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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

Commission File No. 1-10145

LYONDELL CHEMICAL COMPANY

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (713) 652-7200

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

There were 117,564,920 shares of the Registrant’s common stock outstanding on June 28, 2002, the last business day of the Registrant’s most recently completed second fiscal quarter. The aggregate market value of the voting stock held by non-affiliates of the Registrant on June 28, 2002, based on the closing price of the Registrant’s common stock on the New York Stock Exchange composite tape on that date, was $1,768,373,639.

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

An aggregate of 160,413,810 shares of the Registrant’s common stock were outstanding as of February 28, 2003, including 125,845,586 shares of common stock, $1.00 par value, and 34,568,224 shares of Series B common stock, $1.00 par value.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant’s definitive proxy statement for its 2003 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2002, is incorporated by reference to the extent specified under Part III.

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PART I

Items 1 and 2.    Business and Properties

Lyondell Chemical Company (“Lyondell” or the “Company”) is a global chemical company. Lyondell manufactures and markets a variety of intermediate and performance chemicals, including propylene oxide (“PO”) and its derivatives, propylene glycol (“PG”), propylene glycol ethers (“PGE”) and butanediol (“BDO”), co-products styrene monomer (“SM”) and tertiary butyl alcohol (“TBA”) and its derivative, methyl tertiary butyl ether (“MTBE”), as well as toluene diisocyanate (“TDI”), and methanol, which are collectively known as the Company’s intermediate chemicals and derivatives business.

The Company owns 70.5% of Equistar Chemicals, LP, a Delaware limited partnership (“Equistar”), which operates petrochemicals and polymers businesses. Millennium Chemicals Inc. (“Millennium”) owns the remaining 29.5% of Equistar. Equistar’s petrochemicals business manufactures and markets olefins, oxygenated products, aromatics and specialty products. Equistar’s olefins include ethylene, propylene and butadiene and its oxygenated products include ethylene oxide (“EO”) and its derivatives, ethylene glycol (“EG”), ethanol, and MTBE. Equistar’s aromatics include benzene and toluene. Equistar’s polymers business manufactures and markets polyolefins, including high density polyethylene (“HDPE”), low density polyethylene (“LDPE”), linear low density polyethylene (“LLDPE”), polypropylene and performance polymers. Equistar’s performance polymers include enhanced grades of polyethylene such as wire and cable insulating resins, and polymeric powders.

The Company also owns 58.75% of LYONDELL-CITGO Refining LP, a Delaware limited partnership (“LCR”), which produces refined petroleum products, including gasoline, low sulfur diesel, jet fuel, aromatics and lubricants (“lube oils”). LCR sells its principal refined products primarily to CITGO Petroleum Corporation (“CITGO”), which owns the remaining 41.25% of LCR.

Development of Business

In December 1997, Lyondell and Millennium combined most of their petrochemicals and polymers businesses to form Equistar. Lyondell contributed substantially all of the assets comprising its petrochemicals and polymers business segments, and Millennium contributed substantially all of the assets comprising its olefins, ethanol, polyethylene, polypropylene and performance polymers businesses, which had been held in Millennium Petrochemicals Inc. (“Millennium Petrochemicals”), a wholly owned subsidiary of Millennium. In May 1998, Lyondell and Millennium expanded Equistar with the addition of the ethylene, propylene, EO, EG and other EO derivatives businesses (the “Occidental Contributed Business”) of Occidental Chemical Corporation, a subsidiary of Occidental Petroleum Corporation (“Occidental”). From May 1998 until August 2002, Lyondell owned 41% of Equistar, and Millennium and Occidental each owned 29.5% of Equistar.

On August 22, 2002, Lyondell purchased Occidental’s interest in Equistar, bringing Lyondell’s interest in Equistar to 70.5%. Lyondell financed its acquisition of Occidental’s interest in Equistar by selling the following to a subsidiary of Occidental:

The transactions included concurrent payments between the parties of agreed amounts of approximately $440 million. See “Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters” for a description of the Series B common stock. In addition, as part of these transactions, two Occidental executives, Dr. Ray R. Irani, Chairman and Chief Executive Officer, and Stephen I. Chazen, Chief Financial Officer and Executive Vice President, became members of Lyondell’s Board of Directors.

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In July 1998, Lyondell completed the acquisition (the “ARCO Chemical Acquisition”) of all the outstanding shares of ARCO Chemical Company (“ARCO Chemical”), which was the world’s largest producer of PO and a leading worldwide producer of polyols, PG, PGE, BDO, TDI, SM and MTBE. The acquired business is referred to as “ARCO Chemical” for actions or events prior to the ARCO Chemical Acquisition.

Prior to May 2002, Lyondell and a third party owned Lyondell Methanol Company, L.P. (“LMC”), a Texas limited partnership that produces methanol. Effective May 1, 2002, LMC redeemed the 25% partnership interest owned by the third party. As a result, LMC is now wholly owned by Lyondell and the methanol operations are included in Lyondell’s intermediate chemicals and derivatives business segment.

On March 31, 2000, Lyondell completed the sale of the polyols business and ownership interests in its U.S. PO manufacturing operations to Bayer AG and Bayer Corporation (collectively, “Bayer”) for approximately $2.45 billion. Lyondell used net proceeds of the asset sale to retire a significant portion of its outstanding debt under its credit facility. As part of the transaction, Lyondell entered into a U.S. PO manufacturing joint venture with Bayer (the “PO Joint Venture”) and a separate joint venture with Bayer for certain related PO technology (the “PO Technology Joint Venture”). Lyondell and Bayer take production from the PO Joint Venture in kind. In addition, in December 2000, Lyondell and Bayer formed a separate 50/50 joint venture (the “PO-11 Joint Venture”) for the construction of PO-11, a previously announced world-scale PO/SM plant being constructed near Rotterdam, The Netherlands.

Lyondell was incorporated under the laws of Delaware in 1985. Its principal executive offices are located at 1221 McKinney Street, Suite 700, Houston, Texas 77010 (Telephone: (713) 652-7200). Lyondell’s website address is www.lyondell.com. Lyondell’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available free of charge through Lyondell’s website as soon as reasonably practicable after those reports are electronically filed with or furnished to the Securities and Exchange Commission. Information contained on Lyondell’s website or any other website is not incorporated into this Annual Report and does not constitute a part of this Annual Report.

Strategy

Guiding Principles

Lyondell has built its enterprise around a fundamental belief that, to be a successful competitor in the chemical industry, the Company must have:

Portfolio

Driven by this basic belief, Lyondell assembled a balanced portfolio comprising three businesses that are integrated both operationally and financially. Each plays a strategic role in creating stakeholder value:

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Spun-off from Atlantic Richfield Company in 1989, Lyondell remained relatively stable in size until the mid-1990s, when the Company began to focus on the strategic formation of the enterprise. Through a series of initiatives, Lyondell has grown into a global enterprise with more than $12 billion in assets under management, has acquired considerable intellectual capital and has built a talented, diverse employee base. These initiatives included:

From 1999 to present, Lyondell’s focus has been on solidifying the enterprise’s foundation through:

Operational Excellence

Through intense focus on operational excellence—the enterprise’s approach to continuous improvement in all aspects of its operations—Lyondell continually seeks to maximize the value of each of the businesses in its portfolio. Actions taken have led to:

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Business Focus

Lyondell’s business activities are driven by its fundamental beliefs about what it takes to succeed in the chemical industry.

In the intermediate chemicals and derivatives business segment, global presence and a leadership position in technology are key. Recent major projects with respect to the intermediate chemicals and derivatives business segment include:

At Equistar, major emphasis is on developing scale and maintaining low production costs. Recent major projects with respect to the petrochemicals and polymers business segments include Equistar’s participation with Reliant Energy in the construction of a co-generation facility at Equistar’s Channelview, Texas complex, enabling Equistar to lower energy costs.

Financial Strategy

Lyondell has a financial strategy that is designed to maximize value for all its key financial stakeholders:

During current industry trough conditions, liquidity has been a key focus for Lyondell and this has been reinforced by its operational excellence process. In 2002, the Company enhanced its liquidity by issuing 8.28 million shares of Lyondell’s original common stock and by extending debt maturities through the refinancing of $515 million of Lyondell debt. Longer term, as industry conditions improve, the Lyondell business portfolio is designed to generate significant amounts of cash, which will be directed toward the repayment of debt. The Company’s objective is to improve its financial flexibility by achieving an investment grade credit rating, which the Company believes can be achieved following debt reduction and strengthening of the Company’s financial position.

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Summary Description of Business Segments

The Company reports its results of operations in four segments: intermediate chemicals and derivatives; petrochemicals; polymers; and refining. The Company’s petrochemicals and polymers businesses are conducted through Equistar, and the Company’s refining business is conducted through LCR.

THE COMPANY BUSINESS

The following chart shows the organization of Lyondell, as well as 2002 sales revenues for Lyondell, Equistar and LCR.

Sales revenues shown above include sales to related parties. Sales revenues shown do not include Bayer’s share of production from the PO Joint Venture. For additional segment information for each of the years in the three-year period ended December 31, 2002, see Note 22 of Notes to Consolidated Financial Statements.

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INTERMEDIATE CHEMICALS AND DERIVATIVES

Overview

Lyondell is a leading global manufacturer and marketer of intermediate chemicals and performance chemical products used in a broad range of consumer goods. The segment’s core product is PO, which is currently produced through two distinct technologies based on indirect oxidation processes that yield co-products. One process yields TBA as the co-product; the other yields SM as the co-product. The two technologies are mutually exclusive, necessitating that a manufacturing facility be dedicated either to PO/TBA or to PO/SM. The intermediate chemicals and derivatives business segment also manufactures numerous derivatives of PO and TBA. PG, PGE and BDO are among the derivatives of PO. MTBE is the principal derivative of TBA. This segment also manufactures methanol and manufactures and markets TDI.

In North America, the Company produces PO, TBA, PG and PGE at its Bayport (Pasadena), Texas plants and PO, SM, MTBE and BDO at its Channelview, Texas plants. The Bayport PO/TBA plants and the Channelview PO/SM I plant are owned by the PO Joint Venture. The Channelview PO/SM II plant is owned by the Company together with unaffiliated equity investors. The Company produces TDI at its Lake Charles, Louisiana plant. In Europe, the Company produces PO, TBA, PG, PGE and MTBE at plants near Rotterdam, The Netherlands, and Fos-sur-Mer, France. In Europe, the Company also currently obtains TDI and toluene diamine, a precursor of TDI, through agreements with Rhodia Intermediaries (“Rhodia”). In the third quarter of 2002, Lyondell’s new BDO facility near Rotterdam, with a 275 million pound annual capacity, began production. Additionally, construction of a world-scale PO/SM plant, known as PO-11, located near Rotterdam, began in the second quarter of 2001. PO-11, which has a planned total capacity of 625 million pounds of PO and 1.4 billion pounds of SM, is owned 50% by Lyondell and 50% by Bayer and will be operated by Lyondell. PO-11 currently is expected to start up during the second half of 2003. In the Asia Pacific region, the Company currently has a 50% interest in Nihon Oxirane, which operates a PO/SM plant in Chiba, Japan. See “Joint Ventures and Other Agreements.”

The Company estimates, based in part on published data, that worldwide demand for PO was approximately 11 billion pounds in 2002. Approximately 90% of that volume was consumed in the manufacture of three families of PO derivative products: polyols, PG and PGE. The remainder was consumed in the manufacture of a growing segment of performance products, including BDO and its derivatives. The Company sells approximately one billion pounds of its annual capacity of PO in the merchant market and consumes the rest in the production of derivatives. PO accounted for approximately 13% of Lyondell’s total revenues in 2002, 11% in 2001 and 10% in 2000. PG principally is used to produce unsaturated polyester resins and also is used in certain food, cosmetic and pharmaceutical applications and in automotive coolants and aircraft deicers. PGE are used as lower toxicity solvents for paints, coatings and cleaners. BDO and its derivatives are utilized in the production of fibers, engineering plastics, pharmaceuticals, personal care products and high performance coatings.

TDI is used in the production of polyurethanes for flexible foam applications ranging from furniture, bedding and carpet underlay to transportation and packaging. TDI also is used in the manufacture of coatings, sealants, adhesives and elastomers. TDI accounted for less than 10% of Lyondell’s total revenues in 2002, and accounted for approximately 11% of Lyondell’s total revenues in 2001 and 2000.

SM is produced and traded worldwide for commodity and specialty polymer applications, such as polystyrene and unsaturated polyester resins, as well as various uses in the rubber industry. Based on published data, worldwide demand for SM in 2002 was approximately 48 billion pounds. SM accounted for approximately 15% of Lyondell’s total revenues in 2002, 14% in 2001 and 21% in 2000.

Lyondell converts most of its TBA to isobutylene, which is reacted with methanol to produce MTBE, an oxygenated gasoline blending component that increases octane and reduces automotive emissions. MTBE accounted for approximately 35% of Lyondell’s total revenues in 2002, 38% in 2001 and 33% in 2000.

Worldwide demand for MTBE in 2002 was approximately 460,000 barrels per day, based on published data. In the United States, the Clean Air Act Amendments of 1990 set minimum levels for oxygenates, such as MTBE, in gasoline sold in areas not meeting specified air quality standards, which increased demand for MTBE. However, the presence of MTBE in some water supplies in California and other states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft has led to public concern about the use of MTBE.

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Certain federal and state governmental initiatives in the U.S. have sought either to rescind the oxygen requirement for reformulated gasoline or to restrict or ban the use of MTBE. Lyondell’s North American MTBE sales represented approximately 26% of its total 2002 revenues. At this time, Lyondell cannot predict the impact that these initiatives will have on MTBE margins or volumes during 2003. Lyondell intends to continue marketing MTBE in the U.S. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Environmental Matters.”

The following table outlines the intermediate chemicals and derivatives business segment’s primary products, annual processing capacities as of January 1, 2003, and the primary uses for such products. Unless otherwise specified, annual processing capacities were calculated by estimating the number of days in a typical year that a production unit of a plant is expected to operate, after allowing downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output based on the design raw material mix. Because the processing capacity of a production unit is an estimated amount, actual production volumes may be more or less than capacities set forth below. Capacities shown include 100% of the capacity of joint venture facilities.

Raw Materials

The principal hydrocarbon raw materials purchased by the intermediate chemicals and derivatives business segment are propylene, butane, ethylene, benzene and methanol. The market prices of these raw materials historically have been related to the price of: crude oil and its principal refinery derivatives; natural gas liquids; and natural gas. These materials are received in bulk quantities via pipeline or marine vessels. Generally, the segment’s

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raw materials requirements are purchased at market-based prices from numerous suppliers in the United States and Europe with which the Company has established contractual relationships, as well as in the spot market.

The Company’s raw material suppliers include Equistar, which is a leading producer of propylene, ethylene and benzene and is expected to be the major supplier of these raw materials to Lyondell’s U.S. business in 2003. See Note 7 of Notes to Consolidated Financial Statements.

In December 2002, the Company entered into an agreement with Methanex Corporation (“Methanex”) for Methanex to become the exclusive supplier of the Company’s worldwide methanol raw material requirements. The agreement provides cost-based supplies of methanol and will be phased-in over time beginning in 2003 and extending through 2009. Methanex has an option to extend the agreement for an additional three-year period.

The intermediate chemicals and derivatives business segment is a large volume consumer of isobutane for chemical production. The Company has invested in facilities, or entered into processing agreements with unrelated third parties, to convert the widely available commodity, normal butane, to isobutane. The segment is also a large consumer of oxygen for its PO/TBA plants at Bayport, Texas; Botlek (Rotterdam), The Netherlands; and Fos-sur-Mer, France.

The cost of raw materials generally is the largest component of total production cost for the intermediate chemicals and derivatives business. The segment’s raw materials are, in general, commodity chemicals with numerous bulk suppliers and ready availability at competitive prices. Historically, raw material availability has not been an issue for the intermediate chemicals and derivatives business segment. However, in order to enhance reliability and competitiveness of prices and rates for supplies of raw materials, industrial gas and other utilities, the Company is a party to long-term agreements and other arrangements with suppliers, including Equistar, for a substantial portion of its production requirements. For additional discussion regarding the effects of raw material pricing on recent operating performance, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Marketing and Sales

In 2002, most of the segment’s revenues were derived from sales to, or processing agreements with, unrelated parties. In 2002, no single customer accounted for 10% or more of Lyondell’s total revenues.

The intermediate chemicals and derivatives business segment delivers products through sales agreements, processing agreements and spot sales as well as product exchanges. Production levels at Lyondell’s PO/SM and PO/TBA co-product production facilities are determined by the demand for PO and PO derivatives. The resulting production levels of co-products SM and MTBE thus depend primarily on the demand for PO and PO derivatives and secondarily on the relative market demand for SM and MTBE and the operational flexibility of Lyondell’s multiple production facilities in meeting this demand.

Lyondell purchases SM and MTBE for resale, when necessary, to satisfy customer demand for these co-products above co-product production levels. Lyondell has also purchased SM for resale to satisfy its customer requirements prior to start up of its new PO/SM plant in The Netherlands. Volumes of SM and MTBE purchases made for resale can vary significantly from period to period. However, purchased volumes have not historically had a significant impact on profitability.

The segment has a number of multi-year PO processing (or tolling) and sales agreements. This reflects an effort to mitigate the adverse impact of competitive factors and economic business cycles on demand for the segment’s PO. In addition, Bayer’s ownership interest in the PO Joint Venture represents ownership of an in-kind portion of the PO production of the PO Joint Venture. See “Joint Ventures and Other Agreements.”

The majority of the segment’s PO derivatives are sold through market-based sales contracts under annual or multi-year arrangements.

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Lyondell sells most of its SM production into the North American merchant market and to export markets through long-term sales contracts and processing agreements. See “Joint Ventures and Other Agreements.”

