Item 1. Business
EQUISTAR
Overview of the Business
Equistar Chemicals, LP (together with its consolidated subsidiaries, “Equistar”) is one of the world’s largest producers of basic chemicals, with total 2006 revenues of approximately $12.8 billion, and assets of approximately $5.4 billion as of December 31, 2006. It is North America’s second largest producer of ethylene, the world’s most widely used petrochemical. Equistar also is the third largest producer of polyethylene in North America.
Equistar operates in one reportable business segment: ethylene, co-products and derivatives. Ethylene co-products primarily include propylene, butadiene and aromatics, which include benzene and toluene. Equistar’s derivatives primarily include polyethylene, ethylene oxide (“EO”), ethylene glycol (“EG”) and other EO derivatives, as well as ethanol and polypropylene. Equistar also produces fuel products, such as methyl tertiary butyl ether (“MTBE”) and alkylate.
Since November 30, 2004, Equistar has been an indirect, wholly-owned subsidiary of Lyondell Chemical Company (“Lyondell”). Prior to that, Equistar was owned jointly by Lyondell and Millennium Chemicals Inc. (“Millennium”). Lyondell acquired Millennium in a stock-for-stock business combination on November 30, 2004, thereby also indirectly acquiring Millennium’s 29.5% interest in Equistar. From May 1998 to August 2002, Occidental Petroleum Corporation (together with its subsidiaries and affiliates, collectively, “Occidental”) shared ownership of Equistar with Lyondell and Millennium until Lyondell purchased Occidental’s interest in Equistar. Equistar was formed in October 1997 as a Delaware limited partnership by Lyondell and Millennium, and holds assets contributed by Lyondell, Millennium and Occidental.
Additional Information Available
Equistar’s principal executive offices are located at 1221 McKinney Street, Suite 700, Houston, Texas 77010. Its telephone number is (713) 652-7200 and its website address is www.lyondell.com. Equistar’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available free of charge through www.lyondell.com as soon as reasonably practicable after those reports are electronically filed with or furnished to the Securities and Exchange Commission.
In addition, Equistar has adopted a “code of ethics,” as defined in Item 406(b) of Regulation S-K. Equistar’s code of ethics, known as its Business Ethics and Conduct Policy, is part of the overall Lyondell Business Ethics and Conduct Policy. It applies to all members of Equistar’s Partnership Governance Committee and to all officers and employees of Equistar, including Equistar’s principal executive officer, principal financial officer, principal accounting officer and controller. A copy of the Business Ethics and Conduct Policy is available at www.lyondell.com free of charge. In addition, Equistar intends to satisfy the disclosure requirements of Item 5.05 of Form 8-K regarding any amendment to, or waiver from, a provision of the Business Ethics and Conduct Policy that applies to Equistar’s principal executive officer, principal financial officer, principal accounting officer or controller and relates to any element of the definition of code of ethics set forth in Item 406(b) of Regulation S-K by posting such information at www.lyondell.com.
Information contained on Equistar’s website (www.lyondell.com) or any other website is not incorporated into this Annual Report and does not constitute a part of this Annual Report.
Index to Financial Statements
BUSINESS OPERATIONS
Overview
Equistar produces ethylene, co-products and derivatives at fifteen facilities located in five states in the U.S. Ethylene co-products primarily include propylene, butadiene and aromatics, which include benzene and toluene. Derivatives primarily include polyethylene, EO, EG and other EO derivatives, as well as ethanol and polypropylene. Equistar also produces fuel products, such as MTBE and alkylate. Ethylene is the most significant petrochemical in terms of worldwide production volume and is the key building block for polyethylene and a large number of other chemicals, plastics and synthetics. Ethylene, co-products and derivatives are fundamental to many segments of the economy, including the production of consumer products, packaging, housing and automotive components and other durable and nondurable goods.
The following table outlines:
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Equistar’s primary products;
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annual processing capacity as of December 31, 2006; and
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the primary uses for those products.
See “Item 2. Properties” for the locations where Equistar produces its products.
Unless otherwise specified, annual processing capacity was calculated by estimating the average number of days in a typical year that a production unit of a plant is expected to operate, after allowing for downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output based on the design raw material mix. Because the processing capacity of a production unit is an estimated amount, actual production volumes may be more or less than the capacities set forth below. Capacities shown include 100% of the capacity of joint venture facilities.
Product
Annual Capacity
Primary Uses
ETHYLENE AND CO-PRODUCTS:
Ethylene
10.8 billion pounds (a)
Ethylene is used as a raw material to manufacture polyethylene, EO, ethanol, ethylene dichloride, styrene and vinyl acetate monomer.
Co-Products:
Propylene
4.8 billion pounds (a)(b)
Propylene is used to produce polypropylene, acrylonitrile and propylene oxide.
Butadiene
1.2 billion pounds
Butadiene is used to manufacture styrene-butadiene rubber and polybutadiene rubber, which are used in the manufacture of tires, hoses, gaskets and other rubber products. Butadiene is also used in the production of paints, adhesives, nylon clothing, carpets, paper coatings and engineered plastics.
Aromatics:
Benzene
310 million gallons
Benzene is used to produce styrene, phenol and cyclohexane. These products are used in the production of nylon, plastics, synthetic rubber and polystyrene. Polystyrene is used in insulation, packaging and drink cups.
Toluene
66 million gallons
Toluene is used as an octane enhancer in gasoline, as a chemical raw material for benzene and/or paraxylene production, and a core ingredient in toluene diisocyanate, a compound used in urethane production.
Fuel Products:
MTBE
284 million gallons
(18,500 barrels/day) (c)
MTBE is a high octane gasoline blending component.
Alkylate
337 million gallons (d)
Alkylate is a high octane gasoline blending component.
Index to Financial Statements
Product
Annual Capacity
Primary Uses
DERIVATIVES:
High density
polyethylene (HDPE)
3.2 billion pounds
HDPE is used to manufacture grocery, merchandise and trash bags; food containers for items from frozen desserts to margarine; plastic caps and closures; liners for boxes of cereal and crackers; plastic drink cups and toys; dairy crates; bread trays; pails for items from paint to fresh fruits and vegetables; safety equipment such as hard hats; house wrap for insulation; bottles for household and industrial chemicals and motor oil; milk, water, and juice bottles; large (rotomolded) tanks for storing liquids such as agricultural and lawn care chemicals; and pipe.
Low density
polyethylene (LDPE)
1.4 billion pounds
LDPE is used to manufacture food packaging films; plastic bottles for packaging food and personal care items; dry cleaning bags; ice bags; pallet shrink wrap; heavy-duty bags for mulch and potting soil; boil-in-bag bags; coatings on flexible packaging products; and coatings on paper board such as milk cartons. Ethylene vinyl acetate is a specialized form of LDPE used in foamed sheets, bag-in-box bags, vacuum cleaner hoses, medical tubing, clear sheet protectors and flexible binders.
Linear low density
polyethylene (LLDPE)
1.2 billion pounds
LLDPE is used to manufacture garbage and lawn-leaf bags; industrial can liners; housewares; lids for coffee cans and margarine tubs, dishpans, home plastic storage containers, kitchen trash containers; large (rotomolded) toys like outdoor gym sets; drip irrigation tubing; wire and cable insulating resins and compounds used to insulate copper and fiber optic wiring, and film; shrink wrap for multi-packaging canned food, bag-in-box bags, produce bags, and pallet stretch wrap.
Ethylene Oxide (EO)
1.5 billion pounds EO
equivalents; 400 million
pounds as pure EO (e)
EO is used to produce surfactants, industrial cleaners, cosmetics, emulsifiers, paint, heat transfer fluids and ethylene glycol.
Ethylene Glycol (EG)
1.4 billion pounds (e)
EG is used to produce polyester fibers and film, polyethylene terephthalate (“PET”) resin, heat transfer fluids and automobile antifreeze.
Other Ethylene Oxide
Derivatives
225 million pounds
EO derivatives include ethylene glycol ethers and ethanolamines, and are used to produce paint and coatings, polishes, solvents and chemical intermediates.
Ethanol
50 million gallons
Ethanol is used in the production of solvents as well as household, medicinal and personal care products.
Polypropylene
280 million pounds
Polypropylene is used to manufacture fibers for carpets, rugs and upholstery; housewares; automotive battery cases; automotive fascia, running boards and bumpers; grid-type flooring for sports facilities; fishing tackle boxes; and bottle caps and closures.
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(a) Excludes 850 million pounds/year of ethylene capacity and 200 million pounds/year of propylene capacity at Equistar’s Lake Charles, Louisiana ethylene and co-products facility, which has been idled since the first quarter 2001. Although Equistar retains the physical ability to restart or sell that facility, in the third quarter of 2006 Equistar determined that it had no expectation of resuming production at that facility.
(b) Does not include refinery-grade material from Lyondell’s refinery or production from the product flexibility unit at the Channelview facility, which can convert ethylene and other light petrochemicals into propylene. These facilities have an annual processing capacity of an additional one billion pounds/year of propylene.
(c) Includes up to 44 million gallons/year of capacity produced for and returned to Lyondell.
(d) Includes up to 172 million gallons/year of capacity produced for and returned to Lyondell.
(e) Includes 700 million pounds/year of EO equivalents capacity and 800 million pounds/year of EG capacity at the Beaumont, Texas facility, which represents 100% of the EO equivalents capacity and EG capacity, respectively, at the facility. The Beaumont, Texas facility is owned by PD Glycol, a partnership owned 50% by Equistar and 50% by E. I. du Pont de Nemours and Company (“DuPont”).
Index to Financial Statements
Marketing and Sales
Other than Lyondell, which accounted for approximately 11% of Equistar’s total revenues in 2006, no single customer accounted for 10% or more of Equistar’s total revenues in 2006.
Ethylene and Co-Products-Equistar produces ethylene at six sites located in three states. Ethylene produced by Equistar generally is consumed internally as a raw material in the production of derivatives, or is shipped by pipeline to customers. For the year ended December 31, 2006, approximately 87% of Equistar’s ethylene, based on sales dollars, was used by Equistar’s derivatives facilities or sold to related parties at market-related prices. The sales to related parties during 2006 include significant ethylene sales to Occidental Chemical Corporation pursuant to a long-term ethylene supply agreement. Occidental Chemical Corporation is a subsidiary of Occidental, which owned 8.5% of Lyondell’s outstanding common stock as of December 31, 2006 and after giving effect to Occidental’s January 26, 2007 exercise of its warrant to purchase Lyondell common stock. See Note 5 to the Consolidated Financial Statements. Sales of ethylene accounted for approximately 12% of Equistar’s total revenues in 2006, 13% in 2005 and 12% in 2004.
Ethylene co-products are manufactured by Equistar primarily at four facilities in Texas. The Morris, Illinois and Clinton, Iowa facilities also can produce propylene.
Equistar consumes propylene in the production of polypropylene and also sells propylene to Lyondell at market-related prices. Equistar’s propylene production that is not consumed internally or sold to related parties generally is sold under multi-year contracts. In addition, pursuant to a 15-year propylene supply arrangement entered into in 2003 with a subsidiary of Sunoco, Inc. (“Sunoco”), Equistar supplies 700 million pounds of propylene annually to Sunoco. Under the arrangement, a majority of the propylene is supplied under a cost-based formula and the balance is supplied on a market-related basis. Sales of propylene accounted for approximately 20% of Equistar’s total revenues in 2006 and approximately 18% in 2005 and 2004.
Equistar generally sells its butadiene under multi-year contracts. Equistar sells benzene and toluene to Lyondell at market-related prices. Most of Equistar’s benzene and toluene production that is not sold to related parties generally is sold under multi-year contracts. Equistar also sells benzene produced by Lyondell, which it purchases from Lyondell at market-related prices. Sales of benzene accounted for less than 10% of Equistar’s total revenues in 2006 and 2005 and approximately 10% in 2004. Equistar serves as Lyondell’s sole agent to market toluene, paraxylene and orthoxylene produced by Lyondell and receives a marketing fee for such services.
Equistar at times purchases ethylene, propylene, benzene and butadiene for resale, when necessary, to satisfy customer demand for these products above production levels. Volumes of ethylene, propylene, benzene and butadiene purchased for resale can vary significantly from period to period. However, purchased volumes generally do not have a significant impact on profitability.
MTBE produced at one of the two Channelview units and at the Chocolate Bayou plant is sold to Lyondell at market-related prices. MTBE is produced for Lyondell at the second Channelview unit for a processing fee. Equistar produces alkylate for and returns alkylate to Lyondell for a processing fee, and also sells alkylate both under short-term contracts and on a spot basis.
Most of the ethylene and propylene production of the Channelview, Chocolate Bayou, Corpus Christi and La Porte facilities is shipped via a pipeline system which has connections to numerous U.S. Gulf Coast consumers. This pipeline system, some of which is owned and some of which is leased, extends from Corpus Christi to Mont Belvieu to Port Arthur, Texas as well as around the Lake Charles, Louisiana area. In addition, exchange agreements with other ethylene and co-products producers allow access to customers who are not directly connected to Equistar’s pipeline system. Some ethylene is shipped by railcar from Clinton, Iowa to Morris, Illinois and also to customers. A pipeline owned and operated by an unrelated party is used to transport ethylene from Morris, Illinois to Tuscola, Illinois. Some propylene is shipped by ocean-going vessel. Butadiene, benzene, toluene and other products are distributed by pipeline, railcar, truck, barge or ocean-going vessel.
Index to Financial Statements Derivatives-Polyethylene is manufactured by Equistar using a variety of technologies at five facilities in Texas and at the Morris, Illinois and Clinton, Iowa facilities. Polyethylene includes high density polyethylene (“HDPE”), low density polyethylene (“LDPE”) and linear low density polyethylene (“LLDPE”). HDPE accounted for approximately 12% of Equistar’s total revenues in 2006 and 2005 and 14% in 2004, and polyethylene (HDPE, LDPE and LLDPE collectively) accounted for approximately 21% of Equistar’s total revenues in 2006 and 2005 and 26% in 2004.
Polyethylene products primarily are sold to an extensive base of established customers. Approximately two-thirds of Equistar’s domestic polyethylene product volumes are sold to customers under annual or multi-year contracts. The remainder of the polyethylene volume generally is sold under customary terms and conditions without formal contracts. In either case, in most of the continuous supply relationships, prices are subject to change upon mutual agreement. Equistar also produces performance polymer products, which include enhanced grades of polyethylene and polypropylene. Equistar believes that, over a business cycle, average selling prices and profit margins for performance polymers tend to be higher than average selling prices and profit margins for higher-volume commodity polyethylenes.
EO or EO equivalents, and EO’s primary derivative, EG, are produced at the Bayport facility located in Pasadena, Texas and through a 50/50 joint venture between Equistar and DuPont in Beaumont, Texas. The Bayport facility also produces other derivatives of EO, principally ethylene glycol ethers and ethanolamines. EO and EG typically are sold under multi-year contracts, with market-based pricing. Glycol ethers, ethanolamines and brake fluids are sold primarily into the solvent and distributor markets at market prices. Ethanol and ethers primarily are sold under contracts at market prices. EO is shipped by railcar, and its derivatives are shipped by railcar, truck, isotank or ocean-going vessel.
Other derivatives products are primarily distributed by railcar. The vast majority of the derivatives products are sold in North America, primarily through Equistar’s sales organization. Sales agents are generally engaged to market the derivatives products in the rest of the world.
Raw Materials
Ethylene and Co-Products-Raw material cost is the largest component of the total cost for the production of ethylene and co-products. The primary raw materials used are heavy liquids and natural gas liquids (“NGLs”). Heavy liquids include crude oil-based naphtha and gas oil, as well as condensate, a very light crude oil resulting from natural gas production (collectively referred to as “heavy liquids”). NGLs include ethane, propane and butane. The use of heavy liquid raw materials results in the production of a significant amount of co-products such as propylene, butadiene, benzene and toluene, as well as gasoline blending components, while the use of NGLs results in the production of a smaller amount of co-products, such as propylene.
