Marathon Oil Corporation - SEC Filing

Form 10-K
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2003

 

Commission file number 1-5153

 

Marathon Oil Corporation

(Exact name of registrant as specified in its charter)

 

        Delaware

  25-0996816                      

(State of Incorporation)

  (I.R.S. Employer Identification No.)        

 

5555 San Felipe Road, Houston, TX 77056-2723

(Address of principal executive offices)

Tel. No. (713) 629-6600

 

Securities registered pursuant to Section 12 (b) of the Act:*

 


Title of Each Class


Common Stock, par value $1.00  

Rights to Purchase Series A Junior Preferred Stock (Traded with Common Stock)**


 

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 and (2) has been subject to such filing requirements for at least the past 90 days. Yes þ No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  þ No  ¨

 

Aggregate market value of Common Stock held by non-affiliates as of June 30, 2003: $8 billion. The amount shown is based on the closing price of the registrant’s Common Stock on the New York Stock Exchange composite tape on that date. Shares of Common Stock held by executive officers and directors of the registrant are not included in the computation. However, the registrant has made no determination that such individuals are “affiliates” within the meaning of Rule 405 under the Securities Act of 1933.

 

There were 310,648,972 shares of Marathon Oil Corporation Common Stock outstanding as of January 31, 2004.

 

Documents Incorporated By Reference:

 

Portions of the registrant’s proxy statement relating to its 2004 annual meeting of stockholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, are incorporated by reference to the extent set forth in Part III, Items 10-14 of this report.


 *   The Common Stock is listed on the New York Stock Exchange, the Chicago Stock Exchange and the Pacific Stock Exchange.
**   The Preferred Stock Purchase Rights expired on January 31, 2003, pursuant to the terms of the Rights Agreement, as amended through January 29, 2003, between Marathon Oil Corporation and National City Bank, as rights agent.

 



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MARATHON OIL CORPORATION

 

Unless the context otherwise indicates, references in this Form 10-K to “Marathon,” “we,” or “us” are references to Marathon Oil Corporation, its wholly owned and majority owned subsidiaries, and its ownership interest in equity investees (corporate entities, partnerships, limited liability companies and other ventures, in which Marathon exerts significant influence by virtue of its ownership interest, typically between 20 and 50 percent).

 

TABLE OF CONTENTS

 

PART I     

Item 1. and 2.

    

Business and Properties

   2

Item 3.

    

Legal Proceedings

   24

Item 4.

    

Submission of Matters to a Vote of Security Holders

   26
PART II     

Item 5.

    

Market for Registrant’s Common Equity and Related Stockholder Matters

   26

Item 6.

    

Selected Financial Data

   26

Item 7.

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   27

Item 7A.

    

Quantitative and Qualitative Disclosures About Market Risk

   52

Item 8.

    

Consolidated Financial Statements and Supplementary Data

   F-1

Item 9.

    

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   57

Item 9A.

    

Controls and Procedures

   57
PART III     

Item 10.

    

Directors and Executive Officers of The Registrant

   58

Item 11.

    

Executive Compensation

   59

Item 12.

    

Security Ownership of Certain Beneficial Owners and Management

   59

Item 13.

    

Certain Relationships and Related Transactions

   59

Item 14.

    

Principal Accounting Fees and Services

   59
PART IV     

Item 15.

    

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

   60
SIGNATURES    67
GLOSSARY OF CERTAIN DEFINED TERMS    68


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Disclosures Regarding Forward-Looking Statements

 

This annual report on Form 10-K, particularly Item 1. and Item 2. Business and Properties, Item 3. Legal Proceedings, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosures About Market Risk, includes 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. These statements typically contain words such as “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “plans”, “predicts” or “projects” or variations of these words, suggesting that future outcomes are uncertain. In accordance with “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors, that could cause future outcomes to differ materially from those set forth in the forward-looking statements.

 

Forward-looking statements with respect to Marathon may include, but are not limited to, levels of revenues, gross margins, income from operations, net income or earnings per share; levels of capital, exploration, environmental or maintenance expenditures; the success or timing of completion of ongoing or anticipated capital, exploration or maintenance projects; volumes of production, sales, throughput or shipments of liquid hydrocarbons, natural gas and refined products; levels of worldwide prices of liquid hydrocarbons, natural gas and refined products; levels of reserves, proved or otherwise, of liquid hydrocarbons or natural gas; the acquisition or divestiture of assets; the effect of restructuring or reorganization of business components; the potential effect of judicial proceedings on the business and financial condition; and the anticipated effects of actions of third parties such as competitors, or federal, state or local regulatory authorities.

 

PART I

 

Item 1. and 2. Business and Properties

 

General

 

Marathon Oil Corporation was originally organized in 2001 as USX HoldCo, Inc., a wholly owned subsidiary of old USX Corporation. As a result of a reorganization completed in July 2001 (the “Holding Company Reorganization”), USX HoldCo, Inc. (1) became the parent entity of the consolidated enterprise (the former USX Corporation was merged into a subsidiary of USX HoldCo, Inc.) and (2) changed its name to USX Corporation. In connection with the transaction discussed in the next paragraph (the “Separation”), USX Corporation changed its name to Marathon Oil Corporation.

 

Before December 31, 2001, Marathon had two outstanding classes of common stock: USX-Marathon Group common stock, which was intended to reflect the performance of Marathon’s energy business, and USX-U.S. Steel Group common stock (“Steel Stock”), which was intended to reflect the performance of Marathon’s steel business. On December 31, 2001, Marathon disposed of its steel business through a tax-free distribution of the common stock of its wholly owned subsidiary United States Steel Corporation (“United States Steel”) to holders of Steel Stock in exchange for all outstanding shares of Steel Stock on a one-for-one basis.

 

In connection with the Separation, Marathon’s certificate of incorporation was amended on December 31, 2001 and, from that date, Marathon has only one class of common stock authorized.

 

Marathon’s principal operating subsidiaries are Marathon Oil Company and Marathon Ashland Petroleum LLC (“MAP”). Marathon Oil Company and its predecessors have been engaged in the oil and gas business since 1887. MAP is 62-percent owned by Marathon and 38-percent owned by Ashland Inc.

 

Marathon is engaged in worldwide exploration and production of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily through MAP; and other energy related businesses.

 

Operating Highlights

 

During 2003, Marathon:

 

    Realized continued exploration success with nine discoveries offshore Angola, Norway, Gulf of Mexico, and Equatorial Guinea.

 

    Maintained financial discipline and flexibility:

 

    Completed non-core asset rationalization program generating proceeds over $1.2 billion;

 

    Initiated business transformation with projected annual savings of $135 million starting in 2004;

 

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    Lowered the cash adjusted debt-to-capital ratio to 33 percent at year-end; and

 

    Increased the quarterly dividend from 23 to 25 cents per share.

 

    Established and strengthened core areas:

 

    Achieved 2003 reserve replacement of 124 percent excluding dispositions;

 

    Established core growth area in Russia with the acquisition of Khanty Mansiysk Oil Corporation (“KMOC”);

 

    Initiated production from Equatorial Guinea Phase 2A condensate expansion project and continued progress on Phase 2B liquefied petroleum gas (“LPG”) expansion; and

 

    Acquired interests in three additional Norwegian production licenses.

 

    Advanced integrated gas strategy:

 

    Signed heads of agreement with Equatorial Guinea government and GEPetrol covering fiscal terms of a proposed liquefied natural gas (“LNG”) project in Equatorial Guinea;

 

    Signed letter of understanding with BG Group for long-term LNG offtake agreement for proposed LNG project in Equatorial Guinea; and

 

    Signed statement of intent with Qatar Petroleum to study a gas-to-liquids (“GTL”), LPG, and condensate project in Qatar.

 

    Strengthened MAP:

 

    Commenced an expansion project to increase the capacity of the Detroit, Michigan refinery by 26,000 barrels per day;

 

    Neared completion of Catlettsburg, Kentucky refinery repositioning project;

 

    Increased refinery efficiencies and feedstock throughputs at Garyville, Louisiana and Texas City, Texas;

 

    Enhanced logistics network with the acquisition of an additional interest in the Centennial Pipeline and start-up of the Cardinal Products Pipeline; and

 

    Pilot Travel Centers acquired 60 Williams travel centers.

 

Segment and Geographic Information

 

For operating segment and geographic information, see Note 8 to the Consolidated Financial Statements on page F-20.

 

Exploration and Production

 

Marathon is currently conducting exploration and development activities in nine countries. Principal exploration activities are in the United States, Norway, Equatorial Guinea, Angola, and Canada. Principal development activities are in the United States, the United Kingdom, Ireland, Norway, Equatorial Guinea, Gabon, and Russia. Marathon is also pursuing opportunities in north and west Africa and the Middle East.

 

At year-end 2003, Marathon was producing crude oil and/or natural gas in seven countries, including the United States. Marathon’s worldwide liquid hydrocarbon production, including Marathon’s proportionate share of equity investees’ production, decreased six percent from 2002 levels. Marathon’s 2003 worldwide sales of natural gas production, including Marathon’s proportionate share of equity investees’ production and gas acquired for injection and subsequent resale, decreased approximately five percent from 2002. In total, Marathon’s 2003 worldwide production averaged 389,000 barrels of oil equivalent (“BOE”) per day, including discontinued operations and impacts of acquisitions and dispositions, compared to 412,000 BOE per day in 2002. In 2004, Marathon’s worldwide production is expected to average 365,000 BOE per day, excluding acquisitions and dispositions.

 

The above projection of 2004 worldwide liquid hydrocarbon production and natural gas volumes is a forward-looking statement. Some factors that could potentially affect timing and levels of production include pricing, supply

 

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and demand for petroleum products, amount of capital available for exploration and development, regulatory constraints, production decline rates of mature fields, timing of commencing production from new wells, drilling rig availability, future acquisitions or dispositions of producing properties, unforeseen hazards such as weather conditions, acts of war or terrorist acts and the government or military response thereto, and other geological, operating and economic considerations. These factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statement.

 

United States

 

Including Marathon’s proportionate share of equity investee production, approximately 57 percent of Marathon’s 2003 worldwide liquid hydrocarbon production and 63 percent of its worldwide natural gas production was produced from U.S. operations. Marathon’s ongoing U.S. strategy is to apply its technical expertise in fields with undeveloped potential, to dispose of interests in non-core properties with limited upside potential and high production costs, and to acquire interests in properties with upside potential.

 

During 2003, Marathon drilled 21 gross (11 net) exploratory wells of which 15 gross (9 net) wells encountered hydrocarbons. Of these 15 wells, 3 gross (2 net) wells were temporarily suspended or are in the process of completing.

 

Marathon’s principal U.S. exploration, development, and producing areas are located in the Gulf of Mexico and the states of Texas, New Mexico, Alaska, Wyoming, and Oklahoma.

 

U.S. Southern Business Unit

 

Gulf of Mexico – During 2003, Marathon’s share of Gulf of Mexico production averaged 53,500 barrels per day (“bpd”) of liquid hydrocarbons, representing 48 percent of Marathon’s total U.S. liquid hydrocarbon production, and 135 million cubic feet per day (“mmcfd”) of natural gas, representing 18 percent of Marathon’s total U.S. natural gas production. Liquid hydrocarbon production decreased by 9,000 net bpd and natural gas production increased by 32 net mmcfd from the prior year. The decrease in liquid hydrocarbon production is mainly due to natural field decline. The increase in natural gas production is related to a full year of Camden Hills production in 2003 and new production from Petronius drilling, partially offset by other natural field declines. At year-end 2003, Marathon held interests in 10 producing fields and 17 platforms, of which 7 platforms are operated by Marathon.

 

In 2003, Marathon announced the Neptune-5 discovery, which is located in Atwater Valley Block 574 in 6,215 feet of water. This well was drilled to a total depth of 19,142 feet and encountered more than 500 feet of net oil pay. Although several hydrocarbon-bearing intervals are present, one interval has a gross hydrocarbon column thickness of more than 1,200 feet. Two appraisal sidetrack wells were also drilled. The first sidetrack well, drilled down-dip from the original Neptune-5 location, encountered a similar thickness of net oil pay and penetrated an oil water contact, which extended the gross oil column by approximately 100 feet. The second sidetrack, drilled to an up-dip location, encountered approximately 190 feet of net oil pay in several intervals. Marathon and its partners in the Neptune Unit are integrating the results of this discovery into field development studies. Marathon holds a 30 percent interest in the Neptune Unit.

 

Also announced in 2003, the Perseus discovery is located on Viosca Knoll Block 830 in 3,376 feet of water, approximately five miles from the existing Petronius platform. The well was drilled to a total depth of 13,134 feet and encountered over 130 net feet of oil pay in the primary targets. The Perseus discovery is expected to begin production in 2004 via an extended reach well currently being drilled from the Petronius platform and extend the plateau of the Petronius production profile. Marathon holds a 50 percent interest in the Perseus discovery and the Petronius development. Petronius is currently producing a gross average of 60,000 bpd and 100 mmcfd.

 

The Gulf of Mexico continues to be a core area for Marathon with the potential to add new reserves and increase production. At the end of 2003, Marathon had interests in 149 blocks in the Gulf of Mexico, including 90 in the deepwater area.

 

Permian Basin – The Permian Basin region extends from southeast New Mexico to west Texas. Marathon’s share of production in this region averaged 30,200 bpd and 132 mmcfd in 2003, compared to 32,400 bpd and 146 mmcfd in 2002. The reduction in liquid hydrocarbon and gas production was primarily due to the impact of the disposition of properties.

 

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In June 2003, MKM Partners L.P. (“MKM”), a joint venture of Marathon and Kinder Morgan Energy Partners L.P. (“Kinder Morgan”), sold its interest in the SACROC unit to Kinder Morgan. Also in June 2003, MKM was dissolved and its interest in the Yates field was distributed to Marathon and Kinder Morgan. In November 2003, Marathon sold its interest in the Yates field to Kinder Morgan. These properties contributed approximately 9,000 net bpd to 2003 production.

 

East Texas – Production in the East Texas gas fields averaged 73 net mmcfd in 2003 compared to 84 net mmcfd in 2002. The volume decrease was primarily due to property dispositions totaling approximately 11 mmcfd and natural field decline. Active development of the Mimms Creek Field continued in 2003 with Marathon drilling 22 wells. The 2003 drilling program has resulted in Mimms Creek’s net production increasing from 9 net mmcfd to a peak of 17 net mmcfd.

 

U.S. Northern Business Unit

 

Alaska – Marathon’s primary focus in Alaska is the expansion of its natural gas business through exploration, development and marketing. Marathon’s share of production from Alaska averaged 166 mmcfd of natural gas in 2002 and 2003.

 

In September 2003, Marathon began producing gas from its Ninilchik Unit in the Cook Inlet. Production is currently flowing at a gross rate of 41 mmcfd, 21 mmcfd of which is net to Marathon, and is being transported through the recently completed Kenai Kachemak Pipeline, which connects Ninilchik to the existing natural gas pipeline infrastructure serving residential, utility and industrial markets on the Kenai Peninsula, Anchorage and other parts of south-central Alaska. Marathon operates the Ninilchik Unit and holds a 60 percent interest in it and the Kenai Kachemak Pipeline.

 

Wyoming – Liquid hydrocarbon production for 2003 averaged 21,400 net bpd compared with 22,800 net bpd in 2002. The decrease was primarily attributed to dispositions of approximately 1,000 net bpd of liquids in non-core areas of Wyoming. Average gas production increased to 127 net mmcfd in 2003, compared to 125 net mmcfd in 2002.

 

In early 2001, Marathon completed the acquisition of Pennaco Energy Inc., creating a new core area of coal bed natural gas production in the Powder River Basin (“PRB”) of Wyoming. Marathon expanded its PRB assets by approximately one-third in May 2002 as a result of the acquisition of the assets owned by its major partner in this basin. Marathon now controls more than 650,000 net acres in northeast Wyoming and southeast Montana and is the largest individual acreage holder in the PRB. During 2003, Marathon drilled approximately 320 wells. For 2003, production rates of coal bed natural gas were 82 net mmcfd, compared to 79 net mmcfd in 2002.

 

Oklahoma – Gas production for 2003 averaged 96 net mmcfd, compared with 108 net mmcfd in 2002. The decrease in gas production was primarily due to natural field decline. In 2003, Marathon’s southern Anadarko Basin exploration efforts continued to focus on the western extension of the Cement and Marlow fields. Exploration drilling efforts resulted in five discoveries.

 

International

 

Including Marathon’s proportionate share of equity investee production, approximately 43 percent of Marathon’s 2003 worldwide liquid hydrocarbon production and 37 percent of its worldwide natural gas production was produced from international operations. During 2003, Marathon drilled 54 gross (36 net) exploratory wells of which 47 gross (32 net) wells encountered hydrocarbons. Of these 47 wells, 21 gross (14 net) wells were temporarily suspended or are in the process of completing.

 

Europe

 

U.K. North Sea – Marathon’s primary asset in the U.K. North Sea is the Brae area complex where it is the operator and owns a 42 percent interest in the South, Central, North, and West Brae fields and a 38 percent interest in the East Brae field. The Brae A platform and facilities act as the host for the underlying South Brae field, adjacent Central Brae field and West Brae/Sedgwick fields. The North Brae field, which is produced via the Brae B platform, and the East Brae field are gas-condensate fields. These fields are produced using the gas cycling technique, whereby gas is injected into the reservoir for pressure maintenance, improved sweep efficiency and increased condensate liquid recovery. Although partial cycling continues, the majority of North Brae gas is being transferred to the East Brae reservoir for pressure maintenance and sales.

 

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Marathon’s share of production from the Brae area averaged 17,500 bpd of liquid hydrocarbons in 2003, compared with 20,100 bpd in 2002. The decrease resulted from the natural decline in existing fields partially offset by successful development and remedial well work. Marathon’s share of Brae gas sales averaged 198 mmcfd in 2002 and 2003. Gas sales continue to be maximized on available capacity within the pipeline system.

 

The strategic location of the Brae platforms and pipeline infrastructure has generated third-party processing and transportation business since 1986. Currently, there are 19 agreements with third-party fields contracted to use the Brae system. In addition to generating processing and pipeline tariff revenue, this third-party business also has a favorable impact on Brae-area operations by optimizing infrastructure usage and extending the economic life of the facilities.

 

The Brae group owns a 50 percent interest in the outside-operated Scottish Area Gas Evacuation (“SAGE”) system. The Beryl group owns the other 50 percent. The SAGE pipeline provides transportation for Brae and Beryl area gas and has a total wet gas capacity of approximately 1,000 mmcfd. The SAGE terminal at St. Fergus in northeast Scotland provides processing for gas from the SAGE pipeline and processing for 0.8 bcfd of third party gas from the Britannia field.

 

During 2003, Marathon and its partners announced the startup of oil and gas production from the Marathon-operated Braemar field in the U.K. North Sea. The field was developed with a single subsea well tied back to the East Brae platform 7.5 miles to the south where liquids and gas are processed. Marathon holds a 26 percent interest in Braemar. Production from the field commenced in September 2003 at an initial condensate rate of 3,700 gross bpd and was increased in January 2004 to approximately 5,300 bpd. In August 2002, a 16-inch pipeline link, Linkline, between the Marathon operated Brae B platform and the outside-operated Miller platform was sanctioned. Marathon has a 19 percent interest in the Linkline. The Linkline will initially be used for transportation of Braemar gas that has been contracted to the Miller group for operational purposes.

 

As part of the ongoing rationalization of the European Business Unit, Marathon added one new block (16/1) to its inventory, and exited four blocks (22/7,22/22c,16/3d and 16/6a-S). This resulted in an overall reduction of its UK leasehold interests from 24 blocks at the start of 2003 to 21 blocks as of December 31, 2003.

 

U.K. Atlantic Margin – Marathon has an approximately 30 percent interest in the outside-operated Foinaven area complex. This is made up of a 28 percent interest in the main Foinaven field, 47 percent of East Foinaven and 20 percent of the single well T35 and T25 accumulations. Three successful wells were drilled in 2003. Marathon’s share of production from the Foinaven fields averaged 22,400 bpd of liquid hydrocarbons and 10 mmcfd in 2003, compared to 31,000 net bpd and 9 mmcfd in 2002. Lower production of liquid hydrocarbons was due to a five-month compressor outage, completion failure in two water injection wells, and early water breakthrough in a number of main-field producers. The compressor was returned to service in November 2003 and a remedial program is planned to address the well problems in 2004. In December 2003, production from Foinaven was averaging 25,100 net bpd and 11 net mmcfd.

 

Ireland – Marathon holds a 100 percent interest in the Kinsale Head, Ballycotton and Southwest Kinsale fields in the Irish Celtic Sea. Natural gas sales were 62 net mmcfd in 2003, compared with 81 net mmcfd in 2002. The decrease in sales is primarily the result of the timing effect associated with annual storage injection versus storage withdrawals for the Kinsale storage facility, and natural field decline.

 

Marathon further developed the Kinsale Head area in 2003 by drilling and developing an additional subsea gas well. The Greensand subsea gas well is designed to enhance the productivity of the main Kinsale Head natural gas producing Greensand reservoir and has been tied back to Marathon’s existing Kinsale Head Bravo platform. Production began in July 2003.

 

During 2002, an agreement was entered into with the Seven Heads group to provide gas processing and transportation services, as well as field operating services, for the Seven Heads gas being brought to the Kinsale offshore production facilities beginning in 2003. Production from Seven Heads commenced in December 2003. Under this agreement, Marathon provides capacity to process and transport between 60 mmcfd to 100 mmcfd of Seven Heads gas.

 

Marathon has an 18.5 percent interest in the Corrib gas development project, located approximately 40 miles off Ireland’s west coast. On April 30, 2003, an Irish planning authority denied the application for the proposed onshore terminal to bring ashore gas from the Corrib field. In late 2003, the project partners submitted a new application to the planning authority. Marathon has reclassified approximately 14 million BOE from proved undeveloped reserves until the terminal application is approved, which is expected to be in late 2004.

 

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Norway In the Norwegian North Sea, Marathon’s share of production averaged 1,600 bpd and 16 mmcfd in 2003, compared to 800 bpd and 15 mmcfd in 2002. Marathon owns a 24 percent interest in the Heimdal field and gas-condensate processing center.

 

Marathon owns a 47 percent interest in the Vale field which is located northeast of the Heimdal field in 374 feet of water. This single subsea well tied back to the Heimdal platform came on line in June 2002. A further exploration well was drilled on this license in 2003 and resulted in an oil discovery called the Klegg field. The Klegg well was drilled to a total depth of 7,799 feet and encountered a gross oil column of approximately 223 feet. An evaluation of development options is underway with a decision expected in 2004.

 

Marathon has a 20 percent interest in the Byggve/Skirne gas-condensate field, currently in development on license PL102. This two well development is being tied back to the Heimdal platform gas processing center, with first production expected early 2004. Condensate export will be via the Heimdal-Brae-Forties system and gas export from the Heimdal transportation center.

 

On April 15, 2003, Marathon announced the success of the first well of its 2003 Norwegian continental shelf exploration program on the Kneler prospect in the Alvheim area. Located approximately 140 miles from Stavanger, Norway in 390 feet of water, the Kneler exploration well was drilled to total depth of 7,425 feet and encountered high quality crude oil in a gross oil column of 155 feet with 115 net feet of pay in the Heimdal formation. On May 27, 2003, Marathon announced a second discovery in the Alvheim area on the Boa well. The discovery well is located approximately 4.5 miles northwest of the Kneler discovery. The Boa well was drilled into the Heimdal formation to a total depth of 7,531 feet. This well encountered an 82 foot gross gas column and a 92 foot gross oil column. Marathon and its partners are evaluating several development scenarios for Alvheim, in which Marathon is operator and holds a 65 percent interest. Marathon expects to submit a development plan to the Norwegian authorities during the second quarter of 2004.

 

In December 2003, Marathon continued to grow its position offshore Norway by acquiring interests in three additional production licenses. Marathon is operator of two of the three licenses with 100 percent working interest (PL.307 and PL.311) and 40 percent in the third (PL.304). Work obligations have been established to promote rapid exploration of these offshore areas.

 

Netherlands – Divestment of Marathon’s interest in CLAM Petroleum B.V. (“CLAM”) was completed in May 2003.

 

West Africa

 

Equatorial Guinea—During 2002, in two separate transactions, Marathon acquired interests totaling 63 percent in the Alba field. Additionally, in these transactions, Marathon acquired a net 52 percent interest in an onshore liquefied petroleum gas processing plant and a 45 percent net interest in an onshore methanol production plant, both held through separate equity method investees.

