================================================================================
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 March 31, 2002
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 1-5153
Marathon Oil Corporation
(Exact name of registrant as specified in its charter)
Delaware 25-0996816
(State of Incorporation) (I.R.S. Employer Identification No.)
5555 San Felipe Road, Houston, TX 77056-2723
(Address of principal executive offices)
Tel. No. (713) 629-6600
================================================================================
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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days. Yes X No
----- -----
There were 309,705,270 shares of Marathon Oil Corporation Common Stock
outstanding as of April 30, 2002.
================================================================================
MARATHON OIL CORPORATION
SEC FORM 10-Q
QUARTER ENDED March 31, 2002
----------------------------
INDEX Page
----- ----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statement of Income.................................. 3
Consolidated Balance Sheet........................................ 5
Consolidated Statement of Cash Flows.............................. 7
Selected Notes to Consolidated
Financial Statements............................................ 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations...................................................... 18
Item 3. Quantitative and Qualitative Disclosures about
Market Risk....................................................... 31
Supplemental Statistics........................................... 36
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................. 39
Item 6. Exhibits and Reports on Form 8-K.................................. 40
2
Part I - Financial Information
MARATHON OIL CORPORATION
CONSOLIDATED STATEMENT OF INCOME (Unaudited)
------------------------------------------------
First Quarter Ended
March 31
(Dollars in millions) 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
REVENUES AND OTHER INCOME:
Revenues............................................................................. $6,409 $8,607
Dividend and investee income......................................................... 29 33
Net gains on disposal of assets...................................................... 8 14
Gain on ownership change in Marathon Ashland
Petroleum LLC....................................................................... 2 1
Other income......................................................................... 6 67
------ ------
Total revenues and other income................................................ 6,454 8,722
------ ------
COSTS AND EXPENSES:
Cost of revenues (excludes items shown below)........................................ 4,759 6,221
Selling, general and administrative expenses......................................... 187 145
Depreciation, depletion and amortization............................................. 294 303
Taxes other than income taxes........................................................ 1,060 1,122
Exploration expenses................................................................. 57 23
Inventory market valuation credit.................................................... (71) -
------ ------
Total costs and expenses....................................................... 6,286 7,814
------ ------
INCOME FROM OPERATIONS.................................................................. 168 908
Net interest and other financial costs.................................................. 64 42
Minority interest in income of Marathon Ashland
Petroleum LLC.......................................................................... 11 107
------ ------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .................................. 93 759
Provision for income taxes.............................................................. 39 258
------ ------
INCOME FROM CONTINUING OPERATIONS....................................................... 54 501
DISCONTINUED OPERATIONS:
Income from discontinued operations.................................................. - 18
Costs associated with disposition of United States Steel............................. - (2)
------ ------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGES IN
ACCOUNTING PRINCIPLES.................................................................. 54 517
Cumulative effect of changes in accounting principles................................... 13 (8)
------ ------
NET INCOME.............................................................................. $ 67 $ 509
====== ======
- --------------
Included in revenues and costs and expenses for 2002 and 2001 were $996 million
and $1,038 million, respectively, representing consumer excise taxes on
petroleum products and merchandise.
The accompanying notes are an integral part of these consolidated financial
statements.
3
MARATHON OIL CORPORATION
CONSOLIDATED STATEMENT OF INCOME (Continued) (Unaudited)
INCOME PER COMMON SHARE
------------------------------------------------------------
First Quarter Ended
March 31
(Dollars in millions, except per share amounts) 2002 2001
- -----------------------------------------------------------------------------------------
MARATHON COMMON STOCK:
Income from continuing operations applicable
to Common Stock....................................... $ 54 $ 501
Net income applicable to Common Stock.................. $ 67 $ 500
Per Share Data:
Basic and diluted:
- Income from continuing operations............... $.17 $1.62
- Net Income...................................... $.22 $1.62
STEEL STOCK:
Net income applicable to Steel Stock................... $ - $ 7
Per Share Data:
Basic and diluted:
- Net Income...................................... $ - $ .08
The accompanying notes are an integral part of these consolidated financial
statements.
4
MARATHON OIL CORPORATION
CONSOLIDATED BALANCE SHEET (Unaudited)
----------------------------------------
ASSETS
March 31 December 31
(Dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 237 $ 657
Receivables, less allowance for doubtful
accounts of $7 and $8........................................................ 1,819 1,708
Receivables from United States Steel.......................................... 12 64
Inventories................................................................... 1,991 1,851
Assets held for sale.......................................................... - 16
Deferred income tax benefits.................................................. 13 13
Other current assets.......................................................... 178 102
------- -------
Total current assets.................................................... 4,250 4,411
Investments and long-term receivables......................................... 1,530 1,076
Receivables from United States Steel.......................................... 551 551
Property, plant and equipment, less accumulated
depreciation, depletion and amortization of
$10,648 and $10,384......................................................... 10,026 9,578
Prepaid pensions.............................................................. 209 207
Goodwill...................................................................... 256 88
Intangibles................................................................... 56 61
Other noncurrent assets....................................................... 138 157
------- -------
Total assets............................................................ $17,016 $16,129
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
5
MARATHON OIL CORPORATION
CONSOLIDATED BALANCE SHEET (Continued) (Unaudited)
-------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31 December 31
(Dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES
Current liabilities:
Notes payable................................................................. $ 23 $ -
Accounts payable.............................................................. 2,540 2,431
Payable to United States Steel................................................ 28 28
Payroll and benefits payable.................................................. 213 243
Accrued taxes................................................................. 267 171
Accrued interest.............................................................. 56 85
Obligations to repay preferred securities..................................... - 295
Long-term debt due within one year............................................ 216 215
------- -------
Total current liabilities............................................... 3,343 3,468
Long-term debt................................................................... 4,341 3,432
Deferred income taxes............................................................ 1,368 1,297
Employee benefits................................................................ 698 677
Payable to United States Steel................................................... 8 8
Deferred credits and other liabilities........................................... 377 344
Minority interest in Marathon Ashland Petroleum LLC.............................. 1,976 1,963
STOCKHOLDERS' EQUITY
Common stock:
Common Stock issued - 312,165,978 shares at March 31, 2002 and
December 31, 2001 (par value $1 per share, authorized 550,000,000 shares).... 312 312
Common stock held in treasury - 2,479,928 shares at March 31, 2002 and
2,770,929 shares at December 31, 2001........................................ (71) (74)
Additional paid-in capital....................................................... 3,034 3,035
Retained earnings................................................................ 1,640 1,643
Accumulated other comprehensive income........................................... 2 34
Deferred compensation............................................................ (12) (10)
------- -------
Total stockholders' equity.............................................. 4,905 4,940
------- -------
Total liabilities and stockholders' equity.............................. $17,016 $16,129
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
6
MARATHON OIL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
------------------------------------------------
First Quarter Ended
March 31
(Dollars in millions) 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net income .................................................................... $ 67 $ 509
Adjustments to reconcile to net cash provided
from operating activities:
Cumulative effect of changes in accounting principles ...................... (13) 8
Income from discontinued operations ........................................ -- (18)
Costs associated with disposition of United States Steel ................... -- 2
Minority interest in income of Marathon Ashland
Petroleum LLC ............................................................. 11 107
Depreciation, depletion and amortization ................................... 294 303
Inventory market valuation credits ......................................... (71) --
Exploratory dry well costs ................................................. 49 4
Deferred income taxes ...................................................... (22) (159)
Net gains on disposal of assets ............................................ (8) (14)
Changes in:
Current receivables .................................................. (91) 146
Receivable from United States Steel .................................. (2) --
Inventories .......................................................... (60) (170)
Current accounts payable and accrued expenses ........................ 188 (272)
All other - net ............................................................ (48) 125
------- -------
Net cash provided from continuing operations ......................... 294 571
Net cash provided from discontinued operations ....................... -- 243
------- -------
Net cash provided from operating activities .......................... 294 814
------- -------
INVESTING ACTIVITIES:
Capital expenditures .......................................................... (292) (276)
Acquisition of Equatorial Guinea interests .................................... (1,013) --
Acquisition of Pennaco Energy, Inc. ........................................... -- (506)
Disposal of assets ............................................................ 21 34
Receivable from United States Steel ........................................... 54 --
Restricted cash - withdrawals ................................................. 25 16
- deposits .................................................... (20) (6)
Investees - investments ................................................. (54) --
All other - net ............................................................... -- (6)
------- -------
Net cash used in continuing operations ............................... (1,279) (744)
Net cash used in discontinued operations ............................. -- (24)
------- -------
Net cash used in investing activities ................................ (1,279) (768)
------- -------
The accompanying notes are an integral part of these consolidated financial
statements.
7
MARATHON OIL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) (Unaudited)
-----------------------------------------------------------
First Quarter Ended
March 31
(Dollars in millions) 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Commercial paper and revolving credit arrangements - net ................................. (75) 73
Other debt - borrowings .................................................................. 1,111 139
- repayments .................................................................. (104) (125)
Repayment of preferred securities ........................................................ (294) --
Dividends paid ........................................................................... (71) (95)
Distributions to minority shareholder of
Marathon Ashland Petroleum LLC .......................................................... (2) (3)
------- -------
Net cash provided from (used in) financing activities ........................... 565 (11)
------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH .................................................. -- (3)
------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..................................... (420) 32
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ........................................... 657 559
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................................... $ 237 $ 591
======= =======
Cash provided from (used in) operating activities included:
Interest and other financial costs paid (net of
amount capitalized) .................................................................. $ (97) $ (127)
Income taxes refunded ................................................................. 21 47
The accompanying notes are an integral part of these consolidated financial
statements.
8
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
(Unaudited)
1. These consolidated financial statements are unaudited but, in the opinion
of management, reflect all adjustments necessary for a fair presentation of
the results for the periods reported. All such adjustments are of a normal
recurring nature unless disclosed otherwise. These financial statements,
including selected notes, have been prepared in accordance with the
applicable rules of the Securities and Exchange Commission and do not
include all of the information and disclosures required by accounting
principles generally accepted in the United States of America for complete
financial statements. Certain reclassifications of prior year data have
been made to conform to 2002 classifications. These interim financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the 2001 Annual Report on Form
10-K of Marathon Oil Corporation (Marathon).
