Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis is the Partnership’s analysis of its financial performance and financial condition, and of significant trends that may affect future performance. It should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
EXECUTIVE OVERVIEW AND BUSINESS ENVIRONMENT
Partnership Overview
We are a Delaware limited partnership formed in 2013 by Phillips 66 Company and Phillips 66 Partners GP LLC (our General Partner), both wholly owned subsidiaries of Phillips 66. On August 1, 2019, all of the outstanding incentive distribution rights (IDRs) held by our General Partner were eliminated and its general partner interest in us was converted to a noneconomic interest in exchange for common units issued to Phillips 66 Project Development Inc. (Phillips 66 PDI). We are a master limited partnership formed to own, operate, develop and acquire primarily fee-based midstream assets. Our common units trade on the New York Stock Exchange under the symbol PSXP.
Pending Merger with Phillips 66
On October 26, 2021, we entered into a definitive merger agreement with Phillips 66 and its wholly owned subsidiaries, Phillips 66 Company, Phillips 66 PDI, and Phoenix Sub LLC, and our General Partner pursuant to which Phillips 66 would acquire all of the publicly held common units representing limited partner interests in the Partnership not already owned by Phillips 66 and its subsidiaries on the closing date of the transaction. The agreement provides for an all-stock transaction in which each outstanding common unitholder would receive 0.50 shares of Phillips 66 common stock for each common unit. Pursuant to our partnership agreement, the Partnership’s perpetual convertible preferred units would be converted into common units at a premium to the original issuance price prior to exchange for Phillips 66 common stock. The merger is expected to close in March 2022, subject to customary closing conditions.
Upon closing, we will become an indirect wholly owned subsidiary of Phillips 66, and our common units will cease to be listed on the NYSE and will be subsequently deregistered under the Exchange Act. See Note 1—Business and Basis of Presentation, in the Notes to Consolidated Financial Statements, for additional information regarding the merger agreement.
Executive Overview
Net income attributable to the Partnership was $735 million in 2021. We generated cash from operations of $1,153 million and received $137 million of return of investment distributions from equity affiliates. This cash was primarily used to fund our capital expenditures and investments and make quarterly cash distributions to our common and preferred unitholders. As of December 31, 2021, we had cash and cash equivalents of $62 million and $749 million of unused capacity under our $750 million revolving credit facility.
How We Evaluate Our Operations
Our management uses a variety of financial and operating metrics to analyze our performance, including: (1) volumes handled; (2) operating and maintenance expenses; (3) net income (loss) before net interest expense, income taxes, depreciation and amortization (EBITDA); (4) adjusted EBITDA; and (5) distributable cash flow.
Volumes Handled
The amount of revenue we generate primarily depends on the volumes of crude oil, refined petroleum products and natural gas liquids (NGL) that we handle in our pipeline, terminal, rail rack, processing, storage and fractionator systems. In addition, our equity affiliates generate revenue from transporting and terminaling crude oil, refined petroleum products and NGL. These volumes are primarily affected by the supply of, and demand for, crude oil, refined petroleum products and NGL in the markets served directly or indirectly by our assets, as well as the operational status of the refineries served by our assets. Phillips 66 has committed to minimum throughput volumes under many of our commercial agreements.
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Operating and Maintenance Expenses
Our management seeks to maximize the profitability of our operations by effectively managing operating and maintenance expenses. These expenses primarily consist of labor expenses (including contractor services), utility costs, and repair and maintenance expenses. Operating and maintenance expenses generally remain relatively stable across broad ranges of throughput volumes but can fluctuate from period to period depending on the mix of activities, particularly maintenance activities, performed during the period. Our processing assets are periodically subject to major maintenance, or turnaround activities, which can significantly increase operating and maintenance expenses in a given year. Although we seek to manage our maintenance expenditures on our facilities to avoid significant variability in our quarterly cash flows, we balance this approach with our high standards of safety and environmental stewardship, such that critical maintenance is regularly performed.
Our operating and maintenance expenses are also affected by volumetric gains/losses resulting from variances in meter readings and other measurement methods, as well as volume fluctuations due to pressure and temperature changes. Under certain commercial agreements with Phillips 66, the value of any crude oil, refined petroleum product and NGL volumetric gains and losses are determined by reference to the monthly average reference price for the applicable commodity. Any gains/losses under these provisions decrease or increase, respectively, our operating and maintenance expenses in the period in which they are realized. These contractual volumetric gain/loss provisions could increase variability in our operating and maintenance expenses.
EBITDA, Adjusted EBITDA and Distributable Cash Flow
We define EBITDA as net income plus net interest expense, income taxes, depreciation and amortization.
Adjusted EBITDA is EBITDA attributable to the Partnership after deducting the adjusted EBITDA attributable to noncontrolling interest, further adjusted for:
• The proportional share of equity affiliates’ net interest expense, income taxes, depreciation and amortization, and impairments.
• Transaction costs associated with acquisitions.
• Certain other noncash items, including gains and losses on asset sales and asset impairments.
Distributable cash flow is defined as adjusted EBITDA less (i) equity affiliate distributions less than proportional adjusted EBITDA, (ii) maintenance capital expenditures, (iii) net interest expense, (iv) income taxes paid and (v) preferred unit distributions, plus adjustments for deferred revenue impacts.
