- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31,
20012002Commission file number 1-5153
Marathon Oil Corporation
(Exact(Exact name of registrant as specified in its charter)
Delaware 25-0996816 (State of Incorporation) (I.R.S. Employer Identification No.)
Delaware
25-0996816
(State of Incorporation)
(I.R.S. Employer Identification No.)
5555 San Felipe Road, Houston, TX 77056-2723
(Address(Address of principal executive offices)
Tel. No. (713) 629-6600
Securities registered pursuant to Section 12(b) of the Act:
* - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Title of Each Class - ------------------------------------------------------------------------------- Common Stock, par value $1.00 6.75% Convertible Quarterly Income Preferred Securities (Initial Rights to Purchase Series A Junior Liquidation Amount $50 per Preferred Stock (Currently Traded Security)**(b) with Common Stock) 7% Guaranteed Notes Due 2002 of Marathon Oil Company(c) 6.50% Cumulative Convertible Preferred (Liquidation Preference $50.00 per share)(a) - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Title of Each Class
Common Stock, par value $1.00*
Rights to Purchase Series A Junior Preferred Stock (Traded with Common Stock)**
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for at least the past 90 days. Yes
[X]þ No[_]¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
((S)(§229.405 of this chapter) is not contained herein, and will not be contained, to the best ofregistrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[_]þIndicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No ¨
Aggregate market value of Common Stock held by non-affiliates as of January 31,
2002: $92003: $6 billion. The amount shown is based on the closingpricesprice of theregistrant'sregistrant’s Common Stock on the New York Stock Exchange composite tape on that date. Shares of Common Stock held by executive officers and directors of the registrant are not included in the computation. However, the registrant has made no determination that such individuals are"affiliates"“affiliates” within the meaning of Rule 405 under the Securities Act of 1933.There were
309,518,016309,863,304 shares of Marathon Oil Corporation Common Stock outstanding as of January 31,2002.2003.Documents Incorporated By Reference:
Portions of the
registrant'sregistrant’s proxy statement relating to its20022003 annual meeting of stockholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, are incorporated by reference to the extent set forth in Part III, Items 10-13 of this report.- ------- * These securities are listed on the New York Stock Exchange. In addition, the Common Stock is listed on the Chicago Stock Exchange and the Pacific Exchange. ** Issued by USX Capital Trust I. (a) These securities were converted into the right to receive cash of $50 and are no longer outstanding. A certification and notice of termination of registration was filed with the SEC in January 2002. (b) These securities were redeemed and are no longer outstanding. A certification and notice of termination of registration was filed with the SEC in January 2002. (c) The obligations of Marathon Oil Company, a wholly owned subsidiary of the registrant, have been guaranteed by the registrant. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
* The Common Stock is listed on the New York Stock Exchange, the Chicago Stock Exchange and the Pacific Stock Exchange.
** The Preferred Stock Purchase Rights expired on January 31, 2003, pursuant to the terms of the Rights Agreement, as amended through January 29, 2003, between Marathon Oil Corporation and National City Bank, as rights agent. MARATHON OIL CORPORATION
Unless the context otherwise indicates, references in this Form 10-K to
"Marathon," "we,"“Marathon,” “we,” or"us"“us” are references to Marathon Oil Corporation, its wholly owned and majority owned subsidiaries, and its ownership interest in equityaffiliatesinvestees (corporate entities, partnerships, limited liability companies and other ventures, in which Marathon exerts significant influence by virtue of its ownership interest, typically between 20 and 50 percent).
PART I
Business and
Properties.................................Properties3
Legal
Proceedings....................................... 26Proceedings27
Submission of Matters to a Vote of Security
Holders..... 28Holders29
PART II
Market for
Registrant'sRegistrant’s Common Equity and Related StockholderMatters................................... 28Matters29
Selected Financial
Data.................................Data29
Management’s Discussion and Analysis of Financial Condition and Results of
Operations...................Operations30
Quantitative and Qualitative Disclosures About Market
Risk.................................................. 45Risk51
Consolidated Financial Statements and Supplementary
Data.............DataF-1
Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure................... 48Disclosure55
PART III
Directors and Executive Officers of The
Registrant...... 48Registrant55
Management
Remuneration................................. 48Remuneration55
Security Ownership of Certain Beneficial Owners and
Management............................................ 48Management55
Certain Relationships and Related
Transactions.......... 48Transactions56
PART IV
Controls and Procedures
56
Exhibits, Financial Statement Schedules, and Reports on Form
8-K.............................................. 49 SIGNATURES............................................................... 568-K57
64
GLOSSARY OF CERTAIN DEFINED
TERMS........................................ 57TERMS67
Disclosures Regarding Forward-Looking Statements
This annual report on Form 10-K, particularly Item 1. and Item 2. Business and Properties, Item 3. Legal Proceedings, Item 7.
Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosures About Market Risk, includeforward- lookingforward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements typically contain words such as"anticipates"“anticipates”,"believes"“believes”,"estimates"“estimates”,"expects"“expects”,"forecasts"“forecasts”,"predicts"“plans”, “predicts” or"projects"“projects” or variations of these words, suggesting that future outcomes are uncertain. In accordance with"safe harbor"“safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors, that could cause future outcomes to differ materially from those set forth in the forward-looking statements.Forward-looking statements with respect to Marathon may include, but are not limited to, levels of revenues, gross margins, income from operations, net income or earnings per share; levels of capital, exploration, environmental or maintenance expenditures; the success or timing of completion of ongoing or anticipated capital, exploration or maintenance projects; volumes of production, sales, throughput or shipments of liquid hydrocarbons, natural gas and refined products; levels of worldwide prices of liquid hydrocarbons, natural gas and refined products; levels of reserves, proved or otherwise, of liquid hydrocarbons or natural gas; the acquisition or divestiture of assets; the effect of restructuring or reorganization of business components; the potential effect of judicial proceedings on the business and financial condition; and the anticipated effects of actions of third parties such as competitors, or federal, state or local regulatory authorities.
The oil and gas industry is characterized by a large number of companies, none of which is dominant within the industry, but a number of which have greater resources than Marathon. Marathon must compete with these companies for the rights to explore for oil and gas.
Marathon'sMarathon’s expectations as to revenues, margins and income are based upon assumptions as to future prices and volumes of liquid hydrocarbons, natural gas and refined products. Prices have historically been volatile and have frequently been driven by unpredictable changes in supply and demand resulting from fluctuations in economic activity and political developments in theworld'sworld’s major oil and gas producing areas, including OPEC member countries. Any substantial decline in such prices could have a material adverse effect onMarathon'sMarathon’s results of operations. A decline in such prices could also adversely affect the quantity of liquid hydrocarbons and natural gas that can be economically produced and the amount of capital available for exploration and development.Marathon uses commodity-based and
foreign currencyfinancial instrument related derivative instruments such as futures, forwards, swaps, and options to manage exposure to price fluctuations. While commodity-based derivative instruments are generally used to reduce risks from unfavorable commodity price movements, they also may limit the opportunity to benefit from favorable movements. Levels of hedging activity vary among oil industry competitors and could affectMarathon'sMarathon’s competitive position with respect to those competitors.Liquidity Factors
Marathon'sMarathon’s ability to finance its future business requirements through internally generated funds, proceeds from the sale of stock, borrowings and other external financing sources is affected by the performance of its operations (as measured by various factors, including cash provided from operating activities), the state of worldwide debt and equity markets, investor perceptions and expectations of past and future performance and actions, the overall U.S. financial climate, and, in particular, with respect to borrowings, by
Marathon'sMarathon’s outstanding debt and credit ratings by investor services.Factors Affecting Exploration and Production Operations
Projected production levels for liquid hydrocarbons and natural gas are based on a number of assumptions, including (among others) prices, supply and demand, regulatory constraints, reserve estimates, production decline rates for mature fields, reserve replacement rates, drilling rig availability and geological and operating considerations. These assumptions may prove to be inaccurate. Exploration and production (“E&P”) operations are subject to various hazards, including acts of war or terrorist acts and the governmental or military response thereto, explosions, fires and uncontrollable flows of oil and gas. Offshore production and marine operations in areas such as the Gulf of Mexico, the North Sea, the U.K. Atlantic Margin, the Celtic Sea, offshore Nova Scotia and offshore
2West Africa are also subject to severe weather conditions such as hurricanes or violent storms or other hazards. Development of new production properties in countries outside the United States may require protracted negotiations with host governments and are frequently subject to political considerations, such as tax regulations, which could adversely affect the economics of projects. 2
Factors Affecting Refining, Marketing and Transportation Operations
Marathon conducts domestic refining, marketing and transportation (“RM&T”) operations primarily through its 62 percent owned consolidated subsidiary, Marathon Ashland Petroleum LLC
("MAP"(“MAP”).MAP's operations are conducted mainlyMAP refines, markets and transports crude oil and petroleum products, primarily in the Midwest,Southeast, Ohio River Valley andthe upper GreatPlains.Plains and southeastern United States. The profitability of these operations depends largely on the margin between the cost of crude oil and other feedstocks refined and the selling prices of refined products. MAP is a purchaser of crude oil in order to satisfy its refinery throughput requirements. As a result, its overall profitability could be adversely affected by rising crude oil and other feedstock priceswhichthat are not recovered in the marketplace. Refined product margins have been historically volatile and vary with the level of economic activity in the various marketing areas, the regulatory climate, logistical capabilities and the available supply of refined products. Gross margins on merchandise sold at retail outlets tend tomoderatebe less volatile than thevolatility experienced ingross margin from the retail sale of gasoline and diesel fuel. Environmental regulations, particularly the 1990 Amendments to the Clean Air Act, have imposed (and are expected to continue to impose) increasingly stringent and costly requirements on refining and marketing operationswhichthat may have an adverse effect onmargins. Refining, marketingmargins andtransportationfinancial condition. RM&T operations are subject to business interruptions due to unforeseen events such as explosions, fires, crude oil or refined product spills, inclement weather or labor disputes. They are also subject to the additional hazards of marine operations, such as capsizing, collision and damage or loss from severe weather conditions.Factors Affecting Other Energy Related Businesses
Marathon operates other businesses that market and transport its own and third-party natural gas, crude oil and products manufactured from natural gas, such as LNG and methanol, primarily in the United States, Europe and West Africa. The profitability of these operations depends largely on commodity prices, volume deliveries, margins on resale gas, and demand. OERB operations could be impacted by unforeseen events such as explosions, fires, product spills, inclement weather or availability of LNG vessels. They are also subject to the additional hazards of marine operations, such as capsizing, collision and damage or loss from severe weather conditions.
Technology Factors
Longer-term projections of corporate strategy, including the viability, timing or expenditures required for capital projects, can be affected by changes in technology, especially innovations in processes used in the exploration, production or refining of hydrocarbons. While specific future changes are difficult to project, recent innovations affecting the oil industry include the development of three-dimensional seismic imaging,
and deep-waterdeepwater and horizontal drillingcapabilities.capabilities, and improved gas transportation and processing options.PART I
Item 1. and 2. Business and Properties
General
Marathon Oil Corporation was originally organized in 2001 as USX HoldCo, Inc., a wholly owned subsidiary of USX
Corporation ("Old USX").Corporation. As a result of a reorganization completed in July 2001 (the “Holding Company Reorganization”), USX HoldCo, Inc. (1) became the parent entity of the consolidated enterprise (the former USX Corporation was merged into a subsidiary of USX HoldCo, Inc.) and (2) changed its name to USX Corporation. In connection with theSeparationtransaction discussedbelow,in the next paragraph (the “Separation”), USX Corporation(formerly USX HoldCo, Inc.)changed its name to Marathon Oil Corporation.The accompanying consolidated financial statements reflect Marathon Oil Corporation and its subsidiaries as the continuation of the consolidated enterprise. In this Form 10-K, all references to "United States Steel" mean United States Steel Corporation, its predecessors (including, where applicable, the U.S. Steel Group of USX Corporation) and its subsidiaries.Prior to December 31, 2001, Marathon had two outstanding classes of common stock: USX-Marathon Group common stock,
("Marathon Stock"which was intended to reflect the performance of Marathon’s energy business, and USX-U.S. Steel Group common stock (“Steel Stock”), which was intended to reflect the performance ofMarathon's energy business, and USX-U. S. Steel Group common stock ("Steel Stock"), which was intended to reflect the performance of Marathon'sMarathon’s steel business.As described further in Note 2 to the Financial Statements, onOn December 31, 2001, Marathon disposed of its steel business through a tax-free distribution of the common stock of its wholly owned subsidiary United States Steel Corporation("(“United StatesSteel"Steel”) to holders of Steel Stock in exchange for all outstanding shares of Steel Stock on a one-for-onebasis ("the Separation").basis.In connection with the Separation,
Marathon'sMarathon’s certificate of incorporation was amended on December 31, 2001 and, from that date, Marathon has only one class of common stock authorized.Marathon’s principal operating subsidiaries are Marathon Oil Company and MAP. Marathon Oil Company and its predecessors have been engaged in the oil and gas business since 1887. MAP is 62 percent owned by Marathon and 38 percent owned by Ashland Inc.
Marathon is engaged in worldwide exploration and production of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily through
its 62 percent owned subsidiary Marathon Ashland Petroleum LLC ("MAP");MAP; and other energy related businesses.3
The SeparationOperating Highlights
During 2002, Marathon:
Established and strengthened core exploration and production areas through:Acquisition and successful integration of Equatorial Guinea interests,Approval of Equatorial Guinea phase 2A and 2B expansion projects,Acquisition of additional upstream interests in Norway,First production from Camden Hills ultra-deepwater gas development, andExpansion of Powder River Basin coal bed natural gas interests.Realized exploration success in deepwater focus areas:Plutao oil discovery offshore Angola,Annapolis gas discovery offshore Nova Scotia, andNeptune discovery in deepwater Gulf of Mexico.Advanced its integrated gas strategy through:Award of front-end engineering and design contracts for potential Equatorial Guinea liquefied natural gas (“LNG”) manufacturing project and for the proposed Tijuana Regional Energy Center, LNG import and regasification facility in Baja California, andAcquisition of Elba Island, Georgia, LNG import and regasification capacity.Enhanced MAP’s asset portfolio through:Pilot Travel Center’s agreement to purchase 60 retail travel centers, which closed in 2003,Commencement of Centennial Pipeline operations, andBeginning of construction on Cardinal Products Pipeline.Segment and Geographic Information
For operating segment and geographic information, see Note 7 to the Consolidated Financial Statements on page F-19.
Exploration and Production
Marathon is currently conducting exploration and development activities in 10 countries. Principal exploration activities are in the United States, the United Kingdom, Angola, Canada, Equatorial Guinea and Norway. Principal development activities are in the United States, the United Kingdom, Canada, Equatorial Guinea, Gabon, Ireland, the Netherlands and Norway. Marathon is also pursuing opportunities in north and west Africa, the Middle East, southeast Asia and Russia.
At year-end 2002, Marathon was
originally organizedproducing crude oil and/or natural gas in nine countries, including the United States. Marathon’s worldwide liquid hydrocarbon production, including Marathon’s proportionate share of equity investees’ production, decreased less than one percent from 2001 levels. Marathon’s 2002 worldwide sales of natural gas production, including Marathon’s proportionate share of equity investees’ production, decreased approximately three percent from 2001. In addition to sales of 481 net million cubic feet per day (“mmcfd”) of international natural gas production, Marathon sold 4 net mmcfd of natural gas acquired for injection and resale during 2002. In total, Marathon’s 2002 worldwide production averaged 412,000 barrels of oil equivalent (“BOE”) per day. In 2003 and 2004, Marathon’s worldwide production is expected to average between 390,000 and 395,000 BOE per day, excluding asset sales and dispositions.The above projection of 2003 and 2004 worldwide liquid hydrocarbon production and natural gas volumes is a forward-looking statement. Some factors that could potentially affect timing and levels of production include pricing, supply and demand for petroleum products, amount of capital available for exploration and development, regulatory constraints, reserve estimates, reserve replacement rates, production decline rates of mature fields,
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timing of commencing production from new wells, drilling rig availability, future acquisitions or dispositions of producing properties, and other geological, operating and economic considerations. These factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statement.
United States
Including Marathon’s proportionate share of equity investee production, approximately 60 percent of Marathon’s 2002 worldwide liquid hydrocarbon production and 61 percent of its worldwide natural gas production was produced from U.S. operations. Marathon’s ongoing U.S. strategy is to apply its technical expertise in fields with undeveloped potential, to dispose of interests in non-core properties with limited upside potential and high production costs and to acquire interests in properties with development potential.
During 2002, Marathon drilled 19 gross (12 net) exploratory wells of which 12 gross (8 net) wells encountered hydrocarbons. Of these 12 wells, 2 gross (1 net) wells were temporarily suspended or are in the process of completing.
Exploration expenditures in the United States during the three-year period ended December 31, 2002 totaled $535 million, of which $184 million was incurred in 2002. Development expenditures in the United States during the three-year period ended December 31, 2002, including Marathon’s 85 percent equity interest in the development expenditures of MKM Partners L. P. (“MKM”), totaled $950 million, of which $295 million was incurred in 2002.
Marathon’s principal U.S. exploration, development and producing areas are located in the Gulf of Mexico and the states of Alaska, New Mexico, Oklahoma, Texas and Wyoming.
Gulf of Mexico –During 2002, Marathon’s Gulf of Mexico production averaged 62,500 net barrels per day (“bpd”) of liquid hydrocarbons and 103 net mmcfd of natural gas, representing 50 percent and 14 percent of Marathon’s total U.S. liquid hydrocarbon and natural gas production, respectively. Liquid hydrocarbon and natural gas production decreased by 9,100 net bpd and by 8 net mmcfd, respectively, from the prior year, mainly due to adverse weather from tropical storms Isidore and Lili, well interventions and natural field decline. At year-end 2002, Marathon held interests in 10 producing fields and 17 platforms, of which 7 platforms are operated by Marathon.
Production from Marathon’s interests in the deepwater Gulf of Mexico accounted for approximately 93 percent of its total Gulf of Mexico production in 2002. Major components of Marathon’s deepwater portfolio include the Marathon-operated Ewing Bank 873, 917, and 963 and the outside-operated Green Canyon 244, Viosca Knoll 786 and Mississippi Canyon 348.
The Gulf of Mexico continues to be a core area for Marathon with the potential to add new reserves and increase production. At the end of 2002, Marathon had interests in 155 blocks in the Gulf of Mexico, including 122 in the deepwater area. In 2003, Marathon plans to drill, or complete drilling operations on, three or four deepwater wells, including continued appraisal of the Neptune discovery.
The Neptune 3 discovery, located in Atwater Valley Block 617, was drilled to a total depth of 18,643 feet and encountered approximately 150 feet of net pay in two primary intervals. The well is located on the southern portion of the structure and is on trend with the Neptune 1 and 2 wells drilled several years ago on Blocks 575 and 574, respectfully, which were also successful. The Neptune 4 well, located in Block 573 along the northern portion of the structure, did not encounter hydrocarbons and was temporarily abandoned in early January 2003. Marathon holds a 30 percent working interest in the five blocks comprising the Neptune unit. Further appraisal drilling of Neptune is anticipated in 2003 to determine commerciality.
The Ozona Deep discovery, located in Garden Banks Block 515 was appraised with the drilling of two sidetrack wells in 2002 and was determined to be a smaller, more complicated hydrocarbon accumulation than anticipated. Determination of commerciality is ongoing. Marathon is operator and has a 68 percent working interest.
The Camden Hills field, located in the deepwater Gulf of Mexico on Mississippi Canyon Block 348, was discovered in August 1999. It has been developed as a part of the Canyon Express project, which links wells of the Aconcagua, Kings Peak and Camden Hills gas fields, approximately 150 miles southeast of New Orleans, tying to Williams’ Canyon Station platform on Main Pass 261 through the Canyon Express pipeline infrastructure. The Marathon operated Camden Hills startup in October 2002 sets the world record water depth for production at 7,209 feet, flowing through the world’s third longest gas gathering line at 57 miles. The Camden Hills wells
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achieved their designed peak gross rate of 100 mmcfd in November 2002. Marathon is operator of the Camden Hills field with a 50 percent interest and also has a 10 percent interest in the Canyon Express pipeline infrastructure.
Alaska– Marathon’s primary focus in Alaska is the expansion of its natural gas business through exploration, development and marketing. Marathon’s production from Alaska averaged 166 net mmcfd of natural gas in 2002, compared with 179 net mmcfd in 2001. The decrease in 2002 from 2001 is primarily due to mild temperatures in the first and fourth quarters that reduced local utility demands.
During 2002, Marathon completed successful drilling operations on four wells in Alaska. Included in this program was one well related to the natural gas discovery at the Ninilchik unit on the Kenai peninsula, approximately 35 miles south of Kenai, Alaska. Two wells are scheduled for drilling in 2003, in anticipation of first production on or before January 1, 2004. Additional drilling will occur to fully assess and develop the Ninilchik unit.
Marathon is operator of the Ninilchik unit with a 60 percent interest. Marathon and a co-venturer have formed Kenai Kachemak Pipeline Company LLC to transport natural gas from the Ninilchik unit and other potential southern Kenai peninsula gas prospects for sales into the existing Cook Inlet natural gas infrastructure.
New Mexico– Production in New Mexico, primarily from the Indian Basin field, averaged 17,300 net bpd and 137 net mmcfd in 2002, compared with 15,000 net bpd and 150 net mmcfd in 2001. The increase in liquid hydrocarbon production was primarily due to ongoing development of the Indian Basin field and was preceded by the expansion in 2000 of Marathon’s Indian Basin gas plant. Gas production was down primarily as a result of the disposition of certain properties in the San Juan Basin.
In 2002, eight Marathon operated development wells were completed in the Indian Basin field targeting both oil and gas, focused in the eastern area of the field. These new wells, combined with several recompletions of existing gas wells, increased gross oil production from 6,500 bpd to over 9,000 bpd. These wells also helped keep gas production relatively flat in 2002, ending the year at 165 gross mmcfd from Marathon-operated wells. In 2003, seven new well completions and several recompletions are planned in the east Indian Basin area targeting both oil and gas.
Oklahoma– Gas production for 2002 averaged 108 net mmcfd representing 15 percent of Marathon’s total U.S. gas production, compared with 124 net mmcfd in 2001. The decrease in gas production was primarily due to the natural field decline in Knox Morrow.
In 2002, Marathon’s southern Anadarko Basin exploration efforts concentrated on the western extension of the Cement field Sycamore/Springer play as well as the Granite Wash/Cisco prospects located in the Marlow field. Exploration drilling efforts resulted in four discoveries.
Marathon drilled or participated in the drilling of 14 development wells to further develop the 1998 Granite Wash discovery in western Oklahoma. Current net production from the Granite Wash area stands at approximately 24 mmcfd. In 2003, Granite Wash development will continue as Marathon plans to participate in the drilling of ten additional development wells.
Southern Oklahoma’s 2002 development efforts focused on Springer/Sycamore development in the Cement field. Marathon participated in the drilling of eleven Springer/Sycamore development wells in 2002. Total Springer/Sycamore production in the Cement field is currently 29 net mmcfd. In 2003, Marathon plans to continue its Cement Springer/Sycamore development by drilling, or participating in the drilling of seven additional wells. Development plans for 2003 include participation in the drilling of six wells targeting Cisco/Hoxbar development in the Marlow field, located in Stephens County, Oklahoma. Development drilling of an Arbuckle test began late in the year and will continue into early 2003.
Texas– Onshore production for 2002 averaged 15,892 net bpd of liquid hydrocarbons and 84 net mmcfd of natural gas, representing 13 percent of Marathon’s total U.S. liquid hydrocarbon and 11 percent of natural gas production. Liquid production volumes decreased by 1,506 net bpd from 2001 levels and gas volumes decreased by 27 net mmcfd from 2001 levels. The volume decreases were due to property dispositions and natural field decline.
In east Texas, Marathon drilled 15 wells in the Mimms Creek field with drilling operations continuing at year-end. The 2002 drilling program has resulted in Mimms Creek’s net production increasing from 5 mmcfd to a peak of 11 mmcfd. Current net production in the Mimms Creek field is 9 mmcfd.
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In the James Lime play, Marathon drilled six wells in the Bridges East field. In 2003, two more wells are projected to be drilled.
Wyoming– Liquid hydrocarbon production for 2002 averaged 22,800 net bpd compared with 24,600 net bpd in 2001, representing 18 percent of Marathon’s total U.S. liquid hydrocarbon production. Average gas production increased to 125 net mmcfd in 2002, compared to 90 net mmcfd in 2001, as
USX HoldCo,a result of additional coal bed natural gas wells coming on line in the Powder River Basin (“PRB”) and the acquisition of additional interests in coal bed natural gas wells in the PRB.In early 2001, Marathon completed the acquisition of Pennaco Energy Inc.
("USX HoldCo", creating a new core area of coal bed natural gas production in the PRB of Wyoming. Marathon expanded its PRB assets by approximately one-third in May 2002 as a result of the acquisition of the assets owned by its major partner in this basin. Marathon now controls more than 650,000 net acres in northeast Wyoming and southeast Montana and is the largest individual acreage holder in the PRB. This area remains one of the most active onshore natural gas plays in the continental U.S. During 2002, Marathon drilled approximately 164 net wells. Development activity together with acquisitions increased proved year-end 2002 reserves of coal bed natural gas to 417 net bcf as compared to year-end 2001 reserves of approximately 256 net bcf. For 2002, annualized production rates of coal bed natural gas were 79 net mmcfd, an increase of 32 net mmcfd from a year earlier. The December 2002 rate averaged 91 net mmcfd. The 2003 plan is currently estimated to include the drilling of 400 to 500 net coal bed natural gas wells in the PRB.International
Europe
U.K. North Sea– Marathon’s primary asset in the U.K. North Sea is in the Brae area where it is the operator and owns a 42 percent interest in the South, Central, North, and West Brae fields and a 38 percent interest in the East Brae field. Production from the Brae area averaged 20,100 net bpd of liquid hydrocarbons in 2002, compared with 21,700 net bpd in 2001. The decrease resulted from the natural decline in existing fields partially offset by successful development and remedial well work.
Marathon’s total Brae gas sales from all sources averaged 198 net mmcfd in 2002, compared with 242 net mmcfd in 2001. Of these totals, 194 mmcfd and 234 mmcfd was Brae-area gas in 2002 and 2001, respectively, and 4 mmcfd and 8 mmcfd was gas acquired for injection and subsequent resale in 2002 and 2001, respectively. The decrease resulted from decreased allocated capacity on the Scottish Area Gas Evacuation (“SAGE”) system due to
become a holding companythe Beryl field coming on line.The Brae A platform and facilities act as the host for the
two principal businessesunderlying South Brae field, adjacent Central Brae field and West Brae/Sedgwick fields. The North Brae field, which is produced via the Brae B platform, and the East Brae field are gas-condensate fields. These fields are produced using the gas cycling technique, whereby gas is injected into the reservoir for pressure maintenance, improved sweep efficiency and increased condensate liquid recovery. Although partial cycling continues, the majority of North Brae gas is being transferred to the East Brae reservoir for pressure maintenance and sales.The strategic location of the
former parent company, Old USX: .Brae A, Brae B and East Brae platforms and pipeline infrastructure has generated third-party processing and transportation business since 1986. Currently, there are 18 agreements with third-party fields contracted to use thesteelBrae system. In addition to generating processing and pipeline tariff revenue, this third-party business also has a favorable impact on Brae-area operations by optimizing infrastructure usage and extending the economic life of the facilities.The Brae group owns a 50 percent interest in the outside-operated SAGE system. The other 50 percent is owned by the Beryl group. The SAGE pipeline provides transportation for Brae and Beryl area gas and has a total wet gas capacity of approximately 1.0 bcfd. The SAGE terminal at St. Fergus in northeast Scotland provides processing for gas from the SAGE pipeline and processing for 0.8 bcfd of third party gas from the Britannia field.
Marathon is continuing its development of the Brae area. During 2002, Marathon participated in a successful Central Brae well. The well was completed as a producer from the Brae B platform in February 2002. An additional Central Brae well, drilled from the Brae B platform, is planned for 2003.
In August 2002, the Braemar development in which Marathon has a 28 percent interest was sanctioned. The development is comprised of a single subsea well development tied back to the East Brae platform. First oil from the field is scheduled for October 2003. In August 2002, a 16-inch pipeline link, Linkline, between the Marathon
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operated Brae B platform and the outside-operated Miller platform was sanctioned. Marathon has a 19 percent interest in the Linkline. The Linkline will initially be used for transportation of Braemar gas that has been sold to the Miller group for their water alternating gas project in the Miller field.
As part of an ongoing rationalization of the European Business Unit, Marathon reduced its U.K. leasehold interests from 34 blocks at the start of 2002 to 24 blocks as of December 31, 2002.
U.K. Atlantic Margin –Marathon has a non-operated interest averaging approximately 30 percent in the Foinhaven area. This is made up of a 28 percent interest in the main Foinhaven field, 47 percent of East Foinhaven and 20 percent of the single well T35 accumulation.
Production from the Foinaven fields averaged 31,000 net bpd and 9 net mmcfd in 2002, compared to 24,000 net bpd in 2001. Sales of Foinaven-associated gas via the West of Shetland pipeline system commenced in April 2002. All sales are to the outside-operated Magnus group. Full Foinaven export rates of gross 50 mmcfd were achieved in November after Magnus commissioned their gas injection compressor.
Ireland– Marathon holds a 100 percent interest in the Kinsale Head, Ballycotton and Southwest Kinsale fields in the Irish Celtic Sea. Natural gas sales were 81 net mmcfd in 2002, compared with 79 net mmcfd in 2001.
In fourth quarter 2002, Marathon announced it will be drilling and developing an additional subsea gas well in the Kinsale Head area. The Greensand subsea gas well, which is expected to be drilled in 2003, is designed to enhance the productivity of the main Kinsale Head natural gas producing Greensand reservoir. The well will target the southwestern part of the reservoir that is not being adequately drained by existing Kinsale Head platform wells.
During 2002, an agreement was entered into with the Seven Heads group to provide gas processing and transportation services, as well as field operating services for the Seven Heads gas being brought to the Kinsale offshore production facilities beginning in 2003. This agreement will result in Marathon providing capacity to process and transport between 60 mmcfd to 100 mmcfd of Seven Heads gas and enhances the value and utilization of Marathon’s Kinsale Head infrastructure.
During 2001, a petroleum lease was issued for the Corrib field in License 2/93, located 40 miles off the west coast of Ireland. The development will consist of six subsea wells, tied back to a processing terminal onshore via a 20-inch pipeline. Final planning approval for the onshore terminal is expected by the end of the first quarter of 2003. With approximately two years of onshore and offshore construction activities thereafter, production startup is targeted for first quarter of 2005. Marathon has an 18 percent non-operating interest in the Corrib field.
Norway– In the Norwegian North Sea, total net production averaged 800 bpd and 15 mmcfd in 2002. In 2000, Marathon participated in a project to modify the Heimdal platform to a processing and transportation center for third-party business. Marathon owns a 24 percent interest in the Heimdal field and gas-condensate processing center.
Marathon owns a 47 percent interest in the Vale field which is located northeast of the Heimdal field in 374 feet of water. This single subsea well tied back to the Heimdal platform came on line in June 2002. A further exploration prospect exists on this license and it is planned to drill in late 2003 or early 2004.
Following the successful acquisition of a 20 percent interest in license PL102, the Norwegian government approved the outside-operated Byggve/Skirne gas-condensate field plan of development. This two well development will be tied back to the Heimdal platform gas processing center, with first production expected early 2004. Condensate export will be via the Heimdal-Brae-Forties system and gas export via the Gasled, Statpipe or Vesterled systems.
Marathon also obtained interests in licenses PL088, PL150 and PL203 through acquisitions in 2001 and 2002. Ownership is currently 50 percent in licenses PL088 and PL150, and 65 percent in license PL203. Marathon obtained operatorship of the PL203 license from the Norwegian government in June 2002 and established an office in Stavanger, Norway. To further delineate and evaluate these licenses, two exploration wells are expected to be drilled on PL203 and one on PL088 in 2003.
In the Norwegian North Sea, between the Heimdal field and the U.K. North Sea Brae area, Marathon is evaluating the exploration potential on three additional licenses (PL025, PL187 and PL204) where Marathon holds interests of between 10 and 30 percent.
8
Netherlands– Marathon’s 50 percent equity method interest in CLAM Petroleum B. V. (“CLAM”) provides a five percent entitlement in the production from 25 gas fields, which provided sales of 25 net mmcfd of natural gas in 2002, compared with 31 net mmcfd in 2001. The decrease was mainly due to a planned shutdown to install and commission new export compression modules. In 2002, CLAM participated in four development wells and four exploration wells in the Dutch sector of the North Sea.
Independent of its interest in CLAM, Marathon holds a 24 percent working interest in the A-15 Block in the Dutch sector of the North Sea. Evaluation of the exploration potential is expected to continue during 2003.
West Africa
Equatorial Guinea—During 2002, in two separate transactions, Marathon acquired interests in the Alba field and certain other related assets.
On January 3, 2002, Marathon acquired certain interests from CMS Energy Corporation for $1.005 billion. Marathon acquired three entities that owned a combined 52 percent working interest in the Alba production sharing contract (“Alba PSC”) and a net 43 percent interest in an onshore liquefied petroleum gas processing plant through an equity method investee. Additionally, Marathon acquired a 45 percent net interest in an onshore methanol production plant through an equity method investee, which is reported in the Other Energy Related Business (“OERB”) segment.
On June 20, 2002, Marathon acquired 100 percent of the outstanding stock of Globex Energy, Inc. (“Globex”) for $155 million. Globex owned an additional 11 percent working interest in the Alba PSC and an additional net 9 percent interest in the onshore liquefied petroleum gas processing plant.
The existing production facilities include two offshore platforms, five wells and an onshore condensate stabilization plant. These facilities currently produce gross hydrocarbon volumes of 22,000 bpd of condensate and 130 mmcfd of gas.
The government of Equatorial Guinea approved the Alba PSC phase 2 development plan. The phase 2 development plan increases gross production capacity and expands the condensate recovery and LPG facilities to increase liquids processing capabilities. The first phase of additional development targeted for the Alba field is known as phase 2A. The project includes two new shallow water platforms, twelve new production and
sale business,gas injection wells, pipelines and expansion of onshore condensate processing facilities and gas reinjection compression on Bioko Island. It is expected to increase gross condensate production to 46,000 (26,000 net) bpd. Gas not used in methanol production or fuel will be moved offshore for reinjection at a rate of approximately 600 gross mmcfd. The government of Equatorial Guinea approved thesteel mill2A project in September 2002. Construction of this project has commenced, with startup scheduled for fourth quarter of 2003. The second phase of additional development is known as phase 2B. This project is scheduled to further ramp up production in fourth quarter of 2004. The project includes a new LPG cryogenic gas plant and associated storage, marine terminal and fractionation equipment for propane and heavier gas components. This addition will accommodate additional gross production of 8,000 (4,000 net) bpd of condensate and 13,000 (7,500 net) bpd of LPG. Design work for this phase commenced during 2002 and the plan of development for phase 2B received government approval at the end of 2002. Future development of the Alba field is being considered to monetize the gas.As a result of these acquisitions and the approval of the phase 2 development plan, Marathon added 305 million BOE to its proved reserves.
In 2002, Marathon drilled two development wells and acquired a three-dimensional (“3-D”) seismic survey in preparation for the production ramp-up associated with the phase 2 development of the Alba field. Production averaged 8,500 net bpd and 53 net mmcfd in 2002. The 2003 drilling program is scheduled for a total of six wells. Exploration plans for 2003 include the drilling of up to four wells, one of which will be a deeper test of the Alba field.
Gabon– Marathon is operator of the Tchatamba South, Tchatamba West and Marin fields with a 56 percent working interest. Production in Gabon averaged 16,700 net bpd of liquid hydrocarbons in 2002, compared with 16,000 net bpd in 2001.
In 2002, Marathon installed a 44-kilometer pipeline from the Tchatamba field to the outside-operated Cap Lopez pipeline system onshore and began producing oil into that line in December. The leased floating storage and offloading facility was released in January 2003, improving long-term reliability of export operations. Also in 2002, Marathon installed production facilities for the development of the Azile reservoir. The first completion in the Azile reservoir is scheduled for the first quarter of 2003. A development well is targeted for the Madiela reservoir for the first quarter of 2003.
9
Angola –In May 1999, Marathon was awarded working interests of 10 percent each in Blocks 31 and 32 offshore Angola. In September 2002, Marathon was awarded an additional 20 percent working interest in Block 32. Marathon participated in the first ultra-deepwater discovery offshore Angola in Block 31. The discovery, the Plutao 1-A, was drilled to a depth of 14,607 feet in 6,628 feet of water and tested 5,357 bpd through a 48/64 inch choke. Two exploration wells are planned for 2003 in Block 31. In Block 32, Marathon and co-venturers drilled the Gindungo 1 well to a depth of 15,665 feet in 4,756 feet of water. Plans are to test two zones in this well. One or two additional wells are planned for 2003 in Block 32.
Other International
Australia—Through the Globex acquisition, Marathon acquired a 13 percent working interest in the Stag field and three exploration blocks offshore western Australia. Current net production averages approximately 1,600 net bpd.
Canada– Net production in Canada averaged 4,300 bpd and 104 mmcfd in 2002, compared with 11,000 bpd and 123 mmcfd in 2001. The decline in production was related to divestitures of non-core conventional oil and gas and all heavy oil assets during 2001. Marathon’s onshore Canadian exploration efforts are concentrated in two areas of western Canada.
In south central Alberta, the success of Marathon’s drilling program exceeds ninety percent. The wells are shallow and the geologic setting is such that each well has several reservoir objectives. For 2003, 35 core area step-out wells are planned.
The second area of focus in western Canada is in the Milo Lake area of northern British Columbia. During 2002 and 2001, Marathon drilled two successful wells. The 2003 program includes plans to finish the installation of production facilities and pipelines, tie-in the two successful wells, startup production and drill three additional prospects.
In addition to three existing leases, Marathon was awarded two additional offshore Nova Scotia deepwater exploration licenses in 2002. Marathon has a 100 and 50 percent interest in exploration licenses (“EL”) 2410 and 2411, respectively. Marathon sold its 34 percent interest in EL 2384 (Torbrook) in 2002. This brings Marathon’s total offshore Nova Scotia exploration license acreage to 1.3 million gross acres, positioning Marathon as a major player in the developing deepwater Atlantic Canada Gas Province. One deepwater gas discovery well was drilled in 2002 in EL 2377 (Annapolis). It is anticipated that one to two deepwater wells will be drilled on Annapolis in 2003, and that an extensive 3-D seismic survey will be acquired on EL 2410 (Cortland) and EL 2411 (Empire) licenses.
The above discussions include forward-looking statements concerning various projects, drilling plans, expected production and sales levels, reserves and dates of initial production, which are based on a number of assumptions, including (among others) prices, amount of capital available for exploration and development, worldwide supply and demand for petroleum products,
coke, taconite pellets and coal transportation businessregulatory constraints, reserve estimates, production decline rates of mature fields, reserve replacement rates, drilling rig availability, license relinquishments and othersteel- related businesses comprisinggeological, operating and economic considerations. Offshore production and marine operations in areas such as the Gulf of Mexico, the North Sea, the U.K. Atlantic Margin, the Celtic Sea, offshore Nova Scotia and offshore West Africa are also subject to severe weather conditions, such as hurricanes or violent storms or other hazards. In addition, development of new production properties in countries outside the United States may require protracted negotiations with host governments and is frequently subject to political considerations and tax regulations, which could adversely affect the economics of projects. To the extent these assumptions prove inaccurate and/or negotiations and other considerations are not satisfactorily resolved, actual results could be materially different than present expectations.Reserves
At December 31, 2002, Marathon’s net proved liquid hydrocarbon and natural gas reserves, including its proportionate share of equity investees’ net proved reserves, totaled approximately 1.3 billion BOE, of which 56 percent were located in the United States. (For purposes of determining BOE, natural gas volumes are converted to approximate liquid hydrocarbon barrels by dividing the natural gas volumes expressed in thousands of cubic feet (“mcf “) by six. The liquid hydrocarbon volume is added to the barrel equivalent of gas volume to obtain BOE.) On a BOE basis, excluding dispositions, Marathon replaced 262 percent of its 2002 worldwide oil and gas production. Including dispositions, Marathon replaced 259 percent of worldwide oil and gas production.
10
The table below sets forth estimated quantities of net proved oil and gas reserves at the end of each of the last three years.
Estimated Quantities of Net Proved Oil and Gas Reserves at December 31
Developed
Developed and Undeveloped
(Millions of Barrels)
2002
2001
2000
2002
2001
2000
Liquid Hydrocarbons
United States
226
243
414
245
268
458
Europe
63
69
74
76
88
108
West Africa
113
14
18
203
17
23
Other International
11
11
39
13
13
128
Total Consolidated
413
337
545
537
386
717
Equity Investees(a)
177
178
—
183
184
—
WORLDWIDE
590
515
545
720
570
717
Developed reserves as % of total net proved reserves
81.9%
90.4%
76.0%
(Billions of Cubic Feet)
Natural Gas
United States
1,206
1,308
1,421
1,724
1,793
1,914
Europe
408
473
563
562
615
614
West Africa
552
—
—
653
—
—
Other International
290
308
381
379
399
477
Total Consolidated
2,456
2,089
2,365
3,318
2,807
3,005
Equity Investee(b)
36
32
52
59
51
89
WORLDWIDE
2,492
2,121
2,417
3,377
2,858
3,094
Developed reserves as % of total net proved reserves
73.8%
74.2%
78.1%
(Millions of Barrels)
Total BOE
United States
427
461
651
532
567
777
Europe
132
148
168
170
190
211
West Africa
205
14
18
312
17
23
Other International
59
62
103
76
79
208
Total Consolidated
823
685
940
1,090
853
1,219
Equity Investees(a)
183
183
9
193
193
15
WORLDWIDE
1,006
868
949
1,283
1,046
1,234
Developed reserves as % of total net proved reserves
78.4%
83.0%
76.9%
(a) Represents Marathon’s equity interests in MKM and CLAM in 2002 and 2001 and CLAM in 2000.
