UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
-------------- -------------------
Commission file number 1-8483
UNOCAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-3825062
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2141 ROSECRANS AVENUE, SUITE 4000, EL SEGUNDO, CALIFORNIA 90245
(Address of principal executive offices)
(Zip Code)
(310) 726-7600
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Number of shares of Common Stock, $1 par value, outstanding as of October 31,
1998: 241,369,363
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
CONSOLIDATED EARNINGS UNOCAL CORPORATION
(Unaudited)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars except per share amounts 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues
<S> <C> <C> <C> <C>
Sales and operating revenues ............................................. $ 1,286 $ 1,370 $ 3,683 $ 4,272
Gain on sales of assets and other revenues ............................... 108 27 315 235
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues ..................................................... 1,394 1,397 3,998 4,507
Costs and other deductions
Crude oil and product purchases .......................................... 604 524 1,535 1,616
Operating expense ........................................................ 315 423 1,004 1,076
Selling, administrative and general expense .............................. 34 26 69 81
Depreciation, depletion and amortization ................................. 186 300 566 755
Dry hole costs ........................................................... 58 8 150 51
Exploration expense ...................................................... 53 50 139 114
Interest expense ......................................................... 48 37 131 147
Property and other operating taxes ....................................... 13 18 44 54
Distributions on convertible preferred
securities of subsidiary trust ........................................ 8 8 24 24
- ------------------------------------------------------------------------------------------------------------------------------------
Total costs and other deductions ................................... 1,319 1,394 3,662 3,918
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations
before income taxes ................................................... 75 3 336 589
Income taxes (benefit) ................................................... 39 (174) 177 68
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations
before discontinued operations and extraordinary item ................ $ 36 $ 177 $ 159 $ 521
Discontinued operations
Loss on disposal (net of tax) ......................................... -- -- -- (44)
Extraordinary item
Early extinguishment of debt (net of tax) ............................. -- -- -- (38)
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings applicable to common stock ............................ $ 36 $ 177 $ 159 $ 439
- ------------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share of common stock (a)
Continuing operations ................................................. $ 0.15 $ 0.71 $ 0.66 $ 2.09
Discontinued operations ............................................... -- -- -- (0.18)
Extraordinary item .................................................... -- -- -- (0.15)
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings .......................................................... $ 0.15 $ 0.71 $ 0.66 $ 1.76
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share of common stock (b) (c)
Continuing operations ................................................. $ 0.15 $ 0.70 $ 0.66 $ 2.04
Discontinued operations ............................................... -- -- -- (0.17)
Extraordinary item .................................................... -- -- -- (0.14)
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings .......................................................... $ 0.15 $ 0.70 $ 0.66 $ 1.73
- ------------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per share of common stock ........................ $ 0.20 $ 0.20 $ 0.60 $ 0.60
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Basic weighted average shares outstanding (in thousands) ........... 241,362 247,367 241,621 249,153
(b) Diluted weighted average shares outstanding (in thousands) .......... 242,535 261,395 242,916 263,171
(c) Distributions on preferred securities (net of tax) excluded in numerator. $ -- $ 6 $ -- $ 18
In 1998, the effect of assumed conversion of preferred securities on
earnings per share is antidilutive.
See notes to the consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEET UNOCAL CORPORATION
September 30 December 31
-----------------------------
Millions of dollars 1998 (a) 1997
- --------------------------------------------------------------------------------------------------------------
Assets
Current assets
<S> <C> <C>
Cash and cash equivalents ............................................. $ 183 $ 338
Accounts and notes receivable ......................................... 762 897
Inventories ........................................................... 154 172
Deferred income taxes ................................................. 90 71
Other current assets .................................................. 23 23
- --------------------------------------------------------------------------------------------------------------
Total current assets ............................................... 1,212 1,501
Investments and long-term receivables .................................... 1,171 1,113
Properties (b) ........................................................... 5,190 4,816
Deferred income taxes .................................................... 52 7
Other assets ............................................................. 162 93
- --------------------------------------------------------------------------------------------------------------
Total assets ....................................................... $ 7,787 $ 7,530
- --------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable ...................................................... $ 780 $ 785
Taxes payable ......................................................... 176 126
Interest payable ...................................................... 38 54
Current portion of environmental liabilities .......................... 132 100
Other current liabilities ............................................. 86 95
- --------------------------------------------------------------------------------------------------------------
Total current liabilities .......................................... 1,212 1,160
Long-term debt ........................................................... 2,423 2,169
Deferred income taxes .................................................... 154 137
Accrued abandonment, restoration and environmental liabilities ........... 612 627
Other deferred credits and liabilities ................................... 577 601
Company-obligated mandatorily redeemable convertible
preferred securities of a subsidiary trust holding solely 6-1/4%
convertible junior subordinated debentures of Unocal .................. 522 522
Common stock ($1 par value) .............................................. 252 252
Capital in excess of par value ........................................... 459 452
Foreign currency translation adjustment .................................. (23) (18)
Unearned portion of restricted stock issued .............................. (27) (31)
Retained earnings ........................................................ 2,037 2,021
Treasury stock - at cost (c) ............................................ (411) (362)
- --------------------------------------------------------------------------------------------------------------
Total stockholders' equity ......................................... 2,287 2,314
- --------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity ...................... $ 7,787 $ 7,530
- --------------------------------------------------------------------------------------------------------------
(a) Unaudited
(b) Net of accumulated depreciation: .................................... $ 10,167 $ 9,896
(c) Number of shares (in thousands): .................................... 10,623 9,262
See notes to the consolidated financial statements.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED CASH FLOWS UNOCAL CORPORATION
(Unaudited)
For the Nine Months
Ended September 30
-----------------------------
Millions of dollars 1998 1997
- --------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
<S> <C> <C>
Net earnings ............................................................. $ 159 $ 439
Adjustments to reconcile net earnings to
net cash provided by operating activities
Loss on disposal of discontinued operations (before-tax) ........... -- 71
Depreciation, depletion and amortization ........................... 566 755
Dry hole costs ..................................................... 150 51
Deferred income taxes .............................................. (34) (226)
Gain on sales of assets (before-tax) ............................... (166) (59)
Other .............................................................. 18 (83)
Working capital and other changes related to operations
Accounts and notes receivable ................................... 96 221
Inventories ..................................................... 18 (41)
Accounts payable ................................................ (10) (351)
Taxes payable ................................................... 50 (110)
Other ........................................................... (136) 69
- --------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities .................... 711 736
Cash Flows from Investing Activities
Capital expenditures (includes dry hole costs) ........................ (1,248) (953)
Proceeds from sale of discontinued operations ......................... -- 1,789
Proceeds from sales of assets ......................................... 299 55
- --------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities .......... (949) 891
Cash Flows from Financing Activities
Long-term borrowings .................................................. 666 370
Reduction of long-term debt ........................................... (381) (1,329)
Dividends paid on common stock ........................................ (145) (150)
Repurchases of common stock ........................................... (48) (173)
Other ................................................................. (9) (46)
- --------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities ............. 83 (1,328)
Increase (decrease) in cash and cash equivalents ......................... (155) 299
Cash and cash equivalents at beginning of year ........................... 338 217
- --------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ............................... $ 183 $ 516
- --------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest (net of amount capitalized) ............................... $ 148 $ 178
Income taxes (net of refunds) ...................................... $ 166 $ 265
See notes to the consolidated financial statements.
</TABLE>
3
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) The consolidated financial statements included herein are unaudited and, in
the opinion of management, include all adjustments necessary for a fair
presentation of financial position and results of operations. All
adjustments are of a normal recurring nature. Such financial statements are
presented in accordance with the Securities and Exchange Commission's
(Commission) disclosure requirements for Form 10-Q.
These interim consolidated financial statements should be read in
conjunction with the Consolidated financial statements and the Notes
thereto filed with the Commission in Unocal Corporation's 1997 Annual
Report on Form 10-K.
Results for the nine months ended September 30, 1998, are not necessarily
indicative of future financial results.
Certain items in the prior year financial statements have been reclassified
to conform to the 1998 presentation.
