For The Quarterly Period Ended March 31, 2005

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LFMWanZa1jhaQkcjV7WSH7sTgqDIlzK/uApxkaI0IStyiRSmCnvg73F3MZD4H3F7 qZeKMaHLF/pUT9LpKTcLZA== 0001193125-05-099166.txt : 20050506 0001193125-05-099166.hdr.sgml : 20050506 20050506152400 ACCESSION NUMBER: 0001193125-05-099166 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050506 DATE AS OF CHANGE: 20050506 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EQUISTAR CHEMICALS LP CENTRAL INDEX KEY: 0001081158 STANDARD INDUSTRIAL CLASSIFICATION: AGRICULTURE CHEMICALS [2870] IRS NUMBER: 760550480 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 333-76473 FILM NUMBER: 05807704 BUSINESS ADDRESS: STREET 1: 1221 MCKINNEY ST STREET 2: SUITE 700 CITY: HOUSTON STATE: TX ZIP: 77010 BUSINESS PHONE: 713-652-7200 MAIL ADDRESS: STREET 1: 1221 MCKINNEY ST STREET 2: SUITE 700 CITY: HOUSTON STATE: TX ZIP: 77010 10-Q 1 d10q.htm FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 For The Quarterly Period Ended March 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 333-76473

EQUISTAR CHEMICALS, LP

(Exact name of registrant as specified in its charter)


Delaware		76-0550481
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1221 McKinney Street, Suite 700, Houston, Texas		77010
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (713) 652-7200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

There is no established public trading market for the registrant’s equity securities.

The Registrant meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and, therefore, is filing this form with a reduced disclosure format.

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

EQUISTAR CHEMICALS, LP

CONSOLIDATED STATEMENTS OF INCOME


	For the three months ended March 31,
Millions of dollars	2005			2004
Sales and other operating revenues:
Trade	$	2,242		$	1,490
Related parties		619			472

		2,861			1,962

Operating costs and expenses:
Cost of sales		2,417			1,857
Selling, general and administrative expenses		47			41
Research and development expenses		8			7
Gain on asset dispositions		—			(4	)

		2,472			1,901

Operating income		389			61

Interest expense		(56	)		(57	)
Interest income		2			2
Other expense, net		(3	)		(1	)

Net income	$	332		$	5

See Notes to the Consolidated Financial Statements.

EQUISTAR CHEMICALS, LP

CONSOLIDATED BALANCE SHEETS


Millions of dollars	March 31, 2005			December 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	140		$	39
Accounts receivable:
Trade, net		868			615
Related parties		239			211
Inventories		653			582
Prepaid expenses and other current assets		38			43

Total current assets		1,938			1,490

Property, plant and equipment, net		3,137			3,167
Investments		59			60
Other assets, net		351			357

Total assets	$	5,485		$	5,074

LIABILITIES AND PARTNERS’ CAPITAL
Current liabilities:
Accounts payable:
Trade	$	601		$	447
Related parties		88			85
Current maturities of long-term debt		150			1
Accrued liabilities		204			273

Total current liabilities		1,043			806

Long-term debt		2,162			2,312
Other liabilities and deferred revenues		390			395
Commitments and contingencies
Partners’ capital:
Partners’ accounts		1,912			1,580
Accumulated other comprehensive loss		(22	)		(19	)

Total partners’ capital		1,890			1,561

Total liabilities and partners’ capital	$	5,485		$	5,074

See Notes to the Consolidated Financial Statements.

EQUISTAR CHEMICALS, LP

CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the three months ended March 31,
Millions of dollars	2005			2004
Cash flows from operating activities:
Net income	$	332		$	5
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization		79			76
Deferred maintenance turnaround expenditures		(2	)		(17	)
Gain on asset dispositions		—			(4	)
Changes in assets and liabilities that provided (used) cash:
Accounts receivable		(268	)		—
Inventories		(71	)		(65	)
Accounts payable		149			(12	)
Accrued interest		(17	)		(17	)
Other assets and liabilities, net		(68	)		(39	)

Cash provided by (used in) operating activities		134			(73	)

Cash flows from investing activities:
Expenditures for property, plant and equipment		(35	)		(19	)
Proceeds from sales of assets		3			4

Cash used in investing activities		(32	)		(15	)

Cash flows from financing activities:
Repayment of long-term debt		(1	)		—

Cash used in financing activities		(1	)		—

Increase (decrease) in cash and cash equivalents		101			(88	)
Cash and cash equivalents at beginning of period		39			199

Cash and cash equivalents at end of period	$	140		$	111

See Notes to the Consolidated Financial Statements.

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS


1. Basis of Preparation		5

2. Company Ownership		5

3. Anticipated Accounting Changes		5

4. Accounts Receivable		5

5. Inventories		6

6. Property, Plant and Equipment, Net		6

7. Deferred Revenues		6

8. Long-Term Debt		7

9. Pension and Other Postretirement Benefits		7

10. Commitments and Contingencies		8

11. Comprehensive Income		9

12. Segment and Related Information		9

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Preparation

The accompanying consolidated financial statements are unaudited and have been prepared from the books and records of Equistar Chemicals, LP (“Equistar”) in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X for interim financial information. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and notes thereto for the year ended December 31, 2004 included in the Equistar 2004 Annual Report on Form 10-K.

2. Company Ownership

Equistar, a Delaware limited partnership which commenced operations on December 1, 1997, is owned 70.5% by Lyondell Chemical Company (“Lyondell”) and 29.5% by Millennium Chemicals Inc. (“Millennium”). Equistar became a wholly owned subsidiary of Lyondell as a result of Lyondell’s acquisition of Millennium on November 30, 2004. The consolidated financial statements of Equistar reflect its historical cost basis, and, accordingly, do not reflect any purchase accounting adjustments related to the acquisition by Lyondell of Millennium and Millennium’s interest in Equistar.

3. Anticipated Accounting Changes

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 153, Exchanges of Nonmonetary Assets (“SFAS No. 153”), which amends Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets, which is replaced with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is defined to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Equistar will be required to adopt SFAS No. 153 no later than the third quarter 2005 with prospective application. Equistar is currently evaluating the impact, if any, that implementation of SFAS No. 153 will have on its financial statements.

In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47. “Accounting for Conditional Asset Retirement Obligations,” which clarifies the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Conditional Asset Retirement Obligations,” as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of Equistar. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. Equistar is currently evaluating the impact of adopting this interpretation.

4. Accounts Receivable

Equistar has a four-year, $450 million accounts receivable sales facility. Pursuant to this facility, Equistar sells, through a wholly owned bankruptcy remote subsidiary, on an ongoing basis and without recourse, an interest in a pool of accounts receivable to financial institutions participating in the facility. Equistar is responsible for servicing the receivables. At March 31, 2005, there were no outstanding accounts receivable that had been sold under Equistar’s accounts receivable sales facility. The amount of outstanding accounts receivable that had been sold under the facility as of December 31, 2004 was $200 million.

In consideration of discounts offered to certain customers for early payment for product, some receivable amounts were collected in March 2005 and 2004 that otherwise would have been expected to be collected in April of the respective years. This included collections of $71 million and $39 million in March 2005 and 2004, respectively, from Occidental Chemical Corporation, a subsidiary of Occidental Petroleum Corporation (together with its subsidiaries and affiliates, collectively “Occidental”).

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

5. Inventories

Inventories consisted of the following:


Millions of dollars	March 31, 2005		December 31, 2004
Finished goods	$	404	$	355
Work-in-process		12		13
Raw materials		135		117
Materials and supplies		102		97

Total inventories	$	653	$	582

6. Property, Plant and Equipment, Net

The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows:


Millions of dollars	March 31, 2005			December 31, 2004
Land	$	77		$	77
Manufacturing facilities and equipment		6,088			6,079
Construction in progress		88			64

Total property, plant and equipment		6,253			6,220
Less accumulated depreciation		(3,116	)		(3,053	)

Property, plant and equipment, net	$	3,137		$	3,167

Depreciation and amortization is summarized as follows:


	For the three months ended March 31,
Millions of dollars	2005		2004
Property, plant and equipment	$	63	$	60
Turnaround costs		9		9
Software costs		4		4
Other		3		3

Total depreciation and amortization	$	79	$	76

7. Deferred Revenues

Deferred revenues at March 31, 2005 of $150 million represent advances from customers for partial prepayments for products to be delivered under long-term product supply contracts. Trade sales and other operating revenues include $4 million in each of the three-month periods ended March 31, 2005 and 2004, respectively, of such previously deferred revenues.

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

8. Long-Term Debt

Long-term debt consisted of the following:


Millions of dollars	March 31, 2005		December 31, 2004
Inventory-based revolving credit facility	$	—	$	—
Other debt obligations:
Notes due 2006, 6.50%		150		150
Senior Notes due 2008, 10.125%		700		700
Notes due 2009, 8.75%		600		600
Senior Notes due 2011, 10.625%		700		700
Debentures due 2026, 7.55%		150		150
Other		3		4
Unamortized premium, net		9		9

Total long-term debt		2,312		2,313
Less current maturities		150		1

Total long-term debt, net	$	2,162	$	2,312

Amortization of debt issuance costs of $1 million for each of the three-month periods ended March 31, 2005 and 2004 is included in interest expense in the Consolidated Statements of Income.

Lyondell remains a guarantor of $300 million of Equistar debt, consisting of the 6.5% notes due 2006 and the 7.55% debentures due 2026. The unaudited consolidated financial statements of Lyondell are filed as an exhibit to Equistar’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005.

9. Pension and Other Postretirement Benefits

Net periodic pension and other postretirement benefit costs included the following components for the three months ended March 31:


	Pension Benefits						Other Postretirement Benefits
Millions of dollars	2005			2004			2005		2004
Components of net periodic benefit cost:
Service cost	$	5		$	5		$	1	$	1
Interest cost		3			3			2		2
Recognized return on plan assets		(3	)		(3	)		—		—
Actuarial and investment loss amortization		1			1			—		—

Net periodic benefit cost	$	6		$	6		$	3	$	3

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

10. Commitments and Contingencies

Leased Facility—Equistar has an ethylene facility in Lake Charles, Louisiana that has been idled since the first quarter of 2001, pending sustained improvement in market conditions. The facility and land, which are included in property, plant and equipment at a net book value of $143 million, are leased from Occidental. In May 2003, Equistar and Occidental entered into a new one-year lease, which has renewal provisions for two additional one-year periods at either party’s option. Equistar exercised the second one-year renewal option in April 2005.