 

The large scale Alba field Phase 2 expansion, which began in 2002, made significant progress in 2003. The field development and condensate production expansion portions of the project (Phase 2A) were greater than 90% complete at year end, with completion expected around April 1st of 2004. Work completed in 2003 included:

 

    the fabrication and installation of two new offshore platforms,

 

    installation of production flowlines,

 

    installation of gas re-injection lines between the offshore platforms and Marathon facilities on Bioko Island,

 

    drilling and completion of five new development wells,

 

    tie-back and completion of three pre-drilled wells,

 

    construction of additional condensate storage tanks on Bioko Island, and

 

    installation of onshore pipelines and facilities to stabilize and transfer the increased production levels.

 

As a result of the Phase 2A expansion, gross condensate production had grown from 18,000 to 30,000 bpd (15,800 net) at the end of 2003. At the completion of Phase 2A, gross condensate production will be further increased to approximately 54,000 bpd (30,000 net).

 

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The second phase of additional development (Phase 2B) includes fabrication and installation of a full process steam LPG cryogenic gas plant and associated storage, marine terminal, and fractionation equipment for propane and heavier gas components. This addition is expected to result in additional gross condensate production of 5,000 (2,600 net) bpd. Additionally, 20,000 (11,600 net) bpd of LPG is expected to be recovered. Phase 2B is expected to be completed near the end of 2004 raising total liquid production to a level of approximately 79,000 bpd.

 

On July 23, 2003, Marathon announced a natural gas discovery on Block D offshore Equatorial Guinea, where Marathon is operator with a 90 percent interest. The discovery well is on the Bococo prospect, located in 238 feet of water, approximately six miles west of the Alba gas/condensate field. The well was drilled to a depth of 6,110 feet and encountered 185 feet of net gas pay. The well has been suspended for reentry at a later date. The Bococo gas discovery complements three earlier dry gas discoveries on Block D for future development.

 

Marathon is currently evaluating the results of the recently drilled Deep Luba prospect, which will test for potential resources under the Alba field. This well was drilled from an Alba platform, which could enable early production if successful.

 

Gabon Marathon is operator of the Tchatamba South, Tchatamba West and Marin fields with a 56 percent working interest. Production in Gabon averaged 14,700 net bpd of liquid hydrocarbons in 2003, compared with 16,700 net bpd in 2002. The decrease is attributable to the timing of liftings. Development work during 2003 brought production levels at the Tchatamba fields up to the facility capacity of approximately 42,000 gross bpd.

 

Angola – Offshore Angola, Marathon has a 10 percent working interest in Block 31 and a 30 percent working interest in Block 32. In 2002, Marathon participated in the first ultra-deepwater discovery in Block 31. The discovery, the Plutao 1-A, was drilled to a total depth of 14,607 feet and tested 5,357 bpd through a 48/64–inch choke. In 2003, Marathon announced additional discoveries in Block 31, including the Saturno-1 and Marte-1 wells. The Saturno-1 was drilled to a total depth of 15,444 feet and tested at a maximum rate of 5,000 bpd. The Marte-1 discovery well was drilled to a total depth of 13,756 feet and tested at a maximum rate of 5,200 bpd. Development options for Block 31 are currently being evaluated. Also on Block 31, Marathon has participated in the Venus well, which has reached total depth. Results of the Venus well will be reported upon government approvals.

 

In 2003, Marathon announced the first discovery on Block 32. The Gindungo-1 well was drilled in a water depth of 4,739 feet and successively tested at rates of 7,400 and 5,700 barrels of light oil per day from two separate zones. Also on Block 32, Marathon has participated in the Canela well located approximately 8 miles south of the Gindungo discovery on Block 32. The Canela well has reached total depth. Results of the Canela well will be reported upon government approvals.

 

Other International

 

Russia – On May 13, 2003 Marathon Oil Corporation announced that it had completed the acquisition of KMOC for an aggregate purchase price of approximately $285 million, including the assumption of $31 million in debt. KMOC currently produces approximately 16,000 net bpd in the Khanty Mansiysk region of western Siberia in the Russian Federation.

 

Western Canada On October 1, 2003, Marathon completed the sale of the operations in western Canada for $612 million.

 

Eastern Canada – In 2002, Marathon announced a gas discovery at the Annapolis G-24 deepwater wildcat well approximately 215 miles south of Halifax, Nova Scotia in 5,504 feet of water. The G-24 encountered approximately 100 feet of net gas pay over several zones. Marathon is operator and has a 30 percent interest in the Annapolis lease. In addition, Marathon is operator of the adjacent Empire and Cortland leases with 50 percent and 75 percent interests, respectively. During 2003, 3-D seismic was acquired over both blocks to better define the trend.

 

Qatar – Marathon and three other companies are parties to a memorandum of understanding to further explore the possibility of developing a portion of the North field offshore Qatar. Marathon and its partners are pursuing technical and commercial discussions with Qatar Petroleum that could lead to a GTL, LPG and condensate project as part of the northern field development.

 

Libya Marathon is a member of the Oasis Group, which acquired exploration and production rights in six concessions in the mid-1950s. Marathon has a 16.3 percent interest in these concessions. In 1986, the Oasis Group ceased active participation in the concessions following the imposition of trade sanctions by the U. S. government.

 

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In 2002, the U. S. State Department reaffirmed the authority of the Oasis Group to hold discussions with representatives of the Libyan National Oil Company and the Libyan government relative to the future of the concessions. Based on the U.S. Government’s recent announcement on February 26, 2004, the Oasis Group is in active discussions with the Libyan National Oil Company concerning the negotiation of terms for their eventual return to the country.

 

The above discussions include forward-looking statements concerning the Phase 2A and Phase 2B expansion projects, including estimated completion dates, development plans, expected production levels, dates of initial production, which are based on a number of assumptions, including (among others) prices, amount of capital available for exploration and development, worldwide supply and demand for petroleum products, regulatory constraints, reserve estimates, production decline rates of mature fields, reserve replacement rates, drilling rig availability, unforeseen problems arising from construction and other geological, operating and economic considerations. Offshore production and marine operations in areas such as the Gulf of Mexico, the North Sea, the U.K. Atlantic Margin, the Celtic Sea, offshore Nova Scotia and offshore West Africa are also subject to severe weather conditions, such as hurricanes or violent storms or other hazards. In addition, development of new production properties in countries outside the United States may require protracted negotiations with host governments and is frequently subject to political considerations and tax regulations, which could adversely affect the economics of projects. To the extent these assumptions prove inaccurate and/or negotiations and other considerations are not satisfactorily resolved, actual results could be materially different than present expectations.

 

Reserves

 

At December 31, 2003, Marathon’s net proved liquid hydrocarbon and natural gas reserves, including its proportionate share of equity investees’ net proved reserves, totaled approximately 1.0 billion BOE, of which 46 percent were located in the United States. (For purposes of determining BOE, natural gas volumes are converted to approximate liquid hydrocarbon barrels by dividing the natural gas volumes expressed in thousands of cubic feet (“mcf”) by six. The liquid hydrocarbon volume is added to the barrel equivalent of gas volume to obtain BOE.)

 

Proved developed reserves represented 70 percent of total proved reserves as of December 31, 2003, as compared to 78 percent as of December 31, 2002. The decrease primarily reflects the disposition of the Yates field. Of the just over 300 mmboe of proved undeveloped reserves at year-end 2003, only 10 percent have been included as proved reserves for more than two years. On a BOE basis, excluding dispositions, Marathon replaced 124 percent of its 2003 worldwide oil and gas production. Excluding acquisitions and dispositions, Marathon replaced 76 percent of worldwide oil and gas production.

 

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The following table sets forth estimated quantities of net proved oil and gas reserves at the end of each of the last three years.

 

Estimated Quantities of Net Proved Oil and Gas Reserves at December 31

 

     Developed

  

Developed and

Undeveloped


     2003    2002    2001    2003    2002    2001

Liquid Hydrocarbons (Millions of Barrels)

                             

United States

   193    226    243    210    245    268

Europe

   47    63    69    59    76    88

West Africa

   120    113    14    218    203    17

Other International

   31    2    —      89    3    —  
    
  
  
  
  
  

Total Consolidated Continuing Operations

   391    404    326    576    527    373

Equity Investees(a)

   2    177    178    2    183    184
    
  
  
  
  
  

Worldwide Continuing Operations

   393    581    504    578    710    557

Discontinued Operations(b)

   —      9    11    —      10    13
    
  
  
  
  
  

WORLDWIDE

   393    590    515    578    720    570
    
  
  
  
  
  

Developed reserves as % of total net proved reserves

   68.0%    81.9%    90.4%               

Natural Gas (Billions of Cubic Feet)

                             

United States

   1,067    1,206    1,308    1,635    1,724    1,793

Europe

   421    408    473    484    562    615

West Africa

   528    552    —      665    653    —  
    
  
  
  
  
  

Total Consolidated Continuing Operations

   2,016    2,166    1,781    2,784    2,939    2,408

Equity Investee(c)

   —      36    32    —      59    51
    
  
  
  
  
  

Worldwide Continuing Operations

   2,016    2,202    1,813    2,784    2,998    2,459

Discontinued Operations(b)

   —      290    308    —      379    399
    
  
  
  
  
  

WORLDWIDE

   2,016    2,492    2,121    2,784    3,377    2,858
    
  
  
  
  
  

Developed reserves as % of total net proved reserves

   72.4%    73.8%    74.2%               

Total BOE (Millions of Barrels)

                             

United States

   371    427    461    483    532    567

Europe

   117    132    148    139    170    190

West Africa

   208    205    14    329    312    17

Other International

   31    2    —      89    3    —  
    
  
  
  
  
  

Total Consolidated Continuing Operations

   727    766    623    1,040    1,017    774

Equity Investees(a)

   2    183    183    2    193    193
    
  
  
  
  
  

Worldwide Continuing Operations

   729    949    806    1,042    1,210    967

Discontinued Operations(b)

   —      57    62    —      73    79
    
  
  
  
  
  

WORLDWIDE

   729    1,006    868    1,042    1,283    1,046
    
  
  
  
  
  

Developed reserves as % of total net proved reserves

   70.0%    78.4%    83.0%               

(a)   Represents Marathon’s equity interests in LLC JV Chernogorskoye (“Chernogorskoye”), MKM and CLAM. MKM was dissolved and the Yates interest was sold in 2003. Marathon’s interest in CLAM was sold in 2003.
(b)   Represents Marathon’s western Canadian assets, which were sold in 2003.
(c)   Represents Marathon’s equity interest in CLAM, which was sold in 2003.

 

The above estimates, which are forward-looking statements, are based on a number of assumptions, including (among others) prices, presently known physical data concerning size and character of the reservoirs, economic recoverability, production experience and other operating considerations. To the extent these assumptions prove inaccurate, actual recoveries could be different than current estimates.

 

For additional details of estimated quantities of net proved oil and gas reserves at the end of each of the last three years, see “Consolidated Financial Statements and Supplementary Data – Supplementary Information on Oil and Gas Producing Activities – Estimated Quantities of Proved Oil and Gas Reserves” on pages F-45 through F-46. Marathon has filed reports with the U.S. Department of Energy (“DOE”) for the years 2002 and 2001 disclosing the year-end estimated oil and gas reserves. Marathon will file a similar report for 2003. The year-end estimates reported to the DOE are the same as the estimates reported in the Supplementary Information on Oil and Gas Producing Activities.

 

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Delivery Commitments

 

Marathon has commitments to deliver fixed and determinable quantities of natural gas to customers under a variety of contractual arrangements.

 

In Alaska, Marathon has two long-term sales contracts with the local utility companies, which obligates Marathon to supply approximately 213 bcf of natural gas over the remaining life of these contracts, which terminate in 2012 and 2016. In addition, Marathon has a 30 percent ownership interest in a Kenai, Alaska, LNG plant and a proportionate share of the long-term LNG sales obligation to two Japanese utility companies. This obligation is estimated to total 138 bcf through the remaining life of the contract, which terminates March 31, 2009. These commitments are structured with variable-pricing terms. Marathon’s production from various gas fields in the Cook Inlet supply the natural gas to service these contracts. Marathon’s proved reserves and estimated production rates in the Cook Inlet sufficiently meet these contractual obligations.

 

In the U.K., Marathon has two long-term sales contracts with utility companies, which obligate Marathon to supply approximately 236 bcf of natural gas through September 2009. Marathon’s Brae area production, together with natural gas acquired for injection and subsequent resale, will supply the natural gas to service these contracts. Marathon’s Brae area proved reserves, acquired natural gas contracts and estimated production rates sufficiently meet these contractual obligations. The terms of these gas sales contracts also reflect variable-pricing structures.

 

Oil and Natural Gas Production

 

The following tables set forth daily average net production of liquid hydrocarbons and natural gas for each of the last three years:

 

Net Liquid Hydrocarbons Production(a) (b)

(Thousands of Barrels per Day)    2003    2002    2001

United States(c)

   107    117    127

Europe(d)

   41    52    46

West Africa(d)

   27    25    16

Other International(d)

   10    1    —  
    
  
  

Total Consolidated Continuing Operations

   185    195    189

Equity Investees(d) (e)

   6    8    9
    
  
  

Worldwide Continuing Operations

   191    203    198

Discontinued Operations(f)

   3    4    11
    
  
  

WORLDWIDE

   194    207    209
    
  
  
Net Natural Gas Production(b) (g)               
(Millions of Cubic Feet per Day)    2003    2002    2001

United States(c)

   732    745    793

Europe

   262    299    318

West Africa

   66    53    —  
    
  
  

Total Consolidated Continuing Operations

   1,060    1,097    1,111

Equity Investees(h)

   13    25    31
    
  
  

Worldwide Continuing Operations

   1,073    1,122    1,142

Discontinued Operations(f)

   74    104    123
    
  
  

WORLDWIDE

   1,147    1,226    1,265

(a)   Includes crude oil, condensate and natural gas liquids.
(b)   Amounts reflect production after royalties, excluding the U.K., Ireland and the Netherlands where amounts shown are before royalties.
(c)   Amounts reflect production from leasehold ownership, after royalties and interests of others.
(d)   Amounts reflect equity tanker liftings and direct deliveries of liquid hydrocarbons. The amounts correspond with the basis for fiscal settlements with governments. Crude oil purchases, if any, from host governments are not included.
(e)   Represents Marathon’s equity interests in Chernogorskoye, MKM and CLAM.
(f)   Amounts represent Marathon’s western Canadian operations, which were sold in 2003.
(g)   Amounts exclude volumes purchased from third parties for injection and subsequent resale of 23 mmcfd in 2003, 4 mmcfd in 2002 and 8 mmcfd in 2001.
(h)   Represents Marathon’s equity interests in CLAM.

 

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Productive and Drilling Wells

 

The following tables set forth productive wells and service wells for each of the last three years and drilling wells as of December 31, 2003.

 

Gross and Net Wells

 

2003


   Productive Wells(a)

  

Service

Wells(b)


  

Drilling

Wells(c)


     Oil

   Gas

     
     Gross    Net    Gross    Net    Gross    Net    Gross    Net

United States

   5,580    2,040    4,649    3,555    2,726    834    72    37

Europe

   52    14    65    35    27    9    —      —  

West Africa

   7    4    10    7    1    1    7    3

Other International

   109    109    —      —      21    21    6    6
    
  
  
  
  
  
  
  

Total Consolidated

   5,748    2,167    4,724    3,597    2,775    865    85    46

Equity Investees(d)

   96    21    —      —      15    3    —      —  
    
  
  
  
  
  
  
  

WORLDWIDE

   5,844    2,188    4,724    3,597    2,790    868    85    46
    
  
  
  
  
  
  
  

2002


   Productive Wells(a)

  

Service

Wells(b)


    
     Oil

   Gas

     
     Gross

   Net

   Gross

   Net

   Gross

   Net

         

United States

   6,495    2,715    4,577    2,876    2,752    807          

Europe

   53    20    62    34    26    9          

West Africa

   6    3    6    4    1    1          

Other International

   485    226    1,529    1,032    47    16          
    
  
  
  
  
  
         

Total Consolidated

   7,039    2,964    6,174    3,946    2,826    833          

Equity Investees(d)

   2,298    742    85    4    1,002    174          
    
  
  
  
  
  
         

WORLDWIDE

   9,337    3,706    6,259    3,950    3,828    1,007          
    
  
  
  
  
  
         

2001


   Productive Wells(a)

  

Service

Wells(b)


    
     Oil

   Gas

     
     Gross

   Net

   Gross

   Net

   Gross

   Net

         

United States

   6,550    2,415    4,828    2,935    2,852    856          

Europe

   53    20    63    35    27    9          

West Africa

   6    3    —      —      —      —            

Other International

   529    242    1,463    989    44    17          
    
  
  
  
  
  
         

Total Consolidated

   7,138    2,680    6,354    3,959    2,923    882          

Equity Investees(d)

   2,002    609    83    4    1,142    243          
    
  
  
  
  
  
         

WORLDWIDE

   9,140    3,289    6,437    3,963    4,065    1,125          

(a)   Includes active wells and wells temporarily shut-in. Of the gross productive wells, gross wells with multiple completions operated by Marathon totaled 273, 357, and 341 in 2003, 2002 and 2001, respectively. Information on wells with multiple completions operated by other companies is not available to Marathon.
(b)   Consist of injection, water supply and disposal wells.
(c)   Consists of exploratory and development wells.
(d)   Represents Chernogorskoye in 2003, and MKM and CLAM in 2002 and 2001.

 

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Drilling Activity

 

The following table sets forth, by geographic area, the number of net productive and dry development and exploratory wells completed in each of the last three years (references to “net” wells or production indicate Marathon’s ownership interest or share, as the context requires):

 

Net Productive and Dry Wells Completed(a)

 

          2003    2002    2001

United States(b)

                   

Development(c)

   – Oil    4    8    10
     – Gas    231    174    751
     – Dry    —      1    1
         
  
  
    

Total

   235    183    762

Exploratory(d)

   – Oil    1    2    2
     – Gas    7    5    9
     – Dry    2    6    8
         
  
  
    

Total

   10    13    19
         
  
  
    

Total United States

   245    196    781

International(e)

                   

Development(c)

   – Oil    31    2    1
     – Gas    14    28    54
     – Dry    1    3    5
         
  
  
    

Total

   46    33    60

Exploratory(d)

   – Oil    2    —      —  
     – Gas    21    20    16
     – Dry    5    3    5
         
  
  
    

Total

   28    23    21
    

Total International

   74    56    81
         
  
  
    

Total Worldwide

   319    252    862

(a)   Includes the number of wells completed during the applicable year regardless of the year in which drilling was initiated. Excludes any wells where drilling operations were continuing or were temporarily suspended as of the end of the applicable year. A dry well is a well found to be incapable of producing hydrocarbons in sufficient quantities to justify completion. A productive well is an exploratory or development well that is not a dry well.
(b)   Includes Marathon’s equity interest in MKM.
(c)   Indicates wells drilled in the proved area of an oil or gas reservoir.
(d)   Includes both wildcat and delineation wells.
(e)   Includes Marathon’s equity interest in Chernogorskoye and CLAM.

 

Oil and Gas Acreage

 

The following table sets forth, by geographic area, the developed and undeveloped oil and gas acreage that Marathon held as of December 31, 2003:

 

Gross and Net Acreage

 

     Developed

   Undeveloped

  

Developed and

Undeveloped


(Thousands of Acres)    Gross    Net    Gross    Net    Gross    Net

United States

   3,080    733    4,921    2,182    8,001    2,915

Europe

   402    312    1,430    623    1,832    935

West Africa

   68    42    3,204    937    3,272    979

Other International

   599    599    2,756    2,161    3,355    2,760
    
  
  
  
  
  

Total Consolidated

   4,149    1,686    12,311    5,903    16,460    7,589

Equity Investees(a)

   47    10    —      —      47    10
    
  
  
  
  
  

WORLDWIDE

   4,196    1,696    12,311    5,903    16,507    7,599

(a)   Represents Marathon’s interest in Chernogorskoye.

 

 

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Refining, Marketing and Transportation

 

RM&T operations are primarily conducted by MAP and its subsidiaries, including its wholly owned subsidiaries, Speedway SuperAmerica LLC (“SSA”) and Marathon Ashland Pipe Line LLC.

 

Refining

 

MAP owns and operates seven refineries with an aggregate refining capacity of 935,000 barrels of crude oil per day. The table below sets forth the location and daily throughput capacity of each of MAP’s refineries as of December 31, 2003:

 

In-Use Refining Capacity

(Barrels per Day)

    

Garyville, LA

   232,000

Catlettsburg, KY

   222,000

Robinson, IL

   192,000

Detroit, MI

   74,000

Canton, OH

   73,000

Texas City, TX

   72,000

St. Paul Park, MN

   70,000
    

TOTAL

   935,000
    

 

MAP’s refineries include crude oil atmospheric and vacuum distillation, fluid catalytic cracking, catalytic reforming, desulfurization and sulfur recovery units. The refineries have the capability to process a wide variety of crude oils and to produce typical refinery products, including reformulated gasoline. MAP’s refineries are integrated via pipelines and barges to maximize operating efficiency. The transportation links that connect the refineries allow the movement of intermediate products to optimize operations and the production of higher margin products. For example, naphtha may be moved from Texas City to Robinson where excess reforming capacity is available; gas oil may be moved from Robinson to Detroit where excess fluid catalytic cracking unit capacity is available; and light cycle oil may be moved from Texas City to Robinson where excess desulfurization capacity is available.

 

MAP also produces asphalt cements, polymerized asphalt, asphalt emulsions and industrial asphalts. MAP manufactures petroleum pitch, primarily used in the graphite electrode, clay target and refractory industries. Additionally, MAP manufactures aromatics, aliphatic hydrocarbons, cumene, base lube oil, polymer grade propylene and slack wax.

 

During 2003, MAP’s refineries processed 917,000 bpd of crude oil and 138,000 bpd of other charge and blend stocks. The following table sets forth MAP’s refinery production by product group for each of the last three years:

 

Refined Product Yields

 

 

(Thousands of Barrels per Day)    2003    2002    2001

Gasoline

   567    581    581

Distillates

   284    285    286

Propane

   21    21    22

Feedstocks and Special Products

   93    80    69

Heavy Fuel Oil

   24    20    39

Asphalt

   72    72    76
    
  
  

TOTAL

   1,061    1,059    1,073

 

Planned maintenance activities requiring temporary shutdown of certain refinery operating units, or turnarounds, are periodically performed at each refinery. MAP initiated major turnarounds at its Catlettsburg, Garyville, and Texas City refineries in 2003.

 

Technology upgrades and expansions of the fluid catalytic cracking units (“FCCU”) at the Garyville and Texas City refineries were completed during early 2003. These projects have increased combined FCCU capacity by over 20,000 bpd, and resulted in improved yields, reduced operating costs, and enhanced reliability of these facilities.

 

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At its Catlettsburg, Kentucky refinery, MAP has completed the approximately $440 million multi-year integrated investment program to upgrade product yield realizations and reduce fixed and variable manufacturing expenses. This program involves the expansion, conversion and retirement of certain refinery processing units that, in addition to improving profitability, will allow the refinery to begin producing low-sulfur (TIER 2) gasoline. Project startup was in the first quarter of 2004.

 

In the fourth quarter of 2003, MAP commenced approximately $300 million in new capital projects for its 74,000 bpd Detroit, Michigan refinery. One of the projects, a $110 million expansion project, is expected to raise the crude oil capacity at the refinery by 35 percent to 100,000 bpd. Other projects are expected to enable the refinery to produce new clean fuels and further control regulated air emissions. Completion of the projects is scheduled for the fourth quarter of 2005. Marathon will loan MAP the funds necessary for these upgrade and expansion projects.

 

Marketing

 

In 2003, MAP’s refined product sales volumes (excluding matching buy/sell transactions) totaled 19.8 billion gallons (1,293,000 bpd). Excluding sales related to matching buy/sell transactions, the wholesale distribution of petroleum products to private brand marketers and to large commercial and industrial consumers, primarily located in the Midwest, the upper Great Plains and the Southeast, and sales in the spot market, accounted for approximately 70 percent of MAP’s refined product sales volumes in 2003. Approximately 50 percent of MAP’s gasoline volumes and 91 percent of its distillate volumes were sold on a wholesale or spot market basis to independent unbranded customers or other wholesalers in 2003.

 

Approximately half of MAP’s propane is sold into the home heating markets and industrial consumers purchase the balance. Propylene, cumene, aromatics, aliphatics, and sulfur are marketed to customers in the chemical industry. Base lube oils and slack wax are sold throughout the United States. Pitch is also sold domestically, but approximately 13 percent of pitch products are exported into growing markets in Canada, Mexico, India, and South America.

 

MAP markets asphalt through owned and leased terminals throughout the Midwest and Southeast. The MAP customer base includes approximately 900 asphalt-paving contractors, government entities (states, counties, cities and townships) and asphalt roofing shingle manufacturers.