(b) Represents Marathon’s equity interest in CLAM. The above estimates, which are forward-looking statements, are based on a number of assumptions, including (among others) prices, presently known physical data concerning size and character of the reservoirs, economic recoverability, production experience and other operating considerations. To the extent these assumptions prove inaccurate, actual recoveries could be different than current estimates.
For additional details of estimated quantities of net proved oil and gas reserves at the end of each of the last three years, see “Consolidated Financial Statements and Supplementary Data – Supplementary Information on Oil and Gas Producing Activities – Estimated Quantities of Proved Oil and Gas Reserves” on pages F-40 through F-42. Marathon has filed reports with the U.S.
Steel Group;Department of Energy (“DOE”) for the years 2001 and 2000 disclosing the year-end estimated oil and gas reserves. Marathon will file a similar report for 2002. The year-end estimates reported to the DOE are the same as the estimates reported in the Supplementary Information on Oil and Gas Producing Activities.11
Delivery Commitments
Marathon has commitments to deliver fixed and determinable quantities of natural gas to customers under a variety of contractual arrangements.
In Alaska, Marathon has two long-term sales contracts with the local utility companies, which obligates Marathon to supply approximately 241 bcf of natural gas over the remaining life of these contracts. In addition, Marathon has a 30 percent ownership interest in a Kenai, Alaska, LNG plant and a proportionate share of the long-term LNG sales obligation to two Japanese utility companies. This obligation is estimated to total 155 bcf through the remaining life of the contract, which terminates March 31, 2009. These commitments are structured with variable-pricing terms. Marathon’s production from various gas fields in the Cook Inlet supply the natural gas to service these contracts. Marathon’s proved reserves and estimated production rates in the Cook Inlet sufficiently meet these contractual obligations.
In the U.K., Marathon has two long-term sales contracts with utility companies, which obligate Marathon to supply approximately 236 bcf of natural gas through September 2009. Marathon’s Brae area production, together with natural gas acquired for injection and subsequent resale, will supply the natural gas to service these contracts. Marathon’s Brae area proved reserves, acquired natural gas contracts and estimated production rates sufficiently meet these contractual obligations. The terms of these gas sales contracts also reflect variable-pricing structures.
Oil and Natural Gas Production
The following tables set forth daily average net production of liquid hydrocarbons and natural gas for each of the last three years:
Net Liquid Hydrocarbons Production(a) (e)
(Thousands of Barrels per Day)
2002
2001
2000
United States(b)
117
127
131
Europe(c)
52
46
29
West Africa(c)
25
16
16
Other International(c)
5
11
20
Total Consolidated
199
200
196
Equity Investees (MKM, CLAM and Sakhalin Energy)(c)
8
9
11
WORLDWIDE
207
209
207
Net Natural Gas Production(d) (e)
(Millions of Cubic Feet per Day)
2002
2001
2000
United States(b)
745
793
731
Europe
299
318
327
West Africa
53
—
—
Other International
104
123
143
Total Consolidated
1,201
1,234
1,201
Equity Investees (CLAM)
25
31
29
WORLDWIDE
1,226
1,265
1,230
(a) Includes crude oil, condensate and natural gas liquids.
(b) Amounts reflect production from leasehold ownership, after royalties and interests of others.
(c) Amounts reflect equity tanker liftings, truck deliveries and direct deliveries of liquid hydrocarbons. The amounts correspond with the basis for fiscal settlements with governments. Crude oil purchases, if any, from host governments are not included.
(d) Amounts exclude volumes purchased from third parties for injection and subsequent resale of 4 mmcfd in 2002, 8 mmcfd in 2001 and 11 mmcfd in 2000.
(e) Amounts reflect production after royalties, excluding the U.K., Ireland and the Netherlands where amounts shown are before royalties. 12
Productive and Drilling Wells
The following tables set forth productive wells and service wells for each of the last three years and drilling wells as of December 31, 2002.
Gross and Net Wells
2002
Productive Wells(a)
Service Wells(b)
Drilling
Wells(c)
Oil
Gas
Gross
Net
Gross
Net
Gross
Net
Gross
Net
United States
6,495
2,715
4,577
2,876
2,752
807
25
12
Europe
53
20
62
34
26
9
—
—
West Africa
6
3
9
5
1
1
1
1
Other International
485
226
1,529
1,032
47
16
2
2
Total Consolidated
7,039
2,964
6,177
3,947
2,826
833
28
15
Equity Investees(d)
2,298
742
85
4
1,002
174
2
—
WORLDWIDE
9,337
3,706
6,262
3,951
3,828
1,007
30
15
Service Wells(b)
2001
Productive Wells(a)
Oil
Gas
Gross
Net
Gross
Net
Gross
Net
United States
6,550
2,415
4,828
2,935
2,852
856
Europe
53
20
63
35
27
9
West Africa
6
3
—
—
—
—
Other International
529
242
1,463
989
44
17
Total Consolidated
7,138
2,680
6,354
3,959
2,923
882
Equity Investees(d)
2,002
609
83
4
1,142
243
WORLDWIDE
9,140
3,289
6,437
3,963
4,065
1,125
2000
Productive Wells(a)
Service Wells(b)
Oil
Gas
Gross
Net
Gross
Net
Gross
Net
United States
8,013
3,113
2,526
1,275
3,103
976
Europe
54
18
66
34
25
9
West Africa
6
3
—
—
—
—
Other International
921
662
1,450
1,084
136
109
Total Consolidated
8,994
3,796
4,042
2,393
3,264
1,094
Equity Investees(d)
—
—
85
5
—
—
WORLDWIDE
8,994
3,796
4,127
2,398
3,264
1,094
(a) Includes active wells and wells temporarily shut-in. Of the gross productive wells, gross wells with multiple completions operated by Marathon totaled 357, 341 and 469 in 2002, 2001 and 2000, respectively. Information on wells with multiple completions operated by other companies is not available to Marathon.
(b) Consist of injection, water supply and disposal wells.
(c) Consist of exploratory and development wells.
(d) Represents MKM and CLAM in 2002 and 2001, and CLAM in 2000. 13
Drilling Activity
The following table sets forth, by geographic area, the number of net productive and dry development and exploratory wells completed in each of the last three years (references to “net” wells or production indicate Marathon’s ownership interest or share, as the context requires):
Net Productive and Dry Wells Completed(a)
2002
2001
2000
United States(b)
Development(c)
– Oil
8
10
23
– Gas
174
751
109
– Dry
1
1
2
Total
183
762
134
Exploratory(d)
– Oil
2
2
2
– Gas
5
9
6
– Dry
6
8
5
Total
13
19
13
Total United States
196
781
147
International(e)
Development(c)
– Oil
2
1
12
– Gas
28
54
111
– Dry
3
5
5
Total
33
60
128
Exploratory(d)
– Oil
—
—
4
– Gas
20
16
26
– Dry
3
5
14
Total
23
21
44
Total International
56
81
172
Total Worldwide
252
862
319
(a) Includes the number of wells completed during the applicable year regardless of the year in which drilling was initiated. Does not include any wells where drilling operations were continuing or were temporarily suspended as of the end of the applicable year. A dry well is a well found to be incapable of producing hydrocarbons in sufficient quantities to justify completion. A productive well is an exploratory or development well that is not a dry well.
(b) Includes Marathon’s equity interest in MKM. The reduction from 2001 is primarily the result of fewer coal bed natural gas wells being drilled in Wyoming.
(c) Indicates wells drilled in the proved area of an oil or gas reservoir.
(d) Includes both wildcat and delineation wells.
(e) Includes Marathon’s equity interest in CLAM and, in 2000, Marathon’s equity interest in Sakhalin Energy Investment Company Ltd. (“Sakhalin Energy”). 14
Oil and Gas Acreage
The following table sets forth, by geographic area, the developed and undeveloped oil and gas acreage that Marathon held as of December 31, 2002:
Gross and Net Acreage
Developed
Undeveloped
Developed and Undeveloped
(Thousands of Acres)
Gross
Net
Gross
Net
Gross
Net
United States
1,682
404
3,372
1,636
5,054
2,040
Europe
378
302
1,394
491
1,772
793
West Africa
68
42
3,204
937
3,272
979
Other International
746
448
3,344
1,935
4,090
2,383
Total Consolidated
2,874
1,196
11,314
4,999
14,188
6,195
Equity Investees(a)
529
63
400
23
929
86
WORLDWIDE
3,403
1,259
11,714
5,022
15,117
6,281
(a) Represents Marathon’s equity interests in MKM and CLAM. Refining, Marketing and Transportation
RM&T operations are primarily conducted by MAP and its subsidiaries, including its wholly owned subsidiaries, Speedway SuperAmerica LLC and Marathon Ashland Pipe Line LLC. Marathon holds a 62 percent interest in MAP and Ashland Inc. holds the remaining 38 percent interest.
Refining
MAP owns and operates seven refineries with an aggregate refining capacity of 935,000 barrels of crude oil per day. The table below sets forth the location and daily throughput capacity of each of MAP’s refineries as of December 31, 2002:
In-Use Refining Capacity
(Barrels per Day)
Garyville, LA
232,000
Catlettsburg, KY
222,000
Robinson, IL
192,000
Detroit, MI
74,000
Canton, OH
73,000
Texas City, TX
72,000
St. Paul Park, MN
70,000
TOTAL
935,000
MAP’s refineries include crude oil atmospheric and vacuum distillation, fluid catalytic cracking, catalytic reforming, desulfurization and sulfur recovery units. The refineries have the capability to process a wide variety of crude oils and to produce typical refinery products, including reformulated gasoline. MAP’s refineries are integrated via pipelines and barges to maximize operating efficiency. The transportation links that connect the refineries allow the movement of intermediate products to optimize operations and the production of higher margin products. For example, naphtha may be moved from Texas City and Catlettsburg to Robinson where excess reforming capacity is available; gas oil may be moved from Robinson to Detroit and Catlettsburg where excess fluid catalytic cracking unit capacity is available; and light cycle oil may be moved from Texas City to Robinson where excess desulfurization capacity is available.
MAP also produces asphalt cements, polymerized asphalt, asphalt emulsions and industrial asphalts. MAP manufactures petroleum pitch, primarily used in the graphite electrode, clay target and refractory industries. Additionally, MAP manufactures aromatics, aliphatic hydrocarbons, cumene, base lube oil, polymer grade propylene and slack wax.
15
During 2002, MAP’s refineries processed 906,000 bpd of crude oil and 148,000 bpd of other charge and blend stocks. The following table sets forth MAP’s refinery production by product group for each of the last three years:
Refined Product Yields
(Thousands of Barrels per Day)
2002
2001
2000
Gasoline
581
581
552
Distillates
285
286
278
Propane
21
22
20
Feedstocks and Special Products
80
69
74
Heavy Fuel Oil
20
39
43
Asphalt
72
76
74
TOTAL
1,059
1,073
1,041
Planned maintenance activities requiring temporary shutdown of certain refinery operating units (“turnarounds”) are periodically performed at each refinery. MAP completed major turnarounds at its Robinson and St. Paul Park refineries in the fourth quarter of 2002.
The Garyville, Louisiana coker unit project achieved mechanical completion in October 2001 and was operating at full production capacity by mid-December 2001. To supply this new unit, MAP entered into a multi-year contract with P.M.I. Comercio Internacional, S.A. de C.V., an affiliate of Petroleos Mexicanos S.A., to purchase approximately 90,000 bpd of heavy Mayan crude oil. The contract was increased to approximately 100,000 bpd in July 2002.
At its Catlettsburg, Kentucky refinery, MAP has initiated a multi-year $350 million integrated investment program to upgrade product yield realizations and reduce fixed and variable manufacturing expenses. This program involves the expansion, conversion and retirement of certain refinery processing units that, in addition to improving profitability, will reduce the refinery’s total gasoline pool sulfur below 30 parts per million, thereby eliminating the need for additional low sulfur gasoline compliance investments at the refinery. The project is expected to be completed in late 2003.
Marketing
In 2002, MAP’s refined product sales volumes (excluding matching buy/sell transactions) totaled 19.1 billion gallons (1,247,000 bpd). Excluding sales related to matching buy/sell transactions, the wholesale distribution of petroleum products to private brand marketers and to large commercial and industrial consumers, primarily located in the Midwest, the upper Great Plains and the Southeast, and sales in the spot market, accounted for about 68 percent of MAP’s refined product sales volumes in 2002. Approximately 48 percent of MAP’s gasoline volumes and 90 percent of its distillate volumes were sold on a wholesale or spot market basis to independent unbranded customers or other wholesalers in 2002.
About half of MAP’s propane is sold into the home heating markets and industrial consumers purchase the balance. Propylene, cumene, aromatics, aliphatics, and sulfur are marketed to customers in the chemical industry. Base lube oils and slack wax are sold throughout the United States. Pitch is also sold domestically, but approximately 10 percent of pitch products are exported into growing markets in Canada, Mexico, India, and South America.
MAP markets asphalt through owned and leased terminals throughout the Midwest and Southeast. The MAP customer base includes approximately 900 asphalt-paving contractors, government entities (states, counties, cities and townships) and asphalt roofing shingle manufacturers.
16
The following table sets forth the volume of MAP’s consolidated refined product sales by product group for each of the last three years:
Refined Product Sales
(Thousands of Barrels per Day)
2002
2001
2000
Gasoline
773
748
746
Distillates
346
345
352
Propane
22
21
21
Feedstocks and Special Products
82
71
69
Heavy Fuel Oil
20
41
43
Asphalt
75
78
75
TOTAL
1,318
1,304
1,306
Matching Buy/Sell Volumes included in above
71
45
52
MAP sells reformulated gasoline in parts of its marketing territory, primarily Chicago, Illinois; Louisville, Kentucky; Northern Kentucky; and Milwaukee, Wisconsin. MAP also sells low-vapor-pressure gasoline in nine states.
As of December 31, 2002, MAP supplied petroleum products to about 3,800 Marathon and Ashland branded retail outlets located primarily in Michigan, Ohio, Indiana, Kentucky and Illinois. Branded retail outlets are also located in Florida, Georgia, Wisconsin, West Virginia, Minnesota, Tennessee, Virginia, Pennsylvania, North Carolina, South Carolina and Alabama.
Retail sales of gasoline and diesel fuel were also made through company-operated outlets by a wholly owned MAP subsidiary, Speedway SuperAmerica LLC (“SSA”). As of December 31, 2002, this subsidiary had 2,006 retail outlets in 13 states that sold petroleum products and convenience-store merchandise and services, primarily under the brand names “Speedway” and “SuperAmerica”. Excluding the former SSA travel centers contributed to Pilot Travel Centers LLC (“PTC”) in 2001, SSA’s revenues from the sale of convenience-store merchandise totaled $2.4 billion in 2002, compared with $2.3 billion in 2001. Profit levels from the sale of such merchandise and services tend to be less volatile than profit levels from the retail sale of gasoline and diesel fuel.
PTC, a joint venture with Pilot Corporation (“Pilot”), is the largest operator of travel centers in the United States with about 225 locations in 34 states. The travel centers offer diesel fuel, gasoline and a variety of other services, including on-premises brand name restaurants. PTC provides MAP with the opportunity to participate in the travel center business on a nationwide basis. Pilot and MAP each own a 50 percent interest in PTC.
On February 27, 2003, PTC purchased 60 retail travel centers including fuel inventory, merchandise and supplies. The 60 locations are in 15 states, primarily in the Midwest, Southeast and Southwest regions of the country.
During 2002, SSA sold all of its convenience stores in Tennessee and Louisiana and most of its stores in Georgia. On February 7, 2003, SSA announced the signing of a definitive agreement to sell all 193 of its convenience stores located in Florida, South Carolina, North Carolina and Georgia for $140 million plus store inventory. The transaction is anticipated to close in the second quarter of 2003, subject to any necessary regulatory approvals and customary closing conditions. MAP’s retail marketing strategy is focused on SSA’s Midwest operations, additional growth in the Marathon brand and continued growth for PTC.
Supply and Transportation
MAP obtains the crude oil it processes from negotiated contracts and spot purchases or exchanges. In 2002, MAP’s net purchases of U.S. produced crude oil for refinery input averaged 433,000 bpd, including a net 44,000 bpd from Marathon. In 2002, Canada was the source for 13 percent or 114,000 bpd of crude oil processed and other foreign sources supplied 39 percent or 359,000 bpd of the crude oil processed by MAP’s refineries, including approximately 215,000 bpd from the Middle East. This crude was acquired from various foreign national oil companies, producing companies and traders.
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MAP operates a system of pipelines and terminals to provide crude oil to its refineries and refined products to its marketing areas. At December 31, 2002, MAP owned, leased or had an ownership interest in approximately 3,410 miles of crude oil trunk lines and 3,732 miles of product trunk lines. MAP owned a 47 percent interest in LOOP LLC (“LOOP”), which is the owner and operator of the only U.S. deepwater oil port, located 18 miles off the coast of Louisiana; a 50 percent interest in LOCAP LLC, which owns a crude oil pipeline connecting LOOP and the Capline system; and a 37 percent interest in the Capline system, a large diameter crude oil pipeline extending from St. James, Louisiana to Patoka, Illinois.
MAP also has a 33 percent ownership interest in Minnesota Pipe Line Company, which owns a crude oil pipeline in Minnesota. Minnesota Pipe Line Company provides MAP with access to crude oil common carrier transportation from Clearbrook, Minnesota to Cottage Grove, Minnesota, which is in the vicinity of MAP’s St. Paul Park, Minnesota refinery.
As of December 31, 2002, MAP had a 33 percent ownership interest in Centennial Pipeline LLC, and Marathon Ashland Pipe Line LLC has been designated operator of the pipeline. The Centennial Pipeline system that connects Gulf Coast refineries with the Midwest market has the initial design capacity to transport approximately 210,000 barrels per day of refined petroleum products and began deliveries of refined products in April 2002.
On February 10, 2003, MAP increased its ownership in Centennial Pipeline LLC from 33 percent to 50 percent and as of that date, Centennial Pipeline LLC is owned 50 percent each by MAP and TE Products Pipeline Company, Limited Partnership.
A MAP subsidiary, Ohio River Pipe Line LLC (“ORPL”), is building a pipeline from Kenova, West Virginia to Columbus, Ohio. ORPL is a common carrier pipeline company, and the pipeline will be an interstate common carrier pipeline. The pipeline is currently known as Cardinal Products Pipeline and is expected to initially move approximately 50,000 barrels per day of refined petroleum into the central Ohio region. ORPL has secured all of the rights-of-way required to build the pipeline, and final permits required to build the pipeline have been approved. Construction on the pipeline began in August 2002, with startup of the pipeline expected midyear 2003.
MAP’s eighty-six light product and asphalt terminals are strategically located throughout the Midwest, upper Great Plains and Southeast. These facilities are supplied by a combination of pipelines, barges, rail cars and/or trucks. MAP’s marine transportation operations include towboats and barges that transport refined products on the Ohio, Mississippi and Illinois rivers, their tributaries and the Intercoastal Waterway. MAP also leases and owns rail cars in various sizes and capacities for movement and storage of petroleum products and a large number of tractors, tank trailers and general service trucks.
The above RM&T discussions include forward-looking statements concerning anticipated completion of refinery projects, start-up of a pipeline project and the disposition of SSA stores. Some factors that could potentially cause actual results for the refinery and pipeline projects to differ materially from present expectations include (among others) price of petroleum products, levels of cash flow from operations, unforeseen hazards such as weather conditions and the completion of construction. Some factors that could affect the SSA store sales include the inability or delay in obtaining necessary government and third party approvals, and satisfaction of customary closing conditions. This forward-looking information may prove to be inaccurate and actual results may differ from those presently anticipated.
Other Energy Related Businesses
Marathon operates other businesses that market and transport its own and third-party natural gas, crude oil and products manufactured from natural gas, such as LNG and methanol, primarily in the United States, Europe and West Africa. Some of these businesses, as well as other business projects under development, comprise Marathon’s emerging integrated gas strategy.
Marathon owns an interest in the following pipeline systems that were not contributed to MAP: a 29 percent interest in Odyssey Pipeline LLC and a 28 percent interest in Poseidon Oil Pipeline Company, LLC (both Gulf of Mexico crude oil pipeline systems); a 24 percent interest in Nautilus Pipeline Company, LLC and a 24 percent interest in Manta Ray Offshore Gathering Company, LLC (both Gulf of Mexico natural gas pipeline systems); and a 17 percent interest in Explorer Pipeline Company and a 3 percent interest in Colonial Pipeline Company (both light product pipeline systems extending from the Gulf of Mexico to the Midwest and East Coast, respectively).
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Marathon owns a 34 percent ownership interest in the Neptune natural gas processing plant located in St. Mary Parish, Louisiana, which commenced operations on March 20, 2000. The plant has the capacity to process 300 mmcfd of natural gas, which is transported on the Nautilus pipeline system.
In addition to the sale of its own oil and natural gas production, Marathon purchases oil and gas from third party producers and marketers for resale.
Marathon owns a 30 percent ownership in a Kenai, Alaska, natural gas liquefication plant and leases two 87,500 cubic meter tankers used to transport LNG to customers in Japan. Feedstock for the plant is supplied from a portion of Marathon’s natural gas production in the Cook Inlet. From the first production in 1969, the LNG has been sold under a long-term contract with two of Japan’s largest utility companies. Marathon has a 30 percent participation in this contract, which has been extended to continue through March 31, 2009. LNG deliveries totaled 63 gross bcf (19 net bcf) in 2002.
On January 3, 2002, Marathon acquired a 45 percent interest in a methanol plant located in Malabo, Equatorial Guinea from CMS Energy. Feedstock for the plant is supplied from a portion of Marathon’s natural gas production in the Alba field. Methanol production totaled 719,000 gross metric tons (324,000 net metric tons) in 2002. Production from the plant is used to supply customers in Europe and the U.S.
In August 2002, Marathon acquired the rights to deliver up to 58 bcf of LNG annually to the Elba Island LNG terminal in Savannah, Georgia. The contract has a 17-year term with an option to extend for an additional five-year period. The agreement provides for the right to deliver LNG under a put option with the operator of the facility and, under certain conditions, take redelivery of natural gas for onward sale to third parties.
Marathon’s Atlantic Basin integrated gas activity centers around the monetization of Marathon’s gas reserves from the Alba field. This proposed project would involve construction of an LNG facility located on Bioko Island, Equatorial Guinea. LNG is likely to be shipped to the United States or Europe where it will be regasified and sold into the marketplace. Approvals are required from the partners and government of Equatorial Guinea.
Marathon’s Pacific Basin integrated gas activity centers around construction of the Tijuana Regional Energy Center. The proposed project, to be located near Tijuana, Mexico, is an integrated complex planned to consist of a 750 mmcf per day LNG offloading terminal and regasification plant, a 1,200-megawatt power generation plant, a 20-million gallon per day water desalination plant, wastewater treatment facilities and natural gas pipeline infrastructure. Currently, Marathon is proceeding with regulatory reviews and permits as required by federal authorities in Mexico. Assuming regulatory approval and the development of a successful commercial structure and financing plan, construction of the facilities is scheduled to begin in 2003 with expected startup in 2006.
The above OERB discussion contains forward looking statements concerning the Tijuana Regional Energy Center. Some factors, but not necessarily all factors that could adversely affect these expected results include unforeseen difficulty in negotiation of definitive agreements among project participants, identification of additional participants to reach optimum levels of participation, inability or delay in obtaining necessary government and third-party approvals, arranging sufficient project financing, unanticipated changes in market demand or supply, competition with similar projects, environmental issues, availability or construction of sufficient LNG vessels, and government review and approval of the required permits.
Competition and Market Conditions
Strong competition exists in all sectors of the oil and gas industry and, in particular, in the exploration and
productiondevelopment of new reserves. Marathon competes with major integrated and independent oil and gas companies for the acquisition of oil and gas leases and otherenergy businesses conducted by Marathon Oil Company, an Ohio corporation,properties, for the equipment and labor required to develop and operate those properties and in the marketing of oil and natural gas to end-users. Many of Marathon’s competitors have financial and othersubsidiaries comprisingresources greater than those available to Marathon. As a consequence, Marathon may be at a competitive disadvantage in bidding for the rights to explore for oil and gas. Acquiring the more attractive exploration opportunities frequently requires competitive bids involving front-end bonus payments or commitments-to-work programs. MarathonGroup. In a series of transactions (the "Holding Company Reorganization") Old USX completed on July 2, 2001: . USX HoldCo became the holding company for Marathon Oil Companyalso competes in attracting andUnited States Steel LLC; . Old USX was merged with and into United States Steel LLC; . USX HoldCo assumed a substantial part of the outstanding indebtedness, obligations under various capital and operating leases and guarantee obligationsretaining personnel, including geologists, geophysicists and othercontingent liabilitiesspecialists. Based on industry sources, Marathon believes it currently ranks eighth among U.S.-based petroleum corporations on the basis ofOld USX;2001 worldwide liquid hydrocarbon and natural gas production.Marathon through MAP must also compete with a large number of other companies to acquire crude oil for refinery processing and in the distribution and marketing of a full array of petroleum products. MAP believes it ranks sixth among U.S. petroleum companies on the basis of crude oil refining capacity as of January 1, 2003. MAP competes in four distinct markets – wholesale, spot, branded and retail distribution—for the sale of refined products and believes it competes with about forty companies in the wholesale distribution of petroleum products to private brand marketers and large commercial and industrial consumers; about eighty-seven companies in the sale of petroleum products in the spot market; eleven refiner/marketers in the supply of branded petroleum
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products to dealers and jobbers; and approximately six hundred petroleum product retailers in the retail sale of petroleum products. Marathon competes in the convenience store industry through SSA’s retail outlets. The retail outlets offer consumers gasoline, diesel fuel (at selected locations) and a broad mix of other merchandise and services. Some locations also have on-premises brand-name restaurants such as Subway™ and Taco Bell™.
USX HoldCo changedMarathon also competes in the travel center industry through itsname50 percent ownership in PTC.Marathon’s operating results are affected by price changes in crude oil, natural gas and petroleum products, as well as changes in competitive conditions in the markets it serves. Generally, results from production operations benefit from higher crude oil and natural gas prices while refining and marketing margins may be adversely affected by crude oil price increases. Market conditions in the oil and gas industry are cyclical and subject to
USX Corporation.global economic and political events and new and changing governmental regulations.The Separation
On December 31, 2001, pursuant to an Agreement and Plan of Reorganization dated as of July 31, 2001
("(“ReorganizationAgreement"Agreement”), Marathon completed the Separation,transaction,in which:.its wholly owned subsidiary United States Steel LLC converted into a Delaware corporation named United States Steel Corporation and became a separate, publicly traded company; and. USX HoldCo, then known asUSX Corporation changed its name to Marathon Oil Corporation.Marathon and its subsidiaries are continuing the energy business that comprised the Marathon Group of
Old USX.USX Corporation.Assumption of Indebtedness and Other Obligations by United States Steel
Prior to the Separation,
Old USX, and thenMarathon managed most of its financial activities on a centralized, consolidated basis and, in its financial statements, attributed amounts that related primarily to the following items to the Marathon Group and the U.S. Steel Group on the basis of their cash flows for the applicable periods and the initial capital structure for each group:.invested cash;.short-term and long-term debt, including convertible debt, and related net interest and other financing costs; and.preferred stock and related dividends.The following items, however, were specifically attributed to, and reflected in their entirety in the financial statements of, the group to which they related:
.leases;.collateralized financings;.indexed debt instruments;.financial activities of consolidated entities that were not wholly owned subsidiaries; and.transactions that related to securities convertible solely into common stock that tracked the performance of the Marathon Group or the U.S. Steel Group.These attributions were for accounting purposes only and did not reflect the legal ownership of cash or the legal obligations to pay and discharge debt or other obligations.
In connection with the Separation:
.United States Steel and its subsidiaries incurred indebtedness to third parties and assumed various obligations from Marathon in an aggregate amount approximately equal to all the net amounts attributed to the U. S. Steel Group immediately prior to the Separation, both absolute and contingent, less the amount of a $900 million value transfer (the"Value Transfer"“Value Transfer”); and4.Marathon and its subsidiaries remained responsible for all the liabilities attributed to the Marathon Group, both absolute and contingent, plus$900 million.the Value Transfer.20
These arrangements
requirerequired a post-Separation cash settlement of $54 million between Marathon and United States Steel following the audit of the balance sheets for both the Marathon Group and the U. S. Steel Group as of December 31, 2001, in order to ensure that the Value Transfer was $900 million. At December 31, 2001, Marathon had a $54 million settlement receivable from United States Steel arising from the allocation of net debt and other financings at the time of the Separation, which was paid on February 6, 2002.As a result of its assumption of various items of indebtedness and other obligations from its former parent entity in the Holding Company Reorganization, Marathon remained obligated after the Separation for the following items of indebtedness and other obligations that were attributed to the U.S. Steel Group in accordance with the provisions of the Reorganization
Agreement (amounts as of December 31, 2001): . approximately $470 million ofAgreement:obligations under industrial revenue bonds related to environmental projects for current and former U. S. Steel Group facilities, with maturities ranging from 2009 through 2033;. approximately $84 million ofsale-leaseback financing obligations under a lease for equipment at United StatesSteel'sSteel’s Fairfield Works facility, with the lease term extending to 2012, subject to extensions;. approximately $138 million inobligations relating to various lease arrangements accounted for as operating leases and various guarantee arrangements, all of which were assumed by United States Steel; and.other guarantees referred to under"Relationship“Relationship Between Marathon and United States Steel After the Separation-– Financial MattersAgreement" on page 7.Agreement” below.As contemplated by the Reorganization Agreement, Marathon and United States Steel entered into a financial matters agreement to reflect United States
Steel'sSteel’s agreement to assume and discharge allMarathon'sof Marathon’s obligations referred to above. For additional information relating to the financial matters agreement, see “Relationship Between Marathon and United States Steel After the Separation – Financial Matters Agreement” below.Relationship Between Marathon and United States Steel After the Separation
As a result of the Separation, Marathon and United States Steel are separate companies, and neither has any ownership interest in the other. Thomas J. Usher is chairman of the board of both companies, and, as of December 31, 2002, four of the nine remaining members of Marathon’s board of directors are also directors of United States Steel.
In connection with the Separation and pursuant to the Plan of Reorganization, Marathon and United States Steel have entered into a series of agreements governing their relationship subsequent to the Separation and providing for the allocation of tax and certain other liabilities and obligations arising from periods prior to the Separation. The following is a description of the material terms of those agreements.
Financial Matters Agreement
Marathon and United States Steel have a financial matters agreement that provides for United States Steel’s assumption of the obligations under Marathon’s outstanding industrial revenue bonds, the sale-leaseback financing arrangement and the lease and guarantee obligations referred to above under “The Separation— Assumption of Indebtedness and Other Obligations by United States Steel” on page 20. Under the financial matters agreement, United States Steel has assumed and agreed to discharge all Marathon’s principal repayment, interest payment and other
paymentobligations underthethose industrial revenue bondsthe capital lease arrangementandthe guarantees associated with the otherlease andsimilarguarantee arrangements described above, including any amounts due on any default or acceleration of any of those obligations,referred to above. In addition, the financial matters agreement requires United States Steel to use commercially reasonable efforts to have Marathon released from its obligations under theotherguarantees referred to above.than any default caused by Marathon.The financial matters agreement also provides that, on or before the tenth anniversary of the Separation, United States Steel will provide for
Marathon'sMarathon’s discharge from any remaining liability under any of the assumed industrial revenue bonds. United States Steel may accomplish that discharge by refinancing or, to the extent not refinanced, paying Marathon an amount equal to the remaining principal amount of, all accrued and unpaid debt service outstanding on, and any premium required to immediately retire, the then outstanding industrial revenue bonds.Only $1.8$2 million of the industrial revenue bonds are scheduled to mature in the period extending through2012. For additional information relating toDecember 31, 2009.Under the financial matters agreement,
see "Relationship Between Marathon andUnited States SteelAftershall have theSeparation - Financial Matters Agreement" on page 7. Effects on Historical Relationship Historically,right to exercise all of theU.S. Steel Group has funded its negative operating cash flow with cash supplied by Marathon, a portion of which was reflected as a paymentexisting contractual rights under thetax allocation policy andlease obligations assumed from Marathon, including all rights related to purchase21
options, prepayments or the
remaindergrant or release ofwhich was represented by increased amounts of debt attributed by Marathon. As a stand- alone company,security interests. United States Steelwill needshall have no right to increase amounts due under or lengthen the term of any of the assumed lease obligations without the prior consent of Marathon other than extensions set forth in the terms of the assumed lease obligations.The financial matters agreement also requires United States Steel to use commercially reasonable efforts to have Marathon released from its obligations under a guarantee Marathon provided with respect to all United States Steel’s obligations under a partnership agreement between United States Steel, as general partner, and General Electric Credit Corporation of Delaware and Southern Energy Clairton, LLC, as limited partners. United States Steel may dissolve the partnership under certain circumstances including if it is required to fund
anyaccumulated cash shortfalls ofits negative operating cash flowthe partnership in excess of $150 million. In addition to the normal commitments of a general partner, United States Steel has indemnified the limited partners for certain income tax exposures.The financial matters agreement requires Marathon to use commercially reasonable efforts to take all necessary action or refrain from
external sources,acting so as to assure compliance with all covenants andadequate sources may be unavailableother obligations under the documents relating to the assumed obligations to avoid the occurrence of a default or thecostacceleration ofsuch funding may adversely impactthe payment obligations under the assumed obligations. The agreement also obligates Marathon to use commercially reasonable efforts to obtain and maintain letters of credit and other liquidity arrangements required under the assumed obligations.United States
Steel. As discussed below,Steel’s obligations to Marathon under the financial matters agreement are general unsecured obligations that rank equal to United States Steel’s accounts payable and other general unsecured obligations. The financial matters agreement does not contain any financial covenants, and United States Steel is free to incur additional debt,andgrant mortgages on or security interests in its property and sell or transfer assets withoutMarathon'sour consent.United States Steel is more highly leveraged than Marathon, has a noninvestment grade credit rating and has granted security interests in some of its assets, including its accounts receivable and inventory. Additionally, United States Steel's operations are capital intensive. United States Steel's business also requires substantial expenditures for routine maintenance. The steel business is highly competitive and a large number of industry participants have sought protection under bankruptcy laws in recent periods. Relationship Between Marathon and United States Steel After the Separation As a result of the Separation, Marathon and United States Steel are separate companies, and neither has any ownership interest in the other. Thomas J. Usher is chairman of the board of both companies, and four of the remaining nine members of Marathon's board of directors are also directors of United States Steel. 5In connection with the Separation and pursuant to the Plan of Reorganization, Marathon and United States Steel have entered into a series of agreements governing their relationship subsequent to the Separation and providing for the allocation of tax and certain other liabilities and obligations arising from periods prior to the Separation. Set forth below is a description of the material terms of those agreements.Tax Sharing Agreement
Marathon and United States Steel have a tax sharing agreement that applies to each of their consolidated tax reporting groups. Provisions of this agreement include the following:
.for any taxable period, or any portion of any taxable period, ended on or before December 31, 2001, unpaid tax sharing payments will be made between Marathon and United States Steel generally in accordance with the general tax sharing principles in effect prior to the Separation;.no tax sharing payments will be made with respect to taxable periods, or portions thereof, beginning after December 31, 2001; and.provisions relating to the tax and related liabilities, if any, that result from the Separation ceasing to qualify as a tax-free transaction and limitations on post-Separation activities that might jeopardize the tax-free status of the Separation.Under the general tax sharing principles in effect prior to the Separation:
.the taxes payable by each of the Marathon Group and the U.S. Steel Group were determined as if each of them had filed its own consolidated, combined or unitary tax return; and.the U.S. Steel Group would receive the benefit, in the form of tax sharing payments by the parent corporation, of the tax attributes, consisting principally of net operating losses and various credits, that its business generated and the parent used on a consolidated basis to reduce its taxes otherwise payable.In accordance with the tax sharing agreement, at the time of the Separation, Marathon made a preliminary settlement with United States Steel of approximately $440 million as the net tax sharing payments owed to it for the year ended December 31, 2001 under the pre-Separation tax sharing principles.
The tax sharing agreement also addresses the handling of tax audits and contests and other matters respecting taxable periods, or portions of taxable periods, ended prior to December 31, 2001.
In the tax sharing agreement, each of Marathon and United States Steel promised the other party that it:
.would not, prior to January 1, 2004, take various actions or enter into various transactions that might, under section 355 of the Internal Revenue Code of 1986, jeopardize the tax-free status of the Separation; and.22
would be responsible for, and indemnify and hold the other party harmless from and against, any tax and related liability, such as interest and penalties, that results from the Separation ceasing to qualify as tax-free because of its taking of any such action or entering into any such transaction.The
proscribedprescribed actions and transactions include:.the liquidation of Marathon or United States Steel; and.the sale by Marathon or United States Steel of its assets, except in the ordinary course of business.In case a taxing authority seeks to collect a tax liability from one party
whichthat the tax sharing agreement has allocated to the other party, the other party has agreed in the sharing agreement to indemnify the first party against that liability.Even if the Separation otherwise
qualifiesqualified for tax-free treatment under section 355 of the Internal Revenue Code, the Separation may become taxable to Marathon under section 355(e) of the Internal Revenue Code if capital stock representing a 50 percent or greater interest in either Marathon or United States Steel is acquired, directly or indirectly, as part of a plan or series of related transactions that include the Separation. For this purpose, a"50“50 percent or greaterinterest"interest” means capital stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of capital stock. To minimize this risk, both Marathon and United States Steel agreed in the tax sharing agreement that they would not enter into any transactions or make any change in their equity structures that could cause the6Separation to be treated as part of a plan or series of related transactions to which those provisions of section 355(e) of the Internal Revenue Code may apply. If an acquisition occurs that results in the Separation being taxable under section 355(e) of the Internal Revenue Code, the agreement provides that the resulting corporate tax liability will be borne by the party involved in that acquisition transaction. Although the tax sharing agreement allocates tax liabilities relating to taxable periods ending on or prior to the Separation, each of Marathon and United States Steel, as members of the same consolidated tax reporting group during any portion of a taxable period ended on or prior to the date of the Separation, is jointly and severally liable under the Internal Revenue Code for the federal income tax liability of the entire consolidated tax reporting group for that year. To address the possibility that the taxing authorities may seek to collect all or part of a tax liability from one party where the tax sharing agreement allocates that liability to the other party, the agreement includes indemnification provisions that would entitle the party from whom the taxing authorities are seeking collection to obtain indemnification from the other party, to the extent the agreement allocates that liability to that other party. Marathon can provide no assurance, however, that United States Steel will be able to meet its indemnification obligations, if any, to Marathon that may arise under the tax sharing agreement.
