ITEM 3. LEGAL PROCEEDINGS
The historical method used by the oil industry in the United States to establish the price at which crude oil is bought and sold is being challenged. Buyers and sellers have traditionally determined the market price of crude oil by reference to "posted prices", which are prices published by certain crude oil buyers such as crude oil refiners and transporters as the price at which they are willing to buy. A number of suits have been brought alleging that posted prices have been set consistently below market value, and that, as a result, royalties have been underpaid.
The Partnership was named as a defendant in such a case filed in state court in Starr County, Texas in April, 1995 and a co-defendant in cases filed in state courts in Lee County, Texas and in Louisiana and Alabama and in federal courts in Texas, Louisiana and Mississippi. All of these lawsuits seek certification as class actions on behalf of royalty owners in specific geographic areas, except the Texas and Alabama cases, which seek certification of a nationwide class of royalty owners. These cases also allege that the co-defendants have conspired and acted in concert to establish the price of crude oil in violation of antitrust statutes. These suits are similar to those brought in Texas by the Texas General Land Office, and in New Mexico, Oklahoma and Florida by private royalty owners against major crude oil producers. Suits are also being brought by natural gas royalty interest owners regarding royalty valuation and deductions of post-production costs from royalty.
The Partnership holds and has held interests in a number of federal and Indian oil and gas production leases. The Minerals Management Service (MMS) of the United States Department of the Interior is challenging the prices on which royalties were based for oil and gas produced from certain of these leases. The MMS has claimed that a number of crude oil producers including the Partnership underpaid royalties owed the federal government on California crude oil production from 1980 to 1988 and has sent Orders to Pay to a number of producers including the Partnership. Separately, numerous oil and gas producers, including the managing general partners of certain of the Operating Partnerships, have been named as defendants in lawsuits brought pursuant to the federal False Claims Act in connection with royalty payments on production from federal and Indian lands.
While a number of claims and suits against the Partnership and other crude oil and natural gas producers have already been brought by a variety of governmental and private plaintiffs in a number of jurisdictions, the fact that these suits challenge practices common to the industry suggests that additional lawsuits against the Partnership may be filed. The suits filed to date, to include the actions in which the Partnership is a party, are procedurally in the preliminary stages, though settlement discussions have taken place with respect to a number of claims. The Partnership believes it has meritorious defenses and, if acceptable settlements cannot be reached, intends to defend these claims and lawsuits vigorously.
The Partnership is involved in a number of other legal and administrative proceedings arising in the ordinary course of its oil and gas business. Although the ultimate outcome of these proceedings cannot be ascertained at this time, it is reasonably possible that some of the proceedings could be resolved unfavorably to the Partnership. Management of the Company believes that any liabilities which may arise out of legal claims or proceedings would not be material in relation to its financial position, results of operations or liquidity at December 31, 1998. The Company intends to maintain liability and other insurance for the Partnership of the type customary in the oil and gas business with such coverage limits as the Company deems prudent.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNITHOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S LIMITED PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS
The depositary units of Sun Energy Partners, L.P. are traded on the New York Stock Exchange, Inc. The following table sets forth the high and low sales prices per unit, as reported on the New York Stock Exchange Composite Transactions quotations, for the periods indicated:
The Partnership had approximately 1,445 holders of record of depositary units as of February 23, 1999.
For the years 1998 and 1997, the quarterly cash distributions per unit paid to unitholders were as follows:
Any future quarterly cash distributions to unitholders are expected to be paid on or about the 10th day of March, June, September and December in each year. Distributions will fluctuate due to oil and gas prices, production volumes, operating costs and the timing and amount of capital expenditures and divestment proceeds. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Cash Distribution Policy.")
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
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(1) Effective January 1, 1994, the Partnership adopted a new policy for determining the ceiling test for its oil and gas properties. A one-time non-cash charge of $577 million for the cumulative effect of the change was recognized in the earnings for 1994. As a result of an impairment test related to the application of Statement of Financial Accounting Standards No. 121, the Partnership reported a non-cash write-down of assets of $75 million in the fourth quarter of 1998.
(2) Includes $24 million, $38 million, $51 million, $62 million and $72 million of long-term debt due to the Company.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of the Partnership's financial condition and results of operations which follow should be read in conjunction with the Consolidated Financial Statements and Selected Financial Data included in this report.
RESULTS OF OPERATIONS
The Partnership reported a net loss in 1998 of $44 million. The realized oil price in 1998 decreased 28 percent to $13.58 per barrel and the realized natural gas price decreased 13 percent to $2.10 per mcf. Exploration costs increased 57 percent primarily from increased offshore dry hole costs and increased geological and geophysical expense due to increased activity. Depreciation, depletion and amortization expense increased 29 percent primarily due to a non-cash write down of assets (see Note 6 to the Consolidated Financial Statements).