 

The following table sets forth the volume of MAP’s consolidated refined product sales by product group for each of the last three years:

 

Refined Product Sales

 

(Thousands of Barrels per Day)    2003    2002    2001

Gasoline

   776    773    748

Distillates

   365    346    345

Propane

   21    22    21

Feedstocks and Special Products

   97    82    71

Heavy Fuel Oil

   24    20    41

Asphalt

   74    75    78
    
  
  

TOTAL

   1,357    1,318    1,304
    
  
  

Matching Buy/Sell Volumes included in above

   64    71    45

 

MAP sells reformulated gasoline in parts of its marketing territory, primarily Chicago, Illinois; Louisville, Kentucky; northern Kentucky; and Milwaukee, Wisconsin. MAP also sells low-vapor-pressure gasoline in nine states.

 

As of December 31, 2003, MAP supplied petroleum products to approximately 3,900 Marathon and Ashland branded retail outlets located primarily in Michigan, Ohio, Indiana, Kentucky and Illinois. Branded retail outlets are also located in Florida, Georgia, Wisconsin, West Virginia, Minnesota, Tennessee, Virginia, Pennsylvania, North Carolina, South Carolina and Alabama.

 

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Retail sales of gasoline and diesel fuel were also made through company-operated outlets by SSA. As of December 31, 2003, this subsidiary had 1,775 retail outlets in 9 states that sold petroleum products and convenience-store merchandise and services, primarily under the brand names “Speedway” and “SuperAmerica.” SSA’s revenues from the sale of convenience-store merchandise totaled $2.2 billion in 2003, compared with $2.4 billion in 2002. Profit levels from the sale of such merchandise and services tend to be less volatile than profit levels from the retail sale of gasoline and diesel fuel. During 2003, SSA withdrew from markets in the Southeast when it sold 190 convenience stores located in Florida, South Carolina, North Carolina and Georgia for approximately $140 million plus store inventory.

 

Pilot Travel Centers LLC (“PTC”), a joint venture with Pilot Corporation (“Pilot”), is the largest operator of travel centers in the United States with approximately 260 locations in 34 states. The travel centers offer diesel fuel, gasoline and a variety of other services, including on-premises brand name restaurants. On February 27, 2003, PTC purchased 60 retail travel centers from the Williams Companies located in 15 states, primarily in the Midwest, Southeast and Southwest. Pilot and MAP each own a 50 percent interest in PTC.

 

MAP’s retail marketing strategy is focused on SSA’s Midwest operations, additional growth of the Marathon brand, and continued growth for PTC.

 

Supply and Transportation

 

MAP obtains the crude oil it processes from negotiated contracts and spot purchases or exchanges. In 2003, MAP’s net purchases of U.S. produced crude oil for refinery input averaged 422,000 bpd, including a net 30,000 bpd from Marathon. In 2003, Canada was the source for 13 percent or 122,000 bpd of crude oil processed and other foreign sources supplied 41 percent or 373,000 bpd of the crude oil processed by MAP’s refineries, including approximately 225,000 bpd from the Middle East. This crude was acquired from various foreign national oil companies, producing companies and traders.

 

MAP operates a system of pipelines and terminals to provide crude oil to its refineries and refined products to its marketing areas. At December 31, 2003, MAP owned, leased, or had an ownership interest in approximately 3,073 miles of crude oil trunk lines and 3,850 miles of product trunk lines. MAP owns a 47 percent interest in LOOP LLC (“LOOP”), which is the owner and operator of the only U.S. deepwater oil port, located 18 miles off the coast of Louisiana; a 50 percent interest in LOCAP LLC, which owns a crude oil pipeline connecting LOOP and the Capline system; and a 37 percent interest in the Capline system, a large diameter crude oil pipeline extending from St. James, Louisiana to Patoka, Illinois.

 

MAP also has a 33 percent ownership interest in Minnesota Pipe Line Company, which owns a crude oil pipeline in Minnesota. Minnesota Pipe Line Company provides MAP with access to crude oil common carrier transportation from Clearbrook, Minnesota to Cottage Grove, Minnesota, which is in the vicinity of MAP’s St. Paul Park, Minnesota refinery.

 

On February 10, 2003, MAP increased its ownership in Centennial Pipeline LLC from 33 percent to 50 percent and as of December 31, 2003, MAP and Texas Eastern Products Pipeline Company, L.P. own Centennial Pipeline LLC 50 percent each. The Centennial Pipeline system connects Gulf Coast refineries with the Midwest market.

 

In the fourth quarter 2003, a MAP subsidiary, Ohio River Pipe Line LLC, completed the construction of the Cardinal Products Pipeline, which extends from Kenova, West Virginia to Columbus, Ohio. The first deliveries from the pipeline occurred in late December 2003. The pipeline is an interstate common carrier pipeline and is expected to initially move approximately 36,000 bpd of refined petroleum into the central Ohio region. The pipeline, which has a capacity of up to 80,000 bpd, is expected to provide a stable, cost effective supply of gasoline, diesel and jet fuel to this market.

 

MAP’s 88 light product and asphalt terminals are strategically located throughout the Midwest, upper Great Plains and Southeast. These facilities are supplied by a combination of pipelines, barges, rail cars and/or trucks. MAP’s marine transportation operations include towboats and barges that transport refined products on the Ohio, Mississippi and Illinois rivers, their tributaries and the Intercoastal Waterway. MAP also leases and owns rail cars in various sizes and capacities for movement and storage of petroleum products and a large number of tractors, tank trailers and general service trucks.

 

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Table of Contents

The above RM&T discussions include forward-looking statements concerning anticipated completion of refinery projects and the operation of the Cardinal Products Pipeline. Some factors that could potentially cause actual results for the refinery projects to differ materially from present expectations include (among others) price of petroleum products, levels of cash flow from operations, unforeseen problems arising from construction, regulatory approval constraints and unforeseen hazards such as weather conditions and delays in construction. Some factors that could affect the pipeline system include the price of petroleum products and other supply issues. This forward-looking information may prove to be inaccurate and actual results may differ from those presently anticipated.

 

Other Energy Related Businesses

 

Marathon operates other businesses that market and transport its own and third-party natural gas, crude oil and products manufactured from natural gas, such as LNG and methanol, primarily in the United States, Europe and West Africa. Some of these businesses, as well as other business projects under development, comprise Marathon’s integrated gas strategy.

 

Marathon owns an interest in the following pipeline systems: a 29 percent interest in Odyssey Pipeline LLC and a 28 percent interest in Poseidon Oil Pipeline Company, LLC (both Gulf of Mexico crude oil pipeline systems); a 24 percent interest in Nautilus Pipeline Company, LLC and a 24 percent interest in Manta Ray Offshore Gathering Company, LLC (both Gulf of Mexico natural gas pipeline systems); a 17 percent interest in Explorer Pipeline Company (a light product pipeline system extending from the Gulf of Mexico to the Midwest); and a 6 percent interest in Wolverine Pipe Line Company (a light product pipeline system extending from Chicago, IL to Toledo, OH). None of these refined product systems are part of MAP. Marathon also holds interests in some smaller offshore Gulf of Mexico oil pipeline systems.

 

Marathon owns a 34 percent ownership interest in the Neptune natural gas processing plant located in St. Mary Parish, Louisiana, which commenced operations on March 20, 2000. The plant has the capacity to process 300 mmcfd of natural gas, which is supplied by the Nautilus pipeline system, and is being expanded to 600 mmcfd capacity effective early 2004.

 

In addition to the sale of its own oil and natural gas production, Marathon purchases oil and gas from third party producers and marketers for resale.

 

Marathon owns a 30 percent interest in a Kenai, Alaska, natural gas liquefication plant and two 87,500 cubic meter tankers used to transport LNG to customers in Japan. Feedstock for the plant is supplied from a portion of Marathon’s natural gas production in the Cook Inlet. From the first production in 1969, the LNG has been sold under a long-term contract with two of Japan’s largest utility companies. Marathon has a 30 percent participation in this contract, which will continue through March 31, 2009. LNG deliveries totaled 66 gross bcf (22 net bcf) in 2003.

 

On January 3, 2002, Marathon acquired a 45 percent interest in a methanol plant located in Malabo, Equatorial Guinea from CMS Energy. Feedstock for the plant is supplied from a portion of Marathon’s natural gas production in the Alba field. Methanol production totaled 836,000 gross metric tons (376,000 net metric tons) in 2003. Production from the plant is used to supply customers in Europe and the U.S.

 

In August 2002, Marathon acquired the rights to deliver up to 58 bcf of LNG annually to the Elba Island LNG terminal near Savannah, Georgia. The contract has a 17-year term with an option to extend for an additional five-year period. The agreement provides for the right to deliver LNG under a put option with the capacity owner of the facility and, under certain conditions, take redelivery of natural gas for onward sale to third parties.

 

Marathon’s Atlantic Basin integrated gas activity centers around the monetization of Marathon’s gas reserves from the Alba field. This proposed project would involve construction of a 3.4 million metric tonnes per year LNG facility located on Bioko Island, Equatorial Guinea, with startup currently projected for late 2007. In the second quarter of 2003, Marathon, the Government of Equatorial Guinea, and GEPetrol, the national oil company of Equatorial Guinea, signed a heads of agreement on fiscal terms and conditions for the development of the LNG facility. In addition, Marathon signed a letter of understanding with BG Gas Marketing, Ltd. (“BGML”), a subsidiary of BG Group plc, under which BGML would purchase the LNG plant’s production for a period of 17 years. BGML has stated its intent to deliver the LNG primarily to the LNG receiving terminal in Lake Charles, Louisiana, where it would be regasified and delivered into the Gulf Coast natural gas pipeline grid. The provisions of the letter of understanding are subject to a definitive purchase and sale agreement, which the parties expect to finalize in the second quarter of 2004.

 

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In the Pacific Basin, one of the integrated gas projects Marathon has been pursuing, the Tijuana Regional Energy Center, will not proceed. Marathon has been unable to make significant progress on this project, principally due to the lack of local and regional support that would be necessary to obtain land use and other key permits. More recently, the Baja California State Government announced plans to expropriate land, on which Marathon and its partners held options to purchase, that would have been the site for the proposed project.

 

Marathon has been engaged in GTL research and development since the early 1990s with the goal of creating a process and facility capable of converting natural gas into ultra-clean diesel fuel. Currently, Marathon is participating in a GTL demonstration plant at the Port of Catoosa near Tulsa, Oklahoma. Dedicated during the fourth quarter of 2003, this complex is part of the Department of Energy’s Ultra-Clean Fuels Program. This GTL technology development is being pursued in conjunction with Marathon’s proposed Qatar GTL project.

 

In the first quarter of 2004, Marathon will realign its segment reporting. A new segment, Integrated Gas, will be introduced and the Other Energy Related Businesses (“OERB”) segment will be eliminated. Of the business activities discussed above, the Gulf of Mexico crude oil pipeline systems, crude oil marketing activities and the Catoosa demonstration plant will be reported in the Exploration and Production segment. The refined products pipeline systems will be reported in the Refining, Marketing and Transportation segment. The remaining activities will comprise the Integrated Gas segment which will consist of LNG facilities, certain midstream gas plants and pipelines, non-equity natural gas marketing activity, and continued execution of other integrated gas strategies in the Atlantic and Pacific Basins, which may or may not be connected to Marathon’s E&P activity. For further information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Outlook” on page 47.

 

The above OERB discussion contains forward looking statements concerning the plans for a LNG facility and a LNG offtake transaction. Factors that could affect the plans for the LNG plant and LNG offtake transaction include the successful negotiation and execution of definitive purchase and sale agreements for gas supply and LNG offtake, board approval of the transactions, approval of the LNG project by the Government of Equatorial Guinea, unforeseen difficulty in negotiation of definitive agreements among project participants, inability or delay in obtaining necessary government and third-party approvals, unanticipated changes in market demand or supply, competition with similar projects, environmental issues, availability or construction of sufficient LNG vessels, and unforeseen hazards such as weather conditions. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

 

Competition and Market Conditions

 

Strong competition exists in all sectors of the oil and gas industry and, in particular, in the exploration and development of new reserves. Marathon competes with major integrated and independent oil and gas companies for the acquisition of oil and gas leases and other properties, for the equipment and labor required to develop and operate those properties and in the marketing of oil and natural gas to end-users. Many of Marathon’s competitors have financial and other resources greater than those available to Marathon. As a consequence, Marathon may be at a competitive disadvantage in bidding for the rights to explore for oil and gas. Acquiring the more attractive exploration opportunities frequently requires competitive bids involving front-end bonus payments or commitments-to-work programs. Marathon also competes in attracting and retaining personnel, including geologists, geophysicists and other specialists. Based on industry sources, Marathon believes it currently ranks eighth among U.S.-based petroleum corporations on the basis of 2002 worldwide liquid hydrocarbon and natural gas production.

 

Marathon through MAP must also compete with a large number of other companies to acquire crude oil for refinery processing and in the distribution and marketing of a full array of petroleum products. MAP believes it ranks fifth among U.S. petroleum companies on the basis of crude oil refining capacity as of January 1, 2004. MAP competes in four distinct markets – wholesale, spot, branded and retail distribution—for the sale of refined products and believes it competes with about 40 companies in the wholesale distribution of petroleum products to private brand marketers and large commercial and industrial consumers; about 80 companies in the sale of petroleum products in the spot market; 11 refiner/marketers in the supply of branded petroleum products to dealers and jobbers; and approximately 275 petroleum product retailers in the retail sale of petroleum products. Marathon competes in the convenience store industry through SSA’s retail outlets. The retail outlets offer consumers gasoline, diesel fuel (at selected locations) and a broad mix of other merchandise and services. Some locations also have on-premises brand-name restaurants such as Subway. Marathon also competes in the travel center industry through its 50 percent ownership in PTC.

 

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Marathon’s operating results are affected by price changes in crude oil, natural gas and petroleum products, as well as changes in competitive conditions in the markets it serves. Generally, results from production operations benefit from higher crude oil and natural gas prices while refining and marketing margins may be adversely affected by crude oil price increases. Market conditions in the oil and gas industry are cyclical and subject to global economic and political events and new and changing governmental regulations.

 

The Separation

 

On December 31, 2001, pursuant to an Agreement and Plan of Reorganization dated as of July 31, 2001 (“Reorganization Agreement”), Marathon completed the Separation, in which:

 

    its wholly owned subsidiary United States Steel LLC converted into a Delaware corporation named United States Steel Corporation and became a separate, publicly traded company; and

 

    USX Corporation changed its name to Marathon Oil Corporation.

 

As a result of the Separation, Marathon and United States Steel are separate companies, and neither has any ownership interest in the other. Thomas J. Usher is chairman of the board of both companies, and, as of December 31, 2003, four of the ten remaining members of Marathon’s board of directors are also directors of United States Steel.

 

In connection with the Separation and pursuant to the Plan of Reorganization, Marathon and United States Steel have entered into a series of agreements governing their relationship after the Separation and providing for the allocation of tax and certain other liabilities and obligations arising from periods before the Separation. The following is a description of the material terms of two of those agreements.

 

Financial Matters Agreement

 

Under the financial matters agreement, United States Steel has assumed and agreed to discharge all Marathon’s principal repayment, interest payment and other obligations under the following, including any amounts due on any default or acceleration of any of those obligations, other than any default caused by Marathon:

 

    obligations under industrial revenue bonds related to environmental projects for current and former U.S. Steel Group facilities, with maturities ranging from 2009 through 2033;

 

    sale-leaseback financing obligations under a lease for equipment at United States Steel’s Fairfield Works facility, with the lease term extending to 2012, subject to extensions;

 

    obligations relating to various lease arrangements accounted for as operating leases and various guarantee arrangements, all of which were assumed by United States Steel; and

 

    certain other guarantees.

 

The financial matters agreement also provides that, on or before the tenth anniversary of the Separation, United States Steel will provide for Marathon’s discharge from any remaining liability under any of the assumed industrial revenue bonds. United States Steel may accomplish that discharge by refinancing or, to the extent not refinanced, paying Marathon an amount equal to the remaining principal amount of all accrued and unpaid debt service outstanding on, and any premium required to immediately retire, the then outstanding industrial revenue bonds. $2 million of the industrial revenue bonds are scheduled to mature in the period extending through December 31, 2009.

 

Under the financial matters agreement, United States Steel shall have the right to exercise all of the existing contractual rights under the lease obligations assumed from Marathon, including all rights related to purchase options, prepayments or the grant or release of security interests. United States Steel shall have no right to increase amounts due under or lengthen the term of any of the assumed lease obligations without the prior consent of Marathon other than extensions set forth in the terms of the assumed lease obligations.

 

The financial matters agreement also requires United States Steel to use commercially reasonable efforts to have Marathon released from its obligations under a guarantee Marathon provided with respect to all United States Steel’s obligations under a partnership agreement between United States Steel, as general partner, and General Electric Credit Corporation of Delaware and Southern Energy Clairton, LLC, as limited partners. United States Steel may dissolve the partnership under certain circumstances including if it is required to fund

 

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accumulated cash shortfalls of the partnership in excess of $150 million. In addition to the normal commitments of a general partner, United States Steel has indemnified the limited partners for certain income tax exposures.

 

The financial matters agreement requires Marathon to use commercially reasonable efforts to take all necessary action or refrain from acting so as to assure compliance with all covenants and other obligations under the documents relating to the assumed obligations to avoid the occurrence of a default or the acceleration of the payment obligations under the assumed obligations. The agreement also obligates Marathon to use commercially reasonable efforts to obtain and maintain letters of credit and other liquidity arrangements required under the assumed obligations.

 

United States Steel’s obligations to Marathon under the financial matters agreement are general unsecured obligations that rank equal to United States Steel’s accounts payable and other general unsecured obligations. The financial matters agreement does not contain any financial covenants, and United States Steel is free to incur additional debt, grant mortgages on or security interests in its property and sell or transfer assets without our consent.

 

Tax Sharing Agreement

 

Marathon and United States Steel have a tax sharing agreement that applies to each of their consolidated tax reporting groups. Provisions of this agreement include the following:

 

    for any taxable period, or any portion of any taxable period, ended on or before December 31, 2001, unpaid tax sharing payments will be made between Marathon and United States Steel generally in accordance with the general tax sharing principles in effect before the Separation;

 

    no tax sharing payments will be made with respect to taxable periods, or portions thereof, beginning after December 31, 2001; and

 

    provisions relating to the tax and related liabilities, if any, that result from the Separation ceasing to qualify as a tax-free transaction and limitations on post-Separation activities that might jeopardize the tax-free status of the Separation.

 

Under the general tax sharing principles in effect before the Separation:

 

    the taxes payable by each of the Marathon Group and the U.S. Steel Group were determined as if each of them had filed its own consolidated, combined or unitary tax return; and

 

    the U.S. Steel Group would receive the benefit, in the form of tax sharing payments by the parent corporation, of the tax attributes, consisting principally of net operating losses and various credits, that its business generated and the parent used on a consolidated basis to reduce its taxes otherwise payable.

 

In accordance with the tax sharing agreement, at the time of the Separation, Marathon made a preliminary settlement with United States Steel of approximately $440 million as the net tax sharing payments owed to it for the year ended December 31, 2001 under the pre-Separation tax sharing principles.

 

The tax sharing agreement also addresses the handling of tax audits and contests and other matters respecting taxable periods, or portions of taxable periods, ended before December 31, 2001.

 

In the tax sharing agreement, each of Marathon and United States Steel promised the other party that it:

 

    would not, before January 1, 2004, take various actions or enter into various transactions that might, under section 355 of the Internal Revenue Code of 1986, jeopardize the tax-free status of the Separation; and

 

    would be responsible for, and indemnify and hold the other party harmless from and against, any tax and related liability, such as interest and penalties, that results from the Separation ceasing to qualify as tax-free because of its taking of any such action or entering into any such transaction.

 

The prescribed actions and transactions include:

 

    the liquidation of Marathon or United States Steel; and

 

    the sale by Marathon or United States Steel of its assets, except in the ordinary course of business.

 

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In case a taxing authority seeks to collect a tax liability from one party that the tax sharing agreement has allocated to the other party, the other party has agreed in the sharing agreement to indemnify the first party against that liability.

 

Even if the Separation otherwise qualified for tax-free treatment under section 355 of the Internal Revenue Code, the Separation may become taxable to Marathon under section 355(e) of the Internal Revenue Code if capital stock representing a 50 percent or greater interest in either Marathon or United States Steel is acquired, directly or indirectly, as part of a plan or series of related transactions that include the Separation. For this purpose, a “50 percent or greater interest” means capital stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of capital stock. To minimize this risk, both Marathon and United States Steel agreed in the tax sharing agreement that they would not enter into any transactions or make any change in their equity structures that could cause the Separation to be treated as part of a plan or series of related transactions to which those provisions of section 355(e) of the Internal Revenue Code may apply. If an acquisition occurs that results in the Separation being taxable under section 355(e) of the Internal Revenue Code, the agreement provides that the resulting corporate tax liability will be borne by the party involved in that acquisition transaction.

 

Although the tax sharing agreement allocates tax liabilities relating to taxable periods ending on or prior to the Separation, each of Marathon and United States Steel, as members of the same consolidated tax reporting group during any portion of a taxable period ended on or prior to the date of the Separation, is jointly and severally liable under the Internal Revenue Code for the federal income tax liability of the entire consolidated tax reporting group for that year. To address the possibility that the taxing authorities may seek to collect all or part of a tax liability from one party where the tax sharing agreement allocates that liability to the other party, the agreement includes indemnification provisions that would entitle the party from whom the taxing authorities are seeking collection to obtain indemnification from the other party, to the extent the agreement allocates that liability to that other party. Marathon can provide no assurance, however, that United States Steel will be able to meet its indemnification obligations, if any, to Marathon that may arise under the tax sharing agreement.

 

Obligations Associated with the Separation as of December 31, 2003

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Obligations Associated with the Separation of United States Steel” on page 43 for a discussion of Marathon’s obligations associated with the Separation.

 

Environmental Matters

 

Marathon maintains a comprehensive environmental policy overseen by the Corporate Governance and Nominating Committee of Marathon’s Board of Directors. Marathon’s Health, Environment and Safety organization has the responsibility to ensure that Marathon’s operating organizations maintain environmental compliance systems that are in accordance with applicable laws and regulations. The Health, Environment and Safety Management Committee, which is comprised of officers of Marathon, is charged with reviewing its overall performance with various environmental compliance programs. Marathon also has an Emergency Management Team, composed of senior management, which oversees the response to any major emergency environmental incident involving Marathon or any of its properties.

 

Marathon’s businesses are subject to numerous laws and regulations relating to the protection of the environment. These environmental laws and regulations include the Clean Air Act (“CAA”) with respect to air emissions, the Clean Water Act (“CWA”) with respect to water discharges, the Resource Conservation and Recovery Act (“RCRA”) with respect to solid and hazardous waste treatment, storage and disposal, the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) with respect to releases and remediation of hazardous substances and the Oil Pollution Act of 1990 (“OPA-90”) with respect to oil pollution and response. In addition, many states where Marathon operates have similar laws dealing with the same matters. These laws and their associated regulations are subject to frequent change and many of them have become more stringent. In some cases, they can impose liability for the entire cost of cleanup on any responsible party without regard to negligence or fault and impose liability on Marathon for the conduct of others or conditions others have caused, or for Marathon’s acts that complied with all applicable requirements when we performed them. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable, due in part to the fact that certain implementing regulations for some environmental laws have not yet been finalized or, in some instances, are undergoing revision. These environmental laws and regulations, particularly the 1990

 

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Amendments to the CAA and its implementing regulations, new water quality standards and stricter fuel regulations, could result in increased capital, operating and compliance costs.

 

For a discussion of environmental capital expenditures and costs of compliance for air, water, solid waste and remediation, see “Management’s Discussion and Analysis of Environmental Matters, Litigation and Contingencies” on page 45 and “Legal Proceedings” on page 24.

 

Air

 

Of particular significance to MAP are EPA regulations that require reduced sulfur levels in the manufacture of gasoline and on-road diesel fuel starting in 2004 and 2006, respectively. Marathon estimates that MAP’s combined capital costs to achieve compliance with these rules could amount to approximately $900 million, which includes costs that could be incurred as part of other refinery upgrade projects, between 2002 and 2006. Some factors that could potentially affect MAP’s gasoline and diesel fuel compliance costs include obtaining the necessary construction and environmental permits, completion of project detailed engineering, and project construction and logistical considerations.