Transition Services Agreement Marathon and United States Steel have a transition services agreement that will govern the provision of the following services until December 31, 2002: . common corporate support services; and . inter-unit computer services. Common corporate support services include services personnel at the former Pittsburgh corporate headquarters historically provided prior to the Separation. These include accounting, finance and financial management, government affairs, investor relations, public affairs and tax services. Most of these personnel now work for Marathon or United States Steel. Each company has agreed to provide these services to the other, to the extent it is able to do so and the other company cannot satisfy its own needs. Inter-unit computer services consist of computer and information technology services either company historically provided to the former Pittsburgh corporate headquarters or to the other company. A company providing common corporate support or inter-unit computer services under the transition services agreement will be entitled to recover the costs it incurs in providing those services. The transition services agreement also includes each company's grant to the other company and its subsidiaries of a nonexclusive, fully paid, worldwide license for their internal use only of the granting company's computer programs, software, source code and know-how that were utilized prior to the Separation or are utilized under the transition services agreement to provide common corporate support or inter-unit computer services to the other company and its subsidiaries. Financial Matters Agreement Marathon and United States Steel have a financial matters agreement that provides for United States Steel's assumption of the obligations under Marathon's outstanding industrial revenue bonds, the sale-leaseback financing arrangement and the lease and guarantee obligations referred to above under "The Separation--Assumption of Indebtedness and Other Obligations by United States Steel" on page 5. Under the financial matters agreement, United States Steel has assumed and agreed to discharge all Marathon's principal repayment, interest payment and other obligations under those industrial revenue bonds and lease and guarantee arrangements described above, including any amounts due on any default or acceleration of any of those obligations, other than any default caused by Marathon. The financial matters agreement also provides that, on or before the tenth anniversary of the Separation, United States Steel will provide for Marathon's discharge from any remaining liability under any of the assumed industrial revenue bonds. The financial matters agreement also requires United States Steel to use commercially reasonable efforts to have Marathon released from its obligations under a guarantee Marathon provided with respect to all United States Steel's obligations under a partnership agreement between United States Steel, as general partner, and General Electric Credit Corporation of Delaware and Southern Energy Clairton, LLC, as limited partners. 7United States Steel may dissolve the partnership under certain circumstances including if it is required to fund accumulated cash shortfalls of the partnership in excess of $150 million. In addition to the normal commitments of a general partner, United States Steel has indemnified the limited partners for certain income tax exposures. As of December 31, 2001, United States Steel had no unpaid outstanding obligations to the limited partners. The financial matters agreement requires Marathon to use commercially reasonable efforts to take all necessary action or refrain from acting so as to assure compliance with all covenants and other obligations under the documents relating to the assumed obligations to avoid the occurrence of a default or the acceleration of the payment obligations under the assumed obligations. The agreement also obligates Marathon to use commercially reasonable efforts to obtain and maintain letters of credit and other liquidity arrangements required under the assumed obligations. United States Steel's obligations to Marathon under the financial matters agreement are general unsecured obligations which rank equal to United States Steel's accounts payable and other general unsecured obligations. The financial matters agreement does not contain any financial covenants, and United States Steel is free to incur additional debt, grant mortgages on or security interests in its property and sell or transfer assets without our consent.License Agreement
Marathon and United States Steel have entered into a license agreement under which Marathon granted to United States Steel a
nonexclusive,non-exclusive, fully paid, worldwide license to use the"USX"“USX” name and various trade secrets,know- howknow-how and intellectual property rights previously used in connection with the business of both companies. The license agreement provides that United States Steel may use these rights solely in the conduct of its internal business. It also provides United States Steel with the right to sublicense these rights to any of its subsidiaries. The license agreement provides for a perpetual term, so long as United States Steel performs its obligations under the agreement.Insurance Assistance Agreement
Marathon and United States Steel have an insurance assistance agreement, which provides for:
.the division of responsibility for joint insurance arrangements; and.the entitlement to insurance claims and the allocation of deductibles with respect to claims associated with pre-Separation periods.Under the insurance assistance agreement:
.Marathon is entitled to all rights in and to all claims and is solely liable for the payment of uninsured retentions and deductibles arising out of or relating to pre-Separation events or conditions exclusively associated with the business of the Marathon Group;.23
United States Steel is entitled to all rights in and to all claims and is solely liable for the payment of uninsured retentions and deductibles arising out of or relating to pre-Separation events or conditions exclusively associated with the business of the U. S. Steel Group;.Marathon is entitled to 65 percent and United States Steel is entitled to 35 percent of all rights in and to all claims, and Marathon and United States Steel are liable on the same percentage basis for the payment of uninsured retentions and deductibles, arising out of or relating to pre-Separation events or conditions and not related exclusively to either the Marathon Group or the U.S. Steel Group; and.the cost of extended reporting insurance for pre-Separation periods will be split between Marathon and United States Steel on a 65 percent-35 percent basis, respectively, if both companies elect to purchase the same extended reporting insurance.ExplorationTransition Services Agreement
Marathon and
Production Oil and Natural Gas Exploration and Development Marathon is currently conducting exploration and development activities in 11 countries, including its January 2002 acquisition of interests in Equatorial Guinea, West Africa. Principal exploration activities are in theUnited States Steel had a transition services agreement that governed theUnited Kingdom, Angola, Canada, and Norway. Principal development activities are in the 8United States, the United Kingdom, Canada, Equatorial Guinea, Gabon, Ireland, the Netherlands and Norway. Marathon is also pursuing opportunities in North and West Africa, the Middle East, Southeast Asia and the Commonwealth of Independent States. The following table sets forth, by geographic area, the number of net productive and dry development and exploratory wells completed in eachprovision of thelast three years (references to "net" wells or production indicate Marathon's ownership interest or share, as the context requires): Net Productivecommon corporate support services andDry Wells Completed(a)
2001 2000 1999 - ----------------------------------------------------United States(b) Development(c) - Oil 10 23 11 - Gas 751 109 54 - Dry 3 2 1 --- --- --- Total 764 134 66 Exploratory(d) - Oil 2 2 5 - Gas 9 6 9 - Dry 6 5 13 --- --- --- Total 17 13 27 --- --- --- Total United States 781 147 93 International(e) Development(c) - Oil 1 12 42 - Gas 54 111 55 - Dry 5 5 11 --- --- --- Total 60 128 108 Exploratory(d) - Oil 0 4 2 - Gas 16 26 14 - Dry 5 14 16 --- --- --- Total 21 44 32 Total International 81 172 140 --- --- --- Total Worldwide 862 319 233 - ----------------------------------------------------(a) Includes the number of wells completed during the applicable year regardless of the year in which drilling was initiated. Does not include any wells where drilling operations were continuing or were temporarily suspended as of the end of the applicable year. A dry well is a well found to be incapable of producing hydrocarbons in sufficient quantities to justify completion. A productive well is an exploratory or development well that is not a dry well. (b) Includes Marathon's equity interest in MKM Partners L.P. ("MKM"). Also includes Marathon's ownership of Pennaco Energy Company ("Pennaco"), acquired in February 2001. Pennaco is a coal bed methane exploration and production company with a very active drilling program. (c) Indicates wells drilled in the proved area of an oil or gas reservoir. (d) Includes both wildcat and delineation wells. (e) Includes Marathon's equity interest in CLAM Petroleum B.V. ("CLAM") and in 2000 and 1999 Marathon's equity interest in Sakhalin Energy Investment Company Ltd. ("Sakhalin Energy"). United States In the United States during 2001, Marathon drilled 26 gross (19 net) wildcat and delineation ("exploratory") wells of which 20 gross (12 net) wells encountered hydrocarbons. Of these 20 wells, 2 gross (1 net) wells were temporarily suspended, and will be reported in the Net Productive and Dry Wells Completed table in Marathon's future reports when completed. Marathon's principal domestic exploratory and development activities in 2001 were in the U.S. Gulf of Mexico and the states of Alaska, New Mexico, Oklahoma, Texas and Wyoming. Exploration expenditures in the United States during the three-year period endedinter-unit computer services until December 31,2001, including Marathon's 85 percent equity interest in MKM's exploration expenditures, totaled $492 million, of which $190 million was incurred in 2001. Development expenditures in2002. Common corporate support services included services personnel at theUnited States duringformer Pittsburgh corporate headquarters historically provided prior to thethree-year period ended December 31, 2001, including Marathon's 85 percent equity interest in MKM's development expenditures, totaled $887 million, of which $367 million was incurred in 2001. 9The following is a summary of recent, significant exploration and development activity in the United States including discussion, as deemed appropriate, of completed wells, wells being drilled and wells under evaluation. Gulf of Mexico - The Gulf of Mexico ("Gulf") continues to be a core area for MarathonSeparation.Obligations Associated with the
potential to add new reserves and increase production. At the end of 2001, Marathon had interests in 145 blocks in the Gulf, including 110 in the deepwater area. In 2002, Marathon plans to drill, or complete drilling operations on, three or four deepwater wells, including appraisal of the Ozona Deep discovery. Marathon's 2001 Gulf exploration drilling program was delayed due to the cancellation of the contract for the Cajun Express drilling rig in early July 2001. Of the two wells originally scheduled to be drilled with this rig, the Flathead prospect was delayed until December 2001, and resumption of drilling operations on the Redwood prospect were delayed until January 2002. The Flathead prospect, located in Walker Ridge Block 30, was plugged back to a shallower depth and temporarily abandoned. After further evaluations, Marathon will consider possible options to reenter and sidetrack this well. Marathon holds a 100 percent interest in Block 30. The Redwood prospect, located in Green Canyon Block 1001, completed drilling operations in 2002 and was abandoned as a dry hole. Marathon held a 75 percent interest in Block 1001. Marathon held an 8.25 percent interest in the Timber Wolf prospect, located in Mississippi Canyon 555, which was temporarily abandoned pending further evaluation. Additionally, Marathon participated in the drilling of two other Gulf prospects in 2001. The Paris Carver prospect, located in Green Canyon Block 601, did not encounter hydrocarbons and was abandoned. Marathon holds a 50 percent interest in Block 601. The Ozona Deep prospect, located in Garden Banks Block 515 resulted in a deepwater discovery. The well was drilled to a total measured depth of 26,352 feet and encountered approximately 345 feet of net pay in two primary intervals. Further appraisal drilling is expected to be conducted during 2002 to determine a plan of development. Marathon is operator and has a 68 percent working interest. The Camden Hills field, located in the deepwater Gulf on Mississippi Canyon Block 348 in approximately 7,200 feet of water, was discovered in August 1999 and confirmed by a subsequent well in January 2000. Development is being achieved with the sharing of infrastructure that will service two other fields in the area. The Canyon Express natural gas gathering system will link three gas fields, including Camden Hills, to a host processing platform named Canyon Station. Completion of the discovery well is underway, and installation of the Canyon Express pipeline began in January 2002 after a three-month delay in obtaining permits. Despite the delays, first gas production continues to be targeted for mid-2002. Marathon is operator of the Camden Hills field with a 50.03 percent interest. Alaska - During 2001, Marathon completed successful drilling operations on six wells in Alaska. Included in this program were two exploration wells related to the recently announced natural gas discovery on the Ninilchik Unit on the Kenai Peninsula, approximately 35 miles south of Kenai, Alaska. Proved remaining reserves at year-end 2001 are approximately 19 billion net cubic feet ("bcf") of natural gas. One well is scheduled for drilling in 2002, with additional drilling anticipated during 2003 to further delineate the upside potential of the structure. Marathon is operator of the Ninilchik Unit with a 60 percent interest. Marathon and a co-venturer have formed the Kenai Kachemak Pipeline Company, LLC, to transport natural gas from the Ninilchik Unit and other potential southern Kenai Peninsula gas prospects for sales into the existing Cook Inlet natural gas infrastructure. Initial production from the Ninilchik Field is planned for early 2004 commensurate with completion of pipeline construction. Marathon announced first natural gas production from its 100 percent owned Wolf Lake Field in November 2001. The Wolf Lake Field is located within the Kenai National Wildlife Refuge approximately 12 miles northeast of Soldotna, Alaska. Ultimate development at the Wolf Lake Field may require up to six natural gas wells at three sites. One well is expected to be drilled in 2002. New Mexico - In 2001, nine development wells were completed in the Indian Basin field to take advantage of Marathon's earlier expansion of the Indian Basin gas plant. Focus continued this year in the eastern area of the field which accounted for seven of the new wells. These wells extended last year's record gross production of 160 million cubic feet per day ("mmcfd") to 180 mmcfd from Marathon-operated wells. These new wells, combined with several recompletions of existing gas wells, more than doubled oil production from the field to 6,500 gross barrels of liquid hydrocarbons a day ("bpd"). In 2002, six new well completions and several recompletions are planned in the east Indian Basin area targeting both oil and gas. Oklahoma - Marathon's 2001 Southern Anadarko Basin exploration efforts focused on a continued Western Oklahoma Granite Wash program, as well as the Cement field Springer/Sycamore play. Exploration drilling efforts resulted in seven successful discoveries. The acquisition of approximately 250 square miles of 3-D seismic data has helped in identifying seven exploration projects (five Granite Wash, two Cement) that are scheduled to be drilled in 2002. 10Marathon continued to develop the 1998 Granite Wash discovery by drilling 16 development wells in 2001. Current production rates from the Granite Wash play are approximately 24 net mmcfd and 1,300 net bpd. In 2002, current plans are to drill, or participate in the drilling of, 14 additional Granite Wash development wells. Marathon drilled, or participated in the drilling of, 13 development wells in the Carter Knox field in 2001. Most of this activity focused on completing the development plan associated with properties acquired in 2000. Drilling activity continued in the Cement field where efforts focused on continued Springer/Sycamore development. Six development wells were drilled in 2001, resulting in current production rates of 24 net mmcfd, a 60 percent increase over 2000 levels. In 2002, Marathon expects to drill, or participate in the drilling of, eight additional development wells. Texas - In West Texas, Marathon formed a joint venture with Kinder Morgan Energy Partners, L.P. ("Kinder Morgan"), which commenced operations in January 2001. The formation of the joint venture included contribution of interests in the Yates and SACROC assets. Marathon and Kinder Morgan have equal voting rights and control is shared equally by both partners. As such, the joint venture is accounted for on the equity method of accounting in which Marathon recognizes its 85 percent share of earnings from the partnership. This transaction has allowed Marathon to expand its interests in the Permian Basin and has improved access to materials for use in enhanced recovery techniques in the Yates field. Wyoming - On February 9, 2001, Marathon completed the acquisition of Pennaco Energy Company ("Pennaco"), creating a new core area of coal bed methane production in the Powder River Basin of Wyoming. Pennaco controls more than 400,000 net acres in northeast Wyoming and southeast Montana and is the third largest operator in this very active play. Marathon was successful in retaining the Pennaco expertise in coal bed methane operations and, as a result, was able to execute a significant 2001 drilling program of approximately 660 net wells, which exceeded previous Pennaco annual records. For 2001, annualized production rates averaged 47 net mmcfd, with the December rate reaching 59 net mmcfd. Proved remaining reserves at year-end 2001 are approximately 256 net bcf of natural gas. International Outside the United States during 2001, Marathon drilled 31 gross (18 net) exploratory wells in 6 countries. Of these 31 wells, 22 gross (14 net) wells encountered hydrocarbons, of which 1 gross well was temporarily suspended. Marathon's expenditures for international oil and natural gas exploration activities, including Marathon's 50 percent equity interest in CLAM's exploration expenditures and former 37.5 percent equity interest in Sakhalin Energy's exploration expenditures, during the three-year period ended December 31, 2001, totaled $338 million, of which $91 million was incurred in 2001. Marathon's international development expenditures, including its proportionate share of CLAM and Sakhalin Energy's development expenditures, during the three-year period ended December 31, 2001, totaled $722 million, of which $265 million was incurred in 2001. On January 3, 2002, Marathon announced the completed acquisition of interests in Equatorial Guinea, West Africa. Through this transaction, Marathon acquired a 52.4 percent interest in, and operatorship of, the offshore Alba Block, which contains the currently producing Alba gas field as well as undeveloped oil and gas discoveries and several possible exploration prospects; a 37.6 percent interest in the adjacent offshore Block D; a 52.4 percent interest in a condensate separation facility onshore Bioko Island; a 45 percent interest in a joint venture onshore methanol production plant; and a 43.2 percent interest in an onshore Liquefied Petroleum Gas ("LPG") processing plant. The acquisition will provide an estimated 250 million barrels of oil equivalent ("BOE") to Marathon's proved reserves in 2002. The following is a summary of recent, significant exploration and development activity outside the United States including discussion, as deemed appropriate, of completed wells, wells being drilled and wells under evaluation. United Kingdom - Marathon has interests in 34 blocks in the United Kingdom ("U.K.") and other areas offshore of the U.K. In 2000, Marathon acquired an interest in the BP-operated Foinaven development in the U.K. Atlantic Margin. Marathon's interest is 28 percent in the main Foinaven field (T34), 20 percent in the deeper T35 Foinaven field and 47 percent in the East Foinaven field. First production was achieved in September 2001 from the East Foinaven field, which is estimated to have proved net remaining reserves at year-end 2001 of approximately 14 million barrels of liquid hydrocarbons. The satellite field is produced via subsea completions that flow into the existing floating production, storage and offloading ("FPSO") vessel. A third production well is planned at East Foinaven in 2003. Infill drilling in the main Foinaven field was successful in 2001 with one 11sidetrack, one water injector and two new producers being brought on line. Infill drilling of two additional production wells is expected to continue through spring 2002. Fluid handling upgrades on the FPSO in 2001 have allowed record daily production levels for the field of 132,300 gross bpd. As an interest owner in Foinaven, Marathon also has an 11.465 percent working interest in the West of Shetland gas evacuation line. The line, which is installed and ready for commissioning, will take gas from fields in the West of Shetlands area to the BP-operated Magnus platform for injection and enhanced oil recovery purposes. Gas from the Foinaven field, which is currently injected for disposal, will be sold to the Magnus group, with sales expected to commence in early 2002 upon completion of work by the Magnus group. Marathon is continuing its development of the Brae area in the U.K. North Sea where it is the operator and owns a 41.6 percent interest in the South, Central and North Brae fields and a 38.5 percent interest in the East Brae field. Marathon's share in the West Brae/Sedgwick joint development increased from 28.1 percent to 41.6 percent in September 2001 when the limit on Sedgwick's share of production from the development was reached. During 2001, Marathon participated in a successful Brae area well that was drilled to a deeper exploration target. The well was completed as a gas and condensate producer from the Brae B platform in June 2001. Well performance continues to be monitored to assess upside potential. Angola - In May 1999, Marathon was awarded interests in Blocks 31 and 32 offshore Angola. The blocks, which are located approximately 90 miles northwest of Luanda in water depths between 5,400 and 9,200 feet, are adjacent to Blocks 15, 17 and 18, where major discoveries by others have been made. Marathon presently holds a 10 percent working interest in Blocks 31 and 32, which are operated by co-venturers. Surveys of 3-D seismic data have been acquired over both blocks and advanced processing and interpretation of this data continues. One unsuccessful exploration well was drilled on Block 31 in 2001. Two additional wells in Block 31 are scheduled to begin drilling in the second and third quarters of 2002. The initial exploration well in Block 32 is expected to be drilled during the second half of 2002. Canada - In November 2001, Marathon was awarded two additional offshore Nova Scotia deepwater exploration licenses, with an effective date of January 1, 2002. Marathon has a 100 and 50 percent interest in exploration licenses ("EL") 2410 and 2411, respectively. This brings Marathon's total offshore Nova Scotia exploration license acreage to 1.9 million acres, positioning Marathon as a major player in the developing deepwater Atlantic Canada Gas Province. One shallow-water well was drilled in 2001 in EL 2376 (Southampton), which did not encounter hydrocarbons in commercial quantities. It is anticipated that one deepwater well will be completed in EL 2377 (Annapolis) in 2002. In Western Canada, Marathon anticipates drilling six wells in three exploration plays during 2002. Three wells will test the Milo pinnacle reef play, two wells will test the thrust Debolt foothills play, and one well will test a Southern Alberta tight gas sand play. Five of these wells are expected to be completed late first quarter 2002. Denmark - In June 1998, Marathon acquired one block in Denmark. A 3-D seismic program was completed in 1999, and evaluation of the data continues in 2002. Gabon - In fourth quarter 2001, activities commenced to develop the Azile reservoir of the Tchatamba South field. One existing well is planned for recompletion, and facilities will be added to process the crude oil, which has a higher sulfur content than the existing production. First production from the Azile reservoir is planned for December 2002. Marathon is operator of the Tchatamba South, West and Marin fields in Gabon, with a 56.25 percent working interest. Ireland - The Southwest Kinsale field was converted to a gas storage field in 2001. The Southwest Kinsale field, located in the Celtic Sea 30 miles south of Cork, was brought on line in 1999 through a single subsea well tied back to the Kinsale Head field's Bravo platform. In April 2001, gas injection commenced through this existing well and, by October 2001, two additional wells were drilled and tied back to the existing infrastructure. This gas storage facility, which is the first in Ireland, was fully operational in October 2001. Marathon has a 100 percent interest in this field. During 2001, a Petroleum Lease was issued for the Corrib field in the Slyne Trough License 2/93, located 40 miles off the west coast of Ireland. An additional appraisal well was drilled in the field in 2001, bringing the total number of wells drilled and suspended as producers in the Corrib field to five. Development work on the terminal, offshore pipelines, and subsea well equipment will continue during 2002. First gas production is expected at the beginning of 2004. Marathon has an 18.5 percent interest in the Corrib field. Norway - In 2000, Marathon participated in a project to modify the Heimdal platform to a processing and transportation center for third-party business. Marathon owns a 23.798 percent interest in the Heimdal field and platform. Production of the remaining gas (remnant gas) from the Heimdal field was reinstated on the platform in August 2001, followed by the start-up of two planned third-party projects. 12In November 2000, Marathon approved the development of the Vale field, located northeast of the Heimdal field. The single well was successfully drilled and the flowline installed. Topside modifications on the Heimdal platform continue, and the well is expected to be completed and brought on line second quarter 2002. Marathon owns a 46.904 percent interest in this field. An exploration well between the Vale and Heimdal fields has been deferred until 2003 due to platform capacity constraints. In January 2002, Marathon closed its acquisition of varied interests in five licenses in the Norwegian Sector of the North Sea. In the Heimdal area of the North Sea, Marathon acquired an 18.6 percent interest in License 088, which contains the Peik gas condensate discovery; a 20 percent interest in License 102, which contains the Byggve and Skirne gas discoveries and the East Heimdal oil discovery; and a 10 percent interest in License 150, which also contains an oil discovery. Approval of a plan of development is expected in early 2002 for combined development of the Byggve and Skirne fields with first production expected in early 2004. Close to the Brae fields, Marathon acquired a 28.2 percent interest in License 025, which contains the Gudrun oil and gas condensate discovery; and a 10 percent interest in adjacent License 187. In December 2001, Marathon also successfully bid for an additional license in the Heimdal area. Pending Norwegian governmental approvals, this could result in Marathon becoming operator under the license in 2002. Netherlands - In 2001, Marathon, through its 50 percent equity interest in CLAM, participated in one development well and four exploration wells in the Dutch sector of the North Sea. The Q4-A3 development well successfully completed the planned development of the Q4-A field. CLAM has a 19.8 percent interest in the field. The exploration well K15-16 was drilled into the K15- Mike Prospect and discovered the K15-FK field. It was suspended as a future producer. CLAM has a 9.95 percent interest in the K15-FK field. The Q4-10 exploratory well was drilled into the Q1-Deep Prospect, discovering the Q1-B field. The well was suspended as a future producer. CLAM has a 3.6 percent interest in the field. Two delineation wells were drilled into potential extensions of the F16-E field. The E18-4 well proved up additional reserves and was suspended as a future producer. The E18-5 well was abandoned as a dry hole. CLAM's interest in the F16-E field is 4.2 percent. In 1998, CLAM was awarded two blocks in the Danish sector of the North Sea. Surveys of 3-D seismic data were acquired in 1999 and two exploration wells were drilled in 2000, both of which were dry. CLAM is seeking ways of meeting the minimum requirements of the Danish authorities for relinquishment of the two blocks at a minimum cost. Independent of its interest in CLAM, Marathon holds a 24 percent working interest in the A-15 Block in the Dutch sector of the North Sea. Evaluation of the deeper sands is expected to continue during 2002. The above discussions include forward-looking statements concerning various projects, plans to acquire interests in licenses, drilling plans, expected production and sales levels, reserves and dates of initial production, which are based on a number of assumptions, including (among others) prices, amount of capital available for exploration and development, worldwide supply and demand for petroleum products, regulatory constraints, reserve estimates, production decline rates of mature fields, reserve replacement rates, drilling rig availability, license relinquishments and other geological, operating and economic considerations. Offshore production and marine operations in areas such as the Gulf of Mexico, the North Sea, the U.K. Atlantic Margin, the Celtic Sea, offshore Nova Scotia and offshore West Africa are also subject to severe weather conditions, such as hurricanes or violent storms or other hazards. The plan to acquire an additional license in the Norwegian sector of the North Sea is subject to the execution and closing of definitive agreements, and the receipt of necessary approvals from the applicable Norwegian authorities. In addition, development of new production properties in countries outside the United States may require protracted negotiations with host governments and is frequently subject to political considerations and tax regulations, which could adversely affect the economics of projects. To the extent these assumptions prove inaccurate and/or negotiations and other considerations are not satisfactorily resolved, actual results could be materially different than present expectations. Reserves At December 31, 2001, Marathon's net proved liquid hydrocarbon and natural gas reserves, including its proportionate share of equity investee net proved reserves, totaled approximately 1 billion barrels on a barrel of oil equivalent ("BOE") basis, of which 72 percent were located in the United States. (For purposes of determining BOE, natural gas volumes are converted to approximate liquid hydrocarbon barrels by dividing the natural gas volumes expressed in thousands of cubic feet ("mcf") by 6. The liquid hydrocarbon volume is added to the barrel equivalent of gas volume to obtain BOE.) On a BOE basis, excluding dispositions, Marathon replaced 62 percent of its worldwide oil and gas production. 13The table below sets forth estimated quantities of net proved oil and gas reserves at the end of each of the last three years. Estimated Quantities of Net Proved Oil and Gas Reserves at December 31
Developed & Developed Undeveloped ----------------- ----------------- (Millions of Barrels) 2001 2000 1999 2001 2000 1999 - --------------------------------------------------------------------------------Liquid Hydrocarbons United States............................ 243 414 476 268 458 520 Europe................................... 69 74 90 88 108 90 Other International...................... 25 57 72 30 151 187 ----- ----- ----- ----- ----- ----- Total Consolidated...................... 337 545 638 386 717 797 Equity Investees(a)...................... 178 - 69 184 - 77 ----- ----- ----- ----- ----- ----- WORLDWIDE.................................. 515 545 707 570 717 874 ===== ===== ===== ===== ===== ===== Developed reserves as % of total net proved reserves.................................. 90.4% 76.0% 80.9%(Billions of Cubic Feet)Natural Gas Natural Gas United States................ 1,308 1,421 1,550 1,793 1,914 2,057 Europe................................... 473 563 741 615 614 774 Other International...................... 308 381 497 399 477 833 ----- ----- ----- ----- ----- ----- Total Consolidated...................... 2,089 2,365 2,788 2,807 3,005 3,664 Equity Investee(b)....................... 32 52 65 51 89 123 ----- ----- ----- ----- ----- ----- WORLDWIDE.................................. 2,121 2,417 2,853 2,858 3,094 3,787 ===== ===== ===== ===== ===== ===== Developed reserves as % of total net proved reserves.................................. 74.2% 78.1% 75.3%(Millions of Barrels)Total BOEs United States............................ 461 651 734 567 777 863 Europe................................... 148 168 213 190 211 219 Other International...................... 76 121 155 96 231 326 ----- ----- ----- ----- ----- ----- Total Consolidated...................... 685 940 1,102 853 1,219 1,408 Equity Investees(a)...................... 183 9 80 193 15 98 ----- ----- ----- ----- ----- ----- WORLDWIDE.................................. 868 949 1,182 1,046 1,234 1,506 ===== ===== ===== ===== ===== ===== Developed reserves as % of total net proved reserves.................................. 83.0% 76.9% 78.5% - --------------------------------------------------------------------------------(a) Represents Marathon's equity interests in MKM and CLAM in 2001 and CLAM and Sakhalin Energy in 2000 and 1999. (b) Represents Marathon's equity interests in CLAM. The above estimates, which are forward-looking statements, are based on a number of assumptions, including (among others) prices, presently known physical data concerning size and character of the reservoirs, economic recoverability, production experience and other operating considerations. To the extent these assumptions prove inaccurate, actual recoveries could be materially different than current estimates. For additional details of estimated quantities of net proved oil and gas reserves at the end of each of the last three years, see "Consolidated Financial Statements and Supplementary Data - Supplementary Information on Oil and Gas Producing Activities - Estimated Quantities of Proved Oil and Gas Reserves" on pages F-36 through F-38. Marathon has filed reports with the U.S. Department of Energy ("DOE") for the years 2000 and 1999 disclosing the year- end estimated oil and gas reserves. Marathon will file a similar report for 2001. The year-end estimates reported to the DOE are the same as the estimates reported in the Consolidated Supplementary Data. Delivery Commitments Marathon has commitments to deliver fixed and determinable quantities of natural gas to customers under a variety of contractual arrangements. In Alaska, Marathon has two long-term sales contracts with the local utility companies, which obligates Marathon to supply approximately 270 bcf of natural gas over the remaining life of these contracts. In addition, Marathon has a 30 percent ownership interest in a Kenai, Alaska, liquefied natural gas ("LNG") plant and a proportionate share of the long-term LNG sales obligation to two Japanese utility companies. This obligation is 14estimated to total 178 bcf through the remaining life of the contract, which terminates March 31, 2009. These commitments are structured with variable- pricing terms. Marathon's production from various gas fields in the Cook Inlet supply the natural gas to service these contracts. Marathon's proved reserves and estimated production rates in the Cook Inlet sufficiently meet these contractual obligations. In the U.K., Marathon has two long-term sales contracts with utility companies, which obligate Marathon to supply approximately 269 bcf of natural gas over the remaining life of these contracts. Marathon's Brae-area production, together with natural gas acquired for injection and subsequent resale, will supply the natural gas to service these contracts. Marathon's Brae-area proved reserves, acquired natural gas contracts and estimated production rates sufficiently meet these contractual obligations. The terms of these gas sales contracts also reflect variable-pricing structures. Oil and Gas Acreage The following table sets forth, by geographic area, the developed and undeveloped oil and gas acreage that Marathon heldSeparation as of December 31,2001: Gross and Net Acreage
Developed & Developed Undeveloped Undeveloped ----------- ------------ ------------ (Thousands of Acres) Gross Net Gross Net Gross Net - --------------------------------------------------------------------------------United States............................. 1,955 845 3,435 1,862 5,390 2,707 Europe.................................... 351 289 1,843 881 2,194 1,170 Other International....................... 889 521 6,111 2,190 7,000 2,711 ----- ----- ------ ----- ------ ----- Total Consolidated........................ 3,195 1,655 11,389 4,933 14,584 6,588 Equity Investees(a)....................... 529 63 302 69 831 132 ----- ----- ------ ----- ------ ----- WORLDWIDE................................. 3,724 1,718 11,691 5,002 15,415 6,720 - --------------------------------------------------------------------------------(a) Represents Marathon's equity interests in MKM and CLAM. Oil and Natural Gas Production The following tables set forth daily average net production of liquid hydrocarbons and natural gas for each of the last three years: Net Liquid Hydrocarbons Production(a)
(Thousands of Barrels per Day) 2001 2000 1999 - --------------------------------------------------------------------------------United States(b).............................................. 127 131 145 Europe(c)..................................................... 46 29 31 Other International(c)........................................ 27 36 31 ----- ----- ----- Total Consolidated.......................................... 200 196 207 Equity Investees (MKM, CLAM & Sakhalin Energy)(c)............. 9 11 1 ----- ----- ----- WORLDWIDE..................................................... 209 207 208 ===== ===== ===== Net Natural Gas Production(d)(Millions of Cubic Feet per Day)United States(b).............................................. 793 731 755 Europe(e)..................................................... 318 327 326 Other International(e)........................................ 123 143 163 ----- ----- ----- Total Consolidated.......................................... 1,234 1,201 1,244 Equity Investees (CLAM and MKM)(e)............................ 31 29 36 ----- ----- ----- WORLDWIDE..................................................... 1,265 1,230 1,280 - --------------------------------------------------------------------------------(a) Includes crude oil, condensate and natural gas liquids. (b) Amounts reflect production from leasehold ownership, after royalties and interests of others. (c) Amounts reflect equity tanker liftings, truck deliveries and direct deliveries of liquid hydrocarbons before royalties, if any, excluding Canada, Gabon, Russia and the United States where amounts shown are after royalties. The amounts correspond with the basis for fiscal settlements with governments. Crude oil purchases, if any, from host governments are not included. (d) Amounts exclude volumes purchased from third parties for injection and subsequent resale of 8 mmcfd in 2001 and 11 and 16 mmcfd in 2000 and 1999, respectively. (e) Amounts reflect production before royalties, excluding Canada and the United States where amounts shown are after royalties. 15At year-end 2001, Marathon was producing crude oil and/or natural gas in seven countries, including the United States. Marathon's worldwide liquid hydrocarbon production, including Marathon's proportionate share of equity investees' production, increased one percent over 2000 levels. Marathon's 2001 worldwide sales of natural gas production, including Marathon's proportionate share of equity investees' production, increased approximately three percent from 2000. In addition to sales of 441 net mmcfd of international natural gas production, Marathon sold 8 net mmcfd of natural gas acquired for injection and resale during 2001. In total, Marathon's 2001 worldwide production averaged 421,000 BOE per day. In2002Marathon's worldwide production is expected to average 430,000 BOE per day. The above projection of 2002 worldwide liquid hydrocarbon production and natural gas volumes is a forward-looking statement. Some factors that could potentially affect timing and levels of production include pricing, supply and demand for petroleum products, amount of capital available for exploration and development, regulatory constraints, reserve estimates, reserve replacement rates, production decline rates of mature fields, timing of commencing production from new wells, drilling rig availability, future acquisitions of producing properties, and other geological, operating and economic considerations. These factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statement. United States Including Marathon's proportionate share of equity investee production, approximately 65 percent of Marathon's 2001 worldwide liquid hydrocarbon production, and 63 percent of its worldwide natural gas production were from domestic operations. Marathon's principal domestic producing areas are located in the U.S. Gulf of Mexico and the states of Alaska, New Mexico, Oklahoma, Texas and Wyoming. Marathon's ongoing domestic growth strategy is to apply its technical expertise in fields with undeveloped potential, to dispose of interests in non-core properties with limited upside potential and high production costs, and to acquire significant working interests in properties with high development potential. Gulf of Mexico - During 2001, Marathon's Gulf of Mexico production averaged 71,600 net bpd of liquid hydrocarbons and 112 net mmcfd of natural gas, representing 53 percent and 14 percent of Marathon's total U.S. liquid hydrocarbon and natural gas production, respectively. Liquid hydrocarbon and natural gas production increased by 10,000 net bpd and by 24 net mmcfd, respectively, from the prior year, mainly due to the ramp up and full year's production from Viosca Knoll 786 (Petronius) and the addition of Ursa which Marathon acquired in the December 2000 Sakhalin Energy exchange with Shell. At year-end 2001, Marathon held working interests in 9 producing fields and 17 platforms, of which 7 platforms are operated by Marathon. Production from Marathon's interests in the deepwater Gulf accounted for approximately 93 percent of total Gulf of Mexico production in 2001. Major components of Marathon's deepwater portfolio include the Marathon-operated Ewing Bank 873, 917, and 963 and the co-venturer operated Green Canyon 244 and Viosca Knoll 786. Alaska - Marathon's production from Alaska averaged 179 net mmcfd of natural gas in 2001, compared with 160 net mmcfd in 2000. Marathon's primary focus in Alaska is the expansion of its natural gas business through exploration, development and marketing. New Mexico - Production in New Mexico, primarily from the Indian Basin field, averaged 15,000 net bpd and 150 net mmcfd in 2001, compared with 12,600 net bpd and 121 net mmcfd in 2000. The increase in gas production was primarily due to ongoing development of the eastern area of the Indian Basin field and was preceded by the expansion in 2000 of Marathon's Indian Basin Gas Plant. Oklahoma - Gas production for 2001 averaged 124 net mmcfd, representing 16 percent of Marathon's total U.S. gas production, compared with 151 net mmcfd in 2000. The decrease in gas production was primarily due to the decline in Knox Morrow production. Texas - Onshore production for 2001 averaged 17,400 net bpd of liquid hydrocarbons and 111 net mmcfd of natural gas, representing 13 percent of Marathon's total U.S. liquid hydrocarbon and 14 percent of natural gas production. Liquid production volumes decreased by 6,000 net bpd from 2000 levels, and gas volumes decreased by 21 net mmcfd from 2000 levels. The volume decreases were mainly due to natural decline and reduced net volumes from the Yates field due to the contribution of Yates assets to the MKM joint venture. Wyoming - Liquid hydrocarbon production for 2001 averaged 24,600 net bpd, representing 18 percent of Marathon's total U.S. liquid hydrocarbon production. Average gas production increased to 90 net mmcfd in 2001 compared to 45 net mmcfd in 2000, as a result of the Pennaco acquisition. 16International Marathon holds interests in liquid hydrocarbon and/or natural gas production in the U.K. North Sea, the U.K. Atlantic Margin, the Irish Celtic Sea, the Norwegian North Sea, Canada and Gabon. In addition, Marathon has interests through an equity investee in the Netherlands North Sea and recently completed an acquisition of interests in Equatorial Guinea, West Africa. U.K. North Sea - Production from the Brae area averaged 21,700 net bpd of liquid hydrocarbons in 2001, compared with 26,500 net bpd in 2000. The decrease is mainly within the Central and East Brae fields, reflecting field decline. The Brae A platform and facilities act as the host for the underlying South Brae field, adjacent Central Brae field and West Brae/Sedgwick fields. The North Brae field, which is produced via the Brae B platform, and the East Brae field are gas condensate fields. These fields are produced using the gas cycling technique, whereby gas is injected into the reservoir for pressure maintenance, improved sweep efficiency and increased condensate liquid recovery. Although partial cycling continues, the majority of North Brae gas is being transferred to the East Brae reservoir for pressure maintenance and sales. The strategic location of the Brae A, Brae B and East Brae platforms and pipeline infrastructure has generated significant third-party processing and transportation business since 1986. Currently, there are 14 agreements with third-party fields contracted to use the Brae system. In addition to generating processing and pipeline tariff revenue, this third-party business also has a favorable impact on Brae area operations by optimizing infrastructure usage and extending the economic life of the facilities. Marathon owns a 41.6 percent interest in the Brae group which owns a 50 percent interest in the Scottish Area Gas Evacuation ("SAGE") system. The other 50 percent is owned by the Beryl group, which operates the system. The SAGE system provides pipeline transportation and onshore processing for Brae- area gas and has a total wet gas capacity of approximately 1.0 bcfd. Pipelines connect the Brae, Britannia, Beryl and Scott fields to the SAGE gas processing terminal at St. Fergus in northeast Scotland. Marathon's total United Kingdom gas sales from all sources averaged 242 net mmcfd in 2001, compared with 223 net mmcfd in 2000. Of these totals, 234 mmcfd and 212 mmcfd was Brae-area gas in 2001 and 2000, respectively, and 8 mmcfd and 11 mmcfd was gas acquired for injection and subsequent resale in 2001 and 2000, respectively. U.K. Atlantic Margin - Production from the Foinaven fields averaged 24,300 net bpd of liquid hydrocarbons in 2001. Ireland - Marathon holds a 100 percent working interest in the Kinsale Head, Ballycotton and Southwest Kinsale fields in the Irish Celtic Sea. Natural gas sales were 79 net mmcfd in 2001, compared with 115 net mmcfd in 2000. This reduction is due to natural field declines and changes to the production profile of the Southwest Kinsale field. The Southwest Kinsale field has been converted to a gas storage reservoir, where gas is injected in the summer and produced to meet peak demand in the winter. Norway - In the Norwegian North Sea, Marathon holds a 23.8 percent working interest in the Heimdal field. Production of the remaining remnant gas from Heimdal commenced in August 2001 with sales of 5 net mmcfd. Marathon also holds a 46.904 percent working interest in the Vale field. The Vale single well sub-sea development will be tied back to the Heimdal platform, with first production expected early 2002. Canada - Production in Canada averaged 11,000 bpd and 123 mmcfd in 2001, compared with 18,400 bpd and 143 mmcfd in 2000. During 2001, Marathon executed a strategic plan to rationalize operations in Western Canada. As a result, Marathon disposed of a significant number of non-core conventional oil and gas properties as well as all heavy oil assets, equating to approximately 127 million BOE of net remaining proved reserves. Annualized production sold approximated 9,800 net bpd and 30 net mmcfd. Gabon - Production in Gabon averaged 16,000 net bpd of liquid hydrocarbons in 2001, compared with 15,800 net bpd in 2000. This increase reflected a full year of production from the Cap Lopez formation of the Tchatamba South field, which began production in December 2000, and a full year of production from the Tchatamba West field, which began production in November 2000. These additions were partially offset by a reduction in Marathon's net share of gross production, based on the payout terms of the production sharing contract with Gabonese authorities. 17Netherlands - Marathon's 50 percent equity interest in CLAM provides a 5 percent entitlement in the production from 25 gas fields, which provided sales of 31 net mmcfd of natural gas in 2001, compared with 29 net mmcfd in 2000. The following tables set forth productive wells and service wells for each of the last three years and drilling wells as of December 31, 2001. Gross and Net Wells
