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1998
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 1-10145
LYONDELL CHEMICAL COMPANY
(Exact name of Registrant as specified in its charter)
Delaware 95-4160558
(State or other jurisdiction of (I.R.S. Employee Identification No.)
incorporation or organization)
1221 McKinney Street,
Suite 700, Houston, Texas 77010
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 652-7200
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of Each Class on which registered
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Common Stock ($1.00 par value) New York Stock Exchange
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 [_]
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 the 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. [_]
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There were 77,021,797 shares of the registrant's common stock outstanding on
December 31, 1998. The aggregate market value of the voting stock held by non-
affiliates of the registrant on March 1, 1999 based on the closing price on
the New York Stock Exchange composite tape on that date, was $1,023,630,895.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's definitive proxy statement, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 1998
(incorporated by reference under Part III).
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TABLE OF CONTENTS
PAGE
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PART I..................................................................... 1
Items 1 and 2. Business and Properties.................................... 1
THE COMPANY'S BUSINESS.................................................... 1
Development of Business.................................................. 1
Summary Description of Business Segments................................. 3
INTERMEDIATE CHEMICALS AND DERIVATIVES.................................... 5
Overview................................................................. 5
Raw Materials............................................................ 7
Marketing and Sales...................................................... 7
Joint Ventures and Other Agreements...................................... 8
Competition and Industry Conditions...................................... 8
Properties............................................................... 9
Research and Technology; Patents and Trademarks.......................... 10
Employee Relations....................................................... 10
EQUISTAR CHEMICALS, LP.................................................... 11
Management of Equistar................................................... 11
Agreements between Lyondell and Equistar................................. 11
EQUISTAR PETROCHEMICALS................................................... 13
Overview................................................................. 13
Raw Materials............................................................ 15
Marketing and Sales...................................................... 15
Competition and Industry Conditions...................................... 16
EQUISTAR POLYMERS......................................................... 17
Overview................................................................. 17
Raw Materials............................................................ 19
Marketing and Sales...................................................... 19
Competition and Industry Conditions...................................... 19
EQUISTAR PROPERTIES AND EMPLOYEE RELATIONS................................ 20
EQUISTAR RESEARCH AND TECHNOLOGY; PATENTS AND TRADEMARKS.................. 21
LYONDELL-CITGO REFINING LP................................................ 22
Overview................................................................. 22
Management of LCR........................................................ 23
Agreements between Lyondell or CITGO and LCR............................. 23
Agreements between Equistar and LCR...................................... 24
Raw Materials............................................................ 24
Marketing and Sales...................................................... 25
Competition and Industry Conditions...................................... 25
Properties............................................................... 26
Employee Relations....................................................... 26
LYONDELL METHANOL COMPANY, L.P............................................ 26
Overview................................................................. 26
Management of Lyondell Methanol.......................................... 26
Agreements between Equistar and Lyondell Methanol........................ 27
Raw Materials............................................................ 27
Marketing and Sales...................................................... 27
Competition and Industry Conditions...................................... 27
Properties............................................................... 27
Employee Relations....................................................... 27
PROPERTIES AND EMPLOYEE RELATIONS......................................... 27
i
Page
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INTEGRATION OF RECENTLY ACQUIRED AND COMBINED OPERATIONS................. 28
SHARED CONTROL OF JOINT VENTURES......................................... 28
OPERATING HAZARDS........................................................ 28
ENVIRONMENTAL MATTERS.................................................... 29
Item 3. Legal Proceedings................................................ 30
Litigation Matters...................................................... 30
Environmental Matters................................................... 30
EXECUTIVE OFFICERS OF THE REGISTRANT..................................... 32
Item 4. Submission of Matters to a Vote of Security Holders.............. 34
PART II................................................................... 35
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters................................................................. 35
Item 6. Selected Financial Data.......................................... 36
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 36
Item 7a. Disclosure of Market Risk....................................... 51
Item 8. Financial Statements and Supplementary Data...................... 52
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................... 122
PART III.................................................................. 122
Item 10. Directors and Executive Officers of the Registrant.............. 122
Item 11. Executive Compensation.......................................... 122
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 122
Item 13. Certain Relationships and Related Transactions.................. 122
PART IV................................................................... 123
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-
K....................................................................... 123
Consolidated Financial Statements and Financial Statement Schedules...... 126
Reports on Form 8-K...................................................... 126
ii
PART I
Items 1 and 2. Business and Properties
THE COMPANY'S BUSINESS
Lyondell Chemical Company ("Lyondell" or the "Company"), formerly Lyondell
Petrochemical Company, is a global chemical company with leading market
positions in all of its major products and low cost operations. Lyondell is
vertically integrated into its key raw materials through its equity ownership
in Equistar Chemicals, LP, LYONDELL-CITGO Refining LP and Lyondell Methanol
Company, L.P.
The operations acquired when the Company purchased ARCO Chemical Company
("ARCO Chemical") in July 1998 comprise the Company's intermediate chemicals
and derivatives business. Lyondell manufactures and markets a variety of
intermediate and performance chemicals, including propylene oxide ("PO"),
polyether polyols, propylene glycol ("PG"), propylene glycol ethers ("PGE"),
butanediol ("BDO"), toluene diisocyanate ("TDI"), styrene monomer ("SM"), and
tertiary butyl alcohol ("TBA") and its derivative, methyl tertiary butyl ether
("MTBE").
The Company owns 41 percent of Equistar Chemicals, LP, a Delaware limited
partnership ("Equistar"), which operates petrochemicals and polymers
businesses. Equistar's petrochemicals business manufactures and markets
olefins, oxygenated chemicals, aromatics and specialty chemicals. Equistar's
olefins are ethylene, propylene and butadiene and its oxygenated chemicals
include ethylene oxide ("EO"), ethylene glycol ("EG"), ethanol and MTBE.
Equistar's aromatics are benzene and toluene. Equistar's polymers business
manufactures and markets polyolefins, including high density polyethylene
("HDPE"), low density polyethylene ("LDPE"), linear low density polyethylene
("LLDPE"), polypropylene and performance polymers. Equistar's performance
polymers include enhanced grades of polyethylene such as wire and cable
resins, concentrates and compounds, and polymeric powders.
The Company also owns 58.75 percent of LYONDELL-CITGO Refining LP, a
Delaware limited partnership ("LCR"), which produces refined petroleum
products, including gasoline, low sulfur diesel, jet fuel, aromatics and
lubricants ("lube oils"). LCR sells its principal refined products primarily
to CITGO Petroleum Corporation ("CITGO").
In addition, the Company owns 75 percent of Lyondell Methanol Company, L.P.,
a Texas limited partnership ("Lyondell Methanol"), which produces methanol.
Development of Business
From its formation in 1985 through January 1989, Lyondell operated first as
a division and later as a wholly owned subsidiary of Atlantic Richfield
Company ("ARCO"). In January 1989, ARCO completed an initial public offering
of approximately 50.1 percent of Lyondell's Common Stock. In September 1997,
ARCO divested substantially all of its remaining holdings of the Company's
Common Stock pursuant to the terms of notes issued by ARCO in August 1994,
which were satisfied at maturity by the delivery of shares of Lyondell Common
Stock held by ARCO.
Lyondell has been a leader in the ongoing restructuring of the chemical
industry, taking a series of steps to reposition its business portfolio over
the past several years.
In July 1993, pursuant to agreements between the Company and CITGO (and its
affiliates), the Company contributed its refining business, including its
Houston, Texas refinery (the "Refinery"), its lube oil blending and packaging
plant in Birmingport, Alabama and refining working capital to LCR. The Company
retained an approximately 90 percent interest in LCR, while CITGO held the
remaining approximately 10 percent interest.
1
Following completion of a major upgrade project at the Refinery in the first
quarter of 1997, the Company's interest in LCR was reduced to 58.75 percent.
On December 31, 1998, LCR converted from a Texas limited liability company to
a Delaware limited partnership.
In May 1995, the Company acquired Occidental Chemical Corporation's
("Occidental Chemical") ALATHON(R) HDPE business. Assets involved in this
acquisition included resin production facilities in Matagorda and Victoria,
Texas, related research and development activities and the rights to the
ALATHON(R) trademark.
In December 1996, the Company formed Lyondell Methanol with MCN Investment
Corporation ("MCNIC"), a division of MCN Corporation, to own the Company's 248
million gallons per year methanol plant. Under the terms of the agreement,
MCNIC purchased a 25 percent interest in the methanol plant. Lyondell retained
a 75 percent interest and serves as managing partner. Since December 1997,
Equistar has served as the operator of Lyondell Methanol.
In December 1997, following approval by the stockholders of each company,
Lyondell and Millennium Chemicals Inc. ("Millennium") combined most of their
petrochemicals and polymers businesses to form Equistar. Lyondell contributed
substantially all of the assets comprising its petrochemicals and polymers
business segments, as well as a $345 million note, in exchange for a 57
percent interest in Equistar. Equistar also assumed $745 million of Lyondell's
debt. Millennium contributed substantially all of the assets comprising its
olefins, ethyl alcohol, polyethylene, polypropylene and performance polymers
businesses, which had been held in Millennium Petrochemicals Inc. ("Millennium
Petrochemicals"), a wholly owned subsidiary of Millennium. In exchange,
Millennium received a 43 percent interest in Equistar, Equistar repaid $750
million of debt due to Millennium from its contributed businesses and
Millennium retained $250 million of its accounts receivable.
On May 15, 1998, Lyondell and Millennium expanded Equistar with the addition
of the ethylene, propylene, EO, EG and other EO derivatives businesses (the
"Occidental Contributed Business") of Occidental Chemical Corporation, a
subsidiary of Occidental Petroleum Corporation ("Occidental"). This addition
included two olefins plants, a plant that produces EO and EO derivatives,
including EG, and Occidental's 50 percent interest in a joint venture with
E.I. DuPont de Nemours and Company ("DuPont"), which operates an EO/EG plant.
Occidental also contributed more than 950 miles of owned and leased pipelines
located on the Gulf Coast of the United States and the lease of a Lake
Charles, Louisiana olefins plant. Equistar assumed approximately $205 million
of Occidental's debt. Equistar and Occidental also entered into a long-term
agreement for Equistar to supply the ethylene requirements for Occidental's
chlorovinyls business. In June 1998, Equistar borrowed approximately $500
million of additional debt and distributed cash of approximately $420 million
to Occidental and $75 million to Millennium. Following the transaction,
Lyondell owns 41 percent of Equistar, and Millenium and Occidental each own
29.5 percent.
On July 28, 1998, Lyondell completed the acquisition (the "Acquisition") of
all the outstanding shares of ARCO Chemical, the world's largest producer of
PO and a leading worldwide producer of polyether polyols, PG, PGE, TDI, SM,
MTBE and BDO. The Acquisition was financed through a bank credit agreement
providing for aggregate borrowings of up to $7 billion (the "Credit
Facility"). ARCO Chemical was renamed Lyondell Chemical Worldwide, Inc.
subsequent to the Acquisition. The acquired business is referred to from time
to time hereafter as "ARCO Chemical" for actions or events prior to the
Acquisition and as the "Acquired Business" for actions or events from and
after the Acquisition. Actions or events relating to the Acquired Business may
also be covered by the more general terms Lyondell or the Company.
