Management’s discussion and analysis of financial condition and results of operations
Quantitative and qualitative disclosures about market risk
Financial statements and supplementary data
Changes in and disagreements with accountants on accounting and financial disclosure
Controls and procedures
Other information
Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
PART III
Directors, executive officers and corporate governance
Executive compensation
Security ownership of certain beneficial owners and management and related unitholder matters
Certain relationships and related transactions, and director independence
Principal accounting fees and services
PART IV
Exhibits and Financial Statement Schedules
Index to exhibits
Signatures
PART I
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain “forward-looking statements” within the meaning of the federal securities laws. All statements, other than statements of historical fact included in this Form 10-K, including, but not limited to, statements regarding future operating results, our capital allocation strategy, funding of capital expenditures and distributions, distributable cash flow coverage and leverage targets, and statements under Items 1 and 2. “Business and Properties,” Item 1A. “Risk Factors,” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are forward-looking statements. Forward-looking statements use words such as “anticipate,” “project,” "will," “expect,” “plan,” “goal,” “forecast,” “strategy,” “intend,” “should,” “would,” “could,” “believe,” “may,” and similar expressions and statements regarding our plans and objectives for future operations are intended to identify forward-looking statements. These statements are based on our beliefs and assumptions and those of our general partner using currently available information and expectations as of the date hereof, are not guarantees of future performance and involve certain risks and uncertainties. Although we and our general partner believe that such expectations reflected in such forward-looking statements are reasonable, neither we nor our general partner can give assurance that our expectations will prove to be correct. All statements concerning our expectations for future results of operations are based on forecasts for our existing operations and do not include the potential impact of any future acquisitions. Our forward-looking statements are subject to a variety of risks, uncertainties and assumptions. If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated, projected or expected. Certain factors could cause actual results to differ materially from results anticipated in the forward-looking statements. These factors include, but are not limited to:
• the demand for and supply of crude oil and refined products, including uncertainty regarding the effects of the continuing COVID-19 pandemic on future demand and increasing societal expectations that companies address climate change;
• risks and uncertainties with respect to the actual quantities of petroleum products and crude oil shipped on our pipelines and/or terminalled, stored or throughput in our terminals and refinery processing units;
• the economic viability of HF Sinclair Corporation, our other customers and our joint ventures’ other customers, including any refusal or inability of our or our joint ventures’ customers or counterparties to perform their obligations under their contracts;
• the demand for refined petroleum products in the markets we serve;
• our ability to purchase operations and integrate the operations we have acquired or may acquire, including the recently acquired Sinclair Transportation Company LLC business;
• our ability to complete previously announced or contemplated acquisitions;
• the availability and cost of additional debt and equity financing;
• the possibility of temporary or permanent reductions in production or shutdowns at refineries utilizing our pipelines, terminal facilities and refinery processing units, due to reductions in demand, accidents, unexpected leaks or spills, unscheduled shutdowns, infection in the workforce, weather events, civil unrest, expropriation of assets, and other economic, diplomatic, legislative, or political events or developments, terrorism, cyberattacks, or other catastrophes or disruptions affecting our operations, terminal facilities, machinery, pipelines and other logistics assets, equipment, or information systems, or any of the foregoing of our suppliers, customers, or third-party providers or lower gross margins due to the economic impact of the COVID-19 pandemic, inflation and labor costs, and any potential asset impairments resulting from, or the failure to have adequate insurance coverage for or receive insurance recoveries from, such actions;
• the effects of current and future government regulations and policies, including the effects of current and future restrictions on various commercial and economic activities in response to the COVID-19 pandemic and increases in interest rates;
• delay by government authorities in issuing permits necessary for our business or our capital projects;
• our and our joint venture partners’ ability to complete and maintain operational efficiency in carrying out routine operations and capital construction projects;
• the possibility of terrorist or cyberattacks and the consequences of any such attacks;
• uncertainty regarding the effects and duration of global hostilities, including the Russia-Ukraine war, and any associated military campaigns which may disrupt crude oil supplies and markets for refined products and create instability in the financial markets that could restrict our ability to raise capital;
• general economic conditions, including economic slowdowns caused by a local or national recession or other adverse economic condition, such as periods of increased or prolonged inflation;
• the impact of recent or proposed changes in the tax laws and regulations that affect master limited partnerships; and
• other financial, operational and legal risks and uncertainties detailed from time to time in our Securities and Exchange Commission (the “SEC”) filings.
Cautionary statements identifying important factors that could cause actual results to differ materially from our expectations are set forth in this Form 10-K, including, without limitation, the forward-looking statements that are referred to above. You should not put any undue reliance on any forward-looking statements. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements set forth in this Form 10-K under “Business and Properties” in Items 1 and 2,“Risk Factors” in Item 1A and in conjunction with the discussion in this Form 10-K in “Management's Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Liquidity and Capital Resources.” All forward-looking statements included in this Form 10-K and all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
INDEX TO DEFINED TERMS AND NAMES
The following terms and names that appear in this form 10-K are defined on the following pages:
401(k) Plan
5% Senior Notes
AAI
Allocation Date
ASC
ASC 842
ASU
bpd
Board
BLM
Business Combination Agreement
Change in Control Policy
Change in Control Agreement
Cheyenne Refinery
CISA
Clawback Policy
COBRA
Contribution Agreement
Corps
Credit Agreement
Cushing Connect Joint Venture
Cushing Connect JV Terminal
Cushing Connect Pipeline
CWA
Data protection obligations
EBITDA
Effectively connected income
ESG
Exchange Act
FASB ASC Topic 718
FCC
FERC
Frontier Pipeline
GAAP
Guarantor subsidiaries
HEP
HEP Cushing
HEP Logistics
HFC
HFC Merger
HFC Transaction
HF Sinclair
HLS
IBR
ICA
Incentive Compensation
IRS
Long-Term Incentive Plan
LPGs
mbbls
Meridian
Mid-America
MMPL
MMSCFD
non-employee directors
NDC
NEPA
NQDC Plan
NYSE
NWP
Omnibus
Osage
Parent
Parent Merger Sub
Partnership
PCAOB
PHMSA
Plains
PMLP
PPI
Presiding Director
REH
RINs
SCC
SEC
Secondment Agreement
Sinclair Oil
Sinclair Transportation
SLC Pipeline
SOFR
Target Company
TSA
UNEV
Unitholders Agreement
VIE
Items 1 and 2. Business and Properties
OVERVIEW
Holly Energy Partners, L.P. (“HEP”) is a Delaware limited partnership engaged principally in the business of operating a system of petroleum product and crude pipelines, storage tanks, distribution terminals and loading rack facilities in Colorado, Idaho, Iowa, Kansas, Missouri, Nevada, New Mexico, Oklahoma, Texas, Utah, Washington and Wyoming and refinery processing units in Utah and Kansas. We were formed in Delaware in 2004 and maintain our principal corporate offices at 2828 N. Harwood, Suite 1300, Dallas, Texas 75201-1507. Our telephone number is 214-871-3555 and our internet website address is www.hollyenergy.com . The information contained on our website does not constitute part of this Annual Report on Form 10-K. A copy of this Annual Report on Form 10-K will be provided without charge upon written request to the Vice President, Investor Relations at the above address. A direct link to our filings at the SEC website is available on our website on the Investors page. Also available on our website are copies of our Governance Guidelines, Audit Committee Charter, Compensation Committee Charter, and Code of Business Conduct and Ethics, all of which will be provided without charge upon written request to the Vice President, Investor Relations at the above address. In this document, the words “we,” “our,” “ours” and “us” refer to HEP and its consolidated subsidiaries or to HEP or an individual subsidiary and not to any other person. “HF Sinclair” refers to HF Sinclair Corporation and its subsidiaries, excluding HEP and its subsidiaries and Holly Logistic Services, L.L.C. (“HLS”), a subsidiary of HF Sinclair that is the ultimate general partner of HEP and manages HEP.
On March 14, 2022 (the “Closing Date”), HollyFrontier Corporation (“HFC”) and HEP announced the establishment of HF Sinclair Corporation, a Delaware corporation (“HF Sinclair”), as the new parent holding company of HFC and HEP and their subsidiaries, and the completion of their respective acquisitions of Sinclair Oil Corporation (now known as Sinclair Oil LLC (“Sinclair Oil”)) and Sinclair Transportation Company LLC (“Sinclair Transportation”) from The Sinclair Companies (now known as REH Company and referred to herein as “REH Company”). On the Closing Date, pursuant to that certain Business Combination Agreement, dated as of August 2, 2021 (as amended on March 14, 2022, the “Business Combination Agreement”), by and among HFC, HF Sinclair, Hippo Merger Sub, Inc., a wholly owned subsidiary of HF Sinclair (“Parent Merger Sub”), REH Company, and Hippo Holding LLC (now known as Sinclair Holding LLC), a wholly owned subsidiary of REH Company (the “Target Company”), HF Sinclair completed its acquisition of the Target Company by effecting (a) a holding company merger in accordance with Section 251(g) of the Delaware General Corporation Law whereby HFC merged with and into Parent Merger Sub, with HFC surviving such merger as a direct wholly owned subsidiary of HF Sinclair (the “HFC Merger”), and (b) immediately following the HFC Merger, a contribution whereby REH Company contributed all of the equity interests of the Target Company to HF Sinclair in exchange for shares of HF Sinclair, resulting in the Target Company becoming a direct wholly owned subsidiary of HF Sinclair (together with the HFC Merger, the “HFC Transactions”).
Additionally, on the Closing Date and immediately prior to consummation of the HFC Transactions, HEP acquired all of the outstanding equity interests of Sinclair Transportation from REH Company in exchange for 21 million newly issued common limited partner units of HEP (the “HEP Units”), representing 16.6% of the pro forma outstanding HEP Units with a value of approximately $349 million based on HEP’s fully diluted common limited partner units outstanding and closing unit price on March 11, 2022, and cash consideration equal to $329.0 million, inclusive of final working capital adjustments for an aggregate transaction value of $678.0 million (the “HEP Transaction” and together with the HFC Transactions, the “Sinclair Transactions”). The cash consideration was funded through a draw under HEP’s senior secured revolving credit facility. The HEP Transaction was conditioned on the closing of the HFC Transactions, which occurred immediately following the HEP Transaction.
Sinclair Transportation, together with its subsidiaries, owned REH Company’s integrated crude and refined products pipelines and terminal assets, including approximately 1,200 miles of integrated crude and refined product pipeline supporting the REH Company refineries and other third-party refineries, eight product terminals and two crude terminals with approximately 4.5 million barrels of operated storage. In addition, HEP acquired Sinclair Transportation’s interests in three pipeline joint ventures for crude gathering and product offtake including: Saddle Butte Pipeline III, LLC (25.06% non-operated interest); Pioneer Investments Corp. (49.995% non-operated interest); and UNEV Pipeline, LLC ("UNEV") (the 25% non-operated interest not already owned by HEP, resulting in UNEV becoming a wholly owned subsidiary of HEP).
References herein to HEP with respect to time periods prior to March 14, 2022, include HEP and its consolidated subsidiaries and do not include Sinclair Transportation and its consolidated subsidiaries (collectively, the “HEP Acquired Sinclair Businesses”). References herein to HEP with respect to time periods from and after March 14, 2022 include the operations of the HEP Acquired Sinclair Businesses.
References herein to HF Sinclair Corporation (“HF Sinclair”) with respect to time periods prior to March 14, 2022 refer to HFC and its consolidated subsidiaries and do not include the Target Company, Sinclair Transportation or their respective consolidated subsidiaries (collectively, the “HFS Acquired Sinclair Businesses”). References herein to HF Sinclair with respect
to time periods from and after March 14, 2022 refer to HF Sinclair and its consolidated subsidiaries, which include the operations of the combined business operations of HFC and the HFS Acquired Sinclair Businesses.
Through our subsidiaries and joint ventures we own and/or operate petroleum product and crude pipelines, terminal, tankage and loading rack facilities, and refinery processing units that support the refining and marketing operations of HF Sinclair and other refineries in the Mid-Continent, Southwest and Northwest regions of the United States. At December 31, 2022, HF Sinclair owned approximately 47% of our outstanding common units as well as a non-economic general partner interest. Our assets are categorized into a Pipelines and Terminals segment and a Refinery Processing Unit segment. Segment disclosures are discussed in Note 16 to our consolidated financial statements in Part II, Item 8.
We generate revenues by charging tariffs for transporting petroleum products and crude oil through our pipelines, by charging fees for terminalling and storing refined products and other hydrocarbons, providing other services at our storage tanks and terminals and charging a tolling fee per barrel or thousand standard cubic feet of feedstock throughput in our refinery processing units. We do not take ownership of products that we transport, terminal, store or process, and therefore, we are not directly exposed to changes in commodity prices.
We have a long-term strategic relationship with HF Sinclair that has historically facilitated our growth. Our future growth plans include organic projects around our existing assets and select investments or acquisitions that enhance our service platform while creating accretion for our unitholders. While in the near term, any acquisitions would be subject to the economic conditions discussed in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview”, we also expect over the longer term to continue to work with HF Sinclair on logistic asset acquisitions in conjunction with HF Sinclair’s refinery acquisition strategies.
PIPELINES AND TERMINALS
Pipelines
Our refined product pipelines transport light refined products from HF Sinclair’s Navajo refinery in New Mexico and a third party's refinery in Texas to their customers in the metropolitan and rural areas of Texas, New Mexico, and Arizona, and from various refineries in Utah, Wyoming, and Montana (including HF Sinclair's Woods Cross refinery in Utah, Parco refinery in Sinclair, Wyoming, and Casper refinery in Casper, Wyoming) to Nevada, Utah and Colorado. We also have a product pipeline that transports light refined products from Olathe, Kansas to Carrollton, Missouri and Montrose, Iowa. The refined products transported in these pipelines include conventional gasolines, federal, state and local specification reformulated gasoline, low-octane gasoline for oxygenate blending, distillates that include high- and low-sulfur diesel and jet fuel and liquefied petroleum gases (“LPGs”) (such as propane, butane and isobutane).
Our intermediate product pipelines consist principally of three parallel pipelines that connect the Navajo refinery, Lovington and Artesia facilities. These pipelines primarily transport intermediate feedstocks and crude oil for HF Sinclair’s refining operations in New Mexico. We also own pipelines that transport intermediate product and gas between HF Sinclair's Tulsa East and West refinery facilities, and between HF Sinclair's Casper and Parco refineries.
Our crude pipelines consist of crude oil trunk, gathering and connection pipelines located in West Texas, New Mexico, Kansas, Oklahoma, Utah and Wyoming that deliver crude oil to HF Sinclair's Navajo, El Dorado, Tulsa, Woods Cross, Parco and Casper refineries as well as other unaffiliated refineries.
Our pipelines are regularly inspected. Generally, other than as may be provided in certain pipelines and terminal agreements, substantially all of our pipelines are unrestricted as to the direction in which product flows and the types of crude and refined products that we can transport on them. The Federal Energy Regulatory Commission (“FERC”) regulates the transportation tariffs for interstate shipments on our refined product and crude oil pipelines and state regulatory agencies regulate the transportation tariffs for intrastate shipments on our pipelines.
HF Sinclair shipped an aggregate of 79% of the petroleum products transported on our refined product pipelines, 100% of the throughput volumes transported on our intermediate pipelines, and 76% of the throughput on our crude pipelines in 2022.
The following table details the average aggregate daily number of barrels of petroleum products transported on our pipelines in each of the periods set forth below for HF Sinclair and for third parties.
Years Ended December 31,
Volumes transported for barrels per day (“bpd”):
HF Sinclair
Third parties
Total
Total barrels in thousands (“mbbls”)
Our pipeline assets are managed by geographic region; significant pipeline assets are grouped accordingly, and our major systems are described below.
Mid-Continent Region
Tulsa, Oklahoma Interconnect Pipelines
Five pipelines, totaling seven miles, move intermediate product and gas between HF Sinclair’s Tulsa East and West refinery facilities.
El Dorado Crude Delivery Pipelines
These two 2-mile pipelines supply HF Sinclair's El Dorado Refinery facility with crude oil from HEP's El Dorado crude tankage. HF Sinclair is the only shipper on this line.
Osage Pipe Line Company, LLC
This 135-mile pipeline, which FERC regulates, supplies HF Sinclair's El Dorado Refinery with crude oil from Cushing, Oklahoma and also has a connection to the Jayhawk pipeline that services the CHS refinery in McPherson, Kansas. HEP has a 50% interest in this entity and is the operator of the pipeline.
Cushing Connect Pipeline Holdings LLC
This 50-mile crude oil pipeline, which is regulated by the Oklahoma Corporation Commission, runs from Cushing, Oklahoma to HF Sinclair’s Tulsa East and West refinery facilities. HEP owns a 50% interest in this entity and is the operator of the pipeline. The Cushing Connect Pipeline was placed into service at the end of the third quarter of 2021.
Midcon Products System
This 220-mile refined products pipeline, which is regulated by PHMSA, runs from Olathe, Kansas (Magellan Midstream Partners, LLC Olathe Terminal) and terminates at HEP’s Montrose, Iowa Products Terminal. It operates in two distinct segments, supplying refined petroleum products to two HEP terminal and tank farm facilities located near Carrollton, Missouri and Montrose, Iowa.
Southwest Region
Artesia, New Mexico to El Paso, Texas
These 221 miles of pipeline are comprised of four main segments which are regulated by FERC. The segments primarily ship refined product produced at the Navajo refinery to El Paso terminals: (1) 82 miles of 12-inch pipeline from HF Sinclair's Navajo refinery to our Orla tank farm, (2) 126 miles from our Orla tank farm to outside El Paso, (3) seven miles from outside El Paso to HFC's El Paso terminal and (4) six miles of 12-inch pipeline from outside El Paso to Magellan's El Paso terminal.
Refined products destined to HF Sinclair's El Paso terminal and Magellan's El Paso terminal are delivered to common carrier pipelines for transportation to Arizona, northern New Mexico and northern Mexico and to the terminal’s truck rack for local and export delivery by tanker truck.
Artesia, New Mexico to Moriarty, New Mexico
The Artesia to Moriarty refined product pipeline consists of a 60-mile segment that extends from HF Sinclair's Navajo refinery Artesia facility to White Lakes Junction, New Mexico, and another 155-mile segment that extends from White Lakes Junction to our Moriarty terminal, where it also connects to our Moriarty to Bloomfield pipeline. HEP owns the segment from Artesia to White Lakes Junction and leases the segment from White Lakes Junction to Moriarty from Mid-America Pipeline Company, LLC (“Mid-America”) under a long-term lease agreement which expires in 2027 with an option to renew for an additional 10 years. The current monthly lease payment is $604,000 ( subject to adjustments for changes in Producer Price Index (“PPI”)) to the owner/operator, Mid-America. HF Sinclair is the only shipper on this pipeline.
Moriarty, New Mexico to Bloomfield, New Mexico
This 191-mile pipeline is leased from Mid-America and ships refined product from Moriarty to Marathon Petroleum Corporation's terminal in Bloomfield and our Bloomfield terminal, which is currently idled. This pipeline is operated by Mid-America (or its designee), and HF Sinclair is the only shipper on this pipeline.
Big Spring, Texas to Abilene and Wichita Falls, Texas
These two pipelines carry refined product produced at Delek's Big Spring refinery to the Abilene and Wichita Falls terminals and span 100 miles from Big Spring to Abilene and 227 miles from Big Spring to Wichita Falls.
Wichita Falls, Texas to Duncan, Oklahoma
This 47-mile, common carrier pipeline is regulated by FERC and transports refined product from the Wichita Falls terminal to Delek's Duncan terminal. This pipeline is currently idle.
Midland, Texas to Orla, Texas
This 135-mile pipeline is used for the shipment of refined product from Midland to our tank farm at Orla (refined product produced at Delek's Big Spring refinery).
Intermediate pipelines between Lovington, New Mexico and Artesia, New Mexico
Two of the three 65-mile pipelines are used for the shipment of intermediate feedstocks, crude oil and LPGs from HF Sinclair's Navajo refinery Lovington facility to its Artesia facility. The third pipeline is used to supply both HF Sinclair's Navajo refinery Artesia and Lovington facilities with crude oil from the Barnsdall and Beeson gathering systems. This third pipeline can also connect to the Roadrunner pipeline (described below). HF Sinclair is the primary shipper on these pipelines.
Roadrunner pipeline
The 69-mile Roadrunner crude oil pipeline connects the Navajo refinery Lovington facility to a terminal on the Centurion Pipeline in Slaughter, Texas that extends to Cushing, Oklahoma. This pipeline is currently used to deliver crude oil from Lovington to Slaughter, but has been reversed in prior years for the shipment of crude oil from Cushing, Oklahoma to the Navajo refinery Lovington facility.
New Mexico and Texas crude oil pipelines
The 802-mile network of crude oil gathering and trunk pipelines deliver crude oil to HF Sinclair’s Navajo refinery from New Mexico and Texas. The crude oil trunk pipelines consist of nine pipeline segments that deliver crude oil to the Navajo refinery Lovington facility and fourteen pipeline segments that deliver crude oil to the Navajo refinery Artesia facility. The crude oil gathering pipelines connect crude leases and crude gathering hubs to the crude oil trunk pipeline system.
New Mexico crude expansion pipelines
Three pipelines expand on the existing network of New Mexico crude oil pipelines discussed above. They include (1) the 46-mile Beeson pipeline which delivers crude oil from the crude oil gathering system to the Navajo refinery Lovington facility and the Roadrunner Pipeline, (2) the 61-mile Whites City crude pipeline which delivers crude oil from HEP's Whites City Road crude truck off-loading Station to Artesia Station, and (3) the 13-mile Bisti connector pipeline which delivers crude oil from HEP's Beeson Crude Station to the Plains Bisti Pipeline.
Northwest Region
Utah refined product pipelines
The Utah refined product pipelines consist of four pipeline segments: (1) a 2-mile segment from Woods Cross, UT to Pioneer Investment Corp.'s terminal is used for product shipments to and through the Pioneer terminal, (2) another 4-mile segment is used to ship refined product from HF Sinclair's Woods Cross refinery to the UNEV origin pump station, (3) a 4-mile segment from HF Sinclair's Woods Cross refinery to MPLX LP’s Salt Lake City products pipeline is used for product shipments from HF Sinclair’s Woods Cross refinery to MPLX LP's Northwest Pipeline origin station, and (4) a 1-mile segment is used to move refined product from Chevron's Salt Lake City refining facility into the UNEV pipeline origin pump station. HF Sinclair is the only shipper on the first three pipeline segments and a third party is the only shipper on the fourth, common carrier pipeline segment.
UNEV refined product pipeline
The 427-mile UNEV products pipeline, which FERC regulates, is a common carrier pipeline used for the shipment of refined products from Woods Cross, Utah to terminals in Las Vegas, Nevada and Cedar City, Utah.
Cheyenne Pipeline LLC
This 87-mile crude oil pipeline, which FERC regulates, runs from Fort Laramie, Wyoming to Cheyenne, Wyoming. HEP owns a 50% interest in this entity; the pipeline is operated by an affiliate of Plains All American Pipeline, L.P. (“Plains”).
SLC Pipeline
This 95-mile crude oil pipeline (the “SLC Pipeline”), which FERC regulates, is used to transport crude into the Salt Lake City, Utah area from the Utah terminus of the Frontier Pipeline (described below) as well as crude flowing from Wyoming and Colorado via the Marathon Wamsutter system.
Frontier Aspen Pipeline
This 289-mile crude oil pipeline (the “Frontier Pipeline”), which FERC regulates, spans from Casper, Wyoming to Frontier Station, Utah through a connection to the SLC Pipeline.
Cheyenne Pipeline
This 94-mile crude oil pipeline, which FERC regulates, spans from Cheyenne, Wyoming to Guernsey, Wyoming and previously transported trucked crude gathered in Cheyenne to Guernsey. This pipeline is currently idle.
Guernsey Pipeline
This 115-mile crude oil pipeline spans from Guernsey, Wyoming to the Pathfinder station in Casper, Wyoming. There is a connection at Natural Bridge that allows injection from Saddle Butte who operates a gathering network out of the Powder River Basin. There is also a connection into the HF Sinclair refinery in Casper where crude oil is delivered.
Salvation Pipeline
This 114-mile bi-directional products pipeline spans between the HF Sinclair Casper and Parco refineries. It is a combination of three pipeline segments – 11.3 miles of 12” and two different segments of 8”. It is used to transport finished product as well as intermediates back and forth between the two refineries.
Casper 10” Pipeline
This 102-mile crude oil pipeline spans between Pathfinder station in Casper and the Parco refinery. It delivers a variety of blended sweet crude oils.
Pathfinder Pipeline
This 103-mile crude oil pipeline spans between Pathfinder station in Casper and the Parco refinery. It delivers a variety of blended sour crude oils.
Sand Draw Pipeline
This 61-mile crude oil pipeline spans from Sand Draw station near Riverton, Wyoming to Bairoil station in Bairoil, Wyoming. It delivers crude oil from the Beaver Creek and Big Sand Draw facilities to Bairoil station. There is an injection point three miles upstream of Bairoil station from the Bairoil oil field operated by Amplifier Energy.
Bairoil Pipeline
This 41-mile crude oil pipeline spans from Bairoil station in Bairoil, Wyoming to the Parco refinery in Sinclair, Wyoming. It delivers crude oil from the Beaver Creek, Big Sand Draw and Bairoil fields.
Medicine Bow Pipeline
This 205-mile refined product pipeline spans between the Parco refinery in Sinclair, Wyoming to the Denver Products Terminal in Henderson, Colorado. It is a combination of 166 miles of 6” and 39 miles of 10” pipe. It delivers finished products to the truck terminal.
Pioneer Pipeline
This 252-mile refined product pipeline, which FERC regulates, runs from Sinclair Station in Wyoming to the terminal in North Salt Lake City, Utah also owned by Pioneer Investments Corp. Through connections, this pipeline is also able to deliver refined products to our UNEV refined products pipeline. HEP owns a 49.995% interest in Pioneer Investments Corp. The pipeline and terminal are operated by an affiliate of Phillips 66 Company.
Saddle Butte Pipeline III, LLC
This crude oil pipeline gathering system collects crude oil from the Powder River Basin in Wyoming and primarily delivers into our Guernsey pipeline. HEP owns a 25.06% interest in this entity.
The following table sets forth certain operating data for each of our majority-owned refined product, intermediate and crude pipelines, most of which are described above. We calculate the capacity of our pipelines based on the throughput capacity for barrels of refined product, intermediate or crude that may be transported in the existing configuration; in some cases, this includes the use of drag reducing agents.
Origin and Destination
Diameter
(inches)
Length
(miles)
Capacity
(bpd)
Refined Product Pipelines:
Artesia, NM to Orla, TX to El Paso, TX
Artesia, NM to Moriarty, NM (1)
Moriarty, NM to Bloomfield, NM (1)(2)
Big Spring, TX to Abilene, TX
Big Spring, TX to Wichita Falls, TX
Wichita Falls, TX to Duncan, OK (6)
Midland, TX to Orla, TX
Artesia, NM to Roswell, NM (6)
Mountain Home, ID
Woods Cross, UT
Woods Cross, UT to Las Vegas, NV
Salt Lake City, UT to UNEV Pipeline, UT
Tulsa, OK (3)
Olathe, KS to Carrollton, MO
Carrollton, MO to Montrose, IA
Medicine Bow Pipeline
Aurora (Chase connection) Pipeline
Dupont (Kaneb connection) Pipeline
Intermediate Product Pipelines:
Lovington, NM to Artesia, NM
Lovington, NM to Artesia, NM
Lovington, NM to Artesia, NM
Tulsa, OK (4)
Evans Junction to Artesia, NM (5)
Salvation Pipeline
Crude Pipelines:
Artesia Region Gathering
Various
West Texas Gathering
Various
Roadrunner Pipeline
Beeson Pipeline
El Dorado Crude Delivery Pipeline
Bisti Connection Pipeline
Whites City Pipeline
SLC Pipeline
Frontier Pipeline
Bairoil Pipeline
Cheyenne Pipeline
Guernsey Pipeline
Casper Pipeline
Pathfinder Pipeline
Beaver Creek Pipeline
Sand Draw Pipeline
(1) The White Lakes Junction to Moriarty segment of our Artesia to Moriarty pipeline and the Moriarty to Bloomfield pipeline is leased from Mid-America under a long-term lease agreement.
(2) Capacity for this pipeline is reflected in the information for the Artesia to Moriarty pipeline.