2001 Productive Wells(a) - ---- ------------------------ Service Drilling Oil Gas Wells(b) Wells(c) ------------ ----------- ----------- --------- Gross Net Gross Net Gross Net Gross Net - --------------------------------------------------------------------------------United States.................... 6,550 2,415 4,828 2,935 2,852 856 25 18 Europe........................... 53 20 63 35 27 8 3 1 Other International.............. 508 251 1,352 986 52 25 3 1 ------ ----- ----- ----- ----- ----- --- --- Total Consolidated............. 7,111 2,686 6,243 3,956 2,931 889 31 20 Equity Investees(d).............. 2,002 609 83 4 1,142 243 1 0 ------ ----- ----- ----- ----- ----- --- --- WORLDWIDE........................ 9,113 3,295 6,326 3,960 4,073 1,132 32 20 ====== ===== ===== ===== ===== ===== === ===2000(e) Productive Wells(a) - ------- ------------------------ Service Oil Gas Wells(b) ------------ ----------- ----------- Gross Net Gross Net Gross NetUnited States.................... 8,013 3,113 2,526 1,275 3,103 976 Europe........................... 54 18 66 34 25 9 Other International.............. 927 665 1,450 1,084 136 109 ------ ----- ----- ----- ----- ----- Total Consolidated............. 8,994 3,796 4,042 2,393 3,264 1,094 Equity Investee(d)............... - - 85 5 - - ------ ----- ----- ----- ----- ----- WORLDWIDE........................ 8,994 3,796 4,127 2,398 3,264 1,094 ====== ===== ===== ===== ===== =====1999 Productive Wells(a) - ---- ------------------------ Service Oil Gas Wells(b) ------------ ----------- ----------- Gross Net Gross Net Gross NetUnited States.................... 8,654 3,205 3,122 1,396 3,617 1,056 Europe........................... 36 14 65 33 18 7 Other International.............. 1,590 754 1,746 1,214 461 133 ------ ----- ----- ----- ----- ----- Total Consolidated............. 10,280 3,973 4,933 2,643 4,096 1,196 Equity Investees(d).............. 5 2 83 4 1 - ------ ----- ----- ----- ----- ----- WORLDWIDE........................ 10,285 3,975 5,016 2,647 4,097 1,196 - --------------------------------------------------------------------------------(a) Includes active wells and wells temporarily shut-in. Of the gross productive wells, gross wells with multiple completions operated by Marathon totaled 442, 469 and 478 in 2001, 2000 and 1999, respectively. Information on wells with multiple completions operated by other companies is not available to Marathon. (b) Consist of injection, water supply and disposal wells. (c) Consist of exploratory and development wells. (d) Represents MKM and CLAM in 2001, CLAM in 2000 and CLAM and Sakhalin Energy in 1999. (e) Certain amounts have been restated. 18Refining, Marketing and Transportation Refining, Marketing and Transportation ("RM&T") operations are primarily conducted by MAP and its subsidiaries, including its wholly-owned subsidiaries, Speedway SuperAmerica LLC and Marathon Ashland Pipe Line LLC. Marathon holds a 62 percent interest in MAP and Ashland Inc. holds the remaining 38 percent interest. Refining MAP owns and operates seven refineries with an aggregate refining capacity of 935,000 barrels of crude oil per day. The table below sets forth the location and daily throughput capacity of each of MAP's refineries as of December 31, 2001:
In-Use Refining Capacity (Barrels per Day) Garyville, LA............... 232,000 Catlettsburg, KY............ 222,000 Robinson, IL................ 192,000 Detroit, MI................. 74,000 Canton, OH.................. 73,000 Texas City, TX.............. 72,000 St. Paul Park, MN........... 70,000 ------- TOTAL....................... 935,000 =======MAP's refineries include crude oil atmospheric and vacuum distillation, fluid catalytic cracking, catalytic reforming, desulfurization and sulfur recovery units. The refineries have the capability to process a wide variety of crude oils and to produce typical refinery products, including reformulated gasoline. MAP's refineries are integrated via pipelines and barges to maximize operating efficiency. The transportation links that connect the refineries allow the movement of intermediate products to optimize operations and the production of higher margin products. For example, naphtha may be moved from Texas City and Catlettsburg to Robinson where excess reforming capacity is available, gas oil may be moved from Robinson to Detroit and Catlettsburg where excess fluid catalytic cracking unit capacity is available, and light cycle oil may be moved from Texas City to Robinson where excess desulfurization capacity is available. MAP also produces asphalt cements, polymerized asphalt, asphalt emulsions and industrial asphalts. MAP manufactures petroleum pitch, primarily used in the graphite electrode, clay target and refractory industries. Additionally, MAP manufactures aromatics, aliphatic hydrocarbons, cumene, base lube oil, polymer grade propylene and slack wax. 19During 2001, MAP's refineries processed 929,000 bpd of crude oil and 143,000 bpd of other charge and blend stocks. The following table sets forth MAP's refinery production by product group for each of the last three years: Refined Product Yields
(Thousands of Barrels per Day) 2001 2000 1999 - --------------------------------------------------------------------------------Gasoline...................................................... 581 552 566 Distillates................................................... 286 278 261 Propane....................................................... 22 20 22 Feedstocks & Special Products................................. 69 74 66 Heavy Fuel Oil................................................ 39 43 43 Asphalt....................................................... 76 74 69 ----- ----- ----- TOTAL......................................................... 1,073 1,041 1,027 ===== ===== =====Planned maintenance activities requiring temporary shutdown of certain refinery operating units ("turnarounds") are periodically performed at each refinery. MAP completed a major turnaround at its Detroit refinery in 2001. The Garyville, Louisiana coker unit project achieved mechanical completion in October 2001 and was operating at full production capacity by mid-December 2001. This unit allows for the use of heavier, lower-cost crude and reduces the production of heavy fuel oil. To supply this new unit, MAP entered into a multi-year contract with P.M.I. Comercio Internacional, S.A. de C.V. ("PMI"), an affiliate of Petroleos Mexicanos ("PEMEX"), to purchase approximately 90,000 bpd of heavy Mayan crude oil. Marketing In 2001, MAP's refined product sales volumes (excluding matching buy/sell transactions) totaled 19.3 billion gallons (1,259,000 bpd). Excluding sales related to matching buy/sell transactions, the wholesale distribution of petroleum products to private brand marketers and to large commercial and industrial consumers, primarily located in the Midwest, the upper Great Plains and the Southeast, and sales in the spot market, accounted for about 65 percent of MAP's refined product sales volumes in 2001. Approximately 47 percent of MAP's gasoline volumes and 82 percent of its distillate volumes were sold on a wholesale or spot market basis to independent unbranded customers or other wholesalers in 2001. 20MAP markets asphalt through owned and leased terminals throughout the Midwest and Southeast. The MAP customer base includes approximately 900 asphalt paving contractors, government entities (states, counties, cities and townships) and asphalt roofing shingle manufacturers. The following table sets forth the volume of MAP's consolidated refined product sales by product group for each of the last three years: Refined Product Sales
(Thousands of Barrels per Day) 2001 2000 1999 - --------------------------------------------------------------------------------Gasoline...................................................... 748 746 714 Distillates................................................... 345 352 331 Propane....................................................... 21 21 23 Feedstocks & Special Products................................. 71 69 66 Heavy Fuel Oil................................................ 41 43 43 Asphalt....................................................... 78 75 74 ----- ----- ----- TOTAL......................................................... 1,304 1,306 1,251 ===== ===== ===== Matching Buy/Sell Volumes included in above................... 45 52 45MAP sells reformulated gasoline in parts of its marketing territory, primarily Chicago, Illinois; Louisville, Kentucky; Northern Kentucky; and Milwaukee, Wisconsin. MAP also markets low-vapor-pressure gasoline in nine states.As of December 31,
2001, MAP supplied petroleum products to about 3,8002002, Marathonand Ashland branded retail outlets located primarily in Michigan, Ohio, Indiana, Kentucky and Illinois. Branded retail outlets are also located in Florida, West Virginia, Georgia, Wisconsin, Minnesota, Tennessee, Virginia, Pennsylvania, North Carolina, South Carolina and Alabama. In 2001, retail sales of gasoline and diesel fuel were also made through company-operated outlets by a wholly owned MAP subsidiary, Speedway SuperAmerica LLC ("SSA"). As of December 31, 2001, this subsidiary had 2,104 retail outlets in 16 states which sold petroleum products and convenience- store merchandise and services, primarily underhas identified thebrand names "Speedway" and "SuperAmerica". Excluding the travel centers contributed to Pilot Travel Centers LLC, as described below, SSA's revenuesfollowing obligations totaling $705 million that arise from thesaleSeparation ofconvenience- store merchandise totaled $2.3 billionUnited States Steel:$470 million of obligations under industrial revenue bonds related to environmental projects for current and former U. S. Steel Group facilities, with maturities ranging from 2009 through 2033 and related accrued interest payable of $5 million;$81 million of sale-leaseback financing obligations under a lease for equipment at United States Steel’s Fairfield Works facility, with the lease term extending to 2012, subject to extensions;$131 million of operating lease obligations, of which $78 million was in2001, compared with $2.2 billionturn assumed by purchasers of major equipment used in2000. Profit levelsplants and operations of United States Steel divested by Marathon;a guarantee of United States Steel’s $18 million contingent obligation to repay certain distributions fromthe sale of such merchandise and services tend to be less volatile than profit levels from the retail sale of gasoline and diesel fuel. Effective September 1, 2001, MAP and Pilot Corporation ("Pilot") completed a transaction to form Pilot Travel Centers LLC ("PTC"), which combined SSA's and Pilot's travel centers. Pilot and MAP each own aits 50 percentinterest in PTC. PTC is the largest operatorowned joint venture PRO-TEC Coating Company; anda guarantee oftravel centers in theall obligations of United Stateswith about 230 locations in 35 states. The travel centers offer diesel fuel, gasoline and a varietySteel as general partner ofother services, including on-premises brand-name restaurants. PTC provides MAP with the opportunity to participate in the travel center business on a nationwide basis. Supply and Transportation MAP obtains the crude oil it processes from negotiated contracts and spot purchases or exchanges. In 2001, MAP's net purchases of U.S. crude oil for refinery input averaged 403,000 bpd, including 28,000 bpd from Marathon. In 2001, 57 percent or 526,000 bpd of the crude oil processed by MAP's refineries was from foreign sources, including approximately 303,000 bpd from the Middle East. This crude was acquired from various foreign national oil companies, producing companies and traders. MAP operates a system of pipelines and terminals to provide crude oil to its refineries and refined products to its marketing areas. At December 31, 2001, MAP owned, leased or had an ownership interest in approximately 3,450 miles of crude oil trunk lines and 2,847 miles of products trunk lines. MAP owned a 46.7 percent interest in LOOP LLC ("LOOP"), which is the owner and operator of the only U.S. deepwater oil port, located 18 miles off the coast of Louisiana; a 49.9 percent interest in LOCAP LLC ("LOCAP"), which is the owner and operator of a crude oil pipeline connecting LOOP and the Capline system; and a 37.2 percent interest in the Capline system, a large diameter crude oil pipeline extending from St. James, Louisiana to Patoka, Illinois. MAP also has a 33.3 percent ownership interest in Minnesota Pipe Line Company, which operates a crude oil pipeline in Minnesota. Minnesota Pipe Line Company provides MAP with access to crude oil common carrier 21transportation from Clearbrook, Minnesota to Cottage Grove, Minnesota, which is in the vicinity of MAP's St. Paul Park, Minnesota, refinery. MAP has a 33.3 percent ownership interest in Centennial Pipeline LLC, a limited liability company formed to develop an interstate refined petroleum products pipeline extending from the U.S. Gulf of MexicoClairton 1314B Partnership, L.P. to theMidwest. In March 2001, the Federal Energy Regulatory Commission approved the abandonmentlimited partners, ofa 720-mile, 26-inch diameter pipeline extending from Longville, Louisiana to Bourbon, Illinois, from natural gas service, thereby allowing conversion to refined products service by Centennial Pipeline LLC. Also as part of the project, a two million barrel terminal storage facility has been constructed and a new 74-mile, 24-inch diameter pipeline extending from Beaumont, Texas, to Longville, Louisiana has been built. Marathon Ashland Pipe Line LLC has been designated operator of the pipeline. The Centennial Pipeline system will connect with existing MAP transportation assets and other common carrier lines. It is expected to be operational in the first quarter of 2002. A MAP subsidiary, Ohio River Pipe Line LLC ("ORPL"), plans to build a pipeline from Kenova, West Virginia to Columbus, Ohio. ORPL is a common carrier pipeline company, and the pipeline will be an interstate common carrier pipeline. The pipeline is currently known as Cardinal Products Pipe Line and is expected to initially move about 50,000 barrels per day of refined petroleum into the central Ohio region. As of December 2001, ORPL had secured all of the rights-of-way required to build the pipeline. Applications for the remaining construction permitswhich no outstanding unpaid amounts have beenfiled. Construction is currently planned for summer 2002 pending receipt of permits, with start-up of the pipeline to follow in first half 2003. MAP's 88 light product and asphalt terminals are strategically located throughout the Midwest, upper Great Plains and Southeast. These facilities are supplied by a combination of pipelines, barges, rail cars and/or trucks. MAP's marine transportation operations include towboats and barges that transport refined products on the Ohio, Mississippi and Illinois rivers, their tributaries and the Intercoastal Waterway. MAP also leases and owns rail cars in various sizes and capacities for movement and storage of petroleum products and a large number of tractors, tank trailers and general service trucks. The above RM&T discussions include forward-looking statements concerning anticipated pipeline projects. Some factors that could potentially cause actual results to differ materially from present expectations include (among others) price of petroleum products, levels of cash flow from operations, obtaining the necessary construction and environmental permits, unforeseen hazards such as weather conditions and regulatory approval constraints. This forward-looking information may prove to be inaccurate and actual results may differ significantly from those presently anticipated. Other Energy Related Businesses Natural Gas and Crude Oil Marketing and Transportation Marathon owns an interest in the following pipeline systems that were not contributed to MAP: Marathon has a 29 percent interest in Odyssey Pipeline LLC and a 28 percent interest in Poseidon Oil Pipeline Company, LLC, both Gulf of Mexico crude oil pipeline systems. Marathon has a 24 percent interest in Nautilus Pipeline Company, LLC and a 24 percent interest in Manta Ray Offshore Gathering Company, LLC, both Gulf of Mexico natural gas pipeline systems. Marathon has a 17 percent interest in Explorer Pipeline Company and a 2.5 percent interest in Colonial Pipeline Company, both light product pipeline systems extending from the Gulf of Mexico to the Midwest and East Coast, respectively. Marathon has a 30 percent ownership in a Kenai, Alaska, natural gas liquefication plant and two 87,500 cubic meter tankers used to transport liquefied natural gas ("LNG") to customers in Japan. Feedstock for the plant is supplied from a portion of Marathon's natural gas production in the Cook Inlet. From the first production in 1969, the LNG has been sold under a long- term contract with two of Japan's largest utility companies. Marathon has a 30 percent participation in this contract, which has been extended to continue through March 31, 2009. LNG deliveries totaled 66.5 gross bcf (20 net bcf) in 2001, up slightly from 2000. Marathon has a 34 percent ownership interest in the Neptune natural gas processing plant located in St. Mary Parish, Louisiana, which commenced operations on March 20, 2000. The plant has the capacity to process 300 mmcfd of natural gas, which is transported on the Nautilus pipeline system. 22In addition to the sale of its own oil and natural gas production, Marathon purchases oil and gas from third-party producers and marketers for resale. Power Generation Marathon, through its wholly owned subsidiary, Marathon Power Company, Ltd., pursues development, construction, ownership and operation of integrated gas and electric power projects in the global electrical power market. Competition and Market Conditions Strong competition exists in all sectors of the oil and gas industry and, in particular, in the exploration and development of new reserves. Marathon competes with major integrated and independent oil and gas companies for the acquisition of oil and gas leases and other properties, for the equipment and labor required to develop and operate those properties and in the marketing of oil and natural gas to end-users. Many of Marathon's competitors have financial and other resources substantially greater than those available to Marathon. As a consequence, Marathon may be at a competitive disadvantage in bidding for the rights to explore for oil and gas. Acquiring the more attractive exploration opportunities frequently requires competitive bids involving substantial front-end bonus payments or commitments to work programs. Marathon also competes with its competitors in attracting and retaining personnel, including geologist, geophysicists and other specialists. Based on industry sources, Marathon believes it currently ranks eighth among U.S.-based petroleum corporations on the basis of 2000 worldwide liquid hydrocarbon and natural gas production. Marathon through MAP must also compete with a large number of other companies to acquire crude oil for refinery processing and in the distribution and marketing of a full array of petroleum products. MAP believes it ranks sixth among U.S. petroleum companies on the basis of crude oil refining capacity as of January 1, 2002. MAP competes in four distinct markets - wholesale, spot, branded and retail distribution--for the sale of refined products and believes it competes with about 50 companies in the wholesale distribution of petroleum products to private brand marketers and large commercial and industrial consumers; about 84 companies in the sale of petroleum products in the spot market; 12 refiner/marketers in the supply of branded petroleum products to dealers and jobbers; and over 600 petroleum product retailers in the retail sale of petroleum products. Marathon also competes in the convenience store industry through SSA's retail outlets. The retail outlets offer consumers gasoline, diesel fuel (at selected locations) and a broad mix of other merchandise and services. Some locations also have on-premises brand-name restaurants such as Subway(TM) and Taco Bell(TM). Marathon's operating results are affected by price changes in crude oil, natural gas and petroleum products, as well as changes in competitive conditions in the markets it serves. Generally, results from production operations benefit from higher crude oil and natural gas prices while refining and marketing margins may be adversely affected by crude oil price increases. Market conditions in the oil and gas industry are cyclical and subject to global economic and political events. Employees Marathon had 30,671 active employees as of December 31, 2001, including 27,698 MAP employees.reported.Of the total
number$705 million, obligations ofMAP employees, 21,223$556 million and corresponding receivables from United States Steel wereemployeesrecorded on Marathon’s consolidated balance sheet. The remaining $149 million was related to off-balance sheet arrangements and contingent liabilities ofSpeedway SuperAmerica LLC, most of whom were employees at retail marketing outlets. Certain hourly employees at the Catlettsburg and Canton refineries are represented by the Paper, Allied-Industrial, Chemical and Energy Workers International Union under labor agreements that expired on January 31, 2002. Negotiations are underway on new collective bargaining agreements. Certain hourly employees at the Texas City refinery are represented by the same union under a labor agreement that is scheduled to expire on March 31, 2002. Certain hourly employees at the St. Paul Park and Detroit refineries are represented by the International Brotherhood of Teamsters under labor agreements that are scheduled to expire on May 31, 2002 and January 31, 2003, respectively. Properties The location and general character of the principal oil and gas properties, refineries and gas plants, pipeline systems and other important physical properties of Marathon are described above. Except for oil and gas producing properties, which generally are leased, or as otherwise stated, such properties are held in fee. The plants and facilities have been constructed or acquired over a period of years and vary in age and operating efficiency. At the 23date of acquisition of important properties, titles were examined and opinions of counsel obtained, but no title examination has been made specifically for the purpose of this document. The properties classified as owned in fee generally have been held for many years without any material unfavorably adjudicated claim. The basis for estimating oil and gas reserves is set forth in "Consolidated Financial Statements and Supplementary Data - Supplementary Information on Oil and Gas Producing Activities - Estimated Quantities of Proved Oil and Gas Reserves" on pages F-36 and F-37. Unless otherwise indicated, all reserves shown are as of December 31, 2001. Property, Plant and Equipment Additions For property, plant and equipment additions, see "Management's Discussion and Analysis of Financial Condition, Cash Flows and Liquidity - Capital Expenditures" on page 37.United States Steel.Environmental Matters
Marathon maintains a comprehensive environmental policy overseen by the Corporate Governance and Public Policy Committee of
Marathon'sMarathon’s Board of Directors.Marathon'sMarathon’s Health, Environment and Safety organization has the responsibility to ensure thatMarathon'sMarathon’s operating organizations maintain environmental compliance systems that are in accordance with applicable laws and regulations. The Health, Environment and Safety Management Committee, which is comprised of officers of Marathon, is charged with reviewing its overall performance with various environmental compliance programs. Marathon has also formed an Emergency Management Team, composed of senior management, which will oversee the response to any major emergency environmental incident involving Marathon or any of its properties.Marathon'sMarathon’s businesses are subject to numerous laws and regulations relating to the protection of the environment. These environmental laws and regulations include the Clean Air Act
("CAA"(“CAA”) with respect to air emissions, the Clean Water Act("CWA"(“CWA”) with respect to water discharges, the Resource Conservation and Recovery Act("RCRA"(“RCRA”) with respect to solid and hazardous waste treatment, storage and disposal, the Comprehensive Environmental Response, Compensation, and Liability Act("CERCLA"(“CERCLA”) with respect to releases and remediation of hazardous substances and the Oil Pollution Act of 1990("OPA-90"(“OPA-90”) with respect to oil pollution and response. In addition, many states where Marathon operates have similar laws dealing with the same matters.24
These laws and their associated regulations are subject to frequent change and many of them have become more stringent. In some cases, they can impose liability for the entire cost of cleanup on any responsible party without regard to negligence or fault and impose liability on Marathon for the conduct of others or conditions others have caused, or for
Marathon'sMarathon’s acts that complied with all applicable requirements when we performed them. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable, due in part to the fact that certain implementing regulations for laws such as RCRA and the CAA have not yet been finalized or, in some instances, are undergoing revision. These environmental laws and regulations, particularly the 1990 Amendments to the CAA and its implementing regulations, new water quality standards and stricter fuel regulations, could result in increased capital, operating and compliance costs.For a discussion of environmental capital expenditures and costs of compliance for air, water, solid waste and remediation, see
"Management's“Management’s Discussion and Analysis of Environmental Matters, Litigation andContingencies"Contingencies” on page4043 and"Legal Proceedings"“Legal Proceedings” on page26.27.Marathon has incurred and will continue to incur
substantialcapital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. To the extent these expenditures are not ultimately reflected in the prices ofMarathon'sMarathon’s products and services,Marathon'sMarathon’s operating results will be adversely affected. Marathon believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and whether or not it is engaged in the petrochemical business or the marine transportation of crude oil or refined products.In connection with government inspections at some of its refineries,During the past decade, MAP has received a number of notices of alleged violations of environmental laws from the U.S. Environmental Protection Agency (the
"EPA"“EPA”) and state environmental agencies. In some cases, MAP has entered into consent decrees or orders that require it to pay fines or install pollution controls to settle its alleged liability.For example, MAP agreedThe most significant of these examples was MAP’s agreement to settle alleged violations of24several environmental laws, including New Source Review regulations, with a consent decree signed on May 11,in 2001. Theagreementconsent decree requires MAP to complete certain agreed upon environmental control programs with total one-time expenditures of approximately $360 million over an eight-yearperiod. The current estimated cost to complete these programs is approximately $300period, with about $230 millionin expendituresremaining over the nextsevensix years. Theagreementimpact of this settlement on on-going operating expenses is not expected to be material. The decree also requires MAP to perform supplemental environmental projects whichare expected towill cost approximately$8$9 million. These supplemental environmental projectsare beingwere undertaken as part of this settlement of an enforcement action for alleged CAA violations. In addition, MAP paid a $3.8 million penalty in 2001. MAP believes that this settlement will provide increased permitting and operating flexibility while achieving emission reductions.Air
Of particular significance to MAP are new EPA regulations that require
substantiallyreduced sulfur levels in the manufacture of gasoline and diesel fuel. Marathon estimates thatMAP'sMAP’s combined capital costs to achieve compliance with these rules could amount to approximately$700$900 million, which includes costs that could be incurred as part of other refinery upgrade projects, between 2002 and 2006. Some factors that could potentially affectMAP'sMAP’s gasoline and diesel fuel compliance costs include obtaining the necessary construction and environmental permits, operating and logistical considerations, further refinement of preliminary engineering studies and project scopes and unforeseen hazards.In July 1997, the EPA promulgated more stringent revisions to the National Ambient Air Quality Standards
("NAAQS"(“NAAQS”) for ozone and particulate matter. These revisions had been vacated by the Court of Appeals for the District of Columbia and remanded to the EPA for further action. The EPA sought review of the matter by the United States Supreme Court, and the Supreme Court heard the case in the fall of 2000. On February 27, 2001, the Supreme Court affirmed in part, reversed in part and remanded the case to the EPA to develop a reasonable interpretation of thenonattainmentnon-attainment implementation provisions insofar as they relate to the revised ozone NAAQS. On remand, the EPA stood firm on the new eight-hour ozone standard and recently stated its intention to promulgate a final rule by December 2003, but another part of this case remains with the D.C. Circuit Court of Appeals for further determination. Additionally, in 1998, the EPA published a nitrogen oxide("NOx"(“NOx”) State Implementation Plan("SIP"(“SIP”) call, which would requiresome 22approximately 20 states, including many states where Marathon has operations, to revise their SIPs to reduce NOx emissions. In December 1999, the EPA granted a petition from several northeastern states requesting that stricter NOx standards beadopted byrequired of “upwind” midwestern states, including several states where Marathon has refineries. The impact of the revised NAAQS and NOx standards could be significant to Marathon, but the potential financial effects cannot be reasonably estimated until the EPA takes further action on the revised ozone NAAQS (along with any further judicial review) and the states, as necessary, develop and implement revised SIPs in response to the revised NAAQS and NOx standards.25
Water
Marathon maintains numerous discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA and has implemented systems to oversee its compliance efforts. In addition, Marathon is regulated under OPA-90, which amended the CWA. Among other requirements, OPA-90 requires the owner or operator of a tank vessel or a facility to maintain an emergency plan to respond to releases of oil or hazardous substances. Also, in case of such releases OPA-90 requires responsible companies to pay resulting removal costs and damages, provides for
substantialcivil penalties and imposes criminal sanctions for violations of its provisions.Additionally, OPA-90 requires that new tank vessels entering or operating in
domesticU.S. waters bedouble-hulleddouble hulled and that existing tank vessels that are not double-hulled be retrofitted or removed fromdomesticU.S. service, according to a phase-out schedule.MostAs of December 31, 2002, all of the barges used inMAP'sMAP’s river transportation operations meet the double-hulled requirements of OPA-90.Single-hulled barges owned and operated by MAP are in the process of being phased out. Displaced single-hulled barges will be divested or recycled into docks or floats within MAP's system.Marathon operates facilities at which spills of oil and hazardous substances could occur. Several coastal states in which Marathon operates have passed state laws similar to OPA-90, but with expanded liability provisions, including provisions for cargo owner responsibility as well as ship owner and operator responsibility. Marathon has implemented emergency oil response plans for all of its components and facilities covered by OPA-90.
Solid Waste
Marathon continues to seek methods to minimize the generation of hazardous wastes in its operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of underground storage tanks
("USTs"(“USTs”) containing regulated substances. Since the EPA has not yet promulgated implementing regulations for all provisions of RCRA and has not yet made clear the25practical application of all the implementing regulations it has promulgated, the ultimate cost of compliance with this statute cannot be accurately estimated. In addition, new laws are being enacted and regulations are being adopted by various regulatory agencies on a continuing basis, and the costs of compliance with these new rules can only be broadly appraised until their implementation becomes more accurately defined. Remediation
Marathon owns or operates certain retail outlets where, during the normal course of operations, releases of petroleum products from USTs have occurred. Federal and state laws require that contamination caused by such releases at these sites be assessed and remediated to meet applicable standards. The enforcement of the UST regulations under RCRA has been delegated to the states, which administer their own UST programs.
Marathon'sMarathon’s obligation to remediate such contamination varies, depending on the extent of the releases and the stringency of the laws and regulations of the states in which it operates. A portion of these remediation costs may be recoverable from the appropriate state UST reimbursement fund once the applicable deductible has been satisfied. Accruals for remediation expenses and associated reimbursements are established for sites where contamination has been determined to exist and the amount of associated costs is reasonably determinable.As a general rule, Marathon and Ashland retained responsibility for certain remediation costs arising out of the prior ownership and operation of businesses transferred to MAP. Such continuing responsibility, in certain situations, may be subject to threshold or sunset agreements, which gradually diminish this responsibility over time.
Properties
The location and general character of the principal oil and gas properties, refineries and gas plants, pipeline systems and other important physical properties of Marathon have been described previously. Except for oil and gas producing properties, which generally are leased, or as otherwise stated, such properties are held in fee. The plants and facilities have been constructed or acquired over a period of years and vary in age and operating efficiency. At the date of acquisition of important properties, titles were examined and opinions of counsel obtained, but no title examination has been made specifically for the purpose of this document. The properties classified as owned in fee generally have been held for many years without any material unfavorably adjudicated claim.
26
The basis for estimating oil and gas reserves is set forth in “Consolidated Financial Statements and Supplementary Data – Supplementary Information on Oil and Gas Producing Activities – Estimated Quantities of Proved Oil and Gas Reserves” on pages F-40 through F-42.
Property, Plant and Equipment Additions
For property, plant and equipment additions, see “Management’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity – Capital Expenditures” on page 38.
Employees
Marathon had 28,166 active employees as of December 31, 2002, including 25,166 MAP employees. Of the total number of MAP employees, 18,705 were employees of Speedway SuperAmerica LLC, most of whom were employees at retail marketing outlets.
Certain hourly employees at the Catlettsburg and Canton refineries are represented by the Paper, Allied-Industrial, Chemical and Energy Workers International Union under labor agreements that expire on January 31, 2006. The same union represents certain hourly employees at the Texas City refinery under a labor agreement that expires on March 31, 2006. The International Brotherhood of Teamsters represents certain hourly employees at the St. Paul Park and Detroit refineries under labor agreements that are scheduled to expire on May 31, 2006 and January 31, 2007, respectively.
Available Information
Our Internet address is www.marathon.com. We make available, free of charge through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the SEC.
Marathon is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are included below in this discussion. The ultimate resolution of these contingencies could, individually or in the aggregate, be material. However, management believes that Marathon will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably.
Natural Gas Royalty Litigation
Marathon was served in two qui tam cases, which allege that federal and Indian lessees violated the False Claims Act with respect to the reporting and payment of royalties on natural gas and natural gas liquids. The first case,U.S. ex rel Jack J. Grynberg v. Alaska Pipeline Co., et
al.al. is primarily a gas measurement case, and the second case,U.S. ex rel Harrold e. Wrightvv. Agip Petroleum Co. et al,is primarily a gas valuation case. These cases assert that false claims have been filed by lessees and that penalties, damages and interest total more than $25 billion. The Department of Justice has announced that it would intervene or has reserved judgment on whether to intervene against specified oil and gas companies and also announced that it would not intervene against certain other defendants including Marathon. In July 2001, the court in the consolidated proceeding denieddefendants'defendants’ motions to dismiss. The matters are in the discovery phase and Marathon intends to vigorously defend these cases.Cajun Express Arbitration
In September, 2002, Marathon
canceledsettled its pending arbitration with Transocean Sedco Forex Inc. arising from Marathon’s cancellation of the Cajun Express rig contract on July 5, 2001. Transocean’s July 19, 2001for persistent non-performance. Transocean Sedco Forex Inc. gave notice of itsdemand for arbitrationon July 19, 2001 in which itsought net lost revenue of an unspecified amount. The contract may have generated $90 milliondollarsin gross revenues over the remainder of the 18 month period.Arbitration is scheduled for May 13, 2002The settlement terms included payment of a portion of the disputed claim resulting inHouston, Texas before one arbitrator applying the American Arbitration Association commercial rules. Marathon believes it properly canceled the contract and intends to vigorously defend against this claim.a $9 million after-tax loss.27
Environmental Proceedings
The following is a summary of proceedings involving Marathon that were pending or contemplated as of December 31,
2001,2002, under federal and state environmental laws. Except as described herein, it is not possible to predict accurately the ultimate outcome of these matters; however,management'smanagement’s belief set forth in the first paragraph under Item 3."Legal Proceedings"“Legal Proceedings” above takes such matters into account.Claims under the Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"(“CERCLA”) and related state acts have been raised with respect to the cleanup of various waste disposal and other sites. CERCLA is intended toexpeditefacilitate the cleanup of hazardous substances without regard to fault. Potentially responsible parties("PRPs"(“PRPs”) for each site include present and former owners and operators of, transporters to and generators of the26substances at the site. Liability is strict and can be joint and several. Because of various factors including the ambiguity of the regulations,the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and cleanup costs and the time period during which such costs may be incurred, Marathon is unable to reasonably estimate its ultimate cost of compliance with CERCLA.Projections, provided in the following paragraphs, of spending for and/or timing of completion of specific projects are forward-looking statements. These forward-looking statements are based on certain assumptions including, but not limited to, the factors provided in the preceding paragraph. To the extent that these assumptions prove to be inaccurate, future spending for, or timing of completion of environmental projects may differ materially from those stated in the forward-looking statements.
At December 31,
2001,2002, Marathon had been identified as a PRP at a total of1311 CERCLA waste sites. Based on currently available information, which is in many cases preliminary and incomplete, Marathon believes that its liability for cleanup and remediation costs in connection with all but one of these sites will be under $1 million per site, and most will be under $100,000. Marathon believes that its liability for cleanup and remediation costs in connection with the one remaining site will be under $4 million.In addition, there are
threefour sites where Marathon has received information requests or other indications that it may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability.There are also
11482 additional sites, excluding retail marketing outlets, related to Marathon where remediation is being sought under other environmental statutes, both federal and state, or where private parties are seeking remediation through discussions or litigation. Of these sites,1310 were associated with properties conveyed to MAP by Ashland which have retained liability for all costs associated with remediation. Based on currently available information, which is in many cases preliminary and incomplete, Marathon believes that its liability for cleanup and remediation costs in connection with1812 of these sites will be under $100,000 per site,3228 sites have potential costs between $100,000 and $1 million per site,1213 sites may involve remediation costs between $1 million and $5 million per site and76 sites have incurred remediation costs of more than $5 million per site. Of the76 sites, only 1 site as described in the following paragraph has future costs that are estimated to exceed $5 million. There are3213 sites with insufficient information to estimateanyfuture remediation costs.There is one site that involves a remediation program in cooperation with the Michigan Department of Environmental Quality at a closed and dismantled refinery site located near Muskegon, Michigan. During the next 10 to 20 years, Marathon anticipates spending less than $7 million at this site. Expenditures in
20022003 are expected to be approximately $500,000. Additionally, negotiations are taking place with the Michigan Department of Environmental Quality to eventually perform a risk-based closure on this site.In MayOn December 3, 2001,
MarathonIllinois EPA (“IEPA”) issued a NOV to MAP arising out of the sinking of a floating roof on a storage tank at a Martinsville, Illinois facility. A storm and heavy rainfall caused the floating roof to sink. MAPsettled, in a consent decree, EPA allegations that the Robinson refinery did not qualify forbelieves it may have anexemption under the National Emission Standards for Benzene Waste Operations pursuantemergency or malfunction defense. This matter has been referred to theCAA. The government had alleged inIllinois Attorney General’s office for enforcement proceedings.In March, 2002, MAP attended a
federal court lawsuit that the refinery's Total Annual Benzene releases exceeded the limitation of 10 megagrams per year, and as a result, the refinery was in violation of the benzene waste emission control, record keeping, and reporting requirements. The consent decree was approved by the court on July 26, 2001 and requires Marathon and MAP to pay a combined $1.6 million civil penalty and install various controls and other improvements. Marathon and MAP were also required to perform $125,000 in supplemental environmental projects, with these projects undertaken in connectionmeeting with the Illinois EPA concerning MAP’s self reporting of possible emission exceedences and permitting issues related to some storage tanks at MAP’s Robinson, Illinois facility. In late April, MAP submitted to IEPA a comprehensive settlementof an enforcement action undertakenproposal which was rejected bythe United States. In 1998, the EPA conducted multi-media inspections of MAP's Detroit and Robinson refineries, covering complianceIEPA. We have had subsequent discussions withthe CAA, the CWA, reporting obligations under the Emergency Planning and Community Right to Know Act, CERCLAIEPA and thehandling of process waste. The EPA served a number of Notices of Violation ("NOV")Illinois Attorney General’s office andFindings of Violation as a result of these inspections, but these allegations were resolved as part ofanticipate additional meetings and discussions in theNew Source Review consent decree which MAP agreed to on May 11, 2001. MAP's settlement with the EPA includes all of MAP's refineries and commits MAP to specific control technologies and implementation schedules for environmental expenditures and improvements to MAP's refineries over approximately an eight year period.coming months.28
The
current estimated cost to complete these programs is approximately $300 million in expenditures over the next seven years. MAP is also committed to the performance of about $8 million in supplemental environmental projects and has paid an aggregate civil penalty in 2001 of $3.8 million, as part of this settlement of an enforcement action for alleged CAA violations. MAP believes that this settlement will provide MAP with increased permitting and operating flexibility while achieving significant emission reductions. The court approved this consent decree on August 28, 2001. 27In 2000, theKentucky Natural Resources and Environmental Cabinet("Cabinet") sent(the “Cabinet) issued the MAP Catlettsburg,Refining, LLCKentucky refinery aNOV seeking a $150,000Notice of Violation regarding the Tank 845 rupture which occurred in November of 1999. The tank rupture caused the tank’s contents to be released onto the ground and adjoining retention area. MAP has been involved in discussions with the Cabinet to resolve this matter through an agreed Administrative Order. MAP is optimistic that this matter may be resolved in 2003 and the civil penaltyfor a tank rupture and spill atwill be in theCatlettsburg refinery. This matter is pending.range of $90,000 to $120,000.In 2000, the Kentucky Natural Resources and Environmental Cabinet sent Marathon Ashland Pipe Line LLC a NOV seeking a civil penalty associated with a pipeline spill earlier that year in Winchester, Kentucky. MAP has settled this NOV in the form of an Agreed-to Administrative Order which was finalized and entered in January 2002 and required payment of a $170,000 penalty and reimbursement of past response costs up to $131,000.
MAP entered into a Consent Decree in July of 2002 with the State of Ohio regarding air compliance matters at its Canton refinery during both Ashland’s and MAP’s term of ownership and operation. The Consent Decree required $350,000 in payments which included a penalty of $216,500, several Supplemental Environmental Projects and the funding of a community notification system. The Consent Decree is being implemented.
In July, 2002, Marathon received a Notice of Enforcement from the State of Texas for alleged excess air emissions from its Yates Gas Plant and production operations on its Kloh lease. The Notices did not compute a penalty or fine for these pending enforcement actions.
Item 4. Submission of Matters to a Vote of Security Holders
A description of the matters voted upon by the stockholders of USX Corporation at an October 25, 2001 special meeting was reported in USX Corporation's Form 10-Q for the quarter ended September 30, 2001.Not applicable.
PART II
Item 5. Market for
Registrant'sRegistrant’s Common Equity and Related Stockholder MattersThe principal market on which the
Company'sCompany’s common stock is traded is the New York Stock Exchange. Information concerning the high and low sales prices for the common stock as reported in the consolidated transaction reporting system and the frequency and amount of dividends paid during the last two years is set forth in"Selected“Selected Quarterly Financial Data (Unaudited)"” on pageF-33.F-37.As of January 31,
2002,2003, there were69,26464,857 registered holders of Marathon common stock.The Board of Directors intends to declare and pay dividends on Marathon common stock based on the financial condition and results of operations of Marathon Oil Corporation, although it has no obligation under Delaware law or the Restated Certificate of Incorporation to do so. In determining its dividend policy with respect to Marathon common stock, the Board will rely on the financial statements of Marathon. Dividends on Marathon common stock are limited to legally available funds of Marathon.
On January 29, 2003, Marathon amended the Rights Agreement, dated as of September 28,
1999, as amended, between Marathon and National City Bank, as successor rights agent. The Rights Agreement was amended so that the Rights to Purchase Series A Junior Preferred Stock expired on January 31, 2003, more than six years earlier than initially specified in the plan. Item 6. Selected Financial
Data(a)DataSee page F-46.
29
- -------------------------------------------------------------------------------- (a) Historical data has been restated to reflect the effect of the separation of United States Steel. (b) Consists of revenues, dividend and investee income, gain on ownership change in MAP, net gain/(losses) on disposal of assets and other income. 29
Dollars in millions (except per share data) 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------Other Data: Net cash from operating activities (from continuing operations)................... $2,919 $3,146 $2,008 $1,633 $1,231 Capital expenditures...................... 1,639 1,425 1,378 1,270 1,038 Ratio of earnings to fixed charges(b)..... 7.47 4.06 4.24 2.60 2.55 Ratio of earnings to combined fixed charges and preferred stock dividends(b)............................. 7.26 3.95 4.11 2.51 2.43 - -------------------------------------------------------------------------------- Balance Sheet Data: Cash and cash equivalents................. $ 657 $ 340 $ 111 $ 137 $ 36 Working capital........................... 943 973 937 366 (244) Net property, plant and equipment......... 9,578 9,375 10,293 10,429 7,566 Total assets.............................. 16,129 17,151 17,730 16,637 12,347 Long-term debt............................ 3,432 1,937 3,320 3,456 2,476 Minority interest in Marathon Ashland Petroleum LLC............................ 1,963 1,840 1,753 1,590 - Total stockholders' equity................ 4,940 6,764 6,856 6,405 5,400- ------------------------------------------------------------------------------- (b) Amounts represent fixed charges and earnings from continued operations. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations On December 31, 2001, USX Corporation disposed of its steel business through a tax-free distribution of the common stock of its wholly-owned subsidiary United States Steel Corporation ("United States Steel") to holders of USX-U.S. Steel Group common stock ("Steel Stock") in exchange for all outstanding shares of Steel Stock on a one-for-one basis (the "Separation") and changed its name toMarathon Oil Corporation
("Marathon"(“Marathon”). Marathon, formerly USX Corporation, is engaged in worldwide exploration and production of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily through its 62 percent owned subsidiary, Marathon Ashland Petroleum LLC("MAP"(“MAP”); and other energy related businesses. TheManagement'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements.Marathon'sPrior to December 31, 2001,
financialMarathon had two outstanding classes of common stock: USX–Marathon Group common stock, which was intended to reflect the performancebenefited from strong worldwide natural gas pricesof Marathon’s energy business, anddomestic refining margins. However, laterUSX–U. S. Steel Group common stock (“Steel Stock”), which was intended to reflect the performance of Marathon’s steel business. On December 31, 2001, USX Corporation disposed of its steel business through a tax-free distribution of the common stock of its wholly owned subsidiary United States Steel Corporation (“United States Steel”) to holders of Steel Stock inthe year, performance was negatively impacted by lower crude oilexchange for all outstanding shares of Steel Stock on a one-for-one basis (the “Separation”) andnatural gas prices, as well as lower downstream margins, primarily from decreased demand caused by the general downturn in the global economy and warmer than normal weather.changed its name to Marathon Oil Corporation.Certain sections of
Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations include forward-looking statements concerning trends or events potentially affecting the businesses of Marathon. These statements typically contain words such as"anticipates"“anticipates”,"believes"“believes”,"estimates"“estimates”,"expects"“expects”,"targets"“targets” or similar words indicating that future outcomes are uncertain. In accordance with"safe harbor"“safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors,thatwhich could cause future outcomes to differ materially from those set forth in the forward-looking statements. For additional risk factors affecting the businesses of Marathon, see"Disclosures“Disclosures Regarding Forward-LookingStatements"Statements” on page 2.Management'sUnless specifically noted, amounts for MAP do not reflect any reduction for the 38 percent interest held by Ashland Inc. (“Ashland”).