The flexibility to consume a wide range of raw materials, including heavy liquids, has historically provided plants with that flexibility with an advantage over plants that are restricted in their raw material processing capability to NGLs such as ethane and propane, assuming the co-products were recovered and sold. Facilities using heavy liquids historically have generated, on average, approximately four cents of additional variable margin per pound of ethylene produced compared to facilities restricted to using ethane. This margin advantage is based on an average of historical data over a period of years and is subject to short-term fluctuations, which can be significant. For example, the advantage during first quarter 2006 was well below the historical average. However, strengthening market conditions increased the advantage significantly for the remainder of the year. As a result, the advantage for the full year 2006 was above the historical average. Equistar has the capability to realize this margin advantage due to its ability to process heavy liquids at its Channelview, Corpus Christi and Chocolate Bayou ethylene and co-products facilities. Equistar’s Channelview and Corpus Christi facilities have the greatest operational flexibility among Equistar’s facilities to process significant quantities of either heavy liquids or NGLs, depending upon the relative economic advantage of the alternative raw materials.
Index to Financial Statements As described above, management believes that this raw material flexibility is a key advantage in the production of ethylene and co-products. As a result, Equistar’s heavy liquids requirements are sourced globally via a mix of contractual and spot arrangements. Spot market purchases are made in order to maintain raw material flexibility and to take advantage of raw material pricing opportunities. A large portion of Equistar’s NGLs requirements are purchased via contractual arrangements from a variety of sources, but NGLs also are purchased on the spot market. Equistar also obtains a portion of its heavy liquids requirements from Lyondell’s refinery at market-related prices. Heavy liquids generally are delivered by ship or barge, and NGLs generally are delivered via pipeline.
Equistar purchases all of its methanol requirements for ethylene and co-products from Lyondell at market-based prices. Also, Equistar purchases large amounts of natural gas to be used as energy for consumption in its business via market-based contractual arrangements with a variety of sources.
The raw materials for ethylene and co-products are, in general, commodity heavy liquids and NGLs with numerous bulk suppliers and ready availability at competitive prices. Historically, raw material availability for ethylene and co-products has not been an issue. For additional discussion regarding the effects of raw material pricing and supply on recent operating results, see “Item 1A.
Item 1A. Risk Factors
There are many factors that may affect the businesses and results of operations of Equistar. For additional discussion regarding factors that may affect the businesses and operating results of Equistar, see “Item 1. Business,” “Item 3. Legal Proceedings,” “Forward-Looking Statements,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Disclosure of Market Risk.” If one or more of these risks actually occur, Equistar’s business, financial position or results of operations could be materially and adversely affected.
Risks Relating to the Businesses
Costs of raw materials and energy, as well as reliability of supply, may result in increased operating expenses and reduced results of operations.
Equistar purchases large amounts of raw materials and energy for its businesses. The cost of these raw materials and energy, in the aggregate, represents a substantial portion of its operating expenses. The costs of raw materials and energy used for Equistar’s products generally follow price trends of, and vary with the market conditions for, crude oil and natural gas, which may be highly volatile and cyclical. Raw material and energy costs remain at high levels. There have been in the past, and will likely be in the future, periods of time when Equistar is unable to pass raw material and energy cost increases on to customers quickly enough to avoid adverse impacts on its results of operations. Customer consolidation also has made it more difficult to pass along cost increases to customers. Equistar’s results of operations have been, and could be in the future, significantly affected by increases and volatility in these costs. Cost increases also may increase working capital needs, which could reduce Equistar’s liquidity and cash flow. In addition, when raw material and energy costs increase rapidly and are passed along to customers as product price increases, the credit risks associated with certain customers can be compounded. To the extent Equistar increases its product sales prices to reflect rising raw material and energy costs, demand for products may decrease as customers reduce their consumption or use substitute products, which may have an adverse impact on Equistar’s results of operations. See “Equistar sells commodity products in highly competitive global markets and faces significant price pressures” below.
In addition, higher North American natural gas prices relative to natural gas cost-advantaged regions, such as the Middle East, have diminished the ability of many domestic chemical producers to compete internationally since natural gas prices affect a significant portion of the industry’s raw materials and energy sources. This environment has in the past caused and may in the future cause a reduction in Equistar’s exports, and has in the past reduced and may in the future reduce the competitiveness of U.S. producers. It also has in the past increased the competition for sales of chemicals in North America, as U.S. production that would otherwise have been sold overseas was instead offered for sale domestically, resulting in excess supply and lower margins in North America, and may do so in the future.
Furthermore, across Equistar, there are a limited number of suppliers for some of its raw materials and utilities and, in some cases, the number of sources for and availability of raw materials is specific to the particular geographic region in which a facility is located. In addition, for some Equistar’s products, the facilities and/or distribution channels of raw material suppliers and Equistar form an integrated system. This is especially true in the U.S. Gulf Coast where the infrastructure of the chemical and refining industries is tightly integrated such that a major disruption of supply of a given commodity can negatively affect numerous participants, including suppliers of other raw materials. If one or more of Equistar’s significant suppliers were unable to meet its obligations under present supply arrangements or supplies are otherwise disrupted, Equistar’s businesses could suffer reduced supplies or be forced to incur increased costs for their raw materials, which would have a direct negative impact on plant operations. For example, Hurricanes Katrina and Rita negatively affected crude oil and natural gas supplies, as well as supplies of some of Equistar’s other raw materials, contributing to increases in raw material prices during the second half of 2005 and, in some cases, disrupting production. In addition, hurricane-related disruption of rail and pipeline traffic in the U.S. Gulf Coast area negatively affected shipments of raw materials and product.
Index to Financial Statements The cyclicality and volatility of the chemical industry may cause significant fluctuations in Equistar’s operating results.
Equistar’s historical operating results reflect the cyclical and volatile nature of the supply-demand balance in the chemical industry, and Equistar’s future operating results are expected to continue to be affected by this cyclicality and volatility. The chemical industry historically has experienced alternating periods of capacity shortages leading to tight supply, causing prices and profit margins to increase, followed by periods when substantial capacity is added, resulting in oversupply, declining capacity utilization rates and declining prices and profit margins. The volatility this industry experiences occurs as a result of changes in the supply and demand for products, changes in energy prices and changes in various other economic conditions around the world. This cyclicality and volatility results in significant fluctuations in profits and cash flow from period to period and over the business cycles.
The chemical industry has experienced tight supply in many product areas and increased demand as the global economy has improved over the past several years. As a result, profitability in the industry increased, even in a world of volatile raw material and energy costs. However, the sustainability of these positive business conditions remains subject to uncertainty. The global economic and political environment continues to be uncertain, and a recession or other negative changes could result in a decline in demand and place pressure on Equistar’s results of operations. In addition, new capacity additions by some participants in the industry, especially those in the Middle East and Asia that began in 2006 and are expected to continue through the latter part of the decade, could lead to another period of oversupply and poor profitability.
Equistar may reduce production at or idle a facility for an extended period of time or exit a business because of an oversupply of a particular product and/or a lack of demand for that particular product, or high raw material prices, which makes production uneconomical. Any decision to permanently close facilities or exit a business would result in impairment and other charges to earnings. Temporary outages sometimes last for several quarters or, in certain cases, longer, and could cause Equistar to incur costs, including the expenses of maintaining and restarting these facilities. It is possible that factors such as increases in raw material costs or lower demand in the future will cause Equistar to reduce operating rates, idle facilities or exit uncompetitive businesses.
External factors beyond Equistar’s control can cause fluctuations in demand for its products and in its prices and margins, which may result in lower operating results.
External factors beyond Equistar’s control can cause volatility in the price of raw materials and other operating costs, as well as significant fluctuations in demand for its products and can magnify the impact of economic cycles on its businesses. Examples of external factors include:
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supply of and demand for raw materials;
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changes in customer buying patterns and demand for Equistar’s products;
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general economic conditions;
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domestic and international events and circumstances;
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competitor actions;
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governmental regulation in the U.S. and abroad; and
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severe weather and natural disasters.
Equistar believes that events in the Middle East have had an impact on its businesses in recent years and may continue to do so. In addition, a number of Equistar’s products are highly dependent on durable goods markets, such as the housing and automotive markets, which also are cyclical and impacted by many of the external factors referenced above. Many of Equistar’s products are components of other chemical products that, in turn, are subject to the supply-demand balance of the chemical industry and general economic conditions. The global economy has remained strong, with relatively stable demand for Equistar’s products resulting in improved operating results compared to previous years as operations have remained at high capacity for the majority of Equistar’s products. This has occurred even as the volatility and elevated level of prices for crude oil and natural gas have resulted in
Index to Financial Statements
increased raw material costs. However, the impact of the factors cited above and others may once again cause a slowdown in the business cycle, reducing demand and lowering operating rates and, ultimately, reducing profitability.
Equistar sells commodity products in highly competitive global markets and faces significant price pressures.
Equistar sells its products in highly competitive global markets. Due to the commodity nature of many of its products, competition in these markets is based primarily on price and to a lesser extent on product performance, product quality, product deliverability, reliability of supply and customer service. As a result, Equistar generally is not able to protect its market position for these products by product differentiation and may not be able to pass on cost increases to its customers.
In addition, Equistar faces increased competition from companies that may have different cost structures or strategic goals than Equistar, such as privately-held companies, large integrated oil companies (many of which also have chemical businesses), government-owned businesses, and companies that receive subsidies or other government incentives to produce certain products in a specified geographic region. Increased competition from these companies could limit Equistar’s ability to increase product sales prices in response to raw material and other cost increases, or could cause Equistar to reduce product sales prices to compete effectively, which could reduce Equistar’s profitability.
Accordingly, increases in raw material and other costs may not necessarily correlate with changes in prices for these products, either in the direction of the price change or in magnitude. In addition, Equistar’s ability to increase product sales prices, and the timing of those increases, are affected by the supply-demand balances for its products, as well as the capacity utilization rates for those products. Timing differences in pricing between rising raw material costs, which may change daily, and contract product prices, which in many cases are negotiated only monthly or less often, sometimes with an additional lag in effective dates for increases, have reduced and may continue to reduce profitability.
Further, volatility in costs and pricing can result in commercial disputes with customers and suppliers with respect to interpretations of complex contractual arrangements. Significant adverse resolution of any such disputes also could reduce profitability.
Equistar obtains a portion of its raw materials from sources outside the U.S., which subjects it to exchange controls, political risks and other risks.
Equistar obtains a portion of its principal raw materials from sources outside the U.S., which subjects it to risks such as transportation delays and interruptions, political and economic instability and disruptions, restrictions on the transfer of funds, the imposition of duties and tariffs, import and export controls, changes in governmental policies, labor unrest and current and changing regulatory environments. These events could increase the prices at which Equistar can obtain raw materials or disrupt the supply of raw materials, which could reduce Equistar’s operating results. Although Equistar has compliance programs and processes intended to ensure compliance with applicable customs, currency exchange control regulations, transfer pricing regulations or any other laws or regulations to which it may be subject, Equistar is subject to the risk that its compliance could be challenged.
Equistar’s operations and assets are subject to extensive environmental, health and safety and other laws and regulations, which could result in material costs or liabilities.
Equistar cannot predict with certainty the extent of future liabilities and costs under environmental, health and safety and other laws and regulations and whether liabilities and costs will be material. Equistar also may face liability for alleged personal injury or property damage due to exposure to chemicals or other hazardous substances at its facilities or chemicals that it manufactures, handles or owns. In addition, because Equistar’s chemical products are components of a variety of other end-use products, Equistar, along with other members of the chemical industry, is inherently subject to potential claims related to those end-use products. Although claims of the types described above have not historically had a material impact on Equistar’s operations, a substantial increase in the success of
Index to Financial Statements
these types of claims could result in the expenditure of a significant amount of cash by Equistar to pay claims, and could reduce its operating results.
Equistar (together with the industries in which it operates) is subject to extensive national, state and local environmental laws and regulations concerning, and is required to have permits and licenses regulating, emissions to the air, discharges onto land or waters and the generation, handling, storage, transportation, treatment and disposal of waste materials. Many of these laws and regulations provide for substantial fines and potential criminal sanctions for violations. Some of these laws and regulations are subject to varying and conflicting interpretations. In addition, some of these laws and regulations require Equistar to meet specific financial responsibility requirements. Equistar cannot accurately predict future developments, such as increasingly strict environmental laws, and inspection and enforcement policies, as well as higher compliance costs, which might affect the handling, manufacture, use, emission or disposal of products, other materials or hazardous and non-hazardous waste. Some risk of environmental costs and liabilities is inherent in Equistar’s operations and products, as it is with other companies engaged in similar businesses, and there is no assurance that material costs and liabilities will not be incurred. In general, however, with respect to the costs and risks described above, Equistar does not expect that it will be affected differently than the rest of the chemical industry where its facilities are located.
Environmental laws may have a significant effect on the nature and scope of cleanup of contamination at current and former operating facilities, the costs of transportation and storage of raw materials and finished products and the costs of the storage and disposal of wastewater. Also, U.S. “Superfund” statutes may impose joint and several liability for the costs of remedial investigations and actions on the entities that generated waste, arranged for disposal of the wastes, transported to or selected the disposal sites and the past and present owners and operators of such sites. All such responsible parties (or any one of them, including Equistar) may be required to bear all of such costs regardless of fault, the legality of the original disposal or ownership of the disposal site.
Equistar has on-site solid-waste management units at several facilities. It is anticipated that corrective measures will be necessary to comply with federal and state requirements with respect to these facilities. Equistar also has liabilities under the Resource Conservation and Recovery Act and various state government regulations related to several current and former plant sites. Equistar also is responsible for a portion of the remediation of certain off-site waste disposal facilities. Equistar’s policy is to accrue remediation expenses when it is probable that such efforts will be required and the related expenses can be reasonably estimated. Estimated costs for future environmental compliance and remediation are necessarily imprecise due to such factors as the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of presently unknown remediation sites and the allocation of costs among the potentially responsible parties under applicable statutes. For further discussion regarding Equistar’s environmental matters and related accruals, and environmentally-related capital expenditures, see also “Item 1. Business-Environmental Capital Expenditures,” “Item 3. Legal Proceedings-Environmental Matters,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Environmental Matters” and Note 16 to the Consolidated Financial Statements. If actual expenditures exceed the amounts accrued, that could have an adverse effect on Equistar’s results of operations and financial position.
In addition to the matters described above, Equistar is subject to other material regulatory requirements that could result in higher operating costs, such as regulatory requirements relating to the security of chemical facilities, and the transportation, exportation or registration of products. Although Equistar has compliance programs and other processes intended to ensure compliance with all such regulations, Equistar is subject to the risk that its compliance with such regulations could be challenged. Non-compliance with certain of these regulations could result in the incurrence of additional costs, penalties or assessments that could be significant.
Index to Financial Statements Legislative and other actions have substantially eliminated all U.S. demand for MTBE. Therefore, Equistar has been selling its MTBE for use outside of the U.S. and may produce alternative gasoline blending components that may be less profitable than MTBE.
The presence of MTBE in some water supplies in certain U.S. states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft led to public concern about the use of MTBE and resulted in U.S. federal and state governmental initiatives to reduce or ban the use of MTBE. Substantially all refiners and blenders have discontinued the use of MTBE in the U.S.
Accordingly, Equistar’s MTBE is sold for use outside of the U.S. However, there are higher distribution costs and import duties associated with exporting MTBE outside of the U.S., and the increased supply of MTBE may reduce profitability of MTBE in these export markets. Should it become necessary or desirable to significantly reduce MTBE production, Equistar may make capital expenditures to add the flexibility to produce alternative gasoline blending components, such as iso-octane, iso-octene (also known as “di-isobutylene”) or ETBE, at its MTBE plant. Conversion and product decisions will continue to be influenced by regulatory and market developments. The profit contribution related to iso-octane or iso-octene may be lower than that historically realized on MTBE.
Interruptions of operations at Equistar’s facilities may result in liabilities or lower operating results.
Equistar owns and operates large-scale chemical facilities, and Equistar’s operating results are dependent on the continued operation of its various production facilities and the ability to complete construction and maintenance projects on schedule. Material operating interruptions at Equistar’s facilities, including, but not limited to, interruptions caused by the events described below, may materially reduce the productivity and profitability of a particular manufacturing facility, or Equistar as a whole, during and after the period of such operational difficulties.
