**UNITED
STATES**
 **SECURITIES
AND EXCHANGE COMMISSION**
 Washington,
D. C. 20549
 
 **FORM
10-Q**
 
 x **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**
 **OF
THE SECURITIES EXCHANGE ACT OF 1934**
 
 For the
Quarterly Period Ended March 31, 2005
 
 **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 1-16619
 
 
 **KERR-McGEE
CORPORATION**
 (Exact
Name of Registrant as Specified in its Charter)
 
 
 
 Delaware
    73-1612389(State
      or Other Jurisdiction of
    (I.R.S.
      EmployerIncorporation
      or Organization)
    Identification
      No.)
 
 
 Kerr-McGee
Center, Oklahoma City, Oklahoma 73125
 (Address
of Principal Executive Offices and Zip Code)
 
 Registrant's
telephone number, including area code (405)
270-1313
 
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 
 Yes x    No o
 
 Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).
 
 Yes x    No o
 
 Number
of shares of common stock, $1.00 par value, outstanding as of April 30, 2005:
161,567,286.
 
   
   
 
 **KERR-McGEE
      CORPORATION****INDEX**PAGE**PART
      I - FINANCIAL INFORMATION**Item
      1. Financial StatementsCondensed
      Consolidated Statement of Income for the Three Months Ended March 31, 2005
      and 2004
    1Condensed
      Consolidated Balance Sheet at March 31, 2005 and December 31,
      2004
    2Condensed
      Consolidated Statement of Cash Flows for the Three Months Ended March 31,
      2005 and 2004
    3Condensed
      Consolidated Statement of Comprehensive Income (Loss) and Stockholders’
      Equity for the Three Months Ended March 31, 2005 and 2004
    4Notes
      to Condensed Consolidated Financial Statements
    5Item
      2. Management's Discussion and Analysis of Financial Condition
      and Results of Operations
    27Item
      3. Quantitative and Qualitative Disclosures about Market
    Risk
    41Item
      4. Controls and Procedures
    44Forward-Looking
      Information
    44**PART
      II - OTHER INFORMATION**Item
      1. Legal Proceedings
    44Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
    45Item
      6. Exhibits
    46SIGNATURE
    46
 
  
  **PART
I - FINANCIAL INFORMATION**
 
 **Item
1. Financial Statements** .
 
 **KERR-McGEE
CORPORATION AND SUBSIDIARY COMPANIES**
 **CONDENSED
CONSOLIDATED STATEMENT OF INCOME**
 **(UNAUDITED)**
 
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars, except per-share amounts)
    
    **2005**
    
    2004**Revenues**
    
    **$**
    **1,717**
    
    $
    1,109**Costs
      and Expenses**Costs
      and operating expenses
    
    
    **521**
    
    
    395Selling,
      general and administrative expenses
    
    
    **92**
    
    
    81Shipping
      and handling expenses
    
    
    **48**
    
    
    38Depreciation
      and depletion
    
    
    **310**
    
    
    190Accretion
      expense
    
    
    **9**
    
    
    7Asset
      impairments
    
    
    **4**
    
    
    13(Gain)
      loss associated with assets held for sale
    
    
    **(22**
    **)**
    
    3Exploration,
      including dry hole and amortization of undeveloped leases
    
    
    63
    
    
    51Taxes,
      other than income taxes
    
    
    **47**
    
    
    28Provision
      for environmental remediation and restoration, net of
      reimbursements
    
    
    **24**
    
    
    (1
    )Interest
      and debt expense
    
    
    **61**
    
    
    57Total
      Costs and Expenses
    
    
    **1,157**
    
    
    862**560**
    
    
    247**Other
      Income (Expense)**
    
    
    **(1******
    ******)**
    
    -**Income
      from Continuing Operations before Income Taxes**
    
    
    **559**
    
    
    247**Provision
      for Income Taxes**
    
    
    **(204******
    ******)**
    
    (92
    )**Income
      from Continuing Operations**
    
    
    **355**
    
    
    155**Loss
      from Discontinued Operations (net of income tax benefit of
      $1)**
    
    
    **-**
    
    
    (3
    )**Net
      Income**
    
    **$**
    **355**
    
    $
    152**Income
      (Loss) per Common Share**Basic
      -Continuing
      operations
    
    **$**
    **2.29**
    
    $
    1.55Discontinued
      operations
    
    
    **-**
    
    
    (.03
    )Net
      income
    
    **$**
    **2.29**
    
    $
    1.52Diluted
      -Continuing
      operations
    
    **$**
    **2.20**
    
    $
    1.44Discontinued
      operations
    
    
    **-**
    
    
    (.03
    )Net
      income
    
    **$**
    **2.20**
    
    $
    1.41**Dividends
      Declared per Common Share**
    
    **$**
    **.45**
    
    $
    .45
 
 
 
 The
accompanying notes are an integral part of this statement.
  - 1 -
  **KERR-McGEE
CORPORATION AND SUBSIDIARY COMPANIES**
 **CONDENSED
CONSOLIDATED BALANCE SHEET**
 **(UNAUDITED)**
 
 **March
      31,**
    
    December
      31,(Millions
      of dollars)
    
    **2005**
    
    2004**ASSETS****Current
      Assets**
    
    
    ****Cash
      and cash equivalents
    
    **$**
    **201**
    
    $
    76Accounts
      receivable
    
    
    **890**
    
    
    963Inventories
    
    
    **364**
    
    
    329Derivatives
      and other current assets
    
    
    **205**
    
    
    195Deferred
      income taxes
    
    
    **397**
    
    
    324**Total
      Current Assets**
    
    
    **2,057**
    
    
    1,887**Property,
      Plant and Equipment**
    
    
    **19,297**
    
    
    18,984**Less
      reserves for depreciation, depletion and
    amortization**
    
    
    **(8,430******
    ******)**
    
    (8,157
    )**10,867**
    
    
    10,827**Investments,
      Derivatives and Other Assets**
    
    
    **546**
    
    
    508**Goodwill
      and Other Intangible Assets**
    
    
    **1,284**
    
    
    1,288**Long-Term
      Assets Associated with Properties Held for
    Disposal**
    
    
    **4**
    
    
    8**Total
      Assets**
    
    **$**
    **14,758**
    
    $
    14,518
 
 **LIABILITIES
      AND STOCKHOLDERS' EQUITY****Current
      Liabilities**Accounts
      payable
    
    **$**
    **628**
    
    $
    644Long-term
      debt due within one year
    
    
    **110**
    
    
    463Income
      taxes payable
    
    
    **206**
    
    
    201Derivative
      liabilities
    
    
    **861**
    
    
    372Accrued
      liabilities
    
    
    **757**
    
    
    825**Total
      Current Liabilities**
    
    
    **2,562**
    
    
    2,505**Long-Term
      Debt**
    
    
    **2,946**
    
    
    3,236**Noncurrent
      Liabilities**Deferred
      income taxes
    
    
    **2,129**
    
    
    2,177Asset
      retirement obligations
    
    
    **509**
    
    
    503Derivative
      liabilities
    
    
    **351**
    
    
    208Other
    
    
    **623**
    
    
    571**Total
      Noncurrent Liabilities**
    
    
    **3,612**
    
    
    3,459**Stockholders'
      Equity**Common
      stock, par value $1 - 300,000,000 shares authorized,164,722,534
      and 152,049,127 shares issued at March 31, 2005and
      December 31, 2004, respectively
    
    
    **165**
    
    
    152Capital
      in excess of par value
    
    
    **4,958**
    
    
    4,205Preferred
      stock purchase rights
    
    
    **2**
    
    
    2Retained
      earnings
    
    
    **1,382**
    
    
    1,102Accumulated
      other comprehensive loss
    
    
    **(536**
    **)**
    
    (79
    )Common
      shares in treasury, at cost - 3,334,384 and 159,856 sharesat
      March 31, 2005 and December 31, 2004, respectively
    
    
    **(260**
    **)**
    
    (8
    )Deferred
      compensation
    
    
    **(73******
    ******)**
    
    (56
    )**Total
      Stockholders' Equity**
    
    
    **5,638**
    
    
    5,318**Total
      Liabilities and Stockholders’ Equity**
    
    **$**
    **14,758**
    
    $
    14,518
 
 The
"successful efforts" method of accounting for oil and gas exploration and
production activities has been followed in preparing this balance
sheet.
 
 
 The
accompanying notes are an integral part of this statement.
  - 2 -
  
 **KERR-McGEE
CORPORATION AND SUBSIDIARY COMPANIES**
 **CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS**
 **(UNAUDITED)**
 
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004******Cash
      Flows from Operating Activities**
    
    ****Net
      income
    
    **$**
    **355**
    
    $
    152Adjustments
      to reconcile net income to net cashprovided
      by operating activities -Depreciation,
      depletion and amortization
    
    
    **326**
    
    
    203Deferred
      income taxes
    
    
    **138**
    
    
    73Dry
      hole expense
    
    
    **20**
    
    
    8Asset
      impairments
    
    
    **4**
    
    
    13(Gain)
      loss on assets held for sale and asset disposals
    
    
    **(22**
    **)**
    
    3Accretion
      expense
    
    
    **9**
    
    
    7Provision
      for environmental remediation and restoration,net
      of reimbursements
    
    
    **24**
    
    
    (1
    )Other
      noncash items affecting net income
    
    
    **82**
    
    
    8Changes
      in assets and liabilities
    
    
    **(139******
    ******)**
    
    (191
    )**Net
      Cash Provided by Operating Activities**
    
    
    **797**
    
    
    275******Cash
      Flows from Investing Activities**
    
    
    ****Capital
      expenditures
    
    
    **(374**
    **)**
    
    (162
    )Dry
      hole costs
    
    
    **(24**
    **)**
    
    (8
    )Proceeds
      from sales of assets
    
    
    **31**
    
    
    4Proceeds
      from sale of investments
    
    
    **-**
    
    
    39Other
      investing activities
    
    
    **(30******
    ******)**
    
    (5
    )**Net
      Cash Used in Investing Activities**
    
    
    **(397******
    ******)**
    
    (132
    )******Cash
      Flows from Financing Activities**
    
    
    ****Issuance
      of common stock
    
    
    **132**
    
    
    5Purchases
      of common stock
    
    
    **(250**
    **)**
    
    -Repayment
      of debt
    
    
    **(42**
    **)**
    
    (102
    )Dividends
      paid
    
    
    **(68**
    **)**
    
    (45
    )Settlement
      of Westport derivatives
    
    
    **(43**
    **)**
    
    -Other
      financing activities
    
    
    **(5******
    ******)**
    
    -**Net
      Cash Used in Financing Activities**
    
    
    **(276******
    ******)**
    
    (142
    )******Effects
      of Exchange Rate Changes on Cash and Cash
    Equivalents**
    
    
    **1**
    
    
    1**Net
      Increase in Cash and Cash Equivalents**
    
    
    **125**
    
    
    2**Cash
      and Cash Equivalents at Beginning of Period**
    
    
    **76**
    
    
    142**Cash
      and Cash Equivalents at End of Period**
    
    **$**
    **201**
    
    $
    144
 
 
 
 The
accompanying notes are an integral part of this statement.
 
  - 3 -
  
 **Consolidated
      Statement of Comprehensive Income (Loss) and Stockholders'
      Equity**(Millions
      of dollars)
    
    Common
      Stock
    
    Capital
      in
      Excess
      of
      Par
      Value
    
    Retained
      Earnings
    
    Accumulated
      Other
      Comprehensive
      Income
      (Loss)
    
    Treasury
      Stock
    
    Deferred
      Compensation
      and
      Other
    
    Total
      Stockholders'
      Equity**Balance
      at December 31, 2003**
    
    **$**
    **101**
    
    **$**
    **1,708**
    
    **$**
    **927**
    
    **$**
    **(45**
    **)**
    **$**
    **(2**
    **)**
    **$**
    **(53**
    **)**
    **$**
    **2,636**Comprehensive
      Income (Loss):Net
      income
    
    
    -
    
    
    -
    
    
    152
    
    
    -
    
    
    -
    
    
    -
    
    
    152Other
      comprehensive loss
    
    
    -
    
    
    -
    
    
    -
    
    
    (103
    )
    
    -
    
    
    -
    
    
    (103
    )Comprehensive
      income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49Exercise
      of stock options
    
    
    -
    
    
    5
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    5Restricted
      stock activity
    
    
    -
    
    
    22
    
    
    -
    
    
    -
    
    
    (1
    )
    
    (18
    )
    
    3ESOP
      deferred compensation
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    2
    
    
    2Dividends
      declared ($.45 per share)
    
    
    -
    
    
    -
    
    
    (45
    )
    
    -
    
    
    -
    
    
    -
    
    
    (45
    )**Balance
      at March 31, 2004**
    
    **$**
    **101**
    
    **$**
    **1,735**
    
    **$******
    ******1,034**
    
    **$******
    **(148******
    ******)**
    ******$**********
    **********(3******
    **************)**
    **$**********
    ******(69******
    **********)**
    **$**
    **2,650****Balance
      at December 31, 2004**
    
    **$**
    **152**
    
    **$**
    **4,205**
    
    **$**
    **1,102**
    
    **$**
    **(79**
    **)**
    **$**
    **(8**
    **)**
    **$**
    **(54**
    **)**
    **$**
    **5,318**Comprehensive
      Income (Loss):Net
      income
    
    
    -
    
    
    -
    
    
    355
    
    
    -
    
    
    -
    
    
    -
    
    
    355Other
      comprehensive loss
    
    
    -
    
    
    -
    
    
    -
    
    
    (457
    )
    
    -
    
    
    -
    
    
    (457
    )Comprehensive
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (102
    )Shares
      issued upon conversionof
      5.25% debentures
    
    
    10
    
    
    583
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    593Shares
      repurchased
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (250
    )
    
    -
    
    
    (250
    )Exercise
      of stock options
    
    
    2
    
    
    130
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    132Restricted
      stock activity
    
    
    1
    
    
    24
    
    
    -
    
    
    -
    
    
    (2
    )
    
    (19
    )
    
    4ESOP
      deferred compensation
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    2
    
    
    2Tax
      benefit from stock-based awards
    
    
    -
    
    
    16
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    16Dividends
      declared ($.45 per share)
    
    
    -
    
    
    -
    
    
    (74
    )
    
    -
    
    
    -
    
    
    -
    
    
    (74
    )Other
    
    
    -
    
    
    -
    
    
    (1
    )
    
    -
    
    
    -
    
    
    -
    
    
    (1
    )**Balance
      at March 31, 2005**
    
    **$******
    ******165**
    
    **$**
    **4,958**
    
    **$******
    ******1,382**
    
    **$**********
    ******(536******
    **********)**
    **$**********
    **(****260******
    **********)**
    **$******
    **(71******
    ******)**
    **$******
    ******5,638**
  - 4 -
  **KERR-McGEE
CORPORATION AND SUBSIDIARY COMPANIES**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **MARCH
31, 2005**
 
 
 **1.**
    **The
      Company, Basis of Presentation and Accounting
      Policies**
 
 **The
Company**
 
 Kerr-McGee
is an energy and inorganic chemical company with worldwide operations. The
exploration and production unit explores for, develops, produces and markets
crude oil and natural gas, with major areas of operation in the United States,
the United Kingdom sector of the North Sea and China. Exploration efforts also
extend to Australia, Benin, Bahamas, Brazil, Morocco, Canada, and the Danish and
Norwegian sectors of the North Sea. The chemical unit is primarily engaged in
production and marketing of titanium dioxide pigment and has production
facilities in the United States, Australia, Germany and the
Netherlands.
 
 The
company recently made a number of strategic decisions in an effort to reposition
Kerr-McGee as a pure-play exploration and production company and enhance value
for its stockholders, as outlined below.
 
 ·
    In
      March 2005, the company’s Board of Directors (the Board) authorized
      management to pursue alternatives for the separation of the chemical
      business, including a spinoff or sale. The company is actively pursuing
      both separation alternatives and expects to determine the timing and
      manner of disposal later in 2005. As of May 6, 2005, criteria for
      reporting results of the chemical business unit as discontinued operations
      have not been met.
 
 ·
    Concurrent
      with the decision to pursue the separation of the chemical business, the
      Board authorized a share repurchase program initially set at $1 billion,
      with an expectation toexpand the program as the chemical business separation proceeds.The
      company repurchased 3.1 million shares of its common stock at an aggregate
      cost of $250 million under this program before its termination in
      connection with the Board's approval of the tender offer discussed
      below.
 
 ·
    In
      April 2005, the company announced its decision to divest of lower-growth,
      shorter-life and higher-decline oil and gas properties. Assets being
      considered for divestiture may include oil and gas properties onshore in
      the United States and in the U.K. sector of the North Sea and all of the
      company’s Gulf of Mexico shelf properties, representing approximately 10%
      to 15% of the company’s proved reserves at December 31, 2004. Divestitures
      are expected to result in gross proceeds of approximately $2 billion to
      $2.5 billion. However, the actual proceeds may differ materially form
      management’s estimates due to a change in market conditions or in the
      composition of the properties to be divested, as well as other
      factors.
 
 ·
    On
      April 14, 2005, the company announced its intention to commence a modified
      "Dutch Auction" self tender offer for its common stock with an aggregate
      purchase cost of up to $4 billion. Under the tender offer, which commenced
      on April 18, 2005, the company will repurchase its shares at a price not
      lower than $85 or higher than $92 per share. Based on the number of shares
      tendered and the prices specified by the tendering stockholders, the
      company will determine the lowest per-share price within the range that
      will enable it to buy up to $4 billion of its common stock. Assuming the
      tender offer is fully subscribed, between 43.5 million and 46.7 million
      shares may be repurchased, or 27% to 29% of shares outstanding at March
      31, 2005. Unless extended, the tender offer will expire on May 18, 2005.
      Except for the company’s directors and executive officers, who have
      advised us that they do not intend to tender shares pursuant to the tender
      offer, no stockholders have made commitments to the company regarding the
      tender of their shares. The tender offer is expected to be financed with
      cash on hand and the net proceeds of borrowings. The company obtained
      commitments for financing which may be used to fund the tender offer,
      repay certain existing indebtedness and for general corporate purposes, as
      more fully discussed in Note 8. The tender offer is subject to customary
      terms and conditions, including those contained in the financing
      commitments.
 
 ·
    The
      Board approved a recommendation to revise the company’s dividend policy to
      a dividend level consistent with that of other pure-play exploration and
      production companies. Starting with the quarter ending June 30, 2005, the
      annual dividend is expected to be revised from $1.80 to $.20 per
      share.
 ****
 - 5 -
 **Basis
of Presentation**
 
 The
unaudited condensed consolidated financial statements included herein have been
prepared by the company, pursuant to the rules and regulations of the Securities
and Exchange Commission (SEC) and, in the opinion of management, include all
adjustments, consisting only of adjustments that are normal and recurring in
nature, necessary to a fair statement of the results for the interim periods
presented. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to such
rules and regulations. Although the company believes that the disclosures are
adequate to make the information presented not misleading, these financial
statements should be read in conjunction with the consolidated financial
statements and the notes thereto included in the company's latest annual report
on Form 10-K.
 
 Certain
2004 amounts included in these condensed consolidated financial statements have
been reclassified to conform to the 2005 presentation. The Condensed
Consolidated Statement of Income for the three months ended March 31, 2004
reflects results of the company’s former forest products operations as
discontinued operations. Criteria for classification of the forest products
business as discontinued operations were met in the fourth quarter of
2004.
 
 **Accounting
Policies**
 
 ***Employee
Stock-Based Compensation*** *-* **** The
company accounts for its stock option plans under the intrinsic-value method
permitted by Accounting Principles Board Opinion No. 25, “Accounting for Stock
Issued to Employees” (APB No. 25). Accordingly, net income reflects no
stock-based employee compensation expense for the issuance of stock options
under the company’s plans, since all options were fixed-price options with an
exercise price equal to the market value of the underlying common stock on the
date of grant.
 
 Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation” (FAS No. 123) prescribes a fair-value method of accounting for
employee stock options under which compensation expense is measured based on the
estimated fair value of stock options at the grant date and recognized over the
vesting period. The following table illustrates the effect on net income and
earnings per share assuming the company had applied the fair-value recognition
provisions of FAS No. 123 to stock-based employee compensation.
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars, except per-share amounts)
    
    **2005**
    
    2004Net
      income, as reported
    
    **$**
    **355**
    
    $
    152Add:
      stock-based employee compensation expenseincluded
      in reported net income, net of taxes
    
    
    **9**
    
    
    4Deduct:
      stock-based compensation expense determinedusing
      a fair-value method, net of taxes
    
    
    **(16******
    ******)**
    
    (7
    )Pro
      forma net income
    
    **$**
    **348**
    
    $
    149Net
      income per share -Basic
      -As
      reported
    
    **$**
    **2.29**
    
    $
    1.52Pro
      forma
    
    
    **2.25**
    
    
    1.48Diluted
      -As
      reported
    
    **$**
    **2.20**
    
    $
    1.41Pro
      forma
    
    
    **2.15**
    
    
    1.38
 
 
  - 6 -
  The
fair value of each option granted in 2005 and 2004 was estimated as of the grant
date using the Black-Scholes option pricing model with the following
weighted-average assumptions:
 
 Assumptions
    
    Weighted-AverageRisk-Free
    
    Expected
    
    Expected
    
    Expected
    
    Fair
      Value ofInterest
      Rate
    
    Dividend
      Yield
    
    Life
      (years)
    
    Volatility
    
    Options
      Granted2005
    
    
    3.9
    %
    
    3.5
    %
    
    6.0
    
    
    27.4
    %
    $
    12.502004
    
    
    3.5
    
    
    3.6
    
    
    5.8
    
    
    22.6
    
    
    8.63
 
 In
December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based
Payment” (FAS No. 123R), which replaces FAS No. 123 and supersedes APB No. 25.
FAS No. 123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values beginning with the first interim period after June 15, 2005,
with early adoption encouraged. In April 2005, the SEC amended its rules to
allow public companies more time to implement the standard. Following the
Commission’s rule, the company intends to implement FAS No. 123R effective
January 1, 2006. The company plans to adopt the standard using the modified
prospective method, as permitted by the standard. The modified prospective
method requires that compensation expense be recorded for all unvested
share-based compensation awards at the beginning of the first quarter of
adoption. The company expects that the adoption will not have a material effect
on its financial condition and cash flows, and that the effect on its results of
operations will be comparable to the pro forma disclosures under FAS No. 123
presented above.
 
 
 **2.**
    **Comprehensive
      Income (Loss)**
 
 Comprehensive
income (loss) for the three months ended March 31, 2005 and 2004, is as
follows:
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Net
      income
    
    **$**
    **355**
    
    $
    152After-tax
      changes in:Deferred
      loss on cash flow hedges
    
    
    **(459**
    **)**
    
    (91
    )Foreign
      currency translation adjustments
    
    
    **2**
    
    
    (7
    )Unrealized
      loss on available-for-sale securities
    
    
    **-**
    
    
    (5
    )Comprehensive
      income (loss)
    
    **$******
    **(102******
    ******)**
    $
    49
  
 **3.**
    **Derivative
      Instruments**
 The
company is exposed to risk from fluctuations in crude oil and natural gas
prices, foreign currency exchange rates and interest rates. To reduce the impact
of these risks on earnings and to increase the predictability of its cash flows,
the company enters into certain derivative contracts, primarily swaps and
collars for a portion of its future oil and gas production, forward contracts to
buy and sell foreign currencies and interest rate swaps to hedge the fair value
of its fixed-rate debt. Gains and losses on derivatives designated as cash flow
hedges are deferred in accumulated other comprehensive income (loss) and
reclassified into earnings when the hedged forecasted transactions affect
earnings. Gains and losses associated with hedge ineffectiveness are recognized
in current earnings as a component of revenues. For the quarters ended March 31,
2005 and 2004, losses on hedge ineffectiveness were $9 million and $1 million,
respectively. At March 31, 2005, net after-tax losses on oil and gas derivatives
deferred in accumulated other comprehensive loss related to a portion of the
company’s expected production through 2007. The company expects to reclassify
$440 million of such losses into earnings during the next 12 months, assuming no
further changes in the fair value of the related contracts.
 
 Realized
and unrealized gains and losses arising from derivative instruments that have
not been designated as hedges or that do not qualify for hedge accounting
(“nonhedge derivatives”) are recognized in current earnings. In June 2004, the
company assumed a net liability associated with commodity derivatives in
connection with the Westport merger. While Westport’s fixed-price oil and gas
swaps were designated as hedges, costless and three-way collars do not qualify
for hedge accounting treatment because they represented “net written options” at
the merger date. As a result, even though these collars effectively reduce
commodity price risk, the company will recognize mark-to-market gains and losses
in earnings until the collars mature, rather than deferring such amounts in
accumulated other comprehensive income (loss). The net liability associated with
these derivatives at March 31, 2005 was $112 million.
 
 - 7 -
 The
following tables summarize the balance sheet presentation of the company’s
derivatives as of March 31, 2005 and December 31, 2004:
 
 **As
      of March 31, 2005****Derivative
      Fair Value****Current**
    
    **Long-Term**
    
    **Current**
    
    **Long-Term**
    
    **Deferred
      Gain**(Millions
      of dollars)
    
    **Asset**
    
    **Asset**
    
    **Liability**
    
    **Liability**
    
    **(Loss)
      in AOCI****(1)**Oil
      and gas commodity derivatives -Kerr-McGee
      positions
    
    **$**
    **29**
    
    **$**
    **24**
    
    **$**
    **(683**
    **)**
    **$**
    **(319**
    **)**
    **$**
    **(604**
    **)**Acquired
      Westport positions
    
    
    **-**
    
    
    **-**
    
    
    **(168**
    **)**
    
    **(22**
    **)**
    
    **(30**
    **)**Gas
      marketing-related derivatives
    
    
    **10**
    
    
    **1**
    
    
    **(10**
    **)**
    
    **(1**
    **)**
    
    **-**Foreign
      currency forward contracts
    
    
    **14**
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **14**Interest
      rate swaps
    
    
    **7**
    
    
    **-**
    
    
    **-**
    
    
    **(9**
    **)**
    
    **-**Other
    
    
    **6**
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **4**Total
      derivative contracts
    
    **$**
    **66**
    
    **$**
    **25**
    
    **$******
    **(861******
    ******)**
    **$******
    **(351******
    ******)**
    **$******
    **(616******
    ******)**
 
 As
      of December 31, 2004Derivative
      Fair ValueCurrent
    
    Long-Term
    
    Current
    
    Long-Term
    
    Deferred
      Gain(Millions
      of dollars)
    
    Asset
    
    Asset
    
    Liability
    
    Liability
    
    (Loss)
      in AOCI(1)Oil
      and gas commodity derivatives -Kerr-McGee
      positions
    
    $
    54
    
    $
    12
    
    $
    (235
    )
    $
    (188
    )
    $
    (167
    )Acquired
      Westport positions
    
    
    1
    
    
    1
    
    
    (123
    )
    
    (16
    )
    
    (7
    )Gas
      marketing-related derivatives
    
    
    6
    
    
    2
    
    
    (6
    )
    
    (2
    )
    
    -Foreign
      currency forward contracts
    
    
    20
    
    
    -
    
    
    (6
    )
    
    -
    
    
    16Interest
      rate swaps
    
    
    4
    
    
    -
    
    
    (1
    )
    
    (2
    )
    
    -Other
    
    
    3
    
    
    -
    
    
    (1
    )
    
    -
    
    
    1Total
      derivative contracts
    
    $
    88
    
    $
    15
    
    $
    (372
    )
    $
    (208
    )
    $
    (157
    )
 
 (1)  Amounts
deferred in accumulated other comprehensive income (AOCI) are reflected net of
tax.
 
 The
following table summarizes the classification of gain (loss) on derivative
instruments in the Condensed Consolidated Statement of Income for the
three-month periods ended March 31, 2005 and 2004:
 
 Three
      Months Ended March 31,**2005**
    
    2004**Costs
      and**
    
    **Other
      Income**
    
    
    
    Costs
      and
    
    Other
      Income(Millions
      of dollars)
    
    **Revenues**
    
    **Expenses**
    
    **(Expense)**
    
    Revenues
    
    Expenses
    
    (Expense)Hedge
      Activity:Oil
      and gas commodity derivatives
    
    **$**
    **(37**
    **)**
    **$**
    **-**
    
    **$**
    **-**
    
    $
    (61
    )
    $
    -
    
    $
    -Foreign
      currency contracts
    
    
    **(1**
    **)**
    
    **1**
    
    
    **-**
    
    
    -
    
    
    4
    
    
    -Interest
      rate swaps
    
    
    **-**
    
    
    **1**
    
    
    **-**
    
    
    -
    
    
    4
    
    
    -Total
      hedging contracts
    
    
    **(38******
    ******)**
    
    **2**
    
    
    **-**
    
    
    (61
    )
    
    8
    
    
    -Nonhedge
      Activity:Oil
      and gas commodity derivatives -Kerr-McGee
      positions
    
    
    **8**
    
    
    **-**
    
    
    **-**
    
    
    -
    
    
    -
    
    
    -Acquired
      Westport positions
    
    
    **(59**
    **)**
    
    **-**
    
    
    **-**
    
    
    -
    
    
    -
    
    
    -Gas
      marketing-related derivatives
    
    
    **2**
    
    
    **-**
    
    
    **-**
    
    
    2
    
    
    -
    
    
    (1
    )DECS
      call option(1)
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    -
    
    
    -
    
    
    (6
    )Other
    
    
    **-**
    
    
    **-**
    
    
    **2**
    
    
    -
    
    
    -
    
    
    (1
    )Total
      nonhedge contracts
    
    
    **(49******
    ******)**
    
    **-**
    
    
    **2**
    
    
    2
    
    
    -
    
    
    (8
    )Total
      derivative contracts
    
    **$******
    **(87******
    ******)**
    **$**
    **2**
    
    **$**
    **2**
    
    $
    (59
    )
    $
    8
    
    $
    (8
    )
 (1)
    Other
      income (expense) for the quarter ended March 31, 2004 also includes
      unrealized gains of $7 million on Devon Energy common stock classified as
      trading.
  - 8 -
  **4.**
    **Accounts
      Receivable Sales**
 
 Through
April 2005, the company had an accounts receivable monetization program with a
maximum availability of $165 million. Under the terms of the program, selected
qualifying customer accounts receivable of the company’s chemical - pigment
business were sold monthly to a special-purpose entity (SPE), which in turn sold
an undivided ownership interest in the receivables to a third-party multi-seller
commercial paper conduit sponsored by an independent financial institution. The
company sold, and retained an interest in, excess receivables to the SPE as
over-collateralization for the program. The retained interest in sold
receivables was subordinate to, and provided credit enhancement for, the
conduit's ownership interest in the SPE's receivables, and was available to the
conduit to pay certain fees or expenses due to the conduit, and to absorb credit
losses incurred on any of the SPE's receivables in the event of program
termination. No recourse obligations were recorded since the company had no
obligations for any recourse actions on the sold receivables.
 
 During
the quarters ended March 31, 2005 and 2004, the company sold $279 million and
$237 million, respectively, of its pigment receivables, resulting in pretax
losses reflected in other income (expense) of $3 million and $1 million,
respectively. Both at March 31, 2005 and at December 31, 2004, the outstanding
balance of receivables sold, net of the company's retained interest in
receivables serving as over-collateralization, totaled $165 million. The
outstanding balance of receivables serving as over-collateralization totaled $37
million and $39 million at March 31, 2005 and December 31, 2004, respectively.
These balances are included in accounts receivable in the accompanying Condensed
Consolidated Balance Sheet.
 
 The
accounts receivable monetization program included ratings downgrade triggers
that provided for certain program modifications, including a program termination
event upon which the program would effectively liquidate over time and the
third-party multi-seller commercial paper conduit would be repaid with the
collections on accounts receivable sold by the SPE. In April 2005, following the
announcement of the self tender offer discussed in Note 1, the company’s senior
unsecured debt was downgraded, triggering program termination. As opposed to
liquidating the program over time or modifying its terms, the company elected to
terminate the program by advancing the then outstanding balance of receivables
sold of $165 million to the SPE, which in turn used the funds to repay the
financial institution. The balances of outstanding receivables are expected to
be collected as they become due and will be used by the SPE to repay the company
for its advance.
 
 
 **5.**
    **Inventories**
 
 Major
categories of inventories at March 31, 2005 and December 31, 2004 are as
follows:
 
 **March
      31,**
    
    December
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Chemicals
      and other products
    
    **$**
    **263**
    
    $
    236Materials
      and supplies
    
    
    **88**
    
    
    85Crude
      oil and natural gas liquids
    
    
    **13**
    
    
    8Total
    
    **$**
    **364**
    
    $
    329
 
 
 **6.**
    **Exchange
      of Assets and Asset Impairments**
 
 ***Exchange
of Assets*** - In
February 2005, the company acquired a 37.5% interest in the Blind Faith
discovery in the deepwater Gulf of Mexico from BP Exploration & Production
in exchange for the company's interests in various proved oil and gas properties
in the Arkoma basin of southeast Oklahoma. We received $22 million at the
closing date of the transaction (subject to post-closing adjustments) with an
additional $2 million to be received associated with certain preferential rights
to purchase. The company recognized a $19 million gain on disposal based on the
percentage of the Arkoma properties' fair value that was received in
cash.
 
  - 9 -
  ***Exploratory
Drilling Costs*** - At
March 31, 2005, the company had capitalized exploratory drilling costs of
approximately $192 million associated with ongoing exploration and/or appraisal
activities primarily in the deepwater Gulf of Mexico, China, Alaska and Brazil.
Such capitalized costs may be charged against earnings in a future period if
management determines that commercial quantities of hydrocarbons have not been
discovered or that future appraisal drilling or development activities are not
likely to occur.
 
 ***Asset
Impairments*** - The
chemical - pigment operating unit began production through a new
high-productivity oxidation line at the Savannah, Georgia, chloride process
pigment plant in January 2004. This new technology results in low-cost,
incremental capacity increases through modification of existing chloride
oxidation lines and allows for improved operating efficiencies through
simplification of hardware configurations and reduced maintenance requirements.
As of March 31, 2005, the company continued to operate its new high-productivity
oxidation line and continued to evaluate its performance. The company expects to
have a better understanding of how the Savannah site might be reconfigured to
exploit its capabilities later in 2005. The possible reconfiguration of the
Savannah site, if any, could include redeployment of certain assets, idling of
certain assets and reduction of the future useful life of certain assets,
resulting in the acceleration of depreciation expense and the recognition of
other charges.
 
 
 **7.**
    **Income
      Taxes**
 
 On
October 22, 2004, the President of the United States signed into law the
American Jobs Creation Act of 2004 (the “Act”). A provision of the Act includes
a one-time dividends received deduction of 85% of certain foreign earnings that
are repatriated, as defined in the Act. As of March 31, 2005, management had not
decided on whether, and to what extent, foreign earnings may be repatriated by
the company under the Act, and accordingly, the financial statements do not
reflect any provision for taxes on unremitted foreign earnings. On April 11,
2005, management completed its analysis of the impact of the Act on the
company's plans for repatriation. Based on this analysis, the company plans to
repatriate up to $500 million in extraordinary dividends, as defined in the Act,
by the end of 2005. Accordingly, a tax liability of approximately $28 million
may be recognized in the quarter ending June 30, 2005. Cash requirements for the
dividends are expected to be met with cash on hand, operating cash flows of
certain of our foreign subsidiaries and proceeds from asset sales.
 
 
 **8.**
    **Debt**
 
 In
February 2005, the company called for redemption all of the $600 million
aggregate principal amount of its 5.25% convertible subordinated debentures due
2010 at a price of 102.625%. Prior to March 4, 2005, the redemption date, all of
the debentures were converted by the holders into approximately 9.8 million
shares of common stock.
 
 The
company's $1.5 billion unsecured revolving credit agreement, which extends
through November 2009, contains restrictive covenants, including a maximum total
debt to total capitalization ratio, as defined in the agreement, of 65%. At
March 31, 2005, the company’s total debt to total capitalization ratio was 35%
and the company was in compliance with other debt covenants. On April 15, 2005,
the company’s 5.375% Notes in the aggregate principal amount of $350 million
matured and were repaid with the proceeds of borrowings under the revolving
credit facility. Consequently, the carrying value of the 5.375% Notes was
classified as long-term debt at March 31, 2005, based on the company’s ability
and intent to maintain this obligation for longer than one year.
 
 As
discussed in Note 1, on April 18, 2005, the company commenced a self tender
offer for its common stock. Prior to commencing its offer, the company obtained
commitments for financing, totaling up to $6 billion, which may be used to fund
the tender offer, repay certain existing indebtedness and for general corporate
purposes. In connection with the commitments, the company expects to close the
following facilities:
 
 Amount
    
    TermSenior
      secured term loan facility
    
    $2
      billion
    
    2
      yearsSenior
      secured term loan facility
    
    $2.25
      billion
    
    6
      yearsSenior
      secured revolving credit facility
    
    $1.25
      billion
    
    5
      years
 
 - 10 -
 The
availability of the facilities under the commitments is subject to certain
conditions, including the repayment and termination of the company’s existing
$1.5 billion revolving credit facility. The term facilities may be used to repay
certain of the company’s existing indebtedness, to finance the tender offer and
to pay related fees and expenses. The revolving credit facility may be used to
repay certain of the company’s existing indebtedness and for general corporate
purposes. Borrowings under the facilities will bear interest, at the company’s
selection, based on LIBOR, the JPMorgan Chase Bank prime rate or the federal
funds rate, plus a margin that ranges from .75% to 2.50%. Under the commitments,
the six-year term loan facility will amortize in quarterly installments, amounts
of which will be determined in the final agreements. Additionally, subject to
certain exceptions and step-down provisions, the facilities will be subject to
mandatory prepayment provisions, under which 50% of the net after-tax proceeds
of certain equity issuances and excess cash flow and 100% of the net after-tax
proceeds from dispositions of certain assets and incurrence of certain
indebtedness must be used to repay the term loans. Each facility will be secured
by a perfected first priority security interest, subject to existing liens and
customary exceptions and to the rights of the company’s existing bondholders to
be equally and ratably secured, in all of the company’s tangible and intangible
assets located in the United States (other than certain assets), and all of the
capital stock of the company’s direct and indirect subsidiaries (other than
certain subsidiaries to be agreed and limited, in the case of foreign
subsidiaries, to 66% of the capital stock of the company’s first tier foreign
subsidiaries). The terms of the facilities are expected to include customary
representations and warranties, conditions precedent, events of default,
affirmative and negative covenants and financial covenants.
 
 
 **9.**
    **Exit
      Activities**
 
 The
following table presents a reconciliation of the beginning and ending balances
of reserves for exit activities for the first quarter of 2005. No significant
changes in the status of exit activities occurred during this
period.
 
 Dismantlement
    
    Personnel(Millions
      of dollars)
    
    and
      Closure
    
    Costs
    
    TotalBalance
      at December 31, 2004
    
    $
    10
    
    $
    8
    
    $
    18Payments
    
    
    (1
    )
    
    (2
    )
    
    (3
    )Adjustments
    
    
    (1
    )
    
    -
    
    
    (1
    )Balance
      at March 31, 2005
    
    $
    8
    
    $
    6
    
    $
    14
 
 As
discussed in Note 1, the company plans to dispose of its chemical business unit
and divest of selected oil and gas properties. In April 2005, in connection with
the planned exit activities, the company initiated employee compensation
programs designed to provide an incentive to certain employees to remain with
the company over a stated period ranging from 6 to 18 months. A
total of $34 million will be payable under these programs assuming all
participating employees meet the service and other conditions and before
considering any discretionary awards that may be made in future periods, as
discussed below. The cost associated with these programs generally will be
recognized as the related services are provided by the participating
employees.
 
 Under
the plan covering employees of the chemical business unit, existing awards
totaling $2 million are payable upon the earlier of the disposition of the
chemical business or the end of a  one-year
service period. Additionally, the plan provides for discretionary
bonuses that may be granted to participating employees if they
continue their employment through the date the disposition of the chemical
business is completed, as determined by management.
 
 
 **10.**
    **Employee
      Stock-Based Compensation and Benefit
Plans**
 
 ***Stock-Based
Compensation*** - In
January 2005, annual stock-based compensation awards were granted to eligible
employees and directors under the company’s 2002 Long Term Incentive Plan. The
awards included approximately 450,000 shares of restricted stock, 1.7 million
stock options and 16.3 million performance units that provide for cash awards
based on the company’s achievement of certain financial performance measures
over a stated period. The fair value of the restricted stock grant on the grant
date was $25 million, which will be recognized as compensation expense (net of
forfeitures) ratably over the vesting period of three years or the service
period, if shorter. The exercise price of the options granted of $56.57 per
share equaled the fair value of the underlying stock on the date of grant, and
therefore, did not result in compensation expense. See Note 1 for additional
information related to the company’s accounting policy for stock-based
compensation.
 
 - 11 -
 ***Retirement
and Postretirement Benefits*** - The
company has both noncontributory and contributory defined-benefit retirement
plans and company-sponsored contributory postretirement plans for health care
and life insurance. Most employees are covered under the company’s retirement
plans, and substantially all U.S. employees may become eligible for the
postretirement benefits if they reach retirement age while working for the
company.
 
 Total
costs recognized for employee retirement and postretirement benefit plans for
the first quarter of 2005 and 2004 were as follows:
 
 PostretirementRetirement
      Plans
    
    Health
      and Life PlansThree
      Months Ended
    
    Three
      Months EndedMarch
      31,
    
    March
      31,(Millions
      of dollars)
    
    **2005**
    
    2004
    
    **2005**
    
    2004Net
      periodic cost -Service
      cost
    
    **$**
    **9**
    
    $
    7
    
    **$**
    **1**
    
    $
    1Interest
      cost
    
    
    **18**
    
    
    18
    
    
    **4**
    
    
    5Expected
      return on plan assets
    
    
    **(26**
    **)**
    
    (29
    )
    
    **-**
    
    
    -Net
      amortization -Prior
      service cost
    
    
    **2**
    
    
    2
    
    
    **(1**
    **)**
    
    -Net
      actuarial loss
    
    
    **1**
    
    
    1
    
    
    **1**
    
    
    1Total
      net periodic cost
    
    **$**
    **4**
    
    $
    (1
    )
    **$**
    **5**
    
    $
    7
 
 
 **11.**
    **Earnings
      Per Share**
 
 The
following table sets forth the computation of basic and diluted earnings per
share from continuing operations for the three months ended March 31, 2005 and
2004. Substantially all options outstanding at March 31, 2005 were in-the-money,
and therefore, the dilutive effect of such options is reflected in diluted
earnings per share for the three months ended March 31, 2005. As discussed in
Note 8, during the first quarter of 2005, the company’s 5.25% convertible
subordinated debentures were converted by the holders into approximately 9.8
million shares of common stock.
 
 For
      the Three Months Ended March 31,**2005**
    
    2004**Income
      from**
    
    
    
    
    
    Income
      from(In
      millions, except
    
    **Continuing**
    
    
    
    **Per-Share**
    
    Continuing
    
    
    
    Per-Shareper-share
      amounts)
    
    **Operations**
    
    **Shares**
    
    **Income**
    
    Operations
    
    Shares
    
    IncomeBasic
      earnings per share
    
    **$**
    **355**
    
    
    **154.8**
    
    **$**
    **2.29**
    
    $
    155
    
    
    100.3
    
    $
    1.55Effect
      of dilutive securities:5.25%
      convertible debentures
    
    
    **4**
    
    
    **6.4**
    
    
    
    
    
    5
    
    
    9.8Restricted
      stock
    
    
    **-**
    
    
    **.6**
    
    
    
    
    
    -
    
    
    1.0Stock
      options
    
    
    **-**
    
    
    **1.0**
    
    
    
    
    
    -
    
    
    .2Diluted
      earnings per share
    
    **$**
    **359**
    
    
    **162.8**
    
    **$**
    **2.20**
    
    $
    160
    
    
    111.3
    
    $
    1.44
 
 
 **12.**
    **Capital
      Stock**
 
 Authorized
capital stock of the company consists of 300 million shares of common stock with
a par value of $1.00 per share and 40 million shares of preferred stock without
par value. No shares of preferred stock have been issued. In March 2005, the
company’s Board of Directors recommended that the stockholders approve an
increase of the authorized number of shares of the company’s common stock to 500
million shares. The stockholders will vote on this proposal at the May 10, 2005
Annual Meeting of Stockholders.
 
  - 12 -
  Changes
in common stock issued and treasury stock held for the three-month periods ended
March 31, 2005 and 2004, are as follows:
 
 Common
    
    Treasury(Thousands
      of shares)
    
    Stock
    
    StockBalance
      at December 31, 2003
    
    
    100,892
    
    
    32Exercise
      of stock options
    
    
    128
    
    
    -Issuance
      of restricted stock
    
    
    438
    
    
    -Forfeiture
      of restricted stock
    
    
    -
    
    
    28Balance
      at March 31, 2004
    
    
    101,458
    
    
    60Balance
      at December 31, 2004
    
    
    **152,049**
    
    
    **160**Exercise
      of stock options
    
    
    **2,406**
    
    
    **-**Issuance
      of restricted stock
    
    
    **450**
    
    
    **-**Forfeiture
      of restricted stock
    
    
    **-**
    
    
    **29**Shares
      issued upon conversion of 5.25% debentures
    
    
    **9,818**
    
    
    **-**Shares
      repurchased
    
    
    **-**
    
    
    **3,145**Balance
      at March 31, 2005
    
    
    **164,723**
    
    
    **3,334**
 
 As more
fully discussed in Note 1, the company repurchased 3.1 million shares of its
common stock in March 2005 and has subsequently commenced a self tender offer to
purchase additional shares of its common stock of up to $4 billion.
 
 
 **13.**
    **Contingencies**
 
 The
following table summarizes the contingency reserve balances, provisions,
payments and settlements for the quarter ended March 31, 2005, as well as
balances, accruals and receipts of environmental cost reimbursements from other
parties.
 
 Reserves
      forReserves
      for
    
    Environmental
    
    Reimbursements(Millions
      of dollars)
    
    Litigation
    
    Remediation
    
    ReceivableBalance
      at December 31, 2004
    
    $
    39
    
    $
    255
    
    $
    94Provisions
      / Accruals
    
    
    -
    
    
    44
    
    
    20Payments
      / Settlements
    
    
    (7
    )
    
    (9
    )
    
    (66
    )Balance
      at March 31, 2005
    
    $
    32
    
    $
    290
    
    $
    48
 
 
 Management
believes, after consultation with general counsel, that currently the company
has reserved adequately for the reasonably estimable costs of environmental
matters and other contingencies. However, additions to the reserves may be
required as additional information is obtained that enables the company to
better estimate its liabilities, including liabilities at sites now under
review, though the company cannot now reliably estimate the amount of future
additions to the reserves. Following are discussions regarding certain
environmental sites and litigation. Reserves for each environmental site are
based on assumptions regarding the volumes of contaminated soils and groundwater
involved, as well as associated excavation, transportation and disposal
costs.
 
 The
company provides for costs related to contingencies when a loss is probable and
the amount is reasonably estimable. It is not possible for the company to
reliably estimate the amount and timing of all future expenditures related to
environmental and legal matters and other contingencies because, among other
reasons:
 
 - 13 -
 ·
    some
      sites are in the early stages of investigation, and other sites may be
      identified in the future;
 
 ·
    remediation
      activities vary significantly in duration, scope and cost from site to
      site depending on the mix of unique site characteristics, applicable
      technologies and regulatory agencies
involved;
 
 ·
    cleanup
      requirements are difficult to predict at sites where remedial
      investigations have not been completed or final decisions have not been
      made regarding cleanup requirements, technologies or other factors that
      bear on cleanup costs;
 
 ·
    environmental
      laws frequently impose joint and several liability on all potentially
      responsible parties, and it can be difficult to determine the number and
      financial condition of other potentially responsible parties and their
      respective shares of responsibility for cleanup
costs;
 
 ·
    environmental
      laws and regulations, as well as enforcement policies, are continually
      changing, and the outcome of court proceedings and discussions with
      regulatory agencies are inherently
uncertain;
 
 ·
    some
      legal matters are in the early stages of investigation or proceeding or
      their outcomes otherwise may be difficult to predict, and other legal
      matters may be identified in the future;
 
 ·
    unanticipated
      construction problems and weather conditions can hinder the completion of
      environmental remediation; the inability to implement a planned
      engineering design or use planned technologies and excavation methods may
      require revisions to the design of remediation measures, which delay
      remediation and increase costs; and the identification of additional areas
      or volumes of contamination and changes in costs of labor, equipment and
      technology generate corresponding changes in environmental remediation
      costs.
 
 **West
Chicago, Illinois**
 
 In
1973, the company’s chemical affiliate (Chemical) closed a facility in West
Chicago, Illinois, that processed thorium ores for the federal government and
for certain commercial purposes. Historical operations had resulted in low-level
radioactive contamination at the facility and in surrounding areas. The original
processing facility is regulated by the State of Illinois (the State), and four
vicinity areas are designated as Superfund sites on the National Priorities List
(NPL).
 
 ***Closed
Facility*** ** -
Pursuant to agreements reached in 1994 and 1997 among Chemical, the City of West
Chicago (the City) and the State regarding the decommissioning of the closed
West Chicago facility, Chemical has substantially completed the excavation of
contaminated soils and has shipped those soils to a licensed disposal facility.
Surface restoration was completed in 2004, except for areas designated for use
in connection with the Kress Creek and Sewage Treatment Plant remediation
discussed below. Groundwater monitoring and remediation is expected to continue
for approximately 10 years.
 
 ***Vicinity
Areas*** - The
Environmental Protection Agency (EPA) has listed four areas in the vicinity of
the closed West Chicago facility on the NPL and has designated Chemical as a
Potentially Responsible Party (PRP) in these four areas. Chemical has
substantially completed remedial work for two of the areas (known as the
Residential Areas and Reed-Keppler Park). The other two NPL sites, known as
Kress Creek and the Sewage Treatment Plant, are contiguous and involve low
levels of insoluble thorium residues, principally in streambanks and streambed
sediments, virtually all within a floodway. Chemical has reached an agreement
with the appropriate federal and state agencies and local communities regarding
the characterization and cleanup of the sites, past and future government
response costs, and the waiver of natural resource damages claims. The agreement
has been incorporated in a consent decree, which must be entered by a federal
court. The consent decree was lodged with the court in April 2005, and is
expected to be approved by the court in due course. The cleanup work, which is
expected to take about four to five years to complete following entry of the
consent decree, will require excavation of contaminated soils and stream
sediments, shipment of excavated materials to a licensed disposal facility and
restoration of affected areas.
 
  - 14 -
  ***Financial
Reserves*** *-* In the
first quarter of 2005, $13 million was added to the reserve for the West Chicago
site to cover increased soil volumes encountered during the final stages of
characterization of Kress Creek, increases in labor and materials and required
future payments for past costs and access fees. As of March 31, 2005, the
company had reserves of $111 million for costs related to West Chicago. Although
actual costs may exceed current estimates, the amount of any increase cannot be
reasonably estimated at this time. The amount of the reserve is not reduced by
reimbursements expected from the federal government under Title X of the Energy
Policy Act of 1992 (Title X) (discussed below).
 
 ***Government
Reimbursement*** ** -
Pursuant to Title X, the U.S. Department of Energy (DOE) is obligated to
reimburse Chemical for certain decommissioning and cleanup costs incurred in
connection with the West Chicago sites in recognition of the fact that about 55%
of the facility's production was dedicated to U.S. government contracts. The
amount authorized for reimbursement under Title X is $365 million plus inflation
adjustments. That amount is expected to cover the government's full share of
West Chicago cleanup costs. Through March 31, 2005, Chemical had been reimbursed
approximately $281 million under Title X.
 
 Reimbursements
under Title X are provided by congressional appropriations. Historically,
congressional appropriations have lagged Chemical's cleanup expenditures. As of
March 31, 2005, the government’s share of costs incurred by Chemical but not yet
reimbursed by the DOE totaled approximately $14 million. The company believes
receipt of the $14 million government share in due course following additional
congressional appropriations is probable and has reflected that amount as a
receivable in the accompanying financial statements. The company will recognize
recovery of the government's share of future remediation costs for the West
Chicago sites as Chemical incurs the cash expenditures.
 
 **Henderson,
Nevada**
 
 In
1998, Chemical decided to exit the ammonium perchlorate business. At that time,
Chemical curtailed operations and began preparation for the shutdown of the
associated production facilities in Henderson, Nevada, that produced ammonium
perchlorate and other related products. Manufacturing of perchlorate compounds
began at Henderson in 1945 in facilities owned by the U.S. government. The U.S.
Navy expanded production significantly in 1953, when it completed construction
of a plant for the manufacturing of ammonium perchlorate. The Navy continued to
own the ammonium perchlorate plant as well as other associated production
equipment at Henderson until 1962, when the plant was purchased by a predecessor
of Chemical. The ammonium perchlorate produced at the Henderson facility was
used primarily in federal government defense and space programs. Perchlorate has
been detected in nearby Lake Mead and the Colorado River.
 
 Chemical
began decommissioning the facility and remediating associated perchlorate
contamination, including surface impoundments and groundwater, when it decided
to exit the business in 1998. In 1999 and 2001, Chemical entered into consent
orders with the Nevada Division of Environmental Protection (NDEP) that require
Chemical to implement both interim and long-term remedial measures to capture
and remove perchlorate from groundwater. In April 2005, Chemical entered into an
amended consent order with NDEP that requires, in addition to the capture and
treatment of groundwater, the closure of a certain impoundment related to the
past production of ammonium perchlorate, including treatment and disposal of
solution and sediment contained in the impoundment.
 
 In
1999, Chemical initiated the interim measures required by the consent orders. A
long-term remediation system is operating in compliance with the consent orders.
Initially, the remediation system was projected to operate through 2007.
However, studies of the decline of perchlorate levels in the groundwater
indicate that Chemical may need to operate the system through 2011. The scope,
duration and cost of groundwater remediation ultimately will be driven in the
long term by drinking water standards, which to date have not been formally
established by state or federal regulatory authorities. EPA and other federal
and state agencies continue to evaluate the health and environmental risks
associated with perchlorate as part of the process for ultimately setting
drinking water standards. One state agency, the California Environmental
Protection Agency (CalEPA), has set a public health goal for perchlorate, and
the federal EPA has established a reference dose for perchlorate, which are
preliminary steps to setting drinking water standards. The establishment of
drinking water standards could materially affect the scope, duration and cost of
the long-term groundwater remediation that Chemical is required to
perform.
 
  - 15 -
  ***Financial
Reserves*** - In
the first quarter of 2005, $26 million was added to the reserve for Henderson to
cover the operating and maintenance costs over the extended period for
groundwater treatment and $4 million for closure of the ammonium perchlorate
pond. Remaining reserves for Henderson totaled $39 million as of March 31, 2005.
As noted above, the long-term scope, duration and cost of groundwater
remediation and impoundment closure are uncertain and, therefore, additional
costs beyond those accrued may be incurred in the future. However, the amount of
any additional costs cannot be reasonably estimated at this time.
 
 ***Litigation*** ** - In
2000, Chemical initiated litigation against the United States seeking
contribution for response costs. The suit is based on the fact that the
government owned the plant in the early years of its operation, exercised
significant control over production at the plant and the sale of products
produced at the plant, and was the largest consumer of products produced at the
plant. The discovery stage of litigation is substantially complete, and the
parties have filed certain pretrial motions that are being considered by the
court. Although the outcome of the litigation is uncertain, Chemical believes it
is likely to recover a portion of its costs from the government. The amount and
timing of any recovery cannot be estimated at this time and, accordingly, the
company has not recorded a receivable or otherwise reflected in the financial
statements any potential recovery from the government.
 
 In
addition, on July 26, 2004, the company was served with a lawsuit, which was
filed in the United States District Court for the District of Arizona. The
lawsuit, Alan Curtis and Linda Curtis v. City of Bullhead City, et al., in which
the company is one of several defendants (the Defendants), alleges various
causes of action under a variety of common law theories and federal
environmental laws and seeks recovery for damages allegedly caused by the
alleged exposure to and the migration of various chemical contaminants contained
in the Colorado River. The two plaintiffs, who are not suing on behalf of any
other party, also seek an order requiring the Defendants to remediate the
contamination. The company intends to vigorously defend against the lawsuit. The
company believes that the litigation will not have a material adverse effect on
its financial condition or results of operations.
 
 ***Insurance*** ** - In
2001, Chemical purchased a 10-year, $100 million environmental cost cap
insurance policy for groundwater and other remediation at Henderson. The
insurance policy provides coverage only after Chemical exhausts a self-insured
retention of approximately $61 million and covers only those costs incurred to
achieve cleanup specified in the policy. As noted above, federal and state
agencies have not established a drinking water standard and, therefore, it is
possible that Chemical may be required to achieve a cleanup level more stringent
than that covered by the policy. If so, the amount recoverable under the policy
may be less than the ultimate cleanup cost.
 
 At
March 31, 2005, the company expects estimated aggregate cleanup costs of $95
million less the $61 million self-insured retention (for a net amount of $34
million) to be covered by the insurance policy. The estimated aggregate cleanup
costs of $95 million include qualifying expenditures incurred to date of
approximately $67 million and remaining qualifying expenditures to be incurred
of approximately $28 million, which are included in the environmental reserve at
March 31, 2005. The company believes that a reimbursement of approximately $34
million is probable, and, accordingly, the company has recorded a receivable in
the financial statements for that amount.
 
 **Milwaukee,
Wisconsin**
 
 In
1976, Chemical closed a wood-treatment facility it had operated in Milwaukee,
Wisconsin. Operations at the facility prior to its closure had resulted in the
contamination of soil and groundwater at and around the site with creosote and
other substances used in the wood-treatment process. In 1984, EPA designated the
Milwaukee wood-treatment facility as a Superfund site under the Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA), listed the site
on the NPL and named Chemical a PRP. Chemical executed a consent decree in 1991
that required it to perform soil and groundwater remediation at and below the
former wood-treatment area and to address a tributary creek of the Menominee
River that had become contaminated as a result of the wood-treatment operations.
Actual remedial activities were deferred until after the decree was finally
entered in 1996 by a federal court in Milwaukee.
 
  - 16 -
  Groundwater
treatment was initiated in 1996 to remediate groundwater contamination below and
in the vicinity of the former wood-treatment area. It is not possible to
reliably predict how groundwater conditions will be affected by soil removal in
the vicinity of the former wood-treatment area, which has been completed, and
ongoing groundwater treatment; therefore, it is not known how long groundwater
treatment will continue. Soil cleanup of the former wood-treatment area began in
2000 and was completed in 2002. Also in 2002, terms for addressing the tributary
creek were agreed upon with EPA, after which Chemical began the implementation
of a remedy to reroute the creek and to remediate associated sediment and stream
bank soils. Completion of the creek remedy is expected to take about three more
years.
 
 ***Financial
Reserves*** - As
of March 31, 2005, the company had reserves of $6 million for the costs of the
remediation work described above. Although actual costs may exceed current
estimates, the amount of any increases cannot be reasonably estimated at this
time.
 
 **Cushing,
Oklahoma**
 
 In
1972, an affiliate of the company closed a petroleum refinery it had operated
near Cushing, Oklahoma. Prior to closing the refinery, the affiliate also had
produced uranium and thorium fuel and metal at the site pursuant to licenses
issued by the Atomic Energy Commission (AEC). The uranium and thorium operations
commenced in 1962 and were shut down in 1966, at which time the affiliate
decommissioned and cleaned up the portion of the facility related to uranium and
thorium operations to applicable standards. The refinery also was cleaned up to
applicable standards at the time of closing.
 
 Subsequent
regulatory changes required more extensive remediation at the site. In 1990, the
affiliate entered into a consent agreement with the State of Oklahoma to
investigate the site and take appropriate remedial actions related to petroleum
refining and uranium and thorium residuals. Investigation and remediation of
hydrocarbon contamination is being performed with oversight of the Oklahoma
Department of Environmental Quality. Soil remediation to address hydrocarbon
contamination is expected to continue for about four more years. The long-term
scope, duration and cost of groundwater remediation are uncertain and,
therefore, additional costs beyond those accrued may be incurred in the future.
 
 Additionally,
in 1993, the affiliate received a decommissioning license from the Nuclear
Regulatory Commission (NRC), the successor to AEC’s licensing authority, to
perform certain cleanup of uranium and thorium residuals. All known radiological
contamination has been removed from the site and shipped to a licensed disposal
facility.
 
 ***Financial
Reserves*** - As
of March 31, 2005, the company had reserves of $20 million for the costs of the
ongoing remediation and decommissioning work described above. Although actual
costs may exceed current estimates, the amount of any increases cannot be
reasonably estimated at this time.
 
 **Los
Angeles County, California**
 
 During
2004, the company began remediation and restoration of an oil and gas field in
Los Angeles County, California. The company’s obligation for remediation and
restoration of this oil and gas field is expected to take about five years,
although completion could be delayed by permitting requirements.
 
 ***Financial
Reserves*** - As
of March 31, 2005, the company had environmental reserves of $25 million for
this project. Although actual costs may exceed current estimates, the amount of
any increases cannot be reasonably estimated at this time.
 
 **New
Jersey Wood-Treatment Site**
 
 Chemical
and its ultimate parent were named in 1999 as PRPs under CERCLA at a former
wood-treatment site in New Jersey at which EPA is conducting a cleanup. On
April 15, 2005, Chemical and its ultimate parent received a letter from EPA
asserting that they are liable under CERCLA as former owners or operators of the
site and demanding reimbursement of costs expended by EPA at the site. The
demand is for payment of past costs in the amount of approximately
$179 million, plus interest. Chemical did not operate the site, which had
been sold to a third party before Chemical succeeded to the interests of a
predecessor owner in the 1960’s. The predecessor also did not operate the site,
which had been closed down before it was acquired by the predecessor. Based on
historical records, there are substantial uncertainties about whether or under
what terms the predecessor assumed liabilities for the site. In addition, it
appears there may be other PRPs, though it is not known whether the other PRPs
have received similar letters from EPA. The company intends to vigorously defend
against EPA’s claim. The company has not recorded a reserve for the site, as it
is not possible to reliably estimate the liability, if any, it may have for the
site because of the aforementioned uncertainties and the potential existence of
other PRPs.
 
 - 17 -
 **Other
Sites**
 
 In
addition to the sites described above, the company is responsible for
environmental costs related to certain other sites. These sites relate primarily
to wood-treating, chemical production, landfills, mining and oil and gas
production and refining distribution and marketing. As of March 31, 2005, the
company had remaining reserves of $89 million for the environmental costs in
connection with these other sites. This includes the remaining portion of $1
million added to the reserves during the first quarter of 2005, primarily
because additional remediation, characterization and/or monitoring costs were
identified for certain of these sites. Although actual costs may exceed current
estimates, the amount of any increases cannot be reasonably estimated at this
time.
 
 **Coal
Supply Contract**
 
 An
affiliate of the company entered into a coal supply contract with Peabody
Coaltrade, Inc. (“PCI”) in February 1998. In 1998, the company exited the coal
business and assigned its rights and obligations under the coal supply contract
to a third party. In connection with the assignment, the company agreed to
guarantee performance under the contract. PCI has notified the company of a
threatened default by the assignee under the coal supply contract and that PCI
may seek to hold the company liable under the 1998 guaranty in the event of a
default. In addition to other defenses to the enforceability of the guaranty,
the company believes the guaranty expired in January 2003 when the primary term
of the coal supply contract expired. No reserve has been provided for
performance under the guaranty because the company does not believe a loss is
probable and the amount of any loss is not reasonably estimable.
 
 **CNR
Contract**
 
 In
2002, an affiliate of the company entered into a contract with CNR International
(“CNR”) to sell certain assets located in the United Kingdom sector of the North
Sea. In the fourth quarter of 2004, CNR asserted claims for alleged breaches of
contractual representations and warranties and demanded damages. The company’s
evaluation of the claims is in its early stages. The company has not provided a
reserve for the claims because at this time the company cannot reasonably
determine the probability of a loss and the amount of loss, if any, cannot be
reasonably estimated. The company does not expect the resolution of the claims
to have a material adverse effect on the company’s financial condition or
results of operations.
 
 **Forest
Products Litigation**
 
 Between
1999 and 2001, Chemical and its parent company were named in 22 lawsuits in
three states (Mississippi, Louisiana and Pennsylvania) in connection with former
forest products operations located in those states (in Columbus, Mississippi;
Bossier City, Louisiana; and Avoca, Pennsylvania). The lawsuits sought recovery
under a variety of common law and statutory legal theories for personal injuries
and property damages allegedly caused by exposure to and/or release of creosote
and other substances used in the wood-treatment process. Chemical has executed
settlement agreements that are expected to resolve substantially all of the
Louisiana, Pennsylvania and Columbus, Mississippi, lawsuits described above.
Resolution of the remaining cases is not expected to have a material adverse
effect on the company.
 
 Following
the adoption by the Mississippi legislature of tort reform, plaintiffs’ lawyers
filed many new lawsuits across the state of Mississippi in advance of the
reform’s effective date. On December 31, 2002, approximately 245 lawsuits were
filed against Chemical and its affiliates on behalf of approximately 4,600
claimants in connection with Chemical’s Columbus, Mississippi, operations,
seeking recovery on legal theories substantially similar to those advanced in
the litigation referred to above. Substantially all of these lawsuits have been
removed to the U.S. District Court for the Northern District of Mississippi, and
the court has consolidated these lawsuits for pretrial and discovery purposes.
On December 31, 2002, June 13, 2003, and June 25, 2004, three lawsuits were
filed against Chemical in connection with a former wood-treatment plant located
in Hattiesburg, Mississippi. On September 9, 2004, February 11, 2005, and March
2, 2005, three lawsuits were filed against Chemical in connection with a former
wood-treatment plant located in Texarkana, Texas. In addition, on January 3,
2005, February 16, 2005, and March 11, 2005, 32 lawsuits were filed against
Chemical in connection with the Avoca, Pennsylvania, facility described above.
These lawsuits seek recovery on legal theories substantially similar to those
advanced in the litigation referred to above. A total of approximately 3,300
claimants now have asserted claims in connection with the Hattiesburg plant;
there are 64 plaintiffs named in the Texarkana lawsuits and approximately 4,600
plaintiffs are named in the new Avoca lawsuits. Chemical has resolved
approximately 1,490 of the Hattiesburg claims pursuant to a settlement reached
in April 2003, which has resulted in aggregate payments by Chemical of
approximately $600,000.
 
 - 18 -
 Chemical
and its affiliates believe that the follow-on Columbus and Avoca claims, the
remaining Hattiesburg claims and the claims related to the Texarkana plants are
without substantial merit and are vigorously defending against them. The company
has not provided a reserve for these lawsuits because at this time it cannot
reasonably determine the probability of a loss, and the amount of loss, if any,
cannot be reasonably estimated. The company believes that the ultimate
resolution of the forest products litigation will not have a material adverse
effect on the company's financial condition or results of
operations.
 
 **Other
Matters**
 
 The
company and/or its affiliates are parties to a number of legal and
administrative proceedings involving environmental and/or other matters pending
in various courts or agencies. In the ordinary course of its business, the
company experiences disputes with federal, state, tribal and other regulatory
authorities, as well as with private parties, regarding royalty payments. These
disputes, individually and in the aggregate, are not expected to have a material
adverse effect on the company. There are also proceedings associated with
facilities currently or previously owned, operated or used by the company’s
affiliates and/or their predecessors, some of which include claims for personal
injuries and property damages. Current and former operations of the company’s
affiliates also involve management of regulated materials and are subject to
various environmental laws and regulations. These laws and regulations will
obligate the company’s affiliates to clean up various sites at which petroleum
and other hydrocarbons, chemicals, low-level radioactive substances and/or other
materials have been contained, disposed of or released. Some of these sites have
been designated Superfund sites by EPA pursuant to CERCLA. Similar environmental
regulations exist in foreign countries in which the company’s affiliates
operate.
 
 Kemira
 In
2000, Chemical acquired its titanium dioxide production facility in
Savannah, Georgia, from Kemira Pigments Oy, a Finnish company, and its parent,
Kemira, Oyj (together, “the Sellers”). After acquiring the facility, the company
discovered that certain matters associated with environmental conditions and
plant infrastructure were not consistent with representations made by the
Sellers. Chemical sought recovery for breach of representations and warranties
in a proceeding before the London Court of International Arbitration (LCIA). On
May 9, 2005, Chemical received notice from the LCIA that the LCIA had found in
favor of Chemical as to liability with respect to certain of the claims. The
LCIA still must determine the amount of damages, and, in that regard, Chemical
is seeking in excess of $40 million in damages, together with interest, costs
and attorney fees. In light of the recent receipt of the lengthy arbitration
decision on the liability phase and the complexity of the matter, the company
currently cannot reasonably estimate the amount of damages that will be
awarded.  The company will recognize a receivable if and when damages are
awarded and all contingencies associated with any recovery are
resolved.
 **14.**
    **Commitments**
 
 In
April 2005, the company entered into additional drilling rig commitments to
assure availability for executing our deepwater drilling programs through the
end of 2006. The company’s commitments under these arrangements total $135
million, a portion of which will be billed to other working interest partners
once actual utilization is known.
 
 
 **15.**
    **Business
      Segments**
 
 The
company has three reportable segments: oil and gas exploration and production,
production and marketing of titanium dioxide pigment, and production and
marketing of other chemical products. As discussed in Note 1, the company is
pursuing alternatives for the separation of its chemical business unit.
 
  - 19 -
  Segment
performance is evaluated based on operating profit (loss), which represents
results of continuing operations before considering general corporate expenses,
interest and debt expense, environmental provisions related to businesses in
which the company’s affiliates are no longer engaged, other income (expense) and
income taxes. Following is a summary of revenues and operating profit for each
of the company's business segments for the three months ended March 31, 2005 and
2004.
 
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004**Revenues**Exploration
      and production
    
    **$**
    **1,383**
    
    $
    834Chemical
      - Pigment
    
    
    **311**
    
    
    252Chemical
      - Other
    
    
    **23**
    
    
    23Total
      Revenues
    
    **$**
    **1,717**
    
    $
    1,109**Operating
      Profit (Loss)**Exploration
      and production
    
    **$**
    **655**
    
    $
    330Chemical
      - Pigment
    
    
    **32**
    
    
    7Chemical
      - Other
    
    
    **(9******
    ******)**
    
    (3
    )Total
      Operating Profit
    
    
    **678**
    
    
    334Interest
      and debt expense
    
    
    **(61**
    **)**
    
    (57
    )Corporate
      expenses
    
    
    **(44**
    **)**
    
    (31
    )Provision
      for environmental remediation andrestoration,
      net of reimbursements(1)
    
    
    **(13**
    **)**
    
    1Other
      income (expense)(2)
    
    
    **(1******
    ******)**
    
    -Income
      from Continuing Operationsbefore
      Income Taxes
    
    **$**
    **559**
    
    $
    247
 
 
 (1)
    Includes
      provisions, net of reimbursements, related to sites with no ongoing
      operations or various businesses in which the company’s affiliates are no
      longer engaged; for example, the refining and marketing of oil and gas and
      associated petroleum products, and the mining and processing of uranium
      and thorium. See Note 13.
 
 (2)
    The
      company owns a 50% interest in Avestor, a joint venture involved in the
      production of lithium-metal-polymer batteries. Investment in Avestor is
      accounted for under the equity method. The company’s equity in the net
      losses of Avestor were $7 million and $9 million during the three months
      ended March 31, 2005 and 2004, respectively. The carrying value of the
      company’s investment in Avestor at March 31, 2005 and December 31, 2004,
      was $79 million and $60 million,
respectively.
 
 
 **16.**
    **Condensed
      Consolidating Financial
Information**
 
 On
October 3, 2001, Kerr-McGee Corporation issued $1.5 billion of long-term notes
in a public offering. On July 1, 2004, Kerr-McGee Corporation issued an
additional $650 million of long-term notes. The notes are general, unsecured
obligations of the company and rank in parity with all of the company’s other
unsecured and unsubordinated indebtedness. As discussed in Note 8, the company
obtained commitments for secured term loan and revolving credit facilities,
pursuant to which the company expects to close facilities totaling $5.5 billion.
In accordance with the provisions of the indentures under which the company’s
existing notes were issued, the company’s obligations under the notes will
become equally and ratably secured with the new credit facilities. The notes
have been fully and unconditionally guaranteed, on a joint and several basis, by
Kerr-McGee Chemical Worldwide LLC and Kerr-McGee Rocky Mountain Corporation.
Additionally, Kerr-McGee Corporation has guaranteed all indebtedness of its
subsidiaries. As a result of these guarantee arrangements, the company is
required to present condensed consolidating financial information.
 
  - 20 -
  The
following tables present condensed consolidating financial information for (a)
Kerr-McGee Corporation, the parent company, (b) the guarantor subsidiaries, and
(c) the nonguarantor subsidiaries on a consolidated basis. The guarantor
subsidiaries include Kerr-McGee Chemical Worldwide LLC and Kerr-McGee Rocky
Mountain Corporation, wholly-owned subsidiaries of Kerr-McGee Corporation. Other
income (expense) in the Condensed Consolidating Statement of Income includes
equity interest in income (loss) of subsidiaries for all periods
presented.
 
 
 **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Statement of Income**
 **For
the Three Months Ended March 31, 2005**
 
 Kerr-McGee
    
    Guarantor
    
    Non-Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**Revenues**
    
    $
    -
    
    $
    280
    
    $
    1,437
    
    $
    -
    
    $
    1,717**Costs
      and Expenses**Costs
      and operating expenses
    
    
    -
    
    
    156
    
    
    365
    
    
    -
    
    
    521Selling,
      general and administrative expenses
    
    
    -
    
    
    -
    
    
    92
    
    
    -
    
    
    92Shipping
      and handling expenses
    
    
    -
    
    
    3
    
    
    45
    
    
    -
    
    
    48Depreciation
      and depletion
    
    
    -
    
    
    28
    
    
    282
    
    
    -
    
    
    310Accretion
      expense
    
    
    -
    
    
    1
    
    
    8
    
    
    -
    
    
    9Asset
      impairments
    
    
    -
    
    
    -
    
    
    4
    
    
    -
    
    
    4Gain
      associated with assets held for sale
    
    
    -
    
    
    -
    
    
    (22
    )
    
    -
    
    
    (22
    )Exploration,
      including dry holes and amortization
      of undeveloped leases
    
    
    -
    
    
    2
    
    
    61
    
    
    -
    
    
    63Taxes,
      other than income taxes
    
    
    -
    
    
    9
    
    
    38
    
    
    -
    
    
    47Provision
      for environmental remediationand
      restoration, net of reimbursements
    
    
    -
    
    
    13
    
    
    11
    
    
    -
    
    
    24Interest
      and debt expense
    
    
    42
    
    
    6
    
    
    96
    
    
    (83
    )
    
    61Total
      Costs and Expenses
    
    
    42
    
    
    218
    
    
    980
    
    
    (83
    )
    
    1,157(42
    )
    
    62
    
    
    457
    
    
    83
    
    
    560**Other
      Income (Expense)**
    
    
    390
    
    
    10
    
    
    58
    
    
    (459
    )
    
    (1
    )**Income
      before Income Taxes**
    
    
    348
    
    
    72
    
    
    515
    
    
    (376
    )
    
    559**Benefit
      (Provision) for Income Taxes**
    
    
    7
    
    
    (21
    )
    
    (190
    )
    
    -
    
    
    (204
    )**Net
      Income**
    
    $
    355
    
    $
    51
    
    $
    325
    
    $
    (376
    )
    $
    355
 
  - 21 -
  
 **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Statement of Income**
 **For
the Three Months Ended March 31, 2004**
 
 Kerr-McGee
    
    Guarantor
    
    Non-Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**Revenues**
    
    $
    -
    
    $
    211
    
    $
    898
    
    $
    -
    
    $
    1,109**Costs
      and Expenses**Costs
      and operating expenses
    
    
    -
    
    
    110
    
    
    285
    
    
    -
    
    
    395Selling,
      general and administrative expenses
    
    
    -
    
    
    -
    
    
    81
    
    
    -
    
    
    81Shipping
      and handling expenses
    
    
    -
    
    
    2
    
    
    36
    
    
    -
    
    
    38Depreciation
      and depletion
    
    
    -
    
    
    30
    
    
    160
    
    
    -
    
    
    190Accretion
      expense
    
    
    -
    
    
    1
    
    
    6
    
    
    -
    
    
    7Asset
      impairments
    
    
    -
    
    
    1
    
    
    12
    
    
    -
    
    
    13Loss
      associated with assets held for sale
    
    
    -
    
    
    -
    
    
    3
    
    
    -
    
    
    3Exploration,
      including dry holes andamortization of undeveloped leases
    
    
    -
    
    
    4
    
    
    47
    
    
    -
    
    
    51Taxes,
      other than income taxes
    
    
    -
    
    
    8
    
    
    20
    
    
    -
    
    
    28Provision
      for environmental remediationand restoration, net of reimbursements
    
    
    -
    
    
    (1
    )
    
    -
    
    
    -
    
    
    (1
    )Interest
      and debt expense
    
    
    28
    
    
    9
    
    
    69
    
    
    (49
    )
    
    57Total
      Costs and Expenses
    
    
    28
    
    
    164
    
    
    719
    
    
    (49
    )
    
    862(28
    )
    
    47
    
    
    179
    
    
    49
    
    
    247**Other
      Income (Expense)**
    
    
    271
    
    
    (7
    )
    
    29
    
    
    (293
    )
    
    -**Income
      from Continuing Operations****before
      Income Taxes**
    
    
    243
    
    
    40
    
    
    208
    
    
    (244
    )
    
    247**Provision
      for Income Taxes**
    
    
    (91
    )
    
    (14
    )
    
    (79
    )
    
    92
    
    
    (92
    )**Income
      from Continuing Operations**
    
    
    152
    
    
    26
    
    
    129
    
    
    (152
    )
    
    155Loss
      from Discontinued Operations, Net of**Income
      Tax Benefit of $1**
    
    
    -
    
    
    -
    
    
    (3
    )
    
    -
    
    
    (3
    )**Net
      Income**
    
    $
    152
    
    $
    26
    
    $
    126
    
    $
    (152
    )
    $
    152
  - 22 -
  **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Balance Sheet**
 **March
31, 2005**
 
 Kerr-McGee
    
    Guarantor
    
    Non-Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**ASSETS****Current
      Assets**Cash
      and cash equivalents
    
    $
    2
    
    $
    -
    
    $
    199
    
    $
    -
    
    $
    201Intercompany
      receivables
    
    
    -
    
    
    -
    
    
    55
    
    
    (55
    )
    
    -Accounts
      receivable
    
    
    -
    
    
    141
    
    
    749
    
    
    -
    
    
    890Inventories
    
    
    -
    
    
    3
    
    
    361
    
    
    -
    
    
    364Derivatives
      and other current assets
    
    
    7
    
    
    14
    
    
    184
    
    
    -
    
    
    205Deferred
      income taxes
    
    
    -
    
    
    33
    
    
    364
    
    
    -
    
    
    397Total
      Current Assets
    
    
    9
    
    
    191
    
    
    1,912
    
    
    (55
    )
    
    2,057**Property,
      Plant and Equipment - Net**
    
    
    **-**
    
    
    1,946
    
    
    8,921
    
    
    -
    
    
    10,867**Investments
      in Subsidiaries**
    
    
    6,215
    
    
    659
    
    
    -
    
    
    (6,874
    )
    
    -**Investments,
      Derivatives and Other Assets**
    
    
    17
    
    
    23
    
    
    586
    
    
    (80
    )
    
    546**Goodwill
      and Other Intangible Assets**
    
    
    -
    
    
    351
    
    
    933
    
    
    -
    
    
    1,284**Long-Term
      Assets Associated with Properties****Held
      for Disposal**
    
    
    -
    
    
    -
    
    
    4
    
    
    -
    
    
    4**Total
      Assets**
    
    $
    6,241
    
    $
    3,170
    
    $
    12,356
    
    $
    (7,009
    )
    $
    14,758
 
 **LIABILITIES
      AND STOCKHOLDERS' EQUITY****Current
      Liabilities**Intercompany
      borrowings
    
    $
    64
    
    $
    422
    
    $
    1,680
    
    $
    (2,166
    )
    $
    -Accounts
      payable
    
    
    74
    
    
    52
    
    
    502
    
    
    -
    
    
    628Long-term
      debt due within one year
    
    
    -
    
    
    -
    
    
    110
    
    
    -
    
    
    110Derivative
      liabilities
    
    
    -
    
    
    11
    
    
    850
    
    
    -
    
    
    861Accrued
      liabilities
    
    
    (43
    )
    
    214
    
    
    792
    
    
    -
    
    
    963Total
      Current Liabilities
    
    
    95
    
    
    699
    
    
    3,934
    
    
    (2,166
    )
    
    2,562**Long-Term
      Debt**
    
    
    2,474
    
    
    -
    
    
    472
    
    
    -
    
    
    2,946**Noncurrent
      Liabilities**Deferred
      income taxes
    
    
    (9
    )
    
    493
    
    
    1,645
    
    
    -
    
    
    2,129Derivative
      liabilities
    
    
    7
    
    
    1
    
    
    343
    
    
    -
    
    
    351Other
      noncurrent liabilities
    
    
    -
    
    
    243
    
    
    889
    
    
    -
    
    
    1,132Total
      Noncurrent Liabilities
    
    
    (2
    )
    
    737
    
    
    2,877
    
    
    -
    
    
    3,612**Stockholders'
      Equity**
    
    
    3,674
    
    
    1,734
    
    
    5,073
    
    
    (4,843
    )
    
    5,638**Total
      Liabilities and Stockholders' Equity**
    
    $
    6,241
    
    $
    3,170
    
    $
    12,356
    
    $
    (7,009
    )
    $
    14,758
 
 
  - 23 -
  
 
 **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Balance Sheet**
 **December
31, 2004**
 
 Kerr-McGee
    
    Guarantor
    
    Non-Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**ASSETS****Current
      Assets**Cash
      and cash equivalents
    
    $
    2
    
    $
    -
    
    $
    74
    
    $
    -
    
    $
    76Intercompany
      receivables
    
    
    -
    
    
    -
    
    
    58
    
    
    (58
    )
    
    -Accounts
      receivable
    
    
    -
    
    
    206
    
    
    757
    
    
    -
    
    
    963Inventories
    
    
    -
    
    
    5
    
    
    324
    
    
    -
    
    
    329Derivatives
      and other current assets
    
    
    4
    
    
    24
    
    
    167
    
    
    -
    
    
    195Deferred
      income taxes
    
    
    2
    
    
    13
    
    
    309
    
    
    -
    
    
    324Total
      Current Assets
    
    
    8
    
    
    248
    
    
    1,689
    
    
    (58
    )
    
    1,887**Property,
      Plant and Equipment - Net**
    
    
    -
    
    
    1,947
    
    
    8,880
    
    
    -
    
    
    10,827**Investments
      in Subsidiaries**
    
    
    6,306
    
    
    645
    
    
    -
    
    
    (6,951
    )
    
    -**Investments,
      Derivatives and Other Assets**
    
    
    17
    
    
    24
    
    
    547
    
    
    (80
    )
    
    508**Goodwill
      and Other Intangible Assets**
    
    
    -
    
    
    351
    
    
    937
    
    
    -
    
    
    1,288**Long-Term
      Assets Associated with Properties****Held for Disposal**
    
    
    -
    
    
    -
    
    
    8
    
    
    -
    
    
    8**Total
      Assets**
    
    $
    6,331
    
    $
    3,215
    
    $
    12,061
    
    $
    (7,089
    )
    $
    14,518
 
 **LIABILITIES
      AND STOCKHOLDERS' EQUITY****Current
      Liabilities**Intercompany
      borrowings
    
    $
    68
    
    $
    598
    
    $
    1,189
    
    $
    (1,855
    )
    $
    -Accounts
      payable
    
    
    68
    
    
    55
    
    
    521
    
    
    -
    
    
    644Long-term
      debt due within one year
    
    
    354
    
    
    -
    
    
    109
    
    
    -
    
    
    463Derivative
      liabilities
    
    
    6
    
    
    71
    
    
    295
    
    
    -
    
    
    372Accrued
      liabilities
    
    
    10
    
    
    203
    
    
    813
    
    
    -
    
    
    1,026Total
      Current Liabilities
    
    
    506
    
    
    927
    
    
    2,927
    
    
    (1,855
    )
    
    2,505**Long-Term
      Debt**
    
    
    2,125
    
    
    -
    
    
    1,111
    
    
    -
    
    
    3,236**Noncurrent
      Liabilities**Deferred
      income taxes
    
    
    (2
    )
    
    545
    
    
    1,634
    
    
    -
    
    
    2,177Derivative
      liabilities
    
    
    -
    
    
    59
    
    
    149
    
    
    -
    
    
    208Other
      noncurrent liabilities
    
    
    -
    
    
    224
    
    
    853
    
    
    (3
    )
    
    1,074Total
      Noncurrent Liabilities
    
    
    (2
    )
    
    828
    
    
    2,636
    
    
    (3
    )
    
    3,459**Stockholders'
      Equity**
    
    
    3,702
    
    
    1,460
    
    
    5,387
    
    
    (5,231
    )
    
    5,318**Total
      Liabilities and Stockholders' Equity**
    
    $
    6,331
    
    $
    3,215
    
    $
    12,061
    
    $
    (7,089
    )
    $
    14,518
 
 
  - 24 -
  
 **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Statement of Cash Flows**
 **For
the Three Months Ended March 31, 2005**
 
 
 Non-Kerr-McGee
    
    Guarantor
    
    Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**Cash
      Flows from Operating Activities**Net
      income
    
    $
    355
    
    $
    51
    
    $
    325
    
    $
    (376
    )
    $
    355Adjustments
      to reconcile net income to net cashprovided
      by (used in) operating activities-Depreciation,
      depletion and amortization
    
    
    -
    
    
    29
    
    
    297
    
    
    -
    
    
    326Deferred
      income taxes
    
    
    (2
    )
    
    (2
    )
    
    142
    
    
    -
    
    
    138Dry
      hole expense
    
    
    -
    
    
    -
    
    
    20
    
    
    -
    
    
    20Asset
      impairments
    
    
    -
    
    
    -
    
    
    4
    
    
    -
    
    
    4Gain
      on assets held for sale and asset disposal
    
    
    -
    
    
    -
    
    
    (22
    )
    
    -
    
    
    (22
    )Accretion
      expense
    
    
    -
    
    
    1
    
    
    8
    
    
    -
    
    
    9Provision
      for environmental remediationand
      restoration, net of reimbursements
    
    
    -
    
    
    13
    
    
    11
    
    
    -
    
    
    24Equity
      in earnings of subsidiaries
    
    
    (367
    )
    
    (9
    )
    
    -
    
    
    376
    
    
    -Other
      noncash items affecting net income
    
    
    -
    
    
    (2
    )
    
    84
    
    
    -
    
    
    82Changes
      in assets and liabilities
    
    
    (42
    )
    
    89
    
    
    (186
    )
    
    -
    
    
    (139
    )Net
      Cash Provided by (Used in)Operating
      Activities
    
    
    (56
    )
    
    170
    
    
    683
    
    
    -
    
    
    797**Cash
      Flows from Investing Activities**Capital
      expenditures
    
    
    -
    
    
    (32
    )
    
    (342
    )
    
    -
    
    
    (374
    )Dry
      hole costs
    
    
    -
    
    
    -
    
    
    (24
    )
    
    -
    
    
    (24
    )Proceeds
      from sales of assets
    
    
    -
    
    
    -
    
    
    31
    
    
    -
    
    
    31Other
      investing activities
    
    
    -
    
    
    -
    
    
    (30
    )
    
    -
    
    
    (30
    )Net
      Cash Used in Investing Activities
    
    
    -
    
    
    (32
    )
    
    (365
    )
    
    -
    
    
    (397
    )**Cash
      Flows from Financing Activities**Issuance
      of common stock
    
    
    132
    
    
    -
    
    
    -
    
    
    -
    
    
    132Purchases
      of common stock
    
    
    (250
    )
    
    -
    
    
    -
    
    
    -
    
    
    (250
    )Repayment
      of debt
    
    
    -
    
    
    -
    
    
    (42
    )
    
    -
    
    
    (42
    )Increase
      (decrease) in intercompanynotes
      payable
    
    
    245
    
    
    (138
    )
    
    (107
    )
    
    -
    
    
    -Dividends
      paid
    
    
    (68
    )
    
    -
    
    
    -
    
    
    -
    
    
    (68
    )Settlement
      of Westport derivatives
    
    
    -
    
    
    -
    
    
    (43
    )
    
    -
    
    
    (43
    )Other
      financing activities
    
    
    (3
    )
    
    -
    
    
    (2
    )
    
    -
    
    
    (5
    )Net
      Cash Provided by (Used in)Financing
      Activities
    
    
    56
    
    
    (138
    )
    
    (194
    )
    
    -
    
    
    (276
    )**Effects
      of Exchange Rate Changes on Cash****and
      Cash Equivalents**
    
    
    -
    
    
    -
    
    
    1
    
    
    -
    
    
    1**Net
      Increase in Cash and Cash Equivalents**
    
    
    -
    
    
    -
    
    
    125
    
    
    -
    
    
    125**Cash
      and Cash Equivalents at Beginning of Period**
    
    
    2
    
    
    -
    
    
    74
    
    
    -
    
    
    76**Cash
      and Cash Equivalents at End of Period**
    
    $
    2
    
    $
    -
    
    $
    199
    
    $
    -
    
    $
    201
 
  - 25 -
  **Kerr-McGee
Corporation and Subsidiary Companies**
 **Condensed
Consolidating Statement of Cash Flows**
 **For
the Three Months Ended March 31, 2004**
 
 Non-Kerr-McGee
    
    Guarantor
    
    Guarantor(Millions
      of dollars)
    
    Corporation
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    Consolidated**Cash
      Flows from Operating Activities**Net
      income
    
    $
    152
    
    $
    26
    
    $
    126
    
    $
    (152
    )
    $
    152Adjustments
      to reconcile net income to net cashprovided
      by (used in) operating activities -Depreciation,
      depletion and amortization
    
    
    -
    
    
    33
    
    
    170
    
    
    -
    
    
    203Deferred
      income taxes
    
    
    -
    
    
    6
    
    
    67
    
    
    -
    
    
    73Dry
      hole expense
    
    
    -
    
    
    -
    
    
    8
    
    
    -
    
    
    8Asset
      impairments
    
    
    -
    
    
    1
    
    
    12
    
    
    -
    
    
    13Loss
      on assets held for sale and asset disposal
    
    
    -
    
    
    -
    
    
    3
    
    
    -
    
    
    3Accretion
      expense
    
    
    -
    
    
    1
    
    
    6
    
    
    -
    
    
    7Provision
      for environmental remediationand
      restoration, net of reimbursements
    
    
    -
    
    
    (1
    )
    
    -
    
    
    -
    
    
    (1
    )Equity
      in losses (earnings) of subsidiaries
    
    
    (157
    )
    
    4
    
    
    -
    
    
    153
    
    
    -Other
      noncash items affecting net income
    
    
    -
    
    
    1
    
    
    7
    
    
    -
    
    
    8Changes
      in assets and liabilities
    
    
    (35
    )
    
    51
    
    
    (207
    )
    
    -
    
    
    (191
    )Net
      Cash Provided by (Used in)Operating
      Activities
    
    
    (40
    )
    
    122
    
    
    192
    
    
    1
    
    
    275**Cash
      Flows from Investing Activities**Capital
      expenditures
    
    
    -
    
    
    (34
    )
    
    (128
    )
    
    -
    
    
    (162
    )Dry
      hole costs
    
    
    -
    
    
    -
    
    
    (8
    )
    
    -
    
    
    (8
    )Proceeds
      from sales of assets
    
    
    -
    
    
    1
    
    
    42
    
    
    -
    
    
    43Other
      investing activities
    
    
    -
    
    
    -
    
    
    (5
    )
    
    -
    
    
    (5
    )Net
      Cash Used in Investing Activities
    
    
    -
    
    
    (33
    )
    
    (99
    )
    
    -
    
    
    (132
    )**Cash
      Flows from Financing Activities**Issuance
      of common stock
    
    
    5
    
    
    -
    
    
    -
    
    
    -
    
    
    5Repayment
      of debt
    
    
    -
    
    
    -
    
    
    (102
    )
    
    -
    
    
    (102
    )Increase
      (decrease) in intercompanynotes
      payable
    
    
    81
    
    
    (89
    )
    
    9
    
    
    (1
    )
    
    -Dividends
      paid
    
    
    (45
    )
    
    -
    
    
    -
    
    
    -
    
    
    (45
    )Net
      Cash Provided by (Used in)Financing
      Activities
    
    
    41
    
    
    (89
    )
    
    (93
    )
    
    (1
    )
    
    (142
    )**Effects
      of Exchange Rate Changes on Cash****and
      Cash Equivalents**
    
    
    -
    
    
    -
    
    
    1
    
    
    -
    
    
    1**Net
      Increase in Cash and Cash Equivalents**
    
    
    1
    
    
    -
    
    
    1
    
    
    -
    
    
    2**Cash
      and Cash Equivalents at Beginning of Period**
    
    
    2
    
    
    -
    
    
    140
    
    
    -
    
    
    142**Cash
      and Cash Equivalents at End of Period**
    
    $
    3
    
    $
    -
    
    $
    141
    
    $
    -
    
    $
    144
 
 
 
   - 26 -
   **Item
2.**  **Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.**
 
 **Overview
and Recent Developments**
 
 Kerr-McGee
Corporation is one of the largest U.S.-based independent oil and gas exploration
and production companies and the world's third-largest producer and marketer of
titanium dioxide pigment in terms of volumes produced. Kerr-McGee has three
reportable business segments, oil and gas exploration and production, production
and marketing of titanium dioxide pigment (chemical - pigment), and production
and marketing of other chemical products (chemical - other).
 
 We
recently made a number of strategic decisions in an effort to reposition
Kerr-McGee as a pure-play exploration and production company and enhance value
for our stockholders, as discussed below.
 ******
 ***Planned
Asset Disposals*** *-* In
March 2005, the company’s Board of Directors (the Board) authorized management
to pursue alternatives for the separation of the chemical business, including a
spinoff or sale. The company is actively pursuing both separation alternatives
and expects to determine the timing and manner of disposal later in 2005. As of
May 6, 2005, criteria for reporting results of the chemical business unit as
discontinued operations have not been met.
 
 In
April 2005, the company announced its decision to divest of lower-growth,
shorter-life and higher-decline oil and gas properties. Assets being considered
for divestiture are expected to represent approximately 20% to 25% of current
production and approximately 10% to 15% of the company’s proved reserves at
December 31, 2004. Assuming we sold the following assets, we expect to realize
gross proceeds of approximately $2 billion to $2.5 billion:
 
 ·
    All
      of our Gulf of Mexico shelf properties
 ·
    Several
      fields in the United Kingdom sector of the North
Sea
 ·
    Selected
      assets in the U.S. onshore Mid-Continent
area
 ·
    All
      U.S. onshore Powder River Basin properties
 
 With
the divestiture of these properties, we expect the average life of the company’s
oil and gas reserves to increase. Proved developed reserves are expected to
continue to represent approximately 65% of total proved reserves. However, the
actual impact of any asset divestitures may differ materially from management’s
estimates due to a change in market conditions or in the composition of the
properties to be divested, as well as other factors.
 
 ***Repurchases
of Common Stock and Related Financing*** *-* Concurrent
with the decision to pursue the separation of the chemical business, the Board
authorized a share repurchase program initially set at $1 billion, with an
expectation to expand the program as the chemical business separation proceeds.
The company repurchased 3.1 million shares of its common stock at an aggregate
cost of $250 million under this program before its termination in connection
with the Board's approval of the tender offer discussed below.
 
 On
April 14, 2005, the company announced its intention to commence a modified
"Dutch Auction" self tender offer for its common stock with an aggregate
purchase cost of up to $4 billion. Under the tender offer, which commenced on
April 18, 2005, the company will repurchase its shares at a price not lower than
$85 or higher than $92 per share. Based on the number of shares tendered and the
prices specified by the tendering stockholders, we will determine the lowest
per-share price within the range that will enable us to buy up to $4 billion of
Kerr-McGee common stock. Assuming the tender offer is fully subscribed, between
43.5 million and 46.7 million shares may be repurchased, or 27% to 29% of shares
outstanding at March 31, 2005. Unless extended, the tender offer will expire on
May 18, 2005. Except for the company’s directors and executive officers, who
have advised us that they do not intend to tender shares pursuant to the tender
offer, no stockholders have made commitments to the company regarding the tender
of their shares. The tender offer is expected to be financed with cash on hand
and the net proceeds of borrowings. Assuming the tender offer is fully
subscribed, up to $4.1 billion will be required to purchase the shares under the
tender offer and pay related fees and expenses (including structuring and
arrangement fees of $55 million for loan facilities under commitments described
below).
 
  - 27 -
  Under
the existing commitments from JPMorgan Chase Bank, N.A. and Lehman Commercial
Paper Inc., we expect to obtain financing of up to $5.5 billion, which may be
used to fund the tender offer, repay certain existing indebtedness and for
general corporate purposes, as more fully discussed under *Financial
Condition and Liquidity* below.
The tender offer is subject to customary terms and conditions, including those
contained in the financing commitments. We plan to reduce debt associated with
the tender offer in the range of $3.5 billion to $4.5 billion during the next
two years, using proceeds of the planned divestitures discussed above and cash
flow which has been underpinned by an expanded oil and gas hedging program for
2005 through 2007.
 
 As more
fully discussed under *Financial
Condition and Liquidity,* as a
result of our decision to proceed with the tender offer and the anticipated
increase in the company’s leverage, the company’s credit rating was downgraded
and is no longer investment grade.
 
 ***Expanded
Hedging Program*** *-* To
increase the predictability of cash flows, we expanded our hedging program. As
of May 2, 2005, we had costless collars and fixed-priced swaps covering at least
75% of the company’s 2005 and 2006 expected eligible production (after the
planned divestitures) and approximately 50% of 2007 expected eligible
production. Eligible production excludes oil production in China and gas
production from the North Sea. Additional information regarding our commodity
price risk management activities is included in *Quantitative
and Qualitative Disclosures about Market Risk* below.
 
 ***Revised
Dividend Policy*** *-* The
Board approved a recommendation to revise the company’s dividend policy to a
dividend level consistent with that of other pure-play exploration and
production companies. Starting with the quarter ending June 30, 2005, the annual
dividend is expected to be revised from $1.80 to $.20 per share.
 
 **Results
of Consolidated Operations**
 
 The
following table summarizes segment operating profit with a reconciliation to
consolidated net income for the three months ended March 31, 2005 and
2004:
 
 Three
      Months EndedMarch
      31,(Millions
      ofdollars)
    
    **2005**
    
    2004Segment
      operating profit  (1)-Exploration
      and production
    
    **$**
    **655**
    
    $
    330Chemical
      -Pigment
    
    
    **32**
    
    
    7Other
    
    
    **(9******
    ******)**
    
    (3
    )Total
      Chemical
    
    
    **23**
    
    
    4Total
      segment operating profit
    
    
    **678**
    
    
    334Unallocated
      expenses -Interest
      and debt expense
    
    
    **(61**
    **)**
    
    (57
    )Corporate
      expenses
    
    
    **(44**
    **)**
    
    (31
    )Environmental
      provisions, net of reimbursements
    
    
    **(13**
    **)**
    
    1Other
      income (expense)
    
    
    **(1**
    **)**
    
    -Provision
      for income taxes
    
    
    **(204******
    ******)**
    
    (92
    )Total
      unallocated expenses
    
    
    **(323******
    ******)**
    
    (179
    )Income
      from continuing operations
    
    
    **355**
    
    
    155Loss
      from discontinued operations, net of taxes (2)
    
    
    **-**
    
    
    (3
    )Net
      Income
    
    **$**
    **355**
    
    $
    152Net
      Income per Common Share:Basic
    
    **$**
    **2.29**
    
    $
    1.52Diluted
    
    
    **2.20**
    
    
    1.41
 (1)
    Segment
      operating profit represents results of continuing operations before
      considering general corporate expenses, interest and debt expense,
      environmental provisions related to sites with no ongoing operations or
      businesses in which the company’s affiliates are no longer engaged, other
      income (expense) and income taxes.
 
 (2)
    Loss
      from discontinued operations reflects results of the company’s former
      forest products operations. Criteria for classification of the forest
      products business as discontinued operations were met in the fourth
      quarter of 2004.
  - 28 -
  Total
segment operating profit for the first quarter of 2005 was $678 million,
compared with $334 million for 2004. The increase of $344 million is primarily
attributable to an increase in consolidated revenues of $608 million, partially
offset by higher costs and operating expenses of $126 million and higher
depreciation and depletion expense for our exploration and production operations
of $119 million. Approximately 90% of the total increase in consolidated
revenues is attributable to our exploration and production segment and is due to
higher average realized oil and gas sales prices and higher sales volumes. The
increase in operating costs and expenses was a result of both higher sales
volumes and higher per unit operating costs. Components of segment operating
profit are further analyzed under *Results
of Operations by Segment* below.
 
 Income
from continuing operations for the first quarter of 2005 was $355 million,
representing an increase of $200 million from 2004. The increase is due to $344
million higher segment operating profit, partially offset by $112 million higher
income tax expense and an increase of $27 million in corporate expenses and
environmental provisions.
 
 Corporate
expenses for the first quarter of 2005 increased $13 million compared with 2004,
largely due to an increase in employee incentive compensation and benefits.
Incentive compensation expense was higher primarily due to performance unit
awards. We have additional performance unit awards outstanding following the
January 2005 grant. Further, the per-unit liability associated with the awards
increased as a result of the higher market price of our common stock, since
ultimate payout is based on Kerr-McGee’s total shareholder return as compared to
selected peer companies. Pension and postretirement benefits expense increased
primarily due to changes in the discount rate and long-term rate of return
assumptions effective January 1, 2005. As discussed under *Obligations
and Commitments* below,
we initiated certain employee retention programs in April 2005. Compensation
expense associated with these programs will be recognized as services are
provided and is expected to be $24 million for the remainder of 2005 and $10
million in 2006, assuming all participating employees meet award conditions and
before considering discretionary awards that may be granted in future
periods.
 
 Unallocated
environmental provisions, net of reimbursements, increased $14 million over
2004. This increase primarily was caused by a provision of $13 million recorded
in 2005 for the West Chicago site to cover increased soil volumes encountered
during the final stages of characterization, increases in labor and materials
and required future payments for past costs and access fees.
 
 First-quarter
2005 income tax expense was $204 million, reflecting an effective tax rate of
36.5%, which is comparable to the 37.2% effective income tax rate for the same
2004 period. Higher income tax expense in 2005 is primarily attributable to the
increase in pre-tax income from continuing operations. On October 22, 2004, the
President of the United States signed into law the American Jobs Creation Act of
2004 (the “Act”). A provision of the Act includes a one-time dividends received
deduction of 85% of certain foreign earnings that are repatriated, as defined in
the Act. As of March 31, 2005, management had not decided on whether, and to
what extent, foreign earnings may be repatriated by the company under the Act,
and accordingly, the accompanying financial statements for the three months
ended March 31, 2005 do not reflect any provision for taxes on unremitted
foreign earnings. On April 11, 2005, management completed its analysis of the
impact of the Act on the company's plans for repatriation. Based on this
analysis, the company plans to repatriate up to $500 million in extraordinary
dividends, as defined in the Act, by the end of 2005. Accordingly, a tax
liability of approximately $28 million may be recognized in the quarter ending
June 30, 2005. Cash requirements for the dividends are expected to be met with
cash on hand, operating cash flows of certain of our foreign subsidiaries and
proceeds from asset sales.
 
 ***Tender
Offer and Related Financing*** - The
completion of the self tender offer and the related financing, as discussed
under *Overview
and Recent Developments* above,
is expected to increase interest and debt expense and have other effects on our
results of operations, as summarized below:
 
 ·
    Structuring
      and arrangement fees under the commitments are expected to total $55
      million. Assuming financing is obtained concurrent with the expiration of
      the tender offer in May 2005, approximately $10 million of such costs will
      be recognized as additional interest and debt expense in 2005, with the
      remaining costs being amortized to earnings over the term of the related
      debt ranging from two to six years. Expense recognition will be
      accelerated if the borrowings are repaid prior to their stated maturity.
      Additional information regarding loan financing under the commitments
      obtained by the company is included under*Financial
      Condition and Liquidity*.
 
 - 29 -
  ·
    Assuming
      we borrow approximately $4.1 billion to fund the tender offer and to pay
      the related fees and expenses (including structuring and arrangement fees
      for the loan facilities under the existing commitments), quarterly
      interest expense will increase by approximately $55 million, or $36
      million on an after-tax basis (based on the current LIBOR rate of 3.22%
      and a weighted average margin under the commitments of 2.38%). Actual
      interest expense will depend on the level of borrowings, interest rates
      and interest margins set forth in the final financing
      agreements.
 ·
    Under
      the terms of the tender offer our employees can exercise their vested
      options and tender the shares received from such exercise to the company.
      The company expects to recognize additional compensation expense for any
      such shares accepted for repurchase. Excluding options held by our
      executive officers and directors, who have advised that they do not intend
      to tender shares pursuant to the tender offer, approximately
      2 million options were exercisable as of March 31, 2005, with a
      weighted average exercise price of $53.18 per share. Assuming 27% to 29%
      of such options result in share repurchases under the tender offer
      (consistent with the percentage of total outstanding shares we seek to
      repurchase), we estimate resulting compensation expense to be
      approximately $20 million pre-tax. Actual expense will not be known
      until the tender offer is completed.
 
 ·
    The
      number of shares outstanding after the tender offer may be reduced by up
      to 46.7 million shares, thus affecting per share results of operations in
      future periods.
 
 Additional
information regarding the tender offer and related financing is provided under *Financial
Condition and Liquidity* .
 
 **Results
of Operations by Segment -**
 **Exploration
and Production**
 
 **Segment
Operating Profit**
 
 Revenues,
operating costs and expenses, and marketing activities associated with the
exploration and production segment are shown in the following table.
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Revenues,
      excluding marketing revenues
    
    **$**
    **1,251**
    
    $
    752Operating
      costs and expenses:Lifting
      costs:Lease
      operating expense
    
    
    **142**
    
    
    89Production
      and ad valorem taxes
    
    
    **30**
    
    
    15Total
      lifting costs
    
    
    **172**
    
    
    104Depreciation, depletion and amortization
    
    
    **281**
    
    
    162Accretion expense
    
    
    **8**
    
    
    7Asset impairments
    
    
    **4**
    
    
    13(Gain) loss associated with assets held for sale
    
    
    **(22**
    **)**
    
    3General and administrative expense
    
    
    **30**
    
    
    31Transportation expense
    
    
    **35**
    
    
    26Exploration expense
    
    
    **63**
    
    
    51Gas gathering, pipeline and other expenses
    
    
    **26**
    
    
    25Total
      operating costs and expenses
    
    
    **597**
    
    
    422Operating
      profit, excluding net marketing margin
    
    
    **654**
    
    
    330Marketing
      - Gas sales revenues
    
    
    **132**
    
    
    82Marketing
      - Gas purchase costs (including transportation)
    
    
    **(131******
    ******)**
    
    (82
    )Net
      marketing margin
    
    
    **1**
    
    
    -Total
      Operating Profit
    
    **$**
    **655**
    
    $
    330
 
  - 30 -
  **Revenues**
 
 Revenues,
production statistics and average prices received from sales of crude oil,
condensate and natural gas are shown in the following table.
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars, except per-unit amounts)
    
    **2005**
    
    2004Revenues
      -Crude
      oil and condensate sales
    
    **$**
    **679**
    
    $
    361Natural
      gas sales
    
    
    **607**
    
    
    371Gas
      marketing activities
    
    
    **132**
    
    
    82Other
      revenues
    
    
    **16**
    
    
    20Nonhedge
      derivative losses
    
    
    **(51******
    ******)**
    
    -Total
    
    **$**
    **1,383**
    
    $
    834Production
      -Crude
      oil and condensate (thousands of barrels per day):U.S.
      Gulf of Mexico
    
    
    **62**
    
    
    57U.S.
      onshore
    
    
    **36**
    
    
    19North
      Sea
    
    
    **68**
    
    
    67China
    
    
    **22**
    
    
    -Total
    
    
    **188**
    
    
    143Natural
      gas (million cubic feet per day):U.S.
      Gulf of Mexico
    
    
    **412**
    
    
    328U.S.
      onshore
    
    
    **597**
    
    
    322North
      Sea
    
    
    **95**
    
    
    113Total
    
    
    **1,104**
    
    
    763Total
      equivalent barrels of oil (thousands of boe per day)
    
    
    **372**
    
    
    270Average
      sales prices (excluding hedges) -Crude
      oil and condensate (per barrel):U.S.
      Gulf of Mexico
    
    **$**
    **45.01**
    
    $
    33.00U.S.
      onshore
    
    
    **41.07**
    
    
    30.16North
      Sea
    
    
    **45.42**
    
    
    30.20China
    
    
    **38.37**
    
    
    -Average
    
    
    **43.61**
    
    
    31.30Natural
      gas (per thousand cubic feet):U.S.
      Gulf of Mexico
    
    **$**
    **6.54**
    
    $
    5.80U.S.
      onshore
    
    
    **5.69**
    
    
    5.51North
      Sea
    
    
    **6.17**
    
    
    4.41Average
    
    
    **6.05**
    
    
    5.47Average
      realized sales prices (including hedges) -Crude
      oil and condensate (per barrel):U.S.
      Gulf of Mexico
    
    **$**
    **41.39**
    
    $
    28.75U.S.
      onshore
    
    
    **37.45**
    
    
    25.86North
      Sea
    
    
    **43.43**
    
    
    26.49China
    
    
    **38.37**
    
    
    -Average
    
    
    **40.98**
    
    
    27.30Natural
      gas (per thousand cubic feet):U.S.
      Gulf of Mexico
    
    **$**
    **6.61**
    
    $
    5.66U.S.
      onshore
    
    
    **5.75**
    
    
    5.37North
      Sea
    
    
    **6.17**
    
    
    4.41Average
    
    
    **6.11**
    
    
    5.35
  - 31 -
  ***Crude
Oil Sales Revenues and Production*** - Oil
sales revenues increased $318 million or 88% in the first quarter of 2005
compared with the same period of 2004 due to a combination of higher realized
commodity prices and increased oil production. First-quarter 2005 oil production
of 188 thousand barrels per day (Mbbls/d) represented an increase of 31% over
the same 2004 period. Contributing to the increase was the addition of Westport
properties in late June 2004 (26 Mbbls/d), as well as production from China's
CFD 11-1/11-2 fields, which began producing in July 2004 (22 Mbbls/d). North Sea
production increased slightly due to the impact of strong development drilling
results at the Gryphon field, which offset field declines at Harding, Tullich,
and Leadon. Average oil prices, including the effect of hedging activity,
increased $13.68 per barrel in the first quarter of 2005, contributing an
additional $227 million to oil sales revenues.
 
 ***Natural
Gas Sales Revenues and Production*** -
Natural gas sales revenues increased $236 million in the first quarter of 2005
compared to the same period of 2004 as a result of a 45% increase in gas
production, combined with a $.76 per thousand cubic feet (Mcf) increase in the
average realized price, including hedging. Gas production in the first quarter
of 2005 was 1,104 million cubic feet per day (MMcf/d), 341 MMcf/d higher than
2004 first-quarter production, contributing an additional $161 million in gas
sales revenues. Gas production increased as a result of production from Westport
properties, which contributed approximately 400 MMcf/d in the first quarter of
2005. In addition, the Red Hawk field in the deepwater Gulf of Mexico, which
began producing in July 2004, partially offset declines that occurred in other
Gulf of Mexico and U.S. onshore fields. North Sea gas production declined by 16%
in the first quarter of 2005 compared to 2004, primarily associated with
declines at the Skene field. Higher realized gas prices provided an additional
$75 million in gas sales revenues, averaging $6.11 per Mcf, including the impact
of hedging activity.
 
 ***Other
Revenues*** -
Other revenues include gas processing plant and gathering system revenues in the
U.S. onshore area, along with oil tariffs and non-equity oil and gas sales in
the U.K. Gas marketing activities in the Rocky Mountain area are discussed
below.
 
 Other
revenues totaled $16 million in the first quarter of 2005, a decrease of $4
million from 2004. The decrease resulted from recognizing $9 million of losses
from hedge ineffectiveness, compared with $1 million in the first quarter of
2004. The $8 million reduction in revenues due to hedge ineffectiveness was
partially offset by $2 million higher revenues generated from the resale of
non-equity gas in the North Sea. In addition, higher U.S. commodity prices
increased gas processing revenues from the company's non-operated ownership
interest in a Wattenberg-area gas plant by $2 million.
 
 ***Nonhedge
Derivative Losses*** -
Nonhedge derivative losses represent net realized and unrealized gains and
losses related to crude oil and natural gas derivative instruments that have not
been designated as hedges or that do not qualify for hedge accounting treatment.
Such gains and losses primarily relate to certain contracts assumed in
connection with the Westport merger. While Westport’s fixed-price oil and gas
swaps were designated as hedges after the merger, costless and three-way collars
do not qualify for hedge accounting treatment because they represented “net
written options” at the merger date. As a result, even though these collars
effectively reduce commodity price risk, the company will recognize
mark-to-market gains and losses in earnings until the collars mature, rather
than deferring such amounts in accumulated other comprehensive income (loss).
The net liability associated with these derivatives at March 31, 2005 was $112
million.
 
 For
further discussion of the company’s derivative activities see Note 3 to the
accompanying condensed consolidated financial statements and information
included below in Item 3, *Quantitative
and Qualitative Disclosures about Market Risk.*
 
 **Lease
Operating Expense**
 
 In the
first quarter of 2005, lease operating expense increased 60% or $53 million
compared with 2004. On a per-unit basis, lease operating expense increased $.70
per barrel of oil equivalent (boe), from $3.58 per boe in 2004 to $4.28 per boe
in 2005. The increase was primarily due to additional operating expenses
associated with Westport properties ($35 million) and new production from
China's CFD 11-1/11-2 fields ($9 million). North Sea operating expense also
increased by $3 million in the first quarter of 2005 as compared to 2004,
primarily due to well workover expense for the Janice, Brae and Harding fields.
 
  - 32 -
  **Production
and Ad Valorem Taxes**
 
 Production
and ad valorem taxes are comprised primarily of severance taxes associated with
properties located onshore and in state waters in the U.S. These taxes, which
usually are based on a percentage of oil and gas sales revenues, increased $15
million in the first quarter of 2005 as a result of higher commodity prices and
higher sales volumes. The addition of Westport's properties resulted in higher
production taxes as a percentage of sales revenues by increasing the proportion
of U.S. onshore properties subject to production taxes in our portfolio.
 
 **Depreciation,
Depletion and Amortization (DD&A)**
 
 DD&A
expense of $281 million for the first quarter of 2005 increased $119 million
over 2004, primarily caused by additional DD&A expense for the Westport
properties acquired in June 2004 ($100 million) and new production from China's
CFD 11-1/11-2 fields ($15 million). On a per-unit basis, DD&A expense
increased from $6.52 per boe in the first quarter of 2004 to $8.48 per boe in
2005, reflecting the impact of the Westport merger, which had a higher
acquisition cost per boe than our historical asset base.
 
 **Asset
Impairments and Gain/Loss on Sales of Assets**
 
 Kerr-McGee
records impairment losses when performance analysis and other factors indicate
that future net cash flows from production will not be sufficient to recover the
carrying amounts of the related assets. In general, such write-downs most often
occur on mature properties that are nearing the end of their productive lives or
cease production sooner than anticipated. Impairment losses recorded in the
first quarter of 2005 and 2004 totaled $4 million and $13 million, respectively.
Impairment losses in 2005 were related to two U.S. Gulf of Mexico shelf
properties that ceased producing in the first quarter.
 
 We
recognized a net gain on disposition of assets of $22 million in the first
quarter of 2005, primarily associated with exchanging the company's interests in
certain U.S. onshore properties for an interest in the Blind Faith discovery in
the deepwater Gulf of Mexico. We acquired a 37.5% interest in Blind Faith from
BP Exploration & Production in exchange for our interests in various proved
oil and gas properties in the Arkoma basin of southeast Oklahoma. We received
$22 million at the closing date of the transaction (subject to post-closing
adjustments) with an additional $2 million to be received associated with
certain preferential rights to purchase. The company recognized a $19 million
gain on disposal based on the percentage of the Arkoma properties' fair value
that was received in cash.
 
 **General
and Administrative Expense**
 
 First-quarter
2005 general and administrative expense of $30 million was $1 million lower than
in 2004, primarily as a result of increased recovery of overhead costs in the
Gulf of Mexico that was largely offset by higher compensation, benefits and
other general and administrative costs. Per-unit general and administrative
expense was $.89 per boe in the first quarter of 2005, a decrease of $.37 per
boe compared to the same 2004 period. Additional production from Westport
properties without commensurate increases in general and administrative costs
improved per-unit metrics.
 
 **Transportation
Expense**
 
 Transportation
expense, representing the costs paid to third-party providers to transport oil
and gas  production,
increased by $9 million in the first quarter of 2005, to $35 million. The
increase was primarily due to additional transportation costs associated with
Westport properties ($6 million). In addition, in early 2005 we began
transporting gas from the Rocky Mountain area under a new contract, increasing
overall transportation costs. On a per-unit basis, 2005 transportation expense
was $1.05 per boe compared to $1.08 per boe in 2004.
 
  - 33 -
  
 **Exploration
      Expense**
    
    Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Exploration
      costs(1)
    
    **$**
    **12**
    
    $
    10Geological
      and geophysical costs
    
    
    **16**
    
    
    20Dry
      hole expense
    
    
    **20**
    
    
    8Amortization
      of undeveloped leases
    
    
    **16**
    
    
    13Sales
      of unproved properties
    
    
    **(1******
    ******)**
    
    -Total
      exploration expense
    
    **$**
    **63**
    
    $
    51
 
 (1)
    Exploration
      costs include delay rentals, cost of retaining and carrying unproved
      properties and exploration department
overhead.
 
 In the
first quarter of 2005, total exploration expense was $63 million, an increase of
$12 million. Exploration activity associated with Westport properties
contributed approximately $8 million to the first-quarter 2005 exploration
expense. Dry hole costs increased $12 million in the first quarter of 2005
compared to the same period in 2004, primarily associated with the Gulf of
Mexico and U.S. onshore areas. Amortization of undeveloped leases also increased
by $3 million, primarily as a result of additional Westport leases. Geological
and geophysical data acquisition and processing costs decreased $4 million in
the first quarter of 2005, with lower spending in the deepwater Gulf of Mexico
and U.K. North Sea as compared with the first quarter of 2004.
 
 Capitalized
exploratory well costs associated with ongoing exploration and/or appraisal
activities may be charged to earnings in a future period if management
determines that commercial quantities of hydrocarbons have not been discovered
or that future appraisal drilling or development activities are not likely to
occur. At March 31, 2005, the company had capitalized exploratory well costs of
approximately $192 million associated with such ongoing exploration activities, primarily in the deepwater
Gulf of Mexico, Brazil, Alaska and China.
 
 **Gas
Marketing Activities**
 
 Kerr-McGee
purchases third-party natural gas for aggregation and sale with the company's
own production in the Rocky Mountain area. In addition, we have transportation
capacity to markets in the Midwest to facilitate sale of natural gas outside the
immediate vicinity of our production.
 
 Marketing
revenue was $132 million in the first quarter of 2005, an increase of $50
million as compared to 2004. The increase in 2005 was the result of higher
purchase and resale of third-party natural gas in the Rocky Mountain area and
higher natural gas prices. Increased gas purchase costs of $49 million in 2005
resulted in a net marketing margin of $1 million. Marketing volumes (thousand
MMBtu/day) were 257 in the first quarter of 2005 and 175 in 2004.
 
  - 34 -
  **Results
of Operations by Segment -**
 **Chemical**
 
 Chemical
segment revenues, operating profit (loss) and pigment production volumes are
shown in the following table:
 
 Three
      Months EndedMarch
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Revenues
      -Pigment
    
    **$**
    **311**
    
    $
    252Other
    
    
    **23**
    
    
    23Total
    
    **$**
    **334**
    
    $
    275Operating
      profit (loss)(1)Pigment
    
    **$**
    **32**
    
    $
    7Other
    
    
    **(9******
    ******)**
    
    (3
    )Total
    
    **$**
    **23**
    
    $
    4Titanium
      dioxide pigment production
    
    
    **134**
    
    
    137(thousands
      of tonnes)
 
 (1)
    Operating
      profit (loss) does not include litigation provisions and environmental
      provisions, net of reimbursements, related to sites with no ongoing
      operations or various businesses in which the company’s affiliates are no
      longer engaged, such as the mining and processing of uranium and thorium
      and other businesses.
 
 
 **Chemical
- Pigment**
 
 Operating
profit for the first quarter of 2005 was $32 million on revenues of $311
million, compared with operating profit of $7 million on revenues of $252
million for the same 2004 period. Of the $59 million increase in revenues, $31
million was due to an increase in average selling prices of approximately 11%
and $28 million was due to increased sales volumes of approximately 14,000
tonnes. Strong market conditions contributed to the improvement in both the
pricing and volumes in 2005. Pricing was also impacted by the effect of foreign
currency exchange rates in these two periods. The increase in revenues was
partially offset by increased manufacturing costs and freight due to the
increased volumes sold and increased costs resulting from the effects of foreign
currency exchange rate changes.
 
 The
company has continued to operate its new high-productivity oxidation line for
chloride-process titanium dioxide pigment production at the Savannah facility
during the first quarter of 2005. This project, if successful, will
substantially increase chloride production capability at a reduced asset
intensity level. The company continues to evaluate the performance of this new
oxidation line and expects to have a better understanding of how the Savannah
site might be reconfigured to exploit its capabilities in 2005. The possible
reconfiguration of the Savannah site, if any, could include redeployment of
certain assets, idling of certain assets and reduction of the future useful life
of certain assets, resulting in the acceleration of depreciation expense and the
recognition of other charges.
 
 **Chemical
- Other**
 
 Operating
loss in the first quarter of 2005 was $9 million on revenues of $23 million,
compared with an operating loss of $3 million on revenues of $23 million in the
same 2004 period. In the first quarter of 2005, the company incurred a net $11
million environmental provision (net of expected insurance reimbursement of $19
million) related primarily to ammonium perchlorate remediation associated with
the company's Henderson, Nevada, operations (see Note 13). This charge was
partially offset by improved operations at the company’s Henderson, Nevada,
electrolytic manganese dioxide manufacturing facility during the first quarter
of 2005 compared to the prior year.
 
  - 35 -
  **Financial
Condition and Liquidity**
 
 The
following table provides certain information useful in the analysis of the
company's financial condition.
 
 **March
      31,**
    
    December
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Current
      ratio(1)
    
    
    **0.8
      to 1**
    
    
    0.8
      to 1Total
      debt
    
    **$**
    **3,056**
    
    $
    3,699Stockholders’
      equity
    
    **$**
    **5,638**
    
    $
    5,318Debt
      to total capitalization(2)
    
    
    **35**
    **%**
    
    41
    %Floating-rate
      debt to total debt (fixed-rate debt with interest rateswaps
      to variable rate is treated as floating-rate debt)
    
    
    **29**
    **%**
    
    25
    %
 
 (1)
    Represents a
      ratio of current assets to current
liabilities.
  (2)
    Total
      capitalization is determined as total debt plus stockholders'
      equity.
  
 During
the first quarter, the percentage of debt to total capitalization declined from
41% to 35%, largely as a result of the conversion of the 5.25% convertible
subordinated debentures due 2010. We called for redemption all of the $600
million aggregate principal amount of the debentures in February 2005. By March
4, 2005, the redemption date, all of the debentures were converted by the
holders into approximately 9.8 million shares of common stock, which reduced
debt by $600 million and increased stockholders’ equity by $593 million (net of
a write-off of the related unamortized debt issuance costs). The effect of the
debentures’ conversion on the ratio of debt to total capitalization was
partially offset by a $250 million reduction in equity as a result of
repurchasing approximately 3.1 million shares under a share repurchase program
approved by the Board in March 2005. As discussed in *Overview
and Recent Developments* , the
program was discontinued in connection with the Board's approval of the $4
billion self tender offer. The expected effects of the tender offer on our
financial condition and liquidity are discussed in more detail below.
 
 On
April 15, 2005, our 5.375% Notes in the aggregate principal amount of $350
million matured and were repaid with the proceeds of borrowings under our
five-year $1.5 billion revolving credit facility. Consequently, the carrying
value of the 5.375% Notes was classified as long-term debt at March 31, 2005,
based on the company’s ability and intent to maintain this obligation for longer
than one year. Additionally, our 8.125% Notes in the aggregate principal amount
of $109 million are scheduled to mature in October 2005. We plan to repay the
notes with cash flow from operations.
 
 ***Sources
of Liquidity*** *-* Our
liquidity is derived from both internal and external sources. At March 31, 2005,
we had the following sources of liquidity available to us:
 
 ·
    Cash
      and cash equivalents of $201 million
 ·
    Capacity
      of $1.5 billion under our unsecured revolving credit
    facility
 ·
    Available
      bank lines of credit of $50 million
 ·
    A
      total of $1 billion of debt securities, common or preferred stock, or
      warrants available to issue or sell under our shelf registration with the
      Securities and Exchange Commission (SEC), which was last updated in
      February 2002.
 
 During
the first quarter of 2005, we satisfied our liquidity needs primarily with net
cash provided by operating activities, borrowings under our $1.5 billion
revolving credit facility (none of which were outstanding at quarter-end) and
$165 million accounts receivable monetization program. As discussed under *Credit
Ratings* below,
the program was terminated in April 2005. The company's $1.5 billion unsecured
revolving credit agreement, which extends through November 2009, contains
restrictive covenants, including a maximum total debt to total capitalization
ratio, as defined in the agreement, of 65%. At March 31, 2005, the company’s
total debt to total capitalization ratio was 35% and the company was in
compliance with other debt covenants. As further discussed below, in connection
with the tender offer, our $1.5 billion revolving credit agreement is expected
to be terminated and replaced with a $1.25 billion secured revolving credit
facility.
 
  - 36 -
  The
company had negative working capital of $505 million at quarter-end; however,
that is not indicative of a lack of liquidity as the company maintains
sufficient current assets to settle current liabilities when due. Cash balances
are minimized as one way to finance capital expenditures and lower borrowing
costs. Additionally, our working capital position is affected by current assets
and liabilities associated with our financial derivatives. At March 31, 2005,
the company had recorded approximately $822 million of net current derivative
liabilities for contracts that will effectively adjust the cash flows to be
realized upon the sale of our future oil and gas production. Because those sales
have not yet occurred, the associated accounts receivable are not yet reflected
in our Condensed Consolidated Balance Sheet, while derivative assets and
liabilities are carried on the Condensed Consolidated Balance Sheet at their
estimated fair value. Because of the high degree of volatility in oil and
natural gas commodity markets and increased volume of outstanding commodity
derivative contracts, our working capital position will be continually affected
by changes in the fair value of derivative instruments.
 
 Certain
of our counterparties require margin deposits if unrealized losses on derivative
instruments exceed limits established with individual counterparty institutions.
From time to time, we may advance cash to our counterparties to satisfy margin
deposit requirements. No margin deposits were outstanding at March 31, 2005. As
a result of our credit rating being lowered in April 2005, as discussed below,
we were required to post cash collateral of $31 million as of May 5, 2005 with
one of our counterparties. Future collateral requirements will depend on changes
in fair value of outstanding derivative contracts with certain counterparties.
 
 ***Credit
Ratings*** - In
rating the company’s debt, rating agencies consider our financial and operating
risk profile by analyzing our debt levels, growth profile, cost structure, oil
and gas reserve replacement ratios, capital expenditure requirements,
contingencies, dividend policy and any other factors they deem relevant that
could potentially impact our ability to service debt. In response to the
company’s April 14, 2005 announcement of our intention to commence the tender
offer for up to $4 billion of common stock and increase leverage in the near
term, our credit ratings were downgraded and are no longer investment grade. The
following table provides a summary of our senior unsecured debt ratings by major
rating agencies as of March 31, 2005, and subsequent to the
downgrades:
 
 March
      31, 2005
    
    May
      5, 2005Standard
      & Poor’s
    BBB-
    
    BB+Moody’s
      Investors Service
    Baa3
    
    Ba3
 
 As a
result of the downgrades, the company’s borrowing costs increased by 77.5 basis
points from quarter-end levels. Additionally, as discussed above, certain
counterparties to our derivative instruments required us to post cash
collateral. Further, we had an accounts receivable monetization program under
which selected qualifying customer accounts receivable of the company’s chemical
- pigment business were sold to a special-purpose entity (SPE), which in turn
sold an undivided ownership interest in the receivables to a third-party
multi-seller commercial paper conduit sponsored by an independent financial
institution. The program provided for termination upon a ratings downgrade below
specified levels. Under that provision, the program would effectively liquidate
over time and the third-party multi-seller commercial paper conduit would be
repaid with the collections on accounts receivable sold. The ratings downgrades
in April 2005 triggered the program termination event. As opposed to liquidating
the program over time or modifying its terms, the company elected to terminate
the program by advancing the then outstanding balance of receivables sold of
$165 million to the SPE, which in turn used the funds to repay the financial
institution participating in the program. The balances of outstanding
receivables are expected to be collected as they become due and will be used by
the SPE to repay the company for its advance. As a consequence of lower credit
ratings, the company may be required to post collateral in the form of cash or
letters of credit and/or experience a general increase in the cost of or
modifications to other existing and future programs and agreements.
 
  - 37 -
  ***Tender
Offer and Related Financing*** - As
discussed under *Overview
and Recent Developments* , on
April 18, 2005, the company commenced a modified "Dutch Auction" self tender
offer for up to 43.5 million shares (46.7 million in certain circumstances) of
its common stock with an aggregate purchase cost of up to $4 billion. The tender
offer is expected to be financed with cash on hand and the net proceeds of
borrowings. We obtained commitments for financing from JPMorgan Chase Bank, N.A.
and Lehman Commercial Paper Inc. totaling up to $6 billion. In connection with
the commitments we expect to close the following facilities:
 
 Amount
    
    TermSenior
      secured term loan facility
    
    $2
      billion
    
    2
      yearsSenior
      secured term loan facility
    
    $2.25
      billion
    
    6
      yearsSenior
      secured revolving credit facility
    
    $1.25
      billion
    
    5
      years
 
 The
availability of the facilities under the commitments is subject to certain
conditions, including the repayment and termination of the company’s existing
$1.5 billion revolving credit facility. The term facilities may be used to repay
certain of the company’s existing indebtedness, to finance the tender offer and
to pay related fees and expenses. The revolving credit facility may be used to
repay certain of the company’s existing indebtedness and for general corporate
purposes. Borrowings under the facilities will bear interest, at the company’s
selection, based on LIBOR, the JPMorgan Chase Bank prime rate or the federal
funds rate, plus a margin that ranges from .75% to 2.50%. Under the commitments,
the six-year term loan facility will amortize in quarterly installments, amounts
of which will be determined in the final agreements. Additionally, subject to
certain exceptions and step-down provisions the facilities will be subject to
mandatory prepayment provisions under which 50% of the net after-tax proceeds of
certain equity issuances and excess cash flow and 100% of the net after-tax
proceeds from dispositions of certain assets and incurrence of certain
indebtedness must be used to repay the term loans. Each facility will be secured
by a perfected first priority security interest, subject to existing liens and
customary exceptions and to the rights of the company’s existing bondholders to
be equally and ratably secured, in all of the company’s tangible and intangible
assets located in the United States (other than certain assets), and all of the
capital stock of the company’s direct and indirect subsidiaries (other than
certain subsidiaries to be agreed and limited, in the case of foreign
subsidiaries, to 66% of the capital stock of the company’s first tier foreign
subsidiaries). The terms of the facilities are expected to include customary
representations and warranties, conditions precedent, events of default,
affirmative and negative covenants and financial covenants.
 
 Pro
forma total debt and stockholders’ equity at March 31, 2005 would have been $6.9
billion and $1.6 billion, respectively, had the following transactions occurred
on that date: (a) $3.8 billion of borrowings under the commitments discussed
above, which would have been necessary, along with cash on hand of $201 million,
to fund the tender offer and related fees and expenses (including estimated
tender offer transaction costs of $2 million and structuring and arrangement
fees for the loan facilities under the existing commitments of $55 million) and
(b) repurchase of 43.5 million shares of Kerr-McGee common stock under the
tender offer, incurrence of the related transaction costs and the use of cash.
The resulting pro forma debt to total capitalization ratio would have been 81%.
We plan to reduce debt associated with the tender offer in the range of $3.5
billion to $4.5 billion during the next two years using proceeds of planned
divestitures discussed under *Overview
and Recent Developments* above
and cash flow which has been underpinned by an expanded oil and gas hedging
program for 2005 through 2007.
 
 We
expect to fund capital expenditures, debt payments and working-capital
requirements through cash on hand, cash generated from operations, the sales of
assets, issuance of debt and/or amounts we expect to be available under the
$1.25 billion revolving credit facility under the existing commitment. Based on
the company's forecast of cash flows and liquidity, the company believes that it
has and will continue to have the financial resources and liquidity to meet
future cash requirements. Included in this forecast are expected proceeds from
the separation of the chemical business unit and sales of oil and gas properties
which are expected to be realized over the next two years.
 
  - 38 -
  **Cash
Flows**
 
 ***Operating
Activities*****-**Net cash provided by operating
activities was $797 million in the first quarter of 2005.  The $522 million
increase in cash flows from operating activities in the first quarter of 2005
over the prior year is primarily attributable to higher average realized oil and
gas sales prices and higher sales volumes. Average daily oil and gas production
volumes in the 2005 first quarter were 38% higher than in 2004 as a result of
the Westport merger and the start of new production in the third quarter of
2004, as discussed under *Results of Operations by Segment - Exploration and
Production*. Average realized sales prices on a barrel of oil equivalent
basis increased from $29.54 in 2004 to $38.81 in 2005.
 
 ***Investing
Activities -***We used $397 million of cash in investing activities
in the first quarter of 2005, compared with $132 million in the prior year, as
summarized below:
 
 Three Months
      Ended
      March
      31,(Millions
      of dollars)
    
    **2005**
    
    2004Capital
      expenditures -Exploration
      and production (including dry hole costs)
    
    **$**
    **384**
    
    $
    146Chemical
      - Pigment
    
    
    **11**
    
    
    20Chemical
      - Other
    
    
    **-**
    
    
    2Corporate
      and other
    
    
    **3**
    
    
    2Total capital expenditures
    
    
    **398**
    
    
    170Proceeds
      from sales of assets
    
    
    **(31**
    **)**
    
    (43
    )Other
      investing activities
    
    
    **30**
    
    
    5Total
      net cash used in investing activities
    
    **$**
    **397**
    
    $
    132
 
 Capital
expenditures in 2005 reflect, in part, capital spending associated
with Westport properties, increased expenditures on the company's
Constitution/Ticonderoga development and exploratory drilling in Alaska. Upon
completion of the planned divestitures we expect capital requirements associated
with our drilling program to decline. The extent of the decline will depend
upon the composition of the properties divested.
 
 In
February 2005, we acquired a 37.5% interest in the Blind Faith discovery in the
deepwater Gulf of Mexico from BP Exploration & Production in exchange for
the company's interests in various proved oil and gas properties in the Arkoma
basin of southeast Oklahoma. We received $22 million at the closing date of the
transaction (subject to post-closing adjustments), with an additional $2 million
to be received associated with certain preferential rights to purchase. Proceeds
received from this exchange are included in proceeds from sales of assets above.
Cash used in other investing activities in 2005 consists largely of funds
deposited with an escrow agent that will be used to acquire oil and gas
properties in future periods. The 2004 proceeds from sales of assets consists
primarily of $39 million in proceeds realized upon sales of Devon Energy
Corporation common stock. Our remaining investment in Devon common stock was
disposed of in the third quarter of 2004; therefore, cash flows related to this
investment are not expected to recur.
 
 ***Financing
Activities -***We used $276 million of cash in financing activities
in the first quarter of 2005, compared with $142 million used in the prior year.
The increase of $134 million in cash used in financing activities is largely due
to the share repurchase program, partially offset by higher cash receipts from
exercises of stock options. In the first quarter of 2005, we received cash of
$132 million from exercises of approximately 2.4 million employee and director
stock options, compared with $5 million received in 2004 upon exercise of
approximately 128,000 options. The increase in the volume of exercises is due to
a higher stock price during the first quarter of 2005, which resulted in
substantially all exercisable options being in-the-money at March 31, 2005.
 
 We used $250
million to repurchase 3.1 million shares of Kerr-McGee common stock in the first
quarter of 2005, as discussed under *Overview and Recent Developments*.
No repurchases of treasury stock occurred in 2004. Cash used for debt repayment
was $60 million lower in 2005 compared with 2004, while cash spent to pay
dividends on our common stock increased by $23 million as a result of a higher
number of shares outstanding following the Westport merger. We expect cash
requirements for dividend payments to decline as a result of the revision in our
dividend policy starting with the quarter ending June 30, 2005, when the
quarterly dividend is expected to be revised from $.45 to $.05 per share,
combined with fewer shares outstanding following the completion of the tender
offer for up to 43.5 million shares (46.7 million shares in certain
circumstances). In the first quarter of 2005, we paid $43 million to settle
derivative liabilities assumed in the Westport merger.
 
 - 39 -
 
 **Obligations
and Commitments**
 
 In
April 2005, the company entered into additional drilling rig commitments to
assure availability for executing our deepwater drilling programs through the
end of 2006. The company’s commitments under these arrangements total $135
million, a portion of which will be billed to other working interest partners
once actual utilization is known.
 
 As
discussed under *Overview
and Recent Developments* above,
the company plans to dispose of its chemical business unit and divest of
selected oil and gas properties. In April 2005, in connection with planned exit
activities, the company initiated employee compensation programs designed to
provide an incentive to certain employees to remain with the company over a
stated period ranging from 6 to 18 months.  A total of $34 million
will be payable under these programs assuming all participating employees meet
the service and other conditions (excluding any discretionary awards that may be
made in future periods, as discussed below). The cost associated with these
programs generally will be recognized as the related services are provided by
the participating employees.
 
 Under
the plan covering employees of the chemical business unit, existing awards
totaling $2 million are payable upon the earlier of the disposition of the
chemical business or the end of a  one-year
service period. Additionally, the plan provides for discretionary
bonuses that may be granted to participating employees if they
continue their employment through the date the disposition of the chemical
business is completed, as determined by management.
 
 For
information on contractual maturities of our debt outstanding at March 31, 2005
refer to the *Interest
Rate Risk* section in Item 3 below.
 
 
 **New/Revised
Accounting Standards**
 
 In
December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based
Payment” (FAS No. 123R), which replaces FAS No. 123 and supersedes APB No. 25.
FAS No. 123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values beginning with the first interim period after June 15, 2005,
with early adoption encouraged. In April 2005, the SEC amended its rules to
allow public companies more time to implement the standard. Following the
Commission’s rule, the company intends to implement FAS No. 123R effective
January 1, 2006. The company plans to adopt the standard using the modified
prospective method, as permitted by the standard. The modified prospective
method requires that compensation expense be recorded for all unvested
share-based compensation awards at the beginning of the first quarter of
adoption. The company expects that the adoption will not have a material effect
on its financial condition and cash flows, and that the effect on its results of
operations will be comparable to the pro forma disclosures under FAS No. 123
presented above.
 
 
  - 40 -
  **Item
      3.**
    **Quantitative
      and Qualitative Disclosures about Market
Risk.**
 
 The
company is exposed to a variety of market risks, including credit risk, changes
in oil and gas commodity prices, foreign currency exchange rates and interest
rates. We address these risks through a controlled program of risk management
that includes the use of insurance and derivative financial instruments. In
addition to information included in this section, see Note 3 to the Condensed
Consolidated Financial Statements included in Item 1, Part I of this Form 10-Q
for discussions of the company’s derivatives and hedging
activities.
 
 **Commodity
Price Risk**
 
 The
company is exposed to market risk fluctuations in crude oil and natural gas
prices. To increase the predictability of its cash flows and support capital
expenditure plans, the company periodically enters into financial derivative
instruments that generally fix the commodity prices to be received for a portion
of the company’s oil and gas production in the future. We expanded our hedging
program in early 2005 and, as of May 2, 2005, had costless collars and
fixed-priced swaps covering at least 75% of the company’s 2005 and 2006 expected
eligible production (after the planned divestitures) and approximately 50% of
its 2007 expected eligible production. Eligible production excludes oil
production in China and gas production from the North Sea. At May 2, 2005, the
following commodity-related derivatives were outstanding related to (i) the
company’s hedging program and (ii) Westport’s derivative positions in place at
the merger date.
 
 **April
      - December 2005**
    
    **2006**
    
    **2007**Average
      Contract
      Price
      ($/Barrel)
    Average
      Daily Volume
      (Barrels)
    
    Average
      Contract
      Price
      ($/Barrel)
    Average
      Daily Volume
      (Barrels)
    
    Average
      Contract
      Price
      ($/Barrel)
    Average
      Daily Volume
      (Barrels)**Crude
      Oil (WTI) -****Hedge:**Fixed
      price swaps
    $29.23
    3,000
    (a)
    **-**
    **-**
    
    **-**
    **-**$50.54
    18,108
    
    $53.14
    18,781
    
    $51.45
    27,250Costless
      collars
    $28.50
      - $31.89
    14,000
    (b)
    $27.00
      - $30.58
    19,000
    (b)
    **-**
    **-**$42.42
      - $57.78
    24,158
    
    $45.00
      - $65.58
    18,288
    
    $45.00
      - $61.43
    18,000**Nonhedge:**Three-way
      collars(1)
    $25.00
      - $28.23
    5,000
    (a)
    $25.00
      - $28.65
    2,000
    (a)
    **-**
    **-**Three-way
      average floor
    $20.93
    
    
    $20.88**Crude
      Oil (Brent) -****Hedge:**Fixed
      price swaps
    $45.44
    23,406
    
    $53.05
    12,512
    
    $49.91
    12,750Costless
      collars
    $39.65
      - $53.46
    23,116
    
    $43.00
      - $62.51
    30,512
    
    $43.00
      - $60.11
    12,750
 (a)
    Acquired
      in the Westport merger.
 (b)
    Placed
      by Kerr-McGee in connection with the Westport
merger.
 
 (1)
    These
      derivatives function similar to a costless collar, with the exception that
      if the WTI price falls below the three-way floor, the company loses price
      protection. For example, the company only has $4.07/barrel of price
      protection if the WTI price falls below $20.93/barrel in the case of its
      2005 crude oil three-way collars ($25.00 -
$20.93).
  - 41 -
  
 **April
      - December 2005**
    
    **2006**
    
    **2007**Average
      Contract
      Price
      ($/MMBtu)
    Average
      Daily Volume
      (MMBtu)
    
    Average
      Contract
      Price
      ($/MMBtu)
    Average
      Daily Volume
      (MMBtu)
    
    Average
      Contract
      Price
      ($/MMBtu)
    Average
      Daily Volume
      (MMBtu)**Natural
      Gas (NYMEX) -****Hedge:**Fixed
      price swaps
    $4.42
    55,000
    (a)
    **-**
    **-**
    
    **-**
    **-**$7.04
    255,658
    
    $7.53
    196,000
    
    $7.03
    265,000Costless
      collars
    $5.00
      - $6.25
    280,000
    (b)
    $4.75
      - $ 5.50
    340,000
    (b)
    **-**
    **-**$6.31
      - $8.37
    292,858
    
    $6.00
      - $10.80
    197,000
    
    $6.00
      - $9.03
    265,000**Nonhedge:**Costless
      collars
    $4.09
      - $5.57
    60,000
    (a)
    **-**
    **-**
    
    **-**
    **-**Three-way
      collars(1)
    **-**
    **-**
    
    $4.00
      - $6.00
    20,000
    (a)
    **-**
    **-**Three-way
      average floor
    
    
    
    $3.04**Basis
      Swaps vs. NYMEX -****Hedge:**CIG(2)
    $0.60
    47,236
    
    **-**
    **-**
    
    **-**
    **-**NWPRM(3)
    $0.78
    10,000
    (a)
    **-**
    **-**
    
    **-**
    **-**NWPRM
    $0.58
    55,291
    
    **-**
    **-**
    
    **-**
    **-**HSC(4)
    $0.13
    54,473
    
    **-**
    **-**
    
    **-**
    **-****Nonhedge:**CIG
    $0.73
    93,382
    
    $0.39
    20,000
    
    $0.39
    20,000
    (5)NWPRM
    $0.68
    5,836
    
    $0.20
    15,000
    
    $0.20
    15,000
    (6)HSC
    $0.16
    27,782
    
    **-**
    **-**
    
    **-**
    **-**
 (a)
    Acquired
      in the Westport merger.
 (b)
    Placed
      by Kerr-McGee in connection with the Westport
merger.
 
 (1)
    These
      derivatives function similar to a costless collar, with the exception that
      if the NYMEX price falls below the three-way floor, the company loses
      price protection. For example, the company only has $.96/MMBtu of price
      protection if the NYMEX price falls below $3.04/MMBtu in the case of its
      2006 natural gas three-way collars ($4.00 -
$3.04).
 (2)
    Colorado
      Interstate Gas pipeline index.
 (3)
    Northwest
      Pipeline Rocky Mountain index.
 (4)
    Houston
      Ship Channel index.
 (5)
    These
      basis swaps continue until March 31, 2008.
 (6)
    These
      basis swaps continue until December 31,
2008.
 
 The
fair value of the company’s oil and gas commodity derivative instruments was
determined based on prices actively quoted, generally NYMEX and Dated Brent
prices. Realized and unrealized gains and losses arising from derivative
instruments that have not been designated as hedges or that do not qualify for
hedge accounting (“nonhedge derivatives”) are recognized in current earnings.
Gains and losses on derivatives designated as cash flow hedges are deferred in
accumulated other comprehensive income (loss) and reclassified into earnings
when the hedged forecasted transactions affect earnings. Net after-tax losses on
oil and gas derivatives deferred in accumulated other comprehensive loss were
$634 million at March 31, 2005, related to a portion of the company’s expected
production through 2007. Of this amount, the company expects to reclassify net
after-tax deferred losses of $440 million into earnings during the next 12
months, assuming no further changes in the fair value of the related
contracts.
  - 42 -
  **Interest
Rate Risk**
 
 The
company’s exposure to changes in interest rates relates primarily to debt
obligations. Periodically, we enter into interest rate swap agreements to
effectively change the interest the company will pay on the debt until maturity
from a fixed to a variable rate. No significant changes in our interest rate
swap positions occurred since December 31, 2004.
 
 The
table below presents principal amounts and related weighted-average interest
rates by maturity date for the company’s long-term debt obligations outstanding
at March 31, 2005. All borrowings are in U.S. dollars.
 
 Years
      of Maturity
    
    
    
    
    
    FairThere-
    
    
    
    Value
      at(Millions
      of dollars)
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    after
    
    Total(2)
    
    3/31/05Fixed-rate
      debt -Principal
      amount
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    2,225
    
    $
    2,225
    
    $
    2,370Weighted-averageinterest
      rate
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    7.15
    %
    
    7.15
    %Variable-rate
      debt(1)-Principal
      amount
    
    $
    109
    
    $
    307
    
    $
    150
    
    $
    -
    
    $
    350
    (3)
    $
    -
    
    $
    916
    
    $
    916Weighted-averageinterest
      rate
    
    
    8.66
    %
    
    5.90
    %
    
    6.15
    %
    
    -
    
    
    3.54
    %
    
    -
    
    
    5.36
    %
 
 (1)
    Includes
      fixed-rate debt with interest rate swaps to variable
  rate.
 
 (2)
    Principal
      amounts represent future payments and exclude the unamortized discount on
      issuance of $83 million and the net fair value hedge adjustments of $(2)
      million.
 
 (3)
    As
      discussed under*Financial
      Condition and Liquidity*above, our 5.375% Notes in the aggregate principal amount of $350 million
      are classified as long-term debt based on our ability and intent to
      maintain this obligation for longer than one
year.
 
 
 **Foreign
Currency Exchange Rate Risk**
  Periodically,
the company enters into forward contracts to buy and sell foreign currencies.
Certain of these contracts (purchases of euro, Australian dollars and British
pound sterling, and sales of euro) have been designated and have qualified as
cash flow hedges of the company’s operating and capital expenditure
requirements. These contracts generally have durations of less than three years.
The resulting changes in fair value of these contracts are recorded in
accumulated other comprehensive income (loss).
  Following
are the U.S. dollar equivalent notional amounts at the contract exchange rates
and weighted-average contractual exchange rates for contracts to purchase (sell)
foreign currencies. Contract values for contracts open at March 31, 2005, are
based on the estimated forward exchange rates in effect at quarter-end. All
amounts are U.S. dollar equivalents.
 (Millions
      of dollars,
    
    Notional
    
    Weighted-Averageexcept
      average contract rates)
    
    Amount
    
    Contract
      RateOpen
      contracts at March 31, 2005 -Maturing
      in 2005 -British
      pound sterling
    
    $
    145
    
    
    1.6994Euro
    
    
    132
    
    
    1.3213Australian
      dollar
    
    
    8
    
    
    .7528Euro
    
    
    (241
    )
    
    1.3123New
      Zealand dollar
    
    
    (1
    )
    
    .7259
 
 
  - 43 -
  **Item
4. Controls and Procedures** .
 
 As of
the end of the period covered by this report, an evaluation was carried out
under the supervision and with the participation of the company's management,
including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the company's disclosure controls and
procedures are effective in alerting them in a timely manner to material
information relating to the company (including its consolidated subsidiaries)
required to be included in the company's periodic SEC filings. There was no
change in the company's internal control over financial reporting that occurred
during the first quarter of 2005 that has materially affected or is reasonably
likely to materially affect the company’s internal control over financial
reporting.
 
 **Forward-Looking
Information**
 
 Statements
in this quarterly report regarding the company's or management's intentions,
beliefs or expectations, or that otherwise speak to future events, are
“forward-looking statements” within the meaning of the Private Securities
Litigation Reform Act of 1995. Future results and developments discussed in
these statements may be affected by numerous factors and risks, such as the
accuracy of the assumptions that underlie the statements, the timing, manner and
success of the planned separation of Kerr-McGee’s chemical business and the
divestiture of certain oil and gas properties, the success of the oil and gas
exploration and production program, drilling risks, the market value of
Kerr-McGee's products, uncertainties in interpreting engineering data, demand
for consumer products for which Kerr-McGee's businesses supply raw materials,
the financial resources of competitors, changes in laws and regulations, the
ability to respond to challenges in international markets, including changes in
currency exchange rates, political or economic conditions, trade and regulatory
matters, general economic conditions, and other factors and risks identified in
the Risk Factors section of the company's latest Annual Report on Form 10-K and
other SEC filings. Actual results and developments may differ materially from
those expressed in this quarterly report.
 
 
 **PART
II - OTHER INFORMATION**
 
 **Item
1.**  **Legal
Proceedings**
 
 A.
    In
      April 2005, Kerr-McGee Chemical Worldwide LLC and two other parties
      reached an agreement in principle with the federal government to settle a
      lawsuit filed by the government with respect to the remediation of
      contaminated materials at the site of two uranium mines near Lakeview,
      Oregon, and to settle related claims by the parties. The suit sought
      reimbursement of Forest Service response costs, an injunction requiring
      compliance with a Unilateral Administrative Order issued to the private
      parties regarding cleanup of the site, and civil penalties for alleged
      noncompliance with the administrative order. As a result of the
      settlement, the parties have resolved their respective claims and agreed
      to apportion responsibility for the cleanup. The remediation will begin in
      the third quarter of 2005 and is expected to take between one to two years
      to complete.
 
 B.
    For
      a discussion of other legal proceedings and contingencies, reference is
      made to Note 13 to the Condensed Consolidated Financial Statements
      included in Item 1, Part I of this quarterly report on Form 10-Q, which is
      incorporated herein by reference.
 
 
  - 44 -
  **Item
2.**  **Unregistered
Sales of Equity Securities and Use of Proceeds.**
 
 Issuer
Purchases Of Equity Securities
 
 The
following table summarizes the company’s repurchases of equity securities
registered under Section 12 of the Securities Exchange Act of 1934 that occurred
in the quarter ended March 31, 2005.
 Period
    
    Total
      Number of Shares Purchased(a)
    
    Average
      Price Paid per Share(a)
    
    Total
      Number of Shares Purchased as Part of Publicly Announced Plans or Programs(b)
    
    Maximum
      Approximate Dollar Value of Shares that May Yet Be Purchased Under the
      Plans or Programs(b)January
      1-31, 2005
    
    
    36,496
    
    $
    57.98
    
    
    -
    
    $
    -February
      1-28, 2005
    
    
    17,772
    
    
    67.93
    
    
    -
    
    
    -March
      1-31, 2005
    
    
    3,155,760
    
    
    79.50
    
    
    3,145,660
    
    
    -Total
    
    
    3,210,028
    
    $
    79.19
    
    
    3,145,660
    
    $
    -
 
 (a)
    Includes
      35,500 shares purchased in the open market for the matching contributions
      to Kerr-McGee Corporation Savings Investment Plan, 28,868 shares delivered
      to the company by the employees in satisfaction of withholding taxes and
      upon forfeiture of restricted shares and 3.1 million shares purchased in
      the open market under a share repurchase program discussed
      below.
 
 (b)
    On
      March 8, 2005, the company announced that the company's Board of Directors
      (the Board) authorized a share repurchase program initially set at $1
      billion. The company repurchased 3.1 million shares of common stock under
      this program before its termination in connection with the Board's
      approval of the tender offer further discussed below. No additional shares
      will be repurchased under this program.
 
 On
April 14, 2005, the company announced its intention to commence a modified
"Dutch Auction" self tender offer for its common stock with an aggregate
purchase cost of up to $4 billion. Under the tender offer, which commenced on
April 18, 2005, the company will repurchase its shares at a price within the
range of $85 to $92 per share. Based on the number of shares tendered and the
prices specified by the tendering stockholders, the company will determine the
lowest per share price within the range that will enable it to buy up to $4
billion of its common stock. Assuming the tender offer is fully subscribed,
between 43.5 million and 46.7 million shares may be repurchased, or 27% to 29%
of shares outstanding at March 31, 2005. Unless extended, the tender offer will
expire on May 18, 2005. This authorization is not included in the table above
since it was announced subsequent to March 31, 2005 and because the final
results of the tender offer are not yet available.


- 45 -
  **Item
6.**  **Exhibits.**
 
 Exhibit
No
 
 3.1
    
    Amended
      and restated Certificate of Incorporation of Kerr-McGee Corporation, filed
      as Exhibit 4.1 to the company's Registration Statement on Form S-4 dated
      June 28, 2001, and incorporated herein by reference.3.2
    
    Amended
      and restated Bylaws of Kerr-McGee Corporation, filed as Exhibit 3.1 to the
      company’s Current Report on Form 8-K dated April 14, 2005, and
      incorporated herein by reference.10.1
    
    $5,000,000,000
      Senior Secured Facilities and $1,000,000,000 Interim Facility Commitment
      Letter, dated April 13, 2005, by and among the company,
      J.P. Morgan Securities Inc., JPMorgan Chase Bank, N.A., Lehman
      Brothers Inc. and Lehman Commercial Paper Inc., filed as Exhibit (b)(i) to
      the Company’s Schedule TO-I dated April 18, 2005, and incorporated herein
      by reference.10.2
    
    Agreement,
      dated April 14, 2005, between the Company, Carl C. Icahn, Barberry
      Corporation, Hopper Investments, LLC, High River Limited Partnership,
      Icahn Partners Master Fund LP, Icahn Offshore LP, CCI Offshore LLC, Icahn
      Partners LP, Icahn Onshore LP and CCI Onshore LLC and Barry Rosenstein,
      Gary Claar and JANA Partners LLC., filed as Exhibit 10.1 to the Company’s
      Current Report on Form 8-K dated April 14, 2005, and incorporated herein
      by reference.10.3
    
    Kerr-McGee
      Corporation 2005 Success Bonus Program, filed as Exhibit 99.1 to the
      company’s Current Report on Form 8-K dated April 5, 2005, and incorporated
      herein by reference.31.1
    
    Certification
      pursuant to Securities Exchange Act Rule 15d-14(a), as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification
      pursuant to Securities Exchange Act Rule 15d-14(a), as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.32.2
    
    Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002
 
 **SIGNATURE**
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
 
 **KERR-McGEE
CORPORATION**
 
 Date:May
      9, 2005
    By:
    /s/
      John M. RauhJohn
      M. RauhVice
      President and Controllerand
      Chief Accounting Officer
 
 
 - 46 -