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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(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
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to _________
Commission File Number 001-12138
---------
PDV America, Inc.
(Exact name of registrant as specified in its charter)
Delaware 51-0297556
- ------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
750 Lexington Avenue
New York, New York 10022
--------------------------------------------------
(Address of principal executive offices, Zip Code)
Registrant's telephone number, including area code (212) 753-5340
--------------
Securities registered pursuant to Section 12(b) of the Securities
Exchange Act of 1934:
Name of Each Exchange
Title of Each Class on Which Registered
- ---------------------------------------- -------------------------------------
7-3/4% Senior Notes, Due 2000 New York Stock Exchange, Inc.
7-7/8% Senior Notes, Due 2003 New York Stock Exchange, Inc.
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 __
--
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K:
Not Applicable.
Aggregate market value of the voting stock held by non-affiliates
of the registrant: Not Applicable.
Number of shares of Common Stock outstanding as of March 1, 1999: 1,000
DOCUMENTS INCORPORATED BY REFERENCE
None
Table of Contents
Page
----
FACTORS AFFECTING FORWARD LOOKING STATEMENTS...................................1
PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES.......................................1
ITEM 3. LEGAL PROCEEDINGS....................................................17
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS......................................................18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
..............................................................................19
ITEM 6. SELECTED FINANCIAL DATA..............................................19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..............................21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..........30
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA............................................................33
ITEM 9. CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.......................33
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
OF THE REGISTRANT.............................................................34
ITEM 11. EXECUTIVE COMPENSATION..............................................34
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......................................34
ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS..........................................................35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND
REPORTS ON FORM 8-K...........................................................38
i
FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain "forward
looking statements" within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Specifically, all statements under the captions "Items 1. and 2.
Business and Properties" and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" relating to capital expenditures
and investments related to environmental compliance and strategic planning,
purchasing patterns of refined products and capital resources available to the
Companies (as defined herein) are forward looking statements. In addition, when
used in this document, the words "anticipate", "estimate", "prospect" and
similar expressions are used to identify forward looking statements. Such
statements are subject to certain risks and uncertainties, such as increased
inflation, continued access to capital markets and commercial bank financing on
favorable terms, increases in regulatory burdens, changes in prices or demand
for the Companies' products as a result of competitive actions or economic
factors and changes in the cost of crude oil, feedstocks, blending components or
refined products. Such statements are also subject to the risks of increased
costs in related technologies and such technologies producing anticipated
results. Should one or more of these risks or uncertainties, among others,
materialize, actual results may vary materially from those estimated,
anticipated or projected. Although PDV America, Inc. believes that the
expectations reflected by such forward looking statements are reasonable based
on information currently available to the Companies, no assurances can be given
that such expectations will prove to have been correct.
PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
Overview
PDV America, Inc. ("PDV America" or the "Company" and,
together with its subsidiaries, the "Companies") was incorporated in 1986 in the
State of Delaware and is a wholly owned subsidiary, effective April 2, 1997, of
PDV Holding, Inc. ("PDV Holding"), a Delaware corporation. The Company's
ultimate parent is Petroleos de Venezuela, S.A. (together with one or more of
its subsidiaries, referred to herein as "PDVSA"), the national oil company of
the Republic of Venezuela. Through its wholly owned operating subsidiaries,
CITGO Petroleum Corporation ("CITGO") and PDV Midwest Refining L.L.C. ("PDVMR")
(see below), PDV America refines, markets and transports petroleum products,
including gasoline, diesel fuel, jet fuel, petrochemicals, lubricants, asphalt
and refined waxes, mainly within the continental United States east of the Rocky
Mountains.
Prior to May 1, 1997, the Company had a 50% interest in The
UNO-VEN Company ("UNO-VEN"), an Illinois general partnership. As of May 1, 1997,
pursuant to a Partnership Interest Retirement Agreement, certain UNO-VEN assets
were transferred to PDMVR. Accordingly, the Company's consolidated financial
statements reflect the equity in earnings of UNO-VEN through April 30, 1997
(Consolidated Financial Statements of PDV America - Note 8 of Item 14a), the
results of operations of PDVMR on a consolidated basis since May 1, 1997 and the
financial position of PDVMR at December 31, 1997 and 1998. See "--PDV Midwest
Refining, L.L.C."
PDV America's aggregate net interest in rated crude oil
refining capacity is 858 thousand barrels per day ("MBPD"). The following table
shows the capacity of each U.S. refinery in which PDV America holds an interest
and PDV America's share of such capacity as of December 31, 1998.
PDV America Refining Capacity
Net PDV
America
Total Interest
Rated in
Crude Rated
PDV America Refining Refining
Owner Interest Capacity Capacity
----------------- ------------- --------------- -------------
(%) (MBPD) (MBPD)
Refinery Interests Held By PDV America
as of December 31, 1998
Lake Charles, LA CITGO 100 320 320
Corpus Christi, TX CITGO 100 150 150
Paulsboro, NJ CITGO 100 84 84
Savannah, GA CITGO 100 28 28
Houston, TX(1) LYONDELL-CITGO 41 265 109
Lemont, IL PDVMR 100 167 167
---------- ----------
Total Rated Refining Capacity
as of December 31, 1998 1,014 858
========== ==========
- -------------------------
(1) The initial interest in LYONDELL-CITGO was acquired on July 1, 1993. CITGO's interest in LYONDELL-CITGO at
December 31, 1998 approximates 41%. CITGO has a one-time option to increase, for an additional investment, its
participation interest to 50%. This option may be exercised after January 1, 2000 but no later than September 30, 2000.
See "--CITGO--Refining--LYONDELL-CITGO". See also "Factors Affecting Forward Looking Statements".
2
The following table shows sales revenues and volumes of PDV America for
the three years in the period ended December 31, 1998.
PDV America Sales Revenues and Volumes
Year Ended December 31, Year Ended December 31,
-------------------------------------------- --------------------------------------------
1998 1997 1996 1998 1997 1996
-------------- -------------- -------------- -------------- -------------- --------------
($ in millions) (MM gallons)
Gasoline $ 6,252 $ 7,754 $ 7,451 13,241 11,953 11,308
Jet fuel 828 1,183 1,489 1,919 2,000 2,346
Diesel/#2 fuel 1,945 2,439 2,312 4,795 4,288 3,728
Asphalt 300 398 257 774 749 569
Petrochemicals and industrial
products 952 1,178 846 2,658 1,961 1,408
Lubricants and waxes 441 467 426 230 239 220
-------- -------- -------- -------- -------- --------
Total refined product sales 10,718 $ 13,419 $ 12,781 23,617 21,190 19,579
Other sales 242 203 171 -- -- --
-------- -------- -------- -------- -------- --------
Total sales $ 10,960 $ 13,622 $ 12,952 23,617 21,190 19,579
======== ======== ======== ======== ======== ========
3
The following table shows PDV America's aggregate interest in
refining capacity, refinery input and product yield for the three years in the
period ended December 31, 1998.
PDV America Refinery Production
Year Ended December 31,
-------------------------------------------------------------------------------
1998(6) 1997(2)(3) 1996(1)(4)
------------------------ --------------------------- ------------------------
(MBPD, except as otherwise indicated)
Rated Refining Capacity(5) 858 853 683
Refinery Input
Crude oil 763 82.8% 675 80.9% 561 81.2%
Other feedstocks 159 17.2 159 19.1 130 18.8
--- ----- --- ----- --- -----
Total 922 100.0% 834 100.0% 691 100.0%
=== ===== === ===== === =====
Product Yield
Light fuels
Gasoline 413 44.3% 381 45.3% 313 44.9%
Jet Fuel 69 7.4 68 8.1 70 10.0
Diesel/#2 fuel 175 18.8 144 17.1 122 17.5
Asphalt 45 4.8 42 5.0 34 4.9
Petrochemical and Industrial Products 231 24.7 206 24.5 158 22.7
--- ----- --- ----- --- -----
Total 933 100.0% 841 100.0% 697 100.0%
=== ===== === ===== === =====
- -------------------------
(1) For 1996, includes all of CITGO and 50% of UNO-VEN refinery production, except as otherwise noted.
(2) For 1997, includes all of CITGO refinery production, 50% of UNO-VEN refinery production through April 30, 1997 and all of
PDVMR refinery production beginning May 1, 1997 through December 31, 1997.
(3) Includes a weighted average of 34.44% of the Houston refinery for 1997.
(4) Includes a weighted average of 12.89% of the Houston refinery for 1996.
(5) At year end.
(6) Includes a weighted average of 41.25% of the Houston refinery for 1998.
Competitive Nature of the Petroleum Refining Business
The petroleum refining industry is cyclical and highly
volatile, reflecting capital intensity with high fixed and low variable costs.
Petroleum industry operations and profitability are influenced by a large number
of factors, over some of which individual petroleum refining and marketing
companies have little control. Governmental regulations and policies,
particularly in the areas of taxation, energy and the environment, have a
significant impact on petroleum industry activities, regulating how companies
conduct their operations and formulate their products. The U.S. petroleum
refining industry has entered a period of consolidation in which a number of
former competitors have combined their operations. Demand for crude oil and its
products is largely driven by the health of local and worldwide economies,
although weather patterns and taxation relative to other energy sources also
play significant parts. Generally, U.S. refiners compete for sales on the basis
of price and brand image and, in some areas, product quality.
4
CITGO
CITGO refines, markets and transports gasoline, diesel fuel,
jet fuel, petrochemicals, lubricants, refined waxes, asphalt and other refined
products throughout the United States, primarily east of the Rocky Mountains.
CITGO's transportation fuel customers include CITGO branded wholesale marketers,
convenience stores and airlines. Asphalt is generally marketed to independent
paving contractors on the East Coast of the United States. Lubricants are sold
to independent marketers, mass marketers and industrial customers, and
petrochemical feedstocks and industrial products are sold to various
manufacturers and industrial companies throughout the United States.