 

The U.S. EPA has finalized new and revised National Ambient Air Quality Standards (“NAAQS”) for fine particulate emissions (PM2.5) and ozone. In connection with these new standards, EPA will designate certain areas as “nonattainment,” meaning that the air quality in such areas do not meet the NAAQS. To address these nonattainment areas EPA has proposed a rule called the Interstate Air Quality Rule (“IAQR”) that will require significant reductions of SO2 and NOx emissions in numerous states. All of Marathon’s refinery operations are located within these affected states. If this rule is finalized, it could have a significant impact on Marathon’s operations as well as the operations of many of Marathon’s competitors. At this time, Marathon cannot determine whether the IAQR will be finalized or whether it will be substantially changed before it is final. As a result, Marathon cannot presently reasonably estimate the financial impact of such a rule.

 

Water

 

Marathon maintains numerous discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA and has implemented systems to oversee its compliance efforts. In addition, Marathon is regulated under OPA-90, which amended the CWA. Among other requirements, OPA-90 requires the owner or operator of a tank vessel or a facility to maintain an emergency plan to respond to releases of oil or hazardous substances. Also, in case of such releases OPA-90 requires responsible companies to pay resulting removal costs and damages, provides for civil penalties and imposes criminal sanctions for violations of its provisions.

 

Additionally, OPA-90 requires that new tank vessels entering or operating in U.S. waters be double hulled and that existing tank vessels that are not double-hulled be retrofitted or removed from U.S. service, according to a phase-out schedule. As of December 31, 2003, all of the barges used in MAP’s river transportation operations meet the double-hulled requirements of OPA-90.

 

Marathon operates facilities at which spills of oil and hazardous substances could occur. Several coastal states in which Marathon operates have passed state laws similar to OPA-90, but with expanded liability provisions, including provisions for cargo owner responsibility as well as ship owner and operator responsibility. Marathon has implemented emergency oil response plans for all of its components and facilities covered by OPA-90.

 

Solid Waste

 

Marathon continues to seek methods to minimize the generation of hazardous wastes in its operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of underground storage tanks (“USTs”) containing regulated substances. Since the EPA has not yet promulgated implementing regulations for all provisions of RCRA and has not yet made clear the practical application of all the implementing regulations it has promulgated, the ultimate cost of compliance with this statute cannot be accurately estimated. In addition, new laws are being enacted and regulations are being adopted by various regulatory agencies on a continuing basis, and the costs of compliance with these new rules can only be broadly appraised until their implementation becomes more accurately defined.

 

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Remediation

 

Marathon owns or operates certain retail outlets where, during the normal course of operations, releases of petroleum products from USTs have occurred. Federal and state laws require that contamination caused by such releases at these sites be assessed and remediated to meet applicable standards. The enforcement of the UST regulations under RCRA has been delegated to the states, which administer their own UST programs. Marathon’s obligation to remediate such contamination varies, depending on the extent of the releases and the stringency of the laws and regulations of the states in which it operates. A portion of these remediation costs may be recoverable from the appropriate state UST reimbursement fund once the applicable deductible has been satisfied. Accruals for remediation expenses and associated reimbursements are established for sites where contamination has been determined to exist and the amount of associated costs is reasonably determinable.

 

As a general rule, Marathon and Ashland retained responsibility for certain remediation costs arising out of the prior ownership and operation of businesses transferred to MAP. Such continuing responsibility, in certain situations, may be subject to threshold or sunset agreements, which gradually diminish this responsibility over time.

 

Properties

 

The location and general character of the principal oil and gas properties, refineries and gas plants, pipeline systems and other important physical properties of Marathon have been described previously. Except for oil and gas producing properties, which generally are leased, or as otherwise stated, such properties are held in fee. The plants and facilities have been constructed or acquired over a period of years and vary in age and operating efficiency. At the date of acquisition of important properties, titles were examined and opinions of counsel obtained, but no title examination has been made specifically for the purpose of this document. The properties classified as owned in fee generally have been held for many years without any material unfavorably adjudicated claim.

 

The basis for estimating oil and gas reserves is set forth in “Consolidated Financial Statements and Supplementary Data – Supplementary Information on Oil and Gas Producing Activities – Estimated Quantities of Proved Oil and Gas Reserves” on pages F-45 through F-46.

 

Property, Plant and Equipment Additions

 

For property, plant and equipment additions, see “Management’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity – Capital Expenditures” on page 40.

 

Employees

 

Marathon had 27,007 active employees as of December 31, 2003, including 23,556 MAP employees. Of the total number of MAP employees, 17,139 were employees of Speedway SuperAmerica LLC, most of whom were employees at retail marketing outlets.

 

Certain hourly employees at the Catlettsburg and Canton refineries are represented by the Paper, Allied-Industrial, Chemical and Energy Workers International Union under labor agreements that expire on January 31, 2006. The same union represents certain hourly employees at the Texas City refinery under a labor agreement that expires on March 31, 2006. The International Brotherhood of Teamsters represents certain hourly employees at the St. Paul Park and Detroit refineries under labor agreements that are scheduled to expire on May 31, 2006 and January 31, 2007, respectively.

 

Available Information

 

General information about Marathon, including the Corporate Governance Principles and Charters for the Audit Committee, Compensation Committee, Corporate Governance and Nominating Committee, and Committee on Financial Policy, can be found at www.marathon.com. In addition, Marathon’s Code of Business Conduct and Code of Ethics for Senior Financial Officers is available on the website at www.marathon.com/Values/ Corporate_Governance/. Marathon’s Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments and exhibits to those reports, are available free of charge through the website as soon as reasonably practicable after the reports are filed or furnished with the SEC. These documents are also available in hard copy, free of charge, by contacting Marathon’s Investor Relations office. Information contained on Marathon’s website is not incorporated into this Form 10-K or other securities filings.

 

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Item 3. Legal Proceedings

 

Marathon is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are included below in this discussion. The ultimate resolution of these contingencies could, individually or in the aggregate, be material. However, management believes that Marathon will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably.

 

Natural Gas Royalty Litigation

 

Marathon was served in two qui tam cases, which allege that federal and Indian lessees violated the False Claims Act with respect to the reporting and payment of royalties on natural gas and natural gas liquids. The first case, U.S. ex rel Jack J. Grynberg v. Alaska Pipeline Co., et al. is primarily a gas measurement case, and the second case, U.S. ex rel Harrold E. Wright v. Agip Petroleum Co. et al, is primarily a gas valuation case. These cases assert that false claims have been filed by lessees and that penalties, damages and interest total more than $25 billion. The Department of Justice has announced that it would intervene or has reserved judgment on whether to intervene against specified oil and gas companies and also announced that it would not intervene against certain other defendants including Marathon. The matters are in the discovery phase and Marathon intends to vigorously defend these cases.

 

Powder River Basin Arbitration

 

The U.S. Bureau of Land Management (“BLM”) completed a multi-year review of potential environmental impacts from coal bed methane development on federal lands in the Powder River Basin in Montana and Wyoming. The Agency’s Record of Decision (“ROD”) was signed on April 30, 2003 supporting increased coal bed methane development. Plaintiff environmental and other groups filed four suits in May 2003 in the U.S. District Court for the District of Montana against the BLM alleging the Agency’s environmental impact review was not adequate. Plaintiffs seek a court order enjoining coal bed methane development on federal lands in the Powder River Basin until BLM conducts additional studies on the environmental impact. Marathon has been allowed to intervene as a party in all four of the cases. As the lawsuits to delay energy development in the Powder River Basin progress through the courts, BLM continues to process permits to drill under the ROD. In January 2004, the Court over protests of Plaintiffs, transferred to the District Court of Wyoming, portions of two of the cases dealing with the sufficiency of the environmental impact review as to lands in Wyoming.

 

Environmental Proceedings

 

The following is a summary of proceedings involving Marathon that were pending or contemplated as of December 31, 2003, under federal and state environmental laws. Except as described herein, it is not possible to predict accurately the ultimate outcome of these matters; however, management’s belief set forth in the first paragraph under Item 3. “Legal Proceedings” above takes such matters into account.

 

Claims under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) and related state acts have been raised with respect to the cleanup of various waste disposal and other sites. CERCLA is intended to facilitate the cleanup of hazardous substances without regard to fault. Potentially responsible parties (“PRPs”) for each site include present and former owners and operators of, transporters to and generators of the substances at the site. Liability is strict and can be joint and several. Because of various factors including the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and cleanup costs and the time period during which such costs may be incurred, Marathon is unable to reasonably estimate its ultimate cost of compliance with CERCLA.

 

Projections, provided in the following paragraphs, of spending for and/or timing of completion of specific projects are forward-looking statements. These forward-looking statements are based on certain assumptions including, but not limited to, the factors provided in the preceding paragraph. To the extent that these assumptions prove to be inaccurate, future spending for, or timing of completion of environmental projects may differ materially from those stated in the forward-looking statements.

 

At December 31, 2003, Marathon had been identified as a PRP at a total of 9 CERCLA waste sites. Based on currently available information, which is in many cases preliminary and incomplete, Marathon believes that its liability for cleanup and remediation costs in connection with all but one of these sites will be under $1 million per site, and most will be under $100,000. Marathon believes that its liability for cleanup and remediation costs in connection with the one remaining site will be under $4 million.

 

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In addition, there are four sites where Marathon has received information requests or other indications that it may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability.

 

There are also 125 additional sites, excluding retail marketing outlets, related to Marathon where remediation is being sought under other environmental statutes, both federal and state, or where private parties are seeking remediation through discussions or litigation. Of these sites, 16 were associated with properties conveyed to MAP by Ashland which has retained liability for all costs associated with remediation. Based on currently available information, which is in many cases preliminary and incomplete, Marathon believes that its liability for cleanup and remediation costs in connection with 15 of these sites will be under $100,000 per site, 43 sites have potential costs between $100,000 and $1 million per site, 16 sites may involve remediation costs between $1 million and $5 million per site, 7 sites have incurred remediation costs of more than $5 million per site, and one additional site has the potential to exceed $5 million. There are 27 sites with insufficient information to estimate future remediation costs.

 

There is one site that involves a remediation program in cooperation with the Michigan Department of Environmental Quality at a closed and dismantled refinery site located near Muskegon, Michigan. During the next 10 to 20 years, Marathon anticipates spending less than $7 million at this site. Expenditures in 2003 were approximately $225,000, and expenditures in 2004 will be approximately $500,000. Ongoing work at this site is subject to approval by the Michigan Department of Environmental Quality (“MDEQ”), and a risk-based closure strategy is being developed and will be approved by the MDEQ.

 

MAP has had a pending enforcement matter with the Illinois Environmental Protection Agency and the Illinois Attorney General’s Office since 2002 concerning MAP’s self-reporting of possible emission exceedences and permitting issues related to storage tanks at its Robinson, Illinois refinery. MAP has had periodic discussions with Illinois officials regarding this matter and more discussions are anticipated in 2004.

 

The Kentucky Natural Resources and Environmental Cabinet issued the MAP Catlettsburg, Kentucky Refinery a Notice of Violation (“NOV”) regarding the Tank 845 rupture which occurred in November of 1999. The tank rupture caused the tank’s contents to be released onto the ground and adjoining retention area. MAP resolved this matter in 2003 for a civil penalty of $120,000 and the entering of an agreed Administrative Order.

 

In 2000, the Kentucky Natural Resources and Environmental Cabinet sent Marathon Ashland Pipe Line LLC a NOV seeking a civil penalty associated with a pipeline spill earlier that year in Winchester, Kentucky. MAP has settled this NOV in the form of an Agreed-to Administrative Order which was finalized and entered in January 2002 and required payment of a $170,000 penalty and reimbursement of past response costs up to $131,000.

 

In July, 2002, Marathon received a Notice of Enforcement from the State of Texas for alleged excess air emissions from its Yates Gas Plant and production operations on its Kloh lease. The Notices did not compute a penalty or fine for these pending enforcement actions; a tentative settlement for under $200,000 in civil penalties and a Supplemental Environmental Project has been reached and awaits full Commission approval.

 

In May, 2003, Marathon received a Consolidated Compliance Order & Notice or Potential Penalty from the State of Louisiana for alleged various air permit regulatory violations. This matter has been resolved in principle with the State for a civil penalty of under $150,000 and awaits formal closure with the State.

 

During the third quarter of 2003, a MAP subsidiary, Ohio River Pipe Line LLC (“ORPL”), entered into Director’s Final Findings and Orders with the Ohio Environmental Protection Agency (“OEPA”). The OEPA had alleged ORPL violations of a stormwater permit and pollution prevention plan during construction of the Cardinal Products Pipeline. The Findings and Orders required compliance with the permit, plan and other requirements, and payment of a $104,738 civil penalty.

 

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Item 4. Submission of Matters to a Vote of Security Holders

 

Not applicable.

 

PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

 

The principal market on which the Company’s common stock is traded is the New York Stock Exchange. Information concerning the high and low sales prices for the common stock as reported in the consolidated transaction reporting system and the frequency and amount of dividends paid during the last two years is set forth in “Selected Quarterly Financial Data (Unaudited)” on page F-41.

 

As of January 31, 2004, there were 61,404 registered holders of Marathon common stock.

 

The Board of Directors intends to declare and pay dividends on Marathon common stock based on the financial condition and results of operations of Marathon Oil Corporation, although it has no obligation under Delaware law or the Restated Certificate of Incorporation to do so. In determining its dividend policy with respect to Marathon common stock, the Board will rely on the financial statements of Marathon. Dividends on Marathon common stock are limited to legally available funds of Marathon.

 

On January 29, 2003, Marathon amended the Rights Agreement, dated as September 28, 1999, as amended, between Marathon and National City Bank, as successor rights agent. The Rights Agreement was amended so that the Rights to Purchase Series A Junior Preferred Stock expired on January 31, 2003, more than six years earlier than initially specified in the plan.

 

Item 6. Selected Financial Data

 

See page F-49 through F-51.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Marathon Oil Corporation (“Marathon”) is engaged in worldwide exploration and production of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily through its 62 percent owned subsidiary, Marathon Ashland Petroleum LLC (“MAP”); and other energy related businesses. The Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Items 1. and 2. Business and Properties, Item 6. Selected Financial Data and Item 8. Financial Statements and Supplementary Data.

 

Certain sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations include forward-looking statements concerning trends or events potentially affecting the businesses of Marathon. These statements typically contain words such as “anticipates,” “believes,” “estimates,” “expects,” “targets”, “plan,” “project,” “could,” “may,” “should,” “would” or similar words indicating that future outcomes are uncertain. In accordance with “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors, which could cause future outcomes to differ materially from those set forth in the forward-looking statements.

 

Unless specifically noted, amounts for MAP do not reflect any reduction for the 38 percent interest held by Ashland Inc. (“Ashland”).

 

Overview

 

Marathon’s overall operating results depend on the profitability of its exploration and production (“E&P”) and refining, marketing and transportation (“RM&T”) segments.

 

Exploration and Production

 

E&P segment revenues correlate closely with prevailing prices for crude oil and natural gas. The increase in Marathon’s E&P segment revenues during 2003 tracked the increase in prices for these commodities. The robust prices for crude oil during 2003 were caused in part by increased demand in strengthening economies, particularly in the United States and the Far East, reduced crude oil inventories, as well as civil and political unrest and military actions in various oil exporting countries. The average spot price during 2003 for West Texas Intermediate (WTI), a benchmark crude oil, was $31.06 per barrel – up from an average of $26.16 in 2002 – and ended the year at $32.47.

 

Natural gas prices were significantly higher in 2003 as compared to 2002. A significant portion of Marathon’s United States lower 48 natural gas production is sold at bid week prices, making this indicator particularly important. The average quarterly bid week prices for 2003 were $6.58, $5.40, $4.97 and $4.58, respectively for the first to fourth quarter. Natural gas prices in Alaska are largely contractual, while natural gas production there is seasonal in nature, trending down during the second and third quarters and increasing during the fourth and first quarters. The other major gas-producing region for Marathon is Europe, where a large portion of Marathon’s gas sales are at contractual prices, making them less subject to European price volatility.

 

For additional information on price risk management, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” on page 52.

 

E&P segment income during 2003 was impacted by slightly lower oil-equivalent production – down approximately 6 percent from 2002 levels. 2004 production is expected to decrease about 6 percent from 2003 levels mainly due to sales of non-core properties during 2003. Marathon estimates its 2004 production will average approximately 365,000 barrels of oil equivalent per day (“BOEPD”), excluding the impact of any additional acquisitions or dispositions. While production is expected to remain relatively flat through 2005, significant production growth is expected starting in 2006 from known projects in new core areas and recent exploration successes. Total production is anticipated to grow by more than 3 percent on an average annual basis between 2003 and 2008.

 

Projected production levels for liquid hydrocarbons and natural gas are based on a number of assumptions, including (among others) prices, supply and demand, regulatory constraints, reserve estimates, production decline rates for mature fields, reserve replacement rates, drilling rig availability and geological and operating considerations. These assumptions may prove to be inaccurate. Prices have historically been volatile and have frequently been driven by unpredictable changes in supply and demand resulting from fluctuations in economic activity and political developments in the world’s major oil and gas producing areas, including OPEC member

 

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countries. Any substantial decline in such prices could have a material adverse effect on Marathon’s results of operations. A decline in such prices could also adversely affect the quantity of liquid hydrocarbons and natural gas that can be economically produced and the amount of capital available for exploration and development.

 

E&P operations are subject to various hazards, including acts of war or terrorist acts and the governmental or military response thereto, explosions, fires and uncontrollable flows of oil and gas. Offshore production and marine operations in areas such as the Gulf of Mexico, the North Sea, the U.K. Atlantic Margin, the Celtic Sea, offshore Nova Scotia and offshore West Africa are also subject to severe weather conditions such as hurricanes or violent storms or other hazards. Development of new production properties in countries outside the United States may require protracted negotiations with host governments and are frequently subject to political considerations, such as tax regulations, which could adversely affect the economics of projects.

 

Refining, Marketing and Transportation

 

MAP refines, markets and transports crude oil and petroleum products, primarily in the Midwest, the upper Great Plains and southeastern United States. RM&T segment income primarily reflects MAP’s income from operations which depends largely on the refining and wholesale marketing margin, refinery throughputs, retail marketing margins for gasoline, distillates and merchandise, and the profitability of its pipeline transportation operations.

 

The refining and wholesale marketing margin is the difference between the wholesale prices of refined products sold and the cost of crude oil and other feedstocks refined, the cost of purchased products and manufacturing costs. MAP is a purchaser of crude oil in order to satisfy throughput requirements of its refineries. As a result, its refining and wholesale marketing margin could be adversely affected by rising crude oil and other feedstock prices that are not recovered in the marketplace. The crack spread, which is a measure of the difference between spot market gasoline and distillate prices and spot market crude costs, is an industry indicator of refining margins. In addition to changes in the crack spread, MAP’s refining and wholesale marketing margin is impacted by the types of crude oil processed, the wholesale selling prices realized for all the products sold and the level of manufacturing costs. MAP processes significant amounts of sour crude oil which enhances its competitive position in the industry as sour crude oil typically can be purchased at a discount to sweet crude oil. As crude oil production increases in the coming years, heavy, sour crude oil production growth is expected to outpace sweet crude oil production growth , which may translate into higher sour crude oil discounts going forward. Over the last three years, approximately 60% of the crude oil throughput at MAP’s refineries has been sour crude oil. Sales of asphalt increase during the highway construction season in MAP’s market area which is primarily in the second and third calendar quarters. The selling price of asphalt is dependant on the cost of crude oil, the price of alternative paving materials and the level of construction activity in both the private and public sectors. Changes in manufacturing costs from period to period are primarily dependant on the level of maintenance activities at the refineries and the price of purchased natural gas. The refining and wholesale marketing margin has been historically volatile and varies with the level of economic activity in the various marketing areas, the regulatory climate, logistical capabilities and the available supply of refined products and raw materials.

 

For additional information on price risk management, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” on page 52.

 

Additionally, the retail marketing gasoline and distillate margin, the difference between the ultimate price paid by consumers and the wholesale cost of the refined products, including secondary transportation, plays an important part in downstream profitability. Retail gasoline and distillate margins have been historically volatile, but tend to be countercyclical to the refining and wholesale marketing margin. Factors affecting the retail gasoline and distillate margin include competition, seasonal demand fluctuations, the available wholesale supply, the level of economic activity in the marketing areas and weather situations that impact driving conditions. Gross margins on merchandise sold at retail outlets tend to be less volatile than the gross margin from the retail sale of gasoline and diesel fuel. Factors affecting the gross margin on retail merchandise sales include consumer demand for merchandise items, the impact of competition and the level of economic activity in the marketing areas. The profitability of MAP’s pipeline transportation operations is primarily dependant on the volumes shipped through the pipelines. The volume of crude oil that MAP transports is directly affected by the supply of, and refiner demand for, crude oil in the markets served directly by MAP’s crude oil pipelines. Key factors in this supply and demand balance are the production levels of crude oil by producers, the availability and cost of alternative transportation modes, and the refinery and transportation system maintenance levels. The throughput of the refined products that MAP transports is directly affected by the production level of, and user demand for, refined products in the markets served by MAP’s refined product pipelines. In most of MAP’s markets, demand for gasoline peaks during

 

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the summer driving season, which extends from May through September, and declines during the fall and winter months. The seasonal pattern for distillates is the reverse of this, helping to level overall movements on an annual basis. As with crude, other transportation alternatives and maintenance levels influence refined product movements.

 

Environmental regulations, particularly the 1990 amendments to the Clean Air Act, have imposed (and are expected to continue to impose) increasingly stringent and costly requirements on refining and marketing operations that may have an adverse effect on margins and financial condition. Refining, marketing and transportation operations are subject to business interruptions due to unforeseen events such as explosions, fires, crude oil or refined product spills, inclement weather or labor disputes. They are also subject to the additional hazards of marine operations, such as capsizing, collision and damage or loss from severe weather conditions.

 

Other Energy Related Businesses

 

Marathon operates other businesses that market and transport its own and third-party natural gas, crude oil and products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, primarily in the United States, Europe and West Africa. The profitability of these operations depends largely on commodity prices, volume deliveries, margins on resale gas, and demand. Methanol spot pricing is very volatile largely because global methanol demand is only 30 millions tons and any one major unplanned shutdown or new addition can have a significant impact on the supply-demand balance. Other energy related businesses (“OERB”) operations could be impacted by unforeseen events such as explosions, fires, product spills, inclement weather or availability of LNG vessels. They are also subject to the additional hazards of marine operations, such as capsizing, collision and damage or loss from severe weather conditions.

 

Management’s Discussion and Analysis of Critical Accounting Estimates

 

The preparation of financial statements in accordance 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 year end and the reported amounts of revenues and expenses during the year. Actual results could differ from the estimates and assumptions used.

 

Certain accounting estimates are considered to be critical if a) the nature of the estimates and assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and b) the impact of the estimates and assumptions on financial condition or operating performance is material.

 

Estimated Net Recoverable Quantities of Oil and Gas

 

Marathon uses the successful efforts method of accounting for its oil and gas producing activities. The successful efforts method inherently relies upon the estimation of proved reserves, both developed and undeveloped. The existence and the estimated amount of proved reserves affect, among other things, whether or not certain costs are capitalized or expensed, the amount and timing of costs depleted or amortized into income and the presentation of supplemental information on oil and gas producing activities. Both the expected future cash flows to be generated by oil and gas producing properties and the expected future taxable income available to realize the value of deferred tax assets, which are discussed further below, rely in part on estimates of net recoverable quantities of oil and gas.

 

Marathon’s estimation of net recoverable quantities of oil and gas is a highly technical process performed primarily by in-house reservoir engineers and geoscience professionals. During 2003, approximately 35 percent of Marathon’s total proved reserves were prepared, reviewed or validated by third-party petroleum engineering consultants. The results of these third-party reviews were consistent with Marathon’s proved reserve estimates.

 

Proved reserves are the estimated quantities of oil and gas that geologic and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Estimates of proved reserves are subject to change, either positively and negatively, as additional information becomes available and as contractual, economic and political conditions change. During 2003, net revisions of previous estimates increased total proved reserves by 40 million BOE as a result of 97 million BOE in positive revisions which were partially offset by 57 million BOE in negative revisions.

 

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Proved developed reserves represented 70 percent of total proved reserves as of December 31, 2003, as compared to 78 percent as of December 31, 2002. The decrease primarily reflects the disposition of the Yates field. Of the just over 300 mmboe of proved undeveloped reserves at year-end 2003, only 10 percent have been included as proved reserves for more than two years.

 

Costs incurred for the periods ended December 31, 2003, 2002, and 2001 relating to the development of proved undeveloped oil and gas reserves, including Marathon’s proportionate share of equity investees’ costs incurred, were $780 million, $404 million, and $365 million. As of December 31, 2003, estimated future development costs relating to the development of proved undeveloped oil and gas reserves for the years 2004 through 2006 are projected to be $324 million, $149 million, and $126 million.

 

Expected Future Cash Flows Generated by Certain Oil and Gas Producing Properties

 

Marathon must estimate the expected future cash flows to be generated by its oil and gas producing properties to evaluate the possible need to impair the carrying value of those properties. For purposes of impairment evaluation, long-lived assets must be grouped at the lowest level for which independent cash flows can be identified, which is called an “asset group”. An impairment of any one of Marathon’s five largest producing property asset groups could have a material impact on the presentation of financial condition, changes in financial condition or results of operations. Those asset groups – the Alba field offshore Equatorial Guinea, the coal bed natural gas properties of the Powder River Basin, the Brae Area Complex offshore the United Kingdom, Petronius development in the Gulf of Mexico, and Potanay field in the Russian Federation – comprise approximately 49 percent of Marathon’s total proved oil and gas reserves. The expected future cash flows from these asset groups require assumptions about matters such as the prevailing level of future oil and gas prices, estimated recoverable quantities of oil and gas, expected field performance and the political environment in the host country.

 

Long-lived asset groups held and used in operations must be impaired when the carrying value is not recoverable and exceeds the fair value. Recoverability of the carrying values is determined by comparison with the undiscounted expected future cash flows to be generated by those groups. As of December 31, 2003, no impairment in the value of the Alba field, Powder River Basin, Brae Area Complex, Petronius development or the Potanay field was indicated.

 

Expected Future Taxable Income

 

Marathon must estimate its expected future taxable income to assess the realizability of its deferred income tax assets. As of December 31, 2003, Marathon reported net deferred tax assets of $1.155 billion, which represented gross assets of $1.731 billion net of valuation allowances of $576 million.

 

Numerous assumptions are inherent in the estimation of future taxable income, including assumptions about matters that are dependent on future events, such as future operating conditions (particularly as related to prevailing oil and gas prices) and future financial conditions. The estimates and assumptions used in determining future taxable income are consistent with those used in Marathon’s internal budgets, forecasts and strategic plans.

 

In determining its overall estimated future taxable income for purposes of assessing the need for additional valuation allowances, Marathon considers proved and risk-adjusted probable and possible reserves related to its existing producing properties, as well as estimated quantities of oil and gas related to undeveloped discoveries if, in the judgment of Marathon management, it is likely that development plans will be approved in the foreseeable future. In assessing the propriety of releasing an existing valuation allowance, Marathon considers the preponderance of evidence concerning the realization of the impaired deferred tax asset.

 

Additionally, Marathon must consider any prudent and feasible tax planning strategies that might minimize the amount of deferred tax liabilities recognized or the amount of any valuation allowance recognized against deferred tax assets, if management has the ability to implement these strategies and the expectation of implementing these strategies if the forecasted conditions actually occurred. The principal tax planning strategy available to Marathon relates to the permanent reinvestment of the earnings of foreign subsidiaries. Assumptions related to the permanent reinvestment of the earnings of foreign subsidiaries are reconsidered annually to give effect to changes in Marathon’s portfolio of producing properties and in its tax profile.

 

Marathon’s deferred tax assets include $450 million relating to Norwegian net operating loss carryforwards (“NOLs”). Marathon has established a valuation allowance of $420 million against these NOLs. Currently, Marathon generates income from the Heimdal and Vale fields in the Norwegian North Sea. Marathon acquired

 

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additional interests in Norway in each of the last three years. These interests currently have no proved reserves and generate no income, although some interests hold undeveloped discoveries. To the extent that these interests demonstrate the capability to generate future taxable income, Marathon may be able to release some or all of its $420 million valuation allowance in future periods.

 

Net Realizable Value of Receivables from United States Steel

 

As described further in “Management’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity – Obligations Associated with the Separation of United States Steel” on page 43, Marathon remains obligated (primarily or contingently) for certain debt and other financial arrangements for which United States Steel has assumed responsibility for repayment under the terms of the Separation. As of December 31, 2003, Marathon has reported receivables from United States Steel of $613 million, representing the amount of principal and accrued interest on Marathon debt for which United States Steel has assumed responsibility for repayment. Marathon must assess the realizability of these receivables, based on its expectations of United States Steel’s ability to satisfy its obligations. To make this assessment, Marathon must rely on public information about United States Steel. As of December 31, 2003, Marathon has judged the entire receivable to be realizable.

 

Marathon may continue to be exposed to the risk of nonpayment by United States Steel on a significant portion of this receivable until December 31, 2011. Of the $613 million, $469 million, or 77 percent, relates to industrial revenue bonds that are due in 2011 or later. The Financial Matters Agreement between Marathon and United States Steel provides that, on or before the tenth anniversary of the Separation, which is December 31, 2011, United States Steel will provide for Marathon’s discharge from any remaining liability under any of the assumed industrial revenue bonds.

 

As of December 31, 2003, Marathon’s cash-adjusted debt-to-capital ratio (which includes debt for which United States Steel has assumed responsibility for repayment) was 33 percent. The assessment of Marathon’s liquidity and capital resources may be impacted by expectations concerning United States Steel’s ability to satisfy its obligations.

 

If the debt for which United States Steel has assumed responsibility for repayment were excluded from the computation, Marathon’s cash-adjusted debt-to-capital ratio as of December 31, 2003 would have been approximately 28 percent. On the other hand, if the receivable from United States Steel had been written off as unrealizable, the cash-adjusted debt-to-capital ratio as of December 31, 2003 would have been approximately 34 percent. (If United States Steel were unable to satisfy its obligations, other adjustments in addition to the write-off of the receivable may be necessary.)

 

Net Realizable Value of Inventories

 

Generally accepted accounting principles require that inventories be carried at lower of cost or market. Accordingly, when the cost basis of Marathon’s inventories of liquid hydrocarbons and refined petroleum products exceed market value, Marathon establishes an inventory market valuation (“IMV”) reserve to reduce the cost basis of its inventories to net realizable value. Adjustments to the IMV reserve result in noncash charges or credits to income from operations.

 

When Marathon Oil Company was acquired in March 1982, prices of liquid hydrocarbons and refined petroleum products were at historically high levels. In applying the purchase method of accounting, inventories of liquid hydrocarbons and refined petroleum products were revalued by reference to current prices at the time of acquisition. This became the new LIFO cost basis of the inventories.

 

When Marathon acquired the crude oil and refined petroleum product inventories associated with Ashland’s RM&T operations on January 1, 1998, Marathon established a new LIFO cost basis for those inventories. The acquisition cost of these inventories lowered the overall average cost of the combined RM&T inventories. As a result, the price threshold at which an IMV reserve will be recorded was also lowered.

 

Since the prices of liquid hydrocarbons and refined petroleum products do not correlate perfectly, there is no absolute price threshold below which an IMV adjustment will be recognized. However, generally, Marathon will establish an IMV reserve when crude oil prices fall below $20 per barrel. As of December 31, 2003, with the WTI spotprice at $32.47 per barrel, no IMV reserve was needed.

 

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Contingent Liabilities

 

Marathon accrues contingent liabilities for income and other tax deficiencies, environmental remediation, product liability claims and litigation claims when such contingencies are probable and estimable. Marathon’s in-house legal counsel regularly assesses these contingent liabilities. In certain circumstances, outside legal counsel is utilized. For additional information on contingent liabilities, see “Management’s Discussion and Analysis of Environmental Matters, Litigation and Contingencies” on page 45.

 

Pensions and Other Postretirement Benefit Obligations

 

Accounting for these benefit obligations involves assumptions related to:

 

    discount rate for measuring the present value of future plan obligations

 

    expected long-term rates of return on plan assets

 

    rate of future increases in compensation levels

 

    health care cost projections

 

Marathon develops its demographics and utilizes the work of outside actuaries to assist in the measurement of these obligations. In determining the discount rate, Marathon reviews market yields on high-quality corporate debt. The asset rate of return assumption considers the asset mix of the plans, targeted at 75% equity securities and 25% debt securities, past performance and other factors. Compensation increase assumptions are based on historical experience and anticipated future management actions. Marathon reviews actual recent cost trends and projected future trends in establishing health care cost trend rates.

 

Of the assumptions used to measure the December 31, 2003 obligations and estimated 2004 net periodic benefit cost, the discount rate has the most significant effect on the periodic benefit costs reported for the plans. A .25% basis point decrease in the discount rate of 6.25% for domestic and 5.40% for international would increase pension and other postretirement plan expense by approximately $12 million and $3 million, respectively.

 

Estimated Fair Value of Asset Retirement Obligations

 

The fair value of an asset retirement obligation must be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. For Marathon, asset retirement obligations primarily relate to the abandonment of oil and gas producing facilities. Asset retirement obligations include costs to dismantle and relocate or dispose of production platforms, gathering systems, wells and related structures and restoration costs of land and seabed. Estimates of these costs are developed for each property based upon the type of production structure, depth of water, reservoir characteristics, depth of the reservoir, market demand for equipment, currently available procedures and consultations with construction and engineering professionals. Because these costs typically extend many years into the future, estimating these future costs is difficult and requires management to make estimates and judgments that are subject to future revisions based upon numerous factors, including future retirement costs, future recoverable quantities of oil and gas, future inflation rates, the credit-adjusted risk-free interest rate, changing technology and the political and regulatory environment.

 

Marathon’s estimation of asset retirement obligations and retirement dates is primarily performed by in-house engineers in consultation with in-house legal and environmental experts. Due to the inherent uncertainties in asset retirement obligations and retirement dates, these estimates are subject to potentially substantial changes, either positively or negatively, as additional information becomes available and as contractual, legal, environmental, economic and technological conditions change.

 

While assets such as refineries, crude oil and product pipelines, and marketing assets have asset retirement obligations, certain of those obligations are not recognized since the fair value cannot be estimated due to the uncertainty of the settlement date of the obligation.

 

Marathon’s estimates of the ultimate asset retirement obligations are based on estimates in current dollars, inflated to the estimated date of retirement by an annual inflation factor. Sensitivity analysis of the incremental effects of a hypothetical 1% increase in the inflation rate would have resulted in an approximately $28 million increase in the fair value of the asset retirement obligations at December 31, 2003, and an approximately $5 million decrease in 2003 income from operations.

 

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Estimated Fair Value of Non-Exchange Traded Derivative Contracts

 

Marathon fairly values all derivative instruments. Derivative instruments are used to manage risk throughout Marathon’s different businesses. These risks relate to commodities, interest rates and to a lesser extent our exposure to foreign currency fluctuations. Marathon uses derivative instruments that are exchange traded and non-exchange traded. Non-exchange traded instruments are referred to as over-the-counter (“OTC”) instruments.

 

The fair value of exchange traded instruments is based on existing market quotes derived from major exchanges such as the New York Merchantile Exchange. The fair value for OTC instruments such as options and swap agreements is developed through the use of option-pricing models or third party market quotes. The option-pricing models incorporate assumptions related to market volatility, current market price, strike price, interest rates and time value. Marathon utilizes purchased software option-pricing tools, similar to the Black-Scholes model, to fairly value its options related to commodity-based risks. OTC swap agreements are used to manage our exposure to interest rates. Marathon obtains third party dealer quotes to mark-to-market these financial instruments. In addition, Marathon has developed an internal pricing model which takes into consideration the specific contract terms and the forward market for interest rates. This tool is used to test the reasonableness of the third party dealer quotes associated with the OTC swap agreements.

 

Marathon also fairly values two natural gas long term delivery commitment contracts in the United Kingdom that are accounted for as derivative instruments and recognizes the change in fair value of those contracts on a quarterly basis within income from operations. The fair value is derived from published market data such as the Heren Report that captures the market-based natural gas activity in the United Kingdom. Currently, an 18 month forward pricing curve is utilized as this represents approximately 90% of the market liquidity in that region.

 

For additional information on market risk sensitivity, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” on page 52.

 

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Management’s Discussion and Analysis of Income and Operations

 

Revenues for each of the last three years are summarized in the following table:

 

(In millions)    2003     2002     2001  

 

E&P

   $ 3,990     $ 3,711     $ 4,245  

RM&T

     34,514       26,399       27,247  

OERB

     3,209       2,122       2,062  
    


 


 


Segment revenues

     41,713       32,232       33,554  

Elimination of intersegment revenues

     (750 )     (937 )     (728 )

Elimination of sales to United States Steel

     –         –         (30 )
    


 


 


Total revenues

   $ 40,963     $ 31,295     $ 32,796  
    


 


 


Items included in both revenues and costs and expenses:

                        

Consumer excise taxes on petroleum products and merchandise

   $ 4,285     $ 4,250     $ 4,404  

Matching crude oil and refined product buy/sell transactions settled in cash:

                        

E&P

   $ 222     $ 289     $ 454  

RM&T

     6,936       4,191       3,797  
    


 


 


Total buy/sell transactions

   $ 7,158     $ 4,480     $ 4,251  

 

 

E&P segment revenues increased by $279 million in 2003 from 2002 and decreased by $534 million in 2002 from 2001. The 2003 increase was primarily due to higher worldwide natural gas and liquid hydrocarbon prices. This increase was partially offset by lower liquid hydrocarbon and natural gas volumes. The decrease in 2002 was primarily due to lower worldwide natural gas prices and lower liquid hydrocarbon and natural gas volumes, partially offset by higher worldwide liquid hydrocarbon prices. Derivative gains (losses) totaled $(176) million in 2003, compared to $52 million in 2002 and $85 million in 2001. Derivatives included losses of $66 million in 2003, compared to gains of $18 million in 2002, related to long-term gas contracts in the United Kingdom that are accounted for as derivative instruments and marked-to-market.

 

RM&T segment revenues increased by $8.115 billion in 2003 from 2002 and decreased by $848 million in 2002 from 2001. The 2003 increase primarily reflected higher refined product selling prices and volumes and increased matching crude oil buy/sell transaction volumes and prices. The decrease in 2002 was primarily due to lower refined product prices.

 

OERB segment revenues increased by $1.087 billion in 2003 from 2002 and $60 million in 2002 from 2001. The increase in 2003 is a result of higher natural gas and liquid hydrocarbon prices and increased natural gas and crude oil marketing activity. The increase in 2002 reflected a favorable effect from increased natural gas and crude oil marketing activity partially offset by lower natural gas prices. Derivative gains (losses) totaled $19 million in 2003, compared to $(8) million in 2002 and $(29) million in 2001.

 

For additional information on segment results, see discussion on income from operations on page 36.

 

Income from equity method investments decreased by $108 million in 2003 and increased by $19 million in 2002 from 2001. The decrease in 2003 is due to a $124 million loss on the dissolution of MKM Partners L.P., partially offset by increased earnings of other equity method investments due to higher natural gas and liquid hydrocarbons prices. For further discussion of the dissolution of MKM Partners L.P., see Note 13 to the Consolidated Financial Statements. The increase in 2002 is primarily the result of increased earnings in other equity method investments due to higher liquid hydrocarbons prices.

 

Net gains on disposal of assets increased by $99 million in 2003 from 2002 and $23 million in 2002 from 2001. During 2003, Marathon sold its interest in CLAM Petroleum B.V., interests in several pipeline companies, Yates field and gathering system, SSA stores primarily in Florida, South Carolina, North Carolina and Georgia, and certain fields in the Big Horn Basin of Wyoming. Results from 2002 include the sale of various SSA stores and the sale of San Juan Basin assets. Results from 2001 include the sale of various SSA stores and various domestic producing properties.

 

Gain (loss) on ownership change in MAP reflects the effects of contributions to MAP of certain environmental capital expenditures and leased property acquisitions funded by Marathon and Ashland. In accordance with MAP’s limited liability company agreement, in certain instances, environmental capital

 

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expenditures and acquisitions of leased properties are funded by the original contributor of the assets, but no change in ownership interest may result from these contributions. An excess of Ashland funded improvements over Marathon funded improvements results in a net gain and an excess of Marathon funded improvements over Ashland funded improvements results in a net loss.

 

Cost of revenues increased by $8.718 billion in 2003 from 2002 and $367 million in 2002 from 2001. The increases in the OERB segment were primarily a result of higher natural gas and liquid hydrocarbon costs. The increases in the RM&T segment primarily reflected higher acquisition costs for crude oil, refined products, refinery charge and blend feedstocks and increased manufacturing expenses.

 

Selling, general and administrative expenses increased by $107 million in 2003 from 2002 and $125 million in 2002 from 2001. The increase in 2003 was primarily a result of increased employee benefits (caused by increased pension expense resulting from changes in actuarial assumptions and a decrease in realized returns on plan assets) and other employee related costs. Also, Marathon changed assumptions in the health care cost trend rate from 7.5% to 10%, resulting in higher retiree health care costs. Additionally, during 2003, Marathon recorded a charge of $24 million related to organizational and business process changes. The increase in 2002 primarily reflected increased employee related costs.

 

Inventory market valuation reserve is established to reduce the cost basis of inventories to current market value. The 2002 results of operations include credits to income from operations of $71 million, reversing the IMV reserve at December 31, 2001. For additional information on this adjustment, see “Management’s Discussion and Analysis of Critical Accounting Estimates – Net Realizable Value of Inventories” on page 31.

 

Net interest and other financial costs decreased by $82 million in 2003 from 2002, following an increase of $96 million in 2002 from 2001. The decrease in 2003 is primarily due to an increase in capitalized interest related to increased long-term construction projects, the favorable effect of interest rate swaps, the favorable effect of interest on tax deficiencies and increased interest income on investments. The increase in 2002 was primarily due to higher average debt levels resulting from acquisitions and the Separation. Additionally, included in net interest and other financing costs are foreign currency gains of $13 million and $8 million for 2003 and 2002 and losses of $5 million for 2001.

 

Loss from early extinguishment of debt in 2002 was attributable to the retirement of $337 million aggregate principal amount of debt, resulting in a loss of $53 million. As a result of the adoption of Statement of Financial Accounting Standards No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”), the loss from early extinguishment of debt that was previously reported as an extraordinary item (net of taxes of $20 million) has been reclassified into income before income taxes. The adoption of SFAS No. 145 had no impact on net income for 2002.

 

Minority interest in income of MAP, which represents Ashland’s 38 percent ownership interest, increased by $129 million in 2003 from 2002, following a decrease of $531 million in 2002 from 2001. MAP income was higher in 2003 compared to 2002 as discussed below in the RM&T segment. MAP income was significantly lower in 2002 compared to 2001 as discussed below in the RM&T segment.

 

Provision for income taxes increased by $215 million in 2003 from 2002, following a decrease of $458 million in 2002 from 2001, primarily due to $720 million increase and $1.356 billion decrease in income before income taxes. The effective tax rate for 2003 was 36.6% compared to 42.1% and 37.1% for 2002 and 2001. The higher rate in 2002 was due to the United Kingdom enactment of a supplementary 10 percent tax on profits from the North Sea oil and gas production, retroactively effective to April 17, 2002. In 2002, Marathon recognized a one-time noncash deferred tax adjustment of $61 million as a result of the rate increase.

 

The following is an analysis of the effective tax rate for the periods presented:

 

     2003     2002     2001  

 

Statutory tax rate

   35.0 %   35.0 %   35.0 %

Effects of foreign operations (a)

   (0.4 )   5.6     (0.7 )

State and local income taxes after federal income tax effects

   2.2     3.9     3.0  

Other federal tax effects

   (0.2 )   (2.4 )   (0.2 )
    

 

 

Effective tax rate

   36.6 %   42.1 %   37.1 %

 
(a)   The deferred tax effect related to the enactment of a supplemental tax in the U.K. increased the effective tax rate 7.0 percent in 2002.

 

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Discontinued operations in 2003 primarily relates to Marathon’s E&P operations in western Canada, which were sold in 2003 for a gain of $278 million, including a tax benefit of $8 million. Also, included in 2003 results is an $8 million adjustment to a tax liability due to United States Steel Corporation. Results for 2002 and 2001 have been restated to reflect the western Canadian operations as discontinued. Results for 2001 also include the net loss attributed to Steel Stock, adjusted for certain corporate administrative expenses and interest expense (net of income tax effects), and the loss on disposition of United States Steel Corporation, which is the excess of the net investment in United States Steel over the aggregate fair market value of the outstanding shares of the Steel Stock at the time of the Separation.

 

Cumulative effect of changes in accounting principles of $4 million, net of a tax provision of $4 million, in 2003 represents the adoption of Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” (“SFAS No. 143”), in which Marathon recognized in income the cumulative effect of recording the fair value of asset retirement obligations. The $13 million gain, net of a tax provision of $7 million, in 2002 represents the adoption of subsequently issued interpretations by the Financial Accounting Standards Board (“FASB”) of Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) in which Marathon must recognize in income the effect of changes in the fair value of two long-term natural gas sales contracts in the United Kingdom. The $8 million loss, net of a tax benefit of $5 million, in 2001 was an unfavorable transition adjustment related to the initial adoption of SFAS No. 133.

 

Net income increased by $805 million in 2003 from 2002 and by $359 million in 2002 from 2001, primarily reflecting the factors discussed above.

 

Income from operations for each of the last three years is summarized in the following table:

 

(In millions)    2003     2002     2001  

 

E&P

                        

Domestic

   $ 1,128     $ 687     $ 1,122  

International

     359       351       229  
    


 


 


E&P segment income

     1,487       1,038       1,351  

RM&T

     770       356       1,914  

OERB

     73       78       62  
    


 


 


Segment income

     2,330       1,472       3,327  

Items not allocated to segments:

                        

Administrative expenses(a)

     (203 )     (194 )     (187 )

Business transformation costs(b)

     (24 )     –         –    

Inventory market valuation adjustments(c)

     –         71       (71 )

Gain (loss) on ownership change in MAP

     (1 )     12       (6 )

Gain on offshore lease resolution with U.S. Government

     –         –         59  

Gain on asset dispositions(d)

     106       24       –    

Loss on dissolution of MKM Partners L.P.(e)

     (124 )     –         –    

Contract settlement(f)

     –         (15 )     –    

Separation costs(g)

     –         –         (14 )
    


 


 


Total income from operations

   $ 2,084     $ 1,370     $ 3,108  

 
(a)   Includes administrative expenses related to Steel Stock of $25 million for 2001.
(b)   See Note 11 to the Consolidated Financial Statements for a discussion of business transformation costs.
(c)   The IMV reserve reflects the extent to which the recorded LIFO cost basis of inventories of liquid hydrocarbons and refined petroleum products exceeds net realizable value.
(d)   The net gain in 2003 represents a gain on the disposition of interest in CLAM Petroleum B.V. and certain fields in the Big Horn Basin of Wyoming and SSA stores in Florida, North Carolina, South Carolina and Georgia. In 2002, represents gain on exchange of certain oil and gas properties with XTO Energy, Inc.
(e)   See Note 13 to the Consolidated Financial Statements for a discussion of the dissolution of MKM Partners L.P.
(f)   In 2002 represents a settlement arising from the cancellation of the Cajun Express rig contract on July 5, 2001.
(g)   Represents costs related to the Separation from United States Steel.

 

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Average Volumes and Selling Prices

 

(Dollars in millions, except as noted)    2003    2002    2001

OPERATING STATISTICS

                    

Net Liquid Hydrocarbon Production (mbpd)(a)(b)

                    

United States

     106.5      116.0      126.3

Equity Investee (MKM)

     4.4      8.5      9.4
    

  

  

Total United States

     110.9      124.5      135.7

Europe

     41.5      51.9      46.2

Other International

     10.0      1.0      –  

West Africa

     27.1      25.3      16.0

Equity Investee(c)

     1.2      –        .1
    

  

  

Total International(d)

     79.8      78.2      62.3
    

  

  

Worldwide continuing operations

     190.7      202.7      198.0

Discontinued operations

     3.1      4.4      11.0
    

  

  

Worldwide

     193.8      207.1      209.0

Net Natural Gas Production (mmcfd)(b)(e)

                    

United States

     731.6      744.8      793.1

Europe

     285.9      303.5      326.4

West Africa

     65.9      53.3      –  

Equity Investee (CLAM)

     12.4      24.8      30.7
    

  

  

Total International

     364.2      381.6      357.1
    

  

  

Worldwide continuing operations

     1,095.8      1,126.4      1150.2

Discontinued operations

     74.1      103.9      122.8
    

  

  

Worldwide

     1,169.9      1,230.3      1273.0

Total production (mboepd)

     388.8      412.2      421.2

Average Sales Prices (excluding derivative gains and losses)

                    

Liquid Hydrocarbons ($ per bbl)(a)

                    

United States

   $ 26.92    $ 22.18    $ 20.62

Equity Investee (MKM)

     29.45      24.65      23.37

Total United States

     27.02      22.35      20.81

Europe

     28.50      24.40      23.49

Other International

     18.33      26.98      –  

West Africa

     26.29      22.62      24.36

Equity investee(c)

     13.72      15.87      28.28

Total International

     26.24      23.85      23.74

Worldwide continuing operations

     26.70      22.93      21.73

Discontinued operations

     28.96      23.29      21.26

Worldwide

   $ 26.73    $ 22.94    $ 21.71

Natural Gas ($ per mcf)

                    

United States

   $ 4.53    $ 2.87    $ 3.69

Europe

     3.35      2.67      2.78

West Africa

     .25      .24      –  

Equity Investee (CLAM)

     3.69      3.05      3.38

Total International

     2.80      2.35      2.83

Worldwide continuing operations

     3.95      2.70      3.42

Discontinued operations

     5.43      3.30      4.17

Worldwide

   $ 4.05    $ 2.75    $ 3.49

MAP:

                    

Refined Products Sales Volumes (mbpd)(f)

     1,357.0      1,318.4      1,304.4

Matching buy/sell volumes included in refined product sales volumes (mbpd)

     64.0      70.7      45.0

Refining and Wholesale Marketing Margin(g)(h)

   $ 0.0601    $ 0.0387    $ 0.1167

(a)   Includes crude oil, condensate and natural gas liquids.
(b)   Amounts reflect production after royalties, excluding the U.K., Ireland and the Netherlands where amounts are before royalties.
(c)   Includes activity from CLAM and Chernogorskoye.
(d)   Represents equity tanker liftings and direct deliveries.
(e)   Includes gas acquired for injection and subsequent resale of 23.4, 4.4 and 8.1 mmcfd in 2003, 2002 and 2001, respectively.
(f)   Total average daily volumes of all refined product sales to MAP’s wholesale, branded and retail (SSA) customers.
(g)   Per gallon
(h)   Sales revenue less cost of refinery inputs, purchased products and manufacturing expenses, including depreciation.

 

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Domestic E&P income increased by $441 million in 2003 from 2002 following a decrease of $435 million in 2002 from 2001. The increase in 2003 was primarily due to higher natural gas and liquid hydrocarbon prices, lower dry well expense and a $25 million favorable contract settlement, partially offset by lower liquid hydrocarbon and natural gas volumes and derivative losses. The decrease in 2002 was primarily due to lower natural gas prices, lower volumes, lower derivative gains and higher dry well expense, partially offset by higher liquid hydrocarbon prices. Derivative gains (losses) totaled $(91) million in 2003, compared to $32 million in 2002 and $85 million in 2001.

 

Marathon’s domestic average liquid hydrocarbons price excluding derivative activity was $27.02 per barrel (“bbl”) in 2003, compared with $22.35 per bbl in 2002 and $20.81 per bbl in 2001. Average gas prices were $4.53 per thousand cubic feet (“mcf”) excluding derivative activity in 2003, compared with $2.87 per mcf in 2002 and $3.69 per mcf in 2001.

 

Domestic net liquid hydrocarbons production decreased 11 percent to 111 thousand barrels per day (“mbpd”) in 2003, as a result of natural declines mainly in the Gulf of Mexico and dispositions. Net natural gas production averaged 732 million cubic feet per day (“mmcfd”), down 2 percent from 2002.

 

Domestic net liquid hydrocarbons production decreased 8 percent to 125 mbpd in 2002, as a result of natural declines principally in the Gulf of Mexico and dispositions. Net natural gas production averaged 745 mmcfd, down 6 percent from 2001.

 

International E&P income increased by $8 million in 2003 from 2002 and $122 million in 2002 from 2001. The increase in 2003 was a result of higher natural gas and liquid hydrocarbon prices and higher liquid hydrocarbon volumes partially offset by lower natural gas volumes and derivative losses. The increase in 2002 was a result of higher production volumes and higher derivative gains partially offset by lower natural gas prices. Derivative gains (losses) totaled $(85) million in 2003, compared to $20 million in 2002 and $ – million in 2001. Derivatives included losses of $66 million in 2003, compared to gains of $18 million in 2002, related to long-term gas contracts in the United Kingdom that are accounted for as derivative instruments and marked-to-market.

 

Marathon’s international average liquid hydrocarbons price excluding derivative activity was $26.24 per bbl in 2003, compared with $23.85 per bbl and $23.74 per bbl in 2002 and 2001. Average gas prices were $2.80 per mcf excluding derivative activity in 2003, compared with $2.35 per mcf and $2.83 per mcf in 2002 and 2001.

 

International net liquid hydrocarbons production increased 2 percent to 80 mbpd in 2003 primarily due to the acquisition of KMOC, partially offset by lower production in the U.K. Net natural gas production averaged 364 mmcfd, down 5 percent from 2002, primarily from lower production in Ireland and the disposition of Marathon’s interest in CLAM Petroleum B.V. This decrease was partially offset by increased production in Equatorial Guinea.

 

International net liquid hydrocarbons production increased 26 percent to 78 mbpd in 2002 primarily due to the acquisition of interests in Equatorial Guinea and increased production in the U.K. Net natural gas production averaged 382 mmcfd, up 7 percent from 2001, primarily due to higher production in Equatorial Guinea partially offset by lower production in the U.K.

 

RM&T segment income increased by $414 million in 2003 from 2002 following a decrease of $1.558 billion in 2002 from 2001. The 2003 increase was primarily due to an improved refining and wholesale marketing margin, as well as a higher gasoline and distillate retail gross margin partially offset by higher administrative expenses. The refining and wholesale marketing margin in 2003 averaged 6.0 cents per gallon, versus 2002 level of 3.9 cents. The gasoline and distillate gross margin for its retail business, was 12.3 cents per gallon in 2003, as compared to 10.1 cents per gallon in 2002. The higher administrative expenses were due primarily to higher employee related costs. In 2002, the refining and wholesale marketing margin was severely compressed as crude oil costs increased while average refined product prices decreased. The refining and wholesale marketing margin in 2002 averaged 3.9 cents per gallon, versus 2001 level of 11.7 cents.

 

Derivative losses, which are included in the refining and wholesale marketing margin, were $162 million in 2003 as compared to losses of $124 million and gains of $210 million in 2002 and 2001. These derivative losses were generally incurred to mitigate the price risk of certain crude oil and other feedstock purchases and to protect carrying values of excess inventories.

 

Gains on the sale of SSA stores included in segment income were $8 million, $37 million, and $23 million for 2003, 2002, and 2001.

 

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OERB segment income decreased by $5 million in 2003 from 2002 and increased by $16 million in 2002 from 2001. The 2003 results include a gain of $34 million on the sale of Marathon’s interest in two refined product pipeline companies and earnings of $30 million from Marathon’s equity investment in the Equatorial Guinea methanol plant, which were offset by an impairment charge of $22 million on an equity method investment and a loss of $17 million on the termination of two tanker operating leases. The increase in 2002 reflected a favorable effect of $26 million from increased margins in gas marketing activities and mark-to-market valuation changes in associated derivatives and earnings of $11 million from Marathon’s equity investment in the Equatorial Guinea methanol plant, partially offset by predevelopment costs associated with emerging integrated gas projects.

 

Management’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity

 

Financial Condition

 

Current assets increased $1.561 billion from year-end 2002, primarily due to an increase in cash and cash equivalents and receivables. The increase in cash and cash equivalents was mainly due to approximately $1.256 billion in non-core asset sales in 2003. The increase in receivables was mainly due to higher year-end commodity prices.

 

Current liabilities increased $548 million from year-end 2002, primarily due to an increase in accounts payable, long-term debt due within one year and payroll and benefits payable, partially offset by a decrease in accrued taxes and interest. The increase in accounts payable was due to higher priced year-end crude purchases at MAP. The increase in payroll and benefits payable is primarily due to liabilities related to equity based compensation as a result of an increase in Marathon’s stock price.

 

Investments and long-term receivables decreased $311 million from year-end 2002, primarily due to the dissolution of MKM Partners L.P. and the sale of interest in CLAM Petroleum B.V. in 2003.

 

Net property, plant and equipment increased $440 million from year-end 2002. The increase in E&P international is due to the construction of the Alba field Phase 2A expansion project in Equatorial Guinea and the acquisition of KMOC, partially offset by the disposition of properties in western Canada. The increase in RM&T is primarily due to the Catlettsburg, Kentucky refinery repositioning project and construction of the Cardinal Products Pipeline, partially offset by sales of SSA stores. The increase in OERB is primarily due to the purchase of a 30% interest in two LNG tankers which Marathon previously leased and project development costs associated with Phase 3 in Equatorial Guinea. Net property, plant and equipment for each of the last two years is summarized in the following table:

 

(In millions)    2003    2002

E&P

             

Domestic

   $ 2,608    $ 2,720

International

     3,351      3,186
    

  

Total E&P

     5,959      5,906

RM&T

     4,492      4,234

OERB

     181      67

Corporate

     198      183
    

  

Total

   $ 10,830    $ 10,390

 

Goodwill decreased $18 million from year-end 2002, primarily due to the disposition of properties in western Canada.

 

Long-term debt at December 31, 2003 was $4.085 billion, a decrease of $325 million from year-end 2002. See “Liquidity and Capital Resources” on page 41, for further discussions.

 

Asset retirement obligations increased $167 million from year-end 2002 primarily due to the adoption of SFAS No. 143 on January 1, 2003 and the acquisition of KMOC, partially offset by disposition of properties in western Canada.

 

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Table of Contents

Cash Flows

 

Net cash provided from operating activities (for continuing operations) totaled $2.678 billion in 2003, compared with $2.336 billion in 2002 and $2.749 billion in 2001. The increase in 2003 mainly reflects the effects of higher worldwide natural gas and liquid hydrocarbons prices and a higher refining and wholesale marketing margin. Additionally in 2003, MAP made cash contributions to its pension plans of $89 million. The decrease in 2002 mainly reflects the effects of lower refined product margins and lower prices for natural gas.

 

Net cash provided from operating activities (for discontinued operations) totaled $83 million in 2003, compared with $69 million in 2002 and $887 million in 2001. This is primarily related to Marathon’s E&P operations in western Canada sold in 2003. Also included in 2001 is the business of United States Steel.

 

Capital expenditures for each of the last three years are summarized in the following table:

 

(In millions)    2003    2002    2001

E&P(a)

                    

Domestic

   $ 342    $ 416    $ 537

International

     629      403      294
    

  

  

Total E&P

     971      819      831

RM&T

     772      621      591

OERB

     133      49      4

Corporate

     16      31      107
    

  

  

Total

   $ 1,892    $ 1,520    $ 1,533

(a)   Amounts exclude the acquisitions of KMOC in 2003, the Equatorial Guinea interests in 2002 and Pennaco in 2001.

 

Capital expenditures in 2003 totaled $1.892 billion compared with $1.520 billion and $1.533 billion in 2002 and 2001, excluding the acquisitions of KMOC in 2003, Equatorial Guinea interests in 2002 and Pennaco in 2001. The $372 million increase in 2003 mainly reflected increased spending in the RM&T segment at the Catlettsburg refinery and on the Cardinal Products Pipeline and in the E&P segment in West Africa and Norway. The increase in OERB is due to the purchase of 30% interest in two LNG tankers which Marathon previously leased and project development costs associated with Phase 3 in Equatorial Guinea. The $13 million decrease in 2002 mainly reflected decreased spending in the E&P segment offset by increased spending in the RM&T segment. The decrease in the E&P segment was primarily due to the drilling of fewer gas wells in the United States in 2002 partially offset by higher capital expenditures for completion of a pipeline in Gabon, for a pipeline construction contract in Ireland and for development expenditures in Equatorial Guinea. The increase in the RM&T segment in 2002 was attributable to increased spending on the multi-year integrated investment program at MAP’s Catlettsburg refinery and construction of the Cardinal Products Pipeline in 2002, partially offset by lower capital expenditures for SSA retail outlets and completion of the Garyville coker construction in 2001. The decrease in corporate in 2002 was primarily due to the implementation of SAP financial and operations software in 2001.

 

Acquisitions included cash payments of $252 million in 2003 for the acquisition of KMOC, $1.160 billion in 2002 for the acquisitions of Equatorial Guinea interests and $506 million in 2001 for the acquisition of Pennaco. For further discussion of acquisitions, see Note 5 to the Consolidated Financial Statements.

 

Cash from disposal of assets was $1.256 billion, including the disposal of discontinued operations, in 2003, compared with $146 million in 2002 and $83 million in 2001. In 2003, proceeds were primarily from the disposition of Marathon’s E&P properties in western Canada, Yates field and gathering system, interest in CLAM Petroleum B.V., SSA stores, interest in several pipeline companies and certain fields in the Big Horn Basin of Wyoming. In 2002, proceeds were primarily from the disposition of various SSA stores and the sale of San Juan Basin assets. In 2001, proceeds were primarily from the sale of certain Canadian assets, SSA stores, and various domestic producing properties.

 

Net cash used in financing activities totaled $888 million in 2003, compared with net cash provided of $88 million in 2002 and net cash used of $1.290 billion in 2001. The decrease was due to activity in 2002 primarily associated with financing the acquisitions of Equatorial Guinea interests of $1.160 billion. This was partially offset by the $295 million repayment of preferred securities in 2002 that became redeemable or were converted to a right to receive cash upon the Separation. In early January 2002, Marathon paid $185 million to retire the 6.75% Convertible Quarterly Income Preferred Securities and $110 million to retire the 6.50% Cumulative Convertible Preferred Stock. Additionally, distributions to the minority shareholder of MAP were $262 million in 2003,

 

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compared to $176 million and $577 million in 2002 and 2001. The cash used in 2001 primarily reflects distributions to the minority shareholder of MAP, dividends paid and the redemption of the 8.75 percent Cumulative Monthly Income Preferred Shares.

 

Derivative Instruments

 

See “Quantitative and Qualitative Disclosures About Market Risk” on page 52, for a discussion of derivative instruments and associated market risk.

 

Dividends to Stockholders

 

On January 25, 2004, the Marathon Board of Directors declared a dividend of 25 cents per share on Marathon’s common stock, payable March 10, 2004, to stockholders of record at the close of business on February 18, 2004.

 

Liquidity and Capital Resources

 

Marathon’s main sources of liquidity and capital resources are internally generated cash flow from operations, committed and uncommitted credit facilities, and access to both the debt and equity capital markets. Marathon’s ability to access the debt capital market is supported by its investment grade credit ratings. Because of the liquidity and capital resource alternatives available to Marathon, including internally generated cash flow, Marathon’s management believes that its short-term and long-term liquidity is adequate to fund operations, including its capital spending program, repayment of debt maturities for the years 2004, 2005, and 2006, and any amounts that may ultimately be paid in connection with contingencies.

 

Marathon’s senior unsecured debt is currently rated investment grade by Standard and Poor’s Corporation, Moody’s Investor Services, Inc. and Fitch Ratings with ratings of BBB+, Baa1, and BBB+, respectively.

 

Marathon has a committed $1.354 billion long-term revolving credit facility that terminates in November 2005 and a committed $575 million 364-day revolving credit facility that terminates in November 2004. At December 31, 2003, there were no borrowings against these facilities. At December 31, 2003, Marathon had no commercial paper outstanding under the U.S. commercial paper program that is backed by the long-term revolving credit facility. Additionally, Marathon has other uncommitted short-term lines of credit totaling $200 million, of which no amounts were drawn at December 31, 2003.

 

MAP has a $190 million revolving credit agreement with Ashland that expires in March 2004 and is expected to be renewed until March 2005. As of December 31, 2003, MAP did not have any borrowings against this facility.

 

In 2002, Marathon filed a new universal shelf registration statement with the Securities and Exchange Commission registering $2.7 billion aggregate amount of common stock, preferred stock and other equity securities, debt securities, trust preferred securities and/or other securities, including securities convertible into or exchangeable for other equity or debt securities. As of December 31, 2003, no securities had been offered under this shelf registration statement.

 

Marathon held cash and cash equivalents of $1.396 billion at December 31, 2003, compared to $488 million at December 31, 2002. The increase primarily reflects proceeds from asset sales in the fourth quarter of 2003. Marathon expects to utilize a substantial portion of this cash to fund operations, including its capital and investment program, and to repay debt in 2004.

 

Marathon’s cash-adjusted debt-to-capital ratio (total-debt-minus-cash to total-debt-plus-equity-minus-cash) was 33 percent at December 31, 2003, compared to 45 percent at year-end 2002. This includes approximately $605 million of debt that is serviced by United States Steel.

 

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The table below provides aggregated information on Marathon’s obligations to make future payments under existing contracts as of December 31, 2003:

 

Summary of Contractual Cash Obligations

 

(Dollars in millions)   Total   2004  

2005-

2006

 

2007-

2008

 

Later

Years


Short and long-term debt (a)

  $ 4,181   $ 258   $ 308   $ 850   $ 2,765

Sale-leaseback financing (includes imputed interest) (a)

    107     11     22     31     43

Capital lease obligations (a)

    155     18     24     29     84

Operating lease obligations (a)

    378     89     127     52     110

Operating lease obligations under sublease (a)

    77     19     20     17     21

Purchase obligations:

                             

Crude, refinery feedstock and refined products contracts (b)

    7,743     5,874     1,856     13     —  

Transportation and related contracts

    1,071     138     407     147     379

Contracts to acquire property, plant and equipment

    565     486     72     3     4

LNG facility operating costs (c)

    230     14     27     27     162

Service and materials contracts (d)

    188     89     56     23     20

Unconditional purchase obligations (e)

    67     5     11     11     40

Commitments for oil and gas exploration (non-capital) (f)

    32     8     24     —       —  
   

 

 

 

 

Total purchase obligations

    9,896     6,614     2,453     224     605

Other long-term liabilities reflected on the Consolidated Balance Sheet:

                             

Accrued LNG facility operating costs (c)

    22     3     5     5     9

Employee benefit obligations (g)

    2,082     152     338     379     1,213
   

 

 

 

 

Total other long-term liabilities

    2,104     155     343     384     1,222
   

 

 

 

 

Total contractual cash obligations (h)

  $ 16,898   $ 7,164   $ 3,297   $ 1,587   $ 4,850

(a)   Upon the Separation, United States Steel assumed certain debt and lease obligations. Such amounts have been included in the above table to reflect the fact that Marathon remains primarily liable.
(b)   The majority of 2004’s contractual obligations to purchase crude oil, refinery feedstock and refined products relate to contracts to be satisfied within the first 180 days of the year.
(c)   Marathon has acquired the right to deliver to the Elba Island LNG re-gasification terminal 58 bcf of natural gas per year. The agreement’s primary term ends in 2021. Pursuant to this agreement, Marathon has also bound itself to a commitment to pay for a portion of the operating costs of the LNG re-gasification terminal.
(d)   Services and materials contracts include contracts to purchase services such as utilities, supplies and various other maintenance and operating services.
(e)   Marathon is a party to a long-term transportation services agreement with Alliance Pipeline. This agreement is used by Alliance Pipeline to secure its financing. This arrangement represents an indirect guarantee of indebtedness. Therefore, this amount has also been disclosed as a guarantee. See Note 28 to the consolidated financial statements for a complete discussion of Marathon’s guarantee.
(f)   Commitments for oil and gas exploration (non-capital) include estimated costs within contractually obligated exploratory work programs that are subject to immediate expense, such as geological and geophysical costs.
(g)   Marathon has employee benefit obligations consisting of pensions and other post retirement benefits including medical and life insurance. Marathon has estimated projected funding through 2013 with the exception of the pension plan for employees in Ireland where only 2004 information was included.
(h)   Includes $733 million of contractual cash obligations that have been assumed by United States Steel. For additional information, see “Management’s Discussion and Analysis of Financial Condition, Cash Flows and Liquidity – Obligations Associated with the Separation of United States Steel – Summary of Contractual Cash Obligations Assumed by United States Steel” on page 44.

 

Contractual cash obligations for which the ultimate settlement amounts are not fixed and determinable have been excluded from the above table. These include derivative contracts that are sensitive to future changes in commodity prices and other factors.

 

Marathon management’s opinion concerning liquidity and Marathon’s ability to avail itself in the future of the financing options mentioned in the above forward-looking statements are based on currently available information. To the extent that this information proves to be inaccurate, future availability of financing may be adversely affected. Factors that affect the availability of financing include the performance of Marathon (as measured by various factors including cash provided from operating activities), the state of worldwide debt and equity markets, investor perceptions and expectations of past and future performance, the global financial climate, and, in

 

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particular, with respect to borrowings, the levels of Marathon’s outstanding debt and credit ratings by rating agencies.

 

Off Balance Sheet Arrangements

 

Off-balance sheet arrangements comprise those arrangements that may potentially impact Marathon’s liquidity, capital resources and results of operations, even though such arrangements are not recorded as liabilities under generally accepted accounting principles. Although off-balance sheet arrangements serve a variety of Marathon’s business purposes, Marathon is not dependent on these arrangements to maintain its liquidity and capital resources; nor is management aware of any circumstances that are reasonably likely to cause the off-balance sheet arrangements to have a material adverse effect on liquidity and capital resources.

 

Marathon has provided various forms of guarantees to unconsolidated affiliates, United States Steel and certain lease contracts. These arrangements are described in Note 28 to the Consolidated Financial Statements.

 

Marathon is a party to agreements that would require Marathon to purchase, under certain circumstances, the interests in MAP and in Pilot Travel Centers LLC (“PTC”) not currently owned. These put/call agreements are described in Note 28 to the Consolidated Financial Statements.

 

Nonrecourse Indebtedness of Investees

 

Certain equity investees of Marathon have incurred indebtedness that Marathon does not support through guarantees or otherwise. If Marathon were obligated to share in this debt on a pro rata basis, its share would have been approximately $307 million as of December 31, 2003. Of this amount, $173 million relates to PTC. If any of these equity investees default, Marathon has no obligation to support the debt. Marathon’s partner in PTC has guaranteed $157 million of the total PTC debt.

 

Obligations Associated with the Separation of United States Steel

 

On December 31, 2001, Marathon disposed of its steel business through a tax-free distribution of the common stock of its wholly owned subsidiary United States Steel to holders of its USX—U. S. Steel Group class of common stock (“Steel Stock”) in exchange for all outstanding shares of Steel Stock on a one-for-one basis (the “Separation”).

 

Marathon remains obligated (primarily or contingently) for certain debt and other financial arrangements for which United States Steel has assumed responsibility for repayment under the terms of the Separation. United States Steel’s obligations to Marathon are general unsecured obligations that rank equal to United States Steel’s accounts payable and other general unsecured obligations. If United States Steel fails to satisfy these obligations, Marathon would become responsible for repayment. Under the Financial Matters Agreement, United States Steel has all of the existing contractual rights under the leases assumed from Marathon, including all rights related to purchase options, prepayments or the grant or release of security interests. However, United States Steel has no right to increase amounts due under or lengthen the term of any of the assumed leases, other than extensions set forth in the terms of any of the assumed leases.

 

As of December 31, 2003, Marathon has identified the following obligations totaling $699 million that have been assumed by United States Steel:

 

    $470 million of industrial revenue bonds related to environmental improvement projects for current and former United States Steel facilities, with maturities ranging from 2009 through 2033. Accrued interest payable on these bonds was $8 million at December 31, 2003.

 

    $76 million of sale-leaseback financing under a lease for equipment at United States Steel’s Fairfield Works, with a term extending to 2012, subject to extensions. There was no accrued interest payable on this financing at December 31, 2003.

 

    $59 million of obligations under a lease for equipment at United States Steel’s Clairton cokemaking facility, with a term extending to 2012, subject to extensions. There was no accrued interest payable on this financing at December 31, 2003.

 

    $72 million of operating lease obligations, of which $54 million was in turn assumed by purchasers of major equipment used in plants and operations divested by United States Steel.

 

    A guarantee of United States Steel’s $14 million contingent obligation to repay certain distributions from its 50 percent owned joint venture PRO-TEC Coating Company.

 

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    A guarantee of all obligations of United States Steel as general partner of Clairton 1314B Partnership, L.P. to the limited partners. United States Steel has reported that it currently has no unpaid outstanding obligations to the limited partners. For further discussion of the Clairton 1314B guarantee, see Note 3 to the Consolidated Financial Statements.

 

Of the total $699 million, obligations of $613 million and corresponding receivables from United States Steel were recorded on Marathon’s consolidated balance sheet (current portion—$20 million; long-term portion—$593 million). The remaining $86 million was related to off-balance sheet arrangements and contingent liabilities of United States Steel.

 

The table below provides aggregated information on the portion of Marathon’s obligations to make future payments under existing contracts that have been assumed by United States Steel as of December 31, 2003:

 

Summary of Contractual Cash Obligations Assumed by United States Steel

 

(Dollars in millions)    Total    2004   

2005-

2006

  

2007-

2008

  

Later

Years


Contractual obligations assumed by United States Steel

                                  

Long-term debt

   $ 470    $ –      $ –      $ –      $ 470

Sale-leaseback financing (includes imputed interest)

     107      11      22      31      43

Capital lease obligations

     84      13      13      19      39

Operating lease obligations

     18      5      10      3      –  

Operating lease obligations under sublease

     54      12      11      10      21
    

  

  

  

  

Total contractual obligations assumed by United States Steel

   $ 733    $ 41    $ 56    $ 63    $ 573

 

Each of Marathon and United States Steel, as members of the same consolidated tax reporting group during taxable periods ended on or before December 31, 2001, is jointly and severally liable for the federal income tax liability of the entire consolidated tax reporting group for those periods. Marathon and United States Steel have entered into a tax sharing agreement that allocates tax liabilities relating to taxable periods ended on or before December 31, 2001. The agreement includes indemnification provisions to address the possibility that the taxing authorities may seek to collect a tax liability from one party where the tax sharing agreement allocates that liability to the other party. In 2003, in accordance with the terms of the tax sharing agreement, Marathon paid $16 million to United States Steel in connection with the settlement with the Internal Revenue Service of the consolidated federal income tax returns of USX Corporation for the years 1992 through 1994.

 

United States Steel reported in its Form 10-K for the year ended December 31, 2003, that it has significant restrictive covenants related to its indebtedness including cross-default and cross-acceleration clauses on selected debt that could have an adverse effect on its financial position and liquidity. However, United States Steel management believes that its liquidity will be adequate to satisfy its obligations for the foreseeable future. During periods of weakness in the manufacturing sector of the U.S. economy, United States Steel believes that it can maintain adequate liquidity through a combination of deferral of nonessential capital spending, sale of non-strategic assets and other cash conservation measures.

 

Transactions with Related Parties

 

Marathon owns a combined 63.3% working interest in the Alba field. Marathon owns a net 52.2% interest in an onshore liquefied petroleum gas processing plant through an equity method investee, Alba Plant LLC. Additionally, Marathon owns a 45% net interest in an onshore methanol production plant through an equity method investee, Atlantic Methanol Production Company LLC (“AMPCO”). Marathon sells its marketed natural gas from the Alba field to Alba Plant LLC and AMPCO. AMPCO uses the natural gas to manufacture methanol and sells the methanol through AMPCO Marketing LLC.

 

MAP’s related party sales to its 50% equity method investee, PTC, consists primarily of refined petroleum products which accounted for approximately 2% of its total sales revenue for 2003. PTC is the largest travel center network in the United States and operates 257 travel centers nationwide. MAP also sells refined petroleum products consisting mainly of petrochemicals, base lube oils, and asphalt to Ashland which owns a 38% interest in MAP. MAP’s sales to Ashland accounted for approximately 1% of its total sales revenue for 2003. Management believes that these transactions were conducted under terms comparable to those with unrelated parties.

 

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Management’s Discussion and Analysis of Environmental Matters, Litigation and Contingencies

 

Marathon has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of Marathon’s products and services, operating results will be adversely affected. Marathon believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and whether or not it is engaged in the petrochemical business or the marine transportation of crude oil and refined products.

 

Marathon’s environmental expenditures for each of the last three years were(a):

 

(In millions)    2003    2002    2001

Capital

   $ 331    $ 128    $ 90

Compliance

                    

Operating & maintenance

     243      205      213

Remediation(b)

     44      45      22
    

  

  

Total

   $ 618    $ 378    $ 325

(a)   Amounts are determined based on American Petroleum Institute survey guidelines and include 100 percent of MAP.
(b)   These amounts include spending charged against remediation reserves, where permissible, but exclude noncash provisions recorded for environmental remediation.

 

Marathon’s environmental capital expenditures accounted for 17 percent of total capital expenditures in 2003, eight percent in 2002, and six percent in 2001.

 

Marathon accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs can be reasonably estimated. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required.

 

Marathon has been notified that it is a potentially responsible party (“PRP”) at nine waste sites under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) as of December 31, 2003. In addition, there are 4 sites where Marathon has received information requests or other indications that Marathon may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability. At many of these sites, Marathon is one of a number of parties involved and the total cost of remediation, as well as Marathon’s share thereof, is frequently dependent upon the outcome of investigations and remedial studies.

 

There are also 125 additional sites, excluding retail marketing outlets, related to Marathon where remediation is being sought under other environmental statutes, both federal and state, or where private parties are seeking remediation through discussions or litigation. Of these sites, 16 were associated with properties conveyed to MAP by Ashland for which Ashland has retained liability for all costs associated with remediation.

 

New or expanded environmental requirements, which could increase Marathon’s environmental costs, may arise in the future. Marathon intends to comply with all legal requirements regarding the environment, but since not all of them are fixed or presently determinable (even under existing legislation) and may be affected by future legislation, it is not possible to predict all of the ultimate costs of compliance, including remediation costs that may be incurred and penalties that may be imposed.

 

Marathon’s environmental capital expenditures are expected to be approximately $415 million or 20% of capital expenditures in 2004. Predictions beyond 2004 can only be broad-based estimates, which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, Marathon anticipates that environmental capital expenditures will be approximately $425 million in 2005; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.

 

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New Tier 2 gasoline and on-road diesel fuel rules require substantially reduced sulfur levels for gasoline and diesel starting in 2004 and 2006, respectively. The combined capital costs to achieve compliance with the gasoline and diesel regulations could amount to approximately $900 million over the period between 2002 and 2006 and includes costs that could be incurred as part of other refinery upgrade projects. This is a forward-looking statement. Costs incurred through December 31, 2003, were approximately $205 million. Some factors (among others) that could potentially affect gasoline and diesel fuel compliance costs include obtaining the necessary construction and environmental permits, completion of project detailed engineering, and project construction and logistical considerations.

 

MAP has had a pending enforcement matter with the Illinois Environmental Protection Agency and the Illinois Attorney General’s Office since 2002 concerning MAP’s self-reporting of possible emission exceedences and permitting issues related to storage tanks at its Robinson, Illinois refinery. MAP has had periodic discussions with Illinois officials regarding this matter and more discussions are anticipated in 2004.

 

During 2001, MAP entered into a New Source Review consent decree and settlement of alleged Clean Air Act (“CAA”) and other violations with the U. S. Environmental Protection Agency covering all of MAP’s refineries. The settlement committed MAP to specific control technologies and implementation schedules for environmental expenditures and improvements to MAP’s refineries over approximately an eight-year period. The total one-time expenditures for these environmental projects is approximately $330 million over the eight-year period, with about $170 million incurred through December 31, 2003. The impact of the settlement on ongoing operating expenses is expected to be immaterial. In addition, MAP has nearly completed certain agreed upon supplemental environmental projects as part of this settlement of an enforcement action for alleged CAA violations, at a cost of $9 million. MAP believes that this settlement will provide MAP with increased permitting and operating flexibility while achieving significant emission reductions.

 

Other Contingencies

 

Marathon is a defendant along with many other refining companies in over forty recently filed cases in thirteen states alleging methyl tertiary-butyl ether (MTBE) contamination in groundwater. The plaintiffs generally are water providers or governmental authorities and they allege that refiners, manufacturers and sellers of gasoline containing MTBE are liable for manufacturing a defective product and that owners and operators of retail gasoline sites have allowed MTBE to be discharged into the groundwater. Several of these lawsuits allege contamination that is outside of Marathon’s marketing area. A few of the cases seek approval as class actions. Many of the cases seek punitive damages or treble damages under a variety of statutes and theories. Marathon has stopped producing MTBE at its refineries. The potential impact of these recent cases and future potential similar cases is uncertain. Marathon intends to vigorously defend these cases.

 

Marathon is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to Marathon. However, management believes that Marathon will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to Marathon. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources”.

 

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Outlook

 

Realignment of Business Segments

 

In January 2004, Marathon changed its business segments to fully reflect all the operations of the integrated gas strategy within a single segment. In the first quarter of 2004, Marathon will realign its segment reporting and introduce a new business segment, Integrated Gas. This segment will initially include Marathon’s Alaska LNG operations, Equatorial Guinea methanol operations, and natural gas marketing and transportation activities, along with expenses related to the continued development of an integrated gas business. Crude oil marketing and transportation activities, previously reported in other energy related businesses, will be reported in the exploration and production segment. Refined product transportation activities not included in MAP, also previously reported in other energy related businesses, will be reported in the refining, marketing and transportation segment. The following represents unaudited information for the realigned operating segment for the previous three years:

 

(In millions)   

Exploration

and

Production

  

Refining,

Marketing

and

Transportation

  

Integrated

Gas

    Total

2003

                            

Revenues:

                            

Customer

   $ 4,394    $ 33,508    $ 2,140     $ 40,042

Intersegment(a)

     405      97      108       610

Related parties

     12      909      –         921
    

  

  


 

Total revenues

   $ 4,811    $ 34,514    $ 2,248     $ 41,573
    

  

  


 

Segment income (loss)

   $ 1,514    $ 819    $ (3 )   $ 2,330

Income from equity method investments

     50      82      21       153

Depreciation, depletion and amortization(b)

     755      375      12       1,142

Impairments(c)

     3      –        –         3

Capital expenditures(c)

     973      772      131       1,876

2002

                            

Revenues:

                            

Customer

   $ 3,894    $ 25,384    $ 1,148     $ 30,426

Intersegment(a)

     583      146      69       798

Related parties

     –        869      –         869
    

  

  


 

Total revenues

   $ 4,477    $ 26,399    $ 1,217     $ 32,093
    

  

  


 

Segment income

   $ 1,077    $ 372    $ 23     $ 1,472

Income from equity method investments

     75      48      14       137

Depreciation, depletion and amortization(b)

     769      364      3       1,136

Impairments(c)

     13      –        –         13

Capital expenditures(c)

     820      621      48       1,489

2001

                            

Revenues:

                            

Customer

   $ 4,357    $ 26,778    $ 1,214     $ 32,349

Intersegment(a)

     496      21      68       585

United States Steel(a)

     21      1      8       30

Related parties

     –        447      –         447
    

  

  


 

Total revenues

   $ 4,874    $ 27,247    $ 1,290     $ 33,411
    

  

  


 

Segment income

   $ 1,379    $ 1,927    $ 21     $ 3,327

Income from equity method investments

     71      41      6       118

Depreciation, depletion and amortization(b)

     824      345      1       1,170

Impairments(c)

     –        1      –         1

Capital expenditures(c)

     834      591      1       1,426

(a)   Management believes intersegment transactions and transactions with United States Steel were conducted under terms comparable to those with unrelated parties.
(b)   Differences between segment totals and Marathon totals represent impairments and amounts related to corporate administrative activities.
(c)   Differences between segment totals and Marathon totals represent amounts related to corporate administrative activities.

 

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Capital, Investment and Exploration Budget

 

Marathon’s has approved a capital, investment and exploration expenditure budget of approximately $2.26 billion for 2004. The primary focus of the 2004 budget is to find additional oil and gas reserves, develop existing fields, strengthen RM&T assets and continue implementation of the integrated gas strategy through Phase 3 in Equatorial Guinea. The budget includes worldwide production capital spending of $810 million primarily in Equatorial Guinea, Russia, Norway and the Gulf of Mexico. The worldwide exploration and exploitation budget of $302 million includes plans to drill 11 significant exploration wells in Angola, Equatorial Guinea, Norway, the Gulf of Mexico and Nova Scotia. Exploitation activities will focus on projects primarily in the United States. The budget includes $788 million for RM&T projects, primarily for refinery upgrade projects for the production of low sulfur gasoline and diesel fuel and the Detroit refinery expansion. The integrated gas budget of $263 million is primarily for the development of the LNG project on Bioko Island in Equatorial Guinea. The remaining $96 million balance is designated for corporate activities and capitalized interest.

 

Exploration and Production

 

The outlook regarding Marathon’s upstream revenues and income is largely dependent upon future prices and volumes of liquid hydrocarbons and natural gas. Prices have historically been volatile and have frequently been affected by unpredictable changes in supply and demand resulting from fluctuations in worldwide economic activity and political developments in the world’s major oil and gas producing and consuming areas. Any significant decline in prices could have a material adverse effect on Marathon’s results of operations. A prolonged decline in such prices could also adversely affect the quantity of crude oil and natural gas reserves that can be economically produced and the amount of capital available for exploration and development.

 

Marathon estimates its 2004 and 2005 production will average 365,000 BOEPD, excluding the effect of any acquisitions or dispositions. Marathon replaced 124 percent of production, excluding dispositions, during 2003. Also during the year, the company divested non-core upstream assets with 274 million BOE of proved reserves. Excluding acquisitions and dispositions, Marathon replaced approximately 76 percent of production. At year end, Marathon had proved reserves of 1.042 billion BOE.

 

Exploration

 

Major exploration activities, which are currently underway or under evaluation, include:

 

    Angola, where Marathon recently participated in the drilling of the Venus exploration well on Block 31 and the Canela well on Block 32. Plans are to participate in two to four additional exploration wells in this area during 2004;

 

    Norway, where Marathon has interests in twelve licenses in the Norwegian sector of the North Sea and plans to drill two exploration wells during 2004, one of which is anticipated to be in the Alvheim area;

 

    Gulf of Mexico, where Marathon plans to participate in two deepwater and two shelf exploration wells during 2004;

 

    Equatorial Guinea, where Marathon is currently evaluating the results of recent drilling in the Deep Luba prospect, which will test for potential resources under the Alba field and plans to drill one or two additional exploration wells in 2004;

 

    Eastern Canada, where Marathon plans to drill one exploration well on the Annapolis lease during 2004.

 

Production

 

In Equatorial Guinea, Marathon’s Phase 2A expansion project came on-stream during the fourth quarter. This project began producing less than 15 months after its approval and less than two years since Marathon’s acquisition of its interests in Equatorial Guinea. By year-end 2003, gross condensate production had grown from 18,000 to 30,000 bpd. The Phase 2B LPG expansion project is on schedule with an expected start-up near the end of 2004. Full LPG production of 20,000 bpd gross (11,600 bpd net) is expected in early 2005. Phase 2A and Phase 2B full condensate production of 59,000 bpd gross (32,600 bpd net to Marathon) is expected in early 2005.

 

In Russia, Marathon’s acquisition of KMOC in 2003 resulted in additional proved reserves of approximately 95 million BOE. Current net daily production of 16,000 net bpd from these operations is expected to increase to more than 60,000 net bpd within five years.

 

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In Norway, Marathon is evaluating development options associated with the exploration success in Alvheim and Klegg. Marathon and its partners are evaluating several development scenarios for Alvheim, in which Marathon is operator and holds a 65 percent interest. Marathon expects to submit a development plan to the Norwegian authorities during the second quarter of 2004. Marathon holds a 47 percent interest in Klegg and expects a development plan to be approved in 2004. Production from these combined developments is expected to reach more than 50,000 net bpd during 2007. On February 23, 2004, Marathon and its Alvheim project partners announced the signing of a purchase and sale agreement to acquire a multipurpose shuttle tanker.

 

In the Gulf of Mexico, Marathon and its partners in the Neptune Unit are integrating the results of this discovery into field development studies and plan to spud another appraisal well on this discovery during the first quarter of 2004. Marathon holds a 30 percent interest in the Neptune Unit.

 

In December 2003, Marathon and its partners, in the Corrib project offshore Ireland, submitted a new planning application to construct an onshore gas terminal for the Corrib natural gas discovery. Final planning approval for the onshore terminal is expected by the end of 2004.

 

In Qatar, Marathon and three other companies are exploring the possibility of developing a portion of the North field offshore Qatar, including infrastructure for gas processing facilities and a GTL plant.

 

In Wyoming’s Powder River Basin, Marathon plans to drill approximately 400 coal bed natural gas wells in 2004.

 

The above discussion includes forward-looking statements with respect to the timing and levels of Marathon’s worldwide liquid hydrocarbon and natural gas production, the exploration drilling program, possible additional resources, the Phase 2B LNG expansion project, the possibility of an equipment purchase, and the expected date for final planning approval for an onshore terminal. Some factors that could potentially affect worldwide liquid hydrocarbon and natural gas production, the exploration drilling program and possible additional resources include acts of war or terrorist acts and the governmental or military response, pricing, supply and demand for petroleum products, amount of capital available for exploration and development, occurrence of acquisitions or dispositions of oil and gas properties, regulatory constraints, timing of commencing production from new wells, drilling rig availability, achieving definitive agreements among project participants, inability or delay in obtaining necessary government and third party approvals and permits, unforeseen hazards such as weather conditions and other geological, operating and economic considerations. Factors that could affect the Phase 2B LPG expansion project include unforeseen problems arising from construction and unforeseen hazards such as weather conditions. Factors affecting the possibility of the equipment purchase include the partners’ approval of the development of the Alvheim area and the subsequent approval of a plan of development and operation by the Norwegian authorities. The final planning approval for the onshore terminal is contingent upon governmental approval. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

 

Refining, Marketing and Transportation

 

Marathon’s RM&T segment income is largely dependent upon the refining and wholesale marketing margin for refined products, the retail gross margin for gasoline and distillates, and the gross margin on retail merchandise sales. The refining and wholesale marketing margin reflects the difference between the wholesale selling prices of refined products and the cost of raw materials refined, purchased product costs and manufacturing expenses. Refining and wholesale marketing margins have been historically volatile and vary from the impact of competition and with the level of economic activity in the various marketing areas, the regulatory climate, the seasonal pattern of certain product sales, crude oil costs, manufacturing costs, the available supply of crude oil and refined products, and logistical constraints. The retail gross margin for gasoline and distillates reflects the difference between the retail selling prices of these products and their wholesale cost, including secondary transportation. Retail gasoline and distillate margins have also been historically volatile, but tend to be countercyclical to the refining and wholesale marketing margin. Factors affecting the retail gasoline and distillate margin include competition, seasonal demand fluctuations, the available wholesale supply, the level of economic activity in the marketing areas and weather situations that impact driving conditions. The gross margin on retail merchandise sales tends to be less volatile than the retail gasoline and distillate margin. Factors affecting the gross margin on retail merchandise sales include consumer demand for merchandise items, the impact of competition and the level of economic activity in the marketing area.

 

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MAP has completed the approximately $440 million multi-year Catlettsburg, Kentucky, refinery repositioning project. This major operations improvement project includes the deactivation of the existing, old fluid catalytic cracking unit (FCCU) and the conversion and expansion of the existing atmospheric residue catalytic cracking unit into an FCCU. This project is expected to increase the value of the refined products produced at Catlettsburg, improve cost efficiency and enable the refinery to meet new low sulfur gasoline standards. Project startup was in the first quarter of 2004.

 

MAP has commenced approximately $300 million in new capital projects for its 74,000 bpd Detroit, Michigan refinery. One of the projects, a $110 million expansion project, is expected to raise the crude oil capacity at the refinery by 35 percent to 100,000 bpd. Other projects are expected to enable the refinery to produce new clean fuels and further control regulated air emissions. Completion of the projects are scheduled for the fourth quarter of 2005. Marathon will loan MAP the funds necessary for these upgrade and expansion projects.

 

A MAP subsidiary, Ohio River Pipe Line LLC (“ORPL”), completed a 150-mile refined product pipeline from Kenova, West Virginia to Columbus, Ohio in late 2003. The pipeline is an interstate common carrier pipeline. The pipeline is known as Cardinal Products Pipeline and is expected to initially move about 36,000 bpd of refined petroleum into the central Ohio region. The pipeline, which has a capacity of up to 80,000 bpd, is expected to provide a stable, cost effective supply of gasoline, diesel and jet fuels to this market.

 

Overlapping planned maintenance projects, including investments in the “Tier 2” ultra-low sulfur gasoline production upgrades, will reduce MAP’s 935,000 bpd crude oil capacity such that it expects to process about 775,000 bpd of crude oil in the first quarter of 2004. MAP expects its average crude oil throughput for the total year 2004 to be at or above historical levels.

 

The above discussion includes forward-looking statements with respect to the Detroit capital projects and the Cardinal Products Pipeline system. Some factors that could affect the Detroit construction projects include availability of materials and labor, permitting approvals, unforeseen hazards such as weather conditions, and other risks customarily associated with construction projects. Factors that could impact the Cardinal Products Pipeline include the price of petroleum products and other supply issues. These factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

 

Integrated Gas

 

Marathon continues to make progress on its Phase 3 expansion project in Equatorial Guinea. To commercialize the significant gas resources in Equatorial Guinea’s Alba field, Marathon, the Government of Equatorial Guinea and GEPetrol, the national oil company of Equatorial Guinea, have signed a heads of agreement on a package of fiscal terms and conditions for the development of the LNG project on Bioko Island. Marathon and GEPetrol plan to develop a 3.4 million metric tonnes per year LNG plant, with start up currently projected for late 2007. Marathon and GEPetrol have also signed a letter of understanding (LOU) with a subsidiary of BG Group plc (“BGML”) under which BGML would purchase the LNG plant’s production for a period of 17 years on an FOB Bioko Island basis with pricing linked principally to the Henry Hub index. The LNG would be targeted primarily to a receiving terminal in Lake Charles, Louisiana, where it would be regasified and delivered into the Gulf Coast natural gas pipeline grid. The provisions of the LOU are subject to a definitive purchase and sale agreement which the parties expect to finalize by the second quarter of 2004. Pending final approval of all commercial and governmental agreements, a final investment decision is expected to be concluded by second quarter 2004.

 

The above discussion contains forward-looking statements with respect to the estimated construction and startup dates of a LNG liquefaction plant and related facilities and the purchase of LNG by BGML. Factors that could affect the purchase of LNG by BGML and the estimated construction and startup dates of the LNG liquefaction plant and related facilities include, without limitation, the successful negotiation and execution of a definitive purchase and sale agreement for LNG supply, board approval of the transactions, approval of the LNG project by the Government of Equatorial Guinea, unforeseen difficulty in negotiation of definitive agreements among project participants, inability or delay in obtaining necessary government and third-party approvals, arranging sufficient financing, unanticipated changes in market demand or supply, competition with similar projects, environmental issues, availability or construction of sufficient LNG vessels, and unforeseen hazards such as weather conditions. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

 

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Corporate Matters

 

Marathon has announced organizational and business process changes to increase efficiency, profitability and shareholder value and to achieve projected annual pretax savings of more than $135 million, including $70 million related to MAP. It is anticipated that most of these changes will be completed during the first half 2004, and will result in pretax charges of approximately $75 million ($10 million of which is related to MAP), including benefit plan curtailment and settlement effects of $24 million. Approximately $24 million of the estimated $75 million charges has been recorded in 2003, with the remainder to be recognized when incurred during the first half 2004.

 

Marathon expects that pension and other postretirement plan expense in 2004 will increase approximately $65 million from 2003 levels, of which approximately $21 million relates to MAP. The total includes $34 million related to pension plan settlements as a result of the business transformation. MAP, and Marathon’s foreign subsidiaries expect to contribute approximately $93 million and $22 million to the funded pension plans in 2004.

 

The above discussion includes forward-looking statements with respect to projected annual cost savings from organizational and business process improvements, the projected completion time for implementation of the changes and pension and other postretirement plan expenses. Factors, but not necessarily all factors, that could adversely affect these expected results include possible delays in consolidating the U.S. production organization, future acquisitions or dispositions, technological developments, actions of government or other regulatory bodies in areas affected by these organizational changes, unforeseen hazards, regulatory impacts, and other economic or political considerations. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

 

Accounting Standards Not Yet Adopted

 

An issue currently on the Emerging Issues Task Force (“EITF”) agenda, Issue No. 03-S “Applicability of FASB Statement No. 142, Goodwill and Other Intangible Assets, to Oil and Gas Companies,” will address how oil and gas companies should classify the costs of acquiring contractual mineral interests in oil and gas properties on the balance sheet. The EITF is considering an alternative interpretation of Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets” that mineral or drilling rights or leases, concessions or other interests representing the right to extract oil or gas should be classified as intangible assets rather than oil and gas properties. Management believes that our current balance sheet classification for these costs is appropriate under generally accepted accounting principles. If a reclassification is ultimately required, the estimated amount of the leasehold acquisition costs to be reclassified would be $2.3 billion and $2.4 billion at December 31, 2003 and 2002. Should such a change be required, there would be no impact on our previously filed income statements (or reported net income), statements of cash flow or statements of stockholders’ equity for prior periods. Additional disclosures related to intangible assets would also be required.

 

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Table of Contents

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Management Opinion Concerning Derivative Instruments

 

Management has authorized the use of futures, forwards, swaps and options to manage exposure to market fluctuations in commodity prices, interest rates, and foreign currency exchange rates.

 

Marathon uses commodity-based derivatives to manage price risk related to the purchase, production or sale of crude oil, natural gas, and refined products. To a lesser extent, Marathon is exposed to the risk of price fluctuations on natural gas liquids and on petroleum feedstocks used as raw materials.

 

Marathon’s strategy has generally been to obtain competitive prices for its products and allow operating results to reflect market price movements dictated by supply and demand. Marathon will use a variety of derivative instruments, including option combinations, as part of the overall risk management program to manage commodity price risk within its different businesses. As market conditions change, Marathon evaluates its risk management program and could enter into strategies that assume market risk whereby cash settlement of commodity-based derivatives will be based on market prices.

