Item 1A. Risk Factors
Summary of Risk Factors
The following summary outlines our Risk Factors, which we have grouped into risk categories. These summarized Risk Factors should be read in conjunction with the detailed Risk Factors that follow:
Risks Related to Our Energy Transition Infrastructure Business
• We can provide no assurance that we will be successful in implementing our energy transition infrastructure business due to competition and other factors, which could limit our ability to grow and extend our dependence on Mesquite and our midstream business.
• We may be unable to fund our future capital requirements related to the Levo JV and the HOBO Transaction.
Table of Contents
Risks Related to Our Midstream Business
• Mesquite accounts for the majority of our total revenue in general and all of our revenue relating to the operation of our midstream business, as a result, any development that materially and adversely affects Mesquite’s business, financial condition, cash flows or results of operations could have a material and adverse impact on us.
• All of our midstream assets are located in the Eagle Ford Shale in Texas, making us vulnerable to risks associated with operating in one major geographic area.
• Distributions we receive from Carnero JV may fluctuate from quarter to quarter, which could adversely affect our cash flows and ability to pay our payables timely.
• As a non-operator, our development of successful operations relies extensively on third-parties, including Mesquite and Targa, which could adversely affect our business, financial condition and results of operations
Risks Related to Financing and Credit Environment
• Our independent registered public accounting firm has expressed doubt about our ability to continue as a going concern.
• Our Credit Agreement has substantial prepayment requirements, other restrictions and financial covenants.
• We may not be able to extend, replace or refinance our Credit Agreement on terms reasonably acceptable to us, or at all, which could materially and adversely affect our business, liquidity, cash flows and prospects.
Risks Related to Our Cash Distributions
• You will not receive cash distributions on your common units until we are able to redeem 100% of the outstanding Class C Preferred Units, as a result, you are unlikely to receive cash distributions on your common units for the foreseeable future.
• Our Credit Agreement restricts us from paying any distributions on our outstanding common units.
Risks Related to Regulatory Compliance
• Increased regulation of hydraulic fracturing could result in reductions or delays in the production of natural gas, NGLs and oil by Mesquite, which could reduce the throughput on our facilities and adversely impact our revenues.
Risks Inherent in an Investment in Our Common Units
• In a liquidation, the preferential rights of the holder of our Class C Preferred Units could result in common unitholders losing their entire investment.
• We are currently not in compliance with the NYSE American listing standards. If our common units are delisted, it could result in even further reductions in the trading price and liquidity of our common units, which could materially adversely affect our ability to raise capital or pursue strategic transactions on acceptable terms, or at all.
• Certain events may result in our general partner exercising its limited call right, which may require common unitholders to sell their common units at an undesirable time or price.
• Stonepeak Catarina and its affiliates, including our general partner, will have conflicts of interest with us. They will not owe any fiduciary duties to us or our common unitholders, but instead will owe us and our common unitholders limited contractual duties, and they may favor their own interests to the detriment of us and our other common unitholders.
Table of Contents
• Our partnership agreement replaces our general partner’s fiduciary duties to our common unitholders with contractual standards governing its duties.
• We are able to issue additional units without common unitholder approval, which would dilute unitholder interests.
Tax Risks
• The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
• Our common unitholders’ share of our income will be taxable to them even if they do not receive any cash distributions from us. You will not receive cash distributions on your common units until we are able to redeem 100% of the outstanding Class C Preferred Units, as a result, you are unlikely to receive cash distributions on your common units for the foreseeable future.
Other Risks
• The impact of the Russian invasion of Ukraine on the global economy, energy supplies and raw materials is uncertain, but may prove to negatively impact our business and operations.
Risk Factors
Our business involves a high degree of risk. Limited partner interests are inherently different from the capital stock of a corporation, although many of the business risks to which we are subject are similar to those that would be faced by a corporation engaged in a similar business. You should consider and read carefully all of the risks and uncertainties described below, together with all of the other information contained in this Form 10-K, including the financial statements and the related notes appearing at the end of this Form 10-K. If any of the following risks, or any risk described elsewhere in this Form 10-K, were to occur, our business, financial condition or results of operations could be adversely affected. If any of the following risks, or any risk described elsewhere in this Form 10-K, were to occur, our business, financial condition or results of operations could be adversely affected. The risks below are not the only ones facing the Partnership. Additional risks not currently known to us or that we currently deem immaterial may also adversely affect us. This Form 10-K also contains forward-looking statements, estimates and projections that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of specific factors, including the risks described below. Please read “Cautionary Note Regarding Forward-Looking Statements.”
Risks Related to Our Energy Transition Infrastructure Business
We can provide no assurance that we will be successful in implementing our energy transition infrastructure business due to competition and other factors, which could limit our ability to grow and extend our dependence on Mesquite and our midstream business .
Part of our business strategy is to grow our business through the acquisition and development of infrastructure critical to the transition of energy supply to lower carbon sources. This will involve identifying opportunities to offer services to third parties with our existing assets or constructing or acquiring new assets.
We are currently pursuing energy transition infrastructure opportunities and while we have entered into a Framework Agreement (as amended by the Framework Amendment, the “Framework Agreement”) with HOBO to pursue the development of renewable fuels facilities and completed the formation of Levo Mobility LLC (“Levo”), a joint venture with Nuvve Holding Corp. and Stonepeak Rocket Holdings LP, (such joint venture, “the Levo JV”) we have not developed any project in connection with this business strategy. We can provide no assurance that we will be successful in implementing our energy transition infrastructure business, which could limit our ability to grow and extend our dependence on Mesquite and our midstream business. Moreover, we may fail to realize the anticipated benefit of the Levo JV, any project under the Framework Agreement, which can be terminated in June 2023, or any acquisition we make. Furthermore, if we do make acquisitions, we may be unable to integrate businesses we acquire effectively. Finally, to the extent that Stonepeak, SP Holdings or our general partner are successful in pursuing energy transition opportunities, there is no guarantee that such will be offered to us. Please read “—Risks Inherent in an Investment in Our
Table of Contents
Common Units—Our general partner and its affiliates, including SP Holdings and Stonepeak Catarina, may not allocate corporate opportunities to us.”
We may be unable to fund our future capital requirements related to the Levo JV and the HOBO Transaction.
Upon completion of certain milestones or execution of specific contracts, we will be asked to provide capital to fulfill our funding and reimbursement obligations in connection with the Levo JV. Additionally, upon completion of certain milestones related to the Initial Project (as defined in the Framework Agreement), we will have the option, in our sole discretion, to provide funding related to the transactions contemplated by the Framework Agreement (the “HOBO Transaction”). If we cannot provide capital for such opportunities from cash on hand or borrowings under our Credit Agreement, we may need to raise additional funds through the issuance of securities, including equity, debt or a combination of both. Additional financing may not be available to us on favorable terms, or at all. If we are unable to access the capital markets and other adequate financing is not available to us on acceptable terms, we may be unable to fund these capital requirements, which could adversely affect our business and limit our ability to expand and grow.
Risks Related to Our Midstream Business
Mesquite accounts for the majority of our total revenue in general and all of our revenue relating to the operation of our midstream business, as a result, any development that materially and adversely affects Mesquite’s business, financial condition, cash flows or results of operations could have a material and adverse impact on us.
Mesquite is our most significant customer and accounted for 100% of our total revenue for the year ended December 31, 2022. We are dependent on Mesquite as our only current customer for utilization of the Catarina Gathering System. In addition, Mesquite is the primary customer for utilization of the Carnero Gathering Line and the Raptor Plant. We expect that a majority of revenues relating to these assets will be derived from Mesquite for the foreseeable future. As a result, any event, whether in our area of operations or otherwise, that adversely affects Mesquite’s production, drilling and completion schedule, financial condition, leverage, market reputation, liquidity, results of operations or cash flows could have a material and adverse impact on us. Accordingly, we are indirectly subject to the business risks of Mesquite, including, among others:
• a reduction in or slowing of Mesquite’s development program, especially on Mesquite’s Catarina Asset, which would directly and adversely impact demand for our gathering and processing services;
• a decline in the price of natural gas, NGLs or oil, which have been extremely volatile prior to, and during the pendency of, the COVID-19 pandemic;
• Mesquite’s ability to finance its operations and development activities;
• the availability of capital on an economic basis to fund Mesquite’s exploration and development activities;
• Mesquite’s ability to replace reserves;
• Mesquite’s drilling and operating risks, including potential environmental liabilities;
• transportation capacity restraints and interruptions;
• adverse effects of governmental and environmental regulation; and
• losses from pending or future litigation.
Because of the natural decline in production from existing wells, our success depends, in part, on Mesquite’s ability to replace declining production. Any decrease in volumes of natural gas, NGLs and oil that Mesquite produces or any decrease in the number of wells that Mesquite completes could reduce throughput volumes that could adversely affect our business and operating results.
The volumes that support our facilities depend on the level of production from wells connected to our facilities, which may be less than expected and will naturally decline over time.
Table of Contents
In addition, volumes from completed wells will naturally decline and our cash flows associated with these wells will also decline over time. In order to maintain or increase throughput levels on our facilities, we must obtain new sources of natural gas, NGLs and oil from Mesquite or other third parties. The primary factors affecting our ability to obtain additional sources of natural gas, NGLs and oil include (i) the success of Mesquite’s drilling activity in our areas of operation, (ii) Mesquite’s acquisition of additional acreage and (iii) our ability to obtain additional dedications of acreage from Mesquite or new dedications of acreage from other third parties.
We have no control over Mesquite’s or other producers’ levels of development and completion activity in our areas of operation, the amount of reserves associated with wells connected to our facilities or the rate at which production from a well declines. We have no control over Mesquite or other producers or their development plan decisions, which are affected by, among other things:
• the availability and cost of capital;
• prevailing and projected prices for natural gas, NGLs and oil;
• demand for natural gas, NGLs and oil;
• levels of reserves;
• geologic considerations;
• environmental or other governmental regulations, including the availability and maintenance of drilling permits and the regulation of hydraulic fracturing; and
• the costs of producing natural gas, NGLs and oil and the availability and costs of drilling rigs and other equipment.