2. Prior to December 31, 2001, Marathon, formerly named USX Corporation, had
two outstanding classes of common stock: USX-Marathon Group common stock
(Marathon Stock), which was intended to reflect the performance of
Marathon's energy business, and USX-U.S. Steel Group common stock (Steel
Stock), which was intended to reflect the performance of Marathon's steel
business. On December 31, 2001, Marathon disposed of its steel business
through a tax-free distribution of the common stock of its wholly owned
subsidiary United States Steel Corporation (United States Steel) to holders
of Steel Stock in exchange for all outstanding shares of Steel Stock on a
one-for-one basis (the Separation). At December 31, 2001, the net debt and
other financings of United States Steel was $54 million less than the net
debt and other financings attributable to the Steel Stock, adjusted for a
$900 million value transfer and certain one-time items related to the
Separation. On February 6, 2002, United States Steel made a payment to
Marathon of $54 million, plus applicable interest, to settle this
difference.
Marathon has accounted for the business of United States Steel as a
discontinued operation. The income from discontinued operations for the
period ended March 31, 2001, represents the net income attributable to the
Steel Stock, except for certain limitations on the amounts of corporate
administrative expenses and interest expense (net of income tax effects)
allocated to discontinued operations as required by accounting principles
generally accepted in the United States.
3. Effective January 1, 2001, Marathon adopted Statement of Financial
Accounting Standards No. 133 "Accounting for Derivative Instruments and
Hedging Activities" (SFAS No. 133), as amended by SFAS Nos. 137 and 138.
This Standard requires recognition of all derivatives as either assets or
liabilities at fair value. The transition adjustment related to adopting
SFAS No. 133 on January 1, 2001, was recognized as a cumulative effect of a
change in accounting principle. The unfavorable cumulative effect on net
income, net of a tax benefit of $5 million, was $8 million. The unfavorable
cumulative effect on other comprehensive income (OCI), net of a tax benefit
of $4 million, was $8 million.
Since the issuance of SFAS No. 133, the Financial Accounting Standards
Board (FASB) has issued several interpretations. As a result, Marathon must
recognize in income beginning on January 1, 2002, the effect of changes in
the fair value of two long-term natural gas sales contracts in the United
Kingdom. As of January 1, 2002, Marathon recognized a favorable cumulative
effect of a change in accounting principle of $13 million, net of tax of $7
million. The favorable pretax change in the fair value of the gas contracts
during the quarter was $17 million. The recorded derivative assets will
continue to be marked-to-market.
9
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
3. (Continued)
Effective January 1, 2002, Marathon adopted the following Statements of
Financial Accounting Standards:
. No. 141 "Business Combinations" (SFAS No. 141),
. No. 142 "Goodwill and Other Intangible Assets" (SFAS No. 142) and
. No. 144 "Accounting for Impairment or Disposal of Long-Lived
Assets" (SFAS No.144)
SFAS No. 141 requires that all business combinations initiated after June
30, 2001, be accounted for under the purchase method. The transitional
provisions of SFAS No. 141 required Marathon to reclassify $11 million from
identifiable intangible assets to goodwill at January 1, 2002.
SFAS No. 142 addresses the accounting for goodwill and other intangible
assets after an acquisition. Effective January 1, 2002, Marathon ceased
amortization of existing goodwill, which results in a favorable impact on
annual earnings of approximately $3 million, net of tax. A transitional
impairment test is required for existing goodwill as of the date of
adoption. Marathon will complete the first step of the transitional
goodwill impairment test within six months of the date of adoption, as
required.
SFAS No. 144 establishes a single accounting model for long-lived assets to
be disposed of by sale and provides additional implementation guidance for
assets to be held and used and assets to be disposed of other than by sale.
The adoption of SFAS No. 144 had no initial effect on Marathon's financial
statements.
In June 2001, the FASB issued Statement of Financial Accounting Standard
No. 143 "Accounting for Asset Retirement Obligations" (SFAS No. 143).
Marathon will adopt this Statement effective January 1, 2003, as required.
The adoption of this Standard will result in a cumulative effect and be
reported as a change in accounting principle. At this time, Marathon cannot
reasonably estimate the effect of adoption on either its financial position
or results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standard
No. 145 "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS No. 145). Extinguishment
of debt will be accounted for in accordance with Accounting Principles
Board Opinion No. 30 ("Reporting the Results of Operations Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions"). SFAS No. 145 has a
dual effective date. The provisions relating to the rescission of SFAS No.
4 will be adopted by Marathon on January 1, 2003. The provisions relating
to the amendment of SFAS 13 are applicable to leasing transactions
occurring after May 15, 2002. The adoption of SFAS No. 145 is not expected
to have a material effect on Marathon's financial position or results of
operations.
4. Basic net income per share is calculated by adjusting net income for
dividend requirements of preferred stock when applicable and is based on
the weighted average number of common shares outstanding.
Diluted net income per share assumes exercise of stock options, provided
the effect is not antidilutive.
10
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
4. (Continued)- COMPUTATION OF INCOME PER COMMON SHARE
First Quarter Ended
March 31
2002 2001
(Dollars in millions, except per share data) Basic Diluted Basic Diluted
- ------------------------------------------------------------------------------------------------------------------------------------
Common Stock
- -------------
Income from continuing operations applicable-
to Common Stock ............................................. $ 54 $ 54 $ 501 $ 501
Expenses included in income from continuing
operations applicable to Steel Stock .......................... -- -- 9 9
Costs associated with disposition of
United States Steel .......................................... -- -- (2) (2)
Cumulative effect of changes in
accounting principles ......................................... 13 13 (8) (8)
------- ------- --------- ---------
Net income applicable to Common Stock .......................... $ 67 $ 67 $ 500 $ 500
======= ======= ========= =========
Shares of common stock outstanding (thousands):
Average number of common shares outstanding .................... 309,568 309,568 308,753 308,753
Effect of dilutive securities - stock options .................. -- 268 -- 320
------- ------- --------- ---------
Average common shares and dilutive effect .................... 309,568 309,836 308,753 309,073
======= ======= ========= =========
Per share:
Income from continuing operations .............................. $ .17 $ .17 $ 1.62 $ 1.62
======= ======= ========= =========
Cumulative effect of changes in
accounting principles ......................................... $ .04 $ .04 $ (.03) $ (.03)
======= ======= ========= =========
Net income ..................................................... $ .22 $ .22 $ 1.62 $ 1.62
======= ======= ========= =========
Steel Stock
- -----------
Income from discontinued operations .............................. -- -- $ 18 $ 18
Expenses included in income from continuing
operations applicable to Steel Stock ............................ -- -- (9) (9)
Preferred stock dividends ........................................ -- -- (2) (2)
------- ------- --------- ---------
Net income applicable to Steel Stock ............................. -- -- $ 7 $ 7
======= ======= ========= =========
Shares of common stock outstanding (thousands):
Average number of common shares outstanding .................. -- -- 88,806 88,806
Effect of dilutive securities - stock options ................ -- -- -- --
------- ------- --------- ---------
Average common shares including dilutive effect .............. -- -- 88,806 88,806
======= ======= ========= =========
Per share:
Income from discontinued operations .......................... -- -- $ .20 $ .20
======= ======= ========= =========
Net income ................................................... -- -- $ .08 $ .08
======= ======= ========= =========
11
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
5. Marathon's operations consist of three operating segments: 1) Exploration
and Production (E&P) - explores for and produces crude oil and natural gas
on a worldwide basis; 2) Refining, Marketing and Transportation (RM&T) -
refines, markets and transports crude oil and petroleum products, primarily
in the Midwest and southeastern United States through Marathon Ashland
Petroleum LLC (MAP); and 3) Other Energy Related Businesses (OERB) -
markets and transports, primarily in the United States and Europe, its own
and third-party natural gas and crude oil as well as methanol produced in
West Africa.
The results of segment operations are as follows:
Total
(In millions) E&P RM&T OERB Segments
- ---------------------------------------------------------------------------------------------------------------------------
FIRST QUARTER 2002
- ------------------
Revenues and other income:
Customer................................................................ $ 685 $5,287 $ 437 $6,409
Intersegment (a)........................................................ 142 19 14 175
Equity in earnings of unconsolidated investees.......................... 9 8 11 28
Other................................................................... 1 14 - 15
------ ------ ------ ------
Total revenues and other income......................................... $ 837 $5,328 $ 462 $6,627
====== ====== ====== ======
Segment income............................................................ $ 165 $ (51) $ 25 $ 139
====== ====== ====== ======
FIRST QUARTER 2001
- ------------------
Revenues and other income:
Customer................................................................ $1,176 $6,742 $ 689 $8,607
Intersegment (a)........................................................ 180 6 26 212
United States Steel (a)................................................. 10 - 2 12
Equity in earnings of unconsolidated investees.......................... 20 6 4 30
Other................................................................... 8 15 2 25
------ ------ ------ ------
Total revenues and other income......................................... $1,394 $6,769 $ 723 $8,886
====== ====== ====== ======
Segment income............................................................ $ 600 $ 276 $ 8 $ 884
====== ====== ====== ======
(a) Management believes intersegment transactions and transactions with United
States Steel were conducted under terms comparable to those with unrelated
parties.
12
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
5. (Continued)
The following schedule reconciles segment revenues and income to amounts
reported in the financial statements:
First Quarter
Ended
March 31
(In millions) 2002 2001
- --------------------------------------------------------------------------------
Revenues and other income:
Segment revenues and other income .................. $ 6,627 $ 8,886
Items not allocated to segments:
Gain on ownership change in MAP ................... 2 1
Gain on lease resolution with U.S. Government ..... -- 59
Elimination of intersegment revenues ............... (175) (212)
Elimination of sales to United States Steel ........ -- (12)
------- -------
Total revenues and other income ................. $ 6,454 $ 8,722
======= =======
Income:
Segment income ..................................... $ 139 $ 884
Items not allocated to segments:
Administrative expenses ........................... (44) (36)
Inventory market valuation credit ................. 71 --
Gain on ownership change in MAP ................... 2 1
Gain on lease resolution with U.S. Government ..... -- 59
------- -------
Total income from operations .................... $ 168 $ 908
======= =======
6. On January 3, 2002, Marathon acquired certain interests in Equatorial
Guinea, West Africa from CMS Energy Corporation. The purchase price was
$1,013 million. Marathon acquired three entities that own a combined 52.4%
working interest in oil and gas producing assets and an onshore condensate
separation facility as well as a combined 43.2% net interest in an onshore
liquefied petroleum gas processing plant through an equity method investee.
