EXHIBIT 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion of our financial condition and results of
operations should be read in conjunction with our financial statements.
Petroleum refining industry operations and profitability are influenced by
a large number of factors, some of which individual petroleum refining and
marketing companies cannot control. Governmental regulations and policies,
particularly in the areas of taxation, energy and the environment (see
"Business -- Environment and Safety"), have a significant impact on petroleum
activities, regulating how companies conduct their operations and formulate
their products. Demand for crude oil and refined products is largely driven by
the condition of local and worldwide economies, although weather patterns and
taxation relative to other energy sources also play a significant part. Our
consolidated operating results are affected by these industry-specific factors
and by company-specific factors, such as the success of marketing programs and
refinery operations.
The earnings and cash flows of companies engaged in the refining and
marketing business in the United States are primarily dependent upon producing
and selling quantities of refined products at margins sufficient to cover fixed
and variable costs. The refining and marketing business is characterized by high
fixed costs resulting from the significant capital outlays associated with
refineries, terminals and related facilities. This business is also
characterized by substantial fluctuations in variable costs, particularly costs
of crude oil, feedstocks and blending components, and in the prices realized for
refined products. Crude oil and refined products are commodities whose price
levels are determined by market forces beyond our control.
In general, prices for refined products are significantly influenced by the
price of crude oil, feedstocks and blending components. Although an increase or
decrease in the price for crude oil, feedstocks and blending components
generally results in a corresponding increase or decrease in prices for refined
products, generally there is a lag in the realization of the corresponding
increase or decrease in prices for refined products. The effect of changes in
crude oil prices on our consolidated operating results therefore depends in part
on how quickly refined product prices adjust to reflect these changes. Although
the pricing formulas under our crude supply agreements with PDVSA are designed
to protect us from pricing volatility, we receive only approximately 50% of our
crude oil requirements under these agreements. Therefore, a substantial or
prolonged increase in crude oil prices without a corresponding increase in
refined product prices, or a substantial or prolonged decrease in refined
product prices without a corresponding decrease in crude oil prices, or a
substantial or prolonged decrease in demand for refined products could have a
significant negative effect on our earnings and cash flows.
As noted above, we purchase a significant amount of our crude oil
requirements from PDVSA under long-term supply agreements (expiring in the years
2006 through 2013). This supply represented approximately 50% of the crude oil
processed in refineries operated by us in the year ended December 31, 2002.
These crude supply agreements contain force majeure provisions which entitle
PDVSA to reduce the quantity of crude oil and feedstocks delivered under the
crude supply agreements under specified circumstances. For the years 2001 and
2002, PDVSA deliveries of crude oil to us were slightly less than contractual
base volumes due to PDVSA's declaration of force majeure pursuant to all of the
long-term crude oil supply contracts related to our refineries. Therefore, we
were required to obtain alternative sources of crude oil, which resulted in
lower operating margins.
A nation-wide work stoppage by opponents of President Hugo Chavez began in
Venezuela on December 2, 2002, and has disrupted most activity in that country,
including the operations of PDVSA. We continue to be able to locate and purchase
adequate crude oil, albeit at higher prices than under our supply contracts with
PDVSA, to maintain normal operations at our refineries and to meet our refined
products commitments to our customers. In December 2002, we received
approximately 61 percent of the crude oil volume that we received from PDVSA in
December 2001. In January 2003, we received
1
approximately 94 percent of the crude oil volume that we received from PDVSA in
January 2002. In February 2003, we expect to receive deliveries of approximately
80 percent of the crude oil volume that we received from PDVSA in February 2002.
The reduction in supply and purchase of crude oil from alternative sources has
had the effect of increasing our crude oil cost and decreasing our gross margin
and profit margin from what it would have been if the crude oil were received
under our long-term crude oil supply contracts with PDVSA. If PDVSA continues to
reduce its delivery of crude oil under these crude oil supply agreements due to
force majeure events related to the work stoppage in Venezuela or otherwise, we
will be required to obtain alternative sources of crude oil which may result in
reduced operating margins and increased volatility in our earnings and cash
flow. The effect of this current force majeure declaration on our crude oil
supply and the duration of this situation are not known at this time. See
"Business -- Crude Oil and Refined Product Purchases."
We also purchase significant volumes of refined products to supplement the
production from our refineries to meet marketing demands and to resolve
logistical issues. Our earnings and cash flows are also affected by the cyclical
nature of petrochemical prices. As a result of the factors described above, our
earnings and cash flows may experience substantial fluctuations. Inflation was
not a significant factor in our operations during the three years ended December
31, 2002.
The cost and available coverage level of property and business interruption
insurance to us is driven, in part, by company specific and industry factors. It
is also affected by national and international events. The present environment
for us is one characterized by increased cost of coverage, higher deductibles,
and some restrictions in coverage terms. This has the potential effect of
lowering our profitability in the near term.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with Accounting
Principles Generally Accepted in the United States of America requires that
management apply accounting policies and make estimates and assumptions that
affect results of operations and the reported amounts of assets and liabilities.
The following areas are those we believe are important to our financial
statements and which require significant judgment and estimation because of
inherent uncertainty.
Environmental Expenditures. The costs to comply with environmental
regulations are significant. Environmental expenditures incurred currently that
relate to present or future revenues are expensed or capitalized as appropriate.