Petroleum coke is sold primarily in international markets.
Refining
CITGO's aggregate net interest in rated crude oil refining
capacity is 691 thousand barrels per day ("MBPD"). The following table shows the
capacity of each U.S. refinery in which CITGO holds an interest and CITGO's
share of such capacity as of December 31, 1998.
Total Net
Rated CITGO
Crude Ownership
CITGO Refining In Refining
Owner Interest Capacity Capacity
-------------- -------- -------- --------
Location (%) (MBPD) (MBPD)
Lake Charles, LA CITGO 100 320 320
Corpus Christi, TX CITGO 100 150 150
Paulsboro, NJ CITGO 100 84 84
Savannah, GA CITGO 100 28 28
Houston, TX(1) LYONDELL-CITGO 41 265 109
--- ---
Total Rated Refining Capacity 847 691
as of December 31, 1998 === ===
- ---------------
(1) Initial interest acquired on July 1, 1993. CITGO's interest in LYONDELL-CITGO at December 31, 1998 approximates
41%. CITGO has a one-time option, exercisable after January 1, 2000 but not later than September 30, 2000, to increase
for an additional investment, its participation interest up to a maximum of 50%. See "CITGO--Refining--LYONDELL-CITGO".
See also "Factors Affecting Forward Looking Statements".
5
The following table shows CITGO's aggregate interest in
refining capacity, refinery input and product yield for the three years in the
period ended December 31, 1998.
CITGO Refinery Production (1)
Year Ended December 31,
-------------------------------------------------------------------------------
1998(2) 1997(3) 1996(4)
------------------------ --------------------------- ------------------------
(MBPD, except as otherwise indicated)
Rated Refining Capacity (5) 691 693 606
Refinery Input
Crude oil 615 81.0% 548 79.3% 488 80.3%
Other Feedstocks 144 19.0% 143 20.7% 120 19.7%
--- ----- --- ----- --- -----
Total 759 100.0% 691 100.0% 608 100.0%
===
Product Yield
Light fuels
Gasoline 334 43.3% 309 44.0% 269 44.0%
Jet Fuel 66 8.5% 66 9.4% 65 10.6%
Diesel/#2 fuel 134 17.4% 112 15.9% 103 16.8%
Asphalt 45 5.8% 42 6.0% 34 5.6%
Petrochemicals and industrial products 193 25.0% 174 24.7% 141 23.0%
--- ----- --- ----- --- -----
Total 772 100.0% 703 100.0% 612 100.0%
=== ===== === ===== === =====
Utilization of Rated Refining Capacity 89% 79% 81%
- ---------------
(1) Includes all of CITGO refinery production, except as otherwise noted.
(2) Includes a weighted average of 41.25% of the Houston refinery for 1998.
(3) Includes a weighted average of 34.44% of the Houston refinery for 1997.
(4) Includes a weighted average of 12.89% of the Houston refinery for 1996.
(5) At year end.
CITGO produces its light fuels and petrochemicals primarily
through its Lake Charles and Corpus Christi refineries. Asphalt refining
operations are carried out through CITGO's Paulsboro and Savannah refineries.
CITGO also owns an interest in and obtains refined products from a refinery in
Houston.
Lake Charles, Louisiana Refinery. This refinery was originally
built in 1944 and since then has been continuously upgraded. Today it is a
modern, complex, high conversion refinery, which is one of the largest in the
United States. It has a rated refining capacity of 320 MBPD and is capable of
processing large volumes of heavy crude oil into a flexible slate of refined
products, including significant quantities of high-octane unleaded gasoline and
reformulated gasoline. The Lake Charles refinery has a Solomon Process
Complexity Factor of 17.0 (as compared to an average of 13.8 for U.S. refineries
in the most recently available Solomon Associates, Inc. survey). The Solomon
Process Complexity Rating is an industry measure of a refinery's ability to
produce higher value-added products. A higher rating indicates a greater
capability to produce such products.
6
The following table shows the rated refining capacity,
refinery input and product yield at the Lake Charles refinery for the three
years in the period ended December 31, 1998.
Lake Charles Refinery Production
Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
------------------------ --------------------------- ------------------------
(MBPD, except as otherwise indicated)
Rated Refining Capacity(1) 320 320 320
Refinery Input
Crude oil 288 84.2% 291 87.9% 274 85.1%
Other feedstocks 54 15.8 40 12.1 48 14.9
---- ------ ---- ------ ---- ------
Total 342 100.0% 331 100.0% 322 100.0%
==== ====== ==== ====== ==== ======
Product Yield
Light fuels
Gasoline 187 53.7% 177 52.4% 164 50.3%
Jet Fuel 59 17.0 60 17.7 62 19.0
Diesel/#2 fuel 47 13.5 45 13.3 38 11.7
Petrochemicals and Industrial Products 55 15.8 56 16.6 62 19.0
--- ----- --- ----- --- -----
Total 348 100.0% 338 100.0% 326 100.0%
=== ===== === ===== === =====
Utilization of Rated Refining Capacity 90% 91% 86%
- -------------------------
(1) At year end.
Approximately 66%, 63% and 67% of the total crude runs at the
Lake Charles refinery, in the years 1998, 1997 and 1996, respectively, consisted
of crude oil with an average API gravity of 24 degrees or less. Due to the
complex processing required to refine such crude oil, the Lake Charles
refinery's economic crude oil throughput capacity is approximately 290 MBPD,
which is approximately 90% of its rated capacity of 320 MBPD.
The Lake Charles refinery's Gulf Coast location provides it
with access to crude oil deliveries from multiple sources. Imported crude oil
and feedstocks supplies are delivered by ship directly to the Lake Charles
refinery, and domestic crude oil supplies are delivered by pipeline and barge.
In addition, the refinery is connected by pipelines to the Louisiana Offshore
Oil Port and to terminal facilities in the Houston area through which it can
receive crude oil deliveries if the Lake Charles docks are temporarily
inaccessible. For delivery of refined products, the refinery is connected
through the Lake Charles Pipeline directly to the Colonial and Explorer
Pipelines, which are the major refined product pipelines supplying the northeast
and midwest regions of the United States, respectively. The refinery also uses
adjacent terminals and docks, which provide access for ocean tankers and barges.
The Lake Charles refinery's main petrochemical products are
propylene and benzene. Industrial products include sulphur, residual fuels and
petroleum coke.
Located adjacent to the Lake Charles refinery is a lubricants
refinery operated by CITGO and owned by Cit-Con Oil Corporation ("Cit-Con"),
which is owned 65% by CITGO and 35% by Conoco, Inc. ("Conoco"). Primarily
because of its specific design, the Cit-Con refinery produces extremely high
quality oils and waxes and is one of the few in the industry designed as a
stand-alone lubricants refinery.
7
Feedstocks are supplied 65% from CITGO's Lake Charles refinery and 35% from
Conoco's nearby refinery. Finished refined products are shared on the same pro
rata basis by CITGO and Conoco.
Corpus Christi, Texas Refinery. This refinery complex consists
of the East and West Plants, located within five miles of each other.
Construction began on the East Plant in 1937, and it was extensively
reconstructed and modernized during the 1970s and 1980s. The West Plant was
completed in 1983. The Corpus Christi refinery is an efficient and highly
complex facility, capable of processing high volumes of heavy crude oil into a
flexible slate of refined products, with a Solomon Process Complexity Factor of
20.5 (as compared to an average of 13.8 for U.S. refineries in the most recently
available Solomon Associates, Inc. survey).
The following table shows rated refining capacity, refinery
input and product yield at the Corpus Christi refinery for the three years in
the period ended December 31, 1998.
Corpus Christi Refinery Production
Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
------------------------ --------------------------- ------------------------
(MBPD, except as otherwise indicated)
Rated Refining Capacity(1) 150 150 140
Refinery Input
Crude oil 152 71.4% 115 59.3% 133 66.8%
Other feedstocks 61 28.6 79 40.7 66 33.2
--- ----- --- ----- --- -----
Total 213 100.0% 194 100.0% 199 100.0%
=== ===== === ===== === =====
Product Yield
Light fuels
Gasoline 97 45.7% 93 47.9% 93 47.0%
Diesel/#2 fuel 58 27.4 45 23.2 59 29.8
Petrochemicals and Industrial Products 57 26.9 56 28.9 46 23.2
--- ----- --- ----- --- -----
Total 212 100.0% 194 100.0% 198 100.0%
=== ===== === ===== === =====
Utilization of Rated Refining Capacity 101% 77% 95%
- -------------------------
(1) At year end.
Corpus Christi crude runs during 1998 consisted of 100% heavy
sour Venezuelan crude. The average API gravity of the composite crude slate run
at the Corpus Christi refinery is approximately 24 degrees. Crude oil supplies
are delivered directly to the Corpus Christi refinery through the Port of Corpus
Christi.
CITGO operates the West Plant under a sublease agreement (the
"Sublease") from Union Pacific Corporation ("Union Pacific"). The basic term of
the Sublease ends on January 1, 2004, but CITGO may renew the Sublease for
successive renewal terms through January 31, 2011. CITGO has the right to
purchase the West Plant from Union Pacific at the end of the basic term, the end
of any renewal term, or on January 31, 2011, at a nominal price.
During the last several years, CITGO has increased the
capacity of the Corpus Christi refinery to produce petrochemical products. The
Corpus Christi refinery's main petrochemical products include cumene,
cyclohexane, methyl tertiary butyl ether ("MTBE") and aromatics (including
benzene,
8
toluene and xylene). The Company produces a significant quantity of cumene, an
important petrochemical product used in the engineered plastics market. The
production of xylene, a basic building block used in the manufacture of consumer
plastics, allows the refinery to take advantage of its reforming capacity while
staying within the gasoline specifications of the Clean Air Act Amendments of
1990.