 

Marathon’s E&P segment primarily uses commodity derivative instruments to selectively lock in realized prices on portions of its future production when deemed advantageous to do so.

 

Marathon’s RM&T segment primarily uses commodity derivative instruments to mitigate the price risk of certain crude oil and other feedstock purchases, to protect carrying values of excess inventories, to protect margins on fixed-price sales of refined products and to lock-in the price spread between refined products and crude oil. MAP recently expanded its trading strategies (through the use of sold options) to take advantage of opportunities in the commodity markets.

 

Marathon’s OERB segment is exposed to market risk associated with the purchase and subsequent resale of natural gas. Marathon uses commodity derivative instruments to mitigate the price risk on purchased volumes and anticipated sales volumes.

 

Marathon uses financial derivative instruments to manage interest rate and foreign currency exchange rate exposures. As Marathon enters into derivatives, assessments are made as to the qualification of each transaction for hedge accounting.

 

Management believes that use of derivative instruments along with risk assessment procedures and internal controls does not expose Marathon to material risk. However, the use of derivative instruments could materially affect Marathon’s results of operations in particular quarterly or annual periods. Management believes that use of these instruments will not have a material adverse effect on financial position or liquidity.

 

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Table of Contents

Commodity Price Risk

 

Sensitivity analyses of the incremental effects on income from operations (“IFO”) of hypothetical 10 percent and 25 percent changes in commodity prices for open derivative commodity instruments as of December 31, 2003 and December 31, 2002, are provided in the following table:(a)

 

(In millions)                           

 
      

Incremental Decrease in IFO Assuming a

Hypothetical Price Change of(a)

 
       2003     2002  
Derivative Commodity Instruments(b)(c)      10%     25%     10%     25%  

 

Crude oil(d)

     $ 28.3 (e)   $ 87.9 (e)   $ 42.3 (e)   $ 141.8 (e)

Natural gas(d)

       29.1 (e)     73.5 (e)     39.5 (e)     120.3 (e)

Refined products(d)

       3.6 (e)     9.1 (e)     1.5 (e)     6.5 (e)

 
(a)   Marathon remains at risk for possible changes in the market value of derivative instruments; however, such risk should be mitigated by price changes in the underlying hedged item. Effects of these offsets are not reflected in the sensitivity analyses. Amounts reflect hypothetical 10% and 25% changes in closing commodity prices, excluding basis swaps, for each open contract position at December 31, 2003 and 2002. Marathon evaluates its portfolio of derivative commodity instruments on an ongoing basis and adds or revises strategies to reflect anticipated market conditions and changes in risk profiles. Marathon is also exposed to credit risk in the event of nonperformance by counterparties. The creditworthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical. Changes to the portfolio after December 31, 2003, would cause future IFO effects to differ from those presented in the table.
(b)   Net open contracts for the combined E&P and OERB segments varied throughout 2003, from a low of 24,375 contracts at October 8 to a high of 52,470 contracts at October 17, and averaged 37,068 for the year. The number of net open contracts for the RM&T segment varied throughout 2003, from a low of 30 contracts at July 19 to a high of 23,412 contracts at December 4, and averaged 9,850 for the year. The derivative commodity instruments used and hedging positions taken will vary and, because of these variations in the composition of the portfolio over time, the number of open contracts by itself cannot be used to predict future income effects.
(c)   The calculation of sensitivity amounts for basis swaps assumes that the physical and paper indices are perfectly correlated. Gains and losses on options are based on changes in intrinsic value only.
(d)   The direction of the price change used in calculating the sensitivity amount for each commodity reflects that which would result in the largest incremental decrease in IFO when applied to the derivative commodity instruments used to hedge that commodity.
(e)   Price increase.

 

E&P Segment

 

At December 31, 2003 the following commodity derivative contracts were outstanding. All contracts currently qualify for hedge accounting unless noted.

 

Contract Type(a)    Period   

Daily

Volume(b)

  

% of Estimated

Production(b)

    Average Price

Natural Gas

                    

Option collars

   January – December 2004    23 mmcfd    2 %   $7.15 - $4.25 mcf

Swaps

   January – December 2004    50 mmcfd    5 %   $5.02 mcf

Crude Oil

                    

Option collars

   2004    44 mbpd    23 %   $29.67 - $24.26 bbl

(a)   These contracts may be subject to margin calls above certain limits established by counterparties.
(b)   Volumes and percentages are based on the estimated production on an annualized basis.

 

Derivative gains (losses) included in the E&P segment were $(176) million, $52 million and $85 million for 2003, 2002 and 2001. Losses of $66 million and gains of $18 million are included in segment results for 2003 and 2002, respectively, on long-term gas contracts in the United Kingdom that are accounted for as derivative instruments and marked-to-market. Additionally, losses of $8 million and gains of $23 million from discontinued cash flow hedges are included in segment results for 2003 and 2002. The discontinued cash flow hedge amounts were reclassified from accumulated other comprehensive income (loss) as it was no longer probable that the original forecasted transactions would occur.

 

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Table of Contents

RM&T Segment

 

Marathon’s RM&T operations primarily use derivative commodity instruments to mitigate the price risk of certain crude oil and other feedstock purchases, to protect carrying values of excess inventories, to protect margins on fixed price sales of refined products and to lock-in the price spread between refined products and crude oil. Derivative instruments are used to mitigate the price risk between the time foreign and domestic crude oil and other feedstock purchases for refinery supply are priced and when they are actually refined into salable petroleum products. In addition, natural gas options are in place to manage the price risk associated with approximately 60% of the anticipated natural gas purchases for refinery use through the first quarter of 2004 and 50% through the second quarter of 2004. Derivative commodity instruments are also used to protect the value of excess refined product, crude oil and LPG inventories. Derivatives are used to lock in margins associated with future fixed price sales of refined products to non-retail customers. Derivative commodity instruments are used to protect against decreases in the future crack spreads. Within a limited framework, derivative instruments are also used to take advantage of opportunities identified in the commodity markets. Derivative gains (losses) included in RM&T segment income for each of the last two years are summarized in the following table:

 

Strategy (In Millions)    2003     2002  

 

Mitigate price risk

   $ (112 )   $ (95 )

Protect carrying values of excess inventories

     (57 )     (41 )

Protect margin on fixed price sales

     5       11  

Protect crack spread values

     6       1  

Trading activities

     (4 )     –    
    


 


Total net derivative losses

   $ (162 )   $ (124 )

 

 

Generally, derivative losses occur when market prices increase, which are offset by gains on the underlying physical commodity transaction. Conversely, derivative gains occur when market prices decrease, which are offset by losses on the underlying physical commodity transaction.

 

OERB Segment

 

Marathon has used derivative instruments to convert the fixed price of a long-term gas sales contract to market prices. The underlying physical contract is for a specified annual quantity of gas and matures in 2008. Similarly, Marathon will use derivative instruments to convert shorter term (typically less than a year) fixed price contracts to market prices in its ongoing purchase for resale activity; and to hedge purchased gas injected into storage for subsequent resale. Derivative gains (losses) included in OERB segment income were $19 million, $(8) million and $(29) million for 2003, 2002 and 2001. OERB’s trading activity gains (losses) of $(7) million, $4 million and $(1) million in 2003, 2002 and 2001 are included in the aforementioned amounts.

 

Other Commodity Risk

 

Marathon is subject to basis risk, caused by factors that affect the relationship between commodity futures prices reflected in derivative commodity instruments and the cash market price of the underlying commodity. Natural gas transaction prices are frequently based on industry reference prices that may vary from prices experienced in local markets. For example, New York Mercantile Exchange (“NYMEX”) contracts for natural gas are priced at Louisiana’s Henry Hub, while the underlying quantities of natural gas may be produced and sold in the western United States at prices that do not move in strict correlation with NYMEX prices. To the extent that commodity price changes in one region are not reflected in other regions, derivative commodity instruments may no longer provide the expected hedge, resulting in increased exposure to basis risk. These regional price differences could yield favorable or unfavorable results. OTC transactions are being used to manage exposure to a portion of basis risk.

 

Marathon is subject to liquidity risk, caused by timing delays in liquidating contract positions due to a potential inability to identify a counterparty willing to accept an offsetting position. Due to the large number of active participants, liquidity risk exposure is relatively low for exchange-traded transactions.

 

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Table of Contents

Interest Rate Risk

 

Marathon is subject to the effects of interest rate fluctuations affecting the fair value of certain financial instruments. A sensitivity analysis of the projected incremental effect of a hypothetical 10 percent decrease in interest rates is provided in the following table:

 

(In millions)          

     December 31, 2003    December 31, 2002
Financial Instruments(a)    Fair
Value(b)
  

Incremental

Increase in

Fair Value(c)

  

Fair

Value(b)

  

Incremental

Increase in

Fair Value(c)


Financial assets:

                           

Investments and long-term receivables

   $ 186    $ –      $ 223    $ –  

Interest rate swap agreements

   $ 4    $ 16    $ 12    $ 8

Financial liabilities:

                           

Long-term debt(d)(e)

   $ 4,740    $ 176    $ 5,008    $ 194

(a)   Fair values of cash and cash equivalents, receivables, notes payable, accounts payable and accrued interest approximate carrying value and are relatively insensitive to changes in interest rates due to the short-term maturity of the instruments. Accordingly, these instruments are excluded from the table.
(b)   See Note 17 and 18 to the Consolidated Financial Statements for carrying value of instruments.
(c)   For long-term debt, this assumes a 10% decrease in the weighted average yield to maturity of Marathon’s long-term debt at December 31, 2003 and 2002. For interest rate swap agreements, this assumes a 10% decrease in the effective swap rate at December 31, 2003.
(d)   Includes amounts due within one year.
(e)   Fair value was based on market prices where available, or current borrowing rates for financings with similar terms and maturities.

 

At December 31, 2003 and 2002, Marathon’s portfolio of long-term debt was substantially comprised of fixed rate instruments. Therefore, the fair value of the portfolio is relatively sensitive to effects of interest rate fluctuations. This sensitivity is illustrated by the $176 million increase in the fair value of long-term debt assuming a hypothetical 10 percent decrease in interest rates. However, Marathon’s sensitivity to interest rate declines and corresponding increases in the fair value of its debt portfolio would unfavorably affect Marathon’s results and cash flows only to the extent that Marathon would elect to repurchase or otherwise retire all or a portion of its fixed-rate debt portfolio at prices above carrying value.

 

Marathon has initiated a program to manage its exposure to interest rate movements by utilizing financial derivative instruments. The primary objective of this program is to reduce Marathon’s overall cost of borrowing by managing the fixed and floating interest rate mix of the debt portfolio. Beginning in 2002, Marathon entered into several interest rate swap agreements, designated as fair value hedges, which effectively resulted in an exchange of existing obligations to pay fixed interest rates for obligations to pay floating rates. The following table summarizes, by individual debt instrument, the interest rate swap activity as of December 31, 2003:

 

Floating Rate to be Paid   

Fixed Rate

to be

Received

   

Notional

Amount

($Millions)

  

Swap

Maturity

  

Fair Value

($Millions)

 

 

Six Month LIBOR +4.226%

   6.650 %   $ 300    2006    $ 1  

Six Month LIBOR +1.935%

   5.375 %   $ 450    2007    $ 6  

Six Month LIBOR +3.285%

   6.850 %   $ 400    2008    $ 3  

Six Month LIBOR +2.142%

   6.125 %   $ 200    2012    $ (6 )

 

 

55


Table of Contents

Foreign Currency Exchange Rate Risk

 

Marathon has a program to manage its exposure to foreign currency exchange rates by utilizing forward contracts. The primary objective of this program is to reduce Marathon’s exposure to movements in the foreign currency markets by locking in foreign currency rates. As of December 31, 2003, Marathon had no open contracts.

 

Credit Risk

 

Marathon has significant credit risk exposure to United States Steel arising from the Separation. That exposure is discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Obligations Associated with the Separation of United States Steel” on page 43.

 

Safe Harbor

 

Marathon’s quantitative and qualitative disclosures about market risk include forward-looking statements with respect to management’s opinion about risks associated with the use of derivative instruments. These statements are based on certain assumptions with respect to market prices and industry supply of and demand for crude oil, natural gas, refined products and other feedstocks. To the extent that these assumptions prove to be inaccurate, future outcomes with respect to Marathon’s hedging programs may differ materially from those discussed in the forward-looking statements.

 

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Table of Contents

Item 8. Consolidated Financial Statements and Supplementary Data

 

   MARATHON OIL CORPORATION  

 

 

Index to 2003 Consolidated Financial Statements and Supplementary Data
     Page

Management’s Report

   F-1

Audited Consolidated Financial Statements:

    

Report of Independent Auditors

   F-1

Consolidated Statement of Income

   F-2

Consolidated Balance Sheet

   F-4

Consolidated Statement of Cash Flows

   F-5

Consolidated Statement of Stockholders’ Equity

   F-6

Notes to Consolidated Financial Statements

   F-8

Selected Quarterly Financial Data (Unaudited)

   F-41

Principal Unconsolidated Investees (Unaudited)

   F-41

Supplementary Information on Oil and Gas Producing Activities (Unaudited)

   F-42

Five-Year Operating Summary

   F-49

Five-Year Selected Financial Data

   F-51


Table of Contents

Management’s Report

 

The accompanying consolidated financial statements of Marathon Oil Corporation and its consolidated subsidiaries (Marathon) are the responsibility of management and have been prepared in conformity with accounting principles generally accepted in the United States of America. They necessarily include some amounts that are based on best judgments and estimates. The financial information displayed in other sections of this report is consistent with these financial statements.

Marathon seeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.

Marathon has a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the financial statements, Marathon’s independent auditors, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.

The Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of independent directors, regularly meets (jointly and separately) with the independent auditors, management and internal auditors to monitor the proper discharge by each of their responsibilities relative to internal accounting controls and the consolidated financial statements.

 

LOGO

Clarence P. Cazalot, Jr.

 

LOGO

Janet F. Clark

 

LOGO

Albert G. Adkins

President and

Chief Executive Officer

 

Senior Vice President and

Chief Financial Officer

 

Vice President–

Accounting and Controller

 

Report of Independent Auditors

 

To the Stockholders of Marathon Oil Corporation:

 

In our opinion, the accompanying consolidated financial statements appearing on pages F-2 through F-40 present fairly, in all material respects, the financial position of Marathon Oil Corporation and its subsidiaries (Marathon) at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Marathon’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 auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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 financial statements, Marathon changed its methods of accounting for asset retirement costs, stock-based compensation and the effects of early extinguishment of debt in 2003.

As discussed in Note 2 to the financial statements, Marathon changed its method for accounting for certain long-term natural gas sales contracts in 2002.

As discussed in Note 3 to the financial statements, on December 31, 2001, Marathon distributed its steel business to the holders of USX-U.S. Steel Group common stock and has accounted for this business as a discontinued operation.

 

LOGO

PricewaterhouseCoopers LLP

Houston, Texas
February 25, 2004

 

F-1


Table of Contents

Consolidated Statement of Income

 

(Dollars in millions)    2003     2002     2001  

 
Revenues and other income:                         

Sales and other operating revenues (including consumer excise taxes)

   $ 40,042     $ 30,426     $ 32,349  

Sales to related parties

     921       869       447  

Income from equity method investments

     29       137       118  

Net gains on disposal of assets

     166       67       44  

Gain (loss) on ownership change in Marathon Ashland Petroleum LLC

     (1 )     12       (6 )

Other income

     77       44       110  
    


 


 


Total revenues and other income

     41,234       31,555       33,062  
    


 


 


Costs and expenses:                         

Cost of revenues (excludes items shown below)

     32,109       23,391       23,024  

Purchases from related parties

     187       178       158  

Consumer excise taxes

     4,285       4,250       4,404  

Depreciation, depletion and amortization

     1,175       1,176       1,187  

Selling, general and administrative expenses

     946       839       714  

Other taxes

     299       255       269  

Exploration expenses

     149       167       127  

Inventory market valuation charges (credits)

     –         (71 )     71  
    


 


 


Total costs and expenses

     39,150       30,185       29,954  
    


 


 


Income from operations      2,084       1,370       3,108  

Net interest and other financing costs

     186       268       172  

Loss from early extinguishment of debt

     –         53       –    

Minority interest in income of
Marathon Ashland Petroleum LLC

     302       173       704  
    


 


 


Income from continuing operations before income taxes      1,596       876       2,232  

Provision for income taxes

     584       369       827  
    


 


 


Income from continuing operations      1,012       507       1,405  
Discontinued operations      305       (4 )     (1,240 )
    


 


 


Income before cumulative effect of changes in accounting principles

     1,317       503       165  

Cumulative effect of changes in accounting principles

     4       13       (8 )
    


 


 


Net income    $ 1,321     $ 516     $ 157  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-2


Table of Contents

Income Per Common Share

 

(Dollars in millions, except per share data)    2003    2002    2001  

 
MARATHON COMMON STOCK                       

Income from continuing operations applicable to Common Stock

   $ 1,012    $ 507    $ 1,404  
    

  

  


Net income applicable to Common Stock

   $ 1,321    $ 516    $ 377  
    

  

  


Per Share Data

                      

Basic and diluted:

                      

Income from continuing operations

   $ 3.26    $ 1.63    $ 4.54  
    

  

  


Net income

   $ 4.26    $ 1.66    $ 1.22  
    

  

  


STEEL STOCK                       

Net loss applicable to Steel Stock

   $ –      $ –      $ (243 )
    

  

  


Per Share Data

                      

Basic:

                      

Net loss

   $ –      $ –      $ (2.73 )
    

  

  


Diluted:

                      

Net loss

   $ –      $ –      $ (2.74 )

 

See Note 7 for a description and computation of income per common share.

The accompanying notes are an integral part of these consolidated financial statements.

 

F-3


Table of Contents

Consolidated Balance Sheet

 

(Dollars in millions) December 31    2003     2002  

 
Assets                 

Current assets:

                

Cash and cash equivalents

   $ 1,396     $ 488  

Receivables, less allowance for doubtful accounts of $5 and $6

     2,463       1,807  

Receivables from United States Steel

     20       9  

Receivables from related parties

     47       38  

Inventories

     1,953       1,984  

Other current assets

     161       153  
    


 


Total current assets

     6,040       4,479  

Investments and long-term receivables, less allowance for doubtful
accounts of $10 and $14

     1,323       1,634  

Receivables from United States Steel

     593       547  

Property, plant and equipment – net

     10,830       10,390  

Prepaid pensions

     181       201  

Goodwill

     256       274  

Intangibles

     118       119  

Other noncurrent assets

     141       168  
    


 


Total assets

   $ 19,482     $ 17,812  

 
Liabilities                 

Current liabilities:

                

Accounts payable

   $ 3,352     $ 2,841  

Payables to United States Steel

     4       28  

Payables to related parties

     17       16  

Payroll and benefits payable

     230       198  

Accrued taxes

     247       307  

Accrued interest

     85       108  

Long-term debt due within one year

     272       161  
    


 


Total current liabilities

     4,207       3,659  

Long-term debt

     4,085       4,410  

Deferred income taxes

     1,489       1,445  

Employee benefit obligations

     984       847  

Asset retirement obligations

     390       223  

Payables to United States Steel

     8       7  

Deferred credits and other liabilities

     233       168  
    


 


Total liabilities

     11,396       10,759  

Minority interest in Marathon Ashland Petroleum LLC

     2,011       1,971  

Commitments and contingencies

     –         –    
Stockholders’ Equity                 

Common Stock issued – 312,165,978 shares at December 31, 2003 and
2002 (par value $1 per share, authorized 550,000,000 shares)

     312       312  

Common Stock held in treasury – 1,744,370 shares at December 31, 2003
and 2,292,986 shares at December 31, 2002

     (46 )     (60 )

Additional paid-in capital

     3,033       3,032  

Retained earnings

     2,897       1,874  

Accumulated other comprehensive loss

     (112 )     (69 )

Unearned compensation

     (9 )     (7 )
    


 


Total stockholders’ equity

     6,075       5,082  
    


 


Total liabilities and stockholders’ equity

   $ 19,482     $ 17,812  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-4


Table of Contents

Consolidated Statement of Cash Flows

 

(Dollars in millions)   2003     2002     2001  

 

Increase (decrease) in cash and cash equivalents

                       
Operating activities:                        

Net income

  $ 1,321     $ 516     $ 157  

Adjustments to reconcile to net cash provided from operating activities:

                       

Cumulative effect of changes in accounting principles

    (4 )     (13 )     8  

Loss (income) from discontinued operations

    (305 )     4       1,240  

Deferred income taxes

    71       77       (147 )

Minority interest in income of Marathon Ashland Petroleum LLC

    302       173       704  

Loss from early extinguishment of debt

    –         53       –    

Depreciation, depletion and amortization

    1,175       1,176       1,187  

Pension and other postretirement benefits – net

    68       87       33  

Inventory market valuation charges (credits)

    –         (71 )     71  

Exploratory dry well costs

    55       91       54  

Net gains on disposal of assets

    (166 )     (67 )     (44 )

Impairment of investments

    129       –         –    

Changes in: Current receivables

    (671 )     (103 )     124  

Inventories

    33       (53 )     (68 )

Accounts payable and other current liabilities

    496       614       (544 )

All other – net

    174       (148 )     (26 )
   


 


 


Net cash provided from continuing operations

    2,678       2,336       2,749  

Net cash provided from discontinued operations

    83       69       887  
   


 


 


Net cash provided from operating activities

    2,761       2,405       3,636  
   


 


 


Investing activities:                        

Capital expenditures

    (1,892 )     (1,520 )     (1,533 )

Acquisitions

    (252 )     (1,160 )     (506 )

Disposal of discontinued operations

    612       54       (147 )

Disposal of assets

    644       146       83  

Restricted cash – withdrawals

    146       91       67  

– deposits

    (108 )     (123 )     (62 )

Investments – contributions

    (34 )     (111 )     (8 )

– loans and advances

    (91 )     –         (6 )

– returns and repayments

    42       5       10  

All other – net

    (19 )     –         5  

Investing activities of discontinued operations

    (29 )     (48 )     (147 )
   


 


 


Net cash used in investing activities

    (981 )     (2,666 )     (2,244 )
   


 


 


Financing activities:                        

Commercial paper and revolving credit arrangements – net

    (131 )     (375 )     (51 )

Other debt – borrowings

    –         1,828       537  

 – repayments

    (208 )     (604 )     (646 )

Redemption of preferred stock of subsidiary

    –         (185 )     (223 )

Preferred stock repurchased

    –         (110 )     –    

Treasury common stock – proceeds from issuances

    17       2       12  

 – purchases

    (6 )     (7 )     (1 )

Dividends paid – Common Stock

    (298 )     (285 )     (284 )

– Steel Stock

    –         –         (49 )

– Preferred stock

    –         –         (8 )

Distributions to minority shareholder of Marathon Ashland Petroleum LLC

    (262 )     (176 )     (577 )
   


 


 


Net cash provided from (used in) financing activities

    (888 )     88       (1,290 )
   


 


 


Effect of exchange rate changes on cash:                        

Continuing operations

    8       4       (3 )

Discontinued operations

    8       –         (1 )
   


 


 


Net increase (decrease) in cash and cash equivalents     908       (169 )     98  
Cash and cash equivalents at beginning of year     488       657       559  
   


 


 


Cash and cash equivalents at end of year   $ 1,396     $ 488     $ 657  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

F-5


Table of Contents

Consolidated Statement of Stockholders’ Equity

 

     Dollars in millions

    Shares in thousands

 
     2003     2002     2001     2003     2002     2001  
Preferred stock:                                           

6.50% Cumulative Convertible:

                                          

Balance at beginning of year

   $ –       $ –       $ 2     –       –       2,413  

Repurchased

     –         –         –       –       –       (9 )

Converted into Steel Stock

     –         –         –       –       –       (1 )

Exchanged for debt

     –         –         –       –       –       (195 )

Converted to right to receive cash at Separation

     –         –         (2 )   –       –       (2,208 )
    


 


 


 

 

 

Balance at end of year

   $ –       $ –       $ –       –       –       –    

 
Common stocks:                                           

Common Stock:

                                          

Balance at beginning of year

   $ 312     $ 312     $ 312     312,166     312,166     312,166  
    


 


 


 

 

 

Balance at end of year

   $ 312     $ 312     $ 312     312,166     312,166     312,166  

 

Steel Stock:

                                          

Balance at beginning of year

   $ –       $ –       $ 89     –       –       88,767  

Issued for:

                                          

Employee stock plans

     –         –         –       –       –       430  

Conversion of preferred stock

     –         –         –       –       –       1  

Distributed to United States Steel shareholders

     –         –         (89 )   –       –       (89,198 )