ITEM 3. LEGAL PROCEEDINGS
Various lawsuits and claims arising in the ordinary course of business are pending against the Company. The Company records accruals for potential losses when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to the
Company, and in amounts greater than the Company's accruals, then such determinations could have a material adverse effect on the Company's results of operations in a given reporting period. 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 Company. 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. In June 1998, the trial court granted the motions for summary judgment filed by CITGO and the other defendants; the Union has appealed this ruling.
In May 1997, an explosion and fire occurred at CITGO's Corpus Christi refinery. No serious personal injuries were reported. The Company 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 the Company 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 the Company. The remaining cases are not currently scheduled for trial. The Company 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 the Company 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, the Company offered to purchase about 275 properties in a neighborhood adjacent to the Company's Corpus Christi refinery, which were included in the lawsuit. Related to this offer, $15.7 million was expensed in 1997. To date, the Company 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 the Company's employment practices. Trials in this case are set to begin in the fall of 1999.
The Company 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 the Company 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 stages and no discovery has been conducted against the Company. The Company intends to deny all of the allegations and is pursuing its defenses.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
ITEM 5.
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 America, a Delaware corporation whose ultimate parent is PDVSA. In 1998, CITGO declared and paid dividends of $486 million to PDV America.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected historical consolidated financial and operating data of CITGO as of the end of and for each of the five years in the period ended December 31, 1998. The following table should be read in conjunction with the consolidated financial statements of CITGO 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 CITGO 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.
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(1) Includes operations of Cato Oil & Grease since May 1, 1995.
(2) Represents extraordinary gain (or charges) for the early extinguishment of debt (net of related income tax provision of $2 million and income tax benefit 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 Post-Employment 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 and capital lease obligations.
(6) Includes short-term bank loans, current portion of capital lease obligations and long-term debt, long-term debt and capital lease obligations.
ITEM 7.
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 CITGO should be read in conjunction with the consolidated financial statements of CITGO 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. CITGO's consolidated operating results are affected by these industry- specific factors and by company-specific factors, such as the success of marketing programs and refinery operations.
The earnings and cash flows of companies engaged in the refining and marketing business in the United States are primarily dependent upon producing and selling quantities of refined products at margins sufficient to cover fixed and variable costs. The refining and marketing business is characterized by high fixed costs resulting from the significant capital outlays associated with refineries, terminals and related facilities. This business is also characterized by substantial fluctuations in variable costs, particularly costs of crude oil, feedstocks and blending components, and in the prices realized for refined products. Crude oil and refined products are commodities whose price levels are determined by market forces beyond the control of CITGO.
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 increase or decrease in prices for refined products, generally there is a lag in the realization of the corresponding increase or decrease in prices for refined products. The effect of changes in crude oil prices on CITGO's consolidated operating results therefore depends in part on how quickly refined product prices adjust to reflect these changes. 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 supply agreements (expiring in the years 2006 through 2013). These 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% percent of the crude oil processed in refineries operated 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 the Company 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. CITGO'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 CITGO may experience substantial fluctuations.
Inflation was not a significant factor in the operations of CITGO during the three years ended December 31, 1998.
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 the Company'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 CITGO's sales revenues and volumes.
CITGO SALES REVENUES AND VOLUMES
The following table summarizes CITGO's cost of sales and operating expenses.
CITGO COST OF SALES AND OPERATING EXPENSES
RESULTS OF OPERATIONS -- 1998 COMPARED TO 1997
Sales revenues and volumes. Sales decreased by $2,679 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 11%. (See CITGO Sales Revenue and Volumes table above.)
Equity in earnings (losses) of affiliates. Equity in earnings of affiliates increased by approximately $13 million, or 20% from $64 million in 1997 to $77 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 CITGO -- Note 3 in Item 14a).
Cost of sales and operating expenses. Cost of sales and operating expenses decreased by $2,680 million, or 21% from 1997 to 1998. (See CITGO Cost of Sales and Operating Expenses table above.)
CITGO purchases refined products to supplement the production from its refineries to meet marketing demands and resolve logistical issues. The refined product purchases represented 59% of cost of sales for the years 1998 and 1997. These refined product purchases included purchases from LYONDELL-CITGO, PDVMR, Chalmette and HOVENSA. CITGO estimates that margins on purchased products, on average, are lower than margins on produced products due to the fact that CITGO can only receive the marketing portion of the total margin received on the produced refined products. However, purchased products are not segregated from CITGO produced products and margins may vary due to market conditions and other factors beyond the Company's control. As such, it is difficult to measure the effects on profitability of changes in volumes of purchased products. CITGO anticipates its purchased product requirements will continue to 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, CITGO does not anticipate operational actions or market conditions which might cause a material change in anticipated purchased product requirements; however, there could be events beyond the control of CITGO which impact the volume of refined products purchased. See also "Factors Affecting Forward Looking Statements".
Gross margin. The gross margin in 1998 was $572 million, which is essentially unchanged from 1997. This occurred because a sales volume increase of approximately 11% was sufficient to offset the 9% erosion of gross margin on a per gallon basis which includes a lower of cost or market adjustment of $159 million.
Selling, general and administrative expenses. Selling, general and administrative expenses increased $42 million, or 21% 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 $25.6 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. 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. CITGO's provision for income taxes in 1998 was $103 million, representing an effective tax rate of 35%. In 1997, CITGO's provision for income taxes was $91 million, representing an effective tax rate of 31%. 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 $639 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 CITGO Sales Revenue and Volumes table above.)
Equity in earnings (losses) of affiliates. Equity in earnings of affiliates increased by approximately $43 million, or 205% from $21 million in 1996 to $64 million in 1997. This increase was due primarily to a $43 million increase in CITGO's equity earnings of LYONDELL-CITGO. This increase 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 (See Consolidated Financial Statements of CITGO -- Note 3 in Item 14a).
Other income (expense). Other income (expense) was $(10.5) million for the year ended December 31, 1997 as compared to $(4.2) 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 million 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, a $3.1 million net management fee charged to PDVMR over the year 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 $529 million, or 4% from 1996 to 1997. (See CITGO Cost of Sales and Operating Expenses table above.)
CITGO purchases refined products to supplement the production from its refineries to meet marketing demands and resolve logistical issues. The refined product purchases represented 59% and 57% of cost of sales for the years 1997 and 1996, respectively. These refined product purchases included purchases from LYONDELL-CITGO, PDVMR and Chalmette.
Gross margin. The gross margin for 1997 was $571 million, or 4.2%, 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.
Selling, general and administrative expenses. Selling, general and administrative expenses increased $35 million, or 21%, due primarily to increased selling expenses in 1997 including the effect of the change in focus of the Company's 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.
Interest expense. Interest expense increased $11.5 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.
Income taxes. CITGO's provision for income taxes in 1997 was $91 million, representing an effective tax rate of 31%. In 1996, CITGO's provision for income taxes was $70 million, representing an effective tax rate of 36%. The decrease is 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.