Additionally, Marathon acquired 50% of the voting interest of an entity
that owns (through an equity method investee) a 90% interest in an onshore
methanol production plant. First quarter 2002 results of operations include
the results of the Equatorial Guinea interests from January 3, 2002.
The allocation of the purchase price is preliminary. The allocation of
purchase price to intangible assets is not expected to be significant. The
goodwill arising from the preliminary allocation was $160 million, which
was assigned to the E&P segment. Significant factors contributing to a
purchase price that resulted in the recognition of goodwill include: the
ability to acquire an established business with an assembled workforce, a
proven track record and the right to operatorship, and a strategic
acquisition in a new core geographic area.
Additionally, the purchase price allocated to the equity method investments
is $201 million higher than the underlying net assets of the investees.
This excess will be amortized over the expected useful life of the
underlying assets except for $36 million of goodwill relating to the equity
investments.
13
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
6. (Continued)
The following table summarizes the allocation of the purchase price to the
assets acquired and liabilities assumed at the date of acquisition:
(In millions)
---------------------------------------------------------------------------
Receivables .................................................... $ 15
Property, plant and equipment .................................. 506
Inventory and other ............................................ 14
Investment in equity investees ................................. 439
Goodwill (none deductible for income tax purposes) ............. 160
-------
Total assets acquired ...................................... $ 1,134
-------
Current liabilities ............................................ $ (12)
Deferred income taxes .......................................... (109)
-------
Total liabilities assumed .................................. $ (121)
-------
Net assets acquired ........................................ $ 1,013
=======
In the first quarter 2001, Marathon acquired Pennaco Energy, Inc.
(Pennaco), a natural gas producer. Marathon acquired 87% of the outstanding
stock of Pennaco through a tender offer completed on February 7, 2001 at
$19 a share. On March 26, 2001, Pennaco was merged with a wholly owned
subsidiary of Marathon. Under the terms of the merger, each share not held
by Marathon was converted into the right to receive $19 in cash. The total
cash purchase price of Pennaco was $506 million. The acquisition was
accounted for under the purchase method of accounting. The goodwill totaled
$70 million. Goodwill amortization ceased upon adoption of SFAS No. 142 on
January 1, 2002. First quarter results of operations for 2001 include the
results of Pennaco from February 7, 2001.
The following unaudited pro forma data for Marathon for the first quarter
ended March 31, 2001, includes the results of operations of the above
acquisitions giving effect to them as if they had been consummated at the
beginning of 2001. The pro forma data is based on historical information
and does not necessarily reflect the actual results that would have
occurred nor is it necessarily indicative of future results of operations.
(In millions, except per share amounts)
-----------------------------------------------------------------
Revenues and other income .............................. $8,737
Income from continuing operations ...................... 493
Net income ............................................. 500
Per share amounts applicable to Common Stock
- Income from continuing operations - basic and diluted 1.60
- Net income - basic and diluted ...................... 1.57
14
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
7. Inventories are carried at lower of cost or market. Cost of inventories of
crude oil and refined products is determined under the last-in, first-out
(LIFO) method.
(In millions)
----------------------
March 31 December 31
2002 2001
-------- -----------
Crude oil and natural gas liquids .............. $ 699 $ 693
Refined products and merchandise ............... 1,197 1,143
Supplies and sundry items ...................... 96 87
------ ------
Total (at cost) ............................. 1,992 1,923
Less inventory market valuation reserve ..... 1 72
------ ------
Net inventory carrying value ................... $1,991 $1,851
====== ======
Marathon has established an inventory market valuation (IMV) reserve to
adjust the cost basis of its inventories to current market value. Quarterly
adjustments to the IMV reserve result in noncash charges or credits to
income from operations. Decreases in market prices below the cost basis
result in charges to income from operations. Once a reserve has been
established, subsequent inventory turnover and increases in prices (up to
the cost basis) result in credits to income from operations. First quarter
2002 results of operations include a credit to income from operations of
$71 million.
8. The following sets forth Marathon's comprehensive income for the periods
shown:
March 31 March 31
(In millions) 2002 2001
------------- -------- --------
Net income ......................................... $ 67 $ 509
Other comprehensive income (loss)
Foreign currency translation adjustments ........ (1) (2)
Deferred gains (losses) on derivative instruments (31) 34
----- -----
Total comprehensive income ......................... $ 35 $ 541
===== =====
9. The provision for income taxes for the periods reported is based on tax
rates and amounts which recognize management's best estimate of current and
deferred tax assets and liabilities.
In the first quarter of 2002 and 2001, the provision for income taxes
includes unfavorable adjustments of $4 million and $5 million,
respectively, related to prior years' taxes.
15
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
10. At March 31, 2002, Marathon had $400 million in borrowings against its
$1,354 million long-term revolving credit facility and no borrowings
against its $451 million short-term revolving credit facility.
Certain banks provide Marathon with uncommitted short-term lines of credit
totaling $200 million. At March 31, 2002, there were no borrowings against
these facilities.
At March 31, 2002, MAP had no borrowings against its $450 million revolving
credit agreements with banks and had $22 million outstanding against its
$190 million revolving credit agreement with Ashland, Inc., which was
amended and extended for one year to March 15, 2003.
At March 31, 2002, in the event of a change in control of Marathon, debt
obligations totaling $3,191 million and operating lease obligations of $101
million may be declared immediately due and payable. In such event,
Marathon may also be required to either repurchase the leased Fairfield
slab caster for $100 million or provide a letter of credit to secure the
remaining obligation.
11. In early March 2002, Marathon issued notes of $450 million due 2012 and
$550 million due 2032, bearing interest at 6.125 percent and 6.8 percent,
respectively. Marathon used the net proceeds to repay amounts borrowed to
fund the purchase price and associated costs of the January 2002
acquisition of interests in oil and gas properties and related assets in
Equatorial Guinea, West Africa. Marathon initially funded this acquisition
through a combination of borrowings under long-term and short-term
revolving credit facilities, borrowings under other short-term credit
facilities and cash on hand.
12. Marathon is the subject of, or party to, a number of pending or threatened
legal actions, contingencies and commitments involving a variety of
matters, including laws and regulations relating to the environment.
Certain of these matters are discussed below. The ultimate resolution of
these contingencies could, individually or in the aggregate, be material to
the consolidated financial statements. However, management believes that
Marathon will remain a viable and competitive enterprise even though it is
possible that these contingencies could be resolved unfavorably.
Marathon is subject to federal, state, local and foreign laws and
regulations relating to the environment. These laws generally provide for
control of pollutants released into the environment and require responsible
parties to undertake remediation of hazardous waste disposal sites.
Penalties may be imposed for noncompliance. At March 31, 2002 and December
31, 2001, accrued liabilities for remediation totaled $80 million and $77
million, respectively. It is not presently possible to estimate the
ultimate amount of all remediation costs that might be incurred or the
penalties that may be imposed. Receivables for recoverable costs from
certain states, under programs to assist companies in cleanup efforts
related to underground storage tanks at retail marketing outlets, were $63
million at March 31, 2002, and $60 million at December 31, 2001.
16
MARATHON OIL CORPORATION
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
---------------------------------------------------------------
(Unaudited)
12. (Continued)
For a number of years, Marathon has made substantial capital expenditures
to bring existing facilities into compliance with various laws relating to
the environment. In the first quarter of 2002 and for the years 2001 and
2000, such capital expenditures totaled $8 million, $67 million and $73
million, respectively. Marathon anticipates making additional such
expenditures in the future; however, the exact amounts and timing of such
expenditures are uncertain because of the continuing evolution of specific
regulatory requirements.
At March 31, 2002 and December 31, 2001, accrued liabilities for platform
abandonment and dismantlement totaled $203 million and $193 million,
respectively.
Marathon guaranteed certain obligations related to the business of United
States Steel. As of March 31, 2002 and December 31, 2001, the exposure for
all of these matters totaled $23 million and $28 million, respectively.
United States Steel is the sole general partner of Clairton 1314B
Partnership, L.P., which owns certain cokemaking facilities formerly owned
by United States Steel. Marathon has guaranteed to the limited partners all
obligations of United States Steel under the partnership documents. United
States Steel may dissolve the partnership under certain circumstances,
including if it is required to fund accumulated cash shortfalls of the
partnership in excess of $150 million. In addition to the normal
commitments of a general partner, United States Steel has indemnified the
limited partners for certain income tax exposures. United States Steel
currently has no unpaid outstanding obligations to the limited partners.
At March 31, 2002, and December 31, 2001, Marathon's pro rata share of
obligations of LOOP LLC and various pipeline investees secured by
throughput and deficiency agreements totaled $112 million. Under the
agreements, Marathon is required to advance funds if the investees are
unable to service debt. Any such advances are prepayments of future
transportation charges.
At March 31, 2002, and December 31, 2001, MAP had guaranteed the repayment
of $47 million and $35 million, respectively of the outstanding balance of
Centennial Pipeline LLC's Master Shelf Agreement.
At March 31, 2002, and December 31, 2001, Marathon's contract commitments
to acquire property, plant and equipment and long-term investments totaled
$404 million and $297 million, respectively.
17
MARATHON OIL CORPORATION AND SUBSIDIARY COMPANIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Marathon Oil Corporation (Marathon), formerly USX Corporation, is engaged
in worldwide exploration and production of crude oil and natural gas; domestic
refining, marketing and transportation of crude oil and petroleum products
primarily through its 62 percent owned subsidiary, Marathon Ashland Petroleum
LLC; and other energy related businesses. Management's Discussion and Analysis
should be read in conjunction with the Consolidated Financial Statements and
Notes to Consolidated Financial Statements. The discussion of the Consolidated
Statement of Income should be read in conjunction with the Supplemental
Statistics provided on page 36.