Although Equistar takes precautions to enhance the safety of its operations and minimize the risk of disruptions, its operations, along with the operations of other members of the chemical industry, are subject to hazards inherent in chemical manufacturing and the related storage and transportation of raw materials, products and wastes. These potential hazards include:
•
pipeline leaks and ruptures;
•
explosions;
•
fires;
•
severe weather and natural disasters;
•
mechanical failure;
•
unscheduled downtimes;
•
supplier disruptions;
•
labor shortages or other labor difficulties;
•
transportation interruptions;
•
remediation complications;
•
chemical spills;
•
discharges or releases of toxic or hazardous substances or gases;
•
storage tank leaks;
•
other environmental risks; and
•
terrorist acts.
Index to Financial Statements Some of these hazards can cause personal injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. Furthermore, Equistar also will continue to be subject to present and future claims with respect to workplace exposure, workers’ compensation and other matters.
Equistar maintains property, business interruption and casualty insurance that it believes are in accordance with customary industry practices, but it is not fully insured against all potential hazards incident to its businesses, including losses resulting from natural disasters, war risks or terrorist acts. Changes in insurance market conditions have caused, and may in the future cause, premiums and deductibles for certain insurance policies to increase substantially and, in some instances, for certain insurance to become unavailable or available only for reduced amounts of coverage. If Equistar were to incur a significant liability for which it was not fully insured, it might not be able to finance the amount of the uninsured liability on terms acceptable to it or at all, and might be obligated to divert a significant portion of its cash flow from normal business operations.
Conflicts of interest between Equistar and its owners could be resolved in a manner that may be perceived to be adverse to Equistar.
Lyondell owns 70.5% of Equistar, and Millennium owns the remaining 29.5% of Equistar. As a result of Lyondell’s November 30, 2004 acquisition of Millennium, Millennium and Equistar are wholly-owned subsidiaries of Lyondell. All executive officers of Millennium and Equistar and all members of Equistar’s Partnership Governance Committee and Millennium’s Board of Directors also serve as officers of Lyondell. Conflicts of interest may arise between Lyondell, Equistar and/or Millennium when decisions arise that could have different implications for Lyondell, Equistar and/or Millennium. Their respective debt agreements generally require related party transactions to be on an arm’s-length basis; however, because Lyondell owns both Millennium and Equistar, conflicts of interest could be resolved in a manner that may be perceived to be adverse to Equistar.
Equistar depends to a significant degree on its owners for the administration of its business and has product supply arrangements with its owners and other related parties. If those parties do not fulfill their obligations under the arrangements, Equistar’s revenues, margins and cash flow could be adversely affected.
Equistar has various agreements and transactions with its owners (Lyondell and Millennium) and other related parties. For example, Equistar is party to shared services, loaned employee and operating arrangements with Lyondell and Millennium pursuant to which Lyondell, Equistar and Millennium provide many administrative and operating services to each other. Lyondell provides to Equistar services that are essential to the administration and management of Equistar’s business, including information technology, human resources, sales and marketing, raw material supply, supply chain, health, safety and environmental, engineering, research and development, facility services, legal, accounting, treasury, internal audit and tax. Accordingly, Equistar depends to a significant degree on Lyondell for the administration of Equistar’s business. If Lyondell did not fulfill its obligations under the shared services arrangement, it would disrupt Equistar’s business and could have a material adverse effect on Equistar’s business and results of operations. In addition, Equistar has product supply agreements with Lyondell and Millennium and various other related parties, pursuant to which Equistar sells a substantial amount of its products. Equistar expects to continue to derive a significant portion of its business from transactions with these parties. If they are unable or otherwise cease to purchase Equistar’s products, Equistar’s revenues, margins and cash flow could be adversely affected.
Equistar pursues acquisitions, dispositions and joint ventures, which may not yield the expected benefits.
Equistar may purchase or sell assets or enter into contractual arrangements or joint ventures in an effort to generate value. To the extent permitted under Equistar’s credit facility and other debt agreements, some of these transactions may be financed with additional borrowings by Equistar. Although these transactions may be expected to yield longer-term benefits if the expected efficiencies and synergies of the transactions are realized, they could reduce Equistar’s operating results in the short term because of the costs, charges and financing arrangements associated with such transactions or the benefits of a transaction may not be realized to the extent anticipated. Other transactions may advance future cash flows from some of Equistar’s businesses, thereby yielding increased short-term liquidity, but consequently resulting in lower cash flows from these operations over the longer term.
Index to Financial Statements
Risks Relating to Debt
Equistar’s consolidated balance sheet is highly levered, and Equistar’s business and future prospects could be limited by its significant amount of debt and other financial obligations.
Equistar’s consolidated balance sheet is highly levered. Equistar’s total consolidated debt was $2.2 billion at December 31, 2006. This debt represented approximately 57% of Equistar’s total capitalization. In addition, Equistar has contractual commitments and ongoing pension and post-retirement benefit obligations that will require cash contributions in 2007 and beyond, as described in “-Contractual and Other Obligations” under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Equistar’s level of debt and other obligations could have significant adverse consequences on its business and future prospects, including the following:
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Equistar may not be able to obtain financing in the future for working capital, capital expenditures, acquisitions, debt service requirements or other purposes;
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less levered competitors could have a competitive advantage because they have lower debt service requirements; and
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in the event of poor business conditions, Equistar may be less able to take advantage of significant business opportunities and to react to changes in market or industry conditions than its competitors.
For a discussion regarding Equistar’s ability to pay or refinance its debt, see the “-Liquidity and Capital Resources” section under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Equistar requires a significant amount of cash to service its indebtedness, and its ability to generate cash depends on many factors beyond its control.
Due to debt covenant limitations on transferring cash between the entities discussed below in this “Item 1A. Risk Factors,” the ability of Equistar to make payments on and to refinance its indebtedness may depend solely upon its individual ability to generate cash. Equistar is separately responsible for its outstanding debt (except that $150 million of Equistar’s debt is guaranteed by Lyondell). Equistar’s businesses may not generate sufficient cash flow from operations to meet its debt service obligations, future borrowings may not be available under current or future credit facilities in an amount sufficient to enable Equistar to pay its indebtedness at or before maturity, and Equistar may not be able to refinance its indebtedness on reasonable terms, if at all. Factors beyond Equistar’s control affect its ability to make these payments and refinancings. These factors include those discussed elsewhere in these “Risk Factors” and the “Forward-Looking Statements” section of this Annual Report on Form 10-K.
Further, Equistar’s ability to fund capital expenditures and working capital depends on its ability to generate cash and depends on the availability of funds under lines of credit and other liquidity facilities. If, in the future, sufficient cash is not generated from Equistar’s operations to meet its debt service obligations and sufficient funds are not available under lines of credit or other liquidity facilities, Equistar may need to reduce or delay non-essential expenditures, such as capital expenditures and research and development efforts. In addition, Equistar may need to refinance debt, obtain additional financing or sell assets, which it may not be able to do on reasonable terms, if at all.
Index to Financial Statements Debt and other agreements restrict Equistar’s ability to take certain actions; failure to comply with these requirements could result in acceleration of debt.
Equistar has an inventory-based revolving credit facility and an accounts receivable sales facility. Both of these facilities and Equistar’s indentures contain covenants that, subject to exceptions, restrict, among other things, lien incurrence, debt incurrence, dividends, sales of assets, investments, accounts receivable securitizations, purchase of equity, payments on indebtedness, affiliate transactions, sale and leaseback transactions and mergers. Equistar’s credit facility does not require the maintenance of specified financial ratios as long as certain conditions are met. Some of Equistar’s indentures require additional interest payments to the note holders if Equistar makes distributions when Equistar’s Fixed Charge Coverage Ratio (as defined) is less than 1.75 to 1. Equistar met this ratio as of December 31, 2006.
A breach by Equistar of any of the covenants or other requirements in its debt instruments could (1) permit its note holders or lenders to declare the outstanding debt under the breached debt instrument due and payable, (2) permit its lenders under the credit facility to terminate future lending commitments and (3) permit acceleration of Equistar’s other debt instruments that contain cross-default or cross-acceleration provisions. The debt agreements of Equistar contain various event of default and cross-default provisions. It is not likely that Equistar would have, or be able to obtain, sufficient funds to make these accelerated payments. In that event, Equistar’s lenders could proceed against any assets that secure their debt. Similarly, the breach by Equistar of covenants in its accounts receivable sales facility would permit the counterparties under the facility to terminate further purchases of interests in accounts receivable and to receive all collections from previously sold interests until they had collected on their interests in those receivables, thus reducing Equistar’s liquidity.
Debt covenants limit the ability of Lyondell and Millennium to contribute cash to Equistar and Equistar’s partnership agreement requires it to distribute cash.
Although Equistar and Millennium are wholly-owned subsidiaries of Lyondell, debt covenants limit the ability of Lyondell and Millennium to contribute cash to Equistar. For example, Lyondell’s indentures contain a covenant that prohibits it from making investments in subsidiaries and joint ventures that are not restricted subsidiaries as defined in the indentures, subject to limited exceptions. Equistar currently is not a restricted subsidiary. Lyondell’s credit facility also contains a covenant that places limitations on its ability to make investments in joint ventures. Millennium’s flexibility to make investments in Equistar also is limited by its debt covenants. Future borrowings by Lyondell or Millennium also may contain restrictions on making investments in Equistar. As a result of these limitations, cash flow of Lyondell and Millennium may not be available to fund cash needs of Equistar, such as servicing debt or paying capital expenditures. The ability of Lyondell and Millennium to make investments in Equistar also is dependent upon their economic performance, which is dependent on a variety of factors, including factors described elsewhere in these “Risk Factors” and the “Forward-Looking Statements” section of this Annual Report on Form 10-K.
Conversely, under its partnership agreement, Equistar is required to distribute to its owners (Lyondell and Millennium), as soon as practicable following the end of each month, all of its surplus cash in excess of its estimated cash needs for its next 12 months. Under the partnership agreement, distributions other than of surplus cash may only be made upon approval of Equistar’s Partnership Governance Committee. Equistar’s credit facility and indentures do not contain any restrictions on Equistar’s ability to make distributions to its owners in accordance with its partnership agreement, except that the credit facility prohibits distributions during any default under the facility. However, some of Equistar’s indentures require additional interest payments to the note holders if Equistar makes distributions when Equistar does not meet a specified fixed charge coverage ratio. Equistar met this ratio as of December 31, 2006.
Index to Financial Statements
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this report are “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements can be identified by words such as “estimate,” “believe,” “expect,” “anticipate,” “plan,” “budget” or other words that convey the uncertainty of future events or outcomes. Many of these forward-looking statements have been based on expectations and assumptions about future events that may prove to be inaccurate. While management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond Equistar’s control. Equistar’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to:
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the availability, cost and price volatility of raw materials and utilities,
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the supply/demand balances for Equistar’s products, and the related effects of industry production capacities and operating rates,
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uncertainties associated with the U.S. and worldwide economies, including those due to political tensions in the Middle East and elsewhere,
•
the cyclical nature of the chemical industry,
•
operating interruptions (including leaks, explosions, fires, weather-related incidents, mechanical failures, unscheduled downtimes, supplier disruptions, labor shortages or other labor difficulties, transportation interruptions, spills and releases and other environmental risks),
•
legal and environmental proceedings,
•
current and potential governmental regulatory actions in the U.S. and in other countries,
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terrorist acts and international political unrest,
•
competitive products and pricing pressures,
•
access to capital markets,
•
technological developments, and
•
Equistar’s ability to implement its business strategies.
Any of the factors, or a combination of these factors, could materially affect Equistar’s future results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of Equistar’s future performance, and Equistar’s actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels.
All forward-looking statements in this Form 10-K are qualified in their entirety by the cautionary statements contained in this section and elsewhere in this report. See “Item 1. Business,” “Item 1A. Risk Factors,” “Item 3. Legal Proceedings,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Disclosure of Market Risk” for additional information about factors that may affect the businesses and operating results of Equistar. These factors are not necessarily all of the important factors that could affect Equistar. Use caution and common sense when considering these forward-looking statements. Equistar does not intend to update these statements unless securities laws require it to do so.
In addition, this report contains summaries of contracts and other documents. These summaries may not contain all of the information that is important to an investor, and reference is made to the actual contract or document for a more complete understanding of the contract or document involved.
Index to Financial Statements
INDUSTRY AND OTHER INFORMATION
The data included or incorporated by reference in this report regarding the chemical industry, product capacity and ranking, including Equistar’s capacity positions, the capacity positions of its competitors for certain products and expected rates of demand, is based on independent industry publications, reports from government agencies or other published industry sources and estimates of Equistar. These estimates are based on information obtained from Equistar’s customers, distributors, suppliers, trade and business organizations and other contacts in the markets in which Equistar operates and Equistar’s managements’ knowledge and experience. These estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under “Item 1A. Risk Factors” and “Forward-Looking Statements.”
NON-GAAP FINANCIAL MEASURES
The body of generally accepted accounting principles is commonly referred to as “GAAP.” For this purpose, a non-GAAP financial measure is generally defined by the Securities and Exchange Commission as one that purports to measure historical or future financial performance, financial position or cash flows but excludes or includes amounts that would not be so adjusted in the most comparable U.S. GAAP measure. From time to time Equistar discloses so-called non-GAAP financial measures, primarily EBITDA, or earnings before interest, taxes, depreciation and amortization of long-lived assets. The non-GAAP financial measures described herein or in other documents issued by Equistar are not a substitute for the GAAP measures of earnings, for which management has responsibility.
Equistar sometimes uses EBITDA in its communications with investors, financial analysts and the public. This is because EBITDA is perceived as a useful and comparable measure of operating performance and the contributions of operations to liquidity. For example, interest expense is dependent on the capital structure and credit rating of a company. However, debt levels, credit ratings and, therefore, the impact of interest expense on earnings vary in significance between companies. Similarly, the tax positions of individual companies can vary. Equistar, as a partnership, is not subject to U.S. federal income taxes. Other companies may be subject to U.S. federal or state income taxes as well as income taxes in countries outside of the U.S., and will differ in their abilities to take advantage of tax benefits, with the result that their effective tax rates and tax expense can vary considerably. Finally, companies differ in the age and method of acquisition of productive assets, and thus the relative costs of those assets, as well as in the depreciation (straight-line, accelerated, units of production) method, which can result in considerable variability in depreciation and amortization expense between companies. Thus, for comparison purposes, management believes that EBITDA can be useful as an objective and comparable measure of operating profitability and the contribution of operations to liquidity because it excludes these elements of earnings that do not provide information about the current operations of existing assets. Accordingly, management believes that disclosure of EBITDA can provide useful information to investors, financial analysts and the public in their evaluation of companies’ operating performance and the contribution of operations to liquidity.
Equistar also sometimes reports adjusted net income (loss) or adjusted EBITDA, excluding specified items that are unusual in nature or are not comparable from period to period and that are included in GAAP measures of earnings. Management believes that excluding these items may help investors compare operating performance between two periods. Such adjusted data is always reported with an explanation of the items that are excluded.
Index to Financial Statements
Item 2.
Item 2. Properties
Principal Manufacturing Facilities
The principal manufacturing facilities used by Equistar are set forth below. The facilities are wholly owned, except as otherwise noted below.
Location
Principal Products
Bayport (Pasadena), Texas 
EO, EG and other EO Derivatives
Bayport (Pasadena), Texas (a)
LDPE
Beaumont, Texas (b)
EG
Channelview, Texas (c)
Ethylene, Propylene, Butadiene, Benzene, Toluene, Alkylate and MTBE
Chocolate Bayou, Texas (d)(e)
Ethylene, Propylene, Butadiene, Benzene, Toluene and MTBE
Chocolate Bayou, Texas (d) 
HDPE
Clinton, Iowa 
Ethylene, Propylene, LDPE and HDPE
Corpus Christi, Texas 
Ethylene, Propylene, Butadiene and Benzene
Fairport Harbor, Ohio (f)
Performance polymers
Lake Charles, Louisiana (g)
Ethylene and Propylene
La Porte, Texas 
Ethylene, Propylene, LDPE and LLDPE
Matagorda, Texas 
HDPE
Morris, Illinois 
Ethylene, Propylene, LDPE, LLDPE and Polypropylene
Newark, New Jersey
Denatured Alcohol
Tuscola, Illinois 
Ethanol
Victoria, Texas (e)
HDPE
 Facilities which received the OSHA Star Certification, which is the highest safety designation issued by the U.S. Department of Labor.