LIQUIDITY AND CAPITAL RESOURCES
For the year ended December 31, 1998, CITGO's net cash provided by operating activities totaled approximately $583 million, primarily reflecting $194 million of net income, $222 million of depreciation and amortization, a lower of cost or market adjustment to inventory of $159 million and the net effect of other items of $8 million. The more significant changes in other items included the decrease in accounts receivable, including receivables from affiliates, of approximately $94 million, the decrease in accounts payable and other current liabilities, including payables to affiliates, of approximately $126 million and the increase of other assets of approximately $52 million.
Net cash used in investing activities in 1998 totaled $215 million consisting primarily of capital expenditures of $200 million and a loan to LYONDELL-CITGO of $19.8 million.
During the same period, consolidated net cash used in financing activities totaled approximately $363 million comprised primarily of $486 million of dividends offset by net additional borrowings of $73 million and a $50 million capital contribution from PDV America.
CITGO currently estimates that its capital expenditures for the years 1999 through 2003 will total approximately $1.5 billion. These include:
CITGO ESTIMATED CAPITAL EXPENDITURES -- 1999 THROUGH 2003(1)
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(1) These estimates may change as future regulatory events unfold. See "Factors Affecting Forward Looking Statements".
As of December 31, 1998, the Company and its subsidiaries 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 Company's contractual commitments to make principal payments on this indebtedness were $84.1 million, $47.1 million and $47.1 million for 1999, 2000 and 2001, respectively. The Company'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 $21.4 million was outstanding at December 31, 1998. The Company's other principal indebtedness consists of (i) $199.7 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 CITGO -- Note 9 and 10 in Item 14a.)
As of December 31, 1998, capital resources available to CITGO included cash provided by operations, available borrowing capacity of $385 million under CITGO's revolving credit facility and $138 million in unused availability under uncommitted short-term borrowing facilities 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. CITGO believes that it has sufficient capital resources to carry out planned capital spending programs, including regulatory and environmental projects in the near term, and to meet currently anticipated future obligations as they arise. CITGO periodically evaluates other sources of capital in the marketplace and anticipates long-term capital requirements will be satisfied with current capital resources and future financing arrangements, including the issuance of debt securities. The Company's ability to obtain such financing will depend on numerous factors, including market conditions and the perceived creditworthiness of the Company at that time. See "Factors Affecting Forward Looking Statements".
CITGO's debt instruments impose restrictions on CITGO's ability to incur additional debt, place liens on property, sell or acquire fixed assets, and make restricted payments, including dividends.
CITGO is a member of the PDV America consolidated Federal income tax return. CITGO has a tax allocation agreement with PDV America, which is designed to provide PDV America with sufficient cash to pay its consolidated income tax liabilities. (See Consolidated Financial Statements of CITGO -- Note 1 and Note 4 in Item 14a).
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 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, CITGO has 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 its 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 percent of CITGO's total information systems. The implementation of SAP is 70 to 75 percent 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. CITGO's 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./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 Company's primary business operations, including refinery operations, terminal operations, crude oil purchase and shipment operations, and refined product distribution operations. The Company 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 inter-company communications began in June 1998. CITGO now requires that all new contracts with vendors, suppliers, or business partners include a clause covering Year 2000 readiness. CITGO also seeks evidence of Year 2000 readiness from service providers prior to procuring new services.
While the CITGO 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 Company will successfully and timely reprogram, replace, or test all of their own computer hardware, software and process control systems. CITGO has 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.
CITGO has also established a Year 2000 Contingency Planning Team. The strategy for Contingency Planning includes a review and analysis of existing contingency plans for CITGO 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 underway 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 CITGO's definition of Year 2000 Readiness:
- Correctly and accurately handle date information before, during and after midnight, December 31, 1999.
- Function correctly and accurately, and without disruption, before, during and after January 1, 2000.
- Respond to two-digit year date input in a way that resolves ambiguity as to the century in a disclosed, defined and predetermined manner.
- Process all date data to reflect the year 2000 as a leap year.
- 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 $25 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 CITGO's potential share of Year 2000 costs that may be incurred by partnerships and joint ventures in which CITGO participates but is not the managing partner or operator. The total amount expended through December 31, 1998 was approximately $5.9 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, 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 Company is dependent, to a very substantial degree, upon the proper functioning of its computer systems and its 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 Company. 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 CITGO's 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, CITGO management is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's operations, liquidity or financial position. The Project is expected to significantly reduce the Company's level of uncertainty about the Year 2000 impact. CITGO 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 7 A.
ITEM 7 A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction. CITGO has exposure to price fluctuations of crude oil and refined products as well as fluctuations in interest rates. To manage these exposures, management has defined certain benchmarks consistent with its preferred risk profile for the environment in which the Company operates and finances its assets. CITGO does not attempt to manage the price risk related to all of its inventories of crude oil and refined products. As a result, at December 31, 1998, CITGO was exposed to the risk of broad market price declines with respect to a substantial portion of its crude oil and refined product inventories. The following disclosures do not attempt to quantify the price risk associated with such commodity inventories.
Commodity Instruments. CITGO balances its crude oil and petroleum product supply/demand and manages a portion of its price risk by entering into petroleum futures contracts, options and other over-the-counter commodity derivatives. Generally, CITGO's risk management strategies qualify as hedges. However, certain strategies do not qualify as hedges. CITGO may take commodity positions based on its views or expectations of specific commodity prices or price differentials between commodity types.
NON TRADING COMMODITY DERIVATIVES OPEN POSITIONS AT DECEMBER 31, 1998
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(1) 1,000 barrels per contract
(2) Weighted average price
Debt Related Instruments. CITGO has fixed and floating U.S. currency denominated debt. CITGO uses interest rate swaps to manage its debt portfolio toward a benchmark of 40 to 60 percent fixed rate debt to total fixed and floating rate debt. These instruments have the effect of changing the interest rate with the objective of minimizing CITGO's long-term costs. At December 31, 1998, CITGO's primary exposures were to U.S. dollar LIBOR and U.S. Treasury rates.
For interest rate swaps, the table below presents notional amounts and interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contracts.
NON TRADING INTEREST RATE DERIVATIVES OPEN POSITIONS AT DECEMBER 31, 1998
For debt obligations, the table below presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date.
LONG-TERM DEBT AT DECEMBER 31, 1998
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Independent Auditors' Report are included in Item 14a of this report. The Quarterly results of Operations are reported in Note 16 of the Notes to Consolidated Financial Statements included in Item 14a.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The registrant meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K and is therefore omitting certain information otherwise required by Item 10 of Form 10-K relating to Directors and Executive Officers as permitted by General Instruction (I)(2)(c).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The registrant meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K and is therefore omitting certain information otherwise required by Item 11 of Form 10-K relating to executive compensation as permitted by General Instruction (I)(2)(c).
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Not applicable.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain members of the Board of Directors of CITGO are also directors or executive officers of PDVSA.
