Shell Midstream Partners, L.P. ("we," "us," "our" or "the Partnership") is aDelaware limited partnership formed by Royal Dutch Shell plc onMarch 19, 2014 to own and operate pipeline and other midstream assets, including certain assets acquired fromShell Pipeline Company LP ("SPLC") and its affiliates. We conduct our operations either through our wholly owned subsidiaryShell Midstream Operating LLC (the "Operating Company") or through direct ownership. Our general partner isShell Midstream Partners GP LLC (the "general partner"). References to "RDS," "Shell" or "Parent" refer collectively to Royal Dutch Shell plc and its controlled affiliates, other than us, our subsidiaries and our general partner. The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes in this quarterly report and Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2019 (our "2019 Annual Report") and the consolidated financial statements and related notes therein. Our 2019 Annual Report contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates and contractual obligations. You should also read the following discussion and analysis together with the risk factors set forth in our 2019 Annual Report, Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 , Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter endedJune 30, 2020 and Part II, Item 1A of this report and the "Cautionary Statement Regarding Forward-Looking Statements" in this report.
Partnership Overview
We own, operate, develop and acquire pipelines and other midstream and logistics assets. As ofSeptember 30, 2020 , our assets include interests in entities that own (a) crude oil and refined products pipelines and terminals that serve as key infrastructure to transport onshore and offshore crude oil production toGulf Coast and Midwest refining markets and deliver refined products from those markets to major demand centers and (b) storage tanks and financing receivables that are secured by pipelines, storage tanks, docks, truck and rail racks and other infrastructure used to stage and transport intermediate and finished products. Our assets also include interests in entities that own natural gas and refinery gas pipelines that transport offshore natural gas to market hubs and deliver refinery gas from refineries and plants to chemical sites along theGulf Coast .
For a description of our assets, see Part I, Item 1 - Business and Properties in our 2019 Annual Report.
2020 developments include: -Purchase and Sale Agreement. OnApril 1, 2020 , we closed the following transactions (collectively referred to as the "April 2020 Transaction") pursuant to the Purchase and Sale Agreement dated as ofFebruary 27, 2020 (the "Purchase and Sale Agreement") by and among the Partnership,Triton West LLC ("Triton"), SPLC,Shell GOM Pipeline Company LLC ("SGOM"),Shell Chemical LP ("Shell Chemical") andEquilon Enterprises LLC d/b/aShell Oil Products US ("SOPUS"): i.We acquired 79% of the issued and outstanding membership interests inMattox Pipeline Company LLC from SGOM (the "Mattox Transaction"). ii.SOPUS and Shell Chemical transferred to Triton, as a designee of the Partnership, certain logistics assets at theShell Norco Manufacturing Complex located inNorco, Louisiana , which are comprised of crude, chemicals, intermediate and finished product pipelines, storage tanks, docks, truck and rail racks and supporting infrastructure (such assets, the "Norco Assets" and such transaction, the "Norco Transaction"). -Partnership Interests Restructuring Agreement. OnApril 1, 2020 , simultaneously with the closing of the transactions contemplated by the Purchase and Sale Agreement, we also closed the transactions contemplated by the Partnership Interests Restructuring Agreement with our general partner, dated as ofFebruary 27, 2020 (the "Partnership Interests Restructuring Agreement"), eliminating all incentive distribution rights ("IDRs") and converting the economic general partner interest in the Partnership into a non-economic general partner interest (the "GP/IDR Restructuring"). As consideration for the transactions contemplated by the Purchase and Sale Agreement and the Partnership Interests Restructuring Agreement, SPLC received 160,000,000 newly issued common units, plus 50,782,904 Series A perpetual convertible preferred units (the "Series A Preferred Units"). The general partner (or its assignee) has also agreed to waive a portion of the distributions that would otherwise be payable on the common units issued to SPLC as part of theApril 2020 Transaction, in an amount of$20 million per quarter for four consecutive fiscal quarters, beginning with the distribution made with respect to the second quarter of 2020. 35 --------------------------------------------------------------------------------
Refer to Note 2 - Acquisitions and Other Transactions in the Notes to the Unaudited Consolidated Financial Statements for more details.
We generate revenue from the transportation, terminaling and storage of crude oil, refined products, and intermediate and finished products through our pipelines, storage tanks, docks, truck and rail racks, generate income from our equity and other investments, and generate interest income from financing receivables on the Norco Assets. Our revenue is generated from customers in the same industry, our Parent's affiliates, integrated oil companies, marketers and independent exploration, production and refining companies primarily within theGulf Coast region ofthe United States . We generally do not own any of the crude oil, refinery gas or refined petroleum products we handle, nor do we engage in the trading of these commodities. We therefore have limited direct exposure to risks associated with fluctuating commodity prices, although these risks indirectly influence our activities and results of operations over the long-term. As a result of Hurricanes Laura, Marco and Sally, we incurred an impact of approximately$12 million to net income and cash available for distribution ("CAFD") in the third quarter of 2020. Certain producers in theGulf of Mexico elected to shut-in and evacuate as a safety precaution, while others were forced to shut-in or curtail production due to onshore closures. Further, certain onshore assets were impacted by power outages related to the storms. There was no material impact to our people or assets as a result of the storms. Further, as a result ofHurricanes Delta and Zeta, we anticipate an impact of approximately$10 million to net income and CAFD in the fourth quarter of 2020. Certain connected producers have had planned turnarounds during 2020. We generally expect turnaround work to be performed mostly in the second and third quarters; however, we have seen a delay in that schedule due to hurricanes in the region, the effects of the COVID-19 pandemic and increased complexity of the work required by certain producers. As a result, the impact to net income and CAFD from this turnaround activity was approximately$10 million during the third quarter of 2020, and we expect the impact for the fourth quarter of 2020 to be approximately$5 million . Further, we anticipate a similar level of planned turnaround activity in 2021. The broader market environment for our customers was challenging in 2019, and has continued to be challenging during the first nine months of 2020 given the continuing effects of the COVID-19 pandemic, which has impacted worldwide demand for oil and gas and increased downward pressure on oil prices. The responses of oil and gas producers to the lower demand for, and price of, oil and natural gas are constantly evolving and remain uncertain. The master limited partnership ("MLP") market has also changed significantly, as capital for high growth fueled by dropdown activity continues to be constrained. We are fortunate to have the support of RDS, who has provided us favorable loan and equity terms, allowing us flexibility to acquire high quality assets from our affiliates. While we expect to retain this flexibility, we anticipate continuing to moderate inorganic growth in our asset base and focusing on the sustainable operation of our core assets, cash preservation and the organic growth of our business in 2021.
Executive Overview
Net income was$423 million and net income attributable to the Partnership was$414 million during the nine months endedSeptember 30, 2020 . We generated cash from operations of$503 million . As ofSeptember 30, 2020 , we had cash and cash equivalents of$329 million , total debt of$2,694 million and unused capacity under our credit facilities of$896 million .
Our 2020 operations and strategic initiatives demonstrate our continuing focus on our business strategies:
•Maintain operational excellence through prioritization of safety, reliability and efficiency; •Enhanced focus on cash optimization and reduced discretionary project spend; •Focus on advantageous commercial agreements with creditworthy counterparties to enhance financial results and deliver reliable distribution growth over the long-term; and •Optimize existing assets and pursue organic growth opportunities.
How We Evaluate Our Operations
Our management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include: (i) revenue (including pipeline loss allowance ("PLA") from contracted capacity and throughput); (ii) operations and maintenance expenses (including capital expenses); (iii) Adjusted EBITDA (defined below); and (iv) CAFD.
Contracted Capacity and Throughput
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The amount of revenue our assets generate primarily depends on our transportation and storage services agreements with shippers and the volumes of crude oil, refinery gas and refined products that we handle through our pipelines, terminals and storage tanks.
The commitments under our transportation, terminaling and storage services agreements with shippers and the volumes we handle in our pipelines and storage tanks are primarily affected by the supply of, and demand for, crude oil, refinery gas, natural gas and refined products in the markets served directly or indirectly by our assets. This supply and demand is impacted by the market prices for these products in the markets we serve. The COVID-19 pandemic continues to cause significant disruptions in theU.S. economy and financial and energy markets, including substantial demand destruction in the oil and gas markets. Responses of oil and gas producers to the lower demand for, and price of, oil and natural gas are constantly evolving and unpredictable, but further or continued decreases in demand (including due to renewed economic shutdowns and restrictions in response to increased COVID-19 infection rates) could force producers to shut-in certain wellheads or otherwise cease or curtail their operations. It also could reduce the volumes running through our pipelines and terminals.
We utilize the commercial arrangements we believe are the most prudent under the market conditions to deliver on our business strategy. The results of our operations will be impacted by our ability to:
•maintain utilization of and rates charged for our pipelines and storage facilities; •utilize the remaining uncommitted capacity on, or add additional capacity to, our pipeline systems; •increase throughput volumes on our pipeline systems by making connections to existing or new third-party pipelines or other facilities, primarily driven by the anticipated supply of, and demand for, crude oil and refined products; and •identify and execute organic expansion projects.
Operations and Maintenance Expenses
Our operations and maintenance expenses consist primarily of:
•labor expenses (including contractor services); •insurance costs (including coverage for our consolidated assets and operated joint ventures); •utility costs (including electricity and fuel); •repairs and maintenance expenses; and •major maintenance costs (related to the terminaling service agreements of the Norco Assets, which are expensed as incurred because the Partnership does not own the related assets). Certain costs naturally fluctuate based on throughput volumes and the grades of crude oil and types of refined products we handle, whereas other costs generally remain stable across broad ranges of throughput and storage volumes, but can vary depending upon the level of both planned and unplanned maintenance activity in the particular period. Our maintenance activity can be impacted by events such as turnarounds, asset integrity work and storms. Our management seeks to maximize our profitability by effectively managing operations and maintenance expenses. For example, our property and business interruption insurance is provided by a wholly owned subsidiary of Shell, which results in cost savings and improved coverage. Further, we, along with our Parent, are currently undertaking an initiative to reduce operational costs. We expect that some of these activities, such as re-scoping and/or deferring projects, evaluating third-party service contracts and reducing the use of contractors, will directly benefit our assets and their contribution to our net income. Other activities, such as the streamlining of structure and processes at the Parent level, will result in a reduction of certain costs and fees for which we reimburse and pay SPLC. While cost effectiveness has always been a focus of the business, it is of increased importance given the current operating environment.
Adjusted EBITDA and Cash Available for Distribution
Adjusted EBITDA and CAFD have important limitations as analytical tools because they exclude some, but not all, items that affect net income and net cash provided by operating activities. You should not consider Adjusted EBITDA or CAFD in isolation or as a substitute for analysis of our results as reported under GAAP. Additionally, because Adjusted EBITDA and CAFD may be defined differently by other companies in our industry, our definition of Adjusted EBITDA and CAFD may not be comparable to similarly titled measures of other companies, thereby diminishing their utility. The GAAP measures most directly comparable to Adjusted EBITDA and CAFD are net income and net cash provided by operating activities. Adjusted EBITDA and CAFD should not be considered as an alternative to GAAP net income or net cash provided by operating activities. Please refer to "Results of Operations - Reconciliation of Non-GAAP Measures" for the 37 --------------------------------------------------------------------------------
reconciliation of the GAAP measures net income and cash provided by operating activities to the non-GAAP measures, Adjusted EBITDA and CAFD.
We define Adjusted EBITDA as net income before income taxes, interest expense, interest income, gain or loss from dispositions of fixed assets, allowance oil reduction to net realizable value, loss from revision of asset retirement obligations, and depreciation, amortization and accretion, plus cash distributed to us from equity method investments for the applicable period, less equity method distributions included in other income and income from equity investments. We define Adjusted EBITDA attributable to the Partnership as Adjusted EBITDA less Adjusted EBITDA attributable to noncontrolling interests and Adjusted EBITDA attributable to Parent. We define CAFD as Adjusted EBITDA attributable to the Partnership less maintenance capital expenditures attributable to the Partnership, net interest paid by the Partnership, cash reserves, income taxes paid and Series A Preferred Units distribution, plus net adjustments from volume deficiency payments attributable to the Partnership, reimbursements from Parent included in partners' capital, principal and interest payments received on financing receivables, and certain one-time payments received. CAFD does not reflect changes in working capital balances. The definition of CAFD was updated for the second quarter of 2020 due to the closing of theApril 2020 Transaction, which resulted in part in the transfer of the Norco Assets to be accounted for as a failed sale leaseback under ASC Topic 842, Leases (the "lease standard"). As a result, the Partnership recognized financing receivables from SOPUS and Shell Chemical. These assets impact CAFD since principal payments on the financing receivables are not included in net income. As a result, such principal and interest payments on the financing receivables have been included as an adjustment to CAFD since the second quarter of 2020. Also as partial consideration for theApril 2020 Transaction, SPLC received 50,782,904 Series A Preferred Units. The distributions on these Series A Preferred Units have been deducted from CAFD since the second quarter of 2020. We define maintenance capital expenditures as cash expenditures, including expenditures for (a) the acquisition (through an asset acquisition, merger, stock acquisition, equity acquisition or other form of investment) by the Partnership or any of its subsidiaries of existing assets or assets under construction, (b) the construction or development of new capital assets by the Partnership or any of its subsidiaries, (c) the replacement, improvement or expansion of existing capital assets by the Partnership or any of its subsidiaries or (d) a capital contribution by the Partnership or any of its subsidiaries to a person that is not a subsidiary in which the Partnership or any of its subsidiaries has, or after such capital contribution will have, directly or indirectly, an equity interest, to fund the Partnership or such subsidiary's share of the cost of the acquisition, construction or development of new, or the replacement, improvement or expansion of existing, capital assets by such person), in each case if and to the extent such acquisition, construction, development, replacement, improvement or expansion is made to maintain, over the long-term, the operating capacity or operating income of the Partnership and its subsidiaries, in the case of clauses (a), (b) and (c), or such person, in the case of clause (d), as the operating capacity or operating income of the Partnership and its subsidiaries or such person, as the case may be, existed immediately prior to such acquisition, construction, development, replacement, improvement, expansion or capital contribution. For purposes of this definition, "long-term" generally refers to a period of not less than twelve months.
We believe that the presentation of these non-GAAP supplemental financial measures provides useful information to management and investors in assessing our financial condition and results of operations.
Adjusted EBITDA and CAFD are non-GAAP supplemental financial measures that management and external users of our consolidated financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:
•our operating performance as compared to other publicly traded partnerships in the midstream energy industry, without regard to historical cost basis or, in the case of Adjusted EBITDA, financing methods; •the ability of our business to generate sufficient cash to support our decision to make distributions to our unitholders; •our ability to incur and service debt and fund capital expenditures; and •the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.
Factors Affecting Our Business and Outlook
We believe key factors that impact our business are the supply of, and demand for, crude oil, natural gas, refinery gas and refined products in the markets in which our business operates. We also believe that our customers' requirements, competition and government regulation of crude oil, refined products, natural gas and refinery gas play an important role in how we manage 38 -------------------------------------------------------------------------------- our operations and implement our long-term strategies. In addition, acquisition opportunities, whether from Shell or third parties, and financing options, will also impact our business. These factors are discussed in more detail below.
Changes in Crude Oil Sourcing and Refined Product Demand Dynamics
To effectively manage our business, we monitor our market areas for both short-term and long-term shifts in crude oil and refined products supply and demand. Changes in crude oil supply such as new discoveries of reserves, declining production in older fields, operational impacts at producer fields and the introduction of new sources of crude oil supply affect the demand for our services from both producers and consumers. In addition, general economic, broad market and worldwide health considerations, including the continuing effects of the COVID-19 pandemic, can also affect sourcing and demand dynamics for our services. One of the strategic advantages of our crude oil pipeline systems is their ability to transport attractively priced crude oil from multiple supply markets to key refining centers along theGulf Coast . Our crude oil shippers periodically change the relative mix of crude oil grades delivered to the refineries and markets served by our pipelines. They also occasionally choose to store crude longer term when the forward price is higher than the current price (a "contango market"). While these changes in the sourcing patterns of crude oil transported or stored are reflected in changes in the relative volumes of crude oil by type handled by our pipelines, our total crude oil transportation revenue is primarily affected by changes in overall crude oil supply and demand dynamics, including the demand destruction resulting from the COVID-19 pandemic, as well asU.S. exports. Similarly, our refined products pipelines have the ability to serve multiple major demand centers. Our refined products shippers periodically change the relative mix of refined products shipped on our refined products pipelines, as well as the destination points, based on changes in pricing and demand dynamics. While these changes in shipping patterns are reflected in relative types of refined products handled by our various pipelines, our total product transportation revenue is primarily affected by changes in overall refined products supply and demand dynamics, including the continuing effects of the COVID-19 pandemic. Demand can also be greatly affected by refinery performance in the end market, as refined products pipeline demand will increase to fill the supply gap created by refinery issues. We can also be constrained by asset integrity considerations in the volumes we ship. We may elect to reduce cycling on our systems to reduce asset integrity risk, which in turn would likely result in lower revenues. As these supply and demand dynamics shift, we anticipate that we will continue to actively pursue projects that link new sources of supply to producers and consumers and to create new services or capacity arrangements that meet customer requirements. For example, production from Shell's Appomattox platform in theGulf of Mexico , which came online during 2019, tied into our existing Proteus and Endymion systems to bring crude onshore. Similarly, we expect to continue extending our corridor pipelines to provide developing growth regions in theGulf of Mexico with access via our existing corridors to onshore refining centers and market hubs. By way of example, in the latter part of 2019 we announced a solicitation of interest for a potential expansion of the Mars system to address growing production volumes in theGulf of Mexico regions served by Mars. We anticipate bringing that project online in late 2021, with incremental growth volumes beginning to arrive into the Mars system in 2022. We believe this strategy will allow our offshore business to grow profitably throughout demand cycles.
Changes in
We generate a portion of our revenue under long-term transportation service agreements with shippers, including ship-or-pay agreements and life-of-lease transportation agreements, some of which provide a guaranteed return, and storage service agreements with marketers, pipelines and refiners. Historically, the commercial terms of these long-term transportation and storage service agreements have substantially mitigated volatility in our financial results by limiting our direct exposure to reductions in volumes due to supply or demand variability. Our business could be negatively affected if we are unable to renew or replace our contract portfolio on comparable terms, by sustained downturns or sluggishness in commodity prices, or the economy in general (as with the continuing effects of the COVID-19 pandemic, including the impacts on the demand for oil and gas), and is impacted by shifts in supply and demand dynamics, the mix of services requested by the customers of our pipelines, competition and changes in regulatory requirements affecting our operations. Our business can also be impacted by asset integrity or customer interruptions and natural disasters or other events that could lead customers to invoke force majeure or other defenses to avoid contractual performance.
During the second quarter of 2019, Zydeco recontracted previously expired volumes under certain of its throughput and deficiency agreements ("T&D agreements"). Although we replaced the volumes, the rates under the new T&D agreements were lower than those previously contracted, and therefore net income and CAFD have been lower. Two of these T&D agreements
39 -------------------------------------------------------------------------------- will expire in the fourth quarter of 2020, as the shippers did not elect the option to extend their contracts for an additional six months. The T&D agreements that are expiring account for less than 10% of our revenue for the nine months endedSeptember 30, 2020 . The market environment at any given time will dictate the rates, terms and duration of agreements that shippers are willing to enter into, as well as the contracts that best satisfy the needs of our business. As we have grown and diversified our business over the past several years, and as recently as the second quarter of 2020 with theApril 2020 Transaction, we have benefited from shifting reliance away from the results of any one asset. While Zydeco continues to serve an important market, and we strive to maximize the long-term value of the system to both shippers and the pipeline, we will continue to diversify our risk across products, customers and geographies.
Changes in Commodity Prices and Customers' Volumes
Crude oil prices have fluctuated significantly over the past few years, often with drastic moves in relatively short periods of time. In the first nine months of 2020, the demand for, and price of, oil and natural gas decreased significantly due to the continuing effects of the COVID-19 pandemic and the resulting governmental regulations and travel restrictions aimed at slowing the spread of the virus. The current global geopolitical and economic uncertainty continues to contribute to future volatility in financial and commodity markets. Our direct exposure to commodity price fluctuations is limited to the PLA provisions in our tariffs. Indirectly, global demand for refined products and chemicals could impact our terminal operations and refined products and refinery gas pipelines, as well as our crude pipelines that feedU.S. manufacturing demand. Likewise, changes in the global market for crude oil could affect our crude oil pipeline and terminals and require expansion capital expenditures to reach growing export hubs. Demand for crude oil, refined products and refinery gas may decline in the areas we serve as a result of decreased production by our customers, depressed commodity prices, decreased third-party investment in the industry, increased competition and other adverse economic factors such as the current COVID-19 pandemic, which affect the exploration, production and refining industries. Although we have seen the earlier depressed demand due to the pandemic for crude oil and refined products level off, an increase in COVID-19 infection rates could have further negative impacts on demand. This could force producers to shut-in certain wellheads or otherwise cease or curtail their operations. It also could reduce the volumes running through our pipelines and terminals. However, fixed contracts with volume minimums and demand for tanks for storage are expected to moderate any impact on our terminaling and storage service revenue. Certain of our assets benefit from long-term fee-based arrangements and are strategically positioned to connect crude oil volumes originating from key onshore and offshore production basins to theTexas andLouisiana refining markets, where demand for throughput has remained strong. Historically, we have not experienced a material decline in throughput volumes on our crude oil pipeline systems as a result of lower crude oil prices. However, if crude oil prices remain at lower levels for a sustained period due to the continuing effects of the COVID-19 pandemic or other factors, we will continue to see a reduction in our transportation volumes if production coming into our systems is deferred and our associated allowance oil sales decrease. Our customers may also experience liquidity and credit problems or other unexpected events, which could cause them to defer development or repair projects, avoid our contracts in bankruptcy, invoke force majeure clauses or other defenses to avoid contractual performance or renegotiate our contracts on terms that are less attractive to us or impair their ability to perform under our contracts. Our throughput volumes on our refined products pipeline systems depend primarily on the volume of refined products produced at connected refineries and the desirability of our end markets. These factors in turn are driven by refining margins, maintenance schedules and market differentials. Refining margins depend on the cost of crude oil or other feedstocks and the price of refined products, which have decreased significantly in the three and nine months endedSeptember 30, 2020 . These margins are affected by numerous factors beyond our control, including the domestic and global supply of and demand for crude oil and refined products. Our refined products pipelines are continuing to experience demand destruction in the near term due to the COVID-19 pandemic, which has resulted in a significant decrease in consumer demand for refined products such as gasoline and jet fuel.
Other Changes in Customers' Volumes
Onshore crude transportation volumes were down in both the three months endedSeptember 30, 2020 (the "Current Quarter ") and the nine months endedSeptember 30, 2020 (the "Current Period") versus the three months endedSeptember 30, 2019 (the "Comparable Quarter ") and the nine months endedSeptember 30, 2019 (the "Comparable Period") due to demand destruction resulting from the COVID-19 pandemic. 40 --------------------------------------------------------------------------------
Offshore crude transportation volumes were down in the
Onshore terminaling and storage volumes were down in theCurrent Quarter and Current Period versus theComparable Quarter and Comparable Period due to lower volume throughput from our customers as a result of the demand destruction due to the COVID-19 pandemic. Major Maintenance Projects At the end of 2019, we finalized a directional drill project on the Zydeco pipeline system to address soil erosion over a two-mile section of our 22-inch diameter pipeline under theAtchafalaya River and Bayou Shaffer inLouisiana (the "directional drill project"). Zydeco incurred approximately$42 million in maintenance capital expenditures for the total directional drill project. In connection with the acquisitions of additional interests in Zydeco, SPLC agreed to reimburse us for our proportionate share of certain costs and expenses with respect to this project. Costs incurred and reimbursed for the three and nine months endedSeptember 30, 2020 were not material. During 2020, we incurred costs related to theBessie Heights project ("Bessie Heights "), which is a directional drill project on the Zydeco pipeline system to replace an exposed and suspended 22-inch diameter pipe in the low-lying marsh area betweenBird Island andBridge City, Texas , as well as to replace lap welded pipe below theNeches River . Zydeco is expected to incur approximately$16 million in maintenance capital expenditures related to the project. Since inception in early 2020, Zydeco has incurred$13 million in maintenance capital expenditures related toBessie Heights , of which$9 million was incurred in theCurrent Quarter .
For expected capital expenditures in 2020, refer to Capital Resources and Liquidity - Capital Expenditures and Investments.
Major Expansion Projects
On Mars, we announced in the latter part of 2019 a solicitation of interest for a potential expansion of the system. Letters of intent are in place, and we are now progressing definitive agreements with producers and expect to complete them before the end of 2020. SPLC has elected to fund the installation of the equipment necessary to enable greater throughput volumes on the system, but the revenue associated with increased throughput volumes will benefit Mars. It is expected that the project would be fully operational in late 2021, with incremental growth volumes beginning to arrive into the Mars system in 2022.
Customers
We transport and store crude oil, refined products, natural gas and refinery gas for a broad mix of customers, including producers, refiners, marketers and traders, and are connected to other crude oil and refined products pipelines. In addition to serving directly-connectedU.S. Gulf Coast markets, our crude oil and refined products pipelines have access to customers in various regions ofthe United States through interconnections with other major pipelines. Our customers use our transportation and storage services for a variety of reasons. Refiners typically require a secure and reliable supply of crude oil over a prolonged period of time to meet the needs of their specified refining diet and frequently enter into long-term firm transportation agreements to ensure a ready supply of crude oil, rate surety and sometimes sufficient transportation capacity over the life of the contract. Similarly, chemical sites require a secure and reliable supply of refinery gas to crackers and enter into long-term firm transportation agreements to ensure steady supply. Producers of crude oil and natural gas require the ability to deliver their product to market and frequently enter into firm transportation contracts to ensure that they will have sufficient capacity available to deliver their product to delivery points with greater market liquidity. Marketers and traders generate income from buying and selling crude oil and refined products to capitalize on price differentials over time or between markets. Our customer mix can vary over time and largely depends on the crude oil and refined products supply and demand dynamics in our markets. Competition Our pipeline systems compete primarily with other interstate and intrastate pipelines and with marine and rail transportation. Some of our competitors may expand or construct transportation systems that would create additional competition for the services we provide to our customers. For example, newly constructed transportation systems in the onshoreGulf of Mexico region may increase competition in the markets where our pipelines operate. In addition, future pipeline transportation capacity could be constructed in excess of actual demand in the market areas we serve, which could reduce the demand for our services, and could lead to the reduction of the rates that we receive for our services. While we do see some variation from quarter-to 41 -------------------------------------------------------------------------------- quarter resulting from changes in our customers' demand for transportation, this risk has historically been mitigated by the long-term, fixed rate basis upon which we have contracted a substantial portion of our capacity. Our storage terminal competes with surrounding providers of storage tank services. Some of our competitors have expanded terminals and built new pipeline connections, and third parties may construct pipelines that bypass our location. These, or similar events, could have a material adverse impact on our operations. Our refined products terminals generally compete with other terminals that serve the same markets. These terminals may be owned by major integrated oil and gas companies or by independent terminaling companies. While fees for terminal storage and throughput services are not regulated, they are subject to competition from other terminals serving the same markets. However, our contracts provide for stable, long-term revenue, which is not impacted by market competitive forces. Regulation
Our assets are subject to regulation by various federal, state and local
agencies; for example, our interstate common carrier pipeline systems are
subject to economic regulation by the
InMay 2020 , Zydeco, Mars,LOCAP and Colonial filed withFERC to increase rates subject toFERC's indexing adjustment methodology by approximately 2.01% starting onJuly 1, 2020 . Rate complaints are currently pending atFERC inDocket Nos . OR18-7-000, et al. challenging Colonial's tariff rates, its market power and its practices and charges related to transmix and product volume loss. While certain procedural deadlines have been extended as a result of the impact of the COVID-19 pandemic, an initial decision by the administrative law judge in this proceeding is anticipated byMay 31, 2021 , with briefs on and opposing exceptions to follow throughJuly 2021 . OnMay 21, 2020 ,FERC issued a Policy Statement resolving the Notice of Inquiry ("NOI") in Docket No. PL19-4-000. The Policy Statement revisesFERC's methodology for calculating the return on equity ("ROE") component of cost-of-service -based rates to include the Capital Asset Pricing Model ("CAPM").FERC's use of the discounted cash flow ("DCF") methodology will continue to be used, but in equal weighting with CAPM. In the Policy Statement,FERC also clarified certain aspects of its requirements regarding proxy group composition and treatment of outliers. Finally,FERC encouraged carriers refile their 2019 FERC Form No. 6 to either revise their ROE to include the CAPM model or state that they used the DCF model. OnJuly 18, 2018 ,FERC issued Order No. 849, which adopts procedures to address the impact of the federal legislation passed onDecember 22, 2017 known as the "Tax Cuts and Jobs Act" ("TCJA") andFERC's Revised Policy Statement on Treatment of Income Taxes in Docket No. PL17-1-000, issued onMarch 15, 2018 (the "Revised Policy Statement").FERC contemporaneously issued the Order on Rehearing in Docket No. PL17-1-000, which affirmsFERC's position in the Revised Policy Statement that eliminated the recovery of an income tax allowance by MLP oil and gas pipelines in cost-of-service-based rates. In Order No. 849, however,FERC has clarified its general disallowance of MLP income tax allowance recovery by providing that an MLP will not be precluded in a future proceeding from making a claim that it is entitled to an income tax allowance.FERC will permit an MLP to demonstrate that its recovery of an income tax allowance does not result in a "double-recovery of investors' income tax costs."FERC affirmed Order No. 849 on rehearing onApril 18, 2019 . Parties sought judicial review of the Revised Policy Statement, and that challenge, initially filed inMarch 2019 , was denied by theU.S. Court of Appeals for the D.C. Circuit onAugust 14, 2020 . No further petitions are outstanding on this matter. As was the case with the Revised Policy Statement,FERC did not propose any industry-wide action regarding review of rates for crude oil and liquids pipelines in itsJuly 2018 issuances. MLP owned crude oil and liquids pipelines are required to report Page 700 information in their FERC Form No. 6 annual reports.FERC intends to address the impact of the elimination of the income tax allowance, as well as the corporate income tax reduction enacted as part of the TCJA, in its five-year review of the oil pipeline rate index level in 2020.FERC will also implement the elimination of the income tax allowance in proceedings involving review of initial cost-of-service rates, rate changes and rate complaints. For crude oil and liquids pipelines owned by non-MLP partnerships and other pass-through businesses,FERC will address such issues as they arise in subsequent proceedings. OnJune 18, 2020 ,FERC issued a NOI as Docket No. RM20-14-000 regarding the five-year review of the oil pipeline rate index formula.FERC proposed a new formula of Producer Price Index for Finished Goods ("PPI-FG") plus 0.09% based on its review of industry data provided in the annual FERC Form 6 reports from 2014 through 2019. The NOI proposal, which would take effect inJuly 2021 , would change the current five-year formula from PPI-FG plus 1.23%.FERC invited comments regarding its proposal and any alternative methodologies for calculating the index level, including issues such as different data 42 -------------------------------------------------------------------------------- trimming methodologies and whether it should reflect the effects of any cost-of-service policy changes in the calculation of the index level. Comments on the NOI were filed by multiple parties byAugust 17, 2020 , and reply comments were filed bySeptember 11, 2020 . A final ruling is expected around year end. We believe that the recent issuances fromFERC , including the Revised Policy Statement and issuances inJuly 2018 , will not have a material impact on our operations and financial performance. SinceFERC only maintains jurisdiction over interstate crude oil and liquids pipelines, the recent decisions are not expected to have an impact on rates charged through our offshore operations.FERC also does not maintain jurisdiction over certain of the onshore assets in which we have interests. Rates related to these assets should not be impacted byFERC's decision. For ourFERC -regulated rates charged through our interstate crude oil and liquids pipelines, the rates are based on either a negotiated or market-based rate and are not set through cost-of-service ratemaking subject toFERC's approval, which are below the cost-of-service rates established byFERC . As such, neither our negotiated nor market-based rate revenue for ourFERC -regulated assets would be subject to the income tax recovery disallowance. Additionally, we have evaluated the impact ofFERC's recent policy changes on our non-operated joint ventures. Due to the nature of their assets, operations and/or their entity form, we do not believe there will be any material impact to their operations and earnings. OnOctober 20, 2016 ,FERC issued an Advance Notice of Proposed Rulemaking in Docket No. RM17-1-000 (the "ANOPR") regarding changes to the oil pipeline rate index methodology and data reporting on Page 700 ofFERC's Form No. 6. OnFebruary 21, 2020 ,FERC withdrew the ANOPR and denied additional shipper requests seeking changes to Page 700 reporting requirements as the ANOPR's proposed changes were not consistent withFERC's simplified and streamlined indexing regime. No further updates are expected on this matter. OnOctober 1, 2019 , thePipeline and Hazardous Materials Safety Administration ("PHMSA") issued three new final rules. One rule establishes procedures to implement the expanded emergency order enforcement authority set forth in anOctober 2016 interim final rule. Among other things, this rule allows PHMSA to issue an emergency order without advance notice or opportunity for a hearing. The other two rules impose several new requirements on operators of onshore gas transmission systems and hazardous liquids pipelines. The rule concerning gas transmission extends the requirement to conduct integrity assessments beyond High Consequence Areas ("HCAs") to pipelines in Moderate Consequence Areas ("MCAs"). It also includes requirements to reconfirm maximum allowable operating pressure ("MAOP"), report MAOP exceedances, consider seismicity as a risk factor in integrity management and use certain safety features on in-line inspection equipment. The rule concerning hazardous liquids extends the required use of leak detection systems beyond HCAs to all regulated non-gathering hazardous liquid pipelines, requires reporting for gravity fed lines and unregulated gathering lines, requires periodic inspection of all lines not in HCAs, calls for inspections of lines after extreme weather events and adds a requirement to make all onshore lines in or affecting HCAs capable of accommodating in-line inspection tools over the next 20 years. There are new MCAs on some of our gas transmission lines; however, these lines are already fully inspected due to HCAs on the lines, so these new areas do not impact inspection or maintenance programs on the lines. On the liquid side, all onshore lines have leak detection and are currently inspected under the Integrity Management Program, so there are no new inspections required. Some of our product lines may need to be made piggable; however, the full evaluations of those lines have not been completed to understand potential cost implications.
For more information on federal, state and local regulations affecting our business, please read Part I, Items 1 and 2, Business and Properties in our 2019 Annual Report.
43 --------------------------------------------------------------------------------
Acquisition Opportunities
We plan to continue to pursue acquisitions of complementary assets from Shell, as well as from third parties. We also may pursue acquisitions jointly with Shell. Given the size and scope of Shell's footprint and its significant ownership interest in us, we expect acquisitions from Shell will be a growth mechanism for the foreseeable future. However, Shell and its affiliates are under no obligation to sell or offer to sell us additional assets or to pursue acquisitions jointly with us, and we are under no obligation to buy any additional assets from them or to pursue any joint acquisitions with them. We will continue to focus our acquisition strategy on transportation and midstream assets. We believe that we would be well positioned to acquire midstream assets from Shell, as well as from third parties, should such opportunities arise. Identifying and executing acquisitions is a key part of our strategy. However, if we do not make acquisitions on economically acceptable terms or if we incur a substantial amount of debt in connection with the acquisitions, our future growth will be limited, and the acquisitions we do make may reduce, rather than increase, our available cash. Our ability to obtain financing or access capital markets may also directly impact our ability to continue to pursue strategic acquisitions. The level of current market demand for equity issued by MLPs may make it more challenging for us to fund our acquisitions with the issuance of equity in the capital markets. However, we believe our balance sheet offers us flexibility, providing us other financing options such as hybrid securities, purchases of common units by RDS and debt. While we expect to retain this flexibility, in 2021 we anticipate continuing to moderate inorganic growth in our asset base and focusing on the sustainable operation of our core assets, cash preservation and organic growth of our business. 44 --------------------------------------------------------------------------------
Results of Operations
The following tables and discussion are a summary of our results of operations, including a reconciliation of Adjusted EBITDA and CAFD to net income and net cash provided by operating activities, the most directly comparable GAAP financial measures, for each of the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Revenue$ 110 $ 125 $ 351 $ 377 Costs and expenses Operations and maintenance 39 33 109 92 Cost of product sold 3 10 20 26 Loss from revision of asset retirement obligation - - - 2 General and administrative 14 16 47 45 Depreciation, amortization and accretion 13 12 39 36 Property and other taxes 6 5 15 14 Total costs and expenses 75 76 230 215 Operating income 35 49 121 162 Income from equity method investments 109 115 330 265 Dividend income from other investments - - - 14 Other income 7 8 27 28 Investment, dividend and other income 116 123 357 307 Interest income 8 1 16 2 Interest expense 22 27 71 69 Income before income taxes 137 146 423 402 Income tax expense - - - - Net income 137 146 423 402 Less: Net income attributable to noncontrolling interests 2 5 9 14 Net income attributable to the Partnership 135 141 414 388 Preferred unitholder's interest in net income attributable to the Partnership 12 - 24 - General partner's interest in net income attributable to the Partnership - 36 55 93 Limited Partners' interest in net income attributable to the Partnership's common unitholders$ 123 $ 105 $ 335 $ 295 Adjusted EBITDA attributable to the Partnership (1)$ 191 $ 186 $ 579 $ 543 Cash available for distribution attributable to the Partnership's common unitholders (1)$ 163
(1) For a reconciliation of Adjusted EBITDA and CAFD attributable to the Partnership's common unitholders to their most comparable GAAP measures, please read "-Reconciliation of Non-GAAP Measures."
45
-------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, Pipeline throughput (thousands of barrels per day) (1) 2020 2019 2020 2019 Zydeco - Mainlines 524 667 575 643 Zydeco - Other segments 128 257 152 262 Zydeco total system 652 924 727 905 Amberjack total system 295 358 334 360 Mars total system 479 519 506 548 Bengal total system 468 522 447 516 Poseidon total system 274 249 269 256 Auger total system 55 69 62 78 Delta total system 151 254 216 259 Na Kika total system 25 26 46 35 Odyssey total system 85 146 117 149 Colonial total system 2,198 2,653 2,403 2,619 Explorer total system 463 694 484 674 Mattox total system (2) 70 57 65 34 LOCAP total system 955 1,134 1,010 1,186 Other systems 399 381 422 315 Terminals (3) (4)Lockport terminaling throughput and storage volumes 208 233 221 225 Revenue per barrel ($ per barrel) Zydeco total system (5)$ 0.47 $ 0.50 $ 0.48 $ 0.54 Amberjack total system (5) 2.33 2.38 2.36 2.38 Mars total system (5) 1.17 1.36 1.31 1.24 Bengal total system (5) 0.43 0.46 0.41 0.41 Auger total system (5) 1.06 1.47 1.36 1.40 Delta total system (5) 0.58 0.60 0.59 0.58 Na Kika total system (5) 1.02 0.81 0.93 0.77 Odyssey total system (5) 0.92 0.93 0.93 0.91 Lockport total system (6) 0.25 0.22 0.23 0.22 Mattox total system (7) 1.52 N/A (8) 1.52 N/A (8) (1) Pipeline throughput is defined as the volume of delivered barrels. For additional information regarding our pipeline and terminal systems, refer to Part I, Item I - Business and Properties - Our Assets and Operations in our 2019 Annual Report. (2) The actual delivered barrels for Mattox are disclosed in the above table for the comparative periods. However, Mattox is billed by monthly minimum quantity per dedication and transportation agreements entered into inApril 2020 . Based on the contracted volume determined in the agreements, the thousands of barrels per day (for revenue calculation purposes) for Mattox are 168 and 163 thousands of barrels per day for the three and nine months endedSeptember 30, 2020 , respectively. (3) Terminaling throughput is defined as the volume of delivered barrels and storage is defined as the volume of stored barrels. (4) Refinery Gas Pipeline and our refined products terminals are not included above as they generate revenue under transportation and terminaling service agreements, respectively, that provide for guaranteed minimum revenue and/or throughput. (5) Based on reported revenues from transportation and allowance oil divided by delivered barrels over the same time period. Actual tariffs charged are based on shipping points along the pipeline system, volume and length of contract. (6) Based on reported revenues from transportation and storage divided by delivered and stored barrels over the same time period. Actual rates are based on contract volume and length. (7) Mattox is billed at a fixed rate of$1.52 per barrel for the monthly minimum quantity in accordance with the terms of dedication and transportation agreements entered into inApril 2020 . (8) Mattox is billed at a fixed rate (see note above) per dedication and transportation agreements. The rates for 2019 are not applicable as we only entered into these agreements inApril 2020 . These agreements do not apply to 2019. 46 --------------------------------------------------------------------------------
Reconciliation of Non-GAAP Measures
The following tables present a reconciliation of Adjusted EBITDA and CAFD to net income and net cash provided by operating activities, the most directly comparable GAAP financial measures, for each of the periods indicated.
Please read "-Adjusted EBITDA and Cash Available for Distribution" for more information. Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Reconciliation of Adjusted EBITDA and Cash Available for Distribution to Net Income Net income$ 137 $ 146 $ 423 $ 402 Add: Loss from revision of asset retirement obligation - - - 2 Allowance oil reduction to net realizable value - 1 8 1 Depreciation, amortization and accretion 17 12 47 36 Interest income (8) (1) (16) (2) Interest expense 22 27 71 69 Cash distributions received from equity method investments 142 130 412 341
Less:
Equity method distributions included in other income 7 8 25 25 Income from equity method investments 109 115 330 265 Adjusted EBITDA 194 192 590 559
Less:
Adjusted EBITDA attributable to noncontrolling interests 3 6 11 16 Adjusted EBITDA attributable to the Partnership 191 186 579 543
Less:
Series A Preferred Units distribution 12 - 24 - Net interest paid by the Partnership (1) 22 26 71 67 Maintenance capex attributable to the Partnership 10 7 18 21
Add:
Principal and interest payments received on financing receivables 8 - 14 - Net adjustments from volume deficiency payments attributable to the Partnership 8 - 16 (10) Reimbursements from Parent included in partners' capital - - - 10 Cash available for distribution attributable to the Partnership's common unitholders$ 163 $
153
(1) Amount represents both paid and accrued interest attributable to the period.
47 -------------------------------------------------------------------------------- Nine
Months Ended
2020 2019
Reconciliation of Adjusted EBITDA and Cash Available for Distribution to Net Cash Provided by Operating Activities Net cash provided by operating activities
$ 503$ 458 Add: Interest income (16) (2) Interest expense 71 69 Return of investment 62 56 Less: Change in deferred revenue and other unearned income 20 (11) Non-cash interest expense - 1 Allowance oil reduction to net realizable value 8 1 Change in other assets and liabilities 2 31 Adjusted EBITDA 590 559
Less:
Adjusted EBITDA attributable to noncontrolling interests 11 16 Adjusted EBITDA attributable to the Partnership 579 543
Less:
Series A Preferred Units distribution 24 - Net interest paid by the Partnership (1) 71 67 Maintenance capex attributable to the Partnership 18 21
Add:
Principal and interest payments received on financing receivables
14 -
Net adjustments from volume deficiency payments attributable to the Partnership
16 (10) Reimbursements from Parent included in partners' capital - 10
Cash available for distribution attributable to the Partnership's common unit holders
$
496
(1) Amount represents both paid and accrued interest attributable to the period.
48 --------------------------------------------------------------------------------
Revenues
Total revenue decreased by$15 million in theCurrent Quarter as compared to theComparable Quarter , comprised of decreases of$25 million in transportation services revenue,$5 million in allowance oil revenue and$5 million attributable to product revenue, partially offset by increases of$19 million attributable to terminaling services revenue and$1 million of lease revenue. Transportation services revenue and allowance oil revenue decreased primarily due to several storms that impacted theGulf of Mexico during theCurrent Quarter which caused several shut-ins of production, as well as downtime related to planned turnaround activities. Further, theCurrent Quarter was impacted by the ongoing effects of the COVID-19 pandemic on the crude and refined products operating environment and related prices. Additionally, deficiency credits were deferred in theCurrent Quarter as compared to deficiency credits being utilized and recognized in revenue in theComparable Quarter .
Terminaling services revenue increased primarily due to the recognition of
revenue related to the service components of the new terminaling service
agreements related to the Norco Assets acquired in
Lease revenue was relatively consistent in the
Product revenue decreased by
Costs and Expenses
Total costs and expenses decreased$1 million in theCurrent Quarter as compared to theComparable Quarter primarily due to a decrease of$7 million of cost of product sold and$2 million of general and administrative expenses. These decreases were almost entirely offset by increases of$6 million of operations and maintenance expenses,$1 million of depreciation expense, and$1 million of property taxes.
Cost of product sold decreased as a result of lower sales of allowance oil
coupled with the lower cost environment in the
General and administrative expenses were relatively flat for the
Operations and maintenance expenses increased mainly as a result of higher
maintenance costs related to the Norco Assets in the
Property tax expense increased as a result of the acquisition of the Norco
Assets in
Investment, Dividend and Other Income
Investment, dividend and other income decreased
Interest Income and Expense
Interest income was$7 million higher in theCurrent Quarter as compared to theComparable Quarter mainly due to interest income related to the financing receivables recorded in connection with the Norco Assets. Interest expense decreased by$5 million due to lower interest rates in theCurrent Quarter versus theComparable Quarter resulting from the ongoing effects of the COVID-19 pandemic on market interest rates. 49 --------------------------------------------------------------------------------
Current Period compared to Comparable Period
Revenues
Total revenue decreased by$26 million in the Current Period as compared to the Comparable Period, comprised of decreases of$44 million in transportation services revenue,$9 million in allowance oil revenue and$16 million attributable to product revenue, partially offset by increases of$42 million attributable to terminaling services revenue and$1 million of lease revenue. Transportation services revenue and allowance oil revenue decreased primarily due to the ongoing effects of the COVID-19 pandemic on the crude and refined products operating environment and related prices in the Current Period, as well as lower rates on the Zydeco committed contracts in the Current Period as compared to the Comparable Period. Additionally, the impact from planned turnaround activities, as well as the impact of storms and the related shut-ins of production, was higher in the Current Period than the Comparable Period. Additionally, deficiency credits were deferred in the Current Period as compared to deficiency credits being utilized and recognized in revenue in the Comparable Period. These decreases were partially offset by new volumes brought online at Na Kika and Odyssey, as well as achieving regulatory approval for an increase in tariffs on Delta in the Current Period.
Terminaling services revenue increased primarily due to the recognition of
revenue related to the service components of the new terminaling service
agreement related to the Norco Assets acquired in
Lease revenue was relatively consistent in the Current Period and Comparable Period.
Product revenue decreased by
Costs and Expenses
Total costs and expenses increased$15 million in the Current Period primarily due to the increases of$17 million in operations and maintenance expenses,$3 million of depreciation expense,$2 million in general and administrative expenses and$1 million in property taxes. These increases were partially offset by decreases of$6 million in cost of products sold and$2 million of loss from the revision of asset retirement obligations and disposition of assets incurred in the Comparable Period.
Operations and maintenance expenses increased mainly as a result of higher maintenance costs related to the Norco Assets in the Current Period as compared to the Comparable Period.
General and administrative expense increased primarily due to higher
professional fees related to the
Property tax expense increased as a result of the acquisition of the Norco
Assets in
Cost of product sold decreased as a result of lower sales of allowance oil coupled with the lower cost environment in the Current Period as compared to the Comparable Period, which was partially offset by a higher net realizable value adjustment on allowance oil inventory in the Current Period.
Investment, Dividend and Other Income
Investment, dividend and other income increased$50 million in the Current Period as compared to the Comparable Period. Income from equity method investments increased by$65 million , primarily as a result of the equity earnings associated with the acquisition of additional interests in Explorer and Colonial inJune 2019 , as well as the acquisition of an interest in Mattox inApril 2020 . These increases were partially offset by a decrease in dividend income from other investments of$14 million due to the change in accounting for Explorer and Colonial as equity method investments in the 50 -------------------------------------------------------------------------------- Current Period rather than other investments in the Comparable Period following the acquisition of additional interests in these entities inJune 2019 . We were entitled to distributions from Explorer and Colonial with respect to the period beginningApril 1, 2019 , as these were paid after the acquisition date and were no longer considered dividend income. Additionally, Other income decreased by$1 million related to lower distributions from Poseidon in the Current Period.
Interest Income and Expense
Interest income was$14 million higher mainly due to interest income related to the financing receivables recorded in connection with the Norco Assets. Interest expense increased by$2 million due to additional borrowings outstanding under our credit facilities during the Current Period versus the Comparable Period, which was partially offset by lower interest rates in the Current Period versus the Comparable Period resulting from the ongoing effects of the COVID-19 pandemic on market interest rates. 51 --------------------------------------------------------------------------------
Capital Resources and Liquidity
We expect our ongoing sources of liquidity to include cash generated from operations, borrowings under our credit facilities and our ability to access the capital markets. We believe this access to credit along with cash generated from operations will be sufficient to meet our short-term working capital requirements and long-term capital expenditure requirements, and to make quarterly cash distributions. However, we cannot accurately predict the effects of the continuing COVID-19 pandemic on our capital resources and liquidity due to the current significant level of uncertainty. Our liquidity as ofSeptember 30, 2020 was$1,225 million , consisting of$329 million cash and cash equivalents and$896 million of available capacity under our credit facilities. OnApril 1, 2020 , we closed the transactions contemplated by the Partnership Interests Restructuring Agreement, which included the elimination of all the IDRs, the conversion of the economic general partner interest into a non-economic general partner interest and the establishment of the rights and preferences of the Series A Preferred Units in the Partnership's Second Amended and Restated Agreement of Limited Partnership, effective as ofApril 1, 2020 (the "Second Amended and Restated Partnership Agreement"). Pursuant to the Partnership Interests Restructuring Agreement, the general partner (or its assignee) has agreed to waive a portion of the distributions that would otherwise be payable on the common units issued to SPLC as part of theApril 2020 Transaction, in an amount of$20 million per quarter for four consecutive fiscal quarters, beginning with the distribution made with respect to the second quarter of 2020. Refer to Note 2 - Acquisitions and Other Transactions in the Notes to the Unaudited Consolidated Financial Statements for more details. OnDecember 21, 2018 , we and our general partner executed Amendment No. 2 (the "Second Amendment") to the Partnership's First Amended and Restated Agreement of Limited Partnership datedNovember 3, 2014 . Under the Second Amendment, our general partner agreed to waive$50 million of distributions in 2019 by agreeing to reduce distributions to holders of the IDRs by: (1)$17 million for the quarter endedMarch 31, 2019 , (2)$17 million for the quarter endedJune 30, 2019 and (3)$16 million for the quarter endedSeptember 30, 2019 .
Credit Facility Agreements
As ofSeptember 30, 2020 , we have entered into the following credit facilities: Total Capacity Current Interest Rate Maturity Date Ten Year Fixed Facility $ 600 4.18 % June 4, 2029 Seven Year Fixed Facility 600 4.06 % July 31, 2025 Five Year Revolver due July 2023 760 1.23 % July 31, 2023 Five Year Revolver due December 2022 1,000 1.24 % December 1, 2022 Five Year Fixed Facility 600 3.23 % March 1, 2022 2019 Zydeco Revolver (1) 30 0.89 % August 6, 2024 (1) EffectiveAugust 6, 2019 , the Zydeco Revolver expired. In its place, Zydeco entered into the 2019 Zydeco Revolver. See Note 8 - Related Party Debt in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in our 2019 Annual Report. Borrowings under the Five Year Revolver dueJuly 2023 , the Five Year Revolver dueDecember 2022 and the 2019 Zydeco Revolver bear interest at the three-month LIBOR rate plus a margin or, in certain instances (including if LIBOR is discontinued) at an alternate interest rate as described in each respective revolver. EffectiveDecember 31, 2021 , LIBOR will be discontinued globally, and as such, a new benchmark will take its place. We are in discussion with our Parent to further clarify the reference rate(s) applicable to our revolving credit facilities once LIBOR is discontinued, and we are evaluating any potential impact on our facilities. Our weighted average interest rate for the nine months endedSeptember 30, 2020 andSeptember 30, 2019 was 3.4% and 3.8%, respectively. The weighted average interest rate includes drawn and undrawn interest fees, but does not consider the amortization of debt issuance costs or capitalized interest. A 1/8 percentage point (12.5 basis points) increase in the interest rate on the total variable rate debt of$894 million as ofSeptember 30, 2020 would increase our consolidated annual interest expense by approximately$1 million . We will need to rely on the willingness and ability of our related party lender to secure additional debt, our ability to use cash from operations and/or obtain new debt from other sources to repay/refinance such loans when they come due and/or to secure additional debt as needed. 52 -------------------------------------------------------------------------------- As ofSeptember 30, 2020 , we were in compliance with the covenants contained in our credit facilities, and Zydeco was in compliance with the covenants contained in the 2019 Zydeco Revolver. For definitions and additional information on our credit facilities, refer to Note 7 - Related Party Debt in the Notes to the Unaudited Consolidated Financial Statements in this report and Note 8 - Related Party Debt in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in our 2019 Annual Report. Equity Issuances
As consideration for the
Cash Flows from Our Operations
Operating Activities. We generated$503 million in cash flow from operating activities in the Current Period compared to$458 million in the Comparable Period. The increase in cash flows was primarily driven by an increase in equity investment income related to the acquisition of an interest in Mattox inApril 2020 and additional interests in Explorer and Colonial inJune 2019 , as well as an increase related to deferred revenue in 2020. These increases were partially offset by the timing of receipt of receivables and payment of accruals in 2020. Investing Activities. Our cash flow provided by investing activities was$45 million in the Current Period compared to$78 million used in investing activities in the Comparable Period. The increase in cash flow provided by investing activities was primarily due to no cash acquisition from Parent, no contributions to investment, lower capital expenditures and higher return of investment in the Current Period compared to the Comparable Period. Financing Activities. Our cash flow used in financing activities was$509 million in theCurrent Quarter compared to$294 million in theComparable Quarter . The increase in cash flow used in financing activities was primarily due to increased distributions paid to the unitholders and our general partner, no borrowings under credit facilities and lower other contributions from Parent in the Current Period compared to the Comparable Period. These increases were partially offset by there being no capital distributions to our general partner in the Current Period.
Capital Expenditures and Investments
Our operations can be capital intensive, requiring investments to maintain, expand, upgrade or enhance existing operations and to meet environmental and operational regulations. Our capital requirements consist of maintenance capital expenditures and expansion capital expenditures. Examples of maintenance capital expenditures are those made to replace partially or fully depreciated assets, to maintain the existing operating capacity of our assets and to extend their useful lives, or other capital expenditures that are incurred in maintaining existing system volumes and related cash flows. In contrast, expansion capital expenditures are those made to acquire additional assets to grow our business, to expand and upgrade our systems and facilities and to construct or acquire new systems or facilities. We regularly explore opportunities to improve service to our customers and maintain or increase our assets' capacity and revenue. We may incur substantial amounts of capital expenditures in certain periods in connection with large maintenance projects that are intended to only maintain our assets' capacity or revenue. We incurred capital expenditures of$20 million and$29 million for the Current Period and the Comparable Period, respectively. The decrease in capital expenditures is primarily due to completion of theHouma tank expansion projects and directional drill projects for Zydeco, coupled with no capital contributions toPermian Basin in the Current Period.
A summary of our capital expenditures and investments is shown in the table below:
53 --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Expansion capital expenditures $ - $ 3 $ 1$ 10 Maintenance capital expenditures 8 5 16 21 Total capital expenditures paid 8 8 17 31 Increase (decrease) in accrued capital expenditures 3 - 3 (2) Total capital expenditures incurred $ 11 $ 8 $ 20$ 29 Contributions to investment $ - $ 3 $ -$ 13
We expect total capital expenditures and investments to be approximately
Actual Expected Total Expected Nine Months Ended Three Months Ending 2020 Capital September 30, 2020 December 31, 2020 Expenditures
Expansion capital expenditures
Triton $ 1 $ - $ 1 Total expansion capital expenditures incurred 1 - 1
Maintenance capital expenditures
Zydeco $ 17 $ 3 $ 20 Pecten 1 1 2 Triton 1 1 2 Total maintenance capital expenditures incurred 19 5 24 Contributions to investment - - - Total capital expenditures and investments $ 20 $ 5 $ 25 Contributions to investment are related to funding expansion capital and other expenditures forPermian Basin . There have been no contributions to investment through the third quarter of 2020, and none are expected for the remainder of 2020. Zydeco's maintenance capital expenditures for the three and nine months endedSeptember 30, 2020 were$10 million and$17 million , respectively. Of the$17 million for the nine months endedSeptember 30, 2020 ,$13 million was forBessie Heights ,$1 million was for upgrade of the motor control center atHouma and$3 million was for various other maintenance projects. We expect Zydeco's maintenance capital expenditures to be$3 million for the remainder of 2020, of which approximately$1 million is for a pipeline exposure requiring replacement,$1 million is related to an upgrade of the motor control center atHouma , and$1 million is for various other maintenance projects. Pecten's maintenance capital expenditures for the three and nine months endedSeptember 30, 2020 were immaterial and$1 million , respectively, and we expect Pecten's maintenance capital expenditures to be approximately$1 million for the remainder of 2020. These expenditures relate to various improvements primarily on Delta. Triton's expansion capital expenditures for the three and nine months endedSeptember 30, 2020 were immaterial and$1 million , respectively, and we expect no further expansion capital expenditures for Triton for the remainder of 2020. Triton's maintenance capital expenditures for both the three and nine months endedSeptember 30, 2020 were$1 million , and we expect Triton's maintenance capital expenditures to be approximately$1 million for the remainder of 2020. These expenditures relate to maintenance at the various terminals.
We anticipate that both maintenance and expansion capital expenditures for the remainder of the year will be funded primarily with cash from operations.
54 --------------------------------------------------------------------------------
Capital Contribution
In accordance with the Member Interest Purchase Agreement datedOctober 16, 2017 pursuant to which we acquired a 50% interest inPermian Basin , we will make capital contributions for our pro rata interest inPermian Basin to fund capital and other expenditures, as approved by a supermajority (75%) vote of the members. We have made no capital contributions in the three and nine months endedSeptember 30, 2020 , and do not expect to make any capital contributions for the remainder of 2020. Contractual Obligations A summary of our contractual obligations as ofSeptember 30, 2020 is shown in the table below: Less than 1 Years 1 to Years 3 to More than 5 Total year 3 5 years Operating leases for land and platform space$ 7 $ - $ 1 $ 1$ 5 Finance leases (1) 57 5 10 10 32 Other agreements (2) 37 6 12 12 7 Debt obligation (3) 2,694 - 1,494 600 600 Interest payments on debt (4) 395 82 126 95 92 Total$ 3,190 $ 93 $ 1,643 $ 718 $ 736 (1) Finance leases includePort Neches storage tanks andGarden Banks 128 "A" platform. Finance leases include$24 million in interest,$25 million in principal and$8 million in executory costs. (2) Includes a joint tariff agreement and tie-in agreement. (3) See Note 7 - Related Party Debt in the Notes to the Unaudited Consolidated Financial Statements for additional information. (4) Interest payments were calculated based on rates in effect atSeptember 30, 2020 for variable rate borrowings. As ofSeptember 30, 2020 , our contractual obligations included long-term debt, finance lease obligations, operating lease obligations and other contractual obligations. There were no material changes to these obligations outside the ordinary course of business sinceDecember 31, 2019 . Our Series A Preferred Units are contractually entitled to receive cumulative quarterly distributions. For the three months endedSeptember 30, 2020 , cumulative preferred distributions paid to our Series A Preferred Unitholders were$12 million . However, subject to certain conditions, we or the holders of the Series A Preferred Units may convert the Series A Preferred Units into common units at certain anniversary dates after the issuance date. Due to the uncertain timing of any potential conversion, distributions related to the Series A Preferred Units were not included in the contractual obligations table above.
Off-Balance Sheet Arrangements
We have not entered into any transactions, agreements or other contractual arrangements that would result in off-balance sheet liabilities.
Environmental Matters and Compliance Costs
Our operations are subject to extensive and frequently changing federal, state and local laws, regulations and ordinances relating to the protection of the environment. Among other things, these laws and regulations govern the emission or discharge of pollutants into or onto the land, air and water, the handling and disposal of solid and hazardous wastes and the remediation of contamination. As with the industry in general, compliance with existing and anticipated environmental laws and regulations increases our overall cost of business, including our capital costs to construct, maintain, operate and upgrade equipment and facilities. While these laws and regulations affect our maintenance capital expenditures and net income, we believe they do not affect our competitive position, as the operations of our competitors are similarly affected. We believe our facilities are in substantial compliance with applicable environmental laws and regulations. However, these laws and regulations are subject to changes, or to changes in the interpretation of such laws and regulations, by regulatory authorities, and continued and future compliance with such laws and regulations may require us to incur significant expenditures. Violation of environmental laws, regulations and permits can result in the imposition of significant administrative, civil and criminal penalties, injunctions limiting our operations, investigatory or remedial liabilities or construction bans or delays in the construction of additional facilities or equipment. Additionally, a release of hydrocarbons or hazardous substances into the environment could, to the 55 -------------------------------------------------------------------------------- extent the event is not insured, subject us to substantial expenses, including costs to comply with applicable laws and regulations and to resolve claims by third parties for personal injury or property damage, or claims by theU.S. federal government or state governments for damages to natural resources. These impacts could directly and indirectly affect our business and have an adverse impact on our financial position, results of operations and liquidity if we do not recover these expenditures through the rates and fees we receive for our services. We believe our competitors must comply with similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including, but not limited to, the type of competitor and location of its operating facilities. For additional information, refer to Environmental Matters, Items 1 and 2, Business and Properties in our 2019 Annual Report. We accrue for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs can be reasonably estimated. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. New or expanded environmental requirements, which could increase our environmental costs, may arise in the future. We believe we substantially comply with all legal requirements regarding the environment; however, as not all of the costs are fixed or presently determinable (even under existing legislation) and may be affected by future legislation or regulations, it is not possible to predict all of the ultimate costs of compliance, including remediation costs that may be incurred and penalties that may be imposed.
Critical Accounting Policies and Estimates
Our critical accounting policies and estimates are set forth in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation - Critical Accounting Policies and Estimates in our 2019 Annual Report. As ofSeptember 30, 2020 , there have been no significant changes to our critical accounting policies and estimates since our 2019 Annual Report was filed other than those noted below.
In connection with theApril 2020 Transaction, we utilized the services of independent valuation specialists to assist in the fair value appraisals to determine the fair value of the total consideration, as well as the fair values of the Mattox Transaction, the Norco Transaction, and the GP/IDR Restructuring as ofApril 1, 2020 . Because the components of theApril 2020 Transaction were entered in contemplation of each other and were transactions among entities under common control, the fair values of theApril 2020 Transaction were used solely for the purpose of allocating a portion of the total consideration on a relative fair value basis to the Norco Transaction. The Partnership issued 50,782,904 Series A Preferred Units and 160,000,000 newly issued common units to SPLC as consideration for theApril 2020 Transaction. See Note 2 - Acquisitions and Other Transactions for additional details. As further described in Note 2-Acquisitions and Other Transactions, we acquired the Mattox equity interests from SGOM as a part of the Mattox Transaction. The acquisition was accounted for as a transaction among entities under common control on a prospective basis as an asset acquisition. As a part of theNorco Transaction, SOPUS and Shell Chemical transferred certain logistics assets at theShell Norco Manufacturing Complex to Triton, as designee of the Partnership. The transfer of the Norco Assets combined with the terminaling service agreements was accounted for as a failed sale leaseback under the lease standard, as control of the assets did not transfer to the Partnership. As a result, the transaction was treated as financing arrangement. The amount of contract assets recognized was dependent on the allocated fair value of the consideration to the Norco Transaction, which was determined using the fair values of the consideration transferred and the fair values of the three components of theApril 2020 Transaction. The common units were valued using a market approach based on the market opening price of the Partnership's common units as ofApril 1, 2020 less a discount for the distribution waiver and marketability. The Series A Preferred Units were valued using an income approach based on a trinomial lattice model. Further, the fair values of the three components of theApril 2020 Transaction were determined using an income approach of discounted cash flows at an average discount rate for each of the Mattox Transaction, the Norco Transaction, and the GP/IDR Restructuring components of 14%, 11% and 20%, respectively. We believe both the estimates and assumptions utilized in the fair value appraisals of theApril 2020 Transaction are individually and in the aggregate reasonable; however, our estimates and assumptions are highly judgmental in nature. Further, there are inherent uncertainties related to these estimates and assumptions, and our judgment in applying them, to determine the fair values. While we believe we have made reasonable estimates and assumptions to calculate the fair values, changes in any 56 -------------------------------------------------------------------------------- one of the estimates, assumptions or a combination of estimates and assumptions, could result in changes to the estimated fair values utilized to determine the relative stand-alone fair value of the Norco Transaction.
Fair value of consideration
The following table summarized the fair valuation approaches and key assumptions
underlying those approaches to value the different components of the
consideration of the
Valuation Technique Key assumptions Discount for lack of marketability; waiver Common Units Market Approach discount Volatility rate; expected term; yield and Series A Preferred Units Income Approach conversion price
Fair value of business enterprise value
The following table summarizes the fair valuation approaches and key assumptions
underlying those approaches to obtain the business enterprise value of the
different components of the
Valuation Technique Key assumptions Discount rates; revenue growth rates; terminal Mattox Transaction Income Approach
growth rates; cash flow projections
Discount rates; revenue growth rates; terminal Norco Transaction Income Approach
growth rates; cash flow projections
Discount rates; revenue growth rates; terminal
growth rates; projected cash available for GP/IDR Restructuring Income Approach distribution
Relative Stand -Alone Selling Price
We allocate the arrangement consideration between the components based on the relative stand-alone selling price ("SASP") of each component in accordance with ASC Topic 606, Revenue from Contracts with Customers. The Partnership established the stand-alone selling price for the financing components based off an expected return on the assets being financed. The Partnership established the SASP for the service components using an expected cost-plus margin approach based on the Partnership's forecasted costs of satisfying the performance obligations plus an appropriate margin for the service. The SASP is used to allocate the annual terminaling service agreement payments between the principal payments and interest income on the financing receivables (financing components) and terminaling service revenue (service components). The key assumptions include forecasts of the future operation and maintenance costs and major maintenance costs and the expected return.
Recent Accounting Pronouncements
Please refer to Note 1- Description of Business and Basis of Presentation in the Notes to the Unaudited Consolidated Financial Statements for a discussion of recently adopted accounting pronouncements and new accounting pronouncements. 57 -------------------------------------------------------------------------------- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This report includes forward-looking statements. You can identify our forward-looking statements by the words "anticipate," "estimate," "believe," "budget," "continue," "could," "intend," "may," "plan," "potential," "predict," "seek," "should," "would," "expect," "objective," "projection," "forecast," "goal," "guidance," "outlook," "effort," "target" and similar expressions. We based the forward-looking statements on our current expectations, estimates and projections about us and the industries in which we operate in general. We caution you these statements are not guarantees of future performance as they involve assumptions that, while made in good faith, may prove to be incorrect, and involve risks and uncertainties we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual outcomes and results may differ materially from what we have expressed in the forward-looking statements. Any differences could result from a variety of factors, including the following: •The continued ability of Shell and our non-affiliate customers to satisfy their obligations under our commercial and other agreements and the impact of lower market prices for crude oil, refined petroleum products and refinery gas. •The volume of crude oil, refined petroleum products and refinery gas we transport or store and the prices that we can charge our customers. •The tariff rates with respect to volumes that we transport through our regulated assets, which rates are subject to review and possible adjustment imposed by federal and state regulators. •Changes in revenue we realize under the loss allowance provisions of our fees and tariffs resulting from changes in underlying commodity prices. •Our ability to renew or replace our third-party contract portfolio on comparable terms. •Fluctuations in the prices for crude oil, refined petroleum products and refinery gas, including fluctuations due to political or economic measures taken by various countries. •The level of production of refinery gas by refineries and demand by chemical sites. •The level of onshore and offshore (including deepwater) production and demand for crude oil byU.S. refiners. •Changes in global economic conditions and the effects of a global economic downturn on the business of Shell and the business of its suppliers, customers, business partners and credit lenders. •The COVID-19 pandemic and related governmental regulations and travel restrictions, and the resulting sustained reduction in the global demand for oil and natural gas. •Availability of acquisitions and financing for acquisitions on our expected timing and acceptable terms. •Changes in, and availability to us, of the equity and debt capital markets. •Liabilities associated with the risks and operational hazards inherent in transporting and/or storing crude oil, refined petroleum products and refinery gas. •Curtailment of operations or expansion projects due to unexpected leaks, spills, or severe weather disruption; riots, strikes, lockouts or other industrial disturbances; or failure of information technology systems due to various causes, including unauthorized access or attack. •Costs or liabilities associated with federal, state and local laws and regulations relating to environmental protection and safety, including spills, releases and pipeline integrity. •Costs associated with compliance with evolving environmental laws and regulations on climate change. •Costs associated with compliance with safety regulations and system maintenance programs, including pipeline integrity management program testing and related repairs. •Changes in tax status or applicable tax laws. •Changes in the cost or availability of third-party vessels, pipelines, rail cars and other means of delivering and transporting crude oil, refined petroleum products and refinery gas. •Direct or indirect effects on our business resulting from actual or threatened terrorist incidents or acts of war. •Our adoption of the new enterprise resource planning system. •The factors generally described in Part I, Item 1A. Risk Factors in our 2019 Annual Report, in Part II, Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 and in Part II, Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the quarter endedJune 30, 2020 and in Part II, Item 1A. Risk Factors of this report. 58
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