ITEM 3. LEGAL PROCEEDINGS
Since 1984, the Company has been named with others as a defendant in numerous product liability cases, including class actions, involving the failure of residential plumbing systems in the United States constructed with polybutylene plastic pipe. The Company has also been sued regarding failures in polybutylene pipe connecting users with utility water lines and polybutylene pipe used in municipal water distribution systems. The polybutylene pipe was manufactured primarily by United States Brass Corporation and Vanguard Plastics, Inc. using polybutylene resin supplied by the Company to fabricate the pipe and initially, in the case of residential plumbing systems, polyacetal resin supplied by E.I. DuPont de Nemours and Company (DuPont) and Hoechst Celanese Corporation (Hoechst Celanese) to fabricate the pipe fittings. The plaintiffs in the litigation claim property damages and, in some cases, fraud and intentional misrepresentation seeking punitive damages. The Company's position is, and most of the judgments to date have confirmed that, most of the leaks in residential plumbing systems have occurred due to the failure of the polyacetal insert fittings. Polyacetal is no longer used to manufacture insert fittings for these systems and during 1996, the Company announced it would no longer sell polybutylene resin for use in the domestic pipe market. The number of new plumbing claims involving residential plumbing systems and problems with polybutylene pipe used to connect to residential utility water lines increased significantly during 1996. The Company, Dupont and Hoechst Celanese have agreed on a mechanism to fund the payment of most of the residential plumbing claims as the result of two class action settlements (the "class action settlement"). The class action settlement provides for the creation of an entity to receive and handle claims and for a $950 million fund to pay such claims, which claims may be made over a period of up to 14 years, depending on various factors. If the settlement funds are exhausted, additional funds may be provided by the defendants or claimants who have not received their full benefits under the class action settlement may seek their remedy in a new court proceeding at that time. Additionally, a small percentage of defendants have opted out of the class action settlement and must assert their claims outside such settlement. Significant issues remain to be resolved as to how costs will be shared among the defendants. One fittings co-defendant has agreed to fund 10% of all acetal fitting costs related to the class action settlement; the Company and the other fittings co-defendant have agreed to arbitrate to determine how the remaining acetal fittings portion of the costs of the class action settlement will be shared between them. Additionally, in matters outside the residential plumbing claims and the class action settlement, claims involving municipal water distribution systems have continued to increase during the past two years. The Company will continue to defend these matters vigorously but it cannot currently predict when or how all polybutylene related matters will finally be resolved.
The Company is a party to litigation regarding Nemagon(R), an agricultural chemical containing DBCP manufactured and sold by the Company from 1955 to 1978. Decreases in the maximum contamination level for DBCP resulted in residual traces of DBCP present in the groundwater in the area of certain water wells
exceeding certain state and federal maximum contamination levels. The claims in this litigation seek the cost of cleanup and future monitoring of such water wells. The Company is a co-defendant in these cases with other substantial manufacturers and suppliers of the same chemical. Almost all of these cases have now been settled, with defendants accepting certain future obligations. The Company believes that it has established adequate reserves to fund its future liabilities in connection with all such cases. Cases involving approximately 25,000 plaintiffs have been filed against the Company, other substantial manufacturers and suppliers of DBCP and various banana growers alleging that the plaintiffs suffer fertility problems arising from exposure to DBCP while working on banana plantations outside the United States. Most of these cases were filed in Texas state court, were removed to federal court in Texas, and have now been sent by the federal court for handling in the courts of the various jurisdictions outside the United States where the plaintiffs allege that damages were incurred. Plaintiffs have appealed this decision. Several cases remain pending in the United States, involving several thousand plaintiffs. Challenges to jurisdiction and appropriate forum are being asserted by the defendants in those cases. The Company is contesting whether any injury has in fact been incurred by plaintiffs, whether DBCP was in fact the cause of any such injury as may exist, and in any case if the Company was a supplier or otherwise had liability in connection with any such injury.
In December 1993, a Los Angeles County Superior Court jury, in two consolidated lawsuits against the Company and its subsidiary involving the condition of the Dominguez oil field, returned a verdict against "Shell" in the amount of $46.9 million compensatory damages and $173 million punitive damages. Plaintiffs allege they were defrauded, that the oil and gas lease was breached, and that soil contamination on the property constitutes a continuing trespass. Final resolution through the appeals process could take several years. For a number of reasons, the Company believes the verdict was wrong and expects ultimately to prevail in the litigation.
The Company, along with its parent companies and other affiliated companies, was sued in the United States District Court for the Southern District of New York in January of 1995 by Union Carbide Corporation concerning a proposed joint venture between affiliates of the Company and another company involving their polyolefins businesses. The plaintiff alleged, among other things, that the new venture caused a breach of certain contractual obligations of the Company to Union Carbide. The Company strongly contests these allegations. Discovery continues in the litigation.
Numerous lawsuits have been filed and demands made against the Company and its subsidiaries, as well as other large producers, by federal and state governmental parties and private parties alleging underpayment of oil and gas royalty. At the federal level, notices of investigation and in some cases claims have been received regarding underpayment of oil royalties on production from federal lands (including offshore leases). Suits have also been filed on behalf of various state agencies and private parties in Texas, New Mexico and Louisiana against the Company, subsidiaries of the Company and other oil companies alleging underpayment of royalties and severance taxes on crude oil production. Further, purported nation-wide private class actions have been filed in Texas and Alabama against numerous oil companies, including the Company and subsidiaries of the Company, alleging a conspiracy to fix posted prices at unreasonably low levels. At issue in all these claims is whether the crude oil price on which royalty was calculated and paid was calculated in compliance with lease terms and regulations. In the case of natural gas production from federal lands, predominantly offshore leases, federal claims of underpayment of royalty have been made, alleging that sales prices between affiliated companies was not the acceptable measure for purposes of royalty determination. Additionally, litigation has been filed in state court by private landowners, mainly in South Texas, challenging primarily market valuation assessments and the appropriateness of certain cost deductions in connection with royalty paid to those royalty owners. While significant amounts have been alleged to be due in connection with these claims, numerous factual issues distinguish each claim and such issues must be individually analyzed in each case. Shell Oil believes that it can defend successfully that its past royalty payments have been made on a fair and legally justifiable basis and expects to resolve these issues over time, as the result of negotiation or successful litigation if necessary.
The Company has been informed that the premises of its former manufacturing plant in Torrance, California have been noticed for listing as a CERCLA site. The plant was used for the manufacture of synthetic rubber by the United States government during World War II and the Korean War. The Company
owned and operated the plant from 1955 to 1972. The Company and the United States have agreed to a cost sharing formula to cover the remediation of 3 acres of the premises on which extensive waste disposal occurred; a final plan for such remediation has not been approved. The Company is currently engaged in an investigation of the remaining portions of the former plant site to determine if any further remediation may be required.
In 1995, the Company received a Notice of Violation/Finding of Violation from the EPA Region V alleging violations under the Clean Air Act and the Illinois State Implementation Plan by the Wood River Manufacturing Complex. The Company and the EPA are engaging in discussions regarding the allegations of the notice. EPA Region V has also given indications to the Wood River Manufacturing Complex that it is contemplating possible enforcement action against the Complex for alleged violations of the Benzene Waste operations NESHAP. In 1996, the Company received a further Notice of Violation from the EPA alleging additional violations. Shell Oil and the EPA are engaging in discussions seeking to resolve these and other previously reported matters at Wood River.
The Company has received numerous claims concerning potential liabilities in connection with environmental laws involving past and present operating and waste disposal locations (as further discussed in the Environmental Matters section of the Management Discussion and Analysis, page 28). Also, numerous federal, state and local income, property and excise tax returns of Shell Oil are being examined by the respective taxing authorities, and certain interpretations by Shell Oil of the complex tax statutes, regulations and practices are being challenged in administrative proceedings and in federal and state actions.
It is not possible for the Company to predict with precision what the final effect of the foregoing litigation will be on the Company. However, while periodic results may be significantly affected by costs in excess of provisions related to one or more of these proceedings, based on developments to date, the Company does not anticipate a material adverse effect on its financial position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is not publicly traded.
Cash dividends were paid quarterly as follows:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Selected financial data is presented below for the periods indicated.
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* Gross investment consists of gross assets less current liabilities.
The above financial results and historical data should not be construed as necessarily indicative of future financial results; see Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
KEY FINANCIAL RESULTS
-- Net income in 1996 was a record $2,021 million, compared with net income of $1,520 million in 1995 and $508 million in 1994.