CITGO has entered into several transactions with PDVSA or other affiliates of PDVSA, including crude oil and feedstock supply agreements, agreements for the purchase of refined products and transportation agreements. These crude oil supply agreements require PDVSA to supply minimum quantities of crude oil and other feedstocks to CITGO for a fixed period, usually 20 to 25 years. The supply agreements differ somewhat for each entity and each CITGO refinery but generally incorporate formula prices based on the market value of a slate of refined products deemed to be produced for each particular grade of crude oil or feedstock, less (i) certain deemed refining costs; (ii) certain actual costs, including transportation charges, import duties and taxes; and (iii) a deemed margin, which varies according to the grade of crude oil or feedstock delivered. Under each supply agreement, deemed margins and deemed costs are adjusted periodically by a formula primarily based on the rate of inflation. Because deemed operating costs and the slate of refined products deemed to be produced for a given barrel of crude oil or other feedstock do not necessarily reflect the actual costs and yields in any period, the actual refining margin earned by a purchaser under the various supply agreements will vary depending on, among other things the efficiency with which such purchaser conducts its operations during such period. These supply agreements are designed to reduce the inherent earnings volatility of the refining operations of CITGO. Prior to 1995, certain costs were used in the CITGO supply agreement formulas, aggregating approximately $70 million per year, which were to cease being deductible after 1996. Commencing in the third quarter of 1995, a portion of such deductions were deferred from 1995 and 1996 to the years 1997 through 1999. In 1998, the effect of the adjustments to the original modifications was to reduce the price of crude oil purchased from PDVSA by approximately $25 million. The Company anticipates that the effect of the adjustments to the original modifications will be to reduce the price of crude oil purchased from PDVSA under these agreements by approximately $25 million in 1999, as compared to the original modification and without giving effect to any other factors that may affect the price payable for crude oil under these agreements. Due to the pricing formula under the supply agreements, the aggregate price actually paid for crude oil purchased from PDVSA under these agreements depends primarily upon the current prices for refined products and certain actual costs of CITGO. This estimate is based on the assumption that CITGO will purchase the base volumes of crude oil under the agreements. See also "Factors Affecting Forward Looking Statements".
LYONDELL-CITGO owns and operates a 265 MBPD refinery in Houston, Texas. LYONDELL-CITGO was formed in 1993 by subsidiaries of CITGO and Lyondell, referred to as the owners. CITGO contributed cash during the years 1993 through 1997 for a participation interest and other commitments related to LYONDELL-CITGO's refinery enhancement project, and Lyondell contributed the Houston refinery and related assets for the remaining participation interest. The refinery enhancement project to
increase the refinery's heavy crude oil high conversion capacity was substantially completed at the end of 1996 with an in-service date of March 1, 1997. The heavy crude oil processed by the Houston refinery is supplied by PDVSA under a long-term crude oil supply agreement through the year 2017, and CITGO purchases substantially all of the refined products produced at the Houston refinery under a long-term contract (See Consolidated Financial Statements of CITGO -- Notes 3 and 4 in Item 14a).
Under such long-term supply agreements and refined product purchase agreements, CITGO and LYONDELL-CITGO purchased approximately $1.4 billion and $0.5 billion respectively, of crude oil, feedstocks and refined products at market related prices from PDVSA in 1998. At December 31, 1998, $74 million was included in CITGO's current payable to affiliates as a result of its transactions with PDVSA.
CITGO's participation interest in LYONDELL-CITGO was approximately 41% at December 31, 1998, in accordance with agreements between the owners concerning such interest. CITGO has a one-time option exercisable after January 1, 2000 but before September 30, 2000, to increase, for an additional investment, its participation interest to 50%.
CITGO loaned $19.8 million and $16.5 million to LYONDELL-CITGO during 1998 and 1997, respectively. The notes bear interest at market rates which were approximately 5.9% at December 31, 1998 and 1997, and are due July 1, 2003. These notes are included in other assets at December 31, 1998 and 1997.
CITGO accounts for its investment in LYONDELL-CITGO using the equity method of accounting and records its share of the net earnings of LYONDELL-CITGO based on allocations of income agreed to by the owners.
On May 1, 1997, PDV America and Union Oil Company of California ("Unocal") closed a transaction relating to The UNO-VEN Company ("UNO-VEN"). The transaction transferred certain assets and liabilities to PDVMR, a subsidiary of PDV America, in liquidation of PDV America's 50% ownership interest in UNO-VEN. The assets include a refinery in Lemont, Illinois, as well as product distribution terminals and retail sites located in the Midwest. CITGO operates these facilities and purchases the products produced at the refinery (See Consolidated Financial Statements of CITGO -- Note 2 in Item 14a). A portion of the crude oil processed by PDVMR is supplied by PDVSA under a long-term crude supply contract.
An affiliate of PDVSA acquired a 50 percent equity interest in 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 (See Consolidated Financial Statements of CITGO -- Note 2 in Item 14a). 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 percent equity interest in HOVENSA and has the right under a product sales agreement to assign periodically to CITGO, or other related parties, its option to purchase 50% of the refined products produced by HOVENSA (less a certain portion of such products that HOVENSA will market directly in the local and Caribbean markets). In addition, under the product sales agreement, the PDVSA affiliate has appointed CITGO as its agent in designating which of its affiliates shall from time to time take deliveries of the refined products available to it. The product sales agreement will be in effect for the life of the joint venture, subject to termination events based on default or mutual agreement (See Consolidated Financial Statements of CITGO -- Note 2 in Item 14a). 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.
The purchase agreements with LYONDELL-CITGO, PDVMR, Chalmette and HOVENSA incorporate various formula prices based on published market prices and other factors. Such purchases totaled $2.9 billion for 1998. At December 31, 1998, $64 million was included in payables to affiliates as a result of these transactions.
CITGO had refined product, feedstock, crude oil and other product sales of $164 million to affiliates, including LYONDELL-CITGO and MVPPP, in 1998. At December 31, 1998, $34 million was included in Due from affiliates as a result of these transactions.
CITGO has guaranteed approximately $99 million of debt of certain affiliates, including $50 million related to HOVENSA and $11 million related to Nelson Industrial Steam Company. (See Consolidated Financial Statements of CITGO -- Note 13 in Item 14a.)
Under a separate guarantee of rent agreement, PDVSA has guaranteed payment of rent, stipulated loss value and termination value due under the lease of the Corpus Christi Refinery West Plant facilities. (See Consolidated Financial Statements of CITGO -- Note 14 in Item 14a.)
The Company and PDV America are parties to a tax allocation agreement that is designed to provide PDV America with sufficient cash to pay its consolidated income tax liabilities. In 1996, $12.7 million due from CITGO to PDV America under this tax allocation agreement for the tax years 1992 through 1994 was reclassified as a noncash contribution of capital. In December 1996, $0.8 million due from PDV America to CITGO under this tax allocation agreement for the 1995 tax year was reclassified as a noncash dividend. In 1997, $10 million due from PDV America under this tax allocation agreement for the 1996 tax year was classified as a noncash dividend. In 1998, $7.6 million due from CITGO to PDV America under this agreement for the 1997 tax year was classified as a noncash contribution of capital. In the event that CITGO should cease to be part of the consolidated federal income tax return, any amounts included in shareholder's equity under this agreement are required to be paid to PDV America. At December 31, 1998, CITGO has income taxes receivable of $12 million included in prepaid expenses and a $5 million receivable from PDV America included in due from affiliates.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
A. CERTAIN DOCUMENTS FILED AS PART OF THIS REPORT
(1) Financial Statements:
(2) Exhibits:
The Exhibit Index in part c. below lists the exhibits that are filed as part of, or incorporated by reference into, this report.