Paulsboro, New Jersey Refinery. This is an asphalt refinery
which consists of Unit I, with a rated capacity of 44 MBPD, and Unit II, with a
rated capacity of 40 MBPD. Unit I was constructed in 1979 primarily to process
low sulphur, light crude oil but has been modified to run heavier crudes. Unit
II, originally constructed in 1980 to produce asphalt from high sulphur, heavy
crude oil high in naphthenic acid, is a combination atmospheric and vacuum
distillation facility.
Savannah, Georgia Refinery. This is an asphalt refinery, which
includes two crude distillation units, with a combined rated capacity of 28
MBPD.
LYONDELL-CITGO REFINING L.P. On July 1, 1993, subsidiaries of
CITGO and Lyondell Chemical Company ("Lyondell") formed LYONDELL-CITGO REFINING
LP ("LYONDELL-CITGO"), which owns and operates a sophisticated 265 MBPD refinery
previously owned by Lyondell and located on the ship channel in Houston, Texas.
At December 31, 1998, CITGO's investment in LYONDELL-CITGO was $597 million. In
addition, at December 31, 1998, CITGO held notes receivable from LYONDELL-CITGO
of $36 million. (See Consolidated Financial Statements of PDV America - Note 2
in Item 14a.) The crude oil processed by this refinery is supplied by PDVSA
under a long-term crude oil supply agreement through the year 2017. CITGO
purchases substantially all of the refined products produced at this refinery
under a long-term contract. (See Consolidated Financial Statements of PDV
America - Note 2 in Item 14a.)
CITGO's participation interest in LYONDELL-CITGO was
approximately 41% at December 31, 1998. CITGO has a one-time option, exercisable
after January 1, 2000 but not later than September 30, 2000, to increase, for an
additional investment, its participation interest to 50%.
Crude Oil and Refined Product Purchases
CITGO owns no crude oil reserves or production facilities, and
must therefore rely on purchases of crude oil and feedstocks for its refinery
operations. In addition, because CITGO's refinery operations do not produce
sufficient refined products to meet the demands of its branded marketers, CITGO
purchases refined products, primarily gasoline, from other refiners, including
LYONDELL-CITGO, PDV Midwest Refining, L.L.C. ("PDVMR"), Chalmette Refining,
L.L.C. ("Chalmette") and a joint venture that owns and operates a refinery in
St. Croix, U.S. Virgin Islands ("HOVENSA"). See "Item 13. Certain Relationships
and Related Transactions".
9
Crude Oil Purchases. The following chart shows CITGO's
purchases of crude oil for the three years in the period ended December 31,
1998:
CITGO Crude Oil Purchases
Lake Charles, LA Corpus Christi, TX Paulsboro, NJ Savannah, GA
---------------------------- -------------------------- -------------------------- ------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Suppliers (MBPD) (MBPD) (MBPD) (MBPD)
PDVSA 134 130 142 153 117 130 52 49 39 17 14 17
PEMEX 51 61 44 0 0 0 0 0 0 0 0 0
Occidental 20 40 43 0 0 0 0 0 0 0 0 0
Other Sources 88 57 45 0 0 3 0 0 0 0 0 0
--- --- --- --- --- --- --- --- --- --- --- ---
Total 293 288 274 153 117 133 52 49 39 17 14 17
=== === === === === === == == == == == ==
CITGO's largest supplier of crude oil is PDVSA, and CITGO has
entered into long-term crude oil supply agreements with PDVSA with respect to
the crude oil requirements for each of CITGO's refineries. See "Item 13. Certain
Relationships and Related Transactions". The following table shows the base and
incremental volumes of crude oil contracted for delivery and the volumes of
crude oil actually delivered under these contracts in the three years ended
December 31, 1998.
The crude supply contracts include force majeure clauses that
have been exercised on certain occasions. Exercise of these clauses requires
that the Company locate alternative sources of supply for its crude oil
requirements, and such action may result in lower operating margins.
CITGO Crude Oil Supply Contracts with PDVSA
Volumes of Crude
Oil Purchased
Contract Crude for the Year Ended Contract
Oil Volume December 31, Expiration
----------------------------- ---------------------------------------
Base Incremental(1) 1998 1997 1996 Date
---------- ------------------ ------------ ------------- ------------ ----------
(MBPD) (MBPD) (year)
Location
Lake Charles, LA 120 50 121(2) 115(2) 121(2) 2006
Corpus Christi, TX 130 -- 128(2) 125(2) 130 2012
Paulsboro, NJ 30 -- 35(2) 35(2) 34(2) 2010
Savannah, GA 12 -- 12(2) 12(2) 11(2) 2013
Houston, TX(3) 200 -- 223 216 134 2017
- --------------------
(1) The supply agreement for the Lake Charles refinery gives PDVSA the right to sell to CITGO incremental volumes
up to the maximum amount specified in the table, subject to certain restrictions relating to the type of crude
oil to be supplied, refining capacity and other operational considerations at the refinery.
(2) Volumes purchased under the supply agreements do not equal purchases from PDVSA shown in the previous table as a result
of spot purchases or transfers between refineries.
(3) CITGO acquired a participation interest in LYONDELL-CITGO, the owner of the Houston refinery, on July 1, 1993. In
connection with such transaction, LYONDELL-CITGO entered into a long-term crude oil supply agreement with PDVSA that
provided for delivery volumes of 135 MBPD until the completion of a refinery enhancement project at which time the
delivery volumes increased to a range that extends from 200 MBPD to 230 MBPD.
Most of the crude oil and feedstocks purchased by CITGO from
PDVSA are delivered on tankers owned by PDV Marina, S.A. ("PDV Marina"), a
wholly owned subsidiary of PDVSA, or by other
10
PDVSA subsidiaries. In 1998, 82% of the PDVSA contract crude oil delivered to
the Lake Charles and Corpus Christi refineries was delivered on tankers operated
by PDVSA subsidiaries.
CITGO purchases additional crude oil under a 90-day evergreen
agreement with an affiliate of Petroleos Mexicanos ("PEMEX"). CITGO's refineries
are particularly well suited to refine PEMEX's Maya heavy, sour crude oil, which
is similar in many respects to several types of Venezuelan crude oil.
CITGO was a party to a contract with an affiliate of
Occidental Petroleum Corporation ("Occidental") for the purchase of light, sweet
crude oil to produce lubricants. This contract expired on August 31, 1998. CITGO
also purchases sweet crude oil under long-standing relationships with numerous
other producers.
Refined Product Purchases. CITGO is required to purchase
refined products to supplement the production of the Lake Charles and Corpus
Christi refineries in order to meet the demand of CITGO's marketing network.
During 1998, CITGO's shortage in gasoline production approximated 329 MBPD.
However, due to logistical needs, timing differences and product grade
imbalances, CITGO purchased approximately 581 MBPD of gasoline and sold into the
spot market or to refined product traders or other refiners, approximately 254
MBPD of gasoline. The following table shows CITGO's purchases of refined
products for the three years in the period ended December 31, 1998.
CITGO Refined Product Purchases
Year Ended December 31,
------------------------------------------------
1998 1997 1996
---------------- ---------------- --------------
(MBPD)
Light Fuels
Gasoline 581 518 484
Jet Fuel 69 74 92
Diesel/#2 fuel 208 190 153
--- --- ---
Total 858 782 729
=== === ===
As of December 31, 1998, CITGO purchased substantially all of
the refined products, excluding petrochemicals, produced at the LYONDELL-CITGO
refinery under a long-term contract through the year 2017. LYONDELL-CITGO was a
major supplier in 1998 providing CITGO with 120 MBPD of gasoline, 79 MBPD of
diesel/#2 fuel and 17 MBPD of jet fuel.
See "--Refining--LYONDELL-CITGO".
As of May 1, 1997, CITGO began purchasing, under a contract
with a sixty-month term, substantially all of the refined products produced at
the PDVMR refinery. During the period ended December 31, 1998, the PDVMR
refinery provided CITGO with 78 MBPD of gasoline, 42 MBPD of diesel/#2 fuel and
5 MBPD of jet fuel.
An affiliate of PDVSA acquired a 50% equity interest in a
refinery in Chalmette, Louisiana ("Chalmette") in October 1997 and has assigned
to CITGO its option to purchase up to 50 percent of the refined products
produced at the refinery through December 31, 1999. CITGO exercised this option
on November 1, 1997, and acquired approximately 65 MBPD of refined products from
the refinery during 1998, approximately one-half of which was gasoline.
In October 1998 an affiliate of PDVSA acquired a 50% equity
interest in HOVENSA and has the right under a product sales agreement to assign
periodically to CITGO, or other related parties, its
11
option to purchase 50% of the refined products produced by HOVENSA (less a
certain portion of such products that HOVENSA will market directly in the local
and Caribbean markets). In addition, under the product sales agreement, the
PDVSA affiliate has appointed CITGO as its agent in designating which of its
affiliates shall from time to time take deliveries of the refined products
available to it. The product sales agreement will be in effect for the life of
the joint venture, subject to termination events based on default or mutual
agreement. Pursuant to the above arrangement, CITGO began acquiring
approximately 120 MBPD of refined products from HOVENSA on November 1, 1998,
approximately one-half of which was gasoline.
Marketing
CITGO's major products are light fuels (including gasoline,
jet fuel and diesel fuel), industrial products, petrochemicals, asphalt, and
lubricants and waxes. The following table shows revenue and volumes of each of
these product categories for the three years in the period ended December 31,
1998.