-- Adjusted net income, which excludes special items, was a record $1,860 million in 1996, compared with $1,408 million in 1995 and $1,118 million in 1994.
-- Cash flows from operating activities in 1996 were $4,124 million, compared with $3,473 million in 1995 and $3,014 million in 1994.
-- Revenues in 1996 were $29.2 billion, up from $24.6 billion in 1995 and $21.6 billion in 1994.
-- Shareholder's equity was $14.4 billion at the end of 1996, up from $13.9 billion in 1995 and $13.7 billion in 1994.
-- Net income as a percent of net investment was 10.5 percent in 1996, compared with 8.0 percent in 1995 and 2.8 percent in 1994.
-- Total debt at the end of 1996 was $3,212 million compared with $3,251 million in 1995 and $2,995 million at year-end 1994. At that level, it represented 18.3 percent of total capital, compared with 19.0 percent at year-end 1995 and 17.9 percent at the end of 1994.
OIL AND GAS EXPLORATION AND PRODUCTION
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* Amounts associated with major product classifications for which there has been no revenue stream or investment in the last five years.
Oil and Gas Exploration and Production income from ongoing operations was $1,351 million in 1996, compared with $622 million in 1995 and $259 million in 1994. Income from ongoing operations excludes charges to segment net income which are associated with major product classifications for which there has been no revenue stream or investment for the past five years.
Segment net income in 1996 was $1,349 million, compared with $621 million in 1995 and $257 million in 1994. Adjusted net income, which excludes special items, was $1,312 million in 1996, an increase of $742 million over 1995 and $855 million over 1994.
For 1996, results improved over 1995 primarily due to higher average crude oil and natural gas prices. These benefits, coupled with increased production of both crude oil and natural gas, more than offset higher producing and exploratory expenses, including dry holes. Domestic crude oil prices in 1996 averaged $18.40 per barrel, up $3.38 over 1995 and $4.99 over 1994. The average selling price of net domestic marketable natural gas produced in 1996 was $2.34 per thousand cubic feet, up 69 cents over 1995 and 44 cents over 1994.
Special items increased segment net income by $37 million in 1996 and $51 million in 1995, but decreased net income by $200 million in 1994. Special items in 1996 included gains totaling $48 million related to the sale of oil and gas properties, and $45 million from prior-year tax adjustments. Partially offsetting these benefits were $30 million in charges against litigation and royalty reserves, and a $24 million asset write-off. Special items in 1995 included a benefit from tax losses totaling $125 million and an additional $30 million benefit as the result of prior-year tax adjustments. Also benefiting net income in 1995 were gains totaling $51 million related to the sale of oil and gas properties and the receipt of $21 million in compensation related to a previously expropriated international asset. Partially offsetting these benefits were a $145 million after-tax charge related to the adoption of Statement of Financial Accounting Standards No. 121 and $26 million in provisions for litigation and property damages. Special items in 1994 included charges of $315 million attributable to write-offs of undeveloped offshore frontier Alaska properties and nonproducing heavy oil properties in California, exploratory dry holes and provisions for restoration costs. Also, 1994 income was reduced $108 million for litigation settlements and provisions. Partially offsetting these charges were benefits of $223 million, primarily related to prior-year tax adjustments.
Cash provided by operating activities was $2,493 million in 1996, compared with $1,923 million in 1995, and $1,546 million in 1994.
Crude Oil Production -- Domestic net crude oil production, on a barrels per day basis, averaged 376,000 in 1996, 371,000 in 1995 and 355,000 in 1994. Increased production in the Gulf of Mexico, particularly in the deepwater Gulf, and in California more than offset normal declines elsewhere.
International net production, on a barrels per day basis, averaged 58,000 in 1996, up 7,000 over 1995 and 15,000 over 1994. Increased production in 1996 over 1995 was primarily attributable to new production in China.
Gas Production -- Average net natural gas production of 1,880 million cubic feet per day in 1996 increased over both 1995 and 1994 by 3 percent and 15 percent, respectively. The increase in 1996 was due in part to new and increased production in the Gulf of Mexico, and also to higher production in Brazil.
Natural Gas Liquids -- Net natural gas liquids production, on a barrels per day basis, was 75,000 in 1996, up 5,000 over 1995 and 14,000 over 1994. The 1996 average price of $15.97 was $3.97 higher than 1995 and $4.03 higher than 1994.
Costs and Expenses -- Production costs in 1996 totaled $1,198 million, up $74 million over 1995 and $59 million over 1994, primarily due to increased costs associated with higher production and higher energy costs. Exploration expenses of $327 million in 1996, including dry hole costs of $142 million, increased $81 million over 1995, but declined $16 million from 1994. Dry hole costs in 1994 were high due primarily to write-offs related to Alaska and other exploratory wells. Exclusive of dry holes, 1996 exploration costs increased $35 million over 1995 and $48 million over 1994, reflecting a more aggressive spending program in the Gulf of Mexico.
Depreciation, depletion and amortization costs were $1,375 million in 1996, down $158 million from 1995, and $230 million from 1994. The higher costs in 1994 were primarily due to the write-offs of certain nonproducing properties and to other property provisions. Excluding these write-offs from 1994 and the impact from the adoption of Statement of Financial Accounting Standards No. 121 from 1995, depreciation, depletion and amortization costs were higher in 1996 due primarily to increased production.
Property sales resulted in gains totaling $48 million in 1996 and $51 million in 1995, and minimal gains in 1994.
New Developments -- In early 1997 Shell Oil completed the merger of its producing assets in the Permian Basin of West Texas/Southeast New Mexico with those of Amoco Corporation. This new limited partnership, Altura Energy, Ltd., is owned approximately 36 percent by Shell Oil and approximately 64 percent by Amoco. The aim of this new venture is to create an entrepreneurial environment that will support the quest for cost leadership in the basin. Also, negotiations are currently underway with Mobil Corporation regarding the possible combination of Mobil's California exploration and production operations with those of Shell Oil; the new venture, if finalized, is expected to be owned 60 percent by Shell Oil and 40 percent by Mobil. The proposed joint venture would offer opportunities to reduce costs and leverage complementary skills and competencies.
Progress continued in 1996 with new development in the deepwater Gulf of Mexico. Production began at Mars, establishing a world water-depth record of 2,940 feet for a permanent drilling and production platform. Also in 1996, production initiated from Phase II of Tahoe, originally a one-well subsea development, as well as from Southeast Tahoe, a new discovery. Development of the Ram/Powell and Mensa projects continued on schedule for 1997 startup, the Troika project was announced with startup of production scheduled in late 1997 and the Ursa project remained on schedule for 1999 startup. Based upon encouraging results from existing operations, existing and planned developments, and expected new opportunities, and assuming no reductions in existing production except due to normal declines in producing fields, Shell Oil's anticipated average annual production growth rate through 2001 is about 15 percent for both oil and gas.
Capital Expenditures -- Capital spending for Oil and Gas Exploration and Production was $2,053 million in 1996, compared with $1,395 million in 1995 and $952 million in 1994. The substantial increase in 1996 over both 1995 and 1994 was due to higher spending for production drilling and development in the Gulf of Mexico
and for gas pipeline facilities to accommodate deepwater production. The higher level of capital spending is expected to continue through the decade as Shell Oil develops the Gulf of Mexico projects.
Hydrocarbon Reserves -- In 1996, reserve additions, mainly from discoveries, extensions, improved recovery techniques and revisions to previous reserve estimates, were 396 million barrels on a crude oil equivalent basis. These additions were more than offset by producing property sales of 91 million equivalent barrels, and by production during the year. In 1995 and 1994, reserves also declined.
Net wells drilled in 1996 totaled 517, up 220 over 1995 and 273 over 1994.
OIL PRODUCTS
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* Amounts associated with major product classifications for which there has been no revenue stream or investment in the last five years.
Oil Products income from ongoing operations in 1996 was $386 million, compared with $457 million in 1995 and $427 million in 1994. Segment net income in 1996 was $383 million, compared with $474 million in 1995 and $373 million in 1994.
Adjusted net income, which excludes special items, was $392 million in 1996, an increase of $95 million over 1995, but $5 million lower than 1994. Results were higher in 1996 compared to 1995 due to slightly improved refined product margins which were weak industry-wide in 1995. In 1996, margins improved during the first half of the year but weakened in the later months as West Coast retail marketing conditions deteriorated and crude costs increased. Fixed operating costs increased in 1996 primarily in marketing, while sales of branded automotive gasoline improved about 1 percent.