B. REPORTS ON FORM 8-K
None
C. EXHIBITS
- ---------------
* Previously filed in connection with the Registrant's Report on Form 10, Registration No. 333-3226.
** Incorporated by reference to the Registration Statement on Form of PDV America, Inc. (No. 33-63742).
*** Incorporated by reference to the Registrant's Report on Form 8-K filed with the Commission on November 18, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CITGO PETROLEUM CORPORATION
/s/ R. M. BRIGHT
------------------------------------ R. M. Bright Controller (Chief Accounting Officer)
Date: March 17, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
CITGO PETROLEUM CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997, AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 AND INDEPENDENT AUDITORS' REPORT
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholder of CITGO Petroleum Corporation:
We have audited the accompanying consolidated balance sheets of CITGO Petroleum Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CITGO Petroleum Corporation and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Tulsa, Oklahoma February 5, 1999
CITGO PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
ASSETS
See notes to consolidated financial statements.
CITGO PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF INCOME EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
CITGO PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (AMOUNTS IN THOUSANDS)
See notes to consolidated financial statements.
CITGO PETROLEUM CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
1. SIGNIFICANT ACCOUNTING POLICIES
Description of Business -- CITGO Petroleum Corporation ("CITGO" or the "Company") is a subsidiary of PDV America, Inc. ("PDV America" or the "Parent"), an indirect wholly owned subsidiary of Petroleos de Venezuela, S.A. ("PDVSA"), the national oil company of the Republic of Venezuela.
CITGO manufactures or refines and markets quality transportation fuels as well as lubricants, refined waxes, petrochemicals, asphalt and other industrial products. CITGO owns and operates two modern, highly complex crude oil refineries (Lake Charles, Louisiana, and Corpus Christi, Texas) and two asphalt refineries (Paulsboro, New Jersey, and Savannah, Georgia) with a combined aggregate rated crude oil refining capacity of 582 thousand barrels per day ("MBPD"). CITGO also owns a minority interest in LYONDELL-CITGO Refining LP, a limited partnership (formerly a limited liability company) that owns and operates a refinery in Houston, Texas, with a rated crude oil refining capacity of 265 MBPD. CITGO also operates a 153 MBPD refinery in Lemont, Illinois, owned by PDV Midwest Refining L.L.C. CITGO's consolidated financial statements also include accounts relating to a 65 percent owned lubricant and wax plant, pipelines, and equity interests in pipeline companies and petroleum storage terminals.
CITGO's transportation fuel customers include primarily CITGO branded wholesale marketers, convenience stores and airlines located mainly east of the Rocky Mountains. Asphalt is generally marketed to independent paving contractors on the East 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.
Principles of Consolidation -- The consolidated financial statements include the accounts of CITGO and its subsidiaries (collectively referred to as the "Company"). All subsidiaries are wholly owned except for Cit-Con Oil Corporation ("Cit-Con"), which is 65 percent owned. All material intercompany transactions and accounts have been eliminated.
The Company's investments in less than majority-owned affiliates are accounted for by the equity method. The excess of the carrying value of the investments over the equity in the underlying net assets of the affiliates is amortized on a straight-line basis over 40 years, which is based upon the estimated useful lives of the affiliates' assets.
Estimates, Risks and Uncertainties -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CITGO's operations can be influenced by domestic and international political, legislative, regulatory and legal environments. In addition, significant changes in the prices or availability of crude oil and refined products could have a significant impact on CITGO's results of operations for any particular year.
Impairment of Long-Lived Assets -- The Company periodically evaluates the carrying value of long-lived assets to be held and used when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the separately identifiable anticipated undiscounted cash flow from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for disposal costs.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition -- Revenue from sales of products is recognized upon transfer of title, based upon the terms of delivery.
Supply and Marketing Activities -- The Company engages in the buying and selling of crude oil to supply its refineries. The net results of this activity are recorded in cost of sales. The Company also engages in the buying and selling of refined products to facilitate the marketing of its refined products. The results of this activity are recorded in cost of sales and sales.
Refined product exchange transactions that do not involve the payment or receipt of cash are not accounted for as purchases or sales. Any resulting volumetric exchange balances are accounted for as inventory in accordance with the Company's last-in, first-out ("LIFO") inventory method. Exchanges that are settled through payment or receipt of cash are accounted for as purchases or sales.
Excise Taxes -- The Company collects excise taxes on sales of gasoline and other motor fuels. Excise taxes of approximately $3 billion, $3.2 billion, and $2.7 billion were collected from customers and paid to various governmental entities in 1998, 1997, and 1996, respectively. Excise taxes are not included in sales.
Cash and Cash Equivalents -- Cash and cash equivalents consist of highly-liquid short-term investments and bank deposits with initial maturities of three months or less.
Restricted Cash -- Restricted cash represents highly-liquid, short-term investments held in trust accounts in accordance with a tax-exempt bond agreement. Funds are released solely for financing construction of environmental facilities as defined in the bond agreements.
Inventories -- Crude oil and refined product inventories are stated at the lower of cost or market and cost is determined using the LIFO method. Materials and supplies are valued using the average cost method.
Property, Plant and Equipment -- Property, plant and equipment is reported at cost, less accumulated depreciation. Depreciation is based upon the estimated useful lives of the related assets using the straight-line method. Depreciable lives are generally as follows: buildings and leaseholds -- 10 to 24 years; machinery and equipment -- 5 to 24 years; and vehicles -- 3 to 10 years.
Upon disposal or retirement of property, plant and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in income.
The Company capitalizes interest on projects when construction entails major expenditures over extended time periods. Such interest is allocated to property, plant and equipment and amortized over the estimated useful lives of the related assets. Interest capitalized totaled $5 million, $7 million, and $12 million during 1998, 1997, and 1996, respectively.
Commodity and Interest Rate Derivatives -- The Company uses commodity and financial instrument derivatives to manage defined commodity price and interest rate risks arising out of the Company's core business activities. The Company has only limited involvement with other derivative financial instruments and does not use them for trading purposes.