Fluctuations in energy prices can also greatly affect the development of reserves. Declines in commodity prices could have a negative impact on Mesquite’s development and production activity, and if sustained, could lead Mesquite to materially reduce its drilling and completion activities. Sustained reductions in development or production activity in our areas of operation could lead to reduced utilization of our services.
Due to these and other factors, even if reserves are known to exist in areas served by our facilities, Mesquite and other producers may choose not to develop, or be prohibited from developing, those reserves. If reductions in development activity result in our inability to maintain the current levels of throughput on our facilities, those reductions could adversely affect our business and operating results.
Interruptions in operations at our facilities or facilities that Targa operates on behalf of Carnero JV may adversely affect our business, financial condition, cash flows and results of operations.
Any significant interruption at any of our facilities or the facilities that Targa operates on behalf of Carnero JV, or in our ability or Targa’s ability on behalf of Carnero JV, as applicable, to gather, treat or process natural gas, NGLs and oil, would adversely affect our business, financial condition, cash flows and results of operations. Operations at impacted facilities could be partially or completely shut down, temporarily or permanently, as a result of circumstances not within our control, such as:
• unscheduled turnarounds or catastrophic events at physical plants or pipeline facilities;
• restrictions imposed by governmental authorities or court proceedings;
• labor difficulties that result in a work stoppage or slowdown;
• a disruption or decline in the supply of resources necessary to operate a facility;
• damage to facilities resulting from natural gas, NGLs and oil that do not comply with applicable specifications; and
Table of Contents
• inadequate transportation or market access to support production volumes, including lack of availability of pipeline capacity.
We may not be able to attract additional third-party volumes, which could limit our ability to grow and would increase our dependence on Mesquite.
Part of our long-term strategy includes identifying additional opportunities to offer gathering, processing and transportation services to other third parties. Our ability to increase throughput on our facilities and any related revenue from third parties is subject to numerous factors beyond our control, including competition from third parties and the extent to which we have available capacity when requested by third parties. To the extent that we lack available capacity on our facilities for third-party volumes, we may not be able to compete effectively with third-party gathering or processing systems for additional volumes. In addition, some of our competitors for third-party volumes have greater financial resources and access to larger supplies of oil and natural gas than those available to us, which could allow those competitors to price their services more aggressively than us. Moreover, the underlying lease for the properties on which the Catarina Gathering System is located restricts the Catarina Gathering System to the handling of hydrocarbons produced on the properties covered by the lease.
We may not be able to attract material third-party service opportunities. Our efforts to attract new unaffiliated customers may be adversely affected by (i) certain rights Mesquite has under applicable agreements and, with respect to the Catarina Gathering System, the fact that a substantial portion of the capacity of the facility will be necessary to service Mesquite’s production and development and completion schedule, (ii) the current nature of our facilities, (iii) our desire to provide services pursuant to fee-based contracts and (iv) the existence of current and future dedications to other gatherers by potential third-party customers. As a result, we may not have the capacity or ability to provide services to third parties, or potential third-party customers may prefer to obtain services pursuant to other forms of contractual arrangements under which we would be required to assume direct commodity exposure.
All of our midstream assets are located in the Eagle Ford Shale in Texas, making us vulnerable to risks associated with operating in one major geographic area.
All of our midstream assets are located in the Eagle Ford Shale in Texas. As a result of this concentration, we may be disproportionately exposed to the impact of regional supply and demand factors, delays or interruptions of production from wells in this area caused by governmental regulation, market limitations or interruption of the processing or transportation of natural gas, NGLs or oil.
We do not intend to obtain independent evaluations of reserves of natural gas, NGLs and oil reserves connected to the Catarina Gathering System on a regular or ongoing basis; therefore, in the future, volumes of natural gas, NGLs and oil on the gathering system could be less than we anticipate.
We have not obtained and do not intend to obtain independent evaluations of the reserves of natural gas, NGLs and oil, including those of Mesquite, connected to the Catarina Gathering System on a regular or ongoing basis. Moreover, even if we did obtain independent evaluations of the reserves of natural gas, NGLs and oil connected to the Catarina Gathering System, such evaluations may prove to be incorrect. Oil and natural gas reserve engineering requires subjective estimates of underground accumulations of oil and natural gas and assumptions concerning future oil and natural gas prices, future production levels and operating and development costs.
Accordingly, we may not have accurate estimates of total reserves dedicated to the Catarina Gathering System or the anticipated life of such reserves. If the total reserves or estimated life of the reserves connected to the Catarina Gathering System are less than we anticipate and we are unable to secure additional sources of natural gas, NGLs and oil, it could adversely affect our business, financial condition, cash flows and results of operations.
A shortage of equipment and skilled labor in the Eagle Ford Shale could reduce equipment availability and labor productivity and increase labor and equipment costs, which could have a material adverse effect on our business and results of operations.
Gathering and processing services require special equipment and laborers skilled in multiple disciplines, such as equipment operators, mechanics and engineers, among others. Decreased levels of production and shrinking margins from lower commodity prices may result in shortages of equipment and skilled labor in the Eagle Ford Shale, as companies seek to deploy their resources in more profitable basins. If we experience shortages of necessary equipment or skilled labor in
Table of Contents
the future, our labor and equipment costs and overall productivity could be materially and adversely affected. Material increases in equipment, labor prices or health and benefit costs for employees, could have a material adverse effect on our business and results of operations.
Distributions we receive from Carnero JV may fluctuate from quarter to quarter, which could adversely affect our cash flows and ability to pay our payables timely.
We received approximately $11.7 million in cash from Carnero JV in the form of distributions during the year ended December 31, 2022. Targa, as the operator of Carnero JV, has certain rights which permit it to affect the amount and timing of distributions to us. For example, Targa has certain discretion with regard to cash reserves and working capital adjustments that may cause the amount of our distributions to fluctuate from quarter-to-quarter. Fluctuations in the amount and timing of distributions from Carnero JV could adversely affect our cash flows and ability to pay our payables timely, including required payments under the Credit Agreement.
Our participation in joint ventures exposes us to liability or harm to our reputation resulting from failures by our joint venture partners.
We and Targa are jointly and severally liable for all liabilities and obligations of Carnero JV. If Targa fails to perform or is financially unable to bear its portion of required capital contributions or other obligations, including liabilities stemming from claims or lawsuits, we could be required to make additional investments, provide additional services or pay more than our proportionate share of a liability to make up for Targa’s shortfall. Further, if we are unable to adequately address Targa’s performance issues, Mesquite, the main customer on the facilities, may terminate its agreements with us, which could result in legal liability to us, harm our reputation and reduce cash flows generated from the Carnero Gathering Line and the Raptor Plant.
Increased competition from other companies that provide gathering services could have a negative impact on the demand for our services, which could adversely affect our business, financial condition, cash flows and results of operations.
Our ability to flow a sufficient volume of throughput prior to and after the expiration of the Gathering Agreement to maintain current revenues and cash flows could be adversely affected by the activities of our competitors. Our facilities compete primarily with other gathering and processing systems. Some competitors have greater financial resources than us and may now, or in the future, have access to greater supplies of natural gas, NGLs and oil than we do. Some of these competitors may expand or construct facilities that would create additional competition for the services that we provide to Mesquite or other future customers. In addition, Mesquite or other future customers may develop their own facilities instead of using our midstream assets.
All of these competitive pressures could make it more difficult for us to retain Mesquite as a customer and/or attract new customers as we seek to expand our business, which could adversely affect our business, financial condition, cash flows and results of operations.
If third-party pipelines or other midstream facilities interconnected to our facilities become partially or fully unavailable, it could adversely affect our business, financial condition, cash flows and results of operations.
Our facilities connect to other pipelines or facilities owned and operated by unaffiliated third parties. The continuing operation of third-party pipelines, compressor stations and other midstream facilities is not within our control. These pipelines, plants and other midstream facilities may become unavailable because of testing, turnarounds, line repair, maintenance, reduced operating pressure, lack of operating capacity, regulatory requirements and curtailments of receipt or deliveries due to insufficient capacity or because of damage from severe weather conditions or other operational issues. In addition, if the costs to us to access and transport on these third-party pipelines significantly increase, our profitability could be reduced. If any such increase in costs occurs or if any of these pipelines or other midstream facilities become unable to receive or transport natural gas, NGLs or oil, it could adversely affect our business, financial condition, cash flows and results of operations.
Table of Contents
We do not own the land on which the Catarina Gathering System or the Seco Pipeline is located, which could have a material adverse effect on our business, results of operations and financial condition.
We do not own the land on which the Catarina Gathering System or the Seco Pipeline is located, and we are, therefore, subject to the possibility of more onerous terms or increased costs to retain necessary land use if we do not have valid rights-of-way or if such rights-of-way lapse or terminate. We currently have certain rights to construct and operate our pipelines on land owned by third parties for a specific period of time and may need to obtain other rights in the future from third parties and governmental agencies to continue these operations or expand the Catarina Gathering System or the Seco Pipeline. Our loss of these rights or inability to obtain additional rights, through our inability to renew or obtain right-of-way contracts or otherwise, could have a material adverse effect on our business, results of operations, financial condition.
Our operations could be disrupted if our information systems are hacked or fail, causing increased expenses and loss of revenue.
We face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information or to render data systems unusable, threats to the security of our facilities and infrastructure, Mesquite’s facilities and infrastructure or other third-party facilities and infrastructure, such as pipelines. The potential for such security threats has subjected our operations to increased risks that could have a material adverse effect on our business.
