3rd Quarter 1999
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------- -------------------
Commission file number 1-8483
UNOCAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-3825062
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2141 ROSECRANS AVENUE, SUITE 4000, EL SEGUNDO, CALIFORNIA 90245
(Address of principal executive offices)
(Zip Code)
(310) 726-7600
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Number of shares of Common Stock, $1 par value, outstanding as of September 30,
1999: 242,417,532
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED EARNINGS UNOCAL CORPORATION
(UNAUDITED)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------- -----------------------
Millions of dollars except per share amounts 1999 1998 1999 1998
- ------------------------------------------------------------------------ ----------------------- -----------------------
Revenues
....................................................................
Sales and operating revenues ........................................... $ 1,546 $ 1,286 $ 4,230 $ 3,683
Interest, dividends and miscellaneous income ........................... 16 12 72 74
Equity in earnings of affiliated companies ............................. 24 23 72 75
Gain/(loss) on sales of assets ......................................... 2 73 -- 166
----------------------- -----------------------
Total revenues ................................................... 1,588 1,394 4,374 3,998
Costs and other deductions
Crude oil, natural gas and product purchases ........................... 891 604 2,329 1,535
Operating expense ...................................................... 270 313 807 993
Selling, administrative and general expense ............................ 34 34 118 73
Depreciation, depletion and amortization ............................... 205 186 588 566
Dry hole costs ......................................................... 33 58 107 150
Exploration expense .................................................... 44 53 117 139
Interest expense ....................................................... 52 48 145 131
Property and other operating taxes ..................................... 13 13 40 44
Distributions on convertible preferred
securities of subsidiary trust ...................................... 8 8 24 24
Minority interests ..................................................... 4 2 8 7
----------------------- -----------------------
Total costs and other deductions ................................. 1,554 1,319 4,283 3,662
----------------------- -----------------------
Earnings (loss) from operations before income taxes .................... 34 75 91 336
Income taxes ........................................................... 10 39 51 177
----------------------- -----------------------
Net earnings (loss) .............................................. $ 24 $ 36 $ 40 $ 159
======================= =======================
Basic earnings (loss) per share of common stock (a) .................... $ 0.10 $ 0.15 $ 0.17 $ 0.66
Diluted earnings (loss) per share of common stock (b) .................. $ 0.10 $ 0.15 $ 0.17 $ 0.66
Cash dividends declared per share of common stock ...................... $ 0.20 $ 0.20 $ 0.60 $ 0.60
<FN>
(a) Basic weighted average shares outstanding (in thousands) ......... 242,404 241,362 241,905 241,621
(b) Diluted weighted average shares outstanding (in thousands) ........ 244,022 242,535 243,050 242,916
</FN>
See notes to the consolidated financial statements.
CONSOLIDATED BALANCE SHEET UNOCAL CORPORATION
September 30 December 31
--------------- ---------------
Millions of dollars 1999(a) 1998
- ------------------------------------------------------------------------ --------------- ---------------
Assets
Current assets
....................................................................
Cash and cash equivalents ........................................... $ 209 $ 238
Accounts and notes receivable ....................................... 798 807
Inventories ......................................................... 197 179
Deferred income taxes ............................................... 130 142
Other current assets ................................................ 26 22
--------------- ---------------
Total current assets ............................................. 1,360 1,388
Investments and long-term receivables .................................. 1,269 1,143
Properties (b) ......................................................... 5,868 5,276
Deferred income taxes .................................................. 71 23
Other assets ........................................................... 120 122
--------------- ---------------
Total assets ..................................................... $ 8,688 $ 7,952
=============== ===============
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable .................................................... $ 899 $ 709
Taxes payable ....................................................... 128 260
Interest payable .................................................... 46 52
Current portion of environmental liabilities ........................ 145 142
Other current liabilities ........................................... 128 213
--------------- ---------------
Total current liabilities ........................................ 1,346 1,376
Long-term debt ......................................................... 2,834 2,558
Deferred income taxes .................................................. 268 132
Accrued abandonment, restoration and environmental liabilities ......... 566 622
Other deferred credits and liabilities ................................. 599 514
Minority interests ..................................................... 421 26
Company-obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust holding solely parent debentures ... 522 522
Common stock ($1 par value) ............................................ 253 252
Shares authorized: 750,000,000 (c)
Capital in excess of par value ......................................... 492 460
Unearned portion of restricted stock issued ............................ (22) (24)
Retained earnings ...................................................... 1,854 1,959
Accumulated other comprehensive income (loss) .......................... (34) (34)
Treasury stock - at cost (d) .......................................... (411) (411)
--------------- ---------------
Total stockholders' equity ....................................... 2,132 2,202
--------------- ---------------
Total liabilities and stockholders' equity .................... $ 8,688 $ 7,952
=============== ===============
<FN>
(a) Unaudited
(b) Net of accumulated depreciation ................................... $ 10,395 $ 10,193
(c) Number of shares outstanding (in thousands) ....................... 242,419 241,378
(d) Number of shares (in thousands) ................................... 10,623 10,623
</FN>
See notes to the consolidated financial statements.
2
CONSOLIDATED CASH FLOWS UNOCAL CORPORATION
(UNAUDITED)
For the Nine Months
Ended September 30
-------------------------------------
Millions of dollars 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
....................................................................
Net earnings (loss) .................................................... $ 40 $ 159
Adjustments to reconcile net earnings to
net cash provided by operating activities
Depreciation, depletion and amortization ......................... 588 566
Dry hole costs ................................................... 107 150
Deferred income taxes ............................................ (54) (34)
(Gain) loss on sales of assets (before-tax) ...................... -- (166)
Other ............................................................ (54) 18
Working capital and other changes related to operations
Accounts and notes receivable ................................. 12 96
Inventories ................................................... (18) 18
Accounts payable .............................................. 92 (10)
Taxes payable ................................................. (132) 50
Other ......................................................... (64) (136)
-------------------------------------
Net cash provided by (used in) operating activities ........ 517 711
Cash Flows from Investing Activities
Capital expenditures (includes dry hole costs) ...................... (761) (1,248)
Acquisition of Northrock Resources Ltd. ............................. (184) --
Proceeds from sales of assets ....................................... 163 299
-------------------------------------
Net cash provided by (used in) investing activities ........ (782) (949)
Cash Flows from Financing Activities
Long-term borrowings ................................................ 833 666
Reduction of long-term debt ......................................... (708) (381)
Dividends paid on common stock ...................................... (145) (145)
Repurchases of common stock ......................................... -- (48)
Minority interests .................................................. 234 (9)
Other ............................................................... 22 --
-------------------------------------
Net cash provided by (used in) financing activities ........... 236 83
Increase (decrease) in cash and cash equivalents ....................... (29) (155)
Cash and cash equivalents at beginning of year ......................... 238 338
-------------------------------------
Cash and cash equivalents at end of period ............................. $ 209 $ 183
=====================================
<FN>
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest (net of amount capitalized).............................. $ 159 $ 148
Income taxes (net of refunds)..................................... $ 218 $ 166
</FN>
See notes to the consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) The consolidated financial statements included herein are unaudited and, in
the opinion of management, include all adjustments necessary for a fair
presentation of financial position and results of operations. All
adjustments are of a normal recurring nature. Such financial statements are
presented in accordance with the Securities and Exchange Commission's
(Commission) disclosure requirements for Form 10-Q.
These interim consolidated financial statements should be read in
conjunction with the consolidated financial statements and the Notes
thereto filed with the Commission in Unocal Corporation's 1998 Annual
Report on Form 10-K.
Results for the nine months ended September 30, 1999, are not necessarily
indicative of future financial results.
Certain items in the prior year financial statements have been reclassified
to conform to the 1999 presentation.
(2) For the purpose of this report, Unocal Corporation (Unocal) and its
consolidated subsidiaries, including Union Oil Company of California (Union
Oil), are referred to as the company.
The consolidated financial statements of the company include the accounts
of subsidiaries in which a controlling interest is held. Investments in
affiliates without a controlling interest are accounted for by the equity
method. Under the equity method, the investments are stated at cost plus
the company's equity in undistributed earnings and losses after
acquisition. Income taxes estimated to be payable when earnings are
distributed are included in deferred taxes.
(3) Other Financial Information
During the third quarters of 1999 and 1998, approximately 51 percent and 40
percent, respectively, of total sales and operating revenues were
attributed to the resale of crude oil, natural gas and natural gas liquids
purchased from others in connection with the company's trading and
marketing activities. For the nine months ended September 30, 1999 and
1998, approximately 48 percent and 34 percent, respectively, of total sales
and operating revenues were attributed to the resale of crude oil, natural
gas and natural gas liquids purchased from others. Related purchase costs
are classified as expense in the crude oil, natural gas and product
purchases category on the consolidated earnings statement.
Capitalized interest totaled $4 million and $5 million for the third
quarters of 1999 and 1998, respectively. Capitalized interest totaled $13
million and $22 million for the first nine months of 1999 and 1998,
respectively.
(4) Income Taxes
Income taxes on earnings from operations for the third quarter and first
nine months of 1999 were $10 million and $51 million, respectively,
compared with $39 million and $177 million for the comparable periods of
1998. The effective income tax rate for the third quarter of 1999 was 29
percent compared with 52 percent for the third quarter of 1998. The lower
tax rate for the third quarter of 1999 was primarily due to
currency-related tax adjustments in Thailand partially offset by the mix
effect of domestic losses versus foreign earnings.
