F O R M 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____to_____
Commission file number: 1-11234
KINDER MORGAN ENERGY PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0380342
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
500 Dallas Street, Suite 1000, Houston, Texas 77002
(Address of principal executive offices)(zip code)
Registrant's telephone number, including area code: 713-369-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X]
No [ ]
The Registrant had 140,041,308 common units outstanding at July 31, 2004.
1
KINDER MORGAN ENERGY PARTNERS, L.P.
TABLE OF CONTENTS
Page
Number
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)................................... 3
Consolidated Statements of Income - Three and Six Months
Ended June 30, 2004 and 2003..................................... 3
Consolidated Balance Sheets - June 30, 2004 and
December 31, 2003................................................ 4
Consolidated Statements of Cash Flows - Six Months Ended
June 30, 2004 and 2003........................................... 5
Notes to Consolidated Financial Statements....................... 6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 44
Results of Operations............................................ 44
Financial Condition.............................................. 55
Information Regarding Forward-Looking Statements................. 59
Item 3: Quantitative and Qualitative Disclosures About Market Risk......... 61
Item 4: Controls and Procedures............................................ 61
PART II. OTHER INFORMATION
Item 1: Legal Proceedings.................................................. 62
Item 2: Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities..................................... 62
Item 3: Defaults Upon Senior Securities.................................... 62
Item 4: Submission of Matters to a Vote of Security Holders................ 62
Item 5: Other Information.................................................. 62
Item 6: Exhibits and Reports on Form 8-K................................... 62
Signatures......................................................... 64
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
KINDER MORGAN ENERGY PARTNERS, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands Except Per Unit Amounts)
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------- ------------- ------------- ---------
Revenues
Natural gas sales............................................ $ 1,449,493 $ 1,239,070 $ 2,775,787 $ 2,617,358
Services..................................................... 380,301 346,888 752,421 681,829
Product sales and other...................................... 127,388 78,489 251,230 154,098
--------- --------- --------- ---------
1,957,182 1,664,447 3,779,438 3,453,285
--------- --------- --------- ---------
Costs and Expenses
Gas purchases and other costs of sales....................... 1,439,326 1,235,375 2,756,635 2,610,789
Operations and maintenance................................... 119,397 100,247 230,589 192,784
Fuel and power............................................... 38,004 23,779 71,512 48,917
Depreciation, depletion and amortization..................... 69,878 53,758 137,409 103,563
General and administrative................................... 39,457 35,685 87,711 71,726
Taxes, other than income taxes............................... 19,756 16,041 39,076 30,792
--------- --------- --------- ---------
1,725,818 1,464,885 3,322,932 3,058,571
--------- --------- --------- ---------
Operating Income............................................... 231,364 199,562 456,506 394,714
Other Income (Expense)
Earnings from equity investments............................. 20,609 22,618 41,078 46,923
Amortization of excess cost of equity investments............ (1,394) (1,394) (2,788) (2,788)
Interest, net................................................ (46,592) (44,896) (93,813) (89,821)
Other, net................................................... (489) 1,508 254 1,785
Minority Interest.............................................. (2,462) (2,125) (4,543) (4,339)
--------- --------- --------- ---------
Income Before Income Taxes and Cumulative Effect of a Change in
Accounting Principle........................................ 201,036 175,273 396,694 346,474
Income Taxes................................................... (5,818) (6,316) (9,722) (10,504)
---------- ---------- ---------- ----------
Income Before Cumulative Effect of a Change in Accounting
Principle....................................................... 195,218 168,957 386,972 335,970
Cumulative effect adjustment from change in accounting for asset
retirement obligations...................................... - - - 3,465
--------- --------- --------- ---------
Net Income..................................................... $ 195,218 $ 168,957 $ 386,972 $ 339,435
========= ========= ========= =========
Calculation of Limited Partners' interest in Net Income:
Income Before Cumulative Effect of a Change in Accounting
Principle....................................................... $ 195,218 $ 168,957 $ 386,972 $ 335,970
Less: General Partner's interest............................... (95,867) (80,530) (187,531) (156,955)
---------- ---------- ---------- ----------
Limited Partners' interest................................... 99,351 88,427 199,441 179,015
Add: Limited Partners' interest in Change in Accounting Principle - - - 3,430
--------- --------- --------- ---------
Limited Partners' interest in Net Income..................... $ 99,351 $ 88,427 $ 199,441 $ 182,445
========= ========= ========= =========
Basic and Diluted Limited Partners' Net Income per Unit:
Income Before Cumulative Effect of a Change in Accounting $ 0.51 $ 0.48 $ 1.03 $ 0.98
Principle.......................................................