CITGO Refined Product Sales Revenues and Volumes
Year Ended December 31, Year Ended December 31,
------------------------------------------------ ---------------------------------------------
1998 1997 1996 1998 1997 1996
--------------- -------------- --------------- --------------- --------------- -------------
($ in millions) (MM gallons)
Light Fuels
Gasoline $6,252 $7,754 $7,451 13,241 11,953 11,308
Jet Fuel 828 1,183 1,489 1,919 2,000 2,346
Diesel/#2 fuel 1,945 2,439 2,312 4,795 4,288 3,728
Asphalt 300 398 257 774 749 569
Petrochemicals and
Industrial Products 937 1,172 846 2,440 1,940 1,408
Lubricants and Waxes 441 467 426 230 239 220
------- ------- ------- ------ ------ ------
Total $10,703 $13,413 $12,781 23,399 21,169 19,579
======= ======= ======= ====== ====== ======
Light Fuels. Gasoline sales accounted for 58% of CITGO's
refined product sales in the years 1998, 1997 and 1996. CITGO markets CITGO
branded gasoline through over 15,000 independently owned and operated CITGO
branded retail outlets (including 13,165 branded retail outlets owned and
operated by approximately 824 independent marketers and 1,888 7-Eleven(TM)
convenience stores) located throughout the United States, primarily east of the
Rocky Mountains. CITGO purchases gasoline to supply its marketing network, as
the gasoline production from the Lake Charles and Corpus Christi refineries was
only equivalent to approximately 48%, 47% and 49% of the volume of CITGO branded
gasoline sold in 1998, 1997 and 1996, respectively. See "--Crude Oil and Refined
Product Purchases--Refined Product Purchases".
CITGO's strategy is to enhance the value of the CITGO brand in
order to obtain premium pricing for its products by appealing to consumer
preference for quality petroleum products and services. This is accomplished
through a commitment to quality, dependability and customer service to its
independent marketers, which constitute CITGO's primary distribution channel.
Sales to independent branded marketers typically are made
under contracts that range from three to seven years. Sales to 7-Eleven(TM)
convenience stores are made under a contract that extends through the year 2006.
Under this contract, CITGO arranges all transportation and delivery of motor
fuels and handles all product ordering. CITGO also acts as processing agent for
the purpose of facilitating and implementing orders and purchases from
third-party suppliers. CITGO receives a processing fee for such services.
12
CITGO markets jet fuel directly to airline customers at 26
airports, including such major hub cities as Atlanta, Chicago, Dallas/Fort
Worth, New York and Miami.
Growth in wholesale rack sales to marketers has been the
primary focus of diesel/#2 marketing efforts. Such marketing efforts have
resulted in increases in wholesale rack sales volume from approximately 1,561
million gallons in 1996 to approximately 1,928 million gallons in 1998. The
remaining diesel/#2 fuel production is sold either in bulk through contract
sales (primarily as heating oil in the Northeast) or on a spot basis.
CITGO's delivery of light fuels to its customers is
accomplished in part through 49 refined product terminals located throughout
CITGO's primary market territory. Of these terminals, 34 are wholly owned by
CITGO and 15 are jointly owned. Fifteen of CITGO's product terminals have
waterborne docking facilities, which greatly enhance the flexibility of CITGO's
logistical system. In addition, CITGO operates eight terminals owned by PDVMR in
the Midwest. Refined product terminals owned or operated by CITGO provide a
total storage capacity of approximately 23 million barrels. Also, CITGO has
active exchange relationships with over 270 other refined product terminals,
providing flexibility and timely response to distribution needs.
Petrochemicals and Industrial Products. CITGO sells
petrochemicals in bulk to a variety of U.S. manufacturers as raw materials for
finished goods. The majority of CITGO's cumene production is sold to Mount
Vernon Phenol Plant Partnership ("MVPPP")(see "Item 13. Certain Relationships
and Related Transactions"), a joint venture phenol production plant in which
CITGO is a limited partner. The phenol plant produces phenol and acetone for
sale primarily to the principal partner in the phenol plant for the production
of plastics. Sulphur is sold to the U.S. and international fertilizer industry;
cycle oils are sold for feedstock processing and blending; natural gas liquids
are sold to the U.S. fuel and petrochemical industry; petroleum coke is sold
primarily in international markets, through a joint venture, for use as kiln and
boiler fuel; and residual fuel blendstocks are sold to a variety of fuel oil
blenders and customers.
Asphalt. CITGO markets asphalt through 15 terminals located
along the East Coast, from Savannah, Georgia to Albany, New York. Asphalt is
sold primarily to independent contractors for use in the construction and
resurfacing of roadways. Demand for asphalt in the Northeastern United States
peaks in the summer months.
Lubricants and Waxes. CITGO markets many different types,
grades and container sizes of lubricants and wax products, with the bulk of
sales consisting of automotive oil and lubricants and industrial lubricants.
Other major lubricant products include 2-cycle engine oil and automatic
transmission fluid.
Pipeline Operations
CITGO owns and operates 339 miles of crude oil pipeline
systems and approximately 1,080 miles of products pipeline systems. CITGO also
has equity interests in three crude oil pipeline companies with a total of
nearly 5,400 miles of pipeline plus equity interest in six refined product
pipeline companies with a total of approximately 8,000 miles of pipeline.
CITGO's pipeline interests provide it with access to substantial refinery
feedstocks and reliable transportation to refined product markets, as well as
cash flows from dividends. One of the refined product pipelines in which CITGO
has an interest, Colonial Pipeline, is the largest refined product pipeline in
the United States transporting gasoline, jet fuel and diesel/#2 fuel oil from
the Gulf Coast to the mid-Atlantic and eastern seaboard states.
13
Employees
CITGO and its subsidiaries have a total of approximately 4,500
employees, approximately 1,900 of whom are covered by 15 union contracts.
Approximately 1,600 of the union employees are employed in refining operations.
The remaining union employees are located primarily at a lubricant blending and
packaging plant and at various refined product terminals.
Effective February 28, 1998, the stock of Petro-Chemical
Transport, Inc. ("PCT"), a wholly owned subsidiary of CITGO, was sold. As a
result of this sale, approximately 420 employees were terminated. The operations
of PCT were not material to CITGO.
PDV Midwest Refining, L.L.C.
Refining
PDVMR produces light fuels, petrochemicals and industrial
products at its refinery in Lemont, Illinois. The refinery has a crude
distillation capacity of 167 MBPD and has a Solomon Process Complexity Factor of
11.3 (as compared to an average of 13.8 for U.S. refineries in the most recently
available Solomon Associates, Inc. survey).
The following table shows refining capacity, refinery input
and product yield at the Lemont refinery for the three years in the period ended
December 31, 1998.
Lemont Refinery Production
Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
------------------------ --------------------------- ------------------------
(MBPD, except as otherwise indicated)
Rated Refining Capacity (1) 167 160 153
Refinery Input
Crude oil 148 90.8% 151 89.1% 146 88.4%
Other feedstocks 15 9.2% 17 10.9 19 11.6
--- ----- --- ----- --- -----
Total 163 100.0% 168 100.0% 165 100.0%
=== ===== === ===== === =====
Product Yield
Light fuels
Gasoline 79 49.1% 87 52.4% 87 53.0%
Jet Fuel 3 1.8% 3 1.8% 7 4.3
Diesel/#2 Fuel 41 25.5% 39 23.5% 37 22.6
Industrial Products &
Petrochemicals 38 23.6% 37 22.3% 33 20.1
--- ----- --- ----- --- -----
Total 161 100.0% 166 100.0% 164 100.0%
=== ===== === ===== === =====
Utilization of Rated 89% 94% 95%
Refining Capacity
- -----------------------
(1) At year end.
14
The average API gravity of the composite crude slate run at
the Lemont refinery is approximately 27.2 degrees. Crude oil is supplied to the
refinery by pipeline.
Petrochemical products at the Lemont refinery include benzene,
toluene and xylene, plus a range of ten different aliphatic solvents.
PDVMR owns a 25% interest in a partnership which operates a
needle coke production facility adjacent to the Lemont refinery (the "Needle
Coker"). The remaining 75% interest is held by various subsidiaries of UNOCAL.
Crude Oil Purchases
PDVMR owns no crude oil reserves or production facilities and,
therefore, relies on purchases of crude oil for its refining operations. A
portion of the crude oil refined at the Lemont refinery is supplied by PDVSA
under a crude oil supply agreement, effective as of April 23, 1997, that expires
in the year 2002 and thereafter is renewable annually. The contract calls for
delivery of a guaranteed volume of up to 100 MBPD; however, PDVMR is not
required to purchase a set minimum. In 1998, the crude oil processed at the
Lemont refinery was 23 percent Venezuelan, 67 percent Canadian and 10 percent
from other sources.
Marketing
Subsequent to the transfer of assets on May 1, 1997,
substantially all of PDVMR's products are sold to and marketed by CITGO. (See
"Item 13. Certain Relationships and Related Transactions".)
Employees
PDVMR has no employees. CITGO operates the Lemont refinery and
provides all administrative functions to the Company pursuant to a Refinery
Operating Agreement (as defined below).
Refinery Operating Agreement with CITGO
CITGO operates the Lemont refinery in accordance with a
Refinery Operating Agreement (the "Refinery Operating Agreement") between CITGO
and PDVMR. The Refinery Operating Agreement sets out the duties, obligations and
responsibilities of the operator and the Company with respect to the operation
of the refinery. CITGO provides all administrative functions to the Company,
including cash management, legal and accounting services. The term of the
agreement is 60 months, commencing May 1, 1997, and shall be automatically
renewed for periods of 12 months (subject to early termination as provided in
the Refinery Operating Agreement). (See "Item 13. Certain Relationships and
Related Transactions".)
Environment and Safety
Environment--General
Beginning in 1994, the U.S. refining industry was required to
comply with stringent product specifications under the 1990 Clean Air Act
("CAA") Amendments for reformulated gasoline and low sulphur diesel fuel, which
necessitated additional capital and operating expenditures, and altered
significantly the U.S. refining industry and the return realized on refinery
investments. In addition, numerous other factors affect the Company's plans with
respect to environmental compliance and related expenditures. See "Factors
Affecting Forward Looking Statements".