(3) Tulsa gasoline and diesel fuel connections to Magellan’s pipeline are less than one mile.
(4) The capacities of the three gas pipelines are 10 million standard cubic feet per day (“MMSCFD”), 22 MMSCFD and 10 MMSCFD, and the two liquid pipelines are 45,000 bpd and 60,000 bpd.
(5) The capacity is in MMSCFD per day.
(6) Pipeline is currently idled.
Terminals, Loading Racks and Refinery and Renewable Diesel Facility Tankage
Our refined product terminals receive products from pipelines connected to HF Sinclair’s refineries and other third party refineries. We then distribute them to HF Sinclair and third parties, who in turn deliver them to end-users and retail outlets. Our terminals are generally complementary to our pipeline assets and serve the marketing activities of HF Sinclair and other customers. Terminals play a key role in moving product to the end-user market by providing the following services:
• distribution;
• blending to achieve specified grades of gasoline and diesel, including the blending of butane, ethanol and biodiesel;
• other ancillary services that include the injection of additives and filtering of jet fuel; and
• storage and inventory management.
Typically, our refined product terminal facilities consist of multiple storage tanks and are equipped with automated truck loading equipment that operates 24 hours a day. This automated system provides for control of security, allocations, and credit and carrier certification by remote input of data by our customers. In addition, nearly all of our terminals are equipped with truck loading racks capable of providing automated blending to individual customer specifications.
Our refined product terminals derive most of their revenues from terminalling fees paid by customers. We charge a fee for transferring refined products from the terminal to trucks or to pipelines connected to the terminal. In addition to terminalling fees, we generate revenues by charging our customers fees for storage, blending, injecting additives, and filtering jet fuel. HF Sinclair currently accounts for the substantial majority of our refined product terminal revenues.
Our crude terminals receives crude from crude pipelines and truck offloading racks owned by us and third-parties and derive most of their revenues from throughput charges.
The table below sets forth the total average throughput for our refined product and crude terminals in each of the periods presented:
Years Ended December 31,
Refined products and crude terminalled for (bpd):
HF Sinclair
Third parties
Total
Total (mbbls)
Our refinery and renewable diesel facility tankage consists of on-site tankage at HF Sinclair’s refineries and renewable diesel facilities. Our refinery and renewable diesel facility tankage derives its revenues from fixed fees or throughput charges in providing HF Sinclair’s refining and renewable diesel facilities with approximately 9,210,000 b arrels of storage.
Our terminals, loading racks and refinery and renewable diesel tankage are managed by geographic region; significant assets are grouped accordingly and described below.
Mid-Continent Region
El Dorado, Kansas crude tankage
This crude tank farm is adjacent to HF Sinclair's El Dorado Refinery and is used, primarily, to store and supply crude oil for this refinery facility.
El Dorado, Kansas facility truck racks
The El Dorado loading rack facilities consist of a light refined products truck rack and a propane truck rack. These racks load refined products and propane onto tanker trucks for delivery to markets in surrounding areas.
Catoosa, Oklahoma terminal
The Catoosa terminal is a water port terminal close to HF Sinclair's Tulsa refinery and stores specialty lubricant products. HF Sinclair is the primary customer utilizing this terminal.
Cushing Connect Terminal Holdings LLC
This entity owns 1.5 million barrels of crude oil storage in Cushing, Oklahoma, which went in service during the second quarter of 2020. HEP owns a 50% interest in this entity; the terminal is operated by an affiliate of Plains.
Tankage at HF Sinclair refinery and renewable diesel facilities
At HF Sinclair's El Dorado and Tulsa refinery facilities as well as HF Sinclair's Cheyenne renewable diesel facility, HEP owns refined product, intermediate and crude tankage that support these refineries in production and distribution. HF Sinclair is the only customer utilizing these tanks. See “Agreements with HF Sinclair” below for a discussion of changes to HF Sinclair's use of assets located in Cheyenne, Wyoming.
Tulsa, Oklahoma facilities truck and rail racks
The Tulsa truck and rail loading rack facilities consist of loading racks located at HF Sinclair’s Tulsa refinery West and East facilities. Loading racks at the Tulsa refinery West facility consist of rail and truck racks that load refined products and lube oil produced at the refinery onto rail cars and tanker trucks. Loading racks at the Tulsa refinery East facility consist of truck and rail racks at which we load refined products and off load crude. The truck racks also load asphalt and LPG.
Tulsa, Oklahoma railyard
HEP constructed 23,500 track feet of rail storage on land situated near HF Sinclair's Tulsa refinery. HEP leases a portion of this land from BNSF Railway Company and subleases this land to HF Sinclair. HEP leases the track to HF Sinclair, and HEP is receiving reimbursement from HF Sinclair for the construction costs over the 25-year term of the lease.
Kansas City terminal
The Kansas City Terminal receives refined products via truck and a Magellan Midstream Partners, LLC (“MMPL”) pipeline from the MMPL Kansas City Terminal. Refined products received at this terminal are sold locally via a truck rack.
Carrollton terminal
The Carrollton Terminal loading rack facility consists of a light refined products truck rack fed from the five tanks at the Carrollton Tank Farm. These racks load refined products onto tanker trucks for delivery to markets in surrounding areas.
Montrose terminal
The Montrose Terminal loading rack facility consists of a light refined products truck rack fed from the six tanks at the Montrose Tank Farm. These racks load refined products onto tanker trucks for delivery to markets in surrounding areas.
Southwest Region
Abilene, Texas terminal
This terminal receives refined products from Delek's Big Spring refinery, which accounted for all of its volumes in 2022. Refined products received at this terminal are sold locally via a truck rack or pumped over a 2-mile pipeline to Dyess Air Force Base.
Artesia, New Mexico facility truck rack
The truck rack at HF Sinclair's Navajo refinery Artesia facility loads light refined product produced at the Navajo refinery onto tanker trucks for delivery to markets in the surrounding area. HF Sinclair is the only customer of this truck rack.
Artesia, New Mexico railyard
HEP constructed 8,300 track feet of rail storage on land situated near the railway station of Artesia, New Mexico. HEP leases this land from BNSF Railway Company and subleases the land to HF Sinclair. HEP leases the track to HF Sinclair, and HEP is receiving reimbursement from HF Sinclair for the construction costs over the 25-year term of the lease.
Lovington, New Mexico facility asphalt truck rack
The asphalt loading rack facility at HF Sinclair's Navajo refinery Lovington facility loads asphalt produced at the Navajo refinery into tanker trucks. HF Sinclair is the only customer of this truck rack.
Moriarty, New Mexico terminal
We receive light refined product at this terminal from the Navajo refinery Artesia facility through our pipelines. Refined product received at this terminal is sold locally, via the truck rack. HF Sinclair is the only customer at this terminal, and there are no competing terminals in Moriarty, New Mexico.
Orla, Texas tank farm
The Orla tank farm receives refined product from Delek's Big Spring refinery. Refined product received at the tank farm is delivered into our Orla to El Paso pipeline segment (described above).
Orla, Texas terminal
This terminal receives diesel from HF Sinclair's Navajo refinery in Artesia, New Mexico and delivers diesel to the truck rack at the facility. HF Sinclair is the only customer at this truck rack.
Tankage at HF Sinclair refinery facilities
At HF Sinclair's Artesia and Lovington refinery facilities, HEP owns crude tankage that supports the refineries in their production of petroleum products. HF Sinclair is the only customer utilizing these tanks.
Wichita Falls, Texas terminal
This terminal receives refined product from Delek's Big Spring refinery, which accounted for all of its volumes in 2022. Refined product received at this terminal is sold via a truck rack or to NuStar Energy L.P.’s Southlake Pipeline.
Northwest Region
Frontier Anshutz and Frontier Arepi Stations
Tankage at these two terminals on the Frontier Pipeline in Wyoming is used to store various grades of crude shipped on the Frontier Pipeline.
Mountain Home, Idaho terminal
We receive jet fuel from third parties at this terminal that is transported on MPLX LP's Salt Lake City to Boise, Idaho pipeline. We then transport the jet fuel from the Mountain Home terminal through our 13-mile pipeline to the United States Air Force base outside of Mountain Home. Our pipeline associated with this terminal is the only pipeline that supplies jet fuel to the air base. We are paid a single fee, from the Defense Energy Support Center, for injecting, storing, testing and transporting jet fuel at this terminal.
Spokane, Washington Terminal
This terminal is connected to the Woods Cross refinery via MPLX LP's common carrier pipeline. The Spokane terminal is also supplied by rail and truck. Refined product received at this terminal is sold locally, via the truck rack. We have several major customers at this terminal.
Woods Cross, Utah Crude Tankage
At HF Sinclair's Woods Cross refinery facility, HEP owns crude tankage that supports the refinery in its production of petroleum products. HF Sinclair is the only customer utilizing these tanks.
UNEV terminals
UNEV owns two terminals, located in Cedar City, Utah and North Las Vegas, Nevada, that receive product through the UNEV Pipeline, originating in Woods Cross, Utah. Refined product received at these terminals is sold locally.
Woods Cross, Utah facility truck rack
The truck rack at the Woods Cross facility loads light refined product produced at HF Sinclair's Woods Cross refinery onto tanker trucks for delivery to markets in the surrounding area. HF Sinclair is the only customer of this truck rack.
Denver Products Terminal
The truck rack at the Denver Products Terminal loads light refined product delivered from multiple pipelines onto tanker trucks for delivery to markets in the surrounding area.
Sinclair Products Terminal
The truck rack at the Sinclair Products Terminal loads light refined product produced at the HF Sinclair Parco refinery onto tanker trucks for delivery to markets in the surrounding area.
Casper Products Terminal
The truck rack at the Casper Products Terminal loads light refined product produced at the HF Sinclair Casper refinery onto tanker trucks for delivery to markets in the surrounding area.
Casper Crude Terminal
The truck unloading facility in Casper receives local gathered crude via truck deliveries into tankage where it is then delivered to either the HF Sinclair Parco or Casper refineries.
Guernsey Crude Terminal
The crude facility in Guernsey receives crude from local gathering systems, the Plains system and others, where it is stored and then delivered to either the HF Sinclair Parco or Casper refineries.
Sinclair Crude Terminal
The truck unloading facility in Sinclair receives local gathered crude via truck deliveries into tankage where it is then delivered to the HF Sinclair Parco refinery.
Parco S-Tank farm
The tank farm at Parco is used for various purposes including seasonal product storage, refinery turnaround support, and intermediate product storage. It can receive product from either the HF Sinclair Parco refinery or from the Salvation pipeline.
Burley Terminal
The truck rack at the Burley Products Terminal loads light refined product delivered from MPLX LP's pipeline onto tanker trucks for delivery to markets in the surrounding area.
Boise Terminal
The truck rack at the Boise Products Terminal loads light refined product delivered from MPLX LP's pipeline onto tanker trucks for delivery to markets in the surrounding area.
Pioneer North Salt Lake Terminal
The truck rack at the North Salt Lake Terminal, which is owned by Pioneer Investments Corp., loads light refined product delivered from the Pioneer Pipeline onto tanker trucks for delivery to markets in the surrounding area. It can receive product from either the HF Sinclair Parco or Casper refineries through the Pioneer Pipeline. HEP owns a 49.995% interest in Pioneer Investments Corp.
The following table outlines the locations of our majority-owned terminals and their storage capacities, number of tanks, supply source, and mode of delivery as of December 31, 2022:
Terminal Location
Storage
Capacity
(barrels)
Number
Tanks
Supply Source
Mode of Delivery
Moriarty, NM
Pipeline
Truck
Mountain Home, ID (1)
Pipeline
Pipeline
Spokane, WA
Pipeline/Rail
Truck
Abilene, TX
Pipeline
Truck/Pipeline
Wichita Falls, TX
Pipeline
Truck/Pipeline
Las Vegas, NV
Pipeline/Truck
Truck
Cedar City, UT
Pipeline/Rail/Truck
Truck
Orla tank farm
Pipeline
Pipeline
Orla, TX
Pipeline
Truck
El Dorado, KS crude tankage
Pipeline
Pipeline
Stations along the SLC and Frontier pipelines
Pipeline
Pipeline
Stations in the Texas, New Mexico crude system
Pipeline
Pipeline
Catoosa, OK lube terminal
Truck/Rail
Truck
Bairoil, WY
Pipeline
Pipeline
Boise Terminal
Pipeline/Truck
Truck
Burley Terminal
Pipeline/Truck
Truck
Carrollton Terminal
Pipeline/Truck
Truck/Pipeline
Casper, WY
Pipeline/Truck
Truck/Pipeline
Denver Terminal
Rail/Truck/Pipeline
Truck/Pipeline
Montrose, IA
Pipeline/Truck
Truck
Guernsey, WY
Pipeline
Pipeline
Kansas City Terminal
Pipeline/Truck
Truck
Sand Draw, WY
Pipeline/Truck
Pipeline
Sinclair, WY
Pipeline
Pipeline
Artesia facility railyard
Rail
Rail
Artesia facility truck rack
Refinery
Truck
Lovington facility asphalt truck rack
Refinery
Truck
Woods Cross facility truck rack
Refinery
Truck
Tulsa West facility truck and rail rack
Refinery
Truck/Rail/Pipeline
Tulsa East facility truck and rail racks
Refinery
Truck/Rail/Pipeline
Tulsa facility railyard
Rail
Rail
Cheyenne facility truck racks (2)
Refinery
Truck
El Dorado facility truck racks
Refinery
Truck
Total
(1) Handles only jet fuel.
(2) Inactive
The following table outlines the locations of our refinery tankage, storage capacity, tankage type and number of tanks as of December 31, 2022 :
Refinery and Renewable Diesel Facility Location
Storage
Capacity
(barrels)
Tankage Type
Number
Tanks
Artesia , NM
Crude oil and refined product
Lovington, NM
Crude oil
Woods Cross, UT
Crude oil
Tulsa, OK
Crude oil and refined product
Cheyenne, WY
Crude oil and refined product
El Dorado, KS
Refined and intermediate product
Total
CONTROL OPERATIONS OF PIPELINES AND TERMINALS
All of our pipelines are operated via satellite, microwave and radio systems from our central control room located in Artesia, New Mexico. We also monitor activity at our terminals from this control room. The control center operates with state-of-the-art Supervisory Control and Data Acquisition, or SCADA, systems. Our control center is equipped with computer systems designed to continuously monitor operational data, including refined product and crude oil throughput, flow rates, and pressures. In addition, the control center monitors alarms and throughput balances. The control center operates remote pumps, motors, engines, and valves associated with the delivery of refined products and crude oil. The computer systems are designed to enhance leak-detection capabilities, sound automatic alarms if operational conditions outside of pre-established parameters occur, and provide for remote-controlled shutdown of pump stations on the pipelines.
REFINERY PROCESSING UNITS
Our refinery processing units are integrated in HF Sinclair's El Dorado, Kansas refinery and HF Sinclair's Woods Cross, Utah refinery and are used to support their daily operations, which chemically transform crude oil into various petroleum products, including gasoline, diesel, LPGs and asphalt.
HF Sinclair has committed to supply these units with a minimum feedstock throughput for each calendar quarter. HEP has committed that these units yield a certain level of petroleum product. The initial terms for the refinery processing units at HF Sinclair's El Dorado and Woods Cross refineries extend through 2030 and 2031, respectively.
The El Dorado units were first operational in the third and fourth quarters of 2015 and the Woods Cross units were first operational in the second quarter of 2016. These units operate on a daily basis until they are taken down for large-scale maintenance, which can be every two to four years and could last from two to four weeks. During this maintenance period (turnaround), the minimum feedstock throughput is adjusted so that HF Sinclair is not penalized for HEP's maintenance requirements.
HEP's revenue is primarily generated from the minimum throughput commitments, and HEP charges a tolling fee per barrel or thousand standard cubic feet of throughput. The tolling fee is meant to provide HEP with revenue that surpasses the amount of its expected operating costs, which include natural gas and maintenance. On any calendar month where the cost of natural gas exceeds what is included in the tolling fee, HEP will charge HF Sinclair for recovery of this additional cost. Additionally, if turnaround costs are more than expected after the first turnaround for each unit, the tolling fee will be permanently adjusted, one time, to recover these costs.
Our refinery processing units are managed by refinery personnel seconded from HF Sinclair; significant assets are grouped accordingly and described below.
El Dorado Refinery
Naphtha Fractionation Unit - El Dorado, Kansas refinery facility
The feedstock used by the naphtha fractionation unit is desulfurized naphtha, which is produced by the refinery earlier in the refining process. Desulfurized naphtha is a key component in gasoline, and this unit is used to reduce the level of benzene precursors. This allows the resulting product to be processed further to produce gasoline that meets regulatory requirements. The unit's feedstock capacity is 50,000 bpd of desulfurized naphtha.
Hydrogen Generation Unit - El Dorado, Kansas refinery facility
The hydrogen unit primarily uses natural gas as a feedstock to produce hydrogen gas that is used in HF Sinclair's operation of its El Dorado, Kansas refinery. This feedstock is supplied from purchased natural gas. The hydrogen unit's natural gas feedstock capacity is 6,100 thousand standard cubic feet per day.
Woods Cross Refinery
Crude Unit - Woods Cross, Utah refinery facility
The crude unit is comprised of several components, primarily an atmospheric distillation tower, a desalter and heat exchangers, together referred to as the crude unit. The crude unit uses black wax and other crudes as feedstock and is the first step in the refining process to separate crude into refined products. This process is accomplished by heating the crude until it is distilled into various intermediate streams. These intermediate streams are further refined downstream of the crude unit. The initial rejection of major contaminants is also performed by the crude unit. Its feedstock capacity is 15,000 bpd of crude oil.
Fluid Catalytic Cracking Unit - Woods Cross, Utah refinery facility
The fluid catalytic cracking unit (“FCC”) is used to convert the high-boiling, high-molecular weight hydrocarbon fractions of crude oil to more valuable products like gasoline, diesel and LPGs. This conversion is performed by the cracking of petroleum hydrocarbons achieved from extremely high temperatures and fluidized catalyst. The FCC's capacity is 8,000 bpd of atmospheric tower bottoms from the crude unit, discussed above, and gas oil.
Polymerization Unit - Woods Cross, Utah refinery facility
The polymerization unit uses the LPGs, propylene and butylene, from the FCC unit and polymerizes them into high octane gasoline blendstock using heat and catalysts. This gasoline blendstock is combined with other blendstocks in the refinery to make finished gasoline. The polymerization unit's feedstock capacity is 2,500 bpd.
INVESTMENT IN JOINT VENTURE
On October 2, 2019, HEP Cushing LLC (“HEP Cushing”), a wholly owned subsidiary of HEP, and Plains Marketing, L.P., a wholly owned subsidiary of Plains, formed a 50/50 joint venture, Cushing Connect Pipeline & Terminal LLC (the “Cushing Connect Joint Venture”), for (i) the development, construction, ownership and operation of a new 160,000 barrel per day common carrier crude oil pipeline (the “Cushing Connect Pipeline”) that will connect the Cushing, Oklahoma crude oil hub to the Tulsa, Oklahoma refining complex owned by a subsidiary of HF Sinclair and (ii) the ownership and operation of 1.5 million barrels of crude oil storage in Cushing, Oklahoma (the “Cushing Connect JV Terminal”). The Cushing Connect JV Terminal went in service during the second quarter of 2020, and the Cushing Connect Pipeline was placed into service at the end of the third quarter of 2021. Long-term commercial agreements have been entered into to support the Cushing Connect Joint Venture assets.
The Cushing Connect Joint Venture contracted with an affiliate of HEP to manage the construction and operation of the Cushing Connect Pipeline and with an affiliate of Plains to manage the operation of the Cushing Connect JV Terminal. The total Cushing Connect Joint Venture investment was generally shared equally among HEP and Plains. However, we were solely responsible for any Cushing Connect Pipeline construction costs that exceeded the budget by more than 10%. HEP's share of the cost of the Cushing Connect JV Terminal contributed by Plains and Cushing Connect Pipeline construction costs were approximately $74 million, including approximately $5 million of Cushing Connect Pipeline construction costs that exceeded the budget by more than 10% borne solely by HEP.
The investment above and the basis of presentation is described further in Note 3 in notes to consolidated financial statements of HEP, and the description in Note 3 is incorporated herein by reference.
AGREEMENTS WITH HF SINCLAIR
We serve HF Sinclair's refineries under long-term pipeline, terminal, tankage and refinery processing unit throughput agreements expiring from 2023 to 2037. Under these agreements, HF Sinclair agrees to transport, store, and process throughput volumes of refined products, crude oil and feedstocks on our pipelines, terminal, tankage, loading rack facilities and refinery processing units that result in minimum annual payments to us. These minimum annual payments or revenues are subject to annual rate adjustments on July 1st each year based on the PPI or the FERC index. As of December 31, 2022, our agreements with HF Sinclair required minimum annualized payments to us of $453 million.
If HF Sinclair fails to meet its minimum volume commitments under the agreements in any quarter, it will be required to pay us the amount of any shortfall in cash by the last day of the month following the end of the quarter. Under certain of the agreements, a shortfall payment may be applied as a credit in the following four quarters after minimum obligations are met.
A significant reduction in revenues under these agreements could have a material adverse effect on our results of operations.
Furthermore, if new laws or regulations that affect terminals or pipelines are enacted that require us to make substantial and unanticipated capital expenditures at the pipelines or terminals, we will have the right after we have made efforts to mitigate their effects to negotiate a monthly surcharge on HF Sinclair for the use of the terminals or to file for an increased tariff rate for use of the pipelines to cover HF Sinclair’s pro rata portion of the cost of complying with these laws or regulations including a reasonable rate of return. In such instances, we will negotiate in good faith with HF Sinclair to agree on the level of the monthly surcharge or increased tariff rate.
On June 1, 2020, HFC announced plans to permanently cease petroleum refining operations at its Cheyenne refinery(the "Cheyenne Refinery") and to convert certain assets at that refinery to renewable diesel production. HFC subsequently began winding down petroleum refining operations at the Cheyenne Refinery on August 3, 2020.
On February 8, 2021, HEP and HFC finalized and executed new agreements for HEP’s Cheyenne assets with the following terms, in each case effective January 1, 2021: (1) a ten-year lease with two five-year renewal option periods for HFC’s (and now HF Sinclair’s) use of certain HEP tank and rack assets in the Cheyenne Refinery to facilitate renewable diesel production with an annual lease payment of approximately $5 million, (2) a five-year contango service fee arrangement that will utilize HEP tank assets inside the Cheyenne Refinery where HFC (and now HF Sinclair) will pay a base tariff to HEP for available crude oil storage and HFC (and now HF Sinclair) and HEP will split any profits generated on crude oil contango opportunities and (3) HFC paid a $10 million one-time cash payment to HEP for the termination of the existing minimum volume commitment.
Omnibus Agreement
Under certain provisions of an omnibus agreement we have with HF Sinclair (the “Omnibus Agreement”), we pay HF Sinclair an annual administrative fee, currently $5.0 million, for the provision by HF Sinclair or its affiliates of various general and administrative services to us. This fee includes expenses incurred by HF Sinclair to perform centralized corporate functions, such as executive management, legal, accounting, treasury, information technology and other corporate services, including the administration of employee benefit plans. In connection with the HEP Transaction, we paid HF Sinclair a temporary monthly fee of $62,500 through November 30, 2022, relating to transition services provided to HEP by HF Sinclair. Neither the annual administrative fee nor the temporary monthly fee includes the salaries of personnel employed by HF Sinclair who perform services for us on behalf of HLS or the cost of their employee benefits, which are separately charged to us by HF Sinclair. We also reimburse HF Sinclair and its affiliates for direct expenses they incur on our behalf. In addition, we also pay for our own direct general and administrative costs, including costs relating to operating as a separate publicly held entity, such as costs for preparation of partners’ K-1 tax information, SEC filings, directors’ compensation, and registrar and transfer agent fees.
Under HLS’s secondment agreement with HF Sinclair (the “Secondment Agreement”), certain employees of HF Sinclair are seconded to HLS, our ultimate general partner, to provide operational and maintenance services for certain of our processing, refining, pipeline and tankage assets, and HLS reimburses HF Sinclair for its prorated portion of the wages, benefits, and other costs of these employees for our benefit.
COMPETITION
As a result of our physical integration with HF Sinclair’s refineries, our contractual relationship with HF Sinclair under the Omnibus Agreement and the HF Sinclair pipelines and terminals, tankage and throughput agreements, we believe that we will not face significant competition for barrels of crude oil transported to or refined products transported from HF Sinclair’s refineries, particularly during the terms of our long-term transportation agreements with HF Sinclair expiring between 2023 and 2037.
However, we do face competition from other pipelines that may be able to supply the end-user markets of HF Sinclair or other customers with refined products on a more competitive basis. Additionally, if HF Sinclair’s wholesale customers reduced their purchases of refined products due to the increased availability of cheaper product from other suppliers, decreased demand for refined products or for other reasons, the volumes transported through our pipelines could be reduced, which, subject to the minimum revenue commitments, could cause a decrease in cash and revenues generated from our operations.
The petroleum refining business is highly competitive. Among HF Sinclair’s competitors are some of the world’s largest integrated petroleum companies, which have their own crude oil supplies and distribution and marketing systems. HF Sinclair competes with independent refiners as well. Competition in particular geographic areas is affected primarily by the amounts of refined products produced by refineries located in such areas and by the availability of refined products and the cost of transportation to such areas from refineries located outside those areas.
In addition, we face competition from trucks that deliver product in a number of areas we serve. Although their costs may not be competitive for longer hauls or large volume shipments, trucks compete effectively for incremental and marginal volumes in many areas we serve. The availability of truck transportation places some competitive constraints on us.
Our refined product terminals compete with other independent terminal operators as well as integrated oil companies based on terminal location, price, versatility and services provided. Our competition primarily comes from integrated petroleum companies, refining and marketing companies, independent terminal companies and distribution companies with marketing and trading arms. Historically, the significant majority of the throughput at our terminal facilities has come from HF Sinclair.
GOVERNMENTAL REGULATION
Safety and Maintenance
Many of our pipelines are subject to regulation by the Pipeline and Hazardous Materials Safety Administration (“PHMSA”) of the Department of Transportation. PHMSA has promulgated regulations governing, among other things, maximum operating pressures, pipeline patrols and leak surveys, control room management, and emergency procedures, as well as other matters intended to prevent accidents and failures. Additionally, PHMSA has promulgated regulations requiring pipeline operators to develop and implement integrity management programs for certain pipelines that, in the event of a pipeline leak or rupture, could affect “high consequence areas,” which are areas where a release could have the most significant adverse consequences, including high-population areas, certain drinking water sources and unusually sensitive ecological areas.
In addition, many states have adopted regulations, similar to, or which go above and beyond, existing PHMSA regulations, for certain intrastate pipelines. For example, Texas has developed regulatory programs that largely parallel the federal regulatory scheme and impose additional requirements for certain pipelines. Furthermore, other related programs, such as the EPA’s Risk Management Program and the Occupational Safety and Health Administration’s Process Safety Management standard apply to some of our terminals and associated facilities.
We perform preventive and normal maintenance on all of our pipeline and terminal systems and make repairs and replacements when necessary or appropriate. We also conduct routine and required inspections of our pipelines and other assets as required by regulations. Corrosion inhibitors, external coatings and impressed current cathodic protection systems are used to protect against internal and external corrosion. We regularly monitor, test and record the effectiveness of these corrosion-control systems. We monitor the structural integrity of covered segments of our pipeline systems through a program of periodic internal inspections using electronic “smart pigs”, hydrostatic testing, and other measures. We follow these inspections with a review of the data, and we make repairs as necessary to maintain the integrity of the pipeline. We have initiated a risk-based approach to prioritizing the pipeline segments for future smart pig runs or other appropriate integrity testing methods. This approach is intended to allow the pipelines that have the greatest risk potential to receive the highest priority in being scheduled for inspections or pressure tests for integrity. Nonetheless, the adoption of new or amended regulations or the reinterpretation of existing laws and regulations by PHMSA or states that result in more or pipeline management or safety standards could possibly have a substantial effect on us and similarly situated midstream operators.
Maintenance facilities containing equipment for pipe repairs, spare parts, and trained response personnel are located along the pipelines. Employees participate in simulated spill response exercises on a regular basis. They also participate in actual spill response boom deployment exercises in planned spill scenarios in accordance with Oil Pollution Act of 1990 requirements.