Net income in 1997 was $239 million. Production volumes increased 2 percent in 1997 compared to 1996 primarily due to offshore development. The realized oil price in 1997 decreased 8 percent to $18.75 per barrel. The realized gas price in 1997 increased 12 percent to $2.40 per mcf. Exploration costs increased 45 percent primarily from increased offshore dry hole costs and increased geological and geophysical expense due to increased activity. Depreciation, depletion and amortization expense increased 19 percent primarily because of additional development and higher production volumes.
Net income in 1996 was $248 million. The realized oil price in 1996 increased 24 percent to $20.43 per barrel. The increase in 1996 followed a 12 percent increase in 1995 compared to 1994. The Partnership's
realized gas price in 1996 increased 24 percent to $2.14 per mcf. Total costs and expenses decreased 3 percent to $438 million in 1996. Operating costs decreased 14 percent in 1996 due to cost efficiency measures. Production taxes increased 27 percent in 1996 due to higher prices.
LIQUIDITY AND CAPITAL RESOURCES
ED&A outlays were $398 million in 1998, $427 million in 1997 and $317 million in 1996. In 1998, 61 percent of the Partnership's total ED&A investment was for development and acquisition and 39 percent was for exploration. In 1999, in the absence of the planned merger of the Partnership, total ED&A outlays would have been expected to be approximately $220 million of which 77 percent was targeted for development and 23 percent for exploration. In 1998, the Partnership replaced 88 percent of its production at an FD&A cost of $11.02 per eb.
In 1998, cash flow from operating activities decreased $240 million compared to 1997 primarily due to lower oil and gas prices and lower production volumes. Cash flow from investing activities used $273 million in 1998 compared to $421 million in 1997. Proceeds from divestments were $113 million higher in 1998 while capital expenditures were $43 million lower. Cash flow from financing activities used $21 million in 1998 compared to a use of $117 million in 1997 primarily due to reduced distributions to unitholders in 1998.
In 1997, cash flow from operating activities increased $143 million compared to 1996 primarily due to favorable increases in cash flow working capital components. Cash flow from investing activities used $421 million in 1997 compared to $323 million in 1996. Capital expenditures were $96 million higher in 1997 while proceeds from divestments were $7 million lower. Cash flow from financing activities used $117 million in 1997 compared to a use of $78 million in 1996. Cash distributions paid to unitholders were $38 million higher in 1997 than 1996.
In 1996, cash flow from operating activities increased $58 million from 1995 primarily due to higher oil and gas prices and lower costs and expenses partially offset by lower production volumes. Cash flow from investing activities used $323 million in 1996 compared to $144 million in 1995. Proceeds from divestments were $67 million lower in 1996 while capital expenditures increased by $108 million. Cash flow used for financing activities decreased by $127 million in 1996 primarily because of the reduced distributions to unitholders.
The Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" effective January 1, 1998. Total comprehensive income and net loss are identical for the year ended December 31, 1998. Additionally, in January 1998, the Partnership adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," resulting in the restatement of selected operating information in years prior to 1998.
In December 1997, the Partnership adopted SFAS No. 128, "Earnings per Share" and SFAS No. 129, "Disclosure of Information about Capital Structure," resulting in no material change.
The Partnership's investing levels will be governed by its cash flow from operating activities which will continue to be affected by prevailing oil and gas prices, cost levels and production volumes. Volatility in oil and gas prices experienced over the past several years is expected to continue. Any shortfall in expected cash flow from operating activities may require adjustment of the business plans. Options include deferral of discretionary ED&A outlays and the sale of Partnership units. The Partnership's long-term cash generation capability is ultimately tied to the value of proved reserves.
RESERVE REPLACEMENT
The ability to sustain cash flow is dependent, among other things, on the level of the Partnership's oil and gas reserves, oil and gas prices and cost containment. Replacement of proved reserves through extensions and discoveries, improved recovery, purchases and revisions to prior reserve estimates in 1998 was 100 percent of liquids production and 78 percent of gas production. Reserve replacement rates of liquids and gas were 185 and 119 percent in 1997 and 122 and 49 percent in 1996.
HEDGING ARRANGEMENTS
The Partnership from time to time has entered into commodity futures contracts to manage its crude oil and natural gas price risk and to maintain specified margins. Effective with the merger of Oryx into Kerr-McGee, the Partnership has elected to eliminate the hedging program and all contracts have been closed.
YEAR 2000 READINESS
In 1996, the Company established a formal Year 2000 Program (Program) to assess and correct Year 2000 problems in both information technology and non-informational technology systems. The Program is organized into two major areas: business systems and facilities integrity. Business systems include replacement and upgrade of computer hardware and software, including major business applications, such as purchasing, inventory, engineering, financial, human resources, etc. Facilities integrity encompasses telecommunications, plant process controls, instrumentation and embedded chip systems as well as an assessment of third party Year 2000 readiness.