15
In addition, the Companies are subject to various federal,
state and local environmental laws and regulations which may require the
Companies to take action to correct or improve the effects on the environment of
prior disposal or release of petroleum substances by the Companies or other
parties. Management believes the Companies are in compliance with these laws and
regulations in all material aspects. Maintaining compliance with environmental
laws and regulations in the future could require significant capital
expenditures and additional operating costs.
The Company's accounting policy establishes environmental
reserves as probable site restoration and remediation obligations become
reasonably capable of estimation. Based on currently available information,
including the continuing participation of former owners in remediation actions
and indemnification agreements with third parties, the Company's management
believes that its accruals are sufficient to address the Companies'
environmental clean-up obligations.
Conditions which require additional expenditures may exist for
various of the Companies' sites including, but not limited to, the Companies'
operating refinery complexes, closed refineries, service stations and crude oil
and petroleum product storage terminals. The amount of such future expenditures,
if any, is indeterminable.
Environment--CITGO
Under a 1992 agreement with CITGO, a former owner of certain
of CITGO's operations and assets, including the Lake Charles refinery,
indemnifies CITGO for certain environmental remediation costs, "Superfund"
liabilities and tort liabilities related to those operations and assets
according to relative ownership periods and the terms of the agreement.
A February 1999 order of a Louisiana agency specifies
requirements to complete closure of certain surface impoundments at the Lake
Charles refinery. CITGO and the former owner are participating in this closure
and sharing the related costs based on estimated contributions of waste and
ownership periods. Final closure is expected to begin in 2000.
Based on publicly available information, CITGO believes that
the former owner has the financial capability to fulfill all of its
responsibilities under the 1992 agreement. Accordingly, CITGO believes that its
liability exposure under the Federal Superfund and similar state laws with
respect to those sites for which the former owner provides indemnity is not
material.
In July 1997, the Texas Natural Resources Conservation
Commission ("TNRCC") issued a Preliminary Report and Petition alleging that
CITGO Refining and Chemicals Company LP ("CITGO Refining") violated TNRCC rules
relating to operation of a hazardous waste management unit without a permit and
recommended a penalty of $699,200. CITGO Refining disagrees with those
allegations and the proposed penalties. As part of the continuing negotiations,
TNRCC has proposed to settle the alleged violation of hazardous waste management
rules and regulations in addition to alleged unauthorized emissions to the
atmosphere and alleged unauthorized discharge to the waters of the state in
return for payment of a penalty of $786,300.
Increasingly stringent regulatory provisions periodically
require additional capital expenditures. During 1998, CITGO expended
approximately $65 million for environmental and regulatory capital improvements
in its operations. Management currently estimates that CITGO will spend
approximately $303 million for environmental and regulatory capital projects
over the five-year period 1999-2003. These estimates may vary due to a variety
of factors. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources". See also
"Factors Affecting Forward Looking Statements".
16
Environment--PDVMR
In accordance with the Partnership Interest Retirement
Agreement, the Company, VPHI Midwest, Inc., a subsidiary of the Company, and
PDVMR assumed joint and several liability for all environmental matters relating
to past operations of UNO-VEN.
During 1998, PDVMR expended approximately $4 million for
environmental and regulatory capital improvements in its operations and
currently anticipates spending approximately $29 million for environmental and
regulatory capital projects over the five-year period 1999-2003. These estimates
may vary due to a variety of factors. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources".
Safety
Due to the nature of petroleum refining and distribution, both
CITGO and PDVMR are subject to stringent occupational health and safety laws and
regulations. CITGO and PDVMR maintain comprehensive safety, training and
maintenance programs, and PDV America believes that both companies are in
substantial compliance with occupational health and safety laws.
ITEM 3. LEGAL PROCEEDINGS
Various lawsuits and claims arising in the ordinary course of
business are pending against the Companies. The Companies record accruals for
potential losses when, in management's opinion, such losses are probable and
reasonably estimable. If known lawsuits and claims were to be determined in a
manner adverse to the Companies, and in amounts greater than the Companies'
accruals, then such determinations could have a material adverse effect on the
Companies' results of operations in a given reporting period. However, in
management's opinion the ultimate resolution of these lawsuits and claims will
not exceed, by a material amount, the amount of the accruals and the insurance
coverage available to the Companies. This opinion is based upon management's and
counsel's current assessment of these lawsuits and claims. The most significant
lawsuits and claims are discussed below.
In a pending case in federal court, Oil Chemical and Atomic
Workers, Local 7-517 (the "Union") has asserted claims against CITGO, PDVSA, PDV
America, PDVMR, UNO-VEN and Unocal pursuant to the Labor Management Relations
Act. The Union alleges that CITGO and the other defendants are bound by the
terms of a collective bargaining agreement between UNO-VEN and the Union
covering certain employees at a refinery in Lemont, Illinois. This refinery was
acquired by PDVMR on May 1, 1997 in a transaction involving the former partners
of UNO-VEN. Pursuant to an operating agreement with PDVMR, CITGO became the
operator of this refinery and employed the substantial majority of the employees
previously employed by UNO-VEN pursuant to its initial terms and conditions of
employment, but CITGO did not assume the existing labor agreement. The Union
seeks monetary compensation for certain differences in employee benefits and
reinstatement of all of the UNO-VEN benefit plans. The Union also seeks to
require CITGO to abide by the terms of the collective bargaining agreement
between the Union and UNO-VEN. As an alternative claim against all defendants
but CITGO, the Union alleges that if the labor agreement is not binding on
CITGO, there was a violation of the Federal Workers Adjustment Retraining and
Notification Act by failure to give 60 days' written notice of termination to
approximately 400 UNO-VEN employees; this would allegedly entitle such workers
to 60 days' pay and benefits, which is estimated to be approximately $6 million.
In March 1999, the federal appeals court affirmed the trial court's grant of the
motions for summary judgment filed by CITGO and the other defendants.
PDVMR and PDV America, jointly and severally, have agreed to
indemnify UNO-VEN and certain other related entities against certain liabilities
and claims, including the preceding matter.
17
In May 1997, an explosion and fire occurred at CITGO's Corpus
Christi refinery. No serious personal injuries were reported. CITGO received
approximately 7,500 individual claims for personal injury and property damage
related to the above noted incident. Approximately 1,300 of these claims have
been resolved for amounts which individually and collectively are not material.
There are presently six lawsuits pending against CITGO in federal and state
courts alleging property damages, personal injury and punitive damages. A trial
in one of the federal court lawsuits in October 1998 involving ten bellwether
plaintiffs, out of approximately 400 plaintiffs, resulted in a verdict for
CITGO. The remaining cases are not currently scheduled for trial. CITGO
anticipates that the claims of the remaining plaintiffs in this lawsuit will be
resolved for an immaterial amount.
A class action lawsuit is pending in Corpus Christi, Texas
state court against CITGO and other operators and owners of nearby industrial
facilities which claims damages for reduced value of residential properties
located in the vicinity of the industrial facilities as a result of air, soil
and groundwater contamination. In 1997, CITGO offered to purchase about 275
properties in a neighborhood adjacent to CITGO's Corpus Christi refinery, which
were included in the lawsuit. Related to this offer, $15.7 million was expensed
in 1997. To date, CITGO has reached agreements to buy all but 18 of such
properties, which include settlements of property damage claims, and has offers
open to purchase the remaining properties. Two related personal injury and
wrongful death lawsuits were filed against the same defendants in 1996 and are
scheduled for trial in 1999.
Litigation is pending in federal court in Lake Charles,
Louisiana, against CITGO by a number of current and former Lake Charles refinery
employees and applicants asserting claims of racial discrimination in connection
with CITGO's employment practices. Trials in this case are set to begin in the
fall of 1999.
CITGO is among defendants to lawsuits in California and North
Carolina alleging contamination of water supplies by methyl tertiary butyl ether
("MTBE"), a component of gasoline. The action in California was filed in
November 1998 by the South Tahoe Public Utility District and CITGO was added as
a defendant in February 1999. The North Carolina case, filed in January 1999, is
a putative class action on behalf of owners of water wells and other drinking
water supplies in the state. Both actions allege that MTBE poses public health
risks. Both actions seek damages as well as remediation of the alleged
contamination. These matters are in early states and there has been no discovery
conducted against CITGO. CITGO intends to deny all of the allegations and is
pursuing its defenses.
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS
Not Applicable.
18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
The Company's common stock is not publicly traded. All of the
Company's common stock is held by PDV Holding, Inc. ("PDV Holding"), a Delaware
corporation, whose ultimate parent is PDVSA. In 1998 PDV America declared and
paid a dividend of $268.5 million to PDV Holding. PDV America did not declare or
pay any dividends in 1997.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected historical
consolidated financial and operating data of PDV America as of the end of and
for each of the five years in the period ended December 31, 1998. The following
table should be read in conjunction with the consolidated financial statements
of PDV America as of December 31, 1998 and 1997, and for each of the three years
in the period ended December 31, 1998, included in Item 8. The audited
consolidated financial statements of PDV America for each of the five years in
the period ended December 31, 1998 have been prepared on the basis of United
States generally accepted accounting principles.