At our terminals, tanks designed for gasoline storage are equipped with internal or external floating roofs that minimize emissions and prevent potentially flammable vapor accumulation between fluid levels and the roof of the tank. Our terminal facilities have facility response plans, spill prevention and control plans, and other plans and programs to respond to emergencies.
Many of our terminal loading racks are protected with water deluge systems activated by either heat sensors or an emergency switch. Several of our terminals are also protected by foam systems that are activated in case of fire. All of our terminals participate in a comprehensive environmental management program to assure compliance with applicable air, solid waste and wastewater regulations.
For further information on pipeline safety and regulatory requirements related to maintenance, see our risk factor “Our operations are subject to evolving federal, state and local laws, regulations and permit/authorization requirements regarding our business, capital projects, environmental protection, health, operational safety and product quality. Potential liabilities arising from these laws, regulations and requirements could affect our operations and have a material adverse effect on our business.” under Item 1A – “Risk Factors.”
FERC Regulation - Liquids Pipelines
Some of our existing refined products and crude oil pipelines provide interstate transportation services subject to regulation by the FERC pursuant to the Interstate Commerce Act (the “ICA”). The ICA requires that the rates charged by these pipelines (referred to as “interstate liquids pipelines”) must be just and reasonable. The ICA also prohibits interstate liquids pipelines from providing services in a manner that unduly discriminates against or confers undue preference upon any shipper. The ICA permits interested persons to challenge newly proposed or changed rates or rules and authorizes the FERC to suspend the effectiveness of such proposed rates or rules for a period of up to seven months, during which the FERC may investigate whether the proposed rate or rules are just and reasonable. Upon completion of an investigation, the FERC may require the interstate liquids pipeline carrier to refund the revenues collected during the pendency of the investigation that are in excess of the amount the FERC determines to be just and reasonable, together with interest. The FERC also may investigate, upon or on its own motion, rates that are already in effect and may order an interstate liquids pipeline to change its rates prospectively. Upon an appropriate showing, a shipper may obtain (including interest) for sustained during the two years prior to the filing of a .
As a general matter, interstate liquids pipelines may change their rates within prescribed ceiling levels that are tied to an inflation index that FERC reviews every five years. Cost-of-service ratemaking, market-based rates, and settlement rates are alternatives to the indexing approach and may be used in certain specified circumstances to change rates. When an interstate liquids pipeline adjusts its rates using the index methodology, shippers may challenge rate increases made within the ceiling levels. The FERC’s regulations provide that a protest against an index rate increase must allege “reasonable grounds” that the index rate increase is “so substantially in excess of the actual cost increases incurred by the carrier that the rate is unjust and unreasonable.”
On December 17, 2020, FERC established a new price index for the five-year period commencing July 1, 2021 and ending June 30, 2026, in which common carriers charging indexed rates were permitted to adjust their indexed ceilings annually by Producer Price Index plus 0.78%. FERC received requests for rehearing of its December 17, 2020 order, and on January 20, 2022, FERC revised the index level used to determine the annual changes to interstate oil pipeline rate ceilings to Producer Price Index minus 0.21%. The order required recalculation of the July 1, 2021 index ceilings to be effective as of March 1, 2022.
State Regulation - Liquids Pipelines
While the FERC regulates the rates for interstate shipments on our interstate liquids pipelines, the New Mexico Public Regulation Commission regulates the rates for intrastate shipments on our pipelines in New Mexico, the Texas Railroad Commission regulates the rates for intrastate shipments on our pipelines in Texas and the Oklahoma Corporation Commission regulates the rates for intrastate shipments on our pipelines in Oklahoma. Generally, these state agencies have not investigated the rates or practices of intrastate pipelines subject to their jurisdiction in the absence of shipper complaints.
Environmental Regulation and Remediation
Our operation of pipelines, terminals, and associated facilities in connection with the transportation and storage of refined products and crude oil is subject to stringent and complex federal, state, and local laws and regulations governing the potential discharge of materials into the environment, or otherwise relating to the protection of human health and the environment and natural resources, including climate change. These laws and regulations may require us to obtain permits for our operations or result in the imposition of strict requirements relating to air emissions, and characteristics and composition of gasoline and diesel fuels, biodiversity, wastewater discharges, waste management, process safety and risk management, spill planning and prevention and the remediation of spills, leaks and other contamination. As with the industry generally, compliance with existing, changing, and new laws, regulations, interpretations and guidance increases our overall cost of business, including our capital costs to construct, maintain, upgrade and operate equipment and facilities. These laws and regulations affect our operations, maintenance, capital expenditures and net income, as well as those of our competitors. These existing and any new laws and regulations, and the interpretation or enforcement thereof, are subject to frequent change by regulatory authorities, and we are unable to predict the ongoing cost to us of complying with these laws and regulations or the future impact of these laws and regulations on our operations. of environmental laws, regulations, and permits can result in the imposition of significant administrative, civil and , and , construction or ; in the permitting, development or expansion of projects; or prohibitions on certain operations; and reputational . In addition, many environmental laws contain citizen suit provisions, allowing environmental groups to bring suits to enforce compliance with environmental laws. Environmental groups frequently pipeline infrastructure projects. Moreover, a major discharge of hydrocarbons or substances into the environment could, to the extent the event is not insured or is not fully insured, subject us to substantial expense, including the cost of remediation and restoration of any natural resources, the cost to comply with applicable laws and regulations, and made by employees, neighboring landowners and other third parties for personal and property .
Contamination resulting from spills of refined products and crude oil is not unusual within the petroleum pipeline industry. Historic spills along our existing pipelines and terminals as a result of past operations have resulted in contamination of the environment, including soils and groundwater. Some environmental laws impose liability without regard to fault or the legality
of the original act on certain classes of persons that contributed to the releases of hazardous substances or petroleum hydrocarbon substances into the environment. These persons include the owner or operator of the site or sites where the release occurred and companies that disposed of, or arranged for the disposal of, the hazardous substances found at the site. Such persons may be subject to strict, joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources, and for the costs of certain health studies. Site conditions, including soils and groundwater, are being evaluated at a few of our properties where operations may have resulted in releases of hydrocarbons and other wastes.
There are environmental remediation projects in progress, including assessment and monitoring activities, that relate to certain assets acquired from HF Sinclair. Under the Omnibus Agreement and certain transportation agreements and purchase agreements with HF Sinclair, HF Sinclair has agreed to indemnify us, subject to certain monetary and time limitations, for environmental noncompliance and remediation liabilities associated with certain assets transferred to us from HF Sinclair and occurring or existing prior to the date of such transfers.
We have an environmental agreement with Delek with respect to pre-closing environmental costs and liabilities relating to the pipelines and terminals acquired from Delek in 2005, under which Delek will indemnify us subject to certain monetary and time limitations.
At December 31, 2022, we have an accr ual of $19.5 million that relates to environmental clean-up projects for which we have assumed liability, including accrued environmental liabilities assumed in the Sinclair Transportation acquisition that have preliminarily been fair valued at $14.7 million as of the acquisition date, or for which the indemnity provided f or by HF Sinclair has expired. There are environmental remediation projects in progress, including assessment and monitoring activities, that relate to certain assets acquired from HF Sinclair. Certain of these projects were underway prior to our purchase, are covered under the HF Sinclair environmental indemnification discussed above, and represent liabilities retained by HF Sinclair.
On July 8, 2022, the Osage pipeline, which carries crude oil from Cushing, Oklahoma to El Dorado, Kansas, suffered a release of crude oil. Our equity in earnings (loss) of equity method investments was reduced in the year ended December 31, 2022 by $17.6 million for our 50% share of incurred and estimated environmental remediation and recovery expenses associated with the release, net of our share of insurance proceeds received to date of $3.0 million. We expect Osage will receive additional insurance recoveries, which will be recorded as they are received. If our insurance policy pays out in full, our share of the remaining insurance coverage is expected to be $9.5 million. The pipeline resumed operations in the third quarter of 2022 and remediation efforts are underway.
We may experience future releases into the environment from our pipelines and terminals or discover historical releases that were previously unidentified or not assessed. Although we maintain an extensive inspection and audit program designed, as applicable, to prevent, detect and address these releases promptly, damages and liabilities incurred due to any future environmental releases from our assets have the potential to substantially affect our business.
CAPITAL REQUIREMENTS
Our pipeline and terminalling operations are capital intensive, requiring investments to maintain, expand, upgrade or enhance existing operations and to meet environmental and operational regulations. Our capital requirements have consisted of, and are expected to continue to consist of, maintenance capital expenditures and expansion capital expenditures. “Maintenance capital expenditures” represent capital expenditures to replace partially or fully depreciated assets to maintain the operating capacity of existing assets. Maintenance capital expenditures include expenditures required to maintain equipment reliability, tankage and pipeline integrity, safety and to address environmental regulations. “Expansion capital expenditures” represent capital expenditures to expand the operating capacity of existing or new assets, whether through construction or acquisition. Expansion capital expenditures include expenditures to acquire assets, to grow our business and to expand existing facilities, such as projects that increase throughput capacity on our pipelines and in our terminals. Repair and maintenance expenses associated with existing assets that are minor in nature and do not extend the useful life of existing assets are charged to operating expenses as incurred.
Each year the board of directors of HLS, our ultimate general partner, approves our annual capital budget, which specifies capital projects that our management is authorized to undertake. Additionally, at times when conditions warrant or as new opportunities arise, additional projects may be approved. The funds allocated for a particular capital project may be expended over a period in excess of a year, depending on the time required to complete the project. Therefore, our planned capital expenditures for a given year consist of expenditures approved for capital projects included in the current year's capital budget as well as, in certain cases, expenditures approved for capital projects in capital budgets for prior years. Our current 2023 capital forecast is comprised of approximately $25 million to $35 million for maintenance capital expenditures and $5 to $10 million for expansion capital expenditures and joint venture investments. In addition to our capital budget, we may spend funds periodically to perform capital upgrades or additions to our assets where a customer reimburses us for such costs. The upgrades or additions would generally benefit the customer over the remaining life of the related service agreements.
We expect that our currently planned sustaining and maintenance capital expenditures, as well as expenditures for capital development projects, will be funded with cash generated by operations. We expect that, to the extent necessary, we can raise additional funds from time to time through equity or debt financings in the public and private capital markets.
Under the terms of the transaction to acquire HFC's 75% interest in UNEV, we issued to a subsidiary of HFC (now HF Sinclair) a Class B unit comprising a noncontrolling equity interest in a wholly owned subsidiary subject to redemption to the extent that HFC is entitled to a 50% interest in 75% of annual UNEV earnings before interest, income taxes, depreciation and amortization above $40 million beginning July 1, 2015, and ending in June 2032, subject to certain limitations. However, to the extent earnings thresholds are not achieved, no redemption payments are required. No redemption payments have been required to date.
HUMAN CAPITAL
Our People
We are managed by HLS, our ultimate general partner. HLS is a subsidiary of HF Sinclair. The employees providing services to us are either provided by HLS, which utilizes people employed by HF Sinclair to perform services for us, or seconded to us by subsidiaries of HF Sinclair, as neither we nor our ultimate general partner have any employees. Under the Secondment Agreement with HF Sinclair, certain employees of HF Sinclair are seconded to HLS, our ultimate general partner, to provide operational and maintenance services for certain of our processing, refining, pipeline and tankage assets, and HLS reimburses HF Sinclair for its prorated portion of the wages, benefits, and other costs of these employees for our benefit. In addition, as more fully described under Part III, Item 11. Executive Compensation, certain executive officers of HLS are also executive officers of HF Sinclair and devote as much of their professional time as necessary to oversee the management our business and affairs.
The “One HF Sinclair Culture” focuses on five key values – safety, integrity, teamwork, ownership and inclusion. These values influence decisions, shape behaviors and provide the opportunity for employees to thrive. Safety is our first priority. We care about our people and have implemented policies and procedures designed to help them return home safely every day. We focus on integrity and doing the right thing. We champion a culture of teamwork and ownership by supporting each other and empowering employees to take action where they see a need or opportunity. Inclusion reflects our desire to foster a work environment in which employees feel valued and included in decisions, opportunities and challenges.
As of December 31, 2022, 405 HF Sinclair employees were dedicated to our business in addition to HF Sinclair employees seconded to HLS for a portion of their time to provide services to our business as described above. From time to time, a portion of HF Sinclair’s employees that are seconded to us, are covered by collective bargaining agreements. The current collective bargaining agreements have various expiration dates between 2023 and 2026. We have experienced no material interruptions of operations due to disputes with those employees and management believes that positive working relationships exist between HF Sinclair and local unions and their members.
Oversight
As a result of our secondment arrangements with HF Sinclair, strategic oversight for human capital management is shared between the HLS Board of Directors and board committees and the HF Sinclair Board of Directors and board committees. As further discussed under Part III, Item 11. Executive Compensation, the HLS Compensation Committee determines cash and bonus compensation for HLS’s Chief Executive Officer, President or Chief Financial Officer if such officers are solely dedicated to HLS. The HF Sinclair Board of Directors and Board committees provide oversight on strategies and policies related to the human capital management of HF Sinclair employees seconded to, and shared with, HLS. The HF Sinclair Compensation Committee is responsible for periodically reviewing HF Sinclair’s strategies and policies regarding the promotion of employee diversity, equity and inclusion, talent and performance management, pay equity and employee engagement, as well as executive succession planning. The HLS Board of Directors and HF Sinclair’s Nominating, Governance and Social Responsibility Committee oversee policies and practices regarding human rights in their respective operations and supply chain. This process is designed to provide high level oversight of our strategies related to attracting, retaining and developing a workforce that aligns with our values and strategies.
Diversity & Inclusion
HLS and HF Sinclair leadership is committed to attracting, retaining and developing a highly engaged, high-performing, diverse workforce and cultivating an inclusive workplace where all employees feel valued and have a sense of belonging. Of HF Sinclair's total employees as of December 31, 2022, approximately 17% identified as female and approximately 83% identified as male. Approximately 22% of HF Sinclair's total employees identified as Hispanic or Latino, Black or African American, Asian, American Indian or Alaskan Native, Native Hawaiian or Other Pacific Islander, or as two or more races. We are also committed to hiring and retaining veterans and reservists of the U.S. armed forces, who represented approximately 5% of HF Sinclair's U.S. workforce as of December 31, 2022.
Increasing diversity and inclusion efforts is an organizational priority for HLS and HF Sinclair. HF Sinclair has introduced diversity awareness programs focused on increasing the number of underrepresented persons in engineering roles. HF Sinclair’s university recruiting team has partnered with historically black colleges and universities to offer full-time and summer internship opportunities and various diversity and inclusion organizations at universities to sponsor and participate in events, such as the North Texas Women’s Energy Network and the National Society of Black Engineers Convention. In addition, to help foster a culture of inclusion, HF Sinclair has two employee resource groups, one focused on developing talent at HF Sinclair by fostering relationships through education, networking and leadership development opportunities and the other focused on veterans. In 2021, HF Sinclair formed an Inclusion and Diversity Working Group to develop and further implement HF Sinclair’s inclusion and diversity initiatives, to gather and report best practices related to inclusion and diversity, and to assist in developing ongoing inclusion and diversity goals and objectives.
Health & Safety
The safety of our employees, contractors and communities is an overarching priority and fundamental to our operational success. We have a comprehensive Pipeline Excellence Program that builds upon best practices and processes and is designed to advance organizational safety and performance, drive reliability and deliver strong results. Our approach allows for flexibility in unique operations and environments and provides a model for continuous improvement and fosters a strong culture of safety within our company. Pipelines are a vital component of our nation’s infrastructure, making it imperative that we safeguard our pipelines against any type of damage. We have implemented rigorous awareness and damage prevention programs that aim to educate the public and other key stakeholders and continually invest in the maintenance and integrity of our assets, including inspection and repair programs to comply with federal and state regulations.
Total Rewards & Development
We believe that the health of our company is linked to the performance and health of our people. The HF Sinclair employees that provide service to us are eligible to participate in the same comprehensive and competitive total rewards programs that are provided to employees of HF Sinclair generally. HF Sinclair’s benefit offerings are designed to support employee health, financial and emotional needs, inclusive of comprehensive coverage for health care, a competitive retirement savings benefit, vacation and holiday time and other income protection and work life benefits. HF Sinclair also provides tools to help recognize and reward employee performance consistent with the One HF Sinclair Culture.
Consistent with the HF Sinclair culture values of ownership and growth, HF Sinclair offers training, development and engagement programs to its employees that provide services to us which provide employees the opportunity to develop their career by enhancing skills and capabilities consistent with the needs of the business. Our suite of programs include: Accelerate, a curated collection of on-demand e-learning for all employees; Refine, interactive, instructor-led workshops focusing on professional development at any career level; Front Line Leadership Development, a series of leadership training for new and existing supervisors; Catalyst, a guided cohort of new leaders learning about leadership styles and executive presence; and Leading the HF Sinclair Way, a deep-dive for our senior leaders on leading through our cultural values and business objectives.
Item 1A. Risk Factors
Risk Factor Summary
Investing in us involves a degree of risk. You should carefully consider all information in this Form 10-K, including the Management’s Discussion & Analysis section and the financial statements and related notes, prior to investing in our common units. These risks and uncertainties include, but are not limited to, the following:
Risks Related to our Business/Industry:
• We depend on HF Sinclair for a substantial portion of our revenues. A significant reduction in those revenues or a material deterioration of HF Sinclair's financial condition could reduce our revenues materially.
• General economic conditions or, due to our lack of asset and geographic diversification, an adverse development in our businesses could materially and adversely affect our financial condition, results of operations, or cash flows.
• Any reduction in the capacity of, or the allocations to, our shippers on interconnecting, third-party pipelines could cause a reduction of volumes transported in our pipelines and through our terminals.
• A material decrease in the supply, or a material increase in the price, of crude oil or other materials available to HF Sinclair's refineries and our pipelines and terminals, and a corresponding decrease in demand for refined products in the markets served by our pipelines and terminals, could reduce our revenues materially.
• Competition from other pipelines that may be able to supply our shippers' customers with refined products at a lower price could cause us to reduce our rates or could reduce our revenues.
• Our operations are subject to catastrophic losses, operational hazards and unforeseen interruptions for which we may not be adequately insured.
• If we are unable to complete capital projects at their expected costs or in a timely manner, incur increased maintenance or repair costs on assets, or if assumed market conditions deteriorate, our financial condition, results of operations, or cash flows could be materially and adversely affected.
• The COVID-19 pandemic, and actions taken in response thereto, has had and may continue to have a material adverse effect on our business.
• We may be unsuccessful in integrating the operations of acquired assets or businesses, including the Sinclair business acquired in the HEP Transaction, and in realizing the anticipated benefits of any such acquisitions.
• We may not be able to fully execute our growth strategy if we encounter illiquid capital markets or increased competition for investment opportunities, if our assumptions concerning population growth are inaccurate, or if an agreement cannot be reached with HF Sinclair for the acquisition of assets on which we have a right of first offer.
• We do not own all of the land on which our pipeline systems and other assets are located, which could result in disruptions to our operations. Regulatory changes related to a state’s use of eminent domain could inhibit our ability to secure rights-of-way for future pipeline construction projects.
• Our business may suffer due to a change in the composition of our Board of Directors, the departure of any of our key senior executives or other key employees who provide services to us.
• Terrorist attacks, and the threat of terrorist attacks or vandalism, have resulted in increased costs to our business. Global hostilities may adversely impact our results of operations.
• We could be subject to damages based on claims brought against us by our customers or lose customers as a result of the failure of products we distribute to meet certain quality specifications.
• We may not be able to retain existing customers or acquire new customers.
• We own certain of our systems through joint ventures, and our control of such systems is limited by provisions of the agreements we have entered into with our joint venture partners and by our percentage ownership in such enterprises.
Risks Related to Government Regulation
• Our operations are subject to evolving federal, state and local laws, regulations, oversight by governmental agencies and permit/authorization requirements regarding our business, capital projects and environmental protection (including greenhouse gases and climate change protection), health, operational safety and product quality, any of which could result in potential liabilities, increased operating costs, and reduced demand for our services.
• Increasing attention to environmental, social and governance (“ESG”) matters may adversely impact our business, financial results, stock price or price of debt securities.
Risks Related to Cybersecurity, Data Security and Privacy, Information Technology and Intellectual Property
• Cyberattacks, data security breaches, information technology system failures, network disruptions, vandalism, terrorist attacks or global hostilities or other sustained military campaigns could have a material adverse effect on our business, financial condition, results of operations or cash flows.
• Our business is subject to complex and evolving laws, security standards, and regulations and policies regarding data privacy, cybersecurity and data protection, and may be subject to additional related laws and regulations in jurisdictions in which we operate or expand. Such laws, standards and regulations could result in claims, increased cost of operations, or otherwise harm our ability to compete in the market.
Risks Related to Liquidity, Financial Instruments and Credit
• Increases in interest rates could adversely affect our business. Our leverage or volatile credit/capital markets may limit our ability to borrow funds on acceptable terms, service our indebtedness or capitalize on business opportunities.
• If we are unable to generate sufficient cash flow, our ability to pay quarterly distributions to our common unitholders at current levels or to increase our quarterly distributions in the future could be impaired materially.
• We are exposed to the credit risks and certain other risks, of our or our joint ventures' key customers, vendors, and other counterparties. Adverse changes in our and/or our general partner's credit ratings and risk profile may negatively affect us.
Risks to Common Unitholders
• HF Sinclair and its affiliates may have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests or engage in limited competition with us.
• Cost reimbursements and fees due to our general partner and its affiliates for services provided are substantial. Our general partner may reduce the amount of cash in reserve available for distribution to unitholders. Even if unitholders are dissatisfied, they cannot remove our general partner without its consent. The control of our general partner may be transferred to a third party without unitholder consent.
• We may issue additional limited partner units without unitholder approval, which would dilute an existing unitholder's ownership interests. Our general partner has a limited call right that may require a unitholder to sell its common units at an undesirable time or price.
Tax Risks to Common Unitholders
• Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, and not being subject to a material amount of entity-level taxation. Our cash available for distribution to unitholders may be substantially reduced if we become subject to entity-level taxation as a result of the Internal Revenue Service (“IRS”) treating us as a corporation or legislative, judicial or administrative changes, and it may also be reduced by any audit adjustments if imposed directly on the partnership.
• Even if unitholders do not receive cash distributions from us, unitholders will be required to pay taxes on their share of our taxable income. Unitholders may be subject to limitation on their ability to deduct interest expense incurred by us.
• Tax-exempt entities and non-U.S. unitholders face unique tax issues from owning our common units that may result in adverse tax consequences to them. The IRS may challenge certain tax positions, treatment methodologies or allocations, which could adversely affect the value of our common units.
Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. If any of the following risks were to actually occur, our business, financial condition, results of operations or treatment of unitholders could be materially and adversely affected. The headings provided in this Item 1A. are for convenience and reference purposes only and shall not affect or limit the extent or interpretation of the risk factors.
RISKS RELATED TO OUR BUSINESS/INDUSTRY
We depend on HF Sinclair (particularly its Navajo and Woods Cross refineries) for a substantial portion of our revenues; if those revenues were significantly reduced or if HF Sinclair's financial condition materially deteriorated, there would be a material adverse effect on our results of operations.
For the year ended December 31, 2022, HF Sinclair accoun ted f or 70% of the revenues of our petroleum product and crude pipelines, 85% of the revenues of our terminals, tankage, and truck loading racks, and 100% of the revenue from our refinery processing units. We expect to continue to derive a majority of our revenues from HF Sinclair for the foreseeable future. If HF Sinclair satisfies only its minimum obligations under the long-term pipeline and terminal, tankage and throughput agreements that it has with us or is unable to meet its minimum annual payment commitment for any reason, including due to prolonged downtime or a shutdown at its refineries, our revenues and cash flow would decline.
Any significant reduction in production at HF Sinclair’s Navajo or Woods Cross refineries could reduce throughput in our pipelines, terminals and refinery processing units, resulting in materially lower levels of revenues and cash flow for the duration of the shutdown. For the year ended December 31, 2022, production from HF Sinclair's Navajo and Woods Cross refineries accounted for approximately 50% of the throughput volumes transported by our refined product, intermediate and crude pipelines. Our Woods Cross refinery processing units also accounted for 70% of our refinery processing units revenues.
Operations at any of HF Sinclair's refineries could be partially or completely shut down, temporarily or permanently, as the result of:
• competition from other refineries and pipelines that may be able to supply the refinery's end-user markets on a more cost-effective basis;
• operational problems such as catastrophic events at the refinery, terrorist or cyberattacks, vandalism, labor difficulties, or weather, including as a result of climate change, public health crisis such as COVID-19, or government response thereto, environmental proceedings or other litigation that cause a stoppage of all or a portion of the operations at the refinery;
• planned maintenance or capital projects;
• increasingly stringent environmental laws and regulations, such as the U.S. Environmental Protection Agency's gasoline and diesel sulfur control requirements that limit the concentration of sulfur in motor gasoline and diesel fuel for both on-road and non-road usage as well as various state and federal emission requirements that may affect the refinery itself and potential future climate change regulations;
• an inability to obtain crude oil for the refinery at competitive prices; or
• a general reduction in demand for refined products in the area due to:
◦ a local or national recession, public health crisis such as COVID-19, or other adverse event or economic condition that results in lower spending by businesses and consumers on gasoline and diesel fuel;
◦ higher gasoline prices due to higher crude oil costs, higher taxes or stricter environmental laws or regulations; or
◦ a shift by consumers to more fuel-efficient or alternative fuel vehicles or an increase in fuel efficiency, whether as a result of technological advances by manufacturers, legislation either mandating or encouraging higher fuel efficiency or the increased use of alternative fuel sources or otherwise.
For example, on June 1, 2020, HF Sinclair announced plans to permanently cease petroleum refining operations at its Cheyenne Refinery and to convert certain assets at that refinery to renewable diesel production. HF Sinclair subsequently began winding down petroleum refining operations at the Cheyenne Refinery on August 3, 2020.
The effect on us of any shutdown would depend on the length of the shutdown and the extent of the refinery operations affected by the shutdown. We have no control over the factors that may lead to a shutdown or the measures HF Sinclair may take in response to a shutdown. HF Sinclair makes all decisions at each of its refineries concerning levels of production, regulatory compliance, refinery turnarounds (planned shutdowns of individual process units within the refinery to perform major maintenance activities), labor relations, environmental remediation, emission control and capital expenditures and is responsible for all related costs. HF Sinclair is not under contractual obligation to us to maintain operations at its refineries.
Furthermore, HF Sinclair's obligations under the long-term pipeline and terminal, tankage, tolling and throughput agreements with us would be temporarily suspended during the occurrence of a force majeure event that renders performance impossible with respect to an asset for at least 30 days. If such an event were to continue for a year, we or HF Sinclair could terminate the agreements. The occurrence of any of these events could reduce our revenues and cash flows.
General economic conditions may adversely affect our business, operating results and financial condition.
Economic slowdowns may have serious negative consequences for our business and operating results, because our performance is subject to domestic economic conditions and their impact on demand for crude oil and refined products. Some of these factors include general economic conditions, unemployment, consumer debt, inflation, reductions in net worth based on declines in equity markets and residential real estate values, adverse developments in mortgage markets, taxation, energy prices, gasoline and diesel fuel prices, interest rates, consumer confidence and other macroeconomic factors. The demand for crude oil and refined and finished lubricant products can be reduced due to a local or national recession or other adverse economic condition, such as periods of increased or prolonged inflation, which results in lower spending by businesses and consumers on gasoline and diesel fuel, higher gasoline prices due to higher crude oil prices, a shift by consumers to more fuel-efficient vehicles or alternative fuel vehicles (such as ethanol or wider adoption of electric, gas/electric hybrid or hydrogen powered vehicles), or an increase in vehicle fuel economy, whether as a result of technological by manufacturers, legislation mandating or higher fuel economy or the use of alternative fuel.
Political instability, actual or potential hostilities or other conflicts in oil producing areas, such as the Russia-Ukraine war, and global health crises, such as the COVID-19 pandemic, can also impact the global economy and decrease worldwide demand for oil and refined products, which affects the prices of crude oil. Increased volatility in the global oil markets, including the prices our customers and suppliers pay for crude oil and other raw materials, has, and may continue to, materially adversely affect our business, financial condition, results of operations and/or cash flows as well as our ability to pay distributions to our common unitholders.