As a result of the merger of Oryx with Kerr-McGee, the Company is undertaking steps to minimize Year 2000 problems that might adversely impact the Partnership.
To date, activities associated with business systems have included:
- inventory and assessment
- remediation and testing of legacy systems and hardware
- communication with critical business partners
Future activities will include:
- conversion of data from Oryx's financial, human resources, production, technical and other systems into Year 2000 compliant systems utilized by the Partnership
- remediating and testing certain Oryx legacy systems that will be retained and utilized by the Partnership
- replacement of hardware and operating systems with Kerr-McGee Year 2000 compliant systems
- Year 2000 integration testing of converted and remediated systems to ensure proper functionality beyond 2000.
These activities are scheduled to be complete near the end of third quarter, 1999. Costs expended to date by the Partnership are approximately $1.4 million. Total forecasted costs are approximately $3.6 million, but are being re-evaluated by the Company as a result of the merger. However, management believes that the costs are not material to the Partnership's results of operations, financial position or cash flow.
To date, major activities associated with facilities integrity have included:
- inventory and assessment
- remediation
- testing and verification
Inventory and assessment activities are essentially complete with remediation and testing and verification scheduled for completion in third quarter, 1999. Additional activities will be incorporated and include communication with third party vendors, suppliers and partners, and development of contingency plans. These activities are expected to be completed in late third quarter or early fourth quarter, 1999.
Costs expended to date have been minor for facilities associated with the Partnership. Forecasted costs to complete these activities are approximately $300,000, but are being re-evaluated by the Company as a result of the merger.
Management believes that the Program is comprehensive and reduces Year 2000 risks associated with internal systems to a manageable level. Regardless of management's efforts to assess and verify readiness there can be no assurance that all entities affecting the Company will be Year 2000 ready. To address these
concerns, contingency plans will be developed. However, failure by a third party to remediate their Year 2000 issues in a timely manner could have a material effect to the Partnership's result of operations and cash flows in a particular quarter or annual period. Failure of a critical operating or safety component, or failure by a key third party supplier or customer are believed to be the most reasonably likely worst case scenarios that could impact the Partnership.
ENVIRONMENTAL
The Partnership's oil and gas operations are subject to stringent environmental regulations. The Company is dedicated to the preservation of the environment and has committed significant resources to comply with such regulations. Although the Partnership has been named as a potentially responsible party at sites related to past operations, the Company believes the Partnership is in general compliance with applicable governmental regulations and that the potential costs to it, in the aggregate, are not material to its financial condition. However, risks of substantial costs and liabilities are inherent in the oil and gas business. Should other developments occur, such as increasingly strict environmental laws, regulations and enforcement policies or claims for damages resulting from the Partnership's operations, they could result in additional costs and liabilities in the future. (See Note 12 to the Consolidated Financial Statements.)
CASH DISTRIBUTION POLICY
The Partnership funds its capital outlays from internally generated funds, including cash proceeds from asset sales and makes distributions of only that cash remaining after such outlays.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION
SUN ENERGY PARTNERS, L.P. REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners of Sun Energy Partners, L.P. and the Board of Directors of Oryx Energy Company:
In our opinion, the accompanying consolidated balance sheets of Sun Energy Partners, L.P. and its Subsidiaries and the related consolidated statements of income and cash flows present fairly, in all material respects, the consolidated financial position of Sun Energy Partners, L.P. and its Subsidiaries as of December 31, 1998 and 1997 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. These financial statements are the responsibility of Oryx Energy 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.
/s/ PRICEWATERHOUSECOOPERS LLP
Dallas, Texas February 22, 1999, except for Note 14 as to which the date is March 9, 1999
SUN ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF INCOME (MILLIONS OF DOLLARS, EXCEPT PER UNIT AMOUNTS)
(See Accompanying Notes)
SUN ENERGY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS (MILLIONS OF DOLLARS)
ASSETS
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The successful efforts method of accounting is followed.
(See Accompanying Notes)
SUN ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS (MILLIONS OF DOLLARS)
(See Accompanying Notes)
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Control
Sun Energy Partners, L.P. (Sun Energy Partners) engages in the oil and gas exploration and production business in the United States. Prior to February 26, 1999, Oryx Energy Company (Oryx) controlled Sun Energy Partners and was its managing general partner. On that date, Kerr-McGee Corporation (Kerr-McGee) became managing general partner following its merger with Oryx, and Kerr-McGee now controls Sun Energy Partners. The Company refers to Oryx prior to February 26, 1999 and to Kerr-McGee since February 26, 1999. As of December 31, 1998, the Company owned 98.2 percent of Sun Energy Partners. The remaining 1.8 percent interest is comprised of limited partnership interests held by public unitholders in the form of depositary units (Units).