19
Year Ended December 31,
-----------------------------------------------------------------------
1998 1997(8) 1996 1995(7) 1994
------------- -------------- -------------- -------------- ------------
($ in millions)
Income Statement Data
Sales $10,960 $13,622 $12,952 $10,522 $9,247
Equity in earnings (losses) of affiliates(1) 82 69 45 48 55
Net revenues 11,107 13,754 13,071 10,647 9,374
Income before extraordinary items
and cumulative effect of accounting
changes 231 228 138 143 205
Extraordinary gain (charges)(2) -- -- -- 3 (2)
Cumulative effect of accounting
changes(3) -- -- -- -- (4)
Net income 231 228 138 146 199
Ratio of Earnings to Fixed Charges(4) 3.06x 2.58x 1.91x 2.02x 2.65x
Balance Sheet Data
Total assets $7,075 $7,244 $6,938 $6,220 $5,770
Long-term debt (excluding current
portion)(5) 2,174 2,164 2,595 2,297 2,155
Total debt(6) 2,273 2,526 2,755 2,428 2,279
Shareholder's equity 2,601 2,589 2,111 1,973 1,812
- -------------------------
(1) Includes the equity in the earnings of UNO-VEN of $0.4 million, $23 million, $15 million and $27 million for the four months
ended April 30, 1997 and the years ended December 31, 1996, 1995 and 1994, respectively.
(2) Represents extraordinary gain or (charges) for the early extinguishment of debt (net of related income tax provision of
$2 million and income tax benefits of $1 million in 1995 and 1994, respectively).
(3) Represents the cumulative effect of the accounting change to Statement of Financial Accounting Standards ("SFAS") No. 112,
"Employers' Accounting for Postemployment Benefits" in 1994 (net of related income tax benefits of $3 million).
(4) For the purpose of calculating the ratio of earnings to fixed charges, "earnings" consist of income before income taxes
and cumulative effect of accounting changes plus fixed charges (excluding capitalized interest), amortization of previously
capitalized interest and certain adjustments to equity in income of affiliates. "Fixed charges" include interest expense,
capitalized interest, amortization of debt issuance costs and a portion of operating lease rent expense deemed to be
representative of interest.
(5) Includes long-term debt to third parties, note payable to affiliate and capital lease obligations.
(6) Includes short-term bank loans, current portion of capital lease obligations and long-term debt, long-term debt, capital
lease obligations and note payable to affiliate.
(7) Includes operations of Cato Oil and Grease Company since May 1, 1995.
(8) Includes operations of PDVMR since May 1, 1997.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion of the financial condition and
results of operations of PDV America should be read in conjunction with the
consolidated financial statements of PDV America included elsewhere herein.
Petroleum industry operations and profitability are influenced
by a large number of factors, some of which individual petroleum refining and
marketing companies cannot entirely control. Governmental regulations and
policies, particularly in the areas of taxation, energy and the environment,
have a significant impact on petroleum activities, regulating how companies
conduct their operations and formulate their products, and, in some cases
limiting their profits directly. Demand for crude oil and refined products is
largely driven by the condition of local and worldwide economies, although
weather patterns and taxation relative to other energy sources also play a
significant part. PDV America's consolidated operating results are affected by
these industry-specific factors and by company-specific factors, such as the
success of marketing programs and refinery operations.
The earnings and cash flows of companies engaged in the
refining and marketing business in the United States are primarily dependent
upon producing and selling quantities of refined products at margins sufficient
to cover fixed and variable costs. The refining and marketing business is
characterized by high fixed costs resulting from the significant capital outlays
associated with refineries, terminals and related facilities. This business is
also characterized by substantial fluctuations in variable costs, particularly
costs of crude oil, feedstocks and blending components, and in the prices
realized for refined products. Crude oil and refined products are commodities
whose price levels are determined by market forces beyond the control of the
Companies.
In general, prices for refined products are significantly
influenced by the price of crude oil, feedstocks and blending components.
Although an increase or decrease in the price for crude oil, feedstocks and
blending components generally results in a corresponding change in prices for
refined products, there is usually a lag in the realization of the corresponding
increase or decrease in prices for refined products. The effect of changes in
crude oil prices on PDV America's consolidated operating results therefore
depends in part on how quickly refined product prices adjust to reflect these
changes. A substantial or prolonged increase in crude oil prices without a
corresponding increase in refined product prices, a substantial or prolonged
decrease in refined product prices without a corresponding decrease in crude oil
prices, or a substantial or prolonged decrease in demand for refined products
could have a significant negative effect on the Company's earnings and cash
flows. CITGO purchases a significant amount of its crude oil requirements from
PDVSA under long-term crude oil supply agreements (expiring in the years 2006
through 2013). CITGO's supply agreements were designed to reduce the volatility
of earnings and cash flows from CITGO's refining operations by providing a
relatively stable level of gross margin on crude oil supplied by PDVSA. This
supply represented approximately 58% of the crude oil processed in refineries
owned by CITGO in the year ended December 31, 1998. The crude supply contracts
include force majeure clauses that have been exercised on certain occasions.
Exercise of these clauses requires that CITGO locate alternative sources of
supply for its crude oil requirements, and such action may result in lower
operating margins. CITGO also purchases significant volumes of refined products
to supplement the production from its refineries to meet marketing demands and
to resolve logistical issues. PDV America's earnings and cash flows are also
affected by the cyclical nature of petrochemical prices. As a result of these
factors, the earnings and cash flows of PDV America may experience substantial
fluctuations. Inflation was not a significant factor in the operations of PDV
America for the three years ended 1998.
21
CITGO's revenues accounted for approximately 99% of PDV
America's consolidated revenues in 1998, 1997 and 1996. PDVMR's sales of $1,034
million for the period ended December 31, 1998 were primarily to CITGO and,
accordingly, these were eliminated in consolidation. However, the operations of
PDVMR contributed approximately $77 million to the Companies' consolidated gross
margin.
In July 1997 the Company's senior management implemented a
Transformation Program designed to ensure that numerous expense controls,
business information systems and business efficiency initiatives underway were
effectively coordinated to achieve desired results. Included in this program
were reviews of CITGO's business units, assets, strategies, and business
processes. These combined actions include personnel reductions (the "Separation
Programs"). The cost of the Separation Programs was approximately $8 million and
$22 million for the years ended December 31, 1998 and 1997, respectively. In
addition, as part of the Transformation Program, the first phase of Systems,
Applications and Products in Data Processing ("SAP") implementation, which
included the financial reporting and materials management systems, was brought
into production on January 1, 1998. Additional SAP modules, including plant
maintenance work order and cost tracking, were implemented throughout 1998. The
implementation will continue in 1999.
The following table summarizes the sources of PDV America's sales
revenues and volumes.
PDV America Sales Revenues and Volumes
Year Ended December 31, Year Ended December 31,
------------------------------------------- ---------------------------------------
1998 1997 1996 1998 1997 1996
-------------- ------------- -------------- ------------- ------------ ------------
($ in millions) (MM gallons)
Gasoline $ 6,252 $ 7,754 $ 7,451 13,241 11,953 11,308
Jet fuel 828 1,183 1,489 1,919 2,000 2,346
Diesel/#2 fuel 1,945 2,439 2,312 4,795 4,288 3,728
Asphalt 300 398 257 774 749 569
Petrochemicals and industrial
products 952 1,178 846 2,658 1,961 1,408
Lubricants and waxes 441 467 426 230 239 220
--------- --------- --------- ------- ------- -------
Total refined product sales 10,718 $ 13,419 $ 12,781 23,617 21,190 19,579
Other sales 242 203 171 -- -- --
--------- --------- --------- ------- ------- -------
Total sales $ 10,960 $ 13,622 $ 12,952 23,617 21,190 19,579
========= ========= ========= ======= ======= =======
The following table summarizes PDV America's cost of sales and
operating expenses.
PDV America Cost of Sales and Operating Expense
Year Ended December 31,
------------------------------------------------
1998 1997 1996
--------------- ---------------- ---------------
($ in millions)
Crude oil $ 2,571 $ 3,552 $ 3,053
Refined products 5,102 6,739 7,139
Intermediate feedstocks 900 1,240 1,000
Refining and manufacturing costs 949 940 801
Other operating costs and expenses and inventory changes 784 527 498
--------- --------- ---------
Total cost of sales and operating expenses $ 10,306 $ 12,998 $ 12,491
========= ========= =========
22
Results of Operations--1998 Compared to 1997
Sales revenues and volumes. Sales decreased by $2,662 million,
representing a 20% decrease from 1997 to 1998. This was due to a decrease in
average sales price of 28% partially offset by an increase in sales volumes of
12%. (See PDV America Sales Revenues and Volumes table above.)
Equity in earnings (losses) of affiliates. Equity in earnings
of affiliates increased by approximately $13 million, or 18.8% from $69 million
in 1997 to $82 million in 1998. This increase was due primarily to a $14 million
increase in CITGO's equity in earnings of LYONDELL-CITGO as a result of the
change in CITGO's interest in LYONDELL-CITGO which increased from approximately
13% at December 31, 1996 to approximately 42% on April 1, 1997 and the
improvement in LYONDELL-CITGO's operations since completion of its refinery
enhancement project during the first quarter of 1997 (See Consolidated Financial
Statements of PDV America - Note 2 in Item 14a.)
Cost of sales and operating expenses. Cost of sales and
operating expenses decreased by $2,692 million, or 21% from 1997 to 1998. (See
PDV America Cost of Sales and Operating Expense table above.)
The Companies purchase refined products to supplement the
production from their refineries to meet marketing demands and resolve
logistical issues. The refined product purchases represented 50% and 52% of cost
of sales for the years 1998 and 1997, respectively. These refined product
purchases included purchases from LYONDELL-CITGO, Chalmette and HOVENSA. The
Companies estimate that margins on purchased products, on average, are lower
than margins on produced products due to the fact that the Companies can only
receive the marketing portion of the total margin received on the produced
refined products. However, purchased products are not segregated from the
Companies produced products and margins may vary due to market conditions and
other factors beyond the Companies' control. As such, it is difficult to measure
the effects on profitability of changes in volumes of purchased products. The
Companies anticipate their purchased product requirements will increase, in
volume and as a percentage of refined products sold, in order to meet marketing
demands, although in the near term, other than normal refinery turnaround
maintenance, the Companies do not anticipate operational actions or market
conditions which might cause a material change in anticipated purchased product
requirements; however, there could be events beyond the control of the Companies
which impact the volume of refined products purchased. See also "Factors
Affecting Forward Looking Statements".