Prior to December 31, 2001, Marathon had two outstanding classes of common
stock: USX-Marathon Group common stock (Marathon Stock), which was intended to
reflect the performance of Marathon's energy business, and USX-U. S. Steel Group
common stock (Steel Stock), which was intended to reflect the performance of
Marathon's steel business. On December 31, 2001, Marathon disposed of its steel
business by distributing the common stock of its wholly owned subsidiary United
States Steel Corporation (United States Steel) to holders of Steel Stock in
exchange for all outstanding shares of Steel Stock on a one-for-one basis (the
Separation).
Certain sections of Management's Discussion and Analysis include
forward-looking statements concerning trends or events potentially affecting
Marathon. These statements typically contain words such as "anticipates",
"believes", "estimates", "expects" or similar words indicating that future
outcomes are uncertain. In accordance with "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995, these statements are
accompanied by cautionary language identifying important factors, though not
necessarily all such factors, that could cause future outcomes to differ
materially from those set forth in the forward-looking statements. For
additional risk factors affecting the businesses of Marathon, see the
information preceding Part I in the Marathon 2001 Form 10-K.
New Accounting Standards
- ------------------------
Since the issuance of Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133),
the Financial Accounting Standards Board (FASB) has issued several
interpretations. As a result, Marathon must recognize in income beginning on
January 1, 2002, the effect of changes in the fair value of two long-term
natural gas sales contracts in the United Kingdom. As of January 1, 2002,
Marathon recognized a favorable cumulative effect of a change in accounting
principle of $13 million, net of tax of $7 million. The favorable pretax change
in the fair value of the gas contracts during the quarter was $17 million. The
recorded derivative assets will continue to be marked-to-market. Marathon
expects to experience some volatility in earnings as a result of these
interpretations.
Effective January 1, 2002, Marathon adopted the following Statements of
Financial Accounting Standards:
. No. 141 "Business Combinations" (SFAS No. 141),
. No. 142 "Goodwill and Other Intangible Assets" (SFAS No. 142) and
. No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets"
(SFAS No. 144).
18
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
SFAS No. 141 requires that all business combinations initiated after June
30, 2001, be accounted for under the purchase method. The transitional
provisions of SFAS No. 141 required Marathon to reclassify $11 million from
identifiable intangible assets to goodwill.
SFAS No. 142 addresses the accounting for goodwill and other intangible
assets after an acquisition. Effective January 1, 2002, Marathon ceased
amortization of all goodwill, which results in a favorable impact on annual
earnings of approximately $3 million, net of tax. A transitional impairment test
is required for existing goodwill as of the date of adoption. Marathon will
complete the first step of the transitional goodwill impairment test within six
months of the date of adoption, as required.
SFAS No. 144 establishes a single accounting model for long-lived assets to
be disposed of, by sale, and provides additional implementation guidance for
assets to be held and used and assets to be disposed of other than by sale. The
adoption of SFAS No. 144 had no initial effect on Marathon's financial
statements.
In June 2001, the FASB issued Statement of Financial Accounting Standard
No. 143 "Accounting for Asset Retirement Obligations" (SFAS No. 143). Marathon
will adopt this Statement effective January 1, 2003, as required. The adoption
of this Standard will result in a cumulative effect and be reported as a change
in accounting principle. At this time, Marathon cannot reasonably estimate the
effect of adoption on either its financial position or results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standard
No. 145 "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS No. 145). Extinguishment of
debt will be accounted for in accordance with Accounting Principles Board
Opinion No. 30 ("Reporting the Results of Operations Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions"). SFAS No. 145 has a dual effective date. The
provisions relating to the rescission of SFAS No. 4 will be adopted by Marathon
on January 1, 2003. The provisions relating to the amendment of SFAS 13 are
applicable to leasing transactions occurring after May 15, 2002. The adoption of
SFAS No. 145 is not expected to have a material effect on Marathon's financial
position or results of operations.
Critical Accounting Policies
- ----------------------------
The adoption of SFAS No. 133 in 2001 and of SFAS No. 141, 142, and 144 in
2002 have increased the importance of the estimates and judgments used to
determine the fair value of certain assets and liabilities. Derivatives are
reported at fair value. The allocation of purchase price to assets acquired and
liabilities assumed in business combinations are now always based on fair value.
When an impairment of the reported amount of long-lived assets, goodwill or
other intangible assets is indicated, the reported amount of such asset is
reduced to its fair value. As a result, changes in the fair value of assets
could impact reported earnings from period-to-period. The fair value methodology
varies by type of asset and may be based on the use of specifically discounted
cash flows, forward pricing curves and other enterprise-wide evaluation models.
Generally, when employing discounted cash flow methodologies, Marathon uses a
traditional approach, determining the most likely set of future cash flows and
using a discount rate adjusted for uncertainties in the realization of those
cash flows. Marathon does not consider credit risk in the determination of the
fair value of assets but rather separately provides for such uncertainties by
providing an allowance for uncollectible amounts, where appropriate.
19
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Results of Operations
- ---------------------
Revenues and other income for the first quarter of 2002 and 2001 are
summarized in the following table:
First Quarter Ended
March 31
(Dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------------------
Exploration & production ..................................................... $ 837 $ 1,394
Refining, marketing & transportation ......................................... 5,328 6,769
Other energy related businesses .............................................. 462 723
------- -------
Segment revenues and other income ................................... 6,627 8,886
Revenues and other income not allocated to segments:
Gain on ownership change in MAP .......................................... 2 1
Gain on lease resolution with the U.S. Government ........................ -- 59
Elimination of intersegment revenues ......................................... (175) (212)
Elimination of sales to United States Steel .................................. -- (12)
------- -------
Total revenues and other income ..................................... $ 6,454 $ 8,722
======= =======
Items included in both revenues and costs and expenses, resulting in no effect
on income:
Consumer excise taxes on petroleum
products and merchandise ................................................. $ 996 $ 1,038
Matching crude oil, gas and refined product
buy/sell transactions settled in cash:
E&P ................................................................... 72 106
RM&T .................................................................. 833 993
------- -------
Total buy/sell transactions ......................................... $ 905 $ 1,099
======= =======
E&P segment revenues decreased by $557 million in the first quarter of 2002
from the comparable prior-year period. The decrease primarily reflected lower
worldwide natural gas and liquid hydrocarbon prices.
RM&T segment revenues decreased by $1,441 million in the first quarter of
2002 from the comparable prior-year period. The decrease primarily reflected
lower refined product prices.
Other energy related businesses segment revenues decreased by $261 million
in the first quarter of 2002 from the comparable prior-year period. The decrease
primarily reflected lower natural gas resale activity accompanied by lower
natural gas prices.
20
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Income from operations for the first quarter of 2002 and 2001 is summarized
in the following table:
First Quarter Ended
March 31
(Dollars in millions) 2002 2001
- ----------------------------------------------------------------------------------------
E&P
Domestic ............................................ $ 82 $ 442
International ....................................... 83 158
----- -----
E&P segment income ............................... 165 600
RM&T ..................................................... (51) 276
Other energy related businesses .......................... 25 8
----- -----
Segment income ................................ 139 884
Items not allocated to segments:
Administrative expenses ............................ (44) (36)
Inventory Market Valuation ......................... 71 --
Gain on ownership change - MAP ..................... 2 1
Gain on lease resolution with U.S. Government ...... -- 59
----- -----
Total income from operations .................. $ 168 $ 908
===== =====
In the first quarter of 2002 segment income decreased by $745 million from
last year's first quarter, due primarily to lower worldwide natural gas and
liquid hydrocarbon prices, lower refined product margins and lower worldwide
liquid hydrocarbon volumes. This was partially offset by higher natural gas
volumes.
Worldwide E&P segment income in the first quarter of 2002 decreased by $435
million from last year's first quarter, primarily due to the factors discussed
below.
Domestic E&P income in the first quarter of 2002 decreased by $360 million
from last year's first quarter. This decrease was mainly due to lower natural
gas and liquid hydrocarbon prices and lower hydrocarbon and natural gas volumes.
Other factors included higher exploratory dry well expense, partially offset by
lower production taxes and a decrease in derivative losses.
International E&P income in the first quarter of 2002 decreased by $75
million from last year's first quarter. This decrease was mainly due to lower
natural gas and liquid hydrocarbon prices and lower liquid hydrocarbon volumes.
This was partially offset by higher natural gas volumes due to acquisition of
the Equatorial Guinea properties and lower depreciation expense. The lower
volumes and depreciation expense largely resulted from a first quarter 2001 U.K.
overlift versus a first quarter 2002 underlift, as well as the disposition of
Canadian heavy oil properties in late 2001. In addition, first quarter 2002
income includes a $17 million gain related to changes in the fair value of
natural gas sales contracts in the U.K. See Note 3 to the Consolidated Financial
Statements.
21
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
RM&T segment income in the first quarter of 2002 decreased by $327 million
from last year's first quarter. This was the first quarterly loss for the
downstream segment since formation of MAP in January 1998. The decrease in
downstream segment income was primarily due to lower refining and wholesale
marketing gross margins. The refining and wholesale marketing margins were
severely compressed as crude oil costs increased more quickly than refined
product prices during the quarter. A narrowing of the price differential between
sweet and sour crude oil in the first quarter 2002 also negatively impacted
refining and wholesale marketing gross margins.
Other energy related businesses segment income in the first quarter of 2002
increased by $17 million from last year's first quarter. This increase was
primarily the result of marked-to-market valuation changes in derivatives used
to support trading activities, increased gas marketing margins and increased
earnings from pipeline investments.
Net interest and other financial costs were $64 million in the first
quarter of 2002 compared with $42 million in the first quarter of 2001. This
increase was due to higher average debt levels resulting from acquisitions and
the Separation. Also, in the first quarter of 2001, interest and other financial
costs included a favorable adjustment of $9 million related to prior year taxes.
The minority interest in income of MAP, which represents Ashland's 38
percent ownership interest, decreased by $96 million in the first quarter of
2002 from the comparable 2001 period, due to lower RM&T segment income as
discussed above.
The provision for income taxes in the first quarter of 2002 decreased by
$219 million from last year's first quarter primarily due to a decrease in
income before income taxes. In the first quarter of 2002 and 2001, the provision
for income taxes includes unfavorable adjustments of $4 million and $5 million,
respectively, related to prior years' taxes.
Discontinued operations income and costs in the first quarter 2001 related
to the businesses of United States Steel.