During 2002 and prior years, the Company sold MTBE pursuant to a take-or-pay MTBE sales contract with Atlantic Richfield Company (“ARCO”), now wholly owned by BP p.l.c. (“BP”). Sales pursuant to this contract represented approximately 14% of Lyondell’s 2002 worldwide MTBE sales volumes. The contract provided for formula-based prices, which have been significantly higher than market prices, and expired December 31, 2002. In addition, during 2002 and prior years, the Company also sold its MTBE production under market-based sales agreements, including multi-year agreements, and in the spot market. The Company anticipates that the MTBE production previously sold under the expired MTBE sales contract with BP referenced above will be sold under market-based annual sales contracts and in the spot market. For additional discussion regarding the effects of the expiration of the MTBE sales contract with BP, see Item 7a. “Disclosure of Market and Regulatory Risk—Regulatory Risk.”

The Company’s sales agreements with unrelated parties for methanol typically contain automatic one-year term extension provisions. The agreements also generally provide monthly price adjustments based on current market prices. Lyondell sold its U.S. distributor sales agreements to Southern Garrett LLC, effective October 2002. Lyondell will assign its larger volume sales agreements with its North American methanol customers to Methanex, effective January 1, 2004. Methanol sales agreements that are not assigned to Methanex will be terminated by December 31, 2003. Subject to product availability and market conditions, it is the Company’s intent to shutdown its methanol production in 2004. If the Company continues to manufacture methanol in 2004, Methanex will purchase 100% of Lyondell’s methanol production at cost-based prices in 2004.

The segment’s sales are made by Company marketing and sales personnel and through distributors and independent agents located in the Americas, Europe, the Middle East, Africa and the Asia Pacific region. The Company has centralized certain sales and order fulfillment functions in regional customer service centers located in Houston, Texas; Rotterdam, The Netherlands; Hong Kong, China and Sao Paolo, Brazil. Lyondell also has long-term contracts for distribution and logistics to ensure reliable and efficient supply to its customers.

For data relating to non-U.S. operations, see Note 22 of Notes to Consolidated Financial Statements.

Joint Ventures and Other Agreements

On March 31, 2000, Lyondell contributed its Channelview, Texas PO/SM I plant and its Bayport, Texas PO/TBA plants to the PO Joint Venture. Bayer’s ownership interest in the PO Joint Venture represents ownership of an in-kind portion of the PO production. Bayer’s share of PO production from the PO Joint Venture will increase from approximately 1.5 billion pounds in 2002 to approximately 1.6 billion pounds annually in 2004 and thereafter. Lyondell takes in-kind the remaining PO production and all co-product (SM and TBA) production from the PO Joint Venture. As part of the transaction, Lyondell and Bayer also formed the separate PO Technology Joint Venture through which Bayer was granted a non-exclusive and non-transferable right to use certain PO technology in the PO Joint Venture. Under the terms of the operating and logistics agreements, Lyondell operates the PO Joint Venture plants and arranges and coordinates the logistics of PO delivery from the plants. Lyondell and Bayer also have formed a separate joint venture for the construction of PO-11 near Rotterdam, The Netherlands with an expected startup date during the second half of 2003. Lyondell and Bayer each have a 50% share in the PO-11 Joint Venture, pursuant to which they each will take in-kind 50% of the PO and SM production of the PO-11 Joint Venture. Lyondell and Bayer do not share marketing or product sales under either the PO Joint Venture or PO-11 Joint Venture.

Lyondell’s PO/SM II plant at the Channelview, Texas complex is owned by the Company together with third-party equity investors. The Company retains a majority interest in the PO/SM II plant and is the operator of the plant. A portion of the SM output of the PO/SM II plant is committed to the third-party investors under long-term processing agreements. As of December 31, 2002, the Company had 1.1 billion pounds of SM capacity, or 30% of its worldwide capacity, committed to third party investors under long-term processing arrangements.

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The Company currently has a 50% equity interest in Nihon Oxirane, a joint venture with Sumitomo. Since 1976, Nihon Oxirane has operated a PO/SM plant in Chiba, Japan. Lyondell and Sumitomo conduct joint research and development programs under various agreements in connection with Nihon Oxirane.

In January 1995, ARCO Chemical entered into agreements with Rhodia covering the entire TDI output of Rhodia’s Pont de Claix and Lille plants in France. Since the completion of an expansion at the end of 2001, all of the TDI that Lyondell receives from Rhodia comes from the Pont de Claix plant, which is designed to have a more efficient cost structure by introducing Lyondell’s proprietary technology for TDI. Lyondell’s average minimum TDI purchase commitment under the revised tolling agreement is approximately 200 million pounds of TDI per year. The revised tolling agreement has been extended through 2016. The agreement that covered TDI output from Rhodia’s Lille plant expired December 31, 2001. The TDI that Lyondell purchases from Rhodia is marketed principally in Europe, the Middle East, Africa and Asia. Lyondell purchases toluene diamine (“TDA”), a precursor of TDI, from Rhodia’s Lille plant pursuant to an agreement that expires December 31, 2005. Under the agreement, Lyondell can purchase up to a maximum of approximately 70 million pounds of TDA per year. The TDA that Lyondell purchases from the Lille plant is used in the production of the TDI that Lyondell purchases from the Pont de Claix plant.

Competition and Industry Conditions

Competition within the intermediate chemicals and derivatives business is significant and is based on a variety of factors, including quality, product price, reliability of supply, technical support, customer service and potential substitute materials. Profitability in this segment is affected by the worldwide level of demand along with vigorous price competition, which may intensify due to, among other things, new industry capacity. Demand is a function of economic growth in the United States and elsewhere in the world, which fluctuates. It is not possible to predict accurately the changes in raw material costs, market conditions and other factors that will affect industry margins in the future. Capacity share figures for this segment and its competitors, discussed below, are based on completed production facilities and, where appropriate, include the full capacity of joint-venture facilities and certain long-term supply agreements.

The Company’s major worldwide PO competitors are The Dow Chemical Company (“Dow”) and Shell Chemical Company (“Shell”). Dow’s operations are based on chlorohydrin technology. Shell utilizes a proprietary PO/SM technology. Based on published data relating to the PO market, including the PO Joint Venture’s total capacity, the Company believes it owns and/or operates approximately 29% of the total worldwide capacity for PO.

Approximately 1.1 billion pounds of new industry PO capacity, or nearly 10% of existing worldwide capacity, was added in 2000, primarily in Europe. In addition, Shell and BASF AG (“BASF”), as 50/50 partners, commissioned a PO/SM plant in Singapore in July 2002, and reached full production by year-end. Lyondell and Bayer expect PO-11, near Rotterdam, The Netherlands, to start-up during the second half of 2003. The Company also is cooperating with Sumitomo on the commercialization of new PO technology, including Sumitomo’s new plant in Chiba, Japan that is expected to begin production in the second quarter of 2003. PO and derivatives markets continue to be adversely affected by excess capacity as a result of recent capacity additions, which have not yet been fully absorbed by demand growth.

The Company both manufactures and has long-term tolling agreements for TDI. The Company competes with many TDI producers worldwide, including BASF, Bayer and Dow. Based on published data regarding TDI capacity and including the capacity committed to the Company under agreement with Rhodia, the Company believes it is the second largest producer of TDI worldwide and has approximately 16% of total worldwide capacity.

The Company competes with many MTBE producers worldwide, the most significant of which is Saudi Arabia Basic Industries Corp. (“SABIC”). Based on published data regarding MTBE capacity, the Company believes that, combined with Equistar, it is the largest producer of MTBE worldwide. MTBE also faces competition from substitute products such as ethanol as well as other octane components. See “Certain Factors That May Affect Lyondell And Its Joint Ventures—Environmental Matters.”

The Company competes with several SM producers worldwide, among which are BASF, BP, Chevron Phillips Chemical Company LP (“Chevron Phillips”), Shell and TotalFinaElf. Based on published data regarding SM capacity, the Company believes that it is the third largest producer of SM worldwide.

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Properties

The Company leases its corporate offices located in Houston, Texas. Lyondell also maintains a research facility in Newtown Square, Pennsylvania, which is leased. The Company’s European headquarters are located in leased facilities in Maidenhead, England, and its Asia Pacific headquarters are located in leased facilities in Hong Kong. The regional customer service center for Europe, the Middle East and Africa is located in leased facilities in Rotterdam, The Netherlands.

Depending on location and market needs, the Company’s production facilities can receive primary raw materials by pipeline, railcar, truck, barge or ship and can deliver finished products by pipeline, railcar, truck, barge, isotank, ship or in drums. The Company charters ships, owns and charters barges and leases isotanks and railcars for the dedicated movement of products between plants, products to customers or terminals, or raw materials to plants, as necessary. The Company leases liquid and bulk storage and warehouse facilities at terminals in the Americas, Europe and the Asia Pacific region. In the Rotterdam outer harbor area, the Company owns and operates an on-site butane storage tank, propylene spheres, pipeline connections and a jetty that accommodates deep-draft vessels.

The principal manufacturing facilities of the segment are set forth below. These facilities are wholly owned by Lyondell unless otherwise noted.

Research and Technology; Patents and Trademarks

Lyondell conducts research and development principally at its Newtown Square, Pennsylvania technical center. The Company’s research and development expenditures were $30 million for 2002, $32 million for 2001 and $35 million for 2000, all of which were expensed as incurred.

The Company maintains an extensive patent portfolio related to its intermediate chemicals and derivatives business, and continues to grow its patent portfolio by filing new patent applications in the United States and other countries. As of December 31, 2002, Lyondell owned 362 United States patents and 1,130 worldwide patents. Lyondell has numerous trademark and trademark registrations in the United States and other countries, including the Lyondell logo. The Company does not regard its business as being materially dependent upon any single patent or trademark.

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Employee Relations

On December 31, 2002, Lyondell had approximately 3,350 full-time employees, approximately 950 of whom were located in Europe, approximately 50 of whom were located in Asia and approximately 15 of whom were located in Latin America. As of December 31, 2002, approximately 19% of the U.S. employees were represented by labor unions. Lyondell also uses the services of independent contractors in the routine conduct of its business. The Company believes its relations with its employees are good.

Equistar, the operations of which are managed by Lyondell, employed approximately 3,400 full-time employees as of December 31, 2002. LCR employed approximately 1,000 full-time employees as of December 31, 2002. See “Equistar Employee Relations” and “LYONDELL-CITGO Refining LP—Employee Relations.”

EQUISTAR CHEMICALS, LP

Management of Equistar

Equistar is a limited partnership organized under the laws of the State of Delaware. Each owner holds its interest in Equistar through wholly owned subsidiaries, one of which serves as a general partner of Equistar and one or more of which serves as a limited partner. From May 1998 until August 2002, Equistar’s owners were subsidiaries of each of Lyondell, Millennium and Occidental, with Lyondell owning a 41% interest in Equistar, and each of Millennium and Occidental owning a 29.5% interest in Equistar. On August 22, 2002, Lyondell purchased Occidental’s 29.5% interest in Equistar. As a result, Lyondell owns a 70.5% interest in Equistar, and Millennium owns the remaining 29.5% interest in Equistar. Lyondell and Equistar have implemented an agreement (the “Shared Services Agreement”) to share office space and utilize shared services over a broad range. See “Agreements Between Lyondell and Equistar” for more information regarding transactions between Lyondell and Equistar.

The Amended and Restated Partnership Agreement of Equistar (the “Equistar Partnership Agreement”) governs, among other things, ownership, cash distributions, capital contributions and management of Equistar. The Equistar Partnership Agreement provides that Equistar is governed by a Partnership Governance Committee, consisting of six representatives, three appointed by each general partner. Matters requiring approval by two or more of the representatives of each of Lyondell and Millennium include changes in the scope of Equistar’s business, the five-year strategic plan (and annual updates thereof), the sale or purchase of assets or capital expenditures of more than $30 million not contemplated by the strategic plan, capital contributions to Equistar by Equistar’s owners over certain amounts, merging or combining with another business and certain other matters. All decisions of the Partnership Governance Committee that do not require at least two of the three representatives of each of Lyondell and Millennium may be made by Lyondell’s representatives alone, except in situations where Lyondell has a conflict. In situations where Lyondell has a conflict, decisions are made by the representatives of Millennium. The day-to-day operations of Equistar are managed by the officers of Equistar. Dan F. Smith, the President and Chief Executive Officer of Lyondell, also serves as Chief Executive Officer of Equistar.

EQUISTAR PETROCHEMICALS

Overview

Petrochemicals are fundamental to many segments of the economy, including the production of consumer products, housing and automotive components and other durable and nondurable goods. Equistar produces a variety of petrochemicals, including olefins, oxygenated products, aromatics and specialty products, at eleven facilities located in five states. Olefins include ethylene, propylene and butadiene. Oxygenated products include EO and derivatives, EG, ethanol, and MTBE. Aromatics produced are benzene and toluene. Equistar’s petrochemical products are used to manufacture polymers and intermediate chemicals, which are used in a variety of consumer and industrial products. Ethylene is the most significant petrochemical in terms of worldwide production volume and is the key building block for polyethylene and a large number of other chemicals, plastics and synthetics.

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The Chocolate Bayou, Corpus Christi and two Channelview, Texas olefins plants use petroleum liquids, including naphtha, condensates and gas oils, to produce ethylene. The use of petroleum liquids results in the production of a significant amount of co-products such as propylene, butadiene, benzene and toluene, and specialty products, such as dicyclopentadiene (“DCPD”), isoprene, resin oil and piperylenes. Based upon independent third-party surveys, management believes that its Channelview facility is one of the lowest cash production cost olefins facilities in the United States. Equistar’s Morris, Illinois; Clinton, Iowa; Lake Charles, Louisiana; and LaPorte, Texas plants are designed to consume primarily natural gas liquids, including ethane, propane and butane (collectively “NGLs”), to produce ethylene with some co-products such as propylene. The Corpus Christi and Channelview plants also may consume NGL’s to produce ethylene, depending upon the relative economic advantage of the alternative raw materials. A comprehensive pipeline system connects the Gulf Coast plants with major olefins customers. Raw materials are sourced both internationally and domestically and are shipped via vessel and pipeline. Equistar’s Lake Charles, Louisiana facility has been idled since the first quarter of 2001. Olefins accounted for approximately 59% of Equistar’s total revenues in 2002, 60% in 2001 and 63% in 2000.

Equistar produces EO and its primary derivative, EG, at facilities located in Bayport (Pasadena), Texas and through a 50/50 joint venture with DuPont in Beaumont, Texas. The Bayport facility also produces other derivatives of EO, principally ethers and ethanolamines. EG is used in antifreeze, polyester fibers, resins and films. EO and its derivatives are used in many consumer and industrial end uses, such as detergents and surfactants, brake fluids and polyurethane seating and bedding foams.

Equistar produces synthetic ethanol at its Tuscola, Illinois plant by a direct hydration process that combines water and ethylene. Equistar also owns and operates a facility in Newark, New Jersey for denaturing ethanol by the addition of certain chemicals. In addition, it produces small volumes of diethyl ether, a by-product of its ethanol production, at its Tuscola facility. These ethanol products are ingredients in various consumer and industrial products as described more fully in the table below. In March 2002, Equistar permanently shut down its Anaheim, California ethanol denaturing facility.

The following table outlines Equistar’s primary petrochemical products, annual processing capacity as of January 1, 2003, and the primary uses for such products. Unless otherwise specified, annual processing capacity was calculated by estimating the number of days in a typical year that a production unit of a plant is expected to operate, after allowing for downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output based on the design raw material mix. Because the processing capacity of a production unit is an estimated amount, actual production volumes may be more or less than the capacities set forth below. Capacities shown represent 100% of the capacity of Equistar, of which Lyondell owns 70.5%.

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Raw Materials

The raw materials cost for olefins production is the largest component of total cost for the petrochemicals business. Olefins plants with the flexibility to consume a wide range of raw materials historically have had lower variable costs than olefins plants that are restricted in their raw material processing capability to NGLs. The primary raw materials used in the production of olefins are petroleum liquids (also referred to as “heavy raw materials”) and NGLs (also referred to as “light raw materials”). Petroleum liquids generally are delivered by ship or barge. NGLs are delivered to Equistar’s facilities primarily via pipeline. Petroleum liquids have had a historical cost advantage over NGLs such as ethane and propane, assuming the co-products were recovered and sold. For example, facilities using petroleum liquids historically have generated approximately four cents additional variable margin on average per pound of ethylene produced compared to using ethane. This margin advantage is based on an average of historical data over a period of years and is subject to short-term fluctuations, which can be significant. During the second half of 2001 and in 2002, the advantage has been significantly less than the historical average. Equistar has the capability to realize this margin advantage due to its ability to process petroleum liquids at the Channelview, Corpus Christi and Chocolate Bayou, Texas facilities.

The Channelview facility is particularly flexible because it can process 100% petroleum liquids or up to 80% NGLs. The Corpus Christi plant can process up to 70% petroleum liquids or up to 70% NGLs. The Chocolate Bayou facility processes 100% petroleum liquids. Equistar’s LaPorte facility can process natural gasoline and NGLs, including heavier NGLs such as butane. Equistar’s three other olefins facilities currently process only NGLs.

As described above, Equistar believes that its raw material flexibility is a key advantage in the production of olefins. As a result, although the majority of Equistar’s petroleum liquids requirements are purchased via contractual arrangements from a variety of domestic and international sources, Equistar also purchases petroleum liquids on the spot market from domestic and international sources in order to maintain its raw material flexibility and to take advantage of raw material pricing opportunities. Similarly, Equistar purchases a majority of its NGLs requirements via contractual arrangements from a variety of sources, but also purchases NGLs on the spot market. Equistar also obtains a portion of its petroleum liquids requirements from LCR at market-related prices. Equistar purchases all of its methanol requirements from Lyondell and its subsidiaries at a mix of cost-based and market-based prices. Also, Equistar purchases large amounts of natural gas to be used as energy for consumption in its business via market-based contractual arrangements with a variety of sources.