The Company enters into petroleum futures contracts, options and other over the counter commodity derivatives, primarily to hedge a portion of the price risk associated with crude oil and refined products. In order for a transaction to qualify for hedge accounting, the Company requires that the item to be hedged exposes the Company to price risk and that the commodity contract reduces that risk and is designated as a hedge. The high correlation between price movements of a product and the commodity contract in that product is well demonstrated in the petroleum industry and, generally, the Company relies on those historical relationships and on periodic comparisons of market price changes to price changes of futures and options contracts accounted for as hedges. Gains or losses on contracts, which qualify as hedges, are recognized when the related inventory is sold or the hedged transaction is consummated. Changes in the market value of commodity derivatives, which are not hedges, are recorded as gains or losses in the period in which they occur.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also enters into various interest rate swap and cap agreements to manage its risk related to interest rate changes on its debt. Premiums paid for purchased interest rate swap and cap agreements are amortized to interest expense over the terms of the agreements. Unamortized premiums are included in other assets. The interest rate differentials received or paid by the Company related to these agreements are recognized as adjustments to interest expense over the term of the agreements. Gains or losses on terminated swap agreements are either amortized over the original term of the swap agreement if the hedged borrowings remain in place, or are recognized immediately if the hedged borrowings are no longer held.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). The statement 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.
Refinery Maintenance -- Costs of major refinery turnaround maintenance are charged to operations over the estimated period between turnarounds. Turnaround periods range approximately from one to seven years. Unamortized costs are included in other assets. Amortization of refinery turnaround costs is included in depreciation and amortization expense. Amortization was $47 million, $49 million, and $53 million for 1998, 1997, and 1996, respectively. Ordinary maintenance is expensed as incurred.
Environmental Expenditures -- Environmental expenditures that relate to current or future revenues are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations and do not contribute to current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or cleanups are probable and the costs can be reasonably estimated. Environmental liabilities are not discounted to their present value. Subsequent adjustments to estimates, to the extent required, may be made as more refined information becomes available.
Income Taxes -- The Company is included in the consolidated U.S. Federal income tax return filed by PDV America. The Company's current and deferred income tax expense has been computed on a stand-alone basis using an asset and liability approach.
Comprehensive Income -- 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.
Reclassifications -- Certain reclassifications have been made to the 1997 financial statements to conform with the classifications used in 1998.
2. REFINERY AGREEMENTS
Effective May 1, 1997, CITGO became the operator of a refinery owned by PDV Midwest Refining, L.L.C. ("PDVMR"), a subsidiary of PDV America. CITGO also purchases the products produced at the refinery (Note 4).
An affiliate of PDVSA acquired a 50 percent 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 (Note 4). 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.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In October, 1998 an affiliate of PDVSA acquired a 50 percent equity interest in a joint venture that owns and operates a refinery in St. Croix, U.S. Virgin Islands ("HOVENSA") and has the right under a product sales agreement to assign periodically to CITGO, or other related parties, its option to purchase 50% of the refined products produced by HOVENSA (less a certain portion of such products that HOVENSA will market directly in the local and Caribbean markets). In addition, under the product sales agreement, the PDVSA affiliate has appointed CITGO as its agent in designating which of its affiliates shall from time to time take deliveries of the refined products available to it. The product sales agreement will be in effect for the life of the joint venture, subject to termination events based on default or mutual agreement (Note 4). Pursuant to the above arrangement, CITGO began acquiring approximately 120 MBPD of refined products from HOVENSA on November 1, 1998, approximately one-half of which was gasoline.
3. INVESTMENT IN LYONDELL-CITGO REFINING LP
LYONDELL-CITGO Refining LP ("LYONDELL-CITGO") owns and operates a 265 MBPD refinery in Houston, Texas. LYONDELL-CITGO was formed in 1993 by subsidiaries of CITGO and Lyondell Chemical Company ("Lyondell"), referred to as the owners. CITGO contributed cash for a participation interest and other commitments related to LYONDELL-CITGO's refinery enhancement project and Lyondell contributed the Houston refinery and related assets for the remaining participation interest. The refinery enhancement project to increase the refinery's heavy crude oil high conversion capacity was substantially completed at the end of 1996 with an in-service date of March 1, 1997. The heavy crude oil processed by the Houston refinery is supplied by a subsidiary of PDVSA under a long-term crude oil supply contract that expires in 2017, and CITGO purchases substantially all of the refined products produced at the Houston refinery under a long-term contract (Note 4).
CITGO's participation interest in LYONDELL-CITGO increased from 13% at December 31, 1996 to approximately 42% on April 1, 1997, in accordance with agreements between the owners concerning such interest. CITGO has a one-time option to increase, for an additional investment, its participation interest to 50 percent. This option may be exercised after January 1, 2000 but not later than September 30, 2000.
CITGO loaned $19.8 million and $16.5 million to LYONDELL-CITGO during 1998 and 1997, respectively. The notes bear interest at market rates which were approximately 5.9% at December 31, 1998 and 1997, and are due July 1, 2003. These notes are included in other assets in the accompanying consolidated balance sheets.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CITGO accounts for its investment in LYONDELL-CITGO using the equity method of accounting and records its share of the net earnings of LYONDELL-CITGO based on allocations of income agreed to by the owners. Information on CITGO's investment in LYONDELL-CITGO follows:
4. RELATED PARTY TRANSACTIONS
The Company purchases approximately two-thirds of the crude oil processed in its refineries from subsidiaries of PDVSA under long-term supply agreements. These supply agreements extend through the year 2006 for the Lake Charles refinery, 2010 for the Paulsboro refinery, 2012 for the Corpus Christi refinery and 2013 for the Savannah refinery. The Company purchased $1.4 billion, $2 billion, and $2.4 billion of crude oil, feedstocks and other products from wholly owned subsidiaries of PDVSA in 1998, 1997, and 1996, respectively, under these and other purchase agreements. The crude supply contracts include force majeure clauses that have been exercised on various 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.
The crude oil supply contracts incorporate formula prices based on the market value of a number of refined products deemed to be produced from each particular crude oil, less (i) certain deemed refining costs adjustable for inflation, (ii) certain actual costs, including transportation charges, import duties and taxes and (iii) a deemed margin, which varies according to the grade of crude oil. At December 31, 1998 and 1997, $74 million and $138 million, respectively, were included in payables to affiliates as a result of these transactions.
The Company also purchases refined products from various other affiliates including LYONDELL-CITGO, PDVMR, HOVENSA and Chalmette, under long-term contracts. These agreements incorporate various formula prices based on published market prices and other factors. Such purchases totaled $2.9 billion, $2.8 billion, and $1.6 billion for 1998, 1997, and 1996, respectively. At December 31, 1998 and 1997, $64 million and $59 million, respectively, were included in payables to affiliates as a result of these transactions.
The Company had refined product, feedstock, and other product sales to affiliates of $164 million, $221 million, and $190 million, in 1998, 1997, and 1996, respectively. The Company's sales of crude oil to affiliates were $18 million, $3 million, and $64 million in 1998, 1997, and 1996, respectively. At December 31,
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 and 1997, $34 million and $23 million, respectively, were included in due from affiliates as a result of these and related transactions.