Environmental Remediation—Equistar’s accrued liability for environmental matters as of December 31, 2004 and March 31, 2005 was $1 million and primarily related to the Port Arthur facility, which was permanently shut down in February 2001. In the opinion of management, there is currently no material estimable range of possible loss in excess of the liability recorded for environmental remediation.

Clean Air Act—Under the Clean Air Act, the eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the U.S. Environmental Protection Agency (“EPA”) under a “one-hour” ozone standard. Emission reduction controls for nitrogen oxides (“NOx”) must be installed at each of Equistar’s six facilities in the Houston/Galveston region prior to the November 2007 compliance deadline for the one-hour ozone standard.

In addition, in December 2004, the regulatory agency for the state of Texas, the Texas Commission on Environmental Quality (“TCEQ”) finalized controls over highly reactive, volatile organic compounds (“HRVOCs”). Equistar is still assessing the impact of the HRVOC revisions. In addition, in April 2004, the EPA designated the eight-county Houston/Galveston region a moderate non-attainment area under an “eight-hour” ozone standard. As a result, the TCEQ must submit a plan to the EPA in 2007 to demonstrate compliance with the eight-hour ozone standard in 2010. Although the one-hour ozone standard expires in 2005, the controls under that standard will not be relaxed under the EPA’s new eight-hour transition rules. As a result, Equistar still will be required to meet the new emission standards for NOx and HRVOCs. The timing and amount of the estimated expenditures are subject to regulatory and other uncertainties, as well as to obtaining the necessary permits and approvals. The ultimate cost of implementing any plan developed to comply with the final ozone standards cannot be estimated at this time.

Other—Equistar is, from time to time, a defendant in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, management does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it currently is involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on the financial position, liquidity or results of operations of Equistar.

General—In the opinion of management, any liability arising from the matters discussed in this note is not expected to have a material adverse effect on the financial position or liquidity of Equistar. However, the adverse resolution in any reporting period of one or more of these matters discussed in this note could have a material impact on Equistar results of operations for that period, which may be mitigated by contribution or indemnification obligations of others, or by any insurance coverage that may be available.

EQUISTAR CHEMICALS, LP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

11. Comprehensive Income

The components of comprehensive income were as follows:


	For the three months ended March 31,
Millions of dollars	2005			2004
Net income	$	332		$	5
Other comprehensive loss		(3	)		(2	)

Comprehensive income	$	329		$	3

12. Segment and Related Information

Equistar operates in one reportable segment, ethylene, co-products and derivatives, which includes: the ethylene and co-products product group, including primarily ethylene, propylene, butadiene, fuels and aromatics; and the derivatives product group, including primarily ethylene oxide, ethylene glycol and polyethylene.

Although Equistar operates in one integrated reportable segment, Equistar has chosen to provide certain additional data, as shown below, for two product groups: the ethylene and co-products group, reflecting the products of the core ethylene manufacturing processes, and the derivative products group.


	Ethylene, Co-Products and Derivatives
In Millions	Ethylene & co-products		Derivatives			Eliminations			Consolidated
For the three months ended March 31, 2005:
Sales and other operating revenues:
Customers	$	1,890	$	971		$	—		$	2,861
Intersegment		599		—			(599	)		—

Total sales and other operating revenues		2,489		971			(599	)		2,861
Operating income		303		86			—			389

For the three months ended March 31, 2004:
Sales and other operating revenues:
Customers	$	1,245	$	717		$	—		$	1,962
Intersegment		461		—			(461	)		—

Total sales and other operating revenues		1,706		717			(461	)		1,962
Operating income (loss)		75		(14	)		—			61

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with information contained in the Consolidated Financial Statements of Equistar Chemicals, LP (“Equistar”) and the notes thereto.

In addition to comparisons of current operating results with the same period in the prior year, Equistar has included, as additional disclosure, certain “trailing quarter” comparisons of first quarter 2005 operating results to fourth quarter 2004 operating results. Equistar’s businesses are highly cyclical in addition to experiencing some less significant seasonal effects. Trailing quarter comparisons may offer important insight into the current business direction of Equistar.

References to industry benchmark prices or costs, including the weighted average cost of ethylene production, are generally to industry prices and costs reported by Chemical Marketing Associates, Incorporated (“CMAI”), except that crude oil and natural gas benchmark price references are to industry prices reported by Platts, a reporting service of The McGraw-Hill Companies.

Overview

General—Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene and aromatics, which include benzene and toluene. Equistar also manufactures and markets derivatives, primarily polyethylene (including high density polyethylene (“HDPE”), low density polyethylene (“LDPE”) and linear-low density polyethylene (“LLDPE”)), ethylene glycol, ethylene oxide and its derivatives, and ethanol. Equistar also produces fuels, such as methyl tertiary butyl ether (“MTBE”) and alkylate. As a result of the acquisition of Millennium Chemicals Inc. (“Millennium”) by Lyondell Chemical Company (“Lyondell”) on November 30, 2004, Equistar became a wholly owned subsidiary of Lyondell.

During 2004, the chemical industry experienced broad-based improvement as a strengthening global economy led to increases in demand and tighter chemical industry supply/demand balances. The improved market conditions in the first quarter 2005 led to higher sales prices and generally higher product margins for the industry compared to the first quarter 2004.

Equistar’s average sales prices for ethylene and derivatives in the first quarter 2005 were higher compared to the first quarter 2004. In addition, Equistar’s average sales prices for ethylene co-products such as propylene and benzene, and fuels were significantly higher and substantially offset the effect of higher raw material and energy costs in the first quarter 2005.

The higher raw material and energy costs in the first quarter 2005 compared to the first quarter 2004 reflected the effect of a significant escalation in crude oil prices and ongoing high natural gas prices. Benchmark crude oil and natural gas prices generally have been indicators of the level and direction of movement of raw material and energy costs for Equistar. Ethylene and its co-products are produced from two major raw material groups:

•

crude oil-based liquids (“liquids” or “heavy liquids”), including naphthas, condensates, and gas oils, the prices of which are generally related to crude oil prices; and

•

natural gas liquids (“NGLs”), principally ethane and propane, the prices of which are generally affected by natural gas prices.

Equistar has the ability to shift its ratio of raw materials used in the production of ethylene and co-products to take advantage of the relative costs of liquids and NGLs.

The following table shows the average U.S. benchmark prices for crude oil and natural gas for the applicable three-month period, as well as benchmark U.S. sales prices for ethylene and co-product propylene, which Equistar produces and sells. The benchmark weighted average cost of ethylene production, which is reduced by co-product revenues, is based on CMAI’s estimated average ratio of crude-oil based liquid and NGL raw materials used in U.S. ethylene production and is subject to revision.


	Average Benchmark Price and Percent Change Versus Prior Year Period Average
	First Quarter 2005	Percent Change		First Quarter 2004
Crude oil – dollars per barrel	49.65	41	%	35.20
Natural gas – dollars per million BTUs	5.98	13	%	5.31
Weighted average cost of ethylene production– cents per pound	23.34	6	%	22.12
Ethylene – cents per pound	41.50	32	%	31.50
Propylene – cents per pound	43.50	59	%	27.42

As indicated in the above table, benchmark crude oil prices and natural gas prices increased, resulting in higher raw material and energy costs in the first quarter 2005 compared to the first quarter 2004.

RESULTS OF OPERATIONS

Revenues—Equistar’s revenues of $2,861 million in the first quarter 2005 increased 46% compared to revenues of $1,962 million in the first quarter 2004, reflecting higher average sales prices. Benchmark sales prices of ethylene were 32% higher, benzene averaged 67% higher, and propylene sales prices averaged 59% higher in the first quarter 2005 compared to the first quarter 2004. Benchmark sales prices of HDPE averaged 38% higher in the first quarter 2005 than in the first quarter 2004. Ethylene and derivative sales volumes in the first quarter 2005 were comparable to the first quarter 2004.

Cost of Sales—Equistar’s cost of sales was $2,417 million in the first quarter 2005 and $1,857 million in the first quarter 2004. The 30% increase reflects the higher cost of liquids and, to a lesser extent, NGL raw materials. The cost of liquid raw materials was affected by 41% higher crude oil costs in the first quarter 2005 compared to the first quarter 2004.

Operating Income—Equistar had operating income of $389 million in the first quarter 2005 and $61 million in the first quarter 2004. The improvement of $328 million was primarily due to higher product margins compared to the first quarter 2004. The higher first quarter 2005 product margins were a result of higher average sales prices, especially for co-products propylene and benzene, and fuels which substantially offset significant increases in the costs of raw materials compared to the first quarter 2004. Sales prices of ethylene derivatives also increased significantly in the first quarter 2005 compared to the first quarter 2004.

Net Income—Equistar had net income of $332 million in the first quarter 2005 compared to $5 million in the first quarter 2004. The $327 million improvement was primarily due to the above-noted $328 million increase in the first quarter 2005 operating income compared to the first quarter 2004.

First Quarter 2005 versus Fourth Quarter 2004

Equistar’s first quarter 2005 net income of $332 million compares to net income of $156 million in the fourth quarter 2004. The $176 million improvement primarily resulted from higher sales prices for ethylene derivatives and co-products, which more than offset higher raw material costs of heavy liquids attributable to higher crude oil prices in the first quarter 2005 compared to the fourth quarter 2004. The first quarter 2005 also benefited from lower prices for NGL raw materials, which decreased compared to the fourth quarter 2004. Ethylene and derivative sales volumes were 5% lower compared to the fourth quarter 2004 due to lower export sales of polyethylene. Although benchmark crude oil prices averaged only 3% higher in the first quarter 2005 than in the fourth quarter of 2004, benchmark crude oil prices escalated significantly at the end of the first quarter 2005.

Product Group Analysis

The following analysis discusses Equistar’s operating results, focusing on two product groups: ethylene and co-products; and derivatives. Ethylene co-products primarily include propylene, butadiene, fuels, which include MTBE and alkylates, and aromatics, which include benzene and toluene. Derivatives primarily include polyethylene, ethylene glycol, ethylene oxide and its derivatives, and ethanol and polypropylene.

The following tables reflect selected sales data, including sales of ethylene and co-products used as derivative raw materials, and summarized financial information for the two product groups.