(2) For the purpose of this report, Unocal Corporation (Unocal) and its
consolidated subsidiaries, including Union Oil Company of California (Union
Oil), will be referred to as the company.
(3) Other Financial Information
Sales and operating revenues are derived principally from the sale of crude
oil, natural gas, natural gas liquids, geothermal steam, specialty minerals
and nitrogen-based agricultural products produced by the company. During
the third quarters of 1998 and 1997, approximately 40 percent and 29
percent, respectively, of total sales and operating revenues were
attributed to the resale of purchased crude oil, natural gas and natural
gas liquids produced by others, that the company purchased in connection
with its trading and marketing activities. For the nine months ended
September 30, 1998 and 1997, the percentage of total sales and operating
revenues attributed to the resale of purchased crude oil, natural gas and
natural gas liquids produced by others was approximately 34 percent and 28
percent, respectively. Related purchase costs are classified as expense in
the crude oil and product purchases category of the consolidated earnings
statement.
Capitalized interest totaled $5 million and $10 million for the third
quarters of 1998 and 1997, respectively. Capitalized interest was $22
million and $26 million for the first nine months of 1998 and 1997,
respectively.
(4) Income Taxes
Taxes on earnings from continuing operations totaled $39 million for the
third quarter of 1998 versus a net tax benefit of $174 million for the
comparable period in 1997. For the first nine months of 1998, taxes on
earnings from continuing operations were $177 million compared to $68
million for the same period in 1997.
The effective income tax rate for the first nine months of 1998 was 53
percent versus 12 percent for the same period in 1997. The higher
year-to-date effective tax rate for 1998 reflects an increase in the
foreign-versus-domestic earnings mix and tax adjustments related to the
appreciation of the Thai baht. The first nine months and third quarter of
1997 reflect $182 million in deferred income tax benefits: $114 million
related to a reassessment of Unocal's exposure for pending federal income
tax appeals and $68 million related to the currency devaluation in
Thailand.
(5) Comprehensive Income
Effective for the first quarter 1998, the company adopted Financial
Accounting Standard No. 130, "Reporting Comprehensive Income", which
establishes standards for reporting and displaying comprehensive income and
its components in a full set of financial statements. The company's
comprehensive earnings were as follows:
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------------------------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net earnings ............................................................. $ 36 $ 177 $ 159 $ 439
Change in foreign currency translation adjustments (net of tax) ......... (5) -- (5) --
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive earnings ............................................. $ 31 $ 177 $ 154 $ 439
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
(6) Earnings Per Share
The following are reconciliations of the numerators and denominators of the
basic and diluted earnings per share (EPS) computations for earnings from
continuing operations for the third quarters and the nine months ended
September 30, 1998 and 1997:
<TABLE>
<CAPTION>
Earnings Shares Per Share
Millions except per share amounts (Numerator) (Denominator) Amount
- ----------------------------------------------------------------------------------------------------------------------
Three Months ended September 30, 1998
<S> <C> <C> <C>
Earnings from continuing operations .................... $ 36 241.4
Basic EPS ........................................... $ 0.15
==============
Effect of Dilutive Securities
Options/common stock equivalents .................... 1.1
------------------------------------
Diluted EPS ......................................... 36 242.5 $ 0.15
==============
Distributions on preferred securities (after-tax) ... 6 12.3
------------------------------------
Antidilutive ........................................ $ 42 254.8 $ 0.16
Three Months ended September 30, 1997
Earnings from continuing operations .................... $ 177 247.4
Basic EPS ........................................... $ 0.71
==============
Effect of Dilutive Securities
Options/common stock equivalents .................... 1.7
------------------------------------
177 249.1 $ 0.71
Distributions on preferred securities (after-tax) ... 6 12.3
------------------------------------
Diluted EPS ......................................... $ 183 261.4 $ 0.70
==============
Nine Months ended September 30, 1998
Earnings from continuing operations .................... $ 159 241.6
Basic EPS ........................................... $ 0.66
==============
Effect of Dilutive Securities
Options/common stock equivalents .................... 1.3
------------------------------------
Diluted EPS ......................................... 159 242.9 $ 0.66
==============
Distributions on preferred securities (after-tax) ... 18 12.3
------------------------------------
Antidilutive ........................................ $ 177 255.2 $ 0.69
Nine Months ended September 30, 1997
Earnings from continuing operations .................... $ 521 249.2
Basic EPS ........................................... $ 2.09
==============
Effect of Dilutive Securities
Options/common stock equivalents .................... 1.7
------------------------------------
521 250.9 $ 2.08
Distributions on preferred securities (after-tax) ... 18 12.3
------------------------------------
Diluted EPS ......................................... $ 539 263.2 $ 2.04
==============
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Not included in the computation of diluted EPS were options outstanding at
September 30, 1998 to purchase approximately 5.4 million shares of common
stock. These options were not included in the computation as the exercise
prices were greater than the year-to-date average market price of the
common shares. The exercise prices of these options range from $36.88 to
$51.01 per share and they expire in 2007 and 2008.
(7) Long Term Debt and Credit Agreements
Financing activities during the third quarter of 1998 included the
retirement of $65 million in medium-term notes. In addition, the company
increased outstanding commercial paper borrowings by $12 million to a
balance of $468 million at September 30, 1998.
(8) Financial Instruments
The fair values of the company's financial instruments at September 30,
1998 are described below:
In August, the company's Canadian subsidiary repaid $250 million in US
dollar denominated loans and terminated related currency swap agreements of
$162 million. Unocal also terminated $162 million of offsetting currency
swap agreements in August. At September 30, 1998, an $88 million currency
swap agreement remained outstanding on the Canadian subsidiary's books.
This currency swap agreement was offset by an $88 million currency swap
agreement on Unocal's books. The net fair value of the currency swap
agreements outstanding at September 30 was approximately zero.
On October 1, Unocal and the company's Canadian subsidiary terminated the
remaining $88 million outstanding currency swap agreements. All costs
associated with termination of the aggregate $250 million of currency swap
agreements were recorded in the third quarter and were immaterial.
At September 30, 1998, the company had two foreign currency forward
exchange contracts outstanding to purchase Thai baht. The contracts are
designed to hedge the company's foreign currency exposure for estimated
baht income tax payments scheduled to be paid to the government of Thailand
in May 1999. The first contract calls for the company to pay approximately
$19 million in exchange for 800 million baht at maturity on May 25, 1999.
The second contract calls for the company to pay approximately $12 million
in exchange for 500 million baht at maturity on May 25, 1999. The fair
values of the contracts at September 30, 1998 were immaterial. The fair
values approximated the net gains that would have been realized if the
contracts had been closed out at September 30 and were estimated by
comparing the contract rates to the forward rates in effect at the balance
sheet date.
The estimated fair value of the company's long-term debt was $2,607
million. The fair values of debt instruments were based on the discounted
amount of future cash outflows using the rates offered to the company for
debt with similar remaining maturuties.
The estimated fair value of the mandatorily redeemable convertible
preferred securities of the company's subsidiary trust was $546 million.
The fair value of the preferred securities was based on the trading prices
of the preferred securities on September 30, 1998.
(9) Accrued Abandonment, Restoration and Environmental Liabilities
At September 30, 1998, the company had $452 million accrued for the
estimated future costs to abandon and remove wells and production
facilities. The total costs for abandonments are predominately accrued for
on a units-of-production basis and are estimated to be approximately $629
million. This estimate was derived in large part from abandonment cost
studies performed by an independent firm and is used to calculate the
amount to be amortized. The company's reserve for environmental remediation
obligations at September 30, 1998 totaled $292 million, of which $132
million was included in current liabilities.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
(10) Contingent Liabilities
The company has certain contingent liabilities with respect to material
existing or potential claims, lawsuits and other proceedings, including
those involving environmental, tax and other matters, certain of which are
discussed more specifically below. The company accrues liabilities when it
is probable that future costs will be incurred and such costs can be
reasonably estimated. Such accruals are based on developments to date, the
company's estimates of the outcomes of these matters and its experience in
contesting, litigating and settling other matters. As the scope of the
liabilities becomes better defined, there will be changes in the estimates
of future costs, which could have a material effect on the company's future
results of operations and financial condition or liquidity.
