS RECEIVABLE
2004 2003 (000s OMITTED) Trade $ 1,146,274 $ 972,534 Credit card 133,586 93,830 Other 40,745 18,468 ----------- ---------- 1,320,605 1,084,832 Allowance for uncollectible accounts (27,854) (24,499) ----------- ---------- $ 1,292,751 $1,060,333 =========== ==========
Sales are made on account, based on pre-approved unsecured credit terms established by CITGO management. The Company also has a proprietary credit card program which allows commercial customers to purchase fuel at CITGO branded outlets. Allowances for uncollectible accounts are established based on several factors that include, but are not limited to, analysis of specific customers, historical trends, current economic conditions and other information. The Company has a limited purpose consolidated subsidiary, CITGO Funding Company L.L.C. ("CITGO Funding"), which established a non-recourse agreement to sell an undivided interest in specified trade accounts receivables ("pool") to independent third parties. Under the terms of the agreement, new receivables are added to the pool as collections (administered by CITGO) reduce previously sold receivables. CITGO pays specified fees related to its sale of receivables under the program. The outstanding invested amount of the interest sold to third-parties at any one time under the trade accounts receivable sales agreement is limited to a maximum of $275 million (increased from $200 million through an amendment in November 2003). As of December 31, 2004 and 2003, $755 million and $652 million, respectively, of CITGO's accounts receivable comprised the designated pool of trade receivables owned by CITGO Funding. The pool of receivables had a weighted average life of 2.9 and 4.7 days at December 31, 2004 and 2003, respectively. As of December 31, 2004 and 2003, no outstanding investment in the receivables in the designated pool had been sold to the third party and the entire amount of the receivables was retained by CITGO Funding. This retained interest, which is included in receivables, net in the consolidated balance sheets, is recorded at fair value. Due to (i) a short average collection cycle for such trade receivables, (ii) CITGO's positive collection history, and (iii) the characteristics of such trade accounts receivables, the fair value of CITGO's retained interest approximates the total amount of trade accounts receivable reduced by the outstanding invested amount of the third parties in the trade accounts receivable in which interests are sold to the third-party under the facility. CITGO recorded no gains or losses associated with the sales in the years ended December 31, 2004 and 2003 other than the fees incurred by CITGO related to this facility, which were included in other income (expense), net in the consolidated statements of income. Such fees were $4 million, $6 million and $3 million for the years ended December 31, 2004, 2003 and 2002, respectively. The third party's outstanding investments in CITGO trade accounts receivables were never in excess of the sales facility limits at any time under this program. F-14 CITGO is responsible for servicing the transferred receivables for which it receives a monthly servicing fee equal to 1% per annum times the average outstanding amount of receivables in the program for the prior month. Because the servicing fee is an intercompany obligation from CITGO Funding to CITGO, CITGO does not believe that it incurs incremental costs associated with the activity. CITGO has not, on a consolidated basis, recorded any servicing assets or liabilities related to this servicing activity. 6. INVENTORIES
2004 2003 (000s OMITTED) Refined product $ 787,795 $ 686,483 Crude oil 284,301 239,974 Materials and supplies 93,564 91,156 ----------- ------------ $ 1,165,660 $ 1,017,613 =========== ============
At December 31, 2004 and 2003, estimated net market values exceeded historical cost by approximately $1.3 billion and $707 million, respectively. The reduction of hydrocarbon LIFO inventory quantities resulted in a liquidation of prior years' LIFO layers and decreased cost of goods sold by $3 million and $66 million in 2004 and 2003, respectively. 7. PROPERTY, PLANT AND EQUIPMENT
2004 2003 (000s OMITTED) Land $ 132,189 $ 137,010 Buildings and leaseholds 445,224 442,765 Machinery and equipment 5,295,813 4,985,068 Vehicles 13,520 35,209 Construction in process 392,533 300,361 ----------- ----------- 6,279,279 5,900,413 Accumulated depreciation and amortization (2,240,774) (1,993,210) ----------- ----------- $ 4,038,505 $ 3,907,203 =========== ===========
Depreciation expense for 2004, 2003, and 2002 was $258 million, $237 million, and $223 million, respectively. Net losses on disposals and retirements of property, plant and equipment were approximately $4 million, $3 million, and $5 million in 2004, 2003, and 2002, respectively. F-15 8. INVESTMENTS IN AFFILIATES In addition to LYONDELL-CITGO, the Company's investments in affiliates consist primarily of equity interests of 6.8 percent to 50 percent in joint interest pipelines and terminals, including a 15.79 percent interest in Colonial Pipeline Company; a 49.5 percent partnership interest in Nelson Industrial Steam Company ("NISCO"), which is a qualified cogeneration facility; and a 49 percent partnership interest in Mount Vernon Phenol Plant. The carrying value of these investments exceeded the Company's equity in the underlying net assets by approximately $121 million and $125 million at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, NISCO had a partnership deficit. CITGO's share of this deficit, as a general partner, was $23 million and $31 million at December 31, 2004 and 2003, respectively, which is included in other noncurrent liabilities in the accompanying consolidated balance sheets. Information on the Company's investments, including LYONDELL-CITGO, follows:
DECEMBER 31, --------------------------------- 2004 2003 2002 (000s OMITTED) Company's investments in affiliates (excluding NISCO) $ 580,647 $ 647,649 $ 716,469 Company's equity in net income of affiliates 242,108 118,268 101,326 Dividends and distributions received from affiliates 313,721 218,338 123,639
Selected financial information provided by the affiliates is summarized as follows:
DECEMBER 31, ------------------------------------------------ 2004 2003 2002 (000s OMITTED) Summary of financial position: Current assets $ 705,057 $ 636,379 $ 740,019 Noncurrent assets 3,253,469 3,372,509 3,396,209 Current liabilities (including debt of $175,870, $43,902 and $52,417 at December 31, 2004, 2003, and 2002, respectively) 1,099,324 778,974 846,623 Noncurrent liabilities (including debt of $1,940,898, $2,121,018 and $2,185,502 at December 31, 2004, 2003, and 2002, respectively) 2,702,698 2,830,317 2,863,505 Summary of operating results: Revenues $ 7,630,497 $ 5,909,974 $4,906,397 Gross profit 1,194,205 918,327 879,907 Net income 802,436 504,548 449,779
F-16 9. LONG-TERM DEBT AND FINANCING ARRANGEMENTS
2004 2003 (000s OMITTED) Senior Secured Term Loan, due 2006 with variable interest rate $ - $ 200,000 Senior Notes, $250 million face amount, due 2011 interest rate of 6% 248,299 - Senior Notes, $200 million face amount, due 2006 with interest rate of 7-7/8% 149,969 149,946 Senior Notes, $550 million face amount, due 2011 with interest rate of 11-3/8% 6,613 546,949 Private Placement Senior Notes, due 2004 to 2006 with an interest rate of 9.30% 22,727 34,091 Master Shelf Agreement Senior Notes, due 2004 to 2009 with interest rates from 7.17% to 8.94% 165,000 185,000 Tax-Exempt Bonds, due 2004 to 2033 with variable and fixed interest rates 459,283 332,478 Taxable Bonds, due 2026 to 2028 with variable interest rates 80,000 25,000 ------------- ------------ 1,131,891 1,473,464 Current portion of long-term debt (11,364) (31,364) ------------- ------------ $ 1,120,527 $ 1,442,100 ============= ============
REVOLVING BANK LOANS - The Company has a $260 million, three-year, unsecured revolving bank loan maturing in December 2005. There was no outstanding balance under this credit agreement at December 31, 2004 and 2003. SENIOR SECURED TERM LOAN - The Company had a senior secured term loan under an agreement with a syndication of various lenders. The senior loan was secured by CITGO's equity interest in two pipeline companies. CITGO retired the senior loan on June 25, 2004. The costs to retire the senior loan prior to the maturity date of February 2006 included a prepayment charge of $4 million. SHELF REGISTRATION - SENIOR NOTES - In October 2004, the Company issued $250 million of 6% unsecured senior notes due October 15, 2011. In connection with this transaction, CITGO repurchased approximately $543 million principal amount of its 11-3/8% senior notes due 2011 as part of a tender offer for such notes. CITGO recorded, as charges to interest expense, a $121.9 million tender premium, $10.6 million unamortized fees and $2.7 million unamortized discounts. In February 2003, the Company issued $550 million aggregate principal amount of 11-3/8% unsecured senior notes due February 1, 2011. In connection with this debt issuance, CITGO redeemed $50 million principal amount of its 7-7/8% senior notes due 2006. After the tender offer for the 11-3/8% notes in October 2004, approximately $6.6 million remain outstanding at December 31, 2004. F-17 In April 1996, the Company filed a registration statement with the Securities and Exchange Commission relating to the shelf registration of $600 million of debt securities. In May 1996, CITGO issued $200 million aggregate principle amount of 7-7/8% unsecured senior notes due 2006. Due to CITGO's credit ratings, the shelf registration is not presently available. PRIVATE PLACEMENT - At December 31, 2004, the Company has outstanding approximately $23 million of privately placed, unsecured Senior Notes. Principal amounts are payable in annual installments in November and interest is payable semiannually in May and November. MASTER SHELF AGREEMENT - At December 31, 2004, the Company has outstanding $165 million of privately-placed senior notes under an unsecured Master Shelf Agreement with an insurance company. The notes have various fixed interest rates and maturities. COVENANTS - The various debt agreements above contain certain covenants that, depending upon the level of the Company's capitalization and earnings, could impose limitations on the Company's ability to pay dividends, incur additional debt, place liens on property, and sell fixed assets. The Company's debt instruments described above do not contain any covenants that trigger prepayment or increased costs as a result of a change in its debt ratings. The Company was in compliance with the debt covenants at December 31, 2004. TAX-EXEMPT BONDS - At December 31, 2004, through state entities, CITGO has outstanding $196 million of industrial development bonds for certain Lake Charles, Corpus Christi and Lemont port facilities and pollution control equipment and $263 million of environmental revenue bonds to finance a portion of the Company's environmental facilities at its Lake Charles, Corpus Christi and Lemont refineries and at the LYONDELL-CITGO refinery. The bonds bear interest at various fixed and floating rates, which ranged from 2.2 percent to 8.0 percent at December 31, 2004 and ranged from 2.1 percent to 8.3 percent at December 31, 2003. Additional credit support for the variable rate bonds is provided through letters of credit. TAXABLE BONDS - At December 31, 2004, through a state entity, the Company has outstanding $80 million of taxable environmental revenue bonds to finance a portion of the environmental facilities at the Lake Charles refinery. Such bonds are secured by letter of credit and have a floating interest rate (ranged from 2.3 percent to 2.4 percent at December 31, 2004 and 2.3 percent at December 31, 2003). At the option of the Company and upon the occurrence of certain specified conditions, all or any portion of such taxable bonds may be converted to tax-exempt bonds. During 2004 and 2002, $35 million and $31 million of originally issued taxable bonds were converted to tax-exempt bonds. There were no taxable bonds converted to tax-exempt bonds during 2003. DEBT MATURITIES - Future maturities of long-term debt as of December 31, 2004, are: 2005 - $11.4 million, 2006 - $201.3 million, 2007 - $61.8 million, 2008 - $44.9 million, 2009 - $50 million and $762.5 million thereafter. F-18 INTEREST RATE SWAP AGREEMENTS - The Company has entered into the following interest rate swap agreements to reduce the impact of interest rate changes on its variable interest rate debt:
NOTIONAL PRINCIPAL AMOUNT -------------------------- EXPIRATION FIXED RATE 2004 2003 VARIABLE RATE INDEX DATE PAID (000s OMITTED) J.J. Kenny February 2005 5.30% $ 12,000 $ 12,000 J.J. Kenny February 2005 5.27% 15,000 15,000 J.J. Kenny February 2005 5.49% 15,000 15,000 ----------- --------- $ 42,000 $ 42,000 =========== =========
