CITGO PETROLEUM CORP - 10-Q Quarterly Report

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United States

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
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COMMISSION FILE NUMBER 1-14380

CITGO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 73-1173881
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(State or other jurisdiction of (I. R. S. Employer Identification No.)
incorporation or organization)

ONE WARREN PLACE, 6100 SOUTH YALE AVENUE, TULSA, OKLAHOMA 74136
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(Address of principal executive office) (Zip Code)

(918) 495-4000
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(Registrant's telephone number, including area code)

N. A.
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(Former name, former address and former fiscal year,
if changed since last report)

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 whether the registrant is an accelerated filer
(as described in Rule 12b-2 of the Act): Yes [ ] No [X]

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

COMMON STOCK, $1.00 PAR VALUE 1,000
(Class) (outstanding at July 31, 2003)

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CITGO PETROLEUM CORPORATION

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

TABLE OF CONTENTS
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FACTORS AFFECTING FORWARD LOOKING STATEMENTS

This Report contains "forward looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Specifically, all statements under
the caption "Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations" pertaining to capital expenditures and
investments related to environmental compliance, strategic planning, purchasing
patterns of refined products and capital resources available to CITGO Petroleum
Corporation ("CITGO", "our Company", "we", "us", "our", or similar references)
are forward looking statements. In addition, when used in this document, the
words "anticipate," "estimate," "project," "believe" and similar expressions are
used to identify forward looking statements.

Those forward looking statements are subject to risks and uncertainties
that could cause actual results to differ materially from the forward looking
statements. Those risks and uncertainties include changes in the availability
and cost of crude oil, feedstocks, blending components and refined products;
changes in prices or demand for our products as a result of competitive actions
or economic factors; changes in environmental and other regulatory requirements,
which may affect operations, operating costs and capital expenditure
requirements; costs and uncertainties associated with technological change and
implementation; inflation; and continued access to capital markets and
commercial bank financing on favorable terms. In addition, we purchase a
significant portion of our crude oil requirements from Petroleos de Venezuela,
S.A. (as defined herein), our ultimate parent corporation, under long-term
supply agreements, and could be adversely affected by social, economic and
political conditions in Venezuela. (See Exhibit 99.4 to the Form 8-K filed by
CITGO on February 25, 2003 for additional information concerning risk factors).

Readers are cautioned not to place undue reliance on these forward
looking statements, which speak only as of the date of this Report. We undertake
no obligation to publicly release any revision to these forward looking
statements to reflect events or circumstances after the date of this Report.

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
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See notes to condensed consolidated financial statements.

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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
(DOLLARS IN THOUSANDS)
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See notes to condensed consolidated financial statements.

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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY (UNAUDITED)
(DOLLARS AND SHARES IN THOUSANDS)
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See notes to condensed consolidated financial statements.

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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(DOLLARS IN THOUSANDS)
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See notes to condensed consolidated financial statements.

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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 2003 AND 2002
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1. BASIS OF PRESENTATION

The financial information for CITGO Petroleum Corporation ("CITGO" or "the
Company") subsequent to December 31, 2002 and with respect to the interim
three-month and six-month periods ended June 30, 2003 and 2002 is
unaudited. In management's opinion, such interim information contains all
adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the results of such periods. The results of
operations for the six-month periods ended June 30, 2003 and 2002 are not
necessarily indicative of the results to be expected for the full year.
Reference is made to CITGO's Annual Report for the fiscal year ended
December 31, 2002 on Form 10-K, dated March 21, 2003, for additional
information.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements."
FIN 46 defines variable interest entities and how an enterprise should
assess its interests in a variable interest entity to decide whether to
consolidate that entity. The interpretation requires certain minimum
disclosures with respect to variable interest entities in which an
enterprise holds significant variable interest but which it does not
consolidate. FIN 46 applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which
an enterprise obtains an interest after that date. It applies in the first
fiscal year or interim period beginning after June 15, 2003 to variable
interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. FIN 46 may be applied prospectively with
a cumulative-effect adjustment as of the date on which it is first applied
or by restating previously issued financial statements for one or more
years with a cumulative-effect adjustment as of the beginning of the first
year restated. CITGO expects that the application of FIN 46 to variable
interest entities in which it acquired an interest before February 1, 2003
will not have a material impact on its financial position or results of
operations.

On January 1, 2003 the Company adopted Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" (SFAS No.
143) which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. It applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and/or the normal operation of a
long-lived asset, except for certain obligations of lessees. The Company
has identified certain asset retirement obligations that are within the
scope of the standard, including obligations imposed by certain state laws
pertaining to closure and/or removal of storage tanks, contractual removal
obligations included in certain easement and right-of-way agreements
associated with the Company's pipeline operations, and contractual removal
obligations relating to a refinery processing unit located within a
third-party entity's facility. The Company cannot currently determine a
reasonable estimate of the fair value of its asset retirement obligations
due to the fact that the related assets have indeterminate useful lives
which preclude development of assumptions about the potential timing of
settlement dates. Such obligations will be recognized in the period in
which sufficient information exists to estimate a range of potential
settlement dates and estimated amounts of costs to be incurred.
Accordingly, the adoption of SFAS No. 143 did not impact the Company's
financial position or results of operations.

In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS No. 149"). The changes in SFAS

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No. 149 improve financial reporting by requiring that contracts with
comparable characteristics be accounted for similarly. Those changes will
result in more consistent reporting of contracts as either derivatives or
hybrid instruments. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, except for certain issues from SFAS No. 133
which have been effective for fiscal quarters that began prior to June 15,
2003 and for hedging relationships designated after June 30, 2003. In
addition, all provisions of SFAS No. 149 should be applied prospectively.
The Company has not yet determined the impact of the adoption of SFAS No.
149 on its financial position or results of operations.

2. ACCOUNTS RECEIVABLE

On February 28, 2003, the Company established a new accounts receivable
sales facility. This facility allows for the non-recourse sale of trade
accounts receivable meeting specified requirements to independent third
parties. A maximum of $200 million in accounts receivable may be sold at
any one time. At June 30, 2003 no accounts receivable were sold through
this facility.

3. INVENTORIES

Inventories, primarily at LIFO, consist of the following:

4. RESTRICTED CASH

Restricted cash of approximately $24 million at June 30, 2003 is related to
tax-exempt industrial revenue bonds and a product sales and option
agreement.

CITGO issued $30 million of tax-exempt environmental facilities revenue
bonds in June 2002 and $39 million in May 2003. The proceeds from these
bonds will be used for spending on qualified projects at the Lemont and
Corpus Christi refineries. Restricted cash of approximately $15 million at
June 30, 2003 represents highly liquid investments held in trust accounts
in accordance with these bond agreements. Funds may be released solely to
finance the qualified capital expenditures as defined in the related bond
agreements.

Restricted cash of approximately $9 million at June 30, 2003 relates to a
product sales and option agreement and represents highly liquid investments
held in accordance with a contract related to that product sales and option
agreement.

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5. LONG-TERM DEBT AND FINANCING ARRANGEMENTS

CITGO's revolving bank loan agreements with various banks consist of (i) a
$260 million, three-year, revolving bank loan, maturing in December 2005;
and (ii) a $260 million, 364-day, revolving bank loan, maturing in
December 2003. CITGO does not intend to replace the $260 million, 364-day,
revolving bank loan when it matures.

On June 28, 2002, CITGO issued $30 million of tax-exempt environmental
facilities revenue bonds due 2032. The proceeds from the issuance will be
used for capital projects at the Lemont refinery. On May 15, 2003, CITGO
issued $39 million of tax-exempt revenue bonds due 2008. The proceeds of
those bonds were used to refund a $25 million issue of tax-exempt bonds
that had been repurchased in March 2003 as a result of the loss of letter
of credit support and will be used for spending on qualified projects at
the Corpus Christi refinery.

On February 27, 2003, CITGO closed on a three-year $200 million, senior
secured term loan with a variable interest rate. The loan is secured by a
pledge of CITGO's 15.8 percent equity interest in Colonial Pipeline and
6.8 percent equity interest in Explorer Pipeline.

On February 27, 2003 CITGO issued $550 million aggregate principal amount
of 11-3/8% unsecured senior notes due February 1, 2011. In connection with
this debt issuance, CITGO redeemed $50 million principal amount of its
7-7/8% senior notes due 2006.

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The taxable and tax-exempt bonds are supported by letters of credit. Some
of the providers of these letters of credit indicated they would not renew
such letters of credit. As a result, CITGO repurchased $90 million of
taxable bonds and $138 million of tax-exempt bonds that were supported by
these letters of credit in the six-month period ending June 30, 2003.

Our various debt instruments require maintenance of a specified minimum
net worth and impose restrictions on our ability to: incur additional debt
unless we meet specified interest coverage and debt to capitalization
ratios; place liens on our property, subject to specified exceptions; sell
assets, subject to specified exceptions; make restricted payments,
including dividends, repurchases of capital stock and specified
investments; and merge, consolidate or transfer assets. CITGO is in
compliance with its covenants under its debt financing arrangements at
June 30, 2003.

6. INVESTMENT IN LYONDELL-CITGO REFINING LP

LYONDELL-CITGO Refining LP ("LYONDELL-CITGO") owns and operates a 265
thousand barrels per day refinery in Houston, Texas and is owned by
subsidiaries of CITGO (41.25%) and Lyondell Chemical Company (58.75%)
("the Owners"). This refinery processes heavy crude oil supplied by
Petroleos de Venezuela, S.A. ("PDVSA") under a long-term supply contract
that expires in 2017. CITGO purchases substantially all of the gasoline,
diesel and jet fuel produced at the refinery under a long-term contract.

In April 1998, from February 1999 through October 2000 and from February
2001 through March 2003 PDVSA, pursuant to its contractual rights,
declared force majeure and reduced deliveries of crude oil to
LYONDELL-CITGO. This action required LYONDELL-CITGO to obtain replacement
crude oil supplies, which resulted in lower operating margins. Most
recently, LYONDELL-CITGO received notice of force majeure from PDVSA in
December 2002. Crude oil was purchased in the spot market to replace the
volume not delivered under the contract during December 2002. By February
2003, crude oil deliveries had returned to contract volumes and the force
majeure was lifted March 6, 2003.

CITGO has a note receivable from LYONDELL-CITGO which totals approximately
$35 million at June 30, 2003 and December 31, 2002. The note bears
interest at market rates. Principal and interest are due in December 2004.
Accordingly, this note is included in the balance sheet caption other
assets and related accrued interest is included in the balance sheet
caption due from affiliates in the accompanying consolidated balance
sheets.

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CITGO accounts for its investment in LYONDELL-CITGO using the equity
method of accounting and records its share of the net earnings of
LYONDELL-CITGO based on allocations of income agreed to by the Owners
which differ from participation interests. Cash distributions are
allocated to the Owners based on participation interest. Information on
CITGO's investment in LYONDELL-CITGO follows:

On December 11, 2002, LYONDELL-CITGO completed a refinancing of its working
capital revolver and its term bank loan. The new term loan and working
capital revolver will mature in June 2004 and is shown in current
liabilities.

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7. COMMITMENTS AND CONTINGENCIES

LITIGATION AND INJURY CLAIMS - Various lawsuits and claims arising in the
ordinary course of business are pending against the Company. The Company
records accruals for potential losses when, in management's opinion, such
losses are probable and reasonably estimable. If known lawsuits and
claims were to be determined in a manner adverse to the Company, and in
amounts greater than the Company's accruals, then such determinations
could have a material adverse effect on the Company's results of
operations in a given reporting period. The most significant lawsuits and
claims are discussed below.

The electricity supplier to the Lemont, Illinois refinery is seeking
recovery from the Company of alleged underpayments for electricity in a
proceeding before the Illinois Commerce Commission. The Company made a
motion for summary judgment before the administrative law judge in this
matter. Of the four issues before the judge, the judge ruled in favor of
CITGO in three of the four issues, and ruled that the electric supplier
was not the proper party in interest with regard to the final issue.
Unless the electric supplier elects to appeal this decision, this matter
should now be concluded.

In September 2002, a Texas court has ordered the Company to pay property
owners and their attorneys approximately $6 million based on an alleged
settlement of class action property damage claims as a result of alleged
air, soil and groundwater contamination from emissions released from the
Company's Corpus Christi, Texas refinery. CITGO has appealed the ruling
to the Texas Court of Appeals.

CITGO is one of several refinery defendants to state and federal lawsuits
in New York and state actions in Illinois and California alleging
contamination of water supplies by methyl tertiary butyl ether ("MTBE"),
a component of gasoline. The plaintiffs claim that MTBE is a defective
product and that refiners failed to adequately warn customers and the
public about risks associated with the use of MTBE in gasoline. These
actions allege that MTBE poses public health risks and seek testing,
damages and remediation of the alleged contamination. The plaintiffs
filed putative class action lawsuits in federal courts in Illinois,
California, Florida and New York. CITGO was named as a defendant in all
but the California case. The federal cases were all consolidated in a
Multidistrict Litigation case in the United States District Court for the
Southern District of New York ("MDL"). In July 2002, the court in the MDL
case denied plaintiffs' motion for class certification. The California
plaintiffs in the MDL action then dismissed their federal lawsuit and
refiled in state court in California. Subsequently, the remaining MDL
plaintiffs settled with the Company and its codefendants for an amount
that did not have a material impact on CITGO's financial condition or
results of operations. The Company anticipates a similar settlement of
the California lawsuit. In August 2002, a New York state court judge
handling two separate but related individual MTBE lawsuits dismissed
plaintiffs' product liability claims, leaving only traditional nuisance
and trespass claims for leakage from underground storage tanks at
gasoline stations near plaintiffs' water wells. Subsequently, a putative
class action involving the same leaking underground storage tanks has
been filed. CITGO has filed a motion to dismiss the case and will also
oppose class certification. Also, in late October 2002, the County of
Suffolk, New York, and the Suffolk County Water Authority filed suit in
state court, claiming MTBE contamination of that county's water supply.
The Illinois state action has been brought on behalf of a class of
contaminated well owners in Illinois and a second class of all well
owners within a defined distance of leaking underground storage tanks.
The judge in the Illinois state court action is expected to hear
plaintiffs' motion for class certification in that case sometime within
the next year. On July 20, 2001, the Village of East Alton, Illinois,
sued Union Oil Company of California ("Unocal") and other defendants in
Illinois state court for alleged MTBE contamination of its public water
supply. Plaintiff, in the original complaint and two subsequent
amendments, has asserted claims of strict liability, negligence, trespass
and nuisance, and seeks compensatory damages and declaratory judgment
that defendants are liable for the full cost of remediation. Unocal
tendered the defense of the case to PDV Midwest Refining, LLC ("PDVMR")
pursuant to a Partnership Interest Retirement Agreement among the Uno-Ven
Company, PDV America, Inc. ("PDV America"), PDVMR, Unocal, Midwest 76,
Inc., and Lemont Carbon, Inc., dated April 11,

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1997. PDVMR is a subsidiary of the Company and has accepted the tender of
defense with a reservation of rights. Unocal has answered the most recent
amended complaint and discovery has commenced. The case is expected to be
mediated in late summer or early fall of 2003.

In August 1999, the U.S. Department of Commerce rejected a petition filed
by a group of independent oil producers to apply antidumping measures and
countervailing duties against imports of crude oil from Venezuela, Iraq,
Mexico and Saudi Arabia. The petitioners appealed this decision before
the U.S. Court of International Trade based in New York. On September 19,
2000, the Court of International Trade remanded the case to the
Department of Commerce with instructions to reconsider its August 1999
decision. The Department of Commerce was required to make a revised
decision as to whether or not to initiate an investigation within 60
days. The Department of Commerce appealed to the U.S. Court of Appeals
for the Federal Circuit, which dismissed the appeal as premature on July
31, 2001. The Department of Commerce issued its revised decision, which
again rejected the petition, in August 2001. The revised decision was
affirmed by the Court of International Trade on December 17, 2002. In
February 2003, the independent oil producers appealed the decision of the
Court of International Trade.

CITGO has been named as a defendant in approximately 125 asbestos
lawsuits pending in state and federal courts, primarily in Louisiana,
Texas and Illinois. These cases, most of which involve multiple
defendants, are brought by former employees or contractor employees
seeking damages for asbestos related illnesses allegedly caused, at least
in part, from exposure at refineries owned or operated by CITGO in Lake
Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois. In many
of these cases, the plaintiffs' alleged exposure occurred over a period
of years extending back to a time before CITGO owned or operated the
premises at issue. In some of these cases, CITGO is indemnified by or has
the right to seek indemnification for losses and expenses that CITGO may
incur from prior owners of the refineries or employers of the claimants.
In other cases, CITGO's involvement arises not from having been sued
directly but because prior owners of the CITGO refineries have asserted
indemnification rights against CITGO. The Company does not believe that
the resolution of these cases will have a material adverse effect on its
financial condition or results of operations.

ENVIRONMENTAL COMPLIANCE AND REMEDIATION - CITGO is subject to the
federal Clean Air Act ("CAA") which includes the New Source Review
("NSR") program as well as the Title V air permitting program; the
federal Clean Water Act which includes the National Pollution Discharge
Elimination System program; the Toxic Substances Control Act; and the
federal Resource Conservation and Recovery Act and their equivalent state
programs. CITGO is required to obtain permits under all of these programs
and believes it is in material compliance with the terms of these
permits. CITGO does not have any material Comprehensive Environmental
Response, Compensation, and Liability Act ("CERCLA") liability because
the former owners of many of CITGO's assets have by explicit contractual
language assumed all or the material portion of CERCLA obligations
related to those assets. This includes the Lake Charles refinery and the
Lemont refinery.

The U.S. refining industry is required to comply with increasingly
stringent product specifications under the 1990 Clean Air Act Amendments
for reformulated gasoline and low sulphur gasoline and diesel fuel that
have necessitated additional capital and operating expenditures, and
altered significantly the U.S. refining industry and the return realized
on refinery investments. Also, regulatory interpretations by the U.S. EPA
regarding the term "modifications" to refinery equipment under the NSR
provisions of the CAA have created uncertainty about the extent to which
additional capital and operating expenditures will be required and
administrative penalties imposed.

In addition, CITGO is subject to various other federal, state and local
environmental laws and regulations that may require CITGO to take
additional compliance actions and also actions to remediate the effects
on the environment of prior disposal or release of petroleum, hazardous
substances and other waste and/or pay

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for natural resource damages. Maintaining compliance with environmental
laws and regulations could require significant capital expenditures and
additional operating costs. Also, numerous other factors affect the
Company's plans with respect to environmental compliance and related
expenditures. See "Factors Affecting Forward Looking Statements."

CITGO's accounting policy establishes environmental reserves as probable
site restoration and remediation obligations become reasonably capable of
estimation. CITGO believes the amounts provided in its consolidated
financial statements, as prescribed by generally accepted accounting
principles, are adequate in light of probable and estimable liabilities
and obligations. However, there can be no assurance that the actual
amounts required to discharge alleged liabilities and obligations and to
comply with applicable laws and regulations will not exceed amounts
provided for or will not have a material adverse affect on its
consolidated results of operations, financial condition and cash flows.

In 1992, the Company reached an agreement with the Louisiana Department
of Environmental Quality ("LDEQ") to cease usage of certain surface
impoundments at its Lake Charles refinery by 1994. A mutually acceptable
closure plan was filed with the LDEQ in 1993. The Company and the former
owner of the refinery are participating in the closure and sharing the
related costs based on estimated contributions of waste and ownership
periods. The remediation commenced in December 1993. In 1997, CITGO
presented a proposal to the LDEQ revising the 1993 closure plan. In 1998
and 2000, CITGO submitted further revisions as requested by the LDEQ. The
LDEQ issued an administrative order in June 2002 that addressed the
requirements and schedule for proceeding to develop and implement the
corrective action or closure plan for these surface impoundments and
related waste units. Compliance with the terms of the administrative
order has begun. CITGO has incurred remediation costs to date related to
these surface impoundments of approximately $45 million.. Based on
currently available information and proposed remedial approach, CITGO
currently anticipates closure and post-closure costs related to these
surface impoundments and related solid waste management units to range
from $36 million to $41 million.

The Texas Commission on Environmental Quality ("TCEQ") and CITGO have had
preliminary discussions in which it was agreed that the Company and the
TCEQ will begin settlement negotiations intended to resolve all
outstanding enforcement issues between the Company and the TCEQ related
to the Corpus Christi Refinery. It is contemplated that this settlement
will include, among other issues, all outstanding issues associated with
the notice of enforcement arising from the 2002 multi-media investigation
of the Corpus Christi refinery as well as the proposed penalties for
failure to maintain equipment upset records, to obtain authority for
certain sulfur dioxide and hydrogen sulfide emissions and to comply with
certain air limitations at the Corpus Christi refinery during 2000 and
2001. The Company does not believe that the resolution of these
enforcement matters will have a material adverse effect on its
consolidated results of operations, financial condition and cash flows.

In June 1999, CITGO and numerous other industrial companies received
notice from the U.S. EPA that the U.S. EPA believed that CITGO and these
other companies have contributed to contamination in the Calcasieu
Estuary, in the proximity of Lake Charles, Calcasieu Parish, Louisiana
and are potentially responsible parties ("PRPs") under the CERCLA. The
U.S. EPA made a demand for payment of its past investigation costs from
CITGO and other PRPs and since 1999 has been conducting a remedial
investigation/feasibility study ("RI/FS") under its CERCLA authority. The
U.S. EPA released the draft of the remedial investigation phase of the
report in May 2003. CITGO and other PRPs may be potentially responsible
for the costs of the RI/FS, subsequent remedial actions and natural
resource damages. Although CITGO is still reviewing the recent remedial
investigation phase of the report and its implications, CITGO submitted
initial comments on the report in July 2003. Also the EPA and the LDEQ
issued a memorandum of understanding in June 2003 assigning the primary
areas of responsibility between the agencies related to the Calcasieu
Estuary. While the Company disagrees with many of the U.S. EPA's earlier
allegations and conclusions, the Company is in discussions with the LDEQ
on issues relative to its

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operations adjacent to the Bayou D'Inde tributary section of the
Calcasieu Estuary and separately on issues relative to its refinery
operations on other sections of the Estuary. If necessary, the Company
still intends to contest this matter.

In January and July 2001, CITGO received notices of violation ("NOVs")
from the U.S. EPA alleging violations of the CAA. The NOVs are an
outgrowth of an industry-wide and multi-industry U.S. EPA enforcement
initiative alleging that many refineries and electric utilities modified
air emission sources without obtaining permits or installing new control
equipment under the NSR provisions of the CAA. The NOVs followed
inspections and formal information requests regarding the Company's Lake
Charles, Louisiana, Corpus Christi, Texas and Lemont, Illinois
refineries. Since mid-2002, CITGO has been engaged in global settlement
negotiations with the United States. The settlement negotiations have
focused on different levels of air pollutant emission reductions and the
merits of various types of control equipment to achieve those reductions.
No settlement agreement, or agreement in principal, has been reached.
Based primarily on the costs of control equipment reported by the United
States and other petroleum companies and the types and number of emission
control devices that have been agreed to in previous petroleum companies'
NSR settlements with the United States, CITGO estimates that the capital
costs of a settlement with the United States could range from $130
million to $200 million. Any such capital costs would be incurred over a
period of years, anticipated to be from 2003 to 2008. Also, this cost
estimate range, while based on current information and judgment, is
dependent on a number of subjective factors, including the types of
control devices installed, the emission limitations set for the units,
the year the technology may be installed, and possible future operational
changes. The Company also may be subject to possible penalties. If
settlement discussions fail, CITGO is prepared to contest the NOVs. If
CITGO is found to have violated the provisions cited in the NOVs, it
estimates the capital expenditures and penalties that might result could
range up to $290 million, to be incurred over a period of years.

In June 1999, an NOV was issued by the U.S. EPA alleging violations of
the National Emission Standards for Hazardous Air Pollutants regulations
covering benzene emissions from wastewater treatment operations at the
Company's Lemont, Illinois refinery. CITGO is in settlement discussions
with the U.S. EPA. CITGO believes this matter will be consolidated with
the matters described in the previous paragraph.

In June 2002, a Consolidated Compliance Order and Notice of Potential
Penalty was issued by the LDEQ alleging various violations of the
Louisiana air quality regulations at CITGO's Lake Charles, Louisiana
refinery. CITGO is in settlement discussions with the LDEQ.

Various regulatory authorities have the right to conduct, and from time
to time do conduct, environmental compliance audits of CITGO and its
subsidiaries' facilities and operations. Those audits have the potential
to reveal matters that those authorities believe represent non-compliance
in one or more respects with regulatory requirements and for which those
authorities may seek corrective actions and/or penalties in an
administrative or judicial proceeding. Based upon current information,
CITGO is not aware that any such audits or their findings have resulted
in the filing of such a proceeding or is the subject of a threatened
filing with respect to such a proceeding, nor does CITGO believe that any
such audit or their findings will have a material adverse effect on its
future business and operating results, other than matters described
above.

Conditions which require additional expenditures may exist with respect
to the Company's various sites including, but not limited to, its
operating refinery complexes, former refinery sites, service stations and
crude oil and petroleum product storage terminals. Based on currently
available information, CITGO cannot determine the amount of any such
future expenditures.

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DERIVATIVE COMMODITY AND FINANCIAL INSTRUMENTS - As of June 30, 2003
CITGO's petroleum commodity derivatives included exchange traded futures
contracts, forward purchase and sale contracts, exchange traded and
over-the-counter options and over-the-counter swaps. At June 30, 2003,
the balance sheet captions prepaid expenses and other current assets and
other current liabilities include $8 million and $7 million,
respectively, related to the fair values of open commodity derivatives.

CITGO has also entered into various interest rate swaps to manage the
Company's risk related to interest rate changes on its debt. The fair
value of the interest rate swap agreements in place at June 30, 2003,
based on the estimated amount that the Company would receive or pay to
terminate the agreements as of that date and taking into account current
interest rates, was a loss of $3 million, the offset of which is recorded
in the balance sheet caption other current liabilities. In connection
with the determination of fair market value, the Company considered the
creditworthiness of the counterparties, but no adjustment was determined
to be necessary as a result.

GUARANTEES - As of June 30, 2003, the Company has guaranteed the debt of
others in a variety of circumstances including letters of credit issued
for an affiliate, bank debt of an affiliate, bank debt of an equity
investment, bank debt of customers and customer debt related to the
acquisition of marketing equipment as shown in the following table:

In each case, if the debtor fails to meet its obligation, CITGO would be
obligated to make the required payment. The Company has not recorded any
amounts on the Company's balance sheet relating to these guarantees.

In the event of debtor default on the letters of credit, CITGO has been
indemnified by PDV Holding, Inc. ("PDV Holding"), the direct parent of
PDV America. In the event of debtor default on the affiliate's and equity
investment bank debt, CITGO has no recourse. In the event of debtor
default on customer bank debt, CITGO generally has recourse to personal
guarantees from principals or liens on property, except in one case, in
which the guaranteed amount is $170 thousand, CITGO has no recourse. In
the event of debtor default on financing debt incurred by customers,
CITGO would receive an interest in the equipment being financed after
making the guaranteed debt payment.

CITGO has granted indemnities to the buyers in connection with past sales
of product terminal facilities. These indemnities provide that CITGO will
accept responsibility for claims arising from the period in which CITGO
owned the facilities. Due to the uncertainties in this situation, the
Company is not able to estimate a liability relating to these
indemnities.

15

The Company has not recorded a liability on its balance sheet relating to
product warranties because historically, product warranty claims have not
been significant.

8. RELATED PARTY TRANSACTIONS

CITGO purchases approximately one-half of the crude oil processed in its
refineries from subsidiaries of PDVSA under long-term supply agreements.
These supply agreements extend through the year 2006 for the Lake Charles
refinery, 2010 for the Paulsboro refinery, 2012 for the Corpus Christi
refinery and 2013 for the Savannah refinery.

These crude supply agreements contain force majeure provisions that excuse
the performance by either party of its obligations under the agreement
under specified circumstances. PDVSA invoked the force majeure provisions
and reduced the volume of crude oil supplied under the contracts in April
1998, from February 1999 through October 2000 and from February 2001
through March 2003. As a result of these declarations of force majeure,
the Company was required to obtain crude oil from alternative sources,
which resulted in increased volatility in its operating margins. The
Company was notified that effective March 6, 2003, PDVSA ended its most
recent declaration of force majeure under the crude oil supply agreements.

In August 2002, three affiliates entered into agreements to advance excess
cash to the Company from time to time under demand notes for amounts of up
to a maximum of $10 million with PDV Texas, Inc. ("PDV Texas"), $30
million with PDV America and $10 million with PDV Holding. The notes bear
interest at rates equivalent to 30-day LIBOR plus .875% payable quarterly.
Amounts outstanding on these notes at December 31, 2002 were $5 million,
$30 million and $4 million from PDV Texas, PDV America and PDV Holding,
respectively. At June 30, 2003, there was no outstanding balance on these
notes.

9. INSURANCE RECOVERIES

On August 14, 2001, a fire occurred at the crude oil distillation unit of
the Lemont refinery. The crude unit was destroyed and the refinery's other
processing units were temporarily taken out of production. A new crude
unit was operational at the end of May 2002.

On September 21, 2001, a fire occurred at the hydrocracker unit of the
Lake Charles refinery. The hydrocracker unit was damaged and operations at
other processing units were temporarily affected. Operation of the other
refinery units returned to normal on October 16, 2001. Operations at the
hydrocracker resumed on November 22, 2001.

The Company recognizes property damage insurance recoveries in excess of
the amount of recorded losses and related expenses, and business
interruption insurance recoveries when such amounts are realized. During
the three-month periods ended June 30, 2003 and 2002, the Company recorded
$27 million and $116 million, respectively, of insurance recoveries
primarily related to these fires. During the six-month periods ended June
30, 2003 and 2002, the Company recorded $144 million and $211 million,
respectively, of insurance recoveries primarily related to these fires.
The Company received cash proceeds of $79 million and $142 million during
the three-month periods ended June 30, 2003 and 2002. The Company received
cash proceeds of $126 million and $243 million during the six-month
periods ended June 30, 2003 and 2002. At June 30, 2003, the Company had a
receivable balance of approximately $19 million related to insurance
recoveries associated with the Lemont fire. In July 2003, the Company
received this final payment of approximately $19 million.

16

10. SUBSEQUENT EVENTS

On July 25, 2003, CITGO made a $500 million dividend payment for the
purpose of enabling its parent, PDV America, to make the principal payment
on their $500 million, 7-7/8% senior notes due August 1, 2003. CITGO's
$550 million, 11-3/8% senior notes due 2011 have certain minimum liquidity
requirements for payment of such a dividend and CITGO was in compliance
with those requirements on July 25, 2003.

A maximum of $200 million in accounts receivable may be sold at any one
time under the accounts receivable sales facility. On August 1, 2003, $200
million of trade receivables were sold under this facility.

On August 1, 2003, CITGO repurchased approximately $28 million of
tax-exempt industrial revenue bonds as a result of the loss of letter of
credit support. These tax-exempt bonds are now held as company bonds and
may be reissued, with replacement letter of credit in support, if we are
able to obtain such letters of credit from other financial institutions
or, alternatively, the tax-exempt bonds may be reissued with new
tax-exempt bonds that will not require letter of credit support.

17

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

This discussion of our financial condition and results of operations
should be read in conjunction with our unaudited condensed consolidated
financial statements included elsewhere in this report. We also direct your
attention to our Form 10-K annual report for our fiscal year ended December 31,
2002, for additional information and a description of critical accounting
policies and factors that may cause substantial fluctuations in our earnings and
cash flows.

We generated net income of $108.7 million on total revenue of $6.1
billion in the quarter ended June 30, 2003 compared to a net income of $96.3
million on total revenue of $4.9 billion for the same period last year. We
generated net income of $248.5 million on revenue of $12.6 billion in the six
months ended June 30, 2003 compared to net income of $80.7 million on total
revenue of $8.7 billion for the same period last year. (See "Gross margin").

RESULTS OF OPERATIONS

The following table summarizes the sources of our sales revenues and
sales volumes for the three-month and six-month periods ended June 30, 2003 and
2002:

CITGO SALES REVENUES AND VOLUMES

18

The following table summarizes our cost of sales and operating expenses
for the three-month and six-month periods ended June 30, 2003 and 2002:

CITGO COST OF SALES AND OPERATING EXPENSES

Sales revenues and volumes. Sales increased $1.2 billion, or
approximately 26%, in the three-month period ended June 30, 2003 as compared to
the same period in 2002. This increase was due to an increase in average sales
price of 9% and an increase in sales volume of 15%. The change in sales volume
was principally the result of increased sales of gasoline and diesel fuel. Sales
increased $3.9 billion, or approximately 46%, in the six-month period ended June
30, 2003. This increase was due to an increase in average sales price of 30% and
an increase in refined product sales volume of 12%. (See CITGO Sales Revenues
and Volumes table above.)

Equity in earnings of affiliates. Equity in earnings of affiliates
increased by $600 thousand for the three-month period ended June 30, 2003 and
decreased $4.7 million for the six-month period ended June 30, 2003 as compared
to the same period in 2002. The decrease in the six-month period was primarily
due to the decrease in the earnings of LYONDELL-CITGO, our share of which
decreased $7 million. The decrease in LYONDELL-CITGO's earnings was primarily
due to the write-off of refinery project costs and higher fuel costs offset in
part by higher margins during the first six-months of 2003. This decrease was
offset by the increase in the earnings of The Needle-Coker Company, our share of
which increased $2 million.

Insurance recoveries. The insurance recoveries of $27 million included
in the three months ended June 30, 2002 and $144 million included in the six
months ended June 30, 2003 relate primarily to a fire which occurred on August
14, 2001 at the Lemont refinery. The crude unit was destroyed and the refinery's
other processing units were temporarily taken out of production. These
recoveries are, in part, reimbursements for expenses incurred in 2002 and 2001
to mitigate the effect of the fire on our earnings. In July 2003, we received
the final payment of approximately $19 million.

Cost of sales and operating expenses. Cost of sales and operating
expenses increased by $1.1 billion or 24%, in the quarter ended June 30, 2003 as
compared to the same period in 2002. Cost of sales and operating expenses
increased by $3.6 billion or 43%, in the six months ended June 30, 2003 as
compared to the same period in 2002. (See CITGO Cost of Sales and Operating
Expenses table above.)

We purchase refined products to supplement the production from our
refineries to meet marketing demands and resolve logistical issues. Refined
product purchases represented 57% and 54% of total cost of sales and operating
expenses for the second quarter of 2003 and 2002, respectively and 57% and 56%
for the six-months of 2003 and 2002, respectively. We estimate margins on
purchased products, on average, are lower than margins on

19

produced products due to the fact that we can only receive the marketing portion
of the total margin received on the produced refined products. However,
purchased products are not segregated from our produced products and margins may
vary due to market conditions and other factors beyond our control. As such, it
is not practical to measure the effects on profitability of changes in volumes
of purchased products. In the near term, other than normal refinery turnaround
maintenance, we do not anticipate operational actions or market conditions which
might cause a material change in anticipated purchased product requirements;
however, there could be events beyond our control which impact the volume of
refined products purchased. (See also "Factors Affecting Forward Looking
Statements".)

Gross margin. The gross margin for the three-month period ended June
30, 2003 was approximately 3.0 cents per gallon, compared to approximately 1.7
cents per gallon for the same period in 2002. The gross margin for the six-month
period ended June 30, 2003 was approximately 2.8 cents per gallon, compared to
approximately 0.6 cents per gallon for the same period in 2002. The revenue per
gallon component in the three-month period ended June 30, 2003 increased
approximately 9% and the cost per gallon component increased approximately 8%.
As a result, the gross margin increased approximately 1.3 cents on a per gallon
basis in the quarter ended June 30, 2003 compared to the same period in 2002. In
the six-month period ended June 30, 2003, the revenue per gallon component
increased approximately 30% and the cost per gallon component increased
approximately 27%. As a result, the gross margin increased approximately 2.2
cents on a per gallon basis in the six month ended June 30, 2003 compared to the
same period in 2002. The gross margin is directly affected by changes in selling
prices relative to changes in costs. An increase or decrease in the price for
crude oil, feedstocks and blending products generally results in a corresponding
increase or decrease in prices for refined products. Generally, the effect of
changes in crude oil and feedstock prices on our consolidated operating results
therefore depends in part on how quickly refined product prices adjust to
reflect these changes. However, in the first half of 2002, there was a
substantial decrease in sales price without an equivalent decrease in refined
product costs resulting in a significant negative impact on our gross margin and
earnings.

Selling, general and administrative expenses. Selling, general and
administrative expenses decreased 15% from $75 million in the second quarter of
2002 to $64 million in the second quarter of 2003. Selling, general and
administrative expenses decreased 9% from $151 million in the first six months
of 2002 to $137 million in the same period in 2003. The decrease in selling,
general and administrative expenses is related primarily to a decrease in legal
and related expenses and settlements during the six-month period ended June 30,
2003.

Interest expense. Interest expense increased by $15 million in the
three-month period ended June 30, 2003 and increased $22 million in the
six-month period ended June 30, 2003 as compared to the same period in 2002.
This was primarily due to the net increase in the outstanding debt balance and
higher overall interest rates resulting from the issuance of the $550 million
senior notes and the closing of the $200 million secured term loan in February
2003.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated net cash provided by operating activities totaled
approximately $327 million for the six-month period ended June 30, 2003.
Operating cash flows were derived primarily from net income of $249 million,
depreciation and amortization of $163 million, distributions in excess of equity
in earnings of affiliates of $82 million, increase in deferred taxes of $64
million, and changes in operating assets and liabilities of $(248) million. The
more significant changes in operating assets and liabilities include an increase
in notes and accounts receivable and a decrease in current liabilities offset,
in part, by a decrease in inventory.

20

Net cash used in investing activities in the six month period ended
June 30, 2003 totaled $225 million consisting primarily of capital expenditures
of $209 million. These capital expenditures consisted of:

Net cash provided by financing activities totaled $111 million for the
six-month period ended June 30, 2003, consisting primarily of the proceeds from
our 11-3/8% senior notes due in 2011 of $547 million and the proceeds from our
senior secured term loan of $200 million. These proceeds were offset by the
payment of $279 million on revolving bank loans; the repurchase of $50 million
of our 7-7/8% senior notes due 2006 for a cash payment of $47.5 million; the
payment of $50 million on master shelf agreement notes; the repurchase of $98
million of tax-exempt bonds; the repurchase of $90 million of taxable bonds; the
repayment of loans from affiliates of $39 million; $19 million in debt issuance
costs associated with the 11-3/8% senior notes due 2011, the senior secured term
loan, and the repurchase of taxable and tax-exempt bonds; and capital lease
payments of $12 million.

As of June 30, 2003, capital resources available to us included cash on
hand totaling $246 million generated by operations and other sources, and
available borrowing capacity under our committed bank facilities of $518
million. Our Company's management believes that we have sufficient capital
resources to carry out planned capital spending programs, including regulatory
and environmental projects in the near term and to meet currently anticipated
future obligations as they arise. We periodically evaluate other sources of
capital in the marketplace and anticipate that long-term capital requirements
will be satisfied with current capital resources and future financing
arrangements, including the issuance of debt securities. Our ability to obtain
such financing will depend on numerous factors, including market conditions and
our perceived creditworthiness at that time. (See also "Factors Affecting
Forward Looking Statements".)

Our various debt instruments require maintenance of a specified minimum
net worth and impose restrictions on our ability to:

o incur additional debt unless we meet specified interest coverage and
debt to capitalization ratios;

o place liens on our property, subject to specified exceptions;

o sell assets, subject to specified exceptions;

o make restricted payments, including dividends, repurchases of capital
stock and specified investments; and

o merge, consolidate or transfer assets.

We are in compliance with our covenants under our debt financing
arrangements at June 30, 2003.

21

Upon the occurrence of a change of control of our Company, as defined
in the Indenture governing our 11-3/8% senior notes due 2011, the holders of
those notes have the right to require us to repurchase them at a price equal to
101% of the principal amount plus accrued interest. In addition, our bank credit
agreements provide that, unless lenders holding two-thirds of the commitments
thereunder otherwise agree, a change in control of our Company, as defined in
those agreements, will constitute a default under those credit agreements.

Internally generated cash flow, together with borrowings available
under our credit facilities, are expected to be sufficient to fund capital
expenditures during the remainder of 2003. In addition, we have taken steps to
reduce our capital expenditures in 2003 by approximately $250 million, resulting
in budgeted total 2003 expenditures of $460 million, and will reassess the
economics of the postponed projects at a later date. We accomplished this
reduction in capital expenditures by authorizing no new discretionary spending
for 2003, suspending discretionary projects already underway where practical and
delaying maintenance and regulatory projects. In addition, two major refinery
maintenance turnarounds were delayed past 2003 so capital spending for these
projects was also delayed. Of the $250 million spending reduction, 60% was
discretionary, 27% was maintenance of the business and 13% was regulatory. The
regulatory and maintenance of the business projects will be completed under a
delayed schedule. Discretionary spending will be restarted as funds become
available. Finally, we are continuing to review the timing and amount of
scheduled expenditures under our planned capital spending programs, including
regulatory and environmental projects in the near term.

CITGO is required by various state regulations to demonstrate financial
responsibility for environmental liability coverage, closure and post-closure
care related to its facilities. Historically, CITGO has satisfied the
requirements based upon the credit rating of its bonds and various financial
ratios. CITGO's credit rating and 2002 financial ratios did not satisfy the
requirements of Louisiana. We have filed a request for a variance from the
Louisiana regulations and are awaiting the state's response.

We have outstanding letters of credit that support taxable and
tax-exempt bonds that were issued previously for our benefit. Some of the
providers of these outstanding letters of credit have indicated that they will
not renew such letters of credit. As a result, in 2003 through June 30, we
repurchased $90 million of taxable bonds and $138 million of tax-exempt bonds
that were supported by these letters of credit. We expect that we will seek to
reissue these bonds, with replacement letters of credit in support, if we are
able to obtain such letters of credit from other financial institutions or,
alternatively, we will seek to replace these bonds with new bonds that will not
require letter of credit support. As of August 1, 2003, we have an additional
$61 million of letters of credit outstanding that back or support other bond
issues that we have issued through governmental entities, which are subject to
renewal during the period ending June 30, 2004. We have not received any notice
from the issuers of these additional letters of credit indicating an intention
not to renew. We cannot be certain that any of our letters of credit will be
renewed, that we will be successful in obtaining replacements if they are not
renewed, that any replacement letters of credit will be on terms as advantageous
as those we currently hold or that we will be able to arrange for replacement
bonds that will not require letter of credit support. To the extent that issuers
of these letters of credit do not renew, the Company is not successful in
obtaining replacements if they are not renewed, or that the Company is not
successful in arranging for replacement bonds that will not require letter of
credit support, this will increase the Company's cash needs and reduce its
liquidity. We believe that we have and will continue to have sufficient
liquidity to accommodate any of these potential outcomes.

In August 2002, three of our affiliates entered into agreements to
advance excess cash to us from time to time under demand notes. These notes
provide for maximum amounts of $10 million from PDV Texas, $30 million from PDV
America and $10 million from PDV Holding. Amounts outstanding on these notes at
December 31, 2002 were $5 million, $30 million and $4 million from PDV Texas,
PDV America and PDV Holding, respectively. At June 30, 2003, there was no
outstanding balance on these notes.

22

Our senior unsecured debt ratings, as currently assessed by the three
major debt rating agencies, are as follows:

Moody's Investor's Services Ba3
Standard & Poor's Ratings Group BB
Fitch Investors Services, Inc. BB-

On May 9, 2003, Standard & Poor's Ratings Group ("S&P") upgraded our
senior unsecured debt rating to BB-. S&P upgraded our senior unsecured debt
rating to BB on July 31, 2003 and Fitch Investors Services, Inc. ("Fitch")
upgraded our senior unsecured debt rating to BB- on August 8, 2003.

Our secured debt ratings, as currently assessed by the three major debt
rating agencies, are as follows:

Moody's Investor's Services Ba2
Standard & Poor's Ratings Group BB+
Fitch Investors Services, Inc. BB+

On May 9, 2003, S&P upgraded our secured debt rating to BB. S&P
upgraded our secured debt rating to BB+ on July 31, 2003 and Fitch upgraded our
secured debt rating to BB+ on August 8, 2003.

On February 28, 2003, a new accounts receivable sales facility was
established. This facility allows for the non-recourse sale of certain accounts
receivable to independent third parties. A maximum of $200 million in accounts
receivable may be sold at any one time. The amounts sold under this facility
vary on a daily basis. On August 11, 2003, $200 million of trade receivables
were sold under the facility.

On July 25, 2003 we made a $500 million dividend payment for the
purpose of enabling our parent, PDV America to make the principal payment on
$500 million, 7-7/8% senior notes due August 1, 2003. Our $550 million, 11-3/8%
senior notes due 2011 have certain minimum liquidity requirements for payment of
such a dividend and we were in compliance with those requirements on July 25,
2003. Our liquidity after the dividend on July 25, 2003, was $526 million,
comprised of $518 million in available capacity under our revolving credit
facilities and $8 million in cash on hand.

Our debt instruments do not contain any covenants that trigger
increased costs or burdens as a result of a change in our securities ratings.
However, certain of our guarantee agreements, which support approximately $20
million of PDV Texas, an affiliate, letters of credit, require us to cash
collateralize the applicable letters of credit upon a reduction of our credit
rating below a stated level.

We believe that we have adequate liquidity from existing sources to
support our operations for the foreseeable future. We are continuing to review
our operations for opportunities to reduce operating and capital expenditures.

NEW ACCOUNTING STANDARDS

On January 1, 2003 we adopted Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143)
which addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the retirement
of long-lived assets that result from the acquisition, construction, development
and/or the normal operation of a long-lived asset, except for certain
obligations of lessees. We have identified certain asset retirement obligations
that are within the scope of the standard, including obligations imposed by
certain state laws pertaining to closure and/or removal of storage tanks,
contractual removal obligations included in certain easement and right-of-way
agreements associated with our

23

pipeline operations, and contractual removal obligations relating to a refinery
processing unit located within a third-party entity's facility. We cannot
currently determine a reasonable estimate of the fair value of our asset
retirement obligations due to the fact that the related assets have
indeterminate useful lives which preclude development of assumptions about the
potential timing of settlement dates. Such obligations will be recognized in the
period in which sufficient information exists to estimate a range of potential
settlement dates. Accordingly, the adoption of SFAS No. 143 did not impact our
financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"), which clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46
defines variable interest entities and how an enterprise should assess its
interests in a variable interest entity to decide whether to consolidate that
entity. The interpretation requires certain minimum disclosures with respect to
variable interest entities in which an enterprise holds significant variable
interest but which it does not consolidate. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15, 2003
to variable interest entities in which an enterprise holds a variable interest
that it acquired before February 1, 2003. FIN 46 applies to public enterprises
as of the beginning of the applicable interim or annual period, and it applies
to nonpublic enterprises as of the end of the applicable annual period. FIN 46
may be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated. We expect that the application of FIN 46
to variable interest entities in which we acquired an interest before February
1, 2003 will not have a material impact on our financial position or results of
operations.

In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS No. 149"). The changes in SFAS No. 149 improve
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. Those changes will result in more consistent
reporting of contracts as either derivatives or hybrid instruments. SFAS No. 149
is effective for contracts entered into or modified after June 30, 2003, except
for certain issues from SFAS No. 133 which have been effective for fiscal
quarters that began prior to June 15, 2003 and for hedging relationships
designated after June 30, 2003. In addition, all provisions of SFAS No. 149
should be applied prospectively. We have not yet determined the impact of the
adoption of SFAS No. 149 on our financial position or results of operations.

PROPOSED ACCOUNTING CHANGE

The American Institute of Certified Public Accountants ("AICPA") has
issued a "Statement of Position" exposure draft on cost capitalization that is
expected to require companies to expense the non-capital portion of major
maintenance costs as incurred. The statement is expected to require that any
existing unamortized deferred non-capital major maintenance costs be expensed
immediately. This statement also has provisions which will change the method of
determining depreciable lives. The impact on future depreciation expense is not
determinable at this time. The exposure draft indicates that the effect of
expensing existing unamortized deferred non-capital major maintenance costs will
be reported as a cumulative effect of an accounting change in the consolidated
statement of income. The final accounting requirements are not known at this
time. Currently, adoption is not expected to be required before fiscal years
beginning after December 15, 2004. At June 30, 2003, we have included turnaround
costs of $186 million in other assets. Our management has not determined the
amount, if any, of these costs that could be capitalized under the provisions of
the exposure draft.

24

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Introduction. We have exposure to price fluctuations of natural gas,
crude oil, feedstocks, and refined products as well as fluctuations in interest
rates. To manage these exposures, our management has authorized the use of
commodity derivatives in a Risk Management Program. We do not attempt to manage
the price risk related to all of our inventories and fixed forward commitments.
As a result at June 30, 2003, we were exposed to the risk of broad market price
movements with respect to a substantial portion of our current and anticipated
commodity needs. We have at least 30 million barrels of current inventory and
fixed forward price contracts at price risk on any given day. In addition, we
have price risk on purchasing 1.8 trillion Btu of natural gas every month. As of
June 30, 2003 aggregate commodity derivative positions entered into for price
risk management purposes totaled 2.4 million barrels and 3.3 trillion Btu.

Commodity Instruments. We balance our crude oil and petroleum product
supply/demand and manage a portion of our price risk by entering into petroleum
commodity derivatives. Generally, our risk management strategies qualified as
hedges through December 31, 2000. Effective January 1, 2001, our policy is to
elect hedge accounting only under limited circumstances involving derivatives
with initial terms of 90 days or greater and notional amounts of $25 million or
greater. At June 30, 2003, none of our commodity derivatives were accounted for
as hedges.

NON TRADING COMMODITY DERIVATIVES
OPEN POSITIONS AT JUNE 30, 2003

- ----------

(1) 1,000 barrels per contract

(2) Ten-thousands of mmbtu per contract

(3) Floating price based on market index designated in contract; fixed price
agreed upon at date of contract

(4) Pay floating price based on a market index designated in contract; receive
floating price based on a different market index designated in contract

(5) Based on actively quoted prices

26

Debt Related Instruments. We have fixed and floating U.S. currency
denominated debt. We use interest rate swaps to manage our debt portfolio toward
a benchmark of 40 to 70 percent fixed rate debt to total fixed and floating rate
debt. These instruments have the effect of changing the interest rate with the
objective of minimizing our long-term costs. At June 30, 2003 and 2002, our
primary exposures were to LIBOR and floating rates on tax exempt bonds.

For interest rate swaps, the table below presents notional amounts and
interest rates by expected (contractual) maturity dates. Notional amounts are
used to calculate the contractual payments to be exchanged under the contracts.

NON TRADING INTEREST RATE DERIVATIVES
OPEN POSITIONS AT JUNE 30, 2003 AND 2002

Changes in the fair value of these agreements are recorded in other
income (expense). The fair value of the interest rate swap agreements in place
at June 30, 2003, based on the estimated amount that we would receive or pay to
terminate the agreements as of that date and taking into account current
interest rates, was a loss of $3 million, the offset of which is recorded in the
balance sheet caption other current liabilities.

27

For debt obligations, the table below presents principal cash flows and
related weighted average interest rates by expected maturity dates. Weighted
average variable rates are based on implied forward rates in the yield curve at
the reporting date.

DEBT OBLIGATIONS
AT JUNE 30, 2003

DEBT OBLIGATIONS
AT JUNE 30, 2002

28

ITEM 4. CONTROLS AND PROCEDURES

During the second quarter of 2003, the Company's management, including the
principal executive officer and principal financial officer, evaluated the
Company's disclosure controls and procedures related to the recording,
processing, summarization and reporting of information in the Company's periodic
reports that it files with the Securities and Exchange Commission ("SEC"). These
disclosure controls and procedures have been designed to ensure that (a)
material information relating to the Company, including its consolidated
subsidiaries, is made known to the Company's management, including these
officers, by other employees of the Company and its subsidiaries, and (b) this
information is recorded, processed, summarized, evaluated and reported, as
applicable, within the time periods specified in the SEC's rules and forms. Due
to the inherent limitations of control systems, not all misstatements may be
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The Company's controls and procedures can only provide
reasonable, not absolute, assurance that the above objectives have been met.
Also, the Company does not control or manage certain of its unconsolidated
entities and as such, the disclosure controls and procedures with respect to
such entities are more limited than those it maintains with respect to its
consolidated subsidiaries.

As of June 30, 2003, these officers concluded that the design of the
disclosure controls and procedures provide reasonable assurance that they can
accomplish their objectives.

There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.

29

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The required information is incorporated by reference into Part II of this
Report from Note 7 of the Notes to the Condensed Consolidated Financial
Statements included in Part I of this Report.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the
Securities Exchange Act of 1934 as to the Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2003 filed by the
following officers:

31.1 Filed by Luis Marin, President and Chief Executive Officer.
31.2 Filed by Eddie R. Humphrey, Chief Financial Officer.

Certifications Pursuant to Section 1350 of Chapter 63 of Title 18
United States Code as to the Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2003 filed by the following
officers:

32.1 Filed by Luis Marin, President and Chief Executive Officer.
32.2 Filed by Eddie R. Humphrey, Chief Financial Officer.

(b) Reports on Form 8-K:

A report on Form 8-K was filed with the Securities and Exchange
Commission on June 30, 2003 in regard to the selection of KPMG LLP as the
independent accountant of CITGO.

A report on Form 8-K/A was filed with the Securities and Exchange
Commission on July 7, 2003 to amend the information in our report on Form
8-K filed June 30, 2003.

A report on Form 8-K was filed with the Securities and Exchange
Commission on July 7, 2003 in regard to the selection of KPMG LLP as the
independent accountant of CITGO.

A report on Form 8-K was filed with the Securities and Exchange
Commission on July 11, 2003 in regard to the appointment of Luis Marin as
President and Chief Executive Officer of CITGO.

A report on Form 8-K was filed with the Securities and Exchange
Commission on August 6, 2003 in regard to our Company's July 25, 2003
dividend payment of $500 million for the purpose of enabling our parent,
PDV America, Inc. to make the principal payment on $500 million, 7-7/8%
senior notes due August 1, 2003.

A report on Form 8-K was filed with the Securities and Exchange
Commission on August 8, 2003. The purpose of this report was to furnish
information included in our News Release, announcing that we postponed our
second quarter earnings conference call.

30

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.

CITGO PETROLEUM CORPORATION

Date: August 18, 2003 /s/ Larry E. Krieg
---------------- -------------------------------------
Larry E. Krieg
Controller (Chief Accounting Officer)

31

EXHIBIT INDEX