CASE 11-1 Off-Balance-Sheet Financing Techniques for Texaco and Caltex

The objective of this case is to extend the analysis of the off-balance-sheet nancing activities of Texaco begun in Exhibit 11-7 of the text. Specically the case focuses on Texacos afliates and their OBS activities and the adjustments to reported nancial statements required to reect these activities. Caltex is a joint venture between Texaco and Chevron [CHV] (another oil multinational); each partner owns 50%. Exhibit 11C-1 contains the 1999 condensed balance sheet, income statement, and selected footnotes of Caltex as well as general information, all extracted from Texacos 1999 10-K report. Relevant nancial information relating to Texaco can be obtained from Texacos 1999 Annual Report (on the website/CD) and from the information provided in Exhibits 11-6 and 11-7 in the text. Required: 1. Exhibit 11-7 shows Texacos reported and adjusted debt-to-equity ratios. To extend the analysis, compute the following ratios on a reported and adjusted basis for 1999: Return on assets (Use 1999 year end total assets) Times interest earned 2. (a) Using the Caltex reported balance sheet and income statement (without any adjustments), prepare a capitalization table for Caltex for the year ended December 31, 1999. (b) Compute the following Caltex ratios for 1999: Debt-to-equity Return on assets Times interest earned 3. (a) Using the footnote data from Exhibit 11C-1, compute the appropriate adjustments to Caltex debt for its off-balance-sheet obligations. (b) Using the result of part (a), recompute the ratios in question 2(b). (c) Discuss the signicance of your results. 4. Use the results of Questions 2 and 3 to further adjust Texacos debt and equity, and ratios calculated in Question 1. 5. Describe the information not contained in the Texaco and Caltex nancial data that would help you evaluate the impact of their off-balance-sheet obligations on future cash ows. (Your discussion should include both nancial and operational factors.) In addition to Caltex, Texacos major afliates are Equilon Enterprises LLC (44% owned) and Motiva Enterprises LLC (32.5% owned).1 A description of these afliates follows. Equilon was formed and began operations in January 1998 as a joint venture between Texaco and Shell. Equilon, which is headquartered in Houston, Texas, combines major elements of Texacos and Shells western and midwestern U.S. rening and marketing businesses and their nationwide transportation and lubricants businesses. Texaco owns 44% and Shell owns 56% of the company. Equilon renes and markets gasoline and other petroleum products under both the Texaco and Shell brand names in all or parts of 32 states. Equilon is the seventh largest rening company in the U.S. (Continued on page W87.)

Equilon and Motiva are limited liability companies (LLC) and do not pay income taxes directly. Taxes are the responsibility of the limited partners. As such, their nancial statements do not record a provision for taxes.

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EXHIBIT 11C-1. CALTEX GROUP OF COMPANIES Excerpts from 1999 Financial Statements ($millions) Condensed Consolidated Income Statement Year Ended December 31, 1999 Sales and other operating revenue Cost of sales Selling, general and administrative Depreciation, depletion, and amortization Maintenance and repairs Total expenses Operating income Income in equity afliates Dividends, interest, and other income Foreign exchange, net Interest expense Minority interest Total other income (deductions) Income before income taxes Income taxes Net income Condensed Consolidated Balance Sheet December 31, 1999 Assets Current assets Investments and advances Net property Other Total assets Liabilities and Equity Short-term debt Accounts payable Other Current liabilities Long-term debt Deferred income taxes Other Minority interest Long-term liabilities Stockholders equity Total liabilities and equity General Information The Caltex Group of Companies (Group) is jointly owned 50% each by Chevron Corporation and Texaco Inc. (collectively, the Stockholders) and was created in 1936 by its two owners to produce, transport, rene, and market crude oil and petroleum products. Note 4Equity in Afliates Investments in afliates at equity include the following: Equity % Caltex Australia Limited Koa Oil Company, Limited (sold August, 1999) LG-Caltex Oil Corporation Star Petroleum Rening All other 50% 50% 50% 64% Various 1999 $ 260 1,441 269 $2,157 $2,127 1998 $ 324 298 1,170 304 $2,158 $2,254 $ 1,588 1,545 $10,262 $ 3,395 1,054 206 1,356 $10,223 $ 2,639 $14,275 $10,309 $ 2,705 2,223 5,170 $10,211 $10,309 $14,583 12,775 582 459 $13,154 $13,970 613 252 80 (11) (152) $1211(2) $ 167 780 $13,390 $ 390

OFF-BALANCE-SHEET FINANCING TECHNIQUES FOR TEXACO AND CALTEX

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EXHIBIT 11C-1 (continued) Shown below is summarized combined nancial information for equity afliates: 100% 1999 Current assets Other assets Current liabilities Other liabilities Net worth $3,005 6,333 (3,351) .(1,883) $4,104 1998 $3,689 7,689 (3,547) .(3,505) $4,326 100% 1999 Operating revenues Operating income Net income $12,796 726 539 1998 $11,811 1,101 193 1997 $14,669 1,078 853 1999 $6,511 358 252 Equity Share 1999 $1,535 3,287 (1,816) ..$(937) $2,069 1998 $1,855 4,004 (1,795) .(1,866) $2,198 Equity Share 1998 $5,968 539 58 1997 $7,452 532 390

Cash dividends received from these afliates were $71 million, $50 million, and $43 million in 1999, 1998, and 1997, respectively. Retained earnings as of December 31, 1999 and 1998 includes $1.4 billion which represents the Groups share of undistributed earnings of afliates at equity. Note 7Operating Leases The Group has operating leases involving various marketing assets for which net rental expense was $112 million, $103 million, and $105 million in 1999, 1998, and 1997, respectively. Future net minimum rental commitments under operating leases having non-cancelable terms in excess of one year are as follows (in Millions of U.S. Dollars): 2000$66; 2001$42; 2002$30; 2003$13; 2004$10; and 2005 and thereafter$37. Note 9Commitments and Contingencies . . . .A Caltex subsidiary has a contractual commitment until 2007 to purchase petroleum products in conjunction with the nancing of a renery owned by an afliate. Total future estimated commitments under this contract, based on current pricing and projected growth rates, are approximately $700 million per year. Purchases (in billions of U.S. dollars) under this and other similar contracts were $0.7, $0.8, and $1.0 in 1999, 1998, and 1997, respectively. . . .Caltex is contingently liable for sponsor support funding for a maximum of $278 million in connection with an afliates project nance obligations. The project has been operational since 1996 and has successfully completed all mechanical, technical, and reliability tests associated with the plant physical completion covenant. However, the afliate has been unable to satisfy a covenant relating to a working capital requirement. As a result, a technical event of default exists which has not been waived by the lenders. The lenders have not enforced their rights and remedies under the nance agreements and they have not indicated an intention to do so. The afliate is current on these nancial obligations and anticipates resolving the issue with its secured creditors during further restructuring discussions. During 1999, Caltex and the other sponsor provided temporary short-term extended trade credit related to crude oil supply with an outstanding balance owing to Caltex at December 31, 1999 of $149 million. Environmental Matters The Groups environmental policies encompass the existing laws in each country in which the Group operates, and the Groups own internal standards. Expenditures that create future benets or contribute to future revenue generation are capitalized. Future remediation costs are accrued based on estimates of known environmental exposure even if uncertainties exist about the ultimate cost of the remediation. Such accruals are based on the best available undiscounted estimates using data primarily developed by third party experts. Costs of environmental compliance for past and ongoing operations, including maintenance and monitoring, are expensed as incurred. Recoveries from third parties are recorded as assets when realizable.

EXHIBIT 11C-2. TEXACO AFFILIATES: EQUILON AND MOTIVA Excerpts from 1999 Financial Statements ($millions) Condensed Consolidated Income Statement Year Ended December 31, 1999 Equilon Sales and other operating revenue Cost of sales Selling, general, and administrative Depreciation, depletion, and amortization Total expenses Operating income Equity in income of afliates Dividends, interest and other income Interest expense Minority interest Total other income (deductions) Net income $29,174 26,747 1,308 $28,878 $28,933 241 154 70 (115) $2891(3) $ 106 $ 347 Motiva $12,196 10,917 876 $12,378 $12,171 25 , , (94) $12 , $ (94) $ (69)

Condensed Consolidated Balance Sheet December 31, 1999 Equilon Assets Current assets Investments & advances Net property Other assets Total assets Liabilities and Equity Short-term debt Accounts payable Other Current liabilities Long-term debt Other liabilities Long-term liabilities Stockholders equity Total liabilities and equity Equity in Afliates Equilon: Summarized nancial information for Equilons afliate investments and Equilons equity share thereof for the year ended December 31, 1999 is as follows: Equity Companies at 100% and at Equilons Percentage Ownership ($ millions) 100% Current assets Noncurrent assets Current liabilities Noncurrent liabilities and deferred credits Net assets Revenues Income before income taxes Net income Dividends received $1,684 3,601 (1,585) (2,543) $1,157 2,002 664 494 Equilons Share $ 750 1,097 (629) $1(692) $ 526 615 176 154 144 2,157 2,481 1 1,998 $ 5,636 5 11 ,730 $ ,735 2 5,046 $11,417 363 377 1 ,538 $1,278 1,451 2 ,644 $2,095 $3,205 $6,578 $ 4,209 529 6,312 1 1,367 $11,417 $1,271 180 4,974 6 ,153 $6,578 Motiva

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OFF-BALANCE-SHEET FINANCING TECHNIQUES FOR TEXACO AND CALTEX

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EXHIBIT 11C-2 (continued) Operating Leases and Throughput Agreements As of December 31, 1999 Equilon and Motiva had estimated minimum commitments for payment of rentals under leases that, at inception, had a non-cancelable term of more than one year, as follows: ($ millions) Equilon 2000 2001 2002 2003 2004 After 2004 Total Less sublease rental income Total lease commitments 76 63 62 61 59 $1,775 $1,096 $1,075 $1,021 $ Motiva $ 51 49 47 39 38 $410 $634 $1 $634

Equilon has assumed crude and rened product throughput commitments previously made by Shell and Texaco to ship through afliated pipeline companies and an offshore oil port, some of which relate to nancing arrangements. As of December 31, 1999 and 1998, the maximum exposure was estimated to be $297 million and $333 million, respectively. No advances have resulted from these obligations. Motiva was formed and began operations in July 1998 as a joint venture among Shell, Texaco, and Saudi Refining, Inc., a corporate affiliate of Saudi Aramco. Motiva combines Texacos and Saudi Aramcos interests and major elements of Shells eastern and Gulf Coast U.S. refining and marketing businesses. Texaco and Saudi Refining, Inc., each owns 32.5% and Shell owns 35% of Motiva. Motiva refines and markets gasoline and other petroleum products under the Shell and Texaco brand names in all or part of 26 states and the District of Columbia, providing product to almost 14,000 Shell- and Texaco-branded retail outlets. Exhibit 11C-2 contains the condensed balance sheet, income statement, and selected footnotes of Equilon and Motiva, all extracted from Texacos 1999 10-K report. 6. Using the data from Exhibit 11C-2, compute the appropriate adjustments to Texacos nancial statements and recompute the ratios calculated in Question 1.