Adverse developments in the global economy or in regional economies could also negatively impact our customers and suppliers, and therefore have a negative impact on our business or financial condition. In the event of adverse developments or stagnation in the economy or financial markets, our customers and suppliers may experience deterioration of their businesses, reduced demand for their products, cash flow shortages and difficulty obtaining financing. As a result, existing or potential customers might delay or cancel plans to use our services and may not be able to fulfill their obligations to us in a timely fashion. Further, suppliers may experience similar conditions, which could impact their ability to fulfill their obligations to us. Moreover, a financial market crisis may have a material adverse impact on financial institutions and limit access to capital and credit. This could, among other things, make it more for us to obtain ( or increase our cost of obtaining) capital and financing for our operations. Our access to additional capital may not be available on terms acceptable to us or at all.
Due to our lack of asset and geographic diversification, an adverse development in our businesses could materially and adversely affect our financial condition, results of operations or cash flows.
A significant concentration of our pipeline assets serve HF Sinclair's Navajo refinery. Due to our limited asset and geographic diversification, an adverse development in our business (including adverse developments as a result of catastrophic events or weather, including as a result of climate change, terrorist or cyberattacks, vandalism, public health crisis, decreased supply of crude oil and feedstocks and/or decreased demand for refined petroleum products), could have a significantly greater impact on our financial condition, results of operations or cash flows than if we maintained more diverse assets in more diverse locations.
Any reduction in the capacity of, or the allocations to, our shippers on interconnecting, third-party pipelines could cause a reduction of volumes transported in our pipelines and through our terminals.
HF Sinclair and the other users of our pipelines and terminals are dependent upon connections to third-party pipelines to receive and deliver crude oil and refined products. Any reduction of capacities of these interconnecting pipelines due to testing, line repair, reduced operating pressures, catastrophic events, terror or cyberattacks, vandalism or other causes could result in reduced volumes transported in our pipelines or through our terminals. Similarly, if additional shippers begin transporting volumes of refined products over interconnecting pipelines, the allocations to existing shippers in these pipelines would be reduced, which could also reduce volumes transported in our pipelines or through our terminals.
A material decrease in the supply, or a material increase in the price, of crude oil or other materials available to HF Sinclair's refineries and our pipelines and terminals, and a corresponding decrease in demand for refined products in the markets served by our pipelines and terminals, could reduce our revenues materially.
The volume of refined products we transport in our refined product pipelines depends on the level of production of refined products from HF Sinclair's refineries, which, in turn, depends on the availability of attractively-priced crude oil produced in the areas accessible to those refineries. In order to maintain or increase production levels at their refineries, our shippers must continually contract for new crude oil supplies. A material decrease in crude oil production from the fields that supply their refineries, as a result of depressed commodity prices, decreased demand, lack of drilling activity, natural production declines, governmental regulations, including travel bans and restrictions, quarantines, shelter in place orders, and shutdowns, catastrophic events or otherwise, could result in a decline in the volume of crude oil our shippers refine, absent the availability of transported crude oil to offset such declines. Such an event would result in an overall decline in volumes of refined products transported through our pipelines and therefore a corresponding reduction in our cash flow. In addition, the future growth of our
shippers' operations will depend in part upon whether our shippers can contract for additional supplies of crude oil at a greater rate than the rate of natural decline in their currently connected supplies.
Fluctuations in crude oil prices can greatly affect production rates and investments by third parties in the development of new oil reserves. Drilling activity generally decreases as crude oil prices decrease. We and our shippers have no control over producers or their production decisions, which are affected by, among other things, prevailing and projected energy prices, demand for hydrocarbons, geological considerations, governmental regulation, global market conditions, actions by foreign nations and the availability and cost of capital, or over the level of drilling activity in the areas of operations, the amount of reserves underlying the wells and the rate at which production from a well will decline. Similarly, a material increase in the price of crude oil supplied to refineries without an increase in the market value of the products produced by the refineries, either temporary or permanent, which causes a reduction in the production of refined products at the refineries, would cause a reduction in the volumes of refined products we transport, and our cash flow could be adversely affected.
In addition, periods of disruption in the global supply chain, including as a result of COVID-19, have caused shortages in the equipment and parts necessary to operate our facilities and to complete our capital projects. Certain suppliers have experienced, and may continue to experience, delays related to a variety of factors, including logistical delays and component shortages from vendors. We continue to monitor the situation and work closely with our suppliers to minimize disruption to our operations as a result of supply chain interruptions.
Finally, our business depends in large part on the demand for the various petroleum products we gather, transport and store in the markets we serve. Reductions in that demand adversely affect our business. Market demand varies based upon the different end uses of the petroleum products we gather, transport and store. We cannot predict the impact of future fuel conservation measures, alternate fuel requirements, government regulation, global pandemic, technological advances in fuel economy and energy-generation devices, exploration and production activities, actions by foreign nations, and any potential litigation related to climate change effects and resulting negative public perception, any of which could reduce the demand for the petroleum products in the areas we serve. The volatility in global oil markets, while uncertain, has, and may continue to, materially adversely affect our business, financial condition, results of operations and/or cash flows, as well as our ability to pay distributions to our common unitholders.
Competition from other pipelines that may be able to supply our shippers' customers with refined products at a lower price could cause us to reduce our rates or could reduce our revenues.
We and our shippers could face increased competition if other pipelines are able to supply our shippers' end-user markets competitively with refined products. For example, increased supplies of refined product delivered by Kinder Morgan's El Paso to Phoenix pipeline could result in additional downward pressure on wholesale-refined product prices and refined product margins in El Paso and related markets. Additionally, further increases in products from Gulf Coast refiners entering the El Paso and Arizona markets on this and other pipelines and a resulting increase in the demand for shipping product on the interconnecting common carrier pipelines could cause a decline in the demand for refined product from HF Sinclair. This could reduce our opportunity to earn revenues from HF Sinclair in excess of its minimum volume commitment obligations.
An additional factor that could affect some of HF Sinclair's markets is excess pipeline capacity from the West Coast into our shippers' Arizona markets. Additional increases in shipments of refined products from the West Coast into our shippers' Arizona markets could result in additional downward pressure on refined product prices that, if sustained over the long term, could influence product shipments by HF Sinclair to these markets.
Our operations are subject to catastrophic losses, operational hazards and unforeseen interruptions for which we may not be adequately insured.
Our operations are subject to catastrophic losses, operational hazards and unforeseen interruptions such as natural disasters, adverse weather, earthquakes, accidents, fires, explosions, hazardous materials releases or spills (such as the release of crude oil on the Osage pipeline in July 2022), terror or cyberattacks, vandalism, power failures, mechanical failures and other events beyond our control, and we have experienced certain of these events in the past. These events could result in an injury or loss of life; and have in the past and could in the future result in property damage or or or in our operations. In addition, third-party , mechanical , leaks in pipelines, measurement or other may result in significant costs or revenues.
We may not be able to maintain or obtain insurance of the type and amount we desire at commercially reasonable rates and exclusions from coverage may limit our ability to recover the amount of the full loss in all situations. As a result of market conditions, premiums and deductibles for certain of our insurance policies and insurance policies for our joint ventures are increasing. In some instances, certain insurance has become unavailable or has become available only for reduced amounts of coverage or at a significantly increased cost.
There can be no assurance that insurance will cover all or any damages and losses resulting from these types of hazards. We are not fully insured against all risks or incidents to our business and therefore, we self-insure certain risks. We are not insured against all environmental accidents that might occur. Our property insurance includes business interruption coverage for lost profit arising from physical damage to our facilities. If a significant accident or event occurs that is self-insured or not fully insured, our operations could be temporarily or permanently impaired, our liabilities and expenses could be significant and it could have a material adverse effect on our financial position. Because our partnership agreement requires us to distribute all available cash (less operating surplus cash reserves) to our unitholders, we do not have the same flexibility as other legal entities to accumulate cash to protect under insured or .
If we are unable to complete capital projects at their expected costs or in a timely manner, if we incur increased maintenance or repair costs on assets, or if the market conditions assumed in our project economics deteriorate, our financial condition, results of operations, or cash flows could be materially and adversely affected.
Delays or cost increases related to capital spending programs involving construction of new facilities (or improvements and increased maintenance or repair expenditures on our existing facilities) could adversely affect our ability to achieve forecasted operating results. Although we evaluate and monitor each capital spending project and try to anticipate difficulties that may arise, such delays or cost increases may arise as a result of numerous factors, such as:
• third-party challenges to, denials, or delays in issuing requisite regulatory approvals and/or permits;
• societal and political pressures and other forms of opposition;
• compliance with or liability under environmental or pipeline safety regulations;
• unplanned increases in the cost of construction materials or labor;
• disruptions in transportation of modular components and/or construction materials;
• severe adverse weather conditions, natural disasters, terror or cyberattacks, domestic vandalism other events (such as equipment malfunctions, explosions, fires or spills) affecting our facilities, or those of vendors and suppliers;
• shortages of sufficiently skilled labor, or labor disagreements resulting in unplanned work stoppages;
• market-related increases in a project's debt or equity financing costs; and/or
• nonperformance or force majeure by, or disputes with, vendors, suppliers, contractors, or sub-contractors involved with a project.
The COVID-19 pandemic or any other widespread outbreak of an illness or pandemic or other public health crisis, and actions taken in response thereto, has had and may continue to have a material adverse effect on our operations, business, financial condition, results of operations or cash flows.
COVID-19’s spread across the globe and government regulations in response thereto have negatively affected worldwide economic and commercial activity, impacted global demand for oil, gas and refined products, and created significant volatility and disruption of financial and commodity markets. The spread of COVID-19 has caused us to modify our business practices from time to time as needed (including limiting employee and contractor presence at our work locations, restricting travel unless approved by senior leadership, quarantining employees when necessary and reducing utilization at our refineries) and could significantly disrupt our operations and ability to perform critical functions in the future. The effects of COVID-19 or any other pandemic are difficult to predict, and the duration of any potential business disruption or the extent to which it may negatively affect our operating results or our liquidity is unknown. The extent to which the COVID-19 pandemic will continue to impact our business and operating results remains undetermined and depends on future developments related to the duration and of the spread of the virus, emerging variants, vaccine and booster effectiveness, and government measures, designed to and contain the spread of COVID-19, among others, and, all of which are beyond our control. These effects of the COVID-19 pandemic, while uncertain, have, and may continue to, materially affect our business, financial condition, results of operations and/or cash flows, as well as our ability to pay distributions to our common unitholders.
We may be unsuccessful in integrating the operations of the assets we have acquired or may acquire with our operations, including the Sinclair business acquired in the HEP Transaction, and in realizing all or any part of the anticipated benefits of any such acquisitions.
From time to time, we evaluate and acquire assets and businesses that we believe complement our existing assets and businesses, such as the HEP Transaction with Sinclair. Acquisitions such as the HEP Transaction require, and may continue to require, management to devote significant attention and resources to integrating the acquired business with our business. We may encounter difficulties integrating personnel from the acquired business while maintaining focus on providing consistent, high-quality products and services. The disruption of, or the loss of momentum in, each company's ongoing business or inconsistencies in standards, controls, procedures and policies may result from the integration process. Further, we may lose key employees or encounter difficulties integrating relationships with customers, vendors, and business partners.
Delays or difficulties in the integration process could adversely affect our business, financial results, financial condition and common unit price. Even if we are able to integrate our business operations successfully, there can be no assurance that this
integration will result in the realization of the full benefits of synergies, cost savings, innovation and operational efficiencies that we currently expect or have communicated from this integration or that these benefits will be achieved within the anticipated time frame.
Acquisitions may require substantial capital or the incurrence of substantial indebtedness. Our capitalization and results of operations may change significantly as a result of completed or future acquisitions. Acquisitions and business expansions involve numerous risks, including difficulties in the assimilation of the assets and operations of the acquired businesses, inefficiencies and difficulties that arise because of unfamiliarity with new assets and the businesses associated with them, and new geographic areas and the diversion of management's attention from other business concerns. Performance at HEP or the acquired business may suffer as a result of any such diversion of management’s attention. Further, unexpected costs and challenges may arise whenever businesses with different operations or management are combined, and we may experience unanticipated delays in realizing the benefits of an acquisition. Also, following an acquisition, we may discover previously unknown and liabilities associated with the acquired business or assets for which we have no recourse under applicable indemnification provisions.
We m ay not be able to fully execute our growth strategy if we encounter illiquid capital markets or increased competition for investment opportunities, if our assumptions concerning population growth are inaccurate, or if an agreement cannot be reached with HF Sinclair for the acquisition of assets on which we have a right of first offer.
Our strategy contemplates growth through the development and acquisition of crude, intermediate and refined products transportation and storage assets while maintaining a strong balance sheet. This strategy includes constructing and acquiring additional assets and businesses, either from HF Sinclair or third parties, to enhance our ability to compete effectively and diversifying our asset portfolio, thereby providing more stable cash flow. We regularly consider and enter into discussions regarding, and are currently contemplating and/or pursuing, potential joint ventures, stand-alone projects or other transactions that we believe will present opportunities to realize synergies, expand our role in our chosen businesses and increase our market position.
We will require substantial new capital to finance the future development and acquisition of assets and businesses. Any limitations on our access to capital will impair our ability to execute this strategy. If the cost of such capital becomes too expensive, or if the development or acquisition opportunities are on terms that do not allow us to obtain appropriate financing, our ability to develop or acquire accretive assets will be limited. We may not be able to raise the necessary funds on satisfactory terms, if at all. The primary factors that influence our cost of equity include market conditions, fees we pay to underwriters and other offering costs, which include amounts we pay for legal and accounting services. The primary factors influencing our cost of borrowing include interest rates, credit spreads, credit ratings, covenants, underwriting or loan origination fees and similar charges we pay to lenders.
In addition, we experience competition for the types of assets and businesses we have historically purchased or acquired. High competition, particularly for a limited pool of assets, may result in higher, less attractive asset prices, and therefore, we may lose to more competitive bidders. Such occurrences limit our ability to execute our growth strategy, which may materially adversely affect our ability to maintain or pay higher distributions in the future.
Our growth strategy also depends upon:
• the accuracy of our assumptions about growth in the markets that we currently serve or have plans to serve in the Southwestern, Northwest and Mid-Continent regions of the United States;
• HF Sinclair's willingness and ability to capture a share of additional demand in its existing markets; and
• HF Sinclair's willingness and ability to identify and penetrate new markets in the Southwestern, Northwest and Mid-Continent regions of the United States.
If our assumptions about increased market demand prove incorrect, HF Sinclair may not have any incentive to increase refinery capacity and production or shift additional throughput to our pipelines, which would adversely affect our growth strategy.
Our Omnibus Agreement with HF Sinclair provides us with a right of first offer on certain of HF Sinclair’s existing or acquired logistics assets. The consummation and timing of any future acquisitions of these assets will depend upon, among other things, our ability to negotiate acceptable purchase agreements and commercial agreements with respect to the assets and our ability to obtain financing on acceptable terms. We can offer no assurance that we will be able to successfully consummate any future acquisitions pursuant to our right of first offer. In addition, certain of the assets covered by our right of first offer may require substantial capital expenditures in order to maintain compliance with applicable regulatory requirements or otherwise make them suitable for our commercial needs. For these or a variety of other reasons, we may decide not to exercise our right of first offer if and when any assets are offered for sale, and our decision will not be subject to unitholder approval. In addition, our right of first offer may be terminated upon a change of control of HF Sinclair.
We do not own all of the land on which our pipeline systems and other assets are located, which could result in disruptions to our operations. Additionally, a change in the regulations related to a state’s use of eminent domain could inhibit our ability to secure rights-of-way for future pipeline construction projects. Finally, certain of our assets are located on or adjacent to Native American tribal lands.
We do not own all of the land on which our pipeline systems and other assets are located, and we are, therefore, subject to the risk of increased costs or more burdensome terms to maintain necessary land use. We obtain the right to construct and operate pipelines and other assets on land owned by third parties and government agencies for specified periods. If we were to lose these rights through an inability to renew leases, right-of-way contracts or similar agreements, we may be required to relocate our pipelines or other assets and our business could be adversely affected. Additionally, it may become more expensive for us to obtain new rights-of-way or leases or to renew existing rights-of-way or leases. If the cost of obtaining or renewing such agreements increases, it may adversely affect our operations and the cash flows available for distribution to unitholders.
The adoption or amendment of laws and regulations that limit or eliminate a state’s ability to exercise eminent domain over private property in a state in which we operate could make it more difficult or costly for us to secure rights-of-way for future pipeline construction and other projects.
Certain of our pipelines are located on or adjacent to Native American tribal lands. Various federal agencies, along with each Native American tribe, promulgate and enforce regulations, including environmental standards, regarding operations on Native American tribal lands. In addition, each Native American tribe is a sovereign nation having the right to enforce laws and regulations (including various taxes, fees, and other requirements and conditions) and to grant approvals independent from federal, state and local statutes and regulations. Following a decision issued in May 2017 by the federal Tenth Circuit Court of Appeals, tribal ownership of even a very small fractional interest in an allotted land, that is, tribal land owned or at one time owned by an individual Native American landowner, bars condemnation of any interest in the allotment. Consequently, the inability to condemn such allotted lands under circumstances where existing pipeline rights-of-way may soon lapse or terminate serves as an additional impediment for pipeline operations. In addition, following the Supreme Court's ruling in McGirt v. Oklahoma that the Muscogee (Creek) Nation reservation in Eastern Oklahoma has not been disestablished, and therefore retains jurisdiction over criminal matters, and a subsequent ruling in July 2022 in Oklahoma v. Castro-Huerta narrowing McGirt’s holding to find concurrent tribal and state jurisdiction with respect to committed by non-Native Americans Native Americans on tribal lands, substantial uncertainty exists with respect to matters over which tribes may have or concurrent jurisdiction. Although the ruling in McGirt indicates that it is limited to law, the ruling has significant potential implications for civil law. At this time, we cannot predict how these jurisdictional issues may ultimately be resolved. These factors may increase our cost of doing business on Native American tribal lands.
In addition, our industry is subject to potentially disruptive activities by those concerned with the possible environmental impacts of pipeline routes. Activists, non-governmental organizations and others may seek to restrict the transportation of crude oil and refined products by exerting social or political pressure to influence when, and whether, such rights-of-way or permits are granted. This interference could impact future pipeline development, which could interfere with or block expansion or development projects and could have a material adverse effect on our business, financial condition, results of operations and our ability to make cash distributions to our unitholders.
Our business may suffer due to a change in the composition of our Board of Directors, the departure of any of our key senior executives or other key employees who provide services to us, or if certain of our executive officers, who also allocate time to our general partner and its affiliates, do not have enough time to dedicate to our business. Furthermore, a shortage of skilled labor or disruptions in the labor force that provides services to us may make it difficult for us to maintain labor productivity.
Our future performance depends to a significant degree upon the continued contributions of HLS's Board of Directors, key senior executives and key senior employees who provide services to us. Also, our business depends on the continuing ability to recruit, train and retain highly qualified employees in all areas of our operations, including accounting, business operations, finance and other key back-office and mid-office personnel. The competition for these employees is intense, and the loss of these executives or employees could harm our business. If any of these executives or other key personnel resign or become unable to continue in their present roles and are not adequately replaced, our business operations could be materially adversely affected. We do not currently maintain “key person” life insurance for any executives. Furthermore, our operations require skilled and experienced laborers with proficiency in multiple tasks. A shortage of trained workers due to retirements or otherwise or an increase in labor costs as a result of inflation or otherwise could have an adverse impact on productivity and costs, which could affect our operations.
Our general partner shares officers and administrative personnel with HF Sinclair to operate both our business and HF Sinclair's business. These officers face conflicts regarding the allocation of their and other employees' time, which may affect adversely our results of operations, cash flows and financial condition.
A portion of HF Sinclair's employees that are seconded to us from time to time are represented by labor unions under collective bargaining agreements with various expiration dates. HF Sinclair may not be able to renegotiate the collective bargaining agreements when they expire on satisfactory terms or at all. A failure to do so may increase our costs. In addition, existing labor agreements may not prevent a future strike or work stoppage, and any work stoppage could negatively affect our results of operations and financial condition.
Terrorist attacks, and the threat of terrorist attacks or vandalism, have resulted in increased costs to our business. Global hostilities may adversely impact our results of operations.
The long-term impact of (and threat of future) terrorist attacks and vandalism, on the energy transportation industry in general, and on us in particular, is unknown. Any attack on our facilities, those of our customers and, in some cases, those of other pipelines could have a material adverse effect on our business. Increased security measures taken by us as a precaution against possible terrorist attacks or vandalism have resulted in increased costs to our business.
The U.S. government has issued public warnings that indicate that pipelines and other assets might be specific targets of terrorist organizations. These potential targets might include our pipeline systems or operating systems and may affect our ability to operate or control our pipeline assets or our operations could be disrupted. The occurrence of one of these events could cause a substantial decrease in revenues, increased costs to respond or other financial loss, damage to reputation, increased regulation or litigation and or inaccurate information reported from our operations. These developments may subject our operations to increased risks, as well as increased costs, and, depending on their ultimate magnitude, could have a material adverse effect on our business, results of operations and financial condition.
Uncertainty surrounding global hostilities or other sustained military campaigns, and the possibility that infrastructure facilities could be direct targets of, or indirect casualties of, an act of terror, may affect our operations in unpredictable ways, including disruptions of crude oil supplies and markets for refined products or instability in the financial markets that could restrict our ability to raise capital.
In addition, changes in the insurance markets attributable to terrorist attacks, vandalism, or cyberattacks or extortion could make certain types of insurance more difficult for us to obtain. Moreover, the insurance that may be available to us may be significantly more expensive than our existing insurance coverage. Instability in the financial markets as a result of terrorism, cyberattacks, vandalism or war could also affect our ability to raise capital, including our ability to repay or refinance debt.
We could be subject to damages based on claims brought against us by our customers or lose customers as a result of the failure of products we distribute to meet certain quality specifications. In addition, we could be required to make substantial expenditures in the event of any changes in product quality specifications.
A significant portion of our operating responsibility on refined product pipelines is to manage the quality and purity of the products loaded at our loading racks. If our quality control measures fail, off-specification product could be sent out to public gasoline stations. This type of incident could result in liability claims regarding damages caused by the off-specification fuel or could impact our ability to retain existing customers or to acquire new customers, any of which could have a material adverse impact on our results of operations and cash flows.
In addition, various federal, state and local agencies have the authority to prescribe specific product quality specifications of refined products. Changes in product quality specifications or blending requirements could reduce our throughput volume, require us to incur additional handling costs or require capital expenditures. For example, different product specifications for different markets impact the fungibility of the products in our system and could require the construction of additional storage. If we are unable to recover these costs through increased revenues, our cash flows and ability to pay cash distributions could be adversely affected. In addition, changes in the product quality of the products we receive on our petroleum products pipeline system could reduce or eliminate our ability to blend products.
We may not be able to retain existing customers or acquire new customers.
The renewal or replacement of existing contracts with our customers at rates sufficient to maintain current revenues and cash flows depends on a number of factors outside our control, including competition from other pipelines and the demand for refined products in the markets that we serve.
We own certain of our systems through joint ventures, and our control of such systems is limited by provisions of the agreements we have entered into with our joint venture partners and by our percentage ownership in such joint ventures.
Certain of our systems are operated by joint venture entities for which we do not serve as the operator, or in which we do not have an ownership stake that permits us to control the business activities of the entity. We have limited ability to influence the business decisions of such joint venture entities.
Because we have partial ownership in the joint ventures, we may be unable to control the amount of cash we will need for capital projects or will receive from the operation and could be required to contribute significant cash to fund our share of their projects and operations, which could adversely affect our ability to distribute cash to our unitholders.
An impairment of our long-lived assets or goodwill could reduce our earnings or negatively impact our financial condition and results of operations.
An impairment of our long-lived assets or goodwill could reduce our earnings or negatively impact our results of operations and financial condition. We continually monitor our business, the business environment and the performance of our operations to determine if an event has occurred that indicates that a long-lived asset or goodwill may be impaired. If a triggering event occurs, which is a determination that involves judgment, we may be required to utilize cash flow projections to assess our ability to recover the carrying value based on the ability to generate future cash flows. We may also conduct impairment testing based on both the guideline public company and guideline transaction methods. Our long-lived assets and goodwill impairment analyses are sensitive to changes in key assumptions used in our analysis, estimates of future tariff rates, forecasted throughput levels, operating costs and capital expenditures. If the assumptions used in our analysis are not realized, it is possible a material impairment charge may need to be recorded in the future. We cannot accurately predict the amount and timing of any additional impairments of long-lived assets or goodwill in the future.
Growing our business by constructing new pipelines and terminals, or expanding existing ones, subjects us to construction risks.
One of the ways we may grow our business is through the construction of new pipelines and terminals or the expansion of existing ones. The construction of a new pipeline or the expansion of an existing pipeline, by adding horsepower or pump stations or by adding a second pipeline along an existing pipeline, involves numerous regulatory, environmental, political, and legal uncertainties, most of which are beyond our control. For example, the Biden Administration temporarily suspended the grant of certain authorizations for oil and gas activities on federal lands, although the order did not affect existing authorizations. Pipeline construction projects requiring federal approvals are generally subject to environmental review requirements under the National Environmental Policy Act ("NEPA"), and must also comply with other natural resource review requirements imposed pursuant to the Endangered Species Act and the National Historic Preservation Act. In April 2022, the Biden Administration revised NEPA’s implementing regulations, and now requires NEPA reviews to incorporate consideration of indirect and cumulative impacts of a proposed project, including the effects of climate change and greenhouse gas emissions. These revisions marked the end of the first phase of a two part review being undertaken by the Council on Environmental Quality (the “CEQ”), and thus additional changes to the NEPA rules may be forthcoming, though we cannot predict the substance or form of such revisions. Moreover, for over 35 years, the U.S. Army Corps of Engineers ("Corps") has authorized construction, maintenance, and repair of pipelines under a streamlined nationwide permit program under the federal Clean Water Act (“CWA”) known as Nationwide Permit 12 (“NWP 12”) program. From time to time, environmental groups have the use of NWP 12 for oil and gas pipeline projects. In April 2020, the U.S. District Court for the District of Montana determined that NWP 12 to comply with consultation requirements under the federal Species Act, vacated NWP 12, and the issuance of new authorizations for oil and gas pipeline projects under NWP 12, though the district court’s order was subsequently limited on appeal. In January 2021, the Corps published a reissuance of NWP 12, but this permit is similarly being in federal court on the same grounds that were in the April 2020 case. More recently, in May 2022 the Corps announced it was beginning a formal review of NWP 12. The outcome of involving the Biden Administration’s Social Cost of Carbon (“SCC”) metric may also impact future regulatory decision-making with respect to our construction and development. In May 2022, the Fifth Circuit stayed a lower court’s order blocking the Biden Administration’s use of an interim SCC value while the government’s appeal remains in . While the full extent and impact of these recent developments is unclear at this time, we could face significant and financial costs if we must obtain individual permit coverage from the Corps for our projects or more environmental conditions or reviews. These projects may not be completed on schedule (or at all) or at the budgeted cost. In addition, our revenues may not increase immediately upon the expenditure of funds on a particular project. For instance, if we build a new pipeline, the construction will occur over an extended period of time and we will not receive any material increases in revenues until after completion of the project.
Moreover, we may construct facilities to capture anticipated future growth in demand for refined products in a region in which such growth does not materialize. As a result, new facilities may not be able to attract enough throughput to achieve our expected investment return, which could adversely affect our earnings, results of operations and financial condition.
RISKS RELATED TO GOVERNMENT REGULATION
Our operations are subject to evolving federal, state and local laws, regulations and permit/authorization requirements regarding our business, capital projects and environmental protection, health, operational safety and product quality. Potential liabilities arising from these laws, regulations and requirements could affect our operations and have a material adverse effect on our business.
Our pipelines and terminal, tankage and loading rack operations are subject to increasingly stringent federal, state, and local laws, regulations and oversight regarding, among other things, the generation, storage, handling, use, transportation and distribution of petroleum and hazardous materials by pipeline, truck, rail, ship and barge, the emission and discharge of materials into the environment, waste management, the characteristics and composition of gasoline and diesel fuels, and other matters otherwise relating to the protection of human health and the environment and natural resources, including climate change.
Environmental laws and regulations have raised operating costs for the oil and refined products industry, and compliance with such laws and regulations may cause us, the HF Sinclair refineries, and other refineries that we support to incur potentially material expenditures associated with the construction, maintenance, and upgrading of equipment and facilities. Future environmental, health and safety requirements (or changed interpretations of existing requirements), may impose new and/or more stringent requirements on our assets and operations and require us to incur potentially material expenditures to comply. Failure to comply with any applicable laws, regulations, and requirements of regulatory authorities could subject us to substantial penalties and fines.
Our operations require numerous authorizations and permits under various laws and regulations, including environmental and worker health and safety laws and regulations. These authorizations and permits are subject to revocation, renewal, modification, or third-party challenge, and can require operational changes that may involve significant costs to limit impacts or potential impacts on the environment and/or worker health and safety. For example, on January 23, 2020, the EPA, in conjunction with the Corps, issued a final rule regarding the definition of "waters of the United States," which became effective June 22, 2020 and narrowed the regulatory reach of the CWA regulations relative to a prior 2015 rulemaking. However, that rule was vacated by one court in 2021, and the Biden Administration subsequently announced a proposed rule that would generally reinstate with modifications the pre-2015 definition of “waters of the United States.” The proposed rule was finalized on January 18, 2023, and will become effective March 20, 2023. This new rule expands CWA jurisdiction relative to the June 2020 rule and will likely be subject to further litigation. This increase in scope could result in increased costs and delays with respect to obtaining permits for dredge and fill activities in wetland areas. A of authorization or permit conditions or other legal or regulatory requirements could result in substantial , sanctions, permit and prohibiting our operations. In addition, major modifications of our operations could require modifications to our existing permits or expensive upgrades to our existing pollution control equipment that could have a material effect on our business, financial condition, results of operations and cash flows.
We may also be required to address conditions that require environmental response actions or remediation. The transportation and storage of refined products produces a risk that refined products and other hydrocarbons may be suddenly or gradually released into the environment, potentially causing substantial expenditures for a response action, significant government penalties, liability to government agencies for natural resources damages, personal injury or property damages to private parties and significant business interruption. Further, we own or lease a number of properties that have been used to store or distribute refined products for many years. Many of these properties have also been operated by third parties whose handling, disposal, or release of hydrocarbons and other wastes were not under our control. Environmental laws can impose strict, joint and several liability for releases of oil and hazardous substances into the environment, and we could be held liable for past releases caused by third parties. If we were to incur a significant liability pursuant to environmental laws or regulations, it could have a material adverse effect on us.
Our operations are also subject to various laws and regulations relating to occupational health and safety, including chemical accident prevention. We maintain safety, training and maintenance programs as part of our ongoing efforts to comply with applicable laws and regulations but cannot guarantee that these efforts will always be successful. Compliance with applicable health and safety laws and regulations has required and continues to require substantial expenditures. Failure to appropriately manage occupational health and safety risks associated with our business could also adversely impact our employees, communities, reputation and results of operations.
We may incur significant costs and liabilities resulting from performance of pipeline integrity programs and related repairs.
We are regulated under federal pipeline safety statutes by DOT through the Pipeline and Hazardous Materials Safety Administration (“PHMSA”). PHMSA sets and enforces pipeline safety regulations. Failure to comply with PHMSA or comparable state pipeline safety regulations could result in a number of consequences which may have a materially adverse effect on our operations. PHMSA’s enforcement authority includes the ability to assess civil penalties for violations of pipeline safety regulations, issue orders directing compliance, and issue orders directing corrective action to abate hazardous conditions. Among other things, pipeline safety laws and regulations require pipeline operators to develop integrity management programs, including more frequent inspections and other measures for pipelines located in “high consequence areas,” which are areas where a release could have the most significant adverse consequences, including certain population areas, certain drinking water sources and unusually sensitive ecological areas. These regulations require operators of covered pipelines to perform a variety of heightened assessment, analysis, prevention and repair activities on the segments of pipe located within high
consequence areas. Routine assessments under the integrity management program may result in findings that require repairs or other actions.
Moreover, changes to pipeline safety laws by Congress and regulations by PHMSA or states that result in more stringent or costly pipeline integrity management or safety standards could possibly have a substantial effect on us and similarly situated midstream operators. In December 2020, Congress passed the PIPES Act, some elements of which could affect our operations. Further, PHMSA adopted new regulations related to Valve Installation and Minimum Rupture Detection Standards, which became effective on October 5, 2022. These regulations expand PHMSA's regulation of the safety of hazardous liquid pipelines by establishing certain new procedural and notification requirements for managing rupture events, and requiring the installation of rupture-mitigation valves on new or certain replaced pipelines. This final rule may result in additional capital and operations and maintenance costs in the coming years. Additionally, where PHMSA has not pursued any legal requirements, state agencies, to the extent authorized, could enact regulatory standards for certain pipelines.
Rate regulation, changes to rate-making rules, or a successful challenge to the rates we charge on our pipeline systems may reduce our revenues and the amount of cash we generate.
For a general overview of federal and state regulations applicable to our pipeline assets, see “Overview – Governmental Regulation” included within Part I, Items 1 and 2 “Business and Properties” of this annual report. The federal and state regulations that apply to our pipeline assets can affect certain aspects of our business and the market for our products and can have a material adverse effect on our financial position, results of operations and cash flows.
The FERC, pursuant to the ICA and the rules and orders promulgated thereunder, regulates the tariff rates and terms and conditions of service on our interstate liquids pipelines. To be lawful under the ICA, tariff rates and terms and conditions of service must be on file at FERC, just and reasonable, and not unduly discriminatory. Shippers may protest (and the FERC may investigate) the lawfulness of new or changed tariff rates. The FERC can suspend those tariff rates for up to seven months. It can also require refunds of amounts collected (including interest) pursuant to rates that are ultimately found to be unlawful and prescribe new rates prospectively. The FERC and interested parties can also challenge tariff rates and provisions that have become final and effective. The FERC can also order new rates to take effect prospectively and order reparations (plus interest) for past rates that exceed the just and reasonable level up to two years prior to the date of a complaint.
The FERC uses prescribed rate methodologies for approving regulated tariff rate changes for interstate liquids pipelines. These methodologies may limit our ability to set rates based on our actual costs or may delay the use of rates reflecting increased costs. We believe the transportation rates currently charged by our interstate liquids pipelines are in accordance with the ICA and applicable FERC regulations. However, due to the complexity of rate making, the lawfulness of any rate is never assured. Adverse decisions by the FERC related to our rates could adversely affect our revenue, financial position, results of operations, and cash flows. In addition, if any of our pipelines were found to have provided services or otherwise operated in violation of the ICA, this could result in the imposition of administrative and criminal remedies and civil penalties, as well as a requirement to disgorge charges collected for such services in excess of the rate established by the FERC. Any of the foregoing could adversely affect revenues and cash flow related to the affected assets.
The intrastate liquids and natural gas pipeline transportation services we provide are subject to various state laws and regulations that apply to the rates we charge and the terms and conditions of the services we offer. These state commissions have generally not been aggressive in regulating common carrier pipelines and generally have not investigated the rates or practices of petroleum pipelines in the absence of shipper complaints. However, a state regulatory commission could investigate our rates if such a challenge were filed and any adverse decisions could adversely affect our revenue, financial position, results of operations, and cash flows.
There are various risks associated with greenhouse gases, climate change legislation or regulations, and increasing societal expectations that companies address climate change that could result in increased operating costs, reduced demand for our services and reduced access to capital markets.
Climate change continues to attract considerable attention in the United States. Numerous proposals have been made and could continue to be made at the international, national, regional and state levels of government to monitor and limit existing emissions of greenhouse gases. These efforts have included consideration of cap-and-trade programs, carbon taxes, climate-related disclosure obligations, and regulations that directly limit greenhouse gas emissions from certain sources. While it presently appears unlikely that comprehensive climate change legislation will be passed by Congress in the near future, energy legislation and other regulatory initiatives are expected to be proposed that may be relevant to greenhouse gas emissions issues. Moreover, in 2021, President Biden issued several executive orders that committed to substantial action on climate change and released “The Long-Term Strategy of the United States: Pathways to Net-Zero Greenhouse Gas Emissions by 2050,” which establishes a roadmap to net zero emissions in the United States by 2050 through, among other things, improving energy efficiency, decarbonizing energy sources via electricity, hydrogen, and sustainable biofuels, eliminating subsidies provided to the fossil fuel industry, and increased emphasis on climate-related risk across governmental agencies and economic sectors. As
a result, our operations, and those of our customers, are subject to a series of regulatory, political, litigation, and financial risks associated with the transport of fossil fuels and emission of greenhouse gases.
The EPA has adopted rules that, among other things, establish construction and operating permit reviews for greenhouse gas emissions from certain large stationary sources, require the monitoring and annual reporting of greenhouse gas emissions from certain petroleum and natural gas sources in the United States or require control or reduction of emissions of greenhouse gases, including methane, from such sources. In 2021, the EPA announced its intent to reconsider and revise rules related to the oil and gas sector (primarily oil production and natural gas production, distribution, and storage) to further reduce greenhouse gas emissions, and on December 6, 2022, the EPA proposed a supplement that would revise and expand the 2021 proposal. Separately, the Bureau of Land Management (“BLM”) has also proposed rules to limit venting, flaring, and methane leaks for oil and gas operations on federal lands, which could in turn adversely impact production of oil and gas on federal lands and reduce demand for the services we provide in those areas. More recently, in January 2023, the CEQ released updated guidance for agency consideration of greenhouse gas emissions and climate change impacts in environmental reviews, which includes, among other recommendations, best practices for analyzing and communicating climate change effects. In addition, the EPA, together with the DOT, implemented greenhouse gas emission and corporate average fuel economy standards for vehicles manufactured in the United States, which standards were revised in December 2021 to impose more stringent requirements for emissions reductions. President Biden also reinstated the Interagency Working Group on the Social Cost of Greenhouse Gases in 2021 and directed the group to publish interim estimates of the social cost of carbon dioxide, nitrous oxide, and methane, with a view to using such estimates in federal rulemakings greenhouse gases, which it did. In November 2022, the EPA published a draft report assigning new and higher social cost values to greenhouse gas emissions for use in its rulemaking initiatives. These and other federal efforts to reduce greenhouse gas emissions from the transportation sector could increase our operating costs or reduce demand for our customers’ products.
In March 2022, the SEC issued proposed rules that, if adopted, would require public companies to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks, climate-related financial statement metrics, and greenhouse gas emissions. In November 2022, the Biden Administration issued a proposed rule that would require government contractors to publicly disclose their greenhouse gas emissions and set emissions reduction targets, which could affect us if we enter into contractual and business arrangements with government contractors.
Internationally, the United Nations-sponsored Paris Agreement requires member nations to submit non-binding, individually determined emissions reduction goals every five years after 2020. In 2021, the United States rejoined the Paris Agreement and issued its corresponding “nationally determined contribution” (“NDC”) to reduce economy-wide net greenhouse gas emissions 50-52% below 2005 levels by 2030. While the NDC does not identify specific actions necessary to achieve these reductions, it lists several sectors as pathways for reductions, including the power, transportation, building, industrial, and agricultural sectors. The administration has acknowledged that a combination of regulatory actions and legislation will be necessary to achieve the U.S. NDC. In regards to legislation, in November 2021 the United States enacted a nearly $1 trillion bipartisan infrastructure law, which provided significant funding for electric vehicles and clean energy technologies, and in August 2022 the United States enacted the Inflation Reduction Act of 2022, which allocated $369 billion to climate change and environmental initiatives, including transportation electrification, fees on and greater regulation of methane emissions, and support for green energy manufacturing programs. Certain of these initiatives are subject to ongoing litigation, and the impacts of these international initiatives and the terms of any legislation or regulation to implement the United States’ commitment under the Paris Agreement remain unclear at this time.
Additionally, various states and groups of states have adopted or are considering adopting legislation, regulations or other regulatory initiatives that are focused on such areas as greenhouse gas cap and trade programs, carbon taxes, reporting and tracking programs, restriction of emissions, electric vehicle mandates and combustion engine phaseouts. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the crude oil and refined products that we deliver.
Increasing societal expectations that companies address climate change, including international, federal, state and local rules and regulations relating to climate change driven by such societal expectations, and use of substitutes for energy commodities may result in increased costs, reduced demand for our customers’ products and our services, reduced profits, increased investigations and litigation, diversion of financial resources from other initiatives and negative impacts on our unit price and access to capital markets. To the extent that societal pressures or political or other factors are involved, it is possible that such liability could be imposed on us without regard to our causation of or contribution to the asserted damage, or to other mitigating factors. In addition, certain capital markets participants, including certain institutional investors and indices, have been divesting and promoting divestment of or screening out of fossil fuel equities, which could have a negative impact on our unit price and our access to and costs of capital. There is also the possibility that financial institutions may be pressured or required to adopt policies that limit funding for fossil fuel energy companies. For example, in January 2023 the Federal Reserve published instructions for its pilot climate scenario analysis exercise, which the six largest American banks are required to complete by July 31, 2023. Any material reduction in the capital available to the fossil fuel industry could make it more
to secure funding for exploration, development, production, transportation, and processing activities, which could adversely impact our business and operations.
Finally, increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, floods, rising sea levels and other climatic events, as well as chronic shifts in temperature and precipitation patterns. These climatic developments have the potential to cause physical damage to our assets or those of our customers or disrupt our supply chains and thus could have an adverse effect on our operations or demand for our services. Additionally, changing meteorological conditions, particularly temperature, may result in changes to the amount, timing, or location of demand for energy or its production.
Increasing attention to environmental, social and governance (“ESG”) matters may adversely impact our business, financial results, stock price or price of debt securities.
In recent years the investment community, including investment advisors, sovereign wealth funds, pension funds, universities, financial institutions, including institutional banks, lenders, and insurance companies, and other groups have become more attentive to ESG and sustainability related practices and have been lobbied intensively, and often publicly, by environmental activists concerned about climate change to limit or curtail activities with fossil fuel energy companies. There has also been an increase in third-party providers of company ESG ratings, and more ESG-focused voting policies among proxy advisory firms, portfolio managers, and institutional investors. As a result, some investors, funds, financial institutions and other capital markets participants may screen companies such as ours for ESG performance before investing in our common stock or debt securities, or lending to us or have imposed restrictions upon or otherwise limited lending to, investing in, or providing insurance coverage for, companies that operate in industries with higher perceived environmental exposure, such as the energy industry. If we are unable to meet the ESG standards or investment, lending, ratings, or voting criteria and policies set by these parties, we may lose investors, investors may allocate a portion of their capital away from us, we may become a target for ESG-focused activism, we may face increased costs of or on access to capital or insurance necessary to sustain or grow our business, the price of our common stock or debt securities may be impacted, demand for our services and refined petroleum products may be impacted, and our reputation may be affected, all of which could impact our future financial results.
Members of the investment community are also increasing their focus on ESG practices and disclosures, including those related to climate change, GHG emissions targets, business resilience under the assumptions of demand-constrained scenarios, and net-zero ambitions in the energy industry in particular, as well as diversity, equality, and inclusion initiatives, political activities, and governance standards among companies more generally. As a result, we may face increasing pressure or negative publicity regarding our ESG practices and disclosures and demands for ESG-focused engagement from investors, stakeholders, and other interested parties. This could result in higher costs, disruption and diversion of management attention, an increased strain on our resources, and the implementation of certain ESG practices or disclosures that may present a heightened level of legal and regulatory risk, or that threaten our credibility with other investors and stakeholders.
RISKS RELATED TO CYBERSECURITY, DATA SECURITY AND PRIVACY, INFORMATION TECHNOLOGY AND INTELLECTUAL PROPERTY
Our business is subject to information technology and cybersecurity risks to operational systems, security systems, infrastructure, and customer data processed by us, third-party vendors or suppliers, and any material failure, weakness, interruption, cyber event, including an incident or breach of security, could prevent us or third parties we rely on from effectively operating our business, harm our reputation or materially adversely affect our business, results of operations or financial condition.
Our business is dependent upon increasingly complex information technology systems and other digital technologies for controlling our plants and pipelines, processing transactions and summarizing and reporting results of operations. The secure collection, processing, maintenance, storage and transmission of information is critical to our operations. We are at risk for interruptions, outages and breaches of operational systems, including business, financial, accounting, data or processing, owned by us or our third-party vendors or suppliers; or third-party data that we process or our third-party partners process on our behalf. Such cyber incidents could materially disrupt or shut down operational systems; result in loss of, access to, or copying or transfer of intellectual property, trade secrets or other proprietary or competitively sensitive information; compromise certain information of customers, employees, suppliers, drivers or others; and jeopardize the security of our facilities. We monitor our information technology systems on a 24/7 basis in an effort to detect cyberattacks, security or access. Preventative and detective measures we utilize include independent cybersecurity audits and penetration tests. We implemented these efforts along with other risk mitigation procedures designed to detect and address and activity on our network, stay abreast of the increasing cybersecurity landscape and our cybersecurity posture, but such efforts will require updates and and there is no guarantee that such measures will be adequate to detect, prevent or mitigate cyber . Any implementation, maintenance, segregation and of our systems may require significant management time, support and cost and may not be or adequate.
A cyber incident could be caused by disasters, insiders (through inadvertence or with malicious intent) or malicious third parties (including nation-states or nation-state supported actors) using sophisticated, targeted methods to circumvent firewalls, encryption and other security defenses, including hacking, fraud, trickery or other forms of deception that are generally beyond our control despite our implementation of protective measures. While there have been immaterial incidents of unauthorized access to our information technology systems, we have not experienced any material impact on our business or operations from these attacks. In addition, information technology system failures, communications network disruptions (whether intentional by a third party or due to natural disaster), and security could still impact equipment and software used to control plants and pipelines, resulting in operation of our assets, potentially including in the delivery or availability of our customers’ products, contamination or of the products we transport, store or distribute, or releases of hydrocarbon products and other to our facilities for which we could be held liable. These information technology system , communications network , and security could also cause us to our contractual arrangements with other parties, or subject us to regulatory actions or .
Furthermore, we collect and store sensitive data in the ordinary course of our business, including personally identifiable information of our employees as well as our proprietary business information and that of our customers, suppliers, investors and other stakeholders. We also work with third-party partners that may in the course of their business relationship with us collect, store, process and transmit sensitive data on our behalf and in connection with our products and services offerings. Despite our security measures, ours or our third-party partners' information technology systems may become the target of cyberattacks or security breaches (including employee error, malfeasance or other intentional or unintentional breaches), which are generally beyond our control, which could result in the theft or loss of the stored information, misappropriation of assets, disruption of transactions and reporting functions, our ability to protect confidential information and our financial reporting. Our efforts to security and protect data may result in increased capital and operating costs to modify, upgrade or our security measures to protect such cyber-attacks and we may face in fully anticipating or implementing adequate security measures or mitigating potential . Moreover, as technologies evolve and become increasingly sophisticated, we may not be to anticipate, detect or prevent or security , particularly because the methodologies used by attackers change frequently or may not be recognized until after such attack is launched, and because attackers are increasingly using technologies specifically designed to cybersecurity measures and avoid detection. Even with insurance coverage for , data or access of our or a third-party partner’s information technology systems, a claim could be or coverage . Moreover, it is increasingly to buy sufficient cyber insurance coverages as the insurance market has been limiting both liability under cyber policies and the issuance of said policies, generally. A or security could result in liability under data privacy laws, regulatory , to our reputation, or additional costs for remediation and modification or of our information systems to prevent future occurrences, all of which could have a material and effect on our business, financial condition, results of operations or cash flows.
We may be subject to information technology system failures, communications network disruptions and data breaches that are generally beyond our control.
We depend on the efficient and uninterrupted operation of third-party hardware and software systems and infrastructure, including our operating, communications and financial reporting systems. We have implemented safeguards and other preventative measures designed to protect our systems and data, however, our information technology systems and communications network, and those of our information technology and communication service providers, remain vulnerable to interruption by natural disasters, power loss, telecommunications failure, terrorist attacks, vandalism, Internet failures, computer malware, ransomware, cyberattacks, data breaches and other events unforeseen or generally beyond our control. Additionally, the implementation of social distancing measures and other limitations on our employees, service providers and other third parties in response to the COVID-19 pandemic have necessitated in certain cases to switching to remote work arrangements on less secure systems and environments. The increase in companies and individuals working remotely has increased the risk of and potential cybersecurity , both attacks and events. Any of these events could cause system , , and of data, and could prevent us from operating, which could make our business and services less and subject us to liability. Any of these events could our reputation and be expensive to remedy.
In addition, information technology system failures, network disruptions (whether intentional by a third party or due to natural disaster), breaches of network or data security, or disruption or failure of the network system used to monitor and control pipeline and terminal operations could disrupt our operations by impeding our processing of transactions, our ability to protect customer or company information and our financial reporting. Although we have taken steps to address these concerns by implementing sophisticated network security and internal control measures, a system failure or data security breach could have a material adverse effect on our financial condition, results of operations or cash flows.
Our business is subject to complex and evolving laws, regulations and security standards regarding data privacy, cybersecurity and data protection (“data protection obligations”). Many of these data protection obligations are subject to change and uncertain interpretation, any real or perceived failure to comply with such obligations and could result in
claims, changes to our business practices, monetary penalties, increased cost of operations or other harm to our business.
The constantly evolving regulatory and legislative environment surrounding data privacy and protection poses increasingly complex compliance challenges, and complying with such data protection obligations could increase the costs and complexity of compliance and enforcement risks. While we do not collect significant amounts of personal information from consumers, we do have personal information from our employees, job applicants and some business partners, such as contractors and distributors. Any failure, whether real or perceived, by us to comply with applicable data privacy and protection obligations could result in proceedings or actions against us by governmental entities or others, subject us to significant fines, penalties, judgments, and negative publicity, require us to change our business practices, increase the costs and complexity of compliance, and adversely affect our business. Our compliance with emerging data privacy/security laws, as well as any associated inquiries or investigations or any other government actions related to these laws, may increase our operating costs or subject us to legal and reputational risks, including significant awards, , civil or or judgments, proceedings or by governmental agencies or customers, class action privacy in certain jurisdictions and publicity.
In the second quarter of 2021, the Department of Homeland Security’s Transportation Security Administration (“TSA”) announced two new security directives. These directives require critical pipeline owners to comply with mandatory reporting measures, including, among other things, to appoint personnel, report confirmed and potential cybersecurity incidents to the DHS Cybersecurity and Infrastructure Security Agency (“CISA”) and provide vulnerability assessments. As legislation continues to develop and cyber incidents continue to evolve, we may be required to expend significant additional resources to respond to cyberattacks, to continue to modify or enhance our protective measures, or to detect, assess, investigate and remediate any critical infrastructure security vulnerabilities and report any cyber incidents to the applicable regulatory authorities. Any failure to maintain compliance with these evolving government regulations may result in enforcement actions which may then result in significant time, support and cost and have a material effect on our business and operations.
RISKS RELATED TO LIQUIDITY, FINANCIAL INSTRUMENTS AND CREDIT
Increases in interest rates could adversely affect our business.
We use both fixed and variable rate debt, and we are exposed to market risk due to the floating interest rates on our credit facility. In addition, interest rates on future debt offerings could be higher, causing our financing costs to increase accordingly. Our results of operations, cash flows and financial position could be adversely affected by significant increases in interest rates.
Our leverage may limit our ability to borrow additional funds, comply with the terms of our indebtedness or capitalize on business opportunities.
As of December 31, 2022, the principal amount of our total outstanding debt was $1,556 million. On February 4, 2020, we closed a private placement of $500 million 5.0% senior notes due 2028 (the “5% Senior Notes”) and on April 8, 2022, we closed a private placement of $400 million 6.375% senior notes due 2027 (the "6.375% Senior Notes, " and together with the 5% Senior Notes, the "Senior Notes"). Various limitations in our Credit Agreement and the indenture for our Senior Notes may reduce our ability to incur additional debt, to engage in some transactions and to capitalize on business opportunities. Any subsequent refinancing of our current indebtedness or any new indebtedness could have similar or greater restrictions.
Our leverage could have important consequences. We require substantial cash flow to meet our payment obligations with respect to our indebtedness. Our ability to make scheduled payments, to refinance our indebtedness or our ability to obtain additional financing in the future will depend on our financial and operating performance, which, in turn, is subject to then-current economic conditions and to financial, business, competitive, regulatory and other factors. We believe that we will have sufficient cash flow from operations and available borrowings under our Credit Agreement to service our indebtedness. However, a significant downturn in our business or other development adversely affecting our cash flow could materially impair our ability to service our indebtedness. We cannot guarantee that we would be able to refinance our existing indebtedness at maturity or otherwise or sell assets on terms that are commercially reasonable.
The instruments governing our debt contain restrictive covenants that may prevent us from engaging in certain transactions. The agreements governing our debt generally require us to comply with various affirmative and negative covenants including the maintenance of certain financial ratios and restrictions on incurring additional debt, entering into mergers, consolidations and sales of assets, making investments and granting liens. Our leverage may adversely affect our ability to fund future working capital, capital expenditures and other general partnership requirements, future acquisitions, construction or development activities, or to otherwise realize fully the value of our assets and opportunities because of the need to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness or to comply with any restrictive terms of our indebtedness. Our leverage also may make our results of operations more susceptible to adverse economic and industry conditions by limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate and may place us at a competitive disadvantage as compared to our competitors that have less debt.
We may not be able to obtain funding on acceptable terms or at all because of volatility and uncertainty in the credit and capital markets. This may hinder or prevent us from meeting our future capital needs.
The domestic and global financial markets and economic conditions are disrupted and volatile from time to time due to a variety of factors, including low consumer confidence, high unemployment, geoeconomic and geopolitical issues, including U.S. government shutdowns, weak economic conditions and uncertainty in the financial services sector. In addition, the fixed-income markets have experienced periods of extreme volatility, which negatively impacted market liquidity conditions. As a result, the cost of raising money in the debt and equity capital markets has increased substantially at times while the availability of funds from these markets diminished significantly. In particular, as a result of concerns about the stability of financial markets generally and the solvency of lending counterparties specifically, the cost of obtaining money from the credit markets may increase as many lenders and institutional investors increase interest rates, enact tighter lending standards, to refinance existing debt on similar terms or at all and reduce, or in some cases , to provide funding to borrowers. In addition, lending counterparties under existing revolving credit facilities and other debt instruments may be or to meet their funding obligations.
Due to these factors, we cannot be certain that new debt or equity financing will be available on acceptable terms. If funding is not available when needed, or is available only on unfavorable terms, we may be unable to:
• continue our business as currently structured and/or conducted;
• meet our obligations as they come due;
• execute our growth strategy;
• complete future acquisitions or construction projects;
• take advantage of other business opportunities; or
• respond to competitive pressures.
Any of the above could have a material adverse effect on our revenues and results of operations.
If we are unable to generate sufficient cash flow, our ability to pay quarterly distributions to our common unitholders at current levels or to increase our quarterly distributions in the future could be impaired materially.
Our ability to pay quarterly distributions depends primarily on cash flow (including cash flow from operations, financial reserves and credit facilities) and not solely on profitability, which is affected by non-cash items. As a result, we may pay cash distributions during periods of losses and may be unable to pay cash distributions during periods of income. Our ability to generate sufficient cash from operations is largely dependent on our ability to manage our business successfully which may also be affected by economic, financial, competitive, regulatory, and other factors that are beyond our control. Because the cash we generate from operations will fluctuate from quarter to quarter, quarterly distributions may also fluctuate from quarter to quarter.
We are exposed to the credit risks and certain other risks, of our or our joint ventures' key customers, vendors, and other counterparties.
We are subject to risks of loss resulting from nonpayment or nonperformance by our or our joint ventures' customers, vendors or other counterparties. We and our joint ventures derive a significant portion of our revenues from contracts with key customers, particularly HF Sinclair, under its pipelines and terminals, tankage, tolling and throughput agreements. To the extent that our or our joint ventures' customers are unable to meet the specifications of their customers, we would be adversely affected unless we were able to make comparably profitable arrangements with other customers.
Mergers among our existing customers could provide strong economic incentives for the combined entities to use systems other than ours, and we could experience difficulty in replacing lost volumes and revenues. Because a significant portion of our operating costs are fixed, a reduction in volumes would result not only in a reduction of revenues, but also a decline in net income and cash flow of a similar magnitude, which would reduce our ability to meet our financial obligations and make distributions to unitholders.
If any of our or our joint ventures' key customers default on their obligations, our financial results could be adversely affected. Furthermore, some of our or our joint ventures' customers may be highly leveraged and subject to their own operating and regulatory risks. In addition, nonperformance by vendors who have committed to provide us with products or services could result in higher costs or interfere with our ability to successfully conduct our business.
Any substantial increase in the nonpayment and/or nonperformance by our or our joint ventures' customers or vendors could have a material adverse effect on our results of operations and cash flows.
In addition, in connection with the acquisition of certain of our assets, we have entered into agreements pursuant to which various counterparties, including HF Sinclair, have agreed to indemnify us, subject to certain limitations, for:
• certain pre-closing environmental liabilities discovered within specified time periods after the date of the applicable acquisition;
• certain matters arising from the pre-closing ownership and operation of assets; and
• ongoing remediation related to the assets.
Our business, results of operation, cash flows and our ability to make cash distributions to our unitholders could be adversely affected in the future if third parties fail to satisfy an indemnification obligation owed to us.
Adverse changes in our and/or our general partner's credit ratings and risk profile may negatively affect us.
Our ability to access capital markets is important to our ability to operate our business. Regional and national economic conditions, increased scrutiny of the energy industry and regulatory changes, as well as changes in our economic performance, could result in credit agencies reexamining our credit rating.
We are in compliance with all covenants or other requirements set forth in our Credit Agreement. Further, we do not have any rating downgrade triggers that would automatically accelerate the maturity dates of any debt.
While credit ratings reflect the opinions of the credit agencies issuing such ratings and may not necessarily reflect actual performance, a downgrade in our credit rating could affect adversely our ability to borrow on, renew existing, or obtain access to new financing arrangements, could increase the cost of such financing arrangements, could reduce our level of capital expenditures and could impact our future earnings and cash flows.
The credit and business risk profiles of our general partner, and of HF Sinclair as the indirect owner of our general partner, may be factors in credit evaluations of us as a master limited partnership due to the significant influence of our general partner and its indirect ownership over our business activities, including our cash distribution policy, acquisition strategy and business risk profile. Another factor that may be considered is the financial condition of our general partner and its owners, including the degree of their financial leverage and their dependence on cash flow from the partnership to service their indebtedness.
RISKS TO COMMON UNITHOLDERS
HF Sinclair and its affiliates may have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests.
Currently, HF Sinclair and certain of its subsidiaries collectively own a 47% limited partner interest and a non-economic general partner interest in us and controls HLS, the general partner of our general partner, HEP Logistics. Conflicts of interest may arise between HF Sinclair and its affiliates, including our general partner, on the one hand, and us, on the other hand. As a result of these conflicts, the general partner may favor its own interests and the interests of its other affiliates over our interests. These conflicts include, among others, the following situations:
• HF Sinclair, as a shipper on our pipelines, has an economic incentive not to cause us to seek higher tariff rates or terminalling fees, even if such higher rates or terminalling fees would reflect rates that could be obtained in arm's -length, third-party transactions;
• HF Sinclair's directors and officers have a fiduciary duty to make business decisions in the best interests of the stockholders of HF Sinclair;
• our general partner is allowed to take into account the interests of parties other than us, such as HF Sinclair, in resolving conflicts of interest;
• our partnership agreement provides for modified or reduced fiduciary duties for our general partner, and also restricts the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty;
• our general partner determines which costs incurred by HF Sinclair and its affiliates are reimbursable by us;
• our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf;
• our general partner may, in some circumstances, cause us to borrow funds to make cash distributions, even where the purpose or effect of the borrowing benefits our general partner or affiliates;
• our general partner determines the amount and timing of our asset purchases and sales, capital expenditures and borrowings, each of which can affect the amount of cash available to us; and
• our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates, including the pipelines and terminals agreement with HF Sinclair.
Cost reimbursements, which will be determined by our general partner, and fees due to our general partner and its affiliates for services provided, are substantial.
Under our Omnibus Agreement, we are obligated to pay HF Sinclair an administrative fee of currently $5.0 million per year for the provision by HF Sinclair or its affiliates of various general and administrative services for our benefit. The administrative fee is subject to an annual upward adjustment for changes in PPI. In addition, we are required to reimburse HF Sinclair pursuant to the secondment arrangement for the wages, benefits, and other costs of HF Sinclair employees seconded to HLS to perform services at certain of our processing, refining, pipeline and tankage assets. We can neither provide assurance that HF Sinclair will continue to provide us the officers and employees that are necessary for the conduct of our business nor that such provision will be on terms that are acceptable to us. If HF Sinclair fails to provide us with adequate personnel, our operations could be adversely impacted.
The administrative fee and secondment allocations are subject to annual review and may increase if we make an acquisition that requires an increase in the level of general and administrative services that we receive from HF Sinclair or its affiliates. For example, in connection with the HEP Transaction, we paid HF Sinclair a temporary monthly fee of $62,500 through November 30, 2022 relating to transition services provided to us by HF Sinclair. Our general partner will determine the amount of general and administrative expenses that will be allocated to us in accordance with the terms of our partnership agreement. In addition, our general partner and its affiliates are entitled to reimbursement for all other expenses they incur on our behalf, including the salaries of and the cost of employee benefits for employees of HLS who provide services to us.
Prior to making any distribution on the common units, we will reimburse our general partner and its affiliates, including officers and directors of the general partner, for all expenses incurred on our behalf, plus the administrative fee. The reimbursement of expenses and the payment of fees could adversely affect our ability to make distributions. The general partner has sole discretion to determine the amount of these expenses. Our general partner and its affiliates also may provide us other services for which we are charged fees as determined by our general partner.
Increases in interest rates could adversely impact our unit price and our ability to issue additional equity to make acquisitions, fund expansion capital expenditures, or for other purposes.
As with other yield-oriented securities, our unit price is impacted by the level of our cash distributions and implied distribution yield. The distribution yield is often used by investors to compare and rank related yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our units and a rising interest rate environment could have an adverse impact on our unit price and our ability to issue additional equity to make acquisitions, fund expansion capital expenditures or for other purposes. If we then issue additional equity at a significantly lower price, material dilution to our existing unitholders could result.
Even if unitholders are dissatisfied, they cannot remove our general partner without its consent.
Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management's decisions regarding our business. Unitholders did not elect our general partner or the board of directors of HLS and have no right to do so on an annual or other continuing basis. The board of directors of HLS is chosen by the sole member of HLS. If unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which the common units trade could be diminished because of the absence or reduction of a takeover premium in the trading price.
The vote of the holders of at least 66 2/3% of all outstanding units voting together as a single class is required to remove the general partner. Unitholders will be unable to remove the general partner without its consent because the general partner and its affiliates own sufficient units to prevent its removal. Unitholders' voting rights are further restricted by the partnership agreement provision providing that any units held by a person that owns 20% or more of any class of units then outstanding (other than the general partner, its affiliates, their transferees, and persons who acquired such units with the prior approval of the board of directors of the general partner's general partner) cannot vote on any matter; however, no such person currently exists. Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings, acquire information about our operations, and influence the manner or direction of management.
The control of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, our partnership agreement does not restrict the ability of the partners of our general partner from transferring their respective partnership interests in our general partner to a third party. The new partners of our general partner would then be in a position to replace the board of directors and officers of the general partner of our general partner with their own choices and to control the decisions made by the board of directors and officers.
We may issue additional limited partner units without unitholder approval, which would dilute an existing unitholder's ownership interests.
Under our partnership agreement, provided there is no significant decrease in our operating performance, we may issue an unlimited number of limited partner interests of any type without the approval of our unitholders, and HEP currently has a shelf registration on file with the SEC pursuant to which it may issue up to $2.0 billion in additional common units. On May 10, 2016, HEP established a continuous offering program under the shelf registration statement pursuant to which HEP may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million. As of December 31, 2022, HEP has issued 2.4 million units under this program for gross consideration of $82.3 million. No units were issued under the program during the year ended December 31, 2022.
The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
• our unitholders' proportionate ownership interest in us will decrease;
• the amount of cash available for distribution on each unit may decrease;
• the relative voting strength of each previously outstanding unit may be diminished; and
• the market price of the common units may decline.
Our partnership agreement does not give our unitholders the right to approve our issuance of equity securities ranking junior to the common units at any time.
In establishing cash reserves, our general partner may reduce the amount of cash available for distribution to unitholders.
Our partnership agreement requires us to distribute all available cash to our unitholders; however, it also requires our general partner to deduct from operating surplus cash reserves that it establishes are necessary to fund our future operating expenditures. In addition, our partnership agreement permits our general partner to reduce available cash by establishing cash reserves for the proper conduct of our business, to comply with applicable law or agreements to which we are a party, or to provide funds for future distributions to partners. These cash reserves will affect the amount of cash available to make the required payments to our debt holders or distributions on our common units every quarter.
HF Sinclair and its affiliates may engage in limited competition with us.
HF Sinclair and its affiliates may engage in limited competition with us. Pursuant to the Omnibus Agreement, HF Sinclair and its affiliates agreed not to engage in the business of operating intermediate or refined product pipelines or terminals, crude oil pipelines or terminals, truck racks or crude oil gathering systems in the continental United States. The Omnibus Agreement, however, does not apply to:
• any business operated by HF Sinclair or any of its subsidiaries at the closing of our initial public offering;
• any business or asset that HF Sinclair or any of its subsidiaries acquires or constructs that has a fair market value or construction cost of less than $5 million; and
• any business or asset that HF Sinclair or any of its subsidiaries acquires or constructs that has a fair market value or construction cost of $5 million or more if we have been offered the opportunity to purchase the business or asset at fair market value, and we decline to do so.
In the event that HF Sinclair or its affiliates no longer control our partnership or there is a change of control of HF Sinclair, the non-competition provisions of the Omnibus Agreement will terminate.
Our general partner has a limited call right that may require a unitholder to sell its common units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 80% of the common units (which it does not presently), our general partner will have the right (which it may assign to any of its affiliates or to us) but not the obligation to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than their then-current market price. As a result, a holder of common units may be required to sell its units at a time or price that is undesirable to it and may not receive any return on its investment. A common unitholder may also incur a tax liability upon a sale of its units.
A unitholder may not have limited liability if a court finds that unitholder actions constitute control of our business or that we have not complied with state partnership law.
Under Delaware law, a unitholder could be held liable for our obligations to the same extent as a general partner if a court determined that the right of unitholders to remove our general partner or to take other action under our partnership agreement constituted participation in the “control” of our business. Our general partner generally has unlimited liability for our obligations, such as our debts and environmental liabilities, except for those contractual obligations that are expressly made without recourse to our general partner.
In addition, Section 17-607 and 17-804 of the Delaware Revised Uniform Limited Partnership Act provides that under some circumstances, a unitholder may be liable to us for the amount of a distribution for a period of three years from the date of the distribution.
Further, we conduct business in a number of states. In some of those states the limitations on the liability of limited partners for the obligations of a limited partnership have not been clearly established. The unitholders might be held liable for the partnership's obligations as if they were a general partner if a court or government agency determined that we were conducting business in the state but had not complied with the state's partnership statute.
HF Sinclair and our other significant unitholders may sell our common units in the public or private markets, and such sales could have an adverse impact on the trading price of our common units. Additionally, HF Sinclair may pledge or hypothecate its common units or its interest in us.
As of February 15, 2023, HF Sinclair held 59,630,030 of our common units and REH Company, our next largest unitholder, held 21,000,000 of our common units, which is approximately 47% and 16.6% of our outstanding common units, respectively. The sale of these common units (or the perception that these sales may occur) in the public or private markets by HF Sinclair or REH Company could have an adverse impact on the trading price of our common units. Additionally, we agreed to provide both HF Sinclair and REH Company registration rights with respect to our common units that they hold. HF Sinclair may pledge or hypothecate its common units, and such pledge or hypothecation may include terms and conditions that might result in an adverse impact on the trading price of our common units.
TAX RISKS TO COMMON UNITHOLDERS
Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes and not being subject to a material amount of entity-level taxation by individual states. If the IRS were to treat us as a corporation for U.S. federal income tax purposes or if we were to become subject to additional amounts of entity-level taxation for federal or state tax purposes, our cash available for distribution to our unitholders could be substantially reduced.
The anticipated after-tax economic benefit of an investment in our common units depends largely on our being treated as a partnership for U.S. federal income tax purposes.
Despite the fact that we are organized as a limited partnership under Delaware law, we would be treated as a corporation for U.S. federal income tax purposes unless we satisfy a “qualifying income” requirement. Based upon our current operations and current Treasury Regulations, we believe we satisfy the qualifying income requirement. Failing to meet the qualifying income requirement or a change in current law could cause us to be treated as a corporation for U.S. federal income tax purposes or otherwise subject us to taxation as an entity.
If we were treated as a corporation for U.S. federal income tax purposes, we would pay U.S. federal income tax on our taxable income at the corporate tax rate. Distributions to unitholders would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to unitholders. Because a tax would be imposed upon us as a corporation, our cash available for distribution to unitholders would be substantially reduced. Therefore, our treatment as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to unitholders, likely causing a substantial reduction in the value of our common units.
At the entity level, if we were subject to U.S. federal income tax, we would also be subject to the income tax provisions of many states. Moreover, states are evaluating ways to independently subject partnerships to entity-level taxation through the imposition of state income taxes, franchise taxes and other forms of taxation. For example, we are required to pay Texas margin tax on any income apportioned to Texas, despite our status as a partnership. Imposition of any additional such taxes or an increase in the existing tax rates could reduce the cash available for distributions to our unitholders. Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.
The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes or differing interpretations, possibly applied on a retroactive basis.
The present U.S. federal income tax treatment of publicly traded partnerships or an investment in our common units may be modified by administrative, legislative or judicial changes and differing interpretations at any time. Members of Congress have frequently proposed and considered similar substantive changes to the existing U.S. federal income tax laws that would affect publicly traded partnerships, including proposals that would eliminate our ability to qualify for partnership tax treatment.
In addition, the Treasury Department has issued, and in the future may issue, regulations interpreting those laws that affect publicly traded partnerships. There can be no assurance that there will not be further changes to U.S. federal income tax laws or the Treasury Department’s interpretation of the qualifying income rules in a manner that could impact our ability to qualify as a partnership in the future, which could also negatively impact the value of an investment in our common units. Any modification to the U.S. federal income tax laws and interpretations thereof may be applied retroactively and could make it more difficult or impossible for us to meet the qualifying income requirement to be treated as a partnership for U.S. federal income tax purposes. We are unable to predict whether any changes or proposals will ultimately be enacted. You are urged to consult with your own tax advisor with respect to the status of legislative, regulatory or administrative developments and proposals and their potential effect on your investment in our common units.
If the IRS contests the U.S. federal income tax positions we take, the market for our common units may be adversely impacted, and the cost of any IRS contest will reduce our cash available for distribution to our unitholders.
The IRS may adopt positions that differ from the positions we have taken or may take on tax matters. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take, and a court may not agree with some or all of the positions we take. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, the costs of any contest with the IRS would be borne indirectly by our unitholders and general partner because the costs will reduce our cash available for distribution.
If the IRS makes audit adjustments to our income tax returns for tax years beginning after December 31, 2017, it (and some states) may assess and collect any taxes (including any applicable penalties and interest) resulting from such audit adjustment directly from us, in which case our cash available for distribution to our unitholders might be substantially reduced, and our current and former unitholders may be required to indemnify us for any taxes (including any applicable penalties and interest) resulting from such audit adjustments that were paid on their behalf.
Pursuant to the Bipartisan Budget Act of 2015, for tax years beginning after December 31, 2017, if the IRS makes audit adjustments to our income tax returns, it (and some states) may assess and collect any taxes (including any applicable penalties and interest) resulting from such audit adjustment directly from us. Under our partnership agreement, our general partner is permitted to make elections under these rules to either pay the taxes (including any applicable penalties and interest) directly to the IRS or, if we are eligible, issue a revised information statement to each affected current and former unitholder with respect to an audited and adjusted return. Although our general partner may elect to have our affected current and former unitholders take such audit adjustment into account and pay any resulting taxes (including any applicable penalties and interest) in accordance with their interests in us during the tax year under audit, there can be no assurance that such election will be practical, permissible or effective in all circumstances. As a result, our current unitholders may bear some or all of the tax liability resulting from such audit adjustment, even if such unitholders did not own units in us during the tax year under audit. If, as a result of any such audit adjustment, we are required to make payments of taxes, penalties or interest, our cash available for distribution to our unitholders might be substantially reduced, and our current and former unitholders may be required to indemnify us for any taxes (including any applicable and interest) resulting from such audit adjustments that were paid on their behalf. These rules are not applicable for tax years beginning on or prior to December 31, 2017.
Even if unitholders do not receive any cash distributions from us, they will be required to pay taxes on their share of our taxable income.
Unitholders will be required to pay U.S. federal income taxes and, in some cases, state and local income taxes, on their share of our taxable income, whether or not they receive cash distributions from us. For example, if we sell assets and use the proceeds to repay existing debt or fund capital expenditures, unitholders may be allocated taxable income and gain resulting from the sale and our cash available for distribution would not increase. Unitholders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax due from the unitholder with respect to that income.
Tax gain or loss on the disposition of our common units could be more or less than expected.
If a unitholder disposes of common units, it will recognize gain or loss equal to the difference between the amount realized and its tax basis in those common units. Because distributions in excess of a unitholder's allocable share of our net taxable income result in a decrease of the unitholder's tax basis in its common units, the amount, if any, of such prior excess distributions with respect to the units sold will, in effect, become taxable income to the unitholder if it sells such units at a price greater than its tax basis in those units, even if the price the unitholder receives is less than its original cost. In addition, because the amount realized includes a unitholder's share of our nonrecourse liabilities, if unitholders sell their units, they may incur a tax liability in excess of the amount of cash they receive from the sale.
A substantial portion of the amount realized from the sale of a unitholder's common units, whether or not representing gain, may be taxed as ordinary income to the unitholder due to potential recapture items, including depreciation recapture. Thus, the unitholder may recognize both ordinary income and capital loss from the sale of such units if the amount realized on a sale of such units is less than the unitholder's adjusted basis in the units. Net capital loss may only offset capital gains and, in the case of individuals, up to $3,000 of ordinary income per year. In the taxable period in which the unitholder sells its units, the unitholder may recognize ordinary income from our allocations of income and gain to the unitholder prior to the sale and from recapture items that generally cannot be offset by any capital loss recognized upon the sale of units.
Unitholders may be subject to limitation on their ability to deduct interest expense incurred by us.
We are generally entitled to a deduction for interest paid or accrued on indebtedness properly allocable to our trade or business during our taxable year. However, our deduction for “business interest” is limited to the sum of our business interest income and 30% of our “adjusted taxable income.” For the purposes of this limitation, our adjusted taxable income is computed without regard to any business interest expense or business interest income.
If our business interest is subject to limitation under these rules, it could result in an increase in the taxable income allocable to a unitholder for such taxable year without any corresponding increase in the cash available for distribution to such unitholder.
Tax-exempt entities face unique tax issues from owning our common units that may result in adverse tax consequences to them.
Investment in our common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs) raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from U.S. federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Tax-exempt entities should consult a tax advisor before investing in our common units.
Non-U.S. unitholders will be subject to U.S. taxes and withholding with respect to their income and gain from owning our units.
Non-U.S. unitholders are generally taxed and subject to U.S. income tax filing requirements on income effectively connected with a U.S. trade or business (“effectively connected income”). Income allocated to our unitholders and any gain from the sale of our units will generally be considered to be effectively connected with a U.S. trade or business. As a result, distributions to a non-U.S. unitholder will be subject to withholding at the highest applicable effective tax rate, and a non-U.S. unitholder who sells or otherwise disposes of a unit will also be subject to U.S. federal income tax on the gain realized from the sale or disposition of that unit. In addition to the withholding tax imposed on distributions of effectively connected income, distributions to a non-U.S. unitholder will also be subject to a 10% withholding tax on the amount of any distribution in excess of our cumulative net income. As we do not compute our cumulative net income for such purposes due to the complexity of the calculation and lack of clarity in how it would apply to us, we intend to treat all of our distributions as being in excess of our cumulative net income for such purposes and subject to such 10% withholding tax. Accordingly, distributions to a non-U.S. unitholder will be subject to a combined withholding tax rate equal to the sum of the applicable tax rate and 10%.
Moreover, the transferee of an interest in a partnership that is engaged in a U.S. trade or business is generally required to withhold 10% of the “amount realized” by the transferor unless the transferor certifies that it is not a foreign person. While the determination of a partner’s amount realized generally includes any decrease of a partner’s share of the partnership’s liabilities, the Treasury Regulations provide that the amount realized on a transfer of an interest in a publicly traded partnership, such as our common units, will generally be the amount of gross proceeds paid to the broker effecting the applicable transfer on behalf of the transferor, and thus will be determined without regard to any decrease in that partner’s share of a publicly traded partnership’s liabilities. For a transfer of interests in a publicly traded partnership that is effected through a broker on or after January 1, 2023, the obligation to withhold is imposed on the transferor’s broker. Current and prospective foreign unitholders should consult their tax advisors regarding the impact of these rules on an investment in our common units.
We treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.
Because we cannot match transferors and transferees of common units, we have adopted depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to our unitholders. It also could affect the timing of these tax benefits or the amount of gain from unitholders' sale of common units and could have a negative impact on the value of our common units or result in audit adjustments.
We generally prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our unitholders.
We generally prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month (the “Allocation Date”) instead of on the date a particular unit is transferred. Similarly, we generally allocate certain deductions for depreciation of capital additions, gain or loss realized on a sale or other disposition of our assets and, in the discretion of the general partner, any other extraordinary item of income, gain, loss or deduction based upon ownership on the Allocation Date. Treasury Regulations allow a similar monthly simplifying convention, but such regulations do not specifically authorize all aspects of our proration method. If the IRS were to challenge our proration method, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
A unitholder whose units are the subject of a securities loan (e.g., a loan to a “short seller” to cover a short sale of units) may be considered as having disposed of those units. If so, it would no longer be treated for tax purposes as a partner with respect to those units during the period of the loan and may recognize gain or loss from the disposition.
Because there are no specific rules governing the U.S. federal income tax consequences of loaning a partnership interest, a unitholder whose units are the subject of a securities loan may be considered as having disposed of the loaned units. In that case, such unitholder may no longer be treated for tax purposes as a partner with respect to those units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan, any of our income, gain, loss or deduction with respect to those units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a securities loan are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their units.
Unitholders likely will be subject to state and local taxes and return filing requirements in jurisdictions where they do not live as a result of investing in our common units.
In addition to U.S. federal income tax, unitholders likely will be subject to other taxes, such as state and local income taxes, unincorporated business taxes and estate, inheritance, or intangible taxes that are imposed by the various jurisdictions in which we do business or own property now or in the future. Unitholders likely will be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions, even if they do not live in these jurisdictions. Further, unitholders may be subject to penalties for failure to comply with those requirements. We currently own property and conduct business in multiple states. Many of these states currently impose a personal income tax on individuals. As we make acquisitions or expand our business, we may own assets or conduct business in additional states that impose a personal income tax. Unitholders should consult with their own tax advisors regarding the filing of such tax returns, the payment of such taxes, and the deductibility of any taxes paid.
Item 1B. Unresolved Staff Comments
We do not have any unresolved SEC staff comments.
Item 3. Legal Proceedings
In the ordinary course of business, we may become party to legal, regulatory or administrative proceedings or governmental investigations, including environmental and other matters. Damages or penalties may be sought from us in some matters and certain matters may require years to resolve. While the outcome and impact of these proceedings and investigations on us cannot be predicted with certainty, based on advice of counsel, management believes that the resolution of these proceedings
and investigations, through settlement or adverse judgment, will not, either individually or in the aggregate, have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for the Registrant’s Common Units, Related Unitholder Matters and Issuer Purchases of Common Units
Our common limited partner units are traded on the New York Stock Exchange under the symbol “HEP.”
As of February 15, 2023, we had approximately 16,748 common unitholders, including beneficial owners of common units held in street name.
We consider regular cash distributions to unitholders on a quarterly basis, although there is no assurance as to future cash distributions since they are dependent upon future earnings, cash flows, capital requirements, financial condition and other factors. See “Liquidity and Capital Resources” under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of conditions and limitations prohibiting distributions under the Credit Agreement and indentures relating to our senior notes.
Common Unit Repurchases Made in the Quarter
The following table discloses purchases of our common units made by us or on our behalf for the periods shown below:
Period
Total Number of
Units Purchased
Average Price
Paid Per Unit
Total Number of
Units Purchased as
Part of Publicly
Announced Plan or
Program
Maximum Number
of Units that May
Yet be Purchased
Under a Publicly
Announced Plan or
Program
October 2022
November 2022
December 2022
Total for October to December 2022
The units reported represent (a) purchases of 72,831 common units in the open market for delivery to the recipients of our phantom unit and performance unit awards under our Long-Term Incentive Plan at the time of grant or settlement, as applicable; and (b) the delivery of 22,409 common units (which units were previously issued to certain officers and other employees pursuant to phantom unit awards at the time of grant or settlement, as applicable) by such officers and employees to provide funds for the payment of payroll and income taxes due at vesting in the case of officers and employees who did not elect to satisfy such taxes by other means.
Item 6. [Reserved]
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Item 7, including but not limited to the sections under “Results of Operations” and “Liquidity and Capital Resources,” contains forward-looking statements. See “Forward-Looking Statements” at the beginning of Part I and Item 1A. “Risk Factors.” In this document, the words “we,” “our,” “ours” and “us” refer to Holly Energy Partners, L.P. (“HEP”) and its consolidated subsidiaries or to HEP or an individual subsidiary and not to any other person.
References herein to HEP with respect to time periods prior to March 14, 2022, include HEP and its consolidated subsidiaries and do not include Sinclair Transportation Company LLC (“Sinclair Transportation”) and its consolidated subsidiaries (collectively, the “HEP Acquired Sinclair Businesses”). References herein to HEP with respect to time periods from and after March 14, 2022 include the operations of the HEP Acquired Sinclair Businesses.
References herein to HF Sinclair Corporation (“HF Sinclair”) with respect to time periods prior to March 14, 2022 refer to HollyFrontier Corporation (“HFC”) and its consolidated subsidiaries and do not include Hippo Holding LLC (now known as Sinclair Holding LLC), Sinclair Transportation or their respective consolidated subsidiaries (collectively, the “HFS Acquired Sinclair Businesses”). References herein to HF Sinclair with respect to time periods from and after March 14, 2022 refer to HF Sinclair and its consolidated subsidiaries, which include the operations of the combined business operations of HFC and the HFS Acquired Sinclair Businesses.
OVERVIEW
HEP, together with its consolidated subsidiaries, is a publicly held master limited partnership. On March 14, 2022 (the “Closing Date”), HFC and HEP announced the establishment of HF Sinclair, as the new parent holding company of HFC and HEP and their subsidiaries, and the completion of their respective acquisitions of Sinclair Oil Corporation (now known as Sinclair Oil LLC ("Sinclair Oil")) and Sinclair Transportation from REH Company (formerly known as The Sinclair Companies, and referred to herein as “REH Company”). On the Closing Date, HF Sinclair completed its acquisition of Sinclair Oil by effecting (a) a holding company merger with HFC surviving such merger as a direct wholly owned subsidiary of HF Sinclair (the “HFC Merger”), and (b) immediately following the HFC Merger, a contribution whereby REH Company contributed all of the equity interests of Hippo Holding LLC (now known as Sinclair Holding LLC), the parent company of Sinclair Oil (the “Target Company”), to HF Sinclair in exchange for shares of HF Sinclair, resulting in the Target Company becoming a direct wholly owned subsidiary of HF Sinclair (together with the HFC Merger, the “HFC Transactions”).
As of December 31, 2022, HF Sinclair and its subsidiaries owned a 47% limited partner interest and the non-economic general partner interest in HEP.
Additionally, on the Closing Date and immediately prior to consummation of the HFC Transactions, HEP acquired all of the outstanding equity interests of Sinclair Transportation from REH Company in exchange for 21 million newly issued common limited partner units of HEP (the “HEP Units”), representing 16.6% of the pro forma outstanding HEP Units with a value of approximately $349 million based on HEP’s fully diluted common limited partner units outstanding and closing unit price on March 11, 2022, and cash consideration equal to $329.0 million, inclusive of final working capital adjustments for an aggregate transaction value of $678.0 million (the “HEP Transaction” and together with the HFC Transactions, the “Sinclair Transactions”). The cash consideration was funded through a draw under HEP’s senior secured revolving credit facility. The HEP Transaction was conditioned on the closing of the HFC Transactions, which occurred immediately following the HEP Transaction.
Sinclair Transportation, together with its subsidiaries, owned REH Company’s integrated crude and refined products pipelines and terminal assets, including approximately 1,200 miles of integrated crude and refined product pipeline supporting the REH Company refineries and other third-party refineries, eight product terminals and two crude terminals with approximately 4.5 million barrels of operated storage. In addition, HEP acquired Sinclair Transportation’s interests in three pipeline joint ventures for crude gathering and product offtake including: Saddle Butte Pipeline III, LLC (25.06% non-operated interest); Pioneer Investments Corp. (49.995% non-operated interest); and UNEV Pipeline, LLC ("UNEV") (the 25% non-operated interest not already owned by HEP, resulting in UNEV becoming a wholly owned subsidiary of HEP).
See Notes 1 and 2 of Notes to Consolidated Financial Statements included in “Item 8. Financial Statements” for additional information regarding the acquisitions.
Through our subsidiaries and joint ventures, we own and/or operate petroleum product and crude oil pipelines, terminal, tankage and loading rack facilities and refinery processing units that support the refining and marketing operations of HF Sinclair and other refineries in the Mid-Continent, Southwest and Northwest regions of the United States. HEP, through its
subsidiaries and joint ventures, owns and/or operates petroleum product and crude pipelines, tankage and terminals in Colorado, Idaho, Iowa, Kansas, Missouri, Nevada, New Mexico, Oklahoma, Texas, Utah, Washington and Wyoming as well as refinery processing units in Utah and Kansas.
We generate revenues by charging tariffs for transporting petroleum products and crude oil through our pipelines, by charging fees for terminalling and storing refined products and other hydrocarbons, providing other services at our storage tanks and terminals and charging a tolling fee per barrel or thousand standard cubic feet of feedstock throughput in our refinery processing units. We do not take ownership of products that we transport, terminal, store or process, and therefore, we are not directly exposed to changes in commodity prices.
We believe the long-term global refined product demand and U.S. crude production should support high utilization rates for the refineries we serve, which in turn should support volumes in our product pipelines, crude gathering systems and terminals.
Market Developments
Our results for the year ended December 31, 2022 were favorably impacted by global demand for transportation fuels, lubricants and transportation and terminal services having returned to pre-pandemic levels. We expect our customers will continue to adjust refinery production levels commensurate with market demand. The extent to which HEP’s future results are affected by the COVID-19 pandemic or volatile regional and global economic conditions will depend on various factors and consequences beyond our control. However, we have long-term customer contracts with minimum volume commitments, which have expiration dates from 2023 to 2037. These minimum volume commitments accounted for approximately 70% o f our total tariffs and fees billed to customers for both the years ended December 31, 2022 and 2021. We are currently not aware of any reasons that would prevent such customers from making the minimum payments required under the contracts or potentially making payments in excess of the minimum payments. In addition to these payments, we also expect to collect payments for services provided to uncommitted shippers.
Investment in Joint Venture
On October 2, 2019, HEP Cushing LLC (“HEP Cushing”), a wholly owned subsidiary of HEP, and Plains Marketing, L.P., a wholly owned subsidiary of Plains All American Pipeline, L.P. (“Plains”), formed a 50/50 joint venture, Cushing Connect Pipeline & Terminal LLC (the “Cushing Connect Joint Venture”), for (i) the development, construction, ownership and operation of a new 160,000 barrel per day common carrier crude oil pipeline (the “Cushing Connect Pipeline”) that connected the Cushing, Oklahoma crude oil hub to the Tulsa, Oklahoma refining complex owned by a subsidiary of HF Sinclair and (ii) the ownership and operation of 1.5 million barrels of crude oil storage in Cushing, Oklahoma (the “Cushing Connect JV Terminal”). The Cushing Connect JV Terminal went in service during the second quarter of 2020, and the Cushing Connect Pipeline was placed into service at the end of the third quarter of 2021. Long-term commercial agreements have been entered into to support the Cushing Connect Joint Venture assets.
The Cushing Connect Joint Venture contracted with an affiliate of HEP to manage the construction and operation of the Cushing Connect Pipeline and with an affiliate of Plains to manage the operation of the Cushing Connect JV Terminal. The total Cushing Connect Joint Venture investment was generally shared equally among the partners. However, we were solely responsible for any Cushing Connect Pipeline construction costs that exceeded the budget by more than 10%. HEP's share of the cost of the Cushing Connect JV Terminal contributed by Plains and Cushing Connect Pipeline construction costs was approximately $74 million, including approximately $5 million of Cushing Connect Pipeline construction costs that exceeded the budget by more than 10% borne solely by HEP.
Agreements with HF Sinclair
We serve HF Sinclair's refineries under long-term pipeline, terminal, tankage and refinery processing unit throughput agreements expiring from 2023 to 2037. Under these agreements, HF Sinclair agrees to transport, store, and process throughput volumes of refined product, crude oil and feedstocks on our pipelines, terminal, tankage, loading rack facilities and refinery processing units that result in minimum annual payments to us. These minimum annual payments or revenues are subject to annual rate adjustments on July 1st each year based on the PPI or the FERC index. On December 17, 2020, FERC established a new price index for the five-year period commencing July 1, 2021 and ending June 30, 2026, in which common carriers charging indexed rates are permitted to adjust their indexed ceilings annually by Producer Price Index plus 0.78%. FERC received requests for rehearing of its December 17, 2020 order, and on January 20, 2022, FERC revised the index level used to determine annual changes to interstate oil pipeline rate ceilings to Producer Price Index minus 0.21%. The order required the recalculation of the July 1, 2021 index ceilings to be effective as of March 1, 2022. As of December 31, 2022, these agreements with HF Sinclair required minimum annualized payments to us of $453 million.
If HF Sinclair fails to meet its minimum volume commitments under the agreements in any quarter, it will be required to pay us the amount of any shortfall in cash by the last day of the month following the end of the quarter. Under certain of the agreements, a shortfall payment may be applied as a credit in the following four quarters after minimum obligations are met.
A significant reduction in revenues under the HF Sinclair agreements could have a material adverse effect on our results of operations.
On June 1, 2020, HFC announced plans to permanently cease petroleum refining operations at its Cheyenne refinery (the "Cheyenne Refinery") and to convert certain assets at that refinery to renewable diesel production. HFC subsequently began winding down petroleum refining operations at the Cheyenne Refinery on August 3, 2020.
On February 8, 2021, HEP and HFC finalized and executed new agreements for HEP’s Cheyenne assets with the following terms, in each case effective January 1, 2021: (1) a ten-year lease with two five-year renewal option periods for HFC’s (and now HF Sinclair’s) use of certain HEP tank and rack assets in the Cheyenne Refinery to facilitate renewable diesel production with an annual lease payment of approximately $5 million, (2) a five-year contango service fee arrangement that will utilize HEP tank assets inside the Cheyenne Refinery where HFC (and now HF Sinclair) will pay a base tariff to HEP for available crude oil storage and HFC (and now HF Sinclair) and HEP will split any profits generated on crude oil contango opportunities and (3) HFC paid a $10 million one-time cash payment to HEP for the termination of the existing minimum volume commitment.
Under certain provisions of an omnibus agreement that we have with HF Sinclair (“Omnibus Agreement”), we pay HF Sinclair an annual administrative fee, currently $5.0 million for the provision by HF Sinclair or its affiliates of various general and administrative services to us. In connection with the HEP Transaction, we paid HF Sinclair a temporary monthly fee of $62,500 through November 30, 2022, relating to transition services provided to HEP by HF Sinclair. Neither the annual administrative fee nor the temporary fee includes the salaries of personnel employed by HF Sinclair who perform services for us on behalf of HLS or the cost of their employee benefits, which are separately charged to us by HF Sinclair. We also reimburse HF Sinclair and its affiliates for direct expenses they incur on our behalf.
Under HLS’s Secondment Agreement with HF Sinclair, certain employees of HF Sinclair are seconded to HLS to provide operational and maintenance services for certain of our processing, refining, pipeline and tankage assets, and HLS reimburses HF Sinclair for its prorated portion of the wages, benefits, and other costs of these employees for our benefit.
We have a long-term strategic relationship with HFC (and now HF Sinclair) that has historically facilitated our growth. Our future growth plans include organic projects around our existing assets and select investments or acquisitions that enhance our service platform while creating accretion for our unitholders. While in the near term, any acquisitions would be subject to economic conditions discussed in “Overview - Market Developments” above, we also expect over the longer term to continue to work with HF Sinclair on logistic asset acquisitions in conjunction with HF Sinclair’s refinery acquisition strategies. See “Overview” above for a discussion of the Sinclair Transactions.
Furthermore, as demonstrated by the HEP Transaction, we plan to continue to pursue third-party logistic asset acquisitions that are accretive to our unitholders and increase the diversity of our revenues.
A more detailed discussion of our financial condition at December 31, 2022 and 2021 and operating results for the years ended December 31, 2022, 2021 and 2020 is presented in the following sections.
RESULTS OF OPERATIONS (Unaudited)
Income, Distributable Cash Flow and Volumes
The following tables present income, distributable cash flow and volume information for the years ended December 31, 2022, 2021 and 2020.
Years Ended December 31,
Change from
(In thousands, except per unit data)
Revenues
Pipelines:
Affiliates—refined product pipelines
Affiliates—intermediate pipelines
Affiliates—crude pipelines
Third parties—refined product pipelines
Third parties—crude pipelines
Terminals, tanks and loading racks:
Affiliates
Third parties
Affiliates—refinery processing units
Total revenues
Operating costs and expenses
Operations (exclusive of depreciation and amortization)
Depreciation and amortization
General and administrative
Goodwill impairment
Operating income
Other income (expense):
Equity in earnings (losses) of equity method investments
Interest expense, including amortization
Interest income
Gain on sales-type leases
Gain on sale of assets and other
Income before income taxes
State income tax expense
Net income
Allocation of net income attributable to noncontrolling interests
Net income attributable to the partners
Limited partners’ earnings per unit—basic and diluted
Weighted average limited partners’ units outstanding
EBITDA (1)
Adjusted EBITDA (1)
Distributable cash flow (2)
Volumes (bpd)
Pipelines:
Affiliates—refined product pipelines
Affiliates—intermediate pipelines
Affiliates—crude pipelines
Third parties—refined product pipelines
Third parties—crude pipelines
Terminals and loading racks:
Affiliates
Third parties
Affiliates—refinery processing units
Total for pipelines, terminals and refinery processing unit assets (bpd)
Years Ended December 31,
Change from
(In thousands, except per unit data)
Revenues
Pipelines:
Affiliates—refined product pipelines
Affiliates—intermediate pipelines
Affiliates—crude pipelines
Third parties—refined product pipelines
Third parties—crude pipelines
Terminals, tanks and loading racks:
Affiliates
Third parties
Affiliates—refinery processing units
Total revenues
Operating costs and expenses
Operations (exclusive of depreciation and amortization)
Depreciation and amortization
General and administrative
Goodwill impairment
Operating income
Other income (expense):
Equity in earnings of equity method investments
Interest expense, including amortization
Interest income
Loss on early extinguishment of debt
Gain on sales-type leases
Gain on sale of assets and other
Income before income taxes
State income tax expense
Net income
Allocation of net income attributable to noncontrolling interests
Net income attributable to the partners
Limited partners’ earnings per unit—basic and diluted
Weighted average limited partners’ units outstanding
EBITDA (1)
Adjusted EBITDA (1)
Distributable cash flow (2)
Volumes (bpd)
Pipelines:
Affiliates—refined product pipelines
Affiliates—intermediate pipelines
Affiliates—crude pipelines
Third parties—refined product pipelines
Third parties—crude pipelines
Terminals and loading racks:
Affiliates
Third parties
Affiliates—refinery processing units
Total for pipelines, terminals and refinery processing unit assets (bpd)
(1) Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is calculated as net income attributable to the partners plus or minus (i) interest expense, (ii) interest income, (iii) state income tax expense and (iv) depreciation and amortization. Adjusted EBITDA is calculated as EBITDA plus (i) loss on early extinguishment of debt, (ii) goodwill impairment, (iii) our share of Osage environmental remediation costs, net of insurance recoveries, included in equity in earnings of equity method investments, (iv) acquisition integration and regulatory costs, (v) tariffs and fees not included in revenues due to impacts from lease accounting for certain tariffs and fees minus (vi) gain on sales-type leases, (vii) gain on significant asset sales, (viii) HEP's pro-rata share of gain on business interruption settlement and (ix) pipeline lease payments not included in operating costs and expenses. Portions of our minimum guaranteed tariffs for assets subject to sales-type lease accounting are recorded as interest income with the remaining amounts recorded as a reduction in net investment in leases. Similarly, certain pipeline lease payments were previously recorded as operating costs and expenses, but the underlying lease was reclassified from an operating lease to a financing lease, and these payments are now recorded as interest expense and reductions in the lease liability. EBITDA and Adjusted EBITDA are not calculations based upon generally accepted accounting principles (“GAAP”). However, the amounts included in the EBITDA and Adjusted EBITDA calculations are derived from amounts included in our consolidated financial statements. EBITDA and Adjusted EBITDA should not be considered as alternatives to net income attributable to the partners or operating income, as indications of our operating performance or as alternatives to operating cash flow as a measure of liquidity. EBITDA and Adjusted EBITDA are not necessarily comparable to similarly titled measures of other companies. EBITDA and Adjusted EBITDA are presented here because they are widely used financial indicators used by investors and analysts to measure performance. EBITDA and Adjusted EBITDA are also used by our management for internal analysis and as a basis for compliance with financial covenants.
(2) Distributable cash flow is not a calculation based upon GAAP. However, the amounts included in the calculation are derived from amounts presented in our consolidated financial statements, with the general exception of maintenance capital expenditures. Distributable cash flow should not be considered in isolation or as an alternative to net income or operating income as an indication of our operating performance or as an alternative to operating cash flow as a measure of liquidity. Distributable cash flow is not necessarily comparable to similarly titled measures of other companies. Distributable cash flow is presented here because it is a widely accepted financial indicator used by investors to compare partnership performance. It is also used by management for internal analysis and for our performance units. We believe that this measure provides investors an enhanced perspective of the operating performance of our assets and the cash our business is generating.
Years Ended December 31,
(In thousands)
Net income attributable to the partners
Add (subtract):
Interest expense
Interest income
State income tax expense
Depreciation and amortization
EBITDA
Loss on early extinguishment of debt
Gain on sales-type lease
Gain on significant asset sales
Goodwill impairment
HEP's pro-rata share of gain on business interruption insurance settlement
Share of Osage environmental remediation costs, net of insurance recoveries
Acquisition integration and regulatory costs
Tariffs and fees not included in revenues
Lease payments not included in operating costs
Adjusted EBITDA
Years Ended December 31,
(In thousands)
Net income attributable to the partners
Add (subtract):
Depreciation and amortization
Amortization of discount and deferred debt charges
Loss on early extinguishment of debt
Customer billings greater (less) than net income recognized
Maintenance capital expenditures (3)
Increase (decrease) in environmental liability
Share of remaining Osage insurance coverage estimated to be received
Decrease in reimbursable deferred revenue
Gain on sales-type lease
Gain on significant asset sales
Goodwill impairment
Other
Distributable cash flow
(3) Maintenance capital expenditures are capital expenditures made to replace partially or fully depreciated assets in order to maintain the existing operating capacity of our assets and to extend their useful lives. Maintenance capital expenditures include expenditures required to maintain equipment reliability, tankage and pipeline integrity, safety and to address environmental regulations.
December 31,
(In thousands)
Balance Sheet Data
Cash and cash equivalents
Working capital
Total assets
Long-term debt
Partners' equity
Results of Operations — Year Ended December 31, 2022 Compared with Year Ended December 31, 2021
Summary
Net income attributable to the partners for the year ended December 31, 2022, was $216.8 million, a $1.8 million increase compared to the year ended December 31, 2021. Results for the year ended December 31, 2022, reflect the impact to our equity in earnings of equity method investments of HEP's 50% share of incurred and estimated environmental remediation and recovery expenses, net of insurance proceeds received to date, associated with a release of crude oil on the Osage Pipe Line Company, LLC ("Osage") pipeline of $17.6 million. In addition, results for the year ended December 31, 2021, reflect special items that collectively increased net income attributable to HEP by a total of $18.9 million. These items included a gain on sales type leases of $24.7 million, a gain on significant asset sales of $5.3 million and a goodwill impairment charge of $11.0 million related to our Cheyenne reporting unit. Excluding these items, net income attributable to the partners for the year ended December 31, 2022 was $234.4 million ($1.92 per basic and diluted limited partner unit) compared to $196.0 million ($1.86 per basic and diluted limited partner unit) for the year ended December 31, 2021. The increase in earnings was mainly due to net income from Sinclair Transportation, which was acquired on March 14, 2022, higher revenues on our UNEV pipeline and higher net income from our Cushing Connect Joint Venture as the Cushing Connect pipeline went into service in September 2021; partially offset by higher interest expense and higher operating costs and expenses.
Revenues
Revenues for the year ended December 31, 2022, were $547.5 million, an increase of $53.0 million compared to the year ended December 31, 2021. The increase was mainly attributable to revenues on our recently acquired Sinclair Transportation assets, increased revenues from our UNEV assets, higher volumes on our crude pipelines in New Mexico, Texas, Wyoming and Utah as well as rate increases that went into effect on July 1, 2022, partially offset by lower revenues on our Cheyenne assets as a result of the conversion of the Cheyenne Refinery to renewable diesel production. The year ended December 31, 2021, included the recognition of the $10 million termination fee related to the termination of HF Sinclair's minimum volume commitment on our Cheyenne assets.
Revenues from our refined product pipelines were $113.2 million, an increase of $5.8 million, on shipments averaging 181.3 mbpd compared to 158.1 mbpd for the year ended December 31, 2021. The volume and revenue increases were mainly due to higher volumes on our recently acquired Sinclair Transportation assets and higher volumes on our UNEV pipeline. We recognized a significant portion of the Sinclair Transportation refined product pipeline tariffs as interest income under sales-type lease accounting.
Revenues from our intermediate pipelines were $32.2 million, an increase of $2.1 million compared to the year ended December 31, 2021. Shipments averaged 129.3 mbpd compared to 125.2 mbpd for the year ended December 31, 2021. The increase in volumes was mainly due to higher throughputs on our intermediate pipelines servicing HF Sinclair's Tulsa and Navajo refineries and the recently acquired Sinclair Transportation intermediate pipelines, and the increase in revenues was mainly due to the recently acquired Sinclair Transportation intermediate pipelines.
Revenues from our crude pipelines were $140.0 million, an increase of $14.4 million compared to the year ended December 31, 2021. Shipments averaged 601.3 mbpd compared to 408.6 mbpd for the year ended December 31, 2021. The increase in volumes was mainly attributable to our Cushing Connect Pipeline, which went into service in September 2021, volumes on our recently acquired Sinclair Transportation crude pipelines and higher volumes on our crude pipeline systems in New Mexico, Texas, Wyoming and Utah. The increase in revenues was mainly due to our recently acquired Sinclair Transportation crude pipelines and higher volumes on our crude pipelines in New Mexico, Texas, Wyoming and Utah. Revenues did not increase in proportion to volumes due to our recognition of most of the Cushing Connect Pipeline tariffs and a significant portion of the Sinclair Transportation crude pipeline tariffs as interest income under sales-type lease accounting.
Revenues from terminal, tankage and loading rack fees were $167.8 million, an increase of $25.5 million compared to the year ended December 31, 2021. Refined products and crude oil terminalled in the facilities averaged 598.2 mbpd compared to 442.9 mbpd for the year ended December 31, 2021. Volumes increased mainly due to volumes on our recently acquired Sinclair Transportation assets and higher throughputs at HF Sinclair's Tulsa refinery. Revenues increased mainly due to revenues on our recently acquired Sinclair Transportation assets, higher butane blending revenues and higher revenues on our Tulsa assets. In addition, the year ended December 31, 2021 included the recognition of the $10 million termination fee related to the termination of HF Sinclair's minimum volume commitment on our Cheyenne assets as a result of the conversion of the Cheyenne Refinery to renewable diesel production.
Revenues from refinery processing units were $94.2 million, an increase of $5.1 million compared to the year ended December 31, 2021. Throughputs averaged 70.2 mbpd compared to 69.6 mbpd for the year ended December 31, 2021. The increase in volumes was mainly due to increased throughput for our Woods Cross processing units. Revenues increased mainly due to higher recovery of natural gas costs as well as higher throughputs.
Operations Expense
Operations (exclusive of depreciation and amortization) expense for the year ended December 31, 2022, increased by $40.1 million compared to the year ended December 31, 2021. The increase was mainly due t o operating costs and expenses associated with our recently acquired Sinclair Transportation assets and higher employee costs, utility costs, natural gas costs, and maintenance costs, partially offset by lower general services costs.
Depreciation and Amortization
Depreciation and amortization for the year ended December 31, 2022, increased by $5.3 million compared to the year ended December 31, 2021. The increase was mainly due to depreciation on our recently acquired Sinclair Transportation assets partially offset by the acceleration of depreciation on certain of our Cheyenne tanks in 2021 as well as retirement of assets due to sales-type lease accounting.
General and Administrative
General and administrative costs for the year ended December 31, 2022, increased by $4.4 million compared to the year ended December 31, 2021 mainly due to integration costs associated with our acquisition of Sinclair Transportation as well as higher fees charged by HF Sinclair under the Omnibus Agreement for the provision of general and administrative services in the year ended December 31, 2022.
Equity in Earnings of Equity Method Investments
See the summary chart below for a description of our equity in earnings of equity method investments:
Years Ended December 31,
Equity Method Investment
(In thousands)
Osage Pipe Line Company, LLC
Cheyenne Pipeline LLC
Cushing Connect Terminal Holdings LLC
Pioneer Investments Corp.
Saddle Butte Pipeline III, LLC
Total
Equity in earnings of Osage decreased for the year ended December 31, 2022, mainly due to HEP's 50% share of incurred and estimated environmental remediation and recovery expenses, net of insurance proceeds received to date, associated with a release of crude oil that occurred in the third quarter of 2022. Additional insurance recoveries will be recorded as they are received. If our insurance policy pays out in full, our share of the remaining insurance coverage is expected to be $9.5 million. The pipeline resumed operations in the third quarter of 2022 and remediation efforts are underway. The decrease in Osage was partially offset by the addition of equity in earnings from Pioneer Investments Corp., which was acquired as part of our Sinclair Transportation acquisition.
Interest Expense
Interest expense for the year ended December 31, 2022, totaled $82.6 million, an increase of $28.7 million compared to the year ended December 31, 2021. The increase was mainly due to our April 2022 issuance of $400 million in aggregate principal amount of 6.375% senior unsecured notes maturing in April 2027, the proceeds of which were used to partially repay outstanding borrowings under our senior secured revolving credit facility following the funding of the cash portion of the Sinclair Transportation acquisition. In addition, market interest rates increased on our senior secured revolving credit facility. Our aggregate weighted-average interest rates were 5.0% and 3.7% for the years ended December 31, 2022 and 2021, respectively.
Interest Income
Interest income for the year ended December 31, 2022, totaled $91.4 million, an increase of $61.5 million compared to the year ended December 31, 2021. The increases were mainly due to higher sales-type lease interest income from our recently acquired Sinclair Transportation pipelines and terminals and our Cushing Connect Pipeline, which was placed into service at the end of the third quarter of 2021.
State Income Tax
We recorded state income tax expense of $111,000 and $32,000 for the years ended December 31, 2022 and 2021, respectively. All state income tax expense is solely attributable to the Texas margin tax.
R esults of Operations—Year Ended December 31, 2021 Compared with Year Ended December 31, 2020
Summary
Net income attributable to the partners for the year ended December 31, 2021, was $214.9 million, a $44.5 million increase compared to the year ended December 31, 2020. Results for the year ended December 31, 2021 reflect special items that collectively increased net income attributable to HEP by a total of $18.9 million. These items include a gain on sales type leases of $24.7 million, a gain on significant asset sales of $5.3 million and a goodwill impairment charge of $11.0 million related to our Cheyenne reporting unit. In addition, net income attributable to HEP for the year ended December 31, 2020 included a goodwill impairment charge of $35.7 million related to our Cheyenne reporting unit, a charge of $25.9 million related to the early redemption of our previously outstanding $500 million aggregate principal amount of 6% Senior Notes due in 2024, a gain on sales-type leases of $33.8 million and a $6.1 million gain related to HEP's pro-rata share of a business interruption insurance claim settlement resulting from a loss at HFC's Woods Cross refinery. Excluding these items, net income attributable to the partners for the year ended December 31, 2021 was $196.0 million ($1.86 per basic and diluted limited partner unit) compared to $192.1 million ($1.82 per basic and diluted limited partner unit) in 2020.
Revenues
Revenues for the year ended December 31, 2021, were $494.5 million, a $3.4 million decrease compared to the same period of 2020. The decrease was mainly attributable to lower on-going revenues from our Cheyenne assets as a result of the conversion of the Cheyenne Refinery to renewable diesel production, lower volumes on our product pipelines servicing HF Sinclair's Navajo refinery and Delek's Big Spring refinery, and recording certain tariffs and fees as interest income under sales-type lease accounting that were previously recorded as revenue in the year ended December 31, 2020, partially offset by higher revenues from our crude pipeline systems in Wyoming and Utah and our Woods Cross and El Dorado refinery processing units mainly due to higher recovery of natural gas costs.
Revenues from our refined product pipelines were $107.4 million, a decrease of $9.5 million, on shipments averaging 158.1 mbpd compared to 161.5 mbpd for the year ended December 31, 2020. The volume and revenue decreases were mainly due to lower volumes on pipelines servicing HFC's Navajo refinery and Delek's Big Spring refinery.
Revenues from our intermediate pipelines were $30.1 million, an increase of $0.1 million, on shipments averaging 125.2 mbpd compared to 137.1 mbpd for the year ended December 31, 2020. The decrease in volumes was mainly due to lower throughputs on our intermediate pipelines servicing HF Sinclair's Tulsa and Navajo refineries while revenue remained relatively constant mainly due to contractual minimum volume guarantees.
Revenues from our crude pipelines were $125.6 million, an increase of $6.7 million, on shipments averaging 408.6 mbpd compared to 387.7 mbpd for the year ended December 31, 2020. The increases were mainly attributable to increased volumes on our crude pipeline systems in Wyoming and Utah partially offset by lower volumes on our pipeline systems servicing HF Sinclair's Navajo refinery. Volumes also increased due to the addition of volumes on our Cushing Connect Pipeline in Oklahoma which went into service at the end of the third quarter of 2021.
Revenues from terminal, tankage and loading rack fees were $142.3 million, a decrease of $9.4 million compared to the year ended December 31, 2020. Refined products and crude oil terminalled in the facilities averaged 442.9 mbpd compared to 442.2 mbpd for the year ended December 31, 2020. Revenues decreased mainly due to lower on-going revenues on our Cheyenne assets as a result of the conversion of the Cheyenne Refinery to renewable diesel production and recording certain tariffs and fees as interest income under sales-type lease accounting that were previously recorded as revenue in the year ended December 31, 2020
Revenues from refinery processing units were $89.1 million, an increase of $8.8 million on throughputs averaging 69.6 mbpd compared to 61.4 mbpd for the year ended December 31, 2020. The increase in volumes was mainly due to increased throughput for both our Woods Cross and El Dorado processing units. Revenues increased mainly due to higher recovery of natural gas costs as well as higher throughputs.
Operations Expense
Operations (exclusive of depreciation and amortization) expense for the year ended December 31, 2021, increased by $22.8 million compared to the year ended December 31, 2020. The increase was mainly due to an increase in employee costs, maintenance costs, pipeline rental costs and natural gas costs.
Depreciation and Amortization
Depreciation and amortization for the year ended December 31, 2021, decreased by $5.8 million compared to the year ended December 31, 2020. The decrease was mainly due to the retirements in Cheyenne operations and sale of El Paso 6-inch pipeline assets.
General and Administrative
General and administrative costs for the year ended December 31, 2021, increased by $2.6 million compared to the year ended December 31, 2020 primarily due to costs related to the HEP Transaction.
Equity in Earnings of Equity Method Investments
See the summary chart below for a description of our equity in earnings of equity method investments:
Years Ended December 31,
Equity Method Investment
(In thousands)
Osage Pipe Line Company, LLC
Cheyenne Pipeline LLC
Cushing Connect Terminal Holdings LLC
Total
Equity in earnings of Osage Pipe Line Company, LLC increased for the year ended December 31, 2021, mainly due to higher throughput volumes. Equity in earnings of Cheyenne Pipeline LLC increased for the year ended December 31, 2021, mainly due to the recognition in revenue of prior contractual minimum commitment billings. Equity in earnings of Cushing Connect Terminal Holdings LLC increased for the year ended December 31, 2021 as the terminal started operations in the second quarter of 2020.
