Year-over-year tone shift - average net-tone change across Risk Factors and MD&A vs the prior 10-K. This filing is 0.04pp more bullish than last year's.
Why YoY instead of absolute: the LM lexicon has ~6.6× more negative words than positive (legal/risk-disclosure language is heavy on hedging), so every 10-K reads bearish on raw tone. Year-over-year change strips that bias and surfaces the actual shift in management's framing.
Tone shift by section
The two components the gauge averages: how Risk Factors and MD&A each shifted in net tone versus last year's 10-K. The headline above is their average, so a green needle over a soft section just means the other section carried it.
Risk Factors
+0.10pp
Flat
Net-tone change vs last year's 10-K.
MD&A
-0.02pp
Flat
Net-tone change vs last year's 10-K.
Per-snippet highlights
Sentence-level sentiment highlighting with category and subcategory filters is coming once the snippet-scoring pipeline lands. For now, dig into the actual section text on the Sections tab.
Language change vs prior 10-K
Risk Factors (Item 1A) - words with the biggest YoY frequency increase
Negative rising
difficulties+3
failure+2
unable+2
declines+2
adverse+1
Positive rising
efficiently+4
successfully+2
best+1
satisfy+1
enhance+1
Risk Factors (Item 1A)
10,788 words
Item 1A. Risk Factors
The nature of our business activities subjects us to a wide variety of hazards and risks. The following is a summary and a description of the most significant risks relating to our business activities that we have identified. In addition to the factors discussed elsewhere in this Annual Report on Form 10-K, you should carefully consider the risks and uncertainties described below, each of which could have a material adverse effect on our business. As used throughout this report, “effect on our business” includes, among other things, effects on our financial condition, results of operations and ability to make cash distributions. You should also consider the interrelationship and potential compounding effects if multiple risks are realized. These risks are not the only risks that we face. Our business could be impacted by additional risks and uncertainties not currently known or that we currently believe to be immaterial.
Risk Factor Summary
The following is a summary of the most significant risks relating to our business activities that we have identified. If any of these risks actually occur, our business could be materially adversely affected. For a more complete understanding of our material risk factors, this summary should be read in conjunction with the detailed description of our risk factors which follows this section.
Language change vs prior 10-K
MD&A (Item 7) - words with the biggest YoY frequency increase
Negative rising
impairment+1
overages+1
challenges+1
overcome+1
disruptions+1
Positive rising
opportunities+4
attractive+2
successful+2
benefit+1
progress+1
MD&A (Item 7)
5,288 words
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
We are a publicly traded limited partnership principally engaged in the transportation, storage and distribution of refined petroleum products and crude oil. As of December 31, 2022, our asset portfolio consisted of:
• our refined products segment, comprised of our approximately 9,800-mile refined petroleum products pipeline system with 54 terminals and two marine storage terminals (one of which is owned through a joint venture); and
• our crude oil segment, comprised of approximately 2,200 miles of crude oil pipelines, a condensate splitter and 39 million barrels of aggregate storage capacity, of which approximately 29 million barrels are used for contract storage. Approximately 1,000 miles of these pipelines, the condensate splitter and 31 million barrels of this storage capacity (including 25 million barrels used for contract storage) are wholly-owned, with the remainder owned through joint ventures.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this annual report on Form 10-K for the year ended December 31, 2022.
See Item 1. Business for a detailed description of our business.
Overview
Fueling Prosperity and Security. World events over the past year have reinforced the criticality of the energy industry to our country and the world. We are well positioned to continue to responsibly provide the essential fuels such as gasoline, diesel fuel and jet fuel that our communities and economy rely on daily.
Changes in demand for and supply of petroleum products
• Unfavorable changes in the demand for the petroleum products that we transport, store and distribute could cause our revenue to decline or be more volatile;
• A decrease in crude oil production in the basins served by our crude oil pipelines could reduce our revenues;
• Our business is subject to the risk of capacity overbuilds in the markets in which we operate;
• Decreased activities of producers, gathering systems, refineries and petroleum pipelines owned and operated by others on which we depend to supply our assets could reduce demand for our services;
• A decrease in contract renewals or renewals at lower rates or shorter terms could cause our revenue to
decline or be more volatile.
Commodity price volatility
• Fluctuations in prices of petroleum products that we purchase and sell could adversely affect our results of operations;
• Reduced volatility in energy prices or new government regulations could discourage our storage customers from holding positions in petroleum products;
• The volume of petroleum products we transport and the tariff rates we collect for transportation services partially depend upon unpredictable market differentials between the origin and destination points of our pipelines.
Capital investment and financial risks
• Our distributions and unit repurchases are not guaranteed to occur, and reductions to either may result in a loss of investor confidence and a decrease in the market value of our units;
• Non-traditional investment criteria used by many investors may diminish investor interest in our partnership and reduce the value of our common units and our access to capital;
• We are exposed to counterparty risk and nonpayment or nonperformance by our customers, vendors, joint venture co-owners, lenders or derivative counterparties;
• Expansion projects or acquisitions may encounter unanticipated costs, and expansion projects as well as potential acquisitions or divestitures could experience unanticipateddelays or fail to close.
Operational hazards
• Our business involves many hazards and operational risks, the occurrence of which could adversely affect our business;
• Failure of critical information technology systems may impact our ability to operate our assets or manage our business.
Cyberattacks, terrorism and other external threats
• Cyberattacks and terrorist attacks could result in increased costs or other damage to our business;
• The occurrence of epidemics and government responses thereto may adversely affect our business.
Regulatory risks
• We and our customers are subject to extensive environmental, health, safety and other laws and regulations, and any new laws or regulations or changes in the interpretation of existing laws and regulations could result in increased costs and decreased demand for our services;
• Rate regulation, challenges by shippers of the rates we charge on our pipelines or changes in the jurisdictional characterization of our assets or activities by federal, state or local regulatory agencies may reduce the amount of cash we generate;
• Climate change legislation or regulations regarding emissions of greenhouse gases could result in increased operating costs and reduced demand for our services and the products that we transport, store or distribute.
MLP structural risks
• Our status as a publicly traded partnership prevents our equity from being included in many prominent equity indices, which reduces the demand for our units from passive investment funds. In addition, some individual investors or investment funds may be unable or unwilling to invest in us for reasons related to our status as a partnership for federal income tax purposes.
Tax risks
• Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, as well as the applicable state and local laws of the various jurisdictions in which we conduct business. The IRS could treat us as a corporation, or we could otherwise become subject to a material amount of entity-level taxation for state or local tax purposes.
General risk factors
• Our business requires the recruitment and retention of a skilled workforce, and difficulties attracting and retaining talent could result in a failure to efficiently operate our business and execute our strategies;
• Our business could be affected adversely by union disputes and strikes or work stoppages by our unionized employees.
Risks Related to Our Business
The following is a description of the most significant risks relating to our business activities that we have identified. You should carefully consider the risks and uncertainties described below, which could have a material adverse effect on our business.
Changes in demand for and supply of petroleum products
Our financial results depend on the demand for the petroleum products that we transport, store and distribute. Unfavorable economic conditions, technological changes, regulatory developments or other factors in the U.S. or global marketplace could result in lower demand for these products for a sustained period of time.
Any sustained decrease in demand for petroleum products in the markets served by our pipelines or terminals could result in a significant reduction in the volume of products that we transport, store or distribute, and thereby reduce our cash flow and our ability to pay distributions. Global economic conditions have from time to time resulted in reduced demand for the products transported and stored by our pipelines and terminals and consequently for the services that we provide. Our financial results may also be affected by uncertain or changing economic conditions within certain regions or by supply or demand shifts between regions. If economic and market conditions remain uncertain or adverse conditions persist for an extended period, we could experience adverse impacts to our business.
Other factors that could lead to a decrease in demand for the petroleum products we transport, store and distribute include:
• an increase in the use of alternative sources of energy for transportation, including but not limited to electric and battery-powered motors, natural gas, hydrogen and renewable fuels such as ethanol, biodiesel and renewable diesel. Several governments and automobile manufacturers have announced plans to significantly reduce or eliminate the use of traditional petroleum fuel powered vehicles, and significant increases in the production of electric vehicles are widely expected. In addition, current U.S. laws and regulations require an increase in the quantity of ethanol, biodiesel and other qualifying renewable fuels used in transportation fuels. Increases in the use of such alternative fuels could have an adverse impact on the volume of petroleum-based fuels transported, stored or distributed by our pipelines or terminals;
• an increase in transportation fuel economy, whether as a result of a shift by consumers to more fuel-efficient vehicles, technological advances by manufacturers or federal, state or international regulations. Government regulations require increasing improvements in fuel economy standards. These standards are intended to reduce demand for petroleum products and could reduce demand for our services;
• changes in population or in consumer preferences, rates of automobile ownership or driving patterns in the markets we serve;
• an increase or decrease in the market prices of petroleum products, which may reduce supply or demand. Petroleum product prices have been volatile in recent years, and that volatility may continue in ways that we are unable to predict;
• higher fuel taxes or fees, including carbon tax, or other governmental or regulatory actions that increase the cost of the products we handle; and
• lower exports of petroleum products to global markets resulting from weak economic conditions, regulatory restrictions, changing preferences for the type of petroleum products we export or preferences for alternative energy sources.