Equistar’s raw materials are, in general, commodity chemicals with numerous bulk suppliers and ready availability at competitive prices. Historically, raw material availability has not been an issue for Equistar’s petrochemicals business segment. For additional discussion regarding the effects of raw material pricing on recent operating performance, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Marketing and Sales

Ethylene produced by the Clinton and Morris facilities generally is consumed as a raw material by the polymers operations at those sites, or is transferred to Tuscola from Morris by pipeline for the production of ethanol. Ethylene produced by Equistar’s LaPorte facility is consumed as a raw material by Equistar’s polymers operations and Millennium’s vinyl acetate operations in LaPorte and also is distributed by pipeline for other internal uses and to third parties. Ethylene and propylene produced at the Channelview, Chocolate Bayou, Corpus Christi and Lake Charles olefins plants are generally distributed by pipeline or via exchange agreements to Equistar’s Gulf Coast polymer and EO and EG facilities as well as to Equistar’s affiliates and third parties. Equistar’s Lake Charles facility has been idled since the first quarter of 2001. For the year ended December 31, 2002, approximately 93% of Equistar’s ethylene production, based on sales dollars, was consumed by Equistar’s polymers or oxygenated products businesses or sold to Equistar’s owners and their affiliates at market-related prices.

With respect to sales to unaffiliated parties, Equistar sells a majority of its olefins products to customers with whom it has had long-standing relationships. These sales generally are made under written agreements that typically provide for monthly negotiation of price; customer purchases of a specified minimum quantity; and three- to six-year terms with automatic one- or two-year term extension provisions. Some contracts may be terminated early if

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deliveries have been suspended for several months. No single customer accounted for 10% or more of Equistar’s total revenues in 2002.

EO and EG typically are sold under three- to five-year contracts, with monthly pricing based on current market conditions. Lyondell provides sales services for Equistar outside of North America for EO derivatives. Glycol ethers are sold primarily into the solvent and distributor markets at current market prices, as are ethanolamines and brake fluids. Ethanol and ethers primarily are sold under one-year contracts at market prices.

Equistar licenses MTBE technology under a license from a subsidiary of Lyondell and sells a significant portion of MTBE produced at one of its two Channelview units to Lyondell at market-related prices. The production from the second unit is processed by Equistar and returned to LCR for gasoline blending. MTBE produced at Chocolate Bayou is sold at market-related prices to Lyondell for resale.

Equistar sells most of its aromatics production under contracts that have initial terms ranging from one to three years and that typically contain automatic one-year term extension provisions. These contracts generally provide for monthly price adjustments based upon current market prices. Benzene produced by LCR is sold directly to Equistar at market-related prices. Equistar currently serves as LCR’s sole agent to market toluene produced by LCR.

Equistar at times purchases ethylene, propylene, benzene and butadiene for resale, when necessary, to satisfy customer demand for these products above production levels. Volumes of ethylene, propylene, benzene and butadiene purchases made for resale can vary significantly from period to period. However, purchased volumes do not have a significant impact on profitability.

Most of the ethylene and propylene production of the Channelview, Chocolate Bayou, Corpus Christi and Lake Charles facilities is shipped via a 1,430-mile pipeline system which has connections to numerous Gulf Coast ethylene and propylene consumers. This pipeline system, some of which is owned and some of which is leased by Equistar, extends from Corpus Christi to Mont Belvieu to Port Arthur, Texas as well as around the Lake Charles, Louisiana area. In addition, exchange agreements with other olefins producers allow access to customers who are not directly connected to Equistar’s pipeline system. Some ethylene is shipped by railcar from Clinton, Iowa to Morris, Illinois. A pipeline owned and operated by a third party is used to transport ethylene from Morris, Illinois to Tuscola, Illinois. Some propylene is shipped by ocean-going vessel. Ethylene oxide is shipped by railcar, and its derivatives are shipped by railcar, truck, isotank or ocean-going vessel. Butadiene, aromatics and other petrochemicals are distributed by pipeline, railcar, truck, barge or ocean-going vessel.

Competition and Industry Conditions

The bases for competition in Equistar’s petrochemicals products are price, product quality, product deliverability and customer service. Equistar competes with other large domestic producers of petrochemicals, including BP, Chevron Phillips, Dow, Exxon Mobil Corporation (“ExxonMobil”), Huntsman Chemical Company, NOVA Chemicals Corporation (“NOVA Chemicals”) and Shell. Industry consolidation, including the combinations of British Petroleum and Amoco, Exxon and Mobil, and Dow and Union Carbide Corporation and the formation of Chevron Phillips, has brought North American production capacity under control of fewer, although larger and stronger, competitors.

Equistar’s combined rated ethylene capacity at January 1, 2003 was approximately 11.6 billion pounds of ethylene per year, or approximately 15% of total North American production capacity. Based on published rated production capacities, Equistar believes it is currently the second largest producer of ethylene in North America. North American ethylene rated capacity at January 1, 2003 was approximately 79 billion pounds per year. Approximately 78% of the total ethylene production capacity in North America is located along the Gulf Coast.

Petrochemicals profitability is affected by raw materials costs and the level of demand for petrochemicals and derivatives, along with vigorous price competition among producers which may intensify due to, among other things, the addition of new capacity. Ethylene markets continue to be affected by excess capacity as a result of recent capacity additions, which have not yet been absorbed by demand growth. In general, demand is a function of economic growth in the United States and elsewhere in the world, which fluctuates. It is not possible to predict accurately the changes in raw material costs, market conditions and other factors that will affect petrochemical

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industry margins in the future. The petrochemicals industry historically has experienced significant volatility in profitability due to fluctuations in capacity utilization.

Equistar’s other major commodity chemical products also experience cyclical market conditions similar to, although not necessarily coincident with, those of olefins.

EQUISTAR POLYMERS

Overview

Through facilities located at nine plant sites in four states, Equistar’s polymers segment manufactures a wide variety of polyolefins, including polyethylene, polypropylene and various performance polymers. Polyolefins are used in a variety of consumer and industrial products, including packaging film, trash bags, automotive parts, plastic bottles and caps and compounds for wire and cable insulation.

Equistar currently manufactures polyethylene using a variety of technologies at five facilities in Texas and at its Morris, Illinois and Clinton, Iowa facilities. The Morris and Clinton facilities enjoy a freight cost advantage over Gulf Coast producers in delivering products to customers in the U.S. Midwest and on the East Coast of the United States. Polyethylene accounted for approximately 27% of Equistar’s total revenues in 2002, 27% in 2001 and 26% in 2000.

Equistar produces performance polymer products, which include enhanced grades of polyethylene and polypropylene, at several of its polymers facilities. The Company believes that, over a business cycle, average selling prices and profit margins for performance polymers tend to be higher than average selling prices and profit margins for higher-volume commodity polyethylenes. Equistar also produces wire and cable insulating resins and compounds at LaPorte, Texas; and Morris, Illinois, and wire and cable insulating compounds at Fairport Harbor, Ohio; and Tuscola, Illinois. Wire and cable insulating resins and compounds are used to insulate copper and fiber optic wiring in power, telecommunication, computer and automobile applications. In August 2002, Equistar permanently shut down its Peachtree City, Georgia wire and cable insulating compounds facility. Equistar’s Morris, Illinois and Bayport (Pasadena), Texas facilities manufacture polypropylene using propylene produced as a co-product of Equistar’s ethylene production as well as propylene purchased from unaffiliated parties. Polypropylene is sold for various applications in the automotive, housewares and appliance industries.

The following table outlines Equistar’s polymers and performance polymers products, annual processing capacity at January 1, 2003, and the primary uses for such products. Unless otherwise specified, annual processing capacity was calculated by estimating the number of days in a typical year that a production unit of a plant is expected to operate, after allowing for downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output based on the design raw material mix. Because the processing capacity of a production unit is an estimated amount, actual production volumes may be more or less than the capacities set forth below. Capacities shown represent 100% of the capacity of Equistar, of which Lyondell owns 70.5%.

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Raw Materials

The primary raw materials for Equistar’s polymers segment are ethylene and propylene. With the exception of the Chocolate Bayou polyethylene plant, Equistar’s polyethylene and polypropylene production facilities can receive their ethylene and propylene directly from Equistar’s petrochemical facilities via Equistar’s olefins pipeline system, by third-party pipelines or from on-site production. Most of the raw materials consumed by Equistar’s polymers

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segment are produced internally by Equistar’s petrochemicals segment. The polyethylene plants at Chocolate Bayou, LaPorte and Bayport, Texas are connected by pipeline to third parties and can receive ethylene via exchanges or purchases. The polypropylene facility at Morris, Illinois also receives propylene from third parties.

Equistar’s raw materials are, in general, commodity chemicals with numerous bulk suppliers and ready availability at competitive prices. Historically, raw material availability has not been an issue for Equistar’s polymers business segment. For additional discussion regarding the effects of raw material pricing on recent operating results, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Marketing and Sales

Equistar’s polymers products are primarily sold to an extensive base of established customers. Approximately 45% of Equistar’s polymers products volumes are sold to customers under term contracts, typically having a duration of one to three years. The remainder generally is sold without contractual term commitments. In either case, in most of the continuous supply relationships, prices are subject to change upon mutual agreement between Equistar and the customer. No single customer accounted for 10% or more of Equistar’s total revenues in 2002.

Polymers are primarily distributed via railcar. Equistar owns or leases, pursuant to long-term lease arrangements, approximately 7,500 railcars for use in its polymers business. Equistar sells the vast majority of its polymers products in the United States and Canada, and such sales primarily are through its own sales organization. It generally engages sales agents to market its polymers in the rest of the world.

Competition and Industry Conditions

The bases for competition in Equistar’s polymers products are price, product performance, product quality, product deliverability and customer service. Equistar competes with other large producers of polymers, including BP Solvay Polyethylene, Chevron Phillips, Dow, Eastman Chemical Company, ExxonMobil, Formosa Plastics, Huntsman Chemical Company, NOVA Chemicals, TotalFinaElf and Westlake Polymers. Industry consolidation, including the combinations of British Petroleum and Amoco, Exxon and Mobil, and Dow and Union Carbide Corporation, the formation of Chevron Phillips, and the polymers business combinations between BP and Solvay, has brought North American production capacity under control of fewer, although larger and stronger, competitors.

Based on published rated industry capacities, Equistar is the third largest producer of polyethylene in North America. Equistar also believes that it is a leading domestic producer of polyolefins powders, wire and cable insulating resins and compounds, and polymers for adhesives. The combined rated capacity of Equistar’s polyethylene units as of January 1, 2003 was approximately 5.7 billion pounds per year, or approximately 13% of total industry capacity in North America. There are 15 other North American producers of polyethylene, including BP Solvay Polyethylene, Chevron Phillips, Dow, ExxonMobil and NOVA Chemicals. Equistar’s polypropylene capacity, 680 million pounds per year as of January 1, 2003, represents approximately 4% of the total North American polypropylene capacity. There are 12 other North American competitors in the polypropylene business, including ATOFINA, Basell Polyolefins Company N.V., BP, Dow, ExxonMobil and Sunoco, Inc.

Polymers profitability is affected by raw material costs and the worldwide level of demand for polymers, along with vigorous price competition among producers which may intensify due to, among other things, the addition of new capacity. In general, demand is a function of economic growth in the United States and elsewhere in the world, which fluctuates. It is not possible to predict accurately the changes in raw material costs, market conditions and other factors which will affect polymers industry margins in the future.

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EQUISTAR PROPERTIES

Equistar’s principal manufacturing facilities and principal products are set forth below. All of these facilities are wholly owned by Equistar unless otherwise noted.

*As of January 1, 2003, facilities which received the OSHA Star Certification, which is the highest safety designation issued by the U. S. Department of Labor.

In March 2002, Equistar permanently shut down its Anaheim, California ethanol denaturing facility. In August 2002, Equistar permanently shut down its Peachtree City, Georgia wire and cable insulating compounds facility.

The Lake Charles facility has been idled since the first quarter of 2001. The facility and land are leased from an affiliate of Occidental under a lease that expires in May 2003. The Equistar Partnership Agreement provides that, if the Lake Charles lease terminates, one of the former-Occidental subsidiaries (now owned by Lyondell) that owns a 6.623% interest in Equistar could lose its partnership interest in Equistar and no longer be an owner of Equistar. If that occurs, the agreements entered into in August 2002 between Lyondell and Occidental in connection with Lyondell’s purchase of Occidental’s interest in Equistar provide that Occidental will either (1) allow Lyondell or, at Lyondell’s election, Equistar to acquire, operate or receive the benefit of operating the previously-leased Lake Charles facility, (2) pay

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Lyondell $75 million in cash or (3) if the value is greater than $75 million, transfer or pay to Lyondell 5.4 million shares of Lyondell common stock or the sale proceeds from 5.4 million shares of Lyondell common stock or a combination of both. The parties are investigating alternatives related to the facility and land, which may include contributing the Lake Charles facility to a partnership owned jointly by Occidental and Equistar.

Equistar owns a storage facility, a tract of land with four brine ponds and a tract of vacant land in Mont Belvieu, Texas, located approximately 15 miles east of the Channelview facility. Storage capacity for up to approximately 13 million barrels of NGLs, ethylene, propylene and other hydrocarbons is provided in caverns within the salt dome at the Mont Belvieu facility. There are an additional 3 million barrels of ethylene and propylene storage and four brine ponds operated by Equistar on leased property in Markham, Texas.

Equistar uses an extensive olefins pipeline system, some of which it owns and some of which it leases, extending from Corpus Christi to Mont Belvieu to Port Arthur and around the Lake Charles area. Equistar owns other pipelines in connection with its Chocolate Bayou, Matagorda, Victoria, Corpus Christi and LaPorte facilities. Equistar uses a pipeline owned and operated by an unaffiliated party to transport ethylene from its Morris facility to its Tuscola facility. Equistar owns and leases several pipelines connecting the Channelview facility, the LCR refinery and the Mont Belvieu storage facility. These pipelines are used to transport feedstocks, butylenes, hydrogen, butane, MTBE and unfinished gasolines. Equistar also owns a barge docking facility near the Channelview facility capable of berthing eight barges and related terminal equipment for loading and unloading raw materials and products. Equistar owns or leases pursuant to long-term lease arrangements approximately 8,900 railcars for use in its petrochemicals and polymers businesses.

Lyondell provides office space to Equistar for its executive offices and headquarters in downtown Houston, Texas as part of the Shared Services Agreement. See “Agreements Between Lyondell and Equistar” below. In addition, Equistar owns facilities, which house the Morris, Cincinnati and Chocolate Bayou research operations. Equistar also leases sales facilities and leases storage facilities, primarily in the Gulf Coast area, from various parties for the handling of products.

AGREEMENTS BETWEEN LYONDELL AND EQUISTAR

Lyondell and Equistar entered into an asset contribution agreement on December 1, 1997 providing for the transfer of assets to Equistar. Among other things, the agreement sets forth representations and warranties by Lyondell with respect to the transferred assets and requires indemnification by Lyondell with respect thereto. The asset contribution agreement with Lyondell also provides for the assumption by Equistar of, among other things, third party claims that are related to certain contingent liabilities arising prior to the contribution transactions that are asserted prior to December 1, 2004, as to Lyondell, to the extent the aggregate thereof does not exceed $7 million, subject to certain terms of the asset contribution agreement. Millennium Petrochemicals and certain subsidiaries of Occidental entered into similar asset contribution agreements with Equistar with respect to the transfer of their respective assets and Equistar’s assumption of liabilities. Lyondell, Millennium and Occidental each remain liable under these indemnification arrangements to the same extent following Lyondell’s acquisition of Occidental’s interest in Equistar as they were before.

If Lyondell or Millennium or any of their affiliates desires to initiate or pursue any opportunity to undertake, engage in, acquire or invest in a business or activity or operation within the scope of the business of Equistar, the opportunity must first be offered to Equistar as provided in the Equistar Partnership Agreement. Equistar has certain options to participate in the opportunity, but if it determines not to participate, the party offering the opportunity is free to pursue the opportunity on its own. If the opportunity within Equistar’s scope of business constitutes less than 25% of an acquisition or investment that is otherwise not within the scope of its business, Lyondell or Millennium, as the case may be, may make the acquisition or investment, provided that the portion within the scope of Equistar’s business is offered to Equistar pursuant to the foregoing provisions as provided in the Equistar Partnership Agreement.

Lyondell and Equistar have implemented the Shared Services Agreement to share office space and utilize shared services over a broad range, including information technology, human resources, sales and marketing, raw material supply, supply chain, health, safety and environmental, engineering and research and development, facility

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services, legal, accounting, treasury, internal audit, and tax. Employee-related and indirect costs are allocated between the two companies in the manner prescribed in the Shared Services Agreement while direct third party costs, incurred exclusively for either Lyondell or Equistar, are charged directly to that entity. In addition, Lyondell and Equistar have entered into an agreement for Lyondell to provide sales services for Equistar outside of North America for EO derivatives. Equistar and Millennium Petrochemicals also are parties to a number of agreements for the provision of services, utilities and materials from one party to the other at common locations, principally LaPorte, Texas and Cincinnati, Ohio. Equistar leases its Lake Charles facility and the land related thereto from an affiliate of Occidental under a lease that expires in May 2003. The Lake Charles facility has been idled since the first quarter of 2001.