(a) The facility is located on leased land. The facility is operated by an unrelated party.
(b) The Beaumont facility is owned by PD Glycol, a partnership owned 50% by an unrelated party.
(c) The Channelview facility has two ethylene processing units. An unrelated party owns an idled facility at the site on land leased from Equistar. Equistar also operates a styrene maleic anhydride unit and a polybutadiene unit, which are owned by an unrelated party and are located on property leased from Equistar within the Channelview facility.
(d) Millennium and Occidental each contributed a facility located at the Chocolate Bayou site. These facilities are not on contiguous property.
(e) The facility is located on leased land.
(f) The building and land are leased.
(g) The Lake Charles facility has been idled since the first quarter of 2001. Although Equistar retains the physical ability to restart or sell that facility, in the third quarter of 2006 Equistar determined that it had no expectation of resuming production at that facility. The facility and land are leased from Occidental under a lease that expires in May 2009.
Other Locations and Properties
Equistar owns storage capacity for NGLs, ethylene, propylene and other hydrocarbons in caverns within a salt dome in Mont Belvieu, Texas. There are additional ethylene and propylene storage facilities with related brine facilities operated by Equistar on leased property in Markham, Texas.
Equistar uses an extensive pipeline system, some of which it owns and some of which it leases, extending from Corpus Christi to Mont Belvieu to Port Arthur and around the Lake Charles area. Equistar owns other pipelines in connection with its Chocolate Bayou, Corpus Christi, La Porte, Matagorda and Victoria facilities. Equistar uses a pipeline owned and operated by an unaffiliated party to transport ethylene from its Morris facility to its Tuscola facility. Equistar owns and leases several pipelines connecting the Channelview facility, Lyondell’s refinery and the Mont Belvieu storage facility, which are used to transport raw materials, butylenes, hydrogen, butane, MTBE and unfinished gasolines. Equistar also has barge docking facilities and related terminal equipment for loading and unloading raw materials and products. Equistar owns and leases railcars for use in its businesses.
Index to Financial Statements Lyondell provides office space to Equistar for its executive offices in downtown Houston, Texas as part of a shared services arrangement. In addition, Equistar owns facilities that house its research operations. Equistar also leases various sales facilities and storage facilities, primarily in the U.S. Gulf Coast area, for the handling of products.
Item 3.
Item 3. Legal Proceedings
Litigation Matters
Equistar is, from time to time, a defendant in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, Equistar does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it currently is involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on its business or financial position. However, the adverse resolution in any reporting period of one or more of these suits could have a material impact on Equistar’s results of operations for that period, which may be mitigated by contribution or indemnification obligations of co-defendants or others, or by any insurance coverage that may be available.
Although Equistar is involved in numerous and varied legal proceedings, a significant portion of its outstanding litigation arose in five contexts: (1) claims for personal injury or death allegedly arising out of exposure to the products produced by Equistar or located on Equistar’s premises; (2) claims for personal injury or death, and/or property damage allegedly arising out of the generation and disposal of chemical wastes at Superfund and other waste disposal sites; (3) claims for personal injury, property damage and/or air, noise and water pollution allegedly arising out of operations; (4) employment and benefits related claims; and (5) commercial disputes.
Environmental Matters
From time to time Equistar receives notices or inquiries from federal, state or local governmental entities of alleged violations of environmental laws and regulations pertaining to, among other things, the disposal, emission and storage of chemical and petroleum substances, including hazardous wastes. Any such alleged violations may become the subject of enforcement actions, settlement negotiations or other legal proceedings and may (individually or in the aggregate) involve monetary sanctions of $100,000 or more (exclusive of interest and costs). For additional information regarding environmental matters, see “Item 1A. Risk Factors-Risks Relating to the Businesses-Equistar’s operations and assets are subject to extensive environmental, health and safety and other laws and regulations, which could result in material costs or liabilities” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Environmental Matters.”
In December 2006, the State of Texas filed a lawsuit in the District Court, Travis County, Texas, against Equistar and its owners, Lyondell and Millennium, alleging past violations of various environmental regulatory requirements at Equistar’s Channelview, Chocolate Bayou and La Porte, Texas facilities and seeking an unspecified amount of damages. The previously disclosed Texas Commission on Environmental Quality notification seeking a civil penalty of $167,000 and alleging noncompliance of emissions monitoring requirements at Equistar’s Channelview facility has been included as part of this lawsuit. Equistar does not believe that the ultimate resolution of this matter will have a material adverse effect on the business, financial position, liquidity or results of operations of Equistar.
Index to Financial Statements
Indemnification
In connection with the formation of Equistar, Lyondell, Millennium and Occidental each agreed to provide certain indemnifications or guarantees thereof to Equistar with respect to the businesses they each contributed to Equistar. Lyondell, Millennium and Occidental remain liable under these indemnification or guarantee arrangements to the same extent as they were before Lyondell’s August 2002 acquisition of Occidental’s interest in Equistar and Lyondell’s November 2004 acquisition of Millennium.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Omitted pursuant to General Instruction I of Form 10-K.
Index to Financial Statements
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Equistar does not have a class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. There is no established public trading market for the partnership interests of Equistar. As a result of Lyondell’s acquisition of Millennium, Equistar is an indirect, wholly-owned subsidiary of Lyondell.
Under its partnership agreement, Equistar is required to distribute to its owners (Lyondell and Millennium), as soon as practicable following the end of each month, all of its surplus cash in excess of its estimated cash needs for its next 12 months. Under the partnership agreement, distributions other than of surplus cash may only be made upon approval of Equistar’s Partnership Governance Committee. Equistar made the following distributions to its owners in 2005 and 2006:
Equistar’s credit facility and indentures do not contain any restrictions on Equistar’s ability to make distributions to its owners in accordance with its partnership agreement, except that the credit facility prohibits distributions during any default under the facility. However, the indentures under which the 10 1/8% Senior Notes due 2008 and the 10 5/8% Notes due 2011 were issued require that Equistar pay additional interest, in the form of additional notes, if Equistar makes distributions when Equistar’s Fixed Charge Coverage Ratio (as defined) is less than 1.75 to 1. All distributions by Equistar to date have been made when that ratio requirement was satisfied and, accordingly, no additional interest was due.
Index to Financial Statements
Item 6.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the Consolidated Financial Statements and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(a) Net income for 2006 includes a $135 million charge for impairment of the net book value of the idled Lake Charles, Louisiana ethylene facility.
(b) The 2002 net loss includes a $1,053 million charge related to goodwill impairment.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with information contained in the Consolidated Financial Statements of Equistar Chemicals, LP, together with its consolidated subsidiaries (collectively, “Equistar”) and the notes thereto.
In addition to comparisons of annual operating results, Equistar has included, as additional disclosure, certain “trailing quarter” comparisons of fourth quarter 2006 operating results to third quarter 2006 operating results. Equistar’s businesses are highly cyclical, in addition to experiencing some less significant seasonal effects. Trailing quarter comparisons may offer important insight into the current business direction of Equistar.
References to industry benchmark prices or costs, including the weighted average cost of ethylene production, are generally to industry prices and costs reported by Chemical Marketing Associates, Incorporated (“CMAI”), except that crude oil and natural gas benchmark price references are to industry prices reported by Platts, a reporting service of The McGraw-Hill Companies.
OVERVIEW
General-Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene and aromatics, which include benzene and toluene. Equistar also manufactures and markets ethylene derivatives, primarily polyethylene (including high density polyethylene (“HDPE”), low density polyethylene (“LDPE”) and linear-low density polyethylene (“LLDPE”)), ethylene glycol, ethylene oxide (“EO”) and other EO derivatives, and ethanol. Equistar also manufactures and markets fuel products, such as methyl tertiary butyl ether (“MTBE”) and alkylate, as well as polypropylene. As a result of the acquisition of Millennium Chemicals Inc. (“Millennium”) by Lyondell Chemical Company (“Lyondell”) on November 30, 2004, Equistar became a wholly-owned subsidiary of Lyondell.
Index to Financial Statements 2006 Versus 2005-During 2006 and 2005, the markets for Equistar’s ethylene products generally continued to experience favorable supply and demand conditions. Raw material costs averaged higher in 2006 compared to the already high levels experienced in 2005, resulting primarily from the effect of higher average crude oil prices. Despite increased volatility during 2006 and a decrease late in the year, crude oil prices averaged higher in 2006 compared to 2005. U.S. market demand increased an estimated 5% for ethylene and an estimated 5% for polyethylene in 2006 compared to 2005.
Equistar’s operating results for 2006 reflected the benefits of higher sales prices, including significantly higher co-product and polyethylene sales prices, which were substantially offset by higher costs, primarily higher raw material costs, compared to 2005. Results for 2006 included a charge of $135 million related to impairment of the net book value of the idled Lake Charles, Louisiana ethylene facility.
2005 Versus 2004-In 2005, the chemical industry experienced improved profitability compared to 2004, despite higher crude oil and natural gas prices that pushed up raw material costs for most of the year and the disruptive effects of two major U.S. Gulf Coast hurricanes. Improvement in supply and demand balances, which began in mid-2004 continued into 2005. Tight gasoline markets in 2005 resulted in higher sales prices and margins for fuel products compared to the already high levels experienced in 2004. U.S. ethylene industry demand decreased 6% and polyethylene demand decreased 4% in 2005 compared to 2004, due primarily to the effects of the U.S. Gulf Coast hurricanes.
The U.S. Gulf Coast hurricanes, Katrina and Rita, negatively affected crude oil and natural gas supplies, as well as supplies of other raw materials, contributing to the increases in raw material prices in 2005. Supply/demand balances and prices were affected beginning in September 2005 as most Gulf Coast refiners and producers of chemicals suspended operations in preparation for the hurricanes, with some sustaining major damage as a result of the hurricanes. Equistar’s Gulf Coast plants experienced only minor hurricane damage; however, Equistar suspended plant operations in preparation for Hurricane Rita, resulting in lost production and higher costs during 2005.
Equistar’s earnings in 2005 reflected higher average product margins compared to 2004, partly offset by the negative effects of hurricane-related costs and lower sales volumes.
Benchmark Indicators-Benchmark crude oil and natural gas prices generally have been indicators of the level and direction of movement of raw material and energy costs for Equistar. Ethylene and its co-products are produced from two major raw material groups:
•
crude oil-based liquids (“liquids” or “heavy liquids”), including naphthas, condensates, and gas oils, the prices of which are generally related to crude oil prices; and
•
natural gas liquids (“NGLs”), principally ethane and propane, the prices of which are generally affected by natural gas prices.
Equistar has the ability to shift its ratio of raw materials used in the production of ethylene and co-products to take advantage of the relative costs of heavy liquids and NGLs.
Index to Financial Statements The following table shows the average U.S. benchmark prices for crude oil and natural gas for the applicable three-year period, as well as benchmark U.S. sales prices for ethylene, propylene, benzene and HDPE, which Equistar produces and sells. The benchmark weighted average cost of ethylene production, which is reduced by co-product revenues, is based on CMAI’s estimated ratio of heavy liquid raw materials and NGLs used in U.S. ethylene production and is subject to revision.
Although benchmark crude oil prices decreased late in 2006, benchmark crude oil prices averaged higher in 2006 compared to 2005 and averaged significantly higher in 2005 compared to 2004. Natural gas prices, which affect energy costs in addition to NGL-based raw materials, averaged lower in 2006 compared to 2005, and averaged significantly higher in 2005 compared to 2004. Despite the 2006 decrease in natural gas prices, NGL-based raw material prices averaged higher in 2006 than in 2005. As a result, overall raw material costs averaged higher in 2006 compared to 2005 and significantly higher in 2005 compared to 2004.
RESULTS OF OPERATIONS
Equistar is a wholly-owned subsidiary of Lyondell. Management evaluates the performance of the Equistar businesses and allocates resources based on the integrated economics of ethylene, co-products and derivatives. Accordingly, Equistar has one reportable segment, ethylene, co-products and derivatives (“EC&D”). As additional information, Equistar’s operating results are reviewed below in two product groups: ethylene and co-products; and derivatives. Ethylene co-products primarily include propylene, butadiene and aromatics, which include benzene and toluene. Fuel products, which include MTBE and alkylates, are included with the co-product group because fuel products are produced from the co-products. Derivatives primarily include polyethylene, ethylene glycol, EO and other EO derivatives, and ethanol and polypropylene.
The operating results of Equistar, as a whole, are analyzed below, followed by a review of the product group results.
Revenues-Equistar’s revenues of $12,765 million in 2006 were 9% higher compared to revenues of $11,686 million in 2005. The higher revenues in 2006 reflected the effects of higher average sales prices compared to 2005. Sales volumes increased 2% in 2006 compared to 2005.
Revenues of $11,686 million in 2005 increased 25% compared to revenues of $9,316 million in 2004. The increase in 2005 reflected higher average sales prices, partially offset by lower sales volumes. As noted in the table above, benchmark sales prices for ethylene, propylene and HDPE averaged significantly higher in 2005 compared to 2004, while benzene average sales prices in 2005 were comparable to 2004. Ethylene and derivative sales volumes were 5% lower in 2005 compared to 2004.
Index to Financial Statements Cost of Sales-Equistar’s cost of sales of $11,562 million in 2006 was 10% higher compared to $10,487 million in 2005. The increase reflected the effects of higher raw material costs, primarily resulting from the effects of higher average crude oil prices. Cost of sales also included charges representing Equistar’s exposure to industry losses expected to be underwritten by industry insurance consortia of $12 million, $28 million and $7 million, respectively, in 2006, 2005 and 2004.
Cost of sales of $10,487 million in 2005 increased 22% compared to $8,583 million in 2004. The increase reflects the effects of significantly higher raw material costs, resulting from the escalation of crude oil and natural gas prices. The costs of raw materials were affected by crude oil prices that averaged 36% higher in 2005, using benchmark prices, compared to 2004. Benchmark natural gas prices averaged 31% higher in 2005 compared to 2004.
Asset Impairment-Charges of $135 million in 2006 reflected impairment of the net book value of Equistar’s idled ethylene facility in Lake Charles, Louisiana. See Note 3 to the Consolidated Financial Statements.
SG&A Expenses-Selling, general and administrative (“SG&A”) expenses were $210 million in 2006, $198 million in 2005 and $205 million in 2004. The higher costs in 2006 compared to 2005 reflect higher compensation expense, including higher provisions for incentive compensation, while the decrease in 2005 compared to 2004 was primarily due to lower incentive compensation expense.
Operating Income-Equistar had operating income of $824 million in 2006 compared to $968 million in 2005. The decrease is primarily due to the $135 million impairment charge. Higher 2006 costs, primarily higher raw material costs, were substantially offset by higher average sales prices, including significantly higher co-product and polyethylene sales prices compared to 2005.
Equistar had operating income of $968 million in 2005 compared to $494 million in 2004. The $474 million improvement was primarily the result of higher average product margins. The benefit of the higher 2005 average product margins was partly offset by the negative effects of hurricane-related costs and lower sales volumes. Hurricane-related costs included $20 million of charges, representing Equistar’s exposure to industry losses expected to be underwritten by industry insurance consortia, and $19 million of costs incurred in conjunction with suspending and restarting operations.
Net Income-Equistar had net income of $614 million in 2006 compared to $748 million in 2005. The decrease was primarily attributable to the $135 million impairment charge. Operationally, higher 2006 sales prices were substantially offset by higher costs, primarily higher raw material costs.
Equistar had net income of $748 million in 2005 compared to $276 million in 2004. The $472 million improvement was primarily the result of higher average product margins. The benefit of the higher 2005 average product margins was partly offset by the negative effects of hurricane-related costs and lower sales volumes. Hurricane-related costs included $20 million of charges, representing Equistar’s exposure to industry losses expected to be underwritten by industry insurance consortia, and $19 million of costs incurred in conjunction with suspending and restarting operations.
