Petroleum Services will increase its capacity from Southern Oklahoma and West Texas refineries via this new pipeline, set to begin service in first-quarter 1998.

Petroleum Services achieved its sixth consecutive year of improved operating profit, primarily because of a return to profitability in the second half of the year by our ethanol segment. Operating profit for the year was up 28 percent from 1996.

Key Points
*Volumes transported, 236 million barrels, dropped
3 million barrels from 1996. A major shipper chose not to fulfill its volume commitment, affecting the total volumes by several
million barrels.

In other activity we:

*Signed the Longhorn Partners Pipeline agreement. We have a 31.5 percent stake, and will design, construct and operate the system. The project directly links Gulf Coast refiners for the first time with the El Paso gateway, providing access to growing and under-served markets in New Mexico, Arizona, California and Mexico. We plan to invest $87 million in this project in 1998. The Longhorn pipeline will have an initial capacity of 80,000 barrels per day and a potential maximum capacity reaching 225,000 barrels per day. Operation should begin during fourth-quarter 1998.

*Began building a $24 million pipeline connecting southern Oklahoma refiners to our Oklahoma City-Reno Avenue terminal. The project, expected to go into service in first-quarter 1998, will allow us to increase capacity from southern Oklahoma and West Texas refineries via connections to other pipelines and will increase volume into our system by about 3.5 million barrels per year.

*Acquired a petroleum terminal in Dallas with anticipated annual throughput of
3.6 million barrels. The December transaction further broadens our terminaling presence beyond our traditional Midwest market.

*Returned our ethanol production/marketing business to profitability in August, in part because of lower corn prices and stronger fuel ethanol sales. Industrial ethanol sales of more than 30 million gallons for the year exceeded expectations. Boosting our production of higher margin industrial ethanol helps reduce our reliance on federal tax incentives for fuel ethanol.

*Corrected design flaws at our Nebraska fuel ethanol production facility, which in September began operating at 100 percent of rated capacity for the first time since the plant went into service in fourth-quarter 1995.

*Congress defeated a move to eliminate the federal tax incentive provided to blenders of fuel ethanol. An extension of the tax exemption for ethanol-blended gasoline through 2007 is possible, pending an early 1998 vote.

*Canceled our transportation volume-incentive program and implemented a revised program at selected locations. The new program should reduce payments to shippers by
$5 million in 1998, with no significant impact on volume.

Outlook
*Competitors and customers are consolidating, reorganizing and closing facilities. Recently completed and pending mergers involve shippers representing 22 percent of our transported volumes. Also, one of our largest customers has committed to build a competing pipeline in our market area. Within this changing environment, we are working with a major refiner to create a new origin on our system in the Chicago area; working with two customers to connect their systems to ours, bringing new volumes into the southern end of our system by mid-1998; and planning to consolidate our Oklahoma City facilities to reduce costs, expand service offerings and potentially bring in new volumes from competing facilities.

*We expect a decision in 1998 concerning our appeal of a 1996 FERC ruling that we failed to prove that a transportation rate increase in our 12 less competitive markets was reasonable. The decision does not affect 20 other markets previously deemed competitive by the FERC.

*We will add new ethanol co-products, including yeast and zein, a coating for pills. The infrastructure in place will allow for relatively low-cost expansion into these new businesses.

*Our 1998 capital expenditure and investment budget of $214 million includes $45 million for projects designed to increase market share in our traditional service area and $29 million to acquire more terminals throughout the United States, primarily in the Pacific Northwest, Southwest and East.

*We expect to achieve another record operating-profit performance in 1998.