The Company's principal executive offices are located at 1221 McKinney
Street, Houston, Texas 77010 (Telephone: (713) 652-7200).
2
Summary Description of Business Segments
Through the year ended December 31, 1996, the Company reported its results
of operations in two segments, petrochemicals and refining. In 1997, the
Company reported the results of its polymers operations as a separate segment.
Following the Acquisition in July 1998, the Company added intermediate
chemicals and derivatives as a reportable segment. The operations of the
Acquired Business form the Company's intermediate chemicals and derivatives
segment. The Company's petrochemicals and polymers segments are operated
through Equistar. The Company's refining segment is conducted through LCR. The
methanol business conducted through Lyondell Methanol is not a reportable
segment for financial disclosure purposes.
3
The following chart shows the organization of Lyondell, as well as 1998 sales
revenues for Lyondell and each of its joint ventures, of which Lyondell owns
the specified percentage. Sales revenue for Lyondell and its subsidiaries
represent the pro forma sales revenue of the Acquired Business for 1998 (as if
the acquisition had occurred on January 1, 1998).
[Chart Appears Here showing: 1998 consolidated pro forma sales revenue
(excluding revenues of Equistar, LCR and Lyondell Methanol) of $3.6 billion
for Lyondell and Subsidiaries and the primary products of Lyondell's
Intermediate Chemicals and Derivatives Business; Lyondell's equity investments
in each of Equistar (41 percent), LCR (58.75 percent) and Lyondell Methanol
(75 percent); the 1998 sales revenues of each of Equistar, LCR and Lyondell
Methanol, which were $4.4 billion, $2.1 billion and $104 million,
respectively; and the primary products of each of the petrochemicals,
polymers, refining and methanol businesses]
Sales revenues above include sales to affiliates. For additional segment
information for each of the years in the three-year period ended December 31,
1998, see Notes 4, 5, 6 and 22 of Notes to Consolidated Financial Statements.
4
INTERMEDIATE CHEMICALS AND DERIVATIVES
Overview
Through the Acquired Business, Lyondell is a leading global manufacturer and
marketer of intermediate chemicals and performance chemical products used in a
broad range of consumer goods. The segment's core product is PO, which is
produced through two distinct technologies based on indirect oxidation
processes that yield co-products. One process yields TBA as the co-product;
the other yields SM as the co-product. The two technologies are mutually
exclusive such that either a dedicated PO/TBA or a dedicated PO/SM plant must
be built. The intermediate chemicals and derivatives segment also manufactures
numerous derivatives of PO and TBA. Among these are polyols and PG,
derivatives of PO, and MTBE, a principal derivative of TBA. This segment also
manufactures and markets TDI.
In North America, the Company produces PO, TBA, PG and PGE at its Bayport,
Texas plant; PO, SM, MTBE, polyols and BDO at its Channelview, Texas plant;
polyols at its South Charleston and Institute, West Virginia plants; and
isocyanates at its Lake Charles, Louisiana plant. In Europe, the Company
produces PO, TBA, PG and MTBE at plants in Rotterdam, The Netherlands, and
Fos-sur-Mer, France; PGE at its Rotterdam plant; and polyols at the Fos-sur-
Mer plant and at a plant in Rieme, Belgium. In the Asia Pacific region, the
Company has a 50 percent interest in the joint venture Nihon Oxirane Co., Ltd.
("Nihon Oxirane"), which operates a PO/SM plant in Chiba, Japan. The Company
produces polyols at majority-owned plants in Kaohsiung, Taiwan and Anyer, West
Java, Indonesia.
The Company estimates, based in part on published data, that worldwide
demand for PO was approximately 8.7 billion pounds in 1998. Approximately 90
percent of that volume was consumed in the manufacture of three families of PO
derivative products: polyols, PG and PGE. The remainder is consumed in the
manufacture of a growing segment of performance-based products, as well as BDO
and its derivatives. The Company consumes approximately 60 percent of its PO
for the production of derivatives.
Polyols and TDI are combined in the production of urethanes for products
such as automotive seating and home furnishings, as well as coatings,
adhesives, sealants and elastomers.
PG is principally used as an intermediate chemical to produce unsaturated
polyester resins. PG has low toxicity and is also used in certain food,
cosmetic, and pharmaceutical applications and in automotive coolants and
aircraft deicers. PGE comprises low toxicity, high performance solvents.
BDO and its derivatives are utilized in the production of engineering
plastics, pharmaceuticals, personal care products, fibers and high performance
coatings.
Lyondell reacts most of its TBA with methanol to make MTBE, a gasoline
blending component that increases octane and reduces emissions. The Company
also has the capability to produce ethyl tertiary butyl ether ("ETBE"), an
alternate gasoline blending component. ETBE is manufactured from TBA and
ethanol and has a lower vapor pressure than MTBE or ethanol.
Worldwide demand for MTBE in 1998 was approximately 428,000 barrels per day,
based on published data. This demand has increased over the past several years
as a result of the Clean Air Act Amendments of 1990 (the "Clean Air Act
Amendments"), state and local regulations and the need for incremental octane
in gasoline in the United States and other countries. In the United States,
the Clean Air Act Amendments set minimum levels for oxygenates, such as MTBE,
in gasoline sold in areas not meeting specified air quality standards. The EPA
has proposed a reduction in permissible ozone levels in the United States,
which, if adopted, may create additional demand for MTBE. However, pending or
future legislative initiatives or litigation may materially adversely affect
the Company's MTBE sales or subject the Company to product liability.
Studies by federal and state agencies and other organizations have shown
that MTBE is safe for use in gasoline and is effective in reducing automotive
emissions. Nevertheless, the presence of MTBE in some water
5
supplies in California and other states due to gasoline leaking from
underground storage tanks and in surface water from recreational water craft
has led to public concern that MTBE may contaminate drinking water supplies,
and thereby result in a possible health risk. The Governor of California has
announced an intention to eliminate MTBE from gasoline sold in California by
December 31, 2002. There have been claims that MTBE travels more rapidly
through soil, and is more soluble in water, than most other gasoline
components, and is more difficult and more costly to remediate. Heightened
public awareness about MTBE has resulted in certain state and federal
legislative initiatives that have sought either to rescind the oxygenate
requirement for reformulated gasoline sold in California and other states or
restrict the use of MTBE. There is ongoing review of this issue and the
ultimate resolution of the appropriateness of using MTBE could result in a
significant reduction in the Company's MTBE sales.
In addition, the Company has a take-or-pay MTBE sales contract with ARCO,
which contributes significant pre-tax margin. If such legislative initiatives
were enacted, ARCO has indicated that it might attempt to invoke a force
majeure provision in the ARCO contract in order to reduce the quantities of
MTBE it purchases under, or to terminate, the contract. The Company would
vigorously dispute such action. The contract has an initial term expiring
December 31, 2002 and provides for formula-based prices that are currently
significantly above spot market prices for MTBE. A significant reduction in
the Company's sales under the ARCO contract could have a negative impact on
the Company's results of operations.
SM is a commodity chemical produced and traded worldwide for commodity and
specialty polymer applications, such as polystyrene and polyester resins, as
well as various uses in the rubber industry. Based on published data,
worldwide demand in 1998 was approximately 40 billion pounds.
In late 1997, ARCO Chemical initiated a restructuring program designed to
simplify the organization, streamline operations and reduce costs. Lyondell is
on target to achieve most of these cost savings by the end of 1999. Lyondell
believes that it will be able to realize additional cost savings primarily
through overhead consolidation, manufacturing and purchasing efficiencies,
reduced transportation costs and raw material integration with Equistar. As
contemplated at the time of the Acquisition, the Company has delayed the
construction of a PO/SM plant in Rotterdam ("PO-11") that ARCO Chemical had
scheduled for startup in late 2000.
The following table outlines the intermediate chemicals and derivatives
segment's primary products, annual capacity and the primary uses for such
products.
Product Rated Capacity(a) Primary Uses
------- ----------------- ------------
Propylene Oxide (PO) 3.85 billion pounds PO is a key component of polyols, PG, PGE and
BDO.
Polyols 1.47 billion pounds Polyols are used to produce flexible foam for
automotive seating and home furnishings,
coatings, adhesives, sealants and elastomers.
Toluene Diisocyanate 250 million pounds(b) TDI is combined with polyols to produce
(TDI) flexible foam for automotive seating and home
furnishings, coatings, adhesives, sealants
and elastomers.
Propylene Glycol (PG) 960 million pounds PG is used to produce unsaturated polyester
resins for bathroom fixtures and boat hulls;
lower toxicity antifreeze, coolants and
aircraft deicers; and cosmetics and cleaners.
Propylene Glycol Ethers 300 million pounds PGE are used as lower toxicity solvents for
(PGE) paints, coatings and cleaners.
Butanediol (BDO) 120 million pounds BDO is used in the manufacture of engineering
resins, films, personal care products,
pharmaceuticals, coatings, solvents and
adhesives.
6
Product Rated Capacity(a) Primary Uses
------- ----------------- ------------
Tertiary Butyl Alcohol 58,500 barrels/day TBA is a key component of MTBE. MTBE is a
(TBA)--fuel oxygenates: gasoline component for reducing emissions in
Methyl Tertiary Butyl reformulated gasolines and enhancing octane
Ether (MTBE) value.
Styrene Monomer (SM) 3.65 billion pounds SM is used to produce plastics, such as
expandable polystyrene for packaging, foam
cups and containers, insulation products and
durables and engineering resins.
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(a) Unless otherwise specified, represents rated capacity as of January 1,
1999. The term "rated capacity," as used in this table, is calculated by
estimating the number of days in a typical year a production unit of a
plant is expected to operate after allowing downtime for regular
maintenance and multiplying that number by an amount equal to the unit's
optimal daily output based on the design feedstock mix. Because the rated
capacity of a production unit is an estimated amount, actual production
volumes may be more or less than rated capacity. Capacities shown include
100 percent of the capacity of joint venture facilities.
(b) Does not include 264 million pounds of supply reserved under long-term TDI
supply agreements with Rhone-Poulenc, pursuant to which Lyondell is
entitled to all of the TDI output of Rhone-Poulenc's two plants in France.
Raw Materials
The principal hydrocarbon raw materials purchased by the intermediate
chemicals and derivatives segment are propylene, butanes, ethylene, benzene
and methanol. The market prices of these raw materials historically have been
related to the price of crude oil and its principal refinery derivatives and
natural gas liquids. These materials are available in bulk quantities via
pipeline or marine vessels. The segment's raw materials requirements are
purchased from numerous suppliers in the United States and Europe, with which
the Company has established contractual relationships, as well as in the spot
market. The segment receives a portion of its methanol requirements under a
cost-based supply arrangement with a third party.
The Company's raw material suppliers include Equistar, which is a leading
producer of propylene, ethylene and benzene. See Note 4 of Notes to
Consolidated Financial Statements.
The intermediate chemicals and derivatives segment is a large volume
consumer of isobutane for chemical production. The Company has invested in
facilities, or entered into processing agreements with unrelated third
parties, to convert the widely available commodity normal butane to isobutane.
The Company is also a large consumer of oxygen for its PO/TBA plants at
Bayport, Texas, Rotterdam, The Netherlands, and Fos-sur-Mer, France.