	For the three months ended March 31,
Millions of dollars	2005			2004
Sales and other operating revenues:
Ethylene and co-products	$	2,489		$	1,706
Derivatives		971			717
Ethylene and co-products sales included in derivatives		(599	)		(461	)

Total	$	2,861		$	1,962

Operating income (loss):
Ethylene and co-products	$	303		$	75
Derivatives		86			(14	)

Total	$	389		$	61


Volumes in millions
Selected ethylene and co-products:
Ethylene and co-products (pounds)		4,521			4,277
Aromatics (gallons)		102			93
Derivatives products (pounds)		1,754			1,887

Ethylene and co-products

Revenues—Revenues of $2,489 million in the first quarter 2005 increased 46% compared to revenues of $1,706 million in the first quarter 2004, reflecting higher sales prices and a 6% increase in sales volumes. Benchmark ethylene sales prices averaged 32% higher in the first quarter 2005 compared to the first quarter 2004, while increases in sales prices of co-products were much more significant. Benchmark sales prices for benzene and propylene averaged 67% and 59% higher, respectively, in the first quarter 2005 compared to the first quarter 2004.

Operating Income—Operating income in the first quarter 2005 of $303 million compares to $75 million in the first quarter 2004. The improvement of $228 million was primarily due to higher product margins and higher sales volumes in the first quarter 2005 due to improved supply/demand fundamentals compared to the first quarter 2004.

Derivatives

Revenues—Revenues of $971 million in the first quarter 2005 increased 35% compared to revenues of $717 million in the first quarter 2004, reflecting higher average sales prices partially offset by lower sales volumes. Sales volumes in the first quarter 2005 decreased 7% compared to the first quarter 2004 due to scheduled maintenance at an ethylene glycol production unit in the first quarter 2005.

Operating Income (Loss)—Operating income for derivatives was $86 million in the first quarter 2005 compared to an operating loss of $14 million in the first quarter 2004. The $100 million improvement was primarily the result of higher product margins as sales prices increased more than raw material costs compared to the first quarter 2004, partially offset by higher costs due to scheduled maintenance at an ethylene glycol production unit in the first quarter 2005.

FINANCIAL CONDITION

Operating Activities—Operating activities provided cash of $134 million in the first quarter 2005 and used cash of $73 million in the first quarter 2004. The $207 million change primarily reflects the improvement in first quarter 2005 net income, which was partly offset by a net increase in the main components of working capital – receivables, inventory and payables – in the first quarter 2005 compared to the first quarter of 2004. The first quarter of each year includes significant payments of annual and semiannual property taxes, interest and compensation related items, which totaled $151 million in 2005 and $116 million in 2004.

In the first quarter 2005 and 2004, increases in the main components of working capital used cash of $190 million and $77 million, respectively. The increase in the first quarter 2005 compared to the first quarter 2004 was primarily due to an increase in accounts receivable, partly offset by an increase in accounts payable.

In total, receivables showed a $268 million increase in the first quarter 2005 and no change in the first quarter 2004. The increase in the first quarter 2005 primarily reflected a decrease in the amount of accounts receivable sold under Equistar’s accounts receivable sales facility and, to a lesser extent, the effect of higher average sales prices in the first quarter 2005. The balance of Equistar’s accounts receivable sold under its accounts receivable sales facility decreased $200 million during the first quarter 2005. At March 31, 2005, no accounts receivable had been sold under Equistar’s accounts receivable sales facility. During the first quarter 2004, the balance of accounts receivable sold increased $115 million to $217 million at March 31, 2004.

Accounts payable increased $149 million in the first quarter 2005 compared to a $12 million decrease in the first quarter 2004. The first quarter 2005 payables increase primarily reflected the effect of higher crude oil prices on liquids raw material costs. Crude oil prices reached a high of $54.30 per barrel in March 2005 compared to $36.70 per barrel in March 2004.

Investing Activities—Investing activities used cash of $32 million and $15 million in the first quarter 2005 and first quarter 2004, respectively. Equistar’s capital expenditures were $35 million in the first quarter of 2005 and $19 million in the first quarter 2004. The higher level of expenditures in the first quarter 2005 reflects increased spending for regulatory and environmental compliance projects. Equistar’s capital budget for 2005 is $167 million.

Financing Activities—Cash used by financing activities was $1 million in the first quarter of 2005. Equistar repaid $1 million of medium-term loans during the first quarter of 2005. There were no financing activities during the first quarter 2004.

Equistar did not make distributions to its owners in the first quarter 2005, but Equistar resumed making cash distributions in the second quarter 2005. Equistar did not make distributions to its owners in the first quarter 2004.

Liquidity and Capital Resources—At March 31, 2005, Equistar’s long-term debt, including current maturities, totaled $2.3 billion, or approximately 55% of its total capitalization. Current maturities include $150 million of 6.50% notes due in February 2006. Equistar had cash on hand of $140 million. In addition, the total amount available at March 31, 2005 under both the $250 million inventory-based revolving credit facility and the $450 million accounts receivable sales facility was approximately $618 million, which gives effect to the borrowing base and is net of a $50 million unused availability requirement, amounts sold under the accounts receivable sales facility, of which there were none at March 31, 2005, and $32 million of outstanding letters of credit under the revolving credit facility as of March 31, 2005. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The revolving credit facility requires that the unused available amounts under that facility and the $450 million accounts receivable sales facility equal or exceed $50 million, or $100 million, if the interest coverage ratio, as defined, is less than 2:1. There was no borrowing under the revolving credit facility at March 31, 2005.

Equistar’s ability to pay or refinance its debt will depend on future operating performance, which could be affected by general economic, financial, competitive, legislative, regulatory, business and other factors, many of which are beyond its control. Management believes that conditions will be such that cash balances, cash flow from operations, cash generated from higher utilization of the accounts receivable sales facility and funding under the credit facility will be adequate to meet anticipated future cash requirements, including scheduled debt repayments, other contractual obligations, necessary capital expenditures and ongoing operations. In the first quarter 2005, Standard & Poors (“S&P”) upgraded Equistar’s debt rating from B+ to BB- and gave Equistar a positive outlook. According to S&P, the rating action reflected favorable prospects over the intermediate term and the strong expectation that management will continue to prioritize debt reduction as the chemicals cycle gradually improves.

Long-Term Debt—The $250 million inventory-based revolving credit facility and the indentures governing Equistar’s Senior Notes contain restrictive covenants. These restrictive covenants are described in Item 7 of Equistar’s Annual Report on Form 10-K for the year ended December 31, 2004. There have been no changes in the quarter ended March 31, 2005. The credit facility does not require Equistar to maintain specified financial ratios. The breach of the covenants could permit the lenders or noteholders to declare any outstanding debt payable and could permit the lenders under Equistar’s credit facility to terminate future lending commitments. In addition, some of Equistar’s indentures require additional interest payments to the noteholders if Equistar makes distributions when Equistar does not meet a specified fixed charge coverage ratio. Equistar met this ratio and was in compliance with all covenants under these agreements as of March 31, 2005.

Off-Balance Sheet Arrangements—Equistar’s off-balance sheet arrangements are described in Item 7 of its Annual Report on Form 10-K for the year ended December 31, 2004. Equistar’s off-balance sheet arrangements did not change materially in the quarter ended March 31, 2005, except as noted below.

At March 31, 2005, no accounts receivable had been sold under Equistar’s accounts receivable sales facility. The balance that had been sold as of December 31, 2004 was $200 million. The facility accelerates availability to the business of cash from product sales that otherwise would have been collected over the normal billing and collection cycle. The availability of the accounts receivable sales facility provides one element of Equistar’s ongoing sources of liquidity and capital resources. Upon termination of the facility, cash collections related to accounts receivable then in the pool would first be applied to the outstanding interest sold, but Equistar would in no event be required to repurchase such interest. See Note 4 to the Consolidated Financial Statements for additional information on accounts receivable.

CURRENT BUSINESS OUTLOOK

Business conditions continue to be positive for the majority of Equistar’s products, and Equistar is continuing to benefit from the competitive advantage provided by its crude oil-based ethylene facilities. Some product prices have weakened compared to the levels experienced in the first quarter 2005. However, these prices remain above average fourth quarter 2004 levels.

Supply/demand conditions for the majority of Equistar’s products remain strong and, despite minor disruptions and market corrections, Equistar expects continued strengthening across its product portfolio. Equistar’s view of industry fundamentals and its belief in the strength of the cyclical recovery are unaltered.

ANTICIPATED ACCOUNTING CHANGES

Item 3. Disclosure of Market and Regulatory Risk

Equistar’s exposure to market and regulatory risks is described in Item 7a of its Annual Report on Form 10-K for the year ended December 31, 2004. Equistar’s exposure to market and regulatory risks has not changed materially in the quarter ended March 31, 2005.

Item 4. Controls and Procedures

Equistar performed an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer (principal executive officer) and Senior Vice President and Chief Financial Officer (principal financial officer), of the effectiveness of Equistar’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of March 31, 2005. Based upon that evaluation, the Chief Executive Officer and the Senior Vice President and Chief Financial Officer concluded that Equistar’s disclosure controls and procedures are effective.

There were no changes in Equistar’s internal control over financial reporting that occurred during Equistar’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, Equistar’s internal control over financial reporting.

FORWARD-LOOKING STATEMENTS

Certain of the statements contained in this report are “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements can be identified by words such as “estimate,” “believe,” “expect,” “anticipate,” “plan,” “budget” or other words that convey the uncertainty of future events or outcomes. Many of these forward-looking statements have been based on expectations and assumptions about future events that may prove to be inaccurate. While management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond Equistar’s control. Equistar’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to:

•

the availability, cost and price volatility of raw materials and utilities,

•

uncertainties associated with the U.S. and worldwide economies, including those due to political tensions in the Middle East and elsewhere,

•

current and potential governmental regulatory actions in the U.S. and in other countries,

•

terrorist acts and international political unrest,

•

operating interruptions (including leaks, explosions, fires, weather-related incidents, mechanical failures, unscheduled downtimes, supplier disruptions, labor difficulties, transportation interruptions, spills and releases and other environmental risks),

•

legal and environmental proceedings,

•

the cyclical nature of the chemical industry,

•

competitive products and pricing pressures,

•

the supply/demand balances for Equistar’s products, and the related effects of industry production capacities and operating rates,

•

access to capital markets,

•

technological developments, and

•

Equistar’s ability to implement its business strategies.

Any of the factors, or a combination of these factors, could materially affect Equistar’s future results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of Equistar’s future performance, and Equistar’s actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels.

All forward-looking statements in this Form 10-Q are qualified in their entirety by the cautionary statements contained in this section and in Equistar’s Annual Report on Form 10-K for the year ended December 31, 2004. These factors are not necessarily all of the important factors that could affect Equistar. Use caution and common sense when considering these forward-looking statements. Equistar does not intend to update these statements unless securities laws require it to do so.

In addition, this Form 10-Q contains summaries of contracts and other documents. These summaries may not contain all of the information that is important to an investor, and reference is made to the actual contract or document for a more complete understanding of the contract or document involved.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

There have been no material developments with respect to Equistar’s legal proceedings previously reported in the Annual Report on Form 10-K for the year ended December 31, 2004.