Lyondell, Millennium Petrochemicals and Occidental Chemical each entered into a Master Intellectual Property Agreement and other related agreements with respect to intellectual property with Equistar. These agreements provide for (1) the transfer of certain intellectual property of Lyondell, Millennium Petrochemicals and Occidental Chemical related to the businesses each contributed to Equistar, (2) the grant of irrevocable, non-exclusive, royalty-free licenses to Equistar (without the right to sublicense) with respect to intellectual property retained by Lyondell, Millennium Petrochemicals or Occidental Chemical that is related to Equistar’s business and (3) the grant of irrevocable, non-exclusive, royalty-free licenses (without the right to sublicense) from Equistar to Lyondell, Millennium Petrochemicals and Occidental Chemical, respectively, with respect to intellectual property each contributed to Equistar. The Master Intellectual Property Agreements were not materially affected by Lyondell’s acquisition of Occidental’s interest in Equistar.

Lyondell, Millennium and Equistar are parties to an Amended and Restated Parent Agreement dated as of November 6, 2002, which provides that, among other things, each of Lyondell and Millennium guarantees the performance by their respective subsidiaries under various agreements entered into in connection with the formation of Equistar, including the Equistar Partnership Agreement and the asset contribution agreements providing for the transfer of assets by Lyondell and Millennium Petrochemicals, respectively, to Equistar.

The Equistar Partnership Agreement and the Parent Agreement also provide each owner a right of first option if the other owner wishes to sell its partnership interest or the stock of its partner subsidiaries. These agreements also set forth other limitations on the right to transfer the interests or stock. The Equistar Partnership Agreement and the Parent Agreement were amended and restated as of November 6, 2002 to reflect that Occidental no longer owns an interest in Equistar and to set forth certain continuing obligations of Occidental with respect to Equistar.

EQUISTAR EMPLOYEE RELATIONS

As of December 31, 2002, Equistar employed approximately 3,400 full-time employees. In addition to its own employees, Equistar uses the services of Lyondell employees pursuant to the Shared Services Agreement and also uses the services of independent contractors in the routine conduct of its business. Approximately 5% of Equistar’s employees are covered by collective bargaining agreements. Equistar believes that its relations with its employees are good. See “Agreements between Lyondell and Equistar” above.

EQUISTAR RESEARCH AND TECHNOLOGY; PATENTS AND TRADEMARKS

Equistar conducts research and development principally at its Cincinnati, Ohio technical center, with additional facilities located in Morris, Illinois and Chocolate Bayou, Texas. Equistar’s research and development expenditures were $38 million for 2002, $39 million for 2001 and $38 million for 2000, all of which were expensed as incurred.

Equistar maintains a growing patent portfolio that is continuously supplemented by new patent applications related to its petrochemicals and polymers businesses. As of December 31, 2002, Equistar owned 229 United States patents and 394 worldwide patents. Equistar has numerous trademarks and trademark registrations in the United States and other countries, including the Equistar logo. Equistar does not regard its business as being materially dependent upon any single patent or trademark.

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LYONDELL-CITGO REFINING LP

Overview

Lyondell participates in petroleum refining through an equity interest in LCR. Lyondell holds a 58.75% interest and CITGO holds a 41.25% interest in LCR. LCR owns and operates a refinery (the “Refinery”), which is located on the Houston Ship Channel in Houston, Texas. LCR was formed in 1993 to upgrade the Refinery’s ability to process substantial additional volumes of lower cost, extra heavy, higher margin crude oil. As of January 1, 2003, the Refinery’s extra heavy crude oil processing capacity was approximately 268,000 barrels per day.

The Refinery is a full conversion refinery designed to run extra heavy (17 degree API), high sulfur crude oil. The 17 degree API gravity crude oil is more viscous and dense than traditional crude oil and contains higher concentrations of sulfur and heavy metals, making it more difficult to refine into gasoline and other high value fuel products but less costly to purchase. Processing extra heavy, high sulfur crude oil in significant quantities requires a refinery with extensive coking, catalytic cracking, hydrotreating and desulfurization capabilities, i.e., a “complex refinery.” The Refinery’s complexity enables it to operate in full conversion mode producing a slate of products that consists primarily of high value, clean products (many refineries produce significant quantities of lower value products such as conventional gasoline, high sulfur diesel and heavy fuel oil due to a lack of equipment to convert these fuels into premium products). In addition, the Refinery’s complexity allows it to produce most of these clean products as premium grades such as reformulated gasoline, jet fuel, low sulfur diesel and aromatics chemicals. The Refinery’s products include conventional and reformulated gasoline, low sulfur diesel, jet fuel, aromatics, lubricants (industrial lubricants, white oils and process oils), carbon black oil, sulfur, residual fuel and petroleum coke. Gasoline accounted for approximately 39% of LCR’s total revenues in 2002, 37% in 2001 and 39% in 2000. Diesel accounted for approximately 26% of LCR’s total revenues in 2002, 23% in 2001 and 23% in 2000. The aromatics chemicals produced by the Refinery are benzene, toluene, orthoxylene and paraxylene. These products are sold to manufacturers of intermediate chemicals and polyester intermediates and are ultimately used in clothing, soft drink bottles and drinking cups, audio and video tapes, and resins.

The following table outlines LCR’s primary products, annual rated capacity as of January 1, 2003, and the primary uses for such products. The term “rated capacity,” as used in this table, is calculated by estimating the number of days in a typical year that a production unit of a plant is expected to operate, after allowing for downtime for regular maintenance, and multiplying that number by an amount equal to the unit’s optimal daily output based on the design feedstock mix. Because the rated capacity of a production unit is an estimated amount, the actual production volumes may be more or less than the rated capacity. Capacities shown represent 100% of the capacity of LCR, of which Lyondell owns 58.75%.

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Management of LCR

LCR is a limited partnership organized under the laws of the state of Delaware. Lyondell owns its interest in LCR through wholly owned subsidiaries, which serve as general partner and limited partner. Similarly, CITGO, which is an indirect wholly owned subsidiary of Petróleos de Venezuela, S.A. (“PDVSA”), the national oil company of the Republic of Venezuela, owns its interest in LCR through wholly owned subsidiaries, which serve as general partner and limited partner.

LCR is governed by a Limited Partnership Agreement (the “LCR Partnership Agreement”), which provides for, among other things, the ownership and cash distribution rights of the partners. The LCR Partnership Agreement also provides that LCR is managed by a Partnership Governance Committee, which is composed of six representatives, three appointed by each general partner. Actions requiring unanimous consent of the representatives include amendment of the LCR Partnership Agreement, borrowing money, delegations of authority to committees, certain purchase commitments and capital expenditures. The day-to-day operations of the Refinery are managed by two general managers, one of which is a loaned employee of Lyondell and the other of which is a loaned employee of CITGO.

Agreements between Lyondell or CITGO and LCR

LCR is a party to a number of agreements with Lyondell and CITGO. Under the terms of a long-term product sales agreement (“Products Agreement”), CITGO purchases from LCR substantially all of the refined products produced at the Refinery. Lyondell and CITGO currently perform administrative services for LCR pursuant to an Administrative Services Agreement, which is renegotiated annually. Under the terms of lubricant sales agreements, CITGO purchases all of the lubricant products manufactured by LCR. In conjunction therewith, CITGO operates LCR’s Birmingport, Alabama lubricants plant. In addition, CITGO currently serves as LCR’s sole agent to market paraxylene and orthoxylene produced by LCR.

Agreements between Equistar and LCR

Prior to the formation of Equistar, Lyondell was a party with LCR to multiple agreements designed to preserve many of the synergies between the Refinery and the Channelview petrochemicals facility. These agreements were assumed by Equistar from Lyondell effective December 1, 1997. Economic evaluations at the Channelview facility and the Refinery are made to maximize product utilization, which may be local use, use at the other site, or third party sales. Certain Refinery products (propane, butane, low-octane naphthas, heating oils, and gas oils) can be used as raw materials for olefins production, and certain Channelview facility olefins by-products can be processed by the Refinery into gasoline. Butylenes from the Refinery are processed by the Channelview facility and returned to LCR for the production of alkylate and MTBE for gasoline blending. Hydrogen from the Channelview facility is used at the Refinery for sulfur removal and product stabilization. Benzene produced by LCR is sold directly to Equistar at market-related prices. In addition, Equistar currently serves as LCR’s sole agent to market toluene produced by LCR. See Note 7 and 8 of Notes to Consolidated Financial Statements.

Raw Materials

In 1993, LCR entered into a long-term crude supply agreement (“Crude Supply Agreement”) with Lagoven, S.A., now known as PDVSA Petróleo, S.A. (“PDVSA Oil”), an affiliate of CITGO and of PDVSA. Most of the crude oil used by LCR as a raw material for the Refinery is purchased under the Crude Supply Agreement. Both PDVSA Oil and CITGO are direct or indirect wholly owned subsidiaries of PDVSA.

The Crude Supply Agreement, which expires on December 31, 2017, incorporates formula prices to be paid by LCR for the crude oil supplied based on the market value of a slate of refined products deemed to be produced from each particular crude oil or feedstock, less: (1) certain deemed refining costs, adjustable for inflation and energy costs; (2) certain actual costs; and (3) a deemed margin, which varies according to the grade of crude oil or other feedstock delivered. The actual refining margin earned by LCR may vary from the formula amount depending on, among other things, timing differences in incorporating changes in refined product market values and energy costs into the Crude Supply Agreement’s deemed margin calculations and the efficiency with which LCR conducts its operations. Although LCR believes that the Crude Supply Agreement reduces the volatility of LCR’s earnings and

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cash flows over the long-term, the Crude Supply Agreement also limits LCR’s ability to enjoy higher margins during periods when the market price of crude oil is low relative to then-current market prices for refined products. In addition, if the actual yields, costs or volumes of the LCR refinery differ substantially from those contemplated by the Crude Supply Agreement, the benefits of this agreement to LCR could be substantially diminished, and could result in lower earnings and cash flow for LCR. Furthermore, there may be periods during which LCR’s costs for crude oil under the Crude Supply Agreement may be higher than might otherwise be available to LCR from other sources. A disparate increase in the price of heavy crude oil relative to the prices for its products has the tendency to make continued performance of its obligations under the Crude Supply Agreement less attractive to PDVSA Oil.

The Crude Supply Agreement provides that Lyondell controls all of LCR’s decisions and enforcement rights in connection with the Crude Supply Agreement so long as PDVSA has a direct or indirect ownership interest in LCR. However, there are risks associated with enforcing the provisions of contracts with companies such as PDVSA Oil that are non-United States affiliates of a sovereign nation. All of the crude oil supplied by PDVSA Oil under the Crude Supply Agreement is produced in the Republic of Venezuela, which has experienced economic difficulties and attendant social and political changes and unrest in recent years, including during the recent national strike. It is impossible to predict how governmental policies may change under the current or any subsequent Venezuelan government. In addition, there are risks associated with enforcing judgments of United States courts against entities whose assets are located outside of the United States and whose management does not reside in the United States. Although the parties have negotiated alternative arrangements in the event of certain force majeure conditions, including Venezuelan governmental or other actions restricting or otherwise limiting PDVSA Oil’s ability to perform its obligations, any such alternative arrangements may not be as beneficial to LCR as the Crude Supply Agreement. From time to time, the Company and PDVSA have had discussions covering both a restructuring of the Crude Supply Agreement and a broader restructuring of the LCR partnership. The Company is unable to predict whether changes in either arrangement will occur.

If the Crude Supply Agreement is modified or terminated or this source of crude oil is otherwise interrupted, due to production difficulties, political or economic events in Venezuela or other factors, LCR could experience significantly lower earnings and cash flows. Subject to the consent of the other partner and rights of first offer and first refusal, the partners each have a right to transfer their interests in LCR to unaffiliated third parties in certain circumstances. In the event that CITGO were to transfer its interest in LCR to an unaffiliated third party, PDVSA Oil would have an option to terminate the Crude Supply Agreement. Depending on then-current market conditions, any breach or termination of the Crude Supply Agreement, or reduction in supply thereunder, would require LCR to purchase all or a portion of its crude oil in the merchant market, could subject LCR to significant volatility and price fluctuations and could adversely affect LCR and, therefore, Lyondell. There can be no assurance that alternative crude oil supplies with similar margins would be available for purchase by LCR.

Under the Crude Supply Agreement, PDVSA Oil is required to sell, and LCR is required to purchase, 230,000 barrels per day of extra heavy crude oil, which constitutes approximately 86% of the Refinery’s refining capacity of 268,000 barrels per day of crude oil. Since April 1998, PDVSA Oil has, from time to time, declared itself in a force majeure situation and subsequently reduced deliveries of crude oil. Such reductions in deliveries were purportedly based on announced OPEC production cuts. PDVSA Oil informed LCR that the Venezuelan government, through the Ministry of Energy and Mines, had instructed that production of certain grades of crude oil be reduced. In certain circumstances, PDVSA Oil made payments under a different provision of the Crude Supply Agreement in partial compensation for such reductions.

In January 2002, PDVSA Oil again declared itself in a force majeure situation and stated that crude oil deliveries could be reduced by up to 20.3% beginning March 1, 2002. Beginning in March 2002, deliveries of crude oil to LCR were reduced to approximately 198,000 barrels per day, reaching a level of 190,000 barrels per day during the second quarter 2002. Crude oil deliveries to LCR under the Crude Supply Agreement increased to the contract level of 230,000 barrels per day during the third quarter 2002, averaging 212,000 barrels per day for the third quarter. Although deliveries increased to contract levels during the third quarter 2002, PDVSA Oil did not revoke its January 2002 force majeure declaration during 2002.

A national strike in Venezuela began in early December 2002 and disrupted deliveries of crude oil to LCR under the Crude Supply Agreement, causing LCR to temporarily reduce operating rates. PDVSA Oil again declared a force majeure and reduced deliveries of crude oil to LCR. LCR compensated for the loss in supply by reducing its

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inventories of Crude Supply Agreement crude oil and increasing purchases of crude oil in the merchant market. Recent media reports indicate that the force majeure has been lifted. For additional discussion regarding the effects of the recent political unrest in Venezuela on operating performance, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

LCR has consistently contested the validity of PDVSA Oil’s and PDVSA’s reductions in deliveries under the Crude Supply Agreement. The parties have different interpretations of the provisions of the contracts concerning the delivery of crude oil. The contracts do not contain dispute resolution procedures, and the parties have been unable to resolve their commercial dispute. As a result, on February 1, 2002, LCR filed a lawsuit against PDVSA and PDVSA Oil in connection with the force majeure declarations. See “Item 3. Legal Proceedings—Litigation Matters.”

Marketing and Sales

The Refinery produces gasoline, low sulfur diesel, jet fuel, aromatics, lubricants and certain industrial products. On a weekly basis, LCR evaluates and determines the optimal product output mix for the Refinery, based on spot market prices and conditions. Under the Products Agreement, CITGO is obligated to purchase and LCR is required to sell 100% of the finished gasoline, jet fuel, heating oil, diesel fuel, coke and sulfur produced by the Refinery. CITGO purchases these products at prices based on industry benchmark indexes. For example, the price for gasoline is based on prices published by Platts Oilgram, an industry trade publication. The Products Agreement provides that Lyondell controls all of LCR’s material decisions and enforcement rights in connection with the Products Agreement so long as CITGO has a direct or indirect ownership interest in LCR. The Products Agreement expires on December 31, 2017.

Competition and Industry Conditions

All of LCR’s finished gasoline, jet fuel, heating oil, diesel fuel, coke, sulfur and lube oils are sold to CITGO at market-related prices.

The refining business tends to be volatile as well as cyclical. However, management believes that the combination of the Crude Supply Agreement and the Products Agreement generally has the effect of stabilizing earnings and cash flows and reducing the market-driven aspects of such volatility over the long-term. Crude oil prices, which are impacted by worldwide political events and the economics of exploration and production in addition to refined products demand, are the largest source of this volatility. Demand for refined products is influenced by seasonal and short-term factors such as weather and driving patterns, as well as by longer term issues such as the economy, energy conservation and alternative fuels. Industry refined products supply is also dependent on industry operating capabilities and on long-term refining capacity trends.

With a capacity of approximately 268,000 barrels per day, the Company believes that the Refinery is North America’s largest full conversion (i.e., not producing asphalt or high sulfur heavy fuel) refinery capable of processing 100% 17 API crude oil.

Among LCR’s refining competitors are major integrated oil companies and domestic refiners that are owned by or affiliated with major integrated oil companies. Based on published industry data, as of January 1, 2003, there were 133 crude oil refineries in operation in the United States, and total domestic refinery capacity was approximately 16.6 million barrels per day. During 2002, LCR processed an average of 259,000 barrels per day of crude oil or approximately 1.7% of all U.S. crude runs.

Properties

LCR owns the real property, plant and equipment, which comprise the Refinery, located on approximately 700 acres in Houston, Texas. Units include a fluid catalytic cracking unit, cokers, reformers, crude distillation units, sulfur recovery plants and hydrodesulfurization units, as well as a lube oil manufacturing plant and an aromatics recovery unit. LCR also owns the real property, plant and equipment, which comprise a lube oil blending and packaging plant in Birmingport, Alabama. LCR owns a pipeline used to transport gasoline, kerosene and heating oil from the Refinery to the GATX Terminal located in Pasadena, Texas to interconnect with common carrier pipelines.

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Employee Relations

At December 31, 2002, LCR employed approximately 1,000 full-time employees. LCR also uses the services of independent contractors in the routine conduct of its business. Approximately 55% of LCR’s employees are covered by a collective bargaining agreement between LCR and the Paper, Allied-Industrial, Chemical and Energy Workers International Union (formerly the Oil, Chemical and Atomic Workers Union), which expires in January 2006. LCR believes that relations with its employees are good.

CERTAIN FACTORS THAT MAY AFFECT LYONDELL AND ITS JOINT VENTURES

There are many factors that may affect the businesses and results of operations of Lyondell and its joint ventures. Some of these factors are discussed below. For additional discussion regarding factors that may affect the businesses and operating results of Lyondell and its joint ventures, see “Items 1 and 2. Business and Properties,” “Forward-Looking Statements,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7a. Disclosure of Market and Regulatory Risk.”