Cumulative effect adjustment from change in accounting for asset
retirement obligations...................................... - - - 0.02
--------- --------- --------- ----------
Net Income..................................................... $ 0.51 $ 0.48 $ 1.03 $ 1.00
========= ========= ========= =========
Weighted average number of units used in computation of Limited Partners' Net
Income per unit:
Basic.......................................................... 195,949 183,595 194,231 182,492
========= ========= ========= =========
Diluted........................................................ 196,030 183,706 194,316 182,614
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
3
KINDER MORGAN ENERGY PARTNERS, L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)
June 30, December 31,
2004 2003
------------ ------------
Assets
Current Assets
Cash and cash equivalents......................... $ 33,727 $ 23,329
Accounts and notes receivable, net
Trade........................................... 709,396 562,974
Related parties................................. 21,338 27,587
Inventories
Products........................................ 10,751 7,214
Materials and supplies.......................... 11,318 10,783
Gas imbalances
Trade........................................... 22,087 36,449
Related parties................................. 1,265 9,084
Gas in underground storage........................ 2,521 8,160
Other current assets.............................. 18,145 19,942
------------- -------------
830,548 705,522
------------- -------------
Property, Plant and Equipment, net................... 7,349,639 7,091,558
Investments.......................................... 405,056 404,345
Notes receivable..................................... 2,422 2,422
Goodwill............................................. 726,470 729,510
Other intangibles, net............................... 14,499 13,202
Deferred charges and other assets.................... 162,864 192,623
------------- -------------
Total Assets......................................... $ 9,491,498 $ 9,139,182
============= =============
Liabilities and Partners' Capital
Current Liabilities
Accounts payable
Trade........................................... $ 631,869 $ 477,783
Related parties................................. 2,928 -
Current portion of long-term debt................. 363,710 2,248
Accrued interest.................................. 49,820 52,356
Deferred revenues................................. 8,598 10,752
Gas imbalances.................................... 37,848 49,912
Accrued other current liabilities................. 288,907 211,328
------------- -------------
1,383,680 804,379
------------- -------------
Long-Term Liabilities and Deferred Credits
Long-term debt, outstanding....................... 3,932,614 4,316,678
Market value of interest rate swaps............... 51,979 121,464
------------- -------------
3,984,593 4,438,142
Deferred revenues................................. 17,888 20,975
Deferred income taxes............................. 38,838 38,106
Asset retirement obligations...................... 35,759 34,898
Other long-term liabilities and deferred credits.. 377,544 251,691
------------- -------------
4,454,622 4,783,812
Commitments and Contingencies (Note 3)
Minority Interest.................................... 41,501 40,064
------------- -------------
Partners' Capital
Common Units...................................... 2,138,511 1,946,116
Class B Units..................................... 118,763 120,582
i-Units........................................... 1,580,271 1,515,659
General Partner................................... 92,770 84,380
Accumulated other comprehensive loss.............. (318,620) (155,810)
-------------- --------------
3,611,695 3,510,927
Total Liabilities and Partners' Capital.............. $ 9,491,498 $ 9,139,182
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
4
KINDER MORGAN ENERGY PARTNERS, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Increase/(Decrease) in Cash and Cash Equivalents In Thousands)
(Unaudited)
Six Months Ended June 30,
-------------------------
2004 2003
----------- -----------
Cash Flows From Operating Activities
Net income................................................................ $ 386,972 $ 339,435
Adjustments to reconcile net income to net cash provided by operating
activities:
Cumulative effect adj. from change in accounting for asset retirement
obligations............................................................. -- (3,465)
Depreciation, depletion and amortization................................ 137,409 103,563
Amortization of excess cost of equity investments....................... 2,788 2,788
Earnings from equity investments........................................ (41,078) (46,923)
Distributions from equity investments..................................... 35,005 43,696
Changes in components of working capital.................................. 37,950 (55,600)
FERC rate reparations and refunds......................................... - (44,464)
Other, net................................................................ (3,240) (2,932)
----------- -----------
Net Cash Provided by Operating Activities............................... 555,806 336,098
----------- -----------
Cash Flows From Investing Activities
Acquisitions of assets.................................................... (51,679) (33,739)
Additions to property, plant and equip. for expansion and maintenance
projects.................................................................. (339,525) (273,402)
Sale of investments, property, plant and equipment, net of removal costs.. 1,452 1,258
Contributions to equity investments....................................... (3,875) (11,199)
Other..................................................................... (1,461) 7,088
----------- ----------
Net Cash Used in Investing Activities................................... (395,088) (309,994)
---------- ----------
Cash Flows From Financing Activities
Issuance of debt.......................................................... 2,744,061 2,064,865
Payment of debt........................................................... (2,767,262) (1,937,412)
Debt issue costs.......................................................... (317) (1,059)
Proceeds from issuance of common units.................................... 238,051 174,958
Proceeds from issuance of i-units......................................... 14,925 --
Contributions from General Partner........................................ 3,272 1,533
Distributions to partners:
Common units............................................................ (188,248) (164,454)
Class B units........................................................... (7,279) (6,721)
General Partner......................................................... (179,140) (150,329)
Minority interest....................................................... (4,716) (4,747)
Other, net................................................................ (3,667) 1,089
----------- ----------
Net Cash Used in Financing Activities................................... (150,320) (22,277)
----------- -----------
Increase in Cash and Cash Equivalents..................................... 10,398 3,827
Cash and Cash Equivalents, beginning of period............................ 23,329 41,088
---------- ----------
Cash and Cash Equivalents, end of period.................................. $ 33,727 $ 44,915
========== ==========
Noncash Investing and Financing Activities:
Assets acquired by the assumption of liabilities........................ $ 3,724 $ 1,905
The accompanying notes are an integral part of these consolidated financial statements.
5
KINDER MORGAN ENERGY PARTNERS, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
General
Unless the context requires otherwise, references to "we," "us," "our" or the
"Partnership" are intended to mean Kinder Morgan Energy Partners, L.P. and its
consolidated subsidiaries. We have prepared the accompanying unaudited
consolidated financial statements under the rules and regulations of the
Securities and Exchange Commission. Under such rules and regulations, we have
condensed or omitted certain information and notes normally included in
financial statements prepared in conformity with accounting principles generally
accepted in the United States of America. We believe, however, that our
disclosures are adequate to make the information presented not misleading. The
consolidated financial statements reflect all adjustments which are solely
normal and recurring adjustments that are, in the opinion of our management,
necessary for a fair presentation of our financial results for the interim
periods. You should read these consolidated financial statements in conjunction
with our consolidated financial statements and related notes included in our
Annual Report on Form 10-K for the year ended December 31, 2003.