Sun Energy Partners operates through Sun Operating Limited Partnership, a Delaware limited partnership, and several other operating partnerships (collectively, the Operating Partnerships). In all of the partnerships which comprise the Operating Partnerships, Sun Energy Partners holds a 99 percent interest as the sole limited partner, while the Company holds a 1 percent interest as the managing general partner.
Sun Energy Partners and the Operating Partnerships (collectively, the Partnership) have no officers or employees. The officers and employees of the Company perform all management functions.
Basis of Presentation
The Partnership's consolidated financial statements have been prepared using the proportionate method of consolidation for Sun Energy Partners and its 99 percent interest in the Operating Partnerships. Such financial statements are prepared in accordance with generally accepted accounting principles which is different from the basis used for reporting taxable income or loss to unitholders.
Cash Equivalents
The Partnership considers highly liquid investments with original maturities of less than 3 months to be cash equivalents. Cash equivalents are stated at cost which approximates market value.
Properties, Plants and Equipment
The successful efforts method of accounting is followed for costs incurred in oil and gas operations.
Capitalization Policy. Acquisition costs are capitalized when incurred. Costs of unproved properties are transferred to proved properties when proved reserves are added. Exploration costs, including geological and geophysical costs and costs of carrying unproved properties, are charged against income as incurred. Exploratory drilling costs are capitalized initially; however, if it is determined that an exploratory well did not find proved reserves, such capitalized costs are charged to expense, as dry hole costs, at that time. Development costs are capitalized. Costs incurred to operate and maintain wells and equipment are expensed.
Leasehold Impairment and Depreciation, Depletion and Amortization. Periodic valuation provisions for impairment of capitalized costs of unproved properties are expensed. The acquisition costs of proved properties are depleted by the unit-of-production method based on proved reserves by field. Capitalized exploratory drilling costs which result in the addition of proved reserves and development costs are amortized by the unit-of-production method based on proved developed reserves by field. In addition, unamortized capital costs at a field level are reduced to fair value if the sum of expected undiscounted future cash flows is less than net book value.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Dismantlement, Restoration and Abandonment Costs. Such costs are estimated and accrued as a component of depreciation, depletion and amortization expense; actual costs are charged to the accrual.
Retirements. Gains and losses on the disposals of fixed assets are generally reflected in income. For certain property groups, the cost less salvage value of property sold or abandoned is charged to accumulated depreciation, depletion and amortization except that gains and losses for these groups are taken into income for unusual retirements or retirements involving an entire property group.
Investment in Affiliate
Effective in 1988, Oryx Energy Company issued three million shares of its $1 par value common stock to an operating partnership of the Partnership in exchange for certain assets. These shares were converted into 1,107,000 shares of Kerr-McGee common stock consistent with the terms of the Kerr-McGee/Oryx merger agreement (Note 14) and continue to be non-voting and legally restricted from disposition. The Partnership accounts for this investment under the cost method, whereby investment income is recognized by the Partnership if and when common dividends are received from the Company.
Capitalized Interest
The Partnership capitalizes interest costs incurred as a result of the acquisition and installation of significant assets.
Income Taxes
The Operating Partnerships and Sun Energy Partners are treated as partnerships for income tax purposes and, as a result, income or loss of the Partnership is includable in the tax returns of the individual unitholders. Accordingly, no recognition has been given to income taxes in the financial statements.
At December 31, 1998, 1997 and 1996, the Partnership's financial reporting bases of assets and liabilities exceeded the tax bases of its assets and liabilities (net temporary differences) by $654 million, $758 million and $596 million.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents includes cash, highly liquid investments with remaining maturities of less than 3 months (see "Cash Equivalents", above) and advances to affiliate.
Interest paid totaled $20 million, $15 million and $17 million in 1998, 1997 and 1996.
Sales of Oil and Gas
Sales of oil and gas are recorded on the entitlement method. Differences between actual production and entitlements result in a receivable when underproduction occurs and a payable when overproduction occurs.
During 1998, 1997 and 1996, sales of oil to the Partnership's top purchaser totaled approximately 16 percent, 18 percent and 8 percent, and sales of natural gas to the Partnership's top purchaser totaled 50 percent, 52 percent and 51 percent. The Partnership believes that the loss of any major purchaser would not have a material adverse effect on its business.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Oil and Gas Price Hedging Activity
The Partnership, from time to time, enters into arrangements to hedge the impact of price fluctuations on anticipated crude oil and natural gas sales. Gains or losses on hedging activities are recognized in oil and gas revenues in the period in which the hedged production is sold (Note 2).
Environmental Costs
The Partnership establishes reserves for environmental liabilities as incurred (Note 12).
Statement Presentation
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" effective January 1, 1998. Total comprehensive income and net loss are identical for the year ended December 31, 1998. Additionally, in January 1998, the Partnership adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," resulting in the restatement of selected operating information in years prior to 1998. In December 1997, the Partnership adopted SFAS No. 128, "Earnings per Share" and SFAS No. 129, "Disclosure of Information about Capital Structure," resulting in no material change.
2) FINANCIAL INSTRUMENTS
Derivatives
As discussed in Note 1, the Partnership enters into hedging arrangements for crude oil and natural gas prices with major financial institutions. The Partnership does not enter into derivative transactions for trading purposes.
At December 31, 1998, the Partnership was a party to crude oil collar contracts to hedge about 7 percent of its estimated 1999 crude oil production at an average floor price of $15.85 per barrel and an average ceiling price of $17.35 per barrel. Approximately 31 percent of its estimated 1999 natural gas production was hedged at an average floor price of $2.29 per mmbtu and an average ceiling price of $2.47 per mmbtu. At December 31, 1997, the Partnership was a party to crude oil and natural gas contracts to hedge about 9 percent of its estimated 1998 crude oil production at an average floor price of $20.17 per barrel and an average ceiling price of $21.24 per barrel and 20 percent of its estimated 1998 natural gas production at an average floor price of $2.19 per mmbtu and an average ceiling price of $2.40 per mmbtu. These arrangements serve to reduce the volatility associated with prices of crude oil and natural gas. The aggregate carrying values of these assets at December 31, 1998 and 1997 were $7 million and $2 million and the aggregate fair values, subject to daily fluctuation, based on quotes from brokers, were approximately $18 million and $5 million.
The above mentioned derivative contracts expose the Partnership to credit risk. The Partnership has established controls to manage this risk and closely monitors the creditworthiness of its counterparties which are major financial institutions. In the normal course of business, collateral is not required for financial instruments with credit risk. The Partnership believes that losses from nonperformance are unlikely to occur.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2) FINANCIAL INSTRUMENTS (CONTINUED) Other Financial Instruments
At December 31, 1998 and 1997, the carrying values of the Partnership's long-term debt, including amounts due within one year, were $39 million and $52 million (Note 8). At December 31, 1998 and 1997, the aggregate fair values of the Partnership's long-term debt were approximately $41 million and $55 million, estimated primarily based on current rates offered to the Partnership for debt of the same remaining maturities.
3) RELATED PARTY TRANSACTIONS
Advances to/from Affiliate
The Company has served as the Partnership's lender and borrower of funds and a clearing-house for the settlement of intercompany receivables and payables. Deposits earn interest at a rate equal to the rate paid by a major money market fund. Demand loans bear interest at a rate based on the prime rate.
Long-Term Debt Due Affiliate
The Partnership is indebted to the Company under a 9.75% note due 1999-2001 (Note 8).
Sales of Natural Gas
During the fourth quarter of 1995, the Partnership, Apache Corporation and Parker & Parsley Petroleum Company formed Producers Energy Marketing Company, LLC (ProEnergy) to jointly market natural gas. Full operations commenced in April 1996. In 1997, Pioneer Natural Resources Company (formerly Parker & Parsley Petroleum Company) terminated its relationship with ProEnergy. As of December 31, 1997 the Partnership had an ownership interest of 40 percent in ProEnergy; however, ownership varied based on the Partnership's share of natural gas throughput for the preceding quarter. The Partnership accounted for its investment in ProEnergy using the equity method, and as of December 31, 1997 had an investment in ProEnergy of $4 million. The Partnership sold substantially all of its natural gas production to ProEnergy at index prices. On June 18, 1998, the Partnership sold its interest in ProEnergy at a gain of $15 million and entered into an agreement with the purchaser whereby the purchaser would market the Partnership's gas production for up to ten years through ProEnergy. Natural gas sales to ProEnergy totaled $82 million for the six months ended June 30, 1998, $219 million for the year ended December 31, 1997 and $193 million for the nine months ended December 31, 1996. At December 31, 1997, the Partnership had an outstanding receivable balance of $22 million from ProEnergy. On June 30, 1998, the Partnership had an outstanding receivable balance of $19 million from ProEnergy which was subsequently collected.
Direct and Indirect Cost
The Company is reimbursed by the Partnership for all direct costs incurred in performing management functions and indirect costs (including payroll and payroll related costs and the cost of postemployment benefits and management incentive plans) allocable to the Partnership. The full cost of direct and indirect costs incurred on behalf of the Partnership by the Company is allocated to the Partnership based on services rendered and extent of use. Such costs, which are charged principally to production cost, exploration cost and general and administrative expense, totaled $57 million, $61 million and $61 million for the years 1998, 1997 and 1996. The Company does not receive any carried interests, promotions, back-ins or other similar compensation as the general partner of the Partnership.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3) RELATED PARTY TRANSACTIONS (CONTINUED) Interest Income
Interest income received from the Company, which is reflected in "Other-net" in the Consolidated Statements of Income, was earned on advances to the Company and totaled $3 million, $4 million and $4 million during the years 1998, 1997 and 1996.
Interest Cost
Interest cost paid to the Company, which is included in "Interest and debt expense" in the Consolidated Statements of Income, was primarily incurred on long-term debt and advances due the Company and totaled $20 million, $14 million and $16 million during the years 1998, 1997 and 1996 (Note 8).
4) OTHER-NET
Other-net consists of the following:
5) PRODUCTION TAXES
Production taxes consisted of the following:
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6) PROPERTIES, PLANTS AND EQUIPMENT
At December 31, the Partnership's properties, plants and equipment and accumulated depreciation, depletion and amortization were as follows:
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* Includes $28 million for dismantlement, restoration and abandonment at December 31, 1998 and 1997.
As a result of an impairment test related to the application of SFAS No. 121, the Partnership reported a non-cash write-down of assets of $75 million in 1998. The Partnership deemed that certain of its oil and gas fields, primarily offshore, were impaired because the assets were no longer expected to recover their net book value through future estimated cash flows. The lower estimated cash flows result primarily from continued weakness in oil and gas prices. In addition, minor downward reserve revisions were deemed necessary for certain oil and gas fields. The prices used in performing the impairment analysis of future cash flows are the Partnership's investment guideline prices, developed internally giving consideration to currently available price forecasts for 1999 of $13.00 to $17.50 per barrel and $1.80 to $2.40 per mmbtu as published by various energy industry consultants and investment banks. The Partnership used crude oil prices of $14.50 per barrel in 1999 escalating to $18.50 per barrel in 2001 and increased by $.50 per barrel annually thereafter and natural gas prices of $2.10 per mmbtu in 1999 escalating to $2.20 per mmbtu in 2000 and increased by $.05 per mmbtu annually thereafter. A discount rate of 10% based on the Partnership's approximate weighted-average cost of capital was used. The Partnership used proven reserves and probable reserves when justified by actual drilling results and planned additional drilling. The impairment loss is included in "Depreciation, depletion and amortization" in the Consolidated Statements of Income. The impairment represents about 6% of the Partnership's oil and gas assets.
7) ACCRUED LIABILITIES
At December 31, the Partnership's accrued liabilities were comprised of the following:
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8) LONG-TERM DEBT
At December 31, the Partnership's long-term debt consisted of the following:
Repayment obligations under the Partnership's long-term debt due affiliate are $14 million, $16 million, and $8 million in 1999, 2000 and 2001.
9) COMMITMENTS AND CONTINGENT LIABILITIES
The Partnership has operating leases for office space and other property and equipment. Total rental expense for such leases for the years 1998, 1997 and 1996 was $13 million, $12 million and $15 million. Under contracts existing as of December 31, 1998, future minimum annual rentals applicable to noncancellable operating leases that have initial or remaining lease terms in excess of 1 year were as follows (in millions of dollars):
Several legal and administrative proceedings are pending against the Partnership. Although the ultimate outcome of these proceedings cannot be ascertained at this time, and it is reasonably possible that some of them could be resolved unfavorably to the Partnership, management of the Company believes that any liabilities which may arise would not be material to the Partnership's financial position, results of operations or liquidity.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10) PARTNERS' CAPITAL
11) CASH DISTRIBUTIONS
Distributable cash is defined as revenues (including interest income) less operating costs; seismic, geological and geophysical costs (including related costs); payments of principal of and interest on debt; general and administrative expenses including reimbursements to the Company as managing general partner; capital expenditures (net of proceeds from divestments); and cash exploration costs. No deduction is made for depreciation, depletion and amortization.
Sun Energy Partners' quarterly cash distributions per unit for the years 1998, 1997 and 1996 were as follows:
12) DEFERRED CREDITS AND OTHER LIABILITIES
At December 31, the Partnership's deferred credits and other liabilities were comprised of the following:
Environmental cleanup costs have been accrued in response to the identification of several sites that require cleanup based on environmental pollution, some of which have been designated as superfund sites by the Environmental Protection Agency (EPA). The Partnership has been named as a Potentially Responsible Party (PRP) at four sites pursuant to the Comprehensive Environmental Response, Compensation, and
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12) DEFERRED CREDITS AND OTHER LIABILITIES (CONTINUED) Liability Act of 1980, as amended. At two of these sites, the Partnership has been named as a de minimis party and therefore expects its liability to be small. At a third site, the Partnership is reviewing its options and anticipates that it will participate in steering committee activities with the EPA. At the fourth and largest site, the Operating Industries, Inc. site in California, the Partnership has participated in a steering committee consisting of 139 companies. The steering committee and other PRPs previously entered into two partial consent decrees with the EPA providing for remedial actions which have been or are to be completed. The steering committee has successfully negotiated a third partial consent decree which provides for the following remedial actions: a clay cover, methane capturing wells and leachate destruction facilities. The remaining work at the site involves groundwater evaluation and long-term operation and maintenance. The Partnership is a member of the group that is responsible for carrying out the first phase of the work, which is expected to take 5 to 8 years. Completion of all phases is estimated to take up to 30 years. The maximum liability of the group, which is joint and several for each member of the group, is expected to range from approximately $450 million to $600 million, of which the Partnership's share is expected to be approximately $10 million. Cleanup costs are payable over the period that the work is completed.
Based on the facts outlined above and the Partnership's ongoing analyses of the actions where it has been identified as a PRP, the Partnership believes that it has accrued sufficient reserves to absorb the ultimate cost of such actions and that such costs therefore will not have a material impact on the Partnership's liquidity, capital resources or financial condition. While liability at superfund sites is typically joint and several, the Partnership has no reason to believe that defaults by other PRPs will result in liability of the Partnership materially larger than expected.
In October 1996, Statement of Position (SOP) 96-1, "Environmental Remediation Liabilities," was issued. It required companies to recognize the costs of environmental remediation on an accrual basis. The Partnership has and continues to recognize the costs required by the SOP, therefore, adoption in 1997 had no material impact on its financial position or results of operations.
13) GEOGRAPHIC SEGMENT INFORMATION
Sales of oil to the Partnership's top purchaser in 1998, 1997 and 1996 totaled approximately 16, 18 and 8 percent of oil revenue. Sales of gas to the Partnership's top purchaser in 1998, 1997 and 1996 totaled approximately 50, 52 and 51 percent of gas revenue. The Partnership believes that the loss of any major purchaser would not have a material adverse effect on the Partnership's business.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13) GEOGRAPHIC SEGMENT INFORMATION (CONTINUED) Financial information by segment, as utilized by management of the Company for making operating decisions, for the years ended December 31, 1998, 1997 and 1996 is summarized as follows:
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* Includes capitalized interest of $12 million.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13) GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
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* Includes capitalized interest of $15 million.
SUN ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13) GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
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* Includes capitalized interest of $16 million.
14) SUBSEQUENT EVENTS
Effective February 26, 1999, Oryx merged into Kerr-McGee.
On March 9, 1999, Kerr-McGee, as managing general partner, announced that its Board of Directors had approved a plan to merge Sun Energy Partners with Kerr-McGee Energy (an indirect wholly-owned subsidiary of Kerr-McGee). As part of the transaction, each of the publicly held limited partnership units will be converted solely into the right to receive $4.52 in cash, and as a result, Kerr-McGee will own 100% of Sun Energy Partners. The transaction is subject to the expiration of the Hart-Scott-Rodino waiting period and other customary closing conditions and regulatory approvals, and is expected to be completed by the end of the third quarter, 1999.
SUN ENERGY PARTNERS, L.P.
SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION (UNAUDITED)
OIL AND GAS DATA
CAPITALIZED COSTS
COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES
- --------------- * Excludes capitalized interest of $12 million, $15 million and $16 million for 1998, 1997 and 1996.
EXPLORATION COSTS
ESTIMATED NET QUANTITIES OF PROVED OIL AND GAS RESERVES
Proved reserve quantities were based on estimates prepared by Company engineers in accordance with guidelines established by the Securities and Exchange Commission and were reviewed by Gaffney, Cline & Associates, Inc., independent petroleum engineers. The Partnership considers such estimates to be reasonable; however, due to inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are imprecise and subject to change over time as additional information becomes available.
There has been no favorable or adverse event that has caused a significant change in estimated proved reserves since December 31, 1998. The Partnership has no long-term supply agreements or contracts with governments or authorities in which it acts as producer nor does it have any interest in oil and gas operations accounted for by the equity method. All reserves are located onshore and offshore within the United States.
- ------------------------------ * Natural gas reserve volumes include liquefiable hydrocarbons approximating 5 percent of total gas reserves which are recoverable downstream. Such recoverable liquids also have been included in natural gas liquids reserve volumes.