Industry Cyclicality and Overcapacity

The historical operating results of Lyondell and its joint ventures reflect the cyclical and volatile nature of the supply-demand balance in both the chemical and refining industries. These industries historically have experienced alternating periods of inadequate capacity and tight supply, causing prices and profit margins to increase, followed by periods when substantial capacity is added, resulting in oversupply, declining capacity utilization rates and declining prices and profit margins. The cyclicality of these industries results in volatile profits and cash flow over the business cycle.

Currently, there is overcapacity in the chemical industry, as a number of participants in the chemical industry have added capacity. There can be no assurance that future growth in product demand will be sufficient to utilize this additional, or even current, capacity. Excess industry capacity has depressed and may continue to depress Lyondell’s and its joint ventures’ volumes and margins. The global economic and political environment continues to be uncertain, contributing to low industry operating rates, adding to the volatility of raw material and energy costs, and forestalling the industry’s recovery from trough conditions, all of which is placing, and may continue to place, pressure on Lyondell’s and its joint ventures’ results of operations.

Raw Materials and Energy Costs

Lyondell and its joint ventures purchase large amounts of raw materials and energy for their businesses. The cost of these raw materials and energy, in the aggregate, represents a substantial portion of Lyondell’s and its joint ventures’ operating expenses. The prices of raw materials and energy generally follow price trends of, and vary with the market conditions for, crude oil and natural gas, which may be highly volatile and cyclical. Results of operations for Lyondell and its joint ventures have been and could be in the future significantly affected by increases in these costs.

In addition, higher natural gas prices adversely affect the ability of many domestic chemicals producers to compete internationally since U.S. producers are disproportionately reliant on natural gas and natural gas liquids as an energy source and as a raw material. In addition to the impact that this has had on Equistar’s exports, reduced competitiveness of U.S. producers also has in the past increased the availability of chemicals in North America, as U.S. production that would otherwise have been sold overseas was instead offered for sale domestically, resulting in excess supply and lower prices in North America.

General Economic Conditions and Other External Factors

External factors beyond Lyondell’s and its joint ventures’ control, such as general economic conditions, international events and circumstances, competitor actions, and governmental regulation in the United States and abroad, can cause volatility in the price of raw materials and other operating costs, as well as significant fluctuations in demand for Lyondell’s and its joint ventures’ products, and can magnify the impact of economic cycles on

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Lyondell’s and its joint ventures’ businesses. Lyondell believes that the events in the Middle East and Venezuela have had a particular influence in recent months and may continue to do so unless tensions subside. In addition, a number of Lyondell’s and its joint ventures’ products are highly dependent on durable goods markets, such as the housing and automotive markets, that are themselves particularly cyclical. Many of Lyondell’s and its joint ventures’ products are components of other chemical products that, in turn, are subject to the supply-demand balance of both the chemical and refining industries and general economic conditions. For example, MTBE is used as a blending component in gasoline, and therefore a substantial decline in gasoline prices could result in decreased profitability from MTBE sales. If the global economy does not improve, demand for Lyondell’s and its joint ventures’ products and their income and cash flows would continue to be adversely affected. With respect to Lyondell’s refining joint venture, management believes that the combination of the Crude Supply Agreement and the Products Agreement generally tends to stabilize earnings and to reduce market driven volatility over the long-term. However, there are risks associated with these agreements. See “–International Operations and Country Risks” below.

Lyondell and its joint ventures may reduce production at or idle a facility for an extended period of time or exit a business because of high raw material prices, an oversupply of a particular product and/or a lack of demand for that particular product, which makes production uneconomical. These temporary outages sometimes last for several quarters or, in certain cases, longer and cause Lyondell or its joint ventures to incur costs, including the expenses of maintaining and restarting these facilities. It is possible that factors like increases in raw material costs or lower demand in the future will cause Lyondell or its joint ventures to further reduce operating rates, or idle facilities or exit uncompetitive businesses.

International Operations and Country Risks

International operations and exports are subject to a number of risks, including currency exchange rate fluctuations, trade barriers, exchange controls, national and regional labor strikes, political risks and risks of increases in duties and taxes, as well as changes in laws and policies governing operations of companies in other countries. In addition, earnings of non-U.S. subsidiaries and intercompany payments may be subject to income tax rules of countries other than the United States, which may reduce cash flow available to meet required debt service and other obligations of Lyondell.

As discussed earlier, LCR is party to a long-term crude supply agreement with PDVSA Oil, a wholly owned subsidiary of PDVSA. There are risks associated with enforcing the provisions of contracts with companies such as PDVSA Oil that are non-U.S. affiliates of a sovereign nation. Additionally, all of the crude oil supplied by PDVSA Oil under the Crude Supply Agreement is produced in the Republic of Venezuela, which has experienced economic difficulties and attendant social and political changes and unrest in recent years, including during the recent national strike. See “LYONDELL-CITGO Refining LP—Raw Materials,” “Item 3. Legal Proceedings—Litigation Matters” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Environmental Matters

The Company cannot predict with certainty the extent of its, its subsidiaries’ or its joint ventures’ future liabilities and costs under environmental, health and safety laws and regulations and the Company cannot guarantee that they will not be material. In addition, the Company, its subsidiaries and its joint ventures may face liability for alleged personal injury or property damage due to exposure to chemicals and other hazardous substances at their facilities or chemicals that they otherwise manufacture, handle or own. Although these types of claims have not historically had a material impact on the Company’s, its subsidiaries’ or its joint ventures’ operations, a significant increase in the success of these types of claims could materially adversely affect the Company’s, its subsidiaries’ or its joint ventures’ business, financial condition, operating results or cash flow.

The production facilities of Lyondell, Equistar and LCR generally are required to have permits and licenses regulating air emissions, discharges to land or water and storage, treatment and disposal of hazardous wastes. Companies such as Lyondell and its joint ventures that are permitted to treat, store or dispose of hazardous waste and maintain underground storage tanks pursuant to the Resource Conservation and Recovery Act (“RCRA”) also are required to meet certain financial responsibility requirements. The Company believes that it and its joint ventures have all permits and licenses generally necessary to conduct its business or, where necessary, are applying

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for additional, amended or modified permits and that it and its joint ventures meet applicable financial responsibility requirements.

The policy of each of Lyondell, Equistar and LCR is to be in compliance with all applicable environmental laws. Lyondell and Equistar also are each committed to Responsible Care^®, an international chemical industry initiative to enhance the industry’s responsible management of chemicals. The Company’s subsidiaries and joint ventures (together with the industries in which they operate) are subject to extensive national, state and local environmental laws and regulations concerning emissions to the air, discharges onto land or waters and the generation, handling, storage, transportation, treatment and disposal of waste materials. Many of these laws and regulations provide for substantial fines and potential criminal sanctions for violations. Some of these laws and regulations are subject to varying and conflicting interpretations. In addition, the Company cannot accurately predict future developments, such as increasingly strict environmental laws, and inspection and enforcement policies, as well as higher compliance costs therefrom, which might affect the handling, manufacture, use, emission or disposal of products, other materials or hazardous and non-hazardous waste. Some risk of environmental costs and liabilities is inherent in particular operations and products of the Company and its joint ventures, as it is with other companies engaged in similar businesses, and there is no assurance that material costs and liabilities will not be incurred. In general, however, with respect to the capital expenditures and risks described above, the Company does not expect that it or its joint ventures will be affected differently than the rest of the chemicals and refining industry where the Company’s or its joint ventures’ facilities are located.

Environmental laws may have a significant effect on the nature and scope of cleanup of contamination at current and former operating facilities, the costs of transportation and storage of raw materials and finished products and the costs of the storage and disposal of wastewater. Also, U.S. “Superfund” statutes may impose joint and several liability for the costs of remedial investigations and actions on the entities that generated waste, arranged for disposal of the wastes, transported to or selected the disposal sites and the past and present owners and operators of such sites. All such responsible parties (or any one of them, including the Company) may be required to bear all of such costs regardless of fault, legality of the original disposal or ownership of the disposed site.

The Company and its joint ventures have on-site solid-waste management units at several of their facilities, which were used in the past to dispose of waste generated at the facilities. It is anticipated that corrective measures will be necessary to comply with federal and state requirements with respect to these facilities. The Company also has liabilities under RCRA and various state and non-U.S. government regulations related to eight current plant sites and four former plant sites. The Company is also responsible for a portion of the remediation of certain off-site waste disposal facilities. The Company currently is contributing funds to the cleanup of two waste sites located near Houston, Texas under CERCLA and the Superfund Amendments and Reauthorization Act of 1986. The Company also has been named, along with several other companies, as a potentially responsible party for six CERCLA sites near Houston, Texas. The Company’s policy is to accrue remediation expenses when it is probable that such efforts will be required and the related expenses can be reasonably estimated. Estimated costs for future environmental compliance and remediation are necessarily imprecise due to such factors as the continuing evolution of environmental laws and regulatory requirements, the availability and application of technology, the identification of presently unknown remediation sites and the allocation of costs among the responsible parties under applicable statutes. The Company, its subsidiaries and its joint ventures, to the extent appropriate, have accrued amounts (without regard to potential insurance recoveries or other third party reimbursements) believed to be sufficient to cover current estimates of the cost for remedial measures at manufacturing facilities and off-site waste disposal facilities based upon their interpretation of current environmental standards. In the opinion of management, there is currently no material range of loss in excess of the amount recorded. Based on the establishment of such accruals, and the status of discussions with regulatory agencies described in this paragraph, the Company does not anticipate any material adverse effect upon its financial statements or competitive position as a result of compliance with the laws and regulations described in this or the preceding paragraphs. See also “Item 3. Legal Proceedings” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations–Environmental Matters.”

In some cases, compliance with environmental, health and safety laws and regulations can only be achieved by capital expenditures. In the years ended December 31, 2002, 2001 and 2000, the Company, its subsidiaries and its joint ventures (on a 100% basis) spent, in the aggregate, approximately $65 million, $34 million and $20 million, respectively, for environmentally related capital expenditures at existing facilities. The increases in 2002 and 2001

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capital expenditures resulted from new emission reduction rules, as discussed below. The Company currently estimates that environmentally related capital expenditures at Company facilities and existing subsidiary and joint venture facilities (on a 100% basis) will be approximately $74 million for 2003, prior to including any expenditures for proposed revisions to emission control standards for highly reactive volatile organic compounds (“HRVOCs”). Lyondell, Equistar and LCR are still completing their assessment of the impact of the proposed HRVOC emission standards.

The eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the EPA. As a result, in December 2000, the Texas Natural Resource Conservation Commission, now known as the Texas Commission on Environmental Quality (“TCEQ”), submitted a plan to the EPA to reach and demonstrate compliance with the ozone standard by November 2007. Ozone is a product of the reaction between volatile organic compounds and nitrogen oxides (“NOx”) in the presence of sunlight, and is a principal component of smog. Emission reduction controls must be installed at the Refinery and each of Lyondell’s two facilities and Equistar’s six facilities in the Houston/Galveston region during the next several years. The rules adopted as part of the TCEQ plan in December 2000 required a 90% NOx emission reduction in aggregate from the industry. Based on this requirement, Lyondell estimated that aggregate related capital expenditures could total between $400 million and $500 million for Lyondell, Equistar and LCR before the 2007 deadline, and could result in higher annual operating costs. In January 2001, Lyondell and an organization composed of industry participants filed a lawsuit to encourage adoption of an alternative plan to achieve the same air quality improvement with less negative economic impact on the region. In response to the lawsuit, the TCEQ conducted an accelerated scientific review during 2001 and 2002. In December 2002, the TCEQ adopted revised rules, which changed the required NOx emission reduction levels from 90% to 80% while requiring new controls on emissions of HRVOCs, such as ethylene, propylene, butadiene and butanes. These new rules still require approval by the EPA. Based on the 80% NOx reduction requirement, Lyondell estimates that aggregate related capital expenditures could total between $250 million and $300 million for Lyondell, Equistar and LCR before the 2007 deadline, and could result in higher annual operating costs. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations–Environmental Matters” for a summary of the estimated capital expenditures for Lyondell and its joint ventures to comply with the 80% NOx emission reduction requirements. Lyondell, Equistar and LCR are still assessing the impact of the new HRVOC control requirements. Additionally, the TCEQ plans to make a final review of these rules, with final rule revisions to be adopted by May 2004. The timing and amount of these expenditures are subject to regulatory and other uncertainties, as well as obtaining the necessary permits and approvals. At this time, there can be no guarantee as to the ultimate capital cost of implementing any final plan developed to ensure ozone attainment by the 2007 deadline. See “Item 3. Legal Proceedings—Environmental Proceedings” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Environmental Matters.”

In the United States, the Clean Air Act Amendments of 1990 set minimum levels for oxygenates, such as MTBE, in gasoline sold in areas not meeting specified air quality standards. However, the presence of MTBE in some water supplies in California and other states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft has led to public concern about the use of MTBE. Certain federal and state governmental initiatives in the U.S. have sought either to rescind the oxygen requirement for reformulated gasoline or to restrict or ban the use of MTBE. Lyondell’s North American MTBE sales represented approximately 26% of its total 2002 revenues.

At this time, Lyondell cannot predict the impact that these initiatives will have on MTBE margins or volumes during 2003. Lyondell intends to continue marketing MTBE in the U.S. However, should it become necessary or desirable to significantly reduce MTBE production, Lyondell would need to make capital expenditures to add the flexibility to produce alternative gasoline blending components, such as iso-octane or ethyl tertiary butyl ether (“ETBE”), at its U.S.-based MTBE plants. The current cost estimates for converting Lyondell’s U.S.-based MTBE plant to iso-octane production range from $65 million to $75 million. The profit margin for iso-octane is likely to be lower than those historically realized on MTBE. Alternatively, Lyondell is pursuing ETBE viability through legislative efforts. One key hurdle is equal access to the federal subsidy provided for ethanol blended into gasoline for the ethanol component of ETBE. Lyondell’s U.S.-based MTBE plant is capable of ETBE production with minimal capital requirements. See “Item 7. Management’s Discussion and Analysis of Financial Condition and the Results of Operations – Environmental Matters” for further discussion.

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The Clean Air Act specified certain emissions standards for vehicles beginning in the 1994 model year and required the EPA to study whether further emissions reductions from vehicles were necessary. In 1998, the EPA concluded that additional controls on gasoline and diesel fuel were necessary to meet these emission standards. New standards for gasoline were finalized in 1999 and will require refiners to produce a low sulfur gasoline by 2004, with final compliance by 2006. A new “on-road” diesel standard was adopted in January 2001 and will require refiners to produce ultra low sulfur diesel by June 2006, with some allowance for a conditional phase-in period that could extend final compliance until 2009. Lyondell estimates that these standards will result in increased capital investment for LCR, totaling between $175 million and $225 million for the new gasoline standards and between $250 million and $300 million for the new diesel standard, before the implementation dates. Lyondell’s proportionate share of LCR’s capital expenditures would be between $250 million and $300 million. In addition, these standards could result in higher operating costs for LCR. Equistar’s business may also be adversely impacted if these standards increase the cost for processing fuel components.

Commodity Products

Lyondell and its joint ventures sell their products in highly competitive markets. Due to the commodity nature of certain of the products of Lyondell and its joint ventures, competition in the markets is based primarily on price and to a lesser extent on performance, product quality, product deliverability and customer service. As a result, Lyondell and its joint ventures generally are not able to protect their market position for these products by product differentiation and may not be able to pass on cost increases to customers. Accordingly, increases in raw material and other costs may not necessarily correlate with changes in prices for these products, either in the direction of the price change or in magnitude. Specifically, timing differences in pricing between raw material prices, which may change daily, and contract product prices, which in many cases are negotiated only monthly or less often, sometimes with an additional lag in effective dates for increases, can have a negative effect on profitability.

Operating Hazards

The occurrence of material operating problems at Lyondell’s or its joint ventures’ facilities, including, but not limited to, the events described below, may have a material adverse effect on the productivity and profitability of a particular manufacturing facility, or on the Company as a whole, during and after the period of such operational difficulties. The Company’s income and cash flow are dependent on the continued operation of the Company’s and its joint ventures’ various production facilities and the ability to complete construction projects on schedule.

Although the Company and its joint ventures take precautions to enhance the safety of their operations and minimize the risk of disruptions, the Company’s and its joint ventures’ operations, along with the operations of other members of the chemical and refining industries, are subject to hazards inherent in chemical manufacturing and refining and the related storage and transportation of raw materials, products and wastes. These hazards include: pipeline leaks and ruptures; explosions; fires; severe weather and natural disasters; mechanical failure; unscheduled downtime; labor difficulties; transportation interruptions; remediation complications; chemical spills; discharges or releases of toxic or hazardous substances or gases; storage tank leaks; other environmental risks; and potential terrorist acts. Some of these hazards can cause personal injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties.

Furthermore, the Company is also subject to present and future claims with respect to workplace exposure, workers’ compensation and other matters. The Company maintains property, business interruption and casualty insurance which it believes is in accordance with customary industry practices, but it is not fully insured against all potential hazards incident to its business, including losses resulting from war risks or terrorist acts. As a result of market conditions, premiums and deductibles for certain insurance policies can increase substantially and, in some instances, certain insurance may become unavailable or available only for reduced amounts of coverage.

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Joint Venture Risks

A substantial portion of the Company’s operations is conducted through joint ventures. The Company shares control of these joint ventures with third parties.

The Company’s forecasts and plans with respect to these joint ventures assume that its joint venture partners will observe their obligations with respect to the joint ventures. In the event that any of the Company’s joint venture partners do not observe their commitments, it is possible that the affected joint venture would not be able to operate in accordance with its business plans or that the Company would be required to increase its level of commitment in order to give effect to such plans.

As with any such joint venture arrangements, differences in views among the joint venture participants may result in delayed decisions or in failures to agree on major matters, potentially adversely affecting the business and operations of the joint ventures and in turn the business and operations of the Company.