EBITDA, adjusted EBITDA, and distributable cash flow are not presentations made in accordance with generally accepted accounting principles in the United States (GAAP). EBITDA, adjusted EBITDA and distributable cash flow are non-GAAP supplemental financial measures that management believes external users of our consolidated financial statements, such as industry analysts, investors, lenders and rating agencies, may find useful to assess:
• Our operating performance as compared to other publicly traded partnerships in the midstream energy industry, without regard to historical cost basis or, in the case of EBITDA and adjusted EBITDA, financing methods.
• The ability of our business to generate sufficient cash to support our decision to make distributions to our unitholders.
• Our ability to incur and service debt and fund capital expenditures.
• The viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.
The GAAP performance measure most directly comparable to EBITDA and adjusted EBITDA is net income. The GAAP liquidity measure most directly comparable to EBITDA and distributable cash flow is net cash provided by operating activities. These non-GAAP financial measures should not be considered alternatives to GAAP net income or net cash provided by operating activities. They have important limitations as analytical tools because they exclude some items that affect net income and net cash provided by operating activities.
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Additionally, because EBITDA, adjusted EBITDA, and distributable cash flow may be defined differently by other companies in our industry, our definition of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.
Business Environment
We do not own any of the crude oil, refined petroleum products and NGL we handle and do not engage in the trading of those commodities, and therefore have limited direct exposure to risks associated with fluctuating commodity prices, although these risks indirectly influence our activities and results of operations over the long term.
Our throughput volumes primarily depend on the volume of crude oil processed and refined petroleum products produced at Phillips 66’s owned or operated refineries with which our assets are integrated. These volumes are primarily dependent on Phillips 66’s refining margins and maintenance schedules. Refining margins depend on the price of crude oil or other feedstocks and the price of refined petroleum products. These prices are affected by numerous factors beyond our or Phillips 66’s control, including the domestic and global supply of and demand for crude oil and refined petroleum products. Throughput volumes of our equity affiliates primarily depend on upstream drilling activities, refinery performance and product supply and demand.
The Coronavirus Disease 2019 (COVID-19) pandemic continues to impact global economic activity. Our results in 2021 reflect the gradual recovery of demand for refined petroleum products following the administration of COVID-19 vaccines and the easing of pandemic restrictions since the beginning of 2021. However, uncertainty remains regarding the depth and duration of the pandemic.
While we believe we and the majority of our joint ventures have substantially mitigated our indirect exposure to commodity price fluctuations through the minimum volume commitments included in our commercial agreements, our ability to execute our growth strategy will depend, in part, on the availability of attractively priced crude oil in the areas served by our crude oil pipelines and rail racks, demand for refined petroleum products in the markets served by our refined petroleum product pipelines and terminals, and the general demand for midstream services, including NGL transportation and fractionation.
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RESULTS OF OPERATIONS
Millions of Dollars
Years Ended December 31
Revenues and Other Income
Operating revenues—related parties
Operating revenues—third parties
Equity in earnings of affiliates
Gain from equity interest transfer
Other income
Total revenues and other income
Costs and Expenses
Operating and maintenance expenses
Depreciation
Impairments
General and administrative expenses
Taxes other than income taxes
Interest and debt expense
Other expenses
Total costs and expenses
Income before income taxes
Income tax expense
Net Income
Less: Net income attributable to noncontrolling interest
Net Income Attributable to the Partnership
Less: Preferred unitholders’ interest in net income attributable to the Partnership
Less: General partner’s interest in net income attributable to the Partnership
Limited Partners’ Interest in Net Income Attributable to the Partnership
Net Cash Provided by Operating Activities
Adjusted EBITDA
Distributable Cash Flow
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Year Ended December 31
Wholly Owned Operating Data
Pipelines
Pipeline revenues (millions of dollars)
Pipeline volumes (1) (thousands of barrels daily)
Crude oil
Refined petroleum products and NGL
Total
Average pipeline revenue per barrel (dollars)
Terminals
Terminal revenues (millions of dollars)
Terminal throughput (thousands of barrels daily)
Crude oil (2)
Refined petroleum products
Total
Average terminaling revenue per barrel (dollars)
Storage, processing and other revenues (millions of dollars)
Total Operating Revenues (millions of dollars)
Joint Venture Operating Data (3)
Crude oil, refined petroleum products and NGL (thousands of barrels
daily)
(1) Represents the sum of volumes transported through each separately tariffed pipeline segment.
(2) Bayway and Ferndale rail rack volumes included in crude oil terminals.
(3) Proportional share of total pipeline and terminal volumes of joint ventures consistent with recognized equity in earnings of affiliates.
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The following tables present reconciliations of EBITDA and adjusted EBITDA to net income, and EBITDA and distributable cash flow to net cash provided by operating activities, the most directly comparable GAAP financial measures, for each of the periods indicated.
Millions of Dollars
Year Ended December 31
Reconciliation to Net Income Attributable to the Partnership
Net Income Attributable to the Partnership
Plus:
Net income attributable to noncontrolling interest
Net Income
Plus:
Depreciation
Net interest expense
Income tax expense
EBITDA
Plus:
Proportional share of equity affiliates’ net interest, taxes, depreciation and amortization, and impairments
Expenses indemnified or prefunded by Phillips 66
Transaction costs associated with acquisitions
Impairments
Less:
Gain from equity interest transfer
Adjusted EBITDA attributable to noncontrolling interest
Adjusted EBITDA
Plus:
Deferred revenue impacts* †
Less:
Equity affiliate distributions less than proportional adjusted EBITDA
Maintenance capital expenditures †
Net interest expense
Preferred unit distributions
Income taxes paid
Distributable Cash Flow
*Difference between cash receipts and revenue recognition.