Item 6. Exhibits


31.1		Rule 13a – 14(a)/15d – 14(a) Certification of Principal Executive Officer

31.2		Rule 13a – 14(a)/15d – 14(a) Certification of Principal Financial Officer

32.1		Section 1350 Certification of Principal Executive Officer

32.2		Section 1350 Certification of Principal Financial Officer

99.1		Consolidated Financial Statements (Unaudited) of Lyondell Chemical Company

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		Equistar Chemicals, LP

Dated: May 6, 2005		/s/ Charles L. Hall
		Charles L. Hall
		Vice President and Controller
		(Duly Authorized and Principal Accounting Officer)

EX-31.1 2 dex311.htm SECTION 302 CEO CERTIFICATION Section 302 CEO Certification

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

I, Dan F. Smith, Chief Executive Officer of Equistar Chemicals, LP, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Equistar Chemicals, LP;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have:

(a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: May 6, 2005		/s/ Dan F. Smith
		Dan F. Smith
		Chief Executive Officer
		(Principal Executive Officer)

EX-31.2 3 dex312.htm SECTION 302 CFO CERTIFICATION Section 302 CFO Certification

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

I, T. Kevin DeNicola, Senior Vice President and Chief Financial Officer of Equistar Chemicals, LP, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Equistar Chemicals, LP;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(a)

(b)

(c)

(d)

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)

(b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: May 6, 2005		/s/ T. Kevin DeNicola
		T. Kevin DeNicola
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer)

EX-32.1 4 dex321.htm SECTION 906 CEO CERTIFICATION Section 906 CEO Certification

Exhibit 32.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

In connection with the accompanying Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 (the “Periodic Report”), I, Dan F. Smith, Chief Executive Officer of Equistar Chemicals, LP, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	the Periodic Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78m or 78o(d)); and

(2)	the information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of Equistar Chemicals, LP.


Date: May 6, 2005		/s/ Dan F. Smith
		Dan F. Smith
		Chief Executive Officer

A signed original of this written statement required by Section 906 has been provided to Equistar Chemicals, LP and will be retained by Equistar Chemicals, LP and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2 5 dex322.htm SECTION 906 CFO CERTIFICATION Section 906 CFO Certification

Exhibit 32.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

In connection with the accompanying Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 (the “Periodic Report”), I, T. Kevin DeNicola, Senior Vice President and Chief Financial Officer of Equistar Chemicals, LP, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	the Periodic Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78m or 78o(d)); and

(2)	the information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of Equistar Chemicals, LP.


Date: May 6, 2005		/s/ T. Kevin DeNicola
		T. Kevin DeNicola
		Senior Vice President and Chief Financial Officer

EX-99.1 6 dex991.htm CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF LYONDELL CHEMICAL COMPANY Consolidated Financial Statements (Unaudited) of Lyondell Chemical Company

EXHIBIT 99.1

LYONDELL CHEMICAL COMPANY

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)


	For the three months ended March 31,
Millions of dollars, except per share data	2005			2004
Sales and other operating revenues:
Trade	$	4,151		$	1,093
Related parties		295			12

		4,446			1,105

Operating costs and expenses:
Cost of sales		3,784			1,029
Selling, general and administrative expenses		129			45
Research and development expenses		23			8

		3,935			1,082

Operating income		510			23

Interest expense		(169	)		(111	)
Interest income		11			2
Other expense, net		(23	)		(1	)

Income (loss) before equity investments and income taxes		329			(87	)

Income from equity investments:
LYONDELL-CITGO Refining LP		67			56
Equistar Chemicals, LP		—			6
Other		1			1

		68			63

Income (loss) before income taxes		397			(24	)

Provision for (benefit from) income taxes		143			(9	)

Net income (loss)	$	254		$	(15	)

Earnings (loss) per share:
Basic	$	1.04		$	(0.08	)

Diluted	$	0.98		$	(0.08	)

See Notes to the Consolidated Financial Statements.

LYONDELL CHEMICAL COMPANY

CONSOLIDATED BALANCE SHEETS


Millions, except shares and par value data	March 31, 2005			December 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	689		$	804
Accounts receivable:
Trade, net		1,770			1,437
Related parties		128			132
Inventories		1,746			1,619
Prepaid expenses and other current assets		146			189
Deferred tax assets		238			276

Total current assets		4,717			4,457
Property, plant and equipment, net		7,055			7,215
Investments and long-term receivables:
Investment in PO joint ventures		814			838
Investment in and receivable from LYONDELL-CITGO Refining LP		188			192
Other investments and long-term receivables		161			160
Goodwill, net		2,175			2,175
Other assets, net		909			891

Total assets	$	16,019		$	15,928

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable:
Trade	$	1,191		$	1,071
Related parties		123			126
Current maturities of long-term debt		256			308
Accrued liabilities		760			790

Total current liabilities		2,330			2,295
Long-term debt		7,386			7,555
Other liabilities		1,750			1,747
Deferred income taxes		1,587			1,477
Commitments and contingencies
Minority interest		172			181
Stockholders’ equity:
Common stock, $1.00 par value, 420,000,000 shares authorized, 246,877,485 and 244,541,913 shares issued, respectively		247			245
Additional paid-in capital		3,034			3,000
Retained deficit		(402	)		(600	)
Accumulated other comprehensive income (loss)		(58	)		56
Treasury stock, at cost, 826,151 and 856,915 shares, respectively		(27	)		(28	)

Total stockholders’ equity		2,794			2,673

Total liabilities and stockholders’ equity	$	16,019		$	15,928

See Notes to the Consolidated Financial Statements.

LYONDELL CHEMICAL COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the three months ended March 31,
Millions of dollars	2005			2004
Cash flows from operating activities:
Net income (loss)	$	254		$	(15	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		178			63
Income from equity investments		(68	)		(63	)
Distributions of earnings from affiliates		67			56
Deferred income taxes		115			(10	)
Debt prepayment premiums and charges		12			—
Changes in assets and liabilities that provided (used) cash:
Accounts receivable		(342	)		(26	)
Inventories		(136	)		11
Accounts payable		133			(6	)
Other assets and liabilities, net		(49	)		58

Net cash provided by operating activities		164			68

Cash flows from investing activities:
Expenditures for property, plant and equipment		(58	)		(11	)
Distributions from affiliates in excess of earnings		35			18
Contributions and advances to affiliates		(30	)		(13	)
Other		3			—

Net cash used in investing activities		(50	)		(6	)

Cash flows from financing activities:
Repayment of long-term debt		(211	)		—
Dividends paid		(55	)		(31	)
Proceeds from stock option exercises		34			4
Other		(2	)		(1	)

Net cash used in financing activities		(234	)		(28	)

Effect of exchange rate changes on cash		5			(1	)

(Decrease) increase in cash and cash equivalents		(115	)		33
Cash and cash equivalents at beginning of period		804			438

Cash and cash equivalents at end of period	$	689		$	471

See Notes to the Consolidated Financial Statements.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

TABLE OF CONTENTS


1.	Basis of Preparation	5

2.	Description of the Company	5

3.	Acquisition of Millennium Chemicals Inc.	5

4.	Accounting Changes	6

5.	Investment in PO Joint Ventures	7

6.	Equity Interest in Equistar Chemicals, LP	8

7.	Equity Interest in LYONDELL-CITGO Refining LP	8

8.	Accounts Receivable	9

9.	Inventories	10

10.	Property, Plant and Equipment and Goodwill	10

11.	Long-Term Debt	11

12.	Pension and Other Postretirement Benefits	12

13.	Commitments and Contingencies	13

14.	Per Share Data	17

15.	Comprehensive Income	18

16.	Segment and Related Information	18

17.	Supplemental Guarantor Information	19

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

1. Basis of Preparation

The accompanying consolidated financial statements are unaudited and have been prepared from the books and records of Lyondell Chemical Company in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X for interim financial information. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and notes thereto for the year ended December 31, 2004 included in the Lyondell Chemical Company 2004 Annual Report on Form 10-K.

2. Description of the Company

Lyondell Chemical Company (“LCC”), together with its consolidated subsidiaries (collectively, “Lyondell” or “the Company”), is a global chemical company that manufactures and markets a variety of basic chemicals and gasoline blending components. As a result of Lyondell’s acquisition of Millennium Chemicals Inc. (“Millennium”) and Lyondell’s resulting 100% ownership of Millennium and Equistar Chemicals, LP (“Equistar”), the operations of Millennium and Equistar are consolidated prospectively from December 1, 2004 (see Note 3). Prior to December 1, 2004, Lyondell accounted for its investment in Equistar using the equity method of accounting (see Note 6).

3. Acquisition of Millennium Chemicals Inc.

On November 30, 2004, Lyondell completed the acquisition of Millennium, in a stock-for-stock business combination, to, among other things, broaden the Company’s product base and to consolidate ownership of Equistar. In the acquisition, Lyondell issued 63.1 million shares of Lyondell common stock to Millennium’s shareholders, and Millennium became a wholly owned subsidiary of Lyondell. Millennium owns a 29.5% interest in Equistar, which, upon completion of the acquisition, also became a wholly owned subsidiary of Lyondell.

The aggregate purchase price was $1,469 million, including the 63.1 million shares of Lyondell common stock valued at $1,438 million, payment of transaction costs of $20 million and the fair value of employee stock options of approximately $11 million.

The unaudited pro forma combined historical results of Lyondell, Millennium and Equistar for the three months ended March 31, 2004, giving effect to the acquisition assuming the transaction was consummated as of the beginning of 2004 are as follows:


Millions of dollars, except per share data	For the three months ended March 31, 2004
Sales and other operating revenues	$	3,345
Net loss		(26	)
Basic loss per share		(0.11	)
Diluted loss per share		(0.11	)

The unaudited pro forma data presented above are not necessarily indicative of the results of operations of Lyondell that would have occurred had such transaction actually been consummated as of the beginning of 2004, nor are they necessarily indicative of future results of operations.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The purchase price of $1,469 million was allocated to the assets acquired and liabilities assumed based upon the estimated fair values of such assets and liabilities at the date of acquisition. The purchase price allocations used in the preparation of the December 31, 2004 and March 31, 2005 financial statements are preliminary due to the continuing analyses relating to the determination of the fair values of the assets acquired and liabilities assumed. Based upon additional information received to date, the fair values of the assets acquired and liabilities assumed were adjusted during the three-month period ended March 31, 2005. The adjustments and their effect on goodwill for the first three months ended March 31, 2005 are summarized in Note 10.