Effective January 1, 2001, changes in the fair value of these agreements are recorded in other income (expense). The fair value of these agreements at December 31, 2004, based on the estimated amount that CITGO would receive or pay to terminate the agreements as of that date and taking into account current interest rates, was a loss of approximately $400 thousand, the offset of which is recorded in the balance sheet caption other current liabilities. 10. EMPLOYEE BENEFIT PLANS EMPLOYEE SAVINGS - CITGO sponsors three qualified defined contribution retirement and savings plans covering substantially all eligible salaried and hourly employees. Participants make voluntary contributions to the plans and CITGO makes contributions, including matching of employee contributions, based on plan provisions. CITGO expensed $22 million, $22 million and $23 million related to its contributions to these plans in 2004, 2003 and 2002, respectively. PDV Midwest Refining, L.L.C. ("PDVMR") is a subsidiary of CITGO. It sponsors a defined contribution plan. This plan was frozen as of May 1, 1997 and no further contributions to the plan could be made after that date and there will be no new participants in the plan. PENSION BENEFITS - CITGO sponsors three qualified noncontributory defined benefit pension plans, two covering eligible hourly employees and one covering eligible salaried employees. CITGO also sponsors three nonqualified defined benefit plans for certain eligible employees. In 2003, CITGO offered an enhanced retirement program to eligible salaried and hourly employees. Approximately $21 million of incremental pension benefits were expensed under this program. PDVMR sponsors a qualified and a nonqualified plan, frozen at their then current levels on April 30, 1997. The plans cover former employees of the partnership who were participants in the plans as of April 30, 1997. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS - In addition to pension benefits, CITGO also provides certain health care and life insurance benefits for eligible salaried and hourly employees at retirement. These benefits are subject to deductibles, copayment provisions and other limitations and are primarily funded on a pay-as-you-go basis. CITGO reserves the right to change or to terminate the benefits at any time. F-19 OBLIGATIONS AND FUNDED STATUS - December 31 is the measurement date used to determine pension and other post retirement benefit measurements for the plans. The following sets forth the changes in benefit obligations and plan assets for the CITGO and PDVMR pension and the CITGO postretirement plans for the years ended December 31, 2004 and 2003, and the funded status of such plans reconciled with amounts reported in the Company's consolidated balance sheets:
PENSION BENEFITS OTHER BENEFITS ------------------------------ ---------------------------- 2004 2003 2004 2003 (000s OMITTED) (000s OMITTED) CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 515,900 $ 449,655 $ 414,525 $ 334,151 Service cost 22,972 19,901 9,139 8,800 Interest cost 31,814 29,330 23,069 22,223 Amendments - (8,764) - (4,020) Actuarial liability (gain) loss 34,915 39,183 (18,331) 62,320 Plan merger/acquisitions - 5,337 - - Curtailment loss - - 381 - Benefits paid (19,439) (18,742) (10,666) (8,949) ------------- ----------- ------------ ------------ Benefit obligation at end of year 586,162 515,900 418,117 414,525 ------------- ----------- ------------ ------------ CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year 343,341 290,594 1,173 1,182 Actual return on plan assets 34,549 59,519 52 (9) Plan merger/acquisitions - 4,594 - - Employer contribution 44,130 23,747 10,666 8,949 Benefits paid (19,439) (18,742) (10,666) (8,949) Enhanced retirement program benefits paid (4,670) (16,371) - - ------------- ----------- ------------ ------------ Fair value of plan assets at end of year 397,911 343,341 1,225 1,173 ------------- ----------- ------------ ------------ Funded status (188,251) (172,559) (416,892) (413,352) Unrecognized net actuarial loss 120,472 89,564 49,503 87,461 Unrecognized prior service cost (5,299) (6,070) (3,318) (4,020) Unrecognized net asset (59) (104) - - ------------- ----------- ------------ ------------ Net amount recognized $ (73,137) $ (89,169) $ (370,707) $ (329,911) ============= =========== ============ ============ Amounts recognized in the Company's consolidated balance sheets consist of: Accrued benefit liability $ (109,812) $ (114,250) $ (370,707) $ (329,911) Intangible asset 6,144 - - - Accumulated other comprehensive income 30,531 25,081 - - ------------- ----------- ------------ ------------ Net amount recognized $ (73,137) $ (89,169) $ (370,707) $ (329,911) ============= =========== ============ ============
The accumulated benefit obligation for all defined benefit plans was $500 million and $435 million at December 31, 2004 and 2003, respectively. F-20 COMPONENTS OF NET PERIODIC BENEFIT COST
PENSION BENEFITS OTHER BENEFITS ------------------------------------------- ---------------------------------- 2004 2003 2002 2004 2003 2002 (000s OMITTED) (000s OMITTED) Components of net periodic benefit cost: Service cost $ 22,972 $ 19,901 $ 17,171 $ 9,139 $ 8,800 $ 7,191 Interest cost 31,814 29,330 27,880 23,069 22,223 18,603 Expected return on plan assets (29,142) (26,254) (30,293) (70) (71) (67) Amortization of prior service cost (771) (766) 350 (521) - - Amortization of net gain at date of adoption (46) (152) (268) - - - Recognized net actuarial loss 3,271 3,224 534 19,645 50,145 11,288 ---------- ---------- ---------- -------- --------- -------- Net periodic benefit cost $ 28,098 $ 25,283 $ 15,374 $ 51,262 $ 81,097 $ 37,015 ========== ========== ========== ======== ========= ========
Actuarial gains (or losses) related to the postretirement benefit obligation are recognized as a component of net postretirement benefit cost by the amount the beginning of year unrecognized net gain (or loss) exceeds 7.5 percent of the accumulated postretirement benefit obligation. ADDITIONAL INFORMATION
PENSION BENEFITS OTHER BENEFITS ------------------- -------------- 2004 2003 2004 2003 WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AT DECEMBER 31: Discount rate 5.75% 6.25% 5.75% 6.25% Rate of compensation increase 4.48% 4.46% 4.48% 4.50%
PENSION BENEFITS OTHER BENEFITS ------------------- -------------- 2004 2003 2004 2003 WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COSTS FOR THE YEARS ENDED DECEMBER 31: Discount rate 6.25% 6.75% 6.25% 6.75% Expected long-term return on plan assets 8.25% 8.50% 6.00% 6.00% Rate of compensation increase 4.48% 5.00% 4.50% 5.00%
CITGO's expected long-term rate of return on plan assets is intended to generally reflect the historical returns of the assets in its investment portfolio. The weighted average return at December 31, 2004 on indices representing CITGO's investment portfolio is 8.99% over the past 10 years and 8.32% over the past 15 years. For measurement purposes, a 10 percent pre-65 and an 11 percent post-65 annual rate of increase in the per capita cost of covered health care benefits was assumed for 2004. These rates are assumed to increase by 10 percent in 2005 for both pre-65 and post-65 and then to decrease 1 percent per year to an ultimate level of 5 percent by 2010, and to remain at that level thereafter. F-21 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
1-PERCENTAGE- 1-PERCENTAGE- POINT INCREASE POINT DECREASE -------------- -------------- (000s OMITTED) Increase (decrease) in total of service and interest cost components $ 6,119 $ (4,820) Increase (decrease) in postretirement benefit obligation 70,948 (56,607)
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("Medicare Reform") was signed into law. Medicare Reform introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a non-taxable federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB Staff issued FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003". The Staff Position permits a sponsor to report the effects of Medicare Reform prospectively in the third quarter of 2004 or retrospectively to the measurement date following enactment of the legislation. CITGO has chosen to use the retrospective method to reflect Medicare Reform as of January 1, 2004. The effect of this legislation at that date was to reduce the benefit obligation by approximately $40 million. The service cost and interest cost components of that reduction total approximately $3 million. Under CITGO's accounting policy for recognizing actuarial gains, net periodic benefit cost for the year ended December 31, 2004 has been reduced $40 million related to this actuarial gain. CASH FLOWS
OTHER BENEFITS ----------------------------------- GROSS BENEFIT IMPLIED MEDICARE PENSION BENEFITS PAYMENTS SUBSIDY ---------------- ------------- ---------------- (000s OMITTED) Expected employer contributions for the year ended December 31, 2005 $ 12,453 $ 12,289 Expected benefit payments for the years ended December 31: 2005 $ 17,095 $ 12,289 - 2006 $ 18,451 $ 14,035 $ 850 2007 $ 20,047 $ 15,784 $ 993 2008 $ 22,097 $ 17,588 $ 1,150 2009 $ 24,517 $ 19,693 $ 1,300 Five years thereafter $ 171,557 $ 126,703 $ 9,272
F-22 PLAN ASSETS The qualified plans' assets include:
PERCENTAGE OF PLAN ASSETS AS OF DECEMBER 31, ------------------------- TARGET ALLOCATION 2004 2003 ---------- ---------- ---------- ASSET CATEGORY: Equity 56% - 66% 63.12% 62.15% Fixed income 34% - 44% 36.08% 37.27% Other 0% - 5% 0.80% 0.58% ------ ------ 100.00% 100.00% ====== ======
The investment return objective for these assets is to achieve returns that meet or exceed the actuarial discount rate over time. This is to be accomplished using a well-diversified portfolio structure. The Company periodically reviews the asset allocation to determine whether it remains appropriate for achieving the investment return objective. CONTRIBUTIONS - CITGO's policy is to fund the qualified pension plans in accordance with applicable laws and regulations and not to exceed the tax deductible limits. CITGO estimates that it will contribute $12 million to these plans in 2005. The nonqualified plans are funded as necessary to pay retiree benefits. The plan benefits for each of the qualified pension plans are primarily based on an employee's years of plan service and compensation as defined by each plan. CITGO's policy is to fund its postretirement benefits other than pension obligation on a pay-as-you-go basis. CITGO estimates that it will contribute $12 million to these plans in 2005. F-23 11. INCOME TAXES The provisions for income taxes are comprised of the following:
2004 2003 2002 (000s OMITTED) Current: Federal $ 301,184 $ 86,139 $ 47,087 State 7,584 1,924 751 Foreign 174 70 222 --------- --------- --------- 308,942 88,133 48,060 Deferred (10,519) 157,303 47,813 --------- --------- --------- $ 298,423 $ 245,436 $ 95,873 ========= ========= =========
The federal statutory tax rate differs from the effective tax rate due to the following:
2004 2003 2002 Federal statutory tax rate 35.0% 35.0% 35.0% State taxes, net of federal benefit 0.8% 1.3% 2.4% Dividend exclusions (1.2)% (1.4)% (3.0)% Medicare subsidy (1.5)% - - Other (0.8)% 1.0% 0.4% ---- ---- ---- Effective tax rate 32.3% 35.9% 34.8% ==== ==== ====
Deferred income taxes reflect the net tax effects of (i) temporary differences between the financial and tax bases of assets and liabilities, and (ii) loss and tax credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability as of December 31, 2004 and 2003 are as follows:
2004 2003 (000s OMITTED) Deferred tax liabilities: Property, plant and equipment $ 817,973 $ 779,481 Inventories 79,327 95,495 Investments in affiliates 200,090 192,458 Other 172,841 155,646 ---------- ---------- 1,270,231 1,223,080 ---------- ---------- Deferred tax assets: Postretirement benefit obligations 154,530 124,272 Employee benefit accruals 92,726 58,345 Other 71,690 75,281 ---------- ---------- 318,946 257,898 ---------- ---------- Net deferred tax liability (of which $11,986 and $5,375 is included in current liabilities at December 31, 2004 and 2003, respectively.) $ 951,285 $ 965,182 ========== ==========