In order to assure adequate and reliable sources of supply at competitive
prices and rates, the Company is a party to long-term agreements and other
arrangements with suppliers of raw materials, products, industrial gas and
other utilities.
Marketing and Sales
In 1998, most of the segment's revenues were derived from sales to, or
processing agreements with, unrelated third parties. Over the past three
years, no single unrelated third party customer, nor any related party
customer, accounted for more than 10 percent of total revenues in any one
year.
The intermediate chemicals and derivatives segment delivers products through
sales agreements, processing agreements and spot sales as well as product
swaps. It purchases limited amounts of MTBE and SM for resale to the extent
that customer demand for these co-products exceeds its production. Production
levels for co-products are based upon the demand for PO and the market
economics of the co-products.
The segment has a number of multi-year PO processing or sales agreements.
This reflects an effort to mitigate the adverse impact of competitive factors
and economic business cycles on demand for the segment's PO. The segment is
also a party to a number of multi-year SM sales and processing agreements and
MTBE sales agreements.
7
Lyondell sells most of its SM production into the United States merchant
market and to selected export markets through sales or tolling agreements. The
SM processing agreements also include long-term processing agreements
providing for the delivery of fixed annual quantities of SM. See "--Joint
Ventures and Other Agreements." As of December 31, 1998, the Company had over
1.1 billion pounds of SM capacity, or 30 percent of its worldwide capacity,
covered by long-term processing arrangements.
In addition to the ARCO contract, the Company also sells its MTBE production
under market-based sales agreements and in the spot market.
The segment's sales are made through Company marketing and sales personnel
and through distributors and independent agents located in the Americas,
Europe and the Asia Pacific region. As part of the restructuring and cost-
reduction program announced in 1997, the segment has centralized certain sales
and order fulfillment functions in regional customer service centers located
in Channelview, Texas, Rotterdam, The Netherlands and Singapore. This will
permit the Company to reduce its sales office infrastructure for this segment
around the world, while maintaining service to its worldwide customer base.
For data relating to foreign operations and export sales, see Note 22 of
Notes to Consolidated Financial Statements.
Joint Ventures and Other Agreements
The PO/SM plant at the Channelview, Texas complex that was completed in 1992
(PO/SM II) is owned by the Company together with third-party equity investors.
The Acquired Business sold additional interests to the investors in 1994, 1996
and 1997. In addition, portions of a 1998 PO/SM II expansion ( see "--
Properties" for additional discussion) were funded through third-party
investment. The Company retains a majority interest in the PO/SM II plant and
is the operator of the plant. A portion of the SM output of the PO/SM II plant
is committed to the third-party investors under long-term processing
agreements. As of December 31, 1998, 1.1 billion pounds per year of the PO/SM
II plant's existing SM capacity was committed under such arrangements.
The Company, through a subsidiary, has a 50 percent equity interest in Nihon
Oxirane, a joint venture with Sumitomo Chemical Co., Ltd. and Showa Denko K.K.
Since 1976, Nihon Oxirane has operated a PO/SM plant in Chiba, Japan.
In January 1995, ARCO Chemical entered into long-term TDI supply agreements
with Rhone-Poulenc entitling the Acquired Business to the entire TDI output of
Rhone-Poulenc's two plants in France, which have a combined annual capacity of
approximately 264 million pounds, and providing the Acquired Business an
option to acquire one of the plants from Rhone-Poulenc at the end of the
supply term. This TDI is marketed principally in Europe, the Middle East,
Africa and Asia.
Competition and Industry Conditions
Competition within the intermediate chemicals and derivatives segment of the
chemical industry is significant and is affected by a variety of factors,
including quality, product price, reliability of supply, technical support,
customer service and potential substitute materials. Profitability in this
segment is affected by the worldwide level of demand along with vigorous price
competition which may intensify due to, among other things, new domestic and
foreign industry capacity. In general, weak economic conditions either in the
United States or in the world tend to reduce demand and put pressure on
margins. It is not possible to predict accurately the changes in feedstock
costs, market conditions and other factors that will affect industry margins
in the future. Capacity share figures for the segment and its competitors,
discussed below, are based on completed production facilities and, where
appropriate, include the full capacity of joint-venture facilities and certain
long-term supply agreements.
The Company's major worldwide PO competitors are Dow Chemical Company
("Dow") and Shell. Dow's operations are based on chlorohydrin technology.
Shell utilizes a proprietary PO/SM technology. Based on published data
relating to the PO market, the Company believes it has 35 percent, Dow has 32
percent and Shell has over 5 percent of the total worldwide capacity for PO.
8
The expansion of the PO/SM II plant in Channelview, Texas in early 1998
added annual PO and SM capacity of 110 million and 248 million pounds,
respectively. As contemplated at the time of the Acquisition, the Company has
delayed the construction of PO-11 in Rotterdam, The Netherlands, which ARCO
Chemical had scheduled for startup in late 2000.
Shell and BASF AG ("BASF") have formed a joint venture to construct a PO/SM
plant in Europe, using Shell technology, with a target completion date in the
1999 time frame. Shell has also announced plans to construct a PO/SM plant in
Singapore, with BASF as a 50 percent partner and with a target completion date
of late 2001. In addition, Repsol Quimica, S.A. has announced plans to build a
PO/SM plant with an early 2000 startup date in Tarragona, Spain, using
technology for the production of PO and SM originally licensed from ARCO
Chemical.
The Company competes with many polyols producers worldwide, including Dow,
Bayer AG ("Bayer") and BASF. Based on published data, Dow is believed to have
26 percent of worldwide polyols capacity while the Company is believed to have
16 percent.
The Company both manufactures and has long-term supply agreements for TDI,
an isocyanate, which is reacted with polyols to produce flexible foams. The
Company competes with many TDI producers worldwide, including Bayer and BASF.
Based on published data, Bayer is believed to have 24 percent of worldwide TDI
capacity while the Company is believed to have 17 percent.
The Company competes with many MTBE producers worldwide, the most
significant of which is Saudi Basic Industries Corp. ("SABIC"). Based on
published data, SABIC is believed to have 11 percent of the total worldwide
capacity for MTBE. The Company believes it has 10 percent through the Acquired
Business. In addition, the Company believes that Equistar's MTBE capacity
comprises an additional 3 percent of worldwide MTBE capacity. MTBE also faces
competition from substitute products such as ethanol as well as other octane
components.
The Company competes with several SM producers worldwide; among them are
Shell, Dow and BASF. Based on published data, Shell is believed to have 9
percent and the Company is believed to have 8 percent of the total worldwide
SM capacity.
Properties
As part of the Acquisition, Lyondell acquired ARCO Chemical's headquarters
office and research facility in Newtown Square, Pennsylvania, which is leased
from ARCO. The Acquired Business' European headquarters are located in leased
facilities in Maidenhead, England, and the Acquired Business' Asia Pacific
headquarters are located in leased facilities in Hong Kong. As part of its
restructuring program, the Acquired Business reduced or relocated staff from
the European and Asia Pacific headquarters with appropriate reductions in the
size of the leased headquarters facilities and established regional service
centers at leased facilities in Rotterdam, The Netherlands and Singapore. The
Company owns the regional service center in Channelview, Texas.
Depending on location and market needs, the Company's production facilities
can receive primary raw materials by pipeline, railcar, truck, barge or ship
and can deliver finished products in drums or by pipeline, railcar, truck,
barge, isotank or ship. The Company charters ships, owns and charters barges
and leases isotanks and railcars for the dedicated movement of products
between plants, products to customers or terminals, or raw materials to
plants, as necessary. The Company leases liquid and bulk storage and warehouse
facilities at terminals in the Americas, Europe and the Asia Pacific region.
In the Rotterdam outer harbor area, the Company operates an on-site butane
storage tank, propylene spheres, pipeline connections and a jetty that
accommodates deep-draft vessels.
9
The principal manufacturing facilities of the segment are set forth below.
All of these facilities are wholly-owned by Lyondell unless otherwise noted.
Location Principal Products
-------- --------------------------
Bayport (Pasadena), Texas.................... PO, PG, PGE, TBA
Channelview, Texas(1)........................ PO, polyols, BDO, SM, MTBE
Lake Charles, Louisiana...................... TDI
Institute and South Charleston, West
Virginia(2)................................. polyols
Rieme, Belgium............................... polyols
Fos-sur-Mer, France.......................... PO, PG, polyols, TBA, MTBE
Botlek, Rotterdam, The Netherlands........... PO, PG, PGE, TBA, MTBE
Anyer, West Java, Indonesia(3)............... polyols
Chiba, Japan(4).............................. PO, SM
Kaohsiung, Taiwan(5)......................... polyols
- --------
(1) Third-party investors hold a minority ownership interest in the PO/SM II
plant at the Channelview facility.
(2) The Company's plants in South Charleston and Institute, West Virginia are
situated on leased land.
(3) The Anyer plant is owned by P.T. Lyondell Indonesia, an Indonesian joint
venture with P.T. Gema Supra Abadi. The Company, through a subsidiary, has
a majority interest in the joint venture.
(4) The PO/SM plant located in Chiba, Japan is owned by Nihon Oxirane, a joint
venture in which the Company holds a 50 percent interest through a
subsidiary.
(5) The Taiwan plant is owned by Lyondell Taiwan Co., Ltd., a Taiwan company
in which the Company, through a subsidiary, has a majority interest.
Research and Technology; Patents and Trademarks
The Acquired Business has been granted 66 patents and has over 34 patents
pending for the Impact(TM) process technology. The Impact(TM) technology,
first introduced in 1995, offers significant cost savings in the production of
conventional polyols products.
The Company possesses a body of patented and unpatented technology and trade
secrets relating to its products, processes and the design and operation of
its plants, all of which are valuable to the segment. The Company does not
believe that the loss of any individual patent or trade secret would have a
material adverse effect on its intermediate chemicals and derivatives
business. The basic patents relating to the Company's PO/SM and PO/TBA
technologies have expired.
The principal research and development facility for the segment is located
in Newtown Square, Pennsylvania, with technical centers in South Charleston,
West Virginia, Villers Saint Paul, France, and Singapore.
Employee Relations
On December 31, 1998, the Acquired Business employed approximately 4,200
employees. Approximately 23 percent of the Acquired Business's domestic
employees are represented by labor unions. The Company believes its relations
with its employees are good.
10
EQUISTAR CHEMICALS, LP
Management of Equistar
Equistar is a limited partnership organized under the laws of the State of
Delaware. Lyondell owns its interest in Equistar through two wholly owned
subsidiaries, one of which serves as a general partner of Equistar and one of
which serves as a limited partner. Similarly, Millennium owns its interest in
Equistar through two wholly owned subsidiaries, one a general partner and one
a limited partner. Occidental owns its interest in Equistar through three
wholly owned subsidiaries, one a general partner and two limited partners.
Lyondell holds a 41 percent interest and Millennium and Occidental each hold a
29.5 percent interest in Equistar. The Amended and Restated Partnership
Agreement of Equistar (the "Equistar Partnership Agreement") governs, among
other things, ownership, cash distributions, capital contributions and
management of Equistar.