Expenditures that relate to an existing condition caused by past operations and
that do not contribute to current or future revenue generation are expensed. We
constantly monitor our compliance with environmental regulations and respond
promptly to issues raised by regulatory agencies. We record liabilities when
environmental assessments and/or cleanups are probable and the costs can be
reasonably estimated. We do not discount environmental liabilities to their
present value. Subsequent adjustments to estimates, to the extent required, may
be made as more refined information becomes available.
Commodity and Interest Rate Derivatives. We enter into petroleum futures
contracts, options and other over-the-counter commodity derivatives, primarily
to reduce our inventory purchase and product sale exposure to market risk. In
the normal course of business, we also enter into certain petroleum commodity
forward purchase and sale contracts, which qualify as derivatives. We also enter
into various interest rate swap agreements to manage our risk related to
interest rate changes on our debt. Effective January 1, 2001, we record fair
values of derivatives in other current assets or other current liabilities, as
applicable, and changes in the fair value of derivatives not designated in
hedging relationships in income. Effective January 1, 2001, our policy is to
elect hedge accounting only under limited circumstances involving derivatives
with initial terms of 90 days or greater and notional amounts of $25 million or
greater. We will continue to review our accounting treatment of derivatives and
may elect hedge accounting under certain circumstances in the future.
Litigation and Injury Claims. Various lawsuits and claims arising in the
ordinary course of business are pending against us. The status of these lawsuits
and claims are continually reviewed by external and
2
internal legal counsel. These reviews provide the basis for which we determine
whether or not to record accruals for potential losses. Accruals for losses are
recorded when, in management's opinion, such losses are probable and reasonably
estimable. If known lawsuits and claims were to be determined in a manner
adverse to us, and in amounts greater than our accruals, then such
determinations could have a material adverse effect on our results of operations
in a given reporting period.
Health Care Costs. The cost of providing health care to current employees
and retired employees continues to increase at a significant rate. Historically,
we have absorbed the majority of these cost increases which reduce profitability
and increase our liability. There is no indication that the trend in health care
costs will be reversed in future periods. Our liability for such health care
costs is based on actuarial calculations that could be subject to significant
revision as the underlying assumptions regarding future health care costs and
interest rates change.
Pensions. Our pension cost and liability are based on actuarial
calculations, which are dependent on assumptions concerning discount rates,
expected rates of return on plan assets, employee turnover, estimated retirement
dates, salary levels at retirement and mortality rates. In addition, differences
between actual experience and the assumptions also affect the actuarial
calculations. While management believes that the assumptions used are
appropriate, differences in actual experience or changes in assumptions may
significantly affect our future pension cost and liability.
CHANGE IN REPORTING ENTITY
On January 1, 2002, PDV America, our direct parent company, made a
contribution to our capital of all of the common stock of PDV America's wholly
owned subsidiary, VPHI. Effective January 1, 2002, the accounts of VPHI were
included in our consolidated financial statements at the historical carrying
value of PDV America's investment in VPHI. In the following discussion and
analysis of financial condition and results of operations, amounts shown for the
years ended December 31, 2000 and 2001, have been restated to give effect to
this transaction as if it took place on January 1, 2000.
RESULTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 2002
The following table summarizes the sources of our sales revenues and
volumes.
CITGO SALES REVENUES AND VOLUMES
<Table>
<Caption>
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
--------------------------- -------------------------
2002 2001 2000 2002 2001 2000
------- ------- ------- ------- ------ ------
(IN MILLIONS) (GALLONS IN MILLIONS)
Gasoline........................... $11,758 $11,316 $12,447 15,026 13,585 13,648
Jet fuel........................... 1,402 1,660 2,065 2,003 2,190 2,367
Diesel/#2 fuel..................... 3,462 3,984 4,750 5,031 5,429 5,565
Asphalt............................ 597 502 546 902 946 812
Petrochemicals and industrial
products......................... 1,485 1,490 1,763 2,190 2,297 2,404
Lubricants and waxes............... 561 536 552 261 240 279
------- ------- ------- ------- ------ ------
Total refined product sales... $19,265 $19,488 $22,123 25,413 24,687 25,075
Other sales........................ 93 113 34 -- -- --
------- ------- ------- ------- ------ ------
Total sales................... $19,358 $19,601 $22,157 25,413 24,687 25,075
======= ======= ======= ======= ====== ======
</Table>
3
The following table summarizes our cost of sales and operating expenses.
CITGO COST OF SALES AND OPERATING EXPENSES
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
(IN MILLIONS)
Crude oil................................................ $ 5,098 $ 4,898 $ 6,784
Refined products......................................... 11,077 10,686 11,638
Intermediate feedstocks.................................. 1,489 1,496 1,573
Refining and manufacturing costs......................... 1,233 1,113 1,058
Other operating costs and expenses and inventory
changes................................................ 314 542 317
------- ------- -------
Total cost of sales and operating expenses.......... $19,211 $18,735 $21,370
======= ======= =======
</Table>
RESULTS OF OPERATIONS
2002 COMPARED TO 2001
Sales revenues and volumes. Sales decreased $243 million, representing a
1% decrease from 2001 to 2002. This was due to a decrease in average sales price
of 4% offset by an increase in sales volume of 3%. (See CITGO Sales Revenues and
Volumes table above.)