Fourth Quarter 2006 versus Third Quarter 2006-Equistar had net income of $152 million in the fourth quarter 2006 compared to $78 million in the third quarter 2006, which included the impairment charge of $135 million. Fourth quarter 2006 underlying operating results reflected lower average sales prices, which were only partly offset by lower raw material costs. Fourth quarter 2006 sales volumes for ethylene and derivatives were comparable to the third quarter 2006.
Index to Financial Statements Product Group Analysis
The following analysis discusses Equistar’s operating results focusing on two product groups: ethylene and co-products; and derivatives. Ethylene co-products primarily include propylene, butadiene and aromatics, which include benzene and toluene. Fuel products, which include MTBE and alkylates, are included with the co-products group because fuel products are produced from the co-products. Derivatives primarily include polyethylene, ethylene glycol, ethylene oxide and its other derivatives, and ethanol and polypropylene.
The following table sets forth Equistar’s sales and other operating revenues, operating income and selected product sales volumes.
Ethylene and Co-products
Revenues-Revenues of $11,319 million in 2006 were 9% higher compared to $10,344 million in 2005. The increase reflected the effects of higher average sales prices, especially for co-products, and 2% higher sales volumes compared to 2005.
Revenues of $10,344 million in 2005 increased 27% compared to $8,136 million in 2004. The increase in revenues reflected higher average sales prices, particularly for propylene and fuel products, partially offset by lower sales volumes. Sales volumes, including sales of ethylene and co-products included in derivatives, decreased 4% in 2005 compared to 2004. Benchmark ethylene prices averaged 31% higher and benchmark propylene sales prices averaged 28% higher in 2005 compared to 2004.
Operating Income-Operating income in 2006 was $691 million compared to $891 million in 2005. The decrease was primarily due to the $135 million impairment charge related to the Lake Charles, Louisiana ethylene facility and lower product margins as higher costs, primarily higher raw material costs, more than offset the effect of higher average sales prices and sales volumes compared to 2005.
Operating income in 2005 for the ethylene and co-products product group was $891 million compared to $476 million in 2004. The increase of $415 million in 2005 was primarily due to higher product margins. The benefit of the higher 2005 average product margins was partly offset by the negative effects of hurricane-related costs and lower sales volumes.
Index to Financial Statements Derivatives
Revenues-Revenues of $4,150 million in the 2006 were 9% higher compared to revenues of $3,793 million in 2005. The increase in 2006 reflected the effects of higher average sales prices and 4% higher sales volumes.
Revenues of $3,793 million in 2005 increased 16% compared to $3,257 million in 2004. The increase reflected higher average sales prices, partially offset by lower sales volumes. Sales volumes of derivatives in 2005 were 9% lower than in 2004. The average benchmark price of HDPE increased 23% in 2005 compared to 2004.
Operating Income-Operating income for derivatives was $133 million in 2006 compared to $77 million in 2005. The increase in 2006 was primarily the result of higher product margins as higher average sales prices and sales volumes more than offset the unfavorable effects of higher raw material costs compared to 2005.
Operating income for derivatives was $77 million in 2005 compared to $18 million in 2004. The improvement of $59 million in 2005 was primarily the result of higher product margins, partially offset by lower sales volumes. Sales prices increased more than raw material costs compared to 2004.
FINANCIAL CONDITION
Operating Activities-Operating activities provided cash of $807 million in 2006, $1,047 million in 2005 and $215 million in 2004.
The $240 million decrease in 2006 compared to 2005 primarily reflected a net increase in the main components of working capital - accounts receivable and inventory, net of accounts payable - in 2006, which used cash of $231 million, compared to a net decrease in 2005, which provided cash of $32 million. In addition, while spending on maintenance turnarounds decreased $39 million, contributions to pension plans increased $33 million in 2006 compared to 2005.
The large net increase in the main components of working capital in 2006 compared to the net decrease in 2005 was primarily due to increases in accounts receivable and inventory in 2006.
Accounts receivable increased $243 million in 2006 compared to $96 million in 2005. The increase in 2006 primarily reflected the effect of a $200 million decrease in the outstanding amount of accounts receivable sold under the accounts receivable sales facility. There were no receivables sold under this facility at December 31, 2006 compared to $200 million at December 31, 2005. The increase in receivables in 2005 primarily reflected higher average sales prices in 2005 compared to 2004.
In addition, prior to January 2006, discounts were offered to certain customers for early payment for product. As a result, some receivable amounts were collected in December 2005 and 2004 that otherwise would have been expected to be collected in January 2006 and 2005, respectively. This included collections of $84 million and $66 million in December 2005 and 2004, respectively, related to receivables from Occidental Chemical Corporation, a subsidiary of Occidental Petroleum Corporation (together with its subsidiaries and affiliates, collectively “Occidental”).
Inventory increased $156 million in 2006 compared to $69 million in 2005. A significant portion of the 2006 increase in inventory was due to higher volumes of water-borne cargos in transit at December 31, 2006 compared to December 31, 2005 due to the timing of the shipments.
The $832 million increase in cash provided by operating activities in 2005 compared to 2004 reflected the earnings improvement in 2005 and the net decrease in the main components of 2005 working capital. The main components of working capital provided cash of $32 million in 2005 and used cash of $360 million in 2004.
Index to Financial Statements Investing Activities-Investing activities used cash of $166 million, $150 million and $60 million in 2006, 2005 and 2004, respectively, reflecting higher capital expenditure levels in 2006 and 2005 and higher proceeds from asset sales in 2004.
Equistar’s capital expenditures were $168 million in 2006, $153 million in 2005 and $101 million in 2004. The expenditures in 2006 and 2005 reflected increased spending for regulatory and environmental compliance projects. See “Environmental Matters” below. Planned capital expenditures for 2007 are $192 million for base support, minor plant efficiency and profit enhancement projects as well as regulatory and environmental compliance projects.
Proceeds from asset sales in 2004 were $41 million, including $37 million from railcar sale-leaseback transactions.
Financing Activities-Financing activities used cash of $723 million, $721 million and $315 million in 2006, 2005 and 2004, respectively. Equistar made cash distributions of $575 million, $725 million and $315 million to its owners in 2006, 2005 and 2004. During 2006, Equistar also repaid the $150 million of 6.5% Notes outstanding, which matured in February 2006.
In 2005, Equistar amended its $250 million inventory-based revolving credit facility and its $450 million accounts receivable sales facility, increasing the commitment to $400 million and $600 million, respectively, extending the maturities to November 2010 and reducing the interest rate on the revolving credit facility from LIBOR plus 2.25% to LIBOR plus 1.5%. In December 2006, Equistar amended its inventory-based revolving credit facility enabling it to sell certain receivables through new accounts receivable sales facilities.
Liquidity and Capital Resources-At December 31, 2006, Equistar’s long-term debt totaled $2.2 billion, or approximately 57% of its total capitalization, and there were no current maturities. At December 31, 2006, Equistar had cash on hand of $133 million and the total amount available under both the $400 million inventory-based revolving credit facility and the $600 million accounts receivable sales facility totaled approximately $938 million, after giving effect to the borrowing base net of a $50 million unused availability requirement, any outstanding amount of accounts receivable sold under the accounts receivable sales facility, of which there was none at December 31, 2006, and $12 million of outstanding letters of credit under the revolving credit facility as of December 31, 2006. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The revolving credit facility requires that the unused available amounts under that facility and the $600 million accounts receivable sales facility equal or exceed $50 million, or $100 million if the Interest Coverage Ratio, as defined, at the end of any period of four consecutive fiscal quarters is less than 2:1. There was no outstanding borrowing under the revolving credit facility at December 31, 2006.
Equistar’s ability to continue to pay or refinance its debt will depend on future operating performance, which could be affected by general economic, financial, competitive, legislative, regulatory, business and other factors, many of which are beyond its control. However, Equistar believes that conditions will be such that cash balances, cash generated from operating activities, cash generated from higher utilization of the accounts receivable sales facility and funding under the credit facility will be adequate to meet anticipated future cash requirements, including scheduled debt repayments, necessary capital expenditures and ongoing operations.
In August 2006, Standard & Poors (“S&P”) removed Equistar’s ratings from CreditWatch and revised its outlook to stable, reflecting S&P’s belief that the intermediate-range benefits of the Houston Refining LP acquisition by Lyondell will outweigh the temporary increase in debt leverage. In September 2006, Moody’s Investors Service (“Moody’s”) confirmed the rating of Equistar and revised its outlook for Equistar to stable, reflecting Moody’s belief that the additional debt incurred in connection with the Houston Refining LP acquisition by Lyondell will be reduced over the next several years using anticipated increased refining cash flow.
Equistar’s inventory-based revolving credit facility, accounts receivable sales facility and indentures contain restrictive covenants. These covenants are described in Notes 6 and 12 to the Consolidated Financial Statements. The credit facility does not require the maintenance of specified financial ratios as long as certain conditions are met. Some of Equistar’s indentures require additional interest payments to the note holders if Equistar makes distributions when its Fixed Charge Coverage Ratio, as defined, is less than 1.75 to 1.
Index to Financial Statements A breach by Equistar of any of the covenants or other requirements in its debt instruments could (1) permit its note holders or lenders to declare the outstanding debt under the breached debt instrument due and payable, (2) permit its lenders under the credit facility to terminate future lending commitments and (3) permit acceleration of Equistar’s other debt instruments that contain cross-default or cross-acceleration provisions. The debt agreements of Equistar contain various event of default and cross-default provisions. If Equistar was unable to obtain sufficient funds to make these accelerated payments, Equistar’s lenders could proceed against any assets that secure their debt. Similarly, the breach by Equistar of covenants in its accounts receivable sales facility would permit the counterparty under the facility to terminate further purchases of interests in accounts receivable and to receive all collections from previously sold interests until they had collected on their interests in those receivables, thus reducing Equistar’s liquidity.
Off-Balance Sheet Arrangements-The Securities and Exchange Commission (“SEC”) has described various characteristics to identify contractual arrangements that would fall within the SEC’s definition of off-balance sheet arrangements. Equistar is a party to the following accounts receivable sales facility that has some of those characteristics.
Equistar has a $600 million accounts receivable sales facility, which matures in November 2010. Pursuant to the facility, Equistar sells, through a wholly-owned bankruptcy remote subsidiary, on an ongoing basis and without recourse, an interest in a pool of domestic accounts receivable to financial institutions participating in the facility. Equistar is responsible for servicing the receivables. The amount of interest in the pool of receivables permitted to be sold is determined by a formula. The $600 million accounts receivable sales facility is subject to substantially the same minimum unused availability requirements and covenant requirements as the $400 million inventory-based revolving credit facility. See discussion of “Liquidity and Capital Resources” above and discussion of “Long-Term Debt” below. At December 31, 2006, there was no outstanding amount of receivables sold under the facility and, at December 31, 2005, the outstanding amount of receivables sold was $200 million. Accounts receivable in the consolidated balance sheets are reduced by the sales of interests in the pool.
The facility accelerates availability to the business of cash from product sales that otherwise would have been collected over the normal billing and collection cycle. The availability of the accounts receivable sales facility provides one element of Equistar’s ongoing sources of liquidity and capital resources. Upon termination of the facility, cash collections related to accounts receivable then in the pool would first be applied to the outstanding interest sold, but Equistar would in no event be required to repurchase such interest. In November 2005, Equistar’s accounts receivable sales facility was amended to increase the commitment to $600 million and to extend the maturity to November 2010. See Note 6 to the Consolidated Financial Statements for additional accounts receivable information.
Other obligations that do not give rise to liabilities that would be reflected in Equistar’s balance sheet are described below under “Purchase Obligations” and “Operating Leases.”
Index to Financial Statements Contractual and Other Obligations-The following table summarizes, as of December 31, 2006, Equistar’s minimum payments for long-term debt, and contractual and other obligations for the next five years and thereafter.
Long-Term Debt-Equistar’s long-term debt includes a credit facility and debt obligations. See Note 12 to the Consolidated Financial Statements for a discussion of covenant requirements under the credit facility and indentures and additional information regarding long-term debt.
Interest-The long-term debt agreements contain provisions for the payment of either monthly or semi-annual interest at a stated rate of interest over the term of the debt. These payment obligations are reflected in the table above.
Pension Benefits-Equistar maintains several defined benefit pension plans, as described in Note 15 to the Consolidated Financial Statements. At December 31, 2006, the projected benefit obligation for Equistar’s pension plans exceeded the fair value of plan assets by $46 million. Subject to future actuarial gains and losses, as well as actual asset earnings, Equistar will be required to fund the $46 million. Equistar’s pension contributions were $50 million, $17 million and $16 million in the years 2006, 2005 and 2004, respectively, and are expected to be less than $1 million in 2007. Estimates of pension benefit payments through 2011 are included in the table above.
Other Postretirement Benefits-Equistar provides other postretirement benefits, primarily medical benefits to eligible participants, as described in Note 15 to the Consolidated Financial Statements. Other postretirement benefits are unfunded and are paid by Equistar as incurred. Estimates of other postretirement benefit payments through 2011 are included in the table above.
Advances from Customers-Equistar receives advances from customers in connection with long-term sales agreements under which Equistar is obligated to deliver product primarily at cost-based prices. These advances are treated as deferred revenue and will be amortized to earnings as the product is delivered over the remaining terms of the respective contracts, which range from 5 to 12 years. The unamortized portion of such advances totaled $175 million and $171 million as of December 31, 2006 and 2005, respectively. See Note 11 to the Consolidated Financial Statements.
Other-Other primarily consists of deferred compensation arrangements other than pension and postretirement benefits.
Index to Financial Statements Purchase Obligations-Equistar is a party to various obligations to purchase products and services, principally for utilities and industrial gases. These commitments are designed to assure sources of supply and are not expected to be in excess of normal requirements. See “Commitments” section of Note 16 to the Consolidated Financial Statements for a description of Equistar’s commitments and contingencies, including these purchase obligations.
Operating Leases-Equistar leases various facilities and equipment, including railcars, under noncancelable operating lease arrangements for various periods. See Note 13 to the Consolidated Financial Statements for related lease disclosures.
CURRENT BUSINESS OUTLOOK
Thus far in 2007, underlying business fundamentals continue to be sound. Equistar’s product sales prices that were under pressure during the fourth quarter 2006 have generally stabilized, and are expected to rebound. Raw material costs continue to be volatile and producer inventories have been reduced. Sales volumes have strengthened from fourth quarter 2006 levels. For 2007, fundamental supply and demand conditions for Equistar’s products should be relatively unchanged from the favorable conditions experienced in 2006.
RELATED PARTY TRANSACTIONS
Equistar makes significant sales of product to Lyondell, Millennium, Occidental and Houston Refining. Equistar also makes significant purchases of raw materials and products from Houston Refining and receives significant administrative services from Lyondell.
As of December 31, 2006 and giving effect to Occidental’s January 26, 2007 exercise of a warrant to purchase Lyondell common stock, Occidental owned 8.5% of Lyondell common stock and had one representative on Lyondell’s Board of Directors. In view of Occidental’s relationship with Lyondell, which indirectly owns 100% of Equistar as a result of the acquisition of Millennium by Lyondell on November 30, 2004, Occidental’s transactions with Equistar are reported as related party transactions in Equistar’s Consolidated Financial Statements.
Equistar believes that such transactions are effected on terms substantially no more or less favorable than those that would have been agreed upon by unrelated parties on an arm’s-length basis. See Note 5 to the Consolidated Financial Statements for further discussion of related party transactions.
CRITICAL ACCOUNTING POLICIES
Equistar applies those accounting policies that management believes best reflect the underlying business and economic events, consistent with accounting principles generally accepted in the U.S. Equistar’s more critical accounting policies include those related to long-lived assets, including the costs of major maintenance turnarounds and repairs, and accruals for long-term employee benefit costs such as pension and other postretirement costs. Inherent in such policies are certain key assumptions and estimates made by management. Management periodically updates its estimates used in the preparation of the financial statements based on its latest assessment of the current and projected business and general economic environment. These critical accounting policies have been discussed with the Equistar Partnership Governance Committee. Equistar’s significant accounting policies are summarized in Note 2 to the Consolidated Financial Statements.