The cumulative effect of changes in accounting principles of $13 million,
net of a tax provision of $7 million in the first quarter of 2002 represents the
adoption of recently issued interpretations by the FASB of SFAS No. 133 in which
Marathon must recognize in income the effect of changes in the fair value of two
long term natural gas contracts in the United Kingdom. The $8 million loss, net
of a tax benefit of $5 million, in the first quarter of 2001 was an unfavorable
transition adjustment related to the adoption of SFAS No. 133. For further
discussion, see Note 3 to the Consolidated Financial Statements.
Net income for the first quarter decreased by $442 million in 2002 from
2001, primarily reflecting the factors discussed above.
Dividends to Stockholders
- -------------------------
On April 24, 2002, the Marathon Board of Directors (the Board) declared
dividends of 23 cents per share, payable June 10, 2002, to stockholders of
record at the close of business on May 16, 2002.
22
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Cash Flows
- ----------
Net cash provided from operating activities was $294 million in the first
quarter of 2002, compared with $571 million (from continuing operations) in the
first quarter of 2001. The $277 million decrease mainly reflects the effects of
lower net income (excluding noncash items) partially offset by net favorable
working capital changes.
Capital expenditures in the first quarter of 2002 totaled $292 million
excluding the acquisition of Equatorial Guinea interests, compared with $276
million in the first quarter of 2001. The $16 million increase mainly reflected
increased spending in the first quarter of 2002 on international production
property acquisitions. For additional information regarding capital
expenditures, refer to the Supplemental Statistics on page 36.
Acquisitions included cash payments of $1,013 million in the first quarter
of 2002 for Equatorial Guinea interests and $506 million in the first quarter of
2001 for Pennaco Energy, Inc. (Pennaco). For further discussion of acquisitions,
see Note 6 to the Consolidated Financial Statements.
Cash from disposal of assets was $21 million in the first quarter of 2002,
compared with $34 million in the first quarter of 2001. In 2002 proceeds were
primarily from the disposition of certain Speedway SuperAmerica LLC (SSA)
stores. Proceeds in 2001 were mainly from the sale of various Canadian oil
fields, various domestic producing properties and certain SSA stores.
Net cash provided from financing activities was $565 million in the first
quarter of 2002, compared with net cash used of $11 million in the first quarter
2001. The increase was due to the financing primarily associated with the
acquisition of Equatorial Guinea interests of approximately $1 billion. This was
partially offset by the $294 million repayment of preferred securities which
became redeemable or were converted to a right to receive cash upon the
Separation. In early January 2002, Marathon paid $185 million to retire the
6.75% Convertible Quarterly Income Preferred Securities and $109 million to
retire the 6.50% Cumulative Convertible Preferred Stock.
Derivative Instruments
- ----------------------
See Quantitative and Qualitative Disclosure About Market Risk for
discussion of derivative instruments and associated market risk.
Debt and Preferred Stock Ratings
- --------------------------------
Marathon's senior debt is currently rated investment grade by Standard and
Poor's Corporation, Moody's Investor Services, Inc. and Fitch Ratings with
ratings of BBB+, Baa1, and BBB+, respectively.
23
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Liquidity
- ---------
Marathon's main sources of liquidity and capital resources are internally
generated cash flow from operations, committed and uncommitted credit
facilities, and access to both the debt and equity capital markets. Marathon's
ability to access the debt capital market is supported by its investment grade
credit ratings. Because of the liquidity and capital resource alternatives
available to Marathon, including internally generated cash flow, Marathon's
management believes that its short-term and long-term liquidity is adequate to
fund operations, including its capital spending program, repayment of debt
maturities for the years 2002, 2003, and 2004, and any amounts that may
ultimately be paid in connection with contingencies.
Marathon has a committed $1,354 million long-term revolving credit facility
and a committed $451 million 364-day revolving credit facility. At March 31,
2002, $400 million had been drawn against these facilities. Additionally, at
March 31, 2002, Marathon had other uncommitted short-term lines of credit
totaling $200 million, of which no amounts were drawn. MAP currently has a
committed $350 million long-term revolving credit facility and a committed $100
million 364-day revolving credit facility. As of March 31, 2002, MAP did not
have any borrowings against these facilities and had $22 million outstanding
under its $190 million revolving credit agreement with Ashland.
In early March 2002, Marathon issued notes of $450 million due 2012 and
$550 million due 2032, bearing interest at 6.125 percent and 6.8 percent,
respectively. Marathon used the net proceeds to repay amounts borrowed to fund
the purchase price and associated costs of the January 2002 acquisition of
interests in oil and gas properties and related assets in Equatorial Guinea,
West Africa. Marathon initially funded this acquisition through a combination of
borrowings under long-term and short-term revolving credit facilities,
borrowings under other short-term credit facilities and cash on hand.
Marathon is not dependent on off-balance sheet arrangements to meet its
liquidity and capital resource needs. Marathon has used and may use in the
future off-balance sheet arrangements to fund specific projects.
Contract commitments for property, plant and equipment acquisitions and
long-term investments at March 31, 2002, totaled $404 million compared with $297
million at December 31, 2001.
In April 2002, Marathon cancelled its stock repurchase program and
reinstated its dividend reinvestment program and direct stock purchase plan for
first-time, non-employee purchasers of Marathon common stock. Since the stock
repurchase program was authorized, Marathon acquired 3,976,800 shares of common
stock at a cost of $106 million as Marathon's financial condition and market
conditions warranted.
Marathon management's opinion concerning liquidity and Marathon's ability
to avail itself in the future of the financing options mentioned in the above
forward-looking statements are based on currently available information. To the
extent that this information changes, future availability of financing may be
adversely affected. Factors that affect the availability of financing include
the performance of Marathon (as measured by various factors including cash
provided from operating activities), the state of worldwide debt and equity
markets, investor perceptions and expectations of past and future performance,
the global financial climate, and, in particular, with respect to borrowings,
the levels of Marathon's outstanding debt and credit ratings by rating agencies.
24
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Obligations Associated with the Separation of United States Steel
- -----------------------------------------------------------------
Marathon remains obligated (primarily or contingently) for certain debt and
other financial arrangements for which United States Steel has assumed
responsibility for repayment under the terms of the Separation. In the event of
United States Steel's failure to satisfy these obligations, Marathon would
become responsible for repayment. As of March 31, 2002, Marathon has identified
the following obligations totaling $701 million which have been assumed by
United States Steel:
. $470 million of industrial revenue bonds related to environmental
improvement projects for current and former United States Steel
facilities, with maturities ranging from 2009 through 2033. Accrued
interest payable on these bonds was $6 million at March 31, 2002.
. $84 million of sale-leaseback financing under a lease for equipment at
United States Steel's Fairfield Works, with a term extending to 2012,
subject to extensions. Accrued interest payable on this financing was
$3 million at March 31, 2002.
. $115 million of operating lease obligations, of which $96 million was
in turn assumed by purchasers of major equipment used in plants and
operations divested by United States Steel.
. A guarantee of United States Steel's $23 million contingent obligation
to repay certain distributions from its 50%-owned joint venture
PRO-TEC Coating Company.
. A guarantee of all obligations of United States Steel as general
partner of Clairton 1314B Partnership, L.P. to the limited partners.
United States Steel currently has no unpaid outstanding obligations to
the limited partners. For further discussion of the Clairton 1314B
guarantee, see Note 12 to the Consolidated Financial Statements.
Of the total $701 million, obligations of $563 million and corresponding
receivables from United States Steel were recorded on Marathon's consolidated
balance sheet (current portion - $12 million; long-term portion - $551 million).
The remaining $138 million was related to off-balance sheet arrangements and
contingent liabilities of United States Steel.
United States Steel reported in its Form 10-Q for the quarterly period
ended March 31, 2002, that it has significant restrictive covenants related to
its indebtedness including cross-default and cross-acceleration clauses on
selected debt which could have an adverse effect on its financial position and
liquidity. However, United States Steel management believes that its liquidity
will be adequate to satisfy its obligations for the foreseeable future. If there
is a prolonged delay in the recovery of the manufacturing sector of the U.S.
economy, United States Steel believes that it can maintain adequate liquidity
through a combination of deferral of nonessential capital spending, sale of
non-strategic assets and other cash conservation measures.
25
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Environmental Matters, Contingencies and Commitments
- ----------------------------------------------------
Marathon has incurred and will continue to incur substantial capital,
operating and maintenance, and remediation expenditures as a result of
environmental laws and regulations. To the extent these expenditures, as with
all costs, are not ultimately reflected in the prices of Marathon's products and
services, operating results will be adversely affected. Marathon believes that
substantially all of its competitors are subject to similar environmental laws
and regulations. However, the specific impact on each competitor may vary
depending on a number of factors, including the age and location of its
operating facilities, marketing areas, production processes and whether or not
it is engaged in the petrochemical business or the marine transportation of
crude oil and refined products.
Marathon has been notified that it is a potentially responsible party (PRP)
at 12 waste sites under the Comprehensive Environmental Response, Compensation
and Liability Act (CERCLA) as of March 31, 2002. In addition, there are three
sites where Marathon has received information requests or other indications that
Marathon may be a PRP under CERCLA but where sufficient information is not
presently available to confirm the existence of liability. There are also 113
additional sites, excluding retail marketing outlets, related to Marathon where
remediation is being sought under other environmental statutes, both federal and
state, or where private parties are seeking remediation through discussions or
litigation. Of these sites, 13 were associated with properties conveyed to MAP
by Ashland for which Ashland has retained liability for all costs associated
with remediation. At many of these sites, Marathon is one of a number of parties
involved and the total cost of remediation, as well as Marathon's share thereof,
is frequently dependent upon the outcome of investigations and remedial studies.
Marathon accrues for environmental remediation activities when the
responsibility to remediate is probable and the amount of associated costs is
reasonably determinable. As environmental remediation matters proceed toward
ultimate resolution or as additional remediation obligations arise, charges in
excess of those previously accrued may be required. See Note 12 to the
Consolidated Financial Statements.