Interest Expense
Interest expense for the year ended December 31, 2021, totaled $53.8 million, a decrease of $5.6 million compared to the year ended December 31, 2020. The decrease was mainly due to lower outstanding balances under our senior secured revolving credit facility. Our aggregate weighted-average interest rates were 3.7% and 3.8% for the years ended December 31, 2021 and 2020, respectively.
Interest Income
Interest income for the year ended December 31, 2021, totaled $29.9 million, an increase of $19.3 million compared to the year ended December 31, 2020. The increase was due to recording certain tariffs and fees as interest income under sales-type lease accounting that were previously recorded as revenue in 2020 as underlying agreements were classified as sales-type leases when the agreements were modified or renewed. See Note 5 of our consolidated financial statements for further discussion of lease accounting.
State Income Tax
We recorded state income tax expense of $32,000 and $167,000 for the years ended December 31, 2021 and 2020, respectively. All state income tax expense is solely attributable to the Texas margin tax.
LIQUIDITY AND CAPITAL RESOURCES
Overview
In April 2021, we amended our senior secured revolving credit facility (the “Credit Agreement”), decreasing the size of the facility from $1.4 billion to $1.2 billion and extending the maturity date to July 27, 2025. In August 2022, the Credit Agreement was amended to, among other things, provide an alternative reference rate for LIBOR. The Credit Agreement is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. The Credit Agreement is also available to fund letters of credit up to a $50 million sub-limit and continues to provide for an accordion feature that allows us to increase commitments under the Credit Agreement up to a maximum amount of $1.7 billion.
During the year ended December 31, 2022, we received advances totaling $510.0 million and repaid $682.0 million, resulting in a net decrease of $172.0 million under the Credit Agreement and an outstanding balance of $668.0 million at December 31, 2022. As of December 31, 2022, we had no letters of credit outstanding under the Credit Agreement, and the available capacity under the Credit Agreement was $532.0 million.
On April 8, 2022, we closed a private placement of $400 million in aggregate principal amount of 6.375% senior unsecured notes due in 2027 (the “6.375% Senior Notes”). The 6.375% Senior Notes were issued at par for net proceeds of approximately $393 million, after deducting the initial purchasers’ discounts and commissions and estimated offering expenses. The total net proceeds from the offering of the 6.375% Senior Notes were used to partially repay outstanding borrowings under the Credit Agreement, increasing our available liquidity.
We have a continuous offering program under which we may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million. No units were issued under the program during the year ended December 31, 2022. As of December 31, 2022, HEP had issued 2,413,153 units under this program, providing $82.3 million in gross proceeds.
Under our registration statement filed with the Securities and Exchange Commission (“SEC”) using a “shelf” registration process, we currently have the authority to raise up to $2.0 billion by offering securities, through one or more prospectus supplements that would describe, among other things, the specific amounts, prices and terms of any securities offered and how the proceeds would be used. Any proceeds from the sale of securities are expected to be used for general business purposes, which may include, among other things, funding acquisitions of assets or businesses, working capital, capital expenditures, investments in subsidiaries, the retirement of existing debt and/or the repurchase of common units or other securities.
We believe our current sources of liquidity, including cash balances, future internally generated funds, funds available under the Credit Agreement, as well as our access to additional bank financing, and public or private capital markets will provide sufficient resources to meet our working capital liquidity, capital expenditure and quarterly distribution needs for the foreseeable future. Future securities issuances, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
We remain committed to our capital allocation strategy focused on funding all capital expenditures and distributions within operating cash flow, with the goal of achieving our leverage target of 3.0 - 3.5x and distributable cash flow coverage of 1.3x or greater. We expect to reach our leverage target in mid-2023, and once that target is achieved, we plan to evaluate incremental cash return to unitholders.
In each of February, May, August and November 2022, we paid regular quarterly cash distributions of $0.3500 on all units for an aggregate amount of $170.0 million during the year ended December 31, 2022. In February 2023, we paid a regular quarterly cash distribution of $0.3500 on all units in an aggregate amount of $44.3 million.
Cash and cash equivalents decreased by $3.5 million during the year ended December 31, 2022. The cash flows provided by operating activities of $331.0 million and financing activities of $35.5 million were less than the cash flows used for investing activities of $370.0 million. Working capital decreased by $0.2 million to a surplus of $17.3 million at December 31, 2022 from a surplus of $17.5 million at December 31, 2021.
Cash Flows—Operating Activities
Year Ended December 31, 2022 Compared with Year Ended December 31, 2021
Cash flows provided by operating activities increased by $37.0 million from $294.1 million for the year ended December 31, 2021, to $331.0 million for the year ended December 31, 2022. This increase was mainly due to higher cash receipts from customers, partially offset by higher payments for turnaround expenses at our Woods Cross refinery processing units, higher payments for operating expenses and higher payments for interest expenses in the year ended December 31, 2022, as compared to the prior year.
Year Ended December 31, 2021 Compared with Year Ended December 31, 2020
Cash flows provided by operating activities decreased by $21.5 million from $315.6 million for the year ended December 31, 2020, to $294.1 million for the year ended December 31, 2021. This decrease was mainly due to higher payments for operating expenses partially offset by higher cash receipts from customers and lower payments for interest expenses in the year ended December 31, 2021, as compared to the prior year.
Cash Flows—Investing Activities
Year Ended December 31, 2022 Compared with Year Ended December 31, 2021
Cash flows used for investing activities increased by $291.6 million from $78.5 million for the year ended December 31, 2021, to $370.0 million for the year ended December 31, 2022. During the year ended December 31, 2022, we made payments of $329.0 million related to the acquisition of Sinclair Transportation. During the years ended December 31, 2022 and 2021, we invested $39.0 million and $90.0 million, respectively, in additions to properties and equipment. In addition, we received proceeds from sales of assets of $0.3 million and $7.4 million during the years ended December 31, 2022 and 2021, respectively.
Year Ended December 31, 2021 Compared with Year Ended December 31, 2020
Cash flows used for investing activities increased by $18.7 million from $59.8 million for the year ended December 31, 2020, to $78.5 million for the year ended December 31, 2021. During the years ended December 31, 2021 and 2020, we invested $90.0 million and $59.3 million, respectively, in additions to properties and equipment. In addition, we received proceeds from sales of assets of $7.4 million during the year ended December 31, 2021.
Cash Flows—Financing Activities
Year Ended December 31, 2022 Compared with Year Ended December 31, 2021
Cash flows from financing activities increased by $258.7 million from $223.2 million used for the year ended December 31, 2021, to $35.5 million provided by financing activities for the year ended December 31, 2022. During the year ended December 31, 2022, we received $510.0 million and repaid $682.0 million in advances under the Credit Agreement. Additionally, we paid $170.0 million in regular quarterly cash distributions to HEP unitholders and $9.7 million to our noncontrolling interests. We also received net proceeds of $393.5 million from the issuance of our 6.375% Senior Notes. During the year ended December 31, 2021, we received $480.5 million and repaid $554.0 million in advances under the Credit Agreement. Additionally, we paid $149.4 million in regular quarterly cash distributions to HEP unitholders and $10.7 million to our noncontrolling interests.
Year Ended December 31, 2021 Compared with Year Ended December 31, 2020
Cash flows used for financing activities decreased by $23.9 million from $247.2 million for the year ended December 31, 2020, to $223.2 million for the year ended December 31, 2021. During the year ended December 31, 2021, we received $480.5 million and repaid $554.0 million in advances under the Credit Agreement. Additionally, we paid $149.4 million in regular quarterly cash distributions to HEP unitholders and $10.7 million to our noncontrolling interests. We received $23.2 million in contributions from our noncontrolling interests during the year ended December 31, 2021 . During the year ended December 31, 2020, we received $258.5 million and repaid $310.5 million in advances under the Credit Agreement. Additionally, we paid $174.4 million in regular quarterly cash distributions to HEP unitholders and $9.8 million to our noncontrolling interests. We also received net proceeds of $491.3 million from the issuance of our 5% Senior Notes and paid $522.5 million to retire our 6% Senior Notes.
Capital Requirements
Our pipeline and terminalling operations are capital intensive, requiring investments to maintain, expand, upgrade or enhance existing operations and to meet environmental and operational regulations. Our capital requirements have consisted of, and are expected to continue to consist of, maintenance capital expenditures and expansion capital expenditures. “Maintenance capital expenditures” represent capital expenditures to replace partially or fully depreciated assets to maintain the operating capacity of existing assets. Maintenance capital expenditures include expenditures required to maintain equipment reliability, tankage and pipeline integrity, safety and to address environmental regulations. “Expansion capital expenditures” represent capital expenditures to expand the operating capacity of existing or new assets, but exclude acquisitions. Expansion capital expenditures include expenditures to grow our business and to expand existing facilities, such as projects that increase throughput capacity on our pipelines and in our terminals. Repair and maintenance expenses associated with existing assets that are minor in nature and do not extend the useful life of existing assets are charged to operating expenses as incurred.
Each year the board of directors of HLS, our ultimate general partner, approves our annual capital budget, which specifies capital projects that our management is authorized to undertake. Additionally, at times when conditions warrant or as new opportunities arise, additional projects may be approved. The funds allocated for a particular capital project may be expended over a period in excess of a year, depending on the time required to complete the project. Therefore, our planned capital expenditures for a given year consist of expenditures approved for capital projects included in the current year’s capital budget as well as, in certain cases, expenditures approved for capital projects in capital budgets for prior years. Our current 2023 capital forecast is comprised of approximately $25 million to $35 million for maintenance capital expenditures and $5 to $10 million for expansion capital expenditures and joint venture investments. In addition to our capita l budget, we may spend funds periodically to perform capital upgrades or additions to our assets where a customer reimburses us for such costs. The upgrades or additions would generally benefit the customer over the remaining life of the related service agreements.
We expect that our currently planned sustaining and maintenance capital expenditures, as well as expenditures for capital development projects, will be funded with cash generated by operations. We expect that, to the extent necessary, we can raise additional funds from time to time through equity or debt financings in the public and private capital markets.
Under the terms of the transaction to acquire HFC’s 75% interest in UNEV, we issued to a subsidiary of HFC (now HF Sinclair) a Class B unit comprising a noncontrolling equity interest in a wholly owned subsidiary subject to redemption to the extent that HFC (now HF Sinclair) is entitled to a 50% interest in 75% of annual UNEV earnings before interest, income taxes, depreciation, and amortization above $40 million beginning July 1, 2015, and ending in June 2032, subject to certain limitations. However, to the extent earnings thresholds are not achieved, no redemption payments are required. No redemption payments have been required to date.
Credit Agreement
In April 2021, we amended our Credit Agreement, decreasing the commitments under the facility from $1.4 billion to $1.2 billion and extending the maturity date to July 27, 2025. In August 2022, the Credit Agreement was amended to, among other things, provide an alternative reference rate for LIBOR. The Credit Agreement is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. The Credit Agreement is also available to fund letters of credit up to a $50 million sub-limit, and it continues to provide for an accordion feature that allows us to increase the commitments under the Credit Agreement up to a maximum amount of $1.7 billion. As of December 31, 2022, we had outstanding borrowings of $668.0 million under the Credit Agreement, no letters of credit outstanding, and the available capacity was $532.0 million.
Our obligations under the Credit Agreement are collateralized by substantially all of our assets, and indebtedness under the Credit Agreement is guaranteed by our material wholly owned subsidiaries. The Credit Agreement requires us to maintain compliance with certain financial covenants consisting of total leverage, senior secured leverage and interest coverage. It also limits or restricts our ability to engage in certain activities. If, at any time prior to the expiration of the Credit Agreement, HEP obtains two investment grade credit ratings, the Credit Agreement will become unsecured and many of the covenants, limitations, and restrictions will be eliminated.
We may prepay all loans at any time without penalty, except for tranche breakage costs. If an event of default exists under the Credit Agreement, the lenders will be able to accelerate the maturity of all loans outstanding and exercise other rights and remedies. We were in compliance with all covenants under the Credit Agreement as of December 31, 2022.
Prior to the Investment Grade Date (as defined in the Credit Agreement), indebtedness under the Credit Agreement bears interest, at our option, at either (a) the Alternate Base Rate (as defined in the Credit Agreement) plus an applicable margin (ranging from 0.75% to 1.75%) or (b) Adjusted Term SOFR (net of our unrestricted cash and Liquid Investments (as defined in the Credit Agreement) at such time in an amount not to exceed $50.0 million) plus an applicable margin (ranging from 1.75% to 2.75%). In each case, the applicable margin is based upon the ratio of our funded debt (as defined in the Credit Agreement) to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in the Credit Agreement). The weighted-average interest rates on our Credit Agreement borrowings for the years ending December 31, 2022 and 2021, were 4.02% and 2.30%, respectively. Prior to the Investment Grade Date, we incur a commitment fee on the unused portion of the Credit Agreement at an annual rate ranging from 0.25% to 0.50% based upon the ratio of our funded debt (net of our unrestricted cash and Liquid Investments at such time in an amount not to exceed $50.0 million) to EBITDA for the four most recently completed fiscal quarters.
Senior Notes
On April 8, 2022, we closed a private placement of $400 million in aggregate principal amount of the 6.375% Senior Notes. The 6.375% Senior Notes were issued at par for net proceeds of approximately $393 million, after deducting the initial purchasers’ discounts and commissions and offering expenses. The total net proceeds from the offering of the 6.375% Senior Notes were used to partially repay outstanding borrowings under the Credit Agreement, increasing our available liquidity.
As of December 31, 2022, we had $500 million in aggregate principal amount of 5% Senior Notes due in 2028 (the “5% Senior Notes,” and together with the 6.375% Senior Notes, the “Senior Notes”).
The Senior Notes are unsecured and impose certain restrictive covenants, including limitations on our ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. We were in compliance with the restrictive covenants for the Senior Notes as of December 31, 2022. At any time when the Senior Notes are rated investment grade by either Moody’s or Standard & Poor’s and no default or event of default exists, we will not be subject to many of the foregoing covenants. Additionally, we have certain redemption rights at varying premiums over face value under the Senior Notes.
Indebtedness under the Senior Notes is guaranteed by all of our existing wholly owned subsidiaries (other than Holly Energy Finance Corp. and certain immaterial subsidiaries).
Long-term Debt
The carrying amounts of our long-term debt are as follows:
December 31,
December 31,
(In thousands)
Credit Agreement
Amount outstanding
5% Senior Notes
Principal
Unamortized debt issuance costs
6.375% Senior Notes
Principal
Unamortized debt issuance costs
Total long-term debt
Long-term Contractual Obligations
The following table presents our long-term contractual obligations as of December 31, 2022.
Payments Due by Period
Total
Less than
1 Year
1-3 Years
3-5 Years
Over 5
Years
(In thousands)
Long-term debt – principal
Long-term debt - interest
Site service fees
Pipeline finance lease
Right-of-way agreements and other
Total
Long-term debt consists of outstanding principal under the Credit Agreement and the Senior Notes. Interest on the Credit Agreement is calculated using the rate in effect at December 31, 2022.
Site service fees consist of site service agreements with HF Sinclair, expiring in 2058 through 2066, for the provision of certain facility services and utility costs that relate to our assets located at HF Sinclair’s refinery facilities. We are presenting obligations for the full term of these agreements; however, the agreements can be terminated with 180 day notice if we cease to operate the applicable assets.
The pipeline finance lease amounts above reflect the exercise of the second 10-year extension, expiring in 2027, on our lease agreement for the refined products pipeline between White Lakes Junction and Kuntz Station in New Mexico.
Most of our right-of-way agreements are renewable on an annual basis, and the right-of-way agreements payments above include only obligations under the remaining non-cancelable terms of these agreements at December 31, 2022. For the foreseeable future, we intend to continue renewing these agreements and expect to incur right-of-way expenses in addition to the payments listed.
Other contractual obligations include capital lease obligations related to vehicles leases, office space leases, and other.
Impact of Inflation
After being relatively moderate in recent years, PPI in the United States increased significantly in 2022 and 2021 (13.5% and 8.9%, respectively).
The substantial majority of our revenues are generated under long-term contracts that provide for increases or decreases in our rates and minimum revenue guarantees annually for increases or decreases in the PPI. These annual rate adjustments generally occur on July 1st each year based on the PPI or FERC index increase or decrease during the prior year. Certain of these
contracts have provisions that limit the level of annual PPI percentage rate increases or decreases, and the majority of our rates do not decrease when PPI is negative. The substantial majority of our rates and minimum revenue guarantees used the 2021 PPI increase of 8.9% in the July 1, 2022 rate adjustment calculations.
A significant and prolonged period of high inflation or a significant and prolonged period of negative inflation could adversely affect our cash flows and results of operations if costs increase at a rate greater than the fees we charge our shippers. However, for the year ended December 31, 2022, the fees we charged our shippers increased at a rate greater than our inflationary cost increase.
Environmental Matters
Our operation of pipelines, terminals, and associated facilities in connection with the transportation and storage of refined products and crude oil is subject to stringent and complex federal, state, and local laws and regulations governing the discharge of materials into the environment, or otherwise relating to the protection of the environment. As with the industry generally, compliance with existing and anticipated laws and regulations increases our overall cost of business, including our capital costs to construct, maintain, and upgrade equipment and facilities. While these laws and regulations affect our maintenance capital expenditures and net income, we believe that they do not affect our competitive position given that the operations of our competitors are similarly affected. However, these laws and regulations, and the interpretation or enforcement thereof, are subject to frequent change by regulatory authorities, and we are unable to predict the ongoing cost to us of complying with these laws and regulations or the future impact of these laws and regulations on our operations. Violation of environmental laws, regulations, and permits can result in the imposition of significant administrative, civil and criminal penalties, injunctions, and construction bans or . A major discharge of hydrocarbons or substances into the environment could, to the extent the event is not insured, subject us to substantial expense, including both the cost to comply with applicable laws and regulations and made by employees, neighboring landowners and other third parties for personal and property .
Contamination resulting from spills of refined products and crude oil is not unusual within the petroleum pipeline industry. Historic spills along our existing pipelines and terminals as a result of past operations have resulted in contamination of the environment, including soils and groundwater. Some environmental laws impose liability without regard to fault or the legality of the original act on certain classes of persons that contributed to the releases of hazardous substances or petroleum hydrocarbon substances into the environment. These persons include the owner or operator of the site or sites where the release occurred and companies that disposed of, or arranged for the disposal of, the hazardous substances found at the site. Such persons may be subject to strict, joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources, and for the costs of certain health studies. Site conditions, including soils and groundwater, are being evaluated at a few of our properties where operations may have resulted in releases of hydrocarbons and other wastes.
There are environmental remediation projects in progress, including assessment and monitoring activities, that relate to certain assets acquired from HF Sinclair. Under the Omnibus Agreement and certain transportation agreements and purchase agreements with HF Sinclair, HF Sinclair has agreed to indemnify us, subject to certain monetary and time limitations, for environmental noncompliance and remediation liabilities associated with certain assets transferred to us from HF Sinclair and occurring or existing prior to the date of such transfers.
We have an environmental agreement with Delek with respect to pre-closing environmental costs and liabilities relating to the pipelines and terminals acquired from Delek in 2005, under which Delek will indemnify us subject to certain monetary and time limitations.
As of December 31, 2022, we have an accrual of $19.5 million that relates to environmental clean-up projects for which we have assumed liability, including accrued environmental liabilities assumed in the Sinclair Transportation acquisition that have preliminarily been fair valued at $14.7 million as of the acquisition date, or for which the indemnity provided for by HF Sinclair has expired.
On July 8, 2022, the Osage pipeline, which carries crude oil from Cushing, Oklahoma to El Dorado, Kansas, suffered a release of crude oil. Our equity in earnings (loss) of equity method investments was reduced in the year ended December 31, 2022 by $17.6 million for our 50% share of incurred and estimated environmental remediation and recovery expenses associated with the release, net of our share of insurance proceeds received to date of $3.0 million. We expect Osage will receive additional insurance recoveries, which will be recorded as they are received. If our insurance policy pays out in full, our share of the remaining insurance coverage is expected to be $9.5 million. The pipeline resumed operations in the third quarter of 2022 and remediation efforts are underway.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities as of the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. We consider the following policies to be the most critical to understanding the judgments that are involved and the uncertainties that could impact our results of operations, financial condition and cash flows.
Revenue Recognition
Revenues are generally recognized as products are shipped through our pipelines and terminals, feedstocks are processed through our refinery processing units or other services are rendered. The majority of our contracts with customers meet the definition of a lease since (1) performance of the contracts is dependent on specified property, plant, or equipment and (2) the possibility is remote that one or more parties other than the customer will take more than a minor amount of the output associated with the specified property, plant, or equipment. Prior to the adoption of the new lease standard (see below), we bifurcated the consideration received between lease and service revenue. The new lease standard allows the election of a practical expedient whereby a lessor does not have to separate non-lease (service) components from lease components under certain conditions. The majority of our contracts meet these conditions, and we have made this election for those contracts. Under this practical expedient, we treat the combined components as a single performance obligation in accordance with Accounting Standards Codification (“ASC”) 606, which largely codified ASU 2014-09, if the non-lease (service) component is the dominant component. If the lease component is the dominant component, we treat the combined components as a lease in accordance with ASC 842, which largely codified ASU 2016-02.
Several of our contracts include incentive or reduced tariffs once a certain quarterly volume is met. Revenue from the variable element of these transactions is recognized based on the actual volumes shipped as it relates specifically to rendering the services during the applicable quarter.
The majority of our long-term transportation contracts specify minimum volume requirements, whereby, we bill a customer for a minimum level of shipments in the event a customer ships below their contractual requirements. If there are no future performance obligations, we will recognize these deficiency payments in revenue.
In certain of these throughput agreements, a customer may later utilize such shortfall billings as credit towards future volume shipments in excess of its minimum levels within its respective contractual shortfall make-up period. Such amounts represent an obligation to perform future services, which may be initially deferred and later recognized as revenue based on estimated future shipping levels, including the likelihood of a customer’s ability to utilize such amounts prior to the end of the contractual shortfall make-up period. We recognize these deficiency payments in revenue when we do not expect we will be required to satisfy these performance obligations in the future based on the pattern of rights projected to be exercised by the customer.
Leases
We adopted ASC 842 effective January 1, 2019, and elected to adopt using the modified retrospective transition method and practical expedients, both of which are provided as options by the standard and further defined below.
Lessee Accounting - At inception, we determine if an arrangement is or contains a lease. Right-of-use assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our payment obligation under the leasing arrangement. Right-of-use assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. We use our estimated incremental borrowing rate (“IBR”) to determine the present value of lease payments as most of our leases do not contain an implicit rate. Our IBR represents the interest rate which we would pay to borrow, on a collateralized basis, an amount equal to the lease payments over a similar term in a similar economic environment. We use the implicit rate when readily determinable.
Operating leases are recorded in operating lease right-of-use assets and current and noncurrent operating lease liabilities on our consolidated balance sheet. Finance leases are included in properties and equipment, current finance lease liabilities and noncurrent finance lease liabilities on our consolidated balance sheet.
When renewal options are defined in a lease, our lease term includes an option to extend the lease when it is reasonably certain we will exercise that option. Leases with a term of 12 months or less are not recorded on our balance sheet, and lease expense is accounted for on a straight-line basis. In addition, as a lessee, we separate non-lease components that are identifiable and exclude them from the determination of net present value of lease payment obligations.
Lessor Accounting - Customer contracts that contain leases are generally classified as either operating leases, direct finance leases or sales-type leases. We consider inputs such as the lease term, fair value of the underlying asset and residual value of the underlying assets when assessing the classification.
Goodwill and Long-Lived Assets
Goodwill represents the excess of our cost of an acquired business over the fair value of the assets acquired, less liabilities assumed. Goodwill is not amortized. We test goodwill at the reporting unit level for impairment annually and between annual tests if events or changes in circumstances indicate the carrying amount may exceed fair value. Our goodwill impairment testing first entails a comparison of our reporting unit fair values relative to their respective carrying values, including goodwill. If carrying value exceeds the estimated fair value for a reporting unit, we measure goodwill impairment as the excess of the carrying amount of the reporting unit over the estimated fair value of the reporting unit.
Our annual goodwill impairment testing for 2022 and 2021 was performed on a qualitative basis during the third quarters of 2022 and 2021. We assessed qualitative factors such as macroeconomic conditions, cost factors and reporting unit financial performance and determined it was not more likely than not that fair value of our reporting units was less than the respective carrying value. Therefore, in accordance with GAAP, further testing was not required.
During the first quarter of 2021, changes in our agreements with HFC related to our Cheyenne assets resulted in an increase in the carrying amount of our Cheyenne reporting unit due to sales-type lease accounting, which led us to determine indicators of potential goodwill impairment for our Cheyenne reporting unit were present.
The estimated fair value of our Cheyenne reporting unit was derived using a combination of income and market approaches. The income approach reflects expected future cash flows based on anticipated gross margins, operating costs and capital expenditures. The market approaches include both the guideline public company and guideline transaction methods. Both methods utilize pricing multiples derived from historical market transactions of other like-kind assets. These fair value measurements involve significant unobservable inputs (Level 3 inputs). See Note 6 for further discussion of Level 3 inputs.
Our interim impairment testing of our Cheyenne reporting unit goodwill identified an impairment charge of $11.0 million, which was recorded in the three months ended March 31, 2021.
Our annual goodwill testing for 2020 was performed on a quantitative basis during the third quarter of 2020. The estimated fair value of our reporting units derived using a combination of both income and market approaches as described above. Our annual testing of goodwill in 2020 identified an impairment charge of $35.7 million, which was recorded in the third quarter of 2020, related to our Cheyenne reporting unit.
We evaluate long-lived assets, including finite-lived intangible assets, for potential impairment by identifying whether indicators of impairment exist and, if so, assessing whether the long-lived assets are recoverable from estimated future undiscounted cash flows. The actual amount of impairment loss, if any, to be recorded is equal to the amount by which a long-lived asset’s carrying value exceeds its fair value.
Valuation of Business Combinations
We recognize and measure the assets acquired and liabilities assumed in a business combination based on their estimated fair values at the acquisition date. Any excess or surplus of the purchase consideration when compared to the fair value of the net tangible assets acquired, if any, is recorded as goodwill or gain from a bargain purchase. The fair value of assets and liabilities as of the acquisition date are often estimated using a combination of approaches, including the income approach, which requires us to project future cash flows and apply an appropriate discount rate; the cost approach, which requires estimates of replacement costs and depreciation and obsolescence estimates; and the market approach which uses market data and adjusts for entity-specific differences. We use all available information to make these fair value determinations and engage third-party consultants for valuation assistance. The estimates used in determining fair values are based on assumptions believed to be reasonable but which are inherently uncertain. Accordingly, actual results may differ materially from the projected results used to determine fair value.
Contingencies
We are subject to proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.
RISK MANAGEMENT
The market risk inherent in our debt positions is the potential change arising from increases or decreases in interest rates as discussed below.
At December 31, 2022, we had an outstanding principal balance of $900.0 million on our Senior Notes. A change in interest rates generally would affect the fair value of the Senior Notes, but not our earnings or cash flows. At December 31, 2022, the fair value of our Senior Notes was $852.7 million. We estimate a hypothetical 10% change in the yield-to-maturity applicable to the Senior Notes at December 31, 2022, would result in a change of approximately $24.2 million in the fair value of the underlying Senior Notes.
For the variable rate Credit Agreement, changes in interest rates would affect cash flows, but not the fair value. At December 31, 2022, borrowings outstanding under the Credit Agreement were $668.0 million. A hypothetical 10% change in interest rates applicable to the Credit Agreement would not materially affect our cash flows.
At our election, certain borrowings under our variable rate Credit Agreement bear interest at a variable rate based on the secured overnight financing rate (“SOFR”) as administered by the Federal Reserve Bank of New York.
Our operations are subject to normal hazards of operations, including fire, explosion and weather-related perils. We maintain various insurance coverages, including business interruption insurance, subject to certain deductibles. We are not fully insured against certain risks because such risks are not fully insurable, coverage is unavailable, or premium costs, in our judgment, do not justify such expenditures.
We have a risk management oversight committee that is made up of members from our senior management. This committee monitors our risk environment and provides direction for activities to mitigate, to an acceptable level, identified risks that may adversely affect the achievement of our goals.