Our business is increasingly dependent on technology infrastructure, certain critical financial, accounting and other data processing systems and other communications and information systems. These systems include data network and telecommunications, internet access, our website, and various computer hardware equipment and software applications, including those that are critical to the safe operations of our assets. We process transactions on a daily basis and rely upon the proper functioning of computer systems. Additionally, we rely on information systems across our operations, including the management of processes and transactions. These systems are subject to damage or interruption from a number of potential sources including natural disasters, software viruses or other malware, power failures, cybersecurity threats to gain unauthorized access to sensitive information, cyber-attacks, which may render data systems unusable, and physical threats to the security of our facilities and infrastructure or third-party facilities and infrastructure. If a key system were hacked or otherwise with by an access, or were to or experience for any reason, even if only for a short period, our financial results could be affected .
As a result of the COVID-19 pandemic, the increase in companies and individuals working remotely has increased the frequency and scope of cyber-attacks and the risk of potential cybersecurity incidents, both deliberate attacks and unintentional events. While, to date, we have not had a significant cybersecurity breach or attack that had a material impact on our business or results of operations, if we were to be subject to a material successful cyber intrusion, it could result in remediation or service restoration costs, increased cyber protection costs, lost revenues, litigation or regulatory actions by governmental authorities, increased insurance premiums, reputational damage and damage to our competitiveness, financial condition, results of operations and cash flows.
Cyber-attacks against us or others in our industry could result in additional regulations, and U.S. government warnings have indicated that infrastructure assets, including pipelines, may be specifically targeted by certain groups. These attacks include, without limitation, malicious software, ransomware, attempts to gain unauthorized access to data, and other electronic security breaches. These attacks may be perpetrated by state-sponsored groups, “hacktivists”, criminal organizations or private individuals (including employee malfeasance). Current efforts by the federal government, including the issuance of new cybersecurity requirements for critical pipeline owners and operators issued by the Department of Homeland Security’s Transportation Security Administration following a cyberattack on a major petroleum pipeline in 2021, and any potential future regulations could lead to increased regulatory compliance costs, insurance coverage cost or capital expenditures. We cannot predict the potential impact to our business or the energy industry resulting from additional regulations.
Further, our business interruption insurance may not compensate us adequately for losses that may occur. We do not carry insurance specifically for cybersecurity events; however, certain of our insurance policies may allow for coverage of associated damages resulting from such events. If we were to incur a significant liability for which we were not fully insured, it could have a material adverse effect on our financial position, results or operations and cash flows. In addition, the proceeds of any such insurance may not be paid in a timely manner and may be insufficient if such an event were to occur.
Table of Contents
As a non-operator, our development of successful operations relies extensively on third-parties, including Mesquite and Targa, which could adversely affect our business, financial condition and results of operations.
We have only participated in wells, leasehold acreage and midstream assets operated by third parties, including Mesquite and Targa. The success of our business operations depends on the success of such operators. If our operators are not successful in the operating activities relating to our midstream business, or are unable or unwilling to perform, it could adversely affect our business, financial condition and results of operations.
The insolvency of an operator of any of our assets, the failure of an operator of any of our assets to adequately perform operations or an operator’s breach of applicable agreements could reduce our revenue and result in our liability to governmental authorities for compliance with environmental, safety and other regulatory requirements, to the operator’s suppliers and vendors or another insolvent owner.
Our operators will make decisions in connection with their operations (subject to their contractual and legal obligations), which may not be in our best interests and could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Financing and Credit Environment
Our independent registered public accounting firm has expressed doubt about our ability to continue as a going concern.
Our historical consolidated financial statements have been prepared under the assumption that we will continue as a going concern. The report on our audited consolidated financial statements for the year ended December 31, 2022 issued by our independent registered public accounting firm included in this Form 10-K includes an explanatory paragraph referring to the Credit Agreement being a current liability that matures on September 30, 2023 and expressing substantial doubt in our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to either (i) refinance or extend the maturity of the Credit Agreement, or (ii) obtain adequate new debt or equity financing to repay the Credit Agreement in full at maturity. Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. However, if we are unable to refinance or extend the maturity of the Credit Agreement, or otherwise raise adequate funds prior to the maturity date, it will further raise substantial doubt about our ability to continue as a going concern. The doubt regarding our potential ability to continue as a going may affect our ability to obtain new financing on reasonable terms or at all. Additionally, if we are to continue as a going , our unitholders may some or all of their investment in us.
Our Credit Agreement has substantial prepayment requirements, other restrictions and financial covenants.
We depend on the Credit Agreement for future capital needs. The Credit Agreement contains various covenants that limit, among other things, our ability to incur certain indebtedness, grant certain liens, merge or consolidate, sell all or substantially all of our assets, make certain loans, acquisitions, capital expenditures and investments, and pay distributions to unitholders. The Credit Agreement provides a quarterly amortizing term loan of $65.0 million (the “Term Loan”). The Term Loan is subject to mandatory amortizing payments of outstanding principal, which are currently $3.0 million per fiscal quarter, decreasing to $2.0 million per fiscal quarter commencing with the quarter ending March 31, 2023. The Credit Agreement matures on September 30, 2023. We are also required to comply with certain financial covenants and ratios. Our ability to comply with these restrictions, requirements and covenants in the future is uncertain and will be affected by the levels of cash flows from our operations and events or circumstances beyond our control, including events and circumstances that may stem from the condition of financial markets and commodity price levels. In addition, our Credit Agreement contains a condition to borrowing and a representation that no material adverse effect has occurred, which includes, among other things, a material adverse change in, or material adverse effect on the business, operations, property, liabilities (actual or contingent) or condition (financial or otherwise) of us and our subsidiaries who are guarantors taken as a whole. If a material effect were to occur, we would be prohibited from borrowing under the Credit Agreement and we would be in under the Credit Agreement, which could cause all of our existing indebtedness to become immediately due and payable. Our to comply with any of the prepayment requirements, or other restrictions and covenants under the Credit Agreement could result in an event of , which could cause all of our existing indebtedness to become immediately due and payable.
Table of Contents
We may not be able to extend, replace or refinance our Credit Agreement on terms reasonably acceptable to us, or at all, which could materially and adversely affect our business, liquidity, cash flows and prospects.
Our Credit Agreement matures on September 30, 2023. We may not be able to extend, replace or refinance our existing Credit Agreement on terms reasonably acceptable to us, or at all, with our existing syndicate of banks or with replacement banks. In addition, we may not be able to access other external financial resources sufficient to enable us to repay the debt outstanding under our Credit Agreement upon its maturity. Any of the foregoing could materially and adversely affect our business, liquidity, cash flows and prospects.
The expected replacement of the LIBOR benchmark interest rate and other interbank offered rates with new benchmark rates may adversely affect our financing costs.
As of March 24, 2023, we had $19.7 million of debt outstanding under our Credit Agreement that bears interest at variable rates that use the London Interbank Offered Rate (“LIBOR”), as a benchmark rate. On July 27, 2017, the Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit LIBOR quotations after 2021. The Alternative Reference Rates Committee, a steering committee consisting of large U.S. financial institutions convened by the U.S. Federal Reserve Board and the Federal Reserve Bank of New York, has recommended replacing LIBOR with the Secured Overnight Financing Rate (SOFR), an index supported by short-term Treasury repurchase agreements. On November 30, 2020, ICE Benchmark Administration, the administrator of USD LIBOR announced that it does not intend to cease publication of the remaining USD LIBOR tenors until June 30, 2023, providing additional time for existing contracts that are dependent on LIBOR to mature.
The Credit Agreement contains fallback language that seeks to facilitate an agreement with the administrative agent under on a replacement benchmark rate for LIBOR upon the occurrence of certain benchmark transition events or an early opt-in election. Upon the occurrence of one of these triggering events, the administrative agent has the right to make conforming changes to the Credit Agreement to reflect the new benchmark rate. We cannot predict what the impact of any such replacement rate would be to our interest expense, however, the replacement of LIBOR or any other benchmark rates may result in fluctuating interest rates that may have a negative impact on or other adverse effect on our financing costs.
We will be required to make substantial capital expenditures to increase our asset base. If we are unable to obtain needed capital or financing on satisfactory terms, our cash flows may be diminished or our financial leverage could increase.
In order to increase our asset base, we will need to make expansion capital expenditures. If we do not make sufficient or effective expansion capital expenditures, we will be unable to expand our business operations which may diminish our cash flows. To fund our expansion capital expenditures and investment capital expenditures, we will be required to use cash from our operations or incur borrowings. Alternatively, we may sell additional common units or other securities to fund our capital expenditures. Our ability to obtain bank financing or our ability to access the capital markets for future equity or debt offerings may be limited by our financial condition at the time of any such financing or offering and the covenants in our existing debt agreements, as well as by general economic conditions, contingencies and uncertainties that are beyond our control. Even if we are successful in obtaining the necessary funds, the terms of such financings may be unfavorable to us and incurring additional debt may significantly increase our interest expense and financial leverage. Issuing additional common units or other securities may result in additional significant unitholder dilution. Stonepeak is not contractually committed to providing any direct or indirect support to fund our growth.
Our ability to access the capital and credit markets to raise capital and borrow on favorable terms will be affected by disruptions in the capital and credit markets, which could adversely affect our operations, our ability to make acquisitions and our ability to pay cash distributions.
Disruptions in the capital and credit markets could limit our ability to access these markets or significantly increase our cost to borrow. Some lenders may increase interest rates, enact tighter lending standards, refuse to refinance existing debt at maturity on favorable terms or at all and may reduce or cease to provide funding to borrowers. If we are unable to access the capital markets on favorable terms, our ability to make acquisitions and pay cash distributions could be affected.
We are exposed to credit risk in the ordinary course of our business activities.