Equity in earnings of affiliates. Equity in earnings of affiliates
decreased by approximately $8 million, or 7% from $109 million in 2001 to $101
million in 2002. An increase in earnings of $4 million attributable to
LYONDELL-CITGO, was more than offset by a $12 million reduction in earnings from
our other investments.
Cost of sales and operating expenses. Cost of sales and operating expenses
increased by $476 million, or 3%, from 2001 to 2002. (See CITGO Cost of Sales
and Operating Expenses table above.)
We purchase refined products to supplement the production from our
refineries to meet marketing demands and resolve logistical issues. The refined
product purchases represented 58% of cost of sales for 2002 and 57% for 2001.
These refined product purchases included purchases from LYONDELL-CITGO and
HOVENSA, L.L.C. ("HOVENSA"). We estimate that margins on purchased products, on
average, are lower than margins on produced products due to the fact that we can
only receive the marketing portion of the total margin received on the produced
refined products. However, purchased products are not segregated from our
produced products and margins may vary due to market conditions and other
factors beyond our control. As such, it is difficult to measure the effects on
profitability of changes in volumes of purchased products. In the near term,
other than normal refinery turnaround maintenance, we do not anticipate
operational actions or market conditions which might cause a material change in
anticipated purchased product requirements; however, there could be events
beyond our control which impact the volume of refined products purchased. (See
also "Forward Looking Statements.")
As a result of purchases of crude oil supplies from alternate sources due
to PDVSA's invocation of the force majeure provisions in its crude oil supply
contracts, we estimate that our cost of crude oil purchased in 2002 increased by
$42 million from what would have otherwise been the case.
Gross margin. The gross margin for 2002 was $147 million, or 0.8% of net
sales, compared to $867 million, or 4.4% of net sales, for 2001. The gross
margin decreased from 3.5 cents per gallon in 2001 to 0.6 cents per gallon in
2002 as a result of general market conditions and factors relating specifically
to us including operating problems, weather related shut downs and crude oil
supply disruptions under contracts with PDVSA.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased $7 million, or 2% in 2002.
4
Interest Expense. Interest expense decreased $4 million, or 5% in 2002,
primarily due to the decline in interest rates on our variable rate debt.
Income taxes. Our provision for income taxes in 2002 was $96 million,
representing an effective tax rate of 35%. In 2001, our provision for income
taxes was $206 million, representing an effective tax rate of 35%.
2001 COMPARED TO 2000
Sales revenues and volumes. Sales decreased $2.6 billion, representing a
12% decrease from 2000 to 2001. This was due to a decrease in average sales
price of 11% and a decrease in sales volume of 2%. (See CITGO Sales Revenues and
Volumes table above.)
Equity in earnings of affiliates. Equity in earnings of affiliates
increased by approximately $50 million, or 85% from $59 million in 2000 to $109
million in 2001. The increase was primarily due to the change in the earnings of
LYONDELL-CITGO, our share of which increased $33 million, from $41 million in
2000 to $74 million in 2001. LYONDELL-CITGO's increased earnings in 2001 are
primarily due to higher refining margins offset by the impact of lower crude
processing rates due to an unplanned production unit outage and a major
turnaround, and higher natural gas costs in the first quarter of 2001. The
earnings for 2000 were impacted by a major planned turnaround which occurred
during the second quarter of 2000.
Cost of sales and operating expenses. Cost of sales and operating expenses
decreased by $2.6 billion, or 12%, from 2000 to 2001. (See CITGO Cost of Sales
and Operating Expenses table above.)
We purchase refined products to supplement the production from our
refineries to meet marketing demands and resolve logistical issues. The refined
product purchases represented 57% and 54% of cost of sales for the years 2001
and 2000. These refined product purchases included purchases from LYONDELL-CITGO
and HOVENSA. We estimate that margins on purchased products, on average, are
lower than margins on produced products due to the fact that we can only receive
the marketing portion of the total margin received on the produced refined
products. However, purchased products are not segregated from our produced
products and margins may vary due to market conditions and other factors beyond
our control. As such, it is difficult to measure the effects on profitability of
changes in volumes of purchased products. In the near term, other than normal
refinery turnaround maintenance, we do not anticipate operational actions or
market conditions which might cause a material change in anticipated purchased
product requirements; however, there could be events beyond our control that
impact the volume of refined products purchased. (See also "Forward Looking
Statements.")
As a result of purchases of crude oil supplies from alternate sources due
to the supplier's invocation of the force majeure provisions in our crude oil
supply contracts, we estimate that our cost of crude oil purchased in 2001
increased by $6 million from what would have otherwise been the case.
Gross margin. The gross margin for 2001 was $867 million, or 4.4% of net
sales, compared to $787 million, or 3.5% of net sales, for 2000. The gross
margin increased from 3.1 cents per gallon in 2000 to 3.5 cents per gallon in
2001 as a result of general market conditions.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $66 million, or 29% in 2001, primarily as a
result of an increase in incentive compensation, promotion expenses, and the
start-up expenses related to an international operation in 2001.
Interest expense. Interest expense decreased $16 million, or 19% in 2001,
primarily due to lower interest rates on our variable rate debt and lower
average debt outstanding during 2001.
Income taxes. Our provision for income taxes in 2001 was $206 million,
representing an effective tax rate of 35%. In 2000, our provision for income
taxes was $183 million, representing an effective tax rate of 37%.