A decrease in crude oil production in the basins served by our crude oil pipelines could adversely impact our business.
Numerous factors can cause reductions in crude oil production in the regions served by our pipelines, including, among other factors, lower overall crude oil prices, regional price or product quality differences, higher costs of crude oil production, exhaustion of reserves, weather or other natural causes, epidemics, adverse regulatory or legal developments, disruptions in financial or credit markets that inhibit production, or lower overall demand for crude oil and the products derived from crude oil. Crude oil prices have historically exhibited significant volatility and are influenced by, among other factors, worldwide and domestic supplies of and demand for crude oil, political and economic developments in often-volatile producing regions, actions taken by OPEC and other non-OPEC countries with large production capacity, technological developments, government regulations, taxes, policies regarding the importing and exporting of crude oil and conditions in global financial markets.
We are unable to predict future prices of crude oil or what impact the crude oil price environment will have on future production overall or specifically on production in the basins we serve. Lower production in the regions served by our pipelines could result in lower shipments of uncommitted volume or cause us to be unable to renew our contracts at existing volumes or rates. A significant reduction in the volume of products that we transport or the rates we are able to charge for such transportation services or both could adversely impact our business.
Our business is subject to the risk of capacity overbuilds in the markets in which we operate.
We and our joint ventures have made significant investments in new energy infrastructure to meet market demand, as have several of our competitors. The increased infrastructure investments combined with production declines in key basins served by our pipelines has resulted in take away and storage capacity that significantly exceeds market demands. For example, excess capacity has created a highly competitive environment that has decreased the crude oil price differential between the Permian Basin and end markets, including Houston, which has reduced the demand for our services resulting in decreases to volumes transported and lower rates we are able to charge to our customers. When infrastructure investments in the markets we serve, including our own investments, result in capacity that exceeds the demand in those markets, our facilities could be underutilized, and we could be forced to reduce the rates we charge for our services, which could adversely affect our business.
We depend on producers, gathering systems, refineries and pipelines owned and operated by others to supply our assets, and any closures, interruptions or reduced activity levels at these facilities may adversely affect our business.
We depend on crude oil production and on connections with gathering systems, refineries and petroleum pipelines owned and operated by third parties to supply our assets. We cannot control or predict the amount of crude oil that will be delivered to us by the gathering systems and pipelines that supply our crude oil assets, nor can we control or predict the output of refineries that supply our refined products pipelines and terminals. Changes in the quality or quantity of this crude oil production, outages at these refineries or reduced or interrupted throughput on these gathering systems or pipelines due to weather-related or other natural causes, competitive forces, testing, line repair, damage, reduced operating pressures or other causes could reduce shipments on our pipelines or result in our being unable to receive products at or deliver products from our terminals or receive products for processing at our condensate splitter, any of which could adversely affect our business.
Refineries that supply or are supplied by our facilities are subject to regulatory developments, including but not limited to low carbon fuel standards, regulations regarding fuel specifications, plant emissions and safety and security requirements that could significantly increase the cost of their operations and reduce their operating margins. In addition, the profitability of the refineries that supply our facilities is subject to regional and global supply and demand dynamics that are difficult to predict. A period of sustained weak demand or increased costs could make refining uneconomic for some refineries, including those directly or indirectly connected to our refined products and crude oil pipelines. The closure of a refinery that delivers product to or receives crude oil from our pipelines could reduce the volumes we transport. Further, the closure of these or other refineries could result in our
customers electing to store and distribute petroleum products through their proprietary terminals, which could result in a reduction in demand for our storage services.
A decrease in contract renewals or renewals at lower rates or shorter terms could cause our revenue to decline or be more volatile, which could adversely impact our business.
A significant portion of the revenue we earn from transportation and storage services is received pursuant to multi-year contracts negotiated with our customers. Many of those contracts require our customers to pay for our services regardless of market conditions during the contract period. Changing market conditions, including changes in petroleum product supply or demand patterns, competitive factors, forward-price structure, financial market conditions, regulations, accounting rules or other factors could cause our customers to be unwilling to renew their contracts with us when those contracts terminate, or make them willing to renew only at lower rates or for shorter contract periods. Failure by our customers to renew any of their contracts with us on terms and at rates substantially similar to our existing contracts could result in lower utilization of our assets or cause our revenues to decline or be more volatile, any of which could adversely affect our business.
Commodity pricing volatility
We hedge our exposure to price fluctuations for our petroleum products purchase and sale activities by utilizing physical purchase and sale agreements and derivatives. These hedging arrangements do not eliminate all price risks, and fluctuations in prices of petroleum products that we purchase and sell could adversely affect our business. Further, non-compliance with our risk management policies and procedures could adversely affect our business.
We purchase and sell commodities related to our blending, fractionation and petroleum products marketing activities, as well as product generated by the operations of our pipelines and terminals. We also maintain product inventories related to these activities. The hedging arrangements we enter into to hedge our exposure to commodity price changes may be for the purchase or sale of product in markets or on time frames different from those in which we are attempting to hedge, resulting in hedges that do not eliminate all price risks. Significant fluctuations in market prices of petroleum products could result in material unrealized gains or losses on our hedge transactions. To the extent these hedges do not qualify for hedge accounting treatment or are not designated as hedges, or if they result in material amounts of ineffectiveness, we could experience adverse fluctuations in our results of operations. In addition, significant fluctuation in market prices of petroleum products could require us to post material amounts of margin and result in adverselosses or lower profits from these activities.
Our product purchases, sales and hedging operations involve the risk of non-compliance with our risk management policies. We cannot assure that our processes and procedures will detect and prevent all violations of our risk management policies, particularly if deception or other intentionalmisconduct is involved. Such violations could result in losses or lower profits.
Reduced volatility in energy prices or new government regulations could discourage our storage customers from holding positions in petroleum products, which could adversely affect our business.
The demand for our storage services has resulted in part from our customers’ desire to have the ability to take advantage of profit opportunities created by the volatility in prices of petroleum products. Periods of prolongedstability or declines in petroleum product prices could reduce demand for our storage services. If federal, state or international regulations are passed that discourage our customers from storing these commodities, demand for our storage services could decrease, in which case we may be unable to identify customers willing to contract for such services or be forced to reduce the rates we charge for our services. The realization of any of these risks could adversely affect our business.
The volume of petroleum products we transport and the tariff rates we collect for transportation services partially depend upon unpredictable market differentials between the origin and destination points of our pipelines.
Our tariff rates are established in accordance with federal and state regulations which, in general, permit us to negotiate rates with shippers so long as such negotiated rates are not unduly discriminatory among similarly situated shippers. Applicable regulations and our obligations to certain classes of committed shippers may limit our ability to change our tariff rates. When the difference in market prices for petroleum between our origin points and our destination points is lower than our tariff rates, the volume of product we transport could decline or the revenue we collect could decrease. For example, when the posted tariff rate for transportation on the Longhorn pipeline is higher than the market differential, it may be uneconomical for shippers to use Longhorn to move volumes from the Permian Basin to Houston. As a result, we experience lower revenues during such periods, which adversely impacts our business.
Capital investment and financial risks
Our distributions and unit repurchases are not guaranteed to occur, and reductions to either may result in a loss of investor confidence and a decrease in the market value of our units.
Neither our distributions nor any unit repurchases are guaranteed to occur. The cash that we generate from operations could decrease or fail to meet expectations, either of which could reduce our ability to pay distributions and repurchase our common units.
The amount of cash we can distribute to our unitholders principally depends upon the cash we generate from our operations, and the amount of cash we generate from operations is affected by numerous factors beyond our control, fluctuates from quarter to quarter and may change over time. Significant or sustained reductions in the cash generated by our operations would reduce our ability to pay distributions.
Additionally, our board has authorized the repurchase of our common units. Our unit repurchase program does not obligate us to acquire a specific number of units during any period, and our decision to commence, discontinue or resume repurchases in any period will depend on many factors, including our expected expansion capital spending, excess cash available, balance sheet metrics, legal and regulatory requirements, market conditions and the trading price of our units. Any failure to pay distributions at expected levels or the discontinuation of our unit repurchase program could result in a loss of investor confidence and a decrease in our unit price.
Non-traditional investment criteria used by many investors may diminish investor interest in our partnership and reduce the value of our common units and our access to capital.
Recently, investor advocacy groups, certain institutional investors and many investment funds have increased their focus on non-traditional investment criteria, such as environmental, social and governance (“ESG”) goals. In particular, numerous investment firms, banks, insurance companies and other financial institutions have made pledges to reduce their carbon emissions, which in many cases may involve reducing or eliminating their investments in organizations involved in the production, transport and use of fossil fuels. In connection with this trend, investor demand for and valuation of our common units may decline, and our access to the debt and equity capital necessary to finance our growth projects and to refinance our existing debt obligations when due may be reduced, either of which could adversely affect our business.