Special items in 1996 reduced segment net income by $9 million due to $20 million in charges against property damage and litigation reserves, offset in part by a $10 million gain on a property sale. Special items improved segment net income in 1995 by $177 million, primarily due to a gain of $166 million from the partial liquidation of crude oil and refined product inventories valued on a last-in, first-out (LIFO) basis. In 1994, net income was reduced by $54 million for environmental provisions related to off-site contamination, partially offset by a gain of $28 million for the partial liquidation of refined product inventories valued on a LIFO basis. The remainder of the special items benefited income $2 million as a net gain from asset sales was offset by environmental provisions.
Cash flow provided by operating activities was $762 million in 1996, down $368 million from 1995 and $191 million from 1994. Capital expenditures in 1996 of $726 million declined $339 million from 1995 and were $361 million lower than 1994. Spending in 1995 and 1994 was mainly for the coker and "clean fuels" project at the Martinez, California refinery, completed in 1996, and the refinery upgrade, including the installation of a coker, at the jointly-owned Deer Park, Texas refinery in 1994.
Refined Product Sales Volumes -- Total 1996 refined product sales volumes were 1,421,000 barrels per day, up from 1,348,000 in 1995 and 1,272,000 in 1994. Automotive gasoline sales volumes in 1996 increased marginally over 1995, but were up 10 percent over 1994. Volumes sold through branded service stations in 1996 were up about 1 percent over 1995 and 3 percent over 1994.
Jet fuel sales increased compared with 1995 and 1994, up 11 percent and 6 percent, respectively. Other light products, including kerosene, heating and diesel oil sales increased 70 percent over 1995 and 110 percent over 1994, reflecting in part the benefits derived from the new coking units at both Martinez and Deer Park. Conversely, residuals sales volumes were down 27 percent from 1995 and 31 percent from 1994.
Overall, lubricants sales volumes in 1996 declined from both 1995 and 1994.
Refined Product Prices -- Average refined product selling prices increased 8 cents per gallon in 1996 over 1995 and were up 10 cents per gallon over 1994. Prices increased in 1996 in all product categories due to rising hydrocarbon costs. Average automotive gasoline selling prices increased 9 cents per gallon over 1995 and 10 cents per gallon over 1994.
New Developments -- During 1996, Shell Oil began discussions with Texaco, Inc. and Star Enterprises (a joint venture of Texaco and Saudi Aramco) regarding a possible joint arrangement involving U.S. downstream operations. While the companies are reviewing a range of options, the specific activities under consideration are refining, marketing, transportation, trading and lubricants.
CHEMICAL PRODUCTS
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* Amounts associated with major product classifications for which there has been no revenue stream or investment in the last five years.
Chemical Products income from ongoing operations in 1996 was $253 million, compared with a record $704 million in 1995 and $223 million in 1994. Segment net income in 1996 was $243 million, compared with $694 million in 1995 and $161 million in 1994.
Adjusted net income, which excludes special items, was $351 million in 1996, a decrease of $374 million from 1995 and $75 million from 1994.
The substantial decline in adjusted net income in 1996 from 1995 was primarily attributable to lower margins across most product lines, partially offset by increased sales volumes of primary chemicals. Income performance in all three years was burdened with significant costs for litigation.
Special items reduced segment net income $108 million in 1996, $31 million in 1995, and $265 million in 1994. In 1996, such charges against income totaled $167 million, including additional provisions for product liability and an asset write-off. Partially offsetting these charges were favorable insurance recoveries and prior-period tax adjustments. In 1995, special items reduced income by $31 million due to $22 million in charges related to environmental provisions, $5 million for asset write-offs, and a $4 million dispute settlement. In 1994, income was reduced by $201 million for litigation provisions, settlements and damage claims, $62 million for environmental provisions related to off-site contamination, and $34 million for write-offs of idle assets. Partially offsetting these 1994 charges were gains of $32 million from asset sales.
Cash provided by operating activities in 1996 was $729 million, compared with $952 million in 1995 and $559 million in 1994.
Results at Sadaf, our 50 percent owned Saudi Arabian petrochemical venture, declined in 1996 over 1995, but improved slightly above 1994. Lower Sadaf earnings in 1996 were due to depressed margins. Partially offsetting this decline were increased sales volumes, as favorable market conditions held in the Far
East and Europe resulting in increased demand. During 1996, the joint venture began commissioning facilities for the manufacture of MTBE and expanded facilities for the manufacture of ethylene dichloride and caustic soda.
Total chemical sales volumes in 1996 improved 11 percent over 1995 and 18 percent over 1994, reflecting higher sales of primary chemicals.
Capital spending for Chemical Products was $582 million in 1996, compared with $422 million in 1995 and $343 million in 1994. Capital projects active in 1996 included spending for the replacement of the Kraton unit located at Belpre, Ohio, additional capital outlays toward the modernization of an olefins unit at Deer Park, the purchase of the Mobile, Alabama site to improve olefins feedstocks, and increased spending for a propylene pipeline.
OTHER SEGMENT
The Other operating segment incurred a net loss of $29 million in 1996, compared with net losses of $78 million in 1995 and $235 million in 1994. In 1996, the loss was mainly due to settlement costs associated with an exited business and losses incurred on real estate properties held for sale. The loss in 1995 was mainly due to special items, which included an $84 million write-down of real estate property held for sale, and a $15 million charge related to the adoption of Statement of Financial Accounting Standards No. 121, partially offset by a tax benefit totaling $25 million. In 1994, the loss was mainly due to special items totaling $208 million, which included the loss on the sale of a coal investment and write-offs of nonproducing coal leases.
NONALLOCATED CORPORATE COSTS
Corporate items not allocated to the operating segments benefited net income $75 million in 1996, while reducing net income $191 million for the year 1995 and $48 million in 1994.
Special items in 1996 included gains from insurance recoveries and the benefit from prior-year tax adjustments. In 1995, special items included asset write-offs of $34 million, partially offset by a gain from an insurance settlement. In 1994, special items included a favorable prior-year tax adjustment of $100 million, partially offset by provisions for claims and litigation settlement. Excluding these effects, corporate costs, primarily related to financing, decreased in 1996 compared to 1995 due primarily to lower interest expense, but increased over 1994 when average debt levels were lower.
CAPITAL RESOURCES AND LIQUIDITY
Cash provided by operating activities continued to be the primary source of funding for Shell Oil's capital investment program, dividends and other needs. In 1996, cash provided by operating activities totaled $4,124 million, up $651 million over 1995, and exceeded cash used for investing activities in 1996 by $1,354 million. Similarly, cash provided by operating activities in 1995 totaled $3,473 million and exceeded
cash used for investing activities by $790 million. In 1994, cash provided by operating activities totaled $3,014 million and exceeded investing activities by $751 million. Total debt in 1996 declined $39 million to $3,212 million, with the debt-to-total-capital ratio decreasing to 18.3 percent. In addition, cash dividends increased to $1,500 million in 1996, compared with $1,400 million in 1995 and 1994.
Cash Provided by Operating Activities -- In 1996, cash provided by operating activities amounted to $4,124 million, compared with $3,473 million in 1995 and $3,014 million in 1994. Higher earnings in 1996 accounted for the improvement over both 1995 and 1994.
Cash Used for Investing Activities -- The major use of cash flows from operating activities was for capital expenditures, which amounted to $3,414 million in 1996, $2,957 million in 1995, and $2,451 million in 1994. Proceeds from property sales in 1996 totaled $743 million and in 1995 totaled $202 million. The increase in net cash used for investing activities in 1996 over 1995 and 1994 was due to higher capital expenditures.
Debt Obligations -- At year-end 1996, Shell Oil had decreased its total debt by $39 million, compared with an increase of $256 million in 1995 and a decrease of $19 million in 1994. Shell Oil's ratio of total debt- to-total-capital was 18.3 percent at the end of 1996, compared with 19.0 percent at the end of 1995 and 17.9 percent at the end of 1994.
Capital Spending -- Shell Oil's capital spending of $3,414 million in 1996 was virtually the same as planned at the beginning of the year. In 1996, exploration and production activities accounted for 61 percent of total capital expenditures, compared with 47 percent in 1995 and 39 percent in 1994. These outlays were primarily in the United States. Oil and Chemical Products accounted for 38 percent of total spending in 1996, compared with 50 percent in 1995 and 58 percent in 1994. The reduction in 1996 was due mainly to the completion of major refinery upgrades. Overall, Shell Oil's capital expenditures increased in 1996 compared to 1995 due to a higher level of spending in the deepwater Gulf of Mexico.