Long-Lived Assets-With respect to long-lived assets, key assumptions include the estimates of useful asset lives and the recoverability of the carrying values of fixed assets and other intangible assets, as well as the existence of any obligations associated with the retirement of fixed assets. Such estimates could be significantly modified and/or the carrying values of the assets could be impaired by such factors as new technological developments, new chemical industry entrants with significant raw material or other cost advantages, uncertainties associated with the U.S. and world economies, the cyclical nature of the chemical industry, and uncertainties associated with governmental regulatory actions.
Index to Financial Statements To reflect economic and market conditions, from time to time Equistar may temporarily idle manufacturing facilities. Assets that are temporarily idled are reviewed for impairment at the time they are idled, and at least annually thereafter. Earnings for 2006 included a $135 million pretax charge for impairment of the net book value of Equistar’s ethylene facility in Lake Charles, Louisiana, which was idled in the first quarter of 2001, pending sustained improvement in market conditions. In 2006, Equistar undertook a study of the feasibility, cost and time required to restart the Lake Charles ethylene facility. As a result, management determined that restarting the facility would not be justified. Equistar had no other major idled facilities as of December 31, 2006.
The estimated useful lives of long-lived assets range from 3 to 30 years. Depreciation and amortization of these assets, including amortization of deferred turnaround costs, under the straight-line method over their estimated useful lives totaled $324 million in 2006. If the useful lives of the assets were found to be shorter than originally estimated, depreciation and amortization charges would be accelerated over the revised life.
Equistar defers the costs of major periodic maintenance and repair activities (“turnarounds”) in excess of $5 million, amortizing such costs over the period until the next expected major turnaround of the affected unit. During 2006, 2005 and 2004, cash expenditures of $12 million, $51 million and $55 million, respectively, were deferred and are being amortized, predominantly over 4 to 7 years. Amortization of previously deferred turnaround costs was $40 million in 2006 and $38 million in each of 2005 and 2004.
Additional information on long-lived assets, deferred turnaround costs and related depreciation and amortization appears in Note 8 to the Consolidated Financial Statements.
Long-Term Employee Benefit Costs-The costs to Equistar of long-term employee benefits, particularly pension and other postretirement medical and life insurance benefits, are incurred over long periods of time, and involve many uncertainties over those periods. The net periodic benefit cost attributable to current periods is based on several assumptions about such future uncertainties, and is sensitive to changes in those assumptions. It is management’s responsibility, often with the assistance of independent experts, to select assumptions that in its judgment represent its best estimates of the future effects of those uncertainties. It also is management’s responsibility to review those assumptions periodically to reflect changes in economic or other factors that affect those assumptions.
The current benefit service costs, as well as the existing liabilities, for pensions and other postretirement benefits are measured on a discounted present value basis. The discount rate is a current rate, related to the rate at which the liabilities could be settled. Equistar’s assumed discount rate is based on average rates published by Moody’s and Merrill Lynch for high-quality (Aa rating) ten-year fixed income securities. For the purpose of measuring the benefit obligations at December 31, 2006, Equistar increased its assumed discount rate from 5.5% to 5.75%, reflecting market interest rates at December 31, 2006. The 5.75% rate also will be used to measure net periodic benefit cost during 2007. A further one percentage point reduction in the assumed discount rate for Equistar would increase Equistar’s benefit obligation for pensions and other postretirement benefits by approximately $51 million, and would reduce Equistar’s net income by approximately $8 million.
The benefit obligation and the periodic cost of postretirement medical benefits also are measured based on assumed rates of future increase in the per capita cost of covered health care benefits. As of December 31, 2006, the assumed rate of increase was 10% for 2007, decreasing 1% per year to 5% in 2012 and thereafter. A one percentage point change in the health care cost trend rate assumption would have no significant effect on either the benefit liability or the net periodic cost, due to limits on Equistar’s maximum contribution level under the medical plan.
The net periodic cost of pension benefits included in expense also is affected by the expected long-term rate of return on plan assets assumption. Investment returns that are recognized currently in net income represent the expected long-term rate of return on plan assets applied to a market-related value of plan assets which, for Equistar, is defined as the market value of assets. The expected rate of return on plan assets is a longer term rate, and is expected to change less frequently than the current assumed discount rate, reflecting long-term market expectations, rather than current fluctuations in market conditions.
Index to Financial Statements Equistar’s expected long-term rate of return on U.S. plan assets of 8% is based on the average level of earnings that its independent pension investment advisor had advised could be expected to be earned over time. The expectation is based on an asset allocation of 55% U.S. equity securities (9.5% expected return), 15% non-U.S. equity securities (9.5% expected return), and 30% fixed income securities (5.5% expected return) recommended by the advisor, and had been adopted for the plans. The actual return on plan assets in 2006 was 12%.
The actual rate of return on plan assets may differ from the expected rate due to the volatility normally experienced in capital markets. Management’s goal is to manage the investments over the long term to achieve optimal returns with an acceptable level of risk and volatility. Based on the market value of plan assets at December 31, 2006, a one percentage point decrease in this assumption for Equistar would decrease Equistar’s net income by approximately $2 million.
Net periodic pension cost recognized each year includes the expected asset earnings, rather than the actual earnings or loss. As a result of asset earnings significantly below the expected return on plan assets rate over the three-year period ended December 31, 2002, the level of unrecognized investment losses, together with the net actuarial gains and losses, is $46 million at December 31, 2006. This unrecognized amount, to the extent it exceeds ten percent of the projected benefit obligation for the respective plan, will be recognized as additional net periodic benefit cost over the average remaining service period of the participants in each plan. This annual amortization charge would be $2 million per year based on the December 31, 2006 unrecognized amount.
Additional information on the key assumptions underlying these benefit costs appears in Note 15 to the Consolidated Financial Statements.
ACCOUNTING AND REPORTING CHANGES
Effective December 31, 2006, Equistar adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-An Amendment of FASB Statements No. 87, 88, 106, and 132R, which primarily requires an employer to recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status through comprehensive income in the year in which changes occur. Equistar’s application of SFAS No. 158 as of December 31, 2006 resulted in increases of $6 million and $8 million in its current and long-term benefit liabilities, respectively, a decrease of $9 million in other assets and an increase of $23 million in accumulated other comprehensive loss in its consolidated balance sheet as of December 31, 2006. (See Note 15)
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements. The new standard defines fair value, establishes a framework for its measurement and expands disclosures about such measurements. For Equistar, the standard will be effective beginning in 2008. Equistar does not expect the application of SFAS No. 157 to have a material effect on its consolidated financial statements.
Effective January 1, 2006, Equistar adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment using the modified prospective method and, consequently, has not adjusted results of prior periods. Equistar previously accounted for these plans according to the provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Equistar’s application of SFAS No. 123 (revised 2004) had no material effect on its consolidated financial statements.
Effective April 1, 2006, Equistar adopted the provisions of Emerging Issues Task Force (“EITF”) Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty. EITF Issue No. 04-13, requires that inventory purchases and sales transactions with the same counterparty that are entered into in contemplation of one another be combined for purposes of applying Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions. The effect of this requirement is to reduce reported revenues and cost of sales for affected transactions. Equistar’s application of EITF Issue No. 04-13 had no material effect on its consolidated financial statements.
Index to Financial Statements
ENVIRONMENTAL AND OTHER MATTERS
Various environmental laws and regulations impose substantial requirements upon the operations of Equistar. Equistar’s policy is to be in compliance with such laws and regulations, which include, among others, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) as amended, the Resource Conservation and Recovery Act (“RCRA”) and the Clean Air Act Amendments (“Clean Air Act”). Equistar does not specifically track all recurring costs associated with managing hazardous substances and pollution in ongoing operations. Such costs are included in cost of sales.
Equistar’s accrued liability for future environmental remediation costs at current and former plant sites and other remediation sites totaled $4 million as of December 31, 2006. In the opinion of management, there is no material estimable range of reasonably possible loss in excess of the liabilities recorded for environmental remediation. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in investigations by regulatory agencies, could require Equistar to reassess its potential exposure related to environmental matters. See the “Environmental Remediation” section of Note 16 for additional discussion of Equistar’s liabilities for environmental remediation.
Equistar also makes capital expenditures to comply with environmental regulations. Capital expenditures for regulatory compliance in 2006, 2005 and 2004 totaled approximately $60 million, $62 million and $44 million, respectively. Equistar currently estimates expenditures at existing facilities of $30 million in 2007 and $15 million in 2008. The high levels of capital expenditures in 2006, 2005 and 2004 reflected increased spending on projects related to air emission reductions and wastewater management, principally at Equistar’s Gulf Coast plants. Under the Clean Air Act, the eight-county Houston/Galveston region was designated a severe non-attainment area for ozone by the EPA. Emission reduction controls are being installed at each of Equistar’s six facilities in the Houston/Galveston region to comply prior to the November 2007 deadline.
The presence of MTBE in some water supplies in certain states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft led to public concern about the use of MTBE and resulted in U.S. federal and state governmental initiatives to reduce or ban the use of MTBE. Substantially all refiners and blenders have discontinued the use of MTBE in the U.S. See the “MTBE” section of Note 16 to the Consolidated Financial Statements for additional discussion regarding these U.S. federal and state initiatives and their potential impact on Equistar.
Index to Financial Statements
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See Note 14 to the Consolidated Financial Statements for discussion of Equistar’s management of commodity price risk and interest rate risk through its use of derivative instruments and hedging activities.
COMMODITY PRICE RISK
A substantial portion of Equistar’s products and raw materials are commodities whose prices fluctuate as market supply and demand fundamentals change. Accordingly, product margins and the level of Equistar’s profitability tend to fluctuate with changes in the business cycle. Equistar tries to protect against such instability through various business strategies. These include entering into multi-year processing and sales agreements, moving downstream into derivatives products whose pricing is more stable, and utilization of the raw material flexibility of Equistar’s ethylene plants.
In addition, Equistar selectively enters into commodity swap, option, and futures contracts with various terms to manage the volatility related to purchases of natural gas and raw materials, as well as product sales. Market risks created by these derivative instruments and the mark-to-market valuations of open positions are monitored by management. During 2006, 2005 and 2004, the derivative transactions were not significant compared to Equistar’s overall inventory purchases and product sales. At December 31, 2006 and 2005, the notional amount of outstanding derivatives and the related market risk were not material.
INTEREST RATE RISK
Equistar had no borrowing outstanding under its inventory-based revolving credit facility as of December 31, 2006 and 2005. Accordingly, Equistar’s exposure to variable interest rate risk was minimal at December 31, 2006 and 2005.
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Item 8.
Item 8. Financial Statements and Supplementary Data
Index to the Consolidated Financial Statements
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Equistar is responsible for establishing and maintaining adequate internal control over financial reporting. Equistar’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting in accordance with generally accepted accounting principles.
Equistar management assessed the effectiveness of Equistar’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on its assessment, Equistar’s management has concluded that Equistar’s internal control over financial reporting was effective as of December 31, 2006 based on those criteria.
PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, has audited management’s assessment of the effectiveness of Equistar’s internal control over financial reporting as of December 31, 2006, as stated in their report that appears on the following page.
Index to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partnership Governance Committee and Partners
of Equistar Chemicals, LP
We have completed integrated audits of Equistar Chemicals, LP’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Equistar Chemicals, LP (the “Partnership”) and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, effective December 31, 2006, the Partnership changed its method of accounting for defined benefit pension and other postretirement plans.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 8, that the Partnership maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Partnership’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
Index to Financial Statements
with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Houston, Texas
February 28, 2007
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EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF INCOME
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
CONSOLIDATED BALANCE SHEETS
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
1. Formation of the Partnership and Operations
Equistar Chemicals, LP together with its consolidated subsidiaries (collectively, “Equistar” or “the Partnership”), a Delaware limited partnership which commenced operations on December 1, 1997, was formed by Lyondell Chemical Company and subsidiaries (“Lyondell”) and Millennium Chemicals Inc. and subsidiaries (“Millennium”). On May 15, 1998, Equistar was expanded with the contribution of certain assets from Occidental Petroleum Corporation and subsidiaries (“Occidental”). Prior to August 22, 2002, Equistar was owned 41% by Lyondell, 29.5% by Millennium and 29.5% by Occidental. On August 22, 2002, Lyondell purchased Occidental’s interest in Equistar and, as a result, Lyondell’s ownership interest in Equistar increased to 70.5%. Equistar became a wholly-owned subsidiary of Lyondell as a result of Lyondell’s acquisition of Millennium on November 30, 2004. The consolidated financial statements of Equistar reflect its historical cost basis, and, accordingly, do not reflect any purchase accounting adjustments related to the acquisition by Lyondell of Millennium and Millennium’s interest in Equistar or of Occidental’s interest in Equistar.
Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene and aromatics. Equistar also manufactures and markets fuel products and ethylene derivatives, primarily ethylene oxide, ethylene glycol and polyethylene.
2. Summary of Significant Accounting Policies
Basis of Presentation-The consolidated financial statements include the accounts of Equistar and its subsidiaries.
Revenue Recognition-Revenue from product sales is recognized at the time of transfer of title and risk of loss to the customer, which usually occurs at the time of shipment. Revenue is recognized at the time of delivery if Equistar retains the risk of loss during shipment. For products that are shipped on a consignment basis, revenue is recognized when the customer uses the product. Costs incurred in shipping products sold are included in cost of sales. Billings to customers for shipping costs are included in sales revenue.
Cash and Cash Equivalents-Cash equivalents consist of highly liquid debt instruments such as certificates of deposit, commercial paper and money market accounts. Cash equivalents include instruments with maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates fair value. Equistar’s policy is to invest cash in conservative, highly rated instruments and to limit the amount of credit exposure to any one institution.
Equistar has no requirements for compensating balances in a specific amount at a specific point in time. Equistar does maintain compensating balances for some of its banking services and products. Such balances are maintained on an average basis and are solely at Equistar’s discretion.
Allowance for Doubtful Accounts-Equistar establishes provisions for doubtful accounts receivable based on management’s estimates of amounts that it believes are unlikely to be collected. Collectability of receivables is reviewed and the allowance for doubtful accounts is adjusted at least quarterly, based on aging of specific accounts and other available information about the associated customers.
Inventories-Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (“LIFO”) method for substantially all inventories, except for materials and supplies, which are valued using the average cost method.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Summary of Significant Accounting Policies - (Continued)
Inventory exchange transactions, which involve fungible commodities and do not involve the payment or receipt of cash, are not accounted for as purchases and sales. Any resulting volumetric exchange balances are accounted for as inventory in accordance with the LIFO valuation policy.
Property, Plant and Equipment-Property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful asset lives, generally 25 years for major manufacturing equipment, 30 years for buildings, 5 to 15 years for light equipment and instrumentation, 15 years for office furniture and 3 to 5 years for information systems equipment. Upon retirement or sale, Equistar removes the cost of the asset and the related accumulated depreciation from the accounts and reflects any resulting gain or loss in the Consolidated Statements of Income. Equistar’s policy is to capitalize interest cost incurred on debt during the construction of major projects exceeding one year.
Long-Lived Asset Impairment-Equistar evaluates long-lived assets, including identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When it is probable that undiscounted future cash flows will not be sufficient to recover an asset’s carrying amount, the asset is written down to its estimated fair value.
Investments-Equistar’s investments primarily consist of a 50% interest in a joint venture that owns an ethylene glycol facility in Beaumont, Texas (“PD Glycol”). The investment in PD Glycol is accounted for using the equity method.
Identifiable Intangible Assets-Costs to purchase and to develop software for internal use are deferred and amortized on a straight-line basis over periods of 3 to 10 years.
Costs of maintenance and repairs exceeding $5 million incurred as part of turnarounds of major units at Equistar’s manufacturing facilities are deferred and amortized using the straight-line method over the period until the next planned turnaround, predominantly 4 to 7 years. These costs are necessary to maintain, extend and improve the operating capacity and efficiency rates of the production units.
Other intangible assets are carried at cost or amortized cost and primarily consist of deferred debt issuance costs, patents and license costs, capacity reservation fees and other long-term processing rights and costs. These assets are amortized using the straight-line method over their estimated useful lives or over the term of the related agreement, if shorter.