Pursuant to the PDVMR operating agreement (Note 2), on May 1, 1997, CITGO became the operator of the PDVMR refinery and employed a substantial number of employees previously employed by UNO-VEN and as a result, CITGO assumed a liability for postretirement benefits other than pensions (Note 11) of approximately $27 million related to those employees. A corresponding amount due from PDVMR is included in other assets at December 31, 1998 and 1997, pending final determination of the method of settlement by the Parent company. CITGO charges PDVMR a management fee which covers various support services ($8 million and $7 million in 1998 and 1997, respectively) which is included in other income. PDVMR reimburses CITGO for all payroll expenses, including pension and benefit costs, related to CITGO employees engaged in the operation of the refinery. Such employee costs and the related reimbursements ($52 million and $36 million in 1998 and 1997, respectively) are not included in CITGO's cost of sales or revenues.
Under a separate guarantee of rent agreement, PDVSA has guaranteed payment of rent, stipulated loss value and terminating value due under the lease of the Corpus Christi refinery facilities described in Note 14. The Company has also guaranteed debt of certain affiliates (Note 13).
The Company and PDV America are parties to a tax allocation agreement that is designed to provide PDV America with sufficient cash to pay its consolidated income tax liabilities. In 1996, $12.7 million due from CITGO to PDV America under this tax allocation agreement for the tax years 1992 through 1994 was reclassified as a noncash contribution of capital. In December 1996, $0.8 million due from PDV America to CITGO under this tax allocation agreement for the 1995 tax year was reclassified as a noncash dividend. In 1997, $10 million due from PDV America under this tax allocation agreement for the 1996 tax year was classified as a noncash dividend. In 1998, $7.6 million due from CITGO to PDV America under this agreement for the 1997 tax year was classified as a noncash contribution of capital. In the event that CITGO should cease to be part of the consolidated federal income tax return, any amounts included in shareholder's equity under this agreement are required to be paid to PDV America. At December 31, 1998, CITGO has income taxes receivable of $12 million included in prepaid expenses and a $5 million receivable from PDV America included in due from affiliates. At December 31, 1997, amounts payable to PDV America of $9.7 million are included in other current liabilities.
5. ACCOUNTS RECEIVABLE
Sales are made on account, based on pre-approved unsecured credit terms established by CITGO management, except sales to airlines, which are made primarily on a prepaid basis. The Company also has a proprietary credit card program and a Companion VISA bankcard program which allow retail consumers to purchase fuel and convenience items at CITGO branded outlets. Allowances for uncollectible accounts are established based on several factors that include, but are not limited to, analysis of specific customers, historical trends, current economic conditions and other information.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective June 27, 1997, and November 19, 1997, the Company established two new limited purpose subsidiaries, CITGO Funding Corporation and CITGO Funding Corporation II, which entered into non-recourse agreements to sell trade accounts and credit card receivables. Under the terms of the agreements, new receivables are added to the pool as collections reduce previously sold receivables. The amounts sold at any one time are limited to a maximum of $125 million of trade accounts receivable and $150 million of credit card receivables. These agreements are renewable for successive one-year terms by mutual agreement. Both agreements were renewed during 1998. Fees and expenses of $16.1 million and $5.8 million related to the agreements were recorded as other expense during the years ended December 31, 1998 and 1997, respectively. Proceeds of approximately $275 million from the initial sales in 1997 were used primarily to make payments on the Company's revolving bank loan.
6. INVENTORIES
Inventories at December 31, 1998, are carried at estimated net market value and results of operations for 1998 include a charge of $159 million representing the excess of cost over net market value. At December 31, 1997, replacement costs approximated LIFO carrying values.
7. PROPERTY, PLANT AND EQUIPMENT
Depreciation expense for 1998, 1997, and 1996 was $176 million, $161 million, and $136 million, respectively.
In 1997 the Company incurred property damages from a fire at the Company's Corpus Christi, Texas, refinery (Note 13). As a result, the Company capitalized $14.5 million of replacement machinery and equipment in 1997. Other income (expense) for the year ended December 31, 1997 includes $9.4 million of gains from insurance recoveries related to this event.
Other income (expense) includes gains and losses on disposals and retirements of property, plant and equipment. Such net losses were approximately $2 million, $14 million, and $2 million in 1998, 1997, and 1996, respectively.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INVESTMENTS IN AFFILIATES
In addition to LYONDELL-CITGO, the Company's investments in affiliates consist of equity interests of 6.8 to 50 percent in joint interest pipelines and terminals, including a 13.98 percent interest in Colonial Pipeline Company; a 49.5 percent partnership interest in Nelson Industrial Steam Company ("NISCO"), which is a qualified cogeneration facility; and a 49 percent partnership interest in Mount Vernon Phenol Plant. The carrying value of these investments exceeded the Company's equity in the underlying net assets by approximately $151 million and $155 million at December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997, NISCO had a partnership deficit. CITGO's share of this deficit, as a general partner, was $56.5 million and $49.6 million at December 31, 1998 and 1997, respectively, which is included in other noncurrent liabilities in the accompanying consolidated balance sheets.
Information on the Company's investments, including LYONDELL-CITGO, follows:
Selected financial information for the affiliates is summarized as follows:
9. SHORT-TERM BANK LOANS
As of December 31, 1998, the Company has established $175 million of uncommitted, unsecured, short-term borrowing facilities with various banks. Interest rates on these facilities are determined daily based upon the Federal funds' interest rates, and maturity options vary up to 30 days. The weighted average interest rates actually incurred in 1998, 1997, and 1996 were 5.8 percent, 5.9 percent, and 5.7 percent, respectively. The Company had $37 million and $3 million of borrowings outstanding under these facilities at December 31, 1998 and 1997, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. LONG-TERM DEBT
Revolving and Term Bank Loans -- On May 13, 1998 the Company terminated its $675 million revolving bank loan and replaced it with a credit agreement with various banks consisting of (i) a $400 million, five year, revolving bank loan and (ii) a $150 million, 364 day, revolving bank loan, both of which are unsecured and have various borrowing maturities and interest rate options. Interest rates on the revolving bank loans were 7.5 percent and 6.9 percent at December 31, 1998 and 1997, respectively.
On September 3, 1998 the Company terminated its term bank loan.
CITGO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shelf Registration -- In April 1996, the Company filed a registration statement with the Securities and Exchange Commission relating to the shelf registration of $600 million of debt securities that may be offered and sold from time to time. In May 1996, the registration became effective and CITGO sold a tranche of debt securities with an aggregate offering price of $200 million. On October 28, 1997, the Company entered into a Selling Agency Agreement with Salomon Brothers Inc. and Chase Securities Inc. providing for the sale of up to an additional $235 million in aggregate principal amount of notes in tranches from time to time by the Company under the shelf registration. No amounts were sold under this agreement as of December 31, 1998.
Private Placement -- At December 31, 1998, the Company has outstanding approximately $177 million of privately placed, unsecured Senior Notes. Principal amounts are payable in annual installments in November and interest is payable semi-annually in May and November.
Master Shelf Agreement -- At December 31, 1998, the Company has outstanding $260 million of privately-placed senior notes under an unsecured Master Shelf Agreement with an insurance company. The notes have various fixed interest rates and maturities.
Covenants -- The various agreements above contain certain covenants that, depending upon the level of the Company's capitalization and earnings, could impose limitations on the Company's ability to pay dividends, incur additional debt, place liens on property, and sell fixed assets. The Company was in compliance with the debt covenants at December 31, 1998.