We do not have the same flexibility as other types of organizations to accumulate cash and retained earnings to protect againstilliquidity in the future, and we rely on access to capital to fund acquisitions and growth projects and to refinance existing debt obligations. Unfavorable developments in capital markets could limit our ability to obtain funding or require us to secure funding on terms that could limit our financial flexibility, reduce our liquidity, dilute the interests of our existing unitholders and otherwise adversely affect our business.
Our partnership agreement requires us to make quarterly distributions to our unitholders of all available cash, after taking into account reserves established by our board. We do not accumulate equity in the form of retained earnings in a manner typical of many other forms of organization, including most traditional public corporations,
and so are more likely than those organizations to require issuances of additional debt or equity to provide liquidity and capital resources.
We consider and pursue growth projects and acquisitions as part of our efforts to increase cash available for distribution to our unitholders. These transactions may occur at any time and may be significant in size relative to our existing assets and operations. We generally do not retain sufficient cash flow to finance growth projects or acquisitions, and consequently we require access to external sources of capital to finance our growth capital spending. Similarly, we generally do not retain sufficient cash flow to repay our indebtedness when it matures, and we rely on new capital to refinance these obligations. Limitations on our access to capital, including on our ability to issue additional debt and equity, could result from events or causes beyond our control, and could include, among other factors, decreases in our creditworthiness or profitability, significant increases in interest rates, increases in the risk premium generally required by investors or in the premium required specifically for investments in energy-related companies or master limited partnerships, and decreases in the availability of credit available for organizations involved with fossil fuels or the tightening of terms required by lenders. Any limitations on our access to capital on satisfactory terms could impair our ability to execute on our strategies and satisfy our debt obligations, resulting in the dilution of the interests of our existing unitholders, and adversely impact our business.
We are exposed to counterparty risk and nonperformance by our customers, vendors, joint venture co-owners, lenders or derivative counterparties could materially reduce our revenue, increase our expenses, impair our liquidity or otherwise negatively impact our business.
We are subject to risks of loss resulting from nonpayment or nonperformance by our customers to whom we extend credit. In addition, we frequently undertake capital expenditures based on commitments from customers from which we expect to realize the expected return on those expenditures, including take-or-pay commitments from our customers. Nonperformance by our customers of those commitments could result in substantial losses to us. Nonperformance by customers who back our growth projects could significantly impact our expected returns from those projects.
We have numerous joint ventures that we do not control and that requires cooperation with and performance by co-owners. Noncooperation by our joint venture co-owners could result in increased costs, delays or business decisions that are not in our best interests, which could decrease our returns on our joint ventures.
We utilize third-party vendors to provide various functions, including, for example, certain construction activities, engineering services, facility inspections and operation of certain software systems. Using third parties to provide these functions has the effect of reducing our direct control over the services rendered. The failure of one or more of our third-party providers to safely and efficiently deliver the expected services on a timely basis at the prices we expect and as required by contract could result in significant disruptions, costs or instances of non-compliance with applicable laws and regulations, which could adversely affect our business.
We also rely to a significant degree on the banks that lend to us under our revolving credit facility for financial liquidity, and any failure of those banks to perform on their obligations to us could significantly impair our liquidity. Furthermore, nonpayment by the counterparties to our interest rate and commodity derivatives could expose us to additional interest rate or commodity price risk. Any nonpayment or nonperformance by our customers, vendors, lenders or derivative counterparties could have an adverse effect on our business.
Changes in price levels could negatively impact our revenue, our expenses, or both, which could adversely affect our business.
The operation and maintenance of our assets and the execution of expansion projects require significant expenditures for labor, materials, property, equipment and services. Recent inflationary pressures in the U.S. could increase our expenses or capital costs, and we may not be able to pass these increased costs to our customers in the form of higher fees for our services. Our revenues are impacted by changes in price levels, and we use the FERC’s PPI-based price indexing methodology to establish tariff rates in certain markets served by our pipelines. In periods of price deflation, the ceiling level provided by the FERC’s index methodology could decrease, requiring us to
reduce our index-based rates, even if the actual costs we incur to operate our assets increase. In periods of inflation, our revenues may not keep pace with costs necessary to operate and maintain our assets, and we may be prevented from increasing our rates consistent with changes to the PPI-FG and our competitors. Changes in price levels that lead to decreases in our revenues or increases in the prices we pay to operate and maintain our assets could adversely affect our business.
Expansion projects or acquisitions may encounter unanticipated costs, and expansion projects as well as potential acquisitions or divestitures could experience unanticipateddelays or fail to close.
We may pursue expansion projects or acquisitions that require us to make significant capital investments, which could include new borrowings necessary to finance the projects. As a result, our indebtedness relative to our earnings could increase, particularly in situations where our expansion projects or acquisitions do not meet our earnings projections. Acquisitions and expansion projects involve numerous risks, including difficulties in the assimilation of the related assets and operations, inefficiencies and difficulties that arise due to unfamiliarity with the new assets and the businesses or geographic areas associated with them, as well as the diversion of management’s attention from other business concerns. Unexpected costs and other challenges may arise whenever new assets are put in service or businesses with different operations or management are combined, and we may discover previously unknown liabilities associated with assets or businesses we acquire.
Expansion projects typically require us to secure and retain permits and rights-of-way in order to complete and operate the new infrastructure, and our inability to do so in a timely manner could result in significant delays or cost overruns. Our ability to secure required permits and rights-of-way or otherwise proceed with construction of our expansion projects could also encounter opposition from political activists, who may attempt to delay energy infrastructure construction through protests, lawsuits and other means. In addition, acquisitions and divestitures typically involve extensive negotiations and numerous conditions that must be met by us and our transaction counterparties before a transaction can be completed, often including review by government agencies such as the Federal Trade Commission or other approval or consent processes over which we may have no control. The failure to meet these conditions could result in significant delays to such transactions or prevent their being completed entirely.
Any cost overruns or unanticipateddelays in the completion or commercial development of our expansion projects or acquisitions could reduce the anticipated returns on these investments, and any delay or failure to complete acquisitions or divestitures could interfere with our capital allocation priorities or otherwise adversely affect our business.
The amount and timing of distributions to us from our joint ventures is not entirely within our control, and we may be unable to cause our joint ventures to take or refrain from taking certain actions in accordance with our best interests.
As of December 31, 2022, we were engaged in eight joint ventures, all of which are in the form of limited liability companies (“LLC”), in which we share control with other entities according to the relevant joint venture agreements. Those agreements provide that the respective LLC management committees, including our representatives along with the representatives of the other owners of those LLCs, determine the amount and timing of distributions. Our joint ventures may establish separate financing arrangements that contain restrictive covenants that may limit or restrict the LLC’s ability to make distributions to us under certain circumstances. Any inability to generate cash or restrictions on distributions we receive from our joint ventures could materially impair our results. In addition, if we are unable to agree with our joint venture co-owners on a significant matter, it could result in delays, litigation or impasses that could result in an adverse effect on that joint venture’s business, and, therefore, our business.
Operational hazards
Our business involves many hazards and operational risks, and measures to maintain our physical assets may not be adequate. The occurrence of a significant event or accident could adversely affect our business.
Our operations are subject to many hazards inherent in the transportation, storage and distribution of petroleum products, including releases and fires. In addition, our operations are exposed to potential heightened risks from natural disasters, including hurricanes, tornadoes, storms, floods and earthquakes. The risk of natural disasters and other operational risks could result in personal injury or loss of life, damage to and destruction of property and equipment, pollution or other environmental damage, and may result in curtailment or suspension of our related operations. Some of our assets are located in or near high consequence areas (“HCAs”) such as residential and commercial centers or sensitive environments, and the potential damages are even greater in these areas. We utilize operational and safety policies and procedures, risk management systems and technologies to manage the physical asset risks associated with our pipeline systems and storage tanks. Failure of those management systems and technologies, non-compliance with policies or failure to otherwise adequately monitor and maintain the condition of our assets could compromise integrity and result in increased maintenance or remediation expenditures and an increased risk of product releases and associated costs and liabilities. Any significant event or accident could adversely affect our business.
Our insurance coverage may not be adequate to cover losses sustained, and we may experience increased costs and decreased availability of insurance options.
We are not fully insured against all hazards or operational risks related to our business, and the insurance we carry requires that we meet certain deductibles before we can receive reimbursement for any covered losses we sustain. If a significant accident or event occurs that is not fully insured, it could adversely affect our business.
Premiums and deductibles for our insurance policies could escalate as a result of market conditions or losses experienced by us or by other companies. In some instances, insurance could become unavailable or available only for reduced amounts of coverage. Increases in the cost of insurance or the inability to obtain insurance at rates that we consider commercially reasonable could adversely affect our business.
Failure of critical information technology systems may adversely impact our ability to operate our assets or manage our business.
We utilize information technology systems to operate our assets and manage our business. Some of these systems are proprietary systems that require specialized programming capabilities, while others are based upon or rely on technology that has been in service for many years. Failures of these systems could result in a failure of critical operational or financial controls and lead to a disruption of our operations, commercial activities or financial processes. Such failures could adversely affect our business.