5
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity has been adversely affected recently as a result of events
directly and indirectly associated with the disruption in our Venezuelan crude
oil supply from PDVSA. That disruption affected a portion of the crude oil
supplies that we receive from PDVSA, requiring us to replace those supplies from
other sources at higher prices and on payment terms generally less favorable
than the terms under our supply agreement with PDVSA. We received approximately
43% and 91% of our contracted crude oil volumes from PDVSA during December and
January, respectively. We expect to receive approximately 80% of our contractual
crude oil volumes from PDVSA during February. During this supply disruption, we
have been successful in covering any shortfall with spot market purchases, but
those purchases generally require payment 15 days sooner than would be the case
for comparable deliveries under our supply agreements with PDVSA. This
shortening of our payment cycle has increased our cash needs and reduced our
liquidity. Also, a number of trade creditors have sought to tighten credit
payment terms on purchases that we make from them. That tightening would further
increase our cash needs and further reduce our liquidity.
In addition, all three major rating agencies lowered our credit ratings
based upon, among other things, concerns regarding the supply disruption. One of
the downgrades caused a termination event under our existing accounts
receivables sale facility, which ultimately led to the repurchase of $125
million in accounts receivable and the cancellation of the facility on January
31, 2003. That facility had a maximum size of $225 million, of which $125
million was used at the time of cancellation. In the ordinary course of business
we maintain uncommitted short-term lines of credit with several commercial
banks. Effective following the debt ratings downgrade, these uncommitted lines
of credit are not currently available. Our committed revolving credit facilities
remain available.
Letter of credit providers for $76 million of our outstanding letters of
credit have indicated that they will not renew such letters of credit. These
letters of credit support approximately $75 million of tax-exempt bond issues
that were issued previously for our benefit. We are arranging for the repurchase
of these tax-exempt bonds. We expect that we will seek to reissue these
tax-exempt bonds with replacement letters of credit in support if we are able to
obtain such letters of credit from other financial institutions or,
alternatively, we will seek to replace these tax-exempt bonds with new
tax-exempt bonds that will not require letter of credit support. We have an
additional $231 million of letters of credit outstanding that back or support
other bond issues that we have issued through governmental entities, which are
subject to renewal during 2003. We have not received any notice from the issuers
of these additional letters of credit indicating an intention not to renew.
However, we cannot assure you that any of our letters of credit will be renewed,
that we will be successful in obtaining replacements if they are not renewed,
that any replacement letters of credit will be on terms as advantageous as those
we currently hold or that we will be able to arrange for replacement tax-exempt
bonds that will not require letter of credit support.
In August 2002, three of our affiliates entered into agreements to advance
excess cash to us from time to time under demand notes. These notes provide for
maximum amounts of $10 million from PDV Texas, Inc., $30 million from PDV
America and $10 million from PDV Holding. If a demand were to be made under
these notes, it would further tighten our liquidity. At December 31, 2002, the
outstanding amounts under these notes were $5 million, $30 million and $4
million, respectively.
Operating cash flow represents a primary source for meeting our liquidity
requirements; however, the termination of our accounts receivable sale facility,
the possibility of additional tightened payment terms and the possible need to
replace non-renewing letters of credit has prompted us to undertake arrangements
to supplement and improve our liquidity. To date, we have undertaken the
following:
- We have reduced our planned discretionary capital expenditures in 2003 by
approximately $200 million.
- Effective February 20, 2003, we entered into a commitment letter, which
is subject to customary terms and conditions, with an affiliate of Credit
Suisse First Boston LLC for the new secured credit facility. The new
secured credit facility will bear interest at a floating rate plus a
spread and will be
6
secured by our equity interests in Colonial Pipeline Company and Explorer
Pipeline Company.
- On February 6, 2003, we signed a commitment letter with a financial
institution pursuant to which, subject to customary terms and conditions,
the financial institution has agreed to provide us with a new
non-recourse facility to sell trade accounts receivable to independent
third parties. The amount funded under this facility will be limited to a
maximum of $200 million outstanding at any one time.
In addition, we are working on a transaction that, if consummated, will
provide us with up to $100 million from the transfer of title to a third party
of certain of our refined products at the time those products are delivered into
the custody of interstate pipelines. We would expect the terms of any such
agreement to include an option to acquire like volumes of refined products from
the third party at prevailing prices at predetermined transfer points.
We have an effective shelf-registration statement with the SEC under which
we can publicly offer up to $400 million principal amount of debt securities.
Notwithstanding that availability, we may not be able to access the public
market if and when we would like to do so. Due, at the time, to the prospect of
the Venezuelan work stoppage, we postponed a planned offering of up to $250
million of our unsecured notes from our shelf-registration statement.
We believe that we have adequate liquidity from existing sources to support
our operations for the foreseeable future. We are continuing to review our
operations for opportunities to reduce operating and capital expenditures. See
"-- Credit Issues" below and see "Risk Factors -- We May Not Be Able to Access
New Sources of Liquidity."
