Sunoco 2004 Annual Report Download - page 69

sales generate cash flows and tax benefits which are allo-
cated to Sunoco and the third-party investors, while ex-
pense is recognized to reflect the investors’ preferential
returns.
The preferential return period for the Jewell operation
was expected to end in 2011. However, due to antici-
pated higher costs associated with coal purchases from
the Coke business’ coal operation over the next few years,
the Company anticipates that the preferential return
period will likely extend indefinitely. The preferential
return period for the Indiana Harbor operation is ex-
pected to end in 2007. Due to the difficulty of forecasting
operations and tax benefits into the future, the accuracy
of these estimates is subject to considerable uncertainty.
The estimated lengths of these preferential return periods
are based upon the Company’s current expectations of
future cash flows and tax benefits, which are impacted by
sales volumes and prices, raw material and operating
costs, capital expenditure levels and the ability to recog-
nize tax benefits under the current tax law (see below).
Better-than-expected cash flows and tax benefits will
shorten the investors’ preferential return periods, while
lower-than-expected cash flows and tax benefits will
lengthen the periods.
Following any expiration of these preferential return peri-
ods, the investor in the Jewell operation would be enti-
tled to a minority interest in the related cash flows and
tax benefits amounting to 18 percent, while the investors
in the Indiana Harbor operation would be entitled to a
minority interest in the related cash flows and tax bene-
fits initially amounting to 34 percent and thereafter de-
clining to 10 percent by 2038.
Under the current tax law, the coke production at Jewell
and Indiana Harbor will no longer be eligible to generate
nonconventional fuel tax credits after 2007. Prior to 2008,
the tax credits would be phased out, on a ratable basis, if
the average annual price of domestic crude oil at the well-
head increases on an inflation-adjusted basis from $50.14
to $62.94 per barrel (in 2003 dollars). If this were to occur,
the Company could be required to make cash payments to
the third-party investors. Payments for the Jewell or In-
diana Harbor operation would be required only if the ex-
pected end of the respective preferential return period is
extended by two years or more and if the respective third-
party investor is expected to achieve a cumulative after-tax
return of less than approximately 6.5 percent. The Com-
pany currently does not believe that any payments to the
investors would be required under this provision of the tax
indemnity agreement, even if the average annual wellhead
crude oil price exceeds the $62.94 per barrel threshold at
which the credits are completely phased out. The domestic
wellhead price averaged $36.75 per barrel for the year
ended December 31, 2004 and $38.10 per barrel for the
month of December 2004.
The Company also indemnifies the third-party investors
in the event the Internal Revenue Service disallows the
tax deductions and benefits allocated to the third parties
or if there is a change in the tax laws that reduces the
amount of nonconventional fuel tax credits which would
be available to them. These tax indemnifications are in
effect until the applicable tax returns are no longer sub-
ject to Internal Revenue Service review. In certain of
these cases, if performance under the indemnification is
required, the Company also has the option to purchase
the third-party investors’ interests. Although the Com-
pany believes it is remote that it will be required to make
any payments under these indemnifications, at December
31, 2004, the maximum potential payment under these
tax indemnifications and the options to purchase the
third-party investors’ interests, if exercised, would have
been approximately $635 million. If this were to occur,
the minority interest balance would be reduced by
approximately $250 million.
An agreement at the Indiana Harbor cokemaking oper-
ation requires the Company to supply the hot exhaust gas
produced at the facility to a contiguous cogeneration
plant operated by an independent power producer for use
in the generation of electricity. In exchange, the in-
dependent power producer is obligated to reduce the sul-
fur and particulate content of that hot exhaust gas to
acceptable emission levels. Under the provisions of a per-
formance guarantee, Sunoco would be required to make
cash payments to the independent power producer until
2013 in the event that the Company failed to supply
sufficient hot exhaust gas pursuant to the supply agree-
ment. Although the Company believes that it is remote
that it would be required to make any payment under this
performance guarantee, the maximum potential payment,
if required, would be approximately $150 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) 2004 2003 2002
Balance at beginning of year $328 $379 $223
Nonconventional fuel credit and
other tax benefits* (52) (58) (77)
Preferential return* 47 55 42
Additional cash investments by
third-party investors —— 215
Cash distributions to third-party
investors (36) (48) (24)
Balance at end of year $287 $328 $379
*The nonconventional fuel credit and other tax benefits and the preferential return,
which comprise the noncash reduction in the minority interest in cokemaking
operations, are included in other income, net, in the consolidated statements of
operations (Note 3).
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