Management’s Discussion and Analysis of Critical Accounting
PoliciesEstimatesThe preparation of
consolidatedfinancial statementsfor Marathonin accordance with generally accepted accounting principles requires management to make estimates andjudgmentsassumptions that affect the reported amountsreported inof assets and liabilities, theprimary financial statementsdisclosure of contingent assets and liabilities at year end and therelated footnote disclosures. Marathon considersreported amounts of revenues and expenses during thefollowing accounting policies to be most significantly impacted byyear. Actual results could differ from the estimates andjudgmentsassumptions used.Certain accounting estimates are considered to be critical a) if such estimates require assumptions about matters that are dependent on events remote in time that may or may not occur, are not capable of being readily calculated from generally accepted methodologies, or cannot be derived with some degree of precision from available data and b) if different estimates that reasonably could have been used or changes in the
preparationestimate that are reasonably likely to occur would have had a material impact on the presentation ofits consolidatedfinancialstatements. Deferred Taxescondition, changes in financial condition or results of operations.Estimated Net Recoverable Quantities of Oil and
gas exploration and production is a global business. As a result, Marathon is subject to taxation on its income in numerous jurisdictions. State and local income taxes are deductible and foreign income taxes in certain circumstances are creditable against U. S. federal income taxes. These interrelationships complicate the assessment of the realizability of deferred income tax assets. Marathon considers future taxable income in making such assessments. Numerous judgments and assumptions are inherent in the determination of future taxable income, including factors such as future operating conditions (particularly as related to prevailing oil prices). The 30judgments and assumptions used in determining future taxable income are consistent with those used for other financial statement purposes, including the determination of possible impairment of long-lived assets held and used. Additionally, generally accepted accounting principles require that Marathon consider any prudent and feasible tax planning strategies that would minimize the amount of deferred tax liabilities recognized or the amount of any valuation allowance recognized against deferred tax assets. The principal tax planning strategy available to Marathon relates to the permanent reinvestment of the earnings of foreign subsidiaries. As a result of the complexities inherent in multiple tax jurisdictions and the focus of generally accepted accounting principles on the proper measurement of deferred taxes recorded on the balance sheet, deferred tax adjustments included in the provision for income taxes do not necessarily correspond with amounts reported in income before income taxes. Property, Plant and EquipmentGasMarathon uses the successful efforts method of accounting for its oil and gas producing activities. The successful efforts method inherently relies upon the estimation of proved reserves,
which includes provedboth developed andproved undeveloped volumes.undeveloped. The existence and the estimated amount of proved reserves affects, among other things, whether or not certain costs are capitalized or expensed, the amount and timing of costs depleted or amortized into income andwhether or notthecosts capitalizedpresentation of supplemental information on oil and gas producing activities. Both the expected future cash flows to be generated by oil and gas producing properties and the expected future taxable income available to realize the value of deferred tax assets, which are discussed further below, rely inthe balance sheet should be impaired. Marathon'spart on estimates of net recoverable quantities of oil and gas.Marathon’s estimation of
total proved reservesnet recoverable quantities of oil and gas is a highly technical process performed primarily by in-house reservoir engineers and geoscience professionals. The actual recoverability of hydrocarbons can vary from estimated amounts. Due to the inherent uncertainties and the limited nature of reservoir data, estimates ofproved reservesnet recoverable quantities of oil and gas are subject to potentially substantial changes, either positively or negatively, as additional information becomes available and as contractual, economic andeconomicpolitical conditions change.30
Expected Future Cash Flows Generated by Certain Oil and Gas Producing Properties
Marathon
adheresmust estimate the expected future cash flows toStatement of Financial Accounting Standard ("SFAS") No. 19 for recognizing any impairment of capitalized costs relating to unproved property investments. Generally, the greatest portion of these costs relate to the acquisition of leasehold interests. The costs incurred are capitalizedbe generated by its oil andperiodically evaluated as to recoverability, based on changes brought about by general economic factors and potential shiftsgas producing properties inthe business strategy employed by management. Marathon considers a combination of time and geologic factorsorder to evaluate the possible needforto impair the carrying value of those properties. An impairment ofthese capitalized costs. Contingent Liabilities Marathon accrues liabilities for income and other tax deficiencies in accordance with SFAS No. 5. Such contingent obligations are assessed regularly by Marathon's in-house tax legal counsel and advisers. In certain circumstances, outside legal counsel is utilized. Each potential issue is assessed individually, although accrued liabilities are aggregated and recorded by jurisdiction and by typeany one oftax. Although it is difficult to predict with any degree of certainty the ultimate outcome of examinations of open tax years, management believes that the recorded amounts are reasonable. Marathon accrues its environmental remediation liabilities in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position 96-1. Liabilities for litigation claims and settlements are accrued in accordance with SFAS No. 5. Such contingent obligations are assessed regularly by Marathon's in-house legal counsel. In certain circumstances, outside legal counsel is utilized. Both environmental remediation liabilities and liabilities for litigation claims and settlements are recognized basedMarathon’s three largest fields could have a material impact on thelikelihoodpresentation ofa third party having a viable claim against Marathon's assets. Each potential liability is assessed individually. For additional information on environmental liabilities, see Note 3 to the Financial Statements. Employee Related Benefits Accounting for pensions and other postretirement benefits involves several assumptions relating to expected rates of return on plan assets, determination of discount rates for remeasuring plan obligations, determination of inflation rates regarding compensation levels and health care cost projections. Marathon develops its demographics and utilizes the work of actuaries to assist with the measurement of employee related obligations. The assumptions used vary from year-to-year, which will affect futurefinancial condition, changes in financial condition or results of operations.Any differences among these assumptions and Marathon's actual return on assets, financial market-based discount rates,Those fields – the Alba field offshore Equatorial Guinea, the Yates field in west Texas and the Brae Area Complex offshore the United Kingdom – comprise approximately 46 percent of Marathon’s total proved oil and gas reserves. The expected future cash flows from these properties require assumptions about matters such as the prevailing level ofcost sharing provisionsfuture oil and gas prices, estimated recoverable quantities of oil and gas, expected field performance and the political environment in the host country.Long-lived assets held and used in operations must be impaired when the carrying value is not recoverable and exceeds the fair value. Recoverability of the carrying value is determined by comparison with the undiscounted expected future cash flows to be generated by those assets. As of December 31, 2002, no impairment in the value of the Alba field or the Brae Area Complex was indicated.
Marathon’s interest in the Yates field is held through its investment in MKM Partners L.P., which is accounted for under the equity method. Equity method investments must be impaired when a loss in value occurs that is other than a temporary decline. As of December 31, 2002, no impairment in the value of MKM Partners L.P. was indicated.
Expected Future Taxable Income
Marathon must estimate its expected future taxable income in order to assess the realizability of its deferred income tax assets. As of December 31, 2002, Marathon reported net deferred tax assets of $1.103 billion, which represented gross assets of $1.585 billion net of valuation allowances of $482 million.
Numerous assumptions are inherent in the estimation of future taxable income, including assumptions about matters that are dependent on future events, such as future operating conditions (particularly as related to prevailing oil and gas prices) and future financial conditions. The estimates and assumptions used in determining future taxable income are consistent with those used in Marathon’s internal budgets, forecasts and strategic plans.
In determining its overall estimated future taxable income for purposes of assessing the need for additional valuation allowances, Marathon considers proved and risk-adjusted probable and possible reserves related to its existing producing properties, as well as estimated quantities of oil and gas related to undeveloped discoveries if, in the judgment of Marathon management, it is likely that development plans will
also impactbe approved in the foreseeable future. In assessing the propriety of releasing an existing valuation allowance, Marathon considers the preponderance of evidence concerning the realization of the deferred tax asset.Additionally, Marathon must consider any prudent and feasible tax planning strategies that might minimize the amount of deferred tax liabilities recognized or the amount of any valuation allowance recognized against deferred tax assets, if management has the ability to implement these strategies and the expectation of implementing these strategies if the forecasted conditions actually occurred. The principal tax planning strategy available to Marathon relates to the permanent reinvestment of the earnings of foreign subsidiaries. Assumptions related to the permanent reinvestment of the earnings of foreign subsidiaries are reconsidered annually to give effect to changes in Marathon’s portfolio of producing properties and in its tax profile.
Marathon’s deferred tax assets include $393 million relating to Norwegian net operating loss carryforwards (“NOLs”). Marathon has established a valuation allowance of $363 million against these NOLs. Currently Marathon generates income from the Heimdal and Vale fields in the Norwegian North Sea. Marathon acquired additional interests in Norway in 2001 and 2002. These interests currently have no proved reserves and generate no income, although some interests hold undeveloped discoveries. To the extent that these newly acquired interests demonstrate the capability to generate future
resultstaxable income, Marathon may be able to release some or all ofoperations. 31Management'sits $363 million valuation allowance in future periods.Net Realizable Value of Receivables from United States Steel
As described further in “Management’s Discussion and Analysis of
IncomeFinancial Condition, Cash Flows andOperations RevenuesLiquidity – Obligations Associated with the Separation of United States Steel” on page 41, Marathon remains obligated (primarily or contingently) for certain debt andOther Incomeother financial arrangements foreachwhich United States Steel has assumed responsibility for repayment under the terms of thelast three years are summarized inSeparation. As of December 31, 2002,31
Marathon has reported receivables from United States Steel of $556 million, representing the
following table:
(Dollars in millions) 2001 2000 1999 - --------------------------------------------------------------------------------Exploration & production ("E&P").................... $ 4,580 $ 4,687 $ 3,104 Refining, marketing & transportation ("RM&T")(a).... 27,356 28,849 20,076 Other energy related businesses(b).................. 1,915 1,691 835 ------- ------- ------- Revenues and other income of reportable segments.. 33,851 35,227 24,015 Revenues and other income not allocated to segments: Loss related to sale of certain Canadian assets.... (221) - - Joint venture formation charges(c)................. - (931) - Gain (loss) on ownership change in MAP............. (6) 12 17 Net gains (losses) on certain asset sales.......... - 124 (36) Gain on offshore lease resolution with U.S. Government........................................ 59 - - Elimination of intersegment revenues................ (587) (573) (289) Elimination of sales to United States Steel......... (30) (60) (41) ------- ------- ------- Total revenues and other income................... $33,066 $33,799 $23,666 ======= ======= ======= Items included in both revenues and costs and expenses, resulting in no effect on income: Consumer excise taxes on petroleum products and merchandise........................................ $ 4,404 $ 4,344 $ 3,973 Matching crude oil and refined product buy/sell transactions settled in cash: E&P............................................... $ 454 $ 643 $ 732 RM&T.............................................. 3,797 3,811 2,472 ------- ------- ------- Total buy/sell transactions...................... $ 4,251 $ 4,454 $ 3,204 - --------------------------------------------------------------------------------(a) Amounts include 100 percentamount ofMAP. (b) Includes domestic natural gasprincipal andcrude oil marketing and transportation, and power generation. (c) Represents a charge relatedaccrued interest on Marathon debt for which United States Steel has assumed responsibility for repayment. Marathon must assess the realizability of these receivables, based on its expectations of United States Steel’s ability to satisfy its obligations. In order to make this assessment, Marathon must rely on public information about United States Steel. As of December 31, 2002, Marathon has judged the entire receivable to be realizable.Marathon may continue to be exposed to the
joint venture formationrisk of nonpayment by United States Steel on a significant portion of this receivable until December 31, 2011. Of the $556 million, $469 million, or 84 percent, relates to industrial revenue bonds that are due in 2011 or later. The Financial Matters Agreement between Marathon andKinder Morgan Energy Partners, L.P. E&P segment revenues decreased by $107 million in 2001 from 2000 following an increase of $1,583 million in 2000 from 1999. The decrease in 2001 was primarily due to lower domestic liquid hydrocarbon production and prices, partially offset by higher domestic natural gas prices and production, and gains from derivative activities. The increase in 2000 was primarily due to higher worldwide liquid hydrocarbon and natural gas prices, partially offset by lower domestic liquid hydrocarbon and worldwide natural gas production. RM&T segment revenues decreased by $1,493 million in 2001 from 2000 following an increase of $8,773 million in 2000 from 1999. The decrease in 2001 primarily reflected lower refined product prices. The increase in 2000 primarily reflected higher refined product prices and increased refined product sales volumes. Other energy related businesses segment revenues increased by $224 million in 2001 from 2000 following an increase of $856 million in 2000 from 1999. The increase in 2001 reflected higher natural gas prices and crude oil resale activity, partially offset by lower crude oil prices and natural gas resale activity. The increase in 2000 reflected higher natural gas and crude oil resale activity accompanied by higher crude oil and natural gas prices. For additional discussion of revenues, see Note 10 toUnited States Steel provides that, on or before theFinancial Statements. 32Income from operations for eachtenth anniversary of thelast three yearsSeparation, which issummarized in the following table:
(Dollars in millions) 2001 2000 1999 - --------------------------------------------------------------------------------E&P Domestic............................................. $1,124 $1,111 $ 494 International........................................ 297 420 124 ------ ------ ------ Income of E&P reportable segment..................... 1,421 1,531 618 RM&T(a) 1,914 1,273 611 Other energy related businesses........................ 60 42 61 ------ ------ ------ Income for reportable segments....................... 3,395 2,846 1,290 Items not allocated to reportable segments: Administrative expenses............................... (162) (136) (108) Gain on offshore lease resolution with U.S. Government........................................... 59 - - Gain/(loss) on disposal of assets(b).................. (221) 124 (36) Charge on formation of MKM Partners L.P. JV(c)........ - (931) - Impairment of oil and gas properties, and assets held for sale(d).......................................... - (197) (16) Gain (loss) on ownership change in MAP................ (6) 12 17 IMV reserve adjustment(e)............................. (72) - 551 Reorganization charges including pension settlement (loss)/gain & benefit accruals(f).................... (14) (70) 15 SG&A costs applicable to Steel Stock.................. (25) (18) (12) ------ ------ ------ Total income from operations........................ $2,954 $1,630 $1,701- ------------------------------------------------------------------------------- (a) Amounts include 100 percent of MAP. (b) In 2001, represents a loss on the sale of certain Canadian assets. The net gain in 2000 represents a gain on the disposition of Angus/Stellaria, a gain on the Sakhalin exchange, a gain on the sale of Speedway SuperAmerica LLC ("SSA") non-core stores, and a loss on the saleDecember 31, 2011, United States Steel will provide for Marathon’s discharge from any remaining liability under any of theHoward Glasscock field.assumed industrial revenue bonds.As of December 31, 2002, Marathon’s cash-adjusted debt-to-capital ratio (which includes debt for which United States Steel has assumed responsibility for repayment) was 44.5 percent. The
net loss in 1999 represents a loss onassessment of Marathon’s liquidity and capital resources may be impacted by expectations concerning United States Steel’s ability to satisfy its obligations.For instance, if the
saledebt for which United States Steel has assumed responsibility for repayment were excluded from the computation, Marathon’s cash-adjusted debt-to-capital ratio as ofScurlock Permian LLC, certain domestic production properties, and Carnegie Natural Gas Company and affiliated subsidiaries, and a gain on certain Egyptian properties. (c) Represents a charge related toDecember 31, 2002 would have been approximately 41 percent. On thejoint venture formation between Marathon and Kinder Morgan Energy Partners, L.P. (d) Represents in 2000, an impairment of certain oil and gas properties, primarily in Canada, and assets held for sale. Represents in 1999, an impairment of certain domestic properties. (e) The inventory market valuation ("IMV") reserve reflectsother hand, if theextent to which the recorded LIFO cost basis of crude oil and refined products inventories exceeds net realizable value. For additional discussion of the IMV, see Note 19 to the Financial Statements. (f) Represents reorganization charges in 2001 and 2000 and pension settlement gains/(losses) and various benefit accruals resulting from retirement plan settlements and voluntary early retirement programs in 2000 and 1999. 2001 reorganization charges include costs related to the Separationreceivable from United StatesSteel. 33Income for reportable segments increased by $549 millionSteel had been written off as unrealizable, the cash-adjusted debt-to-capital ratio as of December 31, 2002 would have been approximately 46 percent. (If United States Steel were not able to satisfy its obligations, other adjustments in2001 from 2000, mainly dueaddition toa higher refining and wholesale marketing margin. Income for reportable segments increased by $1,556 in 2000 from 1999, mainly due to higher worldwide liquid hydrocarbon and natural gas prices, and higher refined product margins, partially offset by decreased natural gas volumes. Average Volumes and Selling Prices
2001 2000 1999 - ------------------------------------------------------------------------------(thousands of barrels per day) Net liquids production(a) - U.S. 127 131 145 - International(b) 73 65 62 ------- ------- ------- - Total consolidated 200 196 207 - Equity investees(c) 9 11 1 ------- ------- ------- - Worldwide 209 207 208 (millions of cubic feet per day) Net natural gas production - U.S. 793 731 755 - International - equity 441 470 489 - International - other(d) 8 11 16 ------- ------- ------- - Total consolidated 1,242 1,212 1,260 - Equity investee(e) 31 29 36 ------- ------- ------- - Worldwide 1,273 1,241 1,296 - ------------------------------------------------------------------------------ (dollars per barrel) Liquid hydrocarbons(a)(f) - U.S. $ 20.62 $ 25.55 $ 16.01 - International 23.26 26.54 16.90 (dollars per mcf) Natural gas(f) - U.S. $ 3.69 $ 3.49 $ 2.07 - International - equity 2.97 2.76 1.90 (thousands of barrels per day) Refined products sold(g) 1,304 1,306 1,251 Matching buy/sell volumes included in above 45 52 45 - ------------------------------------------------------------------------------(a) Includes crude oil, condensate and natural gas liquids. (b) Represents equity tanker liftings, truck deliveries and direct deliveries. (c) Represents Marathon's equity interest in MKM Partners L.P. ("MKM") and CLAM Petroleum B.V. ("CLAM") for 2001 and Sakhalin Energy Investment Company Ltd. ("Sakhalin Energy") and CLAM for 2000 and 1999. (d) Represents gas acquired for injection and subsequent resale. (e) Represents Marathon's equity interest in CLAM. (f) Prices exclude gains/losses from hedging activities, equity investees and gas purchased for injection and subsequent resale. (g) Refined products sold and matching buy/sell volumes include 100 percent of MAP. Domestic E&P income increased by $13 million in 2001 from 2000 following an increase of $617 million in 2000 from 1999. The increase in 2001 was primarily due to gains from derivative activities and higher natural gas volumes and prices, partially offset by lower liquid hydrocarbon prices. The increase in 2000 was primarily due to higher liquid hydrocarbon and natural gas prices, partially offset by lower liquid hydrocarbon and natural gas volumes due to natural field declines and asset sales, and losses from derivative activities. International E&P income decreased by $123 million in 2001 from 2000 following an increase of $296 million in 2000 from 1999. The decrease in 2001 was primarily due to lower liquid hydrocarbon prices, increased depreciation expense due primarily to 2000 reserve write downs and lower natural gas volumes, partially offset by increased natural gas prices, lower dry well expense, and lower foreign royalty and geophysical contract expenditures. The increase in 2000 was mainly due to higher liquid hydrocarbon and natural gas prices, higher liquid hydrocarbon liftings, primarily in Russia and Gabon, and lower dry well expense, partially offset by lower natural gas volumes. 34RM&T segment income increased by $641 million in 2001 from 2000 following an increase of $662 million in 2000 from 1999. The increase in 2001 was primarily due to a higher refining and wholesale marketing gross margin partially offset by lower SSA gasoline and distillate sales volumes and increased refining and wholesale marketing transportation expense. The increase in 2000 was primarily due to higher refined product margins, partially offset by higher operating expenses for SSA, higher administrative expenses including increased variable pay plan costs, and higher transportation costs. Other energy related businesses segment income increased by $18 million in 2001 following a decrease of $19 million in 2000 from 1999. The increase in 2001 was primarily a result of higher crude oil purchase and resale activity accompanied by increased margins and losses from derivative activities recorded in 2000. The decrease in 2000 was primarily due to losses from derivative activities andthereversal of pipeline abandonment accruals recorded in 1999. Items not allocated to reportable segments: IMV reserve adjustment - When Marathon was acquired in March 1982, crude oil and refined product prices were at historically high levels. In applying the purchase method of accounting, crude oil and refined product inventories were revalued by reference to current prices at the time of acquisition, and this became the new LIFO cost basiswrite-off of theinventories.receivable may be necessary.)Net Realizable Value of Inventories
Generally accepted accounting principles require that inventories be carried at lower of cost or market. Accordingly, when the cost basis of Marathon’s inventories of liquid hydrocarbons and refined petroleum products exceed market value, Marathon
establishedestablishes anIMVinventory market valuation (“IMV”) reserve to reduce the cost basis of its inventories to net realizable value.Quarterly adjustmentsAdjustments to the IMV reserve result in noncash charges or credits to income from operations.When Marathon Oil Company was acquired in March 1982, prices of liquid hydrocarbons and refined petroleum products were at historically high levels. In applying the purchase method of accounting, inventories of liquid hydrocarbons and refined petroleum products were revalued by reference to current prices at the time of acquisition. This became the new LIFO cost basis of the inventories.
When Marathon acquired the crude oil and refined petroleum product inventories associated with
Ashland'sAshland’s RM&T operations on January 1, 1998, Marathon established a new LIFO cost basis for those inventories. The acquisition cost of these inventories lowered the overall average cost of the combined RM&T inventories. As a result, the price threshold at which an IMV reserve will be recorded was also lowered.Since the prices of liquid hydrocarbons and refined petroleum products do not correlate perfectly, there is no absolute price threshold below which an IMV adjustment will be recognized. However, generally, Marathon will establish an IMV reserve when crude oil prices fall below $21 per barrel. As of December 31, 2002, no IMV reserve had been recognized.
Contingent Liabilities
Marathon accrues contingent liabilities for income and other tax deficiencies, environmental remediation, product liability claims and litigation claims when such contingencies are probable and estimable. These contingent obligations are assessed regularly by Marathon’s in-house legal counsel. In certain circumstances, outside legal counsel is utilized. For additional information on contingent liabilities, see “Management’s Discussion and Analysis of Environmental Matters, Litigation and Contingencies” on page 43.
Pensions and Other Postretirement Benefit Obligations
Accounting for these benefits involves assumptions related to the appropriate discount rate for measuring the present value of plan obligations, the expected rates of return on plan assets, the rate of future increases in
32
compensation levels and health care cost projections. Marathon develops its demographics and utilizes the work of outside actuaries to assist in the measurement of these obligations.
Effective December 31, 2002, Marathon revised the actuarial assumptions related to its pension and other postretirement benefit plans. The discount rate was lowered from 7 percent to 6.5 percent. The expected rate of return on plan assets was reduced from 9.5 percent to 9 percent. The annual rate of increase in per capita cost of covered health care benefits was increased from 7.5 percent to 10 percent.
Based on the actual 2002 results for the various plans and the revisions to the underlying assumptions, Marathon recognized an unfavorable additional minimum pension adjustment to other comprehensive income (loss) of $33 million at December 31, 2002. Marathon expects that pension and other postretirement plan expense in 2003 will increase approximately $75 million from 2002 levels, of which approximately $45 million relates to MAP. MAP is required to fund a cash contribution of approximately $35 million to its pension plan in the third quarter of 2003.
As of December 31, 2002, the allocation of pension plan assets approximated 75 percent in equity securities, 22 percent in bonds and 3 percent in other investments, which is consistent with the expectations underlying the rate-of-return assumptions. The average rate-of-return on Marathon’s plan assets achieved by its investment advisor has historically exceeded the current expected rate-of-return.
Management’s Discussion and Analysis of Income and Operations
Revenuesfor each of the last three years are summarized in the following table:
(In millions)
2002
2001
2000
Exploration & production (“E&P”)
$
3,880
$
4,524
$
4,623
Refining, marketing & transportation (“RM&T”)
26,399
27,247
28,777
Other energy related businesses (“OERB”)
2,122
2,062
1,919
Segment revenues
32,401
33,833
35,319
Elimination of intersegment revenues
(937
)
(728
)
(765
)
Elimination of sales to United States Steel
–
(30
)
(60
)
Total revenues
$
31,464
$
33,075
$
34,494
Items included in both revenues and costs and expenses:
Consumer excise taxes on petroleum products and merchandise
$
4,250
$
4,404
$
4,344
Matching crude oil and refined product buy/sell transactions settled in cash:
E&P
$
289
$
454
$
643
RM&T
4,191
3,797
3,811
Total buy/sell transactions
$
4,480
$
4,251
$
4,454
E&P segment revenues decreased by $644 million in 2002 from 2001 and $99 million in 2001 from 2000. The 2002 decrease was primarily due to lower worldwide natural gas prices, lower volumes, and lower derivative gains, partially offset by higher worldwide liquid hydrocarbon prices. The decrease in 2001 was primarily due to lower domestic liquid hydrocarbon production and prices, partially offset by higher domestic natural gas prices and production, and gains from derivative activities.
RM&T segment revenues decreased by $848 million in 2002 from 2001 and $1.530 billion in 2001 from 2000. The decrease in 2002 and 2001 was primarily due to lower refined product prices.
OERB segment revenues increased by $60 million in 2002 from 2001 and $143 million in 2001 from 2000. The increase in 2002 reflected a favorable effect from increased natural gas and crude oil resale activity partially offset by lower natural gas prices. The increase in 2001 reflected higher natural gas prices and crude oil resale activity, partially offset by lower crude oil prices and natural gas resale activity.
33
Average Volumes and Selling Prices
2002
2001
2000
(thousands of barrels per day)
Net liquids production(a)
– Domestic
117
127
131
– International(b)
82
73
65
– Total consolidated
199
200
196
– Equity investees(c)
8
9
11
– Worldwide
207
209
207
(millions of cubic feet per day)
Net natural gas production
– Domestic
745
793
731
– International – equity
456
441
470
– International – other(d)
4
8
11
– Total consolidated
1,205
1,242
1,212
– Equity investee(e)
25
31
29
– Worldwide
1,230
1,273
1,241
(dollars per barrel)
Liquid hydrocarbons(a)(f)
– Domestic
$
22.00
$
20.62
$
25.55
– International
23.83
23.37
26.74
– Total consolidated
22.76
21.63
25.95
– Equity investee(c)
24.59
23.41
29.64
– Worldwide
22.84
21.71
26.14
(dollars per mcf)
Natural gas(f)
– Domestic
$
2.87
$
3.69
$
3.49
– International – equity
2.53
3.16
2.96
– Total consolidated
2.74
3.50
3.28
– Equity investee(e)
3.05
3.39
2.75
– Worldwide
2.75
3.49
3.27
(thousands of barrels per day)
Refined products sold
1,318
1,304
1,306
Matching buy/sell volumes included in above
71
45
52
(a) Includes crude oil, condensate and natural gas liquids.
(b) Represents equity tanker liftings, truck deliveries and direct deliveries.
(c) Represents Marathon’s equity interest in MKM Partners L.P. (“MKM”) and CLAM Petroleum B.V. (“CLAM”) for 2002 and 2001 and Sakhalin Energy Investment Company Ltd. (“Sakhalin Energy”) and CLAM for 2000.
(d) Represents gas acquired for injection and subsequent resale.
(e) Represents Marathon’s equity interest in CLAM.
(f) Prices exclude derivative gains and losses. 34
Income from operationsfor each of the last three years is summarized in the following table:
(In millions)
2002
2001
2000
E&P
Domestic
$
687
$
1,122
$
1,110
International
346
297
420
E&P segment income
1,033
1,419
1,530
RM&T
356
1,914
1,273
OERB
78
62
43
Segment income
1,467
3,395
2,846
Items not allocated to segments:
Administrative expenses(a)
(194
)
(187
)
(154
)
IMV reserve adjustment(b)
72
(72
)
–
Gain (loss) on ownership change in MAP
12
(6
)
12
Gain on offshore lease resolution with U.S. Government
–
59
–
Gain (loss) on disposal of assets(c)
24
(221
)
124
Charge on formation of MKM Partners L.P. JV(d)
–
–
(931
)
Impairment of oil and gas properties and assets held for sale(e)
–
–
(197
)
Reorganization charges including pension settlement gain (loss) and benefit accruals(f)
–
(14
)
(70
)
Contract settlement(g)
(15
)
–
–
Total income from operations
$
1,366
$
2,954
$
1,630
(a) Includes administrative expenses related to Steel Stock of $25 million for 2001 and $18 million for 2000.
(b) The IMV reserve reflects the extent to which the recorded LIFO cost basis of inventories of liquid hydrocarbons and refined petroleum products exceeds net realizable value.
(c) In 2002, represents gain on exchange of certain oil and gas properties with XTO Energy, Inc. In 2001, represents a loss on the sale of certain Canadian assets. The net gain in 2000 represents a gain on the disposition of Angus/Stellaria, a gain on the Sakhalin exchange, a gain on the sale of SSA non-core stores, and a loss on the sale of the Howard Glasscock field.
(d) Represents a charge related to the joint venture formation between Marathon and Kinder Morgan Energy Partners, L.P.
(e) Represents in 2000, an impairment of certain oil and gas properties, primarily in Canada, and assets held for sale.
(f) Represents reorganization charges in 2001 and 2000 and pension settlement gains (losses) and various benefit accruals resulting from retirement plan settlements and voluntary early retirement programs in 2000. 2001 reorganization charges include costs related to the Separation from United States Steel.
(g) Represents a settlement arising from the cancellation of the Cajun Express rig contract on July 5, 2001. Domestic E&P incomedecreased by $435 million in 2002 from 2001 following an increase of $12 million in 2001 from 2000. The decrease in 2002 was primarily due to lower natural gas prices, lower volumes, lower derivative gains and higher dry well expense, partially offset by higher liquid hydrocarbon prices.
The increase in 2001 was primarily due to gains from derivative activities and higher natural gas volumes and prices, partially offset by lower liquid hydrocarbon prices.
International E&P income increased by $49 million in 2002 from 2001 following a decrease of $123 million in 2001 from 2000. The increase in 2002 was a result of higher production volumes and higher derivative gains partially offset by lower natural gas prices.
The decrease in 2001 was primarily due to lower liquid hydrocarbon prices, increased depletion expense due primarily to 2000 reserve reductions and lower natural gas volumes, partially offset by increased natural gas prices, lower dry well expense, and lower foreign royalty and geophysical contract expenditures.
RM&T segment income decreased by $1.558 billion in 2002 from 2001 following an increase of $641 million in 2001 from 2000. In 2002, the refining and wholesale marketing margin was severely compressed as crude oil costs increased while average refined product prices decreased.
Gains on the sale of SSA stores included in segment income were $37 million, $23 million, and $7 million for 2002, 2001, and 2000, respectively.
The increase in 2001 was primarily due to a higher refining and wholesale marketing margin partially offset by lower SSA gasoline and distillate sales volumes and increased refining and wholesale marketing transportation expense.
35
OERB segment income increased by $16 million in 2002 following an increase of $19 million in 2001 from 2000. The increase in 2002 reflected a favorable effect of $26 million from increased margins in gas marketing activities and mark-to-market valuation changes in associated derivatives and earnings of $11 million from Marathon’s equity investment in the Equatorial Guinea methanol plant, partially offset by predevelopment costs associated with emerging integrated gas projects.
The increase in 2001 was primarily a result of higher crude oil purchase and resale activity accompanied by increased margins and losses from derivative activities recorded in 2000.
Items not allocated to segments:
Administrative expensesincreased by $7 million in 2002 following an increase of $33 million in 2001 from 2000. Unallocated administrative expenses associated with corporate activities are not included in segment income. The increase in 2002 primarily reflected increased state franchise tax expense.
The increase in 2001 was primarily due to the portion of costs related to the development of an enterprise-wide software application that could not be capitalized and costs resulting from activities related to the Separation.
IMV reserve adjustment– In 2002, the IMV reserve adjustment resulted in a
chargecredit to income from operations of $72 million.No adjustment was required in 2000.Theunfavorable 2001favorable 2002 IMV reserve adjustment was primarily due to an increase in crude oil and refined petroleum product prices, reversing thesignificant2001 IMV charge to income that resulted from a decrease in crude oil and refined petroleum product priceswhich occurred duringat December 31, 2001. For additional information on this adjustment, see “Management’s Discussion and Analysis of Critical Accounting Estimates – Net Realizable Value of Inventories” on page 32.Gain (loss) on ownership change in MAPreflects the
fourth quartereffects of2001.contributions to MAP of certain environmental capital expenditures funded by Marathon and Ashland. In accordance with MAP’s limited liability company agreement, in certain instances, environmental capital expenditures are funded by the original owner of the assets, but no change in ownership interest may result from these contributions. An excess of Ashland funded improvements over Marathon funded improvements results in a net gain and an excess of Marathon funded improvements over Ashland funded improvements results in a net loss.Other items not allocated to segments – Certain nonoperating or infrequently occurring items are not allocated to segments. Such items in the aggregate had a net favorable effect on income from operations of $9 million in 2002 and net unfavorable effects of $176 million in 2001 and $1.074 billion in 2000. A loss on the sale of certain Canadian assets of $221 million was included in 2001 and a charge related to the formation of MKM of $931 million was included in 2000.
Net interest and other financial costs
decreasedincreased by $95 million in 2002 from 2001, following a decrease of $63 million in 2001 from2000, following a decrease of $52 million2000. The increase in20002002 was primarily due to higher average debt levels resulting from1999.acquisitions and the Separation. The decrease in 2001 was primarily due to lower average debt levels and increased capitalized interest on RM&T projects.The decrease in 2000 was primarily due to lower average debt levels and increased interest income. For additional details, see Note 7 to the Financial Statements. The minorityMinority interest in income of MAP, which represents
Ashland'sAshland’s 38 percent ownership interest,increaseddecreased by $531 million in 2002 from 2001, following an increase of $206 million in 2001 from 2000. MAP income was significantly lower in 2002 compared to 2001 as discussed above in the RM&T segment. MAP income was higher in 2001 compared to 2000following an increase of $51as discussed above in the RM&T segment.Provision for income taxeswas $389 million in
2000 from 1999. The increase in 2001 and 2000 was primarily due to higher MAP income. The provision for income taxes was2002, compared with $759 million in 2001compared withand $476 million in2000 and $320 in 1999.2000. Thehigher 20012002 provisionis primarilyincluded a one-time, deferred tax charge of $61 million as a result ofincreased income from operations.the enactment of a supplemental tax in the United Kingdom (“U.K.”). The 2000 provision included a one-time, noncash deferred tax charge of $235 million as a result of the change in the amount, timing and nature of expected future foreign source income due to the exchange ofMarathon'sMarathon’s interest in Sakhalin Energy for other oil and gas producing interests.For additional discussion36
The following is an analysis of
income taxes, see Note 18 totheFinancial Statements.effective tax rate for the periods presented:
2002
2001
2000
Statutory tax rate
35.0
%
35.0
%
35.0
%
Effects of foreign operations(a)
5.4
(1.5
)
19.5
State and local income taxes after federal income tax effects
3.9
3.2
0.6
Other federal tax effects
(2.3
)
(0.2
)
(2.0
)
Effective tax rate
42.0
%
36.5
%
53.1
%
(a) The deferred tax effect related to the enactment of a supplemental tax in the U.K. increased the effective tax rate 6.4 percent in 2002. The deferred tax effect resulting from the exchange of Marathon’s interest in Sakhalin Energy increased the effective tax rate 26.2 percent in 2000. The release of a foreign valuation allowance decreased the effective tax rate 3.3 percent in 2000. Discontinued operationsin 2001 represents the net
income orloss attributed to Steel Stock, adjusted for certain corporate administrative expenses and interest expense (net of income tax effects). The loss on disposition of United States Steel Corporation represents the excess of the net investment in United States Steel over the aggregate fair market value of the outstanding shares of the Steel Stock at the time of the Separation.For additional discussionExtraordinary loss from early extinguishment of
discontinued operations, see Note 2debt in 2002 was attributable to theFinancial Statements.retirement of $337 million aggregate principal amount of debt resulting in an extraordinary loss of $33 million (net of tax of $20 million).Cumulative effect of changes in accounting principles of $13 million, net of a tax provision of $7 million in 2002 represents the adoption of recently issued interpretations by the FASB of SFAS No. 133 in which Marathon must recognize in income the effect of changes in the fair value of two long-term natural gas sales contracts in the United Kingdom. The $8 million loss, net of a tax benefit of $5 million, in 2001 was an unfavorable transition adjustment related to the initial adoption of SFAS No. 133.
Net income
decreasedincreased by $359 million in 2002 from 2001, following a decrease of $254 million in 2001 from 2000,following a decrease of $287 million in 2000 from 1999,primarily reflecting the factors discussed above.35Management'sManagement’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity
Financial Condition
Current assets
decreased $574increased $68 million from year-end2000,2001, primarily due toa decreasean increase in receivables andassets held for sale,inventories, partially offset byan increasea decrease in cash and cash equivalents. Thedecreaseincrease in receivables was mainly due tolowerhigher year-end commodity prices partially offset by a decrease in derivative assets and thedecreaseincrease inassets held for saleinventories was primarily the result ofthe contributionhigher prices ofthe Yates field assets to the MKM Partners L.P. joint venture. The increase in cashliquid hydrocarbons and refined petroleum products that reversed 2001’s IMV reserve. Cash and cash equivalentsprimarily resulted from cash balances which were attributedat year-end 2001 included amounts inpart to United States Steelpreparation for the acquisition of Equatorial Guinea interests and the repayment of preferred securities inprior years.January 2002.Current liabilities
decreased $544increased $191 million from year-end2000,2001, primarily due toa decreasean increase in accounts payableincluding accounts payable to United States Steel,and accrued taxes partially offset byan increase in redeemablethe repayment of preferred securities. Thedecreaseincrease in accounts payable was due tolowerhigher priced year-endcommodity prices. The decrease in accounts payable to United States Steel resulted from the settlement of 2001 income taxes with United States Steel upon Separation. Under Marathon's previous tax allocation policy, income tax settlements with United States Steel generally occurred in March of the following year. Obligations to repay preferred securities reflect securities that became redeemable or that were converted to a right to receive cash upon Separation. These obligations were paid in January 2002.crude purchases at MAP.Investments and long-term receivablesincreased
$714$558 million from year-end2000,2001, primarily due to thecontribution of assets to MKM Partners L.P. and Pilot Travel Centers LLC joint ventures. Net investment in United States Steel was eliminated with the dispositionacquisitions of thesteel business. Long-term receivables from United States Steel of $551 million represents long-term debt for which United States Steel has assumed responsibility for repayment.Equatorial Guinea interests.37
Net property, plant and equipmentincreased
$203$838 million from year-end2000,2001, primarily due to theacquisitionacquisitions ofPennaco Energy, Inc. ("Pennaco"), completion of the coker unit at the Garyville refinery and implementation of an integrated software system, partially offset by the sale of certain Canadian assets and the contribution of travel centers to Pilot Travel Centers LLC.Equatorial Guinea interests. Net property, plant and equipment for each of the lastthreetwo years is summarized in the following table:
(Dollars in millions) 2001 2000 1999 - --------------------------------------------------------------------------------E&P Domestic............................................. $ 2,851 $ 2,229 $ 3,435 International........................................ 2,472 2,924 2,987 ------- ------- -------- Total E&P........................................... 5,323 5,153 6,422 RM&T(a)............................................... 4,010 4,035 3,712 Other(b).............................................. 245 187 159 ------- ------- -------- Total.............................................. $ 9,578 $ 9,375 $ 10,293 - --------------------------------------------------------------------------------(a) Amounts include 100 percent
(In millions)
2002
2001
E&P
Domestic
$
2,720
$
2,839
International
3,186
2,471
Total E&P
5,906
5,310
RM&T
4,234
4,010
OERB
67
55
Corporate
183
177
Total
$
10,390
$
9,552
Goodwill increased $186 million from year-end 2001. The increase is primarily due to the acquisitions of
MAP. (b) Includes other energy related businessesEquatorial Guinea interests. Significant factors that resulted in the recognition of goodwill in these acquisitions include: the ability to acquire an established business with an assembled workforce andother miscellaneous corporate net property, planta proven track record andequipment.a strategic acquisition in a core geographic area.Intangiblesincreased $58 million from year-end 2001 primarily due to the acquisition of the contractual right to deliver to the Elba Island LNG re-gasification terminal.
