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Thomas J. Usher
Chairman of the Board

 

Clarence P. Cazalot Jr.
President and
Chief Executive Officer

Four years ago, we outlined a strategic plan and a business model to differentiate Marathon from our competitors. We resolved to remain an integrated energy company, to grow new core areas and to establish a profitable integrated gas business. We defined our vision — to be the pacesetter in creating sustainable value growth through innovative energy solutions and unique partnerships. Today, that vision is a reality.

In 2005, Marathon charted growth in each of our three business segments and delivered shareholder value by expanding our downstream presence with the largest single transaction in Marathon’s history. By year end, we reached an agreement to return to Libya and advanced all of our major projects, including our $1.4 billion LNG project in Equatorial Guinea.

By acquiring Ashland’s 38 percent minority interest in Marathon Ashland Petroleum LLC, Marathon now owns 100 percent of a premier downstream business in the United States. This business earned record-setting segment income of more than $3 billion in 2005 and achieved record-setting operational performance on several fronts.

We achieved record total and crude oil refinery throughputs, gasoline and distillate production and refined product sales, and our Speedway SuperAmerica LLC (SSA) brand continued its industry-leading growth in merchandise sales, achieving a same store increase of more than 11 percent compared to 2004.

Our recently completed 26,000 barrel-per-day (bpd) Detroit refinery expansion adds one million gallons a day of refined product for Midwest consumers and increases Marathon’s overall refining capacity to 974,000 bpd. During 2006, we will complete a front-end engineering and design (FEED) study for a proposed $2.2 billion, 180,000 bpd capacity expansion project at our refinery in Garyville, Louisiana.

To meet growing energy needs and provide shareholder value growth, we invested approximately $3 billion in a substantial capital and exploration program. In addition, we spent approximately $4 billion in the acquisition of Ashland’s minority interest in our downstream operations.

In 2006, Marathon will invest an estimated $3.4 billion in our capital and exploration program, plus approximately $730 million for our return to Libya. These expenditures will fund development of our growing resource base and strengthen our upstream portfolio while providing capital to grow our downstream and integrated gas businesses.

 

Our upstream growth profile over the next three years is robust and well defined. Our upstream operations saw significant success during 2005, including our 12th exploration discovery offshore Angola, our return to Libya and record production rates in Russia. With an approximate 60 percent exploration success rate during the past four years and the addition of more than 650 million barrels of resource through the drill bit since 2001, we are well positioned for future growth. We will continue our successful exploration program with wells in Angola, Norway, the United Kingdom and the Gulf of Mexico, and we will look for additional opportunities to provide value growth.

Our exploration success, further development of core areas in Norway and Russia, our return to Libya and continued development of our base business have enabled us to achieve a three-year average reserve replacement ratio of 175 percent at very competitive finding and development (F&D) costs of $7.40 per barrel of oil equivalent (boe). This marks our fourth consecutive year of strong reserve replacement.

With the approved projects currently under construction and our return to Libya, we see production growing from 2005 to 2008 by more than 125,000 barrels of oil equivalent per day (boepd) to between 475,000 and 525,000 boepd, excluding any acquisitions or divestitures.

In our downstream business, we will seek to maintain efficiency and reliability, and increase refinery capacities through process improvements. In retail, we will seek opportunities to grow light product and merchandise sales. We expect to make a final investment decision on the Garyville FEED study by the end of 2006 and will continue to look for opportunities to leverage our strong Midwest refining and marketing position.

 

We are delivering on our commitment to commercialize the large amount of stranded gas located around the world. The strategy we laid out four years ago has been validated and confirmed by market events. We gained first-mover advantage with our Equatorial Guinea LNG asset. Understanding the future value of LNG, we acquired throughput rights at Elba Island, Georgia, three years ago and we expect our Equatorial Guinea LNG Train 1 project to begin delivering LNG to the market in the third quarter of 2007.

 

Four years ago, we recognized that to gain access to the world’s energy resources — much of which belongs to national oil companies — we needed innovative energy solutions and successful partnerships. We are realizing the benefits of those partnerships today with our continued success with our LNG project partner in Equatorial Guinea, GEPetrol, the national oil company. In mid 2005, Marathon and the government of Equatorial Guinea entered into agreements with Mitsui & Co., Ltd. and a subsidiary of Marubeni Corporation to sell a partial interest in the LNG project, demonstrating the value of this world-class project where Marathon holds a 60 percent interest. We continue to cultivate our relationships with several key national oil companies in order to develop future value-added partnerships.

 

Exceptional operational performance in 2005 was reinforced by very strong safety and environmental performance. Last year, we saw our safest year ever and turned in a solid environmental performance, exceeding our goals.

The 2005 hurricane season presented many operational challenges. Hurricane Katrina shutdown our Garyville refinery and four Marathon-operated offshore oil and gas production platforms in the Gulf of Mexico. Nearly a month later, Hurricane Rita shutdown those same platforms and our Texas City, Texas, refinery.

Thankfully, all of our impacted employees and their families were accounted for and safe. Our upstream and downstream operations teams responded exceptionally well. The majority of our oil and gas production resumed within weeks. All of our refining operations restarted within days of the storms. In fact, ours were the first refineries up after the storms, enabling us to continue delivering much-needed refined products to our customers.

Marathon employees responded on a personal level with an outpouring of support. Our combined Company, employee, retiree, Marathon dealer, jobber and wholesale customer gifts to tsunami and hurricane relief efforts totaled more than $10 million.

This type of community outreach exemplifies our values as a company. To maintain our strong focus on corporate social responsibility (CSR), Marathon formed the CSR Department to ensure that Marathon speaks with one voice and that the Company’s actions match our words. To share our record of accomplishment and commitment to these values, Marathon published its first Living Our Values report in 2005.

Total shareholder return remains a driving factor at Marathon. During 2005 we increased our dividend 18 percent, the second year of double-digit quarterly dividend growth, and reduced our cash-adjusted debt-to-capital ratio to 11 percent, while increasing our capital spending and acquiring the minority interest in our downstream business, together totaling approximately $7 billion. In early 2006, we announced a plan to repurchase up to $2 billion of Marathon Common Stock over the next two years.

Our achievements in 2005 are the result of the hard work and determination put forth by all Marathon employees. Their performance and work in implementing our vision and strategy, especially in times of crisis, deserve special recognition.

Looking forward, our vision and strategy are unchanged – to remain integrated across the value chain and to deliver innovative energy solutions through unique partnerships. The ever-changing global energy markets require a dynamic mix of these key components to outpace the competition and create sustainable value growth for our shareholders. With a very solid 2005 behind us and defined value growth through 2008, we will remain determined in executing our current projects in our growth portfolio while focusing on opportunities beyond 2008.

On behalf of all employees, thank you, our shareholders, for your continued support.

 
Sincerely, Thomas J. Usher                                              Clarence P. Cazalot Jr.
Chairman                                                          President and Chief Executive Officer

 
March 8, 2006