† Excludes Merey Sweeny capital reimbursements and turnaround impacts.
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Millions of Dollars
Year Ended December 31
Reconciliation to Net Cash Provided by Operating Activities
Net Cash Provided by Operating Activities
Plus:
Net interest expense
Income tax expense
Changes in working capital
Undistributed equity earnings
Impairments
Gain from equity interest transfer
Deferred revenues and other liabilities
Other
EBITDA
Plus:
Proportional share of equity affiliates’ net interest, taxes, depreciation and amortization, and impairments
Expenses indemnified or prefunded by Phillips 66
Transaction costs associated with acquisitions
Impairments
Less:
Gain from equity interest transfer
Adjusted EBITDA attributable to noncontrolling interest
Adjusted EBITDA
Plus:
Deferred revenue impacts* †
Less:
Equity affiliate distributions less than proportional adjusted EBITDA
Maintenance capital expenditures †
Net interest expense
Preferred unit distributions
Income taxes paid
Distributable Cash Flow
*Difference between cash receipts and revenue recognition.
† Excludes Merey Sweeny capital reimbursements and turnaround impacts.
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Statement of Income Analysis
Operating revenues increased $108 million, or 10%, in 2021. The increase was primarily attributable to higher volumes resulting from improved market conditions, additional assets placed into service and improved rates on our processing units, partially offset by the effects of the winter storms impacting the Central and Gulf Coast regions in the first quarter of 2021.
Equity in earnings of affiliates increased $102 million, or 21%, in 2021. The increase was primarily due to higher volumes, including volumes from Gray Oak Pipeline, LLC, which commenced full operations during the second quarter of 2020, South Texas Gateway Terminal LLC, which commenced full operations in the first quarter of 2021, and Dakota Access, LLC and Energy Transfer Crude Oil Company, LLC. These increases were partially offset by a decrease in earnings from DCP Sand Hills Pipeline, LLC (Sand Hills). See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Gain on equity interest transfer reflects the second-quarter 2020 gain recognition related to a co-venturer’s acquisition of a 35% interest in the consolidated holding company that owns an interest in Gray Oak Pipeline, LLC. See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Operating and maintenance expenses increased $41 million, or 12%, in 2021. The increase was primarily due to higher utility costs.
Impairments reflects the 2021 impairment of our investment in Liberty Pipeline LLC (Liberty) and the cancellation of the ACE Pipeline project, and the 2020 impairments of our investments in Phillips 66 Partners Terminal LLC and STACK Pipeline LLC. See Note 4—Equity Investments and Note 7—Properties, Plants and Equipment in the Notes to Consolidated Financial Statements, for additional information.
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Operating revenues decreased $88 million, or 8%, in 2020. The decrease was primarily attributable to the recognition of deferred revenues related to turnaround activity at Merey Sweeny LLC (Merey Sweeny) in the first quarter of 2019, as well as lower volumes in 2020, partially offset by additional assets placed in operation, including the isomerization unit at the Phillips 66 Lake Charles Refinery in mid-2019 and additional storage capacity at the Clemens Caverns in mid-2020.
Equity in earnings of affiliates decreased $42 million, or 8%, in 2020. The decrease was primarily due to decreased volumes, partially offset by an increase in equity earnings from Gray Oak Pipeline, LLC, which commenced full operations during the second quarter of 2020, and South Texas Gateway Terminal, which commenced partial operations in the third quarter of 2020. See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Gain on equity interest transfer reflects the second-quarter 2020 gain recognition related to a co-venturer’s prior-year acquisition of a 35% interest in the consolidated holding company that owns an interest in Gray Oak Pipeline, LLC. See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Operating and maintenance expenses decreased $63 million, or 16%, in 2020. The decrease was primarily due to turnaround activity at Merey Sweeny in 2019.
Depreciation increased $15 million, or 13%, in 2020. The increase was attributable to additional assets placed in operation, including the isomerization unit at the Phillips 66 Lake Charles Refinery in mid-2019 and additional storage capacity at the Clemens Caverns in mid-2020.
Impairments reflects the fourth-quarter 2020 impairments of our investments in Phillips 66 Partners Terminal LLC and STACK Pipeline LLC. See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Interest and debt expense increased $13 million, or 12%, in 2020. The increase was primarily attributable to lower capitalized interest associated with the Gray Oak Pipeline, which commenced full operations during the second quarter of 2020, and increased debt.
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CAPITAL RESOURCES AND LIQUIDITY
Significant Sources of Capital
Our sources of liquidity include cash generated from operations, distributions from our equity affiliates, borrowings from related parties and under our revolving credit facility, issuances of additional debt and equity securities, and funding from joint venture partners. We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements, long-term capital expenditure requirements and our quarterly cash distributions.
Operating Activities
During 2021, we generated $1,153 million in cash from operations, an increase of $198 million, compared with cash from operations of $955 million in 2020. The increase was primarily attributable to higher operating distributions from equity affiliates and higher operating revenues due to improved volumes.