The effective income tax rate for the first nine months of 1999 was 56
percent compared with 53 percent for the first nine months of 1998.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(5) Comprehensive Income
The company's comprehensive earnings were as follows:
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) ........................................................... $ 24 $ 36 $ 40 $159
Change in foreign currency translation adjustments (net of tax) ............... (1) (5) -- (5)
----------------------------------------------------
Comprehensive earnings (loss) ........................................... $ 23 $ 31 $ 40 $154
====================================================
(6) Earnings Per Share
The following are reconciliations of the numerators and denominators of the
basic and diluted earnings per share (EPS) computations for net earnings
for the third quarters and the nine months ended September 30, 1999 and
1998:
Earnings Shares Per Share
Millions except per share amounts (Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 1999
Net Earnings ............................................................ $ 24 242.4
Basic EPS ............................................................ $0.10
=====
Effect of Dilutive Securities
Options/common stock equivalents ..................................... 1.6
-----------------------------
Diluted EPS .......................................................... 24 244.0 $0.10
=====
Distributions on subsidiary trust preferred securities (after-tax) ... 6 12.3
-----------------------------
Antidilutive ......................................................... $ 30 256.3 $0.12
Three Months Ended September 30, 1998
Net Earnings ........................................................... $ 36 241.4
Basic EPS ........................................................... $0.15
=====
Effect of Dilutive Securities
Options/common stock equivalents .................................... 1.1
-----------------------------
Diluted EPS ......................................................... 36 242.5 $0.15
=====
Distributions on subsidiary trust preferred securities (after-tax) .. 6 12.3
-----------------------------
Antidilutive ........................................................ $ 42 254.8 $0.16
Nine Months Ended September 30, 1999
Net Earnings ........................................................... $ 40 241.9
Basic EPS ........................................................... $0.17
=====
Effect of Dilutive Securities
Options/common stock equivalents .................................... 1.1
-----------------------------
Diluted EPS ......................................................... 40 243.0 $0.17
=====
Distributions on subsidiary trust preferred securities (after-tax) .. 19 12.3
-----------------------------
Antidilutive ........................................................ $ 59 255.3 $0.23
Nine Months Ended September 30, 1998
Net Earnings ........................................................... $ 159 241.6
Basic EPS ........................................................... $0.66
=====
Effect of Dilutive Securities
Options/common stock equivalents .................................... 1.3
-----------------------------
Diluted EPS ......................................................... 159 242.9 $0.66
=====
Distributions on subsidiary trust preferred securities (after-tax) .. 18 12.3
-----------------------------
Antidilutive ........................................................ $ 177 255.2 $0.69
- ------------------------------------------------------------------------------------------------------------------------------------
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Not included in the computation of diluted EPS were options outstanding at
September 30, 1999 to purchase approximately 2.2 million shares of common
stock. These options were not included in the computation as the exercise
prices were greater than the year-to-date average market price of $37.51
for the common shares. The exercise prices of these options range from
$37.69 to $51.01 per share and they expire in 2007 through 2009.
(7) Sale of Accounts Receivable
In the second quarter of 1999, the company, through a non-consolidated
subsidiary Unocal Receivables Corp. ("URC"), entered into a sales agreement
with an outside party under which it will sell up to a $204 million
undivided interest in domestic crude oil and natural gas trade receivables.
The company continues to manage the collection and administrative
responsibilities for accounts receivable including the sold interest. The
effect to the company of the interests sold in its domestic trade
receivables under this agreement is $95 million as of September 30, 1999.
The amount sold is reflected as a reduction of accounts receivable in the
consolidated balance sheet and in net cash provided by operating activities
in the consolidated statement of cash flows.
(8) Long Term Debt and Credit Agreements
During the third quarter, the company increased its commercial paper
borrowings by $85 million to a total outstanding balance of $125 million at
September 30, 1999. In addition, the company also increased its borrowings
under its limited recourse project financing for its Azerbaijan activities
by $11 million to an outstanding balance of $55 million at September 30,
1999.
Proceeds from the issuance of commercial paper were used for general
corporate purposes including the refinancing of existing debt. The company
retired $22 million in maturing medium-term notes and reduced its
borrowings under its $1 billion bank credit agreement by $40 million to an
outstanding balance of $60 million at September 30, 1999.
(9) Financial Instruments
The estimated fair value of the company's long-term debt was $2,869 million
on September 30, 1999. The fair values of the debt instruments were based
on the discounted amounts of future cash outflows using rates offered to
the company for debt with similar maturities. The estimated fair value of
the mandatorily redeemable convertible preferred securities of the
company's subsidiary trust was $566 million. The fair value of the
preferred securities was based on the trading prices of the preferred
securities on September 30, 1999.
The company's financial instruments at September 30, 1999 are described
below:
Foreign exchange contracts - The company and its subsidiaries have assorted
currency swap agreements outstanding that are designed to hedge the impacts
of foreign-currency exchange-rate fluctuations on US dollar- denominated
debt. In the third quarter of 1999, the company received income tax refunds
in Canada equivalent to approximately US$49 million as a result of the
company's reinvestment of the proceeds from the 1998 sale of its investment
in the stock of Tarragon Oil and Gas Limited into the stock of Northrock
Resources Ltd. The refund was used to retire approximately US$40 million of
the US$100 million debt outstanding of one of the company's Canadian
subsidiaries. As a result of the debt retirement, the subsidiary reduced
its related currency swap agreement from US$100 million to US$60 million.
The agreement now requires the subsidiary to pay approximately C$88 million
at maturity in exchange for US$60 million. The parent company also reduced
its corresponding currency swap agreement from US$100 million to US$ 60
million. This agreement, which effectively offsets the subsidiary's
agreement, now requires the parent company to pay US$60 million in exchange
for C$88 million at maturity. The combined fair values of the swap
agreements outstanding at the end of the period were approximately zero.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Other outstanding currency swap agreements require the company's Northrock
subsidiary to pay approximately C$115 million at maturity in exchange for
US$75 million. The fair values of these agreements were US$72 million and
were determined by comparing the swap rates to the forward rates in effect
at September 30, 1999. The company's share of the estimated pre-tax
deferred losses related to the US$75 million currency swap agreements was
US$1 million at September 30, 1999 (net of minority interests). The US$75
million to be received by Northrock will be used to retire US
dollar-denominated debt at maturity.
Northrock also has US dollar forward contracts outstanding that are
designed to mitigate its exposure to the US dollar-indexed prices it
receives for the sale of its crude oil. These contracts are subject, in
some cases, to extensions at the counterparty's option and require
Northrock to sell approximately US$200 million in exchange for
approximately C$285 million at maturity. At September 30, 1999, contracts
of US$8 million were scheduled to mature in 1999 with the remaining
contracts scheduled to mature periodically through the year 2005. The fair
values of the contracts were approximately US$194 million. The fair values
were determined by comparing the contract rates to the forward rates in
effect at September 30, 1999. The company's share of estimated pre-tax
unrealized losses relating to these US dollar forward contracts was
approximately US$3 million at September 30, 1999 (net of minority
interests).
During the quarter, the company entered into two forward contracts to
purchase Thai baht. The contracts are designed to hedge the company's
foreign-currency exchange-rate exposure related to expected income tax
payments to be paid to Thailand in 2000. The contracts require the company
to purchase 802 million baht at maturity in exchange for US$20 million. The
fair value of the contracts at September 30, 1999 approximated the notional
amounts.
Other commodity-based contracts - Northrock had various fixed-price and
fixed-price differential sales contracts outstanding at September 30, 1999,
related to the future sale of its natural gas production. The contracts
cover production, which averages 40 million cubic feet per day (mmcfpd) for
the remainder of 1999, 54 mmcfpd in 2000, 52 mmcfpd in 2001 and 52 mmcfpd
in 2002. Northrock also has various fixed-price and fixed-price
differential natural gas purchase contracts outstanding at September 30,
1999, which require the purchase of 63 mmcfpd for the remainder of 1999 and
23 mmcfpd in 2000. The company's pre-tax share of estimated unrealized
losses for these contracts was approximately $13 million at September 30,
1999, (net of minority interests) and primarily relate to contracts with
delivery dates scheduled for the years 2001 through 2002.
At September 30, 1999, the company had futures contracts outstanding with
several couterparties to purchase and sell approximately 19 million and 15
million barrels of crude oil, respectively. The fair values of these
contracts, based on quoted market prices, were approximately $104 million.
The company also had futures contracts outstanding at September 30, 1999 to
purchase and sell approximately 19 million and 18 million thousand cubic
feet (mcf) of natural gas, respectively. The fair values of these
contracts, based on quoted market prices, were approximately $3 million.
These contracts which were purchased as part of the company's overall risk
management strategy were marked to market. Approximately 2 percent of the
company's outstanding crude oil and natural gas futures contracts were
related to the company's non-trading activities. At September 30, 1999, the
company's share of pre-tax unrealized gains related to its non-trading
futures contract activity was approximately $2 million.
The company had various hydrocarbon option contracts (options) outstanding
with several counterparties at September 30, 1999. Generally, options have
been used to limit the company's exposure to adverse commodity price
fluctuations. In some cases, the instruments may also limit the company's
ability to participate fully in future gains from favorable price
movements. These options are generally accounted for as hedges, with gains
and losses deferred and recognized as a component of crude oil and natural
gas revenues upon the sale of the underlying production.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
At September 30, 1999, the company had outstanding purchased natural gas
options covering approximately 31 million mcf and sold natural gas options
covering approximately 73 million mcf. The options consisted of put and
call contracts that related to the company's remaining 1999 US lower 48
production, to the future production of the company's Northrock subsidiary
for the remainder of 1999 through the year 2004, and to the company's
overall risk management activities. At September 30, 1999, the fair value
of these options were approximately $(6) million. The fair values of the
options were determined by dealer quotes, where available, or by financial
modeling using underlying commodity prices. Net premiums paid for the
options totaled $1 million. Approximately 90 percent of the options were
related to the company's non-trading activities. At September 30, 1999, the
company's share (net of minority interests) of pre-tax unrealized losses
related to its non-trading natural gas option activity was approximately
$14 million. Approximately $6 million of the $14 million relates to the
company's interest in Northrock.