Cyberattacks, terrorism and other external threats
Cyberattacks or other information security breaches that circumvent security measures taken by us or others with whom we conduct business or share information could result in increased costs, interruptions or other damages to our business.
We rely on our information technology infrastructure to process, transmit and store electronic information, including data we use to operate our assets. In addition, we rely on third-party systems, including the electric grid and cloud-based software services, which could also experience security breaches or cyberattacks, and the failure of which could have a material adverse effect on the operation of our assets. We and our third-party providers face cybersecurity and other security threats to our information technology infrastructure, including threats to our control systems and safety systems that operate our pipelines and other assets. We could face attempts to gain access to our information technology infrastructure, including coordinated attacks from state-sponsored groups, “hacktivists” or private individuals. The threat of terrorist attacks subjects our operations to increased risks and increased costs as new regulations require us to work with government agencies to verify our information technology systems are sufficiently designed to prevent and deter attacks against our assets. We could also face attempts to obtain unauthorized access by targeted acts of deceptionagainst individuals with legitimate access to physical locations or information.
Breaches in our information technology infrastructure or physical facilities, or other disruptions including those arising from theft, vandalism, fraud or unethical conduct, could result in damage to our assets, business interruptions, mitigation expense, safety incidents, damage to people, property and the environment, reputational damage, potential liability or the loss of contracts, and could otherwise adversely affect our business.
Terrorist attacks aimed at our facilities or that impact our customers or the markets we serve could adversely affect our business.
The U.S. government has issued warnings that energy assets in general, and the nation’s pipeline and terminal infrastructure in particular, may be targets of terrorist organizations. Any terrorist attack on our facilities, those of our customers or, in some cases, on energy infrastructure owned by others, could have an adverse effect on our business. Similarly, any terrorist attack that severelydisrupts the markets we serve could adversely affect our business.
The occurrence of epidemics and government responses thereto may adversely affect our business.
The occurrence of epidemics and the related government responses, as experienced with COVID-19, could result in significant declines in economic activity around the world and reduced demand for petroleum products. It is difficult to predict the occurrence or impact of new outbreaks and the government responses thereto on economic activity or our operations, any of which could adversely affect our business.
Regulatory risks
We are subject to extensive environmental, health, safety and other laws and regulations that impose significant requirements, costs and liabilities on us. These requirements, costs and liabilities could increase as a result of new laws or regulations or changes in the interpretation, implementation or enforcement of existing laws and regulations. Our customers are also subject to extensive environmental, health, safety and other laws and regulations, and any new laws or regulations or changes in the interpretation, implementation or enforcement of existing laws and regulations could result in increased costs and decreased demand for our services.
Our operations are subject to extensive federal, state and local laws and regulations relating to the protection or preservation of the environment, natural resources and human health and safety, including but not limited to the CAA, RCRA, OPA, CWA, CERCLA, HLPSA, Endangered Species Act (“ESA”), Migratory Bird Treaty Act (“MBTA”), the Pipeline Safety, Regulatory Certainty and Job Creation Act of 2011 DOT and OSHA. Such laws and regulations affect almost all aspects of our operations and generally require us to obtain and comply with various environmental registrations, licenses, permits, credits, inspections, material handling procedures and other requirements. We incur substantial costs to comply with these laws and regulations, and any failure to comply may expose us to civil, criminal and administrative fees, fines and penalties and interruptions in our operations that could have an adverse impact on our business. For example, if an accidental release or spill of petroleum products, chemicals or other hazardous substances occurs at or from our pipelines, storage or other facilities, we may experience significant operational disruptions, and we may have to pay a significant amount to remediate releases, pay government penalties, address natural resource damages, compensate for human exposure and property damage, install costly pollution control equipment or undertake a combination of these and other measures. In addition, emission controls required under the CAA and other similar laws could require significant capital expenditures at our facilities.
Liability under such laws and regulations may be incurred without regard to fault, including latent conditions that we did not cause. Private parties, including the owners of properties through which our pipelines pass, also may have the right to pursue legal actions to enforce compliance as well as to seek damages for non-compliance with such laws and regulations or for personal injury or property damage. Our insurance does not cover all environmental risks and costs, including potential fines and penalties, and may not provide sufficient coverage in the event an environmental claim is made against us.
The laws and regulations that affect our operations, and the enforcement thereof, have become increasingly stringent over time. These laws and regulations may be further revised or new laws or regulations may be adopted or
become applicable to us. For instance, in 2022 the Transportation Security Administration released additional pipeline cybersecurity directives requiring mitigation measures to protect against attacks on information technology and operational technology systems and the development and implementation of a cybersecurity contingency and recovery plan. In 2022, PHMSA published expanded hazardous liquid pipeline regulations for the installation of rupture mitigation valves and establishment of a minimum rupture detection standard. Compliance with legislative and regulatory changes could increase our compliance costs, make it more difficult to construct or maintain our assets and have an adverse effect on our business.
Our customers are also subject to extensive laws and regulations, and new laws or regulations could adversely affect their businesses. For example, several of our most significant customers operate refineries that could be significantly impacted by changes in environmental or health-related laws or regulations. In addition, we have made significant investments in crude oil and condensate storage and transportation projects that serve customers largely dependent on production techniques, such as hydraulic fracturing, that have been scrutinized by governmental authorities and have encountered political opposition which could result in increased regulatory costs and restrictions. Any changes in laws or regulations, or in the interpretation, implementation or enforcement of existing laws and regulations, that impose significant costs or liabilities on our customers could reduce demand for our services and adversely affect our business.
Rate regulation, challenges by shippers of the rates we charge for transportation on our pipelines or changes in the jurisdictional characterization of our assets or activities by federal, state or local regulatory agencies may reduce the amount of cash we generate.
The FERC regulates the rates we can charge and the terms and conditions we can offer for interstate transportation service on our pipelines. State regulatory authorities regulate the rates we can charge and the terms and conditions we can offer for intrastate movements on our pipelines. The determination of the interstate or intrastate character of shipments on our pipelines may change over time, which may change the regulatory framework and the rates we are allowed to charge for transportation and other related services. Shippers may protest our pipeline tariff filings, and the FERC or state regulatory authorities may investigate and require changes to tariff terms as a result of the protests or complaints. Further, other than for rates set under market-based rate authority, the FERC may order refunds of amounts collected under interstate rates that are determined to be in excess of a just and reasonable level. State regulatory authorities could take similar measures for intrastate tariffs. In addition, shippers may challenge by complaint the lawfulness of tariff rates that have become final and effective. If existing rates are determined to be in excess of a just and reasonable level, we could be required to pay refunds to shippers, reduce rates and make other concessions.
The FERC’s ratemaking methodologies may limit our ability to increase rates by amounts sufficient to reflect our actual cost or may delay the use of rates that reflect increased costs. We use the FERC’s indexing methodology to establish our rates in approximately 30% of the markets serviced by our refined products pipelines. The FERC’s indexing methodology is subject to review every five years and currently allows a pipeline to change its rates each year to a new ceiling level. When the change in the ceiling level is negative, we are required to reduce our rates that are subject to the FERC’s indexing methodology.
The FERC and most relevant state regulatory authorities allow us to establish rates based on conditions in competitive markets without regard to the FERC’s index level or our cost-of-service. We establish market-based rates in approximately 70% of the markets for our refined products pipelines. The tariffs on most of our long-haul crude oil pipelines are at negotiated rates, but are still subject to regulation by the FERC or state agencies and subject to protest by shippers. If we were to lose our market-based rate authority, or if our negotiated rates were determined to not be just and reasonable, we could be required to establish rates on some other basis, such as our cost-of-service. Establishing our rates through a cost-of-service filing could be expensive and could result in tariff reductions, which would adversely affect our business.
Climate change legislation or regulations regarding emissions of greenhouse gases could result in increased operating costs and reduced demand for our services and the products that we transport, store or distribute.
Federal and state legislative and regulatory initiatives in the U.S., as well as those in other countries, have attempted to and will likely continue to address climate change and control or limit greenhouse gas emissions. Although it is not possible to predict how they will impact our business, any such laws or regulations could adversely affect demand for the products that we transport, store and distribute. Depending on the particular programs adopted, such as the Securities and Exchange Commission’s proposed rules to Enhance and Standardize Climate-Related Disclosures for Investors , they could also increase our costs to operate and maintain our facilities by, for example, requiring that we measure and report our emissions, install new emission controls at our facilities, acquire allowances to authorize our emissions, pay taxes related to our emissions and administer and manage an emissions program, among other things. We may be unable to include some or all of such increased costs in the rates charged to our customers and any such recovery may depend on events beyond our control, including the outcome of future rate proceedings before the FERC or state regulatory agencies and the provisions of any final legislation or implementing regulations.
Finally, many scientific studies conclude that increasing concentrations of greenhouse gases in the Earth’s atmosphere affect climate changes and that such changes could result in the increased frequency and severity of storms, floods and other climatic events. If any such effects occur, there may be adverse effects on our business.
Our gas liquids blending activities subject us to federal regulations that govern renewable fuel requirements in the U.S.