Gross margin. The gross margin for 1998 was $655 million
compared to $625 million for 1997. Gross margins in 1998 were positively
affected by a 12% increase in sales volume partially offset by an erosion of
gross margin on a per gallon basis which includes a lower of cost or market
adjustment of $172 million.
Selling, general and administrative expenses. Selling, general
and administrative expenses increased $47 million, or 22% in 1998. The increase
is due primarily to salary and related burden allocations as well as increases
in advertising expense and depreciation.
Interest expense. Interest expense decreased $29 million from
1997 to 1998. The decrease was primarily due to the decrease in average debt
outstanding related to a decrease in working capital requirements and the
deferral of a significant 1998 excise tax payment, as well as the repayment of
$250
23
million of the Company's Senior Notes on August 1, 1998. Also the average
interest rate decreased due to a decrease in key rates and replacement of higher
rate debt with lower rate debt.
Income taxes. PDV America's provision for income taxes in 1998
was $131 million, representing an effective tax rate of 36%. In 1997, PDV
America's provision for income taxes was $106 million, representing an effective
tax rate of 32%. The relatively low rate in 1997 was due primarily to the
favorable resolution of a significant tax issue with the Internal Revenue
Service in the second quarter of 1997. The resolution resulted in the reduction
of a contingency reserve previously established related to this matter. The
decrease was partially offset by the recording of a valuation allowance related
to a capital loss carryforward. In 1998 the effective tax rate decreased
slightly compared to the 1996 rate due to a decrease in state taxes.
Results of Operations--1997 Compared to 1996
Sales revenues and volumes. Sales increased by $670 million,
representing a 5% increase from 1996 to 1997. The increase was due to an
increase in sales volumes of 8% partially offset by a decrease in average sales
prices of 3%. (See PDV America Sales Revenue and Volumes table above.)
Equity in earnings (losses) of affiliates. Equity in earnings
of affiliates increased by approximately $24 million, or 53% from $45 million in
1996 to $69 million in 1997. This increase was due primarily to a $43 million
increase in CITGO's equity earnings of LYONDELL-CITGO, which was due primarily
to the change in CITGO's interest in LYONDELL-CITGO, which increased from
approximately 13% at December 31, 1996 to approximately 42% on April 1,
1997, and the improvement in LYONDELL-CITGO's operations since completion of its
refinery enhancement project during the first quarter of 1997. Also, subsequent
to the transfer of UNO-VEN assets, the Companies have recorded $4 million of
equity in the earnings of Needle-Coker from the period from May 1, 1997 to
December 31, 1997. These were offset by a $23 million decrease in the equity in
earnings of UNO-VEN from $23 million in 1996 to $.5 million for the first four
months of 1997. See "--PDV Midwest Refining, LLC" under "Business and
Properties" and Consolidated Financial Statements of PDV America - Note 8 in
Item 14a).
Other income (expense). Other income (expense) was $(14.5)
million for the year ended December 31, 1997 as compared to $(3.4) million for
the same period in 1996. The 1997 amount includes $8.7 million in loss reserves
on a lubricants plant and retail properties, a $5.8 write-off of a capital
project, $5.8 million in fees related to the sale of trade accounts, notes and
credit card receivables in June and November 1997 and a $2.6 million write-off
of miscellaneous assets. These items were offset by a net $8.3 million property
insurance recovery relating to the Corpus Christi alkylation unit fire during
the third quarter and a $1.3 million gain on the sale of pipeline assets in the
first quarter of 1997.
Cost of sales and operating expenses. Cost of sales and
operating expenses increased by $507 million, or 4% from 1996 to 1997. (See PDV
America Cost of Sales and Operating Expense table above.)
The Companies purchase refined products to supplement the
production from their refineries to meet marketing demands and resolve
logistical issues. The refined product purchases represented 52% and 57% of cost
of sales for the years 1997 and 1996, respectively. These refined product
purchases included purchases from LYONDELL-CITGO, and Chalmette.
24
Gross margin. The gross margin for 1997 was $625 million, or
4.6%, compared to $461 million, or 3.6%, for 1996. Gross margins in 1997 were
positively affected by high crude runs during periods of strong refining margins
as well as asphalt and petrochemical activities and the positive contribution
from PDVMR's refining operations.
Selling, general and administrative expenses. Selling, general
and administrative expenses increased $42 million, or 25%, due primarily to
increased selling expenses in 1997, including the effect of the change in focus
of the Companies' marketing programs initiated in April 1996 and increases in
several other areas including purchasing, administrative services, information
systems, corporate executive, credit card and other charges, none of which
increased more than $6 million individually, but in the aggregate increased
approximately $30 million for the year. Additionally, the effect of including
PDVMR's expenses from May 1, 1997 to December 31, 1997 contributed to the
increase.
Interest expense. Interest expense increased $15 million from
1996 to 1997. The increase was primarily due to the public debt and certain
industrial revenue bonds which were outstanding for the entire year in 1997
compared to only a partial year during 1996 and CITGO's revolving bank loan,
which had a higher outstanding balance during most of 1997 as compared to 1996.
The increase was also due to debt related to PDVMR.
Income taxes. PDV America's provision for income taxes in 1997
was $106 million, representing an effective tax rate of 32%. In 1996, PDV
America's provision for income taxes was $78 million, representing an effective
tax rate of 36%. The decrease is due primarily to the favorable resolution with
the Internal Revenue Service of a significant tax issue, related to
environmental expenditures, in the second quarter of 1997. The decrease was
partially offset by the recording of a valuation allowance related to a capital
loss carryforward.
Liquidity and Capital Resources
For the year ended December 31, 1998, PDV America's net cash
provided by operating activities totaled approximately $711 million, primarily
reflecting $231 million of net income and $265 million of depreciation and
amortization, a lower of cost or market adjustment to inventory of $172 million
and the net effect of other items of $43 million. The more significant changes
in other items included the decrease in accounts receivable, including
receivables from affiliates, of approximately $86 million, a decrease in
accounts payable and other liabilities, including payables to affiliates, of
approximately $78 million and the increase of other assets of approximately $79
million.
Net cash used in investing activities in 1998 totaled $232
million, consisting primarily of capital expenditures of $230 million, loans to
PDVSA Finance Ltd. in the aggregate amount of $260 million, and a loan to
LYONDELL-CITGO of $20 million offset by $250 million of proceeds from notes
receivable from PDVSA and $27 million of proceeds from sales of property, plant
and equipment.
During the same period, consolidated net cash used in
financing activities totaled approximately $479 million, consisting primarily of
$309 million of payments on private placement notes, $269 million of dividends
paid to PDV Holding, $59 million of repayment on term bank loan offset by $50
million of capital contribution from PDV Holding and the net additional
borrowings of $108 million.
25
PDV America currently estimates capital expenditures for the
years 1999-2003 will total approximately $2.2 billion, exclusive of investments
in LYONDELL-CITGO, as shown in the following table.
Estimated Capital Expenditures--1999 through 2003(1)
Strategic $1,320 million
Maintenance 503 million
Regulatory/Environmental 332 million
-----------
Total $2,155 million
------------- ==============
(1) These estimates may change as future regulatory events unfold.
PDV America's $750 million senior notes issued in 1993 are
comprised of (i) $250 million of 7 3/4% Senior Notes due August 1, 2000 and (ii)
$500 million 7 7/8% Senior Notes due August 1, 2003 (collectively, the "Senior
Notes"). Interest on these notes is payable in semiannual installments. PDV
America repaid on August 1, 1998 the $250 million 7 1/4% Senior Notes due August
1, 1998, with the proceeds received from the maturity of $250 million of Mirror
Notes due from PDVSA on July 31, 1998.
PDV America's $260 million loan to PDVSA Finance Ltd., a
wholly owned subsidiary of Petroleos de Venezuela, S.A., was issued on November
10, 1998 and is comprised of two promissory notes of $130 million. PDVSA Finance
shall repay the outstanding principal amount of the loan commencing on February
10, 2009, in 20 equal quarterly installments of principal. Interest shall be
payable in arrears quarterly commencing on February 10, 1999, at a rate per
annum equal to 8.558%.
As of December 31, 1998, CITGO had an aggregate of $1,343
million of indebtedness outstanding that matures on various dates through the
year 2028. As of December 31, 1998, the contractual commitments to make
principal payments on this indebtedness were $84 million, $47 million and $47
million for 1999, 2000 and 2001, respectively. CITGO's bank credit facility
consists of a $400 million, five-year revolving bank loan and a $150 million,
364-day revolving bank loan, both of which are unsecured and have various
borrowing maturities, of which $165 million was outstanding at December 31,
1998. Cit-Con has a separate credit agreement under which $21 million was
outstanding at December 31, 1998. Other principal indebtedness consists of (i)
$200 million in senior notes issued in 1996, (ii) $260 million in senior notes
issued pursuant to a master shelf agreement with an insurance company, (iii)
$177 million in senior notes issued in 1991, (iv) $276 million in obligations
related to tax exempt bonds issued by various governmental units, and (v) $208
million in obligations related to taxable bonds issued by a governmental unit.
(See Consolidated Financial Statements of PDV America - Notes 9 and 10 in Item
14a.)
As of December 31, 1998, PDVMR had an aggregate of $65 million
of indebtedness that matures on various dates through the year 2008. PDVMR's
bank credit facility consists of a $125 million revolving credit facility,
committed through April 2002, of which $45 million was outstanding at December
31, 1998. Other indebtedness consists of $20 million in pollution control bonds.
(See Consolidated Financial Statements of PDV America - Note 10 in Item 14a.)