The company had purchased crude oil options covering approximately 43
million barrels and sold crude oil options covering approximately 73
million barrels outstanding at September 30, 1999. The options consisted of
put and call contracts that related to the company's remaining 1999 and
early 2000 production, to the production of the company's Northrock
subsidiary for the remainder of 1999 through the year 2002 and to the
company's overall risk management activities. At September 30, 1999, these
options had fair values of approximately $(18) million. The fair values of
the options were determined by dealer quotes where available, or by
financial modeling using underlying commodity prices. Net premiums paid for
the options totaled $2 million. Approximately 70 percent of the options
were related to the company's non-trading activities. At September 30,
1999, the company's share (net of minority interests) of pre-tax unrealized
losses related to its non-trading crude oil option activity was
approximately $21 million. Approximately $3 million of the $21 million
relates to the company's interest in Northrock.
At September 30, 1999, the company had a ten-year natural gas price swap
agreement outstanding. The agreement effectively refloats the fixed price
the company received in January 1999 for a ten-year natural gas pre-paid
forward sale. As the counterparty to the swap agreement remits a
current-index-price payment amount to the company based upon volumes in the
swap agreement, the company remits a fixed-price payment amount to the
counterparty. The pre-tax deferred gain related to the swap agreement at
September 30, 1999, was approximately $16 million. This gain is offset by a
corresponding loss on the fixed price physical sales contract.
The company's Global Trade segment recorded pre-tax losses of approximately
$10 million and $5 million on its trading activities for the third quarter
and first nine months of 1999, respectively.
(10) Accrued Abandonment, Restoration and Environmental Liabilities
At September 30, 1999, the company had accrued $464 million for the
estimated future costs to abandon and remove wells and production
facilities. The total costs for abandonments are predominantly accrued for
on a unit-of-production basis and are estimated to be approximately $655
million. This estimate was derived in large part from abandonment cost
studies performed by outside firms and is used to calculate the amount to
be amortized. The company's reserve for environmental remediation
obligations at September 30, 1999 totaled $247 million, of which $145
million was included in current liabilities.
(11) Contingent Liabilities
The company has certain contingent liabilities with respect to
material existing or potential claims, lawsuits and other proceedings,
including those involving environmental, tax and other matters,
certain of which are discussed more specifically below. The company
accrues liabilities when it is probable that future costs will be
incurred and such costs can be reasonably estimated. Such accruals are
based on developments to date, the company's estimates of the outcomes
of these matters and its experience in contesting, litigating and
settling other matters. As the scope of the liabilities becomes better
defined, there will be changes in the estimates of
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
future costs, which could have a material effect on the company's future
results of operations and financial condition or liquidity.
Environmental matters - The company is subject to loss contingencies
pursuant to federal, state and local environmental laws and regulations.
These include existing and possible future obligations to investigate the
effects of the release or disposal of certain petroleum, chemical and
mineral substances at various sites; to remediate or restore these sites;
to compensate others for damage to property and natural resources, for
remediation and restoration costs and for personal injuries; and to pay
civil penalties and, in some cases, criminal penalties and punitive
damages. These obligations relate to sites owned by the company or others
andare associated with past and present operations, including sites at
which the company has been identified as a potentially responsible party
(PRP) under the federal Superfund laws and comparable state laws.
Liabilities are accrued when it is probable that future costs will be
incurred and such costs can be reasonably estimated.
However, in many cases, investigations are not yet at a stage where the
company is able to determine whether it is liable or, even if liability is
determined to be probable, to quantify the liability or estimate a range of
possible exposure. In such cases, the amounts of the company's liabilities
are indeterminate due to the potentially large number of claimants for any
given site or exposure, the unknown magnitude of possible contamination,
the imprecise and conflicting engineering evaluations and estimates of
proper clean-up methods and costs, the unknown timing and extent of the
corrective actions that may be required, the uncertainty attendant to the
possible award of punitive damages, the recent judicial recognition of new
causes of action, the present state of the law, which often imposes joint
and several and retroactive liabilities on PRPs, the fact that the company
is usually just one of a number of companies identified as a PRP, or other
reasons.
As disclosed in note 10, at September 30, 1999, the company had accrued
$247 million for estimated future environmental assessment and remediation
costs at various sites where liabilities for such costs are probable. At
those sites where investigations or feasibility studies have advanced to
the stage of analyzing feasible alternative remedies and/or ranges of
costs, the company estimates that it could incur possible additional
remediation costs aggregating approximately $195 million.
Tax matters - The company believes it has adequately provided in its
accounts for tax items and issues not yet resolved.
Other matters - In February 1996, Bridas Corporation filed a petition
against the company and others in the District Court of Fort Bend County,
Texas, alleging that the defendants conspired to and did tortiously
interfere with Bridas' rights under agreements with the government of
Turkmenistan to develop the Yashlar Field and to transport gas from that
field to Pakistan. The petition also alleged that the defendants interfered
with Bridas' exclusive right to lay a gas pipeline in Afghanistan. Bridas
sought actual damages, as well as punitive damages, plus interest. Bridas'
expert witnesses stated in pre-trial discovery that Bridas' total actual
damages for loss of future profits were approximately $1.7 billion. In the
alternative, Bridas was expected to seek an award of approximately $430
million with respect to its total expenditures in Turkmenistan. In October
1998, the court granted the defendants' motion for summary judgement and
dismissed the action. In March 1999, Bridas filed a notice of appeal of the
dismissal.
In May 1999, a Canadian subsidiary of the company acquired an approximately
46 percent controlling interest in Northrock Resources Ltd. (Northrock)
(see note 13). Northrock has the right, until December 31, 1999, to require
that the company purchase additional Northrock common shares from treasury
shares at a price of C$15 per share, up to a maximum ownership level of
49.9 percent.
In 1998, the company signed a letter agreement regarding the Transocean
Discoverer Spirit deepwater drill ship with a minimum daily rate of $210
thousand for five years. The drill ship is scheduled for delivery in the
Gulf of Mexico in 2000.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The company also has certain other contingent liabilities with respect to
litigation, claims, and contractual agreements arising in the ordinary
course of business. Although these contingencies could result in expenses
or judgments that could be material to the company's results of operations
for a given reporting period, on the basis of management's best assessment
of the ultimate amount and timing of these events, such expenses or
judgments are not expected to have a material adverse effect on the
company's consolidated financial condition or liquidity.
(12) Unocal guarantees certain indebtedness of Union Oil. Summarized below is
financial information for Union Oil and its consolidated subsidiaries:
Summarized Financial Data of Union Oil
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues ............................................................... $1,589 $1,394 $4,375 $3,998
Total costs and other deductions
(including income taxes) .................................................. 1,558 1,349 4,314 3,819
----------------------------------------------------
Net Earnings.................................................................. $ 31 $ 45 $ 61 $ 179
====================================================
At September 30 At December 31 (a)
----------------------------------------------------
Millions of dollars 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Current assets ............................................................... $1,360 $1,388
Noncurrent assets ............................................................ 7,344 6,583
Current liabilities .......................................................... 1,345 1,406
Noncurrent liabilities ....................................................... 4,688 3,852
Shareholder's equity ......................................................... 2,671 2,713
<FN>
(a) Audited
</FN>
(13) Acquisition of Assets
In May 1999, a Canadian subsidiary of the company acquired an approximate
46-percent controlling interest in Northrock Resources Ltd. (Northrock), a
Canadian oil and gas exploration and production company, for approximately
$184 million. The acquisition was accounted for as a purchase. The
investment was effected by the acquisition of 10 million shares of
Northrock common stock at C$14 per share pursuant to a partial tender offer
to Northrock's shareholders and 7.64 million shares of Northrock common
stock at C$16 per share pursuant to a private placement. The acquisition is
part of the company's overall North American natural gas strategy.
Northrock is fully consolidated in the company's financial results as of
the acquisition date.
(14) Minority Interests
In April 1999, the company contributed fixed-price overriding royalty
interests from its working interest shares in certain oil and gas producing
properties in the Gulf of Mexico to Spirit Energy 76 Development, L.P.
(Spirit LP), a limited partnership. In exchange for its overriding royalty
contributions, valued at $304 million, the company received an initial
general partnership interest of approximately 55 percent in Spirit LP. An
unaffiliated investor contributed $250 million in cash to the partnership
in exchange for an initial limited partnership interest of approximately 45
percent. Minority interests increased by approximately $244 million at the
close of this transaction. The fixed-price overrides are subject to
economic limitations of production from the affected fields. The limited
partner is entitled to receive a priority allocation of profits and cash
distributions. The partnership has a maximum term of 20 years, but may
terminate after six years, subject to certain conditions.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
As discussed in note 13, in May 1999, a Canadian subsidiary of the company
acquired an approximate 46-percent of Northrock. The net result of this
transaction was to increase minority interests by approximately $145
million as of the acquisition date.
(15) Restructuring Costs
The company adopted a restructuring plan during the second quarter of 1999
that resulted in the accrual of a $18 million pre-tax restructuring charge.
This amount included the costs of terminating approximately 250 employees.
The charge was included in selling, administrative and general expense on
the consolidated earnings statement. The plan involves the blending of
several International and Geothermal organizations, a manpower optimization
program in Thailand, cost cutting and efficiency initiatives in the
company's Diversified Business and Exploration and Production Technology
groups and a company-wide shared resources initiative.
Approximately 100 of the affected employees were from the company's
International operations, 95 were from the Diversified Business group and
55 were from other organizations, including corporate staff. The
restructuring charge included approximately $16 million for termination
costs to be paid to the employees over time and about $2 million related to
outplacement and other costs.
At October 26, 1999, 207 employees had been terminated or had received
termination notices as the result of the plan with additional terminations
scheduled during the remainder of 1999 and early 2000.
In the fourth quarter of 1998, the company adopted a restructuring plan
that resulted in the accrual of a $27 million pre-tax restructuring charge.
This amount included the costs of terminating approximately 475 employees.
The charge was included in selling, administrative and general expense on
the consolidated earnings statement. The plan involves the suspension of
mining and manufacturing operations at the Mountain Pass, California
lanthanide facility, a change in mining operations at the Questa, New
Mexico molybdenum facility, the withdrawal from non-strategic activities in
Central Asia and a reduction in activities of various business units.
Approximately 240 of the affected employees were from the company's mining
operations, 95 were from various exploration and production business units
and 140 were support personnel at various locations. The restructuring
charge included approximately $23 million for termination costs to be paid
to the employees over time, about $2 million in benefit plan curtailment
costs and about $2 million related to outplacement and other costs.