The Equistar Partnership Agreement provides that Equistar is governed by a
Partnership Governance Committee, consisting of nine representatives, three
appointed by each general partner. Matters requiring agreement by the
representatives of Lyondell, Millennium and Occidental include changes in the
scope of Equistar's business, the five year strategic plan (and annual updates
thereof), the sale or purchase of assets or capital expenditures of more than
$30 million not contemplated by the strategic plan, investments by Equistar's
partners over certain amounts, merging or combining with another business and
certain other matters. All decisions of the Partnership Governance Committee
that do not require unanimity between Lyondell, Millennium and Occidental may
be made by Lyondell's representatives alone. The day-to-day operations of
Equistar are managed by the executive officers of Equistar. Dan Smith, the
Chief Executive Officer of Lyondell, also serves as Chief Executive Officer of
Equistar.
Agreements between Lyondell and Equistar
Lyondell and Equistar entered into an agreement on December 1, 1997,
providing for the transfer of assets to Equistar. Among other things, such
agreement sets forth representations and warranties by Lyondell with respect
to the transferred assets and requires indemnification by Lyondell with
respect thereto. Such agreement also provides for the assumption by Equistar
of, among other things, third party claims that are related to certain pre-
closing contingent liabilities that are asserted prior to December 1, 2004, to
the extent the aggregate thereof does not exceed $7 million, third party
claims related to pre-closing contingent liabilities that are asserted for the
first time after December 1, 2004, certain obligations for indebtedness,
liabilities for products sold after December 1, 1997, regardless of when
manufactured, and certain long term liabilities. Millennium Petrochemicals and
affiliates of Occidental (the "Occidental Subsidiaries") entered into similar
agreements with Equistar with respect to the transfer of their respective
assets and Equistar's assumption of liabilities.
Also in connection with the formation of Equistar, Lyondell contributed a
promissory note for $345 million payable to Equistar, which Lyondell repaid
with proceeds of the Credit Facility.
If Lyondell, Millennium or Occidental or any of their affiliates desire to
initiate or pursue an opportunity to undertake, engage in, acquire or invest
in a business or activity or operation within the scope of the business of
Equistar, such opportunity must first be offered to Equistar. Equistar has
certain options to participate in such opportunity but if it determines not to
participate, the party offering the opportunity is free to pursue it on its
own. If the opportunity within Equistar's scope of business constitutes less
than 25 percent of an acquisition that is otherwise not within the scope of
the business of Equistar, Lyondell, Millennium or Occidental, as the case may
be, may make such acquisition provided that after such acquisition, the
portion within the scope of the business of Equistar is offered to Equistar
pursuant to the foregoing provisions.
Lyondell has agreed to provide certain administrative services to Equistar,
including certain legal, risk management, treasury services, tax services and
employee benefit plan administration. Equistar has also agreed to provide
certain services to Lyondell, such as health, safety and environmental
services, human resource
11
services, information services and legal services. As a consequence of
services being provided by Equistar to Lyondell and by Lyondell to Equistar, a
monthly net payment is made by Equistar to Lyondell with respect thereto. See
Note 4 of Notes to Consolidated Financial Statements. Equistar and Millennium
Petrochemicals are also parties to a number of agreements for the provision of
services, utilities and materials from one party to the other at common
locations, principally LaPorte and Cincinnati. An affiliate of Occidental
provides services to Equistar, including services related to accounting,
payroll, office administration, marketing, transportation, purchasing and
procurement, management, human resources, customer service, technical services
and others, pursuant to a Transition Services Agreement, which will terminate
on June 1, 1999.
Lyondell, Millennium Petrochemicals and the Occidental Subsidiaries each
entered into a Master Intellectual Property Agreement with Equistar. The
Master Intellectual Property Agreements provide for (i) the transfer of
certain intellectual property of Lyondell, Millennium Petrochemicals and the
Occidental Subsidiaries related to the businesses each contributed to
Equistar, (ii) certain rights and licenses to Equistar with respect to
intellectual property retained by Lyondell, Millennium Petrochemicals or the
Occidental Subsidiaries that was not solely related to the business of
Equistar but is useful in such business and (iii) certain rights and licenses
from Equistar to Lyondell, Millennium Petrochemicals and the Occidental
Subsidiaries, respectively, with respect to intellectual property transferred
to Equistar that Lyondell, Millennium Petrochemicals and the Occidental
Subsidiaries may use with respect to their other businesses.
Lyondell, Millennium, Occidental and certain of its affiliates and Equistar
are parties to an Amended and Restated Parent Agreement dated as of May 15,
1998, which provides that, among other things, each of Lyondell, Millennium
and an Occidental affiliate guarantees the performance by their respective
subsidiaries under various agreements entered into in connection with the
formation of Equistar, including the Equistar Partnership Agreement and the
asset transfer agreements providing for the transfer of assets by Lyondell,
Millennium Petrochemicals and the Occidental Subsidiaries, respectively, to
Equistar.
12
EQUISTAR PETROCHEMICALS
Overview
Equistar produces a variety of petrochemicals, including olefins, oxygenated
chemicals, aromatics and specialty chemicals, at twelve facilities located in
six states. Olefins include ethylene, propylene and butadiene. Oxygenated
chemicals include EO, EG, ethanol and MTBE. Aromatics produced are benzene and
toluene. Equistar's petrochemical products are used to manufacture polymers
and intermediate chemicals, which are used in a variety of consumer and
industrial products. Ethylene is the most significant petrochemical in terms
of worldwide production volume and is the key building block for polyethylene
and a large number of other chemicals, plastics and synthetics.
The Chocolate Bayou, Corpus Christi and two Channelview, Texas olefins
plants use petroleum liquid feedstocks, including naphtha, condensates and gas
oils (collectively "Petroleum Liquids"), to produce ethylene. The cost of
ethylene production from Petroleum Liquids feedstocks historically has been
less than the cost of producing ethylene from natural gas liquids feedstocks,
including ethane, propane and butane (collectively, "NGLs").
The use of Petroleum Liquids results in the production of a significant
amount of co-products such as propylene, butadiene, benzene and toluene, and
specialty chemicals, such as dicyclopentadiene ("DCPD"), isoprene, resin oil,
piperylenes, hydrogen and alkylate. Based upon independent third-party
surveys, management believes that its Channelview facility is the lowest
production cost olefins facility in North America. Equistar's Morris,
Illinois, Clinton, Iowa, Lake Charles, Louisiana and LaPorte, Texas plants are
designed to use primarily NGLs which produce primarily ethylene with some co-
products such as propylene. In addition, Equistar currently is modifying the
LaPorte plant to run certain Petroleum Liquids feedstocks. A comprehensive
pipeline system connects the Gulf Coast plants with major olefins customers.
Feedstocks are sourced both internationally and domestically and are shipped
via vessel and pipeline.
Equistar produces EO and its primary derivative, EG, at facilities located
at Pasadena, Texas and through a 50/50 joint venture with DuPont in Beaumont,
Texas. The Pasadena facility also produces other derivatives of EO,
principally ethers and ethanolamine. EG is used in antifreeze and in polyester
fibers, resins and films. The other EO derivatives are used in many consumer
and industrial end uses, such as detergents and surfactants, brake fluids and
polyurethane foams for seating and bedding.
Equistar produces synthetic ethyl alcohol at its Tuscola, Illinois plant by
a direct hydration process that combines water and ethylene. Equistar also
owns and operates facilities in Newark, New Jersey and Anaheim, California for
denaturing ethyl alcohol by the addition of certain chemicals. In addition, it
produces small volumes of diethyl ether, a by-product of its ethyl alcohol
production, at Tuscola. These ethyl alcohol products are ingredients in
various consumer and industrial products as described more fully in the table
below.
13
The following table outlines Equistar's primary petrochemical products,
annual rated capacity and the primary uses for such products.
Product Rated Capacity(a) Primary Uses
------- ----------------- ------------
OLEFINS:
Ethylene 11.5 billion pounds Ethylene is used as a feedstock to
manufacture polyethylene, EO, ethylene
dichloride and ethylbenzene.
Propylene 5.0 billion pounds(b) Propylene is used to produce polypropylene,
acrylonitrile and propylene oxide.
Butadiene 1.2 billion pounds Butadiene is used to manufacture styrene
butadiene rubber and polybutadiene rubber,
which are used in the manufacture of tires,
hoses, gaskets and other rubber products.
Butadiene is also used in the production of
paints, adhesives, nylon clothing, carpets
and engineered plastics.
OXYGENATED PRODUCTS:
Ethylene Oxide (EO) and 1.1 billion pounds EOE; EO is used to produce surfactants, industrial
Equivalents (EOE) 400 million pounds as pure EO cleaners, cosmetics, emulsifiers, paint, heat
transfer fluids and ethylene glycol
(polyester fibers and film, polyethylene
terephthalate ("PET") resin and antifreeze).
Ethylene Glycol(EG) 1 billion pounds EG is used to produce polyester fibers and
film, PET resin, heat transfer fluids, paint
and automobile antifreeze.
Ethylene Oxide 225 million pounds EO derivatives are used to produce paint and
Derivatives coatings, polishes, solvents and chemical
intermediates.
MTBE 284 million gallons MTBE is an octane enhancer and clean fuel
(18,500 barrels/day)(c) additive in reformulated gasoline.
AROMATICS:
Benzene 301 million gallons Benzene is used to produce styrene, phenol
and cyclohexane. These products are used in
the production of nylon, plastics, rubber and
polystyrene. Polystyrene is used in
insulation, packaging and drink cups.
Toluene 66 million gallons Toluene is used as an octane enhancer in
gasoline, as a chemical feedstock for benzene
production, and a core ingredient in TDI, a
compound in urethane production.
SPECIALTY CHEMICALS:
Dicyclopentadiene (DCPD) 80 million pounds DCPD is a component of inks, adhesives and
polyester resins for molded parts such as tub
and shower stalls and boat hulls.
Isoprene 105 million pounds Isoprene is a component of premium tires,
adhesive sealants and other rubber products.
Resin Oil 120 million pounds Resin oil is used in the production of hot-
melt-adhesives, inks, sealants, paints and
varnishes.
Piperylenes 100 million pounds Piperylenes are used in the production of
adhesives, inks and sealants.
Hydrogen 44 billion cubic feet Hydrogen is used by refineries to remove
sulfur from process gas in heavy crude oil.
Alkylate 337 million gallons(d) Alkylate is a premium blending component used
by refiners to meet Clean Air Act standards
for reformulated gasoline.
Ethyl Alcohol 50 million gallons Ethyl alcohol is used in the production of
solvents as well as household, medicinal and
personal care products.
Diethyl Ether 5 million gallons Diethyl ether is used in laboratory reagents,
gasoline and diesel engine starting fluid,
liniments, analgesics and smokeless gun
powder.
14
- --------
(a) Unless otherwise specified, represents rated capacity at January 1, 1999.
The term "rated capacity," as used in this table, is calculated by
estimating the number of days in a typical year that a production unit of
a plant is expected to operate, after allowing for downtime for regular
maintenance, and multiplying that number by an amount equal to the unit's
optimal daily output based on the design feedstock mix. Because the rated
capacity of a production unit is an estimated amount, the actual
production volumes may be more or less than the rated capacity. Capacities
shown include 100 percent of the capacity of Equistar, of which the
Company owns 41 percent.