During 2020, cash provided by operating activities was $955 million, a decrease of $61 million, compared with cash from operations of $1,016 million in 2019. The decrease was primarily attributable to lower distributions from equity affiliates and increased interest payments in 2020.
Equity Affiliate Distributions
Our operating and investing cash flows are impacted by distribution decisions made by our equity affiliates. Over the three years ended December 31, 2021, we received aggregate distributions from our equity affiliates of $2,004 million. We cannot control the amount or timing of future distributions from equity affiliates; therefore, future distributions are not assured.
Revolving Credit Facility
Our $750 million revolving credit facility may be used for direct bank borrowings and as support for issuances of letters of credit. We have an option to increase the overall capacity to $1 billion, subject to certain conditions. We also have the option to extend the facility for two additional one-year terms after its July 30, 2024, maturity date, subject to, among other things, the consent of the lenders holding the majority of the commitments and of each lender extending its commitment.
The facility is with a broad syndicate of financial institutions and contains covenants that are usual and customary for an agreement of this type, including that, as of the last day of each fiscal quarter, the ratio of total debt to EBITDA for the prior four fiscal quarters must be no greater than 5.0:1.0 (and 5.5:1.0 during the period following certain specified acquisitions). The facility has customary events of default, such as nonpayment of principal when due; nonpayment of interest, fees or other amounts; and violation of covenants.
Outstanding revolving borrowings under the facility bear interest, at our option, at either: (a) the Eurodollar rate in effect from time to time plus the applicable margin; or (b) the reference rate (as described in the facility) plus the applicable margin. The facility also provides for customary fees, including commitment fees. The pricing levels for the commitment fees and interest-rate margins are determined based on our credit ratings in effect from time to time. Borrowings under the facility may be short-term or long-term in duration, and we may at any time prepay outstanding borrowings under the facility, in whole or in part, without premium or penalty. At December 31, 2021, no borrowings were outstanding under this facility, compared with $415 million borrowings outstanding under this facility at December 31, 2020. At both December 31, 2021 and 2020, $1 million in letters of credit had been issued that were supported by this facility.
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ATM Program
We have authorized an aggregate of $750 million under three $250 million continuous offerings of common units, or at-the-market (ATM) programs. The first two programs concluded in June 2018 and December 2019, respectively. At December 31, 2021, we have $248 million of available capacity under our $250 million ATM program. We suspended issuances under the ATM program in the first quarter of 2020 due to low common unit prices. We did not issue any common units under the ATM program during the twelve months ended December 31, 2021. During the year ended December 31, 2020, on a settlement-date basis, we issued an aggregate of 40,570 common units, generating net proceeds of $2 million. Since inception in June 2016 through December 31, 2021, we issued an aggregate of 9,487,055 common units under our ATM programs, and generated net proceeds of $494 million, after broker commissions of $5 million and other costs of $3 million. The net proceeds from sales under the ATM programs are used for general partnership purposes, which may include debt repayment, acquisitions, capital expenditures and additions to working capital.
On October 26, 2021, we entered into a definitive merger agreement with Phillips 66. If this merger is consummated, our common units will no longer be publicly traded and, as a result, we would not expect any issuances of common units under our ATM Program before or after the closing date of this transaction. See Note 1—Business and Basis of Presentation, in the Notes to Consolidated Financial Statements, for additional information regarding the merger agreement.
2019 Senior Notes
On September 6, 2019, we closed on a public offering of $900 million aggregate principal amount of unsecured notes consisting of:
• $300 million aggregate principal amount of 2.450% Senior Notes due December 15, 2024.
• $600 million aggregate principal amount of 3.150% Senior Notes due December 15, 2029.
Interest on each series of senior notes is payable semi-annually in arrears on June 15 and December 15 of each year, commencing on June 15, 2020. Total proceeds received from the offering were $892 million, net of underwriting discounts and commissions. Net proceeds from the Senior Notes offering were used for general partnership purposes, including debt repayments. On September 13, 2019, we used a portion of the proceeds to repay the $400 million outstanding principal balance of the senior unsecured term loan facility that was drawn during the first half of 2019. On October 15, 2019, we used a portion of the proceeds to repay the aggregate $300 million outstanding principal balance of our 2.646% Senior Notes due February 2020.
Term Loans
On April 6, 2021, we entered into a $450 million term loan agreement and borrowed the full amount. The term loan agreement has a maturity date of April 5, 2022, and the outstanding borrowings can be repaid at any time and from time to time, in whole or in part, without premium or penalty. Borrowings bear interest at a floating rate based on either a Eurodollar rate or a reference rate, plus a margin of 0.875%. Proceeds were primarily used to repay amounts borrowed under our $750 million revolving credit facility.
On March 22, 2019, we entered into a senior unsecured term loan facility with a borrowing capacity of $400 million due March 20, 2020. We borrowed an aggregate amount of $400 million under the facility during the first half of 2019. The proceeds were used for general partnership purposes, including repayment of amounts borrowed under our $750 million revolving credit facility. The outstanding principal balance of the senior unsecured term loan facility was repaid in full in September 2019.
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Transfers of Equity Interests
In April 2021, we transferred our 50% ownership interest in Liberty to our co-venturer for cash and certain pipeline assets with a value that approximated our book value of $46 million at March 31, 2021.