26
The debt instruments of PDV America, PDVMR and CITGO impose
restrictions on PDV America's, PDVMR's and CITGO's ability to incur additional
debt, grant liens, make investments, sell or acquire fixed assets, make
restricted payments and engage in other transactions. In addition, restrictions
exist over the payment of dividends and other distributions to PDV America from
CITGO. PDV America, PDVMR and CITGO were in compliance with all their respective
covenants under such debt instruments at December 31, 1998.
As of December 31, 1998, capital resources available to the
Companies included cash on hand, available borrowing capacity under CITGO's
revolving credit facility of $385 million, $138 million in unused availability
under CITGO's uncommitted short-term borrowing facilities with various banks and
$80 million in unused availability under PDVMR's revolving credit facility with
various banks. Additionally, the remaining $400 million from CITGO's shelf
registration with the Securities and Exchange Commission for $600 million of
debt securities may be offered and sold from time to time. The Companies'
management believes that they have sufficient capital resources to carry out
planned capital spending programs, including regulatory and environmental
projects in the near term, and to meet anticipated operating needs, debt service
and currently anticipated future obligations as they arise. In addition, PDV
America intends that payments received from PDVSA under the Mirror Notes will
provide funds to service PDV America's Senior Notes. The Companies periodically
evaluate other sources of capital in the marketplace and anticipate that
long-term capital requirements will be satisfied with current capital resources
and future financing arrangements. The Companies' ability to obtain such
financing will depend on numerous factors, including market conditions and the
perceived creditworthiness of the Companies at that time. See "Factors Affecting
Forward Looking Statements".
PDV America and its direct subsidiaries are also party to a
tax allocation agreement, which is designed to provide PDV America with
sufficient cash to pay its consolidated income tax liabilities.
New Accounting Standards
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income". The
Company had no items of other comprehensive income during the three years ended
December 31, 1998.
In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS No. 131"), which is effective for the fiscal year
ending December 31, 1998. SFAS No. 131 modifies current segment reporting
requirements and establishes, for public companies, criteria for reporting
disclosures about a company's products and services, geographic areas and major
customers in annual and interim financial statements. The Company has determined
that its operations comprise a single reportable segment.
In February 1998, the FASB issued Statement of Financial
Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS No. 132") which is effective for the Company's
fiscal year ending December 31, 1998. The statement revises current employers'
disclosure requirements for pensions and other postretirement benefits. It does
not change the measurement or recognition of costs or liabilities associated
with those plans.
In June 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). The statement
27
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives, at
fair value, as either assets or liabilities in the statement of financial
position with an offset either to shareholder's equity and comprehensive income
or income depending upon the classification of the derivative. The Company has
not determined the impact on its financial statements that may result from
adoption of SFAS No. 133, which is required no later than January 1, 2000.
Year 2000 Readiness
General. The inability of computers, software and other
equipment using microprocessors to recognize and properly process data fields
containing a two-digit year is commonly referred to as the Year 2000 issue. As
the Year 2000 approaches, such systems may be unable to accurately process
certain date-based information.
To mitigate any adverse impact this may cause, the Companies
have established a company-wide Year 2000 Project ("Project") to address the
issue of computer programs and embedded computer chips which may be unable to
correctly function with the Year 2000. The Project is proceeding on schedule. In
addition, CITGO is updating major elements of their information systems by
implementing programs purchased from SAP. The first phase of SAP implementation,
which included the financial reporting and materials management systems, was
brought into production on January 1, 1998. Additional SAP modules including
plant maintenance work order and cost tracking were implemented throughout 1998.
The implementation will continue in 1999. The total cost of the SAP
implementation is estimated to be approximately $110 million, which includes
software, hardware, reengineering and change management. Management has
determined that SAP is an appropriate solution to the Year 2000 issue related to
the systems for which SAP is implemented. Such systems comprise approximately
80% of the Companies' total information systems. The implementation of SAP is 70
to 75% complete, and is on schedule and on budget as of December 31, 1998.
Remaining business software systems are expected to be made Year 2000 ready
through the Year 2000 Project or they will be replaced.
The Project. The Companies' Year 2000 Project Team is divided
into two groups. One group is working with Information Systems ("I.S.") and
Information Technology ("I.T.") related matters, while the other is analyzing
non-I.S. and non-I.T. business and asset integrity matters. A risk-based
approach toward Year 2000 readiness was applied to non-SAP systems and
processes, with most fix-or-replace decisions made by year-end 1998. The
strategy for achieving Year 2000 business and asset integrity is focused on
equipment, software and relationships that are critical to the Companies'
primary business operations, including refinery operations, terminal operations,
crude oil purchase and shipment operations, and refined product distribution
operations. The Companies engaged third party consultants to review and validate
the methodology and organization of the Project. The Project strategy involves a
number of phases: Inventory and Assessment of Critical Equipment, Software and
Relationships, Contingency Planning, Remediation, Testing and Readiness.
The Inventory and Assessment of Critical Equipment and
Software phase of the Project has been completed. The Inventory and Assessment
of business relationships with customers and suppliers to assure continuity of
purchases, sales and intercompany communications began in June 1998. The
Companies now require that all new contracts with vendors, suppliers or business
partners include a clause covering Year 2000 readiness. The Companies also seek
evidence of Year 2000 readiness from service providers prior to procuring new
services.
28
While the Project is systematically assessing the Year 2000
readiness of third party suppliers and customers, there can be no guarantee that
third parties of business importance to the Companies will successfully and
timely reprogram, replace or test all of their own computer hardware, software
and process control systems. The Companies have therefore chosen to continue
assessment and reevaluation of third party relationships beyond the deadline for
completion of other aspects of Inventory and Assessment phases of the Project.
Reviews of third party Year 2000 readiness will continue through 1999.
The Companies have also established a Year 2000 Contingency
Planning Team. The strategy for Contingency Planning includes a review and
analysis of existing contingency plans for the Companies' refineries, terminals,
pipelines and other operations, in light of potential Year 2000 issues
discovered in the Inventory and Assessment phases of the Project. The
Contingency Planning phase will also evaluate and implement changes to the
existing contingency plans. Contingency plans based on this process are
scheduled to be enacted in phases, with completion scheduled for June 30, 1999.
Additional planning is under way for the Remediation phase of the Project.
Remediation has begun and includes technical analysis, testing and, if
necessary, retrofitting or replacement of systems and equipment determined to be
incapable of reliable operations in the Year 2000. Target for completion of the
Remediation phase is August 1, 1999. The final phase of the Project, Readiness,
is being conducted concurrently with other Project phases. As systems,
equipment, processes and business relationships are determined and documented as
Year 2000 ready, Project resources are being shifted to pursue Readiness in
remaining areas of the enterprise.
The following is the Companies' definition of Year 2000
Readiness:
o Correctly and accurately handle date information before, during
and after midnight, December 31, 1999.
o Function correctly and accurately, and without disruption,
before, during and after January 1, 2000.
o Respond to two-digit year date input in a way that resolves
ambiguity as to the century in a disclosed, defined and
predetermined manner.
o Process all date data to reflect the year 2000 as a leap year.
o Correctly and accurately recognize and process any date with a
year specified as "99" and "00".
Costs. The estimated total cost of the Project is not more
than $28 million, down from an original estimate of $35 million. The reduction
is due to less than expected need for remediation of embedded systems and
refinements in expense estimates. This estimate does not include the Companies'
potential share of Year 2000 costs that may be incurred by partnerships and
joint ventures in which the Companies participate but are not the managing
partner or operator. The total amount expended through December 31, 1998 was
approximately $7.1 million. Approximately 65% of these expenditures were for
internal costs to conduct the company-wide Inventory and Assessment phases of
the Project. The remaining 35% of the cost was for consultants in the
specialized areas of Project Management,
29
Contingency Planning, Information Technology, Database Administration and
Operations Analysis, as well as fees paid to third parties for Quality
Assessment analysis of Project organization and methodology.
The costs of the Project are being funded with cash from
operations. No existing or planned I.T. projects have been deferred or delayed
due to Year 2000 readiness initiatives. The cost of implementing SAP replacement
systems is not included in these estimates.
The majority of estimated future costs for completing the
Project are anticipated to be directed toward the replacement and repair of
systems and equipment found to be incapable of reliable operation in the Year
2000. Estimates for replacement and repair costs will be refined over time as
the Remediation phase progresses.
Risks. The failure to correct a material Year 2000 problem
could result in an interruption, or failure of, certain normal business
activities or operations. Because the Companies are dependent, to a very
substantial degree, upon the proper functioning of their computer systems and
their interaction with third parties, including vendors and customers and their
computer systems, a failure of any of these systems to be Year 2000 compliant
could have a material adverse effect on the Companies. Failure of this kind
could, for example, cause disruption in the supply of crude oil, cause
disruption in refinery operations, cause disruption in the distribution of
refined products, lead to incomplete or inaccurate accounting, recording, or
processing of purchases of supplies or sales of refined products, or result in
generation of erroneous results. If not remedied, potential risks include
business interruption, financial loss, regulatory actions, reputational harm,
and legal liability. Such failures could adversely affect the Companies' results
of operations, liquidity and financial condition. Unlike other business
interruption scenarios, Year 2000 implications could include multiple,
simultaneous events which could result in unpredictable outcomes.
Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third party suppliers and customers, PDV America's management is unable to
determine at this time whether the consequences of Year 2000 failures will have
a material impact on the Companies' operations, liquidity or financial position.
The Project is expected to significantly reduce the Companies' level of
uncertainty about the Year 2000 impact. PDV America's management believes that,
with the implementation of new SAP business systems and completion of the
Project as scheduled, the possibility of significant interruptions of normal
operations should be minimized. See also "Factors Affecting Forward Looking
Statements".
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction. The Companies have exposure to price
fluctuations of crude oil and refined products as well as fluctuations in
interest rates. To manage these exposures, the Companies have defined certain
benchmarks consistent with their preferred risk profile for the environment in
which the Companies operate and finance their assets. The Companies do not
attempt to manage the price risk related to all of their inv