10-Q 1 h17369e10vq.txt CITGO PETROLEUM CORPORATION - JUNE 30, 2004 ================================================================================ United States SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ COMMISSION FILE NUMBER 1-14380 CITGO PETROLEUM CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 73-1173881 -------- ---------- (State or other jurisdiction of I. R. S. Employer Identification No.) incorporation or organization) ONE WARREN PLACE, 6100 SOUTH YALE AVENUE, TULSA, OKLAHOMA 74136 ------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) (918) 495-4000 -------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as described in Rule 12b-2 of the Act): Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. COMMON STOCK, $1.00 PAR VALUE 1,000 ----------------------------- ----- (Class) (outstanding at July 31, 2004) ================================================================================ CITGO PETROLEUM CORPORATION QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 TABLE OF CONTENTS

3 FACTORS AFFECTING FORWARD LOOKING STATEMENTS Except for the historical information contained in this Report, certain of the matters discussed in this Report may be deemed to be "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Specifically, all statements under the caption "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations" pertaining to capital expenditures and investments related to environmental compliance, strategic planning, purchasing patterns of refined products and capital resources available to CITGO Petroleum Corporation ("CITGO") are forward looking statements. Words such as "anticipate," "estimate," "expect," "project," "believe" and similar expressions generally identify a forward-looking statement. We caution readers that these forward looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from the results that are projected, expressed or implied. Some of those risks and uncertainties include: - the availability and cost of crude oil, feedstocks, blending components and refined products, which can affect our ability to operate our refineries and our costs; - accidents, interruptions in transportation, inclement weather and other events that cause unscheduled shutdowns or otherwise adversely affect our refineries, pipelines or equipment, or those of our suppliers or customers; - prices or demand for CITGO products, which are influenced by general economic activity, weather patterns (including seasonal fluctuations), prices of alternative fuels, energy conservation efforts and actions by competitors; - environmental and other regulatory requirements, which affect the content of our products and our operations, operating costs and capital expenditure requirements; - costs and uncertainties associated with technological change and implementation; - inflation; and - continued access to capital markets and commercial bank financing on favorable terms, which can affect our ability to finance capital improvements, our costs and our flexibility. CITGO purchases approximately one-half of its crude oil requirements from Petroleos de Venezuela, S.A., the national oil company of the Bolivarian Republic of Venezuela and CITGO's ultimate parent corporation, under long-term supply agreements. Readers are cautioned not to place undue reliance on these forward looking statements, which apply only as of the date of this Report. CITGO disclaims any duty to publicly release any revision to these forward looking statements to reflect events or circumstances after the date of this Report. 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) CITGO PETROLEUM CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)

See notes to condensed consolidated financial statements. 2 CITGO PETROLEUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) (DOLLARS IN THOUSANDS)

See notes to condensed consolidated financial statements. 3 CITGO PETROLEUM CORPORATION CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY (UNAUDITED) (DOLLARS AND SHARES IN THOUSANDS)

See notes to condensed consolidated financial statements. 4 CITGO PETROLEUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS)

See notes to condensed consolidated financial statements. 5 CITGO PETROLEUM CORPORATION NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SIX-MONTHS ENDED JUNE 30, 2004 AND 2003 1. BASIS OF PRESENTATION CITGO Petroleum Corporation ("CITGO" or the "Company") and its subsidiaries are engaged in the refining, marketing and transportation of petroleum products including gasoline, diesel fuel, jet fuel, petrochemicals, lubricants, asphalt and refined waxes, mainly within the continental United States east of the Rocky Mountains. The Company does not own any crude oil reserves or crude oil exploration or production facilities. It operates as a single segment. It is an indirect wholly owned subsidiary of Petroleos de Venezuela, S.A. ("PDVSA", which may also be used herein to refer to one or more of its subsidiaries), the national oil company of the Bolivarian Republic of Venezuela. The financial information for CITGO subsequent to December 31, 2003 and with respect to the interim three-month and six-month periods ended June 30, 2004 and 2003 is unaudited. In management's opinion, such interim information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of such periods. The results of operations for the three-month and six-month periods ended June 30, 2004 and 2003 are not necessarily indicative of the results to be expected for the full year. Reference is made to CITGO's Annual Report for the fiscal year ended December 31, 2003 on Form 10-K. 2. NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46 defines variable interest entities and how an enterprise should assess its interests in a variable interest entity to decide whether to consolidate that entity. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), primarily to clarify the required accounting for investments in variable interest entities. This standard replaces FIN 46. For CITGO, which meets the definition of a nonpublic enterprise for purposes of applying FIN 46R, application is required immediately for variable interest entities created after December 31, 2003 and for variable interest entities in which an interest is acquired after that date, and to all entities that are subject to FIN 46R by January 1, 2005. The interpretation requires certain minimum disclosures with respect to variable interest entities in which an enterprise holds significant variable interest but which it does not consolidate. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The applicable provisions of FIN 46R had no impact on financial position or results of operations for the six-month period ended June 30, 2004 and CITGO expects that the application of FIN 46R will not have a material impact on its financial position or results of operations in the future. 6 3. ACCOUNTS RECEIVABLE The Company has a limited purpose consolidated subsidiary, CITGO Funding Corporation ("CITGO Funding"), which established a non-recourse agreement to sell an undivided interest in specified trade accounts receivables ("pool") to independent third parties. Under the terms of the agreement, new receivables are added to the pool as collections (administered by CITGO) reduce previously sold receivables. CITGO pays specified fees related to its sale of receivables under the program. The amount sold to third-parties at any one time under the trade accounts receivable sales agreement is limited to a maximum of $275 million (increased from $200 million through an amendment in November 2003). As of June 30, 2004, none of the receivables in the designated pool had been sold to the third party and the entire amount was retained by CITGO Funding. 4. INVENTORIES Inventories, primarily at LIFO, consist of the following:

5. RESTRICTED CASH CITGO issued $30 million of tax-exempt environmental facilities revenue bonds in June 2002 and $39 million in May 2003. The proceeds from these bonds are being used for spending on qualified projects at the Lemont and Corpus Christi refineries. Restricted cash of approximately $2 million at June 30, 2004 represents highly liquid investments held in trust accounts in accordance with these bond agreements. Funds may be released solely to finance the qualified capital expenditures as defined in the related bond agreements. 7 6. LONG-TERM DEBT AND FINANCING ARRANGEMENTS Long-term debt consists of the following:

CITGO has a $260 million unsecured revolving credit facility maturing in December 2005. There was no outstanding balance under this credit facility at June 30, 2004. The Company had a senior secured term loan under an agreement with a syndicate of various lenders. The senior loan was secured by CITGO's equity interest in two pipeline companies. CITGO retired the senior loan on June 25, 2004. The costs to retire the senior loan prior to the maturity date of February 2006 included a prepayment charge of $4 million. In February 2003, CITGO issued $550 million aggregate principal amount of 11-3/8% unsecured senior notes due February 1, 2011. In connection with this debt issuance, CITGO repurchased $50 million principal amount of its 7-7/8% senior notes due 2006. In May 1996, CITGO issued $200 million aggregate principle amount of 7-7/8% unsecured senior notes due 2006. These notes were issued under a shelf-registration statement covering $600 million of debt securities that was filed with the Securities and Exchange Commission. Due to CITGO's credit ratings, the shelf registration statement is not presently available. Approximately $222 million of the outstanding tax-exempt bonds are supported by letters of credit issued by various banks. In February 2004, CITGO reissued $11.8 million of tax-exempt revenue bonds due 2007 which had been repurchased by the Company during 2003 due to lack of letter of credit support. 8 On May 3, 2004, CITGO issued $25 million of tax-exempt environmental revenue bonds due 2032 through a governmental issuer that refunded $25 million of taxable environmental revenue bonds due 2028 previously issued through that issuer. The tax-exempt bonds are supported by a letter of credit issued by a bank. Our various debt instruments require maintenance of a specified minimum net worth and impose restrictions on our ability to: incur additional debt unless we meet specified interest coverage and debt to capitalization ratios; place liens on our property, subject to specified exceptions; sell assets, subject to specified exceptions; make restricted payments, including dividends, repurchases of capital stock and specified investments; and merge, consolidate or transfer assets. Various of our debt agreements, including the agreements governing the Private Placement Senior Notes and the Master Shelf Agreement Senior Notes and the reimbursement agreements relating to various letters of credit that provide liquidity support for our tax-exempt bonds, contain provisions requiring that we equally and ratably secure those instruments if we issue secured debt other than as permitted by those instruments. CITGO is in compliance with its covenants under its debt financing arrangements at June 30, 2004. 7. INVESTMENT IN LYONDELL-CITGO REFINING LP LYONDELL-CITGO Refining LP ("LYONDELL-CITGO") owns and operates a 265 thousand barrels per day refinery in Houston, Texas and is owned by subsidiaries of CITGO (41.25%) and Lyondell Chemical Company (58.75%) ("the Owners"). This refinery processes heavy crude oil supplied by PDVSA under a long-term supply contract that expires in 2017. CITGO purchases substantially all of the gasoline, diesel and jet fuel produced at the refinery under a long-term contract. As of June 30, 2004, CITGO has a note receivable from LYONDELL-CITGO of $35 million. The note bears interest at market rates, which was approximately 1.8 percent at June 30, 2004. Principal and interest are due January 1, 2008. Accordingly, the note and related accrued interest are included in the balance sheet caption other assets, noncurrent, in the accompanying consolidated balance sheets. 9 CITGO accounts for its investment in LYONDELL-CITGO using the equity method of accounting and records its share of the net earnings of LYONDELL-CITGO based on allocations of income agreed to by the Owners which differ from participation interests. Cash distributions are allocated to the Owners based on participation interest. Information on CITGO's investment in LYONDELL-CITGO follows:

On May 21, 2004, LYONDELL-CITGO closed on a three-year, $550 million credit facility to replace its expiring $520 million credit facility. The new credit facility is comprised of a $450 million term loan and a $100 million revolver, both with an interest rate of the London Interbank Offered Rate ("LIBOR") plus 2.5 percent. The facility is secured by substantially all of the assets of LYONDELL-CITGO and contains covenants substantially the same as the previous facility. There was no outstanding balance under the working capital revolving credit facility at June 30, 2004. 10 8. COMMITMENTS AND CONTINGENCIES LITIGATION AND INJURY CLAIMS - Various lawsuits and claims arising in the ordinary course of business are pending against CITGO. CITGO records accruals for potential losses when, in management's opinion, such losses are probable and reasonably estimable. If known lawsuits and claims were to be determined in a manner adverse to CITGO, and in amounts greater than CITGO's accruals, then such determinations could have a material adverse effect on CITGO's results of operations in a given reporting period. The most significant lawsuits and claims are discussed below. In September 2002, a Texas court ordered CITGO to pay property owners and their attorneys approximately $6 million based on an alleged settlement of class action property damage claims as a result of alleged air, soil and groundwater contamination from emissions released from CITGO's Corpus Christi, Texas refinery. CITGO has appealed the ruling to the Texas Court of Appeals. CITGO, along with most of the other major oil companies, is a defendant in a number of federal and state lawsuits alleging contamination of private and public water supplies by methyl tertiary butyl ether ("MTBE"), a gasoline additive. In general, the plaintiffs claim that MTBE renders the water not potable. In addition to compensatory and punitive damages, plaintiffs seek injunctive relief to abate the contamination. CITGO intends to defend all of the MTBE lawsuits vigorously. CITGO's MTBE litigation can be divided into two categories -- pre and post-September 30, 2003 litigation. In the six pre-September 30, 2003 cases, CITGO is defending itself in Madison County, Illinois state court and in two New York county state courts. In several of the New York cases, the judge on March 26, 2004, granted CITGO's Motion for Summary Judgment. As of early July 2004, a settlement in principle had been reached in one Madison County, Illinois case and the parties were close to reaching settlement of the other case. The post-September 30, 2003 cases were filed after new federal legislation was proposed that would have precluded plaintiffs from filing lawsuits based on the theory that gasoline with MTBE is a defective product. These approximately 60 cases, the majority of which were filed by municipal authorities, were removed to federal court and at the defendants' request consolidated in Multi-District Litigation ("MDL") 1358. On March 16, 2004, the judge in MDL 1358 denied the plaintiffs' motion to remand the cases to state court. The remaining New York state case has been removed to federal court and consolidated with the MDL 1358 cases and the judge has denied plaintiffs' motion to remand that case. It is not possible to estimate the loss or range of loss, if any, related to these cases. CITGO has been named as a defendant in approximately 150 asbestos lawsuits pending in state and federal courts. These cases, most of which involve multiple defendants, are brought by former employees or contractor employees seeking damages for asbestos related illnesses allegedly caused, at least in part, from exposure at refineries owned or operated by CITGO in Lake Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois. In many of these cases, the plaintiffs' alleged exposure occurred over a period of years extending back to a time before CITGO owned or operated the premises at issue. CITGO does not believe that the resolution of these cases will have a material adverse effect on its financial condition or results of operations. At June 30, 2004, CITGO's balance sheet included an accrual for lawsuits and claims of $23 million compared with $27 million at December 31, 2003. Unrelated to the reduction in the accrual, CITGO estimates that an additional loss of $4 million is reasonably possible in connection with such lawsuits and claims. ENVIRONMENTAL COMPLIANCE AND REMEDIATION - CITGO is subject to the federal Clean Air Act ("CAA"), which includes the New Source Review ("NSR") program as well as the Title V air permitting program; the federal Clean Water Act, which includes the National Pollution Discharge Elimination System program; the Toxic Substances Control Act; and the federal Resource Conservation and Recovery Act and their equivalent 11 state programs. CITGO is required to obtain permits under all of these programs and believes it is in material compliance with the terms of these permits. CITGO does not have any material Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") liability because the former owners of many of CITGO's assets have by explicit contractual language assumed all or the material portion of CERCLA obligations related to those assets. This includes the Lake Charles refinery and the Lemont refinery. The U.S. refining industry is required to comply with increasingly stringent product specifications under the 1990 Clean Air Act Amendments for reformulated gasoline and low sulfur gasoline and diesel fuel that requires additional capital and operating expenditures, and alters significantly the U.S. refining industry and the return realized on refinery investments. Also, regulatory interpretations by the United States Environmental Protection Agency ("U.S. EPA") regarding "modifications" to refinery equipment under the NSR provisions of the CAA have created uncertainty about the extent to which additional capital and operating expenditures will be required. In addition, CITGO is subject to various other federal, state and local environmental laws and regulations that may require CITGO to take additional compliance actions and also actions to remediate the effects on the environment of prior disposal or release of petroleum, hazardous substances and other waste and/or pay for natural resource damages. Maintaining compliance with environmental laws and regulations could require significant capital expenditures and additional operating costs. Also, numerous other factors affect CITGO's plans with respect to environmental compliance and related expenditures. CITGO's accounting policy establishes environmental reserves as probable site restoration and remediation obligations become reasonably capable of estimation. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties. Subsequent adjustments to estimates, to the extent required, may be made as more refined information becomes available. CITGO believes the amounts provided in its consolidated financial statements, as prescribed by generally accepted accounting principles, are adequate in light of probable and estimable liabilities and obligations. However, there can be no assurance that the actual amounts required to discharge alleged liabilities and obligations and to comply with applicable laws and regulations will not exceed amounts provided for or will not have a material adverse affect on its consolidated results of operations, financial condition and cash flows. In 1992, CITGO reached an agreement with the Louisiana Department of Environmental Quality ("LDEQ") to cease usage of certain surface impoundments at the Lake Charles refinery by 1994. The remediation commenced in December 1993. CITGO is complying with a June 2002 LDEQ administrative order about the development and implementation of a corrective action or closure plan. Based on currently available information and proposed remedial approach, CITGO currently anticipates closure and post-closure costs related to these surface impoundments and related solid waste management units to range from $34 million to $39 million in addition to the approximately $47 million already expended. CITGO and the former owner of the refinery are participating in the closure and sharing the related costs based on estimated contributions of waste and ownership periods. CITGO's Corpus Christi, Texas refinery is being investigated by state and federal agencies for alleged criminal violations of federal environment statutes and regulations, including the CAA and the Migratory Bird Act. CITGO is cooperating with the investigation. CITGO believes that it has defenses to any such charges. At this time, CITGO cannot predict the outcome of or the amount or range of any potential loss that would ensue from any such charges. In June 1999, CITGO and numerous other industrial companies received notice from the U.S. EPA that the U.S. EPA believes these companies have contributed to contamination in the Calcasieu Estuary, near Lake Charles, Louisiana and are potentially responsible parties ("PRPs") under the CERCLA. The U.S. EPA made a demand for payment of its past investigation costs from CITGO and other PRPs and since 1999 has 12 been conducting a remedial investigation/feasibility study ("RI/FS") under its CERCLA authority. While CITGO disagrees with many of the U.S. EPA's earlier allegations and conclusions, CITGO and other industrial companies signed in December 2003, a Cooperative Agreement with the LDEQ on issues relative to the Bayou D'Inde tributary section of the Calcasieu Estuary, and the companies are proceeding with a Feasibility Study Work Plan. CITGO will continue to deal separately with the LDEQ on issues relative to its refinery operations on another section of the Calcasieu Estuary. The Company still intends to contest this matter if necessary. In January and July 2001, CITGO received notices of violation ("NOVs") from the U.S. EPA alleging violations of the CAA. The NOVs are an outgrowth of an industry-wide and multi-industry U.S. EPA enforcement initiative alleging that many refineries, electric utilities and other industrial sources modified air emission sources without obtaining permits or installing new control equipment under the NSR provisions of the CAA. The NOVs followed inspections and formal information requests regarding CITGO's Lake Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois refineries. Since mid-2002, CITGO has been engaged in global settlement negotiations with the United States. The settlement negotiations have focused on different levels of air pollutant emission reductions and the merits of various types of control equipment to achieve those reductions. An agreement in principle has been reached. CITGO estimates that the costs of the proposed settlement with the United States will be approximately $325 million. Any capital costs would be incurred over a period of years, anticipated to be primarily from 2004 to 2008. CITGO also would pay civil penalties under the settlement agreement. If the settlement is not consummated, CITGO is prepared to contest the NOVs. In June 1999, an NOV was issued by the U.S. EPA alleging violations of the National Emission Standards for Hazardous Air Pollutants regulations covering benzene emissions from wastewater treatment operations at CITGO's Lemont, Illinois refinery. CITGO is in settlement discussions with the U.S. EPA. This matter has been consolidated with the matters described in the previous paragraph. In June 2002, a Consolidated Compliance Order and Notice of Potential Penalty was issued by the LDEQ alleging violations of the Louisiana air quality regulations at CITGO's Lake Charles, Louisiana refinery during 2001. The majority of the alleged violations related to the leak detection and repair program. CITGO is in settlement discussions with the LDEQ. This matter has been consolidated with the matters described in the previous paragraph related to the U.S. EPA's NSR enforcement initiative. At June 30, 2004, CITGO's balance sheet included an environmental accrual of $67 million compared with $63 million at December 31, 2003. Results of operations reflect an increase in the accrual during 2004 due primarily to a revision of the Company's estimated share of costs related to two sites indicating higher costs as well as spending on environmental projects. CITGO estimates that an additional loss of $20 million is reasonably possible in connection with environmental matters. Various regulatory authorities have the right to conduct, and from time to time do conduct, environmental compliance audits of CITGO and its subsidiaries' facilities and operations. Those audits have the potential to reveal matters that those authorities believe represent non-compliance in one or more respects with regulatory requirements and for which those authorities may seek corrective actions and/or penalties in an administrative or judicial proceeding. Based upon current information, CITGO is not aware that any such audits or their findings have resulted in the filing of such a proceeding or is the subject of a threatened filing with respect to such a proceeding, nor does CITGO believe that any such audit or their findings will have a material adverse effect on its future business and operating results, other than matters described above. Conditions which require additional expenditures may exist with respect to CITGO's various sites including, but not limited to, its operating refinery complexes, former refinery sites, service stations and crude oil and petroleum product storage terminals. Based on currently available information, CITGO cannot determine the amount of any such future expenditures. 13 DERIVATIVE COMMODITY AND FINANCIAL INSTRUMENTS - As of June 30, 2004, CITGO's petroleum commodity derivatives included exchange traded futures contracts, forward purchase and sale contracts, exchange traded and over-the-counter options and over-the-counter swaps. At June 30, 2004, the balance sheet captions prepaid expenses and other current assets and other current liabilities include $10 million and $14 million, respectively, related to the fair values of open commodity derivatives. CITGO has also entered into various interest rate swaps to manage the Company's risk related to interest rate changes on its debt. The fair value of the interest rate swap agreements in place at June 30, 2004, based on the estimated amount that the Company would receive or pay to terminate the agreements as of that date and taking into account current interest rates, was a loss of $1 million, the offset of which is recorded in the balance sheet caption other current liabilities. In connection with the determination of fair market value, the Company considered the creditworthiness of the counterparties, but no adjustment was determined to be necessary as a result. GUARANTEES - As of June 30, 2004, the Company has guaranteed the debt of others in a variety of circumstances including letters of credit issued for an affiliate, bank debt of an equity investment, bank debt of customers, customer debt related to the acquisition of marketing equipment and financing debt incurred by an equity investment as shown in the following table:

In each case, if the debtor fails to meet its obligation, CITGO could be obligated to make the required payment. The Company has not recorded any amounts on the Company's balance sheet relating to these guarantees. In the event of debtor default on the letters of credit, CITGO has been indemnified by PDV Holding, Inc., the direct parent of PDV America, which is CITGO's direct parent. In the event of debtor default on the equity investment bank debt, CITGO has no recourse. In the event of debtor default on customer bank debt, CITGO generally has recourse to personal guarantees from principals or liens on property. In the event of debtor default on financing debt incurred by customers, CITGO would receive an interest in the equipment being financed after making the guaranteed debt payment. In the event of debtor default on financing debt incurred by an equity investee, CITGO has no recourse. CITGO has granted indemnities to the buyers in connection with past sales of product terminal facilities. These indemnities provide that CITGO will accept responsibility for claims arising from the period in which CITGO owned the facilities. Due to the uncertainties in this situation, the Company is not able to estimate a liability relating to these indemnities. 14 The Company has not recorded a liability on its balance sheet relating to product warranties because historically, product warranty claims have not been significant. 9. RELATED PARTY TRANSACTIONS CITGO purchases approximately one-half of the crude oil processed in its refineries from subsidiaries of PDVSA under long-term supply agreements. These supply agreements extend through the year 2006 for the Lake Charles refinery, 2010 for the Paulsboro refinery, 2012 for the Corpus Christi refinery and 2013 for the Savannah refinery. CITGO and PDVSA are considering the possibility of modifying certain terms and conditions of these supply agreements, including the pricing mechanisms. Such modifications may require the consent of some of CITGO's debt-holders in order to become effective. These crude supply agreements contain force majeure provisions that excuse the performance by either party of its obligations under the agreement under specified circumstances. Three affiliates entered into agreements to advance excess cash to the Company from time to time under demand notes for amounts of up to a maximum of $10 million with PDV Texas, Inc. ("PDV Texas"), $30 million with PDV America and $10 million with PDV Holding. The notes bear interest at rates equivalent to 30-day LIBOR plus 0.875% payable quarterly. At June 30, 2004 and December 31, 2003, there was no outstanding balance on these notes. 10. EMPLOYEE BENEFIT PLANS COMPONENTS OF NET PERIODIC BENEFIT COST For the three months ended June 30:

15 For the six months ended June 30:

EMPLOYER CONTRIBUTIONS CITGO previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $58 million to its pension plan in 2004. On each of April 15 and July 15, 2004, CITGO contributed approximately $5.4 million, for a total of $10.8 million, to its pension plan. CITGO presently anticipates contributing an additional $47 million to fund its pension plan in 2004 for a total of $58 million. 11. CORPORATE HEADQUARTERS RELOCATION In April 2004, CITGO announced its strategic decision to move its corporate headquarters from Tulsa, Oklahoma to Houston, Texas. Approximately 700 positions from a total of approximately 1,000 positions in Tulsa will begin transferring to Houston in August 2004. The relocation is expected to be complete in July 2005. The total cost of this transition is estimated to be approximately $81 million, plus or minus 25%. Primary components of this amount include:

No relocation expenses had been incurred as of June 30, 2004; therefore, no such expenses or liabilities are included in the financial statements as of that date. Currently, CITGO expects to spend approximately $24 million in the third quarter of 2004 related to this relocation. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW This discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements included elsewhere in this report. We generated net income of $172.1 million on total revenue of $8.1 billion in the quarter ended June 30, 2004 compared to net income of $108.7 million on total revenue of $6.1 billion (which included $27 million in insurance recoveries) for the same period last year. We generated net income of $206.8 million on total revenue of $14.8 billion in the six months ended June 30, 2004 compared to net income of $248.5 million on total revenue of $12.6 billion (which included $144 million in insurance recoveries) for the same period in 2003. (See "Gross margin"). CRITICAL ACCOUNTING POLICIES AND ESTIMATES We make a number of significant estimates, assumptions and judgments on the preparation of our financial statements. We direct your attention to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Form 10-K annual report for our fiscal year ended December 31, 2003, for a discussion of the estimates and judgments necessary in our accounting for environmental expenditures, litigation and injury claims, health care costs and pensions. 17 RESULTS OF OPERATIONS

(1) The Gulf Coast 3/2/1 crack spread is the value of two-thirds barrel of gasoline plus one-third barrel of distillate minus one barrel of crude (West Texas Intermediate or "WTI"). Heavy crude refiners also evaluate the light/heavy crude spread (WTI minus Maya). The sum of these benchmarks is the heavy crack spread. During the second quarter of 2004, the heavy crack spread was $17.63 per barrel versus $10.73 per barrel during the second quarter of 2003. The values used to calculate the Gulf Coast 3/2/1 crack spread and the heavy crack spread are obtained from Platts using an average of daily prices for the three-month and six-month periods ended June 30, 2004 (excluding weekends and holidays). (2) The average price per gallon of gasoline is based on CITGO gasoline sales revenue divided by CITGO gasoline sales volume. See the "CITGO Sales Revenues and Volumes" table that follows. (3) The average cost per barrel of crude oil is based on CITGO's crude oil cost divided by CITGO refinery crude inputs. See the "CITGO Cost of Sales and Operating Expenses" table that follows. 18 Sales revenues and volumes. Sales increased $2.0 billion, or approximately 34%, in the three-month period ended June 30, 2004 as compared to the same period in 2003. This increase was primarily due to an increase in average sales price of 38%. Sales increased $2.3 billion, or approximately 19% in the six-month period ended June 30, 2004 as compared to the same period in 2003. This increase was primarily due to an increase in average sales price of 20%. The following table summarizes the sources of our sales revenues and sales volumes for the three-month and six-month periods ended June 30, 2004 and 2003: CITGO SALES REVENUES AND VOLUMES

Equity in earnings of affiliates. The table below shows the changes during the three months and six months ended June 30, 2004 compared to the same periods in 2003 in the equity in earnings of affiliates. The increase in LYONDELL-CITGO's earnings in the second quarter and the first six months of 2004 as compared to the same periods in 2003 was due primarily to higher margins on crude oil refining and aromatics. LYONDELL-CITGO also benefited from higher crude processing rates in the first six months of 2004 as compared to the same period in 2003.

19 Cost of sales and operating expenses. The following table summarizes our cost of sales and operating expenses for the three-month and six-month periods ended June 30, 2004 and 2003: CITGO COST OF SALES AND OPERATING EXPENSES

We purchase refined products to supplement the production from our refineries in order to meet marketing demands and to optimize distribution. Refined product purchases represented 56% and 57% of total cost of sales and operating expenses for the second quarter of 2004 and 2003, respectively, and 57% of total cost of sales for both of the six month periods ended June 30, 2004 and 2003. Margins on purchased products, on average, are lower than margins on refinery produced products because refinery produced products benefit from the whole supply chain upgrade and purchased refined products do not. However, purchased products are not segregated from our produced products and margins may vary due to market conditions and other factors beyond our control. In the near term, other than normal refinery turnaround maintenance, we do not anticipate operational actions or market conditions which might cause a material change in anticipated purchased product requirements; however, there could be events beyond our control which impact the volume of refined products purchased. (See also "Factors Affecting Forward Looking Statements".) Gross margin. Gross margin increased approximately 1.8 cents per gallon in the quarter ended June 30, 2004 compared to the same period in 2003 and five-tenths of one cent per gallon in the six months ended June 30, 2004 compared to the same period in 2003. Gross margin for the quarter ended June 30, 2004 was approximately 4.8 cents per gallon compared to gross margin of approximately 3.0 cents per gallon for the same period in 2003. Gross margin for the six months ended June 30, 2004 was approximately 3.4 cents per gallon compared to the gross margin of approximately 2.8 cents per gallon for the same period in 2003. Revenue per gallon for the second quarter 2004 increased approximately 38% compared to the second quarter 2003 and increased approximately 20% for the first six months of 2004 compared to the first six months of 2003. Cost of sales and operating expenses per gallon for the quarter ended June 30, 2004 increased approximately 37% compared to the same period in 2003 and for the six months ended June 30, 2004 increased approximately 20% compared to the same period in 2003. A change in the price of crude oil, feedstocks and blending products generally results in a corresponding change in the sales price of refined products. The impact of changes in crude oil and feedstock prices on our consolidated income before taxes depends, in part, on how quickly refined product prices are adjusted to reflect these changes in feedstock costs. Our 60% increase in gross margin for the second quarter of 2004 versus the second quarter of 2003 compares to the 65% increase in the industry heavy crack spread over the same period. Gross margin for the six months ended June 30, 2004 increased 21% over the same period for 2003. Although industry heavy crack 20 spreads during the first six months of 2004 were 40% higher than 2003, we did not capture the full benefit of improved industry margins in the six months ended June 30, 2004 due to the heavy turnaround activities at our fuels refineries during the first quarter of 2004. Selling, general and administrative expenses. Selling, general and administrative expenses increased $8 million, or 13% from $64 million in the second quarter of 2003 to $72 million in the second quarter of 2004. Selling, general and administrative expenses increased $9 million, or 7% from $137 million in the first six months of 2003 to $146 million in the first six months of 2004. The increase in selling, general and administrative expenses for both periods is related to an increase in employee benefit expense. Interest expense. Interest expense, including capital lease interest charge, increased $4 million in the three-month period ended June 30, 2004 as compared to the same period in 2003 and increased $12 million in the six-month period ended June 30, 2004 as compared to the same period in 2003. The increase in the second quarter of 2004 was due primarily to a $4 million prepayment penalty on the senior secured term loan. The increase in the six-month period ended June 30, 2004 was primarily due to the net increase in the outstanding debt balance and higher overall interest rates resulting from the issuance of the $550 million senior notes and the closing of the $200 million secured term loan in February 2003. LIQUIDITY AND CAPITAL RESOURCES The following summarizes cash flows during the six-month periods ended June 30, 2004 and 2003:

Cash Provided by Operating Activities Consolidated net cash provided by operating activities totaled approximately $549 million for the six-month period ended June 30, 2004. Operating cash flows were derived primarily from net income of $207 million, depreciation and amortization of $180 million, distributions in excess of equity in earnings of affiliates of $34 million, increase in deferred taxes of $12 million, and changes in operating assets and liabilities of $103 million. The more significant changes in operating assets and liabilities include an increase in current liabilities and an increase in income taxes payable offset, in part, by an increase in notes and accounts receivable and an increase in inventories. 21 Cash Used in Investing Activities Net cash used in investing activities in the six month period ended June 30, 2004 totaled $148 million consisting primarily of capital expenditures of $139 million. These capital expenditures consisted of:

See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" in our Form 10-K for the year ended December 31, 2003 for additional information concerning projected capital expenditures. Cash Used in Financing Activities Net cash used in financing activities totaled $211 million for the six-month period ended June 30, 2004, consisting primarily of the repayment of the senior secured term loan of $200 million, the payment of $20 million on master shelf agreement notes and $25 million on taxable bonds. These payments were offset by proceeds of approximately $37 million from the issuance of tax-exempt bonds. As of June 30, 2004, capital resources available to us included cash on hand totaling $392 million generated by operations and other sources, and available borrowing capacity under our committed bank facilities of $257 million. Our various debt instruments require maintenance of a specified minimum net worth and impose restrictions on our ability to: - incur additional debt unless we meet specified interest coverage and debt to capitalization ratios; - place liens on our property, subject to specified exceptions; - sell assets, subject to specified exceptions; - make restricted payments, including dividends, repurchases of capital stock and specified investments; and - merge, consolidate or transfer assets. We are in compliance with the covenants under our debt financing arrangements at June 30, 2004. Upon the occurrence of a change of control of our Company, as defined in the Indenture governing our 11-3/8% senior notes due 2011, the holders of those notes have the right to require us to repurchase them at a price equal to 101% of the principal amount plus accrued interest. In addition, our bank credit agreements and the reimbursement agreements governing various of the letters of credit issued to provide liquidity support for our tax-exempt bonds provide that, unless lenders holding two-thirds of the commitments thereunder otherwise 22 agree, a change in control of our Company, as defined in those agreements, will constitute a default under those credit agreements. Various of our debt agreements, including the agreements governing the Private Placement Senior Notes and the Master Shelf Agreement Senior Notes and the reimbursement agreements relating to various letters of credit that provide liquidity support for our tax-exempt bonds, contain provisions requiring that we equally and ratably secure those instruments if we issue secured debt other than as permitted by those instruments. We believe that we will have sufficient resources to carry out planned capital spending programs, including regulatory and environmental projects in the near term, and to meet currently anticipated future obligations and other planned expenditures as they arise. We periodically evaluate other sources of capital in the marketplace and anticipate that long-term capital requirements will be satisfied with current capital resources and future financing arrangements, including the issuance of debt securities. Our ability to obtain such financing will depend on numerous factors, including market conditions, compliance with existing debt covenants and the perceived creditworthiness of the Company at that time. See also "Factors Affecting Forward Looking Statements." Three of our affiliates entered into agreements to advance excess cash to us from time to time under demand notes. These notes provide for maximum amounts of $10 million from PDV Texas, $30 million from PDV America and $10 million from PDV Holding. At June 30, 2004 and December 31, 2003, there was no outstanding balance on these notes. Our debt ratings, as currently assessed by the three major debt rating agencies, are as follows:

On February 28, 2003, an accounts receivable sales facility was established. This facility allows for the non-recourse sale of certain accounts receivable to independent third parties. A maximum of $275 million in accounts receivable may be sold at any one time. As of June 30, 2004, no receivables had been sold under this facility. Our debt instruments do not contain any covenants that trigger increased costs or burdens as a result of a change in our securities ratings. However, certain of our guarantee agreements, which support approximately $33 million letters of credit of PDV Texas, an affiliate, require us to cash collateralize the applicable letters of credit upon a reduction of our credit rating below a stated level. We believe that we have adequate liquidity from existing sources to support our operations for the foreseeable future. 23 NEW ACCOUNTING STANDARDS In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46 defines variable interest entities and how an enterprise should assess its interests in a variable interest entity to decide whether to consolidate that entity. In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), primarily to clarify the required accounting for investments in variable interest entities. This standard replaces FIN 46. For CITGO, which meets the definition of a nonpublic enterprise for purposes of applying FIN 46R, application is required immediately for variable interest entities created after December 31, 2003 and for variable interest entities in which an interest is acquired after that date, and to all entities that are subject to FIN 46R by January 1, 2005. The interpretation requires certain minimum disclosures with respect to variable interest entities in which an enterprise holds significant variable interest but which it does not consolidate. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The applicable provisions of FIN 46R had no impact on financial position or results of operations for the six-month period ended June 30, 2004 and CITGO expects that the application of FIN 46R will not have a material impact on its financial position or results of operations in the future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction. CITGO has exposure to price fluctuations of crude oil and refined products as well as fluctuations in interest rates. To manage these exposures, management has defined certain benchmarks consistent with its preferred risk profile for the environment in which the Company operates and finances its assets. CITGO does not attempt to manage the price risk related to all of its inventories of crude oil and refined products. As a result, at June 30, 2004, CITGO was exposed to the risk of broad market price declines with respect to a substantial portion of its crude oil and refined product inventories. As of June 30, 2004, CITGO's total crude and refined products inventory was 50 million barrels. Aggregate commodity derivative positions entered into for price risk management purposes at that date totaled 1 million barrels. The following disclosures do not attempt to quantify the price risk associated with such commodity inventories. Commodity Instruments. CITGO balances its crude oil and petroleum product supply/demand and manages a portion of its price risk by entering into petroleum commodity derivatives. Generally, CITGO's risk management strategies qualified as hedges through December 31, 2000. Effective January 1, 2001, the Company's policy is to elect hedge accounting only under limited circumstances involving derivatives with initial terms of 90 days or greater and notional amounts of $25 million or greater. At June 30, 2004 none of the Company's commodity derivatives were accounted for as hedges. 24 NON TRADING COMMODITY DERIVATIVES Open Positions at June 30, 2004

----------------------- (1) Thousands of barrels (2) Ten-thousands of mmbtu (3) Based on actively quoted prices. 25 NON TRADING COMMODITY DERIVATIVES OPEN POSITIONS AT JUNE 30, 2003

--------------------------- (1) Thousands of barrels (2) Ten-thousands of mmbtu (3) Floating price based on market index designated in contract; fixed price agreed upon at date of contract. (4) Based on actively quoted prices. 26 Debt Related Instruments. We have fixed and floating U.S. currency denominated debt. We use interest rate swaps to manage our debt portfolio toward a benchmark of 40 to 70 percent fixed rate debt to total fixed and floating rate debt. These instruments have the effect of changing the interest rate with the objective of minimizing our long-term costs. At June 30, 2004 and 2003, our primary exposures were to LIBOR and floating rates on tax exempt bonds. For interest rate swaps, the table below presents notional amounts and interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contracts. NON TRADING INTEREST RATE DERIVATIVES OPEN POSITIONS AT JUNE 30, 2004 AND 2003

Changes in the fair value of these agreements are recorded in other income (expense). The fair value of the interest rate swap agreements in place at June 30, 2004, based on the estimated amount that we would receive or pay to terminate the agreements as of that date and taking into account current interest rates, was a loss of $1 million, the offset of which is recorded in the balance sheet caption other current liabilities. 27 For debt obligations, the table below presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. DEBT OBLIGATIONS At June 30, 2004

DEBT OBLIGATIONS AT JUNE 30, 2003

28 ITEM 4. CONTROLS AND PROCEDURES During the second quarter of 2004, the Company's management, including the principal executive officer and principal financial officer, evaluated the Company's disclosure controls and procedures related to the recording, processing, summarization and reporting of information in the Company's periodic reports that it files with the Securities and Exchange Commission ("SEC"). These disclosure controls and procedures have been designed to ensure that (a) material information relating to the Company, including its consolidated subsidiaries, is made known to the Company's management, including these officers, by other employees of the Company and its subsidiaries, and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The Company's controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met. Also, the Company does not control or manage certain of its unconsolidated entities and thus its access and ability to apply its disclosure controls and procedures to entities that it does not control or manage are more limited than is the case for the subsidiaries it controls and manages. Accordingly, as of June 30, 2004, these officers (principal executive officer and principal financial officer) concluded that the Company's disclosure controls and procedures were effective to accomplish their objectives. 29 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The required information is incorporated by reference into Part II of this Report from Note 8 of the Notes to the Condensed Consolidated Financial Statements included in Part I of this Report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 filed by the following officers: 31.1 Filed by Luis Marin, President and Chief Executive Officer. 31.2 Filed by Jerry E. Thompson, Chief Operating Officer (Acting Chief Financial Officer). Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 filed by the following officers: 32.1 Filed by Luis Marin, President and Chief Executive Officer. 32.2 Filed by Jerry E. Thompson, Chief Operating Officer (Acting Chief Financial Officer). (b) Reports on Form 8-K: A report on Form 8-K was filed with the Securities and Exchange Commission on April 30, 2004 to announce the retirement of Eddie R. Humphrey, CITGO's Chief Financial and Administration Officer, effective May 31, 2004 and the announcement of Jerry Thompson, Chief Operating Officer as the interim Chief Financial Officer until the Company names a replacement. A report on Form 8-K was filed with the Securities and Exchange Commission on May 3, 2004 to furnish information included in our press release on earnings for the first quarter of 2004. A report on Form 8-K was filed with the Securities and Exchange Commission on June 25, 2004 to file a copy of a press release announcing CITGO's repayment in full of the amount outstanding under its $200 million senior secured term loan. 30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CITGO PETROLEUM CORPORATION Date: August 9, 2004 /s/ Larry E. Krieg ---------------------------------- Larry E. Krieg Controller (Chief Accounting Officer) 31 EXHIBIT INDEX (a) Exhibits Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 as to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 filed by the following officers: 31.1 Filed by Luis Marin, President and Chief Executive Officer. 31.2 Filed by Jerry E. Thompson, Chief Operating Officer (Acting Chief Financial Officer). Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code as to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 filed by the following officers: 32.1 Filed by Luis Marin, President and Chief Executive Officer. 32.2 Filed by Jerry E. Thompson, Chief Operating Officer (Acting Chief Financial Officer).

CITGO PETROLEUM CORP 10-Q