Gray Oak Pipeline, LLC was formed to develop and construct the Gray Oak Pipeline, which transports crude oil from the Permian and Eagle Ford to Texas Gulf Coast destinations that include Corpus Christi, Texas, and the Sweeny area, including the Phillips 66 Sweeny Refinery. We have a consolidated holding company that owns 65% of Gray Oak Pipeline, LLC.
In December 2018, a third party exercised its option to acquire a 35% interest in the holding company. Because the holding company’s sole asset was its ownership interest in Gray Oak Pipeline, LLC, which was considered a financial asset, and because certain restrictions were placed on the third party’s ability to transfer or sell its interest in the holding company during the construction of the Gray Oak Pipeline, the legal sale of the 35% interest did not qualify as a sale under GAAP at that time. The Gray Oak Pipeline commenced full operations in the second quarter of 2020 and the restrictions placed on the co-venturer were lifted on June 30, 2020, resulting in the recognition of the sale under GAAP. Accordingly, at June 30, 2020, the co-venturer’s 35% interest in the holding company was recharacterized from a long-term obligation to a noncontrolling interest on our consolidated balance sheet, and the premium of $84 million previously paid by the co-venturer in 2019 was recharacterized from a long-term obligation to a gain in our consolidated statement of income. During 2020 and 2019, the co-venturer contributed an aggregate of $61 million and $342 million, respectively, into the holding company, and the holding company used these contributions to fund its portion of Gray Oak Pipeline, LLC’s cash calls.
In February 2019, Gray Oak Holdings LLC transferred a 10% interest in Gray Oak Pipeline, LLC, to a third party that exercised a purchase option, for proceeds of $81 million. The proceeds received from this sale are reflected as an investing cash inflow in the “proceeds from sale of equity interest” line item on our consolidated statement of cash flows.
See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information regarding these transactions.
Off-Balance Sheet Arrangements
Dakota Access, LLC (Dakota Access) and Energy Transfer Crude Oil Company, LLC (ETCO)
In 2020, the trial court presiding over litigation regarding the Dakota Access Pipeline ordered the U.S. Army Corps of Engineers (USACE) to prepare an Environmental Impact Statement (EIS) relating to an easement under Lake Oahe in North Dakota and later vacated the easement. Although the easement has been vacated, the USACE has indicated that it will not take action to stop pipeline operations while it proceeds with the EIS, which is expected to be completed in the second half of 2022. In May 2021, the court denied a request for an injunction to shut down the pipeline while the EIS is being prepared and in June 2021, dismissed the litigation. It is possible that the litigation could be reopened or new litigation challenging the EIS, once completed, could be filed. In September 2021, Dakota Access filed a writ of certiorari, requesting the U.S. Supreme Court to review the lower court’s judgment that ordered the EIS and vacated the easement.
In March 2019, a wholly owned subsidiary of Dakota Access closed an offering of $2.5 billion aggregate principal amount of senior unsecured notes consisting of:
• $650 million aggregate principal amount of 3.625% Senior Notes due 2022.
• $1.0 billion aggregate principal amount of 3.900% Senior Notes due 2024.
• $850 million aggregate principal amount of 4.625% Senior Notes due 2029.
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Dakota Access and ETCO have guaranteed repayment of the notes. In addition, we and our co-venturers in Dakota Access provided a Contingent Equity Contribution Undertaking (CECU) in conjunction with the notes offering. Under the CECU, the co-venturers may be severally required to make proportionate equity contributions to Dakota Access if there is an unfavorable final judgment in the above mentioned ongoing litigation. Contributions may be required if Dakota Access determines that the issues included in any such final judgment cannot be remediated and Dakota Access has or is projected to have insufficient funds to satisfy repayment of the notes. If Dakota Access undertakes remediation to cure issues raised in a final judgment, contributions may be required if any series of the notes become due, whether by acceleration or at maturity, during such time, to the extent Dakota Access has or is projected to have insufficient funds to pay such amounts. At December 31, 2021, our share of the maximum potential equity contributions under the CECU was approximately $631 million.
If the pipeline is required to cease operations, and should Dakota Access and ETCO not have sufficient funds to pay ongoing expenses, we also could be required to support our share of the ongoing expenses, including scheduled interest payments on the notes of approximately $25 million annually, in addition to the potential obligations under the CECU. If we are required to perform under the CECU, we would expect to fund such performance with cash, capacity available under our revolving credit facility, third-party debt financing, and/or sponsor loans from Phillips 66.
Capital Requirements
Capital Expenditures and Investments
Our operations are capital intensive and require investments to expand, upgrade, maintain or enhance existing operations and to meet environmental and operational requirements of our wholly owned and joint venture entities. Our capital requirements consist of maintenance and expansion capital expenditures, as well as contributions to our joint ventures. Maintenance capital expenditures are those made to replace partially or fully depreciated assets, to maintain the existing operating capacity of our assets and to extend their useful lives, or to maintain existing system volumes and related cash flows. In contrast, expansion capital expenditures are those made to expand and upgrade our systems and facilities and to construct or acquire new systems or facilities to grow our business, including contributions to joint ventures that are using the contributed funds for such purposes.