(b) Does not include refinery grade material or production from the product
flexibility unit at Equistar's Channelview facility, which can convert
ethylene and other light petrochemicals into propylene and has a current
rated capacity of one billion pounds per year of propylene.
(c) Includes up to 44 million gallons/year of capacity which is operated for
the benefit of LCR.
(d) Includes up to 172 million gallons/year of capacity which is operated for
the benefit of LCR.
Raw Materials
Olefins feedstock cost is generally the largest component of total cost for
the petrochemicals business. Olefins plants with the flexibility to consume a
wide range of feedstocks are able to maintain higher profitability during
periods of changing energy and petrochemicals prices than olefins plants that
are restricted in their feedstock processing capability. The primary
feedstocks used in the production of olefins are Petroleum Liquids (also
referred to as "heavy feedstocks") and NGLs (also referred to as "light
feedstocks"). As of January 1, 1999, approximately 44 percent of domestic
ethylene capacity was limited to NGL feedstocks and approximately 56 percent
of domestic capacity processed to some extent both NGLs and Petroleum Liquids.
Petroleum Liquids have had a historical variable margin advantage over NGLs
such as ethane and propane. For example, using Petroleum Liquid feedstocks
typically generates between one and four cents additional margin per pound of
ethylene produced compared to using ethane. Equistar has the capability to
realize this margin advantage at the Channelview, Corpus Christi and Chocolate
Bayou facilities. This variable margin advantage is expected to continue due
to the significantly higher capital cost for plants with the capability to
process both heavy feedstocks (Petroleum Liquids) and the co-products which
result from processing Petroleum Liquid feedstocks in contrast to processing
light feedstocks (NGLs).
The Channelview facility is unusually flexible in that it can process 100
percent Petroleum Liquids or up to 80 percent NGL feedstocks. The Corpus
Christi plant can process up to 70 percent Petroleum Liquids or up to 70
percent NGLs. The Chocolate Bayou facility processes 100 percent Petroleum
Liquids. Equistar's four other olefins facilities currently process only NGLs.
Equistar, however, is in the process of upgrading the LaPorte facility to
integrate the operations of the LaPorte and Channelview facilities to permit
the LaPorte facility to process 25 percent to 30 percent Petroleum Liquids and
the Channelview facility to process the co-products resulting from the
processing of Petroleum Liquids at LaPorte.
The majority of Equistar's Petroleum Liquids requirements are obtained under
contracts or on the spot market from a variety of third-party domestic and
foreign sources. Equistar also purchases NGLs from a wide variety of domestic
sources. Equistar obtains a portion of its olefins feedstock requirements from
LCR at market-based prices.
In addition to producing its own ethylene, Equistar assumed certain
agreements of an affiliate of Millennium for the purchase of ethylene from
Gulf Coast producers at market prices. Ethylene purchase obligations under the
assumed contracts will decline to zero at the end of 2000.
Marketing and Sales
Ethylene produced by the LaPorte, Morris and Clinton facilities is generally
consumed as feedstock by the polymers operations at those sites. Ethylene and
propylene produced at the Channelview, Corpus Christi, Chocolate Bayou and
Lake Charles olefins plants are generally distributed by pipeline or via
exchange
15
agreements to Equistar's Gulf Coast polymer and EO facilities as well as to
other third parties. As of December 31, 1998, approximately 75 percent of the
ethylene produced by Equistar was consumed internally or sold to Equistar's
affiliates based on current market prices.
With respect to sales to third parties, Equistar sells a majority of its
olefins products to customers with whom Lyondell and Occidental have had long-
standing relationships. Over the past three years, no single unrelated third
party customer accounted for more than 10% of total segment revenues in any
one year.
Sales to third parties generally are made pursuant to written agreements
which typically provide for monthly negotiation of price. The contracts
typically require the customer to purchase a specified minimum quantity.
Contract terms are typically three to six years with automatic one or two year
term extension provisions. Some contracts are subject to early termination if
deliveries have been suspended for several months.
EO and EG are sold under long-term contracts of three to five years'
duration to third-party customers, with pricing negotiated on a quarterly
basis to reflect market conditions. Glycol ethers are sold primarily into the
solvent and distributor markets under one-year contracts at market prices, as
are ethanolamines and brake fluids. Ethanol and ethers are sold to third-party
customers under one-year contracts at market prices.
Equistar licenses MTBE technology under a license entered into with ARCO
Chemical and sells a significant portion of MTBE produced at one of its two
Channelview units to Lyondell at market-related prices. The production from
the second unit is consumed by LCR for gasoline blending. MTBE produced at
Chocolate Bayou is sold to third parties at market-related prices.
Equistar sells most of its aromatics production under contracts that have
initial terms ranging from two to three years and that typically contain
automatic one-year term extension provisions. These contracts generally
provide for monthly or quarterly price adjustments based upon current market
prices. Aromatics produced by LCR, with the exception of benzene, are marketed
by Equistar for LCR under contracts with similar terms to Equistar's own.
Benzene produced by LCR is sold directly to Equistar at market-related prices.
Most of the ethylene and propylene production of the Channelview, Chocolate
Bayou, Corpus Christi and Lake Charles facilities is shipped via a 1,430-mile
pipeline system which has connections to numerous Gulf Coast ethylene and
propylene consumers. This pipeline system, some of which is owned and some of
which is leased by Equistar, extends from Corpus Christi to Mont Belvieu to
Port Arthur, Texas as well as around the Lake Charles, Louisiana area. In
addition, exchange agreements with other olefins producers allow access to
customers who are not directly connected to Equistar's pipeline system. Some
propylene is shipped by ocean-going vessel. Ethylene oxide and its derivatives
are shipped by railcar. Butadiene, aromatics and other petrochemicals are
distributed by pipeline, railcar, truck, barge or ocean-going vessel.
Competition and Industry Conditions
The basis for competition in Equistar's petrochemicals products is price,
product quality, product deliverability and customer service. Equistar
competes with other large domestic producers of petrochemicals, including
Amoco Chemical Company, Chevron Chemical Company, Dow Chemical Company, Exxon
Chemical Company, Huntsman Chemical Company, Mobil Chemical Company, Phillips
Petroleum Company, Shell Chemical Company and Union Carbide Corporation.
The combined rated capacity of Equistar's olefins units at January 1, 1999
was approximately 11.5 billion pounds of ethylene per year or approximately 18
percent of total North American production capacity. Based on published rated
production capacities, Equistar believes it is the largest producer of
ethylene in North America. North American ethylene rated capacity at January
1, 1999 was approximately 62 billion pounds per year. Of the total ethylene
production capacity in the United States, approximately 95 percent is located
along the Gulf Coast, and approximately 80 percent is owned by nine
manufacturers.
16
Petrochemicals profitability is affected by the level of demand for
petrochemicals and derivatives, along with vigorous price competition among
producers which may intensify due to, among other things, the addition of new
capacity. In general, weak economic conditions either in the United States or
in the world and higher feedstock costs tend to reduce demand and/or put
pressure on margins. Capacity additions in excess of annual growth also put
pressure on margins. In addition, in recent years, industry consolidation has
occurred, a trend the Company expects will continue. It is not possible to
predict accurately the changes in feedstock costs, market conditions and other
factors that will affect petrochemical industry margins in the future.
The petrochemicals industry historically has experienced significant
volatility in capacity utilization and profitability. Producers of olefins
primarily for merchant supply to unaffiliated customers typically experience
greater variations in their sales volumes and profitability when industry
supply and demand relationships are at extremes in comparison to more
integrated competitors, i.e., those with a higher proportion of captive demand
for olefins derivatives production. Equistar currently consumes or sells to
its partners' downstream derivatives facilities approximately 75 percent of
its ethylene production, which has the effect of reducing volatility.
Equistar's other major commodity chemical products also experience cyclical
market conditions similar to, although not necessarily coincident with, those
of ethylene.
EQUISTAR POLYMERS
Overview
Through twelve facilities located in four states, Equistar's polymers
segment manufactures a wide variety of polyolefins, including polyethylene,
polypropylene and various performance polymers.
Equistar currently manufactures polyethylene using a variety of technologies
at six facilities in Texas and at its Morris, Illinois and Clinton, Iowa
facilities. The Morris and Clinton facilities are the only polyethylene
facilities located in the Midwest and enjoy a freight cost advantage over Gulf
Coast producers in delivering products to customers in the Midwest and on the
East Coast of the United States. Polyethylene is used in a wide variety of
consumer products, packaging materials and industrial applications.
Equistar's Morris, Illinois and Pasadena, Texas facilities manufacture
polypropylene using propylene produced as a co-product of Equistar's ethylene
production as well as propylene purchased from third parties. Polypropylene is
sold for various applications in the automotive, housewares and appliance
industries. Equistar also produces performance polymer products, which include
enhanced grades of polyethylene and polypropylene, at several of its polymers
facilities. The Company believes that, over a business cycle, average selling
prices and profit margins for performance polymers tend to be higher than
average selling prices and profit margins for higher-volume commodity
polyethylenes. Equistar produces concentrates and compounds at its facilities
in Crockett, Texas and Heath, Ohio. Concentrates and compounds are
polyethylene compounds impregnated with additives and/or pigments and sold to
converters who mix the compounds with larger volumes of polymers, including
polyethylene, to produce various products. Equistar produces wire and cable
resins and compounds at Morris, Illinois, LaPorte, Texas, Tuscola, Illinois,
Crockett, Texas and Fairport Harbor, Ohio. Wire and cable resins and compounds
are used to insulate copper and fiber optic wiring in power,
telecommunication, computer and automobile applications.
17
The following table outlines Equistar's polymers and performance polymers
products, annual rated capacity, and the primary uses for such products:
Product Rated Capacity(a) Primary Uses
------- ----------------- ------------
High density 3.4 billion pounds(b) HDPE is used to manufacture grocery,
polyethylene (HDPE) merchandise and trash bags; food containers
for items from frozen desserts to
margarine; plastic caps and closures;
liners for boxes of cereal and crackers;
plastic drink cups and toys; dairy crates;
bread trays and pails for items from paint
to fresh fruits and vegetables; safety
equipment such as hard hats; house wrap for
insulation; bottles for
household/industrial chemicals and motor
oil; milk/water/juice bottles; and large
(rotomolded) tanks for storing liquids like
agricultural and lawn care chemicals.
Low density polyethylene 1.7 billion pounds LDPE is used to manufacture food packaging
(LDPE) films; plastic bottles for packaging food
and personal care items; dry cleaning bags;
ice bags; pallet shrink wrap; heavy-duty
bags for mulch and potting soil; boil-in-
bag bags; coatings on flexible packaging
products; and coatings on paper board such
as milk cartons. Specialized forms of LDPE
are Ethyl Methyl Acrylate ("EMA"), which
provides adhesion in a variety of
applications, and Ethylene Vinyl Acetate
("EVA"), which is used in foamed sheets,
bag-in-box bags, vacuum cleaner hoses,
medical tubing, clear sheet protectors and
flexible binders.
Linear low density 1.1 billion pounds LLDPE is used to manufacture garbage and
polyethylene (LLDPE) lawn-leaf bags; housewares; lids for coffee
cans and margarine tubs; and large
(rotomolded) toys like outdoor gym sets.