The Energy Independence and Security Act of 2007 expanded the required use of renewable fuels in the U.S. Each year, the EPA establishes a renewable volume obligation (“RVO”) requirement for refiners and fuel manufacturers based on overall quotas established by the federal government. By virtue of our gas liquids blending activity and resulting gasoline production, we are an obligated party and receive an annual RVO from the EPA. We typically purchase renewable energy credits, called RINs, to meet this obligation. Increases in the cost or decreases in the availability of RINs could have an adverse impact on our business.
Our business is subject to federal, state, local and international laws and regulations that govern the quality specifications of the petroleum products that we transport, store, distribute or sell.
Petroleum products that we transport and store are sold by our customers for consumption into the public market. Various federal, state and local agencies, as well as international regulatory bodies, have the authority to prescribe product quality specifications for commodities sold into the public market. Changes in product quality specifications or blending requirements could reduce demand, reduce our throughput volume, require us to incur additional handling costs or require capital expenditures. For instance, 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 revenue, our business could be adversely affected.
In addition, changes in the quality of the products we receive on our pipelines, or changes in the product specifications in the markets we serve, could reduce or eliminate our ability to blend products, which would result in a reduction of our revenue and operating profit from blending activities. Any such reduction would have an adverse effect on our business.
We do not own all of the property on which our pipelines and facilities are located, and we rely on securing and retaining adequate rights-of-way and permits in order to operate our existing assets and complete growth projects.
We do not own all of the land on which our pipelines and facilities are located. As such, we are subject to the possibility of increased costs to retain necessary land use. We typically obtain the rights to construct and operate our pipelines on land owned by third parties, and sometimes those rights are only for a specific period of time and may result in decommissioning or new acquisition costs when our rights expire. In addition, some of our facilities cross Native American lands pursuant to rights-of-way of limited duration. We may not be able to utilize the right of
eminent domain in some jurisdictions and in some circumstances, such as land owned by Native American tribes or other government entities. Our ability to secure required permits and rights-of-way or otherwise proceed with construction of our new projects could encounter opposition from activists who may attempt to delay construction through protests and other means. The loss of these rights, through our inability to acquire or renew right-of-way contracts or otherwise, could have an adverse effect on our business.
MLP structural risks, including risks to unitholders
Our status as a partnership prevents our equity from being included in many prominent equity indices, which reduces the demand for our units from passive investment funds. In addition, some individual investors or investment funds may be unable or unwilling to invest in us for reasons related to our status as a partnership for federal income tax purposes. Limitations on the demand for our units because we are a partnership could affect the trading liquidity and valuation of our units and could make it more difficult for us to raise funds by issuing additional equity.
Because we are a partnership for federal income tax purposes, we are a pass-through entity and are not generally subject to entity-level taxation, and distributions to our unitholders are not taxed as dividends. Instead, our unitholders are treated as partners and allocated their proportionate share of our income, which is reported to them on Schedule K-1 and which could subject them to other taxes, including state and local taxes imposed by the jurisdictions in which we conduct business. This taxation and reporting arrangement is different from and less common than the arrangement that prevails among most publicly traded companies and may create complexities that could discourage some investors or investment funds from investing in us. In addition, the methodologies of most indices of publicly traded equities exclude publicly traded partnerships, and as a result many passive investment funds are prevented from investing in our equity. The inability or unwillingness of individual investors or investment funds to invest in us reduces demand for our units. This lower demand could result in lower trading liquidity in our equity, which could in turn cause greatervolatility in our unit price, a lower unit price, or both. In addition, a reduction in demand for our units could make it less possible or less attractive for us to raise funds through issuances of additional equity, which could in turn reduce our financial flexibility or raise our cost of capital. Our status as a publicly traded partnership is required by our partnership agreement and can only be changed by a vote of our unitholders. A majority of our unitholders may prefer and our management may estimate and advise our unitholders that it is in their best interest that we continue to benefit from the tax attributes of a publicly traded partnership despite these potential impacts of lower demand for our units on our trading liquidity or valuation.
Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units and has other governance differences from typical corporations.
Unitholders’ voting rights are restricted by a provision in our partnership agreement stating that any units held by a person that owns 20% or more of any class of our common units then outstanding, other than our general partner and its affiliates, cannot be voted on any matter. In addition, our partnership agreement contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting our unitholders’ ability to influence our management. As a result of this provision, the trading price of our common units may be lower than other forms of equity ownership due to the absence of a takeover premium in the trading price or other governance differences.
Our unitholders’ liability may not be limited if a court finds that unitholder action constitutes control of our business.
A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership is organized under Delaware law, and we conduct business in a number of other states. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business. Our unitholders could be liable for any and all of our obligations as if they were a general partner if a court or government agency were to determine that we were conducting business in a state but had not complied with that particular state’s partnership statute. Our unitholders’ rights to act with other unitholders to remove or replace the general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement may constitute
“control” of our business which could result in our unitholders being liable for all of our obligations as if they were a general partner.
Our partnership agreement replaces our general partner’s fiduciary duties to our common unitholders with contractual standards governing its duties and restricts the remedies available to our common unitholders for actions that might otherwise constitute breaches of fiduciary duty by our general partner.
Our partnership agreement contains provisions that eliminate the fiduciary standards to which our general partner and its officers and directors would otherwise be held by state fiduciary law and replaces those duties with several different contractual standards. For example, our partnership agreement permits our general partner to make a number of decisions in its sole discretion, free of any duties to us and our unitholders other than the implied contractual covenant of good faith and fair dealing. In addition, our partnership agreement contains provisions that restrict the remedies available to our unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law. For example, our partnership agreement provides that whenever our general partner is permitted or required to make a decision, in its capacity as our general partner, it may make the decision in good faith and will not be subject to any other or different standard imposed by our partnership agreement, Delaware law or any other law, rule or regulation. In addition, our general partner and its officers and directors will not be liable for monetary damages to us or our unitholders resulting from any act or omission taken in good faith. In the absence of bad faith, our general partner will not be in breach of its obligations under our partnership agreement or its fiduciary duties to us or our unitholders if a transaction with an affiliate or the resolution of a conflict of interest is approved in accordance with our partnership agreement.
Tax risks
Our tax treatment or the tax treatment of our unitholders could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
Current law may change so as to cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to entity-level taxation. Further, certain benefits to our unitholders provided by current law could expire or otherwise change. For example, the 20% federal pass-through deduction enacted as part of the Tax Cuts and Jobs Act, which is generally available for ordinary income allocated to investors of publicly traded partnerships or recognized upon the sale of publicly traded partnership units, will expire at the end of 2025, barring further legislative action. From time to time the U.S. government considers substantive changes to the existing federal income tax laws that affect publicly traded partnerships. We are unable to predict whether any such additional legislation or any other tax-related proposals will ultimately be enacted. Moreover, any modification to the federal income tax laws and interpretations thereof may or may not be applied retroactively. Any such changes could adversely impact a unitholder’s investment in our common units.
At the state level, changes in current state law may subject us to additional entity-level taxation by individual states. States frequently evaluate ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of any such taxes may reduce the cash available for distribution to our unitholders.
If the IRS contests the 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 has made no determination as to our status as a partnership for federal income tax purposes. The IRS may adopt positions that differ from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take. A court may not agree with some or all of the positions we take. Any contest with the IRS may adversely impact the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders as the costs will reduce our cash available for distribution.
The IRS may challenge aspects of our proration method, and, if successful, we would be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
We prorate our items of income, gain, loss and deduction between transferors and transferees of our common units each month based upon the ownership of our common units on the first business day of each month, instead of on the basis of the date a particular unit is transferred. The U.S. Department of Treasury and the IRS issued Treasury Regulations that permit publicly traded partnerships to use a monthly simplifying convention that is similar to ours, but they do not specifically authorize all aspects of the proration method we have adopted. If the IRS were to successfullychallenge this method, we could be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
We have adopted certain valuation methodologies in determining a unitholder’s allocations of income, gain, loss and deduction. The IRS may challenge these methodologies or the resulting allocations, and such a challenge could adversely affect the value of our common units.
In determining the items of income, gain, loss and deduction allocable to our unitholders, including when we issue additional units, we must determine the fair market value of our assets. Although we may from time to time consult with professional appraisers regarding valuation matters, we make many fair market value estimates using a methodology based on the market value of our common units as a means to measure the fair market value of our assets. The IRS may challenge these valuation methods and the resulting allocations of income, gain, loss and deduction.
A successful IRS challenge to these methods or allocations could adversely affect the amount, character and timing of taxable income or loss being allocated to our unitholders. It also could affect the amount of gain from our unitholders’ sale of our common units and could have a negative impact on the value of our common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.
Our unitholders are required to pay taxes on their share of our income, including their share of gains on any dispositions of assets, even if they do not receive any distributions from us.
Our unitholders will be required to pay any federal income taxes and, in some cases, state and local income taxes on their share of our taxable income, including any gains we realize from dispositions of assets. This tax obligation will exist even if our unitholders receive no distributions from us, and any distributions our unitholders may receive from us may be less than their share of our taxable income or even less than the actual tax liability that results from that income.
Tax gain or loss on disposition of our common units could be more or less than expected.