Capital and exploratory expenditures of $3.8 billion are planned for 1997. About $2.5 billion is allocated for exploration and production activities, an increase of $100 million above the 1996 level. These expenditures reflect plans to accelerate development of and production from primarily deepwater Gulf of Mexico discoveries. Oil Products expenditures are budgeted for $800 million in 1997, reflecting increased spending for new and upgraded service stations as compared to recent years. Chemical Products expenditures are expected to be about $500 million, down slightly from 1996 levels. Chemical plans include the expansion of phenol capacity and the polyester resins business.
Dividends -- Cash dividends were $1,500 million in 1996, increasing $100 million over both 1995 and 1994.
Liquidity -- Internally generated cash, access to outside financing based on strong credit ratings, and prudent management of working capital are the essential components of Shell Oil's liquidity position. Cash and cash equivalents amounted to $393 million at year-end 1996, a decrease of $28 million from 1995 and $224 million from 1994.
Shell Oil's strategy continues to rely mainly on internally generated cash to finance routine operating requirements and capital spending. Short-term borrowings will generally be used to fund interim working capital needs and unusual requirements. As of December 31, 1996, unused revolving credit agreements of $500 million were available for general corporate purposes, including support of commercial notes. The Company plans to manage the level of backup facilities consistent with its cash and cash equivalents balances. As of the end of 1996, $500 million of a $1.0 billion shelf registration remained, allowing future flexibility in the public debt markets.
As further discussed in Note 10 of the Notes to Consolidated Financial Statements, from time to time the Company utilizes financial derivatives to minimize its borrowing costs, and to reduce price volatility risks on commodities -- primarily crude oil, natural gas and refined products. During 1994, the Company used interest rate swaps to convert many of its fixed rate debt and other obligations to floating rates. At December 31, 1996 and 1995, the notional principal amounts of interest rate swaps outstanding were $2.1 billion and $2.3 billion, respectively, with maturities extending into the year 2017. The fair value of the swaps
used to convert these fixed rate debt and other obligations to floating rates was $6 million at December 31, 1996, $67 million at the end of 1995, and a negative $174 million at the end of 1994.
Working capital at the end of 1996 increased $53 million over a year earlier due primarily to higher receivables offset in part by increased payables. Shell Oil's liquidity position is considerably stronger than indicated by these working capital levels because of relatively lower historical costs assigned to inventories under LIFO accounting procedures. The year-end inventory values included in working capital were below their current costs by $978 million at the end of 1996, $672 million in 1995 and $1,011 million in 1994.
ENVIRONMENTAL MATTERS
Shell Oil continues to make substantial capital and operating expenditures relating to the environment. Included within such expenditures are costs of compliance with federal, state and local laws, regulations and permit requirements concerning reduction of releases into air and water, disposal and handling of wastes, and corrective action and other cleanup obligations under law and by contract at operating locations, at previously owned or operated properties and at off-premises sites.
Discussions are ongoing with governmental agencies as to the scope and magnitude of Shell Oil's present closure and post-closure Resource Conservation and Recovery Act (RCRA) and similar state or local remediation obligations at operating locations. Such discussions are part of the normal RCRA regulatory process. Shell Oil anticipates that those discussions will result in corrective action being required at its manufacturing locations. The complexity of the factual issues and the evolving legal requirements, coupled with the many choices made available by diverse technologies that may be used in such corrective action, make it difficult to estimate with great reliability the total costs of such action; however, Shell Oil does not currently expect that the costs of taking corrective action over time will be material to Shell Oil's consolidated financial position or operating income in any year. All such expenditures are included in the environmental expenditures reported below and this matter is under continual review. RCRA also imposes obligations with respect to closure of a RCRA covered facility (i.e., a facility at which certain wastes are treated, stored or disposed of) and in certain cases for a 30-year post-closure period. In 1996, Shell Oil confirmed its ability to pay $188 million ($162 million Oil Products, $18 million Chemical Products) for RCRA-related closure, post-closure and liability costs. The calculation of potential exposure in this area was made pursuant to the requirements of applicable federal and state law. Approximately $55 million of this exposure applies to actual closure costs ($44 million Oil Products, $11 million Chemical Products); approximately $125 million ($118 million related to Oil Products, $7 million to Chemical Products) relates to post-closure obligations which extend up to 30 years after closure. It is reasonable to anticipate that all facilities will not incur such closure and post-closure costs at the same time. While the ultimate closure and post-closure costs as required by RCRA cannot be precisely estimated at this time, management does not currently anticipate that they will materially adversely affect Shell Oil's consolidated financial position or operating income in any year.
Shell Oil has established a reserve calculated to provide for RCRA closure and post-closure costs over the estimated useful life of its covered facilities. Shell Oil also recognizes certain abandonment and restoration obligations in connection with its oil and gas operations. Reserves are established and built over the estimated life of production with the intention to provide for the estimated costs of carrying out required statutory and lease obligations to plug and abandon wells and otherwise restore property by the time oil and gas production ceases.
Shell Oil has received allegations or claims under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) or similar state statutes that it is involved at 228 sites. Approximately 132 of these sites are alleged to involve Oil Products operations, 66 Chemical Products operations and 30 E&P operations. In a number of instances more than one business is alleged to be involved. As of December 1996, discussions or activities concerning 71 of these sites were active involving Shell Oil, other potentially responsible parties and relevant agencies or claimants; at a number of these sites, matters remain in the early investigation stages. Ninety-four sites were considered inactive, meaning that no discussions or activity were pending or had occurred for more than one year and 63 sites were considered settled. In 1995 Shell Oil reported 220 such sites, 88 of which were active, 81 inactive and 51 settled.
In 1996, recorded expenses under CERCLA or similar state statutes relating to the 228 sites were approximately $12 million; additionally, approximately $33 million was charged to previously established reserves, primarily for sites related to prior Chemical Products operations. At the Rocky Mountain Arsenal, where Shell Oil is a party to a consent decree concerning required cleanup at that site, Shell Oil has accrued $500 million for its share of the costs of such cleanup. As of December 31, 1996 the balance remaining in such reserve was $213 million, which the Company believes will be adequate to meet its share of the obligations in connection with such site. In 1995 recorded expenses were $3 million; additionally, there were charges to reserves of $45 million for sites related to prior Chemical and Oil Products operations. Included in reserves are costs of cleanup and monitoring and to a much lesser degree administrative costs. All reserves are calculated consistently with Shell Oil's articulated "Accounting Policies -- Environmental Costs," as set forth in Note 1 of the Notes to the Consolidated Financial Statements. At certain third party sites where Shell Oil has only a small dollar exposure, Shell Oil may accept the cleanup cost estimates of the parties managing the site and reserve on that basis; such increases to environmental reserves would be immaterial in the aggregate. The complexities of CERCLA regulations, particularly in relation to joint and several liability and multiple cleanup options, as well as the incomplete factual data at some sites, make it impossible to predict with certainty the total cleanup costs Shell Oil will incur. However, Shell Oil believes the following to be true: at the majority of the above referenced sites, Shell Oil should have responsibility for only a small percentage share of the total cleanup costs (and other viable potentially responsible parties (PRPs) have already been identified to lessen the potential burden of joint and several liability at such sites); the CERCLA sites will be cleaned up over time and not simultaneously; Shell Oil is currently aware of only a small percentage of the active sites where an individually significant financial exposure exists and, basis its current knowledge, Shell Oil has established reserves for such sites reflecting Shell Oil's share of the probable cleanup costs. Shell Oil manages these matters closely to help assure prudent and cost effective cleanup in full compliance with all legal requirements. Changes to reserves are recorded as new information enables Shell Oil to better estimate the cost of cleanup at these sites. Based on the preceding, while operating income may be significantly adversely affected in a particular period, Shell Oil does not currently believe costs related to CERCLA cleanup will materially adversely affect Shell Oil's financial position.