Tax-Exempt Bonds -- Through state entities, the Company has issued $49.8 million of industrial development bonds for certain Lake Charles port facilities and pollution control equipment and $226 million of environmental revenue bonds to finance a portion of the Company's environmental facilities at its Lake Charles and Corpus Christi refineries and at the LYONDELL-CITGO refinery. Additional credit support for these bonds is provided through letters of credit. The bonds bear interest at various floating rates which ranged from 4.1 percent to 6 percent at December 31, 1998, and 3.7 percent to 5.2 percent at December 31, 1997.
Taxable Bonds -- Through state entities, the Company has issued and currently outstanding $208 million of taxable environmental revenue bonds to finance a portion of the Company's environmental facilities at its Lake Charles refinery and at the LYONDELL-CITGO refinery. Such bonds are secured by letters of credit and have floating interest rates (5.3 percent at December 31, 1998, and 5.8 percent at December 31, 1997). At the option of the Company and upon the occurrence of certain specified conditions, all or any portion of such taxable bonds may be converted to tax-exempt bonds. At December 31, 1998, $12 million of the original $120 million in taxable Louisiana revenue bonds had been converted to tax-exempt bonds.
Cit-Con Bank Credit Agreement -- The Cit-Con bank credit agreement consists of a term loan collateralized by throughput agreements of the owner companies. The loan contains various interest rate options (weighted average effective rates of 6.7 percent and 6.5 percent at December 31, 1998 and 1997, respectively), and requires quarterly principal payments through December 2001.
Debt Maturities -- Future maturities of long-term debt as of December 31, 1998, are: 1999 -- $47.1 million, 2000 -- $47.1 million, 2001 -- $47.1 million, 2002 -- $36.4 million, 2003 -- $226.4 million, and $902.2 million thereafter.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Interest Rate Swap and Cap Agreements -- The Company has entered into the following interest rate swap agreements to reduce the impact of interest rate changes on its variable interest rate debt:
Interest expense includes $1.0 million, $0.8 million, and $1.1 million, in 1998, 1997, and 1996, respectively, related to the net settlements on these agreements.
11. EMPLOYEE BENEFIT PLANS
Employee Savings -- The Company sponsors three qualified defined contribution retirement and savings plans covering substantially all eligible salaried and hourly employees. Participants make voluntary contributions to the plans and the Company makes contributions, including matching of employee contributions, based on plan provisions. The Company expensed $19 million, $19 million, and $16 million related to its contributions to these plans for the years 1998, 1997, and 1996, respectively.
Pension Benefits -- The Company sponsors three qualified noncontributory defined benefit pension plans, two covering eligible hourly employees and one covering eligible salaried employees. The Company also sponsors three nonqualified defined benefit plans for certain eligible employees. The qualified plans' assets include corporate securities and shares in a fixed income mutual fund, two collective funds and a short-term investment fund. The nonqualified plans are not funded.
The Company's policy is to fund the qualified pension plans in accordance with applicable laws and regulations and not to exceed the tax-deductible limits. The nonqualified plans are funded as necessary to pay retiree benefits. The plan benefits for each of the qualified pension plans are primarily based on an employee's years of plan service and compensation as defined by each plan.
Postretirement Benefits Other Than Pensions -- In addition to pension benefits, the Company also provides certain health care and life insurance benefits for eligible salaried and hourly employees at retirement. These benefits are subject to deductibles, copayment provisions and other limitations and are primarily funded on a pay as you go basis. The Company reserves the right to change or to terminate the benefits at any time.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following sets forth the changes in benefit obligations and plan assets for the pension and postretirement plans for the years ended December 31, 1998 and 1997, and the funded status of such plans reconciled with amounts reported in the Company's consolidated balance sheets:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For measurement purposes, a 7.5 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1998. The rate was assumed to decrease gradually to 5.5 percent for 2002 and remain at that level thereafter.
Actuarial gains (or losses) related to the postretirement benefit obligation are recognized as a component of net postretirement benefit cost by the amount the beginning of year unrecognized net gain (or loss) exceeds 7.5 percent of the accumulated postretirement benefit obligation.
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plan with accumulated benefit obligations in excess of plan assets were $18.2 million, $17.5 million and $-0-, respectively, as of December 31, 1998 and $16.2 million, $16 million and $-0-, respectively, as of December 31, 1997.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
Employee Separation Programs -- During 1997, the Company's senior management implemented a Transformation Program that resulted in certain personnel reductions (the "Separation Programs"). The Company expensed approximately $8 million and $22 million for the years ended December 31, 1998 and 1997, respectively, relating to the Separation Programs.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. INCOME TAXES
The provisions for income taxes are comprised of the following:
The federal statutory tax rate differs from the effective tax rate due to the following:
The effective tax rate for 1997 decreased due primarily to the favorable resolution with the Internal Revenue Service of a significant tax issue related to environmental expenditures. In 1998 the effective tax rate decreased slightly compared to the 1996 rate due to a decrease in state taxes.
Deferred income taxes reflect the net tax effects of (i) temporary differences between the financial and tax bases of assets and liabilities, and (ii) loss and tax credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability as of December 31, 1998 and 1997, are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998, the Company has capital loss carryforwards of $6.7 million, $2.5 million of which expire in 1999, $0.4 million of which expire in 2000, $2.3 million of which expire in 2001, and $1.5 million of which expire in 2002. At December 31, 1998 and 1997, a valuation allowance of $1.0 million and $1.4 million was established related to that portion of the carryforwards for which it was considered more likely than not that the related tax benefits would not be realized before expiration.
The Company's alternative minimum tax credit carryforwards are available to offset regular federal income taxes in future years without expiration, subject to certain alternative minimum tax limitations.
13. COMMITMENTS AND CONTINGENCIES
Litigation and Injury Claims -- Various lawsuits and claims are pending against the Company. The Company records accruals for potential losses when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to the Company, and in amounts greater than the Company's accruals, then such determinations could have a material adverse effect on the Company's results of operations in a given reporting period. 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 Company. 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. In June 1998, the trial court granted the motions for summary judgment filed by CITGO and the other defendants; the Union has appealed this ruling.
In May 1997, an explosion and fire occurred at CITGO's Corpus Christi refinery. No serious personal injuries were reported. The Company 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 the Company in federal and state courts alleging property damages, personal injury and punitive damages. A trial in October 1998 involving ten bellwether plaintiffs, out of approximately 400 plaintiffs in one of the federal court lawsuits resulted in a verdict for the Company. The trial of another ten plaintiffs is scheduled for February, 1999; the remaining cases are not currently scheduled for trial.
A class action lawsuit is pending in Corpus Christi, Texas state court against the Company 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, the Company offered to purchase about 275 properties in a neighborhood adjacent to the Company's Corpus Christi refinery, which were included in the lawsuit. Related to this offer, $15.7 million was expensed in 1997. To date, the Company 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
properties. Two related personal injury and wrongful death lawsuits were filed against the same defendants in 1996 and are in preliminary stages of discovery.