New or expanded environmental requirements, which could increase Marathon's
environmental costs, may arise in the future. Marathon intends to comply with
all legal requirements regarding the environment, but since many of them are not
fixed or presently determinable (even under existing legislation) and may be
affected by future legislation, it is not possible to predict accurately the
ultimate cost of compliance, including remediation costs which may be incurred
and penalties which may be imposed. However, based on presently available
information, and existing laws and regulations as currently implemented,
Marathon does not anticipate that environmental compliance expenditures
(including operating and maintenance and remediation) will materially increase
in 2002. Marathon's environmental capital expenditures are expected to be
approximately $130 million in 2002. Predictions beyond 2002 can only be
broad-based estimates, which have varied, and will continue to vary, due to the
ongoing evolution of specific regulatory requirements, the possible imposition
of more stringent requirements and the availability of new technologies, among
other matters. Based upon currently identified projects, Marathon anticipates
that environmental capital expenditures will be approximately $157 million in
2003; however, actual expenditures may vary as the number and scope of
environmental projects are revised as a result of improved technology or changes
in regulatory requirements and could increase if additional projects are
identified or additional requirements are imposed.
26
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
Marathon is the subject of, or a party to, a number of pending or
threatened legal actions, contingencies and commitments involving a variety of
matters, including laws and regulations relating to the environment. See Note 12
to the Consolidated Financial Statements for a discussion of certain of these
matters. The ultimate resolution of these contingencies could, individually or
in the aggregate, be material to Marathon. However, management believes that
Marathon will remain a viable and competitive enterprise even though it is
possible that these contingencies could be resolved unfavorably to Marathon. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity".
Outlook
- -------
The outlook regarding Marathon's upstream revenues and income is largely
dependent upon future prices and volumes of liquid hydrocarbons and natural gas.
Prices have historically been volatile and have frequently been affected by
unpredictable changes in supply and demand resulting from fluctuations in
worldwide economic activity and political developments in the world's major oil
and gas producing and consuming areas. Any significant decline in prices could
have a material adverse effect on Marathon's results of operations. A prolonged
decline in such prices could also adversely affect the quantity of crude oil and
natural gas reserves that can be economically produced and the amount of capital
available for exploration and development.
In 2002, worldwide production is expected to average 430,000 barrels of oil
equivalent per day, split evenly between liquid hydrocarbons and natural gas,
including Marathon's proportionate share of equity investee's production.
In 2002, Marathon plans to drill, or complete drilling operations on, three
or four deepwater wells in the Gulf of Mexico, including the appraisal of the
Ozona Deep discovery.
Other major upstream projects, which are currently underway or under
evaluation and are expected to improve future income streams, include:
. Norway, where Marathon has completed the acquisition of various
interests in five licenses in the Norwegian sector of the North Sea;
. Alaska, where Marathon recently had a natural gas discovery on the
Ninilchik Unit on the Kenai Peninsula with additional drilling planned
in 2002;
. Angola, where Marathon expects to participate in the drilling of up to
three exploration wells during 2002; and
. Eastern Canada, where Marathon is currently drilling the Annapolis
well.
On February 28, 2002, Marathon announced proposed plans for a major
liquefied natural gas (LNG) re-gasification and power generation complex near
Tijuana in the Mexican State of Baja California. The proposed complex would
consist of a LNG marine terminal, an off-loading terminal, onshore LNG
re-gasification facilities, and pipeline infrastructure necessary to transport
the natural gas. In addition, a 400 megawatt natural gas-fired power generation
plant would be constructed on the site. The complex would supply natural gas and
electricity for local use as well as for export to Southern California.
Completion and potential start-up is projected for 2005.
27
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
On February 28, 2002, Marathon announced plans to lead an initiative for a
new North Sea natural gas pipeline designed to provide additional gas for the
U.K. market. The proposed natural gas pipeline would connect the Norwegian
Heimdal area of the North Sea to Bacton, on the southeast coast of the U.K. The
pipeline would pass through the Brae complex and pass adjacent to other large
gas processing/transportation facilities in the U.K. North Sea. The pipeline
would terminate at or near the existing Bacton Terminal. The pipeline would
allow gas to be aggregated from numerous U.K. and Norwegian North Sea producers
for transportation to Bacton where it would then be sold to commercial,
industrial and residential customers. Marathon estimates that the pipeline could
begin operations as early as 2005.
On April 8, 2002, Marathon announced it had experienced and contained a
well-control event caused by an influx of gas at Marathon's Annapolis deepwater
exploratory well off shore Nova Scotia. The Annapolis B-24 well is located 215
miles south of Halifax in 5,700 feet of water. Drilling of the well was
suspended on March 24 when the gas influx occurred at an intermediate well depth
of 11,469 feet. The well has been plugged and abandoned for mechanical reasons
and drilling has commenced on a new Annapolis G-24 well located approximately
1,633 feet NNE of the previous surface location. Marathon holds a 30 percent
interest in the Annapolis prospect and serves as operator.
On April 17, 2002, the U.K. Chancellor announced a proposed supplementary
10 percent tax on profits from North Sea oil and gas production. Marathon has
approximately 19 percent of current year production originating from the UK. If
enacted as proposed the potential effects of these tax changes could add
approximately 2 percentage points to Marathon's effective tax rate, excluding a
one-time non-cash deferred tax liability catch-up adjustment.
On May 1, 2002, Marathon completed the recently announced asset trade with
XTO Energy Inc. (XTO), whereby Marathon exchanged certain oil and gas properties
in east Texas and north Louisiana for XTO coalbed methane assets in the Powder
River Basin of northern Wyoming and southern Montana. These assets will allow
Marathon to leverage its expertise in coalbed methane development in this core
area. In a separate transaction expected to close July 1, 2002, XTO will
purchase Marathon's production interests in the San Juan Basin of New Mexico for
$43 million. As a result of the asset trade, Marathon is expected to add some
110 billion cubic feet of proved reserves in the Powder River Basin. Marathon
also expects to reduce per-unit operating expenses by leveraging economies of
scale in this core area. The overall effect of the transactions on 2002
worldwide annual production is expected to be neutral or slightly positive.
These agreements are part of a trade auction announced in late February 2002 to
market selected properties in a competitive process designed to establish a
greater presence in core areas where Marathon's size, infrastructure and
regional expertise will create additional value. Additional trade transactions
are also being pursued.
The above discussion includes forward-looking statements with respect to
the timing and levels of Marathon's worldwide liquid hydrocarbon and natural gas
production, the exploration drilling program, the planned construction of LNG
and pipeline facilities, the anticipated closing for the sale of production
assets, additional reserves and reductions in operating expenses. Some factors
that could potentially affect worldwide liquid hydrocarbon and natural gas
production and the exploration drilling program include acts of war or terrorist
acts and the governmental
28
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
or military response, pricing, supply and demand for petroleum products, amount
of capital available for exploration and development, occurrence of
acquisitions/dispositions of oil and gas properties, regulatory constraints,
timing of commencing production from new wells, drilling rig availability and
other geological, operating and economic considerations. Some factors that could
affect the planned construction of the LNG re-gasification, power generation and
related facilities, as well as the North Sea pipeline transportation and related
facilities, include, but are not limited to, unforeseen difficulty in the
negotiation of definitive agreements among project participants, identification
of additional participants to reach optimum levels of participation, inability
or delay in obtaining necessary government and third-party approvals, arranging
sufficient project financing, unanticipated changes in market demand or supply,
competition with similar projects and environmental and permitting issues.
Additionally, the LNG project could be impacted by the availability or
construction of sufficient LNG vessels. The forward-looking information related
to the sale of production assets, reserve additions and anticipated operating
expense reduction is based on certain assumptions, including, among others,
closing of the transaction, presently known physical data concerning size and
character of reservoirs, economic recoverability, technology development, future
drilling success, production experience, industry economic conditions, levels of
cash flow from operations and operating conditions. The foregoing factors (among
others) could cause actual results to differ materially from those set forth in
the forward-looking statements.
Marathon's downstream income is largely dependent upon the refining and
wholesale marketing margin for refined products, the retail gross margin for
gasoline and distillates, and the gross margin on retail merchandise sales. The
refining and wholesale marketing margin reflects the difference between the
wholesale selling prices of refined products and the cost of raw materials
refined, purchased product costs and manufacturing expenses. Refining and
wholesale marketing margins have been historically volatile and vary with the
level of economic activity in the various marketing areas, the regulatory
climate, the seasonal pattern of certain product sales, crude oil costs,
manufacturing costs, the available supply of crude oil and refined products, and
logistical constraints. The retail gross margin for gasoline and distillates
reflects the difference between the retail selling prices of these products and
their wholesale cost, including secondary transportation. Retail gasoline and
distillate margins have also been historically volatile, but tend to be
countercyclical to the refining and wholesale marketing margin. Factors
affecting the retail gasoline and distillate margin include seasonal demand
fluctuations, the available wholesale supply, the level of economic activity in
the marketing areas and weather situations that impact driving conditions. The
gross margin on retail merchandise sales tends to be less volatile than the
retail gasoline and distillate margin. Factors affecting the gross margin on
retail merchandise sales include consumer demand for merchandise items and the
level of economic activity in the marketing area.
At its Catlettsburg, Kentucky refinery, MAP has initiated a multi-year
integrated investment program to upgrade product yield realizations and reduce
fixed and variable manufacturing expenses. This program involves the expansion,
conversion and retirement of certain refinery processing units which, in
addition to improving profitability, will reduce the refinery's total gasoline
pool sulfur below 30 ppm, thereby eliminating the need for low sulfur gasoline
compliance investments at the refinery. The project is expected to be completed
in 2004.
29
MARATHON OIL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
MAP is working to improve its logistics network, and Marathon Ashland Pipe
Line LLC has been designated operator of the Centennial Pipeline, owned jointly
by Panhandle Eastern Pipe Line Company, a subsidiary of CMS Energy Corporation,
MAP, and TE Products Pipe Line Company, Limited Partnership. The new pipeline
system, which connects the Gulf Coast refiners with the Midwest market, has the
initial capacity to transport approximately 210,000 barrels per day of refined
petroleum products and began deliveries of refined products on April 4, 2002.
A MAP subsidiary, Ohio River Pipe Line LLC (ORPL), plans to build a
pipeline from Kenova, West Virginia to Columbus, Ohio. ORPL is a common carrier
pipeline company and the pipeline will be an interstate common carrier pipeline.
The pipeline is currently known as Cardinal Products Pipe Line and is expected
to initially move about 50,000 barrels per day of refined petroleum into the
central Ohio region. As of December 2001, ORPL had secured all of the
rights-of-way required to build the pipeline. Applications for the remaining
construction permits have been filed. Construction is currently planned for
summer 2002 pending receipt of permits, with start-up of the pipeline expected
to follow in the first half of 2003.