Our capital expenditures and investments represent the total spending for our capital requirements. Our adjusted capital spending is a non-GAAP financial measure that demonstrates our net share of capital spending, and reflects an adjustment for the portion of consolidated capital spending funded by certain joint venture partners. Additionally, the disaggregation of adjusted capital spending between expansion and maintenance is not a distinction recognized under GAAP. We disaggregate adjusted capital spending because our partnership agreement requires that we treat expansion and maintenance capital differently for operating and capital surplus determinations. Further, we generally fund expansion capital spending with both operating and financing cash flows and fund maintenance capital spending with operating cash flows.
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Our capital expenditures and investments for the years ended December 31, 2021, 2020 and 2019 were:
Millions of Dollars
Capital Expenditures and Investments
Capital expenditures and investments
Capital expenditures and investments funded by joint venture partners*
Adjusted Capital Spending
Expansion
Maintenance
*See Note 4—Equity Investments, in the Notes to Consolidated Financial Statements, for additional information.
Our capital expenditures and investments for the three-year period ended December 31, 2021, included:
• Contributions to the Gray Oak Pipeline project and South Texas Gateway Terminal development activities.
• Construction activities related to the C2G Pipeline, a new 16 inch ethane pipeline that connects our Clemens Caverns storage facility to petrochemical facilities in Gregory, Texas, near Corpus Christi.
• Construction activities related to increasing storage capacity at Clemens Caverns.
• Construction activities related to increasing capacity on the Sweeny to Pasadena refined petroleum products pipeline.
• Contributions to Dakota Access for a pipeline optimization project.
• Construction of our new isomerization unit at the Phillips 66 Lake Charles Refinery.
• Contributions to Bayou Bridge Pipeline, LLC for the completion of a pipeline from Nederland, Texas, to Lake Charles, Louisiana, and a pipeline segment from Lake Charles to St. James, Louisiana.
• Contributions to Sand Hills to increase capacity on its NGL system.
• Spending associated with other return, reliability and maintenance projects.
2022 Capital Budget
Our 2022 capital budget is $338 million, including expansion capital of $203 million which will be directed toward pipeline operations and completing optimization and near-term committed projects, and repayment of our 25% share of Dakota Access’ debt due in 2022. The capital budget also includes $135 million for maintenance projects to improve system reliability and pipeline integrity.
Repurchase of Preferred Units
On June 29, 2021, we repurchased 368,528 of the outstanding Series A Perpetual Convertible Preferred Units with an aggregate carrying value of $20 million for $24 million in cash, or $65.124 per unit. Upon the repurchase, these preferred units were canceled and are no longer outstanding.
Restructuring Transaction
On August 1, 2019, we closed on the transactions contemplated by the Partnership Interests Restructuring Agreement, dated July 24, 2019, entered into with our General Partner. Pursuant to this agreement, all of the outstanding IDRs held by our General Partner were eliminated and its approximately 2% general partner interest in us was converted into a non-economic general partner interest; both in exchange for an aggregate of 101 million common units issued to Phillips 66 PDI. Because these transactions were between entities under common control, the common units issued to Phillips 66
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PDI were not assigned any value; rather, our General Partner’s negative equity balance of $1.4 billion at August 1, 2019, was transferred to Phillips 66’s limited partner equity account.
Cash Distributions
On January 18, 2022, the Board of Directors of our General Partner declared a quarterly cash distribution of $0.875 per common unit, which resulted in a total distribution to common unitholders of $200 million attributable to the fourth quarter of 2021. This distribution was paid February 14, 2022, to common unitholders of record as of January 31, 2022.
The following table summarizes our quarterly cash distributions for 2021 and 2020 to our common unitholders:
Quarter Ended
Quarterly Cash Distribution
Per Common Unit*
(Dollars)
Total Quarterly Cash Distribution
(Millions of Dollars)
Date of Distribution
December 31, 2021
February 14, 2022
September 30, 2021
November 12, 2021
June 30, 2021
August 13, 2021
March 31, 2021
May 14, 2021
December 31, 2020
February 12, 2021
September 30, 2020
November 13, 2020
June 30, 2020
August 13, 2020
March 31, 2020
May 14, 2020
*Cash distributions declared attributable to the indicated periods.
Beginning with the distribution to preferred unitholders attributable to the fourth quarter of 2020, the preferred unitholders are entitled to receive cumulative quarterly distributions equal to the greater of $0.678375 per unit, or the per-unit distribution amount paid to the common unitholders. Preferred unitholders received $12 million of distributions attributable to the fourth quarter of 2021. This distribution was paid February 14, 2022, to preferred unitholders of record as of January 31, 2022.
On October 26, 2021, we entered into a definitive merger agreement with Phillips 66. This agreement provides that, unless prohibited by the partnership agreement or applicable law, our General Partner shall cause the Partnership to declare, authorize and pay regular quarterly cash distributions on our common units in an amount not less than $0.875 per unit for the quarterly period ending December 31, 2021, and for each full quarterly period thereafter, unless the merger closes prior to the applicable record date. See Note 1—Business and Basis of Presentation, in the Notes to Consolidated Financial Statements, for additional information regarding the merger agreement.
Contractual Obligations
Our contractual obligations primarily consist of purchase obligations, outstanding debt principal and interest obligations, operating lease obligations, and asset retirement and environmental obligations.