Lyondell or any of the other owners of the joint ventures may transfer control of their joint venture interests or engage in mergers or other business combination transactions with a third party or with one or more of the other owners that could result in a change in control of Lyondell or the joint venture or the other owners. In many instances, such a transfer would be subject to an obligation to first offer the other owner an opportunity to purchase the interest. Lyondell and the other joint venture owners have discussed, and from time to time may continue to discuss, in connection with their ordinary course dialog regarding the joint ventures or otherwise, transactions that could result in a transfer or modification, directly or indirectly, of their ownership in a joint venture.

Lyondell cannot be certain that any of the joint venture owners will not sell, transfer or otherwise modify their ownership interest in a joint venture, whether in a transaction involving third parties and/or the other owner. Upon a transfer of an interest in Equistar, the partnership agreement and key agreements between Equistar and its owners would remain in place, and may not be modified without the consent of all of the owners, but the transfer could affect the governance of Equistar, particularly because Equistar’s partnership agreement requires unanimous approval for some decisions.

Equistar’s credit facility provides that an event of default occurs if Lyondell and/or Millennium cease to collectively hold at least a 50% interest. LCR’s credit facility provides that an event of default occurs if Lyondell and CITGO cease to individually or collectively hold at least a 35% interest. In addition, LCR’s credit facility provides that an event of default occurs if (1) Lyondell transfers its interest as a member of LCR to a person other than an affiliate or (2) neither CITGO nor any of its affiliates is a member of LCR.

Potential Acquisitions, Divestitures and Joint Ventures

Lyondell and its joint ventures seek opportunities to maximize efficiency or value through various transactions. These transactions may include various business combinations, purchases or sales of assets or contractual arrangements or joint ventures that are intended to result in the realization of synergies, the creation of efficiencies or the generation of cash to reduce debt. To the extent permitted under Lyondell’s and its joint ventures’ credit facilities and other debt agreements, some of these transactions may be financed with additional borrowings by Lyondell or its joint ventures or by the issuance of equity securities. Although these transactions are expected to yield longer-term benefits if the expected efficiencies and synergies of the transactions are realized, they could adversely affect the results of operations of Lyondell or its joint ventures in the short term because of the costs associated with such transactions.

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FORWARD-LOOKING STATEMENTS

Certain of the statements contained in this report are “forward-looking statements” within the meaning of the federal securities laws. Although Lyondell believes the current expectations reflected in such forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties, and Lyondell can give no assurance that such expectations will prove to have been correct. Lyondell’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including:

Many of such factors are beyond Lyondell’s or its joint ventures’ ability to control or predict. Any of these factors, or a combination of these factors, could materially affect Lyondell’s or its joint ventures’ future results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of Lyondell’s or its joint ventures’ future performance, and Lyondell’s or its joint ventures’ actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels.

All forward-looking statements in this Form 10-K are qualified in their entirety by the cautionary statements contained in this section and elsewhere in this report. See “Items 1 and 2. Business and Properties,” “Certain Factors That May Affect Lyondell and Its Joint Ventures,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7a. Disclosure of Market and Regulatory Risk” for additional information about factors that may affect the businesses and operating results of Lyondell and its joint ventures. In addition, this report contains summaries of contracts and other documents. These summaries may not contain all of the information that is important to an investor, and reference is made to the actual contract or document for a more complete understanding of the contract or document involved.

NON-GAAP FINANCIAL MEASURES

The body of generally accepted accounting principles is commonly referred to as “GAAP.” For this purpose, a non-GAAP financial measure is generally defined by the Securities and Exchange Commission as one that purports to measure historical or future financial performance, financial position or cash flows but excludes or includes amounts that would not be so adjusted in the most comparable U.S. GAAP measure. From time to time Lyondell discloses so-called non-GAAP financial measures, primarily EBITDA, or earnings before interest, taxes and depreciation and amortization of long-lived assets, as well as proportionate share data for Lyondell and its joint ventures. The non-GAAP financial measures described herein are not a substitute for the GAAP measures of earnings, for which management has responsibility.

EBITDA is a key measure used by the banking and high-yield investing communities in their evaluation of economic performance. Accordingly, management believes that disclosure of EBITDA provides useful information

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to investors because it is frequently cited by financial analysts in evaluating companies’ performance and it is a key measure in the calculation of financial covenants contained in Lyondell’s credit facility and the indentures governing its senior debt. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Liquidity and Capital Resources” and Note 13 to the Consolidated Financial Statements. Management believes that inclusion of EBITDA in certain disclosures is useful because it increases the visibility of this component of the covenant analysis to an investor. Additionally, multiples of EBITDA are one measure of the indicated fair value of certain long-lived assets. For example, Lyondell used the multiples-of-EBITDA approach in evaluating its goodwill for impairment. See Note 2 to the Consolidated Financial Statements.

Lyondell also reports proportionate share data for Lyondell and its joint ventures. The joint ventures are not consolidated, but accounted for by the equity method of accounting. Accordingly, in Lyondell’s financial statements investors only see a single line item – investments – for the joint ventures in the balance sheet and one line item – equity income from joint venture investments – in the income statement. As such, investors may not get a true appreciation of the magnitude of certain operating and financial data for Lyondell and its joint ventures and the scope of their business activities. Management believes that reporting proportionate share data may give investors a more complete picture of the size and scope of the operating activities of Lyondell and its joint ventures.

Lyondell also periodically reports adjusted net income (loss) or adjusted EBITDA, excluding certain items that are unusual in nature or not comparable from period to period and that are included in GAAP measures of earnings. Management believes that excluding these items generally helps investors compare operating performance between two periods. Such adjusted data is not reported without an explanation of the items that are excluded.

Item 3.    Legal Proceedings

Litigation Matters

On February 1, 2002, LCR filed a lawsuit against PDVSA and PDVSA Oil in the United States District Court, Southern District of New York in connection with various force majeure declarations since April 1998. In the lawsuit, LCR alleges that the force majeure declarations by PDVSA and PDVSA Oil are invalid and that PDVSA and PDVSA Oil have breached the contracts related to the delivery of crude oil by PDVSA and PDVSA Oil to LCR. LCR is seeking monetary damages of at least $90 million resulting from PDVSA Oil’s failure to pay LCR the amounts required by contract relating to past crude oil deliveries of less than the contractual amount. LCR is also seeking declaratory relief relating to the force majeure declarations, and is seeking a declaratory interpretation of the disputed contract provisions in order to clarify the rights and obligations of the parties for the remaining duration of the contracts, which expire in December 2017. On May 31, 2002, the defendants filed a motion to dismiss LCR’s complaint on the ground that the “act of state” doctrine prevented the court from deciding LCR’s breach of contract claims. LCR opposed the defendants’ motion. The motion to dismiss was submitted to the court for decision on June 27, 2002. The court has not yet ruled on defendants’ motion.

The Company and its joint ventures are, from time to time, defendants in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, the Company does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it or its joint ventures currently are involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on the business or financial condition of the Company. However, the adverse resolution in any reporting period of one or more of these suits could have a material impact on Lyondell’s results of operations for that period without giving effect to contribution or indemnification obligations of co-defendants or others, or to the effect of any insurance coverage that may be available to offset the effects of any such award.

Although Lyondell and its joint ventures are involved in numerous and varied legal proceedings, a significant portion of its outstanding litigation arose in four contexts: (1) claims for personal injury or death allegedly arising out of exposure to the products produced by the respective entities; (2) claims for personal injury or death, and/or property damage allegedly arising out of the generation and disposal of chemical wastes at Superfund and other

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waste disposal sites; (3) claims for personal injury and/or property damage allegedly arising out of operations and air, noise and water pollution allegedly arising out of operations; and (4) employment related claims.

Environmental Proceedings

On January 19, 2001, Equistar and LCR, individually, and Lyondell, individually and as part of the BCCA Appeal Group (a group of industry participants), filed a lawsuit against the TCEQ in State District Court in Travis County, Texas to encourage the adoption of the plaintiffs’ alternative plan to achieve the same air quality improvement as the TCEQ plan, with less negative economic impact on the region. In June 2001, the parties entered into a consent order with respect to the lawsuit. Pursuant to the consent order, the TCEQ agreed to review by June 2002 the scientific data for ozone formation in the Houston/Galveston region. In October 2001, the EPA approved the original TCEQ plan, and the BCCA Appeal Group filed a timely petition for judicial review of that action in the United States Fifth Circuit Court of Appeals in January 2002. In December 2002, the TCEQ adopted revised NOx and HRVOC rules in response to this litigation. For a discussion of the impact of these rules, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Environmental Matters.” On March 5, 2003, the plaintiffs’ filed for a voluntary dismissal of the case brought in State District Court in Travis County, Texas. The petition for judicial review filed in January 2002 regarding the EPA approval of the original December 2000 TCEQ plan (the 90% reduction requirement) remains active before the United States Fifth Circuit Court of Appeals.

In addition, from time to time the Company receives notices from federal, state or local governmental entities of alleged violations of environmental laws and regulations pertaining to, among other things, the disposal, emission and storage of chemical and petroleum substances, including hazardous wastes. Although the Company has not been the subject of significant penalties to date, such alleged violations may become the subject of enforcement actions or other legal proceedings and may (individually or in the aggregate) involve monetary sanctions of $100,000 or more (exclusive of interest and costs).

In April 1997, the Illinois Attorney General’s Office filed a complaint in Grundy County, Illinois Circuit Court seeking monetary sanctions for releases into the environment at Millennium’s Morris, Illinois plant in alleged violation of state regulations. The Morris, Illinois plant was contributed to Equistar on December 1, 1997 in connection with the formation of Equistar. Equistar now believes that a civil penalty in excess of $100,000 could result, without giving effect to contribution or indemnification obligations of others. Equistar does not believe that the ultimate resolution of this complaint will have a material adverse effect on the business or financial condition of Equistar.

In connection with the transfer of assets and liabilities from ARCO to the Company prior to its initial public offering in 1988, the Company agreed to assume certain liabilities arising out of the operation of the Company’s integrated petrochemicals and refining business prior to July 1, 1988. The Company and ARCO entered into an agreement, updated in 1997 (the “Revised Cross-Indemnity Agreement”), whereby the Company agreed to defend and indemnify ARCO against certain uninsured claims and liabilities which ARCO may incur relating to the operation of the business of the Company prior to July 1, 1988, including certain liabilities that may arise out of pending and future lawsuits. For current and future cases related to Company products and Company operations, ARCO and the Company bear a proportionate share of judgment and settlement costs according to a formula that allocates responsibility based on years of ownership during the relevant time period. Under the Revised Cross-Indemnity Agreement, the Company assumed responsibility for its proportionate share of future costs for waste site matters not covered by ARCO insurance. In connection with the ARCO Chemical Acquisition, the Company is successor to a cross-indemnity agreement between ARCO and ARCO Chemical relating to claims or liabilities that ARCO may incur relating to its former ownership and operation of the oxygenates and polystyrenics businesses of ARCO Chemical for periods after July 1, 1987. On April 18, 2000, ARCO was acquired by BP. Subject to the uncertainty inherent in all litigation, management believes the resolution of the matters pursuant to these indemnity agreements will not have a material adverse effect upon the Consolidated Financial Statements of the Company.

Lyondell’s environmental liability totaled $19 million at December 31, 2002 based on the Company’s latest assessment of potential future remediation costs. This amount comprises liability for remediation responsibility retained by ARCO Chemical in connection with the sale of a plant in 1996 and liability related to several owned plant facilities, including the Channelview facility, and federal Superfund sites for amounts ranging from less than $1 million to $4 million per site. Lyondell is involved in administrative proceedings or lawsuits relating to a

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minimal number of other Superfund sites. The Company estimates, based on currently available information, that potential loss contingencies associated with these sites, individually and in the aggregate, are not significant. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in other CERCLA, RCRA, TCEQ or other comparable state or non-U.S. law investigations, could require the Company to reassess its potential exposure related to environmental matters. Substantially all amounts accrued are expected to be paid out over the next two to seven years. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Lyondell, Millennium Petrochemicals and Occidental and certain of its subsidiaries have each agreed to provide certain indemnifications to Equistar with respect to the petrochemicals and polymers businesses they each contributed. In addition, Equistar agreed to assume third party claims that are related to certain contingent liabilities arising prior to the contribution transactions that are asserted prior to December 1, 2004 as to Lyondell and Millennium Petrochemicals, and May 15, 2005 as to Occidental, to the extent the aggregate thereof does not exceed $7 million for each entity, subject to certain terms of the respective asset contribution agreements. As of December 31, 2002, Equistar had incurred nearly $7 million with respect to the indemnification basket for the business contributed by Lyondell. Lyondell, Millennium and Occidental each remain liable under these indemnification arrangements to the same extent following Lyondell’s acquisition of Occidental’s interest in Equistar as they were before.

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EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below are the executive officers of the Company as of February 28, 2003. The By-Laws of the Company provide that each officer shall hold office until the officer’s successor is elected or appointed and qualified or until the officer’s death, resignation or removal by the Board of Directors. Certain of the executive officers of Lyondell also are officers of Equistar. In addition, others perform their functions for Equistar as part of the Lyondell enterprise. For example, Mr. Bayer oversees manufacturing, health, safety, environmental and engineering services for Equistar, Mr. DeNicola provides financial management services to Equistar, and Ms. Galvin oversees legal and governmental affairs services for Equistar.

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Item 4.    Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

Since August 22, 2002, the Company has had two series of common stock outstanding: (1) common stock, $1.00 par value per share, which is referred to as “original common stock,” and (2) Series B common stock, $1.00 par value per share, which is referred to as “Series B common stock.” The shares of Series B common stock have the same rights as the original common stock, with the exception of the dividend. The Series B common stock pays a dividend at the same rate as the original common stock but, at the Company’s option, the dividend may be paid in additional shares of Series B common stock or in cash. Under the Company’s Certificate of Incorporation and the agreement relating to the issuance of the Series B common stock, the holder of the Series B common stock may elect to convert the shares of Series B common stock into shares of original common stock at any time (1) after August 22, 2004, if the Company would be permitted under its debt agreements at that time, as it is today, to pay cash dividends on the converted shares without a reduction in the dividend then being paid on its then outstanding shares of original common stock, (2) after August 22, 2005, whether or not there would be such a restriction, (3) following an acquisition of a majority of the Company’s outstanding voting securities in a transaction not approved by the Company’s Board of Directors or (4) with the consent of the Company. As of December 31, 2002, there were 125,844,920 shares of the Company’s original common stock outstanding and 34,568,224 shares of the Company’s Series B common stock outstanding.

The shares of the Company’s original common stock are listed on the New York Stock Exchange and may be freely transferred and resold. The shares of the Company’s Series B common stock are not listed on the New York Stock Exchange and are subject to restrictions on transferability and resale. The Series B common stock may not be transferred or resold except as permitted (1) under the Securities Act of 1933, as amended, and applicable state securities laws, pursuant to a registration or exemption therefrom, and (2) by the stockholders agreement between the Company and the holders of the Series B common stock.

The reported high and low sale prices of the original common stock on the New York Stock Exchange (New York Stock Exchange Composite Tape) for each quarter from January 1, 2001 through December 31, 2002, inclusive, were as set forth below.

On February 28, 2003, the closing sale price of the Company’s original common stock was $11.91, and there were approximately 1,692 holders of record of the original common stock.

There is no established public trading market for the Company’s Series B common stock, and all of the shares of Series B common stock outstanding on February 28, 2003 were held by Occidental Chemical Holding Corporation, a subsidiary of Occidental.

Holders of Lyondell’s original common stock and Series B common stock are entitled to receive such dividends as may from time to time be declared by Lyondell’s Board of Directors. Lyondell’s Certificate of Incorporation provides that the Board of Directors may not declare a dividend on shares of original common stock without also declaring a dividend in the same amount and form on shares of Series B common stock. However, if the Board of

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Directors declares a cash dividend on shares of original common stock, it may in its sole discretion declare and pay a dividend on shares of Series B common stock by issuing additional shares of Series B common stock to the holders thereof in lieu of cash.

During the last two years, Lyondell has declared $.225 per share quarterly cash dividends (which were paid after the end of the quarter to which they related). During 2002, Lyondell paid $109 million in cash dividends on its original common stock. The first quarterly dividend on the Series B common stock was paid on December 31, 2002, and Lyondell elected to pay the dividend on the Series B common stock in the form of 568,224 shares of Series B common stock. As described above, the declaration and payment of dividends is at the discretion of the Board of Directors. The future declaration and payout of dividends and the amount thereof will be dependent upon Lyondell’s results of operations, financial condition, cash position and requirements, investment opportunities, future prospects, contractual restrictions and other factors deemed relevant by the Board of Directors. Subject to these considerations, the provisions of Lyondell’s Certificate of Incorporation and the legal considerations discussed in the following paragraph, Lyondell currently intends to distribute dividends to its shareholders at a quarterly rate of $.225 per share, and currently intends to pay the dividends on its original common stock in cash and on its Series B common stock in the form of additional shares of Series B common stock. It is possible that all or a portion of the dividends paid by Lyondell during 2003 could represent a return of capital distribution to recipients. The determination of the actual characterization of distributions made during 2003 cannot be determined until after the close of the year, and will be reflected in the 2003 Form 1099-DIV to be sent in early 2004.

Lyondell’s credit facilities and indentures could limit Lyondell’s ability to pay dividends under certain circumstances. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, pursuant to a settlement agreement entered into with the Pension Benefit Guaranty Corporation in 1998, Lyondell may not pay extraordinary dividends (as defined by regulations under the Employee Retirement Income Security Act of 1974, as amended) without providing a letter of credit meeting certain specified requirements. In February 2002, Lyondell provided a letter of credit meeting these requirements.

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Item 6.    Selected Financial Data

The following selected financial data should be read in conjunction with the Consolidated Financial Statements and the notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with the information contained in the Consolidated Financial Statements and the notes thereto.