If our unitholders sell their common units, they will recognize a gain or loss equal to the difference between the amount realized and their tax basis in those common units. Prior distributions to our unitholders in excess of the total net taxable income they were allocated for a common unit, which decreased their tax basis in that common unit, will, in effect, become taxable income to our unitholders if the common unit is sold at a price greater than their tax basis in that common unit, even if the price they receive is less than their original cost. A substantial portion of the amount realized, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depreciation recapture. In addition, because the amount realized includes a unitholder’s share of nonrecourse liabilities, if our unitholders sell their common units, they may incur a tax liability in excess of the amount of cash received from the sale.
Tax-exempt entities and foreign persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, such as employee benefit plans, individual retirement accounts (known as IRAs) and foreign persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them.
Cash distributions paid to foreign persons will be reduced by withholding taxes at the highest applicable effective U.S. tax rate, and foreign persons will be required to file U.S. federal tax returns and pay tax on their share of our taxable income allocated to them. Upon the sale, exchange or other disposition of a common unit of a publicly traded partnership by a foreign person, the transferee is generally required to withhold 10% of the amount realized on such sale, exchange or other disposition if any portion of the gain on such sale, exchange or other disposition would be treated as effectively connected with a U.S. trade or business. Beginning in 2023, the IRS has clarified the broker is generally responsible for withholding 10% of the gross proceeds upon sale of an investment in a publicly traded partnership by a foreign investor. Distributions to foreign persons may also be subject to additional withholding of 10% under these rules to the extent a portion of a distribution is attributable to an amount in excess of our cumulative net income that has not previously been distributed.
Our unitholders may be subject to state and local taxes and return filing requirements in states where they do not live as a result of investing in our common units.
In addition to federal income taxes, our unitholders may be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if they do not live in any of those jurisdictions. Our unitholders may be required to file tax returns and pay taxes in some or all of these various jurisdictions or be subject to penalties for failure to comply with those requirements. We currently own assets and conduct business in 16 states, most of which impose a personal income tax.
If the IRS makes audit adjustments to our income tax returns, it 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.
If the IRS makes audit adjustments to our income tax returns, it may assess and collect any taxes (including any applicable penalties and interest) resulting from such audit adjustment directly from us. Generally, we expect to elect to have our unitholders take such audit adjustment into account in accordance with their interests in us during the tax year under audit, but there can be no assurance that such election will be made, or applicable, in all circumstances. If we are unable to have our unitholders take such audit adjustment into account in accordance with their interests in us during the tax year under audit, our current unitholders may bear some or all of the economic burden 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 and interest, our cash available for distribution to our unitholders might be substantially reduced.
General risk factors
Our business requires the recruitment and retention of a skilled workforce, and difficulties attracting and retaining talent could result in a failure to efficiently operate our business and execute our strategies.
Our operations and management require the recruitment and retention of a skilled workforce, including engineers, technical personnel and other professionals. We compete with other companies both within and outside the energy industry for this skilled workforce. Successfully competing for talented employees necessary to operate our business may result in increased costs, which could adversely affect our business.
As our employees, including much of our management team, reach retirement age and elect to retire, we may losevaluable skills and institutional knowledge that have been developed over many years of service. If we are unable to transfer knowledge successfully to new employees or are otherwise unable to recruit and retain talented personnel, we could experience increased costs or we could encounter other difficulties in running our business efficiently.
Our business could be affected adversely by union disputes and strikes or work stoppages by our unionized employees.
As of December 31, 2022, approximately 13% of our workforce was represented by the United Steelworkers and covered by a collective bargaining agreement expiring January 2026 . We could experience a work stoppage in the future as a result of disagreements with the labor union. A prolonged work stoppage could have an adverse effect on our business.
Dynamic energy markets provide both challenges and opportunities. We own the longest refined products pipeline in the country and can access nearly 50% of the nation’s refining capacity. During 2022, we shipped record refined products volumes as customers took advantage of our network’s extensive connectivity to overcome various supply disruptions in the markets we serve.
Creating and Returning Value to Investors. Our resilient business model continues to provide strong cash flow to consistently pay distributions. We recognize that investors value steady increases to the cash distribution and currently target annual distribution growth of 1% for 2023. We expect to continue to generate free cash flow after paying distributions to allocate in a manner that creates value for our investors.
We continue to pursue investment opportunities that meet our disciplined financial requirements. For example, we have completed a number of small, bolt-on projects over the past year, including recent pipeline expansions to New Mexico and Colorado. Additionally, during 2022, we launched an expansion of our refined products pipeline to El Paso, Texas, which will connect more supply to growing markets in Texas, Arizona and Mexico and is supported by commitments from high-quality counterparties.
While we expect to continue finding opportunities to invest in new projects, attractiveopportunities have been more limited over the last few years. This more limited capital investment environment, along with the fact that we believe the value of our equity has not reflected the economic potential of our company, has allowed us to simply invest in ourselves by repurchasing equity.
Through our equity repurchase program, we have reduced the number of our outstanding units by 11% over the last three years, providing meaningful growth in earnings and distributable cash flow on a per unit basis.
We believe the combination of investing in good projects as they are available, opportunistically repurchasing units and providing an attractive current cash distribution is a strategy that will allow us to continue creating meaningful value for our investors.
In total, we delivered over $1.3 billion to our investors in 2022 via opportunistic equity repurchases and our attractive cash distribution.
Our Role in Energy Transition. We will remain an important part of a successful energy transition. The services we provide are vital to ensuring our communities and economies function while the U.S. and the world pursue a transition from fossil fuels. Supported by industry and government forecasts, we believe demand for the fuels we deliver will remain steady for the foreseeable future and essential for many more decades, and likely beyond.
Continuing to operate our business in a safe and responsible manner is a fundamental priority. We also believe that we must continue to optimize our business and adapt to future realities. However, we expect energy transition is likely to take longer and be more dynamic than many may currently predict.
For any transition to be truly successful, all of the costs and benefits must be weighed to seek a balance among policy objectives, technological capability and market acceptance in order to make sustainable progress.
Recent Developments
Sale of Independent Terminals Network. On June 8, 2022, we completed the sale of our independent terminals network comprised of 26 refined petroleum products terminals in the southeastern U.S. to Buckeye Partners, L.P. for $446.2 million, including final working capital adjustments.
Impairment of Double Eagle Investment. In December 2022, as a result of the non-renewal on existing terms of customer commitments that expire in 2023 and reduced demand for transportation of condensate from the Eagle Ford basin, we recognized an impairment in our Double Eagle joint venture investment of $58.4 million.
Distribution. In January 2023, our board declared a quarterly distribution of $1.0475 per unit for the period of October 1, 2022 through December 31, 2022. This quarterly distribution was paid on February 14, 2023 to unitholders of record on February 7, 2023.
Results of Operations
We believe that investors benefit from having access to the same financial measures utilized by management. Operating margin, which is presented in the following table, is an important measure used by management to evaluate the economic performance of our core operations. Operating margin is not a U.S. generally accepted accounting principles (“GAAP”) measure, but the components of operating margin are computed using amounts that are determined in accordance with GAAP. A reconciliation of operating margin to operating profit, which is its nearest comparable GAAP financial measure, is included in the following table. Operating profit includes expense items, such as depreciation, amortization and impairment expense and G&A expense, which management does not focus on when evaluating the core profitability of our operating segments. Additionally, product margin, which management primarily uses to evaluate the profitability of our commodity-related activities, is provided in this table. Product margin is a non-GAAP measure but the components of product sales revenue and cost of product sales are determined in accordance with GAAP. Our blending, fractionation and other commodity-related activities generate significant revenue. However, we believe the product margin from these activities, which takes into account the related cost of product sales, better represents its importance to our results of operations.
Year Ended December 31, 2021 Compared to Year Ended December 31, 2022
Year Ended December 31,
Variance
Favorable (Unfavorable)
$ Change
% Change
Financial Highlights ($ in millions, except operating statistics)
Transportation and terminals revenue:
Refined products
Crude oil
Intersegment eliminations
Total transportation and terminals revenue
Affiliate management fee revenue
Operating expenses:
Refined products
Crude oil
Intersegment eliminations
Total operating expenses
Product margin:
Product sales revenue
Cost of product sales
Product margin
Other operating income (expense)
Earnings of non-controlled entities
Operating margin
Depreciation, amortization and impairment expense
G&A expense
Operating profit
Interest expense (net of interest income and interest capitalized)
Gain on disposition of assets
Other (income) expense
Income from continuing operations before provision for income taxes
Provision for income taxes
Income from continuing operations
Income from discontinued operations (including gain on disposition of assets of $164.0 million in 2022)
Net income
Operating Statistics
Refined products:
Transportation revenue per barrel shipped
Volume shipped (million barrels):
Gasoline
Distillates
Aviation fuel
Liquefied petroleum gases
Total volume shipped
Crude oil:
Magellan 100%-owned assets:
Transportation revenue per barrel shipped (1)
Volume shipped (million barrels) (1)
Terminal average utilization (million barrels per month)
Select joint venture pipelines:
BridgeTex - volume shipped (million barrels) (2)
Saddlehorn - volume shipped (million barrels) (2)
(1) Includes shipments related to our crude oil marketing activities.