The above discussion includes forward-looking statements with respect to
the Catlettsburg refinery and the Cardinal Products Pipe Line system. Some
factors that could potentially cause the actual results from the Catlettsburg
investment program to differ materially from current expectations include the
price of petroleum products, levels of cash flows from operations, obtaining the
necessary construction and environmental permits, unforeseen hazards such as
weather conditions and regulatory approval constraints. Some factors that could
impact the Cardinal Products Pipe Line include obtaining the necessary permits
and completion of construction. These factors (among others) could cause actual
results to differ materially from those set forth in the forward-looking
statements.
30
MARATHON OIL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
------------------------------------
Management Opinion Concerning Derivative Instruments
- ----------------------------------------------------
Management has authorized the use of futures, forwards, swaps and options
to manage exposure to market fluctuations related to commodities, interest
rates, and foreign currency.
Marathon uses commodity-based derivatives to manage price risk related to
the purchase, production or sale of crude oil, natural gas, and refined
products. To a lesser extent, Marathon is exposed to the risk of price
fluctuations on natural gas liquids and on petroleum feedstocks used as raw
materials. Marathon's refining, marketing, and transportation (RM&T) segment
generally uses derivative commodity instruments to mitigate the price risk
associated with crude oil and other feedstocks, to protect carrying values of
inventories and to protect margins on fixed-price sales of refined products.
Marathon's other energy related businesses are exposed to market risk associated
with the purchase and subsequent resale of natural gas. Marathon uses derivative
instruments to mitigate the price risk on purchased volumes and anticipated
sales volumes. From time-to-time, as market conditions change, Marathon
evaluates its risk management program and could enter into strategies that
assume market risk whereby cash settlement of commodity-based derivatives will
be based on market prices. In addition, when it is deemed to be advantageous,
Marathon may lock-in market prices on portions of its production.
From time to time Marathon enters into financial instrument hedging
activities involving the economic hedging of interest rate exposures. As
derivative positions are entered into, assessments are made as to the
qualification of each transaction for hedge accounting under SFAS No. 133.
Management believes that use of derivative instruments along with risk
assessment procedures and internal controls does not expose Marathon to material
risk. However, the use of derivative instruments could materially affect
Marathon's results of operations in particular quarterly or annual periods.
Management believes that use of these instruments will not have a material
adverse effect on financial position or liquidity.
Commodity Price Risk and Related Risks
- --------------------------------------
Marathon's strategy for managing market price risk has generally been to
obtain competitive prices for its products and services and allow operating
results to reflect market price movements dictated by supply and demand.
However, Marathon uses derivative commodity instruments to manage a portion of
its commodity price risk associated with fixed-price contracts. Marathon also
may use a variety of instruments, including zero-cost collar options, to
mitigate significant downside price risk on oil and gas production. These
instruments are used as part of Marathon's overall risk management programs.
31
MARATHON OIL CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Commodity Price Risk and Related Risks - (Continued)
- ----------------------------------------------------
Sensitivity analysis of the incremental effects on pretax income of
hypothetical 10 percent and 25 percent changes in commodity prices for open
derivative commodity instruments are provided in the following table(a):
Incremental Decrease in
Income Before Income Taxes
Assuming a Hypothetical
Price Change of:(a)
(Dollars in millions) 10% 25%
- --------------------------------------------------------------------------------
Derivative Commodity Instruments(b)(c)
Crude oil(f) .................................. $10.9(d) $52.7(d)
Natural gas(f) ................................ 36.6(d) 94.3(d)
Refined products(f) ........................... 1.2(e) 2.9(e)
(a) Amounts adjusted to reflect Marathon's 62 percent ownership of MAP.
Marathon remains at risk for possible changes in the market value of
derivative instruments; however, such risk should be mitigated by price
changes in the underlying hedged item. Effects of these offsets are not
reflected in the sensitivity analysis. Amounts reflect hypothetical 10% and
25% changes in closing commodity prices for each open contract position at
March 31, 2002. Marathon management evaluates its portfolio of derivative
commodity instruments on an ongoing basis and adds or revises strategies to
reflect anticipated market conditions and changes in risk profiles.
Marathon is also exposed to credit risk in the event of nonperformance by
counterparties. The creditworthiness of counterparties is subject to
continuing review, including the use of master netting agreements to the
extent practical. Changes to the portfolio subsequent to March 31, 2002,
would cause future pretax income effects to differ from those presented in
the table.
(b) Net open contracts for the combined E&P and OERB segments varied throughout
the first quarter 2002, from a low of 16,520 contracts at February 18, to a
high of 29,863 contracts at March 31, and averaged 18,309 for the quarter.
The number of net open contracts for the RM&T segment varied throughout the
first quarter 2002, from a low of 1,668 contracts at March 11, to a high of
9,081 contracts at January 2, and averaged 2,356 for the quarter. The net
open contracts represent 100% of MAP's positions. The derivative commodity
instruments used and hedging positions taken will vary and, because of
these variations in the composition of the portfolio over time, the number
of open contracts by itself cannot be used to predict future income
effects.
(c) The calculation of sensitivity amounts for basis swaps assumes that the
physical and paper indices are perfectly correlated. Gains and losses on
options are based on changes in intrinsic value only.
(d) Price increase.
(e) Price decrease.
(f) The direction of the price change used in calculating the sensitivity
amount for each commodity reflects that which would result in the largest
incremental decrease in pretax income when applied to the derivative
commodity instruments used to hedge that commodity.
32
MARATHON OIL CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Commodity Price Risk and Related Risks - (Continued)
- ----------------------------------------------------
E&P Segment
Marathon uses derivative instruments in its E&P segment to mitigate the
price risk associated with equity production of crude oil and natural gas. As of
March 31, 2002, Marathon has hedged approximately 22% of its remaining 2002
worldwide equity crude production through the use of zero-cost collar options.
These collars have been structured so that on average Marathon will receive the
following:
. When prices are below $19.25, market price plus $4 per barrel;
. $23.25 when prices are between $19.25 and $23.25;
. Market price when prices are between $23.25 and $28.87; and
. No participation in market price movements above $28.87.
The above-mentioned strategy is being marked-to-market and is reflected in
income for the period.
As of March 31, 2002, Marathon has hedged approximately 29% of its
remaining 2002 worldwide equity natural gas production. Different hedging
strategies have been employed including the use of zero-cost collar options. In
one of the more significant hedges, Marathon has hedged 161 MMCFD at an average
of $4.34 per MCF for the balance of 2002 relating to the Powder River Basin
area. A portion of the above-mentioned strategy is being marked-to-market and is
reflected in income for the period. The balance qualifies for hedge accounting
under SFAS 133. Marathon has also entered into a zero-cost collar on 200 MMCFD
for June through December, whereby Marathon will receive up to $4.48 per MCF but
no less than $3.19 per MCF. The above-mentioned strategy is being
marked-to-market and is reflected in income for the period.
As of May 14, 2002, Marathon has hedged an additional 7% of its remaining
2002 worldwide equity crude production and 4% of its worldwide equity natural
gas production for 2003 through the use of zero-cost collar options.
Total net pretax derivative gains for the E&P segment were $28 million for
the first quarter of 2002 compared with losses of $18 million for the first
quarter of 2001.
RM&T Segment
Total net pretax derivative losses, net of the 38 percent minority interest
in MAP, were $19 million for the first quarter 2002 compared with gains of $24
million for the first quarter 2001. Marathon's trading activity gains and losses
were less than $1 million for the first quarter 2002 and 2001.
OERB Segment
Marathon has sold forward a specified volume of natural gas. Marathon has
used derivatives to convert the fixed price in this contract to market prices.
The underlying physical contract matures in 2008. Marathon generally will use
derivative instruments to assume market risk on these contracts. In addition,
Marathon uses fixed-price physical contracts for portions of its purchase for
resale volumes to manage exposure to fluctuations in natural gas prices. Total
net pretax derivative losses were $3 million and $37 million for the first
quarter of 2002 and 2001, respectively.
33
MARATHON OIL CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Other Commodity Related Risks
- -----------------------------
Marathon is subject to basis risk, caused by factors that affect the
relationship between commodity futures prices reflected in derivative commodity
instruments and the cash market price of the underlying commodity. Natural gas
transaction prices are frequently based on industry reference prices that may
vary from prices experienced in local markets. For example, New York Mercantile
Exchange (NYMEX) contracts for natural gas are priced at Louisiana's Henry Hub,
while the underlying quantities of natural gas may be produced and sold in the
Western United States at prices that do not move in strict correlation with
NYMEX prices. To the extent that commodity price changes in one region are not
reflected in other regions, derivative commodity instruments may no longer
provide the expected hedge, resulting in increased exposure to basis risk. These
regional price differences could yield favorable or unfavorable results. OTC
transactions are being used to manage exposure to a portion of basis risk.
Marathon is subject to liquidity risk, caused by timing delays in
liquidating contract positions due to a potential inability to identify a
counterparty willing to accept an offsetting position. Due to the large number
of active participants, liquidity risk exposure is relatively low for
exchange-traded transactions.
Interest Rate Risk
- ------------------
Sensitivity analysis of the incremental effects on the change in fair value
assuming a hypothetical 10 percent change in interest rates is provided in the
following table:
Incremental
(Dollars in millions) Fair Increase in
Value(c) Fair Value(a)
- ---------------------------------------------------------------------------
Financial liabilities:
Long-term debt(b)....................... $4,693 $206
(a) For financial liabilities, this assumes a 10% decrease in the weighted
average yield to maturity of Marathon's long-term debt at March 31, 2002
(b) Includes amounts due within one year.
(c) Fair value was based on market prices where available, or current borrowing
rates for financings with similar terms and maturities.
At March 31, 2002, Marathon's portfolio of long-term debt was substantially
comprised of fixed-rate instruments. Therefore, the fair value of the portfolio
is relatively sensitive to effects of interest rate fluctuations. This
sensitivity is illustrated by the $206 million increase in the fair value of
long-term debt assuming a hypothetical 10 percent decrease in interest rates.