At October 26, 1999, 414 employees had been terminated or had received
termination notices as a result of the plan, with additional terminations
scheduled during the remainder of 1999 and early 2000.
The amount of unpaid benefits remaining on the consolidated balance sheet
at September 30, 1999 was $20 million for the two plans combined.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(16) Segment Information
The company's reportable segments are: Exploration and Production, Global
Trade, Geothermal & Power Operations and Diversified Businesses.
Unallocated corporate administrative and general expenses and other
miscellaneous operations are included under the Corporate and Unallocated
heading. Effective January 1, 1999, the Pipelines business unit was
transferred from the Diversified Business segment to the Global Trade
segment. For an expanded description of the activities conducted by the
company's business segments, see pages 74 and 75 of the company's 1998
Annual Report on Form 10-K.
--------------------------------------------------------------------------------
Segment Information Exploration & Production Geothermal
For the Three Months United States International Global Trade & Power
ended September 30, 1999 Spirit Far Operations
Millions of dollars Energy 76 Alaska East Other Global Trade Pipelines
--------------------------------------------------------------------------------
External sales & operating revenues ......... $ 1 $ 33 $ 188 $ 69 $ 1,097 $ 9 $ 36
Other revenue (loss) ........................ -- -- (3) 5 4 12 3
Inter-segment revenues ...................... 277 13 40 26 2 3 --
--------------------------------------------------------------------------------
Total revenues ............................. 278 46 225 100 1,103 24 39
Operating profit (loss) before income taxes
and minority interest in earnings ......... 32 10 107 (8) (11) 15 11
Income taxes (benefit) .................. 11 4 29 (2) (6) 2 5
Minority interest in earnings ........... 4 -- -- 1 -- -- --
--------------------------------------------------------------------------------
Net earnings (loss) ......................... 17 6 78 (7) (5) 13 6
Assets (at September 30, 1999) .............. 2,106 304 1,875 1,530 396 249 511
- -----------------------------------------------------------------------------------------------------------------------------
Diversified Corporate & Unallocated Totals
Business
Ag Carbon & Admn & Net Int Env & New
Products Minerals General Exp Litigation Ventures Other(a)
- -----------------------------------------------------------------------------------------------------------------------------
External sales & operating revenue........... $ 69 $ 42 $ -- $ -- $ -- $ -- $ 2 $ 1,546
Other revenue (loss) ........................ -- 6 -- 6 -- -- 9 42
Inter-segment revenues ...................... -- -- -- -- -- -- (361) --
--------------------------------------------------------------------------------
Total revenues ............................. 69 48 -- 6 -- -- (350) 1,588
Operating profit (loss) before income taxes
and minority interest in earnings ......... (14) 7 (33) (45) (21) (5) (7) 38
Income taxes (benefit) .................. (6) -- (10) (7) (9) (1) -- 10
Minority interest in earnings ........... -- 1 -- (2) -- -- -- 4
--------------------------------------------------------------------------------
Net earnings (loss) ......................... (8) 6 (23) (36) (12) (4) (7) 24
Assets (at September 30, 1999) .............. 276 272 -- -- -- 3 1,166 8,688
<FN>
(a) Includes eliminations and consolidation adjustments.
</FN>
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
--------------------------------------------------------------------------------
Segment Information Exploration & Production Geothermal
For the Three Months United States International Global Trade & Power
ended September 30, 1998 Spirit Far Operations
Millions of dollars Energy 76 Alaska East Other Global Trade Pipelines
--------------------------------------------------------------------------------
External sales & operating revenues ......... $ 26 $ 25 $ 181 $ 36 $ 815 $ 10 $ 44
Other revenue (loss) ........................ 1 -- (6) 77 -- 11 13
Inter-segment revenues ...................... 219 17 63 4 -- 3 --
--------------------------------------------------------------------------------
Total revenues ............................. 246 42 238 117 815 24 57
Operating profit (loss) before income taxes
and minority interest in earnings ......... (14) 3 108 38 5 16 22
Income taxes (benefit) .................. (6) 1 68 11 2 2 6
Minority interest in earnings ........... 1 -- -- -- -- -- --
--------------------------------------------------------------------------------
Net earnings (loss) ......................... (9) 2 40 27 3 14 16
Assets (at December 31, 1998) ............... 2,094 329 1,848 641 317 298 598
- -----------------------------------------------------------------------------------------------------------------------------
Diversified Corporate & Unallocated Totals
Business
Ag Carbon & Admn & Net Int Env & New
Products Minerals General Exp Litigation Ventures Other(a)
- -----------------------------------------------------------------------------------------------------------------------------
External sales & operating revenue........... $ 84 $ 52 $ -- $ -- $ -- $ -- $ 13 $ 1,286
Other revenue (loss) ........................ -- 5 -- 7 -- (5) 5 108
Inter-segment revenues ...................... -- -- -- -- -- -- (306) --
--------------------------------------------------------------------------------
Total revenues ............................. 84 57 -- 7 -- (5) (288) 1,394
Operating profit (loss) before income taxes
and minority interest in earnings ......... 9 (1) (37) (40) (19) (7) (6) 77
Income taxes (benefit) .................. (3) (1) (13) (7) (7) (3) (11) 39
Minority interest in earnings ........... -- 1 -- -- -- -- -- 2
--------------------------------------------------------------------------------
Net earnings (loss) ......................... 12 (1) (24) (33) (12) (4) 5 36
Assets (at December 31, 1998) ............... 305 419 -- -- -- -- 1,103 7,952
<FN>
(a) Includes eliminations and consolidation adjustments.
</FN>
--------------------------------------------------------------------------------
Segment Information Exploration & Production Geothermal
For the Nine Months United States International Global Trade & Power
ended September 30, 1999 Spirit Far Operations
Millions of dollars Energy 76 Alaska East Other Global Trade Pipelines
--------------------------------------------------------------------------------
External sales & operating revenues ......... $ 62 $ 86 $ 523 $ 161 $ 2,887 $ 28 $ 113
Other revenue (loss) ........................ 6 -- (5) 15 4 43 8
Inter-segment revenues ...................... 695 46 127 40 5 8 --
--------------------------------------------------------------------------------
Total revenues ............................. 763 132 645 216 2,896 79 121
Operating profit (loss) before income taxes
and minority interest in earnings ......... 57 19 272 (33) (8) 53 35
Income taxes (benefit) .................. 19 7 105 (14) (5) 7 14
Minority interest in earnings ........... 7 -- -- 2 -- -- --
--------------------------------------------------------------------------------
Net earnings (loss) ......................... 31 12 167 (21) (3) 46 21
Assets (at September 30, 1999)............... 2,106 304 1,875 1,530 396 249 511
- -----------------------------------------------------------------------------------------------------------------------------
Diversified Corporate & Unallocated Totals
Business
Ag Carbon & Admn & Net Int Env & New
Products Minerals General Exp Litigation Ventures Other(a)
- -----------------------------------------------------------------------------------------------------------------------------
External sales & operating revenue........... $ 245 $121 $ -- $ -- $ -- $ -- $ 4 $ 4,230
Other revenue (loss) ........................ -- 22 -- 17 -- -- 34 144
Inter-segment revenues ...................... -- -- -- -- -- -- (921) --
--------------------------------------------------------------------------------
Total Revenues ............................. 245 143 -- 17 -- -- (883) 4,374
Operating profit (loss) before income taxes
and minority interest in earnings ......... (11) 21 (94) (127) (39) (12) (34) 99
Income taxes (benefit) .................. (9) -- (29) (23) (15) (3) (3) 51
Minority interest in earnings ........... -- 2 -- (3) -- -- -- 8
--------------------------------------------------------------------------------
Net earnings (loss) ......................... (2) 19 (65) (101) (24) (9) (31) 40
Assets (at September 30, 1999) .............. 276 272 -- -- -- 3 1,166 8,688
<FN>
(a) Includes eliminations and consolidation adjustments.
</FN>
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
--------------------------------------------------------------------------------
Segment Information Exploration & Production Geothermal
For the Nine Months United States International Global Trade & Power
ended September 30, 1998 Spirit Far Operations
Millions of dollars Energy 76 Alaska East Other Global Trade Pipelines
--------------------------------------------------------------------------------
External sales & operating revenues ......... $ 72 $ 82 $ 519 $ 122 $ 2,230 $ 30 $ 121
Other revenue (loss) ........................ 1 -- (25) 178 -- 39 42
Inter-segment revenues ...................... 699 56 192 8 1 7 --
--------------------------------------------------------------------------------
Total revenues ............................. 772 138 686 308 2,231 76 163
Operating profit (loss) before income taxes
and minority interest in earnings ......... 26 24 320 84 21 53 66
Income taxes (benefit) .................. 9 9 194 27 8 9 22
Minority interest in earnings ........... 2 -- -- -- -- -- --
--------------------------------------------------------------------------------
Net earnings (loss) ......................... 15 15 126 57 13 44 44
Assets (at December 31, 1998) ............... 2,094 329 1,848 641 317 298 598
- -----------------------------------------------------------------------------------------------------------------------------
Diversified Corporate & Unallocated Totals
Business
Ag Carbon & Admn & Net Int Env & New
Products Minerals General Exp Litigation Ventures Other(a)
- -----------------------------------------------------------------------------------------------------------------------------
External sales & operating revenues.......... $ 299 $171 $ -- $ -- $ -- $ -- $ 37 $ 3,683
Other revenue (loss) ........................ 1 23 -- 24 -- (5) 37 315
Inter-segment revenues ...................... -- -- -- -- -- -- (963) --
--------------------------------------------------------------------------------
Total revenues ............................. 300 194 -- 24 -- (5) (889) 3,998
Operating profit (loss) before income taxes
and minority interest in earnings ......... 40 26 (87) (106) (119) (26) 21 343
Income taxes (benefit) .................. 7 2 (29) (23) (44) (10) (4) 177
Minority interest in earnings ........... -- 5 -- -- -- -- -- 7
--------------------------------------------------------------------------------
Net earnings (loss) ......................... 33 19 (58) (83) (75) (16) 25 159
Assets (at December 31, 1998) ............... 305 419 -- -- -- -- 1,103 7,952
<FN>
(a) Includes eliminations and consolidation adjustments.