Long-term debtat December 31,
20012002 was$3,432 million,$4.410 billion, an increase of$1,495$978 million from year-end2000. The increase in2001. Public debt totaling $1.850 billion wasmainly dueissued to fund theadditional net debtpurchase price andother financings retained by Marathon upon Separation. See Notes 2 and 13 to the Financial Statements. Preferred stock of subsidiary of $184 million was redeemed in 2001. See Note 23 to the Financial Statements. Stockholders' equity decreased $1,824 million from year-end 2000, primarily reflecting the distribution of Steel Stock to holdersassociated costs of theformer USX-U.S. Steel Group common stock.acquisitions of Equatorial Guinea interests, to refinance $337 million aggregate principal amount of existing debt, to reduce outstanding commercial paper and for other general corporate purposes.Cash Flows
Net cash provided from operating activities (for continuing operations)totaled
$2,919 million$2.405 billion in 2002, compared with $2.919 billion in 2001compared with $3,146 millionand $3.146 billion in2000 and $2,008 million in 1999.2000. The decrease in20012002 mainlyreflected unfavorable working capital changes partially offset byreflects thefavorableeffects ofimproved net income (excluding noncash items). 36lower refined product margins and lower prices for natural gas. Net cash provided from operating activities (for discontinued operations)totaled $717 million in 2001, compared with net cash used in operating activities of $615 million in
2000 and $72 million in 1999.2000. This activity is related to the business of United States Steel.Net cash used in investing activities (for continuing operations)totaled
$1,999 million$2.666 billion in 2002, compared with $1.999 billion in 2001compared withand $923 million in2000 and $1,174 million in 1999.2000. The increase in20012002 primarily resulted from theacquisitionacquisitions ofPennaco,Equatorial Guinea interests and decreased asset disposals,and increasedpartially offset by decreased capital expenditures. Proceeds of $152 million from the disposal of assets in 2002 were primarily from the sale of SSA stores and the sale of San Juan Basin assets. Proceeds from the disposal of assets in 2001 of $296 million were primarily from the sale of certain Canadian assets, SSA stores, and various domestic producing properties. Proceeds in 2000 were mainly from the Sakhalin exchange, the disposition ofMarathon'sMarathon’s interest in the Angus/Stellaria development in the Gulf of Mexico, the sale of non-core SSA stores and the sale of other domestic production properties.Proceeds in 1999 were mainly from the sale of Scurlock Permian LLC, over 150 non-strategic domestic and international production properties and Carnegie Natural Gas Company and affiliated subsidiaries.Capital expendituresfor each of the last three years are summarized in the following table:
(In millions)
2002
2001
2000
E&P(a)
Domestic
$
416
$
537
$
513
International
457
400
226
Total E&P
873
937
739
RM&T
621
591
656
OERB
49
4
5
Corporate
31
107
25
Total
$
1,574
$
1,639
$
1,425
(Dollars(a) Amounts exclude the acquisitions of the Equatorial Guinea interests in millions) 2001 2000 1999 - --------------------------------------E&P Domestic(a) $ 537 $ 516 $ 356 International 400 226 388 ------- ------- ------- Total E&P 937 742 744 RM&T(b) 591 656 612 Other(c) 111 27 22 ------- ------- ------- Total $ 1,639 $ 1,425 $ 1,378 - --------------------------------------2002 and Pennaco in 2001.(a) Amounts exclude38
Capital expenditures in 2002 totaled $1.574 billion excluding the
acquisitionacquisitions ofPennaco. (b) Amounts include 100 percent of MAP. (c) Includes other energy related business and other miscellaneous corporate capital expenditures. During 2001, Domestic E&P capitalEquatorial Guinea interests, compared with $1.639 billion in 2001. The $65 million decrease mainly reflected decreased spendingmainly included exploration and development drillingin theGulf of Mexico, and natural gas developments in gas basins throughout the western United States. InternationalE&Pprojects included projectssegment offset by increased spending in theNorth Sea, primarilyRM&T segment. The decrease in thenewly acquired Foinaven field, naturalE&P segment was primarily due to the drilling of fewer gasdevelopmentswells inCanada and exploration drillingthe United States inNova Scotia and Angola. RM&T spending2002 partially offset byMAP primarily consisted of refinery modifications, includinghigher capital expenditures for completion of a pipeline in Gabon, for a pipeline construction contract in Ireland and for development expenditures in Equatorial Guinea. The increase in thecoker projectRM&T segment was attributable to increased spending on the multi-year integrated investment program atthe GaryvilleMAP’s Catlettsburg refinery andupgrades and expansions of retail marketing outlets. Other spending primarily consisted of the implementation of an integrated software system. Capital expenditures, excluding the portion of exploration expenditures expected to be expensed, are estimated to be approximately $1.7 billion in 2002, a slight increase over 2001 levels. Domestic E&P spending for 2002 will be primarily focused on onshore natural gas exploration and development and offshore deepwater Gulf exploration. International E&P will primarily continue oil developments in the U.K. North Sea and natural gas developments in Canada and exploration in Angola. RM&T spending by MAP will primarily consist of refinery improvements, including the Catlettsburg refinery repositioning project, upgrades and expansions of retail marketing outlets and transportation assets, includingconstruction of the Cardinal ProductsPipe Line. See "Management's DiscussionPipeline in 2002, partially offset by lower capital expenditures for SSA retail outlets andAnalysiscompletion ofFinancial Condition and Results of Operations--Outlook" on page 42, for additional discussion ontheCatlettsburg refinery repositioning project. Other Marathon spending will include funds for natural gas and crude oil marketing and transportation projects as well as various other corporate capital expenditures. An additional $1.1 billion is anticipated for upstream acquisition expenditures, including the recently completed acquisition of interestsGaryville coker construction inEquatorial Guinea. Contract commitments for property, plant and equipment acquisitions and long-term investments at year-end 2001 were $297 million, compared with $457 million at year-end 2000. For further discussion on commitments, see "Management's Discussion and Analysis of Financial Condition, Cash Flows and Liquidity - Liquidity and Capital Resources" on page 38.2001.Costs incurred for the periods ended December 31, 2002, 2001,
2000,and19992000 relating to the development of proved undeveloped oil and gas reserves, includingMarathon'sMarathon’s proportionate share of equityinvestee'sinvestees’ costs incurred, were $404 million, $365 million,$316 million,and$333$316 million, respectively. As of December 31,2001,2002, estimated future development costs relating to the development of proved undeveloped oil and gas reserves for the years20022003 through20042005 are projected to be$308$464 million,$155$139 million, and$40$67 million, respectively.Net cash used in investing activities (for discontinued operations)totaled $245 million in 2001, compared with $270 million in
2000 and $294 million in 1999.2000. This activity related to the business of United States Steel.37Net cash
used inprovided by financing activitiestotaled$1,290$88 million in 2002, compared with net cash used of $1.290 billion in 2001 and $911 million in 2000. The increase was primarily due to financing associated with the two acquisitions of Equatorial Guinea interests of approximately $1.2 billion. This was partially offset by the early extinguishment of $337 million aggregate principal amount of debt and the $295 million repayment of preferred securities that became redeemable or were converted to a right to receive cash upon the Separation. In early January 2002, Marathon paid $185 million to retire the 6.75% Convertible Quarterly Income Preferred Securities and $110 million to retire the 6.50% Cumulative Convertible Preferred Stock. Additionally, distributions to minority shareholder of MAP were $176 million in 2002, compared to $577 million in 2001compared with $911and $420 million in2000 and $480 million in 1999. Marathon manages its financing activities on a centralized, consolidated basis. Generally, financing transactions were not separately associated with either continuing or discontinued operations but rather were attributed to both businesses.2000. The cash used in 2001 primarily reflects distributions to minority shareholder of MAP, dividends paid and the redemption of the8.75%8.75 percent Cumulative Monthly Income PreferredShares ("MIPS").Shares. The cash used in 2000 primarily reflects distributions to minority shareholder of MAP, dividends paid and a stock repurchaseprogram. The cash used in 1999 reflects distributions to minority shareholder of MAP and dividends paid, offset by other net borrowings. Debt Rating Marathon's senior debt is currently rated investment grade by Standard and Poor's Corporation, Moody's Investor Services, Inc. and Fitch Ratings with ratings of BBB+, Baa1, and BBB+, respectively.program for Marathon.Derivative Instruments
See
"Quantitative“Quantitative and Qualitative Disclosures About MarketRisk"Risk” on page45,51, for a discussion of derivative instruments and associated market risk.Liquidity and Capital Resources
Marathon'sMarathon’s main sources of liquidity and capital resources are internally generated cash flow from operations, committed and uncommitted credit facilities, and access to both the debt and equity capital markets.
Marathon'sMarathon’s ability to access the debt capital market is supported by its investment grade credit ratings. Because of the liquidity and capital resource alternatives available to Marathon, including internally generated cash flow,Marathon'sMarathon’s management believes that its short-term and long-term liquidity is adequate to fund operations, including its capital spending program, repayment of debt maturities for the years2002,2003, 2004, and2004,2005, and any amounts that may ultimately be paid in connection withcontingencies (which are discussed in Note 26 to the Financial Statements).contingencies.Marathon’s senior unsecured debt is currently rated investment grade by Standard and Poor’s Corporation, Moody’s Investor Services, Inc. and Fitch Ratings with ratings of BBB+, Baa1, and BBB+, respectively.
Marathon has a committed
$1,354 million$1.354 billion long-term revolving credit facility that terminates in November 2005 and a committed$451$574 million 364-day revolving credit facility that terminates in November 2003. At December 31, 2002, there were no borrowings against these facilities. In April 2002, Marathon initiated a $1.350 billion commercial paper program that is backed by the long-term revolving credit facility. At December 31,2001, $4752002, $100 millionhad been drawn against these facilities.of commercial paper was outstanding. Additionally, at December 31,2001,2002, Marathon hadan aggregateother uncommitted short-term lines of$550credit totaling $200 million,in three other short-term credit facilities,of which no amounts were drawn.MAP currently has a committed $350 million
long-termshort-term revolving credit facilityandwhich expires in July 2003. Additionally, MAP has acommitted $100$190 million364-dayrevolving creditfacility.agreement with Ashland that expires in March 2003. As of December 31,2001,2002, MAP did not have any borrowings against thesefacilities or under its $190 million revolving credit agreement withfacilities. Marathon and AshlandInc. Certain securities became redeemable or were convertedare investigating other alternatives toa rightprovide other liquidity in toreceive cash upon the Separation of United States Steel.MAP.39
In
early January2002, Marathonpaid $185 million to retirefiled a new universal shelf registration statement with the6.75% Convertible Quarterly Income PreferredSecurities and$110 million to retire the 6.50% Cumulative Convertible Preferred Stock.Exchange Commission registering $2.7 billion aggregate amount of common stock, preferred stock and other equity securities, debt securities, trust preferred securities and/or other securities, including securities convertible into or exchangeable for other equity or debt securities. As of December 31, 2002, no securities had been offered under this shelf registration statement.In
early March2002, Marathon issued notes of $1.450 billion as follows: $450 million due 2012,and$550 million due 2032 and $450 million due 2007, bearing interest at 6.125 percent,and6.8 percent and 5.375 percent, respectively. Additionally, Marathon Global Funding Corporation, a 100 percent owned consolidated finance subsidiary of Marathon, issued notes of $400 million due 2012, bearing interest at 6.0 percent. Marathon has fully and unconditionally guaranteed the securities of Marathon Global Funding.Marathon used the net proceeds
to repay amounts borrowedof these borrowings to fund the purchase price and associated costs of theJanuary 2002acquisition of interests inoil and gas properties and related assets inEquatorial Guinea,West Africa. Marathon initially funded this acquisition throughto refinance existing debt, to reduce outstanding commercial paper and for other general corporate purposes. The debt repurchased and retired early had average terms to maturity of between two and 21 years bearing interest at rates ranging from 8.125 percent to 9.375 percent per year, or acombinationweighted average ofborrowings under long-term and short-term revolving credit facilities, borrowings under other short-term credit facilities and cash on hand. Marathon is not dependent on off-balance sheet arrangements to meet its liquidity and capital resource needs. Marathon has used and may use9.04 percent per year. The retirement of $337 million aggregate principal amount of debt inthe future off-balance sheet arrangements to fund specific projects. The largest category2002 resulted in an extraordinary loss ofoff-balance sheet arrangements is operating lease obligations, for which contractual cash obligations totaled $422$33 millionat December 31, 2001. Of that total, $160 million related to three agreements which covered two LNG tankers and Marathon's headquarters building, respectively. Under those three arrangements, Marathon does not have an ownership interest in the entities that hold the leased assets nor does Marathon hold title to the respective leased assets. These entities were established by financial institutions for the purpose(net ofleasing specific assets to Marathon. Such entities are limited in the typetax ofbusiness activity that can be transacted. 38$20 million). The table below provides aggregated information on
Marathon'sMarathon’s obligationsand commitmentsto make future payments under existing contracts as of December 31,2001:2002:Summary of Contractual Cash Obligations
and Commercial
(Dollars in millions)
Total
2003
2004-
2005
2006-
2007
Later Years
Short and long-term debt (a)
$
4,485
$
156
$
413
$
752
$
3,164
Sale-leaseback financing (includes imputed interest) (a)
118
11
22
31
54
Capital lease obligations
9
1
2
2
4
Operating lease obligations(a)
598
129
255
99
115
Operating lease obligations under sublease(a)
96
23
32
14
27
Purchase obligations:
Unconditional purchase obligation(b)
70
5
11
11
43
Contracts to acquire property, plant and equipment
443
370
48
6
19
Crude, refinery feedstock and refined products contracts(c)
7,828
5,001
1,992
823
12
Transportation and related contracts
772
88
153
130
401
LNG facility operating costs(d)
228
14
29
29
156
Service and materials contracts(e)
144
50
47
18
29
Commitments for oil and gas exploration (non-capital) (f)
33
12
21
—
—
Total purchase obligations
9,518
5,540
2,301
1,017
660
Other long-term liabilities reflected on the Consolidated Balance Sheet:
Accrued LNG facility operating costs (d)
15
—
2
2
11
Total other long-term liabilities
15
—
2
2
11
Total contractual cash obligations(g)
$
14,839
$
5,860
$
3,027
$
1,917
$
4,035
(a) Upon the Separation, United States Steel assumed certain debt and lease obligations. Such amounts have been included in the above table to reflect the fact that Marathon remains primarily liable.
(b) Marathon is a party to a long-term transportation services agreement with a natural gas transmission company. This agreement is used by the natural gas transmission company to secure its financing. This arrangement represents an indirect guarantee of indebtedness. Therefore, this amount has also been disclosed as a guarantee. See Note 25 to the Consolidated Financial Statements for a complete discussion of Marathon’s guarantees.
(c) The majority of 2003’s contractual obligations to purchase crude oil, refinery feedstock and refined products relate to contracts to be satisfied within the first 180 days of the year.
(d) Marathon has acquired the right to deliver to the Elba Island LNG re-gasification terminal 58 bcf of natural gas per year. The agreement’s primary term ends in 2018. Pursuant to this agreement, Marathon has also bound itself to a commitment to pay for a portion of the operating costs of the LNG re-gasification terminal.
(e) Services and materials contracts include contracts to purchase services such as utilities, supplies and various other maintenance and consulting services.
(f) Commitments for oil and gas exploration (non-capital) include estimated costs within contractually obligated exploratory work programs that are subject to immediate expense, such as geological and geophysical costs.
2003- 2005- (Dollars in millions) Total 2002 2004 2006 Later Years - --------------------------------------------------------------------------------Contractual(g) Includes $719 million of contractual cash obligations (excluding amountsthat have been assumed by United StatesSteel) ShortSteel. For additional information, see “Management’s Discussion andlong-term debt................. $3,093 210 529 863 1,491 Capital lease obligations................ 10 1 2 2 5 Off-balance sheet arrangements: Operating lease obligations............. 403 86 117 135 65 Operating lease obligations under sublease............................... 16 5 6 3 2 Unconditional purchase obligations...... 70 5 10 10 45 Commercial commitments (excluding amounts related toAnalysis of Financial Condition, Cash Flows and Liquidity – Obligations Associated with the Separation of United StatesSteel) Throughput and deficiency agreements..... 112 14 16 20 62 GuaranteesSteel – Summary ofthe indebtedness of others.................................. 35 -- -- -- 35 Contract commitments to acquire property, plant and equipment..................... 297 184 90 23 -- ------ --- --- ----- ----- Total excluding amounts related to United States Steel.............................. 4,036 505 770 1,056 1,705Contractualcash obligations assumedCash Obligations Assumed by United StatesSteel Long-term debt........................... 470 -- -- -- 470 Sale-leaseback financing................. 128 11 22 22 73 Off-balance sheet arrangements: Operating lease obligations............. 19 7 6 6 -- Operating leaseSteel” on page 42.40
Contractual cash obligations
under sublease............................... 96 18 38 10 30 Commercial commitments related to United States Steel Guarantees of indebtedness of others..... 28 5 -- -- 23 ------ --- --- ----- ----- Total amounts related to United States Steel..................................... 741 41 66 38 596 ------ --- --- ----- ----- Total contractual obligations and commercial commitments.................... $4,777 546 836 1,094 2,301 - --------------------------------------------------------------------------------Marathon remains primarily obligatedforcertain debtwhich the ultimate settlement amounts are not fixed and determinable have been excluded from the above table. These include derivative contracts that are sensitive to future changes in commodity prices and otherfinancings for which United States Steel has assumed responsibility for repayment under the terms of the Separation. In addition,factors.Marathon
remains contingently liable for certain operating lease obligations of United States Steel. Marathon has also guaranteed certain obligations related to the business of United States Steel. United States Steel is the sole general partner of Clairton 1314B Partnership, L.P., which owns certain coke-making facilities formerly owned by United States Steel. Marathon has guaranteed to the limited partners all obligations of United States Steel under the partnership documents. United States Steel may dissolve the partnership under certain circumstances, including if it is required to fund accumulated cash shortfalls of the partnership in excess of $150 million. In addition to the normal commitments of a general partner, United States Steel has indemnified the limited partners for certain income tax exposures. As of December 31, 2001, United States Steel had no unpaid outstanding obligations to the limited partners and, accordingly, no amounts were reflected in the above table for this guarantee. Excluded from the table is indebtedness of equity investees which Marathon does not support through guarantees or otherwise. If Marathon were obligated to share in this debt on a pro rata basis, its share would have been approximately $353 million as of December 31, 2001. In the event of default by any of these equity investees, Marathon has no obligation to support the debt; however, any such default could adversely impact our financial investment in the respective equity investee. The table excludes commitments to transport crude oil, natural gas and refined products that were not negotiated as part of arranging the financing of the transportation facilities under contract, which totaled $780 million at December 31, 2001. The table also excludes contractual obligations under long- term agreements to purchase crude oil, refinery feedstock and refined products used in day-to-day operations to generate revenues. Marathon management'smanagement’s opinion concerning liquidity andMarathon'sMarathon’s ability to avail itself in the future of the financing options mentioned in the above forward-looking statements are based on currently available information. To the extent that this information proves to be inaccurate, future availability of financing may be adversely affected. Factors that affect the availability of financing include the performance of Marathon (as measured by various factors including cash provided from operating activities), the state of worldwide debt and equity markets, investor perceptions and expectations of past and future performance, the global financial climate, and, in particular, with respect to borrowings, the levels ofMarathon'sMarathon’s outstanding debt and credit ratings by rating agencies.39Management'sOff Balance Sheet Arrangements
Off-balance sheet arrangements comprise those arrangements that may potentially impact Marathon’s liquidity, capital resources and results of operations, even though such arrangements may not be currently recorded as liabilities. Although off-balance sheet arrangements serve a variety of Marathon’s business purposes, Marathon is not dependent on these arrangements to meet its liquidity and capital resources; nor is management aware of any circumstances that are reasonably likely to cause the off-balance sheet arrangements to have a material adverse effect on liquidity or capital resources.
One off-balance sheet arrangement in which Marathon participants is in the leasing of two tankers to transport LNG. If Marathon were to purchase such assets rather than lease them, it would assume a liability for the financing. In 2002, Marathon’s share of operating lease payments under this arrangement was $5 million. For additional details on this arrangement, refer to Note 24 to the Consolidated Financial Statements on page F-33.
Marathon has also provided various forms of guarantees of unconsolidated affiliates, United States Steel and certain lease contracts. These arrangements are described in Note 25 to the Consolidated Financial Statements on page F-34.
Marathon also is a party to agreements that would require Marathon to purchase, under certain circumstances, its joint venture partners’ interests in MAP and in Pilot Travel Centers LLC (“PTC”). These put/call agreements are described in Note 25 to the Consolidated Financial Statements.
Nonrecourse Indebtedness of Investees
Certain equity investees of Marathon have incurred indebtedness that Marathon does not support through guarantees or otherwise. If Marathon were obligated to share in this debt on a pro rata basis, its share would have been approximately $331 million as of December 31, 2002. Of this amount, $159 million relates to PTC. Additionally, PTC expects to incur additional indebtedness in connection with its recent acquisition of 60 retail travel centers, of which Marathon’s pro rata share would be $84 million. In the event of default by any of these equity investees, Marathon has no obligation to support the debt.
Obligations Associated with the Separation of United States Steel
Marathon remains obligated (primarily or contingently) for certain debt and other financial arrangements for which United States Steel has assumed responsibility for repayment under the terms of the Separation. In the event of United States Steel’s failure to satisfy these obligations, Marathon would become responsible for repayment. As of December 31, 2002, Marathon has identified the following obligations totaling $705 million that have been assumed by United States Steel:
$470 million of industrial revenue bonds related to environmental improvement projects for current and former United States Steel facilities, with maturities ranging from 2009 through 2033. Accrued interest payable on these bonds was $5 million at December 31, 2002.$81 million of sale-leaseback financing under a lease for equipment at United States Steel’s Fairfield Works, with a term extending to 2012, subject to extensions. There was no accrued interest payable on this financing at December 31, 2002.$131 million of operating lease obligations, of which $78 million was in turn assumed by purchasers of major equipment used in plants and operations divested by United States Steel.A guarantee of United States Steel’s $18 million contingent obligation to repay certain distributions from its 50 percent owned joint venture PRO-TEC Coating Company.41
A guarantee of all obligations of United States Steel as general partner of Clairton 1314B Partnership, L.P. to the limited partners. United States Steel has reported that it currently has no unpaid outstanding obligations to the limited partners. For further discussion of the Clairton 1314B guarantee, see Note 3 to the Consolidated Financial Statements.Of the total $705 million, obligations of $556 million and corresponding receivables from United States Steel were recorded on Marathon’s consolidated balance sheet (current portion—$9 million; long-term portion—$547 million). The remaining $149 million was related to off-balance sheet arrangements and contingent liabilities of United States Steel.
Each of Marathon and United States Steel, as members of the same consolidated tax reporting group during taxable periods ended on or prior to December 31, 2001, is jointly and severally liable for the federal income tax liability of the entire consolidated tax reporting group for those periods. Marathon and United States Steel have entered into a tax sharing agreement that allocates tax liabilities relating to taxable periods ended on or prior to December 31, 2001. To address the possibility that the taxing authorities may seek to collect a tax liability from one party where the tax sharing agreement allocates that liability to the other party, the agreement includes indemnification provisions.
As of December 31, 2001, Marathon had identified obligations totaling $704 million that had been assumed by United States Steel. Also, as of December 31, 2001, Marathon had a $54 million settlement receivable from United States Steel arising from the allocation of net debt and other financings at the time of the Separation, which was paid on February 6, 2002. During 2002, increases resulting from the extension of certain operating lease obligations were partially offset by decreases in obligations assumed by United States Steel resulting from scheduled payments. Under the Financial Matters Agreement, United States Steel has all of the existing contractual rights under the leases assumed from Marathon, including all rights related to purchase options, prepayments or the grant or release of security interests. However, United States Steel has no right to increase amounts due under or lengthen the term of any of the assumed leases, other than extensions set forth in the terms of any of the assumed leases.
The table below provides aggregated information on the portion of Marathon’s obligations to make future payments under existing contracts that have been assumed by United States Steel as of December 31, 2002:
Summary of Contractual Cash Obligations Assumed by United States Steel
(Dollars in millions)
Total
2003
2004-
2005
2006-
2007
Later Years
Contractual obligations assumed by United States Steel
Long-term debt
$
470
$
–
$
–
$
–
$
470
Sale-leaseback financing (includes imputed interest)
118
11
22
31
54
Operating lease obligations
53
5
14
16
18
Operating lease obligations under sublease
78
18
25
9
26
Total contractual obligations assumed by United States Steel
$
719
$
34
$
61
$
56
$
568
United States Steel reported in its Form 10-Q for the quarterly period ended September 30, 2002, that it has significant restrictive covenants related to its indebtedness including cross-default and cross-acceleration clauses on selected debt that could have an adverse effect on its financial position and liquidity. However, United States Steel management believes that its liquidity will be adequate to satisfy its obligations for the foreseeable future. If there is a prolonged delay in the recovery of the manufacturing sector of the U.S. economy, United States Steel believes that it can maintain adequate liquidity through a combination of deferral of nonessential capital spending, sale of non-strategic assets and other cash conservation measures.
On January 28, 2003, United States Steel announced, in a press release reporting 2002 fourth quarter and full-year results, that available sources of liquidity at the end of 2002 were $1.03 billion. In February 2003, United States Steel issued mandatory convertible preferred shares for net proceeds of approximately $242 million. United States Steel has announced its interest in acquiring the assets of bankrupt National Steel Corporation.
42
Management’s Discussion and Analysis of Environmental Matters, Litigation and Contingencies
Marathon has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of
Marathon'sMarathon’s products and services, operating results will be adversely affected. Marathon believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and whether or not it is engaged in the petrochemical businesspower businessor the marine transportation of crude oil and refined products.Marathon'sMarathon’s environmental expenditures for each of the last three years
were(a)were(a):
(In millions)
2002
2001
2000
Capital
$
148
$
110
$
73
Compliance
Operating & maintenance
187
199
176
Remediation(b)
44
34
30
Total
$
379
$
343
$
279
(Dollars in millions) 2001 2000 1999 - --------------------------------------------------------------------------------Capital...................................................... $ 67 $ 73 $ 46 Compliance Operating & maintenance..................................... 155 139 117 Remediation(b).............................................. 34 30 25 ----- ----- ----- Total..................................................... $ 256 $ 242 $ 188 - --------------------------------------------------------------------------------(a) Amounts are determined based on American Petroleum Institute survey guidelines and include 100 percent of MAP. (a) Amounts are determined based on American Petroleum Institute survey guidelines and include 100 percent of MAP. (b) These amounts include spending charged against remediation reserves, net of recoveries, where permissible, but do not include noncash provisions recorded for environmental remediation. Marathon's
(b) These amounts include spending charged against remediation reserves, where permissible, but exclude noncash provisions recorded for environmental remediation. Marathon’s environmental capital expenditures accounted for
fournine percent of total capital expenditures in 2002, seven percent in 2001, and five percent in 2000.During 2000
and three percent in 1999. During 1999through2001,2002, compliance expenditures represented one percent ofMarathon'sMarathon’s total operating costs. Remediation spending during this period was primarily related to retail marketing outletswhichthat incur ongoing clean-up costs for soil and groundwater contamination associated with underground storage tanks and piping.Marathon has been notified that it is a potentially responsible party
("PRP"(“PRP”) at1311 waste sites under the Comprehensive Environmental Response, Compensation and Liability Act("CERCLA"(“CERCLA”) as of December 31,2001.2002.In addition, there are
threefour sites where Marathon has received information requests or other indications that Marathon may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability. At many of these sites, Marathon is one of a number of parties involved and the total cost of remediation, as well as Marathon’s share thereof, is frequently dependent upon the outcome of investigations and remedial studies.There are also
11482 additional sites, excluding retail marketing outlets, related to Marathon where remediation is being sought under other environmental statutes, both federal and state, or where private parties are seeking remediation through discussions or litigation. Of these sites,1310 were associated with properties conveyed to MAP by Ashland for which Ashland has retained liability for all costs associated with remediation.At many of these sites, Marathon is one of a number of parties involved and the total cost of remediation, as well as Marathon's share thereof, is frequently dependent upon the outcome of investigations and remedial studies.Marathon accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs
iscan be reasonablydeterminable.estimated. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required.See Note 26 to the Financial Statements.New or expanded environmental requirements, which could increase
Marathon'sMarathon’s environmental costs, may arise in the future. Marathon intends to comply with all legal requirements regarding the environment, but sincemanynot all of them arenotfixed or presently determinable (even under existing legislation) and may be affected by future legislation, it probably is not possible to predictaccuratelyall of the ultimatecostcosts of compliance, including remediation costs which may be incurred and penalties which may be imposed. However, based on presently available information, and existing laws and regulations as currently implemented, Marathon does not anticipate that environmental compliance expenditures (including operating and maintenance and remediation) will materially increase in2002. Marathon's2003.43
Marathon’s environmental capital expenditures are expected to be approximately
$130$173 million in2002.2003. Predictions beyond20022003 can only be broad-based estimates, which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified40projects, Marathon anticipates that environmental capital expenditures will be approximately $157$300 million in2003;2004; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.New Tier II gasoline rules, which were finalized by the EPA in February 2000, and the diesel fuel rules, which were finalized in January 2001, require substantially reduced sulfur
levels.levels for gasoline and diesel. The combined capital costs to achieve compliance with the gasoline and diesel regulations could amount to approximately$700$900 million, which includes costs that could be incurred as part of other refinery upgrade projects, between 2002 and 2006. This is a forward-looking statement. Some factors (among others) that could potentially affect gasoline and diesel fuel compliance costs include obtaining the necessary construction and environmental permits, operating and logistical considerations, further refinement of preliminary engineering studies and project scopes, and unforeseen hazards.In
May 2001, Marathon andMarch 2002, MAPsettled, inattended aconsent decree, EPA allegations that the Robinson refinery did not qualify for an exemption under the National Emission Standards for Benzene Waste Operations pursuant to the Clean Air Act ("CAA"). The government had alleged in a federal court lawsuit that the refinery's Total Annual Benzene releases exceeded the limitation of 10 megagrams per year, and as a result, the refinery was in violation of the benzene waste emission control, record keeping, and reporting requirements. The consent decree was approved by the court on July 26, 2001 and requires Marathon and MAP to pay a combined $1.6 million civil penalty, perform $125,000 in supplemental environmental projects, as part of an enforcement action for alleged CAA violations, and install various controls and other improvements. In 1998, the EPA conducted multi-media inspections of MAP's Detroit and Robinson refineries, covering compliancemeeting with theCAA, the Clean Water Act,Illinois EPA concerning MAP’s self reportingobligations under the Emergency Planningof possible emission exceedences andCommunity Rightpermitting issues related toKnow Act, CERCLAsome storage tanks at MAP’s Robinson, Illinois facility. In late April, MAP submitted to IEPA a comprehensive settlement proposal that was rejected by IEPA. MAP has had subsequent discussions with IEPA and thehandling of process waste. The EPA servedIllinois Attorney General’s office and anticipates additional meetings and discussions in the coming months.During 2001 MAP entered into a
number of Notices of Violation ("NOV") and Findings of Violation as a result of these inspections, but these allegations were resolved as part of theNew Source Review consent decreewhich MAP agreed to on May 11, 2001. MAP'sand settlement of alleged Clean Air Act (“CAA”) and other violations with the EPAincludescovering all ofMAP's refineries and commitsMAP’s refineries. The settlement committed MAP to specific control technologies and implementation schedules for environmental expenditures and improvements toMAP'sMAP’s refineries over approximately an eight-year period. The total one-time expenditures for these environmental projects is approximately $360 million over the eight yearperiod. The current estimated cost to complete these programs is approximately $300period, with about $230 millionin expendituresremaining over the nextsevensix years. The impact of the settlement on on-going operating expenses is expected to be immaterial. In addition, MAPis also committed to the performance of about $8 million inhas nearly completed certain agreed upon supplemental environmental projectsand has paid an aggregate civil penalty in 2001 of $3.8 million,as part of this settlement of an enforcement action for alleged CAAviolations.violations, at a cost of $9 million. MAP believes that this settlement will provide MAP with increased permitting and operating flexibility while achieving significant emission reductions.MAP entered into a Consent Decree in July of 2002 with the State of Ohio regarding air compliance matters at its Canton refinery during both Ashland’s and MAP’s term of ownership and operation. The
court approved this consent decree on August 28, 2001. In 2000,Consent Decree required $350,000 in payments which included a penalty of $216,500, several Supplemental Environmental Projects and theKentucky Natural Resourcesfunding of a community notification system. The Consent Decree is being implemented.MAP used MTBE as an octane enhancer and
Environmental Cabinet sent Marathon Ashland Pipe Line LLC a NOV seeking a civil penalty associatedoxygenate in reformulated gasoline to comply with applicable laws for many years. The maximum amount of MTBE in gasoline is 15 percent by volume. Approximately 7 percent of MAP’s 2001 gasoline production contained MTBE. MAP had three MTBE units at its refineries in Detroit, Robinson and Catlettsburg with apipeline spill earlier that yearcombined book value of approximately $10 million at December 31, 2001. Because several states inWinchester, Kentucky. MAP has settled this NOVMAP’s marketing area have passed laws banning MTBE as a gasoline component in theformfuture, MAP decided in the first quarter ofan Agreed-to Administrative Order2002 to begin to phase out production of MTBE and to reduce the remaining estimated useful life of the MTBE units. MTBE production was discontinued in October 2002, by whichwas finalized and entered in January 2002 and required payment of a $170,000 penalty and reimbursement of past response costs up to $131,000.time the MTBE units were fully depreciated.Marathon is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. See Note
2625 to the Consolidated Financial Statements on page F-34 for a discussion of certain of these matters. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to Marathon. However, management believes that Marathon will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to Marathon.See "Management's DiscussionOther Contingencies
MAP has instituted a number of process and
Analysisfacility modifications at its Catlettsburg refinery to correct the operating conditions that led to a product quality issue in 2002. MAP has been working with some regional gasoline jobbers and dealers since August 2002 to remedy certain product quality issues in gasoline produced at44
this refinery. As a part of
Financial Condition, Cash Flowsits response to the situation, MAP has inspected a large number of retail, terminal andLiquidity" on page 36. 41transportation facilities, and has systematically cleaned facilities and repaired consumer vehicles that may have been impacted. Credit Risk
Marathon is exposed to credit risk in the form of possible nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. To mitigate this risk, the creditworthiness of customers and other counterparties is subject to ongoing review. When deemed appropriate, Marathon requires prepayment, letters of credit, netting agreements or other security to reduce its exposure. Marathon has taken steps throughout 2002 to manage its exposures to those “energy merchant” firms whose creditworthiness has deteriorated. Where appropriate, Marathon has either obtained security to support its continued sales or has ceased business activity with the affected entities.
Marathon has significant exposures to United States Steel arising from the separation. Those exposures are discussed in “Obligations Associated with the Separation of United States Steel”.
45
Outlook
Exploration and Production
The outlook regarding
Marathon'sMarathon’s upstream revenues and income is largely dependent upon future prices and volumes of liquid hydrocarbons and natural gas. Prices have historically been volatile and have frequently been affected by unpredictable changes in supply and demand resulting from fluctuations in worldwide economic activity and political developments in theworld'sworld’s major oil and gas producing and consuming areas. Any significant decline in prices could have a material adverse effect onMarathon'sMarathon’s results of operations. A prolonged decline in such prices could also adversely affect the quantity of crude oil and natural gas reserves that can be economically produced and the amount of capital available for exploration and development.In 2002, worldwideMarathon estimates its 2003 and 2004 production
is expectedwill average 390,000 toaverage 430,000395,000 barrels of oil equivalent per daysplit evenly between liquid hydrocarbons and natural gas, including Marathon's proportionate share(“BOEPD”), excluding the effect ofequity investee'sany acquisitions or dispositions. This compares to 2002 productionand future acquisitions. On January 3, 2002, Marathon completed its acquisitionofCMS Energy's interests in Equatorial Guinea. For a total cash consideration of $993 million, excluding working capital adjustments, Marathon acquired: . a 52.4 percent interest in, and operatorship of, the offshore Alba Block, which contains the currently producing Alba gas field as well as undeveloped oil and gas discoveries and several possible exploration prospects; . a 37.6 percent interest in the adjacent offshore Block D; . a 52.4 percent interest in an onshore condensate separation facility; . a 45 percent interest in a joint venture onshore methanol production plant; . a 43.2 percent interest in an onshore liquefied petroleum gas processing plant. In 2002, Marathon plans to drill, or complete drilling operations on three or four deepwater wells in the Gulf of Mexico, including the appraisal of the Ozona Deep discovery. Other majorslightly over 412,000 BOEPD.Major upstream
projects,activities, which are currently underway or under evaluation,and are expectedinclude:Gulf of Mexico, where Marathon plans toimprove future income streams, include: .participate in three or four deepwater exploration wells during 2003;Norway, where Marathon hascompleted the acquisition of variousinterests infivenine licenses in the Norwegian sector of the NorthSea; .Sea and plans to drill three or four exploration wells during 2003 and participate in two development wells in the Byggve Skirne fields;Alaska, where Marathonrecentlyhad a natural gas discovery on the Ninilchik Unit on the KenaiPeninsula. AdditionalPeninsula with additional drillingisplanned in2002. .2003;Angola, where Marathonexpects to participateparticipated in the drilling ofupthe successful Plutao exploration well on Block 31, is currently participating in the testing of the Gindungo well on Block 32 and plans to participate in three or four additional exploration wells in this area during2002. On February 28, 2002,2003;Eastern Canada, where Marathonannounced proposeddrilled the Annapolis G-24 gas discovery well and expects to drill one additional exploration well in the Annapolis block during 2003;Equatorial Guinea, where government approved expansion plansfor a major liquefiedare underway to increase liquid and natural gas("LNG") re-gasificationproduction andpower generation complex near Tijuanadrill three or four exploration wells in 2003;Foinaven, in theMexican State of Baja California. The proposed complex would consist of a LNG marine terminal, an off-loading terminal, onshore LNG re-gasification facilities, and pipeline infrastructure necessary to transportAtlantic Margin offshore thenatural gas. In addition, a 400 megawatt natural gas-fired power generation plant would be constructed on the site. The complex would supply natural gas and electricity for local use as well as for export to Southern California. Completion and potential start-up is projected for 2005. On February 28, 2002,U.K., where Marathonannouncedplans tolead an initiative for a new North Sea natural gas pipeline designed to provide additional gas for the U.K. market. The proposed 675 kilometer dry natural gas pipeline would connect the Norwegian Heimdal areadrill three or four developmental wells, all ofthe North Sea to Bacton, on the southeast coast of the U.K. The pipeline would pass through the Brae complex and pass adjacent to other large gas processing/transportation facilitieswhich are permitted;Braemar, in the U.K. NorthSea. The pipeline would terminate at or nearSea, where a subsea development well will be tied back to theexisting Bacton Terminal. The pipeline would allowEast Brae platform;Ireland, where the Greensand subsea well will be drilled and tied back to the Kinsale head facilities; andWyoming’s Powder River Basin, where Marathon plans to drill 400 to 500 coal bed natural gas wells in 2003, all of which are permitted.In Equatorial Guinea, Marathon secured government approval of the Alba field phase 2B liquefied petroleum gas (LPG) expansion project, complementing the phase 2A offshore and condensate expansion project. Upon completion of phase 2A (fourth quarter 2003) and phase 2B (fourth quarter 2004), gross production is expected to
be aggregatedincrease fromnumerous U.K.40,000 (22,000 net) BOEPD to approximately 90,000 (50,000 net) BOEPD. This new total volume will consist of 54,000 (30,000 net) bpd of condensate, 16,000 (9,000 net) bpd of LPG andNorwegian North Sea producers for transportation to Bacton where it would then be sold to commercial, industrial and residential customers. Marathon estimates that the pipeline could begin operations in 2005.120 (68 net) mmcfd of natural gas.The above discussion includes forward-looking statements with respect to the timing and levels of
Marathon'sMarathon’s worldwide liquid hydrocarbon and natural gas production,andthe exploration drillingprogram.program and additional resources. Some factors that could potentially affect worldwide liquid hydrocarbon and natural gas production and the exploration drilling program include acts of war or terrorist acts and the governmental or military response,thereto,pricing, supply and demand for petroleum products, amount of capital available for exploration and development, occurrence of42acquisitions/acquisitions or dispositions of oil and gas properties, regulatory constraints, timing of commencing production from new wells, drilling rig availability and other geological, operating and economic considerations.TheseThe forward-looking information related to production is based on certain assumptions, including, among others, presently known physical data concerning size and character of reservoirs, economic recoverability, technology development, future drilling success, production experience, industry economic conditions, levels of cash flow from operations and operating conditions. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.Some factors that could affect the planned construction of the LNG re-gasification, power generation46
Refining, Marketing and
related facilities, as well as the North Sea pipeline transportation and related facilities, include, but are not limited to, unforeseen difficulty in the negotiation of definitive agreements among project participants, identification of additional participants to reach optimum levels of participation, inability or delay in obtaining necessary government and third party approvals, arranging sufficient project financing, unanticipated changes in market demand or supply, competition with similar projects, and environmental and permitting issues. Additionally, the LNG project could be impacted by the availability or construction of sufficient LNG vessels. Marathon's downstreamTransportationMarathon’s RM&T segment income is largely dependent upon the refining and wholesale marketing margin for refined products, the retail gross margin for gasoline and distillates, and the gross margin on retail merchandise sales. The refining and wholesale marketing margin reflects the difference between the wholesale selling prices of refined products and the cost of raw materials refined, purchased product costs and manufacturing expenses. Refining and wholesale marketing margins have been historically volatile and vary with the level of economic activity in the various marketing areas, the regulatory climate, the seasonal pattern of certain product sales, crude oil costs, manufacturing costs, the available supply of crude oil and refined products, and logistical constraints. The retail gross margin for gasoline and distillates reflects the difference between the retail selling prices of these products and their wholesale cost, including secondary transportation. Retail gasoline and distillate margins have also been historically volatile, but tend to be
counter cyclicalcountercyclical to the refining and wholesale marketing margin. Factors affecting the retail gasoline and distillate margin include seasonal demand fluctuations, the available wholesale supply, the level of economic activity in the marketing areas and weather situationswhichthat impact driving conditions. The gross margin on retail merchandise sales tends to be less volatile than the retail gasoline and distillate margin. Factors affecting the gross margin on retail merchandise sales include consumer demand for merchandise items and the level of economic activity in the marketing area.At its Catlettsburg, Kentucky refinery, MAP has initiated a multi-year $350 million integrated investment program to upgrade product yield realizations and reduce fixed and variable manufacturing expenses. This program involves the expansion, conversion and retirement of certain refinery processing units
which,that, in addition to improving profitability, will reduce therefinery'srefinery’s total gasoline pool sulfur below 30 ppm, thereby eliminating the need for additionalclean fuels programlow sulfur gasoline compliance investments at the refinery. The project is expected to be completed in2004. MAP is working to improve its logistics network and Marathon Ashland Pipe Line LLC has been designated operator of the Centennial Pipeline, owned jointly by Panhandle Eastern Pipe Line Company, a subsidiary of CMS Energy Corporation, MAP, and TE Products Pipe Line Company, Limited Partnership. The new pipeline, which will connect the Gulf Coast refiners with the Midwest market, will have the capacity to transport approximately 210,000 barrels per day of refined petroleum products and is expected to be operational in the first quarter of 2002.late 2003.A MAP subsidiary, Ohio River Pipe Line LLC
("ORPL"(“ORPL”),plans to buildis building a pipeline from Kenova, West Virginia to Columbus, Ohio. ORPL is a common carrier pipeline company and the pipeline will be an interstate common carrier pipeline. The pipeline is currently known as Cardinal ProductsPipe LinePipeline and is expected to initially move about 50,000 barrels per day of refined petroleum into the central Ohio region. As ofDecember 2001,June 2002, ORPLhashad secured all of the rights-of-way required to build thepipeline. Applications forpipeline, and on August 2, 2002, theremaining constructionfinal permitshave been filed.required to build the pipeline were approved. Constructionis currently planned for summerbegan in August 2002pending receipt of permits, withand start-up of the pipeline is expected to follow infirst halfmid-year 2003.On February 7, 2003, MAP, through SSA, announced the signing of a definitive agreement to sell all 193 of its convenience stores located in Florida, South Carolina, North Carolina and Georgia for $140 million plus store inventory. The transaction is anticipated to close in the second quarter of 2003, subject to any necessary regulatory approvals and customary closing conditions.