In addition to comparisons of 2002 annual operating results with results of the prior year, Lyondell Chemical Company (“Lyondell”) has included, as additional disclosure, certain “trailing quarter” comparisons of fourth quarter 2002 operating results to third quarter 2002 operating results. The businesses of Lyondell and its joint venture’s are highly cyclical, in addition to experiencing some less significant seasonal effects. Trailing quarter comparisons may offer important insight into the current business direction of Lyondell and its joint ventures.

References to industry benchmark prices and costs are generally to industry prices and costs reported by Chemical Marketing Associates, Incorporated (“CMAI”), except that crude oil and natural gas benchmark price references are to industry prices reported by Platts, a reporting service of The McGraw-Hill Companies.

Overview

Industrial production in the U.S., a key indicator of demand for products of Lyondell and Equistar Chemicals, LP (“Equistar”), contracted an estimated 1% in 2002 compared to a 4% contraction in 2001 and growth of nearly 5% in 2000. Despite the 2002 contraction, Lyondell and Equistar generally experienced increased demand for most products during 2002 compared to 2001. The 2001 contraction resulted in generally lower demand and sales volumes for Lyondell and Equistar in 2001 compared to 2000.

Crude oil and natural gas prices have generally been indicators of the level and direction of movement of raw material and energy costs for Lyondell and Equistar. The following table shows the average benchmark prices for crude oil and natural gas for the three-year comparison period as well as benchmark sales prices for ethylene and propylene, which Equistar produces and sells. Propylene is also a key raw material for Lyondell’s intermediate chemicals and derivatives segment.

The considerable volatility in raw material prices during the three-year period is not apparent in the annual average raw material prices shown in the table above. For example, the benchmark price of crude oil trended upward from a low of $27.10 per barrel in January 2000 to a high of $34.30 per barrel in November 2000, a 27% increase. Benchmark crude oil prices then trended downward to a low of $19.30 per barrel in December 2001, a 44% decrease from the November 2000 high. During 2002, benchmark crude oil prices trended upward to $29.50 per barrel in December 2002, a 53% increase from the December 2001 low. Benchmark natural gas prices rose from $2.34 per million BTUs in January 2000 to a historical high of $9.84 per million BTUs in January 2001, a 320% increase. Benchmark natural gas prices then trended downward to a low of $1.82 per million BTUs in October 2001, an 81% decrease from the January 2001 spike. During 2002, benchmark natural gas prices resumed an upward trend, increasing to $4.05 per million BTUs in December 2002, a 123% increase from the October 2001 low.

Significant volatility in raw material costs tends to put pressure on product margins, as sales price increases generally tend to lag behind raw material cost increases. Conversely, when raw material costs decrease, customers tend to demand immediate relief in the form of lower sales prices. These dynamics are particularly pronounced during periods of excess industry capacity and contributed to the trough conditions experienced by the chemical industry in 2001 and 2002.

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Other significant events in 2002 included the August 22, 2002 acquisition by Lyondell of Occidental Petroleum Corporation’s (“Occidental”) 29.5% interest in Equistar. Lyondell financed this acquisition by issuing Series B common stock, warrants and a right to a contingent payment to a subsidiary of Occidental. See Notes 7 and 19 to the Consolidated Financial Statements. As a result of the transactions, Lyondell currently has a 70.5% interest in Equistar, while Occidental has an approximate 22% ownership interest in Lyondell.

RESULTS OF OPERATIONS

Lyondell’s operating income relates to the intermediate chemicals & derivatives (“IC&D”) business segment. Lyondell’s activities in the petrochemicals, polymers and refining business segments are conducted through its interests in Equistar and LCR. Lyondell accounts for its investments in Equistar and LCR using the equity method of accounting, as discussed under “Critical Accounting Policies,” below.

Through April 30, 2002, Lyondell’s methanol operations were conducted through its joint venture ownership interest in Lyondell Methanol Company, L.P. (“LMC”), which was not a reportable segment for financial disclosure purposes. Effective May 1, 2002, LMC was wholly owned by Lyondell and the methanol results were included in the IC&D segment from that date. The effects of consolidating the LMC operations, which previously had been accounted for using the equity method, were not material.

Lyondell Chemical Company

Revenues and Operating Income—Lyondell’s operating income was $174 million in 2002, $112 million in 2001 and $929 million in 2000. Lyondell’s operating results are reviewed in the discussion of the IC&D segment below.

Income (Loss) from Equity Investment in Equistar—Lyondell’s equity investment in Equistar resulted in a loss of $117 million in 2002 compared to a loss of $77 million in 2001 and income of $101 million in 2000. The $40 million increase in Lyondell’s equity loss from Equistar was primarily due to deterioration in Equistar’s earnings in the fourth quarter 2002 combined with Lyondell’s ownership percentage increasing from 41% to 70.5% in August 2002. On a 100% basis, Equistar’s loss decreased to $246 million in 2002 from $280 million in 2001 due primarily to $33 million of goodwill amortization and $22 million of Port Arthur facility closing costs, which were included in 2001 annual results. Lyondell’s 41% share of these costs in 2001 was $23 million. Apart from these items, Equistar’s loss, on a 100% basis, would have increased $21 million in 2002 as a decrease in petrochemicals segment operating income and higher interest expense was only partly offset by a decrease in the polymers segment operating loss. The petrochemicals segment operating income decreased as a result of lower product margins in 2002 compared to 2001. Conversely, the polymers segment operating loss decreased due to higher product margins in 2002 compared to 2001.

The decrease of $178 million in Lyondell’s income from its equity investment in Equistar in 2001 compared to 2000 primarily reflected lower petrochemicals segment margins as well as lower volumes for both the petrochemicals and polymers segments. The lower petrochemicals margins were due to lower sales prices, which decreased more than raw material costs, in 2001 compared to 2000. Petrochemical margins were also negatively affected by decreases in prices for co-products propylene, benzene and butadiene during 2001. The lower sales prices and volumes reflected weaker demand in 2001. Polymers segment 2001 operating results were comparable to 2000. Results for 2001 also included Lyondell’s 41% share of shutdown costs for Equistar’s Port Arthur, Texas polymer facility, or $9 million before tax.

Income from Equity Investment in LCR—Lyondell’s income from its equity investment in LCR was $135 million in 2002, $129 million in 2001 and $86 million in 2000. In 2002, LCR’s net income was negatively impacted by lower crude oil deliveries under LCR’s crude supply agreement (“CSA”) with PDVSA Petróleo, S.A. (“PDVSA Oil”) compared to the 2001 periods. See the “Crude Supply Agreement” section of Note 18 to the Consolidated Financial Statements for a description of the CSA. LCR maintained crude oil processing levels through increased purchases of spot market crude oil, which had significantly lower margins in the 2002 periods compared to the 2001 periods and compared to CSA crude oil margins. Operating results benefited from lower

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natural gas prices in 2002 compared to 2001. The improvement in 2001 compared to 2000 was primarily due to higher deliveries and increased margins under the CSA in 2001 as well as higher margins on spot market volumes in 2001. This was partially offset by the negative effect of a major scheduled maintenance turnaround during the fourth quarter 2001.

Interest Expense—Interest expense was $384 million in 2002, $386 million in 2001 and $514 million in 2000. The decrease in 2001 compared to 2000 was principally due to the full-year effect in 2001 of debt reductions made in 2000. During 2000, Lyondell retired a total of $2.4 billion of debt, primarily using net proceeds of the March 31, 2000 asset sale to Bayer.

Interest Income—Interest income was $11 million in 2002, $17 million in 2001 and $52 million in 2000. The decrease in 2002 compared to 2001 reflected lower interest rates in 2002. The higher 2000 interest income reflected higher cash balances for part of the year as a result of proceeds from the asset sale to Bayer. The cash proceeds were used to retire debt during 2000, resulting in lower cash balances and lower interest income during 2001. Interest rates in 2001 were also lower than in 2000.

Income Tax—The 2002 effective tax rate was 31% compared to 34% in 2001 and 32% in 2000. Both the 2002 and 2001 effective rates reflected a tax benefit from operating losses incurred during the year. The lower 2002 rate reflected the effect of taxes on non-U.S. income. The 2001 effective tax rate also reflected the effect of non-U.S. earnings taxed at higher rates, but this was more than offset by a benefit from a change in estimate of prior year items. The change in estimate of prior year items primarily represented certain tax effects related to the sale of assets to Bayer in 2000. The 2000 tax rate of 32% reflected, in part, a federal tax benefit from a financial restructuring of Lyondell’s European operations and the attendant recognition of certain foreign exchange translation losses.

Extraordinary Losses—Extraordinary losses, net of income taxes, were $15 million in 2002, $5 million in 2001, and $33 million in 2000. During 2002, Lyondell retired a significant portion of Term Loan E in the principal amount of $515 million and amended its credit facility. As a result, Lyondell recognized a $10 million prepayment premium and the write-off of unamortized debt issuance costs of $13 million, or a total, after tax, of $15 million as an extraordinary loss on early extinguishment of debt. The debt was retired using proceeds from $278 million of fixed rate debt issued in July 2002 and $337 million of fixed rate debt issued in December 2002.

The extraordinary item for 2001 consisted of the write-off of $7 million of unamortized debt issuance costs and amendment fees related to the early repayment of $384 million principal amount of variable-rate debt. The after-tax charge of $5 million was reported as an extraordinary loss on early extinguishment of debt. The debt was retired using net proceeds from $393 million of fixed rate debt issued in December 2001.

The extraordinary item for 2000 consisted of the write-off of unamortized debt issuance costs and amendment fees of $40 million and prepayment premiums of $10 million. The total of $50 million, or $33 million after tax, related to the early retirement of $2.2 billion of debt, primarily using net proceeds from the Bayer asset sale.

Beginning in 2003, these items will be reclassified to be included in income before extraordinary items. See “Anticipated Accounting Changes.”

Net Income (Loss)—Lyondell had a net loss of $148 million in 2002, a net loss of $150 million in 2001 and net income of $437 million in 2000. The trend of net income (loss) is affected by certain items described below:

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Beyond the items described above, the increased net loss in 2002 compared to 2001 was primarily due to lower product margins at Lyondell and Equistar in 2002 as a result of ongoing industry overcapacity.

In addition to the impact of the items described above, the net loss in 2001 compared to net income in 2000 was primarily the result of lower product margins and volumes at Lyondell and Equistar as a result of weaker global economies in 2001, partly offset by Lyondell’s lower interest expense and higher earnings at LCR. Lyondell’s 2001 interest expense decreased compared to 2000 due to the full-year effect of debt reductions made during 2000. LCR’s refining operations benefited from higher margins and increased deliveries under the CSA with PDVSA Oil.

Pro Forma—The following condensed income statement presents the unaudited pro forma consolidated operating results for 2000 as if the March 31, 2000 sale of the polyols business had occurred as of the beginning of 2000. The pro forma income statement assumes that net proceeds of $2.05 billion were used to retire debt in accordance with the provisions of Lyondell’s credit facility and indentures as of the beginning of 2000. The operating results for 2000 exclude the after-tax gain on the asset sale of $400 million, or $3.40 per share.

The unaudited pro forma data presented above are not necessarily indicative of the results of operations of Lyondell that would have occurred had such transactions actually been consummated as of the indicated dates, nor are they necessarily indicative of future results.

Fourth Quarter 2002 versus Third Quarter 2002

Lyondell’s fourth quarter 2002 net loss of $93 million compares to a net loss for the third quarter 2002 of $2 million. While the fourth quarter 2002 included an $8 million after-tax extraordinary charge from early debt retirement, a substantial portion of the decrease in profitability was due to lower operating results in Equistar’s petrochemicals and polymers segments, and Lyondell’s increased equity interest therein, as well as lower operating results in Lyondell’s IC&D segment in the fourth quarter 2002. Equistar’s and Lyondell’s business segments were affected by higher raw material and energy costs, scheduled maintenance turnaround activity, the normal seasonality of some products and weaker demand in the fourth quarter 2002 due to ongoing economic and political uncertainties.

Higher raw material costs in the fourth quarter 2002 impacted Equistar and Lyondell. Energy costs also increased in the fourth quarter 2002, particularly impacting Equistar’s operating results. Scheduled maintenance turnarounds also negatively impacted both Equistar’s products and Lyondell’s TDI business during the fourth quarter 2002. These effects were partly offset as LCR’s earnings increased despite a national strike in Venezuela that negatively affected CSA deliveries in December 2002. While LCR received and processed full CSA volumes

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during October and November 2002, in December 2002, it drew down CSA crude oil inventory levels, which had a positive effect on earnings.

Intermediate Chemicals and Derivatives (IC&D) Segment

Overview—The IC&D segment produces and markets propylene oxide (“PO”), PO derivatives, toluene diisocyanate (“TDI”), styrene monomer (“SM”) and methyl tertiary butyl ether (“MTBE”), the principal derivative of tertiary butyl alcohol (“TBA”).

Approximately 1.1 billion pounds of new industry PO capacity, or nearly 10% of existing worldwide capacity, was added in 2000, primarily in Europe. During the third quarter 2002, a competitor’s propylene oxide/styrene monomer (“PO/SM”) facility started up in Singapore, adding approximately 4% and 3% to worldwide PO and SM capacity, respectively. PO and derivatives markets continue to be adversely affected by excess capacity as a result of recent capacity additions, which have not yet been fully absorbed by demand growth.

Weaker demand for most products during 2001 put pressure on prices and margins despite decreasing raw material costs. Demand for products in the IC&D segment in 2001 was negatively affected by the weaker global economy. During 2002, the IC&D segment benefited from stronger domestic demand, including increased demand in urethanes end-use markets such as automotive, housing, and home furnishings. This resulted in generally higher sales volumes in 2002 compared to 2001. However, the increased demand did not benefit industry margins for PO derivatives, which continue to be negatively affected by industry overcapacity.

In the U.S., the cost of propylene, a key raw material, trended downward in 2001 after peaking in mid-2000. Average benchmark propylene costs decreased 23% to 17.42 cents per pound in 2001 compared to 22.63 cents per pound in 2000. However, propylene costs rose in 2002, peaking in mid-year and averaging 18.00 cents per pound, or 3% higher than in 2001.

During June 2002, Lyondell completed construction of a new butanediol (“BDO”) production facility in Europe, known as BDO-2. Production of BDO commenced in July 2002. Lyondell also commenced lease payments under the BDO-2 operating lease in July 2002. See “Liquidity and Capital Resources – Operating Leases” below and Note 14 to the Consolidated Financial Statements.

The following table sets forth volumes, including processing volumes, included in sales and other operating revenues for this segment. Volumes for the polyols business, sold on March 31, 2000, are included through the date of sale. The ownership interest of Bayer AG and Bayer Corporation (collectively “Bayer”) in a PO joint venture (“PO Joint Venture”) entered into by Lyondell and Bayer as part of an asset sale transaction represents ownership of an in-kind portion of the PO production of the PO Joint Venture. Bayer’s share of the PO production from the PO Joint Venture is approximately 1.5 billion pounds annually. Lyondell takes in kind the remaining PO production and all SM and TBA co-product production from the PO Joint Venture. Bayer’s PO volumes are not included in sales and are excluded from the table below. See Note 6 to the Consolidated Financial Statements.

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Revenues—Revenues of $3.3 billion in 2002 increased 2% from revenues of $3.2 billion in 2001 as higher sales volumes were substantially offset by lower sales prices. Sales volumes for PO and derivatives increased 8% primarily due to higher demand for PO in urethanes markets and higher BDO volumes due to the BDO-2 plant start up in 2002. These higher volumes were partly offset by lower TDI sales volumes and the absence of ADI sales due to, respectively, 2002 TDI maintenance turnarounds and the shut down of the ADI operations in the third quarter 2001. Sales volumes also increased 7% for SM and 4% for TBA and derivatives, primarily MTBE, in 2002 compared to 2001. Higher SM sales volumes in 2002 were due to the expected start up of a new PO/SM plant in The Netherlands and higher export sales, primarily to Asia. The lower 2002 average sales prices were primarily due to lower sales prices for PO and derivatives and MTBE. The lower 2002 PO and derivatives average sales prices, to a large extent, reflected weaker demand for PO derivatives and industry overcapacity. The lower 2002 MTBE average sales prices primarily reflected lower gasoline prices in 2002 compared to 2001.

Revenues of $3.2 billion in 2001 decreased from $4.0 billion in 2000 partly due to the sale of the polyols business as of March 31, 2000. The polyols business accounted for $220 million in sales revenues and 408 million pounds in sales volumes in 2000. Apart form the effect of the sale of the polyols business, sales revenues decreased $590 million, or 15%, compared to 2000 due to lower prices and lower volumes, reflecting weaker demand in 2001. SM accounted for nearly half of this decrease on significantly lower prices and 10% lower volumes. Benchmark spot SM prices in the U.S. averaged 24% lower in 2001 than in 2000 when SM markets were stronger in the first half of the year. Volumes for PO and derivatives, including TDI, were 6% lower on weak demand, particularly in urethanes markets. MTBE prices and volumes also declined from 2000 when gasoline markets and demand for MTBE were much stronger than in 2001.

Gain on Sale of Assets—On March 31, 2000, Lyondell sold the polyols business and ownership interests in its U.S. PO manufacturing operations to Bayer for approximately $2.45 billion. As part of the transaction, Lyondell and Bayer entered into the PO Joint Venture and a separate PO technology joint venture (“PO Technology Joint Venture”). See Note 6 to the Consolidated Financial Statements for a description of these joint ventures. The sale of assets to Bayer generated a pretax gain in 2000 of $590 million, or $400 million after tax.