</FN>
14
OPERATING HIGHLIGHTS UNOCAL CORPORATION
(UNAUDITED)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
-----------------------------------------------
1999 1998 1999 1998
-----------------------------------------------
NET DAILY PRODUCTION
Crude oil and condensate (thousand barrels daily)
United States
......................................................................
Spirit Energy 76 ................................................ 40 44 40 44
Alaska .......................................................... 27 27 27 29
-----------------------------------------------
Total United States ........................................... 67 71 67 73
International (a)
Far East ........................................................ 73 81 72 83
Other (b) ....................................................... 40 31 35 31
-----------------------------------------------
Total International ........................................... 113 112 107 114
-----------------------------------------------
Worldwide .......................................................... 180 183 174 187
===============================================
Natural gas (million cubic feet daily)
United States
Spirit Energy 76 ................................................ 729 808 756 795
Alaska .......................................................... 106 118 124 126
-----------------------------------------------
Total United States ........................................... 835 926 880 921
International (a)
Far East ........................................................ 884 828 859 851
Other (b) ....................................................... 149 37 93 53
-----------------------------------------------
Total International ........................................... 1,033 865 952 904
-----------------------------------------------
Worldwide .......................................................... 1,868 1,791 1,832 1,825
===============================================
<FN>
(a) Includes host countries' shares of:
Crude oil and condensate ........................................... 30 6 23 11
Natural gas ........................................................ 95 44 86 44
(b) Production includes 100% of Northrock Resources Ltd. in Canada of:
Crude oil and condensate ........................................... 8 -- 4 --
Natural gas ........................................................ 110 -- 56 --
</FN>
15
OPERATING HIGHLIGHTS UNOCAL CORPORATION
(UNAUDITED)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
-----------------------------------------------
1999 1998 1999 1998
-----------------------------------------------
AVERAGE PRICES (a)
Crude oil (per barrel)
United States
......................................................................
Spirit Energy 76 ................................................ $ 18.32 $ 12.20 $ 14.87 $ 12.80
Alaska .......................................................... 14.50 9.35 11.43 9.69
Total United States ........................................... 16.77 11.11 13.43 11.56
International
Far East ........................................................ $ 16.43 $ 12.28 $ 13.75 $ 13.02
Other ........................................................... 16.69 10.58 13.96 11.07
Total International ........................................... 16.55 11.82 13.83 12.48
Worldwide .......................................................... $ 16.65 $ 11.54 $ 13.65 $ 12.09
Natural gas (per thousand cubic feet)
United States
Spirit Energy 76 ................................................ $ 2.26 $ 1.97 $ 2.09 $ 2.08
Alaska .......................................................... 1.20 1.20 1.20 1.38
Total United States ........................................... 2.12 1.87 1.96 1.98
International
Far East ........................................................ $ 2.02 $ 2.23 $ 1.97 $ 2.10
Other ........................................................... 2.09 2.38 1.99 2.26
Total International ........................................... 2.03 2.23 1.98 2.10
Worldwide .......................................................... $ 2.07 $ 2.04 $ 1.97 $ 2.04
<FN>
(a) average prices include hedging gains and losses, but exclude other Global Trade margins.
</FN>
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of Unocal should be read in conjunction with
Management's Discussion and Analysis in Item 7 of the company's 1998 Annual
Report on Form 10-K. Unless otherwise specified, the following discussion
pertains to the company's continuing operations.
CONSOLIDATED RESULTS
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss) ...................................................... $ 24 $ 36 $ 40 $ 159
Less: special items (net of tax)
Environmental and litigation provisions/proceeds............................ (12) (10) (14) (71)
Kenai plant accident........................................................ ( 6) -- ( 6) --
Asset sales ................................................................ -- 49 (10) 102
Deferred tax adjustments ................................................... -- ( 7) -- (21)
Restructuring provision .................................................... -- -- (11) --
Insurance settlement ....................................................... -- -- -- 11
----------------------------------------------------
Total special items ........................................................ (18) 32 (41) 21
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ 42 $ 4 $ 81 $ 138
====================================================
Adjusted after-tax earnings increased $38 million in the third quarter of 1999
compared with the same period last year. The third quarter 1999 results
benefited from higher worldwide average crude oil prices, which increased by 44
percent from the third quarter of 1998. In addition, the third quarter of 1999
benefited from lower dry hole costs and a lower effective tax rate primarily due
to a change in the Thailand foreign exchange rate. These factors were partially
offset by lower crude oil and natural gas sales volumes and reduced earnings
from non-exploration and production businesses. In the third quarter of 1999,
the hedge program lowered sale realizations for crude oil and natural gas by $23
million after-tax.
Adjusted after-tax earnings decreased $57 million in the first nine months of
1999 compared with the first nine months of 1998. The major factors contributing
to the decrease were lower worldwide crude oil and natural gas sales volumes,
lower natural gas prices, lower agricultural products prices, reduced earnings
from other non-exploration and production businesses and higher corporate net
interest expense. These factors were partially offset by higher worldwide crude
oil prices, a lower effective tax rate primarily due to a change in the Thailand
foreign exchange rate and lower dry hole costs. For the first nine months of
1999, the hedge program lowered sale realizations for crude oil and natural gas
by $16 million after-tax.
EXPLORATION AND PRODUCTION
The company engages in oil and gas exploration, development, and production
worldwide.
United States - Included in the United States category are Spirit Energy 76 and
Alaska oil and gas operations. The Spirit Energy 76 business unit is responsible
for oil and gas operations in the Lower 48 United States with emphasis on the
shelf and deepwater areas in the Gulf of Mexico and the Permian Basin in West
Texas. A substantial portion of the crude oil and natural gas produced in the
United States is sold to the company's Global Trade segment. The remainder is
sold to third parties or, in the case of Alaska natural gas production, used in
the company's agricultural products operations.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
Spirit Energy 76 ............................................................ $ 17 $ ( 9) $ 31 $ 15
Alaska ...................................................................... 6 2 12 15
----------------------------------------------------
Total ....................................................................... 23 ( 7) 43 30
Less: special items (net of tax)
Litigation provision/proceeds (Spirit Energy 76)............................ -- -- 7 --
Litigation provisions (Alaska)............................................... (2) -- (4) --
----------------------------------------------------
Total special items ......................................................... (2) -- 3 --
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ 25 $ ( 7) $ 40 $ 30
====================================================
Adjusted after-tax earnings increased $32 million in the third quarter of 1999
compared with the same period last year. The increase was primarily due to
higher United States average crude oil and natural gas prices, which increased
by $5.66 per barrel and $0.25 per MCF, respectively. In addition to the higher
prices, dry hole costs were lower than the same period last year. These factors
were partially offset by lower United States natural gas sales volumes and lower
Spirit Energy 76 crude oil sales volumes. In the third quarter of 1999, the
hedge program lowered sale realizations for crude oil and natural gas by $17
million after-tax.
Adjusted after-tax earnings increased $10 million in the first nine months of
1999 compared with the first nine months of 1998. The increase was primarily due
to higher United States crude oil prices, lower dry hole costs and lower
operating expenses. These factors were partially offset by lower United States
crude oil and natural gas sales volumes, increased exploratory land amortization
and lower Alaska natural gas prices. For the first nine months of 1999, the
hedge program lowered sale realizations for crude oil and natural gas by $10
million after-tax.
International - Includes the company's international exploration and production
activities and related business development activities. The company is engaged
in oil and gas production activities in eight foreign countries: Thailand,
Indonesia, Canada, The Netherlands, Azerbaijan, Myanmar, the Democratic Republic
of Congo and Bangladesh.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
Far East .................................................................. $ 78 $ 40 $ 167 $ 126
Other ..................................................................... ( 7) 27 (21) 57
----------------------------------------------------
Total ..................................................................... 71 67 146 183
Less: special items (net of tax)
Asset sales (Other) ....................................................... -- 49 -- 102
Deferred tax adjustment (Far East) ........................................ -- ( 7) -- (21)
Litigation proceeds (Far East) ............................................ -- -- 2 --
----------------------------------------------------
Total special items ....................................................... -- 42 2 81
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ 71 $ 25 $ 144 $ 102
====================================================
Adjusted after-tax earnings increased $46 million in the third quarter of 1999
compared with the same period last year. The increase was primarily due to
higher average crude oil prices, lower dry hole costs, lower exploration and
operating expenses, and a lower effective tax rate primarily due to a change in
the Thailand foreign exchange rate. Partially offsetting these factors were
lower Far East crude oil sales volumes, primarily in Indonesia, and lower
International natural gas prices.
Adjusted after-tax earnings increased $42 million in the first nine months of
1999 compared with the first nine months of 1998. The major factors contributing
to the increase were higher average crude oil prices, lower exploration and
operating expenses, lower dry hole costs, lower depreciation, depletion and
amortization expense, and a lower effective tax rate primarily due to a change
in the Thailand foreign exchange rate. These factors were partially offset by
lower crude oil sales volumes, primarily in Indonesia, and lower international
natural gas prices.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
For the third quarter and the first nine months of 1999, the hedge program
lowered sale realizations for crude oil by $6 million after-tax.
GLOBAL TRADE
The Global Trade segment conducts most of the company's worldwide crude oil,
condensate and natural gas trading and marketing activities and is responsible
for commodity-specific risk management activities on behalf of most of the
company's exploration and production segment. Global Trade also purchases crude
oil, condensate and natural gas from certain of the company's royalty owners,
joint venture partners and other unaffiliated oil and gas producers for resale.