MAP’s retail marketing strategy is focused on SSA’s Midwest operations, additional growth in the Marathon brand and continued growth for PTC.
On February 10, 2003, MAP increased its ownership in Centennial Pipeline LLC from 33 percent to 50 percent. MAP paid $20 million for the increased ownership interest. As of February 10, 2003, Centennial is owned 50 percent each by MAP and TE Products Pipeline Company, Limited Partnership.
On February 27, 2003, MAP’s 50 percent owned Pilot Travel Centers LLC (“PTC”) purchased 60 retail travel centers including fuel inventory, merchandise and supplies. The 60 locations are in 15 states, primarily in the Midwest, Southeast and the Southwest regions of the country.
The above discussion includes forward-looking statements with respect to the Catlettsburg refinery, the Cardinal Products Pipeline system and the
Centennial Pipeline and Cardinal Products Pipe Line systems.disposition of SSA stores. Some factorswhichthat could potentially cause the actual results from the Catlettsburg investment program to differ materially from current expectations include the price of petroleum products, levels of cash flows from operations,obtaining the necessary construction and environmental permits,unforeseen hazards such as weather conditions, the completion of construction and regulatory approval constraints.The primaryA factorwhich could impact the Centennial Pipeline system, is unforeseen hazards. Some factors, whichthat could impact the Cardinal ProductsPipe Line, include obtaining the necessary permits andPipeline is completion of construction. Some factors that could affect the SSA stores sale include inability or delay in obtaining necessary government and third-party approvals, and satisfaction of customary closing conditions. These factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.4347
Other Energy Related Businesses
Marathon has proposed plans and awarded a front end engineering and design contract for a major LNG regasification and power generation complex near Tijuana in the Mexican state of Baja California to be called the Tijuana Regional Energy Center. The proposed project is an integrated complex planned to consist of a 750 mmcf per day LNG offloading terminal and regasification plant, a 1,200-megawatt power generation plant, a 20-million gallon per day water desalination plant, wastewater treatment facilities and natural gas pipeline infrastructure. Construction of the facilities is scheduled to begin in 2003 with expected startup in 2006.
Marathon has awarded a FEED contract for the proposed phase 3 LNG project in Equatorial Guinea. The phase 3 expansion involves the construction of a LNG liquefaction plant and related facilities to further commercialize the gas resources in the Alba field. This project would be complemented by the long-term LNG delivery rights at Elba Island, Georgia.
In the North Sea, Marathon will continue discussions with interested parties in evaluating the best transportation alternatives to bring Norwegian gas to the U.K. market utilizing Marathon’s Brae infrastructure.
On October 1, 2002, Marathon announced the signing of a letter of intent with Rosneft Oil Company to participate in Urals North American Marketing, a venture that would transport and market Urals crude to the North American market. The venture is subject to the signing of definitive agreements and obtaining necessary U.S. and Russian government approvals. Expected start-up would be in the fourth quarter of 2003.
The above discussion includes forward-looking statements with respect to the planned construction of LNG re-gasification, power generation and related facilities, and the participation in a venture to transport and market Urals crude to North America. Some factors that could affect the planned construction of the LNG re-gasification, power generation and related facilities, include, but are not limited to, unforeseen difficulty in the negotiation of definitive agreements among project participants, identification of additional participants to reach optimum levels of participation, inability or delay in obtaining necessary government and third-party approvals, arranging sufficient project financing, unanticipated changes in market demand or supply, competition with similar projects and environmental and permitting issues. Additionally, the LNG project could be impacted by the availability or construction of sufficient LNG vessels. Factors that could impact the transporting and marketing of Urals crude to the North American market include the inability or delay in obtaining necessary government and third-party approvals, unforeseen difficulty in the negotiation of definitive agreements among project participants, arranging sufficient project financing, unanticipated changes in market demand or supply, competition with similar projects and environmental and permitting issues. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.
Corporate Matters
On February 6, 2003, Marathon announced it had approved a capital, investment and exploration expenditure budget of almost $2 billion for 2003. The budget includes E&P spending of $1.1 billion and $732 million for RM&T projects, with the remaining $121 million balance designated for OERB and corporate activities. Marathon also announced the intention to sell approximately $400 million in non-core assets to enhance financial flexibility.
The above discussion includes forward-looking statements with respect to expected capital, investment and exploration expenditures, as well as planned asset dispositions. This forward-looking information is based on certain assumptions including (among others), property dispositions, prices, worldwide supply and demand for petroleum products, regulatory impacts and constraints, timing and results of future exploitation and development drilling, levels of company cash flow, drilling rig availability and other geological operating and economic considerations. The forward-looking information concerning asset dispositions is based upon certain assumptions including the identification of buyers and the negotiation of acceptable prices and other terms, as well as other customary closing conditions. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.
48
Accounting Standards
Adopted in
2001 -the reporting periodsEffective January 1, 2001, Marathon adopted Statement of Financial Accounting Standards No. 133
"Accounting“Accounting for Derivative Instruments and HedgingActivities"Activities” (SFAS No. 133), as amended by SFAS Nos. 137 and 138. ThisStatement, as amended,statement requires recognition of all derivativesat fair valueas either assets orliabilities. For additional information, see Note 4liabilities at fair value. The transition adjustment related to adopting SFAS No. 133 on January 1, 2001, was recognized as a cumulative effect of a change in accounting principle. The unfavorable cumulative effect on net income was $8 million, net of a tax benefit of $5 million. The unfavorable cumulative effect on other comprehensive income (loss) (OCI) was $8 million, net of a tax benefit of $4 million.Since the
Financial Statements. To be adopted in future periods - In June 2001,issuance of SFAS No. 133, the Financial Accounting Standards Board (FASB) has issued several interpretations. As a result, Marathon has recognized in income the effect of changes in the fair value of two long-term natural gas sales contracts in the United Kingdom. As of January 1, 2002, Marathon recognized a favorable cumulative effect of a change in accounting principle of $13 million, net of tax of $7 million.Effective January 1, 2002, Marathon adopted the following Statements of Financial Accounting
StandardsStandards:No. 141"Business Combinations"“Business Combinations” (SFAS No. 141),No. 142"Goodwill“Goodwill and Other IntangibleAssets"Assets” (SFAS No. 142), andNo.143 "Accounting144 “Accounting forAsset Retirement Obligations"Impairment or Disposal of Long-Lived Assets” (SFASNo. 143).No.144)SFAS No. 141 requires that all business combinations initiated after June 30, 2001, be accounted for under the purchase
method, eliminating the usemethod. The transitional provisions ofthe pooling method. This Statement also establishes for all business combinations made after June 30, 2001, specific criteria for the allocation of the purchase price to intangible assets separately from goodwill.SFAS No. 141also requires that the excess of fair value of acquiredrequired Marathon to reclassify $11 million from identifiable intangible assetsover cost in a business combination (negative goodwill) be recognized immediately as an extraordinary gain, rather than deferred and amortized. Marathon will account for the acquisition of certain interests from CMS Energy into goodwill at January2002 under SFAS No. 141.1, 2002.SFAS No. 142 addresses the accounting for goodwill and other intangible assets after an acquisition.
The most significant changes made by SFAS No. 142 are: 1) goodwill and intangible assets with indefinite lives will no longer be amortized; 2) goodwill and intangible assets with indefinite lives must be tested for impairment at least annually; and 3) the amortization period for intangible assets with finite lives will no longer be limited to forty years. Marathon will adopt SFAS No. 142 effectiveEffective January 1, 2002,as required. At that time, the annualMarathon ceased amortization of existing goodwill, which results in a favorable impact on annual income of approximately $3 million, net oftax, will cease ontax. Marathon has completed theunamortized portion associated with previous acquisitions and certain investments accounted for under the equity method. Arequired transitional impairment testis requiredfor existing goodwill as of the date ofadoptionadoption. No impairment ofthis Standard, which must be completed within the first year. Any impairment loss resulting from applying the transitionalgoodwillimpairment test will be reported as a change in accounting principle. Goodwill recorded after adoption of this Standard is to be tested for impairment at least annually and any resulting impairment is not considered part of the change in accounting principle. SFAS No. 143 establishes a new accounting model for the recognition and measurement of retirement obligations associated with tangible long-lived assets. SFAS No. 143 requires that an asset retirement cost be capitalized as part of the cost of the related long-lived asset and subsequently allocated to expense using a systematic and rational method. Marathon will adopt this Statement effective January 1, 2003, as required. The transition adjustment resulting from the adoption of SFAS No. 143 will be reported as a cumulative effect of a change in accounting principle. At this time, Marathon cannot reasonably estimate the effect of the adoption of this Statement on either its financial position or results of operations. In August 2001, the FASB approvedwas indicated.SFAS No. 144
"Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). This Statementestablishes a single accounting model for long-lived assets to be disposed of by sale and provides additional implementation guidance for assets to be held and used and assets to be disposed of other than by sale. For long-lived assets to be disposed of by sale, SFAS No. 144 broadens the definition of those disposals that should be reported separately as discontinued operations. The adoption of SFAS No. 144 had no initial effect on Marathon’s financial statements.In late 2002 and early 2003, the FASB issued the following:
Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS No. 148),FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), andFASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46).Each of these pronouncements required the immediate adoption of certain disclosure requirements, which have been reflected in these financial statements. The accounting requirements of these pronouncements will be adopted in future periods.
To be adopted in future periods
In 2001, the FASB issued Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (SFAS No. 143). This statement requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The present value of the estimated asset retirement costs is capitalized as part of the carrying amount of the long-lived asset. For Marathon, asset retirement obligations primarily relate to the abandonment of oil and gas producing facilities. Under previous accounting standards, such obligations were recognized over the life of the producing assets on a units-of-production basis.
While certain assets such as refineries, crude oil and product pipelines and marketing assets have retirement obligations covered by SFAS No. 143, those obligations are not expected to be recognized since the fair value cannot be estimated due to the uncertainty of the settlement date of the obligation.
49
Effective January 1, 2003, Marathon will adopt SFAS No. 143, as required. The cumulative effect on net income of adopting SFAS No. 143 is expected to be a net favorable effect of approximately $5 million. At the time of adoption, total assets will increase approximately $120 million, and total liabilities will increase approximately $115 million. The amounts recognized upon adoption are based upon numerous estimates and assumptions, including future retirement costs, future recoverable quantities of oil and gas, future inflation rates and the credit-adjusted risk-free interest rate.
Previous accounting standards used the units-of-production method to match estimated future retirement costs with the revenues generated from the producing assets. In contrast, SFAS No. 143 requires depreciation of the capitalized asset retirement cost and accretion of the asset retirement obligation over time. The depreciation will generally be determined on a units-of-production basis, while the accretion to be recognized will escalate over the life of the producing assets, typically as production declines. Because of the long lives of the underlying producing assets, the impact on net income in the near term is not expected to be material.
In the second quarter of 2002, the FASB issued Statement
prospectivelyof Financial Accounting Standards No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (SFAS No. 145) and Statement of Financial Accounting Standards No. 146 “Accounting for Exit or Disposal Activities” (SFAS No. 146). SFAS No. 145 has a dual effective date. The provisions relating to the early extinguishment of debt will be adopted by Marathon on January 1,2002. The timing2003. As a result, losses from the early extinguishment ofclassifying a long- lived assetdebt in 2002, which are currently reported asheldextraordinary items, will be reported in income from continuing operations in comparative financial statements subsequent to the adoption of SFAS No. 145. SFAS No. 146 will be effective forsale mayexit or disposal activities that are initiated after December 31, 2002.SFAS No. 148 provides alternative methods for the transition of the accounting for stock-based compensation from the intrinsic value method to the fair value method. Effective January 1, 2003, Marathon plans to apply the fair value method to future grants and any modified grants of stock-based compensation. Based upon this change,
as compared toand assuming the number of stock options granted in 2003 approximates the number of those granted in 2002, the estimated impact on Marathon’s 2003 earnings would not be materially different than under previous accounting standards.44Effective for any guarantees issued or modified January 1, 2003 or after, FIN 45 requires the fair-value measurement and recognition of a liability for the issuance of certain guarantees. Enhanced disclosure requirements will continue to apply to both new and existing guarantees subject to FIN 45.
FIN 46 identifies certain off-balance sheet arrangements that meet the definition of a variable interest entity (VIE). The primary beneficiary of a VIE is the party that is exposed to the majority of the risks and/or returns of the VIE. In future accounting periods, the primary beneficiary will be required to consolidate the VIE. In addition, more extensive disclosure requirements apply to the primary beneficiary, as well as other significant investors. Although Marathon participates in an arrangement that is subject to the disclosure requirements of FIN 46, Marathon would not be deemed to be a primary beneficiary under the new rules.
50
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Management Opinion Concerning Derivative Instruments
Marathon uses commodity-based and foreign currency derivative instruments to manage its price risk.Management has authorized the use of futures, forwards, swaps and options to manage exposure to market fluctuations related to commodities, interest rates, and foreign currency.
Marathon uses commodity-based derivatives to manage price
fluctuationsrisk related to the purchase, production or sale of crude oil, natural gas, and refined products.For transactions that qualify for hedge accounting under SFAS No. 133,To a lesser extent, Marathon is exposed to thechanges in fair valuerisk of price fluctuations on natural gas liquids and on petroleum feedstocks used as raw materials.The approach of Marathon’s E&P segment to the use of commodity derivative instruments
are classified within Other Comprehensive Income, if the hedge qualifies as a Cash Flow Hedge. The resulting deferred gains or losses are subsequently recognized in income from operations, in the same period as the underlying physical transaction. If the hedge position qualifies as a Fair Value Hedge, the resulting gains or losses from the change in fair valueis selective and opportunistic. When it is deemed to be advantageous, Marathon may lock-in market prices on portions ofboth the hedged item and the related derivative, are reflected within income in that period. Marathon alsoits future production.Marathon’s RM&T segment uses commodity derivative instruments to
economically hedgemitigate the price riskbut designates such strategies as nonhedge. Changes in fair value for these contracts is reflected within income in that period. Derivative instruments used for tradingassociated with crude oil and otheractivities are marked-to-marketfeedstocks, to protect carrying values of inventories and to protect margins on fixed-price sales of refined products.Marathon’s OERB segment is exposed to market risk associated with the
resulting gains or losses are recognized inpurchase and subsequent resale of natural gas. Marathon uses commodity derivative instruments to mitigate thecurrent period in income from operations. While Marathon'sprice risk on purchased volumes and anticipated sales volumes.As market conditions change, Marathon evaluates its risk management
activities generally reduce market risk exposure due to unfavorable commodity price changes for raw material purchasesprogram andproducts sold, such activities can also encompasscould enter into strategies that assumeprice risk.market risk whereby cash settlement of commodity-based derivatives will be based on market prices.From time to time, Marathon uses financial derivative instruments to manage interest rate and foreign currency exposures. As Marathon enters into derivatives, assessments are made as to the qualification of each transaction for hedge accounting.
Management believes that use of derivative instruments along with risk assessment procedures and internal controls does not expose Marathon to material risk.
TheHowever, the use of derivative instruments could materially affectMarathon'sMarathon’s results of operations in particular quarterly or annual periods.However, managementManagement believes that use of these instruments will not have a material adverse effect on financial position or liquidity.For a summary of accounting policies related to derivative instruments, see Note 3 to the Financial Statements.Commodity Price Risk and Related Risks
In the normal course of its business, Marathon is exposed to market risk or price fluctuations related to the purchase, production or sale of crude oil, natural gas and refined products. To a lesser extent, Marathon is exposed to the risk of price fluctuations on natural gas liquids and petroleum feedstocks used as raw materials.
Marathon's market riskMarathon’s strategy has generally been to obtain competitive prices for its products
and servicesand allow operating results to reflect market price movements dictated by supply and demand.However, Marathon uses fixed-priceAs part of achieving Marathon’s strategy, certain fixed-priced physical contractsandare hedged using derivativecommodityinstrumentsto manage a minor portion of its commodity pricethat assume market risk. Marathonuses fixed-price contracts for portionswill use a variety ofits natural gas production to manage exposure to fluctuations in natural gas prices. Certainderivativecommodityinstruments,have the effect of restoring the equity portion of fixed-price sales of natural gas to variable market-based pricing. These instruments are usedincluding option combinations, as part ofMarathon'sthe overall risk managementprograms. 45Quantitative and Qualitative Disclosures About Marketprogram to manage commodity price risk within its different businesses.51
Commodity Price Risk
CONTINUEDSensitivity analyses of the incremental effects on
pretaxincome from operations (“IFO”) of hypothetical 10 percent and 25 percent changes in commodity prices for open derivative commodity instruments as of December 31,20012002 and December 31,2000,2001, are provided in the following table:(a)
(In millions)
Incremental Decrease in IFO Assuming a Hypothetical Price Change of(a)
2002
2001
Derivative Commodity Instruments(b)(c)
10%
25%
10%
25%
Crude oil(d)
$
32.1
(e)
$
131.6
(e)
$
25.3
(e)
$
57.6
(e)
Natural gas(d)
38.6
(e)
119.4
(e)
8.6
(e)
18.2
(e)
Refined products(d)
1.5
(e)
6.5
(e)
1.6
(f)
6.3
(f)
(Dollars(a) Marathon remains at risk for possible changes in millions) - ------------------------------------------------------------------------------- Incremental Decreasethe market value of derivative instruments; however, such risk should be mitigated by price changes inPretax Income Assuming a Hypothetical Price Change of(a) 2001 2000 Derivative Commodity Instruments(b)(c)the underlying hedged item. Effects of these offsets are not reflected in the sensitivity analyses. Amounts reflect hypothetical 10% and 25%10% 25% - -------------------------------------------------------------------------------Crude oil(d)............................. $ 23.4(e) $ 46.7(e) $9.1(e) $ 27.2(e) Natural gas(d)........................... 8.6(e) 18.2(e) 20.2(e) 50.6(e) Refined products(d)...................... 1.0(f) 3.9(f) 6.1(e) 16.5(e) - -------------------------------------------------------------------------------(a) Marathon remains at risk for possible changes in the market value of derivative instruments; however, such risk should be mitigated by price changes in the underlying hedged item. Effects of these offsets are not reflected in the sensitivity analyses. Amounts reflect the estimated incremental effect on pretax income, after deducting for minority interest. Amounts reflect hypothetical 10% and 25% changes in closing commodity prices for each open contract position at December 31, 2001 and December 31, 2000. Marathon management evaluates their portfolio of derivative commodity instruments on an ongoing basis and adds or revises strategies to reflect anticipated market conditions and changes in risk profiles. Marathon is also exposed to credit risk in the event of nonperformance by counterparties. The credit worthinesschanges in closing commodity prices for each open contract position at December 31, 2002 and 2001. Marathon evaluates its portfolio of derivative commodity instruments on an ongoing basis and adds or revises strategies to reflect anticipated market conditions and changes in risk profiles. Marathon is also exposed to credit risk in the event of nonperformance by counterparties. The creditworthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical. Changes to the portfolio subsequent to December 31, 2002, would cause future IFO effects to differ from those presented in the table.
(b) Net open contracts for the combined E&P and OERB segments varied throughout 2002, from a low of 16,556 contracts at February 16 to a high of 43,678 contracts at October 1, and averaged 31,340 for the year. The number of net open contracts for the RM&T segment varied throughout 2002, from a low of 1 contract at March 4 to a high of 19,209 contracts at December 26, and averaged 4,865 for the year. The derivative commodity instruments used and hedging positions taken will vary and, because of these variations in the composition of the portfolio over time, the number of open contracts by itself cannot be used to predict future income effects.
(c) The calculation of sensitivity amounts for basis swaps assumes that the physical and paper indices are perfectly correlated. Gains and losses on options are based on changes in intrinsic value only.
(d) The direction of the price change used in calculating the sensitivity amount for each commodity reflects that which would result in the largest incremental decrease in IFO when applied to the derivative commodity instruments used to hedge that commodity.
(e) Price increase.
(f) Price decrease. E&P Segment—As of December 31, 2002, Marathon has entered into zero-cost collars on 225 mmcfd of its U.S. natural gas production for January through December 2003, whereby Marathon will receive up to an average $4.72 per mcf but no less than an average $3.72 per mcf. Of the 225 mmcfd, 215 mmcfd currently qualify for hedge accounting, with the non-qualified gas volumes being marked-to-market and included in income. Additionally, Marathon has also entered into zero-cost collars on 29,000 bpd of its U.S. and U.K. crude oil for January through December 2003, whereby Marathon will receive up to an average $28.55 per bbl but no less than an average $23.01 per bbl. All 29,000 bpd currently qualify for hedge accounting.
Subsequent to December 31,
2001, would cause future pretax income effects2002, Marathon has entered into zero-cost collars on an additional 60 mmcfd of its U.S. natural gas production for the last half of 2003, whereby Marathon will receive up todiffer from those presentedan average $5.94 per mcf but no less than an average $4.25 per mcf. Marathon has also placed derivatives on 50 mmcfd at an average of $5.02 per mcf for 2004 relating to the Powder River Basin area. All 60 mmcfd for the last half of 2003 and 50 mmcfd for 2004 currently qualify for hedge accounting. Additionally, Marathon has also used other derivative instruments to sell forward, 37,000 bpd of its U.S. and U.K. crude oil for the last half of 2003 at an average of $26.33 per bbl. All 37,000 bpd currently qualify for hedge accounting.As of December 31, 2002, Marathon had hedged approximately 18 percent and 15 percent of its forecasted 2003 worldwide equity natural gas and liquid hydrocarbon production, respectively. Subsequent to December 31, 2002, Marathon has hedged an additional 3 percent and 10 percent of its forecasted 2003 worldwide equity natural gas and liquid hydrocarbon production, respectively.
Derivative gains included in the
table. (b) The numberE&P segment were $52 million and $85 million for 2002 and 2001, respectively. Gains ofnet open contracts varied throughout 2001,$23 million froma low of 19,040 contracts at July 18, to a high of 41,298 contracts at November 8, and averaged 29,279discontinued cash flow hedges forthe year. The derivative commodity instruments used and hedging positions taken also varied throughout 2001, and will continue to vary2002 are included in thefuture. Because of these variations in the composition of the portfolio over time, the number of open contracts, by itself, cannot be used to predict futureaforementioned amounts. These gains were reclassified from accumulated other comprehensive incomeeffects. (c) The calculation of sensitivity amounts for basis swaps assumes(loss) as it is no longer probable that thephysical and paper indices are perfectly correlated. Gains and losses on options are based on changes in intrinsic value only. (d) The direction of the price change used in calculating the sensitivity amount for each commodity reflects that which would result in the largest incremental decrease in pretax income when applied to the derivative commodity instruments used to hedge that commodity. (e) Price increase. (f) Price decrease. Marathon uses derivative instruments in its exploration and production ("E&P") operations to mitigate the price risk associated with equity production of crude oil and natural gas volumes. In addition, Marathon has sold forward a specified volume of natural gas. Marathon has used derivatives to convert the fixed price in this contract to market prices. The underlying physical contract matures in 2008. Marathon recorded total net pretax derivative gains/(losses) of approximately $85 million in 2001 and $(47) million in 2000. The amounts for 1999 were diminimus. Marathon's refining, marketing, and transportation (RM&T)original forecasted transactions will occur.RM&T Segment —Marathon’s RM&T operations generally use derivative commodity instruments to
lock-in costsmitigate the price risk of certain crude oil and other feedstocks, to protect carrying values of inventories and to protect margins on fixed-price sales of refined products.Marathon'sDerivative losses included in RM&Toperations recorded total net pretax derivative gains/(losses), net of the 38 percent minority interest in MAP, of approximately $130 million in 2001, $(127) million in 2000, and $13segment income were $124 million for1999. Marathon's2002 compared with gains of $210 million for 2001. RM&T’s trading activitygains/(losses) are included in the afore-mentioned amountsgains andtotaled $3 million in 2001, $(11) million in 2000losses were not significant for 2002 and$5 million in 1999, respectively. Marathon's other energy related businesses are exposed to market risk associated with the purchase and subsequent resale of natural gas.2001.52
OERB Segment —Marathon
useshas used derivative instruments tomitigateconvert the fixed pricerisk onof a long-term gas sales contract to market prices. The underlying physical contract is for a specified annual quantity of gas and matures in 2008. Similarly, Marathon will use derivative instruments to convert shorter term (typically less than a year) fixed price contracts to market prices in its ongoing purchase for resale activity; and to hedge purchasedvolumesgas injected into storage for subsequent resale. Derivative losses included in OERB segment income were $8 million andanticipated sales volumes. Marathon recorded net pretax derivative gains/(losses) of $(29)$29 millioninfor 2002 and 2001,$13 million in 2000 and $3 million in 1999,respectively.Other Commodity Risk
Marathon is subject to basis risk, caused by factors that affect the relationship between commodity futures prices reflected in derivative commodity instruments and the cash market price of the underlying commodity. Natural gas transaction prices are frequently based on industry reference prices that may vary from prices experienced in local markets. For example, New York Mercantile Exchange
(NYMEX)(“NYMEX”) contracts for natural gas are priced atLouisiana'sLouisiana’s Henry Hub, while the underlying quantities of natural gas may be produced and sold in the Western United States at prices that do not move in strict correlation with NYMEX prices. To the extent that commodity price changes in one region are not reflected in other regions, derivative commodity instruments may no longer provide the expected hedge, resulting in increased exposure to basis risk. These regional price differences could yield favorable or unfavorable results. OTC transactions are being used to manage exposure to a portion of basis risk.46Quantitative and Qualitative Disclosures About Market Risk CONTINUEDMarathon is subject to liquidity risk, caused by timing delays in liquidating contract positions due to a potential inability to identify a counterparty willing to accept an offsetting position. Due to the large number of active participants, liquidity risk exposure is relatively low for exchange-traded transactions.
Interest Rate Risk
Marathon is subject to the effects of interest rate fluctuations affecting the fair value of certain
non-derivativefinancial instruments. A sensitivity analysis of the projected incremental effect of a hypothetical 10 percent decrease inyear-end 2001 and 2000interest rates is provided in the following table:
(In millions)
December 31, 2002
December 31, 2001
Financial Instruments(a)
Fair Value(b)
Incremental Increase in Fair Value(c)
Fair Value(b)
Incremental Increase in Fair Value(c)
Financial assets:
Investments and long-term receivables
$
223
$
–
$
160
$
–
Interest rate swap agreements
$
12
$
8
$
–
$
–
Financial liabilities:
Long-term debt(d)(e)
$
5,008
$
194
$
3,830
$
127
(Dollars(a) Fair values of cash and cash equivalents, receivables, notes payable, accounts payable and accrued interest approximate carrying value and are relatively insensitive to changes in millions) - -------------------------------------------------------------------------------- Asinterest rates due to the short-term maturity of the instruments. Accordingly, these instruments are excluded from the table.
(b) See Notes 14 and 15 to the Consolidated Financial Statements for carrying value of instruments.
(c) For financial liabilities, this assumes a 10% decrease in the weighted average yield to maturity of Marathon’s long-term debt at December 31, 2001 2000 Incremental Incremental Increase in Increase in Non-Derivative Financial2002 and 2001.
(d) Includes amounts due within one year.
(e) Fair Fair Fair Fair Instruments(a) Value(b) Value(c) Value(b) Value(c) - --------------------------------------------------------------------------------Financial assets: Investmentsvalue was based on market prices where available, or current borrowing rates for financings with similar terms andlong-term receivables(d)................... $ 192 $ - $ 171 $ - Financial liabilities: Long-term debt(e)(f).............. $ 3,830 $127 $ 2,174 $ 86 Preferred stock of subsidiary(g).. - - 175 15 ------- ---- ------- ----- Total liabilities................ $ 3,830 $127 $ 2,349 $ 101 - --------------------------------------------------------------------------------maturities.(a) Fair values of cash and cash equivalents, receivables, notes payable, accounts payable and accrued interest approximate carrying value and are relatively insensitive to changes in interest rates due to the short-term maturity of the instruments. Accordingly, these instruments are excluded from the table. (b) See Note 22 to the Financial Statements for carrying value of instruments. (c) For financial liabilities, this assumes a 10% decrease in the weighted average yield to maturity of Marathon's long-term debt at December 31, 2001 and December 31, 2000. (d) For additional information, see Note 20 to the Financial Statements. (e) Includes amounts due within one year. (f) Fair value was based on market prices where available, or current borrowing rates for financings with similar terms and maturities. For additional information, see Note 13 to the Financial Statements. (g) See Note 22 to the Financial Statements for further explanation.At December 31, 2002 and 2001,
and 2000, Marathon'sMarathon’s portfolio of long-term debt was substantially comprised offixed-ratefixed rate instruments. Therefore, the fair value of the portfolio is relatively sensitive to effects of interest rate fluctuations. This sensitivity is illustrated by the$127$194 million increase in the fair value of long-term debt assuming a hypothetical 10 percent decrease in interest rates. However,Marathon'sMarathon’s sensitivity to interest rate declines and corresponding increases in the fair value of its debt portfolio would unfavorably affectMarathon'sMarathon’s results and cash flows only to the extent that Marathon would elect to repurchase or otherwise retire all or a portion of its fixed-rate debt portfolio at prices above carrying value.Marathon has initiated a program to manage its exposure to interest rate movements by utilizing financial derivative instruments. The primary objective of this program is to reduce the Company’s overall cost of borrowing
53
by managing the fixed and floating interest rate mix of the debt portfolio. In 2002, Marathon entered into seven interest rate swap agreements, designated as fair value hedges, which effectively resulted in an exchange of existing obligations to pay fixed interest rates for obligations to pay floating rates. The following table summarizes Marathon’s interest rate swap activity as of December 31, 2002 and March 1, 2003:
As of December 31, 2002
Floating Rate to be Paid
Fixed Rate to be Received
Notional Amount ($Millions)
Swap Maturity
12/31/02 Fair Value ($Millions)
Six Month LIBOR +1.935%
Six Month LIBOR +3.204%
5.375
6.850
%
%
$
$
450
200
2007
2008
$
$
8
4
Cumulative as of March 1, 2003
Floating Rate to be Paid
Fixed Rate to be Received
Notional Amount ($Millions)
Swap Maturity
Six Month LIBOR +4.140%
6.650
%
$
100
2006
Six Month LIBOR +1.935%
5.375
%
$
450
2007
Six Month LIBOR +3.285%
6.850
%
$
400
2008
During 2002, Marathon entered into U.S. Treasury Rate lock agreements to hedge pending issuances of new debt. The U.S. Treasury Rate lock agreements, which were designated and effective as cash flow hedges, were settled for a net of $14 million concurrent with the issuance of the new debt. The $9 million, net of tax, unrecognized loss is being reclassified from accumulated other comprehensive income (loss) to net interest and other financial cost over the life of the new debt.
Foreign Currency Exchange Rate Risk
Marathon is subject to the risk of price fluctuations related to anticipated revenues and operating costs, firm commitments for capital expenditures and existing assets or liabilities denominated in currencies other than the U.S. dollar. Marathon has used on occasion forward currency contracts or other derivative instruments to manage this risk. At December 31, 2002 and 2001, Marathon had no open forward currency contracts in place.
At December 31, 2000, Marathon had open Canadian dollar forward purchase contracts with a total carrying value of approximately $14 million. A 10 percent increase in the December 31, 2000, Canadian dollar to U.S. dollar forward rate, would have resulted in a charge to income of approximately $1 million.Safe Harbor
Marathon'sMarathon’s quantitative and qualitative disclosures about market risk include forward-looking statements with respect to
management'smanagement’s opinion about risks associated with the use of derivative instruments. These statements are based on certain assumptions with respect to market prices and industry supply of and demand for crude oil, natural gas, refined products and other feedstocks. To the extent that these assumptions prove to be inaccurate, future outcomes with respect toMarathon'sMarathon’s hedging programs may differ materially from those discussed in the forward-looking statements.4754
Item 8.
Financial Statements and Supplementary Data MARATHON OIL CORPORATION Index to 2001Consolidated Financial Statements and Supplementary DataMARATHON OIL CORPORATION
Index to 2002 Consolidated Financial Statements and Supplementary Data
Page
----Management's Report........................................................F-1
Audited Consolidated Financial Statements:
Report of Independent
Accountants........................................AccountantsF-1
Consolidated Statement of
Income.........................................IncomeF-2
Consolidated Balance
Sheet...............................................SheetF-4
Consolidated Statement of Cash
Flows.....................................FlowsF-5
Consolidated Statement of
Stockholders' Equity...........................Stockholders’ EquityF-6
Notes to Consolidated Financial
Statements...............................StatementsF-8
Selected Quarterly Financial
Data.......................................... F-33Data (Unaudited)F-37
F-37
F-38
F-44
F-46
Management'sThe accompanying consolidated financial statements of Marathon Oil Corporation
(formerly USX Corporation)and its consolidated subsidiaries (Marathon) are the responsibility of management and have been preparedby Marathon Oil Corporationin conformity with accounting principles generally accepted in the United States of America. They necessarily include some amounts that are based on best judgments and estimates. The financial information displayed in other sections of this report is consistent with these financial statements.Marathon
Oil Corporationseeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.Marathon
Oil Corporationhas a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the financial statements,Marathon Oil Corporation'sMarathon’s independent accountants, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.The Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of
nonmanagementindependent directors, regularly meets (jointly and separately) with the independent accountants, management and internal auditors to monitor the proper discharge by each of its responsibilities relative to internal accounting controls and the consolidated financial statements./s/ Clarence P. Cazalot, Jr. /s/ John T. Mills /s/ Albert G. Adkins Clarence P. Cazalot, Jr. John T. Mills Albert G. Adkins President and Chief Financial Officer Vice President- Chief Executive Officer Accounting and Controller
Clarence P. Cazalot, Jr.
John T. Mills
Albert G. Adkins
President and
Chief Financial Officer
Vice President–
Chief Executive Officer
Accounting and Controller
Report of Independent Accountants
To the Stockholders of Marathon Oil Corporation:
In our opinion, the accompanying consolidated financial statements appearing on pages F-2 through
F-32F-36 present fairly, in all material respects, the financial position of Marathon Oil Corporation and its subsidiaries (Marathon) at December 31,20012002 and2000,2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31,2001,2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility ofMarathon'sMarathon’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.As discussed in Note
42 to the financial statements, Marathon changed its method of accounting for certain long-term natural gas sales contracts in 2002 and its method of accounting for derivatives in 2001.As discussed in Note
23 to the financial statements, on December 31, 2001, Marathon distributed its steel business to the holders ofUSX-U. S.USX–U.S. Steel Group common stock and has accounted for this business as a discontinued operation./s//s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Pittsburgh, PennsylvaniaHouston, Texas
February
15, 200218, 2003F-1
Consolidated Statement of Income
(Dollars in millions) 2001 2000 1999 - ------------------------------------------------------------------------------Revenues and other income: Revenues $ 33,019 $ 34,427 $ 23,549 Dividend and investee income 138 102 69 Net losses on disposal of assets (177) (785) - Gain (loss) on ownership change in Marathon Ashland Petroleum LLC (6) 12 17 Other income 92 43 31 -------- -------- -------- Total revenues and other income 33,066 33,799 23,666 -------- -------- -------- Costs and expenses: Cost of revenues (excludes items shown below) 23,255 25,417 16,612 Selling, general and administrative expenses 726 643 498 Depreciation, depletion and amortization 1,236 1,245 950 Taxes other than income taxes 4,679 4,626 4,218 Exploration expenses 144 238 238 Inventory market valuation charges (credits) 72 - (551) -------- -------- -------- Total costs and expenses 30,112 32,169 21,965 -------- -------- -------- Income from operations 2,954 1,630 1,701 Net interest and other financial costs 173 236 288 Minority interest in income of Marathon Ashland Petroleum LLC 704 498 447 -------- -------- -------- Income from continuing operations before income taxes 2,077 896 966 Provision for income taxes 759 476 320 -------- -------- -------- Income from continuing operations 1,318 420 646 Discontinued operations Income (loss) from discontinued operations (169) (9) 59 Loss on disposition of United States Steel Corporation (984) - - -------- -------- -------- Income before extraordinary losses and cumulative effect of change in accounting principle 165 411 705 Extraordinary losses - - (7) Cumulative effect of change in accounting principle (8) - - -------- -------- -------- Net income $ 157 $ 411 $ 698 - ------------------------------------------------------------------------------Included in revenues and costs and expenses for 2001, 2000 and 1999 were $4,404 million, $4,344 million and $3,973 million, respectively, representing consumer excise taxes on petroleum products and merchandise.
(Dollars in millions)
2002
2001
2000
Revenues and other income:
Sales and other operating revenues (including consumer excise taxes)
$
30,595
$
32,599
$
34,181
Sales to related parties
869
476
313
Income from equity method investments
137
118
81
Net gains (losses) on disposal of assets
65
(177
)
(785
)
Gain (loss) on ownership change in Marathon Ashland Petroleum LLC
12
(6
)
12
Other income
42
112
64
Total revenues and other income
31,720
33,122
33,866
Costs and expenses:
Cost of revenues (excludes items shown below)
23,574
23,233
25,403
Purchases from related parties
100
83
87
Consumer excise taxes
4,250
4,404
4,344
Depreciation, depletion and amortization
1,201
1,233
1,052
Property impairments
14
3
193
Selling, general and administrative expenses
845
721
637
Other taxes
258
275
282
Exploration expenses
184
144
238
Inventory market valuation charges (credits)
(72
)
72
–
Total costs and expenses
30,354
30,168
32,236
Income from operations
1,366
2,954
1,630
Net interest and other financing costs
268
173
236
Minority interest in income of
Marathon Ashland Petroleum LLC
173
704
498
Income from continuing operations before income taxes
925
2,077
896
Provision for income taxes
389
759
476
Income from continuing operations
536
1,318
420
Discontinued operations
Loss from discontinued operations
–
(169
)
(9
)
Loss on disposition of United States Steel Corporation
–
(984
)
–
Income before extraordinary loss and cumulative effect of changes in accounting principles
536
165
411
Extraordinary loss from early extinguishment of debt
(33
)
–
–
Cumulative effect of changes in accounting principles
13
(8
)
–
Net income
$
516
$
157
$
411
The accompanying notes are an integral part of these consolidated financial statements.
F-2
Income Per Common Share
(Dollars in millions, except per share data) 2001 2000 1999 - ---------------------------------------------------------------------MARATHON COMMON STOCK Income from continuing operations applicable to Common Stock $ 1,317 $ 420 $ 646 ------- ------ ------ Net income applicable to Common Stock $ 377 $ 432 $ 654 ------- ------ ------ Per Share Data Basic and diluted: Income from continuing operations $ 4.26 $ 1.35 $ 2.09 ------- ------ ------ Net income $ 1.22 $ 1.39 $ 2.11 ------- ------ ------ STEEL STOCK Net income (loss) applicable to Steel Stock $ (243) $ (29) $ 35 ------- ------ ------ Per Share Data Basic: Net income (loss) $ (2.73) $ (.33) $ .40 ------- ------ ------ Diluted: Net income (loss) $ (2.74) $ (.33) $ .40 - ---------------------------------------------------------------------
(Dollars in millions, except per share data)
2002
2001
2000
MARATHON COMMON STOCK
Income from continuing operations
applicable to Common Stock
$
536
$
1,317
$
420
Net income applicable to Common Stock
$
516
$
377
$
432
Per Share Data
Basic and diluted:Income from continuing operations
$
1.72
$
4.26
$
1.35
Net income
$
1.66
$
1.22
$
1.39
STEEL STOCK
Net loss applicable to Steel Stock
$
–
$
(243
)
$
(29
)
Per Share Data
Basic:Net loss
$
–
$
(2.73
)
$
(.33
)
Diluted:
Net loss
$
–
$
(2.74
)
$
(.33
)
See Note
8,6 for a description and computation of income per common share.The accompanying notes are an integral part of these consolidated financial statements.