Any further changes to the fair values of net assets acquired would result in additional adjustment to the fair value of the assets acquired and liabilities assumed and corresponding adjustment to goodwill. Management does not expect the finalization of these matters to have a material effect on the allocation. No goodwill that would be deductible for income tax purposes was created by the acquisition.

4. Accounting Changes

In the first quarter 2003, Lyondell adopted the “fair value” method of accounting for employee stock options, the preferred method as defined by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation using the prospective transition method. Under the prospective transition method, an estimate of the fair value of options granted to employees during 2003 and thereafter is charged to earnings over the related vesting periods. Prior to 2003, Lyondell accounted for employee stock options under the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation expense was recognized in connection with stock options granted prior to 2003. Pro forma compensation expense related to stock options for each of the three month periods ended March 31, 2005 and 2004 was less than $1 million.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payment. The primary focus of this Statement is accounting for transactions in which an entity obtains employee services in share-based payment transactions, such as by the granting of stock options. Lyondell will be required to apply the provisions of SFAS No. 123 (revised 2004) in the first quarter 2006. SFAS No. 123 (revised 2004) may affect the computation and resulting fair value of Lyondell’s share-based payment transactions with employees. Lyondell is evaluating the impact, if any, of adopting SFAS No. 123 (revised 2004) on its financial statements.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets, which is replaced with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is defined to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Lyondell will be required to adopt SFAS No. 153 no later than the third quarter 2005 with prospective application. Lyondell is currently evaluating the impact, if any, that implementation of SFAS No. 153 will have on its financial statements.

In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47. “Accounting for Conditional Asset Retirement Obligations,” which clarifies the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Conditional Asset Retirement Obligations,” as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of Lyondell. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. Lyondell is currently evaluating the impact of adopting this interpretation.

5. Investment in PO Joint Ventures

Lyondell, together with Bayer AG and Bayer Corporation (collectively “Bayer”), share interests in a U.S. PO manufacturing joint venture (the “U.S. PO Joint Venture”) and a separate joint venture for certain related PO technology. Bayer’s ownership interest represents ownership of an in-kind portion of the PO production of the U.S. PO Joint Venture. Bayer’s share of PO production is 1.6 billion pounds annually. Lyondell takes in kind the remaining PO production and all co-product (SM and TBA) production from the U.S. PO Joint Venture.

In addition, Lyondell and Bayer each have a 50% interest in a separate manufacturing joint venture (the “European PO Joint Venture”), which includes a world-scale PO/SM plant at Maasvlakte near Rotterdam, the Netherlands. Lyondell and Bayer each are entitled to 50% of the PO and SM production of the European PO Joint Venture.

Changes in Lyondell’s investment in the U.S. and European PO joint ventures for the three months ended March 31, 2004 and 2005 are summarized as follows:


Millions of dollars	U.S. PO Joint Venture			European PO Joint Venture			Total PO Joint Ventures
Investment in PO joint ventures – January 1, 2004	$	570		$	296		$	866
Cash contributions		2			2			4
Depreciation and amortization		(8	)		(3	)		(11	)
Effect of exchange rate changes		—			(19	)		(19	)

Investment in PO joint ventures – March 31, 2004	$	564		$	276		$	840

Investment in PO joint ventures – January 1, 2005	$	541		$	297		$	838
Cash contributions (distributions)		4			(4	)		—
Depreciation and amortization		(8	)		(3	)		(11	)
Effect of exchange rate changes		—			(13	)		(13	)

Investment in PO joint ventures – March 31, 2005	$	537		$	277		$	814

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

6. Equity Interest in Equistar Chemicals, LP

As a result of Lyondell’s acquisition of Millennium and Lyondell’s resulting 100% ownership of Equistar, the operations of Equistar are consolidated prospectively from December 1, 2004 (see Notes 2 and 3). Prior to December 1, 2004, Lyondell accounted for its 70.5% interest in Equistar using the equity method of accounting, because of Lyondell’s and Millennium’s joint control of certain key management decisions, including approval of the strategic plan, capital expenditures and annual budget, issuance of additional debt and the appointment of executive management of the partnership. As a partnership, Equistar is not subject to federal income taxes.

Summarized financial information for Equistar follows for the three months ended March 31, 2004.


Millions of dollars
STATEMENT OF INCOME
Sales and other operating revenues	$	1,962
Cost of sales		1,857
Selling, general and administrative expenses		41
Research and development expenses		7
Gain on asset dispositions		4

Operating income		61
Interest expense, net		(55	)
Other expense, net		(1	)

Net income	$	5

Lyondell’s income from its investment in Equistar consisted of Lyondell’s share of Equistar’s income and accretion of Lyondell’s investment in Equistar up to its underlying equity in Equistar’s net assets. At March 31, 2004, Lyondell’s underlying equity in Equistar’s net assets exceeded the carrying value of its investment in Equistar by approximately $162 million. This difference was being recognized in income over 14 years.

7. Equity Interest in LYONDELL-CITGO Refining LP

Lyondell’s refining operations are conducted through its joint venture ownership interest in LYONDELL-CITGO Refining LP (“LCR”). Lyondell has a 58.75% interest in LCR, while CITGO Petroleum Corporation (“CITGO”) has a 41.25% interest. Because the partners jointly control certain key management decisions, including approval of the strategic plan, capital expenditures and annual budget, issuance of debt and the appointment of the executive management of the partnership, Lyondell accounts for its investment in LCR using the equity method of accounting. As a partnership, LCR is not subject to federal income taxes.

Lyondell’s investment in and receivable from LCR consisted of the following:


Millions of dollars	March 31, 2005			December 31, 2004
Investment in LCR	$	(41	)	$	(37	)
Receivable from LCR		229			229

Investment in and receivable from LCR	$	188		$	192

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Summarized financial information for LCR follows:


Millions of dollars	March 31, 2005		December 31, 2004
BALANCE SHEETS
Total current assets	$	515	$	359
Property, plant and equipment, net		1,243		1,227
Other assets		62		61

Total assets	$	1,820	$	1,647

Current liabilities	$	845	$	588
Long-term debt		442		443
Loans payable to partners		264		264
Other liabilities		113		112
Partners’ capital		156		240

Total liabilities and partners’ capital	$	1,820	$	1,647


	For the three months ended March 31,
	2005			2004
STATEMENTS OF INCOME
Sales and other operating revenues	$	1,536		$	1,154
Cost of sales		1,406			1,037
Selling, general and administrative expenses		12			16

Operating income		118			101
Interest expense, net		(8	)		(10	)

Net income	$	110		$	91

SELECTED ADDITIONAL INFORMATION
Depreciation and amortization	$	28		$	30
Expenditures for property, plant and equipment		34			15

Lyondell’s income from its investment in LCR consists of Lyondell’s share of LCR’s net income and accretion of Lyondell’s investment in LCR up to its underlying equity in LCR’s net assets. At March 31, 2005, Lyondell’s underlying equity in LCR’s net assets exceeded its investment in LCR by approximately $253 million. This difference will be recognized in income over the next 23 years.

8. Accounts Receivable

Lyondell has two four-year, accounts receivable sales facilities of $150 million and $450 million, relating to LCC and Equistar, respectively. Pursuant to these facilities, Lyondell sells, through two wholly owned bankruptcy remote subsidiaries, on an ongoing basis and without recourse, an interest in pools of domestic accounts receivable to financial institutions participating in the facilities. Lyondell is responsible for servicing the receivables. The outstanding amounts of receivables sold under the facilities were $75 million and $275 million as of March 31, 2005 and December 31, 2004, respectively.

In consideration of discounts offered to certain customers for early payment for product, some receivable amounts were collected in March 2005 that otherwise would have been expected to be collected in April 2005. This included collections of $71 million in March 2005, related to Equistar receivables, from Occidental Chemical Corporation, a subsidiary of Occidental Petroleum Corporation (together with its subsidiaries and affiliates, collectively “Occidental”).

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

9. Inventories

Inventories consisted of the following components:


Millions of dollars	March 31, 2005		December 31, 2004
Finished goods	$	1,116	$	1,014
Work-in-process		106		108
Raw materials		308		290
Materials and supplies		216		207

Total inventories	$	1,746	$	1,619

10. Property, Plant and Equipment and Goodwill

The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows:


Millions of dollars	March 31, 2005			December 31, 2004
Land	$	189		$	190
Manufacturing facilities and equipment		9,132			9,224
Construction in progress		210			187

Total property, plant and equipment		9,531			9,601
Less accumulated depreciation		(2,476	)		(2,386	)

Property, plant and equipment, net	$	7,055		$	7,215

Depreciation and amortization is summarized as follows:


	For the three months ended March 31,
Millions of dollars	2005		2004
Property, plant and equipment	$	133	$	44
Investment in PO joint ventures		11		12
Turnaround costs		14		3
Software costs		10		2
Other		10		2

Total depreciation and amortization	$	178	$	63

The increase in depreciation and amortization in the first quarter 2005 primarily reflects the consolidation of Millennium and Equistar prospectively from December 1, 2004.

The following table summarizes the changes to Lyondell’s goodwill during the three months ended March 31, 2005 by reportable segment. Lyondell’s reportable segments include ethylene, co-products and derivatives (“EC&D”), propylene oxide and related products (“PO&RP”), and inorganic chemicals (see Note 16). The refining segment consists of Lyondell’s equity investment in LCR (see Note 7).


Millions of dollars	EC&D			PO&RP			Inorganic Chemicals		Total
Goodwill at January 1, 2005	$	270		$	1,080		$	825	$	2,175
Adjustments to preliminary purchase price allocation related to November 30, 2004 acquisition of Millennium		(3	)		—			12		9
Settlement of income tax issues related to 1998 acquisition of ARCO Chemical Company		—			(9	)		—		(9	)

Goodwill at March 31, 2005	$	267		$	1,071		$	837	$	2,175

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

11. Long-Term Debt

Lyondell’s long-term debt includes credit facilities and debt obligations maintained by Lyondell’s wholly owned subsidiaries, Equistar and Millennium. LCC has not guaranteed the subsidiaries’ credit facilities or debt obligations, except for $300 million of Equistar debt, consisting of the 6.5% Notes due 2006 and the 7.55% Debentures due 2026.