In addition, Global Trade takes pricing positions in hydrocarbon derivative
instruments. Global Trade also manages the company's Pipelines business unit,
which holds the company's equity interests in affiliated pipeline companies.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
Global Trade ................................................................ $ ( 5) $ 3 $ ( 3) $ 13
Pipelines ................................................................... 13 14 46 44
----------------------------------------------------
Total ..................................................................... 8 17 43 57
Less: special items (net of tax) ............................................... -- -- -- --
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ 8 $ 17 $ 43 $ 57
====================================================
Adjusted after-tax earnings decreased $9 million in the third quarter of 1999
compared with the same period last year. The decrease was primarily due to lower
margins on domestic natural gas trading.
Adjusted after-tax earnings decreased $14 million for the first nine months of
1999 compared with the same period last year. The decrease was primarily due to
lower margins on domestic natural gas and crude oil trading.
GEOTHERMAL AND POWER OPERATIONS
The Geothermal and Power Operations segment supplies geothermal steam for power
generation, with operations in the Philippines and Indonesia. The segment's
current activities also include the operation of power plants in Indonesia and
an interest in a gas-fired power plant under construction in Thailand.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss) ...................................................... $ 6 $ 16 $ 21 $ 44
Less: special items (net of tax)
Asset sales (a) ............................................................ -- -- (10) --
----------------------------------------------------
Adjusted after-tax earnings .................................................... $ 6 $ 16 $ 31 $ 44
====================================================
<FN>
(a) Represents the first quarter sale of a geothermal production operation at The Geysers
in Northern California
</FN>
Adjusted after-tax earnings decreased $10 million in the third quarter of 1999
compared with the same period last year. Lower affiliate earnings, higher
foreign exchange losses in Indonesia and the loss of earnings from The Geysers
assets in Northern California contributed to the lower results. These factors
were partially offset by lower Indonesia receivable provisions.
Adjusted after-tax earnings decreased $13 million in the first nine months of
1999 compared with the first nine months of 1998. This decrease was primarily
due to the difference in the recognition of cash received related to the
construction of the Salak power plant units 4 through 6, lower affiliate
earnings and the loss of earnings from The Geysers assets in Northern
California. These factors were partially offset by lower Indonesia receivable
provisions.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
DIVERSIFIED BUSINESS GROUP
The Agricultural Products business unit manufactures, transports and markets
nitrogen-based products for agricultural and industrial uses. The Carbon and
Minerals business unit manufactures and markets petroleum coke, graphites and
specialty minerals.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
Agricultural Products ....................................................... $ ( 8) $ 12 $ ( 2) $ 33
Carbon and Minerals ......................................................... 6 ( 1) 19 19
----------------------------------------------------
Total ....................................................................... ( 2) 11 17 52
Less: special items (net of tax)
Kenai plant accident (Agricultural Products)................................. (6) -- ( 6) --
Environmental and litigation provisions (Carbon and Minerals) ............... -- (2) ( 3) (4)
----------------------------------------------------
Total special items ........................................................ ( 6) (2) ( 9) (4)
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ 4 $ 13 $ 26 $ 56
====================================================
Adjusted after-tax earnings decreased $9 million in the third quarter of 1999
compared with the same period last year. The decrease was primarily due to lower
agricultural products prices and lower tax benefits, the effect of which was
partially offset by decreased mining costs and increased affiliate earnings.
Adjusted after-tax earnings decreased $30 million in the first nine months of
1999 compared with the first nine months of 1998. This decrease was primarily
due to lower agricultural products prices.
CORPORATE AND UNALLOCATED
Corporate and Unallocated includes all unallocated corporate administrative and
general items, miscellaneous operations, including real estate, and
non-exploration and production new ventures activities. Net interest expense
represents interest expense, net of interest income and capitalized interest.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
Administrative and general expense .......................................... $ (23) $ (24) $ (65) $ (58)
Net interest expense ........................................................ (36) (33) (101) (83)
Environmental and litigation expense ........................................ (12) (12) (24) (75)
New ventures ................................................................ (4) (4) (9) (16)
Other ....................................................................... ( 7) 5 (31) 25
----------------------------------------------------
Total ....................................................................... (82) (68) (230) (207)
Less: special items (net of tax)
Environmental and litigation provisions .................................... (10) ( 8) (16) (67)
Restructuring provision (Other) ............................................ -- -- (11) --
Insurance settlement (Other) ............................................... -- -- -- 11
----------------------------------------------------
Total special items ........................................................ (10) ( 8) (27) (56)
----------------------------------------------------
Adjusted after-tax earnings (loss) ............................................. $ (72) $ (60) $(203) $(151)
====================================================
The adjusted after-tax loss increased by $12 million in the third quarter of
1999 compared with the same period last year. The third quarter of 1998 included
a net benefit related to certain tax adjustments, in the Other category. In
addition, the third quarter of 1999 had higher interest expense due to lower
capitalized interest and increased debt levels.
The adjusted after-tax loss increased by $52 million in the first nine months of
1999 compared with the same period last year. The negative factors included
higher interest expense due to lower capitalized interest and increased
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
debt levels, lower pension income and higher employee benefit-related expenses,
both in the Other category. The first nine months of 1998 included a net benefit
related to certain tax adjustments and higher earnings and dividends from a
petroleum industry mutual insurance company, both in the Other category. Those
factors were partially offset by lower new ventures expenditures and gains
related to miscellaneous asset sales, in the Other category.
FINANCIAL CONDITION AND CAPITAL EXPENDITURES
For the first nine months of 1999, net cash flow provided by operating
activities was $517 million compared with $711 million in the same period a year
ago. This decrease reflects the effects of lower worldwide crude oil and natural
gas sales volumes, lower natural gas prices, lower agricultural products prices
and reduced earnings from other non-exploration and production businesses. These
factors were partially offset by higher worldwide crude oil prices. Working
capital and other changes included the effects of increased net foreign income
tax payments over refunds, the delivery of crude oil under a 1998 pre-paid
forward sale and increased inventories. Working capital changes benefited from
the receipt of $120 million in the first quarter of 1999 for a ten-year natural
gas pre-paid forward sale and the advance sale of certain domestic trade
receivables in the third quarter of 1999.
Proceeds from asset sales for the first nine months of 1999 were $163 million,
consisting primarily of $101 million from the sale of the company's interest in
a geothermal operation at The Geysers in Northern California, completed in the
first quarter, $27 million from the sale of Michigan oil and gas assets and $35
million from the sale of other miscellaneous domestic oil and gas and real
estate properties.
Capital expenditures for the first nine months of 1999 totaled $761 million
compared with $1,248 million in the same period a year ago. The decrease was
primarily due to lower worldwide drilling activities and lower lease
acquisitions in the Gulf of Mexico. The company also spent $184 million in the
second quarter of 1999 to acquire an approximate 46-percent ownership interest
in Northrock Resources Ltd. (Northrock). Total capital expenditures are expected
to be approximately $1.17 billion for 1999, excluding the Northrock acquisition.
The company will continue to focus on deepwater exploration programs in
Indonesia and the Gulf of Mexico.
In the second quarter of 1999, the company contributed fixed-price overriding
royalty interests from its working interest shares in certain oil and gas
producing properties in the Gulf of Mexico to Spirit Energy 76 Development, L.P.
(Spirit LP), a limited partnership. The fixed-price overrides are subject to
economic limitations of production from the affected fields. In exchange for its
overriding royalty contributions, valued at $304 million, the company received
an initial general partnership interest of approximately 55 percent in Spirit
LP. An unaffiliated investor contributed $250 million in cash to the partnership
in exchange for an initial limited partnership interest of approximately 45
percent. The limited partner is entitled to receive a priority allocation of
profits and cash distributions.
The company's long-term debt was $2.83 billion at September 30, 1999, compared
with $2.56 billion at year-end 1998. Most of this increase reflects the
consolidation of the company's investment in Northrock, including its
outstanding debt. The company's debt-to-total capitalization ratio was 52
percent at September 30, 1999, compared with 48 percent at year-end 1998.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
ENVIRONMENTAL MATTERS
At September 30, 1999, the company's reserves for environmental remediation
obligations totaled $247 million, of which $145 million was included in current
liabilities. During the third quarter of 1999, cash payments of $30 million were
applied against the reserve. The company also estimates that it possibly could
incur additional remediation costs aggregating approximately $195 million, as
discussed in note 11 to the consolidated financial statements. The company's
total environmental reserve amount is grouped into the following five
categories:
Reserve Summary
September 30,
Millions of dollars 1999
- --------------------------------------------------------------------------------
Superfund and similar sites $ 11
Former company-operated sites 14
Company facilities sold with retained liabilities 50
Inactive or closed company facilities 125
Active company facilities 47
- --------------------------------------------------------------------------------
Total reserves $247
================================================================================
OUTLOOK
Certain of the statements in this discussion, as well as other forward-looking
statements within this document, contain estimates and projections of amounts of
or increases / decreases in future revenues, earnings, cash flows, capital
expenditures, assets, liabilities and other financial items and of future levels
of or increases / decreases in reserves, production, sales including related
costs and prices, and other statistical items; plans and objectives of
management regarding the company's future operations, products and services; and
certain assumptions underlying such estimates, projection plans and objectives.
While these forward-looking statements are made in good faith, future operating,
market, competitive, legal, economic, political, environmental, and other
conditions and events could cause actual results to differ materially from those
in the foward-looking statements. See pages 40 and 41 of Management's Discussion
and Analysis in Item 7 of the company's 1998 Annual Report on Form 10-K for a
discussion of certain of such conditions and events, as well as pages 24 through
26 of this report.
The company's Spirit Energy 76 (Spirit) business unit averaged 729 MMCF per day
of net natural gas production in the third quarter of 1999. The company
estimates that, because of the current drilling activity and the return to
production of key wells after repairs, Spirit's net natural gas production will
average approximately 750 MMCF per day in the fourth quarter of 1999.