We are exposed to risks of loss in the event of nonperformance by our customers, vendors, lenders in our Credit Agreement and counterparties to our hedging arrangements. Some of our customers, vendors, lenders and counterparties
Table of Contents
may be highly leveraged and subject to their own operating and regulatory risks. Despite our credit review and analysis, we may experience financial losses in our dealings with these and other parties with whom we enter into transactions as a normal part of our business activities. Any nonpayment or nonperformance by our customers, vendors, lenders or counterparties could have a material adverse impact on our business, financial condition, results of operations or cash flows.
Our business could be negatively impacted by inflation in the cost of labor, services and materials.
While inflation in the United States has been relatively low in recent years, the U.S. economy is currently experiencing significant inflation. The Federal Reserve continues to raise its benchmark interest rate in response to inflation and the rate is at a historic high that the United States has not experienced since October 2007. Rising inflation has resulted in increased costs for the labor, services and materials we rely upon, including energy rates and prices for chemicals, additives and fuels. A sustained increase in inflation may continue to increase these costs. Our efforts to recover inflation-based cost increases from our customers may be delayed or capped as a result of our contracts as well as the competitive industry and economic conditions in which we operate. The rate and scope of these various inflationary factors may continue to increase our operating costs and capital expenditures materially and may have a material adverse impact on our on our costs, profitability and financial results.
Risks Related to Our Cash Distributions
You will not receive cash distributions on your common units until we are able to redeem 100% of the outstanding Class C Preferred Units, as a result, you are unlikely to receive cash distributions on your common units for the foreseeable future.
Our partnership agreement prohibits us from declaring or making any distributions, redemptions or repurchases in respect of any junior securities or any parity securities until the first quarter in which no Class C Preferred Units remain outstanding. This means that you will not receive any cash distributions on your common units until such time as we are able to redeem all of the outstanding Class C Preferred Units. We currently have the right to redeem 100% of the outstanding Class C Preferred Units for cash at the greater of the current market price or the liquidation preference for the Class C Preferred Units. As of March 24, 2023, the liquidation preference for the Class C Preferred Units was approximately $440.0 million. Our total revenues for the year ended December 31, 2022 were approximately $36.1 million. As a result, you are unlikely to receive cash distributions on your common units for the foreseeable future.
Our Credit Agreement restricts us from paying any distributions on our outstanding common units.
We do not have the ability to pay distributions to our common unitholders under our Credit Agreement other than in certain limited circumstances set forth in the Credit Agreement.
You may continue to experience substantial dilution.
On November 16, 2020, we entered into the Stonepeak Letter Agreement wherein we agreed with Stonepeak Catarina that the distribution on their Class C Preferred Units for the three months ended September 30, 2020 would be paid in common units instead of Class C Preferred PIK Units, cash or a combination thereof. The Stonepeak Letter Agreement also provides Stonepeak Catarina with the ability to elect to receive distributions on the Class C Preferred Units in common units for any quarter following the third quarter of 2020 by providing written notice to us no later than the last day of the calendar month following the end of such quarter. The transactions under the Stonepeak Letter Agreement were approved by the conflicts committee of the Board. We have issued a total of 171,438,187 common units to Stonepeak Catarina pursuant to the Stonepeak Letter Agreement and Stonepeak Catarina may continue to elect to receive future distributions on its Class C Preferred Units in common units. Additionally, in order to fulfill our funding and reimbursement obligations in connection with the Levo JV and the HOBO Transaction, we may issue additional common units, which will result in current common unitholders experiencing dilution. As a result of the foregoing, common unitholders have experienced, and may experience substantial future dilution.
Table of Contents
If we do not complete expansion projects or make and integrate acquisitions, our future growth may be limited.
Our ability to enhance our financial position depends, in part, on our ability to complete expansion projects and make acquisitions that result in an increase in cash generated. We may be unable to complete successful, accretive expansion projects or acquisitions for any of the following reasons:
• we are outbid by competitors for potential acquisition candidates;
• we are unable to identify attractive expansion projects or acquisition candidates;
• we are unable to obtain necessary rights-of-way or governmental approvals, including from regulatory agencies;
• we are unable to successfully integrate the businesses that we develop or acquire;
• we are unable to obtain financing for such expansion projects or acquisitions on economically acceptable terms, or at all;
• we do not make accurate assumptions about potential volumes, reserves, revenues and costs, including synergies and growth; or
• we are unable to secure adequate customer commitments to use the newly developed or acquired facilities.
Inadequate insurance could have a material adverse impact on our business, financial condition and results of operations.
We ordinarily maintain insurance against certain losses and liabilities arising from our operations; however, insurance against all operational risks is not available to us and we may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the perceived risks presented. Losses could therefore occur for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. Additionally, our insurance program may include a number of insurance carriers. Significant disruptions in financial markets could lead to a deterioration in the financial condition of many financial institutions, including insurance companies; therefore, we may not be able to obtain the full amount of our insurance coverage for insured events. The occurrence of an event that is not fully covered by insurance could have a material adverse impact on our business, financial condition and results of operations.
Risks Related to Regulatory Compliance
Potential regulatory actions could increase our operating or capital costs and delay our operations or otherwise alter the way we conduct our business.
Our business activities are subject to extensive federal, state, and local regulations. Changes to existing regulations or new regulations may unfavorably impact us, our suppliers or our customers. In the United States, legislation that directly impacts the oil and natural gas industry has been proposed covering areas such as emission reporting and reductions, and the repeal of certain oil and natural gas tax incentives and tax deductions. The EPA has also ruled that carbon dioxide, methane and other greenhouse gases endanger human health and the environment. This allows the EPA to adopt and implement regulations restricting greenhouse gases under existing provisions of the federal Clean Air Act. These and other potential regulations could increase our costs, reduce our liquidity, delay our operations or otherwise alter the way that we conduct our business, negatively impacting our financial condition, results of operations and cash flows.
We are subject to federal, state, and local laws and regulations as interpreted and enforced by governmental authorities possessing jurisdiction over various aspects of the production and transportation of oil and natural gas. The possibility exists that any new laws, regulations or enforcement policies could be more stringent than existing laws and could significantly increase our compliance costs.
Our failure to obtain or maintain necessary permits could adversely affect our operations.
Our operations are subject to complex and stringent laws and regulations. In order to conduct our operations in compliance with these laws and regulations, we must obtain and maintain numerous permits, approvals and certificates from various federal, state and local governmental authorities. Failure or delay in obtaining regulatory approvals or leases
Table of Contents
could have a material adverse effect on our ability to develop our properties. In addition, regulations regarding conservation practices and the protection of correlative rights affect our operations by limiting the quantity of oil and natural gas we may produce and sell.
Increased regulation of hydraulic fracturing could result in reductions or delays in the production of natural gas, NGLs and oil by Mesquite, which could reduce the throughput on our facilities and adversely impact our revenues.
A substantial portion of Mesquite’s production of natural gas, NGLs and oil is being developed from unconventional sources, such as shale formations. These reservoirs require hydraulic fracturing completion processes to release the liquids and natural gas from the rock so it can flow through casing to the surface. Hydraulic fracturing is a well stimulation process that utilizes large volumes of water and sand (or other proppant) combined with fracturing chemical additives that are pumped at high pressure to crack open previously impenetrable rock to release hydrocarbons. Hydraulic fracturing is typically regulated by state oil and gas commissions and similar agencies. Various studies are currently underway by the EPA and other federal and state agencies concerning the potential environmental impacts of hydraulic fracturing activities. For example, the EPA issued an advanced notice of proposed rulemaking under the Toxic Substances Control Act in 2014 requesting comments related to disclosures for hydraulic fracturing chemicals. At the same time, certain environmental groups have suggested that additional laws may be needed to more closely and uniformly regulate the hydraulic fracturing process, and legislation has been proposed by some members of the U.S. Congress to provide for such regulation. We cannot predict whether any such legislation will ever be enacted and if so, what its provisions would be. Additionally, President Biden has declared that he would support federal government efforts to limit or prohibit hydraulic fracturing. These declarations include threats to take actions banning hydraulic fracturing of crude oil and natural gas wells and banning new leases for production of minerals on federal properties, including onshore lands and offshore waters. We cannot predict whether additional levels of regulations and permits will be required through the adoption of new laws and regulations at the federal or state level, and if so, what the provisions would be. If additional levels of regulation and permits were to be implemented through the adoption of new laws and regulations at the federal or state level, that could lead to and process prohibitions that could reduce the volumes of liquids and natural gas that move through our facilities, which in turn could materially affect our revenues and results of operations.
We may incur significant liability under, or costs and expenditures to comply with, environmental and worker health and safety regulations, which are complex and subject to frequent change.
As an owner, lessee or operator of gathering pipelines and compressor stations, we are subject to various stringent federal, state and local laws and regulations relating to the discharge of materials into, and protection of, the environment. Numerous governmental authorities, such as the EPA and analogous state agencies, have the power to enforce compliance with these laws and regulations and the permits issued under them, oftentimes requiring difficult and costly response actions. These laws and regulations may impose numerous obligations that are applicable to our and our customer’s operations, including the acquisition of permits to conduct regulated activities, the incurrence of capital or operating expenditures to limit or prevent releases of materials from our or our customers’ operations, the imposition of specific standards addressing worker protection, and the imposition of substantial liabilities and remedial obligations for pollution or contamination resulting from our and our customer’s operations. Failure to comply with these laws, regulations and permits may result in joint and several, strict liability and the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, and the issuance of injunctions limiting or some or all of our operations. Private parties, including the owners of the properties through which our facilities pass and facilities where wastes resulting from our operations are taken for reclamation or disposal, may also have the right to pursue legal actions to enforce compliance, as well as to seek for non-compliance, with environmental laws and regulations or for personal or property . We may not be to recover all or any of these costs from insurance, the operators of our facilities and properties or other third parties. In addition, we may experience a in obtaining or be to obtain required permits, which may our operations and limit our growth and revenues, which in turn could affect our . There is no assurance that changes in or additions to public policy regarding the protection of the environment will not have a significant impact on our operations and .
