ITEMS 1 & 2. BUSINESS and PROPERTIES
BUSINESS
Formation and Initial Public Offering
We are a Delaware limited partnership formed in July 2013 by Valero. On
December 16, 2013
, we completed our initial public offering (the Offering) of
17,250,000
common units representing limited partner interests. Our common units are listed on the New York Stock Exchange (NYSE) under the symbol “VLP.” See
Note 1
of Notes to Consolidated Financial Statements for further discussion of our initial public offering.
After completion of the Offering, the Partnership includes the assets, liabilities, and results of operations of certain crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets previously owned and operated by Valero (as described below and referred to as the Contributed Assets). Prior to the Offering, the assets, liabilities, and results of operations of the Contributed Assets related to our Predecessor.
Overview
We are a traditional master limited partnership formed by Valero to own, operate, develop, and acquire crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets. Our Contributed Assets consist of crude oil and refined petroleum products pipeline and terminal systems in the United States (U.S.) Gulf Coast and U.S. Mid-Continent regions that are integral to the operations of Valero’s Port Arthur Refinery located in Port Arthur, Texas, Valero’s McKee Refinery located in Sunray, Texas, and Valero’s Memphis Refinery located in Memphis, Tennessee. We generate revenues by charging tariffs and fees for transporting crude oil and refined petroleum products through our pipelines and terminals.
In connection with the Offering, we entered into a master transportation services agreement with Valero with respect to our pipelines and a master terminal services agreement with Valero with respect to our terminals. These fee-based commercial agreements have minimum quarterly throughput commitments, inflation escalators, and initial terms through December 16, 2023. With the exception of our El Paso truck rack and Memphis truck rack, Valero has the option to renew the agreements with respect to each of our assets for one additional five-year term.
For the year ended December 31, 2013, Valero accounted for all of our revenues. We expect to continue to derive substantially all of our revenues from Valero for the foreseeable future. We also expect Valero to serve as a critical source of our future growth by providing us opportunities to purchase additional transportation and logistics assets that Valero currently owns or may acquire or develop in the future. In connection with the Offering, we entered into an omnibus agreement with Valero under which Valero granted us a right of
first offer for a period of five years after the closing of the Offering to acquire certain of Valero’s transportation and logistics assets. Our agreements with Valero are discussed more fully in other sections of this report.
Available Information
Our website address is www.valeroenergypartners.com. Information on our website is not part of this report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with or furnished to the Securities and Exchange Commission (SEC) are available, free of charge, on our website (under Reports & SEC Filings), soon after we file or furnish such material.
Organizational Structure
The following simplified diagram depicts our organizational structure as of December 31, 2013.
Segments
Our operations consist of one reportable segment and are conducted in the U.S. All of our assets are located in the U.S.
Our Assets and Operations
The following sections describe our Contributed Assets and the related services that we provide.
Port Arthur Logistics System
Our Port Arthur logistics system includes our Lucas crude system and our Port Arthur products system.
Lucas Crude System.
Our Lucas crude system supports diverse and flexible crude oil supply options for Valero’s Port Arthur Refinery.
Our Lucas crude system comprises the following pipelines and terminals:
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Lucas Terminal.
Our Lucas terminal is located 12 miles from Valero’s Port Arthur Refinery on 495 acres. The facility consists of seven storage tanks with an aggregate of
1.9 million
barrels of storage capacity. The Lucas terminal receives crude oil through our Nederland pipeline that connects to the Sunoco Logistics Partners L.P. marine terminal in Nederland, Texas, as well as through connections to the Cameron Highway crude oil pipeline and Oiltanking’s Beaumont marine terminal. The terminal will connect to TransCanada’s Cushing MarketLink pipeline via our TransCanada connection, as more fully described below. The Lucas terminal delivers crude oil to Valero’s Port Arthur Refinery through our Lucas pipeline.
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Lucas Pipeline
. Our Lucas pipeline is a 12-mile, 30-inch pipeline with 400,000 barrels per day of capacity that delivers crude oil from our Lucas terminal to Valero’s Port Arthur Refinery.
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Nederland Pipeline.
Our Nederland pipeline is a five-mile, 32-inch pipeline with 600,000 barrels per day of capacity that delivers crude oil to our Lucas terminal from the Sunoco Logistics Nederland marine terminal.
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TransCanada Connection.
Our TransCanada connection is currently under construction and is expected to be placed into service during the second quarter of 2014. The connection is expected to have
400,000
barrels per day of capacity and connect our Lucas terminal to TransCanada’s Cushing MarketLink pipeline, which began transporting crude oil from Cushing, Oklahoma to the U.S. Gulf Coast in early 2014. TransCanada is currently awaiting certain permits necessary to construct its Keystone XL pipeline, which is designed to provide connectivity from Alberta, Canada to the Cushing MarketLink origin point at Cushing.
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Port Arthur Products System.
Our Port Arthur products system transports refined petroleum products from Valero’s Port Arthur Refinery to major third-party pipeline systems, including the Explorer, Colonial, Sunoco Logistics MagTex and Enterprise TE Products refined petroleum products pipeline systems, for delivery to various marketing outlets, and to Oiltanking’s Beaumont marine terminal for diesel exports. The Explorer, Colonial, and Enterprise TE Products pipeline systems are major interstate pipeline systems that transport refined petroleum products from the U.S. Gulf Coast to marketing terminals throughout the midwestern, southeastern, and northeastern regions of the U.S. The Sunoco Logistics MagTex pipeline system transports refined petroleum products from the Port Arthur area to marketing terminals in Texas. Oiltanking’s Beaumont marine terminal is capable of exporting refined petroleum products in ship sizes of up to 400,000 barrels.
Our Port Arthur products system comprises the following pipelines and terminals:
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Port Arthur Products Pipelines
. Our Port Arthur products pipelines consist of a
four
-mile, 20-inch pipeline with
144,000
barrels per day of capacity that delivers gasoline from Valero’s Port Arthur Refinery to our El Vista terminal and a
three
-mile, 20-inch pipeline with
216,000
barrels per day of capacity that delivers diesel from Valero’s Port Arthur Refinery to our Port Arthur Products Station
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(PAPS) terminal. Our Port Arthur products pipelines are key distribution outlets for diesel and gasoline from Valero’s Port Arthur Refinery.
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12-10 Pipeline
. Our 12-10 pipeline consists of 13 miles of 12-inch and 10-inch pipeline with 60,000 barrels per day of capacity that delivers refined petroleum products from Valero’s Port Arthur Refinery to the Enterprise TE Products pipeline connection, the Sunoco Logistics MagTex pipeline connection, and Oiltanking’s Beaumont marine terminal.
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PAPS and El Vista Terminals
. Our PAPS and El Vista terminals consist of an aggregate 16 storage tanks with over two million barrels of storage capacity. Our PAPS terminal consists of eight tanks with 821,000 barrels of diesel storage capacity, and our El Vista terminal consists of eight tanks with 1.2 million barrels of gasoline storage capacity. Our PAPS terminal also contains storage tanks owned by Shell, who serves as the operator of both our PAPS and El Vista terminals. Each party owns its own tanks at the PAPS terminal and its own external pipelines connecting to the terminal, but certain equipment and improvements located at and serving the terminal are jointly owned. The El Vista terminal is owned exclusively by us.
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McKee Products System
Our McKee products system transports refined petroleum products from Valero’s McKee Refinery to our refined petroleum products terminal in El Paso, Texas and on to Kinder Morgan’s SFPP system for marketing in the southwest U.S. We own a 33⅓ percent undivided interest in the system. Capacity on the McKee products system is allocated between the other interest owner and us according to our respective ownership interests.
Our McKee products system comprises the following pipelines and terminal:
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McKee to El Paso Pipeline
. Our McKee to El Paso pipeline consists of 408 miles of 10-inch pipeline that delivers diesel and gasoline produced at Valero’s McKee Refinery to our El Paso terminal. The pipeline has a total capacity of 63,000 barrels per day (of which 21,000 barrels per day of capacity are allocable to our 33⅓ percent undivided interest).
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SFPP Pipeline Connection
. Our SFPP pipeline connection consists of 12 miles of 16- and 8‑inch pipelines that deliver diesel and gasoline from our El Paso terminal to Kinder Morgan’s SFPP system. The SFPP pipeline connection has 98,400 barrels per day of capacity (of which 33,000 barrels per day of capacity are allocable to our 33⅓ percent undivided interest).
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El Paso Terminal
. Our El Paso terminal is located on 117 acres and consists of 10 storage tanks with 499,000 barrels of storage capacity (of which 166,000
barrels of capacity are allocable to our 33⅓ percent undivided interest). The El Paso terminal receives refined petroleum products delivered to the terminal through our McKee to El Paso pipeline and delivers refined petroleum products to our four-bay truck rack at our El Paso terminal and to Kinder Morgan’s SFPP system through our SFPP pipeline connection. Our El Paso terminal truck rack has 30,000 barrels per day of capacity (of which 10,000 barrels per day of capacity are allocable to our 33⅓ percent undivided interest).
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Memphis Logistics System
Our Memphis logistics system includes our Collierville crude system and our Memphis products system.
Collierville Crude System.
Our Collierville crude system is the primary crude oil supply source for Valero’s Memphis Refinery, delivering crude oil from the Capline pipeline.
Our Collierville crude system comprises the following assets:
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Collierville Pipeline System
. Our Collierville pipeline system consists of 52 miles of 10- to 20-inch pipelines with 210,000 barrels per day of capacity that deliver crude oil to Valero’s Memphis Refinery.
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Collierville Terminal
. Our Collierville terminal is located in Byhalia, Mississippi on 60 acres. The facility consists of three storage tanks with 975,000 barrels of storage capacity. The Collierville terminal receives crude oil delivered to the terminal through the Capline pipeline.
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St
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James Crude Tank
. We own a 330,000 barrel crude oil storage tank in St. James, Louisiana located on land we lease from Shell. The tank is used to aggregate crude oil volumes to batch deliveries through the Capline pipeline to our Collierville terminal.
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Memphis Products System.
Our Memphis products system is the primary outlet for refined petroleum products produced at Valero’s Memphis Refinery with distribution through our Memphis truck rack and our terminal in West Memphis, Arkansas for further distribution via truck and barge to marketing outlets along the central Mississippi River, to Exxon’s Memphis refined petroleum products terminal, and to the Memphis International Airport.
Our Memphis products system comprises the following assets:
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Shorthorn Pipeline System
. Our Shorthorn pipeline system consists of seven miles of 14-inch pipeline that delivers diesel and gasoline produced at Valero’s Memphis Refinery to our West Memphis terminal and two miles of 12-inch pipeline that delivers diesel and gasoline from our West Memphis terminal and Valero’s Memphis Refinery to Exxon’s Memphis refined petroleum products terminal. The Shorthorn pipeline system has a total capacity of 120,000 barrels per day.
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Memphis Airport Pipeline System.
Our Memphis Airport pipeline system consists of a nine-mile, six-inch pipeline that delivers jet fuel produced at Valero’s Memphis Refinery to the Swissport Fueling, Inc. terminal located at the Memphis International Airport and a two-mile, six-inch pipeline that delivers jet fuel from Valero’s Memphis Refinery to the FedEx jet fuel terminal located at the Memphis International Airport. The Memphis Airport pipeline system has a total capacity of 20,000 barrels per day.
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West Memphis Terminal
. Our West Memphis terminal is located in West Memphis, Arkansas on 75 acres. The facility consists of 18 storage tanks with over one million barrels of storage capacity, a truck rack, and a barge dock on the Mississippi River. Our West Memphis terminal receives refined petroleum products through our Shorthorn pipeline system and through a biodiesel truck unloading rack located at the terminal. The terminal delivers refined petroleum products to the five-bay, 50,000 barrels per day truck rack at the terminal, our two-berth, 4,000 barrels per hour barge dock on the Mississippi River and to our Shorthorn pipeline system for deliveries to Exxon’s Memphis terminal.
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Memphis Truck Rack
. Our Memphis truck rack is located on five acres of land adjacent to Valero’s Memphis Refinery. The facility consists of a high-capacity seven-bay truck rack and five biodiesel
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storage tanks with
8,000
barrels of storage capacity. The truck rack has a capacity of 110,000 barrels per day.
Pipelines
The following table summarizes information with respect to our pipelines described above:
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Pipeline
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Diameter
(inches)
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Length
(miles)
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Throughput Capacity
(thousand barrels
per day (MBPD))
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Commodity
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Associated
Valero
Refinery
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Significant
Third-party
System
Connections
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Port Arthur logistics system
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Lucas crude system
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Lucas pipeline
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30
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12
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400
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Crude oil
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Port Arthur
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Sunoco Logistics Nederland;
Oiltanking Beaumont;
Cameron Highway;
TransCanada Cushing
MarketLink
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Nederland pipeline
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32
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5
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600
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Crude oil
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Port Arthur
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Sunoco Logistics
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Port Arthur products system
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20-inch gasoline pipeline
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20
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4
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144
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Gasoline
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Port Arthur
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Explorer; Colonial
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20-inch diesel pipeline
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20
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3
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216
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Diesel
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Port Arthur
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Explorer; Colonial
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12-10 pipeline
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12, 10
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13
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60
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Refined
petroleum
products
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Port Arthur
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Sunoco Logistics MagTex;
Enterprise TE Products;
Oiltanking Beaumont
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McKee products system
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McKee to El Paso pipeline
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10
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408
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21
(1)
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Refined
petroleum
products
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McKee
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—
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SFPP pipeline connection
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16, 8
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12
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33
(2)
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Refined
petroleum
products
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McKee
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Kinder Morgan
SFPP System
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Memphis logistics system
(3)
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Collierville crude system
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Collierville pipeline
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10-20
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52
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210
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Crude oil
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Memphis
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Capline
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Memphis products system
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Shorthorn pipeline system
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14, 12
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9
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120
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Refined
petroleum
products
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Memphis
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Exxon Memphis
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Memphis Airport pipeline
system
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6
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11
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20
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Jet fuel
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Memphis
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Memphis International Airport
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(1)
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Capacity shown represents our 33⅓ percent undivided interest in the system. Total capacity for the system is 63,000 barrels per day.
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(2)
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Capacity shown represents our 33⅓ percent undivided interest in the system. Total capacity for the system is 98,400 barrels per day.
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(3)
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Portions of our Memphis logistics system pipelines are owned by Memphis Light, Gas and Water, a division of the City of Memphis (MLGW), but operated and maintained exclusively by us under long-term arrangements with MLGW.
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Terminals
The following table summarizes information with respect to our terminals described above:
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Terminal
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Tank
Storage
Capacity
(thousands of barrels (MBbls))
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Throughput
Capacity
(MBPD)
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Commodity
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Associated
Valero
Refinery
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Significant
Third-party
System
Connections
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Port Arthur logistics system
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Lucas crude system
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Lucas terminal
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1,915
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—
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Crude oil
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Port Arthur
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Sunoco Logistics Nederland;
Oiltanking Beaumont;
Cameron Highway;
TransCanada Cushing
MarketLink
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TransCanada connection
(1)
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—
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400
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Crude oil
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Port Arthur
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TransCanada Cushing
MarketLink
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Port Arthur products system
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PAPS terminal
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821
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Diesel
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Port Arthur
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Explorer; Colonial
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El Vista terminal
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1,210
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Gasoline
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Port Arthur
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Explorer; Colonial
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McKee products system
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El Paso terminal
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166
(2)
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Refined
petroleum
products
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McKee
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Kinder Morgan
SFPP System
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El Paso terminal truck rack
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—
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10
(3)
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Refined
petroleum
products
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McKee
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—
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Memphis logistics system
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Collierville crude system
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Collierville terminal
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975
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—
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Crude oil
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Memphis
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Capline
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St. James crude tank
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330
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Crude oil
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Memphis
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Capline
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Memphis products system
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West Memphis terminal
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1,080
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—
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Refined
petroleum
products
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Memphis
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Exxon Memphis;
Enterprise TE Products
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West Memphis terminal truck rack
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—
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50
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Refined
petroleum
products
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Memphis
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—
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West Memphis terminal dock
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—
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4
(4)
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Refined
petroleum
products
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Memphis
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—
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Memphis truck rack
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8
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110
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Refined
petroleum
products
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Memphis
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—
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(1)
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Our TransCanada connection is currently under construction and is expected to be placed into service during the second quarter of 2014.
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(2)
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Capacity shown represents our 33⅓ percent undivided interest in the system. Total storage capacity for the system is 499,000 barrels.
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(3)
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Capacity shown represents our 33⅓ percent undivided interest in the system. Total truck rack capacity for the system is 30,000 barrels per day.
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(4)
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Dock throughput is reflected in thousands of barrels per hour.
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Volumes Handled
The following table sets forth the historical throughput volumes and leased storage capacity with respect to our systems for the periods presented:
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Year Ended December 31,
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2013
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2012
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2011
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Pipelines (MBPD)
(1)
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Crude oil throughput
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Lucas crude system
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178
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158
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84
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Collierville crude system
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149
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144
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144
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Total crude oil throughput
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327
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302
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228
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Refined petroleum products throughput
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Port Arthur products system
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154
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117
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94
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McKee products system
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53
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52
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53
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Memphis products system
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56
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49
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37
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Total refined petroleum products throughput
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263
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218
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184
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Total pipelines throughput
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590
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520
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412
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Terminals (MBPD)
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Crude oil terminaling throughput
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Lucas crude system
(2)
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179
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158
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84
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Refined petroleum products terminaling throughput
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Port Arthur products system
(3)
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123
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109
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84
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McKee products system
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43
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42
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43
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Memphis products system
(3)
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86
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78
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82
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Total refined petroleum products terminaling throughput
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252
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229
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209
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Total terminaling throughput
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431
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387
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293
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Leased storage capacity (MBbls)
(3)
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Port Arthur products system
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2,031
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2,031
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2,031
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Collierville crude system
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330
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330
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330
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Memphis products system
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975
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900
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853
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Total leased storage capacity
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3,336
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3,261
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3,214
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(1)
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Represents the sum of volumes transported through each separately tariffed pipeline segment.
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(2)
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Throughput volumes represent actual throughput volumes at our Lucas terminal. However, prior to the Offering, we did not charge a terminaling fee for throughput volumes at our Lucas terminal. Under our master terminal services agreement with Valero that became effective upon the closing of the Offering, we charge a terminaling fee for throughput volumes at our Lucas terminal.
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(3)
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Throughput volumes include actual throughput volumes at our PAPS, El Vista and West Memphis terminals. However, prior to the Offering, we charged a fee for leased storage capacity at these terminals. Under our master terminal services agreement with Valero that became effective upon the closing of the Offering, we charge a terminaling fee for throughput volumes at these terminals.
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Percentage of Volumes Transported
The following table lists the percentage of volumes transported on our pipeline systems relative to the total amount of refined petroleum products transported from, or the total amount of crude oil and feedstocks throughput at, the applicable Valero refinery serviced by our pipeline systems, for each of the periods described below:
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Year Ended December 31,
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Pipeline System
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2013
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2012
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2011
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Port Arthur logistics system
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Lucas crude system
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55%
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55%
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36%
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Port Arthur products system
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50%
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46%
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43%
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McKee products system
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13%
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13%
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13%
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Memphis logistics system
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Collierville crude system
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92%
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96%
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100%
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Memphis products system
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68%
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68%
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66%
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Our Commercial Agreements with Valero
General
At the closing of the Offering, we entered into a master transportation services agreement with Valero with respect to our pipelines and a master terminal services agreement with Valero with respect to our terminals. Under these agreements, we provide transportation and terminaling services to Valero, and Valero pays us for minimum quarterly throughput volumes of crude oil and refined petroleum products, regardless of whether such volumes are physically delivered by Valero in any given quarter. These agreements have initial terms through December 31, 2023, and, with the exception of our El Paso truck rack and Memphis truck rack, Valero has the option to renew the agreements with respect to each asset for one additional five-year term.
Minimum Quarterly Throughput Commitments and Tariff Rates—Pipelines
The following table describes Valero’s minimum quarterly throughput commitments and applicable initial tariff rates for our pipelines:
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Pipelines
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Minimum Quarterly
Throughput Commitment
(barrels per day (BPD))
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Tariff Rates
($ per Barrel)
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Port Arthur logistics system
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Lucas crude system
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Lucas pipeline
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150,000
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$0.176 up to 160,000 BPD then
$0.071 up to 200,000 BPD and
$0.06 above 200,000 BPD
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Port Arthur products system
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20-inch gasoline pipeline
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127,000
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$0.1855 up to 127,000 BPD and
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20-inch diesel pipeline
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combined on
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$0.14 above 127,000 BPD
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12-10 pipeline
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all three lines
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combined on all three lines
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McKee products system
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McKee to El Paso pipeline
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17,836
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$1.302
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SFPP pipeline connection
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27,880
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$0.151
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Memphis logistics system
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Collierville crude system
(1)
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Collierville pipeline
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100,000
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$0.1557
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Memphis products system
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Shorthorn pipeline system
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43,300
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$0.1471 up to 43,300 BPD and
$0.12 above 43,300 BPD
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Memphis Airport pipeline system
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2,000
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$0.81 up to 2,000 BPD and
$0.45 above 2,000 BPD
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(1)
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Included within the tariff rate is the ability for Valero to use break-out tankage at our Collierville terminal and our St. James crude tank for staging crude oil into the Capline pipeline.
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Under our master transportation services agreement, Valero is obligated to transport minimum volumes of crude oil and refined petroleum products on our pipeline systems and pay a tariff rate with respect to such volumes. Tariff rates with respect to our pipeline systems may be adjusted annually in accordance with the Federal Energy Regulatory Commission’s (FERC) indexing methodology. With respect to any pipelines that may be subject to a jurisdictional tariff, we and Valero have agreed not to commence or support any tariff filing, application, protest, complaint, petition, motion, or other proceeding before FERC for the purpose of requesting that FERC accept or set tariff rates that would be inconsistent with the terms of the master transportation services agreement, provided that Valero will continue to have the right under FERC regulations to challenge any proposed changes in our base tariff rates to the extent the changes are inconsistent with FERC’s indexing methodology or other rate changing methodologies, or to the extent the challenge is in response to any proceeding brought against us by a third party that could affect our ability to provide transportation services to Valero under our master transportation services agreement or the applicable tariff.
Minimum Quarterly Throughput Commitments and Fees—Terminals
The following table sets forth Valero’s minimum quarterly throughput commitments and fees charged with respect to our terminals:
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Terminals
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Minimum Quarterly
Throughput Commitment
(BPD)
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Fees
($ per Barrel)
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Port Arthur logistics system
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Lucas crude system
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Lucas terminal
(1)
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150,000
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$0.243 up to 160,000 BPD then
$0.071 up to 200,000 BPD and
$0.06 above 200,000 BPD
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TransCanada connection
(2)
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45,000
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$0.05
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Port Arthur products system
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PAPS and El Vista terminals
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100,000
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$0.3165 up to 100,000 BPD and
$0.05 above 100,000 BPD
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McKee products system
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El Paso terminal
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36,380
(3)
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$0.301
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Memphis logistics system
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Memphis products system
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West Memphis terminal
(4)
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30,000
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$0.62 up to 30,000 BPD and
$0.24 above 30,000 BPD
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Memphis truck rack
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51,100
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$0.252
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(1)
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Included in the Lucas terminal fee is the right to use our Nederland pipeline to transport crude oil from the Sunoco Logistics Nederland marine terminal to our Lucas terminal.
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(2)
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Our TransCanada connection is currently under construction and is expected to be placed into service during the second quarter of 2014. The minimum quarterly throughput commitment will not commence until the connection is in service; however, under our omnibus agreement with Valero, Valero has agreed to indemnify us for lost throughput fees based on minimum quarterly throughput commitments resulting from the connection not being in service (for any reason whatsoever, other than our gross negligence or willful misconduct) by March 1, 2014. In addition, if and when TransCanada’s Keystone XL pipeline is placed into service, the minimum quarterly throughput commitment with respect to our TransCanada connection will increase from 45,000 barrels per day to 150,000 barrels per day and the fee will reset to $0.015 per barrel.
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(3)
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The El Paso terminal truck rack has a minimum quarterly throughput commitment of 8,500 barrels per day and the SFPP pipeline connection has a separate minimum quarterly throughput commitment of 27,880 barrels per day.
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(4)
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Includes all volumes delivered to our West Memphis terminal through pipeline, dock, or truck rack.
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Under the master terminal services agreement relating to our terminals, Valero is obligated to throughput minimum volumes of crude oil and refined petroleum products and pay us throughput fees, as well as fees for providing related ancillary services (such as ethanol, biodiesel and renewable diesel blending,
and additive injection). Valero provides and pays for its own inventory of ethanol, biodiesel and renewable diesel blending, and additives to be blended or injected at the terminal, where applicable. Throughput fees with respect to our terminals will be increased on July 1, 2014, and on July 1 of each year thereafter, and other fees with respect to our terminals may be increased annually at our discretion, in each case by a percentage not to exceed the corresponding percentage change in the Consumer Price Index (CPI) during the 12-month period ending on March 31 of such year. If CPI decreases during any period, we are not required to reduce our fees, but any subsequent increases in fees based on an increase in CPI will be limited to the amount by which such increase exceeds the aggregate amount of cumulative decreases in CPI during the intervening periods. The first CPI adjustment on July 1, 2014 will be based on 50 percent of the increase in the CPI.
Quarterly Deficiency Payments
If Valero fails to meet its minimum quarterly throughput commitments under our commercial agreements in any given quarter, it is obligated to pay a deficiency payment equal to the volume deficiency multiplied by the applicable tariff and/or fee with respect to such asset. We refer to this payment as a “quarterly deficiency payment.” Quarterly deficiency payments may be applied as a credit for amounts owed on throughput volumes in excess of Valero’s minimum quarterly throughput commitment with respect to such asset during any of the following four quarters, after which time any unused credits will expire. Upon the expiration of our commercial agreements, Valero may apply any such remaining credit amounts with respect to such asset until the completion of any such four-quarter period against any throughput volumes on such asset in excess of the minimum quarterly throughput commitment that was in place during the term of the agreement with respect to such asset.
Minimum Capacity
Under each of our commercial agreements, we are obligated to provide Valero access to capacity of at least the minimum quarterly throughput commitment for our assets. If the minimum capacity of any of our assets falls below the level of Valero’s minimum quarterly throughput commitment at any time due to events affecting such assets (whether planned or unplanned) or if capacity on any of our assets is required to be allocated among users because volume nominations exceed available capacity, Valero’s minimum quarterly throughput commitments with respect to such assets may be proportionately reduced during the period for which capacity is less than Valero’s minimum quarterly throughput commitment.
Product Gains and Losses
Under each of our commercial agreements, other than those commercial agreements covering assets that may be subject to a jurisdictional tariff or are operated by a third party and such tariff or third-party operating agreement specifically provides otherwise, we have no liability for physical losses except to the extent such losses result from our gross negligence or willful misconduct. In the event a terminal or pipeline asset is equipped to measure volume gains and losses through the installation of custody transfer meters and we begin to accept third-party volumes for throughput, we are required to negotiate provisions regarding loss allowance and allocate gains and losses among us and our customers in accordance with standard industry practices.
Termination and Suspension
Valero is permitted under our commercial agreements to suspend, reduce, or terminate its obligations under certain circumstances. If Valero determines to totally or partially suspend refining operations at a refinery that is supported by our assets for a period of at least 12 consecutive months, we and Valero are required to negotiate in good faith to agree upon a reduction of Valero’s minimum quarterly throughput commitments under the applicable commercial agreement(s), and if we are unable to agree to an appropriate reduction, then after Valero has made a public announcement of such suspension, Valero may terminate the applicable agreement(s) upon 12 months’ notice to us (unless in the interim Valero publicly announces its intent to resume operations at the refinery, in which case its termination notice is deemed revoked). If a force majeure event with respect to our assets prevents us from performing any of our obligations under a commercial agreement, Valero’s obligations with respect to the affected assets under the applicable commercial agreement, including its minimum quarterly throughput commitments, will be suspended to the extent we cannot perform our obligations. In addition, if a force majeure event prevents Valero from fulfilling any of its obligations under our commercial agreements for more than 60 days, Valero’s applicable obligations with respect to the affected assets, including its minimum quarterly throughput commitments, under our
commercial agreements will be suspended for the remainder of the force majeure event. Force majeure events include:
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acts of God, fires, floods, or storms;
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compliance with orders of courts or any governmental authorities;
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explosions, wars, terrorist acts, or riots;
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inability to obtain or unavoidable delays in obtaining material or equipment;
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accidental disruptions of service;
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disruptions of utilities or other services caused by events or circumstances beyond the reasonable control of the affected party;
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strikes, lockouts, or other industrial disturbances; and
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breakdowns of refinery facilities, machinery, storage tanks, or pipelines irrespective of the cause thereof.
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Turnarounds or other planned outages at a refinery are not force majeure events. If a force majeure event prevents any party from performing its obligations under a commercial agreement for a period of more than 12 consecutive months, then either party may terminate the agreement with respect to the affected assets. If Valero elects to terminate or suspend any of our commercial agreements, our financial condition, results of operations, cash flows, and ability to make distributions to our unitholders may be materially and adversely affected. We cannot assure you that Valero will continue to use our assets or that we will be able to generate additional revenues from third parties.
Reimbursements of Capital Expenditures
Our commercial agreements provide that, if we agree to make any capital expenditures at Valero’s request, Valero is required to reimburse us for the expenditures; the reimbursements may be recovered through tariff and/or fee increases in certain cases. In addition, if new laws or regulations are enacted or promulgated or if existing laws or their interpretations are materially changed, and if such new or changed laws or regulations will have a material adverse economic impact on either us or Valero, then either of us, acting in good faith, may request to renegotiate the relevant provisions of the affected commercial agreement(s) relating to the parties’ future performance. In such event, we and Valero are required to negotiate in good faith amendments to the affected agreement(s) to conform them to the new or changed laws or regulations while preserving our economic, operational, commercial, and competitive arrangements in accordance with the understandings set forth in the applicable agreement(s).
Valero also is required to reimburse us for any taxes that we incur on Valero’s behalf for services we provide to Valero under these agreements to the extent permitted by law.
Alternative Arrangements
Under our commercial agreements, if Valero restructures its supply, refining, or sales operations at a refinery that is supported by our assets in such a manner that materially and adversely affects the economics of Valero’s performance under the applicable commercial agreement, we and Valero are required to negotiate in good faith an alternative arrangement that is no worse economically for us, and that may include a
substitution of new minimum quarterly throughput commitments for Valero on other assets owned or to be acquired or constructed by us.
Assignment
Neither we nor Valero may assign our rights or obligations under our commercial agreements without the other party’s written consent, except that, if Valero transfers a refinery that is supported by our assets to a third party, Valero may assign the commercial agreement that relates to such refinery to such third party.
Our Relationship with Valero
Valero is an international manufacturer and marketer of transportation fuels, other petrochemical products, and power. Valero’s assets include 16 petroleum refineries located in the U.S., Canada, the U.K., and Aruba, with a combined throughput capacity of approximately 3.1 million barrels per day. Valero also has a substantial portfolio of transportation and logistics assets.
We are dependent upon Valero as our primary customer and the loss of Valero as a customer would have a material and adverse effect on us. For the years ended
December 31, 2013
,
2012
, and
2011
, Valero accounted for all of our revenues. We expect to continue to derive substantially all of our revenues from Valero for the foreseeable future.
Following the closing of the Offering, Valero retained a significant interest in us through its ownership of our general partner, a 68.6 percent limited partner interest in us, and all of our incentive distribution rights. We believe Valero will promote and support the successful execution of our business strategies given its significant ownership in us, the importance of our initial assets to Valero’s refining and marketing operations, and its stated intention to use us as its primary vehicle to expand the transportation and logistics assets supporting its business.
In addition to our commercial agreements with Valero, we entered into the following agreements with Valero in connection with the Offering. These agreements are described more fully in Item 13., “Certain Relationships and Related Transactions, and Director Independence—Agreements with Valero” of this report.
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Omnibus Agreement.
Under our omnibus agreement with Valero, Valero granted us a right of first offer with respect to certain of Valero’s transportation and logistics assets through December 16, 2018. The omnibus agreement requires us to reimburse Valero for certain general and administrative services, requires Valero to indemnify us for certain matters, including environmental, title and tax matters, and grants Valero a right of first refusal with respect to certain of our assets. Pursuant to the omnibus agreement, prior to making any distribution, we are required to pay all accrued monthly payments on our annual fee of
$7.9 million
to Valero for general and administrative services, and we are required to reimburse Valero for any out-of-pocket costs and expenses incurred by Valero in providing these services to us.
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Services and Secondment Agreement
. Under our services and secondment agreement with Valero, employees of Valero are seconded to our general partner to provide operational and maintenance services with respect to certain of our pipelines and terminals, and our general partner is required to reimburse Valero for certain costs and expenses of the seconded employees, including their wages and benefits.
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Tax Sharing Agreement.
Under our tax sharing agreement with Valero, we are required to reimburse Valero for our share of state and local income and other taxes incurred by Valero as a result of our tax items and attributes being included in a combined or consolidated state tax return filed by Valero
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with respect to taxable periods including or beginning on the closing date of the Offering. The amount of any such reimbursement is limited to any entity-level tax that we would have paid directly had we not been included in a combined group with Valero. While Valero may use its tax attributes to cause its combined or consolidated group, of which we may be a member for this purpose, to owe no tax, we would nevertheless reimburse Valero for the tax we would have owed had the attributes not been available or used for our benefit, even though Valero had no cash expense for that period.
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Ground Lease Agreement.
Under our ground lease with Valero, we lease the land on which the Memphis truck rack is located.
Initially, our base rent under the lease is $35,007 per year.
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Insurance
Our assets may experience physical damage as a result of an accident or natural disaster. These hazards can also cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage, and suspension of operations. We are insured under certain of Valero’s corporate insurance policies and are subject to the shared deductibles and limits under those policies. We may also carry separate insurance policies for certain property damage, business interruption, and third-party liabilities, which includes pollution liabilities, at varying levels of deductibles and limits that we believe are reasonable and prudent under the circumstances to cover our operations and assets. These separate policies may be issued by Valero’s wholly owned captive insurance company.
Pipeline Control Operations
Our pipeline systems, other than the El Paso pipeline operated by NuStar Energy (NuStar), are operated from a central control room located in San Antonio, Texas. The control center operates with a supervisory control and data acquisition system equipped with computer systems designed to continuously monitor operational data. Monitored data includes pressures, temperatures, gravities, flow rates, and alarm conditions. The control center operates remote pumps, motors, and valves associated with the receipt and delivery of crude oil and products, and provides for the remote-controlled shutdown of pump stations on the pipeline system. A fully functional back-up operations center is also maintained and routinely operated throughout the year to ensure safe and reliable operations.
Seasonality
The volumes of crude oil and refined petroleum products transported in our pipelines and stored in our terminals are directly affected by the levels of supply and demand for crude oil and refined petroleum products in the markets served directly or indirectly by our assets. Demand for gasoline is generally higher during the summer months than during the winter months due to seasonal increases in motor vehicle traffic. As a result, our customers’ operating results are generally lower for the first and fourth quarters of each year. Unfavorable weather conditions during the spring and summer months and a resulting lack of the expected seasonal upswings in traffic and sales could adversely affect Valero’s business, financial condition, and results of operations, which may adversely affect our business, financial condition, and results of operations. However, many effects of seasonality on our revenues will be substantially mitigated through the use of our fee-based commercial agreements with Valero that include minimum quarterly throughput commitments.
Competition
As a result of our contractual relationship with Valero under our commercial agreements and our direct connections to three of Valero’s refineries, we believe that our pipelines and terminals will not face significant competition from other pipelines and terminals for Valero’s crude oil or refined petroleum products transportation requirements to and from the refineries we support.
If Valero’s customers reduce their purchases of refined petroleum products from Valero due to the increased availability of less expensive products from other suppliers or for other reasons, Valero may ship only the minimum volumes through our pipelines (or pay the shortfall payment if it does not ship the minimum volumes), which would cause a decrease in our revenues. Valero competes with integrated petroleum companies, which have their own crude oil supplies and distribution and marketing systems, as well as with independent refiners, many of which also have their own distribution and marketing systems. Valero also competes with other suppliers that purchase refined petroleum products for resale. Competition in any particular geographic area is affected significantly by the volume of products produced by refineries in that area and by the availability of products and the cost of transportation to that area from distant refineries.
Environmental Matters
Our operations are subject to extensive environmental regulations by governmental authorities relating to the discharge and remediation of materials in the environment, greenhouse gas emissions, waste management, pollution prevention, species and habitat preservation, pipeline integrity, and other safety-related regulations, and characteristics and composition of fuels. Because environmental laws and regulations are becoming more complex and stringent and new environmental laws and regulations are continuously being enacted or proposed, the level of future expenditures required for environmental matters could increase in the future. In addition, any major upgrades in any of our operating facilities could require material additional expenditures to comply with environmental laws and regulations.
There are existing remedial obligations at some of our assets including our West Memphis terminal and our Lucas terminal. These existing environmental conditions are retained obligations of the prior operators of these facilities and Valero has agreed to indemnify us with respect to such conditions under the terms of our omnibus agreement. For additional information regarding our environmental matters, please see
Note 5
of the Notes to Consolidated Financial Statements.
Rate and Other Regulations
FERC and Common Carrier Regulations
We own pipeline assets in Texas, New Mexico, Tennessee, Mississippi, and Arkansas, and we provide both interstate and intrastate transportation services. Our common carrier pipeline systems are subject to regulation by various federal, state, and local agencies.
FERC regulates interstate transportation on our common carrier pipeline systems under the Interstate Commerce Act (ICA), the Energy Policy Act (EPAct), and the rules and regulations promulgated under those laws. FERC regulations require that rates for interstate service pipelines that transport crude oil and refined petroleum products (collectively referred to as petroleum pipelines) and certain other liquids, be just and reasonable and must not be unduly discriminatory or confer any undue preference upon any shipper. FERC’s regulations also require interstate common carrier petroleum pipelines to file with FERC and publicly post tariffs stating their interstate transportation rates and terms and conditions of service. Under the ICA, FERC or interested persons may challenge existing or changed rates or services. FERC is authorized to investigate such charges and may suspend the effectiveness of a new rate for up to seven months. A successful rate challenge could result in a common carrier paying refunds together with interest for the period that the rate was in effect. FERC may also order a pipeline to change its rates, and may require a common carrier to pay shippers reparations for damages sustained for a period up to two years prior to the filing of a complaint.
Intrastate services provided by certain of our pipeline systems are subject to regulation by state regulatory authorities, such as the Texas Railroad Commission (TRRC), which currently regulates our portion of the McKee to El Paso pipeline. The TRRC uses a complaint-based system of regulation, both as to matters
involving rates and priority of access. FERC and state regulatory commissions generally have not investigated rates, unless the rates are the subject of a protest or a complaint. However, FERC or a state commission could investigate our rates on its own initiative or at the urging of a third party.
If our rate levels were investigated by FERC or a state commission, the inquiry could result in a comparison of our rates to those charged by others or to an investigation of our costs. We do not anticipate any complaints against our rates or any investigation by FERC or a state regulatory commission related to our rates or terms of service. Valero has agreed not to contest our tariff rates or terms of service for the term of our transportation services agreements, provided that our tariff changes and rate increases are consistent with the terms of the transportation services agreements. Even so, FERC or a state commission could order us to change our rates or terms of service or require us to pay shippers reparations, together with interest and subject to the applicable statute of limitations, if it were determined that an established rate or terms of service were unjust or unreasonable.
Pipeline Safety
Our assets are subject to increasingly strict safety laws and regulations. The transportation and storage of crude oil and refined petroleum products involve a risk that hazardous liquids may be released into the environment, potentially causing harm to the public or the environment. In turn, such incidents may result in substantial expenditures for response actions, significant government penalties, liability to government agencies for natural resources damages, and significant business interruption. The Department of Transportation (DOT) and Pipeline and Hazardous Materials Safety Administration have adopted safety regulations with respect to the design, construction, operation, maintenance, inspection, and management of our assets. These regulations contain requirements for the development and implementation of pipeline integrity management programs, which include the inspection and testing of pipelines and necessary maintenance or repairs. These regulations also require that pipeline operation and maintenance personnel meet certain qualifications and that pipeline operators develop comprehensive spill response plans.
Product Quality Standards
Refined petroleum products that we transport are generally sold by our customer for consumption by the public. Various federal, state, and local agencies have the authority to prescribe product quality specifications for products. Changes in product quality specifications or blending requirements could reduce our throughput volumes, require us to incur additional handling costs, or require capital expenditures. For example, different product specifications for different markets affect the fungibility of the products in our system and could require the construction of additional storage. If we are unable to recover these costs through increased revenues, our cash flows and ability to make distributions could be adversely affected. In addition, changes in the product quality of the products we receive on our product pipeline systems or at our terminals could reduce or eliminate our ability to blend products.
Security
We are also subject to Department of Homeland Security Chemical Facility Anti-Terrorism Standards, which are designed to regulate the security of high-risk chemical facilities, and to the Transportation Security Administration’s Pipeline Security Guidelines. We have an internal program of inspection designed to monitor and enforce compliance with all of these requirements. We believe that we are in material compliance with all applicable laws and regulations regarding the security of our facilities.
While we are not currently subject to governmental standards for the protection of computer-based systems and technology from cyber threats and attacks, proposals to establish such standards are being considered by the U.S. Congress and by U.S. Executive Branch departments and agencies, including the Department
of Homeland Security, and we may become subject to such standards in the future. We are currently implementing our own cyber-security programs and protocols; however, we cannot guarantee their effectiveness. A significant cyber-attack could have a material effect on operations and those of our customers.
Employees
We are managed by the board of directors and executive officers of Valero Energy Partners GP LLC, our general partner. Neither we nor our subsidiaries have any employees. Our general partner has the sole responsibility for providing the personnel necessary to conduct our operations, whether through directly hiring employees or by obtaining the services of personnel employed by Valero or others. All of the personnel that conduct our business are employed or contracted by our general partner and its affiliates.
Item 1A. RISK FACTORS
You should carefully consider each of the following risks and all of the other information contained in this Annual Report on Form 10-K in evaluating us and our common units. Some of these risks relate principally to our business and the industry in which we operate, while others relate principally to the business and operations of Valero, tax matters, ownership of our common units, and securities markets generally.
Our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders could be materially and adversely affected by these risks, and, as a result, the trading price of our common units could decline.
Risks Related to Our Business
Valero accounts for all of our revenues. Therefore, we are subject to the business risks associated with Valero’s business. Furthermore, if Valero changes its business strategy, is unable for any reason, including financial or other limitations, to satisfy its obligations under our commercial agreements or significantly reduces the volumes transported through our pipelines or terminals, our revenues would decline and our financial condition, results of operations, cash flows, and ability to make distributions to our unitholders would be materially and adversely affected.
For the years ended
December 31, 2013
,
2012
, and
2011
Valero accounted for all of our revenues. We expect to continue to derive substantially all of our revenues from Valero for the foreseeable future, and as a result, any event, whether in our areas of operation or elsewhere, that materially and adversely affects Valero’s business may adversely affect our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders. Accordingly, we are indirectly subject to the operational and business risks of Valero, the most significant of which include the following:
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disruption of Valero’s ability to obtain crude oil;
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the ability to obtain credit and financing on acceptable terms, which could also adversely affect the financial strength of business partners;
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the costs to comply with environmental laws and regulations;
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large capital projects can take many years to complete, and market conditions could deteriorate significantly between the project approval date and the project startup date, negatively impacting project returns;
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interruptions of supply and increased costs as a result of Valero’s reliance on third-party transportation of crude oil and refined petroleum products;
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significant losses resulting from the hazards and risks of operations may not be fully covered by insurance, and could adversely affect Valero’s operations and financial results;
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competitors that produce their own supply of feedstocks, have more extensive retail outlets, or have greater financial resources may have a competitive advantage over Valero;
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potential losses from Valero’s derivative transactions;
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any decision by Valero to temporarily or permanently curtail or shut down operations at one or more of its refineries or other facilities and reduce or terminate its obligations under our commercial agreements; and
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interruptions at Valero’s refineries and other facilities.
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The volumes of crude oil and refined petroleum products that we transport and terminal depend substantially on Valero’s refining margins. Refining margins are dependent both upon the price of crude oil or other refinery feedstocks and refined petroleum products. These prices are affected by numerous factors beyond our or Valero’s control, including the global supply and demand for crude oil, gasoline and other refined petroleum products, competition from alternative energy sources, and the impact of new and more stringent regulations affecting the energy industry. A material decrease in the refining margins at Valero’s refineries supported by our assets could cause Valero to reduce the volumes we transport and terminal for Valero, which could materially and adversely affect our financial condition, results of operations, and ability to make distributions to our unitholders.
We may not have sufficient distributable cash flow following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to our general partner and its affiliates, to enable us to pay minimum quarterly distributions to our unitholders.
We may not generate sufficient cash flows each quarter to enable us to pay minimum quarterly distributions. The amount of cash we can distribute on our units principally depends upon the amount of cash we generate from our operations, which will fluctuate from quarter to quarter based on, among other things, our throughput volumes, tariff rates and fees, and prevailing economic conditions. In addition, the actual amount of cash flows we generate will also depend on other factors, some of which are beyond our control, including:
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the amount of our operating expenses and general and administrative expenses, including reimbursements to Valero, which are not subject to any caps or other limits, in respect of those expenses;
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the amount and timing of capital expenditures and acquisitions we make;
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our debt service requirements and other liabilities, and restrictions contained in our revolving credit facility;
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fluctuations in our working capital needs; and
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the amount of cash reserves established by our general partner.
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If we are unable to obtain needed capital or financing on satisfactory terms to fund expansions of our asset base, our ability to make quarterly distributions may be diminished or our financial leverage could increase. We do not have any commitment with any of our affiliates to provide any direct or indirect financial assistance to us.
If we do not make sufficient or effective expansion capital expenditures, we will be unable to expand our business operations and may be unable to maintain or raise the level of our quarterly distributions. We will be required to use cash from our operations, incur borrowings or access the capital markets in order to fund our expansion capital expenditures. Our ability to obtain bank financing or access the capital markets may be limited by our financial condition at such time as well as the covenants in our debt agreements, general economic conditions and contingencies, and uncertainties that are beyond our control. The terms of any such financing could also limit our ability to make distributions to our common unitholders. Incurring additional debt may significantly increase our interest expense and financial leverage, and issuing additional limited
partner interests may result in significant common unitholder dilution and increase the aggregate amount of cash required to maintain the then-current distribution rate, which could materially decrease our ability to pay distributions at the then-current distribution rate.
If Valero satisfies only its minimum quarterly throughput commitments under, or if Valero terminates or we are unable to renew or extend, our commercial agreements with Valero, our ability to make distributions to our unitholders will be reduced.
Valero is not obligated to use our services with respect to volumes of crude oil or refined petroleum products in excess of the minimum quarterly throughput commitments under our commercial agreements. During refinery turnarounds, which typically last 30 to 60 days and are performed every four to five years, we expect that Valero will only satisfy its minimum quarterly throughput commitments under our commercial agreements. Our commercial agreements with Valero, which we expect to be the source of substantially all of our revenues for the foreseeable future, have initial terms through December 16, 2023, and with the exception of our El Paso truck rack and Memphis truck rack, Valero has the option to renew the agreement with respect to each asset for one additional five-year term. If Valero fails to use our facilities and services after expiration of those agreements and we are unable to generate additional revenues from third parties, our ability to make distributions to our unitholders will be reduced.
Further, Valero may suspend, reduce or terminate its obligations under our commercial agreements if certain events occur, such as Valero’s determination to totally or partially suspend refining operations at one of its refineries that our assets support for a period that will continue for at least 12 months, or a force majeure event that impacts one of Valero’s refineries for more than 60 days. Any such reduction, suspension, or termination of Valero’s obligations would have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
We may not be able to obtain third-party revenues due to competition and other factors, which could limit our ability to grow and may extend our dependence on Valero.
Our ability to obtain third-party revenues is subject to numerous factors beyond our control, including competition from third parties and the extent to which we have available capacity when third-party shippers require it. We can provide no assurance that we will be able to attract material third-party revenues. Our efforts to establish our reputation and attract new unaffiliated customers may be adversely affected by our relationship with Valero and our desire to provide services pursuant to fee-based contracts. Our potential customers may prefer to obtain services under contracts through which we could be required to assume direct commodity exposure.
Our right of first offer to acquire certain of Valero’s transportation and logistics assets is subject to risks and uncertainty, and ultimately we may not acquire any of those assets.
Our omnibus agreement provides us with a right of first offer with respect to certain of Valero’s transportation and logistics assets through December 16, 2018. The consummation and timing of any future acquisitions pursuant to this right will depend upon, among other things, Valero’s willingness to offer such assets for sale, our ability to negotiate acceptable purchase agreements and commercial agreements with respect to such assets, and our ability to obtain financing on acceptable terms. We can provide no assurance that we will be able to successfully consummate any future acquisitions pursuant to our right of first offer, and Valero is under no obligation to accept any offer that we may choose to make. In addition, we may decide not to exercise our right of first offer if any assets are offered for sale, and our decision will not be subject to unitholder approval. In addition, our right of first offer may be terminated by Valero at any time in the event that it no longer controls our general partner.
If we are unable to make acquisitions on economically acceptable terms from Valero or third parties, our future growth would be limited, and any acquisitions we may make may reduce, rather than increase, our cash flows and ability to make distributions to unitholders.
Our strategy to grow our business and increase distributions to unitholders is dependent in part on our ability to make acquisitions that result in an increase in distributable cash flow per unit. Our growth strategy is based in part on our expectation of ongoing divestitures by industry participants, including our right of first offer from Valero.
The consummation and timing of any future acquisitions will depend upon, among other things, whether:
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we are able to identify attractive acquisition candidates;
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we are able to negotiate acceptable purchase agreements;
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we are able to obtain financing for these acquisitions on economically acceptable terms; and
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we are outbid by competitors.
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We can provide no assurance that we will be able to successfully consummate any future acquisitions, whether from Valero or any third parties. If we are unable to make future acquisitions, our future growth and ability to increase distributions will be limited. Furthermore, even if we do consummate acquisitions that we believe will be accretive, they may in fact result in a decrease in distributable cash flow per unit as a result of incorrect assumptions in our evaluation of such acquisitions, unforeseen consequences, or other external events beyond our control. Acquisitions involve numerous risks, including difficulties in integrating acquired businesses, inefficiencies, and unexpected costs and liabilities.
Our ability to expand may be limited if Valero does not grow its business.
Part of our growth strategy depends on organic growth that depends in part on the growth of Valero’s business. For example, in our terminals business, we believe our growth will be driven in part by identifying and executing organic expansion products that will result in increased throughput volumes from Valero and third parties. If Valero focuses on other growth areas or does not make capital expenditures to fund the organic growth of its transportation and logistics assets, we may not be able to fully execute our growth strategy.
Our and Valero’s operations are subject to many risks and operational hazards. If a significant accident or event occurs that results in a business interruption or shutdown for which we are not adequately insured, our financial condition, results of operations, and cash flows and our ability to sustain or increase distributions to our unitholders could be materially and adversely affected.
Our operations are subject to all of the risks and operational hazards inherent in transporting, terminaling, and storing crude oil and refined petroleum products, including:
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damages to facilities, equipment, and surrounding properties caused by third parties, severe weather, natural disasters, and acts of terrorism;
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maintenance, repairs, mechanical or structural failures at our or Valero’s facilities or at third-party facilities on which our or Valero’s operations are dependent, including electrical shortages, power disruptions, and power grid failures;
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damages to and loss of availability of interconnecting third-party pipelines, terminals, and other means of delivering crude oil, feedstocks, and refined petroleum products;
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disruption or failure of information technology systems and network infrastructure due to various causes, including unauthorized access or attack;
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curtailments of operations due to severe seasonal weather; and
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riots, strikes, lockouts, or other industrial disturbances.
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These risks could result in substantial losses due to personal injury and/or loss of life, severe damage to and destruction of property and equipment, and pollution or other environmental damage, as well as business interruptions or shutdowns of our facilities. Any such event or unplanned shutdown could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders. In addition, Valero’s refining operations supported by our assets, on which our operations are substantially dependent and over which we have no control, are subject to similar operational hazards and risks inherent in refining crude oil.
Our insurance policies do not cover all losses, costs, or liabilities that we may experience, and insurance companies that currently insure companies in the energy industry may cease to do so or substantially increase premiums.
We do not maintain insurance coverage against all potential losses and could suffer losses for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. We are insured under Valero’s insurance policies for certain property damage, business interruption, and third-party liabilities, which includes pollution liabilities, and are subject to Valero’s policy limits under these policies. The occurrence of an event that is not fully covered by insurance or failure by one or more insurers to honor its coverage commitments for an insured event could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders. Insurance companies may reduce the insurance capacity they are willing to offer or may demand significantly higher premiums or deductibles to cover these facilities. If significant changes in the number or financial solvency of insurance underwriters for the energy industry occur, we may be unable to obtain and maintain adequate insurance at a reasonable cost. We can provide no assurance that Valero’s insurers will renew our insurance coverage on acceptable terms, if at all, or that we will be able to arrange for adequate alternative coverage in the event of non-renewal. The unavailability of full insurance coverage to cover events in which we suffer significant losses could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
We are exposed to the credit risks, and certain other risks, of our customers, and any material nonpayment or nonperformance by our customers could reduce our ability to make distributions to our unitholders.
Although we expect Valero to be the source of substantially all of our revenues for the foreseeable future, we intend to grow our customer base beyond Valero. We are subject to the risks of loss resulting from nonpayment or nonperformance by our customers, including Valero. If any of our significant customers default on their obligations to us, our financial results could be adversely affected. Our customers may be highly leveraged and subject to their own operating and regulatory risks. Any material nonpayment or nonperformance by our customers could reduce our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
Our expansion of existing assets and construction of new assets may not result in revenue increases and will be subject to regulatory, environmental, political, legal, and economic risks, which could adversely affect our operations and financial condition.
In order to optimize our existing asset base, we intend to evaluate and capitalize on organic opportunities for expansion projects in order to increase revenues on our pipelines and terminals. The expansion of existing pipelines or terminals, such as by adding horsepower, pump stations, or loading racks, or the construction or expansion of new transportation and logistics assets, involves numerous regulatory, environmental, political, and legal uncertainties, most of which are beyond our control. If we undertake these projects, they may not be completed on schedule or at all or at the budgeted cost. Moreover, we may not receive sufficient long-term contractual commitments from customers to provide the revenues needed to support such projects and we may be unable to negotiate acceptable interconnection agreements with third-party pipelines to provide destinations for increased throughput. Even if we receive such commitments or make such interconnections, we may not realize an increase in revenues for an extended period of time. As a result, new facilities may not be able to attract enough throughput to achieve our expected investment return, which could materially and adversely affect our financial condition, results of operations, and cash flows and our ability in the future to make distributions to our unitholders.
We do not own all of the land on which our pipelines are located, which could result in disruptions to our operations.
We do not own all of the land on which our pipelines are located, and we are, therefore, subject to the possibility of more onerous terms and increased costs to retain necessary land use if we do not have valid leases or rights-of-way or if such rights-of-way lapse or terminate. We obtain the rights to construct and operate our pipelines on land owned by third parties and governmental agencies, and some of our agreements may grant us those rights for only a specific period of time. Our loss of these rights, through our inability to renew leases, right-of-way contracts or otherwise, could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
We are dependent upon third parties to operate some of our facilities.
Our McKee products system is operated by NuStar, which owns a
66⅔ percent
undivided interest in the system. If NuStar fails to operate any portion of the McKee products system in accordance with the terms of our operating agreement with them, such failure could result in our inability to meet our commitments to Valero, which in turn could result in a reduction in our revenues, or in us becoming liable to Valero for any losses it may sustain by reason of our failure to comply, which losses may not be recoverable by us from NuStar. Similarly, our adjacent PAPS and El Vista terminals are both operated by Shell, and any failure by Shell to comply with the terms of our operating agreement with Shell could result in our inability to meet our commitments to Valero with respect to our Port Arthur products system, which in turn could result in a reduction in our revenues, or in us becoming liable to Valero for any losses it may sustain by reason of our failure to comply, which losses may not be recoverable by us from Shell.
Restrictions in our revolving credit facility could adversely affect our business, financial condition, results of operations, ability to make distributions to our unitholders, and the value of our units.
We will be dependent upon the earnings and cash flows generated by our operations in order to meet any debt service obligations and to allow us to make distributions to our unitholders. Restrictions in our revolving credit facility and any future financing agreements could restrict our ability to finance our future operations or capital needs or to expand or pursue our business activities, which may, in turn, limit our ability to make distributions to our unitholders. For example, our revolving credit facility contains a covenant that requires
us to maintain a ratio of total debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) for the prior four fiscal quarters of not greater than 5.0 to 1.0 as of the last day of each fiscal quarter (or 5.5 to 1.0 during specified periods following certain acquisitions).
The restrictions in our revolving credit facility could affect our ability to obtain future financing and pursue attractive business opportunities and our flexibility in planning for, and reacting to, changes in business conditions. In addition, a failure to comply with the provisions of our revolving credit facility could result in an event of default, which would enable our lenders to declare the outstanding principal of that debt, together with accrued interest, to be immediately due and payable. If the payment of our debt is accelerated, defaults under our other debt instruments, if any, may be triggered, and our assets may be insufficient to repay such debt in full, and the holders of our units could experience a partial or total loss of their investment. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity” for additional information about our revolving credit facility.
Increases in interest rates could adversely impact the price of our common units, our ability to issue equity, or incur debt for acquisitions or other purposes and our ability to make distributions at our intended levels.
Interest rates on future credit facilities and debt offerings could be higher than current levels, causing our financing costs to increase accordingly. As with other yield-oriented securities, our unit price is impacted by our level of distributions and implied distribution yield. The distribution yield is often used by investors to compare and rank yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our units, and a rising interest rate environment could have an adverse impact on the price of our common units, our ability to issue equity or incur debt for acquisitions or other purposes, and our ability to make distributions at our intended levels.
Compliance with and changes in environmental laws could adversely affect our performance.
The principal environmental risks associated with our operations are emissions into the air and releases into the soil, surface water, or groundwater. Our operations are subject to extensive environmental laws and regulations, including those relating to the discharge and remediation of materials in the environment, greenhouse gas emissions, waste management, species and habitat preservation, pollution prevention, pipeline integrity and other safety-related regulations, and characteristics and composition of fuels. Certain of these laws and regulations could impose obligations to conduct assessment or remediation efforts at our facilities or third-party sites where we take wastes for disposal or where our wastes migrated. Environmental laws and regulations also may impose liability on us for the conduct of third parties or for actions that complied with applicable requirements when taken, regardless of negligence or fault. If we violate or fail to comply with these laws and regulations, it could lead to administrative, civil, or criminal penalties or liability and imposition of injunctions, operating restrictions, or the loss of permits.
Because environmental laws and regulations are becoming more stringent and new environmental laws and regulations are continuously being enacted or proposed, the level of expenditures required for environmental matters could increase in the future. Current and future legislative action and regulatory initiatives could result in changes to operating permits, material changes in operations, increased capital expenditures and operating costs, increased costs of the goods we transport, and decreased demand for products we handle that cannot be assessed with certainty at this time. We may be required to make expenditures to modify operations or install pollution control equipment or release prevention and containment systems that could materially and adversely affect our business, financial condition, results of operations, and liquidity if these expenditures, as with all costs, are not ultimately reflected in the tariffs and other fees we receive for our
services. For example, the U.S. Environmental Protection Agency (EPA) has, in recent years, adopted final rules making more stringent the National Ambient Air Quality Standards (NAAQS) for ozone, sulfur dioxide, and nitrogen dioxide, and the EPA is considering further revisions to the NAAQS. Emerging rules and permitting requirements implementing these revised standards may require us to install more stringent controls at our facilities, which may result in increased capital expenditures.
We may be unable to obtain or renew permits necessary for our operations, which could inhibit our ability to do business.
Our facilities operate under a number of federal and state permits, licenses, and approvals with terms and conditions containing a significant number of prescriptive limits and performance standards in order to operate. These permits, licenses, approval limits, and standards require a significant amount of monitoring, record keeping, and reporting in order to demonstrate compliance with the underlying permit, license, approval limit, or standard. Noncompliance or incomplete documentation of our compliance status may result in the imposition of fines, penalties, and injunctive relief. A decision by a government agency to deny or delay issuing a new or renewed permit or approval, or to revoke or substantially modify an existing permit or approval, could have a material and adverse effect on our ability to continue operations and on our our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
Many of our assets have been in service for many years and, as a result, our maintenance or repair costs may increase in the future. In addition, there could be service interruptions due to unknown events or conditions or increased downtime associated with our pipelines that could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
Our pipelines and terminals are generally long-lived assets, and many of them have been in service for many years. The age and condition of our assets could result in increased maintenance or repair expenditures in the future. Any significant increase in these expenditures could adversely affect our results of operations, financial position, or cash flows, as well as our ability to make distributions to our unitholders.
The tariff rates of our regulated assets are subject to review and possible adjustment by federal and state regulators, which could adversely affect our revenues and our ability to make distributions to our unitholders.
We own pipeline assets in Texas, New Mexico, Tennessee, Mississippi, and Arkansas, and we provide both interstate and intrastate transportation services for refined petroleum products and crude oil. Many of our pipelines are common carriers and may be required to provide service to any shipper that requests transportation services on our pipelines.
Our Port Arthur logistics system pipelines, Shorthorn pipeline, and Collierville pipeline provide interstate transportation services that are subject to regulation by FERC under the ICA. FERC uses prescribed rate methodologies for developing and changing regulated rates for interstate pipelines. Shippers may protest (and FERC may investigate) the lawfulness of existing, new, or changed tariff rates. FERC can suspend new or changed tariff rates for up to seven months and can allow new rates to be implemented subject to refund of amounts collected in excess of the rate ultimately found to be just and reasonable. If FERC finds a rate to be unjust and unreasonable, it may order payment of reparations for up to two years prior to the filing of a complaint or investigation, and FERC may prescribe new rates prospectively.
State agencies may regulate the rates, terms, and conditions of service for our pipelines offering intrastate transportation services, and such agencies could limit our ability to increase our rates or order us to reduce
our rates and pay refunds to shippers. State agencies have generally not been aggressive in regulating common carrier pipelines, have generally not investigated the rates, terms, and conditions of service of intrastate pipelines in the absence of shipper complaints, and generally resolve complaints informally.
Under our commercial agreements, we and Valero have agreed to the base tariff rates for all of our pipelines and a mechanism to modify those rates during the term of the agreements. Valero has also agreed not to challenge the base tariff rates or changes to those rates during the term of the agreements, except to the extent such changes are inconsistent with the agreements. These agreements do not, however, prevent any other new or prospective shipper, FERC, or a state agency from challenging our tariff rates or our terms and conditions of service, and due to the complexity of rate making, the lawfulness of any rate is never assured. A successful challenge of any of our rates, or any changes to FERC’s approved rate or index methodologies, could adversely affect our revenues and our ability to make distributions to our unitholders. Similarly, if state agencies in the states in which we offer intrastate transportation services change their policies or aggressively regulate our rates or terms and conditions of service, it could also materially and adversely affect our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
In addition, there is not always a clear boundary between interstate and intrastate pipeline transportation services, and such determinations are fact-dependent and made on a case-by-case basis. Our undivided interest in the McKee to El Paso pipeline currently provides transportation services pursuant to an intrastate tariff that is subject to regulation by the TRRC. Because a portion of this pipeline crosses New Mexico and our transportation services may be interstate in nature, we applied for a waiver of the tariff filing and reporting requirements of the ICA for our portion of the pipeline. On February
12, 2014, the FERC conditionally granted the requested waiver. The FERC’s conditions for granting the waiver include that we maintain all books and records in a manner consistent with the Uniform System of Accounts and that we immediately report any change in the circumstances on which the waiver was granted.
If Valero fails to provide the personnel necessary to conduct our operations, our ability to manage our business and continue our growth could be negatively impacted.
Valero is responsible for providing the personnel necessary to conduct our operations, including the executive officers of our general partner. We depend on the services of these individuals. If their services are unavailable to us for any reason, we may be required to hire other personnel to manage and operate our company. We cannot assure our unitholders that we would be able to locate or employ such qualified personnel on acceptable terms or at all.
Terrorist or cyber-attacks and threats, or escalation of military activity in response to these attacks, could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
Terrorist attacks and threats, cyber-attacks, or escalation of military activity in response to these attacks, may have significant effects on general economic conditions, fluctuations in consumer confidence and spending, and market liquidity, each of which could materially and adversely affect our business. Strategic targets, such as energy-related assets and transportation assets, may be at greater risk of future terrorist or cyber-attacks than other targets in the U.S. We do not maintain specialized insurance for possible liability or loss resulting from a cyber-attack on our assets that may shut down all or part of our business. Instability in the financial markets as a result of terrorism or war could also affect our ability to raise capital including our ability to repay or refinance debt. It is possible that any of these occurrences, or a combination of them, could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
Our customer’s operating results are seasonal and generally lower in the first and fourth quarters of the year. Our customer depends on favorable weather conditions in the spring and summer months.
Demand for gasoline is generally higher during the summer months than during the winter months due to seasonal increases in motor vehicle traffic. As a result, our customer’s operating results are generally lower for the first and fourth quarters of each year. Unfavorable weather conditions during the spring and summer months and a resulting lack of the expected seasonal upswings in traffic and sales could adversely affect our customer’s business, financial condition, and results of operations, which may adversely affect our business, financial conditions, and results of operations.
The level and terms of Valero’s indebtedness and its credit ratings could adversely affect our ability to grow our business and our ability to make distributions to our unitholders and our credit ratings and profile.
If the level of Valero’s indebtedness increases significantly in the future, it would increase the risk that Valero may default on its obligations to us under our commercial agreements. The terms of Valero’s indebtedness may limit its ability to borrow additional funds and may impact our operations in a similar manner. If Valero were to default under its debt obligations, Valero’s creditors could attempt to assert claims against our assets during the litigation of their claims against Valero. The defense of any such claims could be costly and could materially impact our financial condition, even absent any adverse determination. If these claims were successful, our ability to meet our obligations to our creditors, make distributions, and finance our operations could be materially and adversely affected. If one or more credit rating agencies were to downgrade Valero’s credit rating, we could experience an increase in our borrowing costs or difficulty accessing the capital markets. Such a development could adversely affect our ability to grow our business and to make distributions to our unitholders.
Risks Inherent in an Investment in Us
Our general partner and its affiliates, including Valero, have conflicts of interest with us and limited duties to us and our unitholders, and they may favor their own interests to the detriment of us and our unitholders. Additionally, we have no control over the business decisions and operations of Valero, and Valero is under no obligation to adopt a business strategy that favors us.
As of January 31, 2014, Valero owned a
68.6 percent
limited partner interest in us and owns and controls our general partner. Although our general partner has a duty to manage us in a manner that is not adverse to the best interests of us and our unitholders, because it is a wholly owned subsidiary of Valero, the directors and officers of our general partner also have a duty to manage our general partner in a manner that is beneficial to Valero. Conflicts of interest may arise between Valero and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts, the general partner may favor its own interests and the interests of its affiliates, including Valero, over the interests of our common unitholders. These conflicts include, among others, the following situations:
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neither our partnership agreement nor any other agreement requires Valero to pursue a business strategy that favors us or utilizes our assets, which could involve decisions by Valero to increase or decrease refinery production, shut down or reconfigure a refinery, shift the focus of its investment and growth to areas not served by our assets, or undertake acquisition opportunities for itself;
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Valero, as our primary customer, has an economic incentive to cause us to not seek higher rates and fees, even if such higher rates and fees would reflect those that could be obtained in arm’s-length, third-party transactions;
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Valero’s directors and officers have a fiduciary duty to make decisions beneficial to the stockholders of Valero, which may be contrary to our interests; in addition, many of the officers and directors of our general partner are also officers and/or directors of Valero and will owe fiduciary duties to Valero and its stockholders;
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Valero may be constrained by the terms of its debt instruments from taking actions, or refraining from taking actions, that may be in our best interests;
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our partnership agreement replaces the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties, limiting our general partner’s liabilities, and restricting the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty;
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except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval;
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disputes may arise under our commercial agreements with Valero;
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our general partner will determine the amount and timing of asset purchases and sales, borrowings, issuance of additional partnership securities and the creation, reduction or increase of cash reserves, each of which can affect the amount of cash that is distributed to our unitholders;
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our general partner will determine the amount and timing of many of our capital expenditures and whether a capital expenditure is classified as an expansion capital expenditure, which would not reduce operating surplus, or a maintenance capital expenditure, which would reduce our operating surplus. This determination can affect the amount of cash that is distributed to our unitholders and the ability of the subordinated units to convert into common units;
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our general partner will determine which costs incurred by it are reimbursable by us;
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our general partner may cause us to borrow funds in order to permit the payment of distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to accelerate expiration of the subordination period;
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our partnership agreement permits us to classify up to $50 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 on our subordinated units or to our general partner in respect of the general partner units or the incentive distribution rights;
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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;
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our general partner intends to limit its liability regarding our contractual and other obligations;
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our general partner may exercise its right to call and purchase all of the common units not owned by it and its affiliates if it and its affiliates own more than 80 percent of the common units. As of January 31, 2014, Valero owned 40.1 percent of our common units, and, as a result, Valero did not have the ability to exercise the limited call right;
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our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates, including under the omnibus agreement and our commercial agreements with Valero;
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our general partner decides whether to retain separate counsel, accountants, or others to perform services for us; and
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our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights without the approval of the conflicts committee of the board of directors of our general partner, which we refer to as our conflicts committee, or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.
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Under 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 its executive officers, directors, and owners. Any such person or entity that becomes aware of a potential transaction, agreement, arrangement, or other matter that may be an opportunity for us will 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 unitholders.
Our partnership agreement requires that we distribute all of our available cash, which could limit our ability to grow and make acquisitions.
Our partnership agreement requires that we distribute all of our available cash to our unitholders and we will rely primarily upon external financing sources, including commercial bank borrowings and the issuance of debt and equity securities, to fund our acquisitions and expansion capital expenditures. As a result, to the extent we are unable to finance growth externally, our cash distribution policy will significantly impair our ability to grow.
In addition, because we intend to distribute all of our available cash, our growth may not be as fast as that of businesses that reinvest their available cash to expand ongoing operations. To the extent we issue additional units in connection with any acquisitions or expansion capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level. There are no limitations in our partnership agreement or our revolving credit facility on our ability to issue additional units, including units ranking senior to the common units. The incurrence of additional commercial borrowings or other debt to finance our growth strategy would result in increased interest expense, which in turn may impact the available cash that we have to distribute to our unitholders.
The fees and reimbursements due to our general partner and its affiliates, including Valero, for services provided to us or on our behalf will reduce our distributable cash flow. In certain cases, the amount and timing of such reimbursements will be determined by our general partner and its affiliates, including Valero.
Pursuant to our partnership agreement, we reimburse our general partner and its affiliates, including Valero, for expenses they incur and payments they make on our behalf. Our partnership agreement
provides that our general partner will determine in good faith the expenses that are allocable to us.
Pursuant to the omnibus agreement, we pay an annual fee of
$7.9 million
to Valero for general and administrative services and reimburse Valero for any out-of-pocket costs and expenses incurred by Valero in providing these services to us
. In addition, we are required to reimburse our general partner for payments to Valero pursuant to the services and secondment agreement for the wages, benefits, and other costs of Valero employees seconded to our general partner to perform operational and maintenance services at certain of our pipeline and terminal systems. Each of these payments will be made prior to making any distributions on our common units. The
reimbursement of expenses and payment of fees, if any, to our general partner and its affiliates reduces our cash flows, and, as a result, reduces our ability to make distributions to our unitholders.
There is no limit on the fees and expense reimbursements that we may be required to pay to our general partner and its affiliates.
Our partnership agreement restricts the remedies available to holders of our common and subordinated units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
Our partnership agreement contains provisions that restrict 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. For example, our partnership agreement provides that:
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whenever our general partner (acting in its capacity as our general partner), the board of directors of our general partner, 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 of directors of our general partner, 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, meaning that it subjectively believed that the decision was not adverse to our best interests, and, except as specifically provided by our partnership agreement, will not 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;
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our general partner is not liable 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;
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our general partner and its officers and directors are not liable to us or our limited partners for monetary damages 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 engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and
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our general partner is not 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:
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approved by the conflicts committee of the board of directors of our general partner, although our general partner is not obligated to seek such approval;
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approved by the vote of a majority of our outstanding common units, excluding any common units owned by our general partner and its affiliates;
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determined by the board of directors of our general partner to be on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or
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determined by the board of directors of our general partner 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.
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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 of directors of our general partner determines 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 subbullet points above, then it will be presumed that, in making its decision, the board of directors of our general partner 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.
If a unitholder is not an Eligible Holder, the unitholder’s common units may be subject to redemption.
Our partnership agreement includes certain requirements regarding those investors who may own our common and subordinated units. Eligible Holders are limited partners whose (a) federal income tax status is not reasonably likely to have a material and adverse effect on the rates that can be charged by us on assets that are subject to regulation by FERC or an analogous regulatory body and (b) nationality, citizenship, or other related status would not create a substantial risk of cancellation or forfeiture of any property in which we have an interest, in each case as determined by our general partner with the advice of counsel. If the unitholder is not an Eligible Holder, in certain circumstances as set forth in our partnership agreement, the unitholder’s units may be redeemed by us at the then-current market price. The redemption price will be paid in cash or by delivery of a promissory note, as determined by our general partner.
Our partnership agreement restricts the voting rights of unitholders owning 20 percent or more of our common units.
Unitholders’ voting rights are further restricted by a provision of our partnership agreement providing that any units held by a person that owns 20 percent or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the board of directors of our general partner, cannot be used to vote on any matter.
Holders of our common units have limited voting rights and are not entitled to elect our general partner or its directors.
Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. For example, unlike a holder of stock in a public corporation, our unitholders do not have “say on pay” advisory voting rights. Unitholders did not elect our general partner or the board of directors of our general partner and will have no right to elect our general partner or the board of directors of our general partner on an annual or other continuing basis. The board of directors of our general partner is chosen by the sole member of our general partner, which is a wholly owned subsidiary of Valero. Furthermore, if the 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.
Even if holders of our common units are dissatisfied, they cannot initially remove our general partner without its consent.
Unitholders will be unable initially to remove our general partner without its consent because our general partner and its affiliates own sufficient units to be able to prevent its removal. The vote of the holders of at least 66
2
/
3
percent of all outstanding common and subordinated units voting together as a single class is required to remove our general partner. As of January 31, 2014, our general partner and its affiliates owned
40.1 percent
of our common units and all of our subordinated units, representing an aggregate
70.0 percent
of our outstanding common and subordinated units (excluding common units held by officers and directors of our general partner and Valero). If our general partner is removed without cause during the subordination period and units held by our general partner and its affiliates are not voted in favor of that removal, all remaining subordinated units will automatically convert into common units and any existing arrearages on
our common units will be extinguished, thereby eliminating the distribution and liquidation preference of common units. “Cause” is narrowly defined to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable to us or any limited partner for actual fraud or willful misconduct in its capacity as our general partner. “Cause” does not include most cases of charges of poor management of the business, so the removal of our general partner because of unitholder dissatisfaction with the performance of our general partner in managing our partnership will most likely result in the termination of the subordination period and conversion of all subordinated units to common units.
Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.
Our general partner interest or the control of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest in us without a vote of our unitholders to an affiliate or another person in connection with its merger or consolidation with or into, or sale of all or substantially all of its assets to, such person. Furthermore, our partnership agreement does not restrict the ability of Valero to transfer all or a portion of its ownership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with its own designees and thereby exert significant control over the decisions made by the board of directors and officers.
The incentive distribution rights of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its incentive distribution rights to a third party at any time without the consent of our unitholders. If our general partner transfers its incentive distribution rights to a third party, it will have less incentive to grow our partnership and increase distributions. A transfer of incentive distribution rights by our general partner could reduce the likelihood of Valero selling or contributing additional assets to us, which in turn would impact our ability to grow our asset base.
We may issue additional units without unitholder approval, which would dilute unitholder interests.
At any time, we may issue an unlimited number of limited partner interests of any type without the approval of our unitholders and our unitholders will have no preemptive or other rights (solely as a result of their status as unitholders) to purchase any such limited partner interests. Further, there are no limitations in our partnership agreement on our ability to issue equity securities that rank equal or senior to our common units as to distributions or in liquidation or that have special voting rights and other rights. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
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our existing unitholders’ proportionate ownership interest in us will decrease;
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the amount of cash we have available to distribute on each unit may decrease;
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because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of minimum quarterly distributions will be borne by our common unitholders will increase;
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because the amount payable to holders of incentive distribution rights is based on a percentage of total available cash, the distributions to holders of incentive distribution rights will increase even if the per unit distribution on common units remains the same;
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the ratio of taxable income to distributions may increase;
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the relative voting strength of each previously outstanding unit may be diminished; and
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the market price of our common units may decline.
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Valero may sell 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 January 31, 2014, Valero held
11,539,989
of our common units and
28,789,989
of our subordinated units. All of the subordinated units will convert into common units at the end of the subordination period and may convert earlier under certain circumstances. Additionally, we have agreed to provide Valero with certain registration rights under applicable securities laws. The sale of these units in the public or private markets could have an adverse impact on the price of the common units or on any trading market that may develop.
Our general partner’s discretion in establishing cash reserves may reduce the amount of cash we have available to distribute to unitholders.
Our partnership agreement requires our general partner to deduct from operating surplus the cash reserves that it determines are necessary to fund our future operating expenditures. In addition, our partnership agreement permits the general partner to reduce available cash by establishing cash reserves for the proper conduct of our business, to comply with applicable law or agreements to which we are a party, or to provide funds for future distributions to partners. These cash reserves will affect the amount of our distribution to unitholders.
Our general partner has a limited call right that may require the unitholders to sell common units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 80 percent of our then-outstanding common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than their then-current market price, as calculated pursuant to the terms of our partnership agreement. As a result, unitholders may be required to sell their common units at an undesirable time or price and may not receive any return on their investment. Unitholders may also incur a tax liability upon a sale of their units. As of January 31, 2014, our general partner and its affiliates own approximately
40.1 percent
of our common units (excluding common units held by officers and directors of our general partner and Valero). At the end of the subordination period (which could occur as early as within the quarter ending March
31, 2015), assuming no additional issuances of common units by us (other than upon the conversion of the subordinated units), our general partner and its affiliates will own approximately
70.0 percent
of our outstanding common units (excluding common units held by officers and directors of our general partner and Valero) and therefore would not be able to exercise the call right at that time.
Our general partner, or any transferee holding a majority of the incentive distribution rights, may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to the incentive distribution rights, without the approval of the conflicts committee of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.
Our general partner has the right, at any time when there are no subordinated units outstanding and the holders have received incentive distributions at the highest level to which they are entitled (48 percent) for each of the prior four consecutive fiscal quarters (and the amount of each such distribution did not exceed adjusted operating surplus for each such quarter), to reset the minimum quarterly distribution and the initial target distribution levels at higher levels based on our cash distribution at the time of the exercise of the reset election. Following a reset election, the minimum quarterly distribution will be reset to an amount equal to the average cash distribution per unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”), and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution. Our general partner has the right to transfer the incentive distribution rights at any time, in whole or in part, and any transferee holding a majority of the incentive distribution rights shall have the same rights as our general partner with respect to resetting target distributions.
In the event of a reset of the minimum quarterly distribution and the target distribution levels, the holders of the incentive distribution rights will be entitled to receive, in the aggregate, the number of common units equal to that number of common units that would have entitled the holders to an average aggregate quarterly cash distribution in the prior two quarters equal to the average of the distributions on the incentive distribution rights in the prior two quarters. Our general partner will also be issued the number of general partner units necessary to maintain the same percentage general partner interest in us that existed immediately prior to the reset election. We anticipate that our general partner would exercise this reset right in order to facilitate acquisitions or internal expansion projects that would not otherwise be sufficiently accretive to distributions per common unit. It is possible, however, that our general partner or a transferee could exercise this reset election at a time when it is experiencing, or expects to experience, declines in the distributions it receives related to its incentive distribution rights and may therefore desire to be issued common units rather than retain the right to receive incentive distribution payments based on target distribution levels that are less certain to be achieved in the then-current business environment. This risk could be elevated if our incentive distribution rights have been transferred to a third party. As a result, a reset election may cause our common unitholders to experience dilution in the amount of distributions that they would have otherwise received had we not issued common units to our general partner in connection with resetting the target distribution levels.
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.
Our partnership agreement replaces our general partner’s fiduciary duties to holders of our common units 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 enforce the reasonable expectations of the partners 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:
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how to allocate corporate opportunities among us and its other affiliates;
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whether to exercise its limited call right;
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whether to seek approval of the resolution of a conflict of interest by the conflicts committee of the board of directors of our general partner;
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how to exercise its voting rights with respect to the units it owns;
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whether to exercise its registration rights;
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whether to elect to reset target distribution levels;
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whether to transfer the incentive distribution rights to a third party; and
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whether or not to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.
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By purchasing a common unit, a common unitholder agrees to become bound by the provisions in our partnership agreement, including the provisions discussed above.
If we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately or prevent fraud, which could have a material and adverse impact on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders. Pursuant to the recently enacted JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we are an emerging growth company.
We are required to disclose material changes made in our internal control over financial reporting on a quarterly basis and we are required to assess the effectiveness of our controls annually (beginning in 2014). However, for as long as we are an “emerging growth company” under the recently enacted Jumpstart Our Business Startups Act of 2012 (the JOBS Act), our independent registered public accounting firm is not required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. We could be an emerging growth company through December 31, 2018. Effective internal controls are necessary for us to provide reliable and timely financial reports, to prevent fraud, and to operate successfully as a publicly traded limited partnership. We may be unable to maintain effective controls over our financial processes and reporting in the future or to comply with our obligations under Section 404 of the Sarbanes-Oxley Act of 2002. For example, Section 404 requires us, among other
things, to annually review and report on the effectiveness of our internal control over financial reporting. We must comply with Section 404 (except for the requirement for an auditor’s attestation report) beginning with our fiscal year ending December 31, 2014. Any failure to develop, implement, or maintain effective internal controls or to improve our internal controls could harm our operating results or cause us to fail to meet our reporting obligations.
Given the difficulties inherent in the design and operation of internal controls over financial reporting, we can provide no assurance as to our, or our independent registered public accounting firm’s, future conclusions about the effectiveness of our internal controls, and we may incur significant costs in our efforts to comply with Section 404. Any failure to maintain effective internal controls over financial reporting will subject us to regulatory scrutiny and a loss of confidence in our reported financial information, which could have a material and adverse effect on our financial condition, results of operations, and cash flows and our ability to make distributions to our unitholders.
A unitholder’s liability may not be limited if a court finds that unitholder action constitutes control of our business.
A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership is organized under Delaware law, and we conduct business in a number of other states. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business. A unitholder could be liable for any and all of our obligations as if a unitholder were a general partner if a court or government agency were to determine that (i) we were conducting business in a state but had not complied with that particular state’s partnership statute; or (ii) a unitholder’s 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.
Our unitholders may have to repay distributions that were wrongfully distributed to them.
Under certain circumstances, unitholders may have to repay amounts wrongfully distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to unitholders 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 the 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 are known to the transferee at the time of the transfer and for unknown obligations if the liabilities could be determined from our partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are nonrecourse to the partnership are not counted for purposes of determining whether a distribution is permitted.
The NYSE 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 does not require us to have, and we do not have or intend to have, a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Additionally, any future issuance of additional common units or other securities, including to affiliates, will not be subject to the NYSE’s shareholder approval rules that apply to a corporation. Accordingly, unitholders will not have the same protections afforded to certain corporations that are subject to all of the NYSE corporate governance requirements.
Tax Risks
Our tax treatment depends on our status as a partnership for federal income tax purposes. If the Internal Revenue Service (IRS) were to treat us as a corporation for federal income tax purposes, which would subject us to entity-level taxation, or if we were otherwise subjected to a material amount of additional entity-level taxation, then our distributable cash flow would be substantially reduced.
The anticipated after-tax economic benefit of an investment in the common units depends largely on our being treated as a partnership for federal income tax purposes.
Despite the fact that we are a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. A change in our business or a change in current law could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.
If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35 percent, and would likely pay state and local income tax at varying rates. Distributions would generally be taxed again as corporate dividends (to the extent of our current and accumulated earnings and profits), and no income, gains, losses, deductions, or credits would flow through to our unitholders. Because a tax would be imposed upon us as a corporation, our distributable cash flow would be substantially reduced. In addition, changes in current state law may subject us to additional entity-level taxation by individual states.
Our partnership agreement provides that, if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state, or local income tax purposes, the minimum quarterly distribution amount and the target distribution levels may be adjusted to reflect the impact of that law on us.
The present federal income tax treatment of publicly traded limited partnerships, including us, or an investment in our common units may be modified by administrative or judicial interpretation, or legislative change, at any time, and potentially retroactively. We are unable to predict whether any such modifications will ultimately occur.
Our unitholders’ share of our income will be taxable to them for federal income tax purposes even if they do not receive any distributions from us.
Because a unitholder will be treated as a partner to whom we will allocate taxable income that could be different in amount than the cash we distribute, a unitholder’s allocable share of our taxable income will be taxable to it, which may require the payment of federal income taxes and, in some cases, state and local income taxes, on the unitholder’s share of our taxable income even if it receives no distributions from us. Our unitholders may not receive distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from that income.
If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our distributable cash flow.
The IRS or a court may reach conclusions that differ from the positions we take. Any contest with the IRS, and the outcome of any IRS contest, may have a materially adverse impact on the market for our common units and the price at which our common units trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our distributable cash flow.
Tax gain or loss on the disposition of our common units could be more or less than expected.
If our unitholders sell common units, the unitholders will recognize a gain or loss for federal income tax purposes equal to the difference between the amount realized and their 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 it 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. In addition, because the amount realized includes a unitholder’s share of our nonrecourse liabilities, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale.
Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons, raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons will be required to file federal income tax returns and pay tax on their share of our taxable income. Any tax-exempt entity or non-U.S. person should consult a tax advisor before investing in our common units.
We treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.
Because we cannot match transferors and transferees of common units and because of other reasons, we will adopt depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to our unitholders. It also could affect the timing of these tax benefits or the amount of gain from the 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.
We prorate our items of income, gain, loss, and deduction for federal income tax purposes between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss, and deduction among our unitholders.
We prorate our items of income, gain, loss, and deduction for federal income tax purposes between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The use of this proration method may not be permitted under existing or proposed Treasury Regulations. If the IRS were to challenge this method or new Treasury regulations were issued, 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 loaned to a “short seller” to effect 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 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 effect 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 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.
We have adopted certain valuation methodologies and monthly conventions for federal income tax purposes that may result in a shift of income, gain, loss, and deduction between our general partner and our unitholders. The IRS may challenge this treatment, which could adversely affect the value of the common units.
When we issue additional units or engage in certain other transactions, we will determine the fair market value of our assets and allocate any unrealized gain or loss attributable to our assets to the capital accounts of our unitholders and our general partner. Our methodology may be viewed as understating the value of our assets. In that case, there may be a shift of income, gain, loss, and deduction between certain unitholders and our general partner, which may be unfavorable to such unitholders. The IRS may challenge our valuation methods and allocations of taxable income, gain, loss, and deduction between our general partner and certain of our unitholders.
A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to our unitholders. It also could affect the amount of taxable gain from our unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.
The sale or exchange of 50 percent or more of our capital and profits interests during any 12-month period will result in the termination of our partnership for federal income tax purposes.
We will be considered to have technically terminated our existing partnership and having formed a new partnership for federal income tax purposes if there is a sale or exchange of 50 percent or more of the total interests in our capital and profits within a 12-month period. Our technical termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns (and our unitholders could receive two Schedules
K-1 if certain relief were unavailable) for one fiscal year and could result in a deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may also result in more than 12 months of our taxable income or loss being includable in the unitholder’s taxable income for the year of termination. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred.
As a result of investing in our common units, a unitholder 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 federal income taxes, our unitholders will likely be subject to other taxes, including state and local taxes, unincorporated business taxes, and estate, inheritance or intangible taxes that are imposed by
the various jurisdictions in which we conduct business or control property now or in the future, even if the unitholders do not live 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. We conduct business and/or control assets in Arkansas, Louisiana, Mississippi, New Mexico, Tennessee, and Texas. Except for Texas, all of these states currently impose a personal income tax on individuals. As we make acquisitions or expand our business, we may control assets or conduct business in additional states that impose a personal income tax. It is each unitholder’s responsibility to file all federal, state, and local tax returns. Unitholders should consult their own tax advisors regarding such matters.
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 federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units, may be modified by administrative, legislative, or judicial interpretation at any time. Any modification to the federal income tax laws and interpretations thereof may or may not be applied retroactively. Moreover, any such modification could make it more difficult or impossible for us to meet the exception that allows publicly traded partnerships that generate qualifying income to be treated as partnerships (rather than corporations) for U.S. federal income tax purposes, affect or cause us to change our business activities, or affect the tax consequences of an investment in our common units. For example, members of Congress have been considering substantive changes to the definition of qualifying income and the treatment of certain types of income earned from profits interests in partnerships. While these specific proposals would not appear to affect our treatment as a partnership, we are unable to predict whether any of these changes, or other proposals, will ultimately be enacted. Any such changes could negatively impact the value of an investment in our common units.