The company drilled a deepwater well in the Sumatra sub-salt prospect in Garden
Banks block 941 in the Gulf of Mexico during the third quarter of 1999. The well
encountered mechanical difficulties before reaching its primary objective and
has been suspended until next year, when the larger Discoverer Spirit drillship
will be delivered and drilling will be resumed. During the third quarter, oil
was discovered on the K-2 deepwater well, on Green Canyon block 562 in the Gulf
of Mexico, in which the company was participating. The joint interest
participants decided to temporarily suspend the well and develop plans for
appraisal of the hydrocarbon zone. The company was drilling an appraisal well of
the McKinley discovery on Garden Banks block 416 at the end of the third
quarter. The company is participating in the drilling of an appraisal well on
the Mad Dog discovery which began at the end of the third quarter. The company
is currently evaluating the Mirage discovery and no additional drilling is
expected this year.
During the third quarter of 1999, the company was the apparent successful high
bidder for interests in 15 lease blocks in the western Gulf of Mexico, including
seven deepwater blocks and eight shelf blocks. The company has been awarded nine
out of the fifteen blocks with the remaining blocks yet to be awarded.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The economic situation in Asia, where much of the company's international
activity is centered, remained largely unchanged from year-end 1998. The company
believes that the governments in the region are committed to undertaking the
reforms and restructuring necessary to enable their nations to recover from the
downturn.
In Thailand, net natural gas sales are expected to average approximately 600
MMCF per day in the fourth quarter of 1999, as compared with an average of 643
MMCF per day for the third quarter of 1999. Production from the Pailin field in
the Gulf of Thailand started in August of 1999 and is currently producing
approximately 185 MMCF (gross) per day in the fourth quarter. Unocal Thailand,
Ltd., is operator of the Pailin field and holds a 35 percent working interest.
In Myanmar, commercial production from the Yadana field is now expected to begin
very late in 1999 or in early 2000.
The company received approvals from Indonesia's national oil company to begin
initial development activities on the West Seno and Merah Besar oil and gas
fields in the deepwater Kutei Basin, offshore East Kalimantan. Unocal Makassar,
Ltd., a wholly owned subsidiary, is operator of the West Seno discovery in the
Makassar Strait production-sharing contract (PSC) area and has a 50-percent
working interest. The Merah Besar field is located on the Makassar Strait PSC
and the East Kalimantan PSC areas. Unocal Indonesia Company, also a wholly owned
subsidiary, holds a 100-percent working interest in the East Kalimantan PSC.
Development activity is planned in two phases, with phase one production from
the West Seno field expected in 2002. With this approval, the two fields now
qualify to supply gas for the latest package of LNG sales and natural gas is
also available for LPG extraction. In November, the company announced
discoveries of oil and gas in the Bangka and Aton prospects in the Rapak PSC
area which further confirm the hydrocarbon resource potential of the Kutei Basin
deepwater properties. The company has a 60-percent working interest in the Rapak
PSC.
The company completed, in October, an exchange of its interest in a subsidiary
holding a 28.57 percent stake in three producing fields in Yemen for the stock
of two Occidental Petroleum Corporation subsidiaries holding 50-percent working
interests in three blocks in northeast Bangladesh. These Bangladesh assets,
received by the company in July 1999, include two production sharing contracts
in which the company already held 50-percent working interests. In addition, the
assets include the Bibiyana gas field, discovered in 1998. The company
transferred to Occidental Petroleum Corporation its working interest in the
production-sharing contract of the East Shabwa contract area in Yemen in the
fourth quarter of 1999.
As of September 30, 1999, the company had a gross receivable balance of
approximately $158 million related to its geothermal operations in Indonesia.
Approximately $61 million related to Salak electric generating Units 1, 2, and 3
and is due by November 27, 1999, of which $53 million represents past due
amounts and accrued interest resulting from partial payments for March 1998
through July 1999. Although invoices have generally not been paid in full,
amounts that have been paid have been received in a timely manner per the steam
sales contract. The remaining $97 million relates to Salak electric generating
Units 4, 5 and 6 which the company has received partial payments for the period
of March 1998 through July 1999. Provisions covering a portion of these
receivables were recorded in 1998 and 1999. The company is vigorously pursuing
collection of the outstanding receivables.
The company, at times, employs a commodity price option program that establishes
a price floor, while retaining most of the benefits of higher price movements.
This program is designed to protect cash flow and the capital spending program
against the effects of severe commodity price deterioration. For the first nine
months of 1999, the program resulted in lower realizations for crude oil and
natural gas totaling about $16 million after-tax. For the full-year 1999, based
on recent NYMEX oil and gas futures prices, the company anticipates this program
will lower earnings by approximately $29 million after-tax. This program's
results exclude hedging activities by Northrock. In 1999, Northrock's hedging
activities are expected to lower the company's share of Northrock's earnings by
approximately $3 million after-tax. Most of the company's existing non-trading
positions close out in the fourth quarter, with the exception of certain options
and fixed-price contracts for Northrock which extend to the year 2004. For more
information, refer to note 9 to the consolidated financial statements.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The company adopted two separate restructuring plans in the second quarter of
1999 and the fourth quarter of 1998that will result in the termination of
approximately 250 and 475 employees, respectively. For more information, refer
to note 15 to the consolidated financial statements. The company expects
implementation of the plans to reduce future annualized salaries and benefits by
an estimated $32 million after-tax. Cash expenditures related to the plans are
estimated to be $19 million and $8 million for the years 1999 and 2000,
respectively.
YEAR 2000
The company is essentially complete in addressing the Year 2000 (Y2K) issue for
critical systems and applications.
Many existing computer programs were designed and developed to use only two
digits to identify a year in the date field. If not addressed, these programs
could result in system failures with possible material adverse effects on the
company's operations at the beginning of the year 2000.
The company's Y2K efforts are divided into three general categories: information
technology (IT) systems and applications, non-IT embedded systems in process
controls, and its relationships with critical business partners. The company
appointed a program manager and assembled various teams of professionals,
principally at the business unit level, which developed plans to implement these
efforts. The plans established a methodology and schedule to identify, assess,
correct and test the company's IT systems, applications, non-IT embedded systems
(such as microcontrollers and other devices used for process control), system
interfaces with vendors, suppliers, customers and other outside parties, as well
as to assess the Y2K readiness of such third parties. The company contracted
with systems consulting firms to assist with the assessment, correction and
testing of the company's internal systems and their interfaces with third
parties. To ensure independent review and validation of the implementation of
the company's Y2K plans, internal auditors, assisted by contract auditors, are
auditing the Y2K projects of key business units within the company and reporting
their findings to senior management.
A company-wide initial awareness campaign was completed in June 1998. The
identification, assessment, and planning phases of the internal systems portion
of the project have been completed. The company has written and tested business
contingency and recovery plans for 99 percent of its "mission critical" systems,
applications and processes. These systems, applications and processes, if not
operable, could materially adversely impact cash flow, operations, safety or the
environment.
The company's Y2K project work includes the writing and updating of existing
contingency plans to address material Y2K issues. The company has existing
processes for managing emergency situations and intends to have its Crisis
Management Center operating at the time of the century rollover to assist with
implementing any contingency plans if required.
The company has completed the inventory and assessment of its IT and non-IT
embedded systems and detailed planning to correct or work around the anticipated
problems in these systems. The remediation/renovation and validation/testing of
its IT and non-IT embedded systems were approximately 98 percent complete as of
September 30, 1999.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The following schedule sets forth the company's estimated timetable for
achieving Y2K readiness of its IT and embedded systems:
Project Phases Target Completion Dates
- ------------------------------------------ ------------------------------------------
Worldwide inventory of systems Completed
Worldwide assessment Completed
Initial plan for corrections/work arounds Completed
Remediation/renovation 98% Completed; Finish fourth quarter 1999
Contingency planning 99% Completed; Finish fourth quarter 1999
Validation/testing 98% Completed; Finish fourth quarter 1999
Implementation 98% Completed; Finish fourth quarter 1999
Continuous system review Ongoing-through first quarter 2000
The company has identified approximately 400 "critical business partners". The
overall assessment of the Year 2000 readiness of these partners has been
positive. Work in this area will continue and contingency plans will incorporate
the possibility of performance failures by multiple critical business partners.
The company estimates the total expenditures on its Y2K project will be
approximately $25 million. These expenditures are recorded at the business unit
and corporate levels and are funded from cash provided by operating activities.
Expenditures as of September 30, 1999, were approximately $21 million. Most of
the remaining expenditures are expected to be incurred in the remainder of 1999.
The company is not aware of any IT projects that have been delayed due to the
Y2K project.
The Y2K problem is real and there is a risk of Y2K related failures. These
failures could result in an interruption in, or a failure of, certain business
activities or functions. Such failures could materially and adversely affect the
company's results of operations, liquidity or financial condition. Due to the
uncertainty surrounding the Y2K problem, including the uncertainty of the Y2K
readiness of the company's customers, suppliers, and partners, the company is
unable at this time to determine the true impact of the Y2K problem to Unocal.
The principal areas of risk are thought to be oil and gas production control
systems, other embedded operations control systems and third party Y2K
readiness. The company's Y2K project is expected to reduce this uncertainty. The
company believes that with the completion of the project as planned, the
possibility of significant interruptions of normal operations should be reduced.
There can be no assurance, however, that such changes will prove 100 percent
effective in resolving all Y2K related issues. Furthermore, there can be no
assurance that critical business partners will not experience failures,
irrespective of the Y2K readiness representations they may have made. A likely
worst case scenario is that despite the company's efforts, there could be
failures of control systems, which might cause some processes to be shut down.
Such failures could have a material adverse impact on the company's operations.
The company is particularly concerned about the status of key critical business
partners' Y2K readiness in Indonesia, Bangladesh, Thailand and The Philippines.
Their failure due to a Year 2000 problem could prevent Unocal from delivering
product and cause a material adverse impact to the company's cash flows.
Future Accounting Changes
In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 137, which delayed the effective
date of SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 133 required that companies recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative instrument depends upon the intended use of the instrument and its
resulting designation. Unless designated as a hedge, changes in the fair value
of a derivative instrument are to be accounted for as gains or losses in the
period of change. In the case of certain hedging activities, changes in the fair
values of derivative instruments that are effective as hedges, are deferred and
reported as part of other comprehensive income.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Changes in the fair value of derivative instruments that are not effective as
hedges are reported in earnings in the period of the change.