Environmental matters - The company is subject to loss contingencies
pursuant to federal, state and local environmental laws and regulations.
These include existing and possible future obligations to investigate the
effects of the release or disposal of certain petroleum, chemical and
mineral substances at various sites; to remediate or restore these sites;
to compensate others for damage to property and natural resources; for
remediation and restoration costs and for personal injuries; and to pay
civil penalties and, in some cases, criminal penalties and punitive
damages. These obligations relate to sites owned by the company or others
and are associated with past and present operations, including sites at
which the company has been identified as a potentially responsible party
(PRP) under the federal Superfund laws and comparable state laws.
Liabilities are accrued when it is probable that future costs will be
incurred and such costs can be reasonably estimated. However, in many
cases, investigations are not yet at a stage where the company is able to
determine whether it is liable or, if liability is probable, to quantify
the liability or estimate a range of possible exposure. In such cases, the
amounts of the company's liabilities are indeterminate due to the
potentially large number of claimants for any given site or exposure, the
unknown magnitude of possible contamination, the imprecise and conflicting
engineering evaluations and estimates of proper clean-up methods and costs,
the unknown timing and extent of the corrective actions that may be
required, the uncertainty attendant to the possible award of punitive
damages, the recent judicial recognition of new causes of action, the
present state of the law, which often imposes joint and several and
retroactive liabilities on PRPs, and the fact that the company is usually
just one of a number of companies identified as a PRP.
As disclosed in note 9, at September 30, 1998, the company had accrued $292
million for estimated future environmental assessment and remediation costs
at various sites where liabilities for such costs are probable. At those
sites where investigations or feasibility studies have advanced to the
stage of analyzing feasible alternative remedies and/or ranges of costs,
the company estimates that it possibly could incur additional remediation
costs aggregating approximately $220 million.
Tax matters - In December 1994, the company received a Notice of Proposed
Deficiency (Notice) from the Internal Revenue Service (IRS) related to the
years 1985 through 1987. A material amount of tax and interest would be
payable if the IRS were ultimately able to prevail on the significant
issues described in the Notice. In February 1995, the company filed a
protest of the proposed tax deficiency with the Appeals section of the IRS.
Discussions with the Appeals Officer are complete, and it now appears
unlikely that any issues raised in the Notice will proceed to either
litigation or mediation as a settlement has been reached. The proposed
settlement for all open taxable years preceding 1988 was received by the
Joint Committee on Taxation of the U.S. Congress in June 1998, and requires
its approval. The company expects this matter to be concluded in 1998 and
believes it is ultimately entitled to a refund for overpayment of tax or
interest.
The company believes it has adequately provided in its accounts for tax
items and issues not yet resolved.
Other matters -In February 1996, Bridas Corporation filed a petition
against the company and others in the District Court of Fort Bend County,
Texas, alleging that the defendants interfered with Bridas' rights under
agreements with the government of Turkmenistan to develop a gas field and
transport the gas to Pakistan as well as Bridas' exclusive right to lay a
gas pipeline in Afghanistan. Bridas sought actual damages as well as
punitive damages, plus interest. Bridas' expert witnesses stated in
pre-trial discovery that Bridas' total actual damages for loss of future
profits were approximately $1.7 billion. In the alternative, Bridas was
expected to seek an award of approximately $430 million with respect to its
total expenditures in Turkmenistan. In October 1998, the court granted the
defendants' motion for summary judgment and dismissed the action. It is not
known whether Bridas will move for a new trial or file an appeal of the
court's ruling.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The company also has certain other liabilities with respect to litigation,
claims and contractual agreements arising in the ordinary course of
business. Although these contingencies could result in expenses or
judgments that could be material to the company's results of operations for
a given reporting period, on the basis of management's best assessment of
the ultimate amount and timing of these events, such expenses or judgments
are not expected to have a material adverse effect on the company's
consolidated financial condition or liquidity.
(11) Unocal guarantees certain indebtedness of Union Oil. Summarized below is
financial information for Union Oil and its consolidated subsidiaries:
<TABLE>
<CAPTION>
Summarized Financial Data of Union Oil
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues ........................................................... $ 1,394 $ 1,397 $ 3,998 $ 4,507
Total costs and other deductions
(including income taxes) .............................................. 1,349 1,211 3,819 3,959
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations ...................................... 45 186 179 548
Discontinued operations
Loss on disposal (a) .................................................. -- -- -- (44)
Extraordinary item
Early extinguishment of debt (b) ...................................... -- -- -- (38)
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings ............................................................. $ 45 $ 186 $ 179 $ 466
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Net of tax benefit of: .............................................. $ -- $ -- $ -- $ (27)
(b) Net of tax benefit of: .............................................. $ -- $ -- $ -- $ (14)
</TABLE>
<TABLE>
<CAPTION>
At September 30 At December 31 (c)
---------------------------------------
Millions of dollars 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets ........................................................... $ 1,212 $ 1,576
Noncurrent assets ........................................................ 6,598 6,053
Current liabilities ...................................................... 1,214 1,124
Noncurrent liabilities ................................................... 3,767 3,534
Shareholder's equity ..................................................... 2,829 2,971
- -----------------------------------------------------------------------------------------------------------------------
(c) Audited
</TABLE>
(12) Other Matters
In August 1998, Unocal entered into a settlement agreement with certain of
its insurers for the recovery of certain past environmental remediation
claims. Under the terms of the agreement, each liable insurer who is a
party to the agreement must place its share of the negotiated settlement
amount of approximately $71 million into an escrow account by November 16,
1998. The final settlement amount will not be known until that date as it
is contingent upon certain conditions, including each of the participating
insurers' ability and intent to abide by the agreement's terms. Unocal
expects to collect substantially all of the negotiated settlement amount,
none of which had been recorded at September 30, 1998.
8
<PAGE>
<TABLE>
<CAPTION>
OPERATING HIGHLIGHTS UNOCAL CORPORATION
(Unaudited)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
NET DAILY PRODUCTION
Crude oil and condensate (thousand barrels daily)
United States
<S> <C> <C> <C> <C>
Spirit Energy 76 ................................................ 44 41 44 45
Alaska .......................................................... 27 30 29 32
---------------------------------------------------
Total United States ........................................... 71 71 73 77
International
Far East (a) .................................................... 81 96 83 95
Other (b) ....................................................... 31 25 31 26
---------------------------------------------------
Total International ........................................... 112 121 114 121
Worldwide .......................................................... 183 192 187 197
---------------------------------------------------
Natural gas (million cubic feet daily)
United States
Spirit Energy 76 ................................................ 808 845 795 876
Alaska .......................................................... 118 110 126 131
---------------------------------------------------
Total United States ........................................... 926 954 921 1,007
International
Far East (a) .................................................... 794 790 816 790
Other (b) ....................................................... 37 55 53 62
---------------------------------------------------
Total International ........................................... 831 845 869 851
Worldwide .......................................................... 1,757 1,799 1,790 1,858
---------------------------------------------------
Natural gas liquids (thousand barrels daily) .......................... 19 18 19 19
Geothermal (million kilowatt-hours daily) ............................. 22 19 21 17
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Includes host country share of:
Crude oil and condensate ........................................... 6 28 11 29
Natural gas ........................................................ 27 22 27 27
(b) Includes production of Canada equity affiliate
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
OPERATING HIGHLIGHTS (continued)
(Unaudited)
For the Three Months For the Nine Months
Ended September 30 Ended September 30
----------------------------------------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE SALES PRICES (a)
Crude oil and condensate (per barrel)
United States
<S> <C> <C> <C> <C>
Spirit Energy 76 ................................................ $ 12.20 $ 17.13 $ 12.80 $ 18.61
Alaska .......................................................... 9.35 13.37 9.69 15.39
Total United States ........................................... 11.11 15.50 11.56 17.28
International
Far East ........................................................ $ 12.28 $ 17.45 $ 13.02 $ 18.72
Other ........................................................... 10.58 16.58 11.07 17.58
Total International ........................................... 11.82 17.23 12.48 18.41
Worldwide .......................................................... $ 11.54 $ 16.44 $ 12.09 $ 17.89
- ------------------------------------------------------------------------------------------------------------------------------------
Natural gas (per thousand cubic feet)
United States
Spirit Energy 76 ................................................ $ 1.97 $ 2.38 $ 2.08 $ 2.39
Alaska .......................................................... 1.20 1.47 1.38 1.39
Total United States ........................................... 1.87 2.28 1.98 2.26
International
Far East ........................................................ $ 2.23 $ 2.39 $ 2.10 $ 2.35
Other ........................................................... 2.38 2.40 2.26 2.23
Total International ........................................... 2.23 2.39 2.10 2.34
Worldwide .......................................................... $ 2.04 $ 2.33 $ 2.04 $ 2.29
- ------------------------------------------------------------------------------------------------------------------------------------
AGRICULTURAL PRODUCTS PRODUCTION VOLUMES
(thousand tons)
Ammonia ............................................................... 365 314 1,129 1,072
Urea .................................................................. 234 188 739 696
AGRICULTURAL PRODUCTS SALES VOLUMES (thousand tons)
Ammonia ............................................................... 186 187 649 590
Urea .................................................................. 259 191 854 690
(a) Excludes Global Trade margins and Canada equity affiliate sales
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the financial condition and results of
operations of Unocal should be read in conjunction with Management's Discussion
and Analysis in Item 7 of the company's 1997 Annual Report on Form 10-K. Unless
otherwise specified, the following discussion pertains to the company's
continuing operations.