Environmental Remediation Costs-Anticipated expenditures related to investigation and remediation of contaminated sites, which include current and former plant sites and other remediation sites, are accrued when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Only ongoing operating and monitoring costs, the timing of which can be determined with reasonable certainty, are discounted to present value. Future legal costs associated with such matters, which generally are not estimable, are not included in these liabilities.
Legal Costs-Equistar expenses legal costs, including those incurred in connection with loss contingencies, as incurred.
Income Taxes-The Partnership is not subject to federal income taxes as income is reportable directly by the individual partners; therefore, there is no provision for income taxes in the accompanying financial statements.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Summary of Significant Accounting Policies - (Continued)
Use of Estimates-The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Reclassifications-Certain previously reported amounts have been reclassified to conform to classifications adopted in 2006.
Accounting and Reporting Changes-Effective December 31, 2006, Equistar adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-An Amendment of FASB Statements No. 87, 88, 106, and 132R, which primarily requires an employer to recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status through comprehensive income in the year in which changes occur. Equistar’s application of SFAS No. 158 as of December 31, 2006 resulted in increases of $6 million and $8 million in its current and long-term benefit liabilities, respectively, a decrease of $9 million in other assets and an increase of $23 million in accumulated other comprehensive loss in its consolidated balance sheet as of December 31, 2006. (See Note 15)
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements. The new standard defines fair value, establishes a framework for its measurement and expands disclosures about such measurements. For Equistar, the standard will be effective beginning in 2008. Equistar does not expect the application of SFAS No. 157 to have a material effect on its consolidated financial statements.
Effective January 1, 2006, Equistar adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment using the modified prospective method and, consequently, has not adjusted results of prior periods. Equistar previously accounted for these plans according to the provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Equistar’s application of SFAS No. 123 (revised 2004) had no material effect on its consolidated financial statements.
Effective April 1, 2006, Equistar adopted the provisions of Emerging Issues Task Force (“EITF”) Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty. EITF Issue No. 04-13, requires that inventory purchases and sales transactions with the same counterparty that are entered into in contemplation of one another be combined for purposes of applying Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions. The effect of this requirement is to reduce reported revenues and cost of sales for affected transactions. Equistar’s application of EITF Issue No. 04-13 had no material effect on its consolidated financial statements.
3. Asset Impairment
Equistar’s 2006 earnings reflect a charge of $135 million for impairment of the net book value of its idled Lake Charles, Louisiana ethylene facility. In the third quarter of 2006, Equistar undertook a study of the feasibility, cost and time required to restart the Lake Charles ethylene facility. As a result, management determined that restarting the facility would not be justified. The remaining net book value of the related assets of $10 million represents an estimate, based on probabilities, of alternative-use value. Equistar does not expect to incur any significant future costs with respect to the facility.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4. Hurricane Effects
During 2005, two major hurricanes impacted the chemical and related industries in the coastal and off-shore regions of the Gulf of Mexico. Net income in 2005 reflected charges totaling $28 million representing Equistar’s exposure to industry losses expected to be underwritten by industry insurance consortia, primarily resulting from hurricane damages.
As a result of Hurricane Rita, Equistar also incurred various costs that are subject to insurance reimbursements. Such costs include those incurred in conjunction with suspending operations at substantially all of its Gulf Coast plants, minor damage to facilities, and costs to restore operations. Net income in 2005 included $19 million of such costs incurred by Equistar, of which all but a $5 million deductible under the relevant insurance policies are subject to reimbursement through insurance. In 2006, Equistar recognized a $1 million benefit from insurance reimbursements related to its plants. No benefits were recognized in 2005.
5. Related Party Transactions
Equistar is a wholly-owned subsidiary of Lyondell. As of December 31, 2006 and giving effect to Occidental’s January 26, 2007 exercise of its warrant to purchase Lyondell common stock, Occidental owned 8.5% of Lyondell, and had one representative on the Lyondell Board of Directors. Lyondell owns 100% of Houston Refining LP (formerly known as LYONDELL-CITGO Refining LP) and Millennium. All of the above companies are considered related parties of Equistar. In the discussion of related party transactions below, Lyondell refers to Lyondell Chemical Company and its wholly-owned subsidiaries other than Houston Refining, Millennium and Equistar and their respective subsidiaries.
Product Transactions with Lyondell-Lyondell purchases ethylene, propylene and benzene at market-related prices from Equistar under various agreements expiring in 2013 and 2014. With the exception of one pre-existing third-party product supply agreement expiring in 2015, Lyondell is required, under the agreements, to purchase 100% of its ethylene, propylene and benzene requirements for its Channelview and Bayport, Texas facilities from Equistar. Lyondell licenses methyl tertiary butyl ether (“MTBE”) technology to Equistar, and purchases MTBE produced by Equistar at market-related prices.
Through December 31, 2004, Equistar acted as sales agent for the methanol products of Lyondell. Equistar also provided operating and other services for Lyondell including the lease to Lyondell by Equistar of the real property on which the methanol plant was located. Pursuant to the terms of the agreement, Lyondell paid Equistar a management fee and reimbursed certain expenses of Equistar at cost.
Product Transactions with Millennium-Equistar sells ethylene to Millennium at market-related prices pursuant to an agreement entered into in connection with the formation of Equistar. Under this agreement, Millennium is required to purchase 100% of its ethylene requirements for its LaPorte, Texas facility from Equistar. The initial term of the contract expired December 31, 2000 and it continues thereafter for one-year periods unless either party serves notice of termination twelve months in advance.
Equistar is required to purchase 100% of its vinyl acetate monomer raw material requirements at market-related prices from Millennium for the production of ethylene vinyl acetate products at its LaPorte, Texas; Clinton, Iowa and Morris, Illinois plants, and 100% of its glacial acetic acid requirements at market-related prices from Millennium for the production of glycol ether acetate at its Bayport, Texas plant. The initial terms of these agreements expired December 31, 2005 and continue year to year thereafter unless terminated by either party.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5. Related Party Transactions - (Continued)
Product Transactions with Occidental-Equistar and Occidental entered into an ethylene sales agreement on May 15, 1998, which was amended effective April 1, 2004, pursuant to which Occidental agreed to purchase a substantial amount of its ethylene raw material requirements from Equistar. Either party has the option to “phase down” volumes over time. However, a “phase down” cannot begin until January 1, 2014 and the annual minimum requirements cannot decline to zero prior to December 31, 2018, unless certain specified force majeure events occur. In addition to the sales of ethylene, from time to time Equistar has made sales of ethers and glycols to Occidental, and Equistar has purchased various other products from Occidental, all at market-related prices.
Product Transactions with Houston Refining LP-Equistar has product sales and raw material purchase agreements with Houston Refining, a wholly-owned subsidiary of Lyondell as of August 16, 2006. Certain ethylene co-products are sold by Equistar to Houston Refining for processing into gasoline and certain refined products are sold by Houston Refining to Equistar as raw materials. Equistar also has processing and storage arrangements with Houston Refining and provides certain marketing services for Houston Refining. All of the agreements between Houston Refining and Equistar are on terms generally representative of prevailing market prices. Subsequent to August 16, 2006, transactions between Equistar and Houston Refining are reported as related party transactions of Lyondell.
Shared Services Agreement with Lyondell-Under a shared services agreement, Lyondell provides office space and various services to Equistar, including information technology, sales and marketing, supply chain, and other administrative and support services. Lyondell charges Equistar for Equistar’s share of the cost of such services. Direct costs, incurred exclusively for Equistar, also are charged to Equistar. Costs related to a limited number of shared services, primarily engineering, continue to be incurred by Equistar on behalf of Lyondell. In such cases, Equistar charges Lyondell for its share of such costs.
Shared Services and Shared-Site Agreements with Millennium-Equistar and Millennium provide operating services, utilities and raw materials to each other at common locations. Millennium and Equistar have various operating, manufacturing and technical service agreements under which, Millennium bills Equistar for certain operational services, including utilities, plant-related transportation and other services, and Equistar bills Millennium for utilities and fuel streams.
Lease Agreements with Occidental-Equistar subleases certain railcars from Occidental and leases its Lake Charles ethylene facility and the land related thereto from Occidental. See Note 3 for additional information related to the Lake Charles ethylene facility.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5. Related Party Transactions - (Continued)
Related party transactions are summarized as follows:
6. Accounts Receivable
Equistar sells its products primarily to other chemical manufacturers in the petrochemical industry. Equistar performs ongoing credit evaluations of its customers’ financial condition and, in certain circumstances, requires letters of credit from them. Equistar’s allowance for doubtful accounts receivable, which is reflected in the Consolidated Balance Sheets as a reduction of accounts receivable, totaled $5 million and $7 million at December 31, 2006 and 2005, respectively. The Consolidated Statements of Income included provisions for doubtful accounts of less than $1 million in each of 2006 and 2004. There were no provisions for doubtful accounts receivable in 2005.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
6. Accounts Receivable - (Continued)
In November 2005, Equistar amended its $450 million accounts receivable sales facility, increasing the commitment to $600 million and extending the maturity to November 2010. Pursuant to this facility, Equistar sells, through a wholly-owned bankruptcy-remote subsidiary, on an ongoing basis and without recourse, an interest in a pool of domestic accounts receivable to financial institutions participating in the facility. Equistar is responsible for servicing the receivables. The $600 million accounts receivable sales facility is subject to substantially the same minimum unused availability requirements and covenant requirements as the $400 million inventory-based revolving credit facility, which also is secured by a pledge of accounts receivable (see Note 12).
The amount of the interest in the pool of receivables permitted to be sold is determined by a formula. Accounts receivable in the Consolidated Balance Sheets are reduced by the sales of interests in the pool. Upon termination of the facility, cash collections related to accounts receivable then in the pool would first be applied to the outstanding interests sold. Increases and decreases in the amount sold are reflected in operating cash flows in the Consolidated Statements of Cash Flows, representing collections of sales revenue. Fees related to the sales are included in “Selling, general and administrative expenses” in the Consolidated Statements of Income. The outstanding amount of receivables sold under the facility was $200 million as of December 31, 2005 and there was none outstanding as of December 31, 2006.
Prior to January 2006, discounts were offered to certain customers for early payment for product. As a result, some receivable amounts were collected in December 2005 and 2004, respectively, that otherwise would have been expected to be collected in January 2006 and 2005, respectively. This included collections of $84 million and $66 million in December 2005 and 2004, respectively, related to receivables from Occidental.
7. Inventories
Inventories consisted of the following components at December 31:
At December 31, 2006, approximately 89% of Equistar’s inventories, excluding materials and supplies and in-transit inventory, were valued using the LIFO method.
The excess of the current replacement cost over book value of those inventories that are carried at cost using the LIFO method was approximately $381 million and $465 million at December 31, 2006 and 2005, respectively.
Equistar’s inventory-based revolving credit facility was amended in November 2005, increasing the availability from $250 million to $400 million and extending the maturity to November 2010. This facility was undrawn at December 31, 2006 and 2005 (see Note 12).
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Property, Plant an d Equipment and Other Assets
The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows at December 31:
Maintenance and repair expenses were $287 million, $261 million and $246 million for the years ended December 31, 2006, 2005 and 2004, respectively. No interest was capitalized to property, plant and equipment during the three-year period.
In 2004, Equistar sold certain railcars for $37 million and leased the railcars from the buyer under an operating lease agreement. The sale resulted in a gain of $7 million that is being recognized over the 10 year term of the lease as a reduction of lease rent expense.
The components of other assets, at cost, and the related accumulated amortization were as follows at December 31:
Amortization of these identifiable intangible assets for the next five years is expected to be $69 million in 2007, $56 million in 2008, $40 million in 2009, $30 million in 2010 and $22 million in 2011.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Property, Plant and Equipment and Other Assets - (Continued)
Depreciation and amortization expense is summarized as follows for the years ended December 31:
In addition to the depreciation and amortization expense shown above, amortization of debt issuance costs of $5 million in each of 2006 and 2005 and $6 million in 2004 is included in interest expense in the Consolidated Statements of Income.
9. Accounts Payable
Accounts payable at December 31, 2006 and 2005 included liabilities in the amounts of $7 million and $6 million, respectively, for checks issued in excess of associated bank balances but not yet presented for collection.
10. Accrued Liabilities
Accrued liabilities consisted of the following components at December 31:
11. Def erred Revenues
Deferred revenues at December 31, 2006 and 2005 of $175 million and $171 million, respectively, represent advances from customers as partial prepayments for products to be delivered under long-term product supply contracts. Equistar is recognizing this deferred revenue as the associated product is delivered. Trade sales and other operating revenues included $13 million, $22 million and $17 million in 2006, 2005 and 2004, respectively, of such previously deferred revenues.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
12.
Long-Term Debt
Long-term debt consisted of the following at December 31:
Aggregate maturities of all long-term debt during the next five years are $700 million in 2008, $600 million in 2009, $3 million in 2010, $707 million in 2011 and $150 million thereafter.
Equistar may currently redeem its 10.125% Senior Notes due 2008, 10.625% Senior Notes due 2011 and 8.75% Notes due 2009 upon payment of the present value of future interest and principal amounts, using a specified discount rate. Alternatively, Equistar may redeem the 10.625% Senior Notes due 2011 beginning in 2007, at a price of 105.313% of the principal amount with the price declining annually to 100% at maturity.
During 2006, Equistar repaid the $150 million of 6.5% Notes outstanding, which matured in February 2006.
During 2005, Equistar amended its $250 million inventory-based revolving credit facility, increasing the availability to $400 million, extending the maturity to November 2010 and reducing the interest rate from LIBOR plus 2.25% to LIBOR plus 1.5%. The total amount available at December 31, 2006 under both the $400 million inventory-based revolving credit facility and the $600 million accounts receivable sales facility (see Note 6) was $938 million, which gave effect to the borrowing base less a $50 million unused availability requirement and any outstanding amount of accounts receivable sold under the accounts receivable facility, of which there was none at December 31, 2006, and $12 million of outstanding letters of credit under the revolving credit facility as of December 31, 2006. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The revolving credit facility requires that the unused available amounts under that facility and the $600 million accounts receivable sales facility equal or exceed $50 million, or $100 million if the Interest Coverage Ratio (as defined) at the end of any period of four consecutive fiscal quarters is less than 2:1. The revolving credit facility is secured by a lien on all inventory and certain personal property, including a pledge of accounts receivable. There was no borrowing under the revolving credit facility at December 31, 2006.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
12. Long-Term Debt - (Continued)
The $400 million revolving credit facility and the indentures contain covenants that, subject to exceptions, restrict, among other things, lien incurrence, debt incurrence, dividends, sales of assets, investments, accounts receivable securitizations, purchase of equity, payments on indebtedness, affiliate transactions, sale and leaseback transactions and mergers. The credit facility does not require the maintenance of specified financial ratios as long as certain conditions are met. In addition, some of Equistar’s indentures require additional interest payments to the note holders if Equistar makes distributions when its Fixed Charge Coverage Ratio (as defined) is less than 1.75 to 1.
Lyondell is a guarantor of Equistar’s 7.55% Debentures due 2026. The consolidated financial statements of Lyondell are filed as an exhibit to Equistar’s Annual Report on Form 10-K for the year ended December 31, 2006.
13. Lease Commitments
Equistar leases various facilities and equipment under noncancelable operating lease arrangements for varying periods. Operating leases include leases of railcars used in the distribution of products in Equistar’s business. As of December 31, 2006, future minimum lease payments for the next five years and thereafter, relating to all noncancelable operating leases with lease terms in excess of one year were as follows:
Net rental expense for 2006, 2005 and 2004 was $106 million, $103 million and $94 million, respectively.