SFAS No. 133 had required companies to adopt its provisions for all fiscal
quarters of fiscal years beginning after June 15, 2000. SFAS 137 delays the
effective date to all fiscal quarters of fiscal years beginning after June 15,
2001. The company is planning to adopt SFAS 133 in the first quarter of the year
2001 and is currently evaluating the impact the statement will have on its
reporting for derivative instruments and hedging activities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk that losses may occur in the values of
financial instruments as a result of movements in interest rates, foreign
currency exchange rates and commodity prices. As part of its overall risk-
management strategies, the company uses derivative financial instruments to
manage and reduce risks associated with these factors. The company also pursues
outright pricing positions in certain hydrocarbon derivative financial
instruments, such as futures and options contracts.
Interest Rate Risk - From time to time the company temporarily invests its
excess cash in interest-bearing securities issued by high-quality issuers.
Company policies limit the amount of investment in securities of any one
financial institution. Due to the short time the investments are outstanding and
their general liquidity, these instruments are classified as cash equivalents in
the consolidated balance sheet and do not represent a material interest rate
risk to the company. The company's primary market-risk exposure for changes in
interest rates relates to the company's long-term debt obligations. The company
manages its exposure to changing interest rates principally through the use of a
combination of fixed and floating-rate debt. Interest-rate risk-sensitive
derivative financial instruments, such as swaps, options, floors, caps, and
collars may also be used depending upon market conditions.
The company evaluated the potential effect that near-term changes in interest
rates would have had on the fair value of its interest-rate risk-sensitive
financial instruments at September 30, 1999. Assuming a ten-percent decrease in
the company's weighted average borrowing costs at September 30, 1999, the
potential increase in the fair value of the company's debt obligations and
associated derivative instruments, including the company's net interests in the
debt obligations and associated derivative instruments of its subsidiaries,
would have been approximately $118 million.
Foreign Exchange Rate Risk - The company conducts business in various parts of
the world and in various foreign currencies. To limit the company's foreign
currency exchange-rate risk related to operating income, foreign sales
agreements generally contain price provisions designed to insulate the company's
sales revenues against adverse foreign-currency exchange rates. In most
countries, energy products are valued and sold in U.S. dollars and foreign
currency operating cost exposures have not been significant. In other countries,
the company is paid for product deliveries in local currencies but at prices
indexed to the U.S. dollar. These funds, less amounts retained for operating
costs, are converted to U.S. dollars as soon as practicable. The company's
Canadian subsidiaries are paid in Canadian dollars for crude oil and natural gas
sales. Excess Canadian funds generally have been invested in other Unocal
foreign operations.
From time to time the company may purchase foreign-currency options or enter
into foreign-currency forward contracts to limit the exposure related to its
foreign-currency obligations. At September 30, 1999, the company evaluated the
effect that near term changes in foreign-exchange rates would have had on the
fair value of the company's foreign-currency position related to its outstanding
foreign-currency forward contracts. Assuming an adverse change of ten percent in
foreign-currency exchange rates at September 30, 1999, the potential decrease in
fair value of the company's foreign-currency forward contracts, including the
company's net interests in the foreign-currency forward contracts of its
subsidiaries, would have been approximately $13 million.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
Commodity Price Risk - The company is a producer, purchaser, marketer and trader
of certain hydrocarbon commodities such as crude oil and condensate, natural gas
and petroleum-based products and is subject to the associated price risks. The
company uses hydrocarbon derivative financial instruments, such as futures
contracts, swaps and options generally with maturities of 24 months or less, to
mitigate its exposure to commodity price fluctuations. However, these
instruments may also limit some of the future gains otherwise available from
favorable commodity price movements.
When these instruments are used to hedge the company's future production, the
impacts are reflected in the average sales prices of the associated commodities
at the time of sale. As a result, the company's reported crude oil and natural
gas revenues may be higher or lower than what would have been reported if the
company had not employed the use of these instruments. From time to time, the
company also enters into longer-term derivative instruments, such as swap
contracts, to refloat its long term fixed-price commitments. The company also
takes pricing positions in hydrocarbon derivative financial instruments
(primarily futures and options contracts).
The company uses a variance-covariance value-at-risk model to assess the market
risk of its hydrocarbon-price-sensitive derivative instruments. Value-at-risk
represents the potential loss in fair value the company would experience on its
hydrocarbon-price-sensitive derivative instruments, using calculated
volatilities and correlations over a specified time period with a given
confidence level. The company's model is based upon historical data and uses a
three-day time interval with a 95-percent confidence level. The model includes
offsetting physical positions for hydrocarbon-price-sensitive derivative
instruments related to the company's pre-paid crude oil and natural gas forward
sales, as well the company's net interests in its subsidiaries' crude oil and
natural gas derivative instruments including offsetting physical positions of
forward sales contracts to which those contracts relate. Based upon the
company's model, the value at risk related to hydrocarbon-price-sensitive
derivative financial instruments held for purposes other than trading was
approximately $7 million at September 30 (refer to note 9 to the consolidated
financial statements for information on pre-tax unrealized losses as of
September 30, 1999 relating to hydrocarbon price-sensitive derivative financial
instruments held for purposes other than trading). The value at risk related to
hydrocarbon-price-sensitive derivative financial instruments held for trading
purposes was approximately $1 million at September 30, 1999.
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
There is incorporated by reference the information with respect to certain legal
proceedings previously reported in Item 3 of Unocal's Annual Report on Form 10-K
for the year ended December 31, 1998 (1998 Form 10-K) and in Item 1 of Part II
of Unocal's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999
(First Quarter 1999 Form 10-Q) and Quarterly Report on Form 10-Q for the quarter
ended June 30, 1999 (Second Quarter Form 10-Q), the information regarding
environmental remediation reserves in note 10 to the consolidated financial
statements in Item 1 of Part I of this report , the discussion of such reserves
in the Environmental Matters section of Management's Discussion and Analysis in
Item 2 of Part I, and the information regarding certain legal proceedings and
other contingent liabilities in note 11 to the consolidated financial
statements. Information with respect to certain recent developments is set forth
below:
1. In connection with the Notices of Preliminary Determination of
Underpaid Royalties received from the MMS, described in Paragraph 6 of
Item 3 of the 1998 Form 10-K, in Paragraph 4 of Item 1 of Part II of
the First Quarter 1999 Form 10-Q and in Paragraph 3 of Item 1 of Part
II of the Second Quarter Form 10-Q, the settlement amount of $7 million
was paid by the company in August 1999.
2. In the lawsuits captioned Aguilar, et al. v. Atlantic Richfield, et al.
and Gilley, et al. v. Atlantic Richfield, et al., described in
Paragraph 7 of Item 3 of the 1998 Form 10-K and in Paragraph 4 of Item
1 of Part II of the Second Quarter Form 10-Q, the Aguilar settlement
amount of $3,000,000 was approved by the court and paid by the company
in September 1999 and the Gilley settlement amount of $525,000 received
the preliminary approval of the court in October 1999.
Certain Environmental Matters Involving Civil Penalties
3. In connection with the company's negotiations with the South Coast Air
Quality Management District concerning issues involving the company's
former Los Angeles Refinery, described in Paragraph 14 of Item 3 of the
1998 Form 10-K and in Paragraph 7 of Item 1 of Part II of the Second
Quarter Form 10-Q, the company settled the past emissions fees issues
for an aggregate of $290,000, which was paid in September 1999.
4. On November 2, 1999, the District Attorney for San Joaquin County,
California filed a lawsuit against the company and Tosco Corporation
(The People of the State of California v. Union Oil Company of
California, et al., Superior Court of California, San Joaquin County
No. CV009241) alleging that company has failed to take appropriate
corrective action with respect to releases from underground fuel
storage tanks at six former company service stations in San Joaquin
County. The complaint seeks civil penalties as well as an injunction
requiring further remedial action and restraining violations of
applicable requirements. As of November 12, 1999, the company had not
been served with the complaint. The company intends to vigorously
contest the allegations of the complaint.
28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits: The Exhibit Index on page 31 of this report lists the
exhibits that are filed as part of this report.
(b) Reports on Form 8-K:
Filed during the third quarter of 1999:
1. Current Report on Form 8-K dated July 6, 1999, and
filed July 9, 1999, for the purpose of reporting, under
Item 5, the results of wells drilled by the company's
Spirit Energy 76 business unit in the Gulf of Mexico.
2. Current Report on Form 8-K dated July 27, 1999, and
filed July 29, 1999, for the purpose of reporting,
under Item 5, the company's second quarter 1999
earnings and related information.
3. Current Report on Form 8-K dated September 29, 1999,
and filed September 30, 1999, for the purpose of
reporting, under Item 5, the results of wells drilled
by the company's Spirit Energy 76 business unit in the
Gulf of Mexico.
Filed during the fourth quarter of 1999 to the date hereof:
1. Current Report on Form 8-K dated October 26, 1999, and
filed October 29, 1999, for the purpose of reporting,
under Item 5, the company's third quarter 1999 earnings
and related information.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNOCAL CORPORATION
(Registrant)
Dated: November 12, 1999 By: /s/ JOE D. CECIL
------------------------------
Joe D. Cecil
Vice President and Comptroller
(Duly Authorized Officer
Principal Accounting Officer)
30
EXHIBIT INDEX
3. Restated Certificate of Incorporation of Unocal Corporation, dated October
1, 1999.
10. Termination and Employment Agreement and Release, by and between John Imle,
Union Oil Company of California and Unocal Corporation, effective as of
September 11, 1999.
12.1 Statement regarding computation of ratio of earnings to fixed charges of
Unocal Corporation for the nine months ended September 30, 1999 and 1998.
12.2 Statement regarding computation of ratio of earnings to fixed charges of
Union Oil Company of California for the nine months ended September 30,
1999 and 1998.
27. Financial data schedule for the period ended September 30, 1999 (included
only in the copy of this report filed electronically with the Commission).
31