CONSOLIDATED RESULTS
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------- ----------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
After-tax earnings from continuing operations ............................ $ 36 $ 177 $ 159 $ 521
Less: special items (net of tax)
Environmental and litigation provisions .............................. (10) (61) (71) (75)
Impairment ........................................................... -- (39) -- (39)
Asset sales .......................................................... 49 (2) 102 30
Deferred tax adjustments ............................................. (7) 185 (21) 192
UNO-VEN restructuring ................................................ -- -- -- 39
Insurance settlement ................................................. -- -- 11 --
Bangladesh well blowout .............................................. -- -- -- (7)
- ------------------------------------------------------------------------------------------------------------------------------------
Total special items .................................................. 32 83 21 140
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings from continuing operations ................... $ 4 $ 94 $ 138 $ 381
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Third Quarter 1998 vs. Third Quarter 1997
Adjusted after-tax earnings from continuing operations decreased $90 million for
the period. Lower worldwide commodity prices for crude oil, natural gas and
fertilizer products and increased dry hole costs were the primary contributors
to the depressed earnings. Compared to 1997, average worldwide sales prices for
crude oil and natural gas declined 30 percent and 12 percent, respectively. The
increase in dry hole costs reflected the company's expanded exploration program.
These negative factors were partially offset by increased crude oil liftings in
Indonesia, new crude oil production in Yemen and Azerbaijan, higher natural gas
production in Indonesia, lower depreciation and depletion expense and increased
geothermal power generation and related sales volumes in Indonesia.
Year-to-date 1998 vs. Year-to-date 1997
Depressed worldwide crude oil, natural gas and fertilizer product sales prices,
lower domestic natural gas production volumes and higher dry hole costs and
exploration expenses as a result of the company's expanded exploration program
were the primary causes of the 64 percent decrease in adjusted after-tax
earnings for the period. Compared to 1997, average worldwide sales prices for
crude oil and natural gas declined 32 percent and 11 percent, respectively.
Positive factors mitigating the lower earnings included increased crude oil
liftings in Indonesia, increased natural gas production in Thailand and
Indonesia, lower domestic depreciation and depletion expense, increased
geothermal power generation and related sales volumes in Indonesia, lower
maintenance related costs at the Kenai, Alaska fertilizer plant due to a plant
turn-around in 1997, higher export sales volumes of fertilizer products and
higher earnings and dividends from a petroleum industry mutual insurance
company.
EXPLORATION AND PRODUCTION
Exploration and Production involves the exploration for and production of crude
oil and natural gas.
United States - Included in the United States category are Spirit Energy 76 and
Alaska oil and gas operations. Spirit Energy 76 is responsible for oil and gas
operations in the Lower 48 United States with emphasis on the Gulf Coast,
deepwater areas in the Gulf of Mexico, and the Permian Basin in West Texas. A
substantial portion of crude oil and natural gas produced domestically is sold
to the company's Global Trade group. The remainder is sold under contract to
third parties, sold in the spot market or, in the case of Alaska natural gas
production, sold to the company's agricultural products operations.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------- ----------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
<S> <C> <C> <C> <C>
Spirit Energy 76 ...................................................... $ (8) $ 4 $ 17 $ 132
Alaska ................................................................ 2 10 15 42
- ------------------------------------------------------------------------------------------------------------------------------------
Total ................................................................. (6) 14 32 174
Less: special items (net of tax)
Impairment (Spirit Energy 76) ......................................... -- (39) -- (39)
Asset sales (Spirit Energy 76) ........................................ -- -- -- 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total special items ................................................... -- (39) -- (37)
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings (loss) ....................................... $ (6) $ 53 $ 32 $ 211
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Third Quarter 1998 vs. Third Quarter 1997
Adjusted after-tax earnings decreased $59 million primarily due to lower average
United States crude oil and natural gas sales prices. Crude oil prices fell 28
percent, or $4.39 per barrel, while natural gas prices fell 18 percent, or $.41
per thousand cubic feet. Increased dry hole costs and exploration expense as a
result of increased exploration activity in the Gulf of Mexico and lower natural
gas production volumes for Spirit Energy 76 as a result of storms in the Gulf of
Mexico also negatively affected earnings for the period. However, these negative
factors were partially offset by a 7 percent increase in crude oil production
and lower depreciation and depletion expense for Spirit Energy 76.
Year-to-date 1998 vs. Year-to-date 1997
Adjusted after-tax earnings decreased 85 percent principally due to lower
average United States crude oil and natural gas prices, higher dry hole costs
and exploration expense as a result of increased Gulf of Mexico exploration
activity and lower natural gas production volumes. The average sales price for
crude oil decreased 33 percent, or $5.72 per barrel, while the average sales
price for natural gas decreased 12 percent, or $.28 per thousand cubic feet.
Natural gas production declined by 9 percent, or 86 million cubic feet daily. In
general, the production decrease is attributable to natural production declines.
These negative factors were partially offset by a decrease in depreciation and
depletion expense.
International - The company's international operations include the company's
foreign exploration and production activities and exploration activities
performed by the company's New Ventures group.
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------- ----------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings (loss)
<S> <C> <C> <C> <C>
Far East ............................................................ $ 44 $ 147 $ 130 $ 290
Other ............................................................... 23 (19) 53 (32)
- ------------------------------------------------------------------------------------------------------------------------------------
Total ............................................................... 67 128 183 258
Less: special items (net of tax)
Asset sales (Other) ................................................. 49 (1) 102 (17)
Deferred tax adjustment (Far East) .................................. (7) 68 (21) 68
Bangladesh well blowout (Other) ..................................... -- -- -- (7)
- ------------------------------------------------------------------------------------------------------------------------------------
Total special items ................................................. 42 67 81 44
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings .............................................. $ 25 $ 61 $ 102 $ 214
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In April 1998, the company received shares of common stock and debt of Tarragon
Oil and Gas Limited (Tarragon) valued at approximately $212 million for the
exchange of its Alberta, Canada exploration and production assets. In the third
quarter 1998, the company converted this debt and common stock to cash as a
result of a tender offer from USX-Marathon for the purchase of Tarragon's
outstanding common stock. The total after-tax gain recorded for these
transactions was $102 million (included in special items).
Third Quarter 1998 vs. Third Quarter 1997
During the third quarter of 1998, earnings decreased 59 percent, or $36 million.
