**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 or 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |   |
|------------|--------|----------------------------------------------------------------------------------------------------|--------|

 

**For the quarterly period endedMarch 31, 2004**

 

**OR**

 

| **o** |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |   |
|-------|--------|-----------------------------------------------------------------------------------------------------|--------|

 

**For the transition period from                   to                   **

 

**Commission File Number 001-14841**

 

**MARKWEST HYDROCARBON, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                     |   | **84-1352233**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS Employer  Identification No.) |

 

**155 Inverness Drive West, Suite 200,Englewood, CO  80112-5000**

(Address of principal executive offices)

 

Registrant’s telephone number, including area code:**  303-290-8700**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes   ý     No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).

Yes   o     No ý

 

The registrant had9,694,100 shares of common stock, $.01 per share par value, outstanding as ofApril 30, 2004.

 

 

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| **PART I—FINANCIAL INFORMATION**                                                                           |   |
|-----------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                            |   |
| Item 1.  Consolidated Financial Statements                                                                 |   |
| Consolidated  Balance Sheets at March 31, 2004 and December 31, 2003                                  |   |
| Consolidated  Statements of Operations for the Three Months Ended March 31, 2004 and  2003                 |   |
| Consolidated  Statements of Other Comprehensive Income for the Three Months Ended March 31,  2004 and 2003 |   |
| Consolidated Statements of  Cash Flows for the Three Months Ended March 31, 2004 and 2003                  |   |
| Consolidated  Statement of Changes in Stockholders’ Equity for the Three Months Ended  March 31, 2004 |   |
| Notes  to the Consolidated Financial Statements                                                                 |   |
|                                                                                                            |   |
| Item 2.   Management’s Discussion and Analysis of Financial Condition and  Results of Operations      |   |
| Item  3.  Quantitative and Qualitative  Disclosures about Market Risk                                      |   |
| Item 4.   Controls and Procedures                                                                          |   |
|                                                                                                            |   |
| **PART II—OTHER INFORMATION**                                                                              |   |
|                                                                                                            |   |
| Item 1.  Legal Proceedings                                                                                 |   |
| Item 6.  Exhibits and Reports on Form 8-K                                                                  |   |
|                                                                                                            |   |
| **SIGNATURE**                                                                                                   |   |

 
| **Glossary  of Terms** |
|------------------------|
|                   |   |
| Bbl/d                  | barrels of oil per day |
| Btu                    | British thermal units,  an energy measurement |
| Gal/d                  | gallons per day |
| Gross margin           | revenues less purchased  product costs |
| Mcf                    | thousand cubic feet of  natural gas |
| Mcf/d                  | thousand cubic feet of  natural gas per day |
| MMBtu                  | million British thermal  units, an energy measurement |
| MMcf                   | million cubic feet of  natural gas |
| MMcf/d                 | million cubic feet of  natural gas per day |
| NGL                    | natural gas liquids,  such as propane, butanes and natural gasoline |

 

----

 

## **PART I—FINANCIAL INFORMATION**

 

## **Item 1. Consolidated Financial Statemen**ts

 

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(UNAUDITED)**

**(inthousands, except share and per share data)**

 
|                                                                                                                                                     |   | **March 31,  2004** |    | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
| **ASSETS**                                                                                                                                               |   |                     |    |                        |   |
| Current  assets:                                                                                                                                         |   |                     |    |                        |   |
| Cash  and cash equivalents                                                                                                                               |   | $                        | 49,115  |                        | $      | 42,144 |   |
| Restricted  cash                                                                                                                                         |   | 2,500                    |    | 2,500                       |   |
| Marketable  securities                                                                                                                                   |   | 4,430                    |    | —                      |   |
| Receivables,  net (including related party receivables of $56 and $40, respectively, and  allowance for doubtful accounts of $84 and $120, respectively) |   | 24,751                   |    | 30,750                      |   |
| Inventories                                                                                                                                              |   | 1,448                    |    | 4,815                       |   |
| Prepaid  replacement natural gas                                                                                                                         |   | 15                       |    | 5,940                       |   |
| Deferred  income taxes                                                                                                                                   |   | 230                      |    | 603                         |   |
| Other  current assets                                                                                                                                    |   | 1,047                    |    | 503                         |   |
| Total  current assets                                                                                                                                    |   | 83,536                   |    | 87,255                      |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Property,  plant and equipment                                                                                                                           |   | 234,756                  |    | 232,257                     |   |
| Less:  accumulated depreciation, depletion, amortization and impairment                                                                                  |   | (47,432                  | )       | (44,134                     | )      |
| Total  property, plant and equipment, net                                                                                                                |   | 187,324                  |    | 188,123                     |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Other  assets:                                                                                                                                           |   |                     |    |                        |   |
| Intangible  assets, net                                                                                                                                  |   | 3,507                    |    | 3,831                       |   |
| Deferred  offering costs                                                                                                                                 |   | —                   |    | 1,037                       |   |
| Investment  in and advances to equity investee                                                                                                           |   | 245                      |    | 250                         |   |
| Note  receivables from officers                                                                                                                          |   | 207                      |    | 217                         |   |
| Other  assets                                                                                                                                            |   | 65                       |    | —                      |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Total  assets                                                                                                                                            |   | $                        | 274,884 |                        | $      | 280,713 |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                           |   |                     |    |                        |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Current  liabilities:                                                                                                                                    |   |                     |    |                        |   |
| Accounts  payable (including related party payables of $48 and $51, respectively)                                                                        |   | $                        | 22,893  |                        | $      | 24,052 |   |
| Accrued  liabilities                                                                                                                                     |   | 14,284                   |    | 16,751                      |   |
| Risk  management liability                                                                                                                               |   | 747                      |    | 1,769                       |   |
| Total  current liabilities                                                                                                                               |   | 37,924                   |    | 42,572                      |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Deferred  income taxes                                                                                                                                   |   | 7,048                    |    | 6,346                       |   |
| Long-term  debt                                                                                                                                          |   | 84,200                   |    | 126,200                     |   |
| Risk  management liability                                                                                                                               |   | 154                      |    | 125                         |   |
| Other  long-term liabilities                                                                                                                             |   | 504                      |    | 504                         |   |
| Non-controlling  interest in consolidated subsidiary                                                                                                     |   | 94,797                   |    | 52,782                      |   |
| Commitments  and contingencies                                                                                                                           |   |                     |    |                        |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Stockholders’  equity:                                                                                                                              |   |                     |    |                        |   |
| Preferred  stock, par value $0.01, 5,000,000 shares authorized, no shares outstanding                                                                    |   | —                   |    | —                      |   |
| Common  stock, par value $0.01, 20,000,000 shares authorized, 9,756,379 and 9,637,977  shares issued, respectively                                       |   | 98                       |    | 96                          |   |
| Additional  paid-in capital                                                                                                                              |   | 51,730                   |    | 50,715                      |   |
| Accumulated  earnings (deficit)                                                                                                                          |   | (329                     | )       | 3,676                       |   |
| Accumulated  other comprehensive loss, net of tax                                                                                                        |   | (768                     | )       | (1,793                      | )      |
| Treasury  stock, 71,328 and 75,930 shares, respectively                                                                                                  |   | (474                     | )       | (510                        | )      |
| Total  stockholders’ equity                                                                                                                         |   | 50,257                   |    | 52,184                      |   |
|                                                                                                                                                     |   |                     |    |                        |   |
| Total  liabilities and stockholders’ equity                                                                                                         |   | $                        | 274,884 |                        | $      | 280,713 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

1

----

 

**MARKWESTHYDROCARBON, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(UNAUDITED)**

**(in thousands, except per share data)**

 
|                                                                                                                                              |   | **Three  Months Ended****March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                              |   | **2004**                                  |   | **2003** |   |
|                                                                                                                                              |   |                                      |   |   |   |
| Revenues                                                                                                                                          |   | $                                         | 93,426 |   | $ | 50,651 |   |
|                                                                                                                                              |   |                                      |   |   |   |
| Operating  expenses:                                                                                                                              |   |                                      |   |   |   |
| Purchased  product costs                                                                                                                          |   | 75,135                                    |   | 46,003 |   |
| Facility  expenses                                                                                                                                |   | 5,975                                     |   | 4,362 |   |
| Selling,  general and administrative expenses                                                                                                     |   | 4,268                                     |   | 2,550 |   |
| Depreciation                                                                                                                                      |   | 3,458                                     |   | 1,530 |   |
| Total  operating expenses                                                                                                                         |   | 88,836                                    |   | 54,445 |   |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) from operations                                                                                                                    |   | 4,590                                     |   | (3,794 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Other  income (expense):                                                                                                                          |   |                                      |   |   |   |
| Interest  expense, net                                                                                                                            |   | (1,358                                    | )      | (1,063 | ) |
| Non-controlling  interest in net income of consolidated subsidiary                                                                                |   | (1,693                                    | )      | (874 | ) |
| Other  income (expense)                                                                                                                           |   | 62                                        |   | (15 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) before income taxes                                                                                                                |   | 1,601                                     |   | (5,746 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Provision  (benefit) for income taxes:                                                                                                            |   |                                      |   |   |   |
| Current                                                                                                                                           |   | 115                                       |   | (170 | ) |
| Deferred                                                                                                                                          |   | 512                                       |   | (2,281 | ) |
| Provision  (benefit) for income taxes                                                                                                             |   | 627                                       |   | (2,451 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) from continuing operations                                                                                                         |   | 974                                       |   | (3,295 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) from discontinued exploration and production operations (net of income  tax benefit of $104 and provision of $1,229, respectively) |   | (177                                      | )      | 2,282 |   |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) before cumulative effect of accounting change                                                                                      |   | 797                                       |   | (1,013 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Cumulative  effect of change in accounting for asset retirement obligations, net of tax                                                           |   | —                                    |   | (29 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Net  income (loss)                                                                                                                                |   | $                                         | 797    |   | $ | (1,042 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Income  (loss) from continuing operations per share:                                                                                              |   |                                      |   |   |   |
| Basic                                                                                                                                             |   | $                                         | 0.10   |   | $ | (0.35 | ) |
| Diluted                                                                                                                                           |   | $                                         | 0.10   |   | $ | (0.35 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Net  income (loss) per share:                                                                                                                     |   |                                      |   |   |   |
| Basic                                                                                                                                             |   | $                                         | 0.08   |   | $ | (0.11 | ) |
| Diluted                                                                                                                                           |   | $                                         | 0.08   |   | $ | (0.11 | ) |
|                                                                                                                                              |   |                                      |   |   |   |
| Weighted  average number of outstanding shares of common stock:                                                                                   |   |                                      |   |   |   |
| Basic                                                                                                                                             |   | 9,615                                     |   | 9,362 |   |
| Diluted                                                                                                                                           |   | 9,632                                     |   | 9,365 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

2

----

 

**MARKWESTHYDROCARBON, INC.**

**CONSOLIDATED STATEMENTS OF OTHER COMPREH****ENSIVEINCOME**

**(UNAUDITED)**

**(in thousands)**

 
|                                            |   | **Three  Months Ended****March 31,** |   |
|-------------------------------------------------|--------|-------------------------------------------|--------|
|                                            |   | **2004**                                  |   | **2003** |   |
|                                            |   |                                      |   |   |   |
| Net  income (loss)                              |   | $                                         | 797    |   | $ | (1,042 | ) |
|                                            |   |                                      |   |   |   |
| Other  comprehensive income (loss), net of tax: |   |                                      |   |   |   |
| Foreign  currency translation                   |   | —                                    |   | 2,264 |   |
| Risk  management activities                     |   | 872                                       |   | (393 | ) |
| Marketable  securities                          |   | 153                                       |   | — |   |
| Total  other comprehensive income               |   | 1,025                                     |   | 1,871 |   |
|                                            |   |                                      |   |   |   |
| Comprehensive  income                           |   | $                                         | 1,822  |   | $ | 829 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

----

 

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

**(inthousands)**

 
|                                                                                                                                    |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                                                    |   | **2004**                                |   | **2003** |   |
| **Cash flows from operating activities:**                                                                                               |   |                                    |   |   |   |
| Net  income (loss)                                                                                                                      |   | $                                       | 797    |   | $ | (1,042 | ) |
| Adjustments  to reconcile net income to net cash provided by operating activities:                                                      |   |                                    |   |   |   |
| Cumulative  effect of change in accounting                                                                                              |   | —                                  |   | 29 |   |
| Depreciation,  depletion and amortization                                                                                               |   | 3,640                                   |   | 5,098 |   |
| Gain  from sale of property, plant and equipment                                                                                        |   | (63                                     | )      | — |   |
| Amortization  of deferred financing costs included in interest expense                                                                  |   | 312                                     |   | 309 |   |
| Non-cash  compensation expense                                                                                                          |   | 374                                     |   | 212 |   |
| Equity  in investee losses                                                                                                              |   | 5                                       |   | — |   |
| Non-controlling  interest in net income of consolidated subsidiary                                                                      |   | 1,693                                   |   | 874 |   |
| Derivative  ineffectiveness and non-cash mark-to-market adjustment                                                                      |   | 476                                     |   | (922 | ) |
| Reclassification  of Enron hedges to purchased gas costs                                                                                |   | —                                  |   | (18 | ) |
| Deferred  income taxes                                                                                                                  |   | 455                                     |   | (1,199 | ) |
| Other                                                                                                                                   |   | —                                  |   | 28 |   |
| Changes  in operating assets and liabilities:                                                                                           |   |                                    |   |   |   |
| (Increase)  decrease in receivables                                                                                                     |   | 5,999                                   |   | (3,844 | ) |
| Decrease  in inventories                                                                                                                |   | 3,367                                   |   | 1,124 |   |
| (Increase)  decrease in prepaid expenses and other assets                                                                               |   | 5,925                                   |   | (873 | ) |
| Increase  in other current assets                                                                                                       |   | (544                                    | )      | — |   |
| Increase  (decrease) in accounts payable and accrued liabilities                                                                        |   | (3,574                                  | )      | 9,773 |   |
| Net  cash flow provided by operating activities                                                                                         |   | 18,862                                  |   | 9,549 |   |
|                                                                                                                                    |   |                                    |   |   |   |
| **Cash flows from investing activities:**                                                                                               |   |                                    |   |   |   |
| Increase  in marketable securities                                                                                                      |   | (4,277                                  | )      | — |   |
| Pinnacle  acquisition, net of cash acquired                                                                                             |   | —                                  |   | (38,238 | ) |
| Capital  expenditures                                                                                                                   |   | (2,863                                  | )      | (6,735 | ) |
| Proceeds  from sale of assets                                                                                                           |   | 94                                      |   | 24 |   |
| Other                                                                                                                                   |   | 3                                       |   | — |   |
| Net  cash used in investing activities                                                                                                  |   | (7,043                                  | )      | (44,949 | ) |
|                                                                                                                                    |   |                                    |   |   |   |
| **Cash flows from financing activities:**                                                                                               |   |                                    |   |   |   |
| Proceeds  from long-term debt                                                                                                           |   | —                                  |   | 45,700 |   |
| Repayment  of long-term debt                                                                                                            |   | (42,000                                 | )      | (6,500 | ) |
| Debt  issuance costs                                                                                                                    |   | —                                  |   | (810 | ) |
| Proceeds  from MarkWest Energy Partners’ secondary public offering                                                                 |   | 44,102                                  |   | — |   |
| Distribution  to MarkWest Energy Partners’ unitholders                                                                             |   | (3,054                                  | )      | (1,530 | ) |
| Acquisition  of general partner’s membership interests and MarkWest Energy Partners’  subordinated units from related parties |   | (147                                    | )      | — |   |
| Exercise  of stock options                                                                                                              |   | 1,017                                   |   | — |   |
| Net  issuance of treasury shares                                                                                                        |   | 36                                      |   | (76 | ) |
| Payment  of dividend                                                                                                                    |   | (4,802                                  | )      | — |   |
| Net  cash provided by (used in) financing activities                                                                                    |   | (4,848                                  | )      | 36,784 |   |
|                                                                                                                                    |   |                                    |   |   |   |
| Effect  of exchange rate on changes in cash                                                                                             |   | —                                  |   | 114 |   |
|                                                                                                                                    |   |                                    |   |   |   |
| Net  increase in cash and cash equivalents                                                                                              |   | 6,971                                   |   | 1,498 |   |
|                                                                                                                                    |   |                                    |   |   |   |
| Cash  and cash equivalents at beginning of period                                                                                       |   | 42,144                                  |   | 6,410 |   |
|                                                                                                                                    |   |                                    |   |   |   |
| Cash  and cash equivalents at end of period                                                                                             |   | $                                       | 49,115 |   | $ | 7,908 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

----

 

**MARKWESTHYDROCARBON, INC.**

**CONSOLIDATED STATEMENT OF CHANGES IN****STOCKHOLDERS’ EQUITY**

**(UNAUDITED)**

**(in thousands)**

 
|                            |   | **Shares of  Common  Stock** |   | **Shares of  Treasury  Stock** |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Accumulated  Earnings  (Deficit)** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Treasury  Stock** |   | **Total  Stockholders’  Equity** |   |
|---------------------------------|--------|------------------------------|--------|--------------------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------------------|--------|------------------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Balance, December 31, 2003 |   | 9,638                        |   | (76                            | )      | $                 | 96     |                             | $      | 50,715                               |   | $                                                    | 3,676  |                | $      | (1,793                                | )      | $ | (510 | ) | $ | 52,184 |   |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Stock option exercises          |   | 118                          |   | —                         |   | 2                 |   | 1,015                            |   | —                               |   | —                                               |   | —              |   | 1,017                                 |   |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Dividend                        |   | —                       |   | —                         |   | —            |   | —                           |   | (4,802                               | )      | —                                               |   | —              |   | (4,802                                | )      |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Net income                      |   | —                       |   | —                         |   | —            |   | —                           |   | 797                                  |   | —                                               |   | —              |   | 797                                   |   |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Other comprehensive income      |   | —                       |   | —                         |   | —            |   | —                           |   | —                               |   | 1,025                                                |   | —              |   | 1,025                                 |   |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Net treasury stock reissuances  |   | —                       |   | 5                              |   | —            |   | —                           |   | —                               |   | —                                               |   | 36                  |   | 36                                    |   |
|                            |   |                         |   |                           |   |              |   |                             |   |                                 |   |                                                 |   |                |   |                                  |   |
| Balance, March 31, 2004    |   | 9,756                        |   | (71                            | )      | $                 | 98     |                             | $      | 51,730                               |   | $                                                    | (329   | )                   | $      | (768                                  | )      | $ | (474 | ) | $ | 50,257 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

5

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**MARKWEST HYDROCARBON, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1. General**

 

MarkWest Hydrocarbon,Inc. (“MarkWest Hydrocarbon”, “we”, “us”, “our” or the “Company”) managesMarkWest Energy Partners, L.P. (“MarkWest Energy Partners” or the“Partnership”), a publicly-traded master limited partnership engaged in thegathering, processing and transmission of natural gas; the transportation,fractionation and storage of natural gas liquids (NGLs); and the gathering andtransportation of crude oil.   We alsomarket natural gas and NGLs. MarkWest Hydrocarbon and MarkWest Energy Partnersprovide services primarily in Appalachia, Michigan, and the Southwest.

 

Theconsolidated financial statements include the accounts of MarkWest Hydrocarbonand its subsidiaries, including MarkWest Energy Partners. Throughconsolidation, we have eliminated all significant intercompany accounts andtransactions. We have reclassified certain prior year amounts to conform to thecurrent year’s presentation.

 

Wehave prepared the unaudited financial statements presented herein in accordancewith the instructions to Form 10-Q.  Thestatements do not include all the information and note disclosures required bygenerally accepted accounting principles for complete financial statements.  Please read the interim consolidated financialstatements in conjunction with the Consolidated Financial Statements andattached notes for the year ended December 31, 2003, included in ourAnnual Report on Form 10-K, as filed with the Securities and ExchangeCommission.  In the opinion of management,we have made all necessary adjustments for a fair statement of the results forthe unaudited interim periods.  All saidadjustments are of a recurring nature.

 

Webase the effective corporate tax rate for interim periods on the estimatedannual effective corporate tax rate.

 

**2.****              MarketableSecurities**

 

Marketablesecurities are classified as available-for-sale and stated at market based onthe closing price of the securities at the balance sheet date.  Accordingly, unrealized gains or temporarylosses are reflected in other comprehensive income, net of applicable incometaxes.  For losses that are other thantemporary, the cost basis of the securities is written down to fair value andthe amount of the write down is reflected in the statement of operations. Tocompute realized gains and losses, the Company reduces revenues by its weightedaverage cost basis. Realized gains and losses, and dividend and interestincome, are reflected in earnings.

 

During the first quarterof 2004, the Company funded a $5.0 million brokerage account to investprimarily in equity securities of other midstream businesses.  As of March 31, 2004, approximately$4.3 million had been invested in securities, with the remaining $0.7 millionheld in cash.

 

Equity securities wereacquired to provide both capital gains and investment income, and areclassified as available-for-sale.  Thefollowing is a summary of gross unrealized gains and losses:

 
|                     |   | **March 31,  2004** |   |
|--------------------------|--------|--------------------------|--------|
|                     |   | **(in  thousands)**      |   |
| Gross  unrealized gains  |   | $                        | 179    |   |
| Gross  unrealized losses |   | (26                      | )      |
|                     |   |                     |   |
| Net  unrealized gains    |   | $                        | 153    |   |

 

**3.****              MarkWest EnergyPartners’ Acquisitions**

 

###### *Pinnacle Acquisition*

 

OnMarch 28, 2003, the Partnership completed the acquisition (the “PinnacleAcquisition”) of Pinnacle Natural Gas Company, Pinnacle Pipeline Company, PNGTransmission Company, Inc., PNG Utility Company and Bright Star 

 

6

----

 

Gathering, Inc. (collectively,“Pinnacle” or the “Sellers”). Pinnacle’s results of operations have been included in the Partnership’sconsolidated financial statements since that date.

 

ThePinnacle Acquisition was accomplished through a merger under Texas law of theSellers and four newly formed wholly owned subsidiaries of the Partnership asbuyers. In the merger, most of the assets and liabilities of the Sellers wereallocated to the Partnership entities, and all entities survived the merger.The assets acquired from the Sellers, primarily located in the State of Texas,with the balance located in New Mexico, Louisiana and Mississippi, arecomprised of three lateral natural gas pipelines and nineteen gatheringsystems.

 

Thepurchase price was allocated as follows (in thousands):

 
| Acquisition  costs:                           |   |   |   |
|-----------------------------------------------|--------|--------|--------|
| Long-term  debt incurred                      |   | $      | 39,471 |   |
| Direct  acquisition costs                     |   | 450    |   |
| Current  liabilities assumed                  |   | 8,945  |   |
| Total                                         |   | $      | 48,866 |   |
|                                          |   |   |   |
| Allocation  of acquisition costs:             |   |   |   |
| Current  assets                               |   | $      | 10,643 |   |
| Fixed  assets (including long-term contracts) |   | 38,223 |   |
| Total                                         |   | $      | 48,866 |   |

###### * *

###### *Western Oklahoma Acquisition*

 

OnDecember 1, 2003, the Partnership completed the acquisition (the “westernOklahoma acquisition”) of certain assets of American Central Western OklahomaGas Company, L.L.C. (“AWOC”) for approximately $38 million, before transactioncosts and subject to certain post-closing adjustments.  AWOC’s results of operations have been included in thePartnership’s consolidated financial statements since that date.

 

The assetsinclude the Foss Lake gathering system (the “gathering system”) located in thewestern Oklahoma counties of Roger Mills and Custer.  The gathering system is comprised of approximately 167 miles ofpipeline, connected to approximately 270 wells, and 11,000 horsepower ofcompression facilities.   The assetsalso include the Arapaho gas processing plant that was installed during 2000.

 

The purchaseprice of approximately $38 million was financed through borrowings under thePartnership line of credit, which was amended at the closing of the acquisitionto increase availability under the credit facility from $75 million to $140million.  Substantially all of theacquired assets are pledged to the credit facility lenders to secure therepayment of the outstanding borrowings under the credit facility.

 

Thepurchase price was comprised of $38.0 million paid in cash to AWOC, andwas allocated as follows (in thousands):

 
| Acquisition  costs:               |   |   |   |
|-----------------------------------|--------|--------|--------|
| Cash  consideration               |   | $      | 37,850 |   |
| Direct  acquisition costs         |   | 101    |   |
|                              |   |   |   |
|                              |   | $      | 37,951 |   |
|                              |   |   |   |
| Allocation  of acquisition costs: |   |   |   |
| Property,  plant and equipment    |   | $      | 37,951 |   |

 

7

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###### *Michigan Crude Pipeline*

 

OnDecember 18, 2003, the Partnership completed the acquisition (the“Michigan Crude Pipeline acquisition”) of Shell Pipeline Company, LP’s andEquilon Enterprises, LLC’s, doing business as Shell Oil Products US (“Shell”),Michigan Crude Gathering Pipeline (the “System”), for approximately $21.3million. The System’s results of operations have been included in thePartnership’s consolidated financial statements since December 18, 2003.The $21.3 million purchase price was financed through borrowings under thePartnership line of credit.

 

The System extendsfrom production facilities near Manistee, Michigan to a storage facility nearLewiston, Michigan.  The trunk lineconsists of approximately 150 miles of pipe. Crude oil is gathered into the System from 57 injection points,including 52 central production facilities and five truck unloading facilities,and comprises approximately 100 miles of pipe. The System also includes truck-unloading stations at Manistee, SeeleyRoad and Junction, and the Samaria Truck Unloading Station located in MonroeCounty, Michigan, near Toledo, Ohio.

 

The System is acommon carrier Michigan intrastate pipeline and gathers light crude oil fromwells.  The oil is transported for a feeto the Lewiston, Michigan station where it is batch injected into the EnbridgeLakehead Pipeline.

 

The purchase pricewas comprised of $21.3 million paid in cash to Shell, and was allocated asfollows (in thousands):

 
| Acquisition  costs:               |   |   |   |
|-----------------------------------|--------|--------|--------|
| Cash  consideration               |   | $      | 21,155 |   |
| Direct  acquisition costs         |   | 128    |   |
|                              |   |   |   |
|                              |   | $      | 21,283 |   |
|                              |   |   |   |
| Allocation  of acquisition costs: |   |   |   |
| Property,  plant and equipment    |   | $      | 21,283 |   |

 

###### *Pro Forma Results of Operations (Unaudited)*

 

The followingtable reflects the unaudited pro forma consolidated results of operations forthe comparable period presented, as though the Pinnacle acquisition, theWestern Oklahoma acquisition and Michigan Crude Pipeline acquisition each hadoccurred on January 1, 2003. The unaudited pro forma results have beenprepared for comparative purposes only and may not be indicative of futureresults.

 
|                        |   | **Three  Months Ended March 31, 2003** |   |
|-----------------------------|--------|---------------------------------------------|--------|
|                        |   | **MarkWest  Hydrocarbon**                   |   | **Pinnacle** |   | **Western  Oklahoma** |   | **Michigan  Crude  Pipeline** |   | **Adjustments** |   | **Total** |   |
|                        |   | **(in  thousands, except per share data)**  |   |
| Revenue                     |   | $                                           | 50,651 |   | $ | 18,614 |   | $ | 11,083 |   | $ | 1,110 |   | $ | (827 | ) | $ | 80,631 |   |
| Net  income                 |   | $                                           | (1,042 | ) | $ | 1,114 |   | $ | 16 |   | $ | 494 |   | $ | (1,297 | ) | $ | (715 | ) |
| Basis  net loss per share   |   | $                                           | (0.11  | ) |   |   |   |   |   |   |   |   | $ | (0.08 | ) |
| Diluted  net loss per share |   | $                                           | (0.11  | ) |   |   |   |   |   |   |   |   | $ | (0.08 | ) |

 

*Subsequent Event*

 

OnApril 1, 2004, the Partnership acquired the Hobbs Lateral pipeline forapproximately $2.3 million.  The HobbsLateral pipeline consists of a four-mile pipeline, with a capacity of 160million cubic feet of natural gas per day, connecting the Northern Natural Gasinterstate pipeline to Southwestern Public Service’s Cunningham and 

 

8

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Maddoxpower generating stations in Hobbs, New Mexico.  The Hobbs Lateral pipeline is a New Mexico intrastate pipelineregulated by the Federal Energy Regulatory Commission.

 

**4.****              Property,Plant and Equipment**

 

The following providescomposition of our property, plant and equipment at:

 
|                                                                    |   | **March 31,  2004** |    | **December 31,  2003** |   |
|-------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                    |   | **(in thousands )**      |    |
| Property,  plant and equipment:                                         |   |                     |    |                        |   |
| Gas  gathering facilities                                               |   | $                        | 75,630  |                        | $      | 73,424 |   |
| Gas  processing plants                                                  |   | 56,289                   |    | 55,888                      |   |
| Fractionation  and storage facilities                                   |   | 22,387                   |    | 22,160                      |   |
| Natural  gas pipelines                                                  |   | 38,817                   |    | 38,790                      |   |
| Crude  oil pipelines                                                    |   | 18,352                   |    | 18,352                      |   |
| NGL  transportation facilities                                          |   | 4,415                    |    | 4,415                       |   |
| Marketing  assets                                                       |   | 1,606                    |    | 1,987                       |   |
| Oil  and gas properties and equipment, full cost method                 |   | 2,495                    |    | 2,380                       |   |
| Land,  buildings and other equipment                                    |   | 12,915                   |    | 12,499                      |   |
| Construction  in-progress                                               |   | 1,850                    |    | 2,362                       |   |
|                                                                    |   | 234,756                  |    | 232,257                     |   |
| Less:  Accumulated depreciation, depletion, amortization and impairment |   | (47,432                  | )       | (44,134                     | )      |
| Total  property, plant and equipment, net                               |   | $                        | 187,324 |                        | $      | 188,123 |   |

 

#### **5.**              Adoptionof SFAS No. 143

# *** ***

On January 1, 2003,we adopted SFAS No. 143, *Asset RetirementObligations*.  SFAS No. 143requires entities to record the fair value of a liability for an assetretirement obligation in the period in which it is incurred and a correspondingincrease in the carrying amount of the related long-lived asset.  Subsequently, the asset retirement costshould be allocated to expense using a systematic and rational method.  During the first quarter of 2003, werecorded a net-of-tax cumulative effect of change in accounting principlecharge of $29,000 ($63,000 before tax), and an asset retirement obligation of$3.2 million (a net increase to long-term liabilities of $2.5 million). We alsoincreased net properties $2.4 million in accordance with the provisions of SFASNo. 143.   There was no impact on ourcash flows as a result of adopting SFAS No. 143.  The asset retirement obligation, which is included on theconsolidated balance sheet in other long-term liabilities, was $0.5 million and$2.4 million at March 31, 2004 and 2003, respectively.

 

**6.****              MarkWest Energy Partners’ Secondary PublicOffering**

 

During January 2004, the Partnershipcompleted a secondary public offering of 1,100,444 common units at $39.90 perunit for gross proceeds of $43.9 million. In addition, of the 172,200 common units available to underwriters tocover over-allotments, 72,500 were sold for gross proceeds of $2.9 million. Tomaintain its 2% interest, the general partner of the Partnership contributed$1.0 million, of which $0.1 million was from directors and officers of thegeneral partner. Gross proceeds from parties other than MarkWest Hydrocarbon of$46.9 million less associated offering costs of $3.8 million resulted in netproceeds from the secondary public offering of $43.1 million.  As approximately $1.0 million of theoffering costs had been incurred during fiscal 2003, net cash generated fromthe offering during 2004 was approximately $44.1 million.

 

9

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**7.****              Segment Reporting**

 

Our operations are classified into two reportablesegments:

 

(1)          Managing MarkWest Energy Partners—we operate MarkWestEnergy Partners, a publicly-traded master limited partnership engaged in thegathering, processing and transmission of natural gas; the transportation,fractionation and storage of natural gas liquids; and the gathering andtransportation of crude oil.

(2)          Marketing—we sell our equity and third party NGLs,purchase third party natural gas and sell our equity and third-party naturalgas.

 

During 2003, we discontinued our exploration and production businesssegment. Our continuing operations are conducted solely in the United States.

 

The table below presentsinformation about operating income (loss) for the reported segments for thethree months ended March 31, 2004 and 2003. Segment operating income(loss) includes total revenues less purchased product costs, facility expensesand depreciation. Items excluded from segment operating income (loss) arereflected in the reconciliation of total segment operating income (loss) to income(loss) from continuing operations before taxes. We have not reported assetinformation by reportable segment because we do not produce such informationinternally.

 
|                                        |   | **Marketing**      |   | **MarkWest  Energy  Partners** |   | **Eliminating  Entries** |   | **Total** |    |
|---------------------------------------------|--------|--------------------|--------|--------------------------------|--------|--------------------------|--------|-----------|---------|
|                                        |   | **(in thousands)** |   |
| **Three Months Ended March 31, 2004:** |   |               |   |                           |   |                     |   |      |    |
| Revenues  from external customers           |   | $                  | 43,907 |                           | $      | 49,519                   |   | $         | —  |   | $ | 93,426 |   |
| Intersegment  revenues                      |   | $                  | 224    |                           | $      | 14,294                   |   | $         | (14,518 | ) | $ | — |   |
| Segment  operating income                   |   | $                  | 2,126  |                           | $      | 6,732                    |   | $         | —  |   | $ | 8,858 |   |
|                                        |   |               |   |                           |   |                     |   |      |    |
| **Three Months Ended March 31, 2003:** |   |               |   |                           |   |                     |   |      |    |
| Revenues  from external customers           |   | $                  | 46,352 |                           | $      | 4,299                    |   | $         | —  |   | $ | 50,651 |   |
| Intersegment  revenues                      |   | $                  | 267    |                           | $      | 13,394                   |   | $         | (13,661 | ) | $ | — |   |
| Segment  operating income (loss)            |   | $                  | (4,863 | )                              | $      | 3,619                    |   | $         | —  |   | $ | (1,244 | ) |

 

Areconciliation of total segment operating income (loss) to income (loss) fromcontinuing operations before taxes is as follows:

 
|                                                               |   | **Three  Months Ended March 31,** |   |
|--------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                               |   | **2004**                               |   | **2003** |   |
|                                                               |   | **(in  thousands)**                    |   |
| Total  segment operating income (loss)                             |   | $                                      | 8,858  |   | $ | (1,244 | ) |
| Selling,  general and administrative expenses                      |   | (4,268                                 | )      | (2,550 | ) |
| Interest  expense, net                                             |   | (1,358                                 | )      | (1,063 | ) |
| Non-controlling  interest in net income of consolidated subsidiary |   | (1,693                                 | )      | (874 | ) |
| Other  income (expense)                                            |   | 62                                     |   | (15 | ) |
| Income  (loss) from continuing operations before taxes             |   | $                                      | 1,601  |   | $ | (5,746 | ) |

 

**8.****              Commitments andContingencies**

 

Weare involved in various litigation and administrative proceedings arising inthe normal course of business. In the opinion of management, any liabilitiesthat may result from these claims will not, individually or in the aggregate,have a material adverse effect on our financial position or results ofoperations.

 

**9.****              Stock and UnitCompensation**

 

As permitted under SFASNo. 123, *Accountingfor Stock-Based Compensation,*we have elected to continue to measurecompensation costs for stock-based and unit-based employee compensation plansas prescribed by Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees.*We have two fixed 

 

10

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compensation plans and,through our consolidated subsidiary, MarkWest Energy Partners, we have avariable plan. We account for these plans using fixed and variable accountingas appropriate.

 

Had compensationcost for our two stock-based compensation plans been determined based on thefair value at the grant dates under those plans consistent with the methodprescribed by SFAS No. 123,**our net income (loss) and net income(loss) per share would have been revised to the pro forma amounts listed below:

 

|                                                                                                                                         |   | **Three  Months Ended March 31,**     |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                                                         |   | **2004**                                   |   | **2003** |   |
|                                                                                                                                         |   | **(in  thousands, except per share data)** |   |
|                                                                                                                                         |   |                                       |   |   |   |
| Net  income (loss), as reported                                                                                                              |   | $                                          | 797    |   | $ | (1,042 | ) |
| Add:  compensation expense included in reported  net income (loss)                                                                      |   | 374                                        |   | 212 |   |
| Deduct:  total stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effect |   | (407                                       | )      | (285 | ) |
| Pro  forma net income (loss)                                                                                                                 |   | $                                          | 764    |   | $ | (1,115 | ) |
|                                                                                                                                         |   |                                       |   |   |   |
| Net  income (loss) per share:                                                                                                                |   |                                       |   |   |   |
| Basic:                                                                                                                                       |   |                                       |   |   |   |
| As  reported                                                                                                                                 |   | $                                          | 0.08   |   | $ | (0.12 | ) |
| Pro  forma                                                                                                                                   |   | $                                          | 0.08   |   | $ | (0.13 | ) |
| Diluted:                                                                                                                                     |   |                                       |   |   |   |
| As  reported                                                                                                                                 |   | $                                          | 0.08   |   | $ | (0.12 | ) |
| Pro  forma                                                                                                                                   |   | $                                          | 0.08   |   | $ | (0.13 | ) |

 

##### **Compensationexpense for the variable plan, including restricted unit grants, is measuredusing the market price of MarkWest Energy Partners’ common units on the datethe number of units in the grant becomes determinable and is amortized intoearnings over the period of service. Our stock options are issued under a fixedplan. Accordingly, compensation expense is not recognized for stock optionsunless the options were granted at an exercise price lower than market on thegrant date.**

 

11

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**Item 2****.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

##### **ManagementOverview of the Quarter Ended March 31, 2004**

 

MarkWestHydrocarbon reported net income of $0.8 million, or $0.08 per dilutedshare, for the three months ended March 31, 2004, compared to a net lossof $1.0 million, or $(0.11) per diluted share, for the first quarter of2003.

 

OnApril 22, 2004, the board of directors of MarkWest Hydrocarbon declaredthe Company’s first quarterly cash dividend of $0.025 per share of itscommon stock, which implies an annual dividend of $0.10 per share. The board ofdirectors declared that the dividend is to be paid on May 19, 2004, to thestockholders of record as of the close of business on May 5, 2004. Theex-dividend date is May 3, 2004. The board announced that its objective is tomaintain a regular quarterly dividend, but that any such future declarationwill be dependent upon the financial performance of the Company.

 

Firstquarter 2004 results benefited primarily from two events. First, thefull-quarter contributions from MarkWest Energy Partners’ 2003 acquisitionsincreased income from continuing operations by approximately $2.4 millionrelative to first quarter 2003. MarkWest Energy Partners is our consolidatedsubsidiary. First quarter 2003 did not include any financial impact fromMarkWest Energy Partners’ 2003 acquisitions except for approximately $50,000,which represents four days of results from its March 28, 2003,  acquisition of Pinnacle. Second, healthiermargins from our marketing business, primarily due to a favorable pricingenvironment and a reduction in hedging losses, accounted for an approximate$7.0 million increase in income from continuing operations. These increaseswere offset by increases in selling, general and administrative expenses due tothe significant growth of MarkWest Energy Partners.

 

## **Our Business**

 

We were founded in 1988as a partnership and later incorporated in Delaware.  We completed our initial public offering in 1996.

 

Weare an energy company primarily focused on increasing shareholder value bygrowing MarkWest Energy Partners, our consolidated subsidiary and apublicly-traded master limited partnership engaged in the gathering, processingand transmission of natural gas; the transportation, fractionation and storageof natural gas liquids; and the gathering and transportation of crude oil. Wealso market natural gas and natural gas liquids (NGLs). We discontinued ourexploration and production activities during 2003.

 

Our assets consistprimarily of partnership interests in MarkWest Energy Partners.  As of March 31, 2004, our partnershipinterests consisted of the following:

 

•                  2,469,496 subordinated units,representing a 34.6% limited partner interest in the Partnership; and

•                  A 90.2% ownership interest inMarkWest Energy GP, L.L.C., the general partner of the Partnership, which ownsa 2.0% general partner interest and all of the incentive distribution rights inthe Partnership.

 

Tobetter understand our business and the results of operations discussed below,it is important to have an understanding of three factors:

 

•                  The nature of our relationship withMarkWest Energy Partners;

•                  The nature of the contracts fromwhich we derive our revenues and from which MarkWest Energy Partners derivesits revenues; and

•                  The comparability within our resultsof operations across periods because of MarkWest Energy Partners significantand recent acquisition activity.

 

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***Our Relationship with MarkWest Energy Partners***

 

We spun off the majority of our then-existingnatural gas gathering and processing and NGL transportation, fractionation andstorage assets into MarkWest Energy Partners in May 2002, just before thePartnership completed its initial public offering. At the time of its formationand initial public offering, we entered into four contracts with MarkWestEnergy Partners whereby MarkWest Energy Partners provides midstream services inAppalachia in exchange for a fee. Additionally, MarkWest Energy Partnersreceives 100% of all fee and percent-of-proceeds consideration for the first 10MMcf/d that it gathers and processes in Michigan. MarkWest Hydrocarbon retainsa 70% net profits interest in the gathering and processing income earned onquarterly pipeline throughput in excess of 10 MMcf/d. In accordance withgenerally accepted accounting principles, MarkWest Energy Partners’ financialresults are included in our consolidated financial statements.  All intercompany accounts and transactionsare eliminated during consolidation. You should read Note 7 to our ConsolidatedFinancial Statements, which is incorporated herein by reference, appearingearlier in this Form 10-Q for further information regarding our two businesssegments: operating MarkWest Energy Partners and marketing.

 

Asa result of our contracts with MarkWest Energy Partners mentioned above, we arethe Partnership’s largest customer, accounting for 22% of its revenues and 44%of its gross margin for the three months ended March 31, 2004. We expectto account for less of MarkWest Energy Partners’ business in the future as itcontinues to acquire assets and increase its customer and businessdiversification.

 

Also at the time of theinitial public offering, we entered into an Omnibus Agreement with MarkWestEnergy Partners and related parties that governs potential competition andindemnification obligations among the parties.

 

Through our majorityownership in the Partnership’s general partner, we control and operate MarkWestEnergy Partners. Our employees are responsible for conducting the Partnership’sbusiness and operating its assets pursuant to a Services Agreement, which wasformalized effective January 1, 2004. We receive $5,000 annually fromMarkWest Energy Partners for services provided under the Services Agreement. Wealso are reimbursed for any reasonable costs incurred in the operation of thePartnership.

 

***Our Contracts***

 

Excluding therevenues and gross margin derived from MarkWest Energy Partners, we generatethe majority of our revenues and gross margin from the marketing of NGLs and,to a lesser extent, natural gas. As compensation for providing processingservices to our Appalachian producers (we have since outsourced these servicesto MarkWest Energy Partners as discussed below), we earn a fee and receivetitle to the NGLs produced. In return, we are required to replace, in drynatural gas, the Btu value of the NGLs extracted. This Btu replacementobligation is referred to in the industry as a “keep-whole” arrangement. Inkeep-whole arrangements, our principal cost is the replacement of the Btusextracted from the gas stream in the form of NGLs or consumed as fuel duringprocessing with dry gas of an equivalent Btu content. The spread between theNGL product sales price and the purchase price of natural gas with anequivalent Btu content is called the “frac spread.” Generally, the frac spreadand, consequently, the operating margins, are favorable under these contracts.In the event natural gas becomes more expensive on a Btu equivalent basis thanNGL products, the cost of keeping the producer “whole” results in operatinglosses.

 

At the closing ofMarkWest Energy Partners’ initial public offering on May 24, 2002, weoutsourced our midstream services to the Partnership. Pursuant to the terms ofthe operating agreements, we retained all the benefits and associated risks ofour keep-whole contracts with producers. Our NGL and gas marketing operationswere retained by us and not contributed to MarkWest Energy Partners.

 

Our keep-whole contractsexpose us to commodity price risk, both on the sales side (of NGLs) and on thepurchase side (of natural gas), which may increase the volatility of ourmarketing results and cash flows. We attempt to mitigate our commodity pricerisk through our hedging program. Under our hedging program, implemented two 

 

13

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years ago based in parton historical pricing data through that point in time, we have incurredsignificant hedging losses. For the three months ended March 31, 2004 and2003, we lost $2.2 million and $7.3 million, respectively, as a result of ourhedging program. The last transactions associated with this unfavorable hedgingprogram settled in April 2004. You should read Item 3, “Quantitative andQualitative Disclosures About Market Risk” for further details about ourcommodity price risk management program, which is incorporated herein byreference.

 

### ***MarkWestEnergy Partners’ Contracts***

 

The Partnershipgenerates the majority of its revenues and gross margin from natural gasgathering, processing and transmission, NGL transportation, fractionation andstorage, and crude oil gathering and transportation. While all of theseservices constitute midstream energy operations, the Partnership provides itsservices pursuant to four different types of contracts.

 

•                  *Fee-basedcontracts.*  Under fee-basedcontracts, the Partnership receives a fee or fees for one or more of thefollowing services: gathering, processing, and transmission of natural gas,transportation, fractionation and storage of NGLs, and gathering andtransportation of crude oil. The revenue MarkWest Energy Partners earns fromthese contracts is generally directly related to the volume of natural gas,NGLs or crude oil that flows through its systems and facilities and is notdirectly dependent on commodity prices. In certain cases, the Partnership’scontracts provide for minimum annual payments. To the extent a sustaineddecline in commodity prices results in a decline in volumes, however, thePartnership’s revenues from these contracts would be reduced.

 

•                  *Percent-of-proceedscontracts.*  Underpercent-of-proceeds contracts, MarkWest Energy Partners generally gathers andprocesses natural gas on behalf of producers, sells the resulting residue gasand NGLs at market prices and remits to producers an agreed upon percentage ofthe proceeds based on an index price. In other cases, instead of remitting cashpayments to the producer, the Partnership delivers an agreed upon percentage ofthe residue gas and NGLs to the producer and sells the volumes it keeps tothird parties at market prices. Under these types of contracts, MarkWest EnergyPartners’ revenues and gross margins increase as natural gas prices and NGLprices increase, and its revenues and gross margins decrease as natural gasprices and NGL prices decrease.

 

•                  *Percent-of-indexcontracts.*  Underpercent-of-index contracts, the Partnership generally purchases natural gas ateither (1) a percentage discount to a specified index price, (2) aspecified index price less a fixed amount or (3) a percentage discount toa specified index price less an additional fixed amount. MarkWest EnergyPartners then gathers and delivers the natural gas to pipelines where itresells the natural gas at the index price, or at a different percentagediscount to the index price. With respect to (1) and (3) above, the grossmargins the Partnership realizes under the arrangements decrease in periods oflow natural gas prices because these gross margins are based on a percentage ofthe index price. Conversely, MarkWest Energy Partners’ gross margins increaseduring periods of high natural gas prices.

 

•                  *Keep-wholecontracts.*  Under keep-wholecontracts, the Partnership gathers natural gas from the producer, processes thenatural gas and sells the resulting NGLs to third parties at market prices.Because the extraction of the NGLs from the natural gas during processingreduces the Btu content of the natural gas, MarkWest Energy Partners musteither purchase natural gas at market prices for return to producers or make cashpayment to the producers equal to the value of this natural gas. Accordingly,under these arrangements, the Partnership’s revenues and gross margins increaseas the price of NGLs increases relative to the price of natural gas, and itsrevenues and gross margins decrease as the price of natural gas increasesrelative to the price of NGLs.

 

In its current areas of operations,MarkWest Energy Partners has a combination of contract types, and limitedkeep-whole arrangements. The only keep-whole contracts of MarkWest EnergyPartners are associated with the Arapaho processing plant that were assumed asa part of its December 2003 Oklahoma acquisition. However, since the Btucontent of the inlet natural gas meets the downstream pipeline specifications,MarkWest Energy Partners has the option of not extracting NGLs in a lowprocessing margin environment. In addition, approximately 45% of the relatedgas-gathering contracts include additional fees to cover plant operating costs,fuel costs and shrinkage costs in a low processing margin 

 

14

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environment. Because of itsability to operate the plant in several recovery modes, including turning itoff, and the additional fees provided for in the gas gathering contracts, thePartnership’s exposure is limited to a portion of the operating costs of theplant.

 

In many cases, MarkWest Energy Partnersprovides services under contracts that contain a combination of more than oneof the arrangements described above. The terms of our contracts vary based ongas quality conditions, the competitive environment at the time the contractsare signed and customer requirements. The Partnership’s contract mix and,accordingly, its exposure to natural gas and NGL prices, may change as a resultof changes in producer preferences, its expansion in regions where some typesof contracts are more common and other market factors. Any change in mix mayimpact MarkWest Energy Partners’ financial results.

 

##### ***Items Impacting Comparability of Financial Results***

 

*RecentMarkWest Energy Partners Acquisition Activity*

 

In reading thediscussion of our historical results of operations, you should be aware of theimpact of MarkWest Energy Partners’ recent significant acquisitions, whichimpact the comparability of our results of operations for the periodsdiscussed.

 

From its initialpublic offering through March 31, 2004, the Partnership has completed fouracquisitions for an aggregate purchase price of approximately $110.0 million. These four acquisitions include:

 

•                  The Pinnacle acquisition, whichclosed on March 28, 2003, for consideration of $38.5 million;

•                  The Lubbock pipeline acquisition(also known as the Power-Tex Lateral pipeline), which closed September 2,2003, for consideration of $12.2 million;

•                  The western Oklahoma acquisition,which closed December 1, 2003, for consideration of $38.0 million;and

•                  The Michigan Crude Pipelineacquisition, which closed December 18, 2003, for consideration of$21.3 million.

 

                                                Exceptfor four days of activity from the Pinnacle acquisition, our consolidatedstatement of operations for the three months ended March 31, 2003, doesnot reflect the impact of these acquisitions. However, our consolidated resultsof operations for the three months ended March 31, 2004, do reflect theimpact from these acquisitions.

 

*CobbProcessing Facility Repair*

 

First quarter 2004results were adversely impacted by unexpected downtime at the Partnership’sCobb processing plant in Appalachia. The facility was shutdown forapproximately 45 days during the first quarter due to equipment failure. Theplant has since been repaired and is operating normally.  Current plans are to replace the existingplant with a new facility during the second half of 2004.

 

15

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##### **Results of Operations**

 

***Operating Data***

 
|                                    |   | **Three  Months Ended March 31,** |   |
|-----------------------------------------|--------|----------------------------------------|--------|
|                                    |   | **2004**                               |   | **2003** |   | **% Change** |   |
|                                    |   |                                   |   |   |   |   |   |
| Marketing                               |   |                                   |   |   |   |   |   |
| NGL product sales (gallons)             |   | 51,525,000                             |   | 53,986,000 |   | (5 | )% |
|                                    |   |                                   |   |   |   |   |   |
| MarkWest Energy Partners                |   |                                   |   |   |   |   |   |
| Appalachia:                             |   |                                   |   |   |   |   |   |
| Natural gas processed (Mcf/d)(1)        |   | 207,000                                |   | 203,000 |   | 2 | % |
| NGLs fractionated (Gal/d)               |   | 462,000                                |   | 446,000 |   | 4 | % |
|                                    |   |                                   |   |   |   |   |   |
| Michigan:                               |   |                                   |   |   |   |   |   |
| Natural gas volumes transported (Mcf/d) |   | 13,900                                 |   | 15,400 |   | (10 | )% |
| NGL product sales (gallons)             |   | 2,700,000                              |   | 2,900,000 |   | (7 | )% |
| Crude oil transported (Bbl/d)(2)        |   | 14,600                                 |   | NA |   | NA |   |
| Southwest:                              |   |                                   |   |   |   |   |   |
| Gathering system throughput (Mcf/d)(3)  |   | 97,800                                 |   | NA |   | NA |   |
| Lateral pipeline throughput (Mcf/d)(4)  |   | 28,900                                 |   | NA |   | NA |   |

 

----

NA– Not applicable.

(1)          Includes throughput from the Kenova, Cobb, and Boldman processing plants.

(2)          The Partnership acquired its Michigan Crude Pipeline inDecember 2003.

(3)          Includes volumes from the Partnership’s Pinnacle gathering systems, whichwere acquired in late March 2003, and its Oklahoma gathering systems,which were acquired in December 2003.

(4)          Includes volumes from the Partnership’s Power-Tex Lateral pipeline, whichwas acquired in September 2003. The Power-Tex Lateral pipeline (previouslyreferred to as the Lubbock Pipeline) is the only lateral the Partnership ownedduring the first quarter of 2004 that produces revenue on aper-unit-of-throughput basis. MarkWest Energy Partners receives a flat fee fromthe other three lateral pipelines it owned during the first quarter of 2004and, therefore, the throughput data from these lateral pipelines is excludedfrom this statistic. The Partnership acquired a fifth lateral pipeline,referred to as the Hobbs Lateral, on April 1, 2004.  The Hobbs Lateral generates revenue on aper-unit-of-throughput basis similar to the Power-Tex Lateral.

 

16

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***ThreeMonths Ended March 31, 2004 Compared to the Three Months EndedMarch 31, 2003***

 
|                                         |   | **Marketing**       |   | **MarkWest  Energy  Partners** |   | **Eliminating  Entries** |   | **Total** |    |
|----------------------------------------------|--------|---------------------|--------|--------------------------------|--------|--------------------------|--------|-----------|---------|
|                                         |   | **(in  thousands)** |   |
| **Three Months Ended March 31, 2004:**  |   |                |   |                           |   |                     |   |      |    |
| Revenues                                     |   | $                   | 44,131 |                           | $      | 63,813                   |   | $         | (14,518 | ) | $ | 93,426 |   |
|                                         |   |                |   |                           |   |                     |   |      |    |
| Purchased product costs                      |   | 35,851              |   | 47,500                         |   | (8,216                   | )      | 75,135    |    |
| Facility expenses                            |   | 5,953               |   | 6,324                          |   | —                   |   | 5,975     |    |
| Depreciation                                 |   | 201                 |   | 3,257                          |   | —                   |   | 3,458     |    |
| Total segment operating expenses             |   | 42,005              |   | 57,081                         |   | (14,518                  | )      | 84,568    |    |
|                                         |   |                |   |                           |   |                     |   |      |    |
| Segment operating income                     |   | $                   | 2,126  |                           | $      | 6,732                    |   | $         | —  |   | $ | 8,858 |   |
|                                         |   |                |   |                           |   |                     |   |      |    |
| **Three  Months Ended March 31, 2003:** |   |                |   |                           |   |                     |   |      |    |
| Revenues                                     |   | $                   | 46,619 |                           | $      | 17,693                   |   | $         | (13,661 | ) | $ | 50,651 |   |
|                                         |   |                |   |                           |   |                     |   |      |    |
| Purchased product costs                      |   | 45,210              |   | 8,392                          |   | (7,599                   | )      | 46,003    |    |
| Facility expenses                            |   | 6,087               |   | 4,337                          |   | (6,062                   | )      | 4,362     |    |
| Depreciation                                 |   | 185                 |   | 1,345                          |   | —                   |   | 1,530     |    |
| Total segment operating expenses             |   | 51,482              |   | 14,074                         |   | (13,661                  | )      | 51,895    |    |
|                                         |   |                |   |                           |   |                     |   |      |    |
| Segment operating income (loss)              |   | $                   | (4,863 | )                              | $      | 3,619                    |   | $         | —  |   | $ | (1,244 | ) |

 
|                                                        |   | **Three  Months Ended March 31,** |   |
|-------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                        |   | **2004**                          |   | **2003** |   |
|                                                        |   | **(in thousands)**                |   |
| Segment operating income (loss)                             |   | $                                 | 8,858  |   | $ | (1,244 | ) |
| Selling, general and administrative                         |   | (4,268                            | )      | (2,550 | ) |
| Interest expense, net                                       |   | (1,358                            | )      | (1,063 | ) |
| Minority interest in net income of consolidated  subsidiary |   | (1,693                            | )      | (874 | ) |
| Other income (expense)                                      |   | 62                                |   | (15 | ) |
|                                                        |   |                              |   |   |   |
| Income (loss) from continuing operations before  taxes      |   | $                                 | 1,601  |   | $ | (5,746 | ) |

 

*Marketing.*Our marketing segmentoperating income was $2.1 million for the three months ended March 31,2004, compared to a loss of $4.9 million for the three months endedMarch 31, 2003, an increase of $7.0 million. The increase is primarilyattributable to a $5.2 million reduction in our hedging losses. The remainderof the increase is attributable to a more favorable pricing environment coupledwith our ability to leverage off of existing storage arrangements, therebyallowing us to buy replacement natural gas when prices were lower in advance ofdelivery when prices were higher.

 

*MarkWest Energy Partners.*Segment operating income from MarkWestEnergy Partners was $6.7 million for the three months ended March 31,2004, compared to $3.6 million for the three months ended March 31, 2003,an increase of $3.1 million, or 86%. The increase is primarily attributable tothe Partnership’s 2003 acquisitions, which increased segment operating incomeby $2.7 million.

 

*Selling,*g*eneral andadministrative expenses.* Selling, general and administrativeexpenses were $4.3 million for the three months ended March 31, 2004,compared to $2.6 million for the three months ended March 31, 2003, anincrease of $1.7 million, or 67%.  Theincrease is primarily attributable to increased back office costs associatedwith the growth of MarkWest Energy Partners, bonus and profit sharing (bonuswas not accrued during the quarter ended March 31, 2003), and severance.

 

17

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*Interest expense, net.*  Interest expense, net was $1.4 million forthe three months ended March 31, 2004, compared to $1.1 million for thethree months ended March 31, 2003, an increase of $0.3 million, or 28%.The increase was principally attributable to MarkWest Energy Partners’increased outstanding debt levels, a function of financing its 2003acquisitions.

 

*Income (loss) from discontinued operations.*Lossfrom discontinued operations was $0.2 million for the three months endedMarch 31, 2004, compared to income of $2.3 million for the three monthsended March 31, 2003, a decrease of $2.5 million. The decrease is a resultof the sales of substantially all of our exploration and production businesssubsequent to the first quarter of 2003.

 

**Liquidity and Capital Resources**

 

During 2003, wediscontinued our exploration and production activities and sold all of ourrelated Canadian oil and gas properties and substantially all of our U.S. oiland gas properties.  The sales netted us$106.7 million in cash.  The proceedswere primarily used to pay off and terminate our existing credit facility inits entirety in December 2003. We also had $33.4 million in unrestrictedcash on hand at December 31, 2003, exclusive of MarkWest Energy Partners’cash on hand. As a result, exclusive of MarkWest Energy Partners’ debt, we hadno debt as of March 31, 2004 and December 31, 2003. InFebruary 2004, we disbursed approximately $4.8 million to pay a specialone-time dividend of $0.50 per share to our common stockholders.

 

Going forward, we expectMarkWest Hydrocarbon’s primary sources of liquidity to be quarterlydistributions received from MarkWest Energy Partners and cash flows generatedprincipally from the marketing of natural gas and NGLs.

 

We own 90.2% of thegeneral partner of MarkWest Energy Partners. The general partner of MarkWest Energy Partners owns a 2% generalpartner interest and all of the incentive distribution rights in MarkWestEnergy Partners.  The incentivedistribution rights entitle us to receive an increasing percentage of cashdistributed by the Partnership upon attainment of target distribution levels.Specifically, they entitle us to receive 13.0% of all cash distributed in aquarter after each unit has received $0.55 for that quarter, 23.0% of all cashdistributed after each unit has received $0.625 for that quarter and 48.0% ofall cash distributed after each unit has received $0.75 for that quarter. Forthe three months ended March 31, 2004, we received $1.7 million in distributionsfor our subordinated units, and the general partner received $0.2 million,including $0.2 million representing payments on incentive distribution rights.As the Partnership continues to grow and increase its quarterly distributionsper limited partner unit, we expect corresponding increases to ourdistributions.

 

Cashflows generated from our marketing operations are subject to volatilityprimarily in NGLs and natural gas prices. Our cash flows are enhanced inperiods when the prices received for NGLs exceed the prices paid for naturalgas we purchase to satisfy our “keep-whole” contractual arrangements inAppalachia, and are reduced in periods when the prices received for NGLs arelow relative to the price of natural gas we purchase to satisfy suchcontractual arrangements. Under “keep-whole” contracts, we retain and sell theNGLs produced in our processing operations for third-party producers, and thenreimburse or “keep whole” the producers for the Btu content of the NGLs removedthrough the re-delivery to the producers of an equivalent amount (on a Btubasis) of dry natural gas. Generally, the frac spread and, consequently, theoperating margins, are favorable. Periodically, when natural gas becomes moreexpensive, on a Btu equivalent basis, than NGL products, the cost of keepingthe producer “whole” can result in operating losses. We, however, cannotpredict with any certainty what the pricing environment will be in the future.

 

We believe that cash onhand, cash received from quarterly distributions (including the incentivedistribution rights) from MarkWest Energy Partners, and cash generated from ourmarketing operations will be sufficient to meet our working capitalrequirements and fund our required capital expenditures, if any, for the foreseeablefuture. Most of our future capital expenditures are discretionary and minimalin nature.  During 2004, we havebudgeted $1.7 million for our contribution to the Cobb plant replacement and anadditional $0.3 million for other miscellaneous projects.  Cash generated from our marketing operationswill depend on our operating performance, which will be affected by prevailingcommodity prices and other factors, some of which are beyond our control.

 

18

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In an effort to increaseour liquidity, we may seek to establish a bank credit facility and renegotiatecertain keep-whole contracts in order to reduce our commodity price risk.

 

*MarkWestEnergy Partners*

 

The Partnership expectsto finance future acquisitions through a combination of debt and issuance ofadditional units, as is common practice with master limited partnerships.

 

The Partnership paid downits debt by approximately $42 million in January 2004 with the proceedsfrom its secondary offering. As of March 31, 2004, the Partnership hadborrowed $84.2 million of the $140 million available under its creditfacility.

 

***MarkWest Energy Partners’ Credit Facility***

 

The Partnership’s $140 million creditfacility is available to fund capital expenditures and acquisitions, workingcapital requirements (including letters of credit) and distributions to unitholders. Advances to fund distributions to unit holders may not exceed $0.50per outstanding unit in any 12-consecutive-month period. To date there have beenno advances to fund distributions to unit holders. At March 31, 2004,$84.2 million was outstanding, and $55.8 million was available, under thePartnership’s credit facility. The Partnership’s credit facility matures inNovember 2006. The Partnership’s average interest rate was approximately4.6% at March 31, 2004.

 

## ***Cash Flows***

## ** **

|                                                 |   | **Three  Months Ended March 31,** |   |
|------------------------------------------------------|--------|----------------------------------------|--------|
|                                                 |   | **2004**                               |   | **2003** |   |
|                                                 |   | **(in  thousands)**                    |   |
|                                                 |   |                                   |   |   |   |
| Net  cash provided by operating activities           |   | $                                      | 18,862 |   | $ | 9,549 |   |
| Net  cash used in investing activities               |   | $                                      | (7,043 | ) | $ | (44,949 | ) |
| Net  cash provided by (used in) financing activities |   | $                                      | (4,848 | ) | $ | 36,784 |   |

 

Net cash provided byoperating activities was higher during the three months ended March 31,2004, than during the three months ended March 31, 2003, primarily due toincreased activities as a result of the Partnership’s Pinnacle, Power-Texlateral pipeline, western Oklahoma, and Michigan Crude Pipelineacquisitions.  Net cash used ininvesting activities during the three months ended March 31, 2004, was dueto capital expenditures for existing facilities; net cash used in investingactivities during the three months ended March 31, 2003, was primarily dueto the Pinnacle acquisition.  Net cashused in financing activities during the three months ended March 31, 2004,included net proceeds from a secondary public offering of $44.1 million; of thenet proceeds from the secondary offering, $42.0 million were used for therepayment of long-term debt.  Inaddition, the Partnership distributed $3.0 million to unitholders other thanMarkWest Hydrocarbon and the general partner, and the Company paid a specialdividend of $4.8 million. Other financing activities included $1.0 million ofproceeds from the exercise of stock options. Net cash provided by financingactivities during the three months ended March 31, 2003, included $45.7million of net proceeds from long-term debt, the majority of which was used tofund the Pinnacle acquisition, and repayments of long-term debt of $6.5million.  In addition, the Partnershipdistributed $1.5 million to unitholders other than MarkWest Hydrocarbon and thegeneral partner.

 

19

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**Forward-LookingInformation**

 

Statements included in this Management’s Discussion and Analysis thatare not historical facts are forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities and Exchange Act of 1934, as amended.  We use words such as “may,” “believe,”“estimate,” “expect,” “plan,” “intend,” “project,” “anticipate,” and similarexpressions to identify forward-looking statements.

 

These forward-looking statements are made based upon management’scurrent plans, expectations, estimates, assumptions and beliefs concerningfuture events impacting us and therefore involve a number of risks anduncertainties. We caution that forward-looking statements are not guaranteesand that actual results could differ materially from those expressed or impliedin the forward-looking statements. Forward-looking statements includestatements relating to, among other things:

 

•                  Ourexpectations regarding MarkWest Energy Partners, L.P.

•                  Ourability to grow MarkWest Energy Partners, L.P. and successfully integrate itsacquisitions.

•                  Ourability to amend certain producer contracts.

•                  Ourexpectations regarding natural gas, NGL product and prices.

•                  Ourefforts to increase fee-based contract volumes.

•                  Ourability to manage our commodity price risk.

•                  Ourability to maximize the value of our NGL output.

•                  Theadequacy of our general public liability, property, and business interruptioninsurance.

•                  Ourability to comply with environmental and governmental regulations.

•                  Ourability to secure a credit facility.

 

Important factors that could cause our actual results of operations orour actual financial condition to differ include, but are not necessarilylimited to:

 

•                  Changes in general economic conditions in regions in which our productsare located.

•                  The availability and prices of NGL and competing commodities.

•                  The availability and prices of raw natural gas supply.

•                  Our ability to negotiate favorable marketing agreements.

•                  The risks that third party natural gas exploration and productionactivities will not occur or be successful.

•                  Our dependence on certain significant customers, producers, gatherers,treaters, and transporters of natural gas.

•                  Competition from other NGL processors, including major energycompanies.

•                  Our ability to identify and consummate grass-roots projects oracquisitions complementary to our business.

•                  Winter weather conditions.

 

Forward-lookingstatements involve many uncertainties that are beyond our ability to control.In many cases, we cannot predict what factors would cause actual results todiffer materially from those indicated by the forward-looking statements.

 

20

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#### **Item 3. Quantitative and Qualitative Di**sclosures about Market Risk

 

Market risk includes therisk of loss arising from adverse changes in market rates and prices. We facemarket risk from commodity price variations and also incur, to a lesser extent,credit risks and risks related to interest rate variations.

 

***Commodity Price Risk***

 

Throughour consolidated subsidiary, MarkWest Energy Partners, L.P., we are engaged inthe gathering processing and transmission of natural gas, the transportation,fractionation and storage of NGLs and the gathering and transportation of crudeoil. We also market natural gas and NGL products. Our products are commoditiesthat are subject to price risk resulting from material changes in response tofluctuations in supply and demand, general economic conditions and other marketconditions, such as weather patterns, over which we have no control.

 

Our primary riskmanagement objective is to reduce volatility in our cash flows.  Our hedging approach uses a statisticalmethod that analyzes momentum and average pricing over time, and variousfundamental data such as industry inventories, industry production, demand andweather. A committee, which includes members of senior management, oversees allof our hedging activity.

 

We may utilize acombination of fixed-price forward contracts, fixed-for-float price swaps andoptions on the over-the-counter (OTC) market. New York Mercantile Exchange (NYMEX) traded futures are authorized foruse.  Swaps and futures allow us toprotect our margins because corresponding losses or gains in the value offinancial instruments are generally offset by gains or losses in the physicalmarket.

 

We enter OTC swaps withfinancial institutions and other energy company counterparties. We conduct astandard credit review on counterparties and have agreements containingcollateral requirements where deemed necessary. We use standardized swapagreements that allow for offset of positive and negative exposures.  Net credit exposure is marked to marketdaily.  We are subject to margin depositrequirements under OTC agreements and NYMEX positions.

 

The use of financialinstruments may expose us to the risk of financial loss in certaincircumstances, including instances when (i) NGLs do not trade at historicallevels relative to crude oil, (ii) sales volumes are less than expectedrequiring market purchases to meet commitments, or (iii) our OTC counterpartiesfail to purchase or deliver the contracted quantities of natural gas, NGLs, orcrude oil or otherwise fail to perform. To the extent that we engage in hedgingactivities, we may be prevented from realizing the benefits of favorable pricechanges in the physical market. However, we are similarly insulated against decreases in such prices.

 

In addition to these riskmanagement tools, we utilize our NGL product storage facilities and contractsfor third-party storage to build product inventories during lower-demand periodsfor resale during higher-demand periods.

 

*Types of Price Risk*

 

Within our NGL marketing segment, our price riskvaries by contract as well as by spot market prices for both NGL and naturalgas commodities.  Our Appalachianproducers compensate us for providing midstream services under one of twocontract types:

 

•                  Under “keep-whole” contracts, we taketitle to and sell the NGLs produced in our processing operations. We alsoreimburse or “keep whole” the producers for the Btu content of the NGLs removedthrough the re-delivery to the producers of an equivalent amount (on a Btubasis) of dry natural gas.  Keep-wholecontracts therefore expose us to NGL product price risk (on the sales side) andnatural gas price risk (on the purchase or reimbursement side).  Generally, the value of the NGLs extracted isgreater than the cost of replacing those Btus with dry gas, resulting inpositive operating margins under these contracts. In the event natural gasbecomes more expensive, on a Btu equivalent basis, than NGL products, the costof keeping the producer “whole” results in operating losses.  The spread between the 

 

21

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NGL product sales price and the purchase price ofnatural gas with an equivalent Btu content is called the “frac spread”.

 

•                  Under “percent-of-proceeds” contracts, wetake title to the NGLs produced in our processing operations, sell the NGLs tothird parties and pay the producer a specified percentage of the proceedsreceived from the sales. Percent-of-proceeds contracts therefore expose us toNGL product price risk.  All of ourMichigan processing business is also governed by percent-of-proceeds contracts.

 

Our consolidated subsidiary, MarkWest Energy Partners,is also subject to NGL price risk. For the three months ended March 31,2004, approximately 31% of MarkWest Energy Partners’ business (as measured bygross margin) was directly subject to NGL product price risk stemming from itspercent-of-index contracts, percent-of-proceeds contracts and keep-wholecontracts. Approximately 8% of MarkWest Energy Partners’ business is governedby keep-whole contracts. The related commodity price risk exposure is activelymanaged, to the extent possible, by not operating the Arapaho processing plantin Oklahoma during low processing margin environments.

 

*Natural Gas Price Risk*

 

In response to our natural gas price risk in Texas (aspart of MarkWest Energy Partners’ Pinnacle acquisition), we enter intofixed-for-float swaps or buy puts. As of March 31, 2004, we hedged ourTexas natural gas price risk via swaps as follows:

 
|                                |   | **Year  Ending December 31,** |   |
|-------------------------------------|--------|------------------------------------|--------|
|                                |   | **2004**                           |   | **2005** |   |
| **MarkWest  Energy Partners, L.P.** |   |                               |   |   |   |
| MMBtu                               |   | 137,500                            |   | 182,500 |   |
| $/MMBtu                             |   | $                                  | 4.57   |   | $ | 4.26 |   |
|                                     |        |                                    |        |  |  |  |  |

 

As of March 31, 2004,we hedged our Texas natural gas price risk with puts as follows:

 
|                                |   | **Year  Ending December 31** |   |
|-------------------------------------|--------|-----------------------------------|--------|
|                                |   | **2004**                          |   | **2005** |   |
| **MarkWest  Energy Partners, L.P.** |   |                              |   |   |   |
| MMBtu                               |   | 274,500                           |   | — |   |
| $/MMBtu                             |   | $                                 | 4.00   |   | $ | — |   |
|                                     |        |                                   |        |  |  |  |  |

 

*NGL Product Price Risk*

 

We hedge our NGL product sales by selling forwardpropane or crude oil.  As ofMarch 31, 2004, we hedged Appalachian NGL product sales by selling crudeoil forward as follows:

 
|                            |   | **Year  Ending  December 31, 2004** |   |
|---------------------------------|--------|------------------------------------------|--------|
| **MarkWest  Hydrocarbon, Inc.** |   |                                     |   |
| NGL gallons                     |   | 993,000                                  |   |
| NGL  sales prices per gallon    |   | $                                        | 0.46   |   |
|                                 |        |                                          |        |  |

 

For NGL hedges using crude oil, all projected marginsor prices on open positions assume that both (a) the basis differentialsbetween our sales location and the hedging contract’s specified location and(b) the correlation between crude oil and NGL products, are consistent withhistorical averages.

 

##### ***Interest Rate Risk***

 

MarkWest Energy Partnersis exposed to changes in interest rates, primarily as a result of its long-termdebt under its credit facility with floating interest rates.  The Partnership makes use of interest rate swapagreements expiring May 19, 2005 to adjust the ratio of fixed and floatingrates in the debt portfolio.  As ofMarch 31, 2004, the Partnership is a party to contracts to fix interestrates on $8.0 million of debt at 3.84% compared to floating LIBOR, plus anapplicable margin.

 

22

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##### **Item 4**. Controls and Procedures

 

Attached as exhibits31.1, 31.2 and 31.3 to this Quarterly Report are certifications of ourprincipal executive and accounting officers (who we refer to in this periodicreport as our Certifying Officers) required in accordance with Section 302of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). Thisportion of our Quarterly Report on Form 10-Q discloses the results of our evaluationof our disclosure controls and procedures as of March 31, 2004, referredto in paragraphs (4) and (5) of the Section 302 Certifications and shouldbe read in conjunction with the Section 302 Certifications for a morecomplete understanding of the topics presented.

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed by us in the reports that we file or submit to the Securitiesand Exchange Commission under the Securities Exchange Act of 1934, as amended,is recorded, processed, summarized and reported within the time periodsspecified by the Commission’s rules and forms, and that information isaccumulated and communicated to our management, including our CertifyingOfficers, as appropriate to allow timely decisions regarding requireddisclosure. Our management evaluated, with the participation of our CertifyingOfficers, the effectiveness of our disclosure controls and procedures as ofMarch 31, 2004, pursuant to Rule 13a-15(b) under the Exchange Act.  Basedupon that evaluation, our Certifying Officers concluded that as of March 31,2004, our disclosure controls and procedures were effective.

 

Nevertheless,we are continuing to conduct an internal review under the supervision and withthe participation of our management and our Certifying Officers of theeffectiveness of the design and operation of our disclosure controls andprocedures.  The purpose of such reviewis to identify and establish enhancements to our disclosure controls and proceduresthat can help prevent any potential misstatements or omissions in ourconsolidated financial statements.  Suchenhancements are also focused on assisting our management in evaluating theeffectiveness of our internal controls over financial reporting as required bySection 404 of the Sarbanes-Oxley Act of 2002 commencing with our fiscalyear ending December 31, 2004.

 

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**PART II—OTHER INFORMATION**

 

##### **Item 1.  Legal Proceedings**

 

Reference is madeto Note 8 of our Consolidated Financial Statements in Item 1 of this Form 10-Q.

 

**Item 6.  Exhibits and Reports on Form 8-****K**

 

(a)          Exhibits

 
| 31.1   |   | Certification of the  Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                  |
| 31.2   |   | Certification of the  Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                |
|   |   |                                                                                                                                                                                                  |
| 31.3   |   | Certification of the  Vice President, Treasurer and Secretary pursuant to Rule 13a-14(a) of the  Securities Exchange Act, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                  |
| 32.1   |   | Certification of the  Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                    |
|   |   |                                                                                                                                                                                                  |
| 32.2   |   | Certification of the  Chief Accounting Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                   |
|   |   |                                                                                                                                                                                                  |
| 32.3   |   | Certification of the  Vice President, Treasurer and Secretary Pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                   |

 

(b)         Reports on Form 8-K

 
| 1.     |   | On January 2, 2004  MarkWest Hydrocarbon filed a Current Report on Form 8-K under Items 2 and 7,  to announce the Partnership’s acquisition of Shell Pipeline Company, LP’s and  Equilon Enterprises, LLC’s, dba Shell Oil Products US, Michigan Crude  Gathering Pipeline.                                                                                                                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2.     |   | On January 26,  2004, MarkWest Hydrocarbon filed a Current Report on Form 8-K under Item 5,  to announce that, on January 23, 2004, the board of directors declared a  one-time extraordinary cash dividend in the amount of $0.50 per share,  payable on February 18, 2004 to the stockholders of record on  February 4, 2004.                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.     |   | On February 27,  2004, MarkWest Hydrocarbon filed a Current Report on Form 8-K under Items 4  and 7, to announce that, on February 23, 2004, MarkWest Hydrocarbon  dismissed PricewaterhouseCoopers LLP as its independent accountants and was  is in the process of interviewing prospective independent accountants and  expects to announce its decision as to the engagement of its new independent  accountant in the near future. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.     |   | On March 25, 2004,  MarkWest Hydrocarbon filed a Current Report on Form 8-K/A, Amendment No. 1,  under Items 2 and 7, to properly reflect the sales price, net proceeds  received and gain on sale, using a correct conversion rate of Canadian into  U.S. dollars, resulting from the sale of the Company’s wholly owned  subsidiary, MarkWest Resources Canada Corp.                                                                  |

 

24

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, MarkWest Hydrocarbon, asregistrant, has duly caused this report to be signed on its behalf by theundersigned, thereunto authorized.

 
|                     |   | MarkWest Hydrocarbon, Inc. |
|--------------------------|--------|----------------------------|
|                     |   | (Registrant)               |
|                     |   |                       |
| Date:  May 12, 2004 |   | /s/ Ted S. Smith           |
|                     |   | Ted S. Smith               |
|                     |   | Chief Accounting  Officer  |

 

25

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| **Exhibit  Number** |   | **Exhibit Index**                                                                                                                                                                                     |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                  |
| 31.1                |   | Certification of the  Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                 |
|                |   |                                                                                                                                                                                                  |
| 31.2                |   | Certification of the  Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                |
|                |   |                                                                                                                                                                                                  |
| 31.3                |   | Certification of the  Vice President, Treasurer and Secretary pursuant to Rule 13a-14(a) of the  Securities Exchange Act, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                                                                                                                  |
| 32.1                |   | Certification of the  Chief Executive Officer pursuant to 18 U.S. C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                   |
|                |   |                                                                                                                                                                                                  |
| 32.2                |   | Certification of the  Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                   |
|                |   |                                                                                                                                                                                                  |
| 32.3                |   | Certification of the  Vice President, Treasurer and Secretary pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                    |

 

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