F-3
Consolidated Balance Sheet
(Dollars in millions) December 31 2001 2000 - -----------------------------------------------------------------------------Assets Current assets: Cash and cash equivalents $ 657 $ 340 Receivables, less allowance for doubtful accounts of $8 and $3 1,708 2,262 Receivables from United States Steel 64 5 Inventories 1,851 1,867 Assets held for sale 16 330 Deferred income tax benefits 13 60 Other current assets 102 121 -------- -------- Total current assets 4,411 4,985 Investments and long-term receivables 1,076 362 Net investment in United States Steel - 1,919 Receivables from United States Steel 551 - Property, plant and equipment - net 9,578 9,375 Prepaid pensions 207 207 Other noncurrent assets 306 303 -------- -------- Total assets $ 16,129 $ 17,151 - ----------------------------------------------------------------------------- Liabilities Current liabilities: Notes payable $ - $ 80 Accounts payable 2,431 3,019 Payable to United States Steel 28 366 Payroll and benefits payable 243 230 Accrued taxes 171 108 Accrued interest 85 61 Obligations to repay preferred securities 295 - Long-term debt due within one year 215 148 -------- -------- Total current liabilities 3,468 4,012 Long-term debt 3,432 1,937 Deferred income taxes 1,297 1,354 Employee benefits 677 648 Payable to United States Steel 8 97 Deferred credits and other liabilities 344 315 Preferred stock of subsidiary - 184 Minority interest in Marathon Ashland Petroleum LLC 1,963 1,840 Stockholders' Equity Preferred stock - 6.50% Cumulative Convertible issued - 2,413,487 shares ($121 liquidation preference) at December 31, 2000 - 2 Common stocks: Common Stock issued - 312,165,978 shares at December 31, 2001 and 2000 (par value $1 per share, authorized 550,000,000 shares) 312 312 Steel Stock issued - 88,767,395 shares at December 31, 2000 (par value $1 per share, authorized 200,000,000 shares) - 89 Securities exchangeable solely into Common Stock - issued - 281,148 shares at December 31, 2000 - - Common Stock held in treasury - 2,770,929 shares at December 31, 2001 and 3,899,714 shares at December 31, 2000 (74) (104) Additional paid-in capital 3,035 4,676 Retained earnings 1,643 1,847 Accumulated other comprehensive income (loss) 34 (50) Deferred compensation (10) (8) -------- -------- Total stockholders' equity 4,940 6,764 -------- -------- Total liabilities and stockholders' equity $ 16,129 $ 17,151 - -----------------------------------------------------------------------------
(Dollars in millions)
December 31
2002
2001
Assets
Current assets:
Cash and cash equivalents
$
488
$
657
Receivables, less allowance for doubtful accounts of $6 and $4
1,807
1,672
Receivables from United States Steel
9
64
Receivables from related parties
38
36
Inventories
1,984
1,851
Other current assets
153
131
Total current assets
4,479
4,411
Investments and long-term receivables, less allowance for doubtful
accounts of $14 and $4
1,634
1,076
Receivables from United States Steel
547
551
Property, plant and equipment – net
10,390
9,552
Prepaid pensions
201
207
Goodwill
274
88
Intangibles
119
61
Other noncurrent assets
168
183
Total assets
$
17,812
$
16,129
Liabilities
Current liabilities:
Accounts payable
$
2,847
$
2,407
Payables to United States Steel
28
28
Payables to related parties
10
24
Payroll and benefits payable
198
243
Accrued taxes
307
171
Accrued interest
108
85
Obligations to repay preferred securities
–
295
Long-term debt due within one year
161
215
Total current liabilities
3,659
3,468
Long-term debt
4,410
3,432
Deferred income taxes
1,445
1,297
Employee benefit obligations
847
677
Asset retirement obligations
223
193
Payables to United States Steel
7
8
Deferred credits and other liabilities
168
151
Minority interest in Marathon Ashland Petroleum LLC
1,971
1,963
Commitments and contingencies
–
–
Stockholders’ Equity
Common Stock issued – 312,165,978 shares at December 31, 2002 and 2001 (par value $1 per share, authorized 550,000,000 shares)
312
312
Common Stock held in treasury – 2,292,986 shares at December 31, 2002 and 2,770,929 shares at December 31, 2001
(60
)
(74
)
Additional paid-in capital
3,032
3,035
Retained earnings
1,874
1,643
Accumulated other comprehensive income (loss)
(69
)
34
Unearned compensation
(7
)
(10
)
Total stockholders’ equity
5,082
4,940
Total liabilities and stockholders’ equity
$
17,812
$
16,129
The accompanying notes are an integral part of these consolidated financial statements.
F-4
Consolidated Statement of Cash Flows
(Dollars in millions) 2001 2000 1999 - ---------------------------------------------------------------------------Increase (decrease) in cash and cash equivalents Operating activities: Net income $ 157 $ 411 $ 698 Adjustments to reconcile to net cash provided from operating activities: Cumulative effect of change in accounting principle 8 - - Extraordinary losses - - 7 Loss (income) from discontinued operations 169 9 (59) Loss on disposition of United States Steel 984 - - Minority interest in income of Marathon Ashland Petroleum LLC 704 498 447 Depreciation, depletion and amortization 1,236 1,245 950 Exploratory dry well costs 60 86 109 Inventory market valuation charges (credits) 72 - (551) Deferred income taxes (217) (240) 105 Net losses on disposal of assets 177 785 - Changes in: Current receivables 172 (377) (844) Inventories (66) 17 (63) Current accounts payable and accrued expenses (601) 717 1,106 All other - net 64 (5) 103 ------- ------- ------- Net cash provided from continuing operations 2,919 3,146 2,008 Net cash provided from (used in) discontinued operations 717 (615) (72) ------- ------- ------- Net cash provided from operating activities 3,636 2,531 1,936 ------- ------- ------- Investing activities: Capital expenditures (1,639) (1,425) (1,378) Acquisition of Pennaco Energy, Inc. (506) - - Disposal of assets 296 539 356 Cash held by United States Steel upon disposition (147) - - Restricted cash - withdrawals 67 271 45 - deposits (62) (268) (44) Investees - investments (17) (65) (59) - loans and advances (6) (6) (70) - returns and repayments 10 10 1 All other - net 5 21 (25) ------- ------- ------- Net cash used in continuing operations (1,999) (923) (1,174) Net cash used in discontinued operations (245) (270) (294) ------- ------- ------- Net cash used in investing activities (2,244) (1,193) (1,468) Financing activities: Commercial paper and revolving credit arrangements--net (51) 62 (381) Other debt - borrowings 649 273 810 - repayments (758) (339) (242) Redemption of preferred stock of subsidiary (223) - - Preferred stock repurchased - (12) (2) Common stock - issued - - 89 - repurchased (1) (105) - Treasury common stock reissued 12 1 - Dividends paid (341) (371) (354) Distributions to minority shareholder of Marathon Ashland Petroleum LLC (577) (420) (400) ------- ------- ------- Net cash used in financing activities (1,290) (911) (480) ------- ------- ------- Effect of exchange rate changes on cash: Continuing operations (3) (2) (1) Discontinued operations (1) 1 - ------- ------- ------- Net increase (decrease) in cash and cash equivalents 98 426 (13) Cash and cash equivalents at beginning of year 559 133 146 ------- ------- ------- Cash and cash equivalents at end of year $ 657 $ 559 $ 133 - ---------------------------------------------------------------------------Cash and cash equivalents at end of year for 2000 and 1999 include $219 million and $22 million, respectively, of cash held by United States Steel.
(Dollars in millions)
2002
2001
2000
Increase (decrease) in cash and cash equivalents
Operating activities:
Net income
$
516
$
157
$
411
Adjustments to reconcile to net cash provided from operating activities:
Cumulative effect of changes in accounting principles
(13
)
8
–
Extraordinary loss from early extinguishment of debt
33
–
–
Loss from discontinued operations
–
169
9
Loss on disposition of United States Steel
–
984
–
Minority interest in income of Marathon Ashland Petroleum LLC
173
704
498
Depreciation, depletion and amortization
1,201
1,233
1,052
Property impairments
14
3
193
Exploratory dry well costs
100
60
86
Inventory market valuation charges (credits)
(72
)
72
–
Deferred income taxes
96
(217
)
(240
)
Net losses (gains) on disposal of assets
(65
)
177
785
Changes in: Current receivables
(110
)
172
(377
)
Inventories
(51
)
(66
)
17
Accounts payable and other current liabilities
614
(601
)
717
All other – net
(31
)
64
(5
)
Net cash provided from continuing operations
2,405
2,919
3,146
Net cash provided from (used in) discontinued operations
–
717
(615
)
Net cash provided from operating activities
2,405
3,636
2,531
Investing activities:
Capital expenditures
(1,574
)
(1,639
)
(1,425
)
Acquisitions
(1,160
)
(506
)
–
Disposal of assets
152
296
539
Cash held by United States Steel upon disposition
–
(147
)
–
Receivable from United States Steel
54
–
–
Restricted cash – withdrawals
91
67
271
– deposits
(123
)
(62
)
(268
)
Investments – contributions
(111
)
(17
)
(65
)
– loans and advances
–
(6
)
(6
)
– returns and repayments
5
10
10
All other – net
–
5
21
Net cash used in continuing operations
(2,666
)
(1,999
)
(923
)
Net cash used in discontinued operations
–
(245
)
(270
)
Net cash used in investing activities
(2,666
)
(2,244
)
(1,193
)
Financing activities:
Commercial paper and revolving credit arrangements – net
(375
)
(51
)
62
Other debt – borrowings
1,828
537
–
– repayments
(604
)
(646
)
(66
)
Redemption of preferred stock of subsidiary
(185
)
(223
)
–
Preferred stock repurchased
(110
)
–
(12
)
Treasury common stock – proceeds from issuances
2
12
1
– purchases
(7
)
(1
)
(105
)
Dividends paid – Common Stock
(285
)
(284
)
(274
)
– Steel Stock
–
(49
)
(89
)
– Preferred stock
–
(8
)
(8
)
Distributions to minority shareholder of
Marathon Ashland Petroleum LLC
(176
)
(577
)
(420
)
Net cash provided from (used in) financing activities
88
(1,290
)
(911
)
Effect of exchange rate changes on cash:
Continuing operations
4
(3
)
(2
)
Discontinued operations
–
(1
)
1
Net increase (decrease) in cash and cash equivalents
(169
)
98
426
Cash and cash equivalents at beginning of year
657
559
133
Cash and cash equivalents at end of year
$
488
$
657
$
559
The accompanying notes are an integral part of these consolidated financial statements.
F-5
Consolidated Statement of
Stockholders'Stockholders’ Equity
Dollars in millions Shares in thousands ------------------- ------------------------- 2001 2000 1999 2001 2000 1999 - --------------------------------------------------------------------------------Preferred stock - 6.50% Cumulative Convertible: Balance at beginning of year $ 2 $ 3 $ 3 2,413 2,715 2,768 Repurchased - (1) - (9) (302) (53) Converted into Steel Stock - - - (1) - - Exchanged for debt - - - (195) - - Converted to right to receive cash at Separation (2) - - (2,208) - - ----- ----- ----- ------- ------- ------- Balance at end of year $ - $ 2 $ 3 - 2,413 2,715 - -------------------------------------------------------------------------------- Common stocks: Common Stock: Balance at beginning of year $ 312 $ 312 $ 308 312,166 311,767 308,459 Issued in public offering - - - - - 67 Issued for: Employee stock plans - - 3 - 391 2,903 Dividend Reinvestment and Direct Stock Purchase Plan - - - - - 120 Exchangeable Shares - - 1 - 8 218 ----- ----- ----- ------- ------- ------- Balance at end of year $ 312 $ 312 $ 312 312,166 312,166 311,767 - -------------------------------------------------------------------------------- Steel Stock: Balance at beginning of year $ 89 $ 88 $ 88 88,767 88,398 88,336 Issued for: Employee stock plans - 1 - 430 369 62 Conversion of preferred stock - - - 1 - - Exchanged for investment in United States Steel (89) - - (89,198) - - ----- ----- ----- ------- ------- ------- Balance at end of year $ - $ 89 $ 88 - 88,767 88,398 - -------------------------------------------------------------------------------- Securities exchangeable solely into Common Stock: Balance at beginning of year $ - $ - $ 1 281 289 507 Exchanged for Common Stock - - (1) (281) (8) (218) ----- ----- ----- ------- ------- ------- Balance at end of year $ - $ - $ - - 281 289 - -------------------------------------------------------------------------------- Treasury common stocks, at cost: Common Stock: Balance at beginning of year $(104) $ - $ - (3,900) - - Repurchased (1) (105) - (27) (3,957) - Reissued for: Exchangeable shares 7 - - 281 - - Employee stock plans 24 1 - 875 43 - Nonemployee directors deferred compensation plan - - - - 14 - ----- ----- ----- ------- ------- ------- Balance at end of year $ (74) $(104) $ - (2,771) (3,900) - - -------------------------------------------------------------------------------- Steel Stock: Balance at beginning of year $ - $ - $ - - - - Repurchased - - - (20) - - Reissued for employee stock plans - - - 18 - - Distributed to United States Steel - - - 2 - - ----- ----- ----- ------- ------- ------- Balance at end of year $ - $ - $ - - - - - --------------------------------------------------------------------------------(Table
Dollars in millions
Shares in thousands
2002
2001
2000
2002
2001
2000
Preferred stock:
6.50% Cumulative Convertible:
Balance at beginning of year
$
–
$
2
$
3
–
2,413
2,715
Repurchased
–
–
(1
)
–
(9
)
(302
)
Converted into Steel Stock
–
–
–
–
(1
)
–
Exchanged for debt
–
–
–
–
(195
)
–
Converted to right to receive cash at Separation
–
(2
)
–
–
(2,208
)
–
Balance at end of year
$
–
$
–
$
2
–
–
2,413
Common stocks:
Common Stock:
Balance at beginning of year
$
312
$
312
$
312
312,166
312,166
311,767
Issued for:
Employee stock plans
–
–
–
–
–
391
Exchangeable Shares
–
–
–
–
–
8
Balance at end of year
$
312
$
312
$
312
312,166
312,166
312,166
Steel Stock:
Balance at beginning of year
$
–
$
89
$
88
–
88,767
88,398
Issued for:
Employee stock plans
–
–
1
–
430
369
Conversion of preferred stock
–
–
–
–
1
–
Distributed to United States Steel shareholders
–
(89
)
–
–
(89,198
)
–
Balance at end of year
$
–
$
–
$
89
–
–
88,767
Securities exchangeable solely into Common Stock:
Balance at beginning of year
$
–
$
–
$
–
–
281
289
Exchanged for Common Stock
–
–
–
–
(281
)
(8
)
Balance at end of year
$
–
$
–
$
–
–
–
281
Treasury common stocks, at cost:
Common Stock:
Balance at beginning of year
$
(74
)
$
(104
)
$
–
(2,771
)
(3,900
)
–
Repurchased
(7
)
(1
)
(105
)
(297
)
(27
)
(3,957
)
Reissued for:
Exchangeable Shares
–
7
–
–
281
–
Employee stock plans
19
24
1
727
875
43
Non-employee directors deferred compensation plan
2
–
–
48
–
14
Balance at end of year
$
(60
)
$
(74
)
$
(104
)
(2,293
)
(2,771
)
(3,900
)
Steel Stock:
Balance at beginning of year
$
–
$
–
$
–
–
–
–
Repurchased
–
–
–
–
(20
)
–
Reissued for employee stock plans
–
–
–
–
18
–
Distributed to United States Steel
–
–
–
–
2
–
Balance at end of year
$
–
$
–
$
–
–
–
–
(Table continued on next page)
F-6
Comprehensive Stockholders' Equity Income ------------------------ ------------------- (Dollars in millions) 2001 2000 1999 2001 2000 1999 - --------------------------------------------------------------------------------Additional paid-in capital: Balance at beginning of year $ 4,676 $ 4,673 $4,587 Marathon Stock issued 4 9 92 Steel Stock issued 8 5 2 Exchanged for investment in United States Steel (1,526) - - Exchangeable Shares exchanged for Common Stock (9) - (6) 6.50% Preferred stock: Repurchased - (11) (2) Converted to right to receive cash at Separation (118) - - ------- ------- ------ Balance at end of year $ 3,035 $ 4,676 $4,673 - -------------------------------------------------------------------------------- Deferred compensation net of taxes: Balance at beginning of year $ (8) $ - $ 1 Change during year (11) (8) (1) Transfer to United States Steel 9 - - ------- ------- ------ Balance at end of year $ (10) $ (8) $ - - -------------------------------------------------------------------------------- Retained earnings: Balance at beginning of year $ 1,847 $ 1,807 $1,467 Net income 157 411 698 $ 157 $ 411 $ 698 Excess redemption value over carrying value of preferred securities (20) - - Dividends on preferred stock (8) (8) (9) Dividends on Common Stock (per share: $.92 in 2001, $.88 in 2000 and $.84 in 1999) (284) (274) (261) Dividends on Steel Stock (per share $.55 in 2001 and $1.00 in 2000 and 1999) (49) (89) (88) ------- ------- ------ Balance at end of year $ 1,643 $ 1,847 $1,807 - -------------------------------------------------------------------------------- Accumulated other comprehensive income (loss) net of taxes(a): Minimum pension liability adjustments: Balance at beginning of year $ (21) $ (10) $ (37) Changes during year (13) (11) 27 (13) (11) 27 Reclassified to earnings 20 - - 20 - - ------- ------- ------ Balance at end of year (14) (21) (10) ------- ------- ------ Foreign currency translation adjustments: Balance at beginning of year $ (29) $ (17) $ (11) Changes during year (3) (12) (6) (3) (12) (6) Reclassified to earnings 29 - - 29 - - ------- ------- ------ Balance at end of year (3) (29) (17) ------- ------- ------ Unrealized holding losses on investments: Balance at beginning of year $ - $ - $ - Changes during year - - (1) - - (1) Reclassified to earnings - - 1 - - 1 ------- ------- ------ Balance at end of year - - - ------- ------- ------ Deferred gains (losses) on derivative instruments: Balance at beginning of year $ - $ - $ - Cumulative effect adjustment (8) - - (8) - - Reclassification of the cumulative effect adjustment into earnings 23 - - 23 - - Changes in fair value 34 - - 34 - - Reclassification to earnings 2 - - 2 - - ------- ------- ------ Balance at end of year $ 51 $ - $ - ------- ------- ------ Total balances at end of year $ 34 $ (50) $ (27) - -------------------------------------------------------------------------------- Total comprehensive income $ 241 $ 388 $ 719 - -------------------------------------------------------------------------------- Total stockholders' equity $ 4,940 $ 6,764 $6,856 - -------------------------------------------------------------------------------- (a) Related income tax provision (credit): 2001 2000 1999 Minimum pension liability adjustments $ 4 $ (4) $ 13 Foreign currency translation adjustments - (1) (3) Net deferred gains on derivative instruments 27 - -
Stockholders’ Equity
Comprehensive Income
(Dollars in millions)
2002
2001
2000
2002
2001
2000
Additional paid-in capital:
Balance at beginning of year
$
3,035
$
4,676
$
4,673
Common Stock issued
–
4
9
Treasury Common Stock reissued
(3
)
–
–
Steel Stock issued
–
8
5
Steel Stock distributed to United States Steel shareholders
–
(1,526
)
–
Exchangeable Shares exchanged for Common Stock
–
(9
)
–
6.50% Preferred stock:
Repurchased
–
–
(11
)
Converted to right to receive cash at Separation
–
(118
)
–
Balance at end of year
$
3,032
$
3,035
$
4,676
Unearned compensation:
Balance at beginning of year
$
(10
)
$
(8
)
$
–
Change during year
3
(11
)
(8
)
Transferred to United States Steel
–
9
–
Balance at end of year
$
(7
)
$
(10
)
$
(8
)
Retained earnings:
Balance at beginning of year
$
1,643
$
1,847
$
1,807
Net income
516
157
411
$
516
$
157
$
411
Excess redemption value over carrying value of preferred securities
–
(20
)
–
Dividends paid on:
Preferred stock
–
(8
)
(8
)
Common Stock (per share: $.92 in 2002, $.92 in 2001 and $.88 in 2000)
(285
)
(284
)
(274
)
Steel Stock (per share: $.55 in 2001 and $1.00 in 2000)
–
(49
)
(89
)
Balance at end of year
$
1,874
$
1,643
$
1,847
Accumulated other comprehensive income (loss)(a):
Minimum pension liability adjustments:
Balance at beginning of year
$
(14
)
$
(21
)
$
(10
)
Changes during year
(33
)
(13
)
(11
)
(33
)
(13
)
(11
)
Reclassified to income
–
20
–
–
20
–
Balance at end of year
(47
)
(14
)
(21
)
Foreign currency translation adjustments:
Balance at beginning of year
$
(3
)
$
(29
)
$
(17
)
Changes during year
2
(3
)
(12
)
2
(3
)
(12
)
Reclassified to income
–
29
–
–
29
–
Balance at end of year
(1
)
(3
)
(29
)
Deferred gains (losses) on derivative instruments:
Balance at beginning of year
$
51
$
–
$
–
Cumulative effect adjustment
–
(8
)
–
–
(8
)
–
Reclassification of the cumulative effect adjustment into income
(1
)
23
–
(1
)
23
–
Changes in fair value
(36
)
34
–
(36
)
34
–
Reclassification to income
(35
)
2
–
(35
)
2
–
Balance at end of year
$
(21
)
$
51
$
–
Total balances at end of year
$
(69
)
$
34
$
(50
)
Total comprehensive income
$
413
$
241
$
388
Total stockholders’ equity
$
5,082
$
4,940
$
6,764
(a) Related income tax provision (credit):
2002
2001
2000
Minimum pension liability adjustments
$
(25
)
$
(4
)
$
(4
)
Foreign currency translation adjustments
–
–
(1
)
Net deferred gains (losses) on derivative instruments
(11
)
27
–
The accompanying notes are an integral part of these consolidated financial statements.
F-7
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------1. Summary of Principal Accounting Policies
Basis of
Presentationpresentation – Marathon Oil Corporation(Marathon)was originally organized in 2001 as USX HoldCo, Inc., a wholly owned subsidiary of USX Corporation. As a result of a reorganizationtransactioncompleted in July 2001, USX HoldCo, Inc. (1) became the parent entity of the consolidated enterprise (the former USX Corporation was merged into a subsidiary of USX HoldCo, Inc.) and (2) changed its name to USX Corporation. In connection with theSeparationtransaction discussedbelow,in the next paragraph (the Separation), USX Corporation changed its name to Marathon Oil Corporation. The accompanying consolidated financial statements reflect Marathon Oil Corporation and its subsidiaries as the continuation of the consolidated enterprise.Prior to December 31, 2001, Marathon had two outstanding classes of common stock:
USX-MarathonUSX- Marathon Group common stock(Marathon(Common Stock), which was intended to reflect the performance ofMarathon'sMarathon’s energy business, andUSX-U. S.USX—U.S. Steel Group common stock (Steel Stock), which was intended to reflect the performance ofMarathon'sMarathon’s steel business. As described further in Note2,3, on December 31, 2001, Marathon disposed of its steel business through a tax-free distribution of the common stock of its wholly owned subsidiary United States Steel Corporation (United States Steel) to holders of Steel Stock in exchange for all outstanding shares of Steel Stock on a one-for-onebasis (the Separation).basis.In connection with the Separation,
Marathon'sMarathon’s certificate of incorporation was amended on December 31, 2001 and, from that date, Marathon has only one class of common stock authorized.Marathon is engaged in worldwide exploration and production of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily through its 62 percent owned consolidated subsidiary Marathon Ashland Petroleum LLC (MAP); and other energy related businesses.
- -------------------------------------------------------------------------------Principles applied in consolidation – These consolidated financial statements include the accounts of the businesses comprising Marathon.
The assets and liabilities of MAP are consolidated in these financial statements and minority interest representing 38 percent of the carrying value of the net assets of MAP has been recognized. Under certain circumstances, the MAP Limited Liability Company Agreement requires unanimous approval of certain matters brought to the MAP Board of Managers. Marathon does not believe that the rights of the minority shareholder of MAP are substantive because the likelihood of those rights being triggered is remote.
Investments in unincorporated oil and gas joint ventures, undivided interest pipelines and jointly owned gas processing plants are consolidated on a pro rata basis.
Investments in entities over which Marathon has significant influence are accounted for using the equity method of accounting and are carried at Marathon’s share of net assets plus loans and advances. Differences in the basis of the investment and the separate net asset value of the investee, if any, are amortized into income in accordance with the underlying remaining useful life of the associated assets.
Investments in companies whose stock is publicly traded are carried at market value. The difference between the cost of these investments and market value is recorded in other comprehensive income (net of tax). Investments in companies whose stock has no readily determinable fair value are carried at cost.
Income from equity method investments represents Marathon’s proportionate share of income from equity method investments. Other income includes dividend income from other investments. Dividend income is recognized when dividend payments are received.
Gains or losses from a change in ownership of a consolidated subsidiary or an unconsolidated investee are recognized in the period of change.
Use of estimates – The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at year-end and the reported amounts of revenues and expenses during the year. Items subject to such estimates and assumptions include the carrying value of property, plant and equipment, goodwill, intangibles and equity method investments; valuation allowances for receivables, inventories and deferred income tax assets; environmental remediation liabilities; liabilities for potential tax deficiencies and potential litigation claims and settlements; assets and obligations related to employee benefits; and the classification of gains or losses on cash flow hedges of forecasted transaction. Actual results could differ from the estimates and assumptions used.
Income per common share – Basic net income (loss) per share is calculated by adjusting net income for dividend requirements of preferred stock and is based on the weighted average number of common shares outstanding. Diluted net income (loss) per share assumes exercise of stock options and warrants and conversion of convertible debt and preferred securities, provided the effect is not antidilutive.
F-8
Segment information – Marathon’s operations consist of three reportable operating segments:
Exploration and Production – explores for and produces crude oil and natural gas on a worldwide basis;Refining, Marketing and Transportation – refines, markets and transports crude oil and petroleum products, primarily in the Midwest, the upper Great Plains and southeastern United States through MAP; andOther Energy Related Businesses – markets and transports its own and third-party natural gas, crude oil and products manufactured from natural gas, such as liquefied natural gas and methanol, primarily in the United States, Europe and West Africa.Segment income represents income from operations allocable to operating segments. Marathon corporate general and administrative costs are not allocated to operating segments. These costs primarily consist of employment costs (including pension effects), professional services, facilities and other related costs associated with corporate activities. Inventory market valuation adjustments and gain (loss) on ownership change in MAP also are not allocated to operating segments. Additionally, certain nonoperating or infrequently occurring items are not allocated to operating segments (see segment income reconcilement table on page F-20).
Information on assets by segment is not provided as it is not reviewed by the chief operating decision maker.
Revenue recognition– Revenues are recognized when products are shipped or services are provided to customers and the sales price is fixed or determinable and collectibility is reasonably assured. Costs associated with revenues are recorded in costs of revenues.
Marathon recognizes revenues from the production of oil and gas in the United States when title is transferred. Outside the United States, revenues are recognized at the time of lifting. Royalties on the production of oil and gas are either paid in cash or settled through the delivery of volumes. Marathon includes royalties in its revenue and cost of revenues when settlement of royalties is paid in cash, while settlement of royalties based on the delivery of volumes are excluded from revenue and cost of revenues.
Rebates from vendors are recognized as revenues when the initiating transaction occurs. Incentives that are derived from contractual provisions are accrued based on past experience and recognized within cost of revenues.
Matching buy/sell transactions settled in cash are recorded in both revenues and costs of revenues as separate sales and purchase transactions.
Marathon follows the sales method of accounting for gas production imbalances and would recognize a liability if the existing proved reserves were not adequate to cover the current imbalance situation.
Cash and cash equivalents – Cash and cash equivalents include cash on hand and on deposit and investments in highly liquid debt instruments with maturities generally of three months or less.
Inventories – Inventories are carried at lower of cost or market. Cost of inventories is determined primarily under the last-in, first-out (LIFO) method.
The inventory market valuation reserve reflects the extent that the recorded LIFO cost basis of crude oil and refined products inventories exceeds net realizable value. The reserve is decreased to reflect increases in market prices and inventory turnover and increased to reflect decreases in market prices. Changes in the inventory market valuation reserve result in noncash charges or credits to costs and expenses.
Derivative instruments – Marathon uses commodity-based derivatives and financial instrument related derivatives to manage its exposure to commodity price risk, interest rate risk or foreign currency risk. Management has authorized the use of futures, forwards, swaps and combinations of options related to the purchase, production or sale of crude oil, natural gas and refined products, fair value of certain assets and liabilities, future interest expense and also certain business transactions denominated in foreign currencies. Changes in the fair value of all derivatives are recognized immediately in income, within revenues, costs of revenues or net interest and other financing costs, unless the derivative qualifies as a hedge of future cash flows or certain foreign currency exposures. Cash flows related to the use of derivatives are classified in operating activities with the underlying hedged transaction.
For derivatives qualifying as hedges of future cash flows or certain foreign currency exposures, the effective portion of any changes in fair value is recognized in a component of stockholders’ equity called other comprehensive income and then reclassified to income, within revenues, costs of revenues or net interest and other financing costs, when the underlying anticipated transaction occurs . Any ineffective portion of such hedges is recognized in income as it occurs. For discontinued cash flow hedges prospective changes in the fair value of the derivative are recognized in income. Any gain or loss accumulated in other comprehensive income at the time a hedge is discontinued continues to be
F-9
deferred until the original forecasted transaction occurs. However, if it is determined that the likelihood of the original forecasted transaction occurring is no longer probable, the entire gain or loss accumulated in other comprehensive income is immediately reclassified into income.
For derivatives designated as hedges of the fair value of recognized assets, liabilities or firm commitments, changes in the fair value of both the hedged item and the related derivative are recognized immediately in income, within revenues, costs of revenues or net interest and other financing costs, with an offsetting effect included in the basis of the hedged item. The net effect is to reflect in income the extent to which the hedge is not effective in achieving offsetting changes in fair value.
Property, plant and equipment – Marathon uses the successful efforts method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed.
Capitalized costs of producing oil and gas properties are depreciated and depleted by the units-of-production method. Support equipment and other property, plant and equipment are depreciated over their estimated useful lives.
Marathon evaluates its oil and gas producing properties for impairment of value on a field-by-field basis or, in certain instances, by logical grouping of assets if there is significant shared infrastructure, using undiscounted future cash flows based on total proved and risk-adjusted probable and possible reserves. Oil and gas producing properties deemed to be impaired are written down to their fair value, as determined by discounted future cash flows based on total proved and risk-adjusted probable and possible reserves or, if available, comparable market values. Unproved oil and gas properties that are individually significant are periodically assessed for impairment of value, and a loss is recognized at the time of impairment. Other unproved properties are amortized over their remaining holding period.
For property, plant and equipment unrelated to oil and gas producing activities, depreciation is computed on the straight-line method over their estimated useful lives, which range from 3 to 42 years.
When property, plant and equipment depreciated on an individual basis are sold or otherwise disposed of, any gains or losses are reflected in income. Gains on disposal of property, plant and equipment are recognized when earned, which is generally at the time of closing. If a loss on disposal is expected, such losses are recognized when the assets are reclassified as held for sale. Proceeds from disposal of property, plant and equipment depreciated on a group basis are credited to accumulated depreciation, depletion and amortization with no immediate effect on income.
Major maintenance activities – Marathon incurs planned major maintenance costs primarily for refinery turnarounds. Such costs are expensed in the same annual period as incurred; however, estimated annual turnaround costs are recognized in income throughout the year on a pro rata basis.
Environmental remediation liabilities – Environmental remediation expenditures are capitalized if the costs mitigate or prevent future contamination or if the costs improve existing assets’ environmental safety or efficiency. Marathon provides for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs can be reasonably estimated. The timing of remediation accruals coincides with completion of a feasibility study or the commitment to a formal plan of action. Remediation liabilities are accrued based on estimates of known environmental exposure and are discounted when the estimated amounts are reasonably fixed and determinable. If recoveries of remediation costs from third parties are probable, a receivable is recorded.
Asset retirement obligations – Estimated abandonment and dismantlement costs of offshore production facilities are accrued over the life of the producing assets on a units-of-production method.
Deferred taxes – Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The realization of deferred tax assets is assessed periodically based on several interrelated factors. These factors include Marathon’s expectation to generate sufficient future taxable income including future foreign source income, tax credits, operating loss carryforwards, and management’s intent regarding the permanent reinvestment of the income from certain foreign subsidiaries.
Pensions and other postretirement benefits – Marathon has noncontributory defined benefit pension plans covering substantially all domestic employees, international employees located in Ireland and the United Kingdom, and most MAP employees. Benefits under these plans are based primarily upon years of service and final average pensionable earnings. MAP also participates in a multiemployer plan that provides coverage for less than 5% of its employees. The benefits provided include both pension and health care.
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Marathon also has a retiree health plan covering most employees upon their retirement. Health care benefits are provided through comprehensive hospital, surgical and major medical benefit provisions or through health maintenance organizations, subject to various cost sharing features. In addition, life insurance benefits are provided to certain nonunion and most union represented employees primarily based on annual base salary at retirement. Retiree health and life insurance benefits (other benefits) have not been prefunded.
Stock-based compensation – The Marathon Oil Corporation 1990 Stock Plan authorizes the Compensation Committee of the board of directors of Marathon to grant restricted stock, stock options and stock appreciation rights to key management employees. Up to 0.5 percent of the outstanding stock, as determined on December 31 of the preceding year, is available for grants during each calendar year the 1990 Plan is in effect. In addition, awarded shares that do not result in shares being issued are available for subsequent grant, and any ungranted shares from prior years’ annual allocations are available for subsequent grant during the years the 1990 Plan is in effect.
Stock options represent the right to purchase shares of stock at the market value of the stock at date of grant. Certain options contain the right to receive cash and/or common stock equal to the excess of the fair market value of shares of common stock, as determined in accordance with the plan, over the option price of shares. Most stock options vest after a one-year service period and all expire 10 years from the date they are granted.
Restricted stock represents stock granted for such consideration, if any, as determined by the Compensation Committee, subject to forfeiture provisions and restrictions on transfer. Those restrictions may be removed as conditions such as performance, continuous service and other criteria are met. Restricted stock is issued at the market price per share at the date of grant and vests over service periods that range from one to five years.
Marathon also has a restricted stock plan for certain salaried employees that are not officers of Marathon. Participants in the plan are awarded restricted stock by the Compensation Committee based on their performance within certain guidelines. 50% of the awarded stock vests at the end of two years from the date of grant and the remaining 50% vests in four years from the date of grant. Prior to vesting, the employee has the right to vote such stock and receive dividends thereon. The nonvested shares are not transferable and are retained by the Corporation until they vest.
In connection with the Separation, a special restricted stock program for most employees other than officers of Marathon was implemented. On January 23, 2002, participants were awarded a one-time grant of ten shares, which vested one year after the date of grant. Prior to vesting, the employee had the right to vote such stock and receive dividends thereon. The nonvested shares were not transferable and were retained by the Corporation until they vested.
Unearned compensation is charged to equity when the restricted stock is granted. Amounts related to the 1990 Stock Plan are subsequently adjusted for changes in the market value of the underlying stock. Compensation expense is recognized over the balance of the vesting period and is adjusted if conditions of the restricted stock grant are not met.
Marathon uses the intrinsic value model for accounting for stock-based compensation. The following net income and per share data illustrates the effect on net income and net income per share if the fair value method had been applied to all outstanding and unvested awards in each period.
(In millions, except per share data)
2002
2001
2000
Net income applicable to Common Stock
As reported
$
516
$
377
$
432
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
5
5
1
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects
(16
)
(11
)
(6
)
Pro forma net income applicable to Common Stock
$
505
$
371
$
427
Basic and diluted net income per share
– As reported
$
1.66
$
1.22
$
1.39
– Pro forma
$
1.63
$
1.20
$
1.38
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The above pro forma amounts were based on a Black-Scholes option-pricing model, which included the following information and assumptions:
(In millions, except per share data)
2002
2001
2000
Weighted-average grant-date exercise price per share
$
28.12
$
32.52
$
25.18
Expected annual dividends per share
$
.92
$
.92
$
.88
Expected life in years
5
5
5
Expected volatility
35
%
34
%
33
%
Risk free interest rate
4.5
%
4.9
%
6.5
%
Weighted-average grant-date fair value of options granted during the year, as calculated from above
$
7.79
$
9.45
$
7.51
Concentrations of credit risk– Marathon is exposed to credit risk in the event of nonpayment by counterparties, a significant portion of which are concentrated in energy related industries. The creditworthiness of customers and other counterparties is subject to continuing review, including the use of master netting agreements, where appropriate. While no single customer accounts for more than 5% of annual revenues, Marathon has significant exposures to United States Steel arising from the Separation. These exposures are discussed in Note 3.
Reclassifications—Certain reclassifications of prior years’ data have been made to conform to 2002 classifications.
2.
Discontinued OperationsNew Accounting StandardsAdopted in the reporting periods –Effective January 1, 2001, Marathon adopted Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133), as amended by SFAS Nos. 137 and 138. This statement requires recognition of all derivatives as either assets or liabilities at fair value. The transition adjustment related to adopting SFAS No. 133 on January 1, 2001, was recognized as a cumulative effect of a change in accounting principle. The unfavorable cumulative effect on net income was $8 million, net of a tax benefit of $5 million. The unfavorable cumulative effect on other comprehensive income (loss) (OCI) was $8 million, net of a tax benefit of $4 million.
Since the issuance of SFAS No. 133, the Financial Accounting Standards Board (FASB) has issued several interpretations. As a result, Marathon has recognized in income the effect of changes in the fair value of two long-term natural gas sales contracts in the United Kingdom. As of January 1, 2002, Marathon recognized a favorable cumulative effect of a change in accounting principle of $13 million, net of tax of $7 million.
Effective January 1, 2002, Marathon adopted the following Statements of Financial Accounting Standards:
No. 141 “Business Combinations” (SFAS No. 141),No. 142 “Goodwill and Other Intangible Assets” (SFAS No. 142), andNo. 144 “Accounting for Impairment or Disposal of Long-Lived Assets” (SFAS No.144)SFAS No. 141 requires that all business combinations initiated after June 30, 2001, be accounted for under the purchase method. The transitional provisions of SFAS No. 141 required Marathon to reclassify $11 million from identifiable intangible assets to goodwill at January 1, 2002.
SFAS No. 142 addresses the accounting for goodwill and other intangible assets after an acquisition. Effective January 1, 2002, Marathon ceased amortization of existing goodwill, which results in a favorable impact on annual income of approximately $3 million, net of tax. Marathon has completed the required transitional impairment test for existing goodwill as of the date of adoption. No impairment of goodwill was indicated.
SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale and provides additional implementation guidance for assets to be held and used and assets to be disposed of other than by sale. For long-lived assets to be disposed of by sale, SFAS No. 144 broadens the definition of those disposals that should be reported separately as discontinued operations. The adoption of SFAS No. 144 had no initial effect on Marathon’s financial statements.
In late 2002 and early 2003, the FASB issued the following:
Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS No. 148),FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), andFASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46).F-12
Each of these pronouncements required the immediate adoption of certain disclosure requirements, which have been reflected in these financial statements. The accounting requirements of these pronouncements will be adopted in future periods.
To be adopted in future periods –In 2001, the FASB issued Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (SFAS No. 143). This statement requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The present value of the estimated asset retirement costs is capitalized as part of the carrying amount of the long-lived asset. For Marathon, asset retirement obligations primarily relate to the abandonment of oil and gas producing facilities. Under previous accounting standards, such obligations were recognized over the life of the producing assets on a units-of-production basis.
While certain assets such as refineries, crude oil and product pipelines and marketing assets have retirement obligations covered by SFAS No. 143, those obligations are not expected to be recognized since the fair value cannot be estimated due to the uncertainty of the settlement date of the obligation.
Effective January 1, 2003, Marathon will adopt SFAS No. 143, as required. The cumulative effect on net income of adopting SFAS No. 143 is expected to be a net favorable effect of approximately $5 million. At the time of adoption, total assets will increase approximately $120 million, and total liabilities will increase approximately $115 million. The amounts recognized upon adoption are based upon numerous estimates and assumptions, including future retirement costs, future recoverable quantities of oil and gas, future inflation rates and the credit-adjusted risk-free interest rate.
Previous accounting standards used the units-of-production method to match estimated future retirement costs with the revenues generated from the producing assets. In contrast, SFAS No. 143 requires depreciation of the capitalized asset retirement cost and accretion of the asset retirement obligation over time. The depreciation will generally be determined on a units-of-production basis, while the accretion to be recognized will escalate over the life of the producing assets, typically as production declines. Because of the long lives of the underlying producing assets, the impact on net income in the near term is not expected to be material.
In the second quarter of 2002, the FASB issued Statement of Financial Accounting Standards No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (SFAS No. 145) and Statement of Financial Accounting Standards No. 146 “Accounting for Exit or Disposal Activities” (SFAS No. 146). SFAS No. 145 has a dual effective date. The provisions relating to the early extinguishment of debt will be adopted by Marathon on January 1, 2003. As a result, losses from the early extinguishment of debt in 2002, which are currently reported as extraordinary items, will be reported in income from continuing operations in comparative financial statements subsequent to the adoption of SFAS No. 145. SFAS No. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002.
SFAS No. 148 provides alternative methods for the transition of the accounting for stock-based compensation from the intrinsic value method to the fair value method. Effective January 1, 2003, Marathon plans to apply the fair value method to future grants and any modified grants of stock-based compensation. Based upon this change, and assuming the number of stock options granted in 2003 approximates the number of those granted in 2002, the estimated impact on Marathon’s 2003 earnings would not be materially different than under previous accounting standards.
Effective for any guarantees issued or modified January 1, 2003 or after, FIN 45 requires the fair-value measurement and recognition of a liability for the issuance of certain guarantees. Enhanced disclosure requirements will continue to apply to both new and existing guarantees subject to FIN 45.
FIN 46 identifies certain off-balance sheet arrangements that meet the definition of a variable interest entity (VIE). The primary beneficiary of a VIE is the party that is exposed to the majority of the risks and/or returns of the VIE. In future accounting periods, the primary beneficiary will be required to consolidate the VIE. In addition, more extensive disclosure requirements apply to the primary beneficiary, as well as other significant investors. Although Marathon participates in an arrangement that is subject to the disclosure requirements of FIN 46, Marathon would not be deemed to be a primary beneficiary under the new rules.
3. Information about United States Steel
The Separation – On December 31, 2001, in a tax-free distribution to holders of Steel Stock, Marathon exchanged the common stock of United States Steel for all outstanding shares of Steel Stock on a one-for-one basis. The net assets of United States Steel at Separation were approximately the same as the net assets attributable to Steel Stock immediately prior to the Separation, except for a value transfer of $900 million in the form of additional net debt and other financings retained by Marathon. During the last six months of 2001, United States Steel completed a number of financings so that, upon Separation, the net debt and other financings of United States Steel as a separate legal entity would approximate the net debt and other financings attributable to Steel Stock. At December 31, 2001, the net debt and other financings of United States Steel was $54 million less than the net debt and other
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