However, Marathon's sensitivity to interest rate declines and corresponding
increases in the fair value of its debt portfolio would unfavorably affect
Marathon's results and cash flows only to the extent that Marathon would elect
to repurchase or otherwise retire all or a portion of its fixed-rate debt
portfolio at prices above carrying value.
34
MARATHON OIL CORPORATION
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
-----------------------------
Foreign Currency Exchange Rate Risk
- -----------------------------------
As of March 31, 2002, the discussion of foreign currency exchange rate risk
has not changed materially from that presented in Quantitative and Qualitative
Disclosures About Market Risk included in Marathon's 2001 Form 10-K.
Safe Harbor
- -----------
Marathon's quantitative and qualitative disclosures about market risk
include forward-looking statements with respect to management's opinion about
risks associated with the use of derivative instruments. These statements are
based on certain assumptions with respect to market prices and industry supply
and demand for crude oil, natural gas, and refined products. To the extent that
these assumptions prove to be inaccurate, future outcomes with respect to
Marathon's hedging programs may differ materially from those discussed in the
forward-looking statements.
35
MARATHON OIL CORPORATION
SUPPLEMENTAL STATISTICS (Unaudited)
-----------------------------------
First Quarter
Ended March 31
(Dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS
Exploration & Production
United States.............................................................. $82 $442
International.............................................................. 83 158
----- -----
E&P Segment Income....................................................... 165 600
Refining, Marketing & Transportation(a)...................................... (51) 276
Other Energy Related Businesses(b)........................................... 25 8
----- -----
Segments Income........................................................ $139 $884
Items Not Allocated To Segments:
Administrative Expenses...................................................... $(44) $(36)
Inventory market valuation credit............................................ 71 -
Gain on Ownership Change - MAP............................................... 2 1
Gain on lease resolution with U.S. Government................................ - 59
----- -----
Income From Operations................................................... $168 $908
CAPITAL EXPENDITURES
Exploration & Production..................................................... $218 $157
Refining, Marketing & Transportation......................................... 69 97
Other(c)..................................................................... 5 22
----- -----
Total.................................................................... $292 $276
EXPLORATION EXPENSE
United States................................................................ $49 $13
International................................................................ 8 10
----- -----
Total.................................................................... $57 $23
OPERATING STATISTICS
Net Liquid Hydrocarbon Production(d)
United States................................................................ 122.2 124.4
Equity Investee (MKM)........................................................ 8.8 10.3
----- -----
Total United States........................................................ 131.0 134.7
Europe....................................................................... 45.4 53.9
Other International.......................................................... 4.1 14.6
West Africa.................................................................. 25.4 19.6
Equity Investee (CLAM)....................................................... .1 .1
----- -----
Total International........................................................ 75.0 88.2
----- -----
Worldwide.................................................................. 206.0 222.9
Net Natural Gas Production(e)(f)
United States................................................................ 786.7 789.0
Europe....................................................................... 335.8 345.6
Other International.......................................................... 105.5 130.1
West Africa.................................................................. 49.1 -
Equity Investee (CLAM)....................................................... 31.5 34.7
----- -----
Total International........................................................ 521.9 510.4
----- -----
Worldwide.................................................................. 1,308.6 1,299.4
Total production (MBOEPD)......................................................... 424.1 439.5
36
MARATHON OIL CORPORATION
SUPPLEMENTAL STATISTICS (Unaudited)
-----------------------------------
First Quarter
Ended March 31
2002 2001
- --------------------------------------------------------------------------------------------------------------------
OPERATING STATISTICS
Average Sales Prices (excluding derivative gains and losses)
Liquids Hydrocarbons
United States.............................................................. $ 17.98 $ 23.97
Equity Investee (MKM)...................................................... 20.05 25.57
Total United States...................................................... 18.12 24.09
Europe..................................................................... 20.35 25.37
Other International........................................................ 18.35 22.00
West Africa................................................................ 20.84 24.99
Equity Investee (CLAM)..................................................... - 37.12
Total International...................................................... 20.37 24.74
Worldwide................................................................ $ 18.94 $ 24.35
Natural Gas/(g)/
United States.............................................................. $ 2.35 $ 5.73
Europe..................................................................... 2.92 2.96
Other International........................................................ 1.88 6.08
West Africa................................................................ .24 -
Equity Investee (CLAM)..................................................... 3.04 3.33
Total International...................................................... 2.46 3.80
Worldwide................................................................ $ 2.39 $ 4.98
Average Sales Prices (including derivative gains and losses)
Liquids Hydrocarbons
United States.............................................................. $ 16.50 $ 23.97
Equity Investee (MKM) 20.05 25.57
Total United States...................................................... 16.74 24.09
Europe..................................................................... 20.35 25.37
Other International........................................................ 18.35 22.00
West Africa................................................................ 20.84 24.99
Equity Investee (CLAM)..................................................... - 37.12
Total International...................................................... 20.37 24.74
Worldwide................................................................ $ 18.06 $ 24.35
Natural Gas/(g)/
United States.............................................................. $ 2.46 $ 5.47
Europe .................................................................... 3.48 2.96
Other International........................................................ 1.88 6.06
West Africa................................................................ .24 -
Equity Investee (CLAM)..................................................... 3.04 3.33
Total International...................................................... 2.82 3.79
Worldwide................................................................ $ 2.59 $ 4.82
MAP:
Crude Oil Refined/(d)/............................................................ 891.0 869.9
Consolidated Refined Products Sold/(d)/........................................... 1,227.8 1,253.0
Matching buy/sell volumes included in refined
products sold/(d)/.............................................................. 54.1 53.4
Refining and Wholesale Marketing Margin/(h)(i)/................................... $ .0162 $ 0.0865
Number of SSA retail outlets/(k)/................................................. 2,097 2,088
SSA Gasoline and Distillate Sales/(j)(k)/......................................... 852 848
SSA Gasoline and Distillate Gross Margin/(h)(k)/.................................. $ .0827 $ 0.1068
SSA Merchandise Sales/(k)/........................................................ $ 540 $ 488
SSA Merchandise Gross Margin/(k)/................................................. $ 130 $ 114
- --------------
37
MARATHON OIL CORPORATION
SUPPLEMENTAL STATISTICS (Unaudited)
-----------------------------------
/(a)/ Includes MAP at 100%. RM&T segment income (loss) includes Ashland's 38%
interest in MAP of $(17) million, and $108 million in the first quarter
of 2002 and 2001, respectively.
/(b)/ Includes United States and Europe natural gas and crude oil marketing and
transportation, and methanol production in West Africa.
/(c)/ Includes other energy related businesses and corporate capital
expenditures.
/(d)/ Thousands of barrels per day
/(e)/ Millions of cubic feet per day
/(f)/ Includes gas acquired for injection and subsequent resale of 3.8 and 9.1
mmcfd in the first quarters of 2002 and 2001, respectively.
/(g)/ Prices exclude gas acquired for injection and subsequent resale.
/(h)/ Per gallon
/(i)/ Sales revenue less cost of refinery inputs, purchased products and
manufacturing expenses, including depreciation.
/(j)/ Millions of gallons
/(k)/ Excludes travel centers contributed to Pilot Travel Centers LLC.
Periods prior to September 1, 2001 have been restated.
38
Part II - Other Information:
- ---------------------------
Item 1. LEGAL PROCEEDINGS
Environmental Proceedings
On December 3, 2001, Illinois EPA (IEPA) issued a NOV to Marathon Ashland
Petroleum LLC (MAP) arising out of the sinking of a floating roof on a storage
tank at a Martinsville, Illinois facility. A heavy rainfall caused the floating
roof to sink. MAP believes it may have an Act of God/emergency defense. Based
upon recent discussions with IEPA, MAP expects the matter to be referred to the
Illinois Attorney General's office for enforcement proceedings.
In March, 2002, MAP attended a meeting with the Illinois EPA concerning MAP's
self reporting of possible emission exceedences and permitting issues related to
some storage tanks at MAP's Robinson, Illinois facility. In late April, MAP
submitted to IEPA a comprehensive settlement proposal which was rejected by
IEPA.
39
Part II - Other Information (Continued):
- ----------------------------------------
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
12.1 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends
12.2 Computation of Ratio of Earnings to Fixed Charges
(b) REPORTS ON FORM 8-K
Form 8-K/A dated January 3, 2002 (filed January 15, 2002), reporting under
Item 2. Acquisition or Disposition of Assets, that Marathon Oil Corporation,
formerly known as USX Corporation, is furnishing information relating to the
completion on December 31, 2001 of the separation of USX Corporation's steel and
energy businesses pursuant to the Agreement and Plan of Reorganization, dated as
of July 31, 2001, by and between USX Corporation and United States Steel LLC,
filing by amendment to this 8-K of Pro Forma Financial Information, and
information for the December 31, 2001, press release titled "USX to Complete
Previously Announced Spin-Off of its Steel Business".
Form 8-K/A dated January 3, 2002, reporting under Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits, that Marathon Oil
Corporation is filing Unaudited Pro Forma Condensed Financial Statements to give
effect to the separation of and significant transactions related to the
separation of USX Corporation (renamed Marathon Oil Corporation) into two
separate companies, Marathon Oil Corporation and United States Steel
Corporation.
Form 8-K dated February 27, 2002, reporting under Item 5. Other Events, the
filing of the audited Financial Statements and Supplementary Data for the fiscal
year ended December 31, 2001, reports of independent accountants, the
computation of the ratio of earnings to combined fixed charges and preferred
stock dividends, and the ratio of earnings to fixed charges for Marathon Oil
Corporation for the fiscal year ended December 31, 2001.
Form 8-K dated February 27, 2002, reporting under Item 5. Other Events,
that Marathon Oil Corporation entered into an underwriting agreement for the
public offering of $450 million aggregate principal amount of 6.125% Notes due
2012 and $550 million aggregate principal amount of 6.800% Notes due 2032.
Form 8-K dated April 23, 2002, as amended, reporting under Item 9.
Regulation FD Disclosure, Marathon Oil Corporation updated Outlook section of
its Form 10-K for the fiscal year ended December 31, 2001.
40
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 chief accounting officer thereunto duly authorized.
MARATHON OIL CORPORATION
By /s/ A. G. Adkins
--------------------------
Albert G. Adkins
Vice President -
Accounting and Controller
May 15, 2002
41