Purchase Obligations
Our purchase obligations represent agreements to purchase goods or services that are enforceable, legally binding and specify all significant terms. We expect to fulfill these purchase obligations with operating cash flows in the period when due. As of December 31, 2021, our purchase obligations totaled $110 million, with $100 million due within one year.
In addition to the contractual obligations discussed above, we are party to an amended omnibus agreement with Phillips 66. The amended omnibus agreement contractually requires us to pay a monthly operational and administrative support fee in the amount of $8 million to Phillips 66 for certain administrative and operational support services provided to us. The amended omnibus agreement generally remains in full force and effect so long as Phillips 66 controls our General Partner.
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Our preferred units are contractually entitled to receive cumulative quarterly distributions. Subject to certain conditions, we or the holders of the preferred units may convert the preferred units into common units at certain anniversary dates after the issuance date. See Note 13—Equity, in the Notes to Consolidated Financial Statements, for additional information.
Debt Principal and Interest Obligations
As of December 31, 2021, our aggregate principal amount of outstanding debt was $3.9 billion, with $450 million due within one year. Our obligations for interest on the debt totaled $1.7 billion, with $134 million due within one year. See Note 10—Debt, in the Notes to Consolidated Financial Statements, for additional information regarding our outstanding debt principal and interest obligations.
Operating Lease Obligations
See Note 9—Lease Assets and Liabilities, in the Notes to Consolidated Financial Statements, for information regarding our lease obligations and timing of our expected lease payments.
Asset Retirement and Environmental Obligations
See Note 12—Asset Retirement Obligations and Accrued Environmental Costs, in the Notes to Consolidated Financial Statements, for information regarding asset retirement and environmental obligations.
Contingencies
From time to time, lawsuits involving a variety of claims that arise in the ordinary course of business are filed against us. We also may be required to remove or mitigate the effects on the environment of the placement, storage, disposal or release of certain chemical, mineral and petroleum substances at various sites. We regularly assess the need for accounting recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the case of income-tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is uncertain.
Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include any contingent liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other potentially responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes.
Regulatory Matters
Our interstate common carrier crude oil and refined petroleum products pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission under the Interstate Commerce Act and Energy Policy Act of 1992, and certain of our pipeline systems providing intrastate service are subject to rate regulation by applicable state authorities under their respective laws and regulations. Our pipeline, rail rack and terminal operations are also subject to safety regulations adopted by the Department of Transportation, as well as to state regulations.
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Legal and Tax Matters
Under our amended omnibus agreement, Phillips 66 provides certain services for our benefit, including legal and tax support services, and we pay an operational and administrative support fee for these services. Phillips 66’s legal and tax organizations apply their knowledge, experience and professional judgment to the specific characteristics of our cases and uncertain tax positions. Phillips 66’s legal organization employs a litigation management process to manage and monitor the legal proceedings against us. The process facilitates the early evaluation and quantification of potential exposures in individual cases and enables tracking of those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, Phillips 66’s legal organization regularly assesses the adequacy of current accruals and recommends if adjustment of existing accruals, or establishment of new accruals, is required. As of December 31, 2021 and 2020, we did not have any material accrued contingent liabilities associated with litigation matters.
Environmental
We are subject to extensive federal, state and local environmental laws and regulations. These requirements, which frequently change, regulate the discharge of materials into the environment or otherwise relate to protection of the environment. Compliance with these laws and regulations may require us to remediate environmental damage from any discharge of petroleum or chemical substances from our facilities or require us to install additional pollution control equipment at or on our facilities. Our failure to comply with these or any other environmental or safety-related regulations could result in the assessment of administrative, civil, or criminal penalties, the imposition of investigatory and remedial liabilities, and the issuance of governmental orders that may subject us to additional operational constraints. Future expenditures may be required to comply with the Federal Clean Air Act and other federal, state and local requirements in respect of our various sites, including our pipelines and storage assets. The impact of legislative and regulatory developments, if enacted or adopted, could result in increased compliance costs and additional operating restrictions on our business, each of which could have an adverse impact on our financial position, results of operations and liquidity.
As with all costs, if these expenditures are not ultimately recovered in the tariffs and other fees we receive for our services, our operating results will be adversely affected. We believe that substantially all similarly situated parties and holders of comparable assets must comply with similar environmental laws and regulations. However, the specific impact on each may vary depending on a number of factors, including, but not limited to, the age and location of its operating facilities.
We accrue for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs can be reasonably estimated. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. New or expanded environmental requirements, which could increase our environmental costs, may arise in the future. We believe we are in substantial compliance with all legal obligations regarding the environment and have established the environmental accruals that are currently required; however, it is not possible to predict all of the ultimate costs of compliance, including remediation costs that may be incurred and penalties that may be imposed, because not all of the costs are fixed or presently determinable (even under existing legislation) and the costs may be affected by future legislation or regulations.
Indemnification and Excluded Liabilities
Under our amended omnibus agreement and pursuant to the terms of various agreements under which we acquired assets from Phillips 66, Phillips 66 will indemnify us, or assume responsibility, for certain environmental liabilities, tax liabilities, litigation and any other liabilities attributable to the ownership or operation of the assets contributed to us and that arose prior to the effective date of each acquisition. These indemnifications and exclusions from liability have, in some cases, time limits and deductibles. When Phillips 66 performs under any of these indemnifications or exclusions from liability, we recognize non-cash expenses and associated non-cash capital contributions from our General Partner, as these are considered liabilities paid for by a principal unitholder.