While certain environmental expenditures are discrete and readily identifiable, others must be reasonably estimated or allocated based on technical and financial judgments as developed over time, affecting comparisons in certain years. All estimates are stated on a before tax basis. Consistent with the preceding, Shell Oil estimates that environmental capital expenditures in 1996 were about $155 million ($108 million Oil Products, $19 million Chemical Products and $28 million Exploration & Production), about $155 million below 1995, due mainly to completion of expenditures to comply with clean fuel requirements, primarily in California. In 1995, total expenditures were $310 million (Oil Products $250 million; Chemical Products $25 million and Exploration & Production $35 million.) Environmental capital expenditures are expected to be about $120 million in 1997 and about $100 million per year over the last two years of the decade, attributable primarily to Clean Air Act regulations relating to control of conventional and toxic emissions. These projections, which are subject to change, are down about $25 million from last year. More cost effective regulations than originally expected are envisioned. Redesign efforts are also contributing to these reduced projections. Risk assessment as a determinant of response action is gaining in importance on both the regulatory and legislative fronts and is leading to more reasoned and cost-effective approaches.
Shell Oil's operating, maintenance and administrative costs related to environmental protection and remediation of waste disposal sites were approximately $740 million in 1996, including $567 million for Oil Products, $110 million for Chemical Products, and $63 million for Exploration and Production. Total 1995 costs were $850 million; (Oil Products $600 million; Chemical Products $160 million and Exploration & Production $90 million.) These costs do not include amounts expended or reserved for restoration and abandonment of oil and gas properties. Expenses in 1996 were lower than 1995, primarily due to reduced tax assessments under federal environmental laws, operating efficiencies, application of improved cost/risk analysis information, cleanup strategies, and more efficient remediation techniques.
During the next several years, total environmental expenditures for both capital and operating, maintenance and administrative costs are expected to average about $900 million per year, as Shell Oil complies with
requirements under existing laws, as well as with regulations yet to be promulgated or finalized. The federal Clean Air Act and related state laws such as the California air emission standards, the federal Oil Pollution Act, reauthorization of RCRA and CERCLA, underground produced water injection regulations under the Safe Drinking Water Act, and numerous related state and local laws affecting all aspects of the environment are expected to have a pronounced effect on all areas of Shell Oil's operations over the next decade as we and those with whom we do business strive to adapt to such evolving requirements. Shell Oil intends to continue its efforts to implement process redesign and operating efficiencies to comply with these laws in the most efficient and cost-effective manner.
Shell Oil is unable to predict with certainty the effect that compliance with above described environmental requirements, particularly laws and regulations not yet finalized, may have upon its competitive position or future earnings. However, while operating income may be materially adversely affected in particular periods as the result of environmental expenses, based on the facts, law and technologies in existence as of this date, including a belief that all major competitors will incur comparably significant costs to comply with these laws, Shell Oil believes that it can comply fully without material adverse impact on its financial position.
OTHER MATTERS
In addition to economic conditions and other matters discussed above affecting Shell Oil, the operations, earnings and financial condition of Shell Oil may be affected by the matters discussed in Note 16 of the Notes to Consolidated Financial Statements, as well as by political developments; litigation; and legislation, regulation and other actions taken by federal, state, local governmental entities, and by governments outside the United States.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Report of Independent Accountants are included in Item 14a of this report. The Quarterly Results of Operations are reported in Note 20 of the Notes to Consolidated Financial Statements included in Item 14a. Information on Oil and Gas producing activities is included in Items 1 and 2.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Not applicable.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Not applicable.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Not applicable.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
a. CERTAIN DOCUMENTS FILED AS PART OF THIS REPORT
b. REPORTS ON FORM 8-K
None.
c. EXHIBITS*
3. (i) Copy of Restated Articles of Incorporation of the Registrant effective December 8, 1986.
(ii) Copy of By-Laws of the Registrant, as amended through December 8, 1986.
4. The Registrant will provide to the Securities and Exchange Commission, upon request, copies of instruments defining the rights of holders of long-term debt listed in Note 9 of the Notes to Consolidated Financial Statements.
10. Material Contracts:
(i) Copy of letter agreement dated December 18, 1996 between the Company and Shell Internationale Research Maatschappij, B.V. continuing for the calendar year 1997 the Agreement for Research Services dated January 1, 1960, as amended.
(ii) Composite copy of the Agreement for Research Services dated January 1, 1960, as amended through August 19, 1982 is incorporated by reference to Item 14 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993.
21. Subsidiaries of the Registrant
23. Consent of Independent Accountants
24. Powers of Attorney
27. Financial Data Schedule - ------------
* Copies of Exhibits may be obtained for 25 cents per page, prepaid, by writing to the Corporate Secretary.
d. FINANCIAL STATEMENT SCHEDULES
The schedules filed by the Company are listed in Item 14a above. No separate financial statements are required to be included because reporting tests are not met. Certain schedules have been omitted because the required information is shown in the financial statements or notes thereto.
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDER OF SHELL OIL COMPANY
In our opinion, the consolidated financial statements listed in the index appearing under Item 14a on page 32 present fairly, in all material respects, the financial position of Shell Oil Company and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for the impairment of long-lived assets in 1995 to comply with the provisions of Statement of Financial Accounting Standards No. 121.
PRICE WATERHOUSE LLP Houston, Texas February 6, 1997
SHELL OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND EARNINGS REINVESTED (Millions of dollars)
The accompanying notes are an integral part of these statements.
SHELL OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Millions of dollars, except per share amounts)
The accompanying notes are an integral part of these statements.
SHELL OIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Millions of dollars)
The accompanying notes are an integral part of these statements.
SHELL OIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACCOUNTING POLICIES
Shell Oil Company (the Company) is wholly owned by Shell Petroleum Inc., a Delaware corporation, whose shares are directly or indirectly owned 60 percent by Royal Dutch Petroleum Company, The Hague, The Netherlands, and 40 percent by The "Shell" Transport and Trading Company, public limited company, London, England.
This summary of the major accounting policies of Shell Oil Company and its consolidated subsidiaries (Shell Oil) is presented to assist the reader in evaluating Shell Oil's financial statements and other data contained in this report.
Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and subsidiaries owned directly or indirectly more than 50 percent. Investments in affiliates in which the Company has a significant ownership interest, generally 20 to 50 percent, are accounted for by the equity method. Other investments are carried at cost. Intercompany accounts and transactions are eliminated.
Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications -- Certain 1995 and 1994 amounts have been reclassified to conform with current year presentation.
Cash Equivalents -- Cash equivalents consist of highly liquid investments that are readily convertible into cash and have a maturity of three months or less at date of acquisition.
Inventories -- Inventories of oils and chemicals are valued at the lower of cost, predominantly on a last-in, first-out (LIFO) basis, or market, and include certain costs directly related to the production process. Materials and supplies are carried at average cost or less.
Exploration and Development -- The "successful efforts" method of accounting is used for oil and gas exploration, development and production activities.
Property Acquisition Costs -- Costs of acquiring developed or undeveloped leaseholds including lease bonus, brokerage and other fees are capitalized. The costs of undeveloped properties which become productive are transferred to a producing property account.
Exploratory Costs -- Costs of exploratory wells are initially capitalized, but should the efforts be determined to be unsuccessful, they are then charged against income. All other exploratory costs are charged to income as incurred.
Development Costs -- Costs of development wells, including dry holes, platforms, well equipment and attendant production facilities are capitalized.
Depreciation, Depletion and Amortization -- Depreciation, depletion and amortization of the capitalized cost of producing properties, both tangible and intangible, are provided on a unit of production basis. On a field basis, developed reserves are used for drilling and development costs, and total proved reserves are used for producing leasehold costs. Amortization of unproven leasehold costs from the date of acquisition is based primarily upon experience in establishing rates in order to fully amortize the cost of those leases that may be productive over the holding period. Estimated dismantlement, restoration and abandonment costs and estimated residual salvage values are taken into account in determining amortization and depreciation provisions.
Other plant and equipment are depreciated on a straight-line basis over their estimated useful lives. Gains and losses are not recognized for normal retirements of properties, plant and equipment subject to
composite group amortization or depreciation. Gains or losses from abnormal retirements or sales are recognized currently in income. Expenditures for maintenance and repairs are expensed as incurred.
Environmental Costs -- Environmental costs relating to current operations are expensed or capitalized, as appropriate, depending on whether such costs provide future economic benefits. Liabilities are recognized when the costs are considered probable and can be reasonably estimated. Measurement of liabilities is based on currently enacted laws and regulations, existing technology and undiscounted, site-specific costs. Environmental liabilities in connection with properties which are sold or closed are realized upon such sale or closure, to the extent they are probable and estimable and not previously reserved. In assessing environmental liabilities, no set-off is made for potential insurance recoveries. Recognition of any joint and several liability is based upon Shell Oil's best estimate of its final pro rata share of the liability. All liabilities are monitored and adjusted regularly as indicated by new facts or changes in law or technology.