Operating Income—Operating income of $174 million in 2002 increased $62 million from $112 million in 2001. However, operating income in 2001 included a $63 million restructuring charge and $30 million of goodwill amortization. Apart from these items, 2002 operating income decreased $31 million from 2001. The decrease primarily reflected lower product margins for PO derivatives and higher fixed costs due to the startup of the new BDO-2 plant. These negative effects were partly offset by the benefits of higher SM and TDI margins, higher sales volumes and the sale of the unprofitable ADI business in the third quarter 2001. Lower PO derivatives margins reflected a weaker pricing environment in 2002 as noted above. Higher SM margins reflected a stronger SM market in most of 2002 compared to 2001. TDI margins improved on lower raw materials costs and supply shortages that led to higher sales prices in 2002.

Operating income of $112 million in 2001 decreased $817 million from operating income of $929 million in 2000. The decrease was primarily due to the gain on sale of assets to Bayer of $590 million in 2000, lower margins and volumes for TDI, SM and PO in 2001, the $63 million restructuring charge in 2001, described above, and the sale of the polyols business on March 31, 2000. TDI margins and volumes were down significantly in 2001 due to weak demand in urethanes markets, which also affected PO. SM margins and volumes decreased significantly due to weak market conditions in 2001. Decreases in selling, general and administrative expenses, as well as in research and development expenses in 2001 compared to 2000 reflected the effects of the sale of the polyols business, cost reduction efforts and a lower level of business activity in 2001. Both 2001 and 2000 included goodwill amortization.

Fourth Quarter 2002 versus Third Quarter 2002

Fourth quarter 2002 operating income of $12 million decreased $47 million from third quarter 2002 operating income of $59 million. The fourth quarter 2002 was negatively impacted by higher energy costs, lower TDI sales volumes and margins and seasonally lower MTBE margins and volumes. TDI turnaround maintenance activity resulted in the lower TDI sales volumes, while TDI margins were negatively impacted by high energy and raw material costs. The fourth quarter 2002 MTBE contribution to operating income decreased as a result of lower

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volumes and typical seasonally lower margins. The fourth quarter 2002 SM contribution to operating income was relatively unchanged from the third quarter 2002. Fourth quarter 2002 PO and derivatives volumes were negatively impacted by holiday shutdowns at some of Lyondell’s customers. Overall, PO and derivatives volumes decreased 3% compared to the third quarter 2002.

Equistar Chemicals, LP

Overview

For the year 2002, U.S. ethylene demand was estimated to be 2.8% higher than for 2001. Nonetheless, the 2002 demand growth was insufficient to absorb excess worldwide ethylene industry capacity and to fully offset the effects of a 9.9% contraction in U.S. ethylene demand in 2001 compared to 2000.

Crude oil and natural gas prices generally have been indicators of the level and direction of movement of raw material and energy costs for Equistar. The following table shows the average benchmark prices for crude oil and natural gas for the three-year comparison period as well as benchmark sales prices for ethylene and co-product propylene, which Equistar produces and sells. The benchmark weighted average cost of ethylene is based on the estimated ratio of petroleum liquids, or heavy liquids, and natural gas liquids (“NGLs”), or light raw materials, used in U.S. ethylene production and is subject to revision.

The considerable volatility in raw material prices during the three-year period is not apparent in the annual average raw material prices shown in the table above. For example, the benchmark price of crude oil trended upward from a low of $27.10 per barrel in January 2000 to a high of $34.30 per barrel in November 2000, a 27% increase. Benchmark crude oil prices then trended downward to a low of $19.30 per barrel in December 2001, a 44% decrease from the November 2000 high. During 2002, benchmark crude oil prices trended upward to $29.50 per barrel in December 2002, a 53% increase from the December 2001 low. Benchmark natural gas prices rose from $2.34 per million BTUs in January 2000 to a historical high of $9.84 per million BTUs in January 2001, a 320% increase. Benchmark natural gas prices then trended downward to a low of $1.82 per million BTUs in October 2001, an 81% decrease from the January 2001 spike. During 2002, benchmark natural gas prices resumed an upward trend, increasing to $4.05 per million BTUs in December 2002, a 123% increase from the October 2001 low.

Significant volatility in raw material costs tends to put pressure on product margins, as sales price increases generally tend to lag behind raw material cost increases. Conversely, when raw material costs decrease, customers tend to demand immediate relief in the form of lower sales prices. These dynamics are particularly pronounced during periods of excess industry capacity and contributed to the trough conditions experienced by the chemical industry in 2001 and 2002.

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RESULTS OF OPERATIONS

Net Income (Loss)—Equistar had a 2002 net loss of $246 million, before the cumulative effect of an accounting change, compared to a 2001 net loss of $283 million. The 2001 period included $33 million of goodwill amortization, $22 million of shutdown costs for Equistar’s Port Arthur, Texas polyethylene facility and a $3 million extraordinary loss due to debt retirement. Apart from these items, the net loss for 2001 would have been $225 million compared to the net loss of $246 million for 2002. This $21 million increase in the net loss primarily reflected a $129 million decrease in petrochemicals segment operating income and $13 million of higher interest expense, partly offset by a $112 million improvement in the polymers segment operating loss. Petrochemicals segment operating income decreased as sales prices decreased more than raw material costs, resulting in lower petrochemicals product margins in 2002 compared to 2001. The polymers segment operating loss was reduced as raw material costs, primarily ethylene and propylene, decreased more than the decreases in average polymers product sales prices, resulting in higher polymers product margins in 2002 compared to 2001.

Equistar had a net loss in 2001 of $283 million compared to net income of $153 million for 2000. The significant decrease of $436 million primarily reflected lower petrochemicals segment margins as well as lower volumes for both the petrochemicals and polymers segments. The lower petrochemicals margins were due to lower sales prices, which decreased more than raw material costs, in 2001 compared to 2000. The lower sales prices and volumes reflected weaker industry demand in 2001. The polymers segment 2001 operating loss was comparable to 2000. Results for 2001 also included the $22 million of costs associated with the shutdown of the Port Arthur, Texas polyethylene facility in the first quarter 2001. Both periods included goodwill amortization.

Fourth Quarter 2002 versus Third Quarter 2002

Equistar had a net loss of $114 million in the fourth quarter 2002 compared to net income of $22 million in the third quarter 2002. Fourth quarter 2002 performance was primarily impacted by higher raw material costs. The benchmark cost of ethylene production increased by approximately 3 cents per pound, or 22%, in the fourth quarter 2002 compared to the third quarter 2002. During the fourth quarter 2002 these cost increases were only partly offset by a 1 cent per pound reported increase in benchmark ethylene sales prices. Equistar also was affected by a scheduled maintenance turnaround of the Chocolate Bayou, Texas olefins plant in the fourth quarter 2002. This heavy liquid cracking plant has significant co-product production capabilities and normally further processes olefins by-product volumes from other Equistar plants and from outside purchases. Equistar was not able to utilize this capability during the turnaround.

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Segment Data

The following tables reflect selected sales volume data, including intersegment sales volumes, and summarized financial information for Equistar’s business segments.

Petrochemicals Segment

Revenues—Revenues of $5.0 billion in 2002 decreased 8% compared to revenues of $5.4 billion in 2001 as lower 2002 average sales prices were only partly offset by a 4% increase in sales volumes. Equistar’s sales prices in 2002 averaged 11% lower than in 2001, reflecting lower raw material costs and low demand growth coupled with excess industry capacity. Benchmark ethylene sales prices averaged 22.2 cents per pound in 2002, a 16% decrease compared to 2001. These lower ethylene sales prices were slightly offset by higher 2002 propylene sales prices. Benchmark propylene sales prices averaged 3% higher in 2002 than in 2001.

Revenues of $5.4 billion in 2001 decreased 23% compared to revenues of $7.0 billion for 2000 as a result of lower average sales prices and lower sales volumes in 2001. Benchmark ethylene sales prices averaged 13% lower in 2001 compared to 2000, while benchmark propylene sales prices averaged 23% lower. Equistar’s sales volumes decreased 12% compared to 2000 due to weaker business conditions in 2001.

Operating Income—Operating income of $146 million in 2002 decreased $129 million from $275 million in 2001 as sales prices decreased more than raw material costs, resulting in lower product margins. The effect of the lower 2002 product margins was only partly offset by the benefit of a 4% increase in sales volumes, which was in line with industry demand growth.

Operating income of $275 million in 2001 decreased $419 million from $694 million in 2000. The decrease was primarily due to lower product margins and, to a lesser extent, lower sales volumes. The lower margins primarily reflected lower sales prices for ethylene and for co-products, such as propylene and benzene, in 2001 compared to 2000. The lower prices and volumes were due to weaker market demand in 2001 compared to 2000.

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Polymers Segment

Revenues—Revenues of $1.9 billion in 2002 decreased 6% compared to revenues of $2.0 billion in 2001 due to a 9% decrease in average sales prices offset by a 4% increase in sales volumes. Lower sales prices in 2002 reflected generally lower raw material costs compared to 2001. Sales volumes increased due to stronger demand in 2002 compared to 2001.

Revenues of $2.0 billion in 2001 decreased 16% compared to revenues of $2.4 billion in 2000 due to a decrease in average sales prices and a 7% decrease in sales volumes. The decreases in sales prices and volumes were both due to weaker demand in 2001.

Operating Loss—The operating loss of $74 million in 2002 decreased $112 million compared to the operating loss of $186 million in 2001. The $112 million improvement was due to higher polymers product margins and, to a lesser extent, higher sales volumes. Margins improved in 2002 compared to 2001, as decreases in sales prices were less than the decreases in polymers raw material costs.

The 2001 operating loss of $186 million was comparable to the operating loss of $185 million in 2000 as the effect of lower polymers sales prices was offset by lower raw material costs.

Unallocated Items

The following discusses costs and expenses that were not allocated to the petrochemicals or polymers segments.

Other Operating Costs and Expenses—These include unallocated general and administrative expenses and, in 2001 and 2000, goodwill amortization. In addition, 2001 included facility closing costs of $22 million. Unallocated expenses were $116 million in 2002, $188 million in 2001 and $175 million in 2000. The decrease from 2001 to 2002 was primarily due to goodwill amortization of $33 million that ceased in 2002 (see Note 2 to the Consolidated Financial Statements) and the $22 million of facility closing costs included in 2001.

Equistar discontinued production at its higher-cost Port Arthur, Texas polyethylene facility in February 2001 and shut down the facility. During 2001, Equistar recorded a $22 million charge, which included environmental remediation liabilities of $7 million, other exit costs of $3 million and severance and pension benefits of $7 million for approximately 125 people employed at the Port Arthur facility. The remaining $5 million balance primarily related to the write down of certain assets.

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LYONDELL-CITGO Refining LP

Lyondell’s activities in the refining segment are conducted through its interest in LCR.

Refining Segment

Overview—Beginning in 1998, PDVSA Oil declared a force majeure and began reducing deliveries to LCR under the CSA from the 230,000 barrels per day contractual rate and did not restore them to the 230,000 barrels per day contractual level until October 2000. See “Crude Supply Agreement” section of Note 18 to the Consolidated Financial Statements. During 2000, processing of CSA volumes averaged 196,000 barrels per day, which forced LCR to make spot purchases of crude oil to maintain production levels. A strong gasoline market during 2000 helped improve the margins that LCR realized on its spot purchases of crude oil.

During 2001, processing of extra heavy Venezuelan crude oil under the CSA averaged 229,000 barrels per day, despite a major maintenance turnaround in the fourth quarter 2001 as volumes were accelerated into the first nine months of 2001. This resulted in higher than contract level CSA crude oil processing rates during the first nine months of 2001, allowing LCR to attain the near-contract processing rate of 229,000 barrels per day for the full year 2001. The strong gasoline market continued through the third quarter 2001, benefiting LCR’s margins on spot purchases of crude oil.

Beginning in March 2002, PDVSA Oil again reduced deliveries of extra heavy Venezuelan crude oil to LCR under the CSA based on a declaration of force majeure. Although deliveries were restored to contract levels in the third quarter 2002, during the fourth quarter 2002, a national strike in Venezuela again disrupted deliveries of CSA crude oil to LCR. LCR compensated for this loss of supply through reductions of CSA inventory and increased spot purchases of crude oil. The net combination of these factors resulted in lower average CSA crude oil processing rates of 213,000 barrels per day for the full year 2002. Weaker industry refining margins during 2002 reduced the margins that LCR realized on its spot purchases of crude oil compared to 2001, when industry refining margins were relatively higher.

The following table sets forth, in thousands of barrels per day, sales volumes for LCR’s refined products and processing rates at the refinery for the periods indicated:

Revenues—Revenues for LCR, including intersegment sales, were $3.4 billion in 2002, $3.3 billion in 2001 and $4.1 billion in 2000. Revenues for 2002 increased 3% compared to 2001. The increase was primarily due to a 5% increase in sales volumes, partly offset by lower sales prices. Total crude processing rates averaged 259,000 barrels per day in 2002, a 4% increase compared to 248,000 barrels per day in 2001. Spot market crude processing rates, however, averaged 46,000 barrels per day in 2002 compared to only 19,000 barrels per day in 2001 as a result of lower CSA crude oil deliveries in 2002.

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Revenues for 2001 decreased 19% compared to 2000. The decrease was primarily attributable to lower sales prices and lower sales volumes, which decreased nearly 6%. The lower sales prices generally reflected downward pressure from lower crude oil prices in 2001 compared to 2000. The lower 2001 sales volumes were primarily due to the effects of the fourth quarter 2001 turnaround.

Interest Expense—LCR’s net interest expense was $32 million in 2002, $51 million in 2001 and $61 million in 2000. Interest expense included interest on loans payable to partners of $6 million in 2002, $12 million in 2001, and $18 million in 2000. Interest expense decreased in 2002 compared to 2001 due to lower interest rates, which benefited LCR’s variable-rate debt, and lower amortization expense related to debt issuance costs. Debt issuance cost amortization was higher in 2001 as a result of the refinancing of LCR’s debt in May 2000 and again in September 2000. LCR’s debt was refinanced again in July 2001 and December 2002. Interest expense also decreased in 2001 compared to 2000 due to lower interest rates.

Extraordinary Loss—LCR had a $1 million extraordinary loss in 2002 and a $2 million extraordinary loss in 2001, both related to the early retirement of its $450 million term loan and $70 million revolving credit facility, which were refinanced in December 2002 and July 2001. See “LCR Liquidity and Capital Resources” below. The extraordinary losses consisted of the write-off of unamortized debt issuance costs.

Net Income—LCR’s net income was $213 million in 2002, $203 million in 2001 and $128 million in 2000. While LCR’s 2002 net income of $213 million was comparable to net income of $203 million in 2001, there were significant offsetting factors. In 2002, as noted in the “Overview” above, LCR’s net income was negatively impacted by lower CSA crude oil deliveries compared to 2001. LCR maintained 2002 crude oil processing levels through increased purchases of spot market crude oil, which had significantly lower margins in 2002 compared to 2001 and compared to CSA crude oil margins. The negative effects of lower CSA volumes and lower spot margins in 2002 were partly offset by lower energy costs and lower interest costs compared to 2001. In addition, a major planned maintenance turnaround in the fourth quarter 2001 and an outage related to Tropical Storm Allison in the second quarter 2001 negatively affected 2001 operating results.

The $75 million net income improvement in 2001 compared to 2000 was primarily due to higher margins and increased deliveries under the CSA, higher margins on spot market volumes and lower fixed costs. These benefits were partly offset by the effect of the major fourth quarter 2001 planned turnaround and higher natural gas costs. The negative impact of the turnaround on operating results was estimated at approximately $60 million. LCR had unplanned outages in 2001 that negatively affected operating results during the first nine months of 2001. However, LCR had a planned turnaround in the second quarter 2000 that had a similar negative effect on operating results during 2000.

Fourth Quarter 2002 versus Third Quarter 2002

LCR had net income of $59 million in the fourth quarter 2002, a $9 million increase compared to net income of $50 million in the third quarter 2002. Despite a brief rate reduction in late December 2002 due to the strike in Venezuela, LCR processed approximately 209,000 barrels per day of CSA crude oil in the fourth quarter 2002 compared to 212,000 barrels per day in the third quarter 2002. LCR maintained the 209,000 barrels per day CSA processing rate partly as a result of drawing down CSA crude oil inventory. Spot market crude oil volumes decreased 20%, but margins were higher than third quarter 2002, leading to a higher fourth quarter 2002 contribution from spot crude oil purchases. Increases in the cost of natural gas were offset by processing lower-cost crude oil from inventory and by timing impacts inherent in the CSA terms.

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FINANCIAL CONDITION

Operating Activities—Lyondell’s operating activities in 2002 generated cash of $289 million compared to $199 million in 2001 and $61 million in 2000. The increase in 2002 compared to 2001 was primarily due to a 2002 federal income tax refund of $97 million and $83 million of lower 2002 cash expenditures for maintenance turnarounds, systems implementation, interest and employee benefits, partly offset by a $136 million lower benefit from reductions in the controllable components of working capital – receivables, inventory and payables. The income tax refund, received in 2002, was reflected in prepaid expenses and other current assets at December 31, 2001. Although other noncurrent liabilities increased $60 million at December 31, 2002 on the Consolidated Balance Sheets, the increase was primarily due to the minimum pension liability, which did not affect cash flow. See “Pension Obligations” below.

Investing Activities—On August 22, 2002, Lyondell increased its equity interest in Equistar by acquiring Occidental’s 29.5% interest. See Notes 7 and 19 to the Consolidated Financial Statements, “Items 1 and 2 – Business and Properties – Development of Business” and “Financing Activities” below. As a result, Lyondell currently has a 70.5% interest in Equistar. In connection with the acquisition, Lyondell issued certain equity securities and a contingent right to Occidental. These transactions included concurrent payments between the parties of agreed amounts of approximately $440 million. The agreed amounts exchanged are included in cash used for investing activities and cash from financing activities.

The following table summarizes the 2002, 2001 and 2000 capital expenditures of Lyondell and its principal joint ventures as well as their 2003 capital budgets: