Sunoco 2006 Annual Report Download - page 66

accuracy of this estimate is somewhat uncertain as the
length of the preferential return period is dependent upon
estimated future cash flows as well as projected tax bene-
fits which could be impacted by their potential phase-out
(see below). Higher-than-expected cash flows and tax
benefits will shorten the investor’s preferential return
period, while lower-than-expected cash flows and tax
benefits will lengthen the period. After payment of the
preferential return, the investors in the Indiana Harbor
operations will be entitled to a minority interest in the
related cash flows and tax benefits initially amounting to
34 percent and thereafter declining to 10 percent by
2038.
Under existing tax law, most of the coke production at
Jewell and all of the production at Indiana Harbor are not
eligible to generate nonconventional fuel tax credits after
2007. In addition, prior to the expiration dates for such
credits, they would be phased out, on a ratable basis, if
the average annual price of domestic crude oil at the
wellhead is within a certain inflation-adjusted price
range. (This range was $53.20 to $66.79 per barrel for
2005, the latest year for which the range is available.)
The domestic wellhead price averaged $60.03 per barrel
for the eleven months ended November 30, 2006. The
corresponding price for West Texas Intermediate (“WTI”)
crude oil, a widely published reference price for domestic
crude oil, was $66.59 per barrel for the eleven months
ended November 30, 2006. Based on the Company’s
estimate of the domestic wellhead price for the full-year
2006, Sun Coke recorded only 65 percent of the benefit
of the tax credits that otherwise would have been avail-
able without regard to these phase-out provisions. The
estimated impact of this phase-out reduced earnings for
2006 by $8 million after tax. The ultimate amount of the
credits to be earned for 2006 will be based upon the aver-
age annual price of domestic crude oil at the wellhead.
The energy policy legislation enacted in August 2005 in-
cludes additional tax credits pertaining to a portion of the
coke production at Jewell, all of the coke production at
Haverhill, where operations commenced in March 2005,
and all future domestic coke plants placed into service by
January 1, 2010. The credits cover a four-year period, ef-
fective January 1, 2006 or the date any new facility is
placed into service, if later. These tax credits, which are
not subject to any phase-out based upon crude oil prices,
increased earnings for 2006 by $6 million after tax.
The Company indemnifies the third-party investors for
certain tax benefits available to them during the prefer-
ential return period in the event the Internal Revenue
Service disallows the tax deductions and benefits allo-
cated to the third parties or if there is a change in the tax
laws that reduces the amount of nonconventional fuel tax
credits. These tax indemnifications are in effect until the
applicable tax returns are no longer subject to Internal
Revenue Service review. In certain of these cases, if per-
formance under the indemnification is required, the
Company also has the option to purchase the remaining
third-party investors’ interests. Although the Company
believes it is remote that it will be required to make any
payments under these indemnifications, at December 31,
2006, the maximum potential payment under these tax
indemnifications and the options to purchase the third-
party investors’ interests, if exercised, would have been
approximately $375 million.
The following table sets forth the minority interest balan-
ces and the changes in these balances attributable to the
third-party investors’ interests in cokemaking operations:
(Millions of Dollars) 2006 2005 2004
Balance at beginning of year $234 $287 $328
Nonconventional fuel credit and
other tax benefits* (45) (57) (52)
Preferential return* 48 42 47
Cash distributions to third-party
investors (43) (38) (36)
Acquisition of third-party investor’s
interest in Jewell
cokemaking operations (Note 2) (92) ——
Balance at end of year $102 $234 $287
*The nonconventional fuel credit and other tax benefits and the preferential return,
which comprise the noncash change in the minority interest in cokemaking operations,
are included in other income (loss), net, in the consolidated statements of income
(Note 3). The preferential return for 2006 includes an $11 million increase ($7 million
after tax) attributable to a correction of an error in the computation of the preferential
return relating to prior years. Prior-period amounts have not been restated as this
adjustment was not deemed to be material.
Logistics Operations
In the second quarter of 2004, Sunoco Logistics Partners
L.P., a master limited partnership in which Sunoco has
an ownership interest, issued 3.4 million limited partner-
ship units at a price of $39.75 per unit. Proceeds from the
offering, net of underwriting discounts and offering ex-
penses, totaled $129 million. Coincident with the offer-
ing, the Partnership redeemed 2.2 million limited
partnership units owned by Sunoco for $83 million. The
proceeds from the offering also were principally used by
the Partnership to finance its acquisitions during 2004. In
the second quarter of 2005, the Partnership issued
2.8 million limited partnership units at a price of $37.50
per unit. Proceeds from the offering, net of underwriting
discounts and offering expenses, totaled approximately
$99 million. These proceeds were used to redeem an
equal number of limited partnership units owned by
Sunoco. In the third quarter of 2005, the Partnership is-
sued 1.6 million limited partnership units at a price of
$39.00 per unit. Proceeds from the offering, which totaled
approximately $61 million, net of underwriting discounts
and offering expenses, were used by the Partnership
principally to repay a portion of the borrowings under its
revolving credit facility. In the second quarter of 2006,
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