Polypropylene 680 million pounds Polypropylene is used to manufacture fibers
for carpets, rugs and upholstery;
housewares; automotive battery cases;
automotive fascia, running boards and
bumpers; grid-type flooring for sports
facilities; fishing tackle boxes; and
bottle caps and closures.
Wire and Cable (c) Wire and cable resins and compounds are
Resins and Compounds used to insulate copper and fiber optic
wiring in power, telecommunication,
computer and automobile applications.
Polymeric Powders (c) Polymeric powders are component products in
structural and bulk molding compounds,
parting agents and filters for appliance,
automotive and plastics processing
industries.
Concentrates and 150 million pounds Concentrates and compounds provide color in
Compounds film, bottles and foam sheets; the "slip"
that keeps film from sticking together;
flame retardancy; resistance to UV
radiation; and the "gas bubbles" to make
foamed plastic products.
Polymers for Adhesives, (c) Polymers are components in hot-metal-
Sealants and Coatings adhesive formulations for case, carton and
beverage package sealing, glue sticks,
automotive sealants, carpet backing and
adhesive labels.
Reactive Polyolefins (c) Reactive polyolefins are functionalized
polymers used to bond non-polar and polar
substrates in barrier food packaging, wire
and cable insulation and jacketing,
automotive gas tanks and metal coating
applications.
Liquid Polyolefins (c) Liquid polyolefins are a diesel fuel
additive to inhibit freezing.
- -------
(a) Unless otherwise specified, represents rated capacity at January 1, 1999.
The term "rated capacity," as used in this table, is calculated by
estimating the number of days in a typical year that a production unit of
a plant is expected to operate, after allowing for downtime for regular
maintenance, and multiplying that number by an
18
amount equal to the unit's optimal daily output based on the design
feedstock mix. Because the rated capacity of a production unit is an
estimated amount, the actual production volumes may be more or less than
the rated capacity. Capacities shown include 100 percent of the capacity of
Equistar, of which the Company owns 41 percent.
(b) Equistar increased its HDPE capacity by approximately 125 million pounds
in 1998. The idling of a portion of the Port Arthur facility effective
March 31, 1999 will result in a decrease in the stated capacity by 300
million pounds at the end of the first quarter of 1999. A 480 million
pound HDPE resin expansion project at the Matagorda facility has a
targeted start-up in the third quarter of 1999.
(c) These are enhanced grades of polyethylene and are included in the capacity
figures for HDPE, LDPE and LLDPE above, as appropriate.
Raw Materials
With the exception of the Chocolate Bayou polyethylene plant, Equistar's
polyethylene and polypropylene production facilities can receive their
ethylene and propylene directly from Equistar's petrochemical facilities via
Equistar's olefins pipeline system or Equistar's own production at the site.
The polyethylene plants at Chocolate Bayou, LaPorte, Port Arthur and Pasadena,
Texas are pipeline-connected to third parties and can receive ethylene via
exchanges or purchases. The polypropylene facility at Morris, Illinois also
receives propylene from a third party.
Marketing and Sales
Equistar's polymers products are primarily sold to an extensive base of
established customers, many under term contracts, typically having a duration
of one to three years. The remainder is generally sold without contractual
term commitments. In either case, in most of the continuous supply
relationships, prices are subject to change upon mutual agreement between
Equistar and the customer.
Polymers are primarily distributed via railcar. Equistar owns or leases,
pursuant to long-term lease arrangements, approximately 10,000 railcars for
use in its polymers business. Equistar sells its polymers products in the
United States primarily through its own sales organization. It generally
engages sales agents to market its products in the rest of the world.
Competition and Industry Conditions
The basis for competition in Equistar's polymers products is product
performance, product quality, product deliverability, customer service and
price. Equistar competes with other large producers of polymers, including
Chevron Chemical Corporation, Dow Chemical Company, Eastman Chemical Company,
Exxon Chemical Company, Formosa Plastics, Huntsman Chemical Company, NOVA
Corporation, Phillips Petroleum Company, Solvay Polymers, Total Fina, Union
Carbide Corporation and Westlake Polymers. Polymers profitability is affected
by the worldwide level of demand for polymers, along with vigorous price
competition which may intensify due to, among other things, new domestic and
foreign industry capacity. Margins for polymers tend to follow the trend of
the margins of their raw materials with a six to nine months' lag. In general,
weak economic conditions either in the United States or elsewhere in the world
tend to reduce demand and put pressure on margins. It is not possible to
predict accurately the changes in feedstock costs, market conditions and other
factors which will affect polymers industry margins in the future.
Based on published rated industry capacities, Equistar is the largest
producer of polyethylene in North America and is a leading domestic producer
of polyolefins powders, compounds, wire and cable resins, and polymers for
adhesives. The combined rated capacity of Equistar's polyethylene units as of
January 1, 1999 was approximately 6.2 billion pounds per year or approximately
18 percent of total industry capacity in North America. There are 19 other
North American producers of polyethylene, including Chevron Chemical Company,
Dow Chemical Company, Exxon Chemical Company, Phillips Petroleum Company,
Solvay Polymers and Union Carbide Corporation. Equistar's polypropylene
capacity, 680 million pounds per year as of January 1, 1999, represents just
under 5 percent of the total North American polypropylene capacity. There are
14 other North American competitors in the polypropylene business, including
Amoco Chemical Company, Exxon Chemical Company, Montell Polyolefins, BV and
Total Fina.
19
EQUISTAR PROPERTIES AND EMPLOYEE RELATIONS
Equistar's principal manufacturing facilities and principal products are set
forth below. All of these facilities are wholly owned by Equistar unless
otherwise noted.
Location Principal Products
-------- ------------------
Beaumont, Texas(a)...... EG
Channelview, Texas(b)... Ethylene, Propylene, Butadiene, Benzene,
Toluene, DCPD, Isoprene, Resin Oil, Piperylenes,
Alkylate and MTBE
Corpus Christi, Texas... Ethylene, Propylene, Butadiene and Benzene
Chocolate Bayou,
Texas(c)............... HDPE
Chocolate Bayou,
Texas(c)(d)............ Ethylene, Propylene, Butadiene, Benzene,
Toluene, DCPD, Isoprene, Resin Oil and MTBE
Crockett, Texas......... Wire and Cable Resins and Compounds and
Concentrates and Compounds
LaPorte, Texas.......... Ethylene, Propylene, LDPE, LLDPE, HDPE and
Liquid Polyolefins
Matagorda, Texas........ HDPE
Pasadena, Texas(e)...... EO, EG and Other EO Derivatives
Pasadena, Texas(e)...... Polypropylene and LDPE
Port Arthur, Texas(f)... LDPE and HDPE
Victoria, Texas(d)...... HDPE
Lake Charles,
Louisiana(g)........... Ethylene, and Propylene
Morris, Illinois........ Ethylene, LDPE, LLDPE and Polypropylene
Tuscola, Illinois....... Ethyl Alcohol, Diethyl Ether, Wire and Cable
Resins and Compounds and Polymeric Powders
Clinton, Iowa........... Ethylene, LDPE and HDPE
Fairport Harbor, Wire and Cable Resins and Compounds,
Ohio(g)................ Concentrates and Compounds
Heath, Ohio............. Wire and Cable Resins and Compounds,
Concentrates and Compounds
Anaheim, California..... Denatured Alcohol
Newark, New Jersey...... Denatured Alcohol
- --------
(a) The Beaumont facility is owned by PD Glycol, a partnership owned 50
percent by Equistar and 50 percent by DuPont.
(b) The Channelview facility has two ethylene processing units. Lyondell
Methanol owns a methanol plant located within the Channelview facility on
property Lyondell Methanol leases from Equistar. A third party owns and
operates a facility on land leased from Equistar that is used to purify
hydrogen from Lyondell Methanol's methanol plant. Equistar also operates a
styrene maleic anhydride unit and a polybutadiene unit which are owned by
a third party and are located on property leased from Equistar within the
Channelview facility.
(c) Millennium and Occidental each contributed a facility located in Chocolate
Bayou. These facilities are not on contiguous property.
(d) The land is leased, and the facility is owned.
(e) Occidental and Lyondell each contributed facilities located in Pasadena.
These facilities are primarily on contiguous property, and Equistar plans
to operate them as one site to the extent practicable. These facilities
are operated in conjunction with the LaPorte facility.
(f) A portion of the HDPE capacity of the Port Arthur facility will be idled
on March 31, 1999 (resulting in a decrease of 300 million pounds of
capacity), and could be restarted when market conditions warrant.
(g) The facilities and land are leased.
20
Equistar also owns a storage facility, a brine pond and a tract of vacant
land in Mont Belvieu, Texas, located approximately 15 miles east of the
Channelview facility. Storage capacity for up to approximately 13 million
barrels of NGL feedstocks, ethylene, propylene and other hydrocarbons is
provided in salt domes at the Mont Belvieu facility. There are an additional 3
million barrels of ethylene and propylene storage operated by Equistar on
leased property in Markham, Texas.
Equistar owns an extensive olefins pipeline system which extends from Corpus
Christi to Mont Belvieu to Port Arthur and around the Lake Charles area.
Equistar owns other pipelines in connection with its Morris, Clinton, Tuscola,
Chocolate Bayou, Matagorda, Victoria, Corpus Christi and LaPorte facilities.
Equistar owns and leases several pipelines connecting the Channelview
facility, the Refinery and the Mont Belvieu storage facility; these pipelines
are used to transport feedstocks, butylenes, hydrogen, butane, MTBE and
unfinished gasolines. Equistar also owns a barge docking facility near the
Channelview facility capable of berthing eight barges and related terminal
equipment for loading and unloading feedstocks and products. Equistar owns or
leases pursuant to long-term lease arrangements approximately 10,000 railcars
for use in its business.
Equistar sub-leases its executive offices and corporate headquarters from
Lyondell in downtown Houston. In addition, Equistar owns facilities which
house the Morris and Cincinnati research operations. Equistar also leases
sales facilities and leases storage facilities, primarily in the Gulf Coast
area, from various third parties for the handling of products.
As of December 31, 1998, Equistar employed approximately 5,000 full-time
employees. Equistar also uses the services of independent contractors in the
routine conduct of its business. Approximately 365 hourly workers are covered
by collective bargaining agreements. Equistar believes that its relations with
its employees are good.
EQUISTAR RESEARCH AND TECHNOLOGY; PATENTS AND TRADEMARKS
Equistar maintains a significant research and development facility in
Cincinnati, Ohio. Equistar has additional research facilities in Morris,
Illinois, Matagorda, Texas and Plano, Texas.
The Channelview facility employs proprietary technology owned by Lyondell to
convert ethylene and other light petrochemical streams into propylene.
Equistar is conducting a research project to investigate alternative
feedstocks for use at the Channelview, Chocolate Bayou and/or Corpus Christi
facilities. These alternative feedstocks could significantly lower costs and
provide an additional competitive advantage at these facilities.
Recent polymers industry announcements relate to the development of single-
site catalysts. Successful development and commercialization of these
catalysts are expected to result in enhanced polymer properties. Equistar is
conducting a broad search to evaluate outside technology and is concentrating
in-house research in an effort to identify and develop single-site catalysts
for use in the production of polyolefins resins. Equistar holds several United
States patents and the rights to certain patents pending in connection with
research and development efforts in this area. Equistar is not dependent upon
obtaining or retaining any particular patent, and it believes the failure to
receive or retain any individual patent would not have a material adverse
effect on its operations.