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net cash provided by operating activities totaled
approximately $818 million for the year ended December 31, 2002. Operating cash
flows were derived primarily from net income of $180 million, depreciation and
amortization of $299 million and changes in working capital of $258 million. The
change in working capital is primarily the result of increases in payables to
affiliates and trade payables and a decrease in prepaid taxes offset, in part,
by an increase in prepaid turnaround charges.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in investing activities in 2002 totaled $789 million
consisting primarily of capital expenditures of $712 million. These capital
expenditures include $220 million in spending to rebuild the crude distillation
unit of the Lemont refinery due to a fire on August 14, 2001. The crude unit was
destroyed and the refinery's other processing units were temporarily taken out
of production. The new crude unit was operational in May 2002.
Capital expenditure projected amounts for 2003 and 2004 through 2007 are as
follows:
CAPITAL EXPENDITURES -- 2003 THROUGH 2007
<Table>
<Caption>
2004-
2003 2007
PROJECTED(1) PROJECTED
------------ ---------
(IN MILLIONS)
Strategic................................................... $ 88 $ 535
Maintenance................................................. 91 502
Regulatory/environmental.................................... 269 1,037
---- ------
Total.................................................. $448 $2,074
==== ======
</Table>
7
- ---------------
(1) Reflects reduction in 2003 projected capital expenditures discussed below.
These estimates may change as future regulatory events unfold. See "Forward
Looking Statements."
Estimated capital expenditures necessary to comply with the Clean Air Act
and other environmental laws and regulations are summarized below. See "Forward
Looking Statements."
<Table>
<Caption>
BEYOND
2003 2004 2005 2006 2006
---- ---- ---- ---- ------
(IN MILLIONS)
Tier 2 gasoline............................................ $231 $125 $ 82 $ 10 $ --
Ultra low sulfur diesel(1)................................. 3 33 179 155 249
Other environmental(2)..................................... 35 51 81 92 81
---- ---- ---- ---- ----
Total regulatory/environmental............................. $269 $209 $342 $257 $330
==== ==== ==== ==== ====
</Table>
- ---------------
(1) Spending on Ultra Low Sulfur Diesel ("ULSD") assumes the EPA will require
ULSD for on-road diesel in 2006 and ULSD for off-road diesel use in 2008.
These regulations are not final and spending could be reduced if certain
alternative regulatory schemes proposed by EPA are adopted.
(2) Other environmental spending assumes $162.9 million in spending to comply
with New Source Review standards under the Clean Air Act.
Internally generated cash flow, together with borrowings available under
our credit facilities, are expected to be sufficient to fund these capital
expenditures. In addition, we have taken steps to reduce our discretionary
capital expenditures in 2003 by approximately $200 million and are continuing to
review the timing and amount of scheduled expenditures under our planned capital
spending programs, including regulatory and environmental projects in the near
term.
We believe that we will have sufficient capital resources to carry out
planned capital spending programs, including regulatory and environmental
projects in the near term, and to meet currently anticipated future obligations
and other planned expenditures as they arise. We periodically evaluate other
sources of capital in the marketplace and anticipate that long-term capital
requirements will be satisfied with current capital resources and future
financing arrangements, including the issuance of debt securities. Our ability
to obtain such financing will depend on numerous factors, including market
conditions and the perceived creditworthiness of the Company at that time. See
also "Forward Looking Statements."
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used in financing activities totaled $101 million for the year
2002, consisting primarily of the payment of $112 million on revolving bank
loans, the payment of $25 million on master shelf agreement notes, the payment
of $31 million on taxable bonds, the payment of capital lease obligations of $20
million and the net repayments of other debt of $20 million. These payments were
offset in part by $69 million in proceeds from tax exempt bonds, and $39 million
in proceeds from loans from affiliates.
CREDIT ISSUES
We have historically met our short-term liquidity requirements primarily
through cash from operations, borrowings under our revolving credit facilities
and our accounts receivable sale facility. We presently have two committed
revolving credit facilities with third party financial institutions consisting
of:
- $260 million 364-day credit facility expiring December 10, 2003 (unless
we request, and the lenders consent to, an extension of that facility);
and
- $260 million three-year credit facility expiring December 9, 2005.
The 364-day credit facility includes a provision which allows us at our
option to term-out for one year any amounts outstanding under such facility at
its original maturity date.
8
Funds are available under these credit facilities for working capital,
capital expenditures and general corporate purposes. As of January 31, 2003,
$210 million was available for borrowing under the 364-day credit facility and
$50 million was available for borrowing under the three-year credit facility.
Borrowings under these credit facilities bear interest at rates based on either
a bank base rate or specified spreads, depending upon our debt to capitalization
ratio, over the euro dollar rate. As noted previously, our accounts
receivable facility was cancelled on January 31, 2003 following a ratings
downgrade. That facility had a maximum availability of $225 million, although
only $125 million was used at the time of its cancellation. On February 6, 2003,
we signed a commitment letter with a financial institution pursuant to which,
subject to customary terms and conditions, the financial institution has agreed
to provide us with a new non-recourse facility to sell trade accounts receivable
to independent third parties. The amount funded under this facility will be
limited to a maximum of $200 million outstanding at any one time. In the
ordinary course of business we maintain uncommitted short-term lines of credit
with several commercial banks. Effective following the debt ratings downgrade,
these uncommitted lines of credit are not currently available. Our committed
revolving credit facilities remain available.
We have guaranteed a 364-day line of credit in the amount of $25 million
provided to our wholly owned subsidiary CITGO International Puerto Rico Company.
Since December 2002, we have experienced a tightening of our payment terms.
Our purchases of crude oil from third parties are made at industry payment terms
that are less favorable than our contractual payment terms to PDVSA. In
addition, a number of our third party crude oil and product suppliers have
shortened the time in which we are required to pay for purchases or require
payment prior to delivery. This tightening of credit terms has negatively
impacted our working capital and liquidity.
Our senior unsecured debt ratings, as currently assessed by the three major
debt rating agencies, are as follows:
Moody's Investor's Services Ba3
Standard & Poor's Ratings Group B+
Fitch Investors Service, Inc. B+
In connection with their recent downgrades of our debt ratings, the three
major rating agencies have all noted concerns regarding the continuing
Venezuelan oil supply disruption. Moody's and Fitch have announced that they
continue to keep our securities on negative watch. S&P recently changed its
review to developing from negative, but noted the importance of improved crude
oil shipping volumes and external financing to restoring liquidity. Moody's also
noted concern that our direct parent, PDV America, may need substantial
assistance from us in order to pay off $500 million of notes maturing in August
2003. PDV America holds a $500 million mirror note from PDVSA which is designed
to provide sufficient liquidity to PDV America to make this payment. While
PDVSA's obligation remains unchanged, in light of the current uncertainties, PDV
America is exploring alternate funding options for the principal repayment due
in August 2003. These alternatives involve varying degrees of assistance from
us, including a possible dividend from us to meet some or all of PDV America's
obligation.
As a result of these events, we have undertaken, and are undertaking, the
steps described at the outset of this "-- Liquidity and Capital Resources"
discussion.
Our debt instruments do not contain any covenants that trigger increased
costs or burdens as a result of a change in our securities ratings. Our debt
instruments do, however, impose restrictions on our ability to incur additional
debt, place liens on property, sell or acquire fixed assets, and make restricted
payments, including dividends.
We were in compliance with our obligations under our debt financing
arrangements at December 31, 2002.
9
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table summarizes future payments for our contractual
obligations at December 31, 2002.
CONTRACTUAL OBLIGATIONS
AT DECEMBER 31, 2002
<Table>
<Caption>
LESS THAN YEAR YEAR AFTER 5
1 YEAR 2-3 4-5 YEARS TOTAL
--------- ---- ---- ------- ------
(IN MILLIONS)
Long-term debt............................... $191 $209 $313 $588 $1,301
Capital lease obligations.................... 23 5 6 13 47
Operating leases............................. 106 101 35 13 255
---- ---- ---- ---- ------
Total contractual cash obligations........... $320 $315 $354 $614 $1,603
==== ==== ==== ==== ======
</Table>
For additional information, see Notes 11 and 15 in our consolidated
financial statements for the year ended December 31, 2002.
The following table summarizes our contingent commitments at December 31,
2002.
OTHER COMMERCIAL COMMITMENTS
AT DECEMBER 31, 2002
<Table>
<Caption>
EXPIRATION
-------------------------------- TOTAL
LESS THAN YEAR YEAR OVER 5 AMOUNTS
1 YEAR 2-3 4-5 YEARS COMMITTED
--------- ---- ---- ------ ---------
(IN MILLIONS)
Letters of credit(1)......................... $ 3 $-- $-- $-- $ 3
Guarantees................................... 67 2 3 1 73
Surety bonds................................. 58 11 2 -- 71
---- --- -- -- ----
Total commercial commitments................. $128 $13 $5 $1 $147
==== === == == ====
</Table>
- ---------------
(1) We have outstanding letters of credit totaling approximately $451 million,
which includes $448 million related to our tax-exempt and taxable revenue
bonds included in long-term debt in the table of contractual obligations
above.
For additional information, see Note 14 in our consolidated financial
statements for the year ended December 31, 2002.
10
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction. We and our subsidiaries have exposure to price fluctuations
of crude oil and refined products as well as fluctuations in interest rates. To
manage these exposures, management has defined certain benchmarks consistent
with its preferred risk profile for the environment in which we operate and
finance our assets. We do not attempt to manage the price risk related to all of
our inventories of crude oil and refined products. As a result, at December 31,
2002, we were exposed to the risk of broad market price declines with respect to
a substantial portion of our crude oil and refined product inventories. The
following disclosures do not attempt to quantify the price risk associated with
such commodity inventories.
Commodity Instruments. We balance our crude oil and petroleum product
supply/demand and manage a portion of our price risk by entering into petroleum
commodity derivatives. Generally, our risk management strategies qualified as
hedges through December 31, 2000. Effective January 1, 2001, our policy is to
elect hedge accounting only under limited circumstances involving derivatives
with initial terms of 90 days or greater and notional amounts of $25 million or
greater. At December 31, 2002, none of our commodity derivatives were accounted
for as hedges.
NON TRADING COMMODITY DERIVATIVES
OPEN POSITIONS AT DECEMBER 31, 2002
<Table>
<Caption>
MATURITY NUMBER OF CONTRACT MARKET
COMMODITY DERIVATIVE DATE CONTRACTS VALUE VALUE(4)
- --------- ---------- -------- --------- -------- --------
(IN MILLIONS)
No lead
gasoline(1)...... Futures Purchased 2003 564 $ 19.9 $ 20.6
Futures Sold 2003 1,023 35.3 37.6
Listed Options Purchased 2003 1,225 -- 4.2
Listed Options Sold 2003 2,225 -- 5.5
Forward Purchase Contracts 2003 2,577 89.2 92.5
Forward Sales Contracts 2003 2,364 81.3 86.2
Distillates(1)..... Futures Purchased 2003 2,227 73.4 78.7
Futures Purchased 2004 31 0.8 0.9
Futures Sold 2003 2,953 93.2 96.7
OTC Options Purchased 2003 66 -- 0.1
OTC Options Sold 2003 66 -- (0.1)
OTC Swaps (Pay Fixed/Receive 2003 12 -- --
Float)(3)
OTC Swaps (Pay Float/Receive 2003 75 -- --
Fixed)(3)
Forward Purchase Contracts 2003 3,134 106.5 111.0
Forward Sales Contracts 2003 2,944 98.1 104.7
Crude Oil(1)....... Futures Purchased 2003 1,986 51.2 54.5
Futures Sold 2003 1,476 41.8 45.3
Listed Options Purchased 2003 2,250 -- 2.3
Listed Options Sold 2003 3,150 -- 3.1
OTC Swaps (Pay Float/Receive 2003 3,500 -- (3.0)
Fixed)
Forward Purchase Contracts 2003 5,721 160.8 174.4
Forward Sales Contracts 2003 4,412 129.8 137.2
Natural Gas(2)..... Listed Options Purchased 2003 85 -- 0.8
Listed Options Sold 2003 40 -- 0.6
</Table>
11
<Table>
<Caption>
MATURITY NUMBER OF CONTRACT MARKET
COMMODITY DERIVATIVE DATE CONTRACTS VALUE VALUE(4)
- --------- ---------- -------- --------- -------- --------
(IN MILLIONS)
Propane(1)......... OTC Swaps (Pay Fixed/Receive 2003 75 -- 0.5
Float)
OTC Swaps (Pay Float/Receive 2003 300 -- (1.5)
Fixed)
</Table>
- ---------------
(1) 1,000 barrels per contract
(2) Ten-thousands of mmbtu per contract
(3) Floating price based on market index designated in contract; fixed price
agreed upon at date of contract
(4) Based on actively quoted prices
NON TRADING COMMODITY DERIVATIVES
OPEN POSITIONS AT DECEMBER 31, 2001
<Table>
<Caption>
MATURITY NUMBER OF CONTRACT MARKET
COMMODITY DERIVATIVE DATE CONTRACTS VALUE VALUE(4)
- --------- ---------- -------- --------- -------- --------
(IN MILLIONS)
No lead
gasoline(1)...... Futures Purchased 2002 994 $25.4 $25.0
Futures Sold 2002 332 8.3 8.1
Forward Purchase Contracts 2002 4,095 95.8 94.0
Forward Sale Contracts 2002 3,148 71.2 73.2
Distillates(1)..... Futures Purchased 2002 1,483 43.4 34.6
Futures Purchased 2003 94 2.4 2.3
Futures Sold 2002 943 25.3 21.8
OTC Options Purchased 2002 30 -- --
OTC Options Sold 2002 30 (0.1) (0.1)
Forward Purchase Contracts 2002 1,123 25.2 24.9
Forward Sale Contracts 2002 2,536 56.3 56.4
Crude oil(1)....... Futures Purchased 2002 517 12.6 10.4
Futures Sold 2002 649 12.7 12.9
OTC Swaps (Pay Float/Receive 2002 2 -- 0.3
Fixed)(3)
OTC Swaps (Pay Fixed/Receive 2002 1 -- --
Float)(3)
Forward Purchase Contracts 2002 6,652 130.3 135.2
Forward Sale Contracts 2002 6,268 135.1 137.0
Natural gas(2)..... Futures Sold 2002 55 1.6 1.4
OTC Options Sold 2002 20 -- (0.1)
</Table>
- ---------------
(1) 1,000 barrels per contract
(2) Ten-thousands of mmbtu per contract
(3) Floating price based on market index designated in contract; fixed price
agreed upon at date of contract
(4) Based on actively quoted prices
12
Debt Related Instruments. We have fixed and floating U.S. currency
denominated debt. We use interest rate swaps to manage our debt portfolio toward
a benchmark of 40 to 60 percent fixed rate debt to total fixed and floating rate
debt. These instruments have the effect of changing the interest rate with the
objective of minimizing our long-term costs. At December 31, 2002 and 2001, our
primary exposures were to LIBOR and floating rates on tax exempt bonds.
For interest rate swaps, the table below presents notional amounts and
interest rates by expected (contractual) maturity dates. Notional amounts are
used to calculate the contractual payments to be exchanged under the contracts.
NON TRADING INTEREST RATE DERIVATIVES
OPEN POSITIONS AT DECEMBER 31, 2002 AND 2001
<Table>
<Caption>
FIXED RATE NOTIONAL PRINCIPAL
VARIABLE RATE INDEX EXPIRATION DATE PAID AMOUNT
- ------------------- --------------- ---------- ------------------
(IN MILLIONS)
J. J. Kenny.............................. February 2005 5.30% $12
J. J. Kenny.............................. February 2005 5.27% $15
J. J. Kenny.............................. February 2005 5.49% $15
---
$42
===
</Table>
Interest expense includes $0.6 million in 2000 related to the net
settlements on these agreements. Effective January 1, 2001, changes in the fair
value of these agreements are recorded in other income (expense). The fair value
of these agreements at December 31, 2002, based on the estimated amount that
CITGO would receive or pay to terminate the agreements as of that date and
taking into account current interest rates, was a loss of $3.5 million, the
offset of which is recorded in the balance sheet caption other current
liabilities.
For debt obligations, the table below presents principal cash flows and
related weighted average interest rates by expected maturity dates. Weighted
average variable rates are based on implied forward rates in the yield curve at
the reporting date.
DEBT OBLIGATIONS
AT DECEMBER 31, 2002
<Table>
<Caption>
EXPECTED
FIXED RATE AVERAGE FIXED VARIABLE RATE AVERAGE VARIABLE
EXPECTED MATURITIES DEBT INTEREST RATE DEBT INTEREST RATE
- ------------------- --------------- ------------- --------------- ----------------
(IN MILLIONS) (IN MILLIONS)
2003........................... $ 61 8.79% $129 2.60%
2004........................... 31 8.02% 16 3.78%
2005........................... 11 9.30% 150 5.77%
2006........................... 252 8.06% -- --
2007........................... 50 8.94% 12 8.76%
Thereafter..................... 183 7.50% 405 10.22%
---- ---- ---- -----
Total.......................... $588 8.06% $712 7.79%
==== ====
Fair Value..................... $567 $712
==== ====
</Table>
13
DEBT OBLIGATIONS
AT DECEMBER 31, 2001
<Table>
<Caption>
EXPECTED
AVERAGE
FIXED RATE AVERAGE FIXED VARIABLE RATE VARIABLE
EXPECTED MATURITIES DEBT INTEREST RATE DEBT INTEREST RATE
- ------------------- --------------- ------------- --------------- ----------------
(IN MILLIONS) (IN MILLIONS)
2002............................ $ 36 8.78% $ 71 3.45%
2003............................ 61 8.79% 320 4.64%
2004............................ 31 8.02% 16 5.72%
2005............................ 11 9.30% -- --
2006............................ 251 8.06% -- --
Thereafter...................... 130 7.85% 485 8.50%
---- ---- ---- ----
Total........................... $520 8.17% $892 6.66%
==== ====
Fair Value...................... $532 $892
==== ====
</Table>
NEW ACCOUNTING STANDARDS
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which is fully
effective in fiscal years beginning after December 15, 2001, although certain
provisions of SFAS No. 142 are applicable to goodwill and other intangible
assets acquired in transactions completed after June 30, 2001. SFAS No. 142
addresses financial accounting and reporting for acquired goodwill and other
intangible assets and requires that goodwill and intangibles with an indefinite
life no longer be amortized but instead be periodically reviewed for impairment.
The adoption of SFAS No. 142 did not materially impact our financial position or
results of operations.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"), which
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. It applies to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, development
and (or) the normal operation of a long-lived asset, except for certain
obligations of lessees. This statement is effective for financial statements
issued for fiscal years beginning after June 15, 2002. The adoption of SFAS No.
143 did not materially impact our financial position or results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
No. 144"), which addresses financial accounting and reporting for the impairment
or disposal of long-lived assets by requiring that one accounting model be used
for long-lived assets to be disposed of by sale, whether previously held and
used or newly acquired, and by broadening the presentation of discontinued
operations to include more disposal transactions. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those fiscal years. The provisions of this statement
generally are to be applied prospectively; therefore, the adoption of SFAS No.
144 did not impact our financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligations it has undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of the interpretation are
applicable on a prospective
14
basis to guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46
defines variable interest entities and how an enterprise should assess its
interests in a variable interest entity to decide whether to consolidate that
entity. The interpretation requires certain minimum disclosures with respect to
variable interest entities in which an enterprise holds significant variable
interests but which it does not consolidate. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. FIN 46 applies to public
enterprises as of the beginning of the applicable interim or annual period, and
it applies to nonpublic enterprises as of the end of the applicable annual
period. FIN 46 may be applied prospectively with a cumulative-effect adjustment
as of the date on which it is first applied or by restating previously issued
financial statements for one or more years with a cumulative-effect adjustment
as of the beginning of the first year restated. We have not determined the
impact on our financial statements that may result from the application of FIN
46.
PROPOSED ACCOUNTING CHANGE
The American Institute of Certified Public Accountants ("AICPA") has issued
a "Statement of Position" exposure draft on cost capitalization that is expected
to require companies to expense the non-capital portion of major maintenance
costs as incurred. The statement is expected to require that any existing
unamortized deferred non-capital major maintenance costs be expensed
immediately. This statement also has provisions which will change the method of
determining depreciable lives. The impact on future depreciation expense is not
determinable at this time. The exposure draft indicates that this change will be
required to be adopted for fiscal years beginning after June 15, 2003, and that
the effect of expensing existing unamortized deferred non-capital major
maintenance costs will be reported as a cumulative effect of an accounting
change in the consolidated statement of income. Currently, the AICPA is
discussing the future of this exposure draft with the FASB. The final accounting
requirements and timing of required adoption are not known at this time. At
December 31, 2002, we had included turnaround costs of $210 million in other
assets. Our management has not determined the amount, if any, of these costs
that could be capitalized under the provisions of the exposure draft.
15