The primary factors affecting earnings were lower average international crude
oil and natural gas prices, lower Thailand and Canada crude oil and natural gas
production, an increase in dry hole costs and higher current taxes in Thailand
related to foreign currency fluctuations. International crude oil prices
declined 31 percent, or $5.41 per barrel, for the period while natural gas
prices declined to $2.23 from $2.39 per thousand cubic feet, or 7 percent.
However, these negative factors were partially offset by increased crude oil
liftings and natural gas production in Indonesia and new crude oil production in
Yemen and Azerbaijan in 1998.
Year-to-date 1998 vs. Year-to-date 1997
Lower average international crude oil and natural gas prices primarily
contributed to the 52 percent drop in adjusted after-tax earnings for the
period. In 1998, average international crude oil prices declined $5.93 per
barrel, or 32 percent, and average international natural gas prices declined
$.24 per thousand cubic feet, or 10 percent. Also contributing to the decline in
adjusted after-tax earnings were higher current taxes in Thailand related to
foreign currency fluctuations, increased dry hole costs and exploration expenses
and foreign exchange losses in Thailand and Indonesia. These negative factors
were offset by higher crude oil liftings in Indonesia and increased natural gas
production volumes in Indonesia and Thailand.
GLOBAL TRADE
The Global Trade group handles substantially all of the company's worldwide
crude oil, condensate, natural gas and natural gas liquids marketing and trading
activities. Global Trade also purchases crude oil, condensate and natural gas
from the company's joint venture partners, royalty owners and other unaffiliated
oil and gas producers for resale.
Global Trade's after-tax earnings during the third quarters of 1998 and 1997
were $3 million and $2 million, respectively. After-tax earnings for the first
nine months of 1998 and 1997 were $13 million in each period.
GEOTHERMAL AND POWER OPERATIONS
The Geothermal and Power Operations segment explores for, produces and sells
geothermal resources, and constructs and operates electric power generation
plants.
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------- ----------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
After-tax earnings ....................................................... $ 16 $ 6 $ 44 $ 25
Less: special items (net of tax)
Deferred tax adjustment .............................................. -- 3 -- 10
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings .............................................. $ 16 $ 3 $ 44 $ 15
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Adjusted after-tax earnings for the third quarter and the first nine months of
1998 increased by $13 million and $29 million, respectively, compared to the
same periods last year. The improved 1998 earnings included an increase in
power generation and the related sale of electricity from the Indonesian Salak
field Units 3 through 6. Unit 3 came on line in the third quarter of 1997 and
Units 4 through 6 came on line in the fourth quarter of 1997.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
DIVERSIFIED BUSINESS GROUP
The Agricultural Products group manufactures, transports and markets
nitrogen-based products for agricultural and industrial uses. The Carbon and
Minerals group manufactures and markets petroleum coke, graphites and specialty
minerals. The Pipelines Group holds the company's equity interests in affiliated
pipeline companies.
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------- ----------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings
<S> <C> <C> <C> <C>
Agricultural Products ................................................. $ 12 $ 4 $ 33 $ 50
Carbon and Minerals ................................................... -- 10 24 76
Pipelines ............................................................. 14 16 44 46
Other ................................................................. -- -- -- 37
- ------------------------------------------------------------------------------------------------------------------------------------
Total ................................................................. 26 30 101 209
Less: special items (net of tax)
Asset sales (Carbon and Minerals) ..................................... -- -- -- 41
Environmental and litigation provisions (Carbon and Minerals) ......... (2) -- (4) --
UNO-VEN restructuring (Other) ......................................... -- -- -- 39
- ------------------------------------------------------------------------------------------------------------------------------------
Total special items ................................................... (2) -- (4) 80
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings .............................................. $ 28 $ 30 $ 105 $ 129
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
In 1997, after-tax earnings reflected the sale of the company's Illinois-based
Unocal Hydrocarbon Sales business unit and the restructuring of the UNO-VEN
partnership. These transactions generated gains (included in special items) of
$41 million and $39 million, respectively.
Third Quarter 1998 vs. Third Quarter 1997
Adjusted after-tax earnings declined due primarily to lower realized sales
prices for export fertilizer products, lower margins on specialty graphite
products sales, and lower realized sales prices for both lanthanides and
molybdenum products. These negative factors were partially offset by increased
worldwide fertilizer products sales volumes, lower maintenance related expenses
at the company's Kenai, Alaska fertilizer plant due to a plant turnaround in
1997 and tax related adjustments in 1998.
Year-to-date 1998 vs. Year-to-date 1997
Adjusted after-tax earnings fell 19 percent primarily due to lower sales prices
for export and domestic fertilizer products, decreased sales volumes for
domestic fertilizer products, lower molybdenum production and losses from the
company's lanthanides operation due to the temporary shutdown of the separations
plant and wastewater pipeline at its Mountain Pass, California, mining facility.
The negative impact of these factors was partially offset by higher fertilizer
product export sales volumes, lower maintenance related expenses at the
company's Kenai, Alaska fertilizer plant due to a plant turnaround in 1997 and
higher earnings from the company's Brazilian affiliate.
CORPORATE AND UNALLOCATED
Corporate and Unallocated expense includes general corporate overhead, the
non-exploration and production related activities of the New Ventures group and
other unallocated costs. Net interest expense represents interest expense, net
of interest income and capitalized interest.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30 Ended September 30
---------------------------------------------------
Millions of dollars 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
After-tax earnings effect
<S> <C> <C> <C> <C>
Administrative and general expense .................................... $ (20) $ (13) $ (43) $ (40)
Net interest expense .................................................. (33) (19) (83) (84)
Environmental and litigation expense .................................. (12) (65) (75) (86)
New Ventures (non-exploration and production) ......................... (4) (1) (16) (23)
Other ................................................................. (1) 95 3 75
- ------------------------------------------------------------------------------------------------------------------------------------
Total ................................................................. (70) (3) (214) (158)
Less: special items (net of tax)
Environmental and litigation provisions .............................. (8) (61) (67) (75)
Asset sales (Other) .................................................. -- (1) -- 4
Deferred tax adjustment (Other) ...................................... -- 114 -- 114
Insurance settlement (Other) ......................................... -- -- 11 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total special items .................................................. (8) 52 (56) 43
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted after-tax earnings effect ....................................... $ (62) $ (55) $ (158) $ (201)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
For the nine months ended September 30, 1998, the Other category included the
benefit of an $11 million insurance settlement, which was included in special
items. In the third quarter of 1997, a $114 million tax benefit was recorded
related to a reassessment of the company's exposure for pending federal income
tax appeals, which was also included in special items.
Third Quarter 1998 vs. Third Quarter 1997
Higher administrative and general and net interest expense due to a higher debt
level primarily contributed to the 13 percent increase in Corporate and
Unallocated expense for the period. These increased expenses were partially
offset by increased earnings from an insurance company subsidiary.
Year-to-date 1998 vs. Year-to-date 1997
Adjusted after-tax expenses decreased 21 percent principally due to lower New
Ventures - non-exploration and production expenses and higher earnings and
dividends from a petroleum industry mutual insurance company in 1998. These
positive factors were slightly offset by an increase in general and
administrative expense.
FINANCIAL CONDITION AND CAPITAL EXPENDITURES
For the first nine months of 1998, cash flow from operating activities,
including working capital changes, was $711 million, compared with $736 million
in 1997. The decrease was primarily attributable to the effect of lower crude
oil, natural gas and fertilizer product prices and increased receivable levels
in Indonesia. Those negative factors were partially offset by an increase in the
accrual of current taxes and capital accruals related to the August lease sale
conducted by the U.S. Minerals Management Service.
Proceeds from asset sales for the first nine months of 1998 were $299 million
and consisted of $262 million from the sale of the company's Tarragon
investment, $28 million from the sale of miscellaneous international, domestic
and real estate properties and $9 million related to the partial collection of a
note received on the sale of Unocal Hydrocarbon Sales in 1997.
Capital expenditures for the first nine months of 1998 totaled $1,248 million
compared to $953 million in the first nine months of 1997. The increase was
primarily due to increased drilling activities and lease acquisitions in the
Gulf of Mexico partially offset by lower geothermal expenditures. The first nine
months of 1997 included $49 million of capital expenditures for discontinued
operations.
The company expects its 1998 capital spending to total about $1.65 billion, up
from an earlier forecast of $1.5 billion. The increase in capital spending is
expected to be funded from a combination of asset sales proceeds and increased
debt.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The company's long-term debt was $2,423 million at September 30, 1998, an
increase of $254 million from the year-end 1997 level of $2,169 million. The
debt-to-total capitalization ratio increased to 46 percent from 42 percent at
year-end 1997.
ENVIRONMENTAL MATTERS
At September 30, 1998, the company's reserves for environmental remediation
obligations totaled $292 million, of which $132 million was included in current
liabilities (see note 9 to the consolidated financial statements). During the
third quarter, cash payments of $19 million were applied against the reserve and
an additional $18 million in liabilities were recorded. The additional $18
million in reserves were primarily for estimated cleanup costs for various
company facilities where the company's operations have been closed or shut down.
The company also estimates that it possibly could incur additional remediation
costs aggregating approximately $220 million as discussed in note 10 to the
consolidated financial statements. The company's total environmental reserve
amount is grouped into the following five categories:
<TABLE>
<CAPTION>
September 30
Millions of dollars 1998
- -----------------------------------------------------------------------------------------------
<S> <C>
Superfund and similar sites ........................................... $ 18
Former company-operated sites ......................................... 23
Company facilities sold with retained liabilities ..................... 70
Inactive or closed company facilities ................................. 152
Active company facilities ............................................. 29
- -----------------------------------------------------------------------------------------------
Total reserves ..................................................... $ 292
- -----------------------------------------------------------------------------------------------
</TABLE>
OUTLOOK
Certain of the statements in this discussion, as well as other forward-looking
statements within this document, contain estimates and projections of amounts of
or increases in future revenues, earnings, cash flows, capital expenditures,
assets, liabilities and other financial items and of future levels of or
increases in reserves, production, sales including related costs and prices, and
other statistical items; plans and objectives of management regarding the
company's future operations, products and services; and certain assumptions
underlying such estimates, projection plans and objectives. While these
forward-looking statements are made in good faith, future operating, market,
competitive, legal, economic, political, environmental, and other conditions and
events could cause actual results to differ materially from those in the
foward-looking statements.
Although Asia continues to struggle with the economic crisis gripping the
region, the company still remains optimistic about its excellent long-term
growth opportunities in Asia. In Thailand and Indonesia, the company is working
closely with host governments and business associates to help them through these
difficult economic times. As of September 30, 1998, the company's geothermal
operations in Indonesia had a gross receivable balance of approximately $79
million, most of which was for steam sales from the Salak field. Approximately
$26 million is due by the end of November 1998, of which $17 million represents
a shortfall in payments for March through July 1998 steam deliveries to Gunung
Salak electric generating Units 1, 2 and 3. Partial payments have been received
on a timely basis. The remaining balance is payable over the next several years.
The company continues to engage in discussions with Indonesian government
entities to explore potential ways to resolve the shortfall issue.
Worldwide energy prices remain depressed and the company expects this trend to
continue to negatively impact 1998 financial results. However, the company
remains confident that it is well positioned to weather this low commodity price
environment.
The company strives to create value for stockholders. To achieve this objective,
the company is focused on finding and developing new high-return business
opportunities in a low-cost manner. In 1998, Spirit Energy 76 achieved a total
of 29 new commercial successes in the onshore Louisiana, the Gulf of Mexico
shelf and deepwater, the Permian Basin and East Texas areas. Deepwater Gulf of
Mexico exploration drilling is currently under way on the Mad Dog and Mirage
prospects. In August, Spirit Energy was the apparent high bidder for interests
in 62 additional blocks in the deepwater Gulf of Mexico lease sale.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
In Indonesia, positive results from the first four wells in the Seno prospect
will allow the company to complete a development plan which should result in
first production during 2001. Current plans also call for drilling on the nearby
Janaka prospect.
YEAR 2000
The company is actively addressing the Year 2000 (Y2K) issue throughout its
operating and office environments. Many existing computer programs were designed
and developed to use only two digits to identify a year in the date field. If
not addressed, these computer applications could result in system failures with
possible material adverse effects on the company's operations at the year 2000.
The company has appointed a program manager and has assembled various teams of
professionals to identify, assess, correct and test these software applications
as well as its embedded systems. In addition, the company has contracted with a
systems consulting firm to assist with the assessment, correction and testing of
the company's internal systems as well as to assess its system relationships
with vendors, suppliers, customers and other outside parties.
Initiation of the company's Y2K project work began in July 1996. A company-wide
initial awareness campaign was completed in June 1998. Identification and
assessment phases of the project are well underway. The company is in the
process of preparing business contingency and recovery plans for its "mission
critical" systems, applications and processes. These systems, applications and
processes, if not operable, could materially adversely impact revenues,
operations, safety or the environment. The company's Y2K project work includes
the updating of these plans to address material Y2K issues.
The company's Y2K efforts can be divided into three general categories:
Information Technology (IT) systems and applications, embedded systems in
process controls, and critical business partners. As of September 30, 1998, the
company had completed 95 percent of the inventory and 85 percent of the
assessment of Y2K problems in the "IT systems and applications" and the
"embedded systems in process controls" categories. In the "IT systems and
applications" category, detailed planning to correct or work around the
anticipated problems is 80 percent complete and corrective action and testing is
20 percent complete. In the "embedded systems in process controls" category,
detailed planning to correct or work around the anticipated problems is
approximately 50 percent complete and the repair and testing of these systems is
20 percent complete. In the "critical business partners" category, the company
is currently assessing its exposure to problems with business partner Y2K
readiness. Although some critical business partners have been identified and
contacted, comprehensive effort in this area will begin in the fourth quarter of
1998.
The following schedule sets forth the company's overall estimated timetable for
achieving Year 2000 readiness:
Project Phases Expected Completion Dates
- -------------- -------------------------
Worldwide Inventory of Systems fourth quarter1998
Worldwide Assessment fourth quarter 1998
Initial Plan for Corrections/Work Arounds first quarter 1999
Remediation/Renovation second quarter 1999
Validation/Testing third quarter 1999
Contingency Planning third quarter 1999
Implementation third quarter 1999
Continuous System Review Ongoing - through fourth
quarter 1999
The company currently estimates the expenditures on the preceding Y2K project
phases to approximate $30 to $35 million. These expenditures will occur
throughout 1998 and 1999. Expenditures as of September 30, 1998 were
approximately $5 million.
The Y2K problem is real and there is a risk of Y2K related failures. These
failures could result in an interruption in, or a failure of, certain business
activities or functions. Such failures could materially and adversely affect the
company's results of operations, liquidity or financial condition. Due to the
uncertainty surrounding the Y2K problem, including the uncertainty of the Y2K
readiness of the company's customers, suppliers, and partners, the company is
unable at this time to determine the true impact of the Y2K problem to Unocal.
The principle areas of risk are thought to be oil and gas production control
systems, other operations control systems and third party Y2K readiness. The
company's Y2K project is expected to reduce this uncertainty. The company
believes that with the completion of the project as planned, the possibility of
significant interruptions of normal operations should be reduced. There can be
no assurance, however, that there will not be a delay in, or increased costs
associated with the implementation of such changes or that such changes will
prove 100 percent effective in resolving all Y2K related issues.
17
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk generally represents the risk that losses may occur in the value of
financial instruments as a result of movements in interest rates, foreign
currency exchange rates and commodity prices. As part of its overall risk
management strategies, the company uses derivative financial instruments to
manage and reduce risks associated with these factors. The company also pursues
outright pricing positions in certain hydrocarbon derivative financial
instruments, such as futures contracts, subject to company controls and
monitoring requirements. The following discussion and analysis focuses on
significant changes in the company's position regarding these risk factors since
year end 1997.
Interest Rate Risk - The company's primary market exposure for changes in
interest rates relates to the company's long term debt obligations. The company
manages its exposure to changing interest rates principally through the use of a
combination of fixed and floating rate debt. Other instruments, such as interest
rate swaps, options, floors, caps or collars may also be used depending upon
market conditions. During the first nine months of 1998, the company increased
its outstanding debt level (excluding capital leases) by approximately $255
million to $2,423 million from its year-end 1997 level of $2,168 million,
primarily through the sale of two new debt issues. On May 6, 1998, Union Oil
issued $100 million of 6 1/2 % notes due May 1, 2008 and $200 million of 7 %
debentures due May 1, 2028, in each case guaranteed by Unocal. Proceeds from the
sale were used to retire $110 million Deutsche Mark bonds and to reduce
outstanding commercial paper borrowings. The company also reduced its
outstanding medium term notes in the third quarter of 1998. The increase in debt
is principally due to increased cash requirements resulting from lower than
anticipated commodity prices in 1998. The following table provides principal
amounts, related weighted average interest rates, and fair values for the
company's outstanding debt obligations by expected maturity dates at September
30, 1998 and constitutes a forward looking statement. The company expects to
refinance its debt obligations that are scheduled to mature during the years
1998 to 2002. Circumstances could arise which may cause interest rates and the
timing and amounts of actual cash flows to differ materially from the
projections.
<TABLE>
<CAPTION>
Debt Obligation Principal Amounts by Expected Maturity Dates at September 30, 1998
Fair
Millions of U.S. dollars 1998-2002 There-after Total Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fixed rate ............................................................... $ -- $ 1,903 $ 1,903 $ 2,087
Average Interest Rates ................................................. -- 7.93% 7.93%
Variable rate ............................................................ -- 520 520 520
Average Interest Rates ................................................. -- 5.93% 5.93%
- ------------------------------------------------------------------------------------------------------------------------------------
$ -- $ 2,423 $2,423 $ 2,607
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Foreign exchange rate risk - Where warranted, the company enters into various
foreign currency contracts, such as forward exchange contracts, options and
currency swaps, to manage its exposure to foreign currency exchange rates. At
September 30, 1998, the company had two foreign currency forward exchange
contracts outstanding to purchase Thai baht. The contracts are designed to hedge
the company's foreign currency exposure for estimated baht income tax payments
scheduled to be paid to the government of Thailand in May 1999. The first
contract calls for the company to pay approximately $19 million in exchange for
800 million baht at maturity on May 25, 1999. The second contract calls for the
company to pay approximately $12 million in exchange for 500 million baht at
maturity on May 25, 1999. The fair value of the contracts at September 30, 1998
was approximately $609 thousand and $172 thousand respectively. Fair values
approximate the net gains that would have been realized if the contracts had
been closed out at September 30 and are estimated by comparing the contract
rates to the forward rates in effect at the balance sheet date.
As a result of the sale of the company's holdings in Tarragon common stock and
debentures, the company's Canadian subsidiary repaid $250 million in outstanding
loans (denominated in US dollars) and terminated its corresponding $250 million
currency swap agreements in August and October 1998. Unocal also terminated its
$250 million off-setting currency swap agreements in August and October 1998.
The Canadian subsidiary's swap agreements had the effect of changing the
subsidiary's US dollar denominated borrowings into its functional Canadian
currency. The purpose of the swap agreements was to limit the subsidiary's
exposure to currency exchange gains and losses and to allow Unocal to maintain
the underlying debt in US dollars for consolidated financial reporting purposes.
Amounts related to the swap agreements terminated in October were accrued in
September accounts.
Commodity price risk - The company uses hydrocarbon derivative financial
instruments, such as futures contracts or options with maturities of 18 months
or less, to mitigate its exposure to fluctuations in hydrocarbon commodity
prices. On occasion, the company may enter into forward sales. The company also
takes pricing positions in hydrocarbon derivative financial instruments
(primarily exchange regulated futures and option contracts) subject to internal
policy limitations. The company monitors its trading activities to ensure
compliance with its policies.
18
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. (CONTINUED)
The company uses a value at risk model to assess the market risk of its price
sensitive hydrocarbon derivative financial instruments. Value at risk represents
the potential loss in fair value the company would experience on its hydrocarbon
derivative financial instruments, using calculated volatilities and correlations
over a specified time period with a given confidence level. The company's
calculation model is based on historical data and uses a one-week time interval
and a 95 percent confidence level. Based upon the company's model, the value at
risk associated with hydrocarbon derivative financial instruments held for
trading purposes was approximately $7 million at September 30, 1998. The value
at risk associated with hydrocarbon derivative financial instruments held for
purposes other than trading was approximately $8 million at September 30, 1998.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There is incorporated by reference the information with respect to certain legal
proceedings previously reported in Item 3 of Unocal's Annual Report on Form 10-K
for the year ended December 31, 1997 (1997 Form 10-K) and in Item 1 of Part II
of Unocal's Quarterly Reports on Form 10-Q for the quarters ended March 31, 1998
(First Quarter 1998 Form 10-Q) and June 30, 1998 (Second Quarter 1998 Form
10-Q), the information regarding environmental remediation reserves in note 9 to
the consolidated financial statements in Item 1 of Part I hereof, the discussion
thereof in the Environmental Matters section of Management's Discussion and
Analysis in Item 2 of Part I, and the information regarding certain legal
proceedings and other contingent liabilities in note 10 to the consolidated
financial statements.
(1) In the lawsuit captioned Portland 76 Auto/Truck Plaza Inc. v. Union Oil
----------------------------------------------
Company of California, et al., described in Paragraph (1) of Item 3 of
------------------------------
the 1997 Form 10-K, on August 19, 1998, the Ninth Circuit Court of
Appeals reversed the Robinson-Patman Act violation portion of the trial
court's judgment, thereby reducing the company's net liability under
the judgment to approximately $960,000. The plaintiff petitioned the
Ninth Circuit Court of Appeals for a rehearing, which was denied on
October 7, 1998.
(2) In the lawsuit captioned Citizens for a Better Environment, et al. v.
----------------------------------------------
Union Oil Company of California, described in Paragraph (3) of Item 3
--------------------------------
of the 1997 Form 10-K and in Paragraph (1) of Item 1 of Part II of each
of the First and Second Quarter 1998 Form 10-Qs, on August 24, 1998,
the parties entered into a definitive agreement to settle the case on
terms which will involve an aggregate payment by the company of
$6,750,000. The agreement was approved by the court on October 14,
1998.
(3) With reference to the matters involving the Guadalupe oil field,
described in Paragraph (4) of Item 3 of the 1997 Form 10-K and in
Paragraph (2) of Item 1 of Part II of each of the First and Second
Quarter 1998 Form 10-Qs, on October 30, 1998, judgement on the
pleadings was granted in the company's favor in the California Superior
Court case captioned Surfers' Environmental Alliance, et al. v. Union
--------------------------------------------------
Oil Company of California, et al.
---------------------------------
(4) With reference to the matters involving the town of Avila Beach,
California, described in Paragraph (5) of Item 3 of the 1997 Form 10-K
and in Paragraph (3) of Item 1 of Part II of each of the First and
Second Quarter 1998 Form 10-Qs, the company has reached a settlement of
the private property damage claims alleged in all but three of the
pending lawsuits.
(5) In the lawsuit captioned Atlantic Richfield Company, et al. v. Unocal
----------------------------------------------
Corporation, et al., described in Paragraph (6) of Item 3 of the 1997
--------------------
Form 10-K, on August 31, 1998, the trial court found that the company
did not engage in "inequitable conduct" in obtaining its Patent No.
5,288,393 for claims for the composition of reformulated gasolines,
with the result that the patent is valid and enforceable. On September
11, 1998, the court assessed an award of $1.5 million against the six
plaintiff oil companies for the company's attorneys' fees. The
plaintiffs have filed a notice of appeal on October 26, 1998.
19
<PAGE>
ITEM 1. LEGAL PROCEEDINGS (CONTINUED)
(6) With reference to the investigation by the U.S. Department of Justice
and the related private lawsuit under the federal False Claims Act with
respect to the alleged underpayment of royalties on crude oil produced
from federal and Indian land leases, the company has recently been made
aware that it has been named as a defendant in two separate proceedings
brought under the False Claims Act, alleging underpayment of royalties
since the mid-1980's on natural gas production from federal and Indian
land leases. The first action, United States, ex rel. Harrold E. (Gene)
----------------------------------------
Wright v. Amerada Hess, et al. (U.S. District Court for the Eastern
--------------------------------
District of Texas), was filed in August 1996 against the company and
130 other energy industry companies and seeks damages of $3 billion
from all defendants. The second action, United States, ex rel. Jack J.
------------------------------
Grynberg v. Unocal (U.S. District Court for the District of Wyoming),
------------------
was filed in September 1997 as one of 77 separate cases filed by Mr.
Grynberg and seeks damages of approximately $200 million from the
company. To date, the U.S. Department of Justice has not elected to
intervene in either proceeding. The company believes the allegations
are without merit and intends to vigorously defend both cases.
(7) With reference to the preliminary determinations of underpaid
royalties, described in Paragraph (10) of Item 3 of the 1997 Form 10-K
and in Paragraph (4) of Item 1 of Part II of the First Quarter 1998
Form 10-Q, the total amount, including interest, claimed by the U.S.
Department of Interior, Minerals Management Service, has been reduced
to approximately $35 million.
(8) With reference to the matters involving the Mountain Pass, California,
lanthanide facility of the company's Molycorp, Inc. (Molycorp),
subsidiary, described in Paragraph (14) of Item 3 of the 1997 Form
10-K, in Paragraph (5) of Item 1 of Part II of the First Quarter 1998
Form 10-Q and in Paragraph (4) of Item 1 of Part II of the Second
Quarter 1998 Form 10-Q, in August 1998 the Office of the District
Attorney of San Bernardino County, California, advised Molycorp that
settlement discussions were suspended, that a grand jury would be
convened to inquire into the matter and that two Molycorp employees
also have been named as targets. To Molycorp's knowledge, the grand
jury has not yet been convened. Settlement discussions were reopened in
October 1998.
In the District Attorney's civil action captioned People of the State
-------------------
of California v. Molycorp, Inc., alleging violations of California's
--------------------------------
Proposition 65 law, on September 10, 1998, Molycorp filed its answer to
the complaint.
(9) In the lawsuit captioned State of Arizona v. Union Oil Company of
-------------------------------------------
California, described in Paragraph (16) of Item 3 of the 1997 Form
----------
10-K, the state has informed the company that it is seeking civil
penalties in excess of $1.5 million, as well as other payments. The
company intends to vigorously contest the state's allegations.
ITEM 2. CHANGES IN SECURITIES
During the third quarter of 1998, Unocal awarded 4,213 restricted stock units to
nonemployee directors pursuant to the terms of the company's Directors'
Restricted Stock Units Plan. The 4,213 units were awarded (1) in consideration
of the prior election by each of the nonemployee directors to defer all or a
portion of his or her cash fees and (2) upon the credit of dividend equivalents
upon units previously awarded. The units were not registered under the
Securities Act of 1933 (the Act) in reliance upon the exemption contained in
Section 4(2) of the Act for transactions by an issuer not involving any public
offering. The units are paid out in an equal number of shares of Unocal common
stock at the end of a deferral period.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The Exhibit Index on page 23 of this report lists the
exhibits that are filed as part of this report.
(b) Reports on Form 8-K:
Filed during the third quarter of 1998:
1. Current Report on Form 8-K dated July 14, 1998, and filed
July 15, 1998, for the purpose of reporting, under Item 5,
highlights from Unocal's security analyst conference.
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
2. Current Report on Form 8-K dated and filed July 28, 1998,
for the purpose of reporting, under item 5, Unocal's second
quarter 1998 earnings and related information.
3. Current Report on Form 8-K dated August 17, 1998, and filed
August 18, 1998, for the purpose of reporting, under item 5,
the discovery of a potentially significant new oil and gas
field in the deepwater Kutei Basin offshore East Kalimantan,
Indonesia.
4. Current Report on Form 8-K dated August 24, 1998, and filed
August 26, 1998, for the purpose of reporting, under item 5,
the test of a second interval in the West Seno #2 deepwater
discovery well offshore Indonesia.
5. Current Report on Form 8-K dated and filed September 2,
1998, for the purpose of reporting, under item 5, judgment
in favor of the company in litigation regarding the
company's reformulated gasolines.
6. Current Report on Form 8-K dated September 16, 1998 and
filed September 26, 1998, for the purpose of reporting,
under item 5, growth, third quarter 1998 earnings outlook,
capital expenditures forecast, suspension of settlement
discussions of criminal investigations arising from
wastewater pipeline incidents at Molycorp's Mountain Pass,
California, lanthanide facility and bylaw changes.
Filed during the fourth quarter of 1998 to the date hereof:
1. Current Report on Form 8-K dated October 27, 1998, and filed
October 29, 1998, for the purpose of reporting, under Item
5, Unocal's third quarter 1998 earnings and related
information.
21
<PAGE>
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.
UNOCAL CORPORATION
(Registrant)
Dated: November 6, 1998 By: /s/ JOE D. CECIL
----------------------------------------
Joe D. Cecil
Vice President and Comptroller
(Duly Authorized Officer and
Principal Accounting Officer)
22
<PAGE>
EXHIBIT INDEX
12.1 Statement regarding computation of ratio of earnings to fixed charges
of Unocal for the nine months ended September 30, 1998 and 1997.
12.2 Statement regarding computation of ratio of earnings to fixed charges
of Union Oil for the nine months ended September 30, 1998 and 1997.
27. Financial data schedule for the period ended September 30, 1998
(included only in the copy of this report filed electronically with the
Commission).
23
<TABLE>
<CAPTION>
EXHIBIT 12.1
UNOCAL CORPORATION AND CONSOLIDATED SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
For the Nine Months
Ended September 30
----------------------
Millions of dollars 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Earnings from continuing operations ...................................... $ 159 $ 521
Provision for income taxes ............................................... 177 68
- -------------------------------------------------------------------------------------------------------
Earnings subtotal ............................................... 336 589
Fixed charges included in earnings:
Interest expense ...................................................... $ 131 $ 147
Distribution on convertible preferred securities ...................... 24 24
Interest portion of rentals ........................................... 17 21
- -------------------------------------------------------------------------------------------------------
Fixed charges subtotal .......................................... 172 192
Earnings from continuing operations
available before fixed charges ........................................ $ 508 $ 781
- -------------------------------------------------------------------------------------------------------
Fixed charges:
Fixed charges included in earnings .................................... $ 172 $ 192
Capitalized interest .................................................. 22 26
- -------------------------------------------------------------------------------------------------------
Total fixed charges ............................................. $ 194 $ 218
- -------------------------------------------------------------------------------------------------------
Ratio of earnings from continuing operations
to fixed charges ...................................................... 2.6 3.6
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT 12.2
UNION OIL COMPANY OF CALIFORNIA AND CONSOLIDATED SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
For the Nine Months
Ended September 30
----------------------
Millions of dollars 1998 1997
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Earnings from continuing operations ...................................... $ 179 $ 548
Provision for income taxes ............................................... 184 68
- -------------------------------------------------------------------------------------------------------
Earnings subtotal .................................................. 363 616
Fixed charges included in earnings:
Interest expense ...................................................... 131 147
Interest portion of rentals ........................................... 17 21
- -------------------------------------------------------------------------------------------------------
Fixed charges subtotal ............................................. 148 168
Earnings from continuing operations
available before fixed charges ........................................ 511 784
- -------------------------------------------------------------------------------------------------------
Fixed charges:
Fixed charges included in earnings .................................... 148 168
Capitalized interest .................................................. 22 26
- -------------------------------------------------------------------------------------------------------
Total fixed charges ................................................ $ 170 $ 194
- -------------------------------------------------------------------------------------------------------
Ratio of earnings from continuing operations
to fixed charges ..................................................... 3.0 4.0
- -------------------------------------------------------------------------------------------------------
</TABLE>
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Unocal Corporation FDS
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<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
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0
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<COMMON> 252
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