Equistar uses numerous technologies in its operations, many of which are
licensed from third parties. Significant licenses held by Equistar include the
BP Chemicals fluid bed polyethylene process for the production of both LLDPE
and HDPE, the Unipol process for the production of LLDPE, and certain other
licenses for the production of polyethylene and polypropylene. Equistar is not
dependent on the retention of any particular license, and it believes that the
loss of any individual license would not have a material adverse effect on its
operations.
Equistar acquired rights to numerous recognized brand names from Lyondell
and Millennium Petrochemicals in connection with its formation, including
ALATHON(R), KromaLon(R), Petrothene(R), Ultrathene(R), Vynathene(R) and
Microthene(R). Equistar's rights to use these trademarks are perpetual as long
as Equistar actively uses the trademarks. Equistar is not dependent upon any
particular trademark, and it believes the loss of any individual trademark
would not have a material adverse effect on its operations.
21
LYONDELL-CITGO REFINING LP
Overview
Lyondell participates in petroleum refining through an equity interest in
LCR. Lyondell holds a 58.75 percent interest and CITGO holds a 41.25 percent
interest in LCR. LCR owns and operates the Refinery which is located on the
Houston Ship Channel in Houston, Texas. The Refinery is a full conversion
refinery designed to run extra heavy (17 degree API), high sulfur crude oil
which is less expensive than other crudes. Processing extra heavy, high sulfur
crude oil in significant quantities requires a refinery with extensive coking,
catalytic cracking, hydrotreating and desulfurization capabilities, i.e., a
"complex refinery." The Refinery's complexity enables it to operate in full
conversion mode producing a slate of products that is approximately 95 percent
high value, clean products (most refineries produce 70 percent or less of high
value, clean products such as gasoline and diesel). In addition, the
Refinery's complexity allows it to produce most of these clean products as
premium grades such as reformulated gasoline, jet fuel, low sulfur diesel and
aromatics chemicals. The Refinery's products include conventional and
reformulated gasoline, low sulfur diesel, jet fuel, aromatics, lubricants
(industrial lubricants, motor oils, white oils and process oils), carbon black
oil, sulfur, residual fuel and petroleum coke. The aromatics chemicals
produced by the Refinery are benzene, toluene, orthoxylene and paraxylene.
These products are sold to intermediate chemicals and polyester intermediate
manufacturers and are ultimately used in clothing, soft drink bottles and
drink cups, audio and video tapes, and resins.
LCR was formed in 1993 to upgrade the Refinery's ability to process
substantial additional volumes of lower cost, extra heavy, higher margin crude
oil. An upgrade project completed in 1997 (the "Upgrade Project") increased
the extra heavy crude oil processing capability of the Refinery from 130,000
barrels per day of 22 degree API gravity crude oil to approximately 260,000
barrels per day of 17 degree API gravity crude oil. The 17 degree API gravity
crude oil is more viscous and dense than traditional crude oil and contains
higher concentrations of sulfur and heavy metals, making it more difficult to
refine into gasoline and other high value fuel products but less costly to
purchase. The Upgrade Project also included expansion of the Refinery's
reformulated gasoline and low sulfur diesel production capability.
The Upgrade Project, which cost approximately $1.1 billion, was funded
through a combination of approximately $485 million in capital contributions
to LCR by CITGO (including cash contributions for financing costs and
reinvestment of operating cash distributions), a $450 million construction
loan credit facility (the "Construction Facility") provided by a group of
banks, and $166 million and $16 million in subordinated loans to LCR from
Lyondell and CITGO, respectively.
In exchange for CITGO's Upgrade Project capital contributions, together with
an additional $130 million in equity contributions CITGO had previously made
to LCR, CITGO's participation interest in LCR increased effective April 1,
1997, and is currently 41.25 percent. CITGO has a one-time option expiring in
the year 2000 to increase its participation interest in LCR up to 50 percent
by making an additional equity contribution.
22
The following table outlines LCR's primary products, annual rated capacity
and the primary uses for such products:
Product Rated Capacity(a) Primary Uses
------- ----------------- ------------
Gasoline(b)............. 120,000 barrels per day Automotive fuel
Diesel (#2
Distillate)(b)......... 75,000 barrels per day Fuel for diesel cars and trucks
Jet Fuel(b)............. 22,000 barrels per day Aviation fuel
Benzene(c).............. 50 million gallons per year Nylon for clothing and consumer items;
polystyrene for insulation, packaging and
drink cups
Toluene(d).............. 37 million gallons per year Gasoline component and chemical feedstock for
producing benzene
Paraxylene(d)........... 400 million pounds per year Polyester fibers for clothing and fabrics,
PET soft drink bottles and films for audio
and video tapes
Orthoxylene(d).......... 270 million pounds per year Plasticizer in products such as rainwear,
shower curtains, toys and auto upholstery and
an intermediate in paints and fiberglass
Lube Oils(e)............ 4,000 barrels per day Automotive and industrial engine and lube
oils, railroad engine additives and white
oils for food-grade applications
- --------
(a) Unless otherwise specified, represents rated capacity at January 1, 1999.
The term "rated capacity," as used in this table, is calculated by
estimating the number of days in a typical year that a production unit of
a plant is expected to operate, after allowing for downtime for regular
maintenance, and multiplying that number by an amount equal to the unit's
optimal daily output based on the design feedstock mix. Because the rated
capacity of a production unit is an estimated amount, the actual
production volumes may be more or less than the rated capacity. Capacities
shown include 100 percent of the capacity of LCR, of which the Company
owns 58.75 percent.
(b) Produced by LCR and sold to CITGO.
(c) Produced by LCR and sold to Equistar.
(d) Produced by LCR and marketed for LCR by Equistar.
(e) Effective January 1999, all lubricant products produced by LCR are sold to
CITGO.
Management of LCR
LCR is a limited partnership organized under the laws of the state of
Delaware, following its conversion from a Texas limited liability company
effective December 31, 1998. Lyondell owns its interest in LCR through two
wholly owned subsidiaries, one of which serves as a general partner and one of
which serves as a limited partner. Similarly, CITGO owns its interest in LCR
through two wholly owned subsidiaries, a general partner and a limited
partner.
LCR is governed by a Limited Partnership Agreement (the "LCR Partnership
Agreement"), which provides for, among other things, the ownership and cash
distribution rights of the partners. The LCR Partnership Agreement also
provides that LCR is managed by a Partnership Governance Committee, which is
composed of six representatives, three appointed by each general partner.
Actions requiring unanimous consent of the representatives include, without
limitation, amendment of the LCR Partnership Agreement, borrowing money,
delegations of authority to committees, certain purchase commitments and
capital expenditures. The day-to-day operations of the Refinery are managed by
the executive officers of LCR as appointed by the Partnership Governance
Committee.
Agreements between Lyondell or CITGO and LCR
LCR is a party to a number of agreements with Lyondell and CITGO. Lyondell
currently performs administrative services for LCR pursuant to an
Administrative Services Agreement, which is renegotiated annually.
Under the terms of certain long-term agreements, CITGO will purchase all of
the lubricant products manufactured by LCR. In conjunction therewith, CITGO
will operate LCR's Birmingport, Alabama lubricants plant.
23
In addition, under the terms of a long-term product sales agreement
("Products Agreement"), CITGO purchases from LCR substantially all of the
refined products produced at the Refinery.
Agreements between Equistar and LCR
Prior to the formation of Equistar, Lyondell was a party with LCR to
multiple agreements designed to preserve much of the synergy between the
Refinery and the Channelview facility. Such agreements were assumed by
Equistar from Lyondell effective December 1, 1997. Economic evaluations at the
Channelview facility and the Refinery are based on sending products to the
highest-value disposition, which may be local use, use at the other site, or
third party sales. Certain Refinery products (propane, butane, low-octane
naphthas, heating oils, and gas oils) can be used as feedstocks for olefins
production, and certain Channelview facility olefins by-products can be
processed by the Refinery into gasoline. Butylenes from the Refinery are
tolled through the Channelview facility for the production of alkylate and
MTBE for gasoline blending. Hydrogen from the Channelview facility is used at
the Refinery for sulfur removal and product stabilization.
In accordance with a marketing services agreement, Equistar currently serves
as LCR's sole agent to market aromatics products produced by LCR.
In addition, under a long-term agreement, Equistar and LCR perform certain
manufacturing services for one another.
Raw Materials
In connection with its formation, LCR entered into a long-term crude supply
agreement ("Crude Supply Agreement") with Lagoven, S.A., now known as PDVSA
Petroleo y Gas S.A. ("PDVSA Oil"), an affiliate of CITGO. A substantial amount
of the crude oil used by LCR as a feedstock for the Refinery is purchased
under the Crude Supply Agreement. Both PDVSA Oil and CITGO are direct or
indirect wholly owned subsidiaries of Petroleos de Venezuela, S.A. ("PDVSA"),
the national oil company of the Republic of Venezuela.
The Crude Supply Agreement pricing structure is designed to reduce the
volatility of cash flow due to market fluctuations in the prices of crude oil
or refined products. Under the Crude Supply Agreement, PDVSA Oil is required
to sell, and LCR is required to purchase, up to 230,000 barrels per day of
heavy crude oil, which constitutes approximately 88 percent of the Refinery's
refining capacity of 260,000 barrels per day of crude oil. PDVSA Oil has a
right of first refusal in certain circumstances to supply incremental amounts
of crude oil above LCR's 230,000 barrel per day contractual obligation. As a
result of the OPEC-mandated supply limitations discussed below, PDVSA's
deliveries have been less than 230,000 barrels per day since August 1998 and
are currently at 195,000 barrels per day. OPEC recently announced an agreement
to further reduce OPEC oil production, which could result in some additional
reductions in the volume of PDVSA's deliveries.
The Crude Supply Agreement provides that Lyondell controls all of the
Partnership's decisions and enforcement rights in connection with the Crude
Supply Agreement so long as PDVSA has a direct or indirect ownership interest
in LCR. The Crude Supply Agreement expires on December 31, 2017.
The Crude Supply Agreement 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 feedstock,
less: (i) certain deemed refining costs, adjustable for inflation and energy
costs; (ii) certain actual costs; and (iii) a deemed margin, which varies
according to the grade of crude oil or other feedstock delivered. Deemed
margins and deemed costs are adjusted periodically. These adjustments are
based on inflation rates and energy costs. Adjustments to margins track, but
are less than, inflation rates. Because deemed operating costs and the slate
of refined products deemed to be produced from a given barrel of crude oil or
other feedstocks do not necessarily reflect the actual costs and yields in any
period and also because the market value of the refined products used in the
pricing formula does not necessarily reflect the actual price received for the
refined products, the actual refining margin earned by LCR under the Crude
Supply Agreement varies depending on, among other things, the efficiency with
which LCR conducts its operations from time to time. Although the Company
believes that the Crude Supply Agreement reduces the volatility of LCR's
earnings and cash flows, the Crude Supply Agreement also limits LCR's ability
to enjoy higher margins during periods when the market price of crude oil
24
is low relative to then current market prices for refined products. In
addition, if the actual yields, costs or volumes of the LCR refinery differ
substantially from those contemplated by the Crude Supply Agreement, 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 Crude Supply
Agreement may be higher than might otherwise be available to LCR from other
sources.