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CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to select appropriate accounting policies and to make estimates and assumptions about future events that affect the reported amounts of assets, liabilities, revenues and expenses.
See Note 2—Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements, for descriptions of our significant accounting policies. Certain of these accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts would have been reported under different conditions, or if different assumptions had been used. The following discussions of critical accounting estimates, along with the discussion of contingencies in this report, address all important accounting areas where the nature of accounting estimates or assumptions could be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.
Depreciation
We calculate depreciation expense using the straight-line method over the estimated useful lives of our properties, plants and equipment (PP&E), currently ranging from 3 years to 45 years. Changes in the estimated useful lives of our PP&E could have a material effect on our results of operations.
Impairments
Long-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate the carrying value of an asset group may not be recoverable. If the sum of the undiscounted expected future pretax cash flows of an asset group is less than the carrying value, including applicable liabilities, the carrying value is written down to estimated fair value. Individual assets are grouped for impairment purposes based on a judgmental assessment of the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other assets, generally at a pipeline system, terminal, processing or fractionation system level. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined using one or more of the following methods: present value of expected future cash flows using discount rates and other assumptions believed to be consistent with those used by principal market participants; estimated replacement cost; a market multiple of earnings for similar assets; or historical market transactions of similar assets, adjusted using principal market participant assumptions when necessary. The expected future cash flows used for impairment reviews and related fair value calculations are based on judgmental assessments of future volumes, commodity prices, operating costs, margins, discount rates and capital project decisions, considering all available information at the date of review.
Investments in nonconsolidated entities accounted for under the equity method are reviewed for impairment when there is evidence of a loss in value. Such evidence of a loss in value might include our inability to recover the carrying amount, the lack of sustained earnings capacity which would justify the current investment amount, or a current fair value less than the investment’s carrying amount. When it is determined such a loss in value is other than temporary, an impairment charge is recognized for the difference between the investment’s carrying value and its estimated fair value. When determining whether a decline in value is other than temporary, management considers factors such as the duration and extent of the decline, the investee’s financial condition and near-term prospects, and our ability and intention to retain our investment for a period that will be sufficient to allow for any anticipated recovery in the market value of the investment. When quoted market prices are not available, the fair value is usually based on the present value of expected future cash flows using discount rates and other assumptions believed to be consistent with those used by principal market participants and a market analysis of comparable assets, if appropriate. Different assumptions could affect the timing and the amount of an of an investment in any period. See Note 4—Equity Investments, and Note 7—Properties, Plants and Equipment, in the Notes to Consolidated Financial Statements, for additional information on recorded in 2021 and 2020.
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Asset Retirement Obligations
Under various contracts, permits and regulations, we have legal obligations to remove tangible equipment and restore the land at the end of operations at certain operational sites. Our largest asset removal obligations involve the abandonment or removal of pipelines. Fair values of legal obligations to abandon or remove long-lived assets are recorded in the period in which the obligation arises. Estimating the timing and cost of future asset removals is difficult and involves judgment in determining the estimated asset removal obligation. Most of these removal obligations are many years, or decades, in the future and the contracts and regulations often have vague descriptions of what removal practices and criteria must be met when the removal event actually occurs. Asset removal technologies and costs, regulatory and other compliance considerations, expenditure timing, and other inputs into valuation of the obligation, including discount and inflation rates, are also subject to change.
Goodwill
At December 31, 2021, we had $185 million of goodwill recorded in conjunction with past business combinations. The majority of our goodwill is related to acquisitions from Phillips 66. In these common control transactions, the net assets acquired are recorded at Phillips 66’s historical carrying value, including any associated goodwill. Goodwill is not amortized. Instead, goodwill is subject to at least annual tests for impairment at a reporting unit level. A reporting unit is an operating segment or a component that is one level below an operating segment and they are determined primarily based on the manner in which the business is managed. We have one reporting unit with a goodwill balance.
We perform our annual goodwill impairment test using a qualitative assessment and a quantitative assessment, if one is deemed necessary. As part of our qualitative assessment, we evaluate relevant events and circumstances that could affect the fair value of our reporting unit, including macroeconomic conditions, overall industry and market considerations and regulatory changes, as well as partnership-specific market metrics, performance and events. The evaluation of partnership-specific events and circumstances includes evaluating changes in our unit price and cost of capital, actual and forecasted financial performance, as well as the effect of significant asset dispositions.
If our qualitative assessment indicates it is likely the fair value of our reporting unit has declined below its carrying value (including goodwill), a quantitative assessment is performed. When a quantitative assessment is performed, management applies judgment in determining the estimated fair value of our reporting unit because a quoted market price for this reporting unit is not available. Management uses available information to make this fair value determination, including estimated cash flows, cost of capital, observed market earnings multiples of comparable companies and partnerships, our common unit price and associated total partnership market capitalization.
We completed our annual qualitative impairment test as of October 1, 2021, and concluded that the fair value of our reporting unit continued to exceed its respective carrying value (including goodwill) by a significant percentage. A decline in the estimated fair value of our reporting unit in the future could result in an impairment. As such, we continue to monitor for indicators of impairment until our next annual impairment assessment is performed.
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