F-24 12. COMMITMENTS AND CONTINGENCIES LITIGATION AND INJURY CLAIMS - Various lawsuits and claims arising in the ordinary course of business are pending against CITGO. CITGO records accruals for potential losses when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to CITGO, and in amounts greater than CITGO's accruals, then such determinations could have a material adverse effect on CITGO's results of operations in a given reporting period. The most significant lawsuits and claims are discussed below. In September 2002, a Texas court ordered CITGO to pay property owners and their attorneys approximately $6 million based on an alleged settlement of class action property damage claims as a result of alleged air, soil and groundwater contamination from emissions released from CITGO's Corpus Christi, Texas refinery. CITGO has appealed the ruling to the Texas Court of Appeals. CITGO, along with most of the other major oil companies, is a defendant in a number of federal and state lawsuits alleging contamination of private and public water supplies by methyl tertiary butyl ether ("MTBE"), a gasoline additive. In general, the plaintiffs claim that MTBE renders the water not potable. In addition to compensatory and punitive damages, plaintiffs seek injunctive relief to abate the contamination. CITGO intends to defend all of the MTBE lawsuits vigorously. CITGO's MTBE litigation can be divided into two categories--pre and post-September 30, 2003 litigation. Of the pre-September 30, 2003 cases, CITGO is defending itself in Madison County, Illinois state court and in a New York county state court. As of early October 2004, settlements in principle had been reached in both Madison County, Illinois cases and one of the cases has been settled subsequent to year-end. There will be no effect on results of operations because the accrual for these cases was adequate. The post-September 30, 2003 cases were filed after new federal legislation was proposed that would have precluded plaintiffs from filing lawsuits based on the theory that gasoline with MTBE is a defective product. These approximately 72 cases, the majority of which were filed by municipal authorities, were removed to federal court and at the defendants' request consolidated in Multi-District Litigation ("MDL") 1358. On March 16, 2004, the judge in MDL 1358 denied the plaintiffs' motion to remand the cases to state court. Subsequently, the judge denied the plaintiffs' motion to certify her rulings on the remand motion for an interlocutory appeal. It is not possible to estimate the loss or range of loss, if any, related to these cases. Claims have been made against CITGO in approximately 350 asbestos lawsuits pending in state and federal courts. These cases, most of which involve multiple defendants, are brought by former employees or contractor employees seeking damages for asbestos related illnesses allegedly caused, at least in part, from exposure at refineries owned or operated by CITGO in Lake Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois. In many of these cases, the plaintiffs' alleged exposure occurred over a period of years extending back to a time before CITGO owned or operated the premises at issue. CITGO does not believe that the resolution of these cases will have a material adverse effect on its financial condition or results of operations. In 2001, Miami-Dade County sued seventeen defendants for the costs of remediation of pollution rising from jet fuel operations during the past decades at the Miami International Airport ("the Airport"). Although not a defendant in this case, CITGO along with approximately 250 other former jet fuel operators at the Airport has received a payment demand from Miami-Dade County for the remediation costs for alleged pollution occurring while CITGO had jet fuel operations at the Airport. CITGO is exploring settlement discussions with Miami-Dade County. CITGO is contesting the amount of damages that Miami-Dade County claims are attributed CITGO's jet fuel operations at the Airport and will vigorously defend itself should no settlement be reached. CITGO does not believe that the resolution of this matter will have a material adverse effect on its financial condition or results of operations. F-25 At December 31, 2004, CITGO's balance sheet included an accrual for lawsuits and claims of $24 million compared with $27 million at December 31, 2003. CITGO estimates that an additional loss of $35 million is reasonably possible in connection with such lawsuits and claims. ENVIRONMENTAL COMPLIANCE AND REMEDIATION - CITGO is subject to the federal Clean Air Act ("CAA"), which includes the New Source Review ("NSR") program as well as the Title V air permitting program; the federal Clean Water Act, which includes the National Pollution Discharge Elimination System program; the Toxic Substances Control Act; and the federal Resource Conservation and Recovery Act and their equivalent state programs. CITGO is required to obtain permits under all of these programs and believes it is in material compliance with the terms of these permits. CITGO does not have any material Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") liability because the former owners of many of CITGO's assets have by explicit contractual language assumed all or the material portion of CERCLA obligations related to those assets. This includes the Lake Charles refinery and the Lemont refinery. The U.S. refining industry is required to comply with increasingly stringent product specifications under the 1990 Clean Air Act Amendments for reformulated gasoline and low sulfur gasoline and diesel fuel that require additional capital and operating expenditures, and alters significantly the U.S. refining industry and the return realized on refinery investments. In addition, CITGO is subject to various other federal, state and local environmental laws and regulations that may require CITGO to take additional compliance actions and also actions to remediate the effects on the environment of prior disposal or release of petroleum, hazardous substances and other waste and/or pay for natural resource damages. Maintaining compliance with environmental laws and regulations could require significant capital expenditures and additional operating costs. Also, numerous other factors affect CITGO's plans with respect to environmental compliance and related expenditures. CITGO's accounting policy establishes environmental reserves as probable site restoration and remediation obligations become reasonably capable of estimation. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, to the extent required, will be made as more refined information becomes available. CITGO believes the amounts provided in its consolidated financial statements, as prescribed by generally accepted accounting principles, are adequate in light of probable and estimable liabilities and obligations. However, there can be no assurance that the actual amounts required to discharge alleged liabilities and obligations and to comply with applicable laws and regulations will not exceed amounts provided for or will not have a material adverse affect on CITGO's consolidated results of operations, financial condition and cash flows. In 1992, CITGO reached an agreement with the Louisiana Department of Environmental Quality ("LDEQ") to cease usage of certain surface impoundments at the Lake Charles refinery by 1994. A mutually acceptable closure plan was filed with the LDEQ in 1993. The remediation commenced in December 1993. CITGO is complying with a June 2002 LDEQ administrative order about the development and implementation of a corrective action or closure plan. CITGO and the former owner of the refinery are participating in the closure and sharing the related costs based on estimated contributions of waste and ownership periods. CITGO's Corpus Christi, Texas refinery and current and former employees are being investigated by state and federal agencies for alleged criminal violations of federal environmental statutes and regulations, including the CAA and the Migratory Bird Act. CITGO is cooperating with the investigation. CITGO believes that it has defenses to any such charges. At this time, CITGO cannot predict the outcome of or the amount or range of any potential loss that would ensue from any such charges. F-26 In June 1999, CITGO and numerous other industrial companies received notice from the United States Environmental Protection Agency ("U.S. EPA") that the U.S. EPA believes these companies have contributed to contamination in the Calcasieu Estuary, near Lake Charles, Louisiana and are potentially responsible parties ("PRPs") under CERCLA. The U.S. EPA made a demand for payment of its past investigation costs from CITGO and other PRPs and since 1999 has been conducting a remedial investigation/feasibility study ("RI/FS") under its CERCLA authority. While CITGO disagrees with many of the U.S. EPA's earlier allegations and conclusions, CITGO and other industrial companies signed in December 2003, a Cooperative Agreement with the LDEQ on issues relative to the Bayou D'Inde tributary section of the Calcasieu Estuary, and the companies are proceeding with a Feasibility Study Work Plan. CITGO will continue to deal separately with the LDEQ on issues relative to its refinery operations on another section of the Calcasieu Estuary. The Company still intends to contest this matter if necessary. In January and July 2001, CITGO received notices of violation ("NOVs") from the U.S. EPA alleging violations of the CAA. The NOVs are an outgrowth of an industry-wide and multi-industry U.S. EPA enforcement initiative alleging that many refineries, electric utilities and other industrial sources modified air emission sources. Without admitting any violation CITGO reached a settlement with the United States and the states of Louisiana, Illinois, New Jersey, and Georgia. A Consent Decree was approved in the District court for the Southern District of Texas in January 2005. The Consent Decree requires the implementation of control equipment at CITGO's refineries and a Supplemental Environment Project at CITGO's Corpus Christi, Texas refinery. CITGO estimates that the costs of the settlement could range up to $325 million which includes a civil penalty of $3.6 million, split between the U.S. EPA and the states. CITGO accrued for the civil penalty during 2003 and paid it in February 2005. The capital costs will be incurred over a period of time, primarily between 2004 and 2009. In June 1999, an NOV was issued by the U.S. EPA alleging violations of the National Emission Standards for Hazardous Air Pollutants regulations covering benzene emissions from wastewater treatment operations at CITGO's Lemont, Illinois refinery. This matter has been consolidated with the matters described in the previous paragraph. In June 2002, a Consolidated Compliance Order and Notice of Potential Penalty was issued by the LDEQ alleging violations of the Louisiana air quality regulations at CITGO's Lake Charles, Louisiana refinery during 2001. The majority of the alleged violations related to the leak detection and repair program. This matter has been consolidated with the matters described in the previous paragraph related to the U.S. EPA's enforcement initiative. In October 2004, the New Jersey Land Trust voted to reject the donation by CITGO of a conservation easement covering the 365 acre Petty's Island, which is located in the Delaware River in Pennsauken, New Jersey and owned by CITGO. Petty's Island contains a CITGO closed petroleum terminal and other industrial facilities, but it is also the habitat for the bald eagle and other wildlife. The City of Pennsauken through a private developer wants to condemn Petty's Island through eminent domain and to redevelop Petty's Island into residential and commercial uses. The granting of the conservation easement would have mitigated the amount of remediation that CITGO would have to perform on Petty's Island. The ultimate outcome cannot be determined at this time. At December 31, 2004, CITGO's balance sheet included an environmental accrual of $65 million compared with $63 million at December 31, 2003. Results of operations reflect an increase in the accrual during 2004 due primarily to a revision of the Company's estimated share of costs related to two sites indicating higher costs offset in part, by spending on environmental projects. CITGO estimates that an additional loss of $33 million is reasonably possible in connection with environmental matters. Various regulatory authorities have the right to conduct, and from time to time do conduct, environmental compliance audits or inspections of CITGO and its subsidiaries' facilities and operations. Those F-27 compliance audits or inspections have the potential to reveal matters that those authorities believe represent non-compliance in one or more respects with regulatory requirements and for which those authorities may seek corrective actions and/or penalties in an administrative or judicial proceeding. Based upon current information, CITGO does not believe that any such prior compliance audit or inspection or any resulting proceeding will have a material adverse effect on its future business and operating results, other than matters described above. Conditions which require additional expenditures may exist with respect to CITGO's various sites including, but not limited to, its operating refinery complexes, former refinery sites, service stations and crude oil and petroleum product storage terminals. Based on currently available information, CITGO cannot determine the amount of any such future expenditures. Increasingly stringent environmental regulatory provisions and obligations periodically require additional capital expenditures. During 2004, CITGO spent approximately $113 million for environmental and regulatory capital improvements in its operations. Management currently estimates that CITGO will spend approximately $1.1 billion for environmental and regulatory capital projects over the five-year period 2005-2009. These estimates may vary due to a variety of factors. SUPPLY AGREEMENTS - The Company purchases the crude oil processed at its refineries and also purchases refined products to supplement the production from its refineries to meet marketing demands and resolve logistical issues. In addition to supply agreements with various affiliates (Notes 2 and 4), the Company has various other crude oil, refined product and feedstock purchase agreements with unaffiliated entities with terms ranging from monthly to annual renewal. The Company believes these sources of supply are reliable and adequate for its current requirements. THROUGHPUT AGREEMENTS - The Company has throughput agreements with certain pipeline affiliates (Note 8). These throughput agreements may be used to secure obligations of the pipeline affiliates. Under these agreements, the Company may be required to provide its pipeline affiliates with additional funds through advances against future charges for the shipping of petroleum products. The Company currently ships on these pipelines and has not been required to advance funds in the past. At December 31, 2004, the Company has no fixed and determinable, unconditional purchase obligations under these agreements. COMMODITY DERIVATIVE ACTIVITY - As of December 31, 2004 the Company's petroleum commodity derivatives included exchange traded futures contracts, forward purchase and sale contracts, exchange traded and over-the-counter options, and over-the-counter swaps. At December 31, 2004 and 2003, the balance sheet captions other current assets and other current liabilities include the following amounts related to the fair values of open commodity derivatives:
2004 2003 ------- ------- (000S OMITTED) Other current asset $16,046 $16,368 Other current liabilities 14,145 5,714
F-28 GUARANTEES - As of December 31, 2004, the Company has guaranteed the debt of others in a variety of circumstances including letters of credit issued for an affiliate, bank debt of an equity investment, bank debt of customers, customer debt related to the acquisition of marketing equipment and financing debt incurred by an equity investment as shown in the following table: Expiration Date --------- (000s omitted) Letters of credit $ 32,981 2005 Bank debt Equity investment 5,500 none Customers 1,494 2006 Financing debt of customers Customer equipment acquisition 272 2005-2007 Equipment acquisition - NISCO 9,550 2008 --------- Total $ 49,797 ========= In each case, if the debtor fails to meet its obligation, CITGO could be obligated to make the required payment. The Company has not recorded any amounts on the Company's balance sheet relating to these guarantees. In the event of debtor default on the letters of credit, CITGO has been indemnified by PDV Holding, Inc., the direct parent of PDV America, which is CITGO's direct parent. In the event of debtor default on the equity investment bank debt, CITGO has no recourse. In the event of debtor default on customer bank debt, CITGO generally has recourse to personal guarantees from principals or liens on property. In the event of debtor default on financing debt incurred by customers, CITGO would receive an interest in the equipment being financed after making the guaranteed debt payment. In the event of debtor default on financing debt incurred by an equity investee, CITGO has no recourse. CITGO has granted indemnities to the buyers in connection with past sales of product terminal facilities. These indemnities provide that CITGO will accept responsibility for claims arising from the period in which CITGO owned the facilities. Due to the uncertainties in this situation, the Company is not able to estimate a liability relating to these indemnities. The Company has not recorded a liability on its balance sheet relating to product warranties because historically, product warranty claims have not been significant. OTHER CREDIT AND OFF-BALANCE SHEET RISK INFORMATION AS OF DECEMBER 31, 2004 - The Company has outstanding letters of credit totaling approximately $415 million, which includes $409 million related to CITGO's tax-exempt and taxable revenue bonds (Note 9). The Company has also acquired surety bonds totaling $57 million primarily due to requirements of various government entities. The Company does not expect liabilities to be incurred related to such letters of credit or surety bonds. Neither the Company nor the counterparties are required to collateralize their obligations under interest rate swaps or over-the-counter derivative commodity agreements. The Company is exposed to credit loss in the F-29 event of nonperformance by the counterparties to these agreements. The Company does not anticipate nonperformance by the counterparties, which consist primarily of major financial institutions. Management considers the credit risk to the Company related to its commodity and interest rate derivatives to be insignificant during the periods presented. 13. LEASES The Company leases certain of its Corpus Christi refinery facilities under a capital lease. The basic term of the lease expired on January 1, 2004; however, the Company renewed the lease for a two year term and may continue to renew the lease until January 31, 2011, the date of its option to purchase the facilities for a nominal amount. A portion of an operating unit at the Corpus Christi refinery is also considered a capital lease. The basic term of the lease expires on February 1, 2009 at which time the Company may purchase the leased unit for a nominal amount. A portion of the Lemont refinery's assets are under two separate capital leases. The leases expire on July 1, 2008 and August 1, 2032. Capitalized costs included in property, plant and equipment related to the leased assets were approximately $238 million at December 31, 2004 and $215 million at December 31, 2003. Accumulated amortization related to the leased assets was approximately $152 million and $143 million at December 31, 2004 and 2003, respectively. Amortization is included in depreciation expense. The Company also has various noncancelable operating leases, primarily for product storage facilities, office space, computer equipment, vessels and vehicles. Rent expense on all operating leases totaled $122 million in 2004, $116 million in 2003, and $102 million in 2002. Future minimum lease payments for the capital lease and noncancelable operating leases are as follows:
CAPITAL OPERATING LEASE LEASES TOTAL YEAR (000s OMITTED) 2005 $ 8,309 $ 100,169 $ 108,478 2006 8,309 61,310 69,619 2007 8,309 32,449 40,758 2008 8,098 21,098 29,196 2009 7,089 5,619 12,708 Thereafter 32,703 24,788 57,491 --------- --------- --------- Total minimum lease payments 72,817 $ 245,433 $ 318,250 Amount represents interest (24,658) ========= ========= --------- Present value of lease payments 48,159 Current portion (4,404) --------- $ 43,755 =========
F-30 14. FAIR VALUE INFORMATION The following estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The carrying amounts of cash equivalents approximate fair values. The carrying amounts and estimated fair values of the Company's other financial instruments are as follows:
2004 2003 ------------------------ ------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE (000s OMITTED) (000s OMITTED) LIABILITIES: Long-term debt $1,131,891 $ 1,160,971 $ 1,473,464 $ 1,605,835 DERIVATIVE AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - UNREALIZED LOSSES: Interest rate swap agreements (388) (388) (2,106) (2,106) Guarantees of debt - (1,782) - (1,805) Letters of credit - (12,855) - (7,664) Surety bonds - (331) - (422)
LONG-TERM DEBT - The fair value of long-term debt is based on interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities. INTEREST RATE SWAP AGREEMENTS - The fair value of these agreements is based on the estimated amount that the Company would receive or pay to terminate the agreements at the reporting dates, taking into account current interest rates and the current creditworthiness of the counterparties. GUARANTEES, LETTERS OF CREDIT AND SURETY BONDS - The estimated fair value of contingent guarantees of third-party debt, letters of credit and surety bonds is based on fees currently charged for similar one-year agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting dates. The fair value estimates presented herein are based on pertinent information available to management as of the reporting dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein. F-31 15. INSURANCE RECOVERIES On August 14, 2001, a fire occurred at the crude oil distillation unit of the Lemont refinery. A new crude unit was operational at the end of May 2002. On September 21, 2001, a fire occurred at the hydrocracker unit of the Lake Charles refinery. Operations at the hydrocracker resumed on November 22, 2001. The Company recognizes property damage insurance recoveries in excess of the amount of recorded losses and related expenses, and business interruption insurance recoveries when such amounts are realized. During the years ended December 31, 2003 and 2002, the Company recorded $146 million and $407 million of insurance recoveries primarily related to these fires. The Company received cash proceeds of $146 million and $442 million during the years ended December 31, 2003 and 2002, respectively. In July 2003, the Company received the final payment related to the Lemont fire. 16. CORPORATE HEADQUARTERS RELOCATION In April 2004, CITGO announced its decision to move its corporate headquarters from Tulsa, Oklahoma to Houston, Texas. The transfer of approximately 700 positions from a total of approximately 1,000 positions in Tulsa began in August 2004. At December 31, 2004, 244 positions have been transferred. The relocation is expected to be complete in July 2005. A summary of relocation costs follows:
Expected Amount Cumulative Total Incurred Amount Amount 4th Quarter 2004 Incurred -------- ---------------- ---------- ($ in millions) Relocation costs $ 32 $ 9 $ 16 Severance and related costs 21 10 13 Property and leasehold improvements 37 16 17 -------- -------- -------- Total $ 90 $ 35 $ 46 ======== ======== ========
Relocation costs and severance and related costs are included in CITGO's consolidated statement of income and comprehensive income as a component of the caption selling, general and administrative expense. Costs related to property and leasehold improvements are included in CITGO's condensed consolidated balance sheet as a component of the caption property, plant and equipment. An accrual of $13 million related to relocation costs is included in CITGO's consolidated balance sheet as a component of the caption current liabilities other. 17. SUBSEQUENT EVENTS In mid-March 2005, representatives of a special commission of the Venezuelan National Assembly (the "VNA Commission") visited CITGO's Houston, Texas offices for the purpose of interviewing several CITGO employees as part of an investigation that the VNA Commission had been charged with conducting. CITGO has not received any direct statements from the VNA Commission describing the scope of their investigation. CITGO understands from the interviewed employees that the questions were directed at the rationale for, and analysis underlying, note financings that CITGO completed in 2003 and 2004, the relocation of its corporate headquarters to Houston, Texas, and several minor transactions. The questions did not identify any unlawful or unrecorded activities, and CITGO is not aware of any such activities. CITGO is cooperating with the VNA Commission's investigation. Shortly following the VNA Commission's visit, a CITGO employee sent a memorandum to both CITGO's auditors and the SEC referencing the VNA Commission's investigation and other matters. CITGO is not aware of any improper activities, but has engaged counsel to investigate the employee's allegations. ****** F-32 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Partnership Governance Committee of LYONDELL-CITGO Refining LP: In our opinion, the accompanying balance sheets and the related statements of income, of partners' capital and of cash flows present fairly, in all material respects, the financial position of LYONDELL-CITGO Refining LP (the "Partnership") at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP PRICEWATERHOUSECOOPERS LLP Houston, Texas February 26, 2005 F-33 LYONDELL-CITGO REFINING LP STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, -------------------------------------- MILLIONS OF DOLLARS 2004 2003 2002 ------------------------------------------------- -------- -------- -------- SALES AND OTHER OPERATING REVENUES $ 5,603 $ 4,162 $ 3,392 OPERATING COSTS AND EXPENSES: Cost of sales: Crude oil and feedstock 4,383 3,209 2,546 Operating and other expenses 645 633 547 Selling, general and administrative expenses 59 56 53 -------- -------- -------- 5,087 3,898 3,146 ======== ======== ======== Operating income 516 264 246 Interest expense (31) (37) (32) Interest income 1 1 -- Other income (expense) 14 -- (1) -------- -------- -------- NET INCOME $ 500 $ 228 $ 213 ======== ======== ========
See Notes to Financial Statements. F-34 LYONDELL-CITGO REFINING LP BALANCE SHEETS
DECEMBER 31, ----------------------- MILLIONS OF DOLLARS 2004 2003 -------------------------------------------------- -------- -------- ASSETS Current assets: Cash and cash equivalents $ 45 $ 43 Accounts receivable: Trade, net 65 51 Related parties 145 121 Inventories 99 98 Prepaid expenses and other current assets 5 3 -------- -------- Total current assets 359 316 -------- -------- Property, plant and equipment, net 1,227 1,240 Other assets, net 61 81 -------- -------- Total assets $ 1,647 $ 1,637 ======== ======== LIABILITIES AND PARTNERS' CAPITAL Current liabilities: Accounts payable: Trade $ 132 $ 71 Related parties and affiliates 253 224 Distribution payable to Lyondell Partners 78 21 Distribution payable to CITGO Partners 55 15 Current maturities of long-term debt 5 -- Accrued liabilities 65 55 -------- -------- Total current liabilities 588 386 ======== ======== Long-term debt 443 450 Loan payable to Lyondell Partners 229 229 Loan payable to CITGO Partners 35 35 Other liabilities 112 114 -------- -------- Total long-term liabilities 819 828 ======== ======== Commitments and contingencies Partners' capital: Partners' accounts 263 442 Accumulated other comprehensive loss (23) (19) -------- -------- Total partners' capital 240 423 ======== ======== Total liabilities and partners' capital $ 1,647 $ 1,637 ======== ========
See Notes to Financial Statements. F-35 LYONDELL-CITGO REFINING LP STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------ MILLIONS OF DOLLARS 2004 2003 2002 ---------------------------------------------------------------- ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 500 $ 228 $ 213 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 115 113 116 Net loss on disposition of assets 10 27 1 Other -- -- 1 Changes in assets and liabilities that provided (used) cash: Accounts receivable (37) (19) (59) Inventories (1) (5) 37 Accounts payable 79 14 70 Other assets and liabilities 1 16 (18) ---------- ---------- ---------- Cash provided by operating activities 667 374 361 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Expenditures for property, plant and equipment (71) (46) (65) Proceeds from sale of property, plant and equipment -- -- 2 Other (1) -- (3) ---------- ---------- ---------- Cash used in investing activities (72) (46) (66) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Distributions to Lyondell Partners (385) (253) (126) Distributions to CITGO Partners (271) (178) (89) Contributions from Lyondell Partners 44 30 46 Contributions from CITGO Partners 30 21 32 Payment of debt issuance costs (9) (6) (10) Payment of current maturities of long-term debt (2) -- -- Net repayment under lines of credit -- -- (50) ---------- ---------- ---------- Cash used in financing activities (593) (386) (197) ---------- ---------- ---------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2 (58) 98 Cash and cash equivalents at beginning of period 43 101 3 ---------- ---------- ---------- Cash and cash equivalents at end of period $ 45 $ 43 $ 101 ========== ========== ==========
See Notes to Financial Statements. F-36 LYONDELL-CITGO REFINING LP STATEMENTS OF PARTNERS' CAPITAL
PARTNERS' ACCOUNTS ACCUMULATED ------------------------------------------ OTHER LYONDELL CITGO COMPREHENSIVE COMPREHENSIVE MILLIONS OF DOLLARS PARTNERS PARTNERS TOTAL INCOME (LOSS) INCOME (LOSS) ---------------------------- -------- -------- -------- ------------- ------------- BALANCE AT JANUARY 1, 2002 $ 12 $ 495 $ 507 $ (15) Net income 135 78 213 -- $ 213 Cash contributions 46 32 78 -- -- Distributions to Partners (215) (151) (366) -- -- Other comprehensive loss - minimum pension liability (14) (14) -------- -------- -------- -------- -------- Comprehensive income $ 199 ======== BALANCE AT DECEMBER 31, 2002 (22) 454 432 (29) Net income 144 84 228 -- $ 228 Cash contributions 30 21 51 -- -- Other contributions 10 7 17 -- -- Distributions to Partners (168) (118) (286) -- -- Other comprehensive income- minimum pension liability 10 10 -------- -------- -------- -------- -------- Comprehensive income $ 238 ======== BALANCE AT DECEMBER 31, 2003 (6) 448 442 (19) Net income 304 196 500 -- $ 500 Cash contributions 44 30 74 -- -- Distributions to Partners (442) (311) (753) -- -- Other comprehensive loss - minimum pension liability (4) (4) -------- -------- -------- -------- -------- Comprehensive income $ 496 ======== BALANCE AT DECEMBER 31, 2004 $ (100) $ 363 $ 263 $ (23) ======== ======== ======== ========
See Notes to Financial Statements. F-37 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS 1. THE PARTNERSHIP LYONDELL-CITGO Refining LP ("LCR" or the "Partnership") was formed on July 1, 1993 by subsidiaries of Lyondell Chemical Company ("Lyondell") and CITGO Petroleum Corporation ("CITGO") primarily in order to own and operate a refinery ("Refinery") located on the Houston Ship Channel in Houston, Texas. Lyondell owns its interest in the Partnership through wholly owned subsidiaries, Lyondell Refining Partners, LP ("Lyondell LP") and Lyondell Refining Company ("Lyondell GP"). Lyondell LP and Lyondell GP are collectively known as Lyondell Partners. CITGO holds its interest through CITGO Refining Investment Company ("CITGO LP") and CITGO Gulf Coast Refining, Inc. ("CITGO GP"), both wholly owned subsidiaries of CITGO. CITGO LP and CITGO GP are collectively known as CITGO Partners. Lyondell Partners and CITGO Partners are collectively known as the Partners. LCR will continue in existence until it is dissolved under the terms of the Limited Partnership Agreement (the "Agreement"). Under the terms of the Agreement, upon dissolution of the Partnership, neither partner shall have any obligation to contribute capital to restore any negative balance in its partner's capital account balance. The Partners have agreed to allocate cash distributions based on an ownership interest that was determined by certain contributions instead of allocating such amounts based on their capital account balances. Based upon these contributions, Lyondell Partners and CITGO Partners had ownership interests of 58.75% and 41.25%, respectively, as of December 31, 2004. Net income as shown on the statements of partners' capital is made up of two components which are allocated to the Partners on different bases: depreciation expense, which is allocated to each partner in proportion to contributed assets and net income other than depreciation expense, which is allocated to each partner based on ownership interests. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition--Revenue from product sales is recognized as risk and title to the product transfer to the customer, which usually occurs when shipment is made. Under the terms of a long-term product sales agreement, CITGO buys substantially all of the gasoline, jet fuel, low sulfur diesel, heating oils, coke and sulfur produced at the Refinery, which represents over 70% of LCR's revenues, at market-based prices. Cash and Cash Equivalents--Cash equivalents consist of highly liquid debt instruments such as certificates of deposit, commercial paper and money market accounts. Cash equivalents include instruments with maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates fair value. The Partnership's policy is to invest cash in conservative, highly rated instruments and to limit the amount of credit exposure to any one institution. Accounts Receivable--The Partnership sells its products primarily to CITGO and to other industrial concerns in the petrochemical and refining industries. The Partnership performs ongoing credit evaluations of its customers' financial condition and in certain circumstances, requires letters of credit from them. The Partnership's allowance for doubtful accounts receivable, which is reflected in the Balance Sheets as a reduction of accounts receivable-trade, totaled $25,000 at both December 31, 2004 and 2003. Inventories--Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out ("LIFO") method for substantially all inventories, except for materials and supplies, which are valued using the average cost method. F-38 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Inventory exchange transactions, which involve fungible commodities and do not involve the payment or receipt of cash, are not accounted for as purchases and sales. Any resulting volumetric exchange balances are accounted for as inventory in accordance with the normal LIFO valuation policy. Property, Plant and Equipment--Property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful asset lives, generally, 24 years for major manufacturing equipment, 24 to 30 years for buildings, 5 to 10 years for light equipment and instrumentation, 10 years for office furniture and 5 years for information system equipment. Upon retirement or sale, LCR removes the cost of the asset and the related accumulated depreciation from the accounts and reflects any resulting gain or loss in the Statement of Income. LCR's policy is to capitalize interest cost incurred on debt during the construction of major projects exceeding one year. Long-Lived Asset Impairment--LCR evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that a carrying amount of an asset may not be recoverable. When it is probable that undiscounted future cash flows will not be sufficient to recover an asset's carrying amount, the asset is written down to its estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or estimated fair value less costs to sell the assets. Turnaround Maintenance and Repair Costs--Costs of maintenance and repairs exceeding $5 million incurred in connection with turnarounds of major units at the Refinery are deferred and amortized using the straight-line method over the period until the next planned turnaround, generally 4 to 6 years. These costs are necessary to maintain, extend and improve the operating capacity and efficiency rates of the production units. Identifiable Intangible Assets--Costs to purchase and to develop software for internal use are deferred and amortized on a straight-line basis over a period of 3 to 10 years. Other intangible assets are carried at amortized cost and primarily consist of deferred debt issuance costs. These assets are amortized using the straight-line method over their estimated useful lives or the term of the related agreement, if shorter. Environmental Remediation Costs--Anticipated expenditures related to investigation and remediation of contaminated sites, which include operating facilities and waste disposal sites, are accrued when it is probable a liability has been incurred and the amount of the liability can reasonably be estimated. Estimated expenditures have not been discounted to present value. Income Taxes--The Partnership is not subject to federal income taxes as income is reportable directly by the individual partners; therefore, there is no provision for federal income taxes in the accompanying financial statements. Use of Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-39 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Anticipated Accounting Changes - In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is defined to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 becomes effective in the third quarter 2005 and will be applied prospectively upon implementation. LCR does not expect application of SFAS No. 153 to have a material impact on its financial statements. In November 2004, the FASB issued SFAS No. 151, Inventory Costs. The statement requires recognition of any abnormal amounts of idle facility expense, freight, handling costs and spoilage as period costs. The provisions of SFAS No. 151 will apply prospectively upon implementation in 2005. LCR does not expect application of SFAS No. 151 to have a material impact on its financial statements. Reclassifications--Certain previously reported amounts have been reclassified to conform to classifications adopted in 2004. 3. RELATED PARTY TRANSACTIONS LCR is party to agreements with the following related parties: - CITGO - CITGO Partners - Equistar Chemicals, LP ("Equistar") - Lyondell - Lyondell Partners - Petroleos de Venezuela, S.A. ("PDVSA"), the national oil company of the Bolivarian Republic of Venezuela - PDVSA Petroleo, S.A. ("PDVSA Oil") - Petrozuata Financial, Inc. - TCP Petcoke Corporation LCR has a long-term crude supply agreement ("Crude Supply Agreement" or "CSA") with PDVSA Oil, an affiliate of CITGO (see "Crude Supply Agreement" section of Note 11). The CSA, which expires on December 31, 2017, incorporates formula prices to be paid by LCR for the crude oil supplied based on the market value of a slate of refined products deemed to be produced from each particular crude oil or raw material, less: (1) certain deemed refining costs, adjustable for inflation and energy costs; (2) certain actual costs; and (3) a deemed margin, which varies according to the grade of crude oil or other raw material delivered. The actual refining margin earned by LCR may vary from the formula amount depending on, among other things, timing differences in incorporating changes in refined product market values and energy costs into the CSA's deemed margin calculations and the efficiency with which LCR conducts its operations from time to time. Although LCR believes that the CSA reduces the volatility of LCR's earnings and cash flows over the long-term, the CSA also limits LCR's ability to enjoy higher margins during periods when the market price of crude oil is low relative to then-current market prices of refined products. In addition, if the actual yields, costs or volumes of the LCR Refinery differ substantially from F-40 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 3. RELATED PARTY TRANSACTIONS (CONTINUED) those contemplated by the CSA, the benefits of this agreement to LCR could be substantially diminished, and could result in lower earnings and cash flow for LCR. Furthermore, there may be periods during which LCR's costs for crude oil under the CSA may be higher than might otherwise be available to LCR from other sources. A disparate increase in the market price of heavy crude oil relative to the prices of heavy crude oil under the CSA has the tendency to make continued performance of its obligations under the CSA less attractive to PDVSA Oil. Under the terms of a long-term product sales agreement, CITGO buys substantially all of the finished gasoline, jet fuel, low sulfur diesel, heating oils, coke and sulfur produced at the Refinery at market-based prices. LCR is party to a number of raw materials, product sales and administrative service agreements with Lyondell, CITGO and Equistar. These include a hydrogen take-or-pay contract with Equistar (see Note 11). In addition, a processing agreement provides for the production of alkylate and methyl tertiary butyl ether for the Partnership at Equistar's Channelview, Texas petrochemical complex. As a result of Lyondell's acquisition on November 30, 2004, of the only other remaining ownership interest holder of Equistar, Equistar became a wholly owned subsidiary of Lyondell on November 30, 2004. Under the terms of a lubricant facility operating agreement, CITGO operated the lubricant blending and packing facility in Birmingport, Alabama while the Partnership retained ownership. During 2003, a decision was made to discontinue the lubes blending and packaging operations at the facility in Birmingport, Alabama and the facility was permanently shut down. Lubes blending and packaging operations are now conducted at CITGO or other locations. Under the terms of the lubricant sales agreements, CITGO buys paraffinic lubricants base oil, naphthenic lubricants, white mineral oils and specialty oils from the Partnership, at market based prices. Related party transactions are summarized as follows:
FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------- MILLIONS OF DOLLARS 2004 2003 2002 --------------------------------------------- -------- -------- -------- LCR billed related parties for the following: Sales of products: CITGO $ 4,141 $ 3,010 $ 2,488 Equistar 425 227 217 Lyondell -- -- 1 TCP Petcoke Corporation 1 33 17 Services and cost sharing arrangements: Equistar 1 -- 1 Lyondell -- 1 1
F-41 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 3. RELATED PARTY TRANSACTIONS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------- MILLIONS OF DOLLARS 2004 2003 2002 --------------------------------------------- -------- -------- -------- Related parties billed LCR for the following: Purchase of products: CITGO $ 108 $ 201 $ 78 Equistar 725 445 324 Lyondell 14 4 1 PDVSA 2,594 1,742 1,259 Petrozuata Financial, Inc. -- -- 22 Transportation charges: CITGO 1 1 1 Equistar 4 4 3 PDVSA -- -- 3 Services and cost sharing arrangements: CITGO 6 6 8 Equistar 23 21 17 Lyondell 3 2 3
See Note 7 for information regarding LCR master notes payable to Lyondell Partners and CITGO Partners. 4. INVENTORIES Inventories consisted of the following components at December 31:
MILLIONS OF DOLLARS 2004 2003 ------------------------ ------ ------ Finished goods $ 16 $ 16 Raw materials 70 69 Materials and supplies 13 13 ------ ------ Total inventories $ 99 $ 98 ====== ======
In 2004 and 2003, all inventory, excluding materials and supplies, were valued using the LIFO method. The excess of replacement cost of inventories over the carrying value was approximately $221 million at December 31, 2004. 5. PROPERTY, PLANT AND EQUIPMENT AND OTHER ASSETS The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows at December 31:
MILLIONS OF DOLLARS 2004 2003 --------------------------------------- ---------- ---------- Land $ 2 $ 2 Manufacturing facilities and equipment 2,528 2,493 Construction in progress 105 67 ---------- ---------- Total property, plant and equipment 2,635 2,562 Less accumulated depreciation (1,408) (1,322) ---------- ---------- Property, plant and equipment, net $ 1,227 $ 1,240 ========== ==========
F-42 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 5. PROPERTY, PLANT AND EQUIPMENT AND OTHER ASSETS (CONTINUED) Maintenance and repair expenses were $50 million, $52 million and $59 million for the years ended December 31, 2004, 2003 and 2002 respectively. The components of other assets, at cost, and the related accumulated amortization were as follows at December 31:
2004 2003 ---------------------------- ------------------------------ ACCUMULATED ACCUMULATED MILLIONS OF DOLLARS COST AMORTIZATION NET COST AMORTIZATION NET ------------------- ----- ------------ ----- ----- ------------ ------ Intangible assets: Turnaround costs $ 59 $ (39) $ 20 $ 58 $ (27) $ 31 Software costs 40 (26) 14 38 (21) 17 Debt issuance costs 24 (17) 7 16 (11) 5 Catalyst costs 11 (5) 6 11 (6) 5 Other 3 - 3 2 - 2 ----- ----- ----- ------ ----- ------ Total intangible assets $ 137 $ (87) $ 50 $ 125 $ (65) $ 60 ===== ===== ====== ===== Company-owned life insurance 6 5 Other 5 16 ----- ------ Total other assets $ 61 $ 81 ===== ======
Scheduled amortization of these intangible assets for the next five years is estimated at $19 million in 2005, $16 million in 2006, $5 million in 2007, $4 million in 2008 and $2 million in 2009. Depreciation and amortization expense is summarized as follows:
FOR THE YEAR ENDED DECEMBER 31, ----------------------------------- MILLIONS OF DOLLARS 2004 2003 2002 ------------------- ------- ------- ------- Property, plant and equipment $ 91 $ 90 $ 89 Turnaround costs 12 12 13 Software costs 5 5 5 Other 7 6 9 ------- ------- ------- Total depreciation and amortization $ 115 $ 113 $ 116 ======= ======= =======
In addition to the depreciation and amortization shown above, amortization of debt issuance costs of $6 million, $11 million and $5 million in 2004, 2003 and 2002, respectively, is included in interest expense in the Statements of Income. F-43 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 6. ACCRUED LIABILITIES Accrued liabilities consisted of the following components at December 31:
MILLIONS OF DOLLARS 2004 2003 ------------------- ------ ------ Payroll and benefits $ 25 $ 25 Taxes other than income 26 25 Interest 6 2 Other 8 3 ------ ------ Total accrued liabilities $ 65 $ 55 ====== ======
7. FINANCING ARRANGEMENTS In May 2004, LCR refinanced its credit facilities with a new facility, consisting of a $450 million senior secured term loan and a $100 million senior secured revolver, which mature in May 2007. The term loan requires quarterly amortization payments of $1.125 million which began in September 2004. The new facility replaced LCR's $450 million term loan facility and $70 million revolving credit facility, which were scheduled to mature in June 2004 and is secured by substantially all of the assets of LCR. At December 31, 2004, $448 million was outstanding under the senior secured term loan with a weighted-average interest rate of 4.2%. Interest for this facility was determined by base rates or eurodollar rates at the Partnership's option. The $100 million senior secured revolver is utilized for general business purposes and for letters of credit. At December 31, 2004, no amount was outstanding under the senior secured revolver. At December 31, 2004, LCR had outstanding letters of credit totaling $12 million. The new facility contains covenants that require LCR to maintain certain financial ratios defined in the agreement. The facility also contains other customary covenants which limit the Partnership's ability to modify certain significant contracts, incur significant additional debt or liens, dispose of assets, make restricted payments as defined in the agreements or merge or consolidate with other entities. In September 2004, LCR obtained an amendment to the new facility that reduced the interest rate and eased certain financial covenants, including the debt-to-total-capitalization ratio. LCR was in compliance with all such covenants at December 31, 2004. As part of the May 2004 refinancing, Lyondell Partners and CITGO Partners extended the maturity of the loans payable to the Partners, including $229 million payable to Lyondell Partners and $35 million payable to CITGO Partners, from July 2005 to January 2008. At December 31, 2004, Lyondell Partners and CITGO Partners loans were $229 million and $35 million, respectively, and both loans had weighted-average interest rates of 2.0%, which were based on eurodollar rates. Interest to both Partners was paid at the end of each calendar quarter through June 30, 1999, but is now deferred in accordance with the restrictions included in the $450 million term loan facility. In December 2002, LCR completed a refinancing of its credit facilities with a new $450 million term bank loan facility and a $70 million working capital revolving credit facility that was scheduled to mature in June 2004. The facilities were secured by substantially all of the assets of LCR. At December 31, 2003, $450 million was outstanding under the bank term loan facility with weighted-average interest rates of 4.1%. Interest for this facility was determined by base rates or eurodollar rates at the Partnership's option. The $70 million working capital revolving credit facility is utilized for general business purposes and for letters of credit. At December 31, 2003, no amounts were outstanding under this facility. At December 31, 2003, LCR had outstanding letters of credit totaling $13 million. F-44 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 7. FINANCING ARRANGEMENTS (CONTINUED) Both of the December 2002 facilities contained covenants that required LCR to maintain a minimum net worth and maintain certain financial ratios defined in the agreements. The facilities also contained other customary covenants which limit the Partnership's ability to modify certain significant contracts, incur significant additional debt or liens, dispose of assets, make restricted payments as defined in the agreements or merge or consolidate with other entities. LCR was in compliance with all such covenants at December 31, 2003. Also, during the December 2002 refinancing, the Partners and LCR agreed to renew and extend a number of existing notes due to Lyondell Partners and CITGO Partners with a master note to each Partner. The master notes extended the due date from July 1, 2003 to December 7, 2004, and are subordinate to the two bank credit facilities. At December 31, 2003, Lyondell Partners and CITGO Partners loans were $229 million and $35 million, respectively, and both loans had weighted-average interest rates of 2.2%, which were based on eurodollar rates. Subsequent to December 31, 2003, the due date of the master notes were extended to March 31, 2005. 8. LEASE COMMITMENTS LCR leases crude oil storage facilities, computer equipment, office equipment and other items under noncancelable operating lease arrangements for varying periods. As of December 31, 2004, future minimum lease payments for the next five years and thereafter, relating to all noncancelable operating leases with terms in excess of one year were as follows:
MILLIONS OF DOLLARS ------------------- 2005 $ 74 2006 47 2007 35 2008 18 2009 14 Thereafter 90 ------ Total minimum lease payments $ 278 ======
Net rental expenses for the years ended December 31, 2004, 2003 and 2002 were approximately $90 million, $63 million and $34 million, respectively. 9. FINANCIAL INSTRUMENTS The fair value of all financial instruments included in current assets and current liabilities, including cash and cash equivalents, accounts receivable, and accounts payable, approximated their carrying value due to their short maturity. The fair value of long-term loans payable approximated their carrying value because of their variable interest rates. F-45 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 10. PENSION AND OTHER POSTRETIREMENT BENEFITS LCR has defined benefit pension plans, which cover full-time regular employees. Retirement benefits are based on years of service and the employee's highest three consecutive years of compensation during the last ten years of service. LCR funds the plans through periodic contributions to pension trust funds as required by applicable law. LCR also has one unfunded supplemental nonqualified retirement plan, which provides pension benefits for certain employees in excess of the U.S. tax-qualified plans' limit. In addition, LCR sponsors unfunded postretirement benefit plans other than pensions, which provide medical and life insurance benefits. The postretirement medical plan is contributory, while the life insurance plan is noncontributory. The measurement date for LCR's pension and other postretirement benefit plans is December 31, 2004. The following table provides a reconciliation of benefit obligations, plan assets and the funded status of the plans:
OTHER POSTRETIREMENT PENSION BENEFITS BENEFITS --------------------- -------------------- MILLIONS OF DOLLARS 2004 2003 2004 2003 ------------------------------------------ ------- -------- ------- ------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation, January 1 $ 125 $ 124 $ 39 $ 35 Service cost 6 6 1 1 Interest cost 8 7 3 2 Plan amendments -- -- 10 -- Actuarial (gain) loss 15 (3) (2) 3 Benefits paid (7) (9) (3) (2) ------- -------- ------- ------- Benefit obligation, December 31 147 125 48 39 ------- -------- ------- ------- CHANGE IN PLAN ASSETS: Fair value of plan assets, January 1 51 49 Actual return on plan assets 7 10 Partnership contributions 27 1 Benefits paid (7) (9) ------- -------- Fair value of plan assets, December 31 78 51 ------- -------- Funded status (69) (74) (48) (39) Unrecognized actuarial and investment loss 52 46 12 16 Unrecognized prior service cost (benefit) 2 2 (4) (16) ------- -------- ------- ------- Net amount recognized $ (15) $ (26) $ (40) $ (39) ======= ======== ======= ======= AMOUNTS RECOGNIZED IN THE BALANCE SHEET CONSIST OF: Accrued benefit liability $ (40) $ (47) $ (40) $ (39) Intangible asset 2 2 -- -- Accumulated other comprehensive loss 23 19 -- -- ------- -------- ------- ------- Net amount recognized $ (15) $ (26) $ (40) $ (39) ======= ======== ======= =======
F-46 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 10. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED)
PENSION BENEFITS ---------------- MILLIONS OF DOLLARS 2004 2003 ------------------------------------------ ----- ----- ADDITIONAL INFORMATION: Accumulated benefit obligation for defined benefit plans, December 31 $ 116 $ 98 Increase (decrease) in minimum liability included in other comprehensive loss 4 (10)
Pension plans with projected benefit obligations and accumulated benefit obligations in excess of the fair value of assets are summarized as follows at December 31:
PENSION BENEFITS ---------------- MILLIONS OF DOLLARS 2004 2003 ------------------------------- ----- ----- Projected benefit obligations $ 147 $ 125 Accumulated benefit obligations 116 98 Fair value of assets 78 51
Net periodic pension and other postretirement benefit costs included the following components:
OTHER POSTRETIREMENT PENSION BENEFITS BENEFITS ------------------------ ------------------------ MILLIONS OF DOLLARS 2004 2003 2002 2004 2003 2002 ------------------------------------- ------ ------ ------ ------ ------ ------ COMPONENTS OF NET PERIODIC BENEFIT COST: Service cost $ 6 $ 7 $ 6 $ 1 $ 1 $ 1 Interest cost 8 7 8 3 2 2 Actual (gain) loss on plan assets (7) (10) 5 -- -- -- Less unrecognized gain (loss) 3 6 (9) -- -- -- ------ ------ ------ ------ ------ ------ Recognized gain on plan assets (4) (4) (4) -- -- -- Prior service costs amortization -- -- -- (2) (3) (3) Actuarial loss amortization 4 4 3 1 1 1 Net effect of settlements 2 -- -- -- -- -- ------ ------ ------ ------ ------ ------ Net periodic benefit cost $ 16 $ 14 $ 13 $ 3 $ 1 $ 1 ====== ====== ====== ====== ====== ======
F-47 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 10. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The weighted-average assumptions used in determining net benefit liabilities were as follows at December 31:
PENSION OTHER POSTRETIREMENT BENEFITS BENEFITS --------------- -------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Discount rate 5.75% 6.25% 5.75% 6.25% Rate of compensation increase 4.50% 4.50% -- --
The weighted-average assumptions used in determining net periodic benefit cost were as follows:
OTHER POSTRETIREMENT PENSION BENEFITS BENEFITS ---------------------- ---------------------- 2004 2003 2002 2004 2003 2002 ---- ---- ---- ---- ---- ---- Discount rate 6.25% 6.50% 6.50% 6.25% 6.50% 6.50% Expected return on plan assets 8.00% 8.00% 9.50% -- -- -- Rate of compensation increase 4.50% 4.50% 4.50% -- -- --
Management's goal is to manage pension investments over the long term to achieve optimal returns with an acceptable level of risk and volatility. Targeted asset allocations of 55% U.S. equity securities, 15% non-U.S. equity securities and 30% fixed income securities were adopted in 2003 for the plans based on recommendations by LCR's independent pension investment advisor. Investment policies prohibit investments in securities issued by an affiliate, such as Lyondell, or investment in speculative, derivative instruments. The investments are marketable securities that provide sufficient liquidity to meet expected benefit obligation payments. Prior to 2003, LCR's expected long-term rate of return on plan assets of 9.5% had been based on the average level of earnings that its independent pension investment advisor had advised could be expected to be earned over time, using the expected returns for the above-noted asset allocations that had been recommended by the advisor, and had been adopted for the plans. Over the three-year period ended December 31, 2003, LCR's actual return on plan assets was a loss averaging 1.8% per year. In 2003, LCR reviewed its asset allocation and expected long-term rate of return assumptions and obtained an updated asset allocation study from the independent pension investment advisor, including updated expectations for long-term market earnings rates for various classes of investments. Based on this review, LCR reduced its expected long-term rate of return on plan assets to 8% and did not significantly change its plan asset allocations. F-48 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 10. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) LCR's pension plan weighted-average asset allocations by asset category were as follows at December 31:
2004 POLICY 2004 2003 ----------- ---- ---- ASSET CATEGORY: U.S. equity securities 55% 57% 53% Non-U.S. equity securities 15% 15% 18% Fixed income securities 30% 28% 29% --- --- --- Total 100% 100% 100% === === ===
LCR expects to contribute approximately $5 million to its pension plans in 2005. The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was enacted in December 2003. In January 2004, the FASB issued FASB Staff Position ("FSP") FAS 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. As permitted by FSP FAS 106-1, LCR elected to defer recognition of the effects of the Act in accounting for its plans until the FASB developed and issued authoritative guidance on accounting for subsidies provided by the Act. In May 2004, the FASB issued FSP FAS 106-2 of the same title, which gave final guidance on accounting for subsidies under the Act and required LCR to implement its provisions no later than the third quarter 2004, if the effects were significant. The effect of the Act was not significant to the Partnership's financial statements and was recognized in the December 31, 2004 accumulated postretirement benefit obligation and the 2004 net periodic postretirement benefit cost. As of December 31, 2004, future expected benefit payments, which reflect expected future service, as appropriate, were as follows:
PENSION OTHER MILLIONS OF DOLLARS BENEFITS BENEFITS ------------------- -------- -------- 2005 $ 5 $ 3 2006 7 3 2007 8 3 2008 10 4 2009 13 4 2010 through 2014 82 19 ------ ----- Total $ 125 $ 36 ====== =====
F-49 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 10. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The assumed annual rate of increase in the per capita cost of covered health care benefits as of December 31, 2004 was 10% for 2005, 7% for 2006 through 2008 and 5% thereafter. The health care cost trend rate assumption does not have a significant effect on the amounts reported due to limits on LCR's maximum contribution level to the medical plan. To illustrate, increasing or decreasing the assumed health care cost trend rates by one percentage point in each year would not change the accumulated postretirement benefit liability as of December 31, 2004 by less than $1 million and would not have a material effect on the aggregate service and interest cost components of the net periodic postretirement benefit cost for the year then ended. LCR also maintains voluntary defined contribution savings plans for eligible employees. Contributions to the plans by LCR were $5 million in each of the three years ended December 31, 2004. 11. COMMITMENTS AND CONTINGENCIES Commitments -- LCR has various purchase commitments for materials, supplies and services incident to the ordinary conduct of business, generally for quantities required for LCR's business and at prevailing market prices. LCR is party to various unconditional purchase obligation contracts as a purchaser for products and services, principally take-or-pay contracts for hydrogen, electricity and steam. At December 31, 2004, future minimum payments under these contracts with noncancelable contract terms in excess of one year and fixed minimum payments were as follows:
MILLIONS OF DOLLARS ------------------- 2005 $ 31 2006 29 2007 27 2008 25 2009 24 Thereafter through 2021 177 ------ Total minimum contract payments $ 313 ======
Total LCR purchases under these agreements were $134 million, $107 million and $68 million during 2004, 2003 and 2002, respectively. A substantial portion of the future minimum payments and purchases were related to a hydrogen take-or-pay agreement with Equistar (see Note 3). Crude Supply Agreement--Under the CSA, which will expire on December 31, 2017, PDVSA Oil is required to sell, and LCR is required to purchase 230,000 barrels per day of extra heavy Venezuelan crude oil, which constitutes approximately 86% of the Refinery's refining capacity of 268,000 barrels per day of crude oil (see Note 3). Since April 1998, PDVSA Oil has, from time to time, declared itself in a force majeure situation and subsequently reduced deliveries of crude oil. Such reductions in deliveries were purportedly based on announced OPEC production cuts. At such times, PDVSA Oil informed LCR that the Venezuelan government, through the Ministry of Energy and Mines, had instructed that production of certain grades of crude oil be reduced. In certain circumstances, PDVSA Oil made payments under a different provision of the CSA in partial compensation for such reductions. F-50 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 11. COMMITMENTS AND CONTINGENCIES (CONTINUED) LCR has consistently contested the validity of the reductions in deliveries by PDVSA Oil and PDVSA under the CSA. The parties have different interpretations of the provisions of the contracts concerning the delivery of crude oil. The contracts do not contain dispute resolution procedures and the parties have been unable to resolve their commercial dispute. As a result, in February 2002, LCR filed a lawsuit against PDVSA and PDVSA Oil in connection with the force majeure declarations, which LCR is continuing to litigate. From time to time, Lyondell and PDVSA have had discussions covering both a restructuring of the CSA and a broader restructuring of the LCR partnership. LCR is unable to predict whether changes in either arrangement will occur. Depending on then-current market conditions, any breach or termination of the CSA, or reduction in supply thereunder, would require LCR to purchase all or a portion of its crude oil in the merchant market, which could subject LCR to significant volatility and price fluctuations and could aversely affect the Partnership. There can be no assurance that alternative crude oil supplies with similar margins would be available for purchase by LCR. During the year ended December 31, 2004, LCR received crude oil under the CSA at or above the contract volumes. Subject to the consent of the other partner and rights of first offer and refusal, the Partners each have a right to transfer their interests in LCR to unaffiliated third parties in certain circumstances. If neither CITGO, PDVSA Oil or their affiliates were a partner in LCR, PDVSA Oil would have an option to terminate the CSA. Environmental Remediation--With respect to liabilities associated with the Refinery, Lyondell generally has retained liability for events that occurred prior to July 1, 1993 and certain ongoing environmental projects at the Refinery under the Contribution Agreement, retained liability section. LCR generally is responsible for liabilities associated with events occurring after June 30, 1993 and ongoing environmental compliance inherent to the operation of the Refinery. LCR's policy is to be in compliance with all applicable environmental laws. LCR is subject to extensive national, state and local environmental laws and regulations concerning emissions to the air, discharges onto land or waters and the generation, handling, storage, transportation, treatment and disposal of waste materials. Many of these laws and regulations provide for substantial fines and potential criminal sanctions for violations. Some of these laws and regulations are subject to varying and conflicting interpretations. In addition, the Partnership cannot accurately predict future developments, such as increasingly strict environmental laws, inspection and enforcement policies, as well as higher compliance costs therefrom, which might affect the handling, manufacture, use, emission or disposal of products, other materials or hazardous and non-hazardous waste. Some risk of environmental costs and liabilities is inherent in particular operations and products of the Partnership, as it is with other companies engaged in similar businesses, and there is no assurance that material costs and liabilities will not be incurred. In general, however, with respect to the capital expenditures and risks described above, the Partnership does not expect that it will be affected differently than the rest of the refining industry where LCR is located. LCR estimates that it has a liability of approximately $6 million at December 31, 2004 related to future assessment and remediation costs. Lyondell has a contractual obligation to reimburse LCR for approximately $5 million. Accordingly, LCR has reflected a current liability for the remaining portion of this liability that will not be reimbursed by Lyondell. In the opinion of management, there is currently no material estimable range of loss in excess of the amount recorded. However, it is possible that new information associated with this liability, new technology or future developments such as involvement in investigations by regulatory agencies, could require LCR to reassess its potential exposure related to environmental matters. F-51 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 11. COMMITMENTS AND CONTINGENCIES (CONTINUED) Clean Air Act - Under the Clean Air Act, the eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the U.S. Environmental Protection Agency ("EPA") under a "one-hour" ozone standard. Emission reduction controls for nitrogen oxides ("NOx") must be installed at the Refinery located in the Houston/Galveston region during the next several years. Revised rules adopted by the regulatory agencies changed the required NOx reduction levels from 90% to 80%. The benefit from the 80% NOx reduction level could be affected by increased costs for stricter proposed controls over highly reactive, volatile organic compounds ("HRVOC"). The regulatory agency for the state of Texas, the Texas Commission on Environmental Quality ("TCEQ"), finalized the HRVOC rules in December 2004. LCR is still assessing the impact of the proposed HRVOC revisions. In addition, in April 2004, the EPA designated the eight-county Houston/Galveston region a moderate non-attainment area under an "eight-hour" ozone standard. As a result, the TCEQ must submit a plan to the EPA in 2007 to demonstrate compliance with the eight-hour ozone standard in 2010. The timing and amount of estimated expenditures are subject to regulatory and other uncertainties, as well as obtaining the necessary permits and approvals. There can be no assurance as to the ultimate cost of implementing any plan developed to comply with the final ozone standards. The Clean Air Act also specified certain emissions standards for vehicles, and in 1998, the EPA concluded that additional controls on gasoline and diesel fuel were necessary. New standards for gasoline were finalized in 1999 and will require refiners to produce a low sulfur gasoline by 2004, with final compliance by 2006. A new "on-road" diesel standard was adopted in January 2001 and will require refiners of on-road diesel fuel to produce 80% as ultra low sulfur diesel ("ULSD") by June 2006 and 100% by the end of 2009, with less stringent standards for "off-road" diesel fuel. To date, the "off-road" diesel fuel standards have not been finalized. These gasoline and diesel fuel standards will result in increased capital investment for LCR. In addition, these standards could result in higher operating costs for LCR. For the years ended December 31, 2004, 2003 and 2002 LCR spent $31 million, $16 million and $31 million, respectively, for environmental related capital expenditures. These expenditures exclude a $25 million charge in 2003 for the impairment of value of project costs incurred as a result of a change to alternative approaches to complying with the gasoline and diesel fuel standards projects that led to a reduction in estimated expenditures for project compliance. LCR currently estimates that environmentally related capital expenditures will be approximately $96 million for 2005 and $129 million for 2006, including preliminary estimated expenditures for engineering studies related to emission control standards for HRVOC's, as described above. LCR is involved in various lawsuits and proceedings. Subject to the uncertainty inherent in all litigation, management believes the resolution of these proceedings will not have a material adverse effect on the financial position, liquidity or results of operations of LCR. In the opinion of management, any liability arising from the matters discussed in this note is not expected to have a material adverse effect on the financial position or liquidity of LCR. However, the adverse resolution in any reporting period of one or more of these matters discussed in this note could have a material impact on LCR's results of operations for that period which may be mitigated by contribution or indemnification obligations of others, or by any insurance coverage that may be available. F-52 LYONDELL-CITGO REFINING LP NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 12. SUPPLEMENTAL CASH FLOW INFORMATION At December 31, 2004, 2003 and 2002, construction in progress included approximately $22 million, $5 million and $6 million, respectively, of non-cash additions which related to accounts payable accruals and accrued liabilities. During 2004, 2003 and 2002, LCR paid interest of $18 million, $20 million and $26 million, respectively. In June 2003, the Partners agreed to contribute part of the outstanding accrued interest payable to the respective Partners' capital accounts based on their relative ownership interests of 58.75% for Lyondell Partners and 41.25% for CITGO Partners. Accordingly, $10 million and $7 million of Lyondell Partners and CITGO Partners accrued interest, respectively, was reclassified to the respective Partners' capital accounts. F-53 INDEX TO EXHIBITS
Exhibit Number Description ------ ----------- 3.1 Restated Certificate of Incorporation, as amended (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 3.1 filed with the Commission on April 4, 1996). 3.2 By-laws of CITGO Petroleum Corporation as amended on March 13, 2001 (incorporated by reference to Registrant's 2000 Form 10-K, File No. 1-14380, Exhibit 3.1(i) filed with the Commission on March 21, 2001). 4.1 Master Shelf Agreement (1994) by and between Prudential Insurance Company of America and CITGO Petroleum Corporation ($100,000,000), dated March 4, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.16 filed with the Commission on April 4, 1996). 4.2 Letter Agreement by and between the Company and Prudential Insurance Company of America, dated March 4, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.17(i) filed with the Commission on April 4, 1996). 4.3 Letter Amendment No. 1 to Master Shelf Agreement with Prudential Insurance Company of America, dated November 14, 1994 (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 10.17(ii) filed with the Commission on April 4, 1996). 4.4 CITGO Senior Debt Securities (1991) Agreement (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.18 filed with the Commission on June 2, 1993). 4.5 Indenture, dated as of May 1, 1996, between CITGO Petroleum Corporation and the First National Bank of Chicago, relating to the 7-7/8% Senior Notes due 2006 of CITGO Petroleum Corporation, including the form of Senior Note (incorporated by reference to the Registrant's Registration Statement on Form 10, File No. 333-3226, Exhibit 4.1 filed with the Commission on April 4, 1996). 4.6 Indenture, dated as of February 27, 2003, between CITGO Petroleum Corporation, as Issuer, and The Bank of New York, as Trustee, relating to the $550,000,000 11-3/8% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 4.2 filed with the Commission on March 24, 2003). 4.7 Supplemental Indenture dated as of October 20, 2004 between CITGO Petroleum Corporation, as Issuer, and The Bank of New York, as Trusted, relating to the $550,000,000 11-3/8% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's Form 8-K dated October 22, 2004, File No. 1-14380, Exhibit 4.1 filed with the Commission on October 28, 2004). 4.8 Indenture, dated as of October 22, 2004, between CITGO Petroleum Corporation, as Issuer, and J.P. Morgan Trust Company, National Association, as Trustee, relating to the $250,000,000 6% Senior Notes due 2011 of CITGO Petroleum Corporation (incorporated by reference to the Registrant's Registration Statement on Form S-4, File No. 333-122100, Exhibit 4.1 filed with the Commission on January 18, 2005). 10.1 Crude Supply Agreement between CITGO Petroleum Corporation and Petroleos de Venezuela, S.A., dated as of September 30, 1986 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.1 filed with the Commission on June 2, 1993).
10.2 Supplemental Crude Supply Agreement dated as of September 30, 1986 between CITGO Petroleum Corporation and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.2 filed with the Commission on June 2, 1993). 10.3 Crude Oil and Feedstock Supply Agreement dated as of March 31, 1987 between Champlin Refining Company and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.3 filed with the Commission on June 2, 1993). 10.4 Supplemental Crude Oil and Feedstock Supply Agreement dated as of March 31, 1987 between Champlin Refining Company and Petroleos de Venezuela, S.A. (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.4 filed with the Commission on June 2, 1993). 10.5 Contract for the Purchase/Sale of Boscan Crude Oil dated as of June 2, 1993 between Tradecal, S.A. and CITGO Asphalt Refining Company (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.1 filed with the Commission on June 2, 1993). 10.6 Restated Contract for the Purchase/Sale of Heavy/Extra Heavy Crude Oil dated December 28, 1990 among Maraven, S.A., Lagoven, S.A. and Seaview Oil Company (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.6 filed with the Commission on June 2, 1993). 10.7 Sublease Agreement dated as of March 31, 1987 between Champlin Petroleum Company, Sublessor, and Champlin Refining Company, Sublessee (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.7 filed with the Commission on June 2, 1993). 10.8 Amended and Restated Limited Liability Company Regulations of LYONDELL-CITGO Refining Company, Ltd., dated July 1, 1993 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.9 filed with the Commission on June 2, 1993). 10.9 Contribution Agreement among Lyondell Petrochemical Company and LYONDELL-CITGO Refining Company, Ltd. and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.10 filed with the Commission on June 2, 1993). 10.10 Crude Oil Supply Agreement between LYONDELL-CITGO Refining Company, Ltd. and Lagoven, S.A. dated as of May 5, 1993 (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.11 filed with the Commission on June 2, 1993). 10.11 Supplemental Supply Agreement dated as of May 5, 1993 between LYONDELL-CITGO Refining Company, Ltd. and Petroleos de Venezuela, S.A (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.12 filed with the Commission on June 2, 1993). 10.12 Tax Allocation Agreement dated as of June 24, 1993 among PDV America, Inc., VPHI Midwest, Inc., CITGO Petroleum Corporation and PDV USA, Inc., as amended (incorporated by reference to PDV America, Inc.'s Registration Statement on Form F-1, File No. 33-63742, Exhibit 10.13 filed with the Commission on June 2, 1993). 10.13 Second Amendment to the Tax Allocation Agreement among PDV America, Inc., VPHI Midwest, Inc., CITGO Petroleum Corporation and PDV USA, Inc., dated as of January 1, 1997 (incorporated
by reference to Registrant's 2001 Form 10-K, File No. 1-14380, Exhibit 10.13(i) filed with the Commission on March 28, 2002). 10.14 Limited Partnership Agreement of LYONDELL-CITGO Refining LP, dated December 31, 1998 (incorporated by reference to the Registrant's 1998 Form 10-K, File No. 1-14380, Exhibit 10.24 filed with the Commission on March 17, 1999). 10.15 $260,000,000 Three-Year Credit Agreement dated as of December 11, 2002 among CITGO Petroleum Corporation, Bank of America, N.A., as Administrative Agent, JP Morgan Chase Bank, as Syndication Agent, Societe Generale, as Documentation Agent and the other lenders party thereto (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 10.22 filed with the Commission on March 24, 2003). 10.16 First Amendment to Three-Year Credit Agreement entered into January 29, 2003, but effective as of December 11, 2002, among CITGO Petroleum Corporation, Bank of America, N.A., as Administrative Agent and the other lenders party thereto (incorporated by reference to the Registrant's 2002 Form 10-K, File No. 1-14380, Exhibit 10.23 filed with the Commission on March 24, 2003). 10.17 Purchase and Sale Agreement dated as of February 28, 2003 between CITGO Petroleum Corporation and CITGO Funding Company, L.L.C. (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.23 filed with the Commission on March 30, 2004). 10.18 Amendment No. 1 dated as of November 26, 2003 to Purchase and Sale Agreement dated as of February 28, 2003 (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.24 filed with the Commission on March 30, 2004). 10.19 Receivables Purchase Agreement dated as of February 28, 2003 among CITGO Funding Company, L.L.C., CITGO Petroleum Corporation, Asset One Securitization, LLC and Societe Generale (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.25 filed with the Commission on March 30, 2004). 10.20 Amendment No. 1 dated as of November 26, 2003 to Receivables Purchase Agreement dated as of February 28, 2003 (incorporated by reference to the Registrant's 2003 Form 10-K, File No. 1-14380, Exhibit 10.26 filed with the Commission on March 30, 2004). 10.21 Amendment No. 2 dated as of November 24, 2004 to Receivables Purchase Agreement dated as of February 28, 2003. 12.1* Computation of Ratio of Earnings to Fixed Charges. 23.1* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.2* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.3* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.4* Consent of Independent Registered Public Accounting Firm of CITGO Petroleum Corporation. 23.5* Consent of Independent Registered Public Accounting Firm of LYONDELL-CITGO Refining LP. 23.6* Consent of Independent Registered Public Accounting Firm of LYONDELL-CITGO Refining LP. 31.1* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Felix Rodriguez, President and Chief Executive Officer.
31.2* Certification Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Larry E. Krieg, Chief Financial Officer. 32.1* Certification Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Felix Rodriguez, President and Chief Executive Officer. 32.2* Certification Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed by Larry E. Krieg, Chief Financial Officer.
-------- * Filed Herewith