2. IMPAIRMENT OF LONG-LIVED ASSETS
Effective with the fourth quarter 1995, Shell Oil adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121 requires that long-lived assets and certain identifiable intangibles to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of affected assets may not be recoverable.
Total 1995 charges resulting from adoption of the Standard increased depreciation, depletion and amortization expenses by $223 million, and selling, general and administrative expenses by $23 million. The affected assets were primarily oil and gas producing properties.
During 1996, certain oil and gas producing properties were reclassified as "assets to be disposed of" and, under the provisions of SFAS No. 121, were written down to their estimated net realizable value resulting in a $38 million charge to depreciation, depletion and amortization expenses.
3. INTEREST
Interest costs were as follows:
4. FOREIGN CURRENCY TRANSACTIONS
The U.S. Dollar is the functional currency for each of Shell Oil's foreign operations. The net after-tax effects of foreign currency transactions were a gain of $3 million in 1996, a loss of $2 million in 1995, and a gain of $8 million in 1994.
5. TRANSACTIONS WITH RELATED PARTIES
Shell Oil has entered into transactions with related parties including companies affiliated with the Royal Dutch/Shell Group. Such transactions were in the ordinary course of business and included the purchase, sale and transportation of crude oil and natural gas, and petroleum and chemical products. The aggregate amount of such transactions was as follows:
These amounts are commingled with other revenues and costs and the profit thereon is not accurately determinable without effort and expense disproportionate to the relative importance of such amount.
The Company is also a partner in international joint ventures with affiliates of the Royal Dutch/Shell Group. Such joint ventures are engaged in the exploration for and development and production of crude oil and natural gas. The Company has also entered into arrangements with affiliated companies for the sharing of research services in petroleum technology, chemicals and other fields.
In 1995, Shell Oil and Tejas Gas Corporation formed a jointly owned gas marketing enterprise, Coral Energy, L.P. (Coral). The partnership markets substantially all of Shell Oil's natural gas production. Shell Oil accounts for its investment in the partnership using the equity method. Shell Oil's sales to Coral in 1996 and 1995 included in the table above were $1,346 million and $175 million, respectively. Shell Oil's purchases from Coral in 1996 and 1995 included in the table above were $622 million and $83 million, respectively.
Also in 1995, Shell Oil purchased $150 million of debt instruments issued by Deer Park Refining Limited Partnership, an equity investee of the Company.
Shell Oil supplements its short-term financing with borrowings at market rates and terms from a company affiliated with the Royal Dutch/Shell Group. At December 31, 1996 the total amount borrowed was $800 million. This amount is included in the Commercial notes amount shown in Note 8 of the Notes to Consolidated Financial Statements.
6. INVENTORIES OF OILS AND CHEMICALS
Inventories are carried predominantly on a LIFO basis which was lower than current cost by $978 million at December 31, 1996, $672 million at December 31, 1995, and $1,011 million at December 31, 1994. Partial liquidations of inventories valued on a LIFO basis improved 1996, 1995 and 1994 net income by $11 million, $167 million and $29 million, respectively.
7. RECEIVABLES AND PREPAYMENTS
Receivables, prepayments and allowances for doubtful accounts as of December 31, 1996 and 1995 consisted of the following:
8. SHORT-TERM DEBT
Debt due within one year from December 31 consisted of the following:
The weighted average interest rate on short-term debt outstanding was 5.42 percent at December 31, 1996 and 5.73 percent at December 31, 1995.
9. LONG-TERM DEBT
Debt due after one year from December 31 consisted of the following:
Shell Oil had $500 million of unused revolving credit agreements in place as of December 31, 1996, which were available for general corporate purposes, including support of commercial notes. None of the agreements require compensating balances. Under the agreements, interest will be based on rates in effect at the time of borrowing.
The amounts of long-term debt maturities during each of the next five years are $473 million, $266 million, $262 million, $9 million and $7 million, respectively.
In previous years, the Company purchased U.S. government securities and deposited them in irrevocable trusts to be used to fund the scheduled principal and interest payments on certain portions of the Company's long-term debt. Such government securities and debt were removed from the balance sheet, and at December 31, 1996, $141 million of such defeased debt remained outstanding.
10. FINANCIAL INSTRUMENTS
Derivative Financial Instruments
Shell Oil uses interest rate swaps to minimize its borrowing costs, and derivative commodity instruments to reduce price volatility risks on commodities -- primarily crude oil, natural gas and refined products, as further discussed below. At December 31, 1996, the notional principal amounts of interest rate swaps outstanding were $2,103 million, all of which were classified as for "purposes other than trading" under the provisions of Statement of Financial Accounting Standards No. 119. At December 31, 1996, Shell Oil held commodity derivatives positions having notional amounts of $697 million. Of that amount, $614 million was classified as for "purposes other than trading."
Interest Rate Swaps. Shell Oil enters into interest rate swaps with the intent of minimizing its borrowing costs. Most of Shell Oil's long-term interest bearing liabilities reflected on its consolidated balance sheet are fixed rate instruments. The Company also has other long-term obligations not reflected on its balance sheet which involve annual fixed rate payments. Shell Oil uses interest rate swaps to modify the interest rate characteristics of these obligations from fixed rates of interest to variable rates of interest, with the ultimate intent of minimizing the interest expense associated with the underlying obligations. All such interest rate swaps require the counterparty to the swap to pay to the Company a fixed rate of interest on "notional" amounts of principal, and for the Company to pay to the counterparty a variable rate of interest on the same amounts of "notional" principal, i.e., "fixed rate to variable rate." In all cases, the Company remains obligated to pay to the holder of the underlying obligation the fixed rate owing.
Both the payment of interest to the holder of the underlying obligation and the payment of the variable rate to the counterparty are recognized as a current charge to interest expense by the Company. Additionally, the receipt of the fixed rate payment from the counterparty is recognized by the Company as a current reduction of interest expense. The effect of this accounting is the current recognition of the net increase or decrease to interest expense resulting from the swap of fixed rates to variable rates.
The terms of the swaps related to the fixed rate bonds and notes issued by the Company, including the mechanism by which the variable interest rate paid by the Company to the counterparty is determined, are indicated in the accompanying Interest Rate Swaps table. During 1996, the net effect of these transactions was that the Company paid 5.38% and received 5.74% effective rates of interest. On the swaps designed to convert on a notional basis the imputed fixed interest component of the other obligations of the Company as shown in the Interest Rate Swaps table to a variable rate, the Company paid 5.36% and received 6.34% effective rates of interest. The combined effect of these transactions, accounted for as described above, was a net pretax decrease in interest expense of $11.4 million and $0.6 million in 1996 and 1995, respectively. As shown in the Fair Value of Financial Instruments table on page 43, the fair value of these interest rate swaps was $6 million and $67 million at year-end 1996 and 1995, respectively. These values were derived from quotes from the counterparties and from a third-party of prices to "buy out" and cancel such swaps. However, assuming no default or other failure by either party to meet contractual requirements, the swaps are noncancellable until the underlying obligation expires. The Company believes that over time variable rate terms are more favorable to the Company than are fixed rates. Therefore, this fair value number has only limited economic significance to the Company until an intention exists to attempt to buy out these swaps.
Shell Oil bears two different risks under these interest rate swaps. There is a credit risk that payment due to Shell Oil from the counterparty will not be made. In such case, Shell Oil loses any benefit of the swap differential between the fixed rate specified under the terms of the swap and the floating rate. However, the counterparties to these contractual arrangements are major financial institutions. The Company does not anticipate nonperformance by counterparties to these contracts and no material loss would be expected from such nonperformance. Shell Oil also bears the market risk that changes in floating interest rates may result in greater total costs than would have arisen on the fixed rate and other obligations alone.
- ---------------
* Imputed interest rate
Derivative Commodity Instruments. Shell Oil uses derivative instruments in certain instances to reduce price volatility risk on commodities -- primarily crude oil, natural gas and refined products. Generally, Shell Oil's strategy is to hedge its exposure to price variances by locking in prices for future purchases and sales. Shell Oil accounts for such commodity derivatives as hedges. In 1996 Shell Oil executed on a limited basis commodity transactions which were not hedges but were entered into as trading transactions. The Company accounts for such transactions, which are limited to common futures, options and swaps transactions with no leverage or multiplier features, on a mark-to market basis, recognizing gains or losses each business period.
Usually, such derivatives are for terms of less than one year and cover volumes substantially below anticipated sales. The exposure on such commodities derivatives includes the credit risk that the counterparty will not pay if the market declines below the established fixed price. In such case, Shell Oil loses the benefit of the derivative differential on the volume of commodities covered by the derivatives. In any case, Shell Oil would continue to receive market price on actual volumes. Shell Oil also bears the risk that it could lose the benefit of market improvements over the fixed derivative price for the term and volume of the derivative securities (as such improvements would accrue to the benefit of the counterparty). In certain instances involving very small volumes relative to Shell Oil's gross purchases and sales, Shell Oil enters into derivative contracts to hedge its exposure under short-term fixed price purchase or sale commitments. In such cases, Shell Oil swaps its fixed price commitment for a floating price, the net economic result being that its covered purchases and sales are at market price.
During 1996, Shell Oil had a loss of $2 million in connection with its commodity derivatives. At December 31, 1996, there were open positions covering 13 million barrels of crude oil and refined petroleum products, and 99.2 million MCF of natural gas. Transactions for all but 3.4 million barrels were classified as for "purposes other than trading." The average fair value during 1996 of the positions "held for trading purposes" was $12 million. Positions held for trading purposes generated a net gain of $0.3 million for the year.
In all cases involving credit risk on derivative securities, it is always possible that Shell Oil will make payments when due, and that the counterparty will subsequently default on payments due the Company, translating into higher costs or further reduced revenues over time. However, the Company believes its credit analysis regarding counterparties and the terms, nature and size of its derivative portfolio significantly reduce this risk.
Fair Value of Financial Instruments
At December 31, 1996 and 1995, the estimated fair values, determined primarily by market quotes, of Shell Oil's financial instruments were as follows:
As indicated in the table, the fair value of outstanding commodity derivatives at December 31, 1996 was $212 million representing primarily the value of natural gas swaps. Such amount will be essentially offset in 1997 as the Company acquires natural gas to fulfill supply obligations.
The reported amounts of financial instruments such as cash equivalents, marketable securities, accounts and notes receivable/payable and short-term debt approximate fair value because of their short maturities.
11. TAXES
Operating and income taxes incurred by Shell Oil were as follows:
Deferred income taxes are provided for the temporary differences between the tax basis of Shell Oil's assets and liabilities and the amounts reported in the financial statements. Significant components of deferred tax liabilities and assets as of December 31, 1996 and 1995 are as follows:
Receivables and prepayments included $217 million and $143 million of net current deferred tax assets as of December 31, 1996 and 1995, respectively.
Total income taxes paid in the years 1996, 1995 and 1994 were $579 million, $648 million and $264 million, respectively. Total income tax expense for the years 1996, 1995 and 1994 was equivalent to effective tax rates of 26.9, 23.0, and (72.0) percent, respectively, on earnings before income taxes and minority interest of $2,835 million, $2,032 million and $307 million, respectively. Reconciliation to the expected tax at the U.S. statutory rate (35 percent) is as follows:
Shell Oil has tax loss carryforwards of $401 million expiring as follows: 1997 ($3 million); 1998 ($7 million); 1999 ($316 million); 2000 ($4 million); 2008 ($20 million); and 2011 ($51 million).
Shell Oil Company is included in the consolidated federal income tax return of its parent, Shell Petroleum Inc. (SPI). Federal income tax amounts are allocated among members of the consolidated tax group based on separate return calculations. Federal income tax balances owing to SPI at December 31, 1996 and 1995 were nil and $4 million, respectively.
12. INVESTMENTS
The equity method of accounting is used for investments in certain partnerships and for investments in companies in which Shell Oil has a voting stock interest between 20 and 50 percent. Such investments include: Saudi Petrochemical Company, a petrochemical company in Saudi Arabia; Shell Exploration and Production Holdings, B.V.*, a Dutch holding company with oil and gas producing operations in the Danish
North Sea; Deer Park Refining Limited Partnership, a domestic refining operation; Coral Energy, L.P., a domestic gas marketing company; and investments in several pipelines.
Aggregate investment in these affiliates at December 31, 1996, 1995 and 1994 was $1,402 million, $1,162 million and $1,131 million, respectively; dividends received on these investments in 1996, 1995 and 1994 were $78 million, $111 million and $91 million, respectively. Undistributed earnings of these equity affiliates included in Shell Oils retained earnings were $132 million at December 31, 1996.
Summarized financial information for these investments and Shell Oil's equity share thereof is as follow:
- ------------ * At December 31, 1996, the unamortized excess of Shell Oil's investment in this Dutch affiliate over its equity in the underlying net assets of the affiliate approximated $206 million.
** Does not include a loss of $232 million on the 1994 sale of Shell Oil's interest in Zeigler Coal Holding Company which was included in Equity earnings, interest and other income on the Consolidated Statement of Income.
13. PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment, including capitalized lease assets, were as follows:
- ------------
* Accumulated depreciation, depletion and amortization.
14. POSTRETIREMENT BENEFITS
The Company and certain of its subsidiaries currently provide health care benefits for retired employees and their dependents. Eligibility for such benefits requires retirement from the Company with entitlement to an immediate pension generally upon the earlier of the attainment of age 50, when such age plus years of service equals 80, or the attainment of age 65. Other postretirement benefits provided by the Company
include life insurance plans. These life insurance plans are primarily funded by employees; as a result, the cost of such plans to the Company is not material.
The health care plans for retired employees and their dependents are unfunded defined benefit plans. The benefit is defined as the Company's contributions to such plans. Annually, retirees are advised of the amount of the Company's monthly contribution to the plans for the following year and the monthly amount such retirees must pay for the particular coverage desired. Coverage under the plans is arranged through insurance companies. The Company's portion of premium payments was $40 million in 1996, $41 million in 1995 and $47 million in 1994.
The assumed annual health care cost trend rate used in measuring the accumulated postretirement benefit obligation (APBO) was 8.5% in 1996, 7.5% in 1997, and gradually declines to 5% by the year 2002, remaining at that level thereafter. Increasing the assumed health care cost trend rate by one percentage point in each year would increase the APBO by approximately $103 million and the aggregate of the 1996 service cost and interest cost components of expense by $11 million. The APBO as of December 31, 1996 and 1995 was based on discount rates of 7.5% and 7%, respectively. Unrecognized net gains or losses in excess of 10% of the APBO (corridor) are amortized over three years.
Net postretirement benefits cost consisted of the following:
The postretirement benefits plan status at December 31 was as follows:
15. PENSION PLANS AND PROVIDENT FUND
The Shell Pension Plan covers employees of the Company and certain subsidiaries. Benefits are based on years of service and the employee's average final compensation. Company contributions to the Shell Pension Trust are based on the projected unit credit actuarial method using rates determined to be reasonable by an independent actuary. The methodology meets the requirements of the Employee Retirement Income Security Act. There were no contributions to the Shell Pension Trust in 1996 and 1995 due to the full-funding limitation of the applicable tax law.
The plan's funded status at December 31 was as follows:
Shell Oil also has a Benefit Restoration Plan and a Senior Staff Plan. The Benefit Restoration Plan generally provides for payments of amounts in excess of limits imposed by federal tax law on benefit payments under the Shell Pension Plan. The Senior Staff Plan provides for defined monthly supplemental pension payments to members of the senior staff (consisting of certain officers and other high-ranking employees). Both of these plans are unfunded. The accumulated benefit obligation for these plans totaled $253 million and $259 million at December 31, 1996 and 1995, respectively. The projected benefit obligation for these plans totaled $284 million and $302 million at December 31, 1996 and 1995, respectively. Of the 1996 projected benefit obligation amount, $165 million will be expensed in the future and $119 million of unfunded accrued pension cost is included in liabilities on the Consolidated Balance Sheet. The estimated additional minimum pension liability recorded at December 31, 1996 and 1995 was $155 million and $93 million, respectively.
The components of net pension expense for the Shell Pension Plan, Benefit Restoration Plan and Senior Staff Plan were:
- ------------
* Estimated long-term rates of return on plan assets of 9.5 percent in 1996 and 1995, and 10 percent in 1994 were used in determining pension expense for the period. The difference between actual return and estimated return is included in Net amortization and deferral.
Current year pension expense is based on measurements of the projected benefit obligation and the market-related value of plan assets as of the end of the previous year. The projected benefit obligation as of December 31, 1996 and 1995 was based on discount rates of 7.5 percent and 7 percent, respectively, and an average long-term rate of compensation growth of 5 percent for 1996 and 1995.
The Shell Provident Fund covers employees of the Company and certain subsidiaries after stated periods of service, and provides for contributions by the employing company based on a stated percentage of the employees' salaries and wages. Employees may also contribute amounts up to a stated percentage.
Total costs of these plans were as follows:
In addition, several subsidiary companies have separate pension plans using actuarial rates and assumptions determined to be appropriate to those companies. Such plans are not material and were excluded from the above disclosures.
16. CONTINGENCIES AND OTHER MATTERS
Shell Oil is subject to a number of possible loss contingencies. These include actions based upon environmental laws involving present and past operating and waste disposal locations and related private claims, contract and product liability actions and federal, state and private actions challenging the correctness of oil and gas royalty calculations. In addition, federal, state and local income, property and excise tax returns are being examined and certain interpretations by Shell Oil of complex tax statutes, regulations and practices are being challenged.
Since 1984, the Company has been named with others as a defendant in numerous product liability cases, including class actions, involving the failure of residential plumbing systems in the United States constructed with polybutylene plastic pipe. The Company has also been sued regarding failures in polybutylene pipe connecting users with utility water lines and polybutylene pipe used in municipal water distribution systems. The plaintiffs in the litigation claim property damages and in some cases fraud and intentional misrepresentation seeking punitive damages. The Company manufactured the resin used to make the pipe in these systems. Two other substantial manufacturers made the resins for the polyacetal insert fittings used in many of the residential plumbing systems (the fittings' co-defendants) and are also defendants in these cases. The Company's position and most of the judgments to date have confirmed that most of the leaks have occurred in residential plumbing systems due to failure of the polyacetal insert fittings. Shell and the fittings co-defendants have agreed on a mechanism to fund the payment of most of the residential plumbing claims as the result of two class action settlements (the "class action settlement"); a small percentage of opt-outs must assert their claims outside the class. The class action settlement provides for the creation of an entity to receive and handle claims and for a $950 million fund to pay such claims, which claims may be made over a period of up to 14 years, depending on various factors. If the settlement funds are exhausted, additional funds may be provided by the defendants, or claimants who have not received their full benefits under the class action settlements may seek their remedy in a new court proceeding at that time. One fittings co-defendant has agreed to fund 10% of all acetal fittings costs related to the class action settlement; the Company and the other fittings co-defendant have agreed to arbitration to determine how the remaining acetyl fittings portion of the costs will be shared between them. Additionally, in matters outside the residential plumbing litigation and class action settlement, claims involving problems with polybutylene pipe used in municipal water distribution systems have increased during the past two years. The Company will continue to defend these matters vigorously but it cannot currently predict when or how polybutylene related matters will finally be resolved.
In December 1993, a Los Angeles Superior Court jury, in two consolidated lawsuits against the Company and its subsidiary involving the condition of the Dominguez oil field, returned a verdict for the plaintiffs in the amount of $46.9 million compensatory damages and $173 million punitive damages. Plaintiffs alleged they were defrauded, that the oil and gas lease was breached, and that soil contamination on the property constitutes a continuing trespass. Final resolution through the appeals process could take several years. The Company and its subsidiary believe the verdict was wrong and expect ultimately to prevail in the litigation.
The Company is a party to litigation regarding Nemagon(R), an agricultural chemical containing DBCP manufactured and sold by it from 1955 to 1978. Cases have been filed against the Company, other substantial manufacturers and suppliers of DBCP and banana growers alleging that the plaintiffs suffer fertility problems
arising from exposure to DBCP while working on banana plantations outside the United States. The Company is contesting whether any injury has in fact been incurred by plaintiffs, whether DBCP was in fact the cause of any such injury as may exist, and in any case if the Company was a supplier or otherwise has liability in connection with any such injury.
The Company's assessment of these matters is continuing. Future provisions may be required as administrative and judicial proceedings progress and the scope and nature of remediation programs and related costs estimates are clarified. However, while periodic results may be significantly affected by costs in excess of provisions related to one or more of these proceedings, based upon developments to date, the management of the Company anticipates that it will be able to meet related obligations without a material adverse effect on its financial position.
17. COMMITMENTS
Shell Oil conducts a portion of its operations using leased facilities, including service stations, barges, tankers and drilling rigs. Future minimum payments under operating leases with initial or remaining terms of one year or more consisted of the following at December 31, 1996:
The composition of total rental expense for all operating leases, except those with terms of a month or less that were not renewed, was as follows:
Under long-term agreements with an offshore port and certain pipeline companies in which stock interests are held, Shell Oil may be required to advance funds against future transportation charges in the event such companies are unable to meet their financial obligations. Also, at December 31, 1996, Shell Oil had commitments related to agreements for the future purchase of materials and services, and for the acquisition and construction of facilities, all made in the normal course of business. Additionally, at December 31, 1996, Shell Oil had guaranteed $156 million of debt and other obligations of others. All such commitments and guarantees are expected to be fulfilled with no adverse consequences material to Shell Oil's operations or financial condition.
18. OPERATING SEGMENTS INFORMATION
Shell Oil is engaged, principally in the United States, in the exploration for, and development, production, purchase, transportation and marketing of, crude oil and natural gas, and the purchase, manufacture, transportation and marketing of oil and chemical products. These activities are conducted through three major business segments -- Oil and Gas Exploration and Production, Oil Products and Chemical Products as follows:
Oil and Gas Exploration and Production explores for and develops and produces crude oil, natural gas and natural gas liquids primarily in the continental United States and the offshore Gulf of Mexico. This segment is also engaged on a limited and selective basis in exploration and production activities outside the United States, including ventures with companies of the Royal Dutch/Shell Group of Companies.
Oil Products transports, refines and markets crude oil and petroleum products principally in the United States. This segment is oriented toward light fuel products; accordingly, refineries are designed to produce large quantities of motor gasoline and other light fuels. The Company is a leading marketer of gasoline in the United States and an important supplier of aviation fuel, lubricants and asphalt. In 1996, Shell Oil's own net produced crude oil and natural gas liquids was equivalent to about 57 percent of its intakes into its crude oil distillation units. The Company further supplements its own crude oil production to meet its refinery requirements by the purchase of crude oil from both domestic and international sources. During 1996, 34 percent of the Company's net crude oil supply came from sources outside the United States; approximately 25 percent was purchased from government oil companies in seven foreign countries and 9 percent was purchased from other international sources including companies affiliated with the Royal Dutch/Shell Group of Companies.
Chemical Products is a major producer in the United States of olefins, aromatics, detergent alcohols, ethylene oxide and derivatives, thermoplastic elastomers, epoxy resins, oxygenated and hydrocarbon solvents and polyester resins. These basic chemical products are used in many consumer and industrial products and processes. They are sold primarily to industrial markets in the United States; approximately 20 percent of chemical volumes are sold outside the United States. In addition, petrochemicals are manufactured by a joint venture with Saudi Basic Industries Corporation and sold in world wide markets. Ethylene oxide and other catalysts are manufactured and sold through joint ventures with affiliates and other parties.
Operating segments information for the years 1996, 1995 and 1994 is presented below. Income taxes are allocated to segments on the basis of contributions to taxable income reduced by applicable tax credits. Shell Oil's activity outside the United States has not reached a level warranting separate reporting.
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(1) After elimination of intersegment transfers of $4,601 million in 1996, $3,780 million in 1995 and $3,266 million in 1994, which are based on estimated market-related values.
(2) Includes non-segment capital expenditures of $4 million in 1996, $62 million in 1995, and $61 million in 1994.
(3) Includes non-segment assets of $1,511 million in 1996, $1,192 million in 1995 and $1,341 million in 1994.
(4) Amounts associated with major product classifications for which there has been no revenue stream or investment in the last 5 years.
19. SUMMARIZED FINANCIAL INFORMATION -- SHELL PIPE LINE CORPORATION
The following summarized financial information for Shell Pipe Line Corporation, a wholly owned subsidiary of Shell Oil Company, is presented here for the information of holders of Shell Pipe Line Corporation's 7 1/2% Guaranteed Sinking Fund Debentures Due 1999, which are fully guaranteed by Shell Oil Company.
20. QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 7, 1997.
SHELL OIL COMPANY (Registrant)
By /s/ PHILIP J. CARROLL ------------------------------------ (Philip J. Carroll, President)
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POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Philip J. Carroll, S. A. Lackey, and Jack B. Edrington, and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 7, 1997 by the following persons on behalf of the Registrant in the capacities indicated.
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INDEX TO EXHIBITS
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* Incorporated by reference; see Item 14c, page 32.