Kinder Morgan, Inc. and Kinder Morgan Management, LLC
Kinder Morgan, Inc., a Kansas corporation, is the sole stockholder of
Kinder Morgan (Delaware), Inc. Kinder Morgan (Delaware), Inc., a Delaware
corporation, is the sole stockholder of our general partner, Kinder Morgan
G.P., Inc. Kinder Morgan, Inc. is referred to as "KMI" in this report.
Kinder Morgan Management, LLC, a Delaware limited liability company, was
formed on February 14, 2001. Our general partner owns all of Kinder Morgan
Management, LLC's voting securities and, pursuant to a delegation of control
agreement, our general partner delegated to Kinder Morgan Management, LLC, to
the fullest extent permitted under Delaware law and our partnership agreement,
all of its power and authority to manage and control the business and affairs of
us, our operating limited partnerships and their subsidiaries. Kinder Morgan
Management, LLC cannot take certain specified actions without the approval of
our general partner and its activities are limited to being a limited partner
in, and managing and controlling the business and affairs of, us, our operating
limited partnerships and their subsidiaries. Kinder Morgan Management, LLC is
referred to as "KMR" in this report.
Basis of Presentation
Our consolidated financial statements include our accounts and those of our
majority-owned and controlled subsidiaries and our operating partnerships. All
significant intercompany items have been eliminated in consolidation. Certain
amounts from prior periods have been reclassified to conform to the current
presentation.
Net Income Per Unit
We compute Basic Limited Partners' Net Income per Unit by dividing our
limited partners' interest in net income by the weighted average number of units
outstanding during the period. Diluted Limited Partners' Net Income per Unit
reflects the potential dilution, by application of the treasury stock method,
that could occur if options to issue units were exercised, which would result in
the issuance of additional units that would then share in our net income.
2. Acquisitions and Joint Ventures
During the first six months of 2004, we completed or made adjustments for the
following significant acquisitions. Each of the acquisitions was accounted for
under the purchase method and the assets acquired and liabilities assumed were
recorded at their estimated fair market values as of the acquisition date. The
preliminary
6
allocation of assets and liabilities may be adjusted to reflect the final
determined amounts during a short period of time following the acquisition. The
results of operations from these acquisitions are included in our consolidated
financial statements from the acquisition date.
Allocation of Purchase Price
---------------------------------------------------------
(in millions)
---------------------------------------------------------
Property Deferred
Purchase Current Plant & Charges Minority
Ref. Date Acquisition Price Assets Equipment & Other Interest
---- ------ ------------------------------------------ ---------- --------- ----------- ---------- ----------
(1) 11/03 Yates Field Unit and Carbon Dioxide Assets $ 259.1 $ 3.6 $ 255.8 $ - $ (0.3)
(2) 12/03 ConocoPhillips Products Terminals......... 15.3 - 14.3 1.0 -
(3) 12/03 Tampa, Florida Bulk Terminals............. 29.7 - 29.7 - -
(4) 3/04 ExxonMobil Products Terminals............. $ 50.8 $ - $ 50.8 $ - $ -
(1) Yates Field Unit and Carbon Dioxide Assets
Effective November 1, 2003, we acquired certain assets in the Permian Basin of
West Texas from a subsidiary of Marathon Oil Corporation. Our purchase price was
approximately $259.1 million, consisting of $230.2 million in cash and the
assumption of $28.9 million of liabilities. The assets acquired consisted of the
following:
o Marathon's approximate 42.5% interest in the Yates oil field unit. We
previously owned a 7.5% ownership interest in the Yates field unit and we
now operate the field;
o Marathon's 100% interest in the crude oil gathering system surrounding the
Yates field unit; and
o Kinder Morgan Carbon Dioxide Transportation Company, formerly Marathon
Carbon Dioxide Transportation Company. Kinder Morgan Carbon Dioxide
Transportation Company owns a 65% ownership interest in the Pecos Carbon
Dioxide Pipeline Company, which owns a 25-mile carbon dioxide pipeline. We
previously owned a 4.27% ownership interest in the Pecos Carbon Dioxide
Pipeline Company and accounted for this investment under the cost method of
accounting. After the acquisition of our additional 65% interest in Pecos,
its financial results are included in our consolidated results and we
recognize the appropriate minority interest.
We recorded our final purchase price adjustments in the first six months of
2004. The adjustments finalized the value of acquired working capital items on
the acquisition date, primarily affecting product inventory balances and
property tax liabilities. We received approximately $0.8 million from Marathon
in the first six months of 2004 resulting from these purchase price adjustments.
The acquisition complemented our existing carbon dioxide assets in the Permian
Basin, increased our working interest in the Yates field to nearly 50% and
allowed us to become the operator of the field. The acquired operations are
included as part of our CO2 business segment.
(2) ConocoPhillips Products Terminals
Effective December 11, 2003, we acquired seven refined petroleum products
terminals in the southeastern United States from ConocoPhillips Company and
Phillips Pipe Line Company. Our purchase price was approximately $15.3 million,
consisting of approximately $14.1 million in cash and $1.2 million in assumed
liabilities. The terminals are located in Charlotte and Selma, North Carolina;
Augusta and Spartanburg, South Carolina; Albany and Doraville, Georgia; and
Birmingham, Alabama. We fully own and operate all of the terminals except for
the Doraville, Georgia facility, which is operated and owned 70% by Citgo. As of
our acquisition date, we expected to invest an additional $1.3 million in the
facilities. Combined, the terminals have 35 storage tanks with total capacity of
approximately 1.15 million barrels for gasoline, diesel fuel and jet fuel. As
part of the transaction, ConocoPhillips entered into a long-term contract to use
the terminals. The contract consists of a five-year terminaling agreement, an
intangible asset which we valued at $1.0 million. The acquisition broadens our
refined petroleum products operations in the southeastern United States as three
of the terminals are connected to the Plantation pipeline system, which is
operated and owned 51% by us. The acquired operations are included as part of
our Products Pipelines business segment. Our allocation of the purchase price to
assets acquired and liabilities assumed is preliminary, pending any minor
purchase price adjustments that we expect to complete in the third quarter of
2004.
7
(3) Tampa, Florida Bulk Terminals
In December 2003, we acquired two bulk terminal facilities in Tampa, Florida
for an aggregate consideration of approximately $29.7 million, consisting of
$26.2 million in cash (including closing and related costs of approximately $1.3
million) and $3.5 million in assumed liabilities. As of our acquisition date, we
expected to invest an additional $16.9 million in the facilities. The principal
facility purchased was a marine terminal acquired from a subsidiary of IMC
Global, Inc. We entered into a long-term agreement with IMC pursuant to which
IMC will be the primary user of the facility, which we will operate and refer to
as the Kinder Morgan Tampaplex terminal. The terminal sits on a 114-acre site,
and serves as a storage and receipt point for imported ammonia, as well as an
export location for dry bulk products, including fertilizer and animal feed. We
closed on the Tampaplex portion of this transaction on December 23, 2003. The
second facility purchased was the former Nitram, Inc. bulk terminal, which we
plan to use as an inland bulk storage warehouse facility for overflow cargoes
from our Port Sutton, Florida import terminal. We closed on the Nitram portion
of this transaction on December 10, 2003. The acquired operations are included
as part of our Terminals business segment and complement our existing business
in the Tampa area by generating additional fee-based income. Our allocation of
the purchase price to assets acquired and liabilities assumed is preliminary,
pending final adjustments that may be necessary to value assumed property tax
liabilities. We expect to make our final purchase price adjustments in the third
quarter of 2004.
(4) ExxonMobil Products Terminals
Effective March 9, 2004, we acquired seven refined petroleum products
terminals in the southeastern United States from Exxon Mobil Corporation. Our
purchase price was approximately $50.8 million, consisting of approximately
$48.1 million in cash and $2.7 million in assumed liabilities. The terminals are
located in Collins, Mississippi; Knoxville, Tennessee; Charlotte and Greensboro
North Carolina; and Richmond, Roanoke and Newington, Virginia. Combined, the
terminals have a total storage capacity of approximately 3.2 million barrels for
gasoline, diesel fuel and jet fuel. As part of the transaction, ExxonMobil has
entered into a long-term contract to store products at the terminals. The
acquisition enhances our terminal operations in the Southeast and complements
our December 2003 acquisition of seven products terminals from ConocoPhillips
Company and Phillips Pipe Line Company. The acquired operations will be included
as part of our Products Pipelines business segment. Our allocation of the
purchase price to assets acquired and liabilities assumed is preliminary,
pending final purchase price adjustments that we expect to make in the third
quarter of 2004.
Pro Forma Information
The following summarized unaudited pro forma consolidated income statement
information for the six months ended June 30, 2004 and 2003, assumes that all of
the acquisitions we have made and joint ventures we have entered into since
January 1, 2003, including the ones listed above, had occurred as of the
beginning of the period presented. We have prepared these unaudited pro forma
financial results for comparative purposes only. These unaudited pro forma
financial results may not be indicative of the results that would have occurred
if we had completed these acquisitions and joint ventures as of the beginning of
the period presented or the results that will be attained in the future. Amounts
presented below are in thousands, except for the per unit amounts:
Pro Forma
Six Months Ended June 30,
---------------------------
2004 2003
------------ ----------
(Unaudited)
Revenues............................................................ $ 3,782,355 $ 3,521,156
Operating Income.................................................... 458,492 433,132
Income Before Cumulative Effect of a Change in Accounting Principle. 388,845 366,810
Net Income.......................................................... $ 388,845 $ 370,275
Basic and Diluted Limited Partners' Net Income per unit:
Income Before Cumulative Effect of a Change in Accounting Principle $ 1.04 $ 1.15
Net Income......................................................... $ 1.04 $ 1.17
8
3. Litigation and Other Contingencies
SFPP, L.P.
Federal Energy Regulatory Commission Proceedings
SFPP, L.P., referred to herein as SFPP, is the subsidiary limited partnership
that owns our Pacific operations, excluding CALNEV Pipe Line LLC and related
terminals acquired from GATX Corporation. Tariffs charged by SFPP are subject to
certain proceedings at the FERC involving shippers' complaints regarding the
interstate rates, as well as practices and the jurisdictional nature of certain
facilities and services, on our Pacific operations' pipeline systems.
OR92-8, et al. proceedings. FERC Docket No. OR92-8-000 et al., is a
consolidated proceeding that began in September 1992 and includes a number of
shipper complaints against certain rates and practices on SFPP's East Line (from
El Paso, Texas to Phoenix, Arizona) and West Line (from Los Angeles, California
to Tucson, Arizona), as well as SFPP's gathering enhancement fee at Watson
Station in Carson, California. The complainants in the case are El Paso
Refinery, L.P. (which settled with SFPP in 1996), Chevron Products Company,
Navajo Refining Company (now Navajo Refining Company, L.P.), ARCO Products
Company (now part of BP West Coast Products, LLC), Texaco Refining and Marketing
Inc., Refinery Holding Company LP (now named Western Refining Company, L.P.),
Mobil Oil Corporation (now part of ExxonMobil Oil Corporation) and Tosco
Corporation (now part of ConocoPhillips Company). The FERC has ruled that the
complainants have the burden of proof in those proceedings.
A FERC administrative law judge held hearings in 1996, and issued an initial
decision in September 1997. The initial decision held that all but one of SFPP's
West Line rates were "grandfathered" under the Energy Policy Act of 1992 and
therefore deemed to be just and reasonable; it further held that complainants
had failed to prove "substantially changed circumstances" with respect to those
rates and that they therefore could not be challenged in the Docket No. OR92-8
et al. proceedings, either for the past or prospectively. However, the initial
decision also made rulings generally adverse to SFPP on certain cost of service
issues relating to the evaluation of East Line rates, which are not
"grandfathered" under the Energy Policy Act. Those issues included the capital
structure to be used in computing SFPP's "starting rate base," the level of
income tax allowance SFPP may include in rates and the recovery of civil and
regulatory litigation expenses and certain pipeline reconditioning costs
incurred by SFPP. The initial decision also held SFPP's Watson Station gathering
enhancement service was subject to FERC jurisdiction and ordered SFPP to file a
tariff for that service.
The FERC subsequently reviewed the initial decision, and issued a series of
orders in which it adopted certain rulings made by the administrative law judge,
changed others and modified a number of its own rulings on rehearing. Those
orders began in January 1999, with FERC Opinion No. 435, and continued through
June 2003.
The FERC affirmed that all but one of SFPP's West Line rates are
"grandfathered" and that complainants had failed to satisfy the threshold burden
of demonstrating "substantially changed circumstances" necessary to challenge
those rates. The FERC further held that the one West Line rate that was not
grandfathered did not need to be reduced. The FERC consequently dismissed all
complaints against the West Line rates in Docket Nos. OR92-8 et al. without any
requirement that SFPP reduce, or pay any reparations for, any West Line rate.
The FERC initially modified the initial decision's ruling regarding the
capital structure to be used in computing SFPP's "starting rate base" to be more
favorable to SFPP, but later reversed that ruling. The FERC also made certain
modifications to the calculation of the income tax allowance and other cost of
service components, generally to SFPP's disadvantage.
On multiple occasions, the FERC required SFPP to file revised East Line rates
based on rulings made in the FERC's various orders. SFPP was also directed to
submit compliance filings showing the calculation of the revised rates, the
potential reparations for each complainant and in some cases potential refunds
to shippers. SFPP filed such revised East Line rates and compliance filings in
March 1999, July 2000, November 2001 (revised December 2001), October 2002 and
February 2003 (revised March 2003). Most of those filings were protested by
particular SFPP shippers. The FERC has held that certain of the rates SFPP filed
at the FERC's directive should be reduced retroactively and/or be subject to
refund; SFPP has challenged the FERC's authority to impose such requirements in
9
this context.
While the FERC initially permitted SFPP to recover certain of its litigation,
pipeline reconditioning and environmental costs, either through a surcharge on
prospective rates or as an offset to potential reparations, it ultimately
limited recovery in such a way that SFPP was not able to make any such surcharge
or take any such offset. Similarly, the FERC initially ruled that SFPP would not
owe reparations to any complainant for any period prior to the date on which
that party's complaint was filed, but ultimately held that each complainant
could recover reparations for a period extending two years prior to the filing
of its complaint (except for Navajo, which was limited to one month of
pre-complaint reparations under a settlement agreement with SFPP's predecessor).
The FERC also ultimately held that SFPP was not required to pay reparations or
refunds for Watson Station gathering enhancement fees charged prior to filing a
FERC tariff for that service.
In April 2003, SFPP paid complainants and other shippers reparations and/or
refunds as required by FERC's orders. In August 2003, SFPP paid shippers an
additional refund as required by FERC's most recent order in the Docket No.
OR92-8 et al. proceedings. We made aggregate payments of $44.9 million in 2003
for reparations and refunds pursuant to a FERC order.
Beginning in 1999, SFPP, the complainants and intervenor Ultramar Diamond
Shamrock Corporation (now part of Valero Energy Corporation) filed petitions for
review of FERC's Docket OR92-8 et al. orders in the United States Court of
Appeals for the District of Columbia Circuit. Certain of those petitions were
dismissed by the Court of Appeals as premature, and the remaining petitions were
held in abeyance pending completion of agency action. However, in December 2002,
the Court of Appeals returned to its active docket all petitions to review the
FERC's orders in the case through November 2001 and severed petitions regarding
later FERC orders. The severed orders were held in abeyance for later
consideration.
Briefing in the Court of Appeals was completed in August 2003, and oral
argument took place on November 12, 2003. On July 20,2004, the U.S. Court of
Appeals for the District of Columbia Circuit issued an opinion affirming the
FERC orders under review on most issues, vacating the tax provision that the
FERC had allowed SFPP to include under the FERC's "Lakehead" policy giving a tax
allowance to partnership pipelines and remanding for further FERC proceedings on
other issues.
The court held that, in the context of the Docket No. OR92-8, et al.
proceedings, all of SFPP's West Line rates were grandfathered other than the
charge for use of SFPP's Watson Station gathering enhancement facility and the
rate for turbine fuel movements to Tucson under SFPP Tariff No. 18. It concluded
that the FERC had a reasonable basis for concluding that the addition of a West
Line origin point at East Hynes, California did not involve a new "rate" for
purposes of the Energy Policy Act. It rejected arguments from West Line Shippers
that certain protests and complaints had challenged West Line rates prior to the
enactment of the Energy Policy Act.
The court also held that complainants had failed to satisfy their burden of
demonstrating substantially changed circumstances, and therefore could not
challenge grandfathered West Line rates in the Docket No. OR92-8 et al.
proceedings. It specifically rejected arguments that other shippers could
"piggyback" on the special Energy Policy Act exception permitting Navajo to
challenge grandfathered West Line rates, which Navajo had withdrawn under a
settlement with SFPP. The court remanded the changed circumstances issue "for
further consideration" by the FERC in light of the court's decision, described
below, regarding SFPP's tax allowance. The FERC has previously held in the
OR96-2 proceeding that the tax allowance policy should not be used as a
stand-alone factor in determining when there have been substantially changed
circumstances.
The court upheld the FERC's rulings on most East Line rate issues. However, it
found the FERC's reasoning inadequate on some issues, including the tax
allowance.
The court held the FERC had sufficient evidence to use SFPP's December 1988
stand-alone capital structure to calculate its starting rate base as of June
1985. It rejected SFPP arguments that would have resulted in a higher starting
rate base.
The court analyzed at length the tax allowance for pipelines that are
organized as partnerships. It concluded that the FERC had provided "no rational
basis" on the record before it for giving SFPP a tax allowance, and denied
10
recovery by SFPP of "income taxes not incurred and not paid."
The court accepted the FERC's treatment of regulatory litigation costs,
including the limitation of recoverable costs and their offset against
"unclaimed reparations" - that is, reparations that could have been awarded to
parties that did not seek them. The court also accepted the FERC's denial of any
recovery for the costs of civil litigation by East Line shippers against SFPP
based on the 1992 re-reversal of the six-inch line between Tucson and Phoenix.
However, the court did not find adequate support for the FERC's decision to
allocate the limited litigation costs that SFPP was allowed to recover in its
rates equally between the East Line and the West Line, and ordered the FERC to
explain that decision further on remand.
The court held the FERC had failed to justify its decision to deny SFPP any
recovery of funds spent to recondition pipe on the East Line, for which SFPP had
spent nearly $6 million between 1995 and 1998. It concluded that the
Commission's reasoning was inconsistent and incomplete, and remanded for further
explanation, noting that "SFPP's shippers are presently enjoying the benefits of
what appears to be an expensive pipeline reconditioning program without sharing
in any of its costs."
The court affirmed the FERC's rulings on reparations in all respects. It held
the Arizona Grocery doctrine did not apply to orders requiring SFPP to file
"interim" rates, and that "FERC only established a final rate at the completion
of the OR92-8 proceedings." It held that the Energy Policy Act did not limit
complainants' ability to seek reparations for up to two years prior to the
filing of complaints against rates that are not grandfathered. It rejected
SFPP's arguments that the FERC should not have used a "test period" to compute
reparations, that it should have offset years in which there were
underrecoveries against those in which there were overrecoveries, and that it
should have exercised its discretion against awarding any reparations in this
case.
The court also rejected:
o Navajo's argument that its prior settlement with SFPP's predecessor did not
limit its right to seek reparations;
o Valero's argument that it should have been permitted to recover
reparations in the Docket No. OR92-8 et al. proceedings rather than
waiting to seek them, as appropriate, in the Docket No. OR96-2 et al.
proceedings;
o arguments that the former ARCO and Texaco had challenged East Line rates
when they filed a complaint in January 1994 and should therefore be entitled
to recover East Line reparations; and
o Chevron's argument that its reparations period should begin two years before
its September 1992 protest regarding the six-inch line reversal rather than
its August 1993 complaint against East Line rates.
We are currently in the process of reviewing the Court of Appeals decision and
determining what effects the rulings made in it could have on our rates and
obligation to pay additional reparations. We may seek rehearing before the Court
of Appeals and/or review by the United States Supreme Court, as well as
participate in any further proceedings before the FERC on remand.
Sepulveda proceedings. In December 1995, Texaco filed a complaint at FERC
(Docket No. OR96-2) alleging that movements on SFPP's Sepulveda pipelines (Line
Sections 109 and 110) to Watson Station, in the Los Angeles basin, were subject
to FERC's jurisdiction under the Interstate Commerce Act, and claimed that the
rate for that service was unlawful. Several other West Line shippers filed
similar complaints and/or motions to intervene.
Following a hearing in March 1997, a FERC administrative law judge issued an
initial decision holding that the movements on the Sepulveda pipelines were not
subject to FERC jurisdiction. On August 5, 1997, the FERC reversed that
decision. On October 6, 1997, SFPP filed a tariff establishing the initial
interstate rate for movements on the Sepulveda pipelines at the pre-existing
rate of five cents per barrel. Several shippers protested that rate. In December
1997, SFPP filed an application for authority to charge a market-based rate for
the Sepulveda service, which application was protested by several parties. On
September 30, 1998, the FERC issued an order finding that SFPP lacks market
power in the Watson Station destination market and set a hearing to determine
whether SFPP possessed market power in the origin market.
11
Following a hearing, on December 21, 2000, an administrative law judge found
that SFPP possessed market power over the Sepulveda origin market. On February
28, 2003, the FERC issued an order upholding that decision. SFPP filed a request
for rehearing of that order on March 31, 2003. The FERC denied SFPP's request
for rehearing on July 9, 2003.
As part of its February 28, 2003 order denying SFPP's application for
market-based ratemaking authority, the FERC remanded to the ongoing litigation
in Docket No. OR96-2, et al. the question of whether SFPP's current rate for
service on the Sepulveda line is just and reasonable. That issue is currently
pending before the administrative law judge in the Docket No. OR96-2, et al.
proceeding. The procedural schedule in this remanded matter is currently
suspended pending issuance of the phase two initial decision in the Docket No.
OR96-2, et al. proceeding (see below).
OR96-2; OR97-2; OR98-1. et al. proceedings. In October 1996, Ultramar Diamond
Shamrock Corporation filed a complaint at FERC (Docket No. OR97-2) challenging
SFPP's West Line rates, claiming they were unjust and unreasonable and no longer
subject to grandfathering. In October 1997, ARCO, Mobil and Texaco filed a
complaint at the FERC (Docket No. OR98-1) challenging the justness and
reasonableness of all of SFPP's interstate rates, raising claims against SFPP's
East and West Line rates similar to those that have been at issue in Docket Nos.
OR92-8, et al. discussed above, but expanding them to include challenges to
SFPP's grandfathered interstate rates from the San Francisco Bay area to Reno,
Nevada and from Portland to Eugene, Oregon - the North Line and Oregon Line. In
November 1997, Ultramar filed a similar, expanded complaint (Docket No. OR98-2).
Tosco Corporation filed a similar complaint in April 1998. The shippers seek
both reparations and prospective rate reductions for movements on all of SFPP's
lines. The FERC accepted the complaints and consolidated them into one
proceeding (Docket No. OR96-2, et al.), but held them in abeyance pending a FERC
decision on review of the initial decision in Docket Nos. OR92-8, et al.
In a companion order to Opinion No. 435, the FERC gave the complainants an
opportunity to amend their complaints in light of Opinion No. 435, which the
complainants did in January 2000. In August 2000, Navajo and Western filed
complaints against SFPP's East Line rates and Ultramar filed an additional
complaint updating its pre-existing challenges to SFPP's interstate pipeline
rates. These complaints were consolidated with the ongoing proceeding in Docket
No. OR96-2, et al.
A hearing in this consolidated proceeding was held from October 2001 to March
2002. A FERC administrative law judge issued his initial decision on June 24,
2003. The initial decision found that, for the years at issue, the complainants
had shown substantially changed circumstances for rates on SFPP's West, North
and Oregon Lines and for SFPP's fee for gathering enhancement service at Watson
Station and thus found that those rates should not be "grandfathered" under the
Energy Policy Act of 1992. The initial decision also found that most of SFPP's
rates at issue were unjust and unreasonable. The initial decision indicated that
a phase two initial decision will address prospective rates and whether
reparations are necessary. Issuance of the phase two initial decision is
expected sometime in the third quarter of 2004.
SFPP filed a brief on exceptions to the FERC that contested the findings in
the initial decision. SFPP's opponents responded to SFPP's brief. On March 26,
2004, the FERC issued an order on the phase one initial decision. The FERC's
phase one order reversed the initial decision by finding that SFPP's rates for
its North and Oregon Lines should remain "grandfathered" and amended the initial
decision by finding that SFPP's West Line rates (i) to Yuma, Tucson and CalNev,
as of 1995, and (ii) to Phoenix, as of 1997, should no longer be "grandfathered"
and are not just and reasonable. The FERC's phase one order did not address
prospective West Line rates and whether reparations are necessary; as noted
above, issuance of an initial decision on those issues from the presiding
administrative law judge is currently pending. The FERC's phase one order also
did not address the "grandfathered" status of the Watson Station fee, noting
that issues regarding Watson Station are pending before the U.S. Court of
Appeals for the District of Columbia Circuit and will be addressed once that
court issues a ruling on those issues. Several of the participants in the
proceeding requested rehearing of the FERC's phase one order, and several
participants, including SFPP, have filed petitions with the United States Court
of Appeals for the District of Columbia Circuit for review of the FERC's phase
one order. FERC and Court action on those petitions is pending.
The FERC's phase one order also held that SFPP failed to seek authorization
for the accounting entries necessary to reflect in SFPP's books, and thus in its
annual report to FERC ("FERC Form 6"), the purchase price adjustment
12
("PPA") arising from SFPP's 1998 acquisition by us. The phase one order
directed SFPP to file for permission to reflect the PPA in its FERC Form 6 for
the calendar year 1998 and each subsequent year. In its April 26, 2004
compliance filing, SFPP noted that it had previously requested such permission
and that the FERC's regulations require an oil pipeline to include a PPA in its
Form 6 without first seeking FERC permission to do so. Several parties protested
SFPP's compliance filing. SFPP answered those protests, and FERC action on this
matter is pending.
Once the administrative law judge issues his non-binding phase two initial
decision, and that decision is briefed by the parties, the FERC will consider
that portion of the proceeding. After reviewing the initial decision, the FERC
could determine that it is necessary to lower SFPP's "ungrandfathered" rates
prospectively and that complaining shippers are entitled to reparations for
prior periods. A FERC order addressing the initial decision is not expected
before the second quarter of 2005.
Currently, we are not able to predict with certainty the final outcome of the
pending FERC proceedings involving SFPP, should they be carried through to their
conclusion, or whether we can reach a settlement with some or all of the
complainants. The final outcome will depend, in part, on the outcomes of the
appeals of these proceedings and the OR92-8, et al. proceedings taken by SFPP,
complaining shippers, and an intervenor.
We previously estimated that shippers sought reparations of $154 million and
prospective rate reductions with an aggregate average annual impact of $45
million. The estimated reparations relief sought by shippers has been reduced as
a result of the FERC's decision to reverse the administrative law judge's
decision to "ungrandfather" the rates from the North and Oregon Lines. However,
our previous estimates assumed that any potential rate reductions would be
implemented in January 2004 and reparations and accrued interest thereon would
be paid in January 2005. If we were to maintain these timing assumptions, the
estimated reparations including accrued interest thereon, and prospective annual
rate reductions would have been reduced to approximately $140 million and $44
million, respectively. Extending the assumed timing for implementation of rate
reductions and the payment of reparations has the effect of increasing total
reparations and the interest accruing on the reparations. For each calendar
quarter of delay in the implementation of rate reductions sought, we estimate
that reparations and accrued interest accumulates by approximately $9 million.
We now assume that any potential rate reductions will be implemented early in
the second quarter of 2005 and that reparations and accrued interest thereon
will be paid early in the second quarter of 2006. We continue to estimate the
combined annual impact of the rate reductions and the capital costs associated
with financing the payment of reparations sought by shippers and accrued
interest thereon to be approximately 15 cents of distributable cash flow per
unit. We believe, however, that the ultimate resolution of these complaints will
be for amounts substantially less than the amounts sought.
Chevron complaint OR02-4 proceedings. On February 11, 2002, Chevron, an
intervenor in the Docket No. OR96-2, et al. proceeding, filed a complaint
against SFPP in Docket No. OR02-4 along with a motion to consolidate the
complaint with the Docket No. OR96-2, et al. proceeding. On May 21, 2002, the
FERC dismissed Chevron's complaint and motion to consolidate. Chevron filed a
request for rehearing, which the FERC dismissed on September 25, 2002. In
October 2002, Chevron filed a request for rehearing of the FERC's September 25,
2002 Order, which the FERC denied on May 23, 2003. On July 1, 2003, Chevron
filed a petition for review of this denial at the U.S. Court of Appeals for the
District of Columbia Circuit. On August 18, 2003, SFPP filed a motion to dismiss
Chevron's petition on the basis that Chevron lacks standing to bring its appeal
and that the case is not ripe for review. Chevron answered on September 10,
2003. SFPP's motion was pending, when the Court of Appeals, on December 8, 2003,
granted Chevron's motion to hold the case in abeyance pending the outcome of the
appeal of the Docket No. OR92-8, et al. proceeding. On January 8, 2004, the
Court of Appeals granted Chevron's motion to have its appeal of the FERC's
decision in Docket No. OR03-5 (see below) consolidated with Chevron's appeal of
the FERC's decision in the Docket No. OR02-4 proceeding. Chevron continues to
participate in the Docket No. OR96-2 et al. proceeding as an intervenor.
OR03-5 proceedings. On June 30, 2003, Chevron filed another complaint against
SFPP - substantially similar to its previous complaint - and moved to
consolidate the complaint with the Docket No. OR96-2, et al. proceeding. This
complaint was docketed as Docket No. OR03-5. Chevron requested that this new
complaint be treated as if it were an amendment to its complaint in Docket No.
OR02-4, which was previously dismissed by the FERC. By this request, Chevron
sought to, in effect, back-date its complaint, and claim for reparations, to
February 2002. SFPP answered Chevron's complaint on July 22, 2003, opposing
Chevron's requests for consolidation and for the back-
13
dating of its complaint. On October 28, 2003 , the FERC accepted Chevron's
complaint, but held it in abeyance pending the outcome of the Docket No. OR96-2,
et al. proceeding. The FERC denied Chevron's request for consolidation and for
back-dating. On November 21, 2003, Chevron filed a petition for review of the
FERC's October 28, 2003 Order at the Court of Appeals for the District of
Columbia Circuit. On January 8, 2004, the Court of Appeals granted Chevron's
motion to have its appeal consolidated with Chevron's appeal of the FERC's
decision in the Docket No. OR02-4 proceeding and to have the two appeals held in
abeyance pending the outcome of the appeal of the Docket No. OR92-8, et al.
proceeding.
California Public Utilities Commission Proceeding
ARCO, Mobil and Texaco filed a complaint against SFPP with the California
Public Utilities Commission on April 7, 1997. The complaint challenges rates
charged by SFPP for intrastate transportation of refined petroleum products
through its pipeline system in the State of California and requests prospective
rate adjustments. On October 1, 1997, the complainants filed testimony seeking
prospective rate reductions aggregating approximately $15 million per year.
On August 6, 1998, the CPUC issued its decision dismissing the complainants'
challenge to SFPP's intrastate rates. On June 24, 