The operation of our facilities also poses risks of environmental liability due to leakage, migration, releases or spills from our facilities to surface or subsurface soils, surface water or groundwater. Certain environmental laws impose strict as well as joint and several liability for costs required to remediate and restore sites where hazardous substances, hydrocarbons, or solid wastes have been stored or released. We may be required to remediate contaminated properties currently or formerly operated by us or facilities of third parties that received waste generated by our operations regardless of whether such contamination resulted from the conduct of others or from consequences of our own actions that were in compliance with all applicable laws at the time those actions were taken. In addition, claims for damages to persons or
Table of Contents
property, including natural resources, may result from the environmental, health and safety impacts of our operations. Moreover, public interest in the protection of the environment has increased dramatically in recent years. The trend of more expansive and stringent environmental legislation and regulations applied to the oil and natural gas industry could continue, resulting in increased costs of doing business and consequently affecting profitability.
We may incur significant costs and liabilities as a result of increasing stringency of pipeline safety regulatory requirements.
PHMSA regularly revises its pipeline safety regulations and has published advanced notices of proposed rulemakings and notices of proposed rulemaking to solicit comments on potential changes to its natural gas and liquid pipeline safety regulations. As an example of this rulemaking activity, in November 2021, PHMSA issued a final rule that extended reporting requirements to gas gathering operators and applied a set of minimum pipeline safety requirements to certain onshore gas gathering pipelines with large diameters and high operating pressures. The rule requires all onshore gas gathering pipeline operators to comply with PHMSA’s incident and annual reporting requirements. It also extends certain existing pipeline safety requirements to a new category of gas gathering pipelines, “Type C” lines, which generally include high-pressure pipelines located in Class 1 areas that are larger than 8.625 inches in outside diameter. Safety requirements applicable to Type C lines vary based on pipeline diameter and potential failure consequences. The final rule went into effect in May 2022 and operators were required to comply with many of the applicable safety requirements by November 2022, although in July 2022 PHMSA announced its intent to exercise limited enforcement discretion until May 17, 2024, for operators of existing Type C gathering pipelines with outer diameter greater than or equal to 8.625” but less than or equal to 12.75” for violations of certain safety requirements established in the November 2021 final rule.
Subsequently, in August 2022, PHMSA issued an additional pipeline safety rule applicable to onshore natural gas transmission pipelines, which updated and bolstered gas transmission pipeline corrosion control requirements, adjusted the repair criteria for pipelines in HCAs, created new criteria for pipelines in non-HCAs, and strengthened integrity management assessment requirements, among other items.
These and other pipeline safety regulatory changes could require us to pursue additional capital projects or conduct integrity or maintenance programs on an accelerated basis and incur increased operating costs that could have a material adverse effect on our business, including cash flows and costs of transportation services.
Please read “Part I, Item 1. Business—Governmental Regulation—Pipeline Safety Regulation” for more information.
Because we handle oil, natural gas and other petroleum products in our business, we may incur significant costs and liabilities in the future resulting from a failure to comply with new or existing environmental regulations.
The operations of our gathering systems, processing facilities, pipelines and other facilities are subject to stringent and complex federal, state and local environmental laws and regulations. Failure to comply with these laws and regulations may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary penalties, the imposition of remedial requirements and the issuance of orders enjoining future operations. There is an inherent risk that we may incur environmental costs and liabilities due to the nature of our business and the substances we handle. Certain environmental statutes, including RCRA, CERCLA and analogous state laws and regulations, impose strict, joint and several liability for costs required to clean up and restore sites where hazardous substances have been disposed of or otherwise released. In addition, an accidental release from one of our facilities could subject us to substantial liabilities arising from environmental cleanup and restoration costs, claims made by neighboring landowners and other third parties for personal injury and property and or for related of environmental laws or regulations.
Moreover, the possibility exists that stricter laws, regulations or enforcement policies could significantly increase our compliance costs and the cost of any remediation that may become necessary, and these costs may not be recoverable from insurance.
Table of Contents
Risks Inherent in an Investment in Our Common Units
In a liquidation, the preferential rights of the holder of our Class C Preferred Units could result in common unitholders losing their entire investment.
Pursuant to the partnership agreement, if an event giving rise to the liquidation of Evolve occurs prior to all of the Class C Preferred Units being redeemed, then the Class C Preferred Units preferential rights require that the capital account for any holder of any Class C Preferred Units is first allocated items of income, gain, loss and deduction until each such holder’s capital account in respect of each Class C Preferred Unit is equal to 100% of the liquidation preference with respect to such Class C Preferred Unit. Such liquidation preference is equal to $11.29 plus all accrued and unpaid distributions and was equal to approximately $440.0 million as of March 24, 2023. As a result, if a liquidation of Evolve were to occur, the holders of Class C Preferred Units would have to receive approximately $440.0 million prior to common unitholders receiving anything. The consolidated balance sheets of Evolve and its subsidiaries included herein disclose total assets of approximately $231.7 million, over $200 million less than the current liquidation preference for with the Class C Preferred Units. As a result, based upon the financial information included herein, if a of Evolve were to occur, the common units would have zero equity value and common unitholders would their entire investment.
We are currently not in compliance with the NYSE American listing standards. If our common units are delisted, it could result in even further reductions in the trading price and liquidity of our common units, which could materially adversely affect our ability to raise capital or pursue strategic transactions on acceptable terms, or at all.
Our common units are currently listed on the NYSE American. Continued listing of a security on the NYSE American is conditioned upon compliance with various continued listing standards. On December 6, 2022, we received notice (the “12.6.22 Notice”) from the NYSE American stating that we were below compliance with certain of the continued listing standards as set forth in Part 10 of the NYSE American Company Guide (the “Company Guide”). The 12.6.22 Notice stated that we are below compliance with Sections 1003(a)(i) and (ii) of the Company Guide, which requires that we have partners’ equity of $2.0 million or more if we have reported losses from continuing operations and/or net losses in two of our three most recent fiscal years ended December 31, 2021, and partners’ equity of $4.0 million or more if we have reported losses from continuing operations and/or net losses in three of our four most recent fiscal years ended December 31, 2021, respectively. Additionally, on December 27, 2022, we received notice (the “12.27.22 Notice” and together with the 12.6.22 Notice, the “NYSE Notices”) from the NYSE American that we are not in compliance with the continued listing standards set forth in Section 1003(f)(v) of the Company Guide because our common units have been selling for a substantial period of time at a low price per common unit, which the NYSE American determined to be a 30-trading-day average of less than $0.20 per common unit.
On January 5, 2023, we submitted a compliance plan to the NYSE American addressing how we intend to regain compliance with the continued listing standards set forth in (i) Section 1003(f)(v) of the Company Guide by June 27, 2023, and (ii) Sections 1003(a)(i) and 1003(a)(ii) of the Company Guide by June 6, 2024. Following discussions with the staff of the NYSE American and subsequent updates to our compliance plan, we received a letter from the NYSE American on February 21, 2023 stating that our compliance plan has been accepted and that we have been granted a targeted completion date of June 6, 2024 to implement our plan and regain compliance (the “Plan Period”).
By the end of the Plan Period, we must either be in compliance or must have made progress that is consistent with the plan during the plan period. Failure to meet the requirements to regain compliance could result in the initiation of delisting proceedings.
We remain subject to the 12.27.22 Notice. Pursuant to Section 1003(f)(v) of the Company Guide, our continued listing is predicated on effecting a reverse split of our common units or otherwise demonstrating sustained price improvement within a reasonable period of time, which the staff of the NYSE American determined to be no later than June 27, 2023.
The NYSE Notices do not affect our business operations or our reporting obligations under the rules and regulations of the SEC, nor do the NYSE Notices conflict with or cause an event of default under any of our material agreements. Our common units will continue to be listed on the NYSE American while we attempt to regain compliance with the listing standards noted above by the targeted completion dates, subject to our compliance with other continued listing requirements of the NYSE American.
Table of Contents
If we cannot meet the NYSE American continued listing requirements by the end of the Plan Period, or if the NYSE American is not otherwise satisfied with our progress as of the end of the Plan Period, the NYSE American may delist our common units resulting in our common units trading in the less liquid over-the-counter market, which could have an adverse effect on us and the liquidity and market price of our common units. The delisting of our common units from the NYSE American could result in even further reductions in the trading price of our common units, substantially limit the liquidity of our common units, and materially adversely affect our ability to raise capital or pursue strategic restructuring, refinancing or other transactions on acceptable terms, or at all. Delisting from the NYSE American could also have other negative results, including the potential loss of confidence by vendors and employees, the loss of institutional investor interest and fewer business development . Our management is considering alternatives to ensure continued compliance with the NYSE American listing standards, but there is no assurance that we will continue to maintain compliance with the NYSE American continued listing standards.
The market price of our common units has been extremely volatile and may continue to be volatile due to numerous circumstances beyond our control.
The market price of our common units has fluctuated, and may continue to fluctuate, widely, due to various factors, many of which are beyond our control. These factors include, without limitation:
• comments by securities analysts or other third parties, including blogs, articles, message boards and social and other media;
• actual or anticipated fluctuations in our financial and operating results;
• provisions in our Amended Credit Agreement which currently prohibit us from paying distributions to our common unitholders other than in certain limited circumstances set forth in our Amended Credit Agreement;
• announcements by us or our competitors of significant contracts or acquisitions;
• changes in accounting standards, policies, guidance, interpretations or principles;
• general economic conditions, including interest rates and governmental policies impacting interest rates;
• future sales of our common units; and
• other factors described in the documents incorporated by reference herein.
Stock markets in general and our common unit price in particular have recently experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the companies impacted, including us. For example, during the year ended December 31, 2022, our common units have closed at a high of $0.96 per common unit and a low of $0.12 per common unit. In addition, during that same period, daily trading volume ranged from approximately 51,200 to 21,503,000 common units. These broad market fluctuations may adversely affect the trading price of our common units, which may limit or prevent investors from readily selling their common units and may otherwise negatively affect the liquidity of our common units.
Certain events may result in our general partner exercising its limited call right, which may require common unitholders to sell their common units at an undesirable time or price.
As of March 24, 2023, Stonepeak owns (i) 200,202,635 common units, representing approximately 78.5% of our total 254,893,417 outstanding common units (the common unit amounts include 23,861,365 common units Stonepeak Catarina has the right to acquire upon exercise of the Stonepeak Warrant), (ii) all of our issued and outstanding Class C Preferred Units, (iii) the Stonepeak Warrant, which entitles Stonepeak Catarina to receive junior securities of the Partnership (including common units) representing 10% of all junior securities deemed outstanding when exercised, (iv) the non-economic general partner interest in the Partnership and (v) all of our incentive distribution rights. Stonepeak Catarina also owns 100% of the issued and outstanding equity interests in SP Holdings, which is the sole member of our general partner.
On November 16, 2020, we entered into the Stonepeak Letter Agreement, which, among other things, provides that Stonepeak Catarina will be able to elect to receive distributions on the Class C Preferred Units in common units for any
Table of Contents
quarter following the third quarter of 2020 by providing written notice to the Partnership no later than the last day of the calendar month following the end of such quarter. There is no restriction in our partnership agreement that prevents our general partner from causing us to issue additional common units and we have issued a total of 171,438,187 common units to Stonepeak Catarina pursuant to the Stonepeak Letter Agreement as of the date of this Form 10-K
Pursuant to Section 15.1 of our partnership agreement, if at any time Stonepeak holds more than 80% of our outstanding common units and transfers all of the common units held by it to our general partner or a controlled affiliate of our general partner, Stonepeak will be able, via its limited call right, to cause our general partner or a controlled affiliate of our general partner to exercise its right to acquire all, but not less than all, of our common units held by persons other than our general partner and its controlled affiliates. During the period from December 28, 2022 to March 15, 2023, Stonepeak held more than 80% of our outstanding common units. As of the date of this Form 10-K Stonepeak holds approximately 76.3% of our common units. If Stonepeak holds more than 80% of our common units at any point following the date of this Form 10-K, Stonepeak will be able to cause our general partner to exercise the limited call right at any time after Stonepeak completes the Stonepeak LCR Transfer by causing our general partner to exercise its limited call right at a price equal to the greater of (1) the average of the daily closing price of our common units over the 20 trading days preceding the date three days before notice of exercise of our general partner’s limited call right is first mailed and (2) the highest per-unit price paid by our general partner or any of its controlled affiliates for common units during the 90-day period preceding the date such notice is first mailed. As a result, common unitholders may be required to sell their common units at an time or price and may not receive any return or a return on their investment. Common unitholders may also incur tax liability upon a sale of their units. Our general partner is not obligated to obtain a fairness opinion regarding the value of common units to be repurchased upon exercise of its limited call right. If our general partner exercises its limited call right, the effect would be to take the Partnership private and, if the common units are subsequently deregistered, the Partnership will no longer be subject to the reporting requirements of the Exchange Act.
Stonepeak Catarina and its affiliates, including our general partner, will have conflicts of interest with us. They will not owe any fiduciary duties to us or our common unitholders, but instead will owe us and our common unitholders limited contractual duties, and they may favor their own interests to the detriment of us and our other common unitholders.
Stonepeak Catarina, through its ownership of SP Holdings, owns and controls our general partner and, through the Representation and Standstill Agreement (as defined in “Part III, Item 10. Directors, Executive Officers and Corporate Governance”) and its ownership of SP Holdings, has the power to appoint all of the directors of our general partner. Although our general partner has a duty to manage us in a manner that is not adverse to us and our unitholders, the directors and officers of our general partner have a fiduciary duty to manage our general partner in a manner that is beneficial to SP Holdings and its affiliates, including Stonepeak Catarina. Conflicts of interest will arise between Stonepeak Catarina and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts of interest, our general partner may favor its own interests and the interests of Stonepeak over our interests and the interests of our unitholders. These conflicts include the following situations, among others:
• Neither our partnership agreement nor any other agreement requires Stonepeak to pursue a business strategy that favors us or utilizes our assets. The directors and officers of SP Holdings and its affiliates, including Stonepeak Catarina, have a fiduciary duty to make these decisions in the best interests of the members of SP Holdings and its affiliates, which may be contrary to our interests. Stonepeak may choose to shift the focus of its investment and growth to areas not served by our assets.
• Our general partner is allowed to take into account the interests of parties other than us, such as Stonepeak Catarina and SP Holdings, in resolving conflicts of interest.
• SP Holdings and its affiliates, including Stonepeak Catarina, may be constrained by the terms of their respective debt instruments from taking actions, or refraining from taking actions, that may be in our best interests.
• Our partnership agreement replaces the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties, limit our general partner’s liabilities and restrict the remedies available to our unitholders for actions that, without such limitations, might constitute breaches of fiduciary duty.
Table of Contents
• Except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval.
• Disputes may arise under our commercial agreements with SP Holdings and its affiliates, including Stonepeak Catarina.
• Our general partner determines the amount and timing of asset purchases and sales, borrowings, issuances of additional partnership units and the creation, reduction or increase of cash reserves, each of which can affect the amount of cash available for distribution.
• Our general partner determines the amount and timing of any capital expenditures and whether a capital expenditure is classified as a maintenance capital expenditure, which will reduce operating surplus, or an expansion or investment capital expenditure, which will not reduce operating surplus. This determination can affect the amount of cash that is distributed.
• Our general partner determines which costs incurred by it are reimbursable by us, the amount of which is not limited by our partnership agreement.
• Our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make incentive distributions.
• Our partnership agreement permits us to classify up to $20.0 million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions to SP Holdings as the holder of the incentive distribution rights.
• Our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf.
• Our general partner intends to limit its liability regarding our contractual and other obligations.
• Our general partner and its controlled affiliates may exercise their right to call and purchase all of the common units not owned by them if they own more than 80% of our common units.
• Our general partner controls the enforcement of the obligations that it and its affiliates owe to us, including the obligations of SP Holdings and Stonepeak Catarina under their commercial agreements with us.
• Our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
• Our general partner may elect to cause us to issue common units to SP Holdings in connection with a resetting of the target distribution levels related to our incentive distribution rights without the approval of the Conflicts Committee or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.
Our general partner and its affiliates, including SP Holdings and Stonepeak Catarina, may not allocate corporate opportunities to us.
Pursuant to the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, does not apply to our general partner or any of its affiliates, including SP Holdings, its executive officers and directors and Stonepeak Catarina. Any such person or entity that becomes aware of a potential transaction, agreement, arrangement or other matter that may be an opportunity for us does not have any duty to communicate or offer such opportunity to us. Any such person or entity will not be liable to us or to any limited partner for breach of any fiduciary duty or other duty by reason of the fact that such person or entity pursues or acquires such opportunity for itself, directs such opportunity to another person or entity or does not communicate such opportunity or information to us. This may create actual and potential conflicts of interest between us and affiliates of our general partner and result in less than favorable treatment of us and our common unitholders.
Table of Contents
Stonepeak may sell common units in the public or private markets, and such sales could have an adverse impact on the trading price of the common units.
As of March 24, 2023, Stonepeak owns (i) 200,202,635 common units, representing approximately 78.5% of our total 254,893,417 outstanding common units (the common unit amounts include 23,861,365 common units Stonepeak Catarina has the right to acquire upon exercise of the Stonepeak Warrant), (ii) all of our issued and outstanding Class C Preferred Units, (iii) the Stonepeak Warrant, which entitles Stonepeak Catarina to receive junior securities of the Partnership (including common units) representing 10% of all junior securities deemed outstanding when exercised, (iv) the non-economic general partner interest in the Partnership and (v) all of our incentive distribution rights. Stonepeak also owns 100% of the issued and outstanding equity interests in SP Holdings, which is the sole member of our general partner. Additionally, we have agreed to provide Stonepeak Catarina with certain registration rights under applicable securities laws. Pursuant to such registration rights, on November 10, 2021, we filed a Registration Statement on Form S-1 to register 9,000,000 common units for resale by a subsidiary of Stonepeak Catarina, which was declared effective by the SEC on December 17, 2021. The sale of the common units owned by Stonepeak in the public or private markets could have an adverse impact on the price of the common units or on the trading market for our common units.
Our partnership agreement permits our general partner to redeem any partnership interests held by a limited partner who is an ineligible holder.
If our general partner, with the advice of counsel, determines that our not being treated as an association taxable as a corporation or otherwise taxable as an entity for U.S. federal income tax purposes, coupled with the tax status (or lack of proof thereof) of one or more of our limited partners, has, or is reasonably likely to have, a material adverse effect on the maximum applicable rates chargeable to customers by us or our subsidiaries, or we become subject to federal, state or local laws or regulations that create a substantial risk of cancellation or forfeiture of any property that we have an interest in because of the nationality, citizenship or other related status of any limited partner, our general partner may redeem the units held by the limited partner at their current market price. In order to avoid any material adverse effect on rates charged or cancellation or forfeiture of property, our general partner may require each limited partner to furnish information about their U.S. federal income tax status or nationality, citizenship or related status. If a limited partner fails to furnish information about their U.S. federal income tax status or nationality, citizenship or other related status after a request for the information or our general partner determines after receipt of the information that the limited partner is not an eligible holder, our general partner may elect to treat the limited partner as an holder. An holder assignee does not have the right to direct the voting of their units and may not receive distributions in kind upon our .
Our partnership agreement replaces our general partner’s fiduciary duties to our common unitholders with contractual standards governing its duties.
Our partnership agreement contains provisions that eliminate the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law and replace those duties with several different contractual standards. For example, our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, free of any duties to us and our unitholders other than the implied contractual covenant of good faith and fair dealing, which means that a court will fill gaps under the partnership agreement to enforce the reasonable expectations of the partners, but only where the language in the partnership agreement does not provide for a clear course of action. This provision entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. Examples of decisions that our general partner may make in its individual capacity include:
• how to allocate business opportunities among us and its other affiliates;
• whether to exercise its limited call right;
• whether to seek approval of the resolution of a conflict of interest by the Conflicts Committee; and
• whether or not to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.
Table of Contents
Our partnership agreement restricts the remedies available to our common unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
The effect of eliminating fiduciary standards in our partnership agreement is that the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law will be significantly restricted. For example, our partnership agreement provides that:
• whenever our general partner, the Board or any committee thereof (including the Conflicts Committee) makes a determination or takes, or declines to take, any other action in their respective capacities, our general partner, the Board and any committee thereof (including the Conflicts Committee), as applicable, is required to make such determination, or take or decline to take such other action, in good faith, and under our partnership agreement, a determination, other action or failure to act by our general partner and any committee thereof (including the Conflicts Committee) will be deemed to be in good faith unless the general partner, the Board or any committee thereof (including the Conflicts Committee) believed that such determination, other action or failure to act was adverse to the interests of the partnership or, with regard to certain determinations by the Board relating to the conflict transactions described below, the Board did not believe that the specified standards were met, and, except as specifically provided by our partnership agreement, neither our general partner, the Board nor any committee thereof (including the Committee) will be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;
• our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as such decisions are made in good faith;
• our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, acted in bad faith or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and
• our general partner will not be in breach of its obligations under the partnership agreement (including any duties to us or our unitholders) if a transaction with an affiliate or the resolution of a conflict of interest is:
◦ approved by the Conflicts Committee of the Board, although our general partner is not obligated to seek such approval;
◦ approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner and its affiliates;
◦ determined by the Board to be on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or
◦ determined by the Board to be fair and reasonable to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.
In connection with a situation involving a transaction with an affiliate or a conflict of interest, any determination by our general partner or the Conflicts Committee must be made in good faith. If an affiliate transaction or the resolution of a conflict of interest is not approved by our common unitholders or the Conflicts Committee and the Board determine that the resolution or course of action taken with respect to the affiliate transaction or conflict of interest satisfies either of the standards set forth in the third and fourth sub-bullets above, then it will be presumed that, in making its decision, the Board acted in good faith, and in any proceeding brought by or on behalf of any limited partner or the partnership challenging such determination, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.
Furthermore, if any limited partner, our general partner or any person holding any beneficial interest in us brings any claims, suits, actions or proceedings (including, but not limited to, those asserting a claim of breach of a fiduciary duty) and such person does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy
Table of Contents
sought, then such limited partner, our general partner or person holding any beneficial interest in us shall be obligated to reimburse us and our Affiliates (as defined in Section 1.1 of our partnership agreement, including our general partner, the directors and officers of our general partner, and Stonepeak) for all fees, costs and expenses of every kind and description, including, but not limited to, all reasonable attorney’s fees and other litigation expenses, that the parties may incur in connection with such claim, suit, action or proceeding.
Our partnership agreement includes exclusive forum, venue and jurisdiction provisions and limitations regarding claims, suits, actions or proceedings. By taking ownership of a common unit, a limited partner is irrevocably consenting to these provisions and limitations regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of Delaware courts.
Our partnership agreement is governed by Delaware law. Our partnership agreement includes exclusive forum, venue and jurisdiction provisions designating Delaware courts as the exclusive venue to the fullest extent permitted by applicable law for most claims, suits, actions and proceedings involving us or our officers, directors and employees and limitations regarding claims, suits, actions or proceedings. By taking ownership of a common unit, a limited partner is irrevocably consenting to these provisions and limitations regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of Delaware courts. If a dispute were to arise between a limited partner and us or our officers, directors or employees, the limited partner may be required to pursue its legal remedies in Delaware, which may be an inconvenient or distant location and which is considered to be a more corporate-friendly environment. Furthermore, if any limited partner, our general partner or person holding any interest in us brings any , suits, actions or proceedings (including, but not limited to, those asserting a claim of of a fiduciary duty) and such person does not obtain a judgment on the merits that substantially , in substance and amount, the full remedy sought, then such limited partner, our general partner or person holding any interest in us shall be obligated to reimburse us and our Affiliates for all fees, costs and expenses of every kind and description, including, but not limited to, all reasonable attorneys’ fees and other expenses, that the parties may incur in connection with such claim, suit, action or proceeding. This provision may have the effect of increasing a unitholder’s cost of asserting a claim and therefore, lawsuits us and our general partner’s directors and officers. Because fee-shifting provisions such as these are relatively new developments in corporate and partnership law, the enforceability of such provisions are uncertain; in addition, future legislation could restrict or limit this provision of our partnership agreement and its effect of saving us and our Affiliates from fees, costs and expenses incurred in connection with , actions, suits or proceedings.
Holders of our common units will have limited voting rights and will not be entitled to elect our general partner or its directors.
Our common unitholders have limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s and our general partner’s decisions regarding our business. Common unitholders will have no right on an annual or ongoing basis to elect our general partner or the Board. Rather, the Board will be appointed by Stonepeak Catarina through its ownership of SP Holding. Furthermore, if common unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which our common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price. Our partnership agreement also contains provisions limiting the ability of common unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting our common unitholders’ ability to influence the manner or direction of management.
Our partnership agreement restricts the voting rights of common unitholders owning 20% or more of our common units.
Common unitholders’ voting rights are further restricted by a provision of our partnership agreement providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, Stonepeak Catarina, their transferees and persons who acquired such units with the prior approval of the Board, cannot vote on any matter.
Our general partner interest or the control of our general partner may be transferred to a third-party without unitholder consent.
Our general partner is able to transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of any assets it may own without the consent of our common unitholders. Furthermore, there is no restriction in the partnership agreement on the ability of SP Holdings to transfer its membership interest in our general
Table of Contents
partner to a third party. The new members of our general partner would then be in a position to replace the directors and officers of our general partner in order to control the decisions taken by the Board or such officers.
We are able to issue additional units without common unitholder approval, which would dilute unitholder interests.
Our partnership agreement does not limit the number of additional limited partner interests, including limited partner interests that rank senior to our common units that we may issue at any time without the approval of our common unitholders. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
• our existing limited partners’ proportionate ownership interest in us will decrease;
• the amount of cash available for distribution on each limited partnership interest may decrease;
• because the amount payable to holders of incentive distribution rights is based on a percentage of the total cash available for distribution, the distributions to holders of incentive distribution rights will increase even if the per unit distribution on common units remains the same;
• the ratio of taxable income to distributions may increase;
• the relative voting strength of each previously outstanding limited partner interest may be diminished; and
• the market price of our common units may decline.
Our general partner intends to limit its liability regarding our obligations.
Our general partner intends to limit its liability under contractual arrangements so that the counterparties to such arrangements have recourse only against our assets and not against our general partner or its assets. Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement permits our general partner to limit its liability, even if we could have obtained more favorable terms without the limitation on liability. In addition, we are obligated to reimburse or indemnify our general partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would reduce the amount of cash otherwise available for distribution to our unitholders.
Your 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 and outside of Delaware. 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. You could be liable for any and all of our obligations as if you 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; or
• your right to act with other unitholders to remove or replace our general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.
Unitholders may have liability to repay distributions that were wrongfully distributed to them.
Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act (the “Delaware Act”), we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of an impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Transferees of common units are liable both for the obligations of the transferor to make contributions to the partnership that were known to the transferee at the time of transfer and for those obligations that
Table of Contents
were unknown if the liabilities could have been determined from the partnership agreement. Neither liabilities to partners on account of their partnership interest nor liabilities that are non-recourse to the partnership are counted for purposes of determining whether a distribution is permitted.
The NYSE American does not require a publicly traded limited partnership like us to comply with certain of its corporate governance requirements.
Because we are a publicly traded limited partnership, the NYSE American does not require us to have a majority of independent directors on the Board or to establish a compensation committee or a nominating and corporate governance committee. Accordingly, unitholders will not have the same protections afforded to certain corporations that are subject to all of the NYSE American corporate governance requirements.
Tax Risks
Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, as well as our not being subject to a material amount of entity-level taxation by states and localities. If the Internal Revenue Service (“IRS”) were to treat us as a corporation for U.S. federal income tax purposes or if we were otherwise subject to a material amount of entity-level taxation, then our cash available for distribution would be substantially reduced.
The anticipated after-tax economic benefit of an investment in our common units depends largely on us being treated as a partnership for U.S. federal income tax purposes. Despite the fact that we are a limited partnership under Delaware law, we will be treated as a corporation for U.S. federal income tax purposes unless we satisfy a “qualifying income” requirement. Based on our current operations, we believe that we satisfy the qualifying income requirement and will continue to be treated as a partnership for U.S. federal income tax purposes. Failure to meet the qualifying income requirement or a change in current law could cause us to be treated as a corporation for U.S. federal income tax purposes or otherwise subject us to taxation as an entity. We have not requested, and do not plan to request, a ruling from the IRS with respect to our treatment as a partnership for U.S. federal income tax purposes.
If we were treated as a corporation for U.S. federal income tax purposes, we would pay U.S. federal income tax on our taxable income at the corporate income tax rate, and we would also likely pay additional state and local income taxes at varying rates. Distributions to unitholders would generally be taxed again as corporate dividends (to the extent of our current and accumulated earnings and profits as determined for U.S. federal income tax purposes), and no income, gains, losses, deductions or credits recognized by us would flow through to the unitholders. Because a tax would be imposed on us as a corporation, our cash available for distribution to our unitholders would be reduced.
At the state level, several states have been evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of a material amount of any these taxes in the jurisdictions in which we own assets or conduct business could substantially reduce the cash available for distribution to our unitholders.
If we were treated as a corporation for U.S. federal income tax purposes or otherwise subjected to a material amount of entity-level taxation, there would be a material reduction cash flows and after-tax return to our unitholders likely causing a substantial reduction in the value of our common units.
Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for U.S. federal, state or local income tax purposes, the minimum quarterly distribution and the target distributions may be adjusted to reflect the impact of that law on us.
The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
The present U.S. federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units may be modified by administrative or legislative changes or differing judicial interpretation at any time. For example, from time to time members of the U.S. Congress have proposed and considered substantive changes to the existing U.S. federal income tax laws that would affect publicly traded partnerships. In addition, the Treasury Department has issued, and in the future may issue, regulations interpreting those laws that affect publicly traded partnerships. We believe the income that we treat as qualifying satisfies the requirements under current regulations. However, there can be
Table of Contents
no assurance that there will not be further changes to U.S. federal income tax laws or the Treasury Department’s interpretation of the qualifying income rules in a manner that could impact our ability to qualify as a partnership for U.S. federal income tax purposes in the future.
We are unable to predict whether legislation or other tax-related proposals will ultimately be enacted. Any modification to the U.S. federal income tax laws and interpretations thereof may or may not be applied retroactively and could make it more difficult or impossible for us to meet the exception for certain publicly traded partnerships to be treated as a partnership for U.S. federal income tax purposes. Any such change could negatively impact the value of an investment in our common units.
Our common unitholders’ share of our income will be taxable to them even if they do not receive any cash distributions from us. You will not receive cash distributions on your common units until we are able to redeem 100% of the outstanding Class C Preferred Units, as a result, you are unlikely to receive cash distributions on your common units for the foreseeable future.
Common unitholders are required to pay U.S. federal income and other taxes and, in some cases, state and local income taxes, on their share of our taxable income, whether or not they receive cash distributions from us. Our Credit Agreement and partnership agreement currently prohibit us from paying distributions to our common unitholders. As a result, for the foreseeable future our common unitholders will not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability due from them with respect to that income.
If the IRS contests the U.S. federal income tax positions we take, the market for our common units may be adversely impacted, and our cash available for distribution might be substantially reduced.
We have not requested a ruling from the IRS with respect to our treatment as a partnership for U.S. federal income tax purposes or any other matter affecting us. 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, and a court may disagree with some or all of those positions. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will result in a reduction in cash available for distribution and thus will be borne indirectly by our unitholders.
Pursuant to partnership audit rules applicable to us, if the IRS makes audit adjustments to our partnership tax returns, it may assess and collect any taxes (including any applicable penalties or interest) resulting from such audit adjustments directly from us. To the extent possible under these rules, our general partner may elect to either pay the taxes (including any applicable penalties and interest) directly to the IRS in the year in which the audit is completed, or, if we are eligible, issue a revised information statement to each current and former unitholder with respect to an audited and adjusted partnership tax return. Although our general partner may elect to have our current and former unitholders take such audit adjustment into account and pay any resulting taxes (including applicable penalties or interest) in accordance with their interests in us during the tax year under audit, there can be no assurance that such election will be practical, permissible or effective in all circumstances. If we make payments of taxes and any penalties and interest directly to the IRS in the year in which the audit is completed, our cash available for distribution might be substantially reduced, in which case our current unitholders may bear some or all of the tax liability resulting from such audit adjustment even if the unitholders did not own units in us during the tax year under audit.
Tax gain or loss on the disposition of our common units could be more or less than expected.
If a common unitholder sells common units, the unitholder will recognize gain or loss equal to the difference between the amount realized and its tax basis in those common units. Because distributions in excess of a unitholder’s allocable share of our net taxable income decrease the unitholder’s tax basis in its common units, the amount, if any, of such prior excess distributions with respect to the common units a unitholder sells will, in effect, become taxable income to the unitholder if the unitholder sells such common units at a price greater than its tax basis in those common units, even if the price received is less than its original cost. Furthermore, 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, depletion and intangible drilling cost recapture. In addition, because the amount realized may include a unitholder’s share of our liabilities, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale.
Table of Contents
Unitholders may be subject to limitations on their ability to deduct interest expense we incur.
Our ability to deduct business interest expense is limited for U.S. federal income tax purposes to an amount equal to the sum of our business interest income and a specified percentage of our “adjusted taxable income” during the taxable year, computed without regard to any business interest income or expense. Business interest expense that we are not entitled to fully deduct will be allocated to each unitholder as excess business interest and can be carried forward by the unitholder to successive taxable years and used to offset any excess taxable income allocated by us to the unitholder. Any excess business interest expense allocated to a unitholder will reduce the unitholder’s tax basis in its partnership interest in the year of the allocation even if the expense does not give rise to a deduction to the unitholder in that year.
Tax-exempt entities face unique tax issues from owning common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, including employee benefit plans and individual retirement accounts (known as IRAs), raises issues unique to them. For example, virtually all of our income allocated to organizations exempt from U.S. federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Tax-exempt entities with multiple unrelated trades or businesses cannot aggregate losses from one unrelated trade or business to offset income from another to reduce total unrelated business taxable income. As a result, it may not be possible for tax-exempt entities to utilize losses from an investment in us to offset unrelated business taxable income from another unrelated trade or business and vice versa. Tax-exempt entities should consult a tax advisor before investing in our common units.
Non-U.S. unitholders will be subject to U.S. federal income taxes and withholding with respect to income and gain from owning our common units.
Non-U.S. persons are generally taxed and subject to U.S. federal income tax filing requirements on income effectively connected with a U.S. trade or business. Income allocated to our unitholders and any gain from the sale of our units will generally be considered to be “effectively connected” with a U.S. trade or business. As a result, distributions to a non-U.S. unitholder will be subject to withholding at the highest applicable effective tax rate and a non-U.S. unitholder who sells or otherwise disposes of a common unit will also be subject to U.S. federal income tax on the gain realized from the sale or disposition of that unit.
Moreover, the transferee of an interest in a partnership that is engaged in a United States trade or business is generally required to withhold 10% of the “amount realized” by the transferor unless the transferor certifies that it is not a non-U.S. person. The U.S. Department of the Treasury and the IRS have issued final regulations providing guidance on the application of these rules for transfers of certain publicly traded partnership interests, including transfers of our common units. Under these regulations, the “amount realized” on a transfer of our common units will generally be the amount of gross proceeds paid to the broker effecting the applicable transfer on behalf of the transferor, and such broker will generally be responsible for the relevant withholding obligations. Distributions to non-U.S. unitholders may also be subject to additional withholding 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. Non-U.S. unitholders should consult their tax advisors regarding the impact of these rules on an investment in our common units.
We treat each purchaser of our common units as having the same tax benefits without regard to the common units purchased. The IRS may challenge this treatment, which could adversely affect the value of our common units.
Because we cannot match transferors and transferees of common units, we have adopted depletion, depreciation and amortization positions that may not conform with all aspects of existing U.S. Treasury regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to our unitholders. A successful IRS challenge also could affect the timing of these tax benefits or the amount of gain on the sale of common units and could have a negative impact on the value of our common units or result in audits of and adjustments to our unitholders’ tax returns.
We prorate our items of income, gain, loss and deduction between transferors and transferees of common units each month based upon the ownership of our common units on the first day of each month, instead of on the basis of the
Table of Contents
date a particular common unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our unitholders.
We prorate our items of income, gain, loss and deduction between transferors and transferees of common units each month based upon the ownership of our common units on the first day of each month, instead of on the basis of the date a particular common unit is transferred. Although Treasury regulations allow publicly traded partnerships to use a similar monthly simplifying convention, these regulations do not specifically authorize all aspects of our proration method. If the IRS were to successfully challenge our proration method, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
A unitholder whose common units are the subject of a securities loan (e.g., a loan to a “short seller” to cover a short sale of common units) may be considered as having disposed of those common units. If so, the unitholder would no longer be treated for U.S. federal income tax purposes as a partner with respect to those common units during the period of the loan and may recognize gain or loss from the disposition.
Because a unitholder whose common units are loaned to a “short seller” to cover a short sale of common units may be considered as having disposed of the loaned common units, the unitholder may no longer be treated for U.S. federal income tax purposes as a partner with respect to those common units during the period of the loan to the short seller, and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any distributions received by the unitholder as to those common units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to consult with their tax advisor about whether it is advisable to modify any applicable brokerage account agreements to prohibit their brokers from loaning their common units.
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, we routinely 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 ourselves using a methodology based on the market value of our common units as a means to determine 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 timing, character or amount of taxable income or loss being allocated to our unitholders. It also could affect the amount of gain from our unitholders’ sale of 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.
As a result of investing in our common units, our unitholders may become subject to state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire properties.
In addition to U.S. federal income taxes, our unitholders will likely be subject to other taxes, including state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own property now or in the future, even if they do not reside in any of those jurisdictions. Our unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Furthermore, our unitholders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each unitholder to file all U.S. federal, state and local tax returns that may be required of such unitholder.
Other Risks
The impact of the Russian invasion of Ukraine on the global economy, energy supplies and raw materials is uncertain, but may prove to negatively impact our business and operations.
The short and long-term implications of Russia’s invasion of Ukraine are difficult to predict at this time. We continue to monitor any adverse impact that the outbreak of war in Ukraine and the subsequent institution of sanctions
Table of Contents
against Russia by the United States and several European and Asian countries may have on the global economy in general, on our business and operations and on the businesses and operations of our suppliers and customers. For example, a prolonged conflict may result in increased inflation, escalating energy prices and constrained availability, and thus increasing costs, of raw materials. To the extent the war in Ukraine may adversely affect our business, it may also have the effect of heightening many of the other risks described in our risk factors, such as those relating to data security, supply chain, volatility in prices of inputs, and market conditions, any of which could negatively affect our business and financial condition.