(2) These volumes reflect total shipments for these joint ventures, which are owned 30% by us.
Transportation and terminals revenue increased by $76.9 million, resulting from:
• an increase in refined products revenue of $69.7 million primarily due to higher average transportation rates and higher volumes. The higher average rate per barrel in the current year was favorably impacted by the 2021 and 2022 mid-year tariff adjustments as well as a higher proportion of long-haul shipments, which move at higher rates. Volume increased between periods as a result of additional contributions from our Texas pipeline expansion projects, higher shipments on our South Texas pipeline segment as well as continued demand recovery from pandemic levels. Higher tender deduction revenue that benefited from increased commodity prices mainly offset less storage revenue due to lower utilization and rates following recent contract expirations; and
• an increase in crude oil revenue of $7.5 million primarily due to higher terminal throughput fees as a result of more customers utilizing a simplified structure for service in the Houston area and higher tender deduction revenue due to higher commodity prices. These favorable items were partially offset by less storage revenue from lower rates and utilization in the current backwardated market and decreased transportation revenues as overall lower tariff rates offset higher shipments on our Houston distribution system, in part due to a recent pipeline connection.
• an increase in refined products expenses of $14.8 million primarily due to higher power costs resulting from the benefit of gains on our power hedges in the prior year driven by the 2021 winter storms and more long-haul shipments in 2022, as well as higher asset integrity spending related to the timing of maintenance work. These higher costs were partially offset by more favorable product overages in the current period (which reduce operating expense); and
• an increase in crude oil expenses of $8.2 million primarily due to less favorable product overages in 2022.
Product margin increased $50.0 million primarily due to improved margins and higher volumes on our gas liquids blending activities as well as additional crude oil marketing opportunities in the current year.
Other operating income was favorable $2.5 million primarily due to settlement of our claims for expense reimbursement related to historical product contaminations.
Earnings of non-controlled entities decreased $7.0 million primarily due to lower average rates on the Saddlehorn pipeline and lower MVP earnings as a result of the sale of a portion of our interest in April 2021, partially offset by additional deficiency revenue recognized for the BridgeTex and Double Eagle pipelines.
Depreciation, amortization and impairment expense increased $64.9 million primarily due to an impairment of $58.4 million related to our Double Eagle joint venture investment and the timing of asset retirements.
G&A expense increased $34.4 million primarily due to expenses related to the retirement agreement for our former chief executive officer, higher incentive compensation costs resulting from overall improved financial results, as well as increased technology fees.
Interest expense, net of interest income and interest capitalized, increased $0.9 million. Our average outstanding debt increased from $5.1 billion in 2021 to $5.2 billion in 2022. Our weighted average interest rate was 4.3% in 2022 compared to 4.4% in 2021.
Gain on disposition of assets was $74.1 million lower primarily due to the sale of a portion of our interest in MVP in 2021.
Other expense was favorable by $0.6 million as lower amounts recognized for certain legal matters were primarily offset by higher pension settlement expenses recognized in 2022.
Income from discontinued operations increased by $127.5 million primarily due to the $164.0 million gain recognized on the sale of the independent terminals network, partially offset by lower contributions from these assets once the sale closed in June 2022.
For a comparative discussion of the years ended December 31, 2020 and 2021, see Part II, Item 7. “ Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations ” in our 2021 Annual Report on Form 10-K .
Adjusted EBITDA, Distributable Cash Flow and Free Cash Flow
In the following tables, we present the financial measures of adjusted EBITDA, distributable cash flow (“DCF”) and free cash flow (“FCF”), which are non-GAAP measures. These measures include the results of our discontinued operations.
Adjusted EBITDA is an important measure utilized by management and the investment community to assess the financial results of a company. A reconciliation of adjusted EBITDA to net income, the nearest comparable GAAP measure, is included in the table below.
Our partnership agreement requires that all of our available cash, less amounts reserved by our board, be distributed to our unitholders. DCF is used by management to determine the amount of cash that our operations generated, after maintenance capital spending, that is available for distribution to our unitholders, as well as a basis for recommending to our board the amount of distributions to be paid each period. We also use DCF as the basis for calculating our performance-based equity long-term incentive compensation. A reconciliation of DCF to net income, the nearest comparable GAAP measure, is included in the table below.
FCF is a financial metric used by many investors and others in the financial community to measure the amount of cash generated by a company during a period after accounting for all investing activities, including both maintenance and expansion capital spending, as well as proceeds from divestitures. We believe FCF is important to the financial community as it reflects the amount of cash available for distributions, additional expansion capital opportunities, equity repurchases, debt reduction or other partnership uses. Reconciliations of FCF to net income and to net cash provided by operating activities, which are the nearest comparable GAAP measures, are included in the following tables.
Since the non-GAAP measures presented here include adjustments specific to us, they may not be comparable to similarly-titled measures of other companies.
Adjusted EBITDA, DCF and FCF are non-GAAP measures. A reconciliation of each of these measures to net income for the years ended December 31, 2021 and 2022 is as follows (in millions):
Year Ended December 31,
Net income
Interest expense, net
Depreciation, amortization and impairment (1)
Equity-based incentive compensation (2)
Gain on disposition of assets (3)
Commodity-related adjustments:
Derivative (gains) losses recognized in the period associated with future transactions (4)
Derivative gains (losses) recognized in previous periods associated with transactions completed in the period (4)
Inventory valuation adjustments (5)
Total commodity-related adjustments
Distributions from operations of non-controlled entities in excess of earnings
(1) Depreciation, amortization and impairment expense is excluded from DCF to the extent it represents a non-cash expense.
(2) Because we intend to satisfy vesting of unit awards under our equity-based long-term incentive compensation plan with the issuance of common units, expenses related to this plan generally are deemed non-cash and excluded for DCF purposes. The amounts above have been reduced by cash payments associated with the plan, which are primarily related to tax withholdings.
(3) Gains on disposition of assets are excluded from DCF to the extent they are not related to our ongoing operations, while proceeds from disposition of assets exclude the related gains to the extent they are already included in our calculation of DCF.
(4) Certain derivatives have not been designated as hedges for accounting purposes and the mark-to-market changes of these derivatives are recognized currently in net income. We exclude the net impact of these derivatives from our determination of DCF until the transactions are settled and, where applicable, the related products are sold.
(5) We adjust DCF for lower of average cost or net realizable value adjustments related to inventory and firm purchase commitments as well as market valuation of short positions recognized each period as these are non-cash items. In subsequent periods when we sell or purchase the related products, we recognize these valuation adjustments in DCF.
(6) Maintenance capital expenditures maintain our existing assets and do not generate incremental DCF (i.e. incremental returns to our unitholders). For this reason, we deduct maintenance capital expenditures to determine DCF.
(7) Includes additions to property, plant and equipment (excluding maintenance capital and capital-related changes in accounts payable and other current liabilities), acquisitions and investments in non-controlled entities, net of distributions from returns of investments in non-controlled entities and deposits from undivided joint interest third parties.
A reconciliation of FCF to net cash provided by operating activities for the years ended December 31, 2021 and 2022, is as follows (in millions) :
Year Ended December 31,
Net cash provided by operating activities
Changes in operating assets and liabilities
Net cash provided by investing activities
Payments associated with settlement of equity-based incentive compensation
Settlement cost, amortization of prior service credit and actuarial loss
Changes in accrued capital items
Commodity-related adjustments (1)
Other
Free cash flow
Distributions paid
Free cash flow after distributions
(1) Please refer to the preceding table for a description of these commodity-related adjustments.
Liquidity and Capital Resources
Cash Flows and Capital Expenditures
Operating Activities. Net cash provided by operating activities was $1,196.2 million and $1,141.3 million for the years ended December 31, 2021 and 2022, respectively. The $54.9 million decrease from 2021 to 2022 was due to changes in our working capital, decreases in income from continuing operations, partially offset by adjustments for non-cash items and distributions in excess of earnings of our non-controlled entities.
Investing Activities. Net cash provided by investing activities for the year ended December 31, 2021 and 2022 was $118.1 million and $274.4 million, respectively, including $148.6 million and $175.3 million used for capital expenditures for those same periods in 2021 and 2022, respectively. Also, during 2022, we sold our independent terminals network for $446.2 million inclusive of final working capital adjustments. During 2021, we sold a portion of our interest in MVP for cash proceeds of $272.1 million.
Financing Activities. Net cash used in financing activities for the years ended December 31, 2021 and 2022 was $1,327.7 million and $1,417.8 million, respectively. During 2022, we paid distributions of $870.0 million to our unitholders and made common unit repurchases of $462.9 million. Additionally, we had net commercial paper payments of $76.0 million. During 2021, we paid distributions of $906.4 million to our unitholders and made common unit repurchases of $523.1 million. Additionally, we had net commercial paper borrowings of $108.0 million.
The quarterly distribution amount related to fourth-quarter 2022 earnings was $1.0475 per unit, which was paid in February 2023. Based on the number of common units currently outstanding and our current quarterly distribution, total distributions paid to our unitholders related to 2023 earnings would be approximately $852 million. Management believes we will have sufficient DCF to fund these distributions.