14. Financial Instruments and Derivatives
The fair value of all nonderivative financial instruments included in current assets and current liabilities, including cash and cash equivalents, accounts receivable and accounts payable, approximated their carrying value due to their short maturity. Based on the borrowing rates currently available to Equistar for debt with terms and average maturities similar to Equistar’s debt portfolio, the fair value of Equistar’s long-term debt, including amounts due within one year, was approximately $2,255 million and $2,456 million at December 31, 2006 and 2005, respectively.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Pension and Other Postretirement Benefits
All full-time regular employees are covered by defined benefit pension plans sponsored by Equistar. Retirement benefits are generally based upon years of service and the employee’s highest compensation for any consecutive 36 month period during the last 120 months of service or other compensation measures as defined under the respective plan provisions. Equistar funds the plans through contributions to pension trust funds, generally subject to minimum funding requirements as provided by applicable law. Equistar also has unfunded supplemental nonqualified retirement plans, which provide pension benefits for certain employees in excess of the U.S. tax-qualified plans’ limits. In addition, Equistar sponsors unfunded postretirement benefit plans other than pensions, which provide medical and life insurance benefits. The postretirement medical plans are contributory, while the life insurance plans are generally non contributory. The life insurance benefits are provided to employees who retired before July 1, 2002.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Pension and Other Postretirement Benefits - (Continued)
The following table provides a reconciliation of projected benefit obligations, plan assets and the funded status of these plans:
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Pension and Other Postretirement Benefits - (Continued)
The 2005 decrease in the benefit obligation and increase in unrecognized prior service benefit reflect the amendment of the Equistar postretirement medical plan, effective January 1, 2006, that reduced retiree medical benefits.
Pension plans with projected benefit obligations in excess of the fair value of assets are summarized as follows at December 31:
Pension plans with accumulated benefit obligations in excess of the fair value of assets are summarized as follows at December 31:
The following table provides the components of periodic pension and other postretirement benefit costs for the year ended December 31:
Estimated amortization of the defined benefit pension plans actuarial loss and prior service cost components of accumulated other comprehensive income (“AOCI”) to be included in 2007 net periodic pension cost is $2 million and less than $1 million, respectively. Estimated amortization of the defined benefit postretirement plans prior service cost component of AOCI to be included in 2007 net periodic benefit cost is less than $1 million.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Pension and Other Postretirement Benefits - (Continued)
The assumptions used in determining the net benefit liability were as follows at December 31:
The assumptions used in determining net benefit cost were as follows for the year ended December 31:
The assumed annual rate of increase in the per capita cost of covered health care benefits as of December 31, 2006 was 10% for 2007, decreasing 1% per year to 5% in 2012 and thereafter. The health care cost trend rate assumption does not have a significant effect on the amounts reported due to limits on Equistar’s maximum contribution level to the medical plan. To illustrate, increasing or decreasing the assumed health care cost trend rates by one percentage point in each year would change the accumulated other postretirement benefit liability as of December 31, 2006 by less than $1 million and would not have a material effect on the aggregate service and interest cost components of the net periodic other postretirement benefit cost for the year then ended.
Management’s goal is to manage pension investments over the long term to achieve optimal returns with an acceptable level of risk and volatility. Targeted asset allocations of 55% U.S. equity securities, 15% non-U.S. equity securities, and 30% fixed income securities are based on recommendations by Equistar’s independent pension investment advisor. Equistar’s expected long-term rate of return on plan assets of 8% is based on the average level of earnings that its independent pension investment advisor has advised could be expected to be earned over time on such allocation. Investment policies prohibit investments in securities issued by Equistar or an affiliate, such as Lyondell or Millennium, or investment in speculative derivative instruments. The investments are marketable securities that provide sufficient liquidity to meet expected benefit obligation payments.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Pension and Other Postretirement Benefits - (Continued)
Equistar’s pension plan weighted-average asset allocations by asset category were as follows at December 31:
Equistar expects to contribute less than $1 million to its pension plans in 2007.
As of December 31, 2006, future expected benefit payments, which reflect expected future service, as appropriate, were as follows:
Equistar also maintains voluntary defined contribution savings plans for eligible employees. Contributions to the plans by Equistar were $13 million in 2006 and $12 million in each of 2005 and 2004.
16. Commitments and Contingencies
Commitments-Equistar has various purchase commitments for materials, supplies and services incident to the ordinary conduct of business, generally for quantities required for its businesses and at prevailing market prices. Equistar is also a party to various obligations to purchase products and services, principally for utilities and industrial gases. These commitments are designed to assure sources of supply and are not expected to be in excess of normal requirements. See also Note 5, describing related party transactions. At December 31, 2006, future minimum payments under those contracts with noncancelable contract terms in excess of one year and fixed minimum payments were as follows:
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
16. Commitments and Contingencies - (Continued)
Equistar’s total purchases under these agreements were $416 million, $494 million and $378 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Asset Retirement Obligation-Equistar believes that there are asset retirement obligations associated with some of its facilities, but that the present value of those obligations normally is not material in the context of an indefinite expected life of the facilities. Equistar continually reviews the optimal future alternatives for its facilities. In many cases, the amount and timing of costs, if any, that may be incurred as a result of such reviews are not known, and no decisions have been reached, but if a decision were reached to retire one or more facilities in the foreseeable future, the asset retirement costs could range from $0 to $30 million, depending upon the scope of the required work and other factors. At December 31, 2006, the balance of the liability that had been recognized for all asset retirement obligations was $12 million. In addition, any decision to retire a facility would result in other costs, including employment related costs.
Environmental Remediation-Equistar’s accrued liability for future environmental remediation costs totaled $4 million and $1 million as of December 31, 2006 and 2005, respectively. In the opinion of management, there is no material estimable range of reasonably possible loss in excess of the liability recorded for environmental remediation. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in investigations by regulatory agencies, could require Equistar to reassess its potential exposure related to environmental matters.
MTBE-The presence of MTBE in some water supplies in certain U.S. states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft led to public concern about the use of MTBE and resulted in U.S. federal and state governmental initiatives to reduce or ban the use of MTBE. Substantially all refiners and blenders have discontinued the use of MTBE in the U.S.
Accordingly, Equistar’s MTBE is sold for use outside of the U.S. However, there are higher distribution costs and import duties associated with exporting MTBE outside of the U.S., and the increased supply of MTBE may reduce profitability of MTBE in these export markets. Should it become necessary or desirable to significantly reduce MTBE production, Equistar may make capital expenditures to add the flexibility to produce alternative gasoline blending components, such as iso-octane, iso-octene (also know as “di-isobutylene”) or ethyl tertiary butyl ether (“ETBE”), at its MTBE plant. Conversion and product decisions will continue to be influenced by regulatory and market developments. The profit contribution related to iso-octane or iso-octene may be lower than that historically realized on MTBE.
Other-Equistar is, from time to time, a defendant in lawsuits and other commercial disputes, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of any liability and resulting financial impact with respect to any such matters cannot be ascertained with any degree of certainty, management does not believe that any ultimate uninsured liability resulting from these matters in which it currently is involved will, individually or in the aggregate, have a material adverse effect on the financial position, liquidity or results of operations of Equistar.
General-In the opinion of management, the matters discussed in this note are not expected to have a material adverse effect on the financial position or liquidity of Equistar. However, the adverse resolution in any reporting period of one or more of these matters could have a material impact on Equistar’s results of operations for that period, which may be mitigated by contribution or indemnification obligations of others, or by any insurance coverage that may be available.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
17. Supplemental Cash Flow Information
Supplemental cash flow information is summarized as follows for the years ended December 31:
18. Segment and Related Information
Equistar operates in one reportable segment, ethylene, co-products and derivatives (“EC&D”), which includes: the ethylene and co-products product group, including primarily manufacturing and marketing of ethylene, its co-products, including propylene, butadiene and aromatics; and the derivatives product group, including primarily manufacturing and marketing of ethylene oxide, ethylene glycol and polyethylene (see Note 1).
The accounting policies of the segment are the same as those described in “Summary of Significant Accounting Policies” (see Note 2). Transfers of product from the ethylene and co-products product group to the derivatives product group are made at prices approximating prevailing market prices. No trade customer accounted for 10% or more of Equistar’s consolidated sales during any year in the three-year period ended December 31, 2006; however, sales to Lyondell were approximately 11% in 2006 and 10% in each of 2005 and 2004.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
18. Segment and Related Information - (Continued)
Although Equistar operates in one integrated reportable segment, Equistar has provided certain additional data, as shown below, for two product groups: the ethylene and co-products group, reflecting the products of the core ethylene manufacturing processes, and the derivatives products group.
Index to Financial Statements EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
18. Segment and Related Information - (Continued)
The following table presents the details of “Total assets” as presented above in the “Other” column as of December 31, for the years indicated:
19. Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss were as follows at December 31:
Index to Financial Statements
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Equistar performed an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer (principal executive officer) and the Senior Vice President and Chief Financial Officer (principal financial officer), of the effectiveness of Equistar’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of December 31, 2006. Based upon that evaluation, the Chief Executive Officer and the Senior Vice President and Chief Financial Officer concluded that Equistar’s disclosure controls and procedures are effective.
There were no changes in Equistar’s internal control over financial reporting that occurred during Equistar’s last fiscal quarter (the fourth quarter 2006) that have materially affected, or are reasonably likely to materially affect, Equistar’s internal control over financial reporting.
Equistar’s management’s report on internal control over financial reporting appears on page 37 of this Annual Report on Form 10-K. In addition, PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, has audited management’s assessment of the effectiveness of Equistar’s internal control over financial reporting, as of December 31, 2006, as stated in their report that appears on page 38 of this Annual Report on Form 10-K.
Item 9B.
Item 9B. Other Information
None.
Index to Financial Statements
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Omitted pursuant to General Instruction I of Form 10-K. See “Additional Information Available” for information regarding Equistar’s code of ethics.
Item 11.
Item 11. Executive Compensation
Omitted pursuant to General Instruction I of Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Omitted pursuant to General Instruction I of Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Omitted pursuant to General Instruction I of Form 10-K.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit and Non-Audit Fees
The following table presents fees for audit services rendered by PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) for the audit of Equistar’s annual financial statements for the years ended December 31, 2006 and 2005, and fees billed or expected to be billed for audit-related, tax and all other services rendered by PricewaterhouseCoopers during those periods.
(a) Audit fees consist of the aggregate fees and expenses billed or expected to be billed for professional services rendered by PricewaterhouseCoopers for the audit of Equistar’s annual financial statements, the review of financial statements included in Equistar’s Form 10-Qs or for services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for those fiscal years. Of the 2005 audit fees shown in the table, $500,000 represents fees and expenses billed in 2006 related to 2005 audit services. Of the 2006 audit fees shown in the table, $300,000 represents fees and expenses expected to be billed in 2007 related to 2006 audit services.
(b) Audit-related fees consist of the aggregate fees billed for assurance and related services by PricewaterhouseCoopers that are reasonably related to the performance of the audit or review of Equistar’s financial statements. This category includes fees related to: the performance of audits of Equistar’s benefit plans; agreed-upon or expanded audit procedures relating to accounting and/or billing records required to respond to or comply with financial, accounting or regulatory reporting matters; and consultations as to the accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standards or interpretations by regulatory or standard setting bodies. Of the 2005 audit-related fees shown in the table, $152,000 represents fees billed in 2006 for 2005 audit-related services. Of the 2006
Index to Financial Statements
audit-related fees shown in the table, $65,000 represents fees expected to be billed in 2007 for 2006 audit-related services.
Pre-Approval Policy
Generally, the Partnership Governance Committee of Equistar serves as Equistar’s Audit Committee, and is directly responsible for overseeing the work of the independent registered public accounting firm. However, as a result of Lyondell’s November 30, 2004 acquisition of Millennium, Equistar and Millennium became consolidated subsidiaries of Lyondell. Therefore, to protect the independence of Equistar’s independent registered public accounting firm and to ensure that services provided by the independent registered public accounting firm are pre-approved by an independent governing body, on December 1, 2004, Equistar’s Partnership Governance Committee revised its pre-approval policy. Under the revised pre-approval policy, Equistar’s Partnership Governance Committee has delegated to Lyondell’s Audit Committee, which consists entirely of independent directors, the responsibility for reviewing and pre-approving all audit and non-audit services to be provided for Equistar by Equistar’s independent registered public accounting firm (including affiliates or related member firms).
Under the revised policy, a centralized service request procedure is used for all requests for the independent registered public accounting firm to provide services to Equistar. Under this procedure, all requests for the independent registered public accounting firm to provide services to Equistar initially are submitted to Lyondell’s Vice President and Controller. Each such request must include a detailed description of the services to be rendered. If the proposed services have not already been pre-approved by Lyondell’s Audit Committee, Lyondell’s Vice President and Controller will submit the request and a detailed description of the proposed services to Lyondell’s Audit Committee. Requests to provide services that require pre-approval by Lyondell’s Audit Committee also must include a statement as to whether, in the view of Lyondell’s Vice President and Controller, the request is consistent with the SEC’s rules on independent registered public accounting firm independence.
Pursuant to the revised policy, the Partnership Governance Committee has designated Lyondell’s Senior Vice President and Chief Financial Officer to review compliance with the pre-approval policy. Lyondell’s Senior Vice President and Chief Financial Officer will report to Lyondell’s Audit Committee periodically on the results of the monitoring.
Index to Financial Statements
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following exhibits are filed as a part of this report:
Index to Financial Statements
Index to Financial Statements The Registrant is a party to several long-term debt instruments under which the total amount of long-term debt securities authorized does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Registration S-K, the Registrant agrees to furnish a copy of such instruments to the Commission upon request.
The Registrant is party to several compensatory plans, contracts or arrangements that the Registrant has not included herein based on paragraph 10(iii)(C)(6) of Item 601(b) of Regulation S-K since the Registrant is a wholly-owned subsidiary of Lyondell Chemical Company, a company that has a class of securities registered pursuant to section 12 or files reports pursuant to section 15(d) of the Exchange Act and is filing a report on Form 10-K.
_________
(1) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-76473) and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-70048) and incorporated herein by reference.
(3) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference.
(4) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference.
(5) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference.
Index to Financial Statements
(6) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 and incorporated herein by reference.
(7) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-111134) and incorporated herein by reference.
(8) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated December 17, 2003 and incorporated herein by reference.
(9) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference.
(10) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference.
(11) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated as of November 30, 2004 and incorporated herein by reference.
(12) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated as of November 2, 2005 and incorporated herein by reference.
(13) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.
(14) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated as of June 30, 2006 and incorporated herein by reference.
(15) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated as of December 6, 2006 and incorporated herein by reference.
(b) Consolidated Financial Statements and Financial Statement Schedules
(1) Consolidated Financial Statements
Consolidated Financial Statements filed as part of this Annual Report on Form 10-K are listed in the Index to Financial Statements on page 36.
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not applicable or the required information is contained in the Financial Statements or notes thereto.
Index to Financial Statements SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized this 28th day of February, 2007.
EQUISTAR CHEMICALS, LP,
by its General Partner
MILLENNIUM PETROCHEMICALS GP LLC
By: Millennium Petrochemicals Inc.
By:
/s/ MORRIS GELB
Morris Gelb
President
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on February 28, 2007.
Name
Title (Millennium Petrochemicals Inc.)
/s/ MORRIS GELB
Morris Gelb
(Principal Executive Officer)
President and Director
/s/ KAREN A. TWITCHELL
Karen A. Twitchell
(Principal Financial and Accounting Officer)
Vice President and Treasurer
/s/ T. KEVIN DENICOLA
T. Kevin DeNicola
Director
/s/ EDWARD J. DINEEN
Edward J. Dineen
Director
Index to Financial Statements SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized this 28th day of February, 2007.
Name
Title
/s/ DAN F. SMITH
Dan F. Smith
(Principal Executive Officer)
Chief Executive Officer
Member, Partnership Governance Committee
/s/ T. KEVIN DENICOLA
T. Kevin DeNicola
(Principal Financial Officer)
Senior Vice President and Chief Financial Officer
Member, Partnership Governance Committee
/s/ CHARLES L. HALL
Charles L. Hall
(Principal Accounting Officer)
Vice President, Controller and Chief Accounting Officer
/s/ C. BART DE JONG
C. Bart de Jong
Member, Partnership Governance Committee
/s/ MORRIS GELB
Morris Gelb
Member, Partnership Governance Committee
Index to Financial Statements SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED
PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED
SECURITIES PURSUANT TO SECTION 12 OF THE ACT
Neither an annual report covering the Registrant’s last fiscal year nor proxy materials with respect to any annual or other meeting of security holders have been sent to security holders.