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 on behalf of themselves and others asserting claims of racial discrimination in connection with the Company's employment practices. The trial court's denial of class certification has been upheld on appeal; the plaintiffs are seeking review by the U.S. Supreme Court. Trials in this case are set for fall, 1999.
Environmental Compliance and Remediation -- The Company is subject to various federal, state and local environmental laws and regulations which may require the Company to take action to correct or improve the effects on the environment of prior disposal or release of petroleum substances by the Company or other parties. Management believes the Company is 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.
In 1992, the Company reached an agreement with a state agency to cease usage of certain surface impoundments at the Company's Lake Charles refinery by 1994. A mutually acceptable closure plan was filed with the state in 1993. The Company and its former owner are participating in the closure and sharing the related costs based on estimated contributions of waste and ownership periods. The remediation commenced in December 1993. In 1997, the Company presented a proposal to a state agency revising the 1993 closure plan. In 1998, the Company amended its 1997 proposal as requested by the state agency. A ruling on the proposal, as amended, is expected in 1999 with final closure to begin in 2000.
In 1992, an agreement was reached between the Company and its former owner concerning a number of environmental issues. The agreement consisted, in part, of payments to the Company totaling $46 million. The former owner will continue to share the costs of certain specific environmental remediation and certain tort liability actions based on ownership periods and specific terms of the agreement.
Based on currently available information, including the continuing participation of the former owner in remediation actions, management believes its accruals for potential environmental liabilities are adequate. Conditions which would require additional expenditures may exist for various Company sites including, but not limited to, the Company's operating refinery complexes, former refinery sites, service stations and crude oil and petroleum product storage terminals. The amount of such future expenditures, if any, is indeterminable.
Capital Expenditures -- The Company's anticipated capital expenditures, excluding the investments in LYONDELL-CITGO, for the five-year period 1999 to 2003 total approximately $1.5 billion (unaudited). The expenditures include environmental and regulatory capital projects as well as strategic capital expenditures. At December 31, 1998, remaining authorized expenditures on incomplete capital projects totaled approximately $269 million.
Supply Agreements -- CITGO purchases the crude oil processed at its refineries and also purchases refined products to supplement the production from its refineries to meet marketing demands and resolve logistical issues. In addition to supply agreements with various affiliates (Note 4), the Company has various other crude oil, refined product and feedstock purchase agreements with unaffiliated entities with terms ranging from monthly to annual renewal. The Company believes these sources of supply are reliable and adequate for its current requirements.
Throughput Agreements -- The Company has throughput agreements with certain pipeline affiliates (Note 8). These throughput agreements may be used to secure obligations of the pipeline affiliates. Under these agreements, the Company may be required to provide its pipeline affiliates with additional funds through advances against future charges for the shipping of petroleum products. The Company currently ships on these
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
pipelines and has not been required to advance funds in the past. At December 31, 1998, the Company has no fixed and determinable, unconditional purchase obligations under these agreements.
Commodity Derivative Activity -- The Company's commodity derivatives are generally entered into through major brokerage houses and traded on national exchanges and can be settled in cash or through delivery of the commodity. Such contracts generally qualify for hedge accounting and correlate to market price movements of crude oil and refined products. Resulting gains and losses, therefore, will generally be offset by gains and losses on the Company's hedged inventory or future purchases and sales. The Company's derivative commodity activity is closely monitored by management and contract periods are generally less than 30 days. Unrealized and deferred gains and losses on these contracts at December 31, 1998 and 1997 and the effects of realized gains and losses on cost of sales and pretax earnings for 1998, 1997, and 1996 were not material. At times during 1998 and 1996, the Company entered into commodity derivatives activities that were not related to the hedging program discussed above. This activity and resulting gains and losses were not material in 1998 or 1996. There was no non-hedging activity in 1997.
Other Credit and Off-Balance Sheet Risk Information as of December 31, 1998 -- The Company has guaranteed approximately $8 million of debt of certain CITGO marketers. Such debt is substantially collateralized by assets of these entities. The Company has also guaranteed approximately $99 million of debt of certain affiliates, including $50 million related to HOVENSA (Note 2) and $11 million related to NISCO (Note 8). The Company has outstanding letters of credit totaling approximately $520 million, which includes $500 million related to the Company's tax-exempt and taxable revenue bonds (Note 10). The Company has also acquired surety bonds totaling $42 million primarily due to requirements of various government entities. The Company does not expect liabilities to be incurred related to such guarantees, letters of credit or surety bonds.
Neither the Company nor the counterparties are required to collateralize their obligations under interest rate swaps or caps or over-the-counter derivative commodity agreements. The Company is exposed to credit loss in the event of nonperformance by the counterparties to these agreements, but has no off-balance sheet risk of accounting loss for the notional amounts. The Company does not anticipate nonperformance by the counterparties, which consist primarily of major financial institutions.
Management considers the market risk to the Company related to its commodity and interest rate derivatives to be insignificant during the periods presented.
14. LEASES
The Company leases certain of its Corpus Christi refinery facilities under a capital lease. The basic term of the lease expires on January 1, 2004; however, the Company may renew the lease until January 31, 2011, the date of its option to purchase the facilities for a nominal amount. Capitalized costs included in property, plant and equipment related to the leased assets were approximately $209 million at December 31, 1998 and 1997. Accumulated amortization related to the leased assets was approximately $102 million and $94 million at December 31, 1998 and 1997, respectively. Amortization is included in depreciation expense.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also has various noncancelable operating leases, primarily for product storage facilities, office space, computer equipment and vehicles. Rent expense on all operating leases totaled $34 million in 1998, $39 million in 1997, and $33 million in 1996. Future minimum lease payments for the capital lease and noncancelable operating leases are as follows:
15. FAIR VALUE INFORMATION
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The carrying amounts of cash equivalents, restricted cash and variable-rate debt approximate fair values. The carrying amounts and estimated fair values of the Company's other financial instruments are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Short-term bank loans and long-term debt -- The fair value of short-term bank loans and long-term debt is based on interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities.
Interest rate swap and cap agreements -- The fair value of these agreements is based on the estimated amount that the Company would receive or pay to terminate the agreements at the reporting dates, taking into account current interest rates and the current creditworthiness of the counterparties.
Guarantees, letters of credit and surety bonds -- The estimated fair value of contingent guarantees of third-party debt, letters of credit and surety bonds is based on fees currently charged for similar one-year agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting dates.
The fair value estimates presented herein are based on pertinent information available to management as of the reporting dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein.
16. QUARTERLY RESULTS OF OPERATIONS -- UNAUDITED
The following is a summary of the quarterly results of operations for the years ended December 31, 1998 and 1997:
EXHIBIT INDEX
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* Previously filed in connection with the Registrant's Report on Form 10, Registration No. 333-3226.
** Incorporated by reference to the Registration Statement on Form of PDV America, Inc. (No. 33-63742).
*** Incorporated by reference to the Registrant's Report on Form 8-K filed with the Commission on November 18, 1997.