There are risks associated with enforcing the provisions of contracts with
companies such as PDVSA Oil that are non-United States affiliates of a
sovereign nation. Specifically, it is impossible to predict how governmental
policies may change under the current or any subsequent Venezuelan government.
In addition, there are risks associated with enforcing judgments of United
States courts against entities whose assets are located outside of the United
States and whose management does not reside in the United States. Although the
parties have negotiated alternative arrangements in the event of certain force
majeure conditions, including Venezuelan governmental or other actions
restricting or otherwise limiting PDVSA Oil's ability to perform its
obligations, any such alternative arrangements may not be as beneficial as the
Crude Supply Agreement. In late April 1998, LCR received notification from
PDVSA Oil of reduced delivery of crude oil related to announced OPEC
production cuts. LCR began receiving the reduced allocation of crude oil from
PDVSA Oil in August 1998. As noted above, OPEC has recently announced an
agreement for additional production cuts, which could result in some further
reductions in LCR's allocations.
All of the crude oil supplied by PDVSA under the Crude Supply Agreement is
produced in Venezuela, which has experienced economic difficulties and
attendant social and political unrest in recent years. If the Crude Supply
Agreement is modified or terminated or this source of crude is otherwise
interrupted due to production difficulties, political or economic events in
Venezuela or other factors, LCR could experience significantly greater
volatility in its earnings and cash flows. The parties each have the right to
transfer their interests in LCR to unaffiliated third parties in certain
circumstances, subject to reciprocal rights of first refusal. In the event
that CITGO were to transfer its interest in LCR to an unaffiliated third
party, PDVSA Oil would have an option to terminate the Crude Supply Agreement.
Depending on then current market conditions, any breach or termination of the
Crude Supply Agreement could adversely affect LCR, since LCR would have to
purchase all of its crude oil feedstocks in the merchant market, which could
subject LCR to significant price fluctuations. There can be no assurance that
alternative crude oils with similar margins would be available for purchase by
LCR. However, the Company believes that this transaction holds substantial
economic and other incentives for all parties to perform their obligations.
Lyondell believes PDVSA's strategic interest in expanding its crude oil
refining operations in the United States in order to increase the markets for
its extra heavy crude oil and continued financial commitments of CITGO should
provide a long-term economic incentive for all PDVSA affiliates to perform
their obligations under the various agreements.
Marketing and Sales
The Refinery produces gasoline, low sulfur diesel, jet fuel, aromatics,
lubricants and certain industrial products. On a weekly basis, LCR evaluates
and determines the optimal product output mix for the Refinery, based on spot
market prices and conditions. Under the Products Agreement, CITGO is obligated
to purchase and LCR is required to sell 100 percent of the gasoline, jet fuel,
heating oil, diesel fuel, coke and sulfur produced by the Refinery. CITGO
purchases these products at prices based on industry benchmark indexes. For
example, the price for gasoline is based on prices published by Platts
Oilgram, an industry trade publication. The Products Agreement provides that
Lyondell controls all of LCR's material decisions and enforcement rights in
connection with the Products Agreement so long as CITGO has a direct or
indirect ownership interest in LCR. The Products Agreement expires on December
31, 2017.
Competition and Industry Conditions
All of LCR's gasoline, low sulfur diesel, jet fuel, and lube oils are sold
to CITGO.
The refining business tends to be volatile as well as cyclical. Crude oil
prices, which are impacted by worldwide political events and the economics of
exploration and production in addition to refined products demand, are the
largest source of this volatility. Demand for refined products is influenced
by seasonal and short-
25
term factors such as weather and driving patterns, as well as by longer term
issues such as energy conservation and alternative fuels. Industry refined
products supply is also dependent on industry operating capabilities and on
long-term refining capacity trends. However, management believes that the
combination of the Crude Supply Agreement and the Products Agreement has the
effect of stabilizing earnings and cash flows and substantially reducing the
market-driven aspects of such volatility.
With a capacity of approximately 260,000 barrels per day, the Company
believes that the Refinery is North America's largest coking (i.e., non-
asphalt producing) refinery capable of processing 100 percent 17 API crude
oil.
Among LCR's refining competitors are major integrated petroleum companies
and domestic refiners that are owned by or affiliated with major integrated
oil companies. Based on published industry data, as of January 1, 1999, there
were 163 crude oil refineries in operation in the United States, and total
domestic refinery capacity was approximately 16 million barrels per day.
During 1998, LCR processed an average of 260,000 barrels per day of crude oil
or over 1 percent of domestic capacity.
Properties
LCR owns the real property, plant and equipment which comprise the Refinery,
located on approximately 700 acres in Houston, Texas. Units include a fluid
catalytic cracking unit, cokers, reformers, crude distillation units, sulfur
recovery plants and hydrodesulfurization units, as well as a lube oil
manufacturing and packaging plant and an aromatics recovery unit. LCR also
owns the real property, plant and equipment which comprise a lube oil blending
and packaging plant in Birmingport, Alabama. LCR owns a pipeline used to
transport gasoline, kerosene and heating oil from the Refinery to the GATX
Terminal located in Pasadena, Texas to interconnect with common carrier
pipelines.
Employee Relations
At December 31, 1998, LCR employed approximately 1,200 full-time employees.
LCR also uses the services of independent contractors in the routine conduct
of its business. Approximately 800 hourly workers are covered by a collective
bargaining agreement between LCR and the Oil, Chemical and Atomic Workers
Union that was recently renegotiated and expires in January 2002.
LYONDELL METHANOL COMPANY, L.P.
Overview
Lyondell produces methanol through its 75 percent interest in Lyondell
Methanol, of which Lyondell serves as the managing partner. The remaining 25
percent interest in Lyondell Methanol is held by MCNIC. Effective December 1,
1997, Equistar began serving as the operator of Lyondell Methanol pursuant to
an operating agreement with Lyondell Methanol. Lyondell Methanol owns a
methanol plant located within the Channelview facility. The methanol plant is
a heat-integrated plant, which includes extraction capabilities for co-
products such as hydrogen and fuel oil.
Methanol is used to produce MTBE and a variety of chemical intermediates,
including formaldehyde, acetic acid and methyl methacrylate. These
intermediates are used to produce bonding adhesives for plywood as well as
polyester fibers and plastics. Other end uses include solvents and antifreeze
applications. Lyondell Methanol is advantageously located near the Gulf Coast
customer base.
Management of Lyondell Methanol
Lyondell Methanol is a limited partnership organized under the laws of the
State of Texas. Lyondell owns its interest in Lyondell Methanol through two
wholly owned subsidiaries, one of which serves as a general partner and the
managing partner of Lyondell Methanol and one of which serves as a limited
partner. Similarly,
26
MCNIC owns its interest in Lyondell Methanol through two wholly owned
subsidiaries, one a general partner and one a limited partner.
Agreements between Equistar and Lyondell Methanol
Certain agreements entered into by Lyondell and Lyondell Methanol were
assigned to Equistar effective December 1, 1997. Equistar acts as operator of
Lyondell Methanol pursuant to an operating agreement with Lyondell Methanol.
In addition, Equistar sells natural gas to Lyondell Methanol and markets
Lyondell Methanol's product pursuant to agreements with Lyondell Methanol.
Lyondell Methanol also leases from Equistar the real property on which its
methanol plant is located.
Raw Materials
Lyondell Methanol's plant processes natural gas feedstocks. Equistar is
connected to a diverse natural gas supply network, and it purchases natural
gas for use as fuel at its Channelview facility and sells natural gas to
Lyondell Methanol as a feedstock for the methanol plant.
Marketing and Sales
Substantially all of the methanol output from Lyondell Methanol is sold to
Equistar, which then sells it to third parties. The agreement between Lyondell
Methanol and Equistar concerning such sales generally provides that Lyondell
Methanol bears the market risk associated with such sales. Equistar's
agreements with third parties for the sale of the methanol have initial terms
ranging from two to three years and typically contain automatic one year term
extension provisions. These contracts generally provide for monthly price
adjustments based upon current market prices. Methanol is distributed by
pipeline, railcar, truck, barge or ocean-going vessel.
Competition and Industry Conditions
The basis for competition in the methanol business is product
deliverability, product quality and price. Lyondell Methanol competes with
other large producers of methanol, including Methanex, Borden Chemicals and
Plastics and Terra Industries.
The rated capacity of Lyondell Methanol's processing unit at January 1, 1999
was 248 million gallons. Based on published rated production capacities, the
Company believes that Lyondell Methanol is the third largest methanol producer
in the United States.
Methanol profitability is affected by the level of demand for products in
which methanol is used, including MTBE and plywood (the production of which
involves the use of formaldehyde), demand for which in turn is driven by the
gasoline and housing markets, respectively. Methanol profitability is also
affected by the price of its feedstock, natural gas.
Properties
Lyondell Methanol's only property is the methanol plant it owns, which is
located within Equistar's Channelview complex on property leased from
Equistar.
Employee Relations
Lyondell Methanol has no employees. Equistar serves as its operator and
marketing agent.
PROPERTIES AND EMPLOYEE RELATIONS
Generally the Company's operations are conducted through the Acquired
Business, Equistar, LCR and Lyondell Methanol. As of December 31, 1998,
Lyondell, excluding the Acquired Business, Equistar, LCR and Lyondell
Methanol, employed approximately 50 full-time employees. Lyondell's only
facility, excluding the properties owned or leased by the Acquired Business
and the joint ventures, is its leased corporate offices located in Houston,
Texas.
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INTEGRATION OF RECENTLY ACQUIRED AND COMBINED OPERATIONS
The Company completed the acquisition of the Acquired Business in July 1998.
The Company combined its petrochemicals and polymers business with that of
Millennium to form Equistar in December 1997. Equistar was expanded by the
addition of certain businesses previously held by Occidental in May 1998. The
process of integrating the operations of the Acquired Business with the
Company has only recently begun, and the process of integrating the operations
of Equistar is not complete.
As is the case with any integration of major businesses that previously
operated independently, the integration processes for the Acquired Business
and for Equistar will require the dedication of significant management and
operational resources. The difficulties of combining operations may be
exacerbated by the necessity of coordinating geographically separate
organizations, integrating personnel with disparate business backgrounds,
combining different transaction processing and financial reporting systems and
processes and combining corporate cultures. The process of integrating
operations could cause an interruption of, or loss of momentum in, the
activities of the combined enterprise's business. In addition, the Company may
suffer a loss of key employees, customers or suppliers, loss of revenues,
increases in costs or other difficulties, some of which may not have been
foreseen. There can be no assurance that the Company will be able to realize
the operating efficiencies, cost savings and other benefits that are sought
from such transactions. Difficulties encountered in the integration processes
could have a material adverse effect on the business and operations of the
Company.
SHARED CONTROL OF JOINT VENTURES
All of the operations of the Company, other than those of the Acquired
Business, are conducted through the Company's joint ventures. The Company
shares control of these joint ventures with unaffiliated third parties.
The Company's forecasts and plans with respect to these joint ventures
assume that its joint venture partners will observe their obligations with
respect to the joint ventures. In the event that any of the Company's joint
venture partners do not observ