For a discussion of cash flows for the year ended December 31, 2020, see Part II, Item 7. “ Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources ” in our 2021 Annual Report on Form 10-K .
Capital Requirements
Capital spending for our business consists primarily of:
• Maintenance capital expenditures. These expenditures include costs required to maintain equipment reliability and safety and to address environmental and other regulatory requirements rather than to generate incremental DCF; and
• Expansion capital expenditures. These expenditures are undertaken primarily to generate incremental DCF and include costs to acquire additional assets to grow our business and to expand or upgrade our existing facilities and to construct new assets, which we refer to collectively as organic growth projects. Organic growth projects include, for example, capital expenditures that increase storage or throughput volumes or develop pipeline connections to new supply sources.
During 2022, our maintenance capital spending was $81.9 million. For 2023, we expect to spend approximately $90.0 million on maintenance capital projects.
During 2022, we spent $83.0 million for our expansion capital projects and in conjunction with our joint ventures. Based on the progress of expansion projects already committed, we expect to spend approximately $110.0 million in 2023 and $40.0 million in 2024 to complete our current slate of expansion capital projects.
Liquidity
Cash generated from operations is a key source of liquidity for funding debt service, maintenance capital expenditures, quarterly distributions and repurchases of common units. Additional liquidity for purposes other than quarterly distributions, such as expansion capital expenditures, is available through borrowings under our commercial paper program and revolving credit facility, as well as from other borrowings or issuances of debt or common units (see Note 10 – Debt and Note 19 – Partners’ Capital and Distributions in Item 8. Financial Statements and Supplementary Data of this report for detail of our borrowings and changes in partners’ capital).
Off-Balance Sheet Arrangements
None.
Other Items
Leadership Changes. In April 2022, Michael N. Mears retired from his positions of President and Chief Executive Officer, and our board elected Aaron L. Milford as Chief Executive Officer and President. Mr. Milford served as Chief Operating Officer since 2019. He served as Senior Vice President and Chief Financial Officer from 2015 to 2019 and various positions of increasing responsibility since joining us and our predecessor in 1995.
In August 2022, Robert L. Barnes, Senior Vice President of Commercial - Crude Oil, retired from his position after 34 years of service. Our board elected Kyle T. Krshka as Senior Vice President of Commercial - Crude Oil in November 2022. Mr. Krshka served as Vice President of Commercial - Marine, Independent Terminals & Commodities since 2020 and various positions of increasing responsibility since joining us in 2016.
In December 2022, Melanie A. Little, Executive Vice President, Chief Operating Officer, announced her resignationeffective January 1, 2023 to pursue another opportunity.
Executive Officer Promotions. Two members of our senior management team were promoted effective June 1, 2022. Jeff L. Holman became Executive Vice President in addition to his titles of Chief Financial Officer and Treasurer. Michael J. Aaronson, who previously held the position of Senior Vice President of Business Development, became Executive Vice President, Chief Commercial Officer.
Board of Director Changes. Michael N. Mears retired from his position of Chair of the Board of Directors in April 2022 and our board elected Barry R. Pearl, our previous independent Lead Director, as Chair of the Board and also elected Aaron L. Milford as a member of our board. In April 2022, Robert G. Croyle retired from our board after 13 years of service. Following Mr. Croyle’s retirement, Sivasankaran Somasundaram was elected as an independent board member beginning in May 2022.
Pipeline Tariff Changes. The FERC regulates the rates charged on interstate common carrier pipelines. The tariff rates on approximately 30% of our refined products shipments have been regulated by the FERC primarily through an annual index methodology, and nearly all the remaining rates are adjustable at our discretion based on market factors. Based on the preliminary PPI-FG estimate for 2022, the ceiling level for our index-based rates will increase by 13.4%. However, we continue to evaluate increases to our index and market-based rates and currently expect to increase all of our refined products rates by an average of approximately 8% on July 1, 2023. Most of the tariffs on our long-haul crude oil pipelines are established at negotiated rates that generally provide for annual adjustments in line with changes in the FERC index, subject to certain modifications. We expect to increase the rates on our long-haul crude oil pipelines between 2% and 5% in July 2023.
Commodity Derivative Agreements . Certain of our business activities result in our owning various commodities, which exposes us to commodity price risk. We use forward physical commodity contracts and derivative instruments to hedge against changes in prices of commodities that we expect to sell or purchase in future periods.
For further information regarding the quantities of refined products and crude oil hedged at December 31, 2022 and the fair value of open hedge contracts at that date, please see Item 7A. Quantitative and Qualitative Disclosures about Market Risk .
Related Party Transactions. See Note 18 – Related Party Transactions in Item 8. Financial Statements and Supplementary Data of this report for detail of our related party transactions.
Critical Accounting Estimates
Our management has discussed the development and selection of the following critical accounting estimates with the audit committee of our board, which has reviewed and approved these disclosures.
Pension Obligations
We sponsor a pension plan covering union employees and a pension plan for non-union employees. Various estimates and assumptions directly affect net periodic benefit expense and obligations for these plans. These estimates and assumptions include the expected long-term rate of return on plan assets, discount rates and the expected rate of compensation increases. Management reviews these assumptions annually and makes adjustments as necessary.
The discount rate directly affects the measurement of the benefit obligations of our pension benefit plans. The objective of the discount rate is to determine the amount, if invested at the December 31 measurement date in a portfolio of high-quality fixed income securities, that would provide the necessary cash flows to make benefit payments when due. Decreases in the discount rate increase the obligation and generally increase the related expense, while increases in the discount rate have the opposite effect. Changes in general economic and market conditions that affect interest rates on long-term high-quality fixed income securities as well as the duration of our plans’ liabilities affect our estimate of the discount rate.
We estimate the long-term expected rate of return on plan assets using expectations of capital market results, which includes an analysis of historical results as well as forward-looking projections. We base these capital market expectations on a long-term period and on our investment strategy and asset allocation. We develop our estimates using input from several external sources, including consultation with our third-party independent investment consultant. We develop the forward-looking capital market projections using a consensus of expectations by economists for inflation and dividend yield, along with expected changes in risk premiums. Because our determined rate is an estimate of future results, it could be significantly different from actual results. The expected rate of return on plan assets are long-term in nature; therefore, short-term market performance does not significantly affect our estimated long-term expected rate of return.
The expected rate of compensation increases represents average long-term salary increases. An increase in this rate causes the pension obligation and expense to increase.
The following table presents the estimated increase (decrease) in net periodic benefit expense and obligations that would result from a 1% change in the specified assumption (in millions):
Benefit Expense
Benefit Obligation
1% Increase
1% Decrease
1% Increase
1% Decrease
Pension benefits:
Discount rate
Expected long-term rate of return on plan assets
Rate of compensation increase
The following table sets forth the increase (decrease) in our pension funding based on our current funding policy assuming a 1% change in the specified criterion (in millions):
1% Increase
1% Decrease
Rate of compensation increase
Impairment of Long-Lived Assets, Goodwill and Investments
Impairment of Long-Lived Assets. Long-lived assets, including fixed assets and intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such indicators include, among others, the nature of the asset, the projected future economic benefit of the asset, changes in regulatory and political environments and historical and future cash flow and profitability measurements. If the carrying value of an asset exceeds the future undiscounted cash flows expected from the asset, we recognize an impairment charge for the excess of carrying value of the asset over its estimated fair value.
Goodwill . The goodwill relating to each of our reporting units is tested for impairment annually as well as when an event or change in circumstances indicates an impairment may have occurred. For purposes of performing the impairment test for goodwill, our reporting units are our refined products and crude oil segments. Under GAAP, we have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of one of our reporting units is greater than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, we are not required to perform any further testing. However, if we conclude otherwise, we perform the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value of the reporting unit is less than its carrying value, an impairmentloss is recorded to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value. Based on our qualitative assessments performed, we determined goodwill was not impaired.
When indicators of impairment are identified, determination as to whether and how much goodwill or long-lived assets are impaired involves management estimates on highly uncertain matters such as future commodity prices, the effects of inflation and technology improvements on operating expenses and the outlook for national or regional market supply and demand conditions. We base the impairment reviews and calculations used in our impairment tests on assumptions that are consistent with our business plans and long-term investment decisions. See Note 6 – Property, Plant and Equipment, Goodwill and Other Intangibles in Item 8. Financial Statements and Supplementary Data for additional information regarding impairments of goodwill and long-lived assets.
Investments. We evaluate investments in non-controlled entities for impairment whenever events or circumstances indicate that there is an other-than-temporary loss in value of the investment. When evidence of loss in value has occurred, we compare our estimate of fair value of the investment to the carrying value of the investment to determine whether an impairment has occurred. If the estimated fair value is less than the carrying value and we consider the decline in value to be other-than-temporary, the excess of the carrying value over the fair value is recognized in our consolidated financial statements as an impairment charge.
In December 2022, we determined the fair value of our investment in Double Eagle was less than the carrying value and recognized an impairment charge of $58.4 million.