Long-term debt consisted of the following:


Millions of dollars	March 31, 2005			December 31, 2004
Bank credit facilities:
LCC $475 million senior secured revolving credit facility	$	—		$	—
Equistar $250 million inventory-based revolving credit facility		—			—
Millennium $150 million revolving credit facility		—			—

LCC notes and debentures:
Senior Secured Notes, Series A due 2007, 9.625%		900			900
Senior Secured Notes, Series B due 2007, 9.875%		500			700
Senior Secured Notes due 2008, 9.5%		730			730
Senior Secured Notes due 2012, 11.125%		278			278
Senior Secured Notes due 2013, 10.5%		325			325
Senior Subordinated Notes due 2009, 10.875%		500			500
Debentures due 2005, 9.375%		100			100
Debentures due 2010, 10.25%		100			100
Debentures due 2020, 9.8%		225			225

Equistar notes and debentures:
Notes due 2006, 6.5%		150			150
Senior Notes due 2008, 10.125%		700			700
Notes due 2009, 8.75%		600			600
Senior Notes due 2011, 10.625%		700			700
Debentures due 2026, 7.55%		150			150

Millennium notes and debentures:
Senior Notes due 2006, 7.0%		500			500
Senior Debentures due 2026, 7.625%		250			250
Senior Notes due 2008, 9.25%		471			471
Convertible Senior Debentures due 2023, 4.0%		150			150

Other debt		26			32
Unamortized premium, net		287			302

Total		7,642			7,863
Less current maturities		(256	)		(308	)

Long-term debt	$	7,386		$	7,555

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

During the first quarter 2005, LCC repaid $200 million of the 9.875% Senior Secured Notes Series B, along with $10 million in prepayment premiums, and in the second quarter 2005 called an additional $300 million. The call price on the $300 million was 102.469% of par, and the debt was paid on May 2, 2005 along with $7 million in prepayment premiums. Current maturities of long-term debt at March 31, 2005 included $100 million of LCC’s 9.375% Debentures due 2005, $150 million of Equistar’s 6.5% Notes due 2006 and other debt of $6 million. At December 31, 2004, current maturities included $200 million of LCC’s 9.875% Senior Secured Notes due 2007, which were called in December 2004, $100 million of LCC’s 9.375% Debentures due 2005 and other debt of $8 million.

Amortization of debt premiums, including adjustments to fair values included in accounting for the acquisition of Millennium, and debt issuance costs resulted in a net credit of $2 million and a charge of $4 million for the three-month periods ended March 31, 2005 and 2004, respectively, that were included in interest expense in the Consolidated Statements of Income.

12. Pension and Other Postretirement Benefits

Net periodic pension benefit costs included the following components for the three months ended March 31:


	2005						2004
Millions of dollars	U.S.			Non-U.S.			U.S.			Non-U.S.
Net periodic pension benefit cost:
Service cost	$	11		$	4		$	4		$	2
Interest cost		21			6			8			2
Recognized return on plan assets		(19	)		(5	)		(5	)		(2	)
Actuarial and investment loss amortization		5			1			5			1

Net periodic pension benefit cost	$	18		$	6		$	12		$	3

Net periodic other postretirement benefit costs, which were entirely incurred in the U.S., included the following components for the three months ended March 31:


Millions of dollars	2005		2004
Components of net periodic benefit cost:
Service cost	$	1	$	1
Interest cost		3		1

Net periodic benefit cost	$	4	$	2

The increases in pension and other postretirement benefit costs in the first quarter 2005 primarily reflect the consolidation of Millennium and Equistar prospectively from December 1, 2004.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

13.Commitments and Contingencies

Crude Supply Agreement—Under a crude supply agreement with PDVSA Oil (“CSA”), PDVSA Oil is required to sell, and LCR is required to purchase, 230,000 barrels per day of heavy, high sulfur crude oil, which constitutes approximately 86% of LCR’s refining capacity of 268,000 barrels per day of crude oil. Since April 1998, PDVSA Oil has, from time to time, declared itself in a force majeure situation and subsequently reduced deliveries of crude oil. Such reductions in deliveries were purportedly based on announced OPEC production cuts. At such times, PDVSA Oil informed LCR that the Venezuelan government, through the Ministry of Energy and Mines, had instructed that production of certain grades of crude oil be reduced. In certain circumstances, PDVSA Oil made payments to LCR under a different provision of the CSA in partial compensation for such reductions.

LCR has consistently contested the validity of the reductions in deliveries by PDVSA Oil and Petróleos de Venezuela, S.A. (“PDVSA”) under the CSA. The parties have different interpretations of the provisions of the contracts concerning the delivery of crude oil. The contracts do not contain dispute resolution procedures, and the parties have been unable to resolve their commercial dispute. As a result, in February 2002, LCR filed a lawsuit against PDVSA and PDVSA Oil in connection with the force majeure declarations, which LCR is continuing to litigate.

From time to time, Lyondell and PDVSA have had discussions covering both a restructuring of the CSA and a broader restructuring of the LCR partnership. Lyondell is unable to predict whether changes in either arrangement will occur. If the CSA is modified or terminated or this source of crude oil is otherwise interrupted, due to production difficulties, political or economic events in Venezuela or other factors, LCR could experience significantly lower earnings and cash flows. Subject to the consent of the other partner and rights of first offer and first refusal, the partners each have a right to transfer their interests in LCR to unaffiliated third parties in certain circumstances. If neither CITGO, PDVSA Oil nor their affiliates were a partner in LCR, PDVSA Oil would have an option to terminate the CSA. Depending on then-current market conditions, any breach or termination of the CSA, or reduction in supply thereunder, would require LCR to purchase all or a portion of its crude oil in the merchant market, could subject LCR to significant volatility and price fluctuations and could adversely affect LCR and, therefore, Lyondell. Alternative crude oil supplies with similar margins may not be available for purchase by LCR. During 2004 and through March 31, 2005, LCR received crude oil under the CSA at or above contract volumes.

Leased Facility—As a result of its consolidation of Equistar, Lyondell has an ethylene facility in Lake Charles, Louisiana, which has been idled since the first quarter of 2001, pending sustained improvement in market conditions. The facility and land, which are included in property, plant and equipment at a net book value of $143 million, are leased from Occidental. In May 2003, Equistar and Occidental entered into a new one-year lease, which has renewal provisions for two additional one-year periods at either party’s option. Equistar exercised the second one-year renewal option in April 2005.

Environmental Remediation—A Millennium subsidiary, which is now a subsidiary of Lyondell, has been identified as a Potential Responsible Party (“PRP”) with respect to the Kalamazoo River Superfund Site. The site involves cleanup of river sediments and floodplain soils contaminated with polychlorinated biphenyls (“PCBs”), cleanup of former paper mill operations, and cleanup and closure of landfills associated with the former paper mill operations. In 2000, the Kalamazoo River Study Group (the “KRSG”), of which the Millennium subsidiary and other PRPs are members, submitted to the State of Michigan a Draft Remedial Investigation and Draft Feasibility Study, which evaluated a number of remedial options for the river. The estimated costs for these remedial options ranged from $0 to $2.5 billion.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

At the end of 2001, the U.S. Environmental Protection Agency (“EPA”) took lead responsibility for the river portion of the site at the request of the State of Michigan. In 2004, the EPA initiated a confidential process to facilitate discussions among the agency, the Millennium subsidiary, other PRPs, the Michigan Departments of Environmental Quality and Natural Resources, and certain federal natural resource trustees about the need for additional investigation activities and different possible approaches for addressing the contamination in and along the Kalamazoo River.

As of March 31, 2005, the probable liability associated with the river cannot be determined with certainty. A liability of $40 million at December 31, 2004 was recognized, representing Millennium’s interim allocation of 55% of the $73 million estimated cost of bank stabilization, recommended as the preferred remedy in 2000 by the KRSG. Although the KRSG study identified a broad range of remedial options, not all of those options would represent reasonably possible outcomes. Management does not believe that it can identify a single remedy among those options that would represent the highest-cost reasonably possible outcome.

In addition, Lyondell has recognized a liability of $38 million at December 31, 2004 primarily related to Millennium’s estimated share of remediation costs for two former paper mill sites and associated landfills, which are also part of the Kalamazoo River Superfund Site. Although no final agreement has been reached as to the ultimate remedy for these locations, Millennium has begun remediation activity related to these sites.

Millennium’s ultimate liability for the Kalamazoo River Superfund Site will depend on many factors that have not yet been determined, including the ultimate remedy selected, the determination of natural resource damages, the number and financial viability of the other PRPs, and the determination of the final allocation among the PRPs.

Lyondell’s accrued environmental liability for future remediation costs at all current and former plant sites and Superfund sites totaled $147 million as of December 31, 2004 and $145 million as of March 31, 2005. The liabilities for individual sites range from $1 million to $77 million and are expected to be incurred over a number of years, and not to be concentrated in any single year. In the opinion of management, there is no material estimable range of reasonably possible loss in excess of the liabilities recorded for environmental remediation. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in investigations by regulatory agencies, could require Lyondell to reassess its potential exposure related to environmental matters.

Clean Air Act—Under the Clean Air Act, the eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the EPA under a “one-hour” ozone standard. Emission reduction controls for nitrogen oxides (“NOx”) must be installed at LCR’s refinery and each of Lyondell’s ten facilities in the Houston/Galveston region prior to the November 2007 compliance deadline for the one-hour ozone standard.

In addition, in December 2004, the regulatory agency for the state of Texas, the Texas Commission on Environmental Quality (“TCEQ”) finalized controls over highly reactive, volatile organic compounds (“HRVOCs”). Lyondell and LCR are still assessing the impact of the HRVOC revisions. In addition, in April 2004, the EPA designated the eight-county Houston/Galveston region a moderate non-attainment area under an “eight-hour” ozone standard. As a result, the TCEQ must submit a plan to the EPA in 2007 to demonstrate compliance with the eight-hour ozone standard in 2010. Although the one-hour ozone standard expires in 2005, the controls under that standard will not be relaxed under the EPA’s new eight-hour transition rules. As a result, Lyondell and LCR still will be required to meet the new emission standards for NOx and HRVOCs. The timing and amount of the estimated expenditures are subject to regulatory and other uncertainties, as well as to obtaining the necessary permits and approvals. The ultimate cost of implementing any plan developed to comply with the final ozone standards cannot be estimated at this time.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Clean Air Act also specified certain emissions standards for vehicles and, in 1998, the EPA concluded that additional controls on gasoline and diesel fuel were necessary. New standards for gasoline were finalized in 1999 and required refiners to produce a low sulfur gasoline by 2004, with final compliance by 2006. A new “on-road” diesel standard was adopted in January 2001 and will require refiners of on-road diesel fuel to produce 80% as ultra low sulfur diesel (“ULSD”) by June 2006 and 100% by the end of 2009, with less stringent standards for “off road” diesel fuel. These gasoline and diesel fuel standards will result in increased capital investment for LCR. In addition, these standards could result in higher operating costs for LCR. Lyondell’s business may also be impacted if these standards increase the cost for processing fuel components.

Lyondell currently estimates that environmentally related capital expenditures at its facilities, including Equistar and Millennium facilities, will be approximately $120 million for 2005 and $108 million for 2006, including estimated expenditures related to emission control standards for NOx and HRVOCs, as described above, and a wastewater management project. Capital spending to comply with environmental regulations at LCR’s facilities (on a 100% basis) is estimated to be approximately $96 million in 2005 and $129 million in 2006. The expected increase in environmental spending at LCR’s facilities reflects spending for low sulfur fuels regulations, as well as emission reductions.

The Clean Air Act Amendments of 1990 set minimum levels for oxygenates, such as MTBE, in gasoline sold in areas not meeting specified air quality standards. However, the presence of MTBE in some water supplies in California and other states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft has led to public concern about the use of MTBE. Certain U.S. states have banned the use of MTBE, while other U.S. federal and state governmental initiatives have sought either to rescind the oxygen requirement for reformulated gasoline or to restrict or also ban the use of MTBE. In April 2005, the U.S. House of Representatives passed an energy bill that would ban the use of MTBE after December 31, 2014, but would also provide limited liability protection for MTBE. The Senate has not yet passed an energy bill in 2005. The final form and timing of reconciliation of any energy bill in the U.S. Congress is uncertain.

At the state level, a number of states have legislated MTBE bans. Of these, several are mid-West states that use ethanol as the oxygenate of choice. Bans in these states should not impact MTBE demand. However, Connecticut, California and New York banned MTBE, effective January 1, 2004, which started to negatively affect MTBE demand during late 2003. In addition, beginning in 2003 several major oil companies substantially reduced or discontinued the use of MTBE in gasoline produced for California markets, negatively affecting 2003 demand. Lyondell estimates that, in 2003, California, Connecticut and New York combined represented approximately one-fourth of U.S. MTBE industry demand.

At this time, Lyondell cannot predict the full impact that these potential U.S. federal and state governmental initiatives and state bans will have on MTBE margins or volumes longer term. Lyondell’s North American MTBE sales represented approximately 14% and 17% of its total revenues for the years ended December 31, 2004 and 2003, respectively. Lyondell intends to continue marketing MTBE in the U.S. However, should it become necessary or desirable to significantly reduce MTBE production, Lyondell would need to make capital expenditures to add the flexibility to produce alternative gasoline blending components, such as iso-octane, iso-octene (also known as “di-isobutylene”) or ethyl tertiary butyl ether (“ETBE”), at its U.S.-based MTBE plant. Lyondell intends to install equipment at its Channelview, Texas facility that would provide Lyondell with the flexibility to produce di-isobutylene, an alternative gasoline component, instead of MTBE at that facility. The current estimated cost of converting Lyondell’s U.S.-based MTBE plant to di-isobutylene production is less than $20 million. Lyondell’s U.S.-based MTBE plant could be converted to ETBE production with minimal capital expenditure. Lyondell is pursuing ETBE viability through legislative efforts. One key hurdle was equal access to the federal subsidy provided for ethanol blended into gasoline for the ethanol component of ETBE, which was addressed in tax legislation enacted in 2004. Lyondell is currently evaluating the effects of the new tax legislation, as well as the di-isobutylene alternative, prior to making any ultimate decision, which will be influenced by further regulatory and market developments. The profit contribution related to alternative gasoline blending components is likely to be lower than that historically realized on MTBE.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Litigation—On April 8, 2005, Lyondell filed a lawsuit against BASF Corporation (“BASF”) seeking declaratory judgment to resolve a commercial dispute regarding the interpretation of various provisions of a propylene oxide sales contract. On April 12, 2005, BASF filed a lawsuit against Lyondell asserting various claims relating to alleged breaches of the same propylene oxide sales contract and seeking damages in excess of $100 million. Management believes that it has valid defenses to all claims and is vigorously defending them. The parties have engaged in negotiations to resolve the claims without success to date. Management does not expect the resolution of the claims to result in any material adverse effect on financial condition, liquidity or results of operations of Lyondell.

Together with alleged past manufacturers of lead-based paint and lead pigments for use in paint, Millennium has been named as a defendant in various legal proceedings alleging that Millennium and other manufacturers are responsible for personal injury, property damage, and remediation costs allegedly associated with the use of these products. The plaintiffs in these legal proceedings include municipalities, counties, school districts, individuals and the State of Rhode Island, and seek recovery under a variety of theories, including negligence, failure to warn, breach of warranty, conspiracy, market share liability, fraud, misrepresentation and nuisance. The majority of these legal proceedings assert unspecified monetary damages in excess of the statutory minimum and, in certain cases, contain general language requesting equitable relief from defendants such as abatement of lead-based paint in buildings. Legal proceedings relating to lead pigment or paint are in various procedural stages of pre-trial, post-trial and post-dismissal settings.

Millennium’s defense costs to date for lead-based paint and lead pigment litigation largely have been covered by insurance. Millennium has not accrued any liabilities for any lead-based paint and lead pigment litigation. Millennium has insurance policies that potentially provide approximately $1 billion in indemnity coverage for lead-based paint and lead pigment litigation. Millennium’s ability to collect under the indemnity coverage would depend upon the timing of any request for indemnity and the solvency of the various insurance carriers that are part of the coverage block at the time of such a request. As a result of insurance coverage litigation initiated by Millennium, an Ohio trial court issued a decision in 2002 effectively requiring certain insurance carriers to resume paying defense costs in the lead-based paint and lead pigment cases. Indemnity coverage was not at issue in the Ohio court’s decision. The insurance carriers may appeal the Ohio decision regarding defense costs, and they have in the past and may in the future attempt to deny indemnity coverage if there is ever a settlement or an adverse judgment in any lead-based paint or lead pigment case.

Indemnification—Lyondell, its subsidiaries and its joint ventures are parties to various indemnification arrangements, including arrangements entered into in connection with acquisitions, divestitures and the formation of joint ventures. For example, Lyondell entered into indemnification arrangements in connection with the transfer of assets and liabilities from Atlantic Richfield Company to Lyondell prior to Lyondell’s initial public offering, in connection with Lyondell’s acquisition of the outstanding shares of ARCO Chemical Company and in connection with the formation of LCR; Equistar and its owner companies (including Lyondell and Millennium) entered into indemnification arrangements in connection with the formation of Equistar; and Millennium entered into indemnification arrangements in connection with its demerger from Hanson plc. Pursuant to these arrangements, Lyondell, its subsidiaries and its joint ventures provide indemnification to and/or receive indemnification from other parties in connection with liabilities that may arise in connection with the transactions and in connection with activities prior to completion of the transactions. These indemnification arrangements typically include provisions pertaining to third party claims relating to environmental and tax matters and various types of litigation. As of March 31, 2005, Lyondell has not accrued any significant amounts for such indemnification obligations, other than amounts under tax sharing agreements that have been reflected in the provision for income taxes, and is not aware of other circumstances that would be likely to lead to significant future indemnification claims against Lyondell. Lyondell cannot determine with certainty the potential amount of future payments under the indemnification arrangements until events arise that would trigger a liability under the arrangements.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Other—Lyondell, its subsidiaries and its joint ventures are, from time to time, defendants in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, management does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it, its subsidiaries or its joint ventures currently are involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on the financial position, liquidity or results of operations of Lyondell.

General—In the opinion of management, any liability arising from the matters discussed in this note is not expected to have a material adverse effect on the financial position or liquidity of Lyondell. However, the adverse resolution in any reporting period of one or more of these matters discussed in this note could have a material impact on Lyondell’s results of operations for that period, which may be mitigated by contribution or indemnification obligations of others, or by any insurance coverage that may be available.

14. Per Share Data

Basic earnings (loss) per share for the periods presented is computed based upon the weighted average number of shares of common stock and Series B common stock outstanding during the periods. Diluted earnings (loss) per share also include the effect of outstanding stock options and warrants and restricted stock. Additionally, diluted earnings per share for the three months ended March 31, 2005 includes the effect of the 4.0% Millennium Convertible Debentures that are convertible into Lyondell common stock. Computation of fully-diluted earnings per share for the three months ended March 31, 2005, reflected the assumed conversion of Millennium’s 4.0% Convertible Debentures, including the related reduction of net income by less than $1 million. The reduction of net income reflected the net after-tax effect of related interest expense including amortization of the adjustment of the Convertible Debentures to fair value in accounting for the acquisition of Millennium. Outstanding stock options, warrants and restricted stock had no effect on the calculation of diluted loss per share for the three months ended March 31, 2004.

Earnings (loss) per share data and dividends declared per share of common stock were as follows:


	For the three months ended March 31,
	2005		2004
Weighted average shares, in millions:
Basic		244.5		176.5
Diluted		259.8		176.5

Earnings (loss) per share:
Basic	$	1.04	$	(0.08	)
Diluted		0.98		(0.08	)
Dividends declared per share of common stock	$	0.225	$	0.225

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

15. Comprehensive Income

The components of the comprehensive income (loss) were as follows:


	For the three months ended March 31,
Millions of dollars	2005			2004
Net income (loss)	$	254		$	(15	)
Other comprehensive loss:
Foreign currency translation loss		(112	)		(36	)
Other		(2	)		(2	)

Total other comprehensive loss		(114	)		(38	)

Comprehensive income (loss)	$	140		$	(53	)

16. Segment and Related Information

Lyondell operates in four reportable segments:

•

Ethylene, co-products and derivatives (“EC&D”), primarily manufacturing and marketing of ethylene; its co-products, including propylene, butadiene and aromatics; and derivatives, including ethylene oxide, ethylene glycol, polyethylene and vinyl acetate monomer.

•

Propylene oxide and related products (“PO&RP”), including manufacturing and marketing of PO; co-products styrene and tertiary butyl alcohol with its derivative, methyl tertiary butyl ether or MTBE; PO derivatives, including propylene glycol, propylene glycol ethers and butanediol; and toluene diisocyanate.

•

Inorganic chemicals, primarily manufacturing and marketing of titanium dioxide and related products.

•

Refining.

The inorganic chemicals segment resulted from the acquisition of Millennium on November 30, 2004. With the acquisition of Millennium, Equistar also became a consolidated subsidiary. Results of Equistar operations, in the EC&D segment, prior to December 2004 reflect Lyondell’s previous equity investment in Equistar (see Note 6).

The refining segment consists of Lyondell’s equity investment in LCR (see Note 7).

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Summarized financial information concerning reportable segments is shown in the following table for the three months ended:


Millions of dollars	EC&D		PO&RP		Inorganic Chemicals		Refining		Other			Total
March 31, 2005:
Sales and other operating revenues:
Customer	$	2,639	$	1,467	$	318	$	—	$	22		$	4,446
Intersegment		335		62		—		—		(397	)		—

		2,974		1,529		318		—		(375	)		4,446
Operating income		395		96		21		—		(2	)		510
Income from equity investments		—		1		—		67		—			68

March 31, 2004:
Sales and other operating revenues	$	—	$	1,105	$	—	$	—	$	—		$	1,105
Operating income		—		23		—		—		—			23
Income from equity investments		6		1		—		56		—			63

Sales and other operating revenues and operating income in the “Other” column above in 2005 include elimination of intersegment transactions and a business that is not a reportable segment.

17. Supplemental Guarantor Information

ARCO Chemical Technology Inc. (“ACTI”), ARCO Chemical Technology L.P. (“ACTLP”) and Lyondell Chemical Nederland, Ltd. (“LCNL”) are guarantors (collectively “Guarantors”), jointly and severally, of the following (see Note 11):

•

Senior Secured Notes, Series A due 2007, 9.625%

•

Senior Secured Notes, Series B due 2007, 9.875%

•

Senior Secured Notes due 2008, 9.5%

•

Senior Secured Notes due 2012, 11.125%

•

Senior Secured Notes due 2013, 10.5%, and

•

Senior Subordinated Notes due 2009, 10.875%.

LCNL, a Delaware corporation and a 100% owned subsidiary of Lyondell, owns a Dutch subsidiary that operates chemical production facilities near Rotterdam, The Netherlands. ACTI is a Delaware corporation, which holds the investment in ACTLP. ACTLP is a Delaware limited partnership, which holds and licenses technology to other Lyondell affiliates and to third parties. The Guarantors are all 100% owned subsidiaries of Lyondell. The guarantees are joint and several and full and unconditional.

Equistar is the issuer (the “Subsidiary Issuer”) of 6.5% Notes due 2006 and 7.55% Debentures due 2026, which are guaranteed by LCC. As a result of Lyondell’s November 30, 2004 acquisition of Millennium, Equistar became a wholly owned subsidiary of Lyondell.

The following condensed consolidating financial information present supplemental information for the Guarantors and the Subsidiary Issuer as of March 31, 2005 and December 31, 2004 and for the three-month periods ended March 31, 2005 and 2004.

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

CONDENSED CONSOLIDATING FINANCIAL INFORMATION

BALANCE SHEET

As of March, 31, 2005


Millions of dollars	Lyondell		Guarantors		Equistar		Non- Guarantors			Eliminations			Lyondell Consolidated
Total current assets	$	815	$	325	$	1,938	$	1,807		$	(168	)	$	4,717
Property, plant and equipment, net		776		850		3,137		2,292			—			7,055
Investments and long-term receivables		7,276		275		62		1,218			(7,668	)		1,163
Goodwill, net		713		349		—		1,113			—			2,175
Other assets		271		73		348		217			—			909

Total assets	$	9,851	$	1,872	$	5,485	$	6,647		$	(7,836	)	$	16,019

Current maturities of long-term debt	$	100	$	—	$	150	$	6		$	—		$	256
Other current liabilities		481		196		893		541			(37	)		2,074
Long-term debt		3,550		—		2,162		1,674			—			7,386
Other liabilities		626		47		386		691			—			1,750
Deferred income taxes		923		158		—		504			2			1,587
Intercompany liabilities (assets)		1,377		152		—		(1,033	)		(496	)		—
Minority interest		—		28		4		168			(28	)		172
Stockholders’ equity		2,794		1,291		1,890		4,096			(7,227	)		2,794

Total liabilities and stockholders’ equity	$	9,851	$	1,872	$	5,485	$	6,647		$	(7,836	)	$	16,019

BALANCE SHEET

As of December 31, 2004


Millions of dollars	Lyondell		Guarantors		Equistar		Non- Guarantors			Eliminations			Lyondell Consolidated
Total current assets	$	1,030	$	292	$	1,490	$	1,787		$	(142	)	$	4,457
Property, plant and equipment, net		778		898		3,167		2,372			—			7,215
Investments and long-term receivables		6,903		295		63		765			(6,836	)		1,190
Goodwill, net		722		349		—		1,104			—			2,175
Other assets		278		77		354		182			—			891

Total assets	$	9,711	$	1,911	$	5,074	$	6,210		$	(6,978	)	$	15,928

Current maturities of long-term debt	$	300	$	—	$	1	$	7		$	—		$	308
Other current liabilities		498		188		805		536			(40	)		1,987
Long-term debt		3,551		—		2,312		1,692			—			7,555
Other liabilities		634		50		394		669			—			1,747
Deferred income taxes		792		163		—		519			3			1,477
Intercompany liabilities (assets)		1,263		221		—		(1,473	)		(11	)		—
Minority interest		—		26		1		180			(26	)		181
Stockholders’ equity		2,673		1,263		1,561		4,080			(6,904	)		2,673

Total liabilities and stockholders’ equity	$	9,711	$	1,911	$	5,074	$	6,210		$	(6,978	)	$	15,928

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

CONDENSED CONSOLIDATING FINANCIAL INFORMATION

STATEMENT OF INCOME

For the Three Months Ended March 31, 2005


Millions of dollars	Lyondell			Guarantors		Equistar			Non- Guarantors			Eliminations			Lyondell Consolidated
Sales and other operating revenues	$	923		$	457	$	2,861		$	737		$	(532	)	$	4,446
Cost of sales		831			398		2,417			669			(531	)		3,784
Selling, general and administrative expenses		32			7		47			43			—			129
Research and development expenses		9			—		8			6			—			23

Operating income (loss)		51			52		389			19			(1	)		510
Interest income (expense), net		(95	)		—		(54	)		(9	)		—			(158	)
Other income (expense), net		(28	)		2		(3	)		5			1			(23	)
Income (loss) from equity investments		441			41		—			28			(442	)		68
Intercompany income (expense)		(34	)		21		—			13			—			—
(Benefit from) provision for income taxes		81			42		—			20			—			143

Net income	$	254		$	74	$	332		$	36		$	(442	)	$	254

STATEMENT OF INCOME

For the Three Months Ended March 31, 2004


Millions of dollars	Lyondell			Guarantors			Non- Guarantors			Eliminations			Lyondell Consolidated
Sales and other operating revenues	$	692		$	330		$	240		$	(157	)	$	1,105
Cost of sales		624			313			249			(157	)		1,029
Selling, general and administrative expenses		33			5			7			—			45
Research and development expenses		8			—			—			—			8

Operating income (loss)		27			12			(16	)		—			23
Interest income (expense), net		(110	)		—			1			—			(109	)
Other income (expense), net		(19	)		(1	)		19			—			(1	)
Income (loss) from equity investments		64			41			22			(64	)		63
Intercompany income		(23	)		10			13			—			—
(Benefit from) provision for income taxes		(46	)		23			14			—			(9	)

Net income (loss)	$	(15	)	$	39		$	25		$	(64	)	$	(15	)

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

CONDENSED CONSOLIDATING FINANCIAL INFORMATION

STATEMENT OF CASH FLOWS

For the Three Months Ended March 31, 2005


Millions of dollars	Lyondell			Guarantors			Equistar			Non- Guarantors			Eliminations			Consolidated Lyondell
Net income	$	254		$	74		$	332		$	36		$	(442	)	$	254
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		16			19			79			64			—			178
(Income) from equity investments		(441	)		(41	)		—			(28	)		442			(68	)
Distributions of earnings from affiliates		37			—			—			67			(37	)		67
Deferred income taxes		82			41			—			(8	)		—			115
Debt prepayment charges and premiums		12			—			—			—			—			12
Intercompany (receivables) payables, net		107			(68	)		—			(38	)		(1	)		—
Net changes in working capital and other		(20	)		(10	)		(277	)		(88	)		1			(394	)

Net cash provided by (used in) operating activities		47			15			134			5			(37	)		164

Expenditures for property, plant and equipment		(11	)		(1	)		(35	)		(11	)		—			(58	)
Distributions in excess of earnings from affiliates		—			4			—			31			—			35
Contributions and advances to affiliates		—			—			—			(67	)		37			(30	)
Other		—			—			3			—			—			3

Net cash provided by (used in) investing activities		(11	)		3			(32	)		(47	)		37			(50	)

Repayment of long-term debt		(210	)		—			(1	)		—			—			(211	)
Dividends paid		(55	)		—			—			—			—			(55	)
Proceeds from stock option exercises		34			—			—			—			—			34
Other		(8	)		—			—			6			—			(2	)

Net cash provided by (used in) financing activities		(239	)		—			(1	)		6			—			(234	)
Effect of exchange rate changes on cash		—			2			—			3			—			5

Increase (decrease) in cash and cash equivalents	$	(203	)	$	20		$	101		$	(33	)	$	—		$	(115	)

LYONDELL CHEMICAL COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

CONDENSED CONSOLIDATING FINANCIAL INFORMATION

STATEMENT OF CASH FLOWS

For the Three Months Ended March 31, 2004


Millions of dollars	Lyondell			Guarantors			Non- Guarantors			Eliminations			Consolidated Lyondell
Net income (loss)	$	(15	)	$	39		$	25		$	(64	)	$	(15	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		17			17			29			—			63
(Income) from equity investments		(64	)		(41	)		(22	)		64			(63	)
Distributions of earnings of affiliates		38			—			56			(38	)		56
Deferred income taxes		(4	)		(6	)		—			—			(10	)
Intercompany (receivables) payables, net		32			—			(32	)		—			—
Net changes in other assets and liabilities		54			1			(18	)		—			37

Net cash provided by (used in) operating activities		58			10			38			(38	)		68

Expenditures for property, plant and equipment		(8	)		(2	)		(1	)		—			(11	)
Distributions from affiliates in excess of earnings		—			10			8			—			18
Contributions and advances to affiliates		—			(2	)		(11	)		—			(13	)

Net cash provided by (used in) investing activities		(8	)		6			(4	)		—			(6	)

Dividends paid		(31	)		—			(38	)		38			(31	)
Proceeds from stock option exercises		4			—			—			—			4
Other		(1	)		—			—			—			(1	)

Net cash used in financing activities		(28	)		—			(38	)		38			(28	)

Effect of exchange rate changes on cash		—			12			(13	)		—			(1	)

Increase (decrease) in cash and cash equivalents	$	22		$	28		$	(17	)	$	—		$	33

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