STANDARDIZED MEASURE
The standardized measure of discounted future net cash flows from estimated production of proved oil and gas reserves is presented in accordance with the provisions of Statement of Financial Accounting Standards No. 69, "Disclosures about Oil and Gas Producing Activities" (SFAS No. 69). In computing this data, assumptions other than those mandated by SFAS No. 69 could produce substantially different results. The Partnership cautions against viewing this information as a forecast of future economic conditions or revenues.
The standardized measure has been prepared assuming year-end selling prices adjusted for future fixed and determinable contractual price changes, year-end development and production costs and a 10 percent annual discount rate. No future income tax expense has been provided for the Partnership since it incurs no income tax liability. (See Summary of Significant Accounting Policies -- Income Taxes in Note 1 to the Consolidated Financial Statements.) The year-end realized prices were $8.86 and $17.16 per barrel of oil and $1.82 and $2.29 per mcf of gas for 1998 and 1997.
SUMMARY OF CHANGES IN THE STANDARDIZED MEASURE
QUARTERLY FINANCIAL INFORMATION
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* Gross profit equals oil and gas revenues plus gas plant margins less production cost, exploration cost and depreciation, depletion and amortization.
QUARTERLY OPERATING INFORMATION
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
The Partnership has no employees. The Company, as the managing general partner of the Partnership, has the responsibility for the Partnership's conduct of operations. Set forth below is information as of March 1, 1999 concerning the 14 directors of the Company and the 13 executive officers of the Company (3 of which are also directors). All elected executive officers of the Company are elected annually by the Board of Directors of the Company. The directors are divided into 3 classes with approximately one-third of the directors constituting the Board being elected each year to serve a three-year term. Class I directors (whose term expires in 2002) are Mr. McDaniel, Mr. Murphy, Mr. Simmons and Mr. White-Thomson. Class II directors (whose term expires in 2000) are Dr. Earle, Dr. Jischke, Mr. Keiser, Mr. Richie and Mr. Rompala. Class III directors (whose term expires in 2001) are Mr. Bradford, Mr. Corbett, Mr. Genever-Watling, Mr. Morris and Ms. Walters.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The directors, officers and employees of the Company (the managing general partner) receive no direct compensation from the Partnership for their services to the Partnership. Such persons receive compensation from the Company, a substantial portion of which is generally reimbursed to the Company by the Partnership as costs allocable to it. (See Note 3 to the Consolidated Financial Statements.)
The Partnership reimburses the Company for all direct costs and indirect costs associated with the Partnership's activities. For the year 1998, the Company received $57 million as reimbursement of costs allocable to the Partnership. Such amounts included salaries of employees and allocations of certain executive and administrative expenses. The aggregate amount reimbursed by the Partnership to the Company in 1998 for the salaries of the Chief Executive Officer of the Partnership and each of the four most highly compensated executive officers of the Partnership other than the Chief Executive Officer was approximately $1 million. (See Note 3 to the Consolidated Financial Statements.)
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides certain information regarding beneficial ownership of the limited partnership units of Sun Energy Partners, L.P. as of March 1, 1999.
UNITS OF SUN ENERGY PARTNERS, L.P.
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* Assumes that Kerr-McGee Corporation's 292,000,000 general partnership units are converted into limited partnership units of Sun Energy Partners, L.P.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In its capacity as managing general partner of the Partnership, the Company controls the Partnership and its operations and has served as a lender and borrower of funds for the Partnership. Following is a table which summarizes lending activities between the Partnership and the Company during the year ended December 31, 1998:
During 1998, no amounts were owed to the Partnership by the Company for variable rate advances. The largest balance owed to the Company by the Partnership during 1998 resulting from advances from Oryx Energy Company and amounts due under the 9.75% Note Payable was $259 million. Certain information required by this section is included in Notes to the Consolidated Financial Statements. See Notes 1, 3 and 8 included elsewhere in this Form 10-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following Documents are filed as a part of this report:
1. Financial Statements:
See Index to Financial Statements, Supplementary Financial and Operating Information on page 13.
2. Exhibits:
(b) Reports on Form 8-K:
The Partnership did not file any reports on Form 8-K during the quarter ended December 31, 1998.
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.
SUN ENERGY PARTNERS, L.P.
By: KERR-MCGEE CORPORATION (Managing General Partner)
By: /s/ JOHN C. LINEHAN ---------------------------------- John C. Linehan Executive Vice President and Chief Financial Officer
Date: March 24, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by or on behalf of the following persons on behalf of the Registrant and in the capacities with Kerr-McGee Corporation, Managing General Partner, and on the date indicated:
- ------------------------------ * Original powers of attorney authorizing Luke R. Corbett, Tom J. McDaniel and John C. Linehan or any one of them, to sign this Form 10-K Annual Report on behalf of Sun Energy Partners, L.P., is being filed as an Exhibit to this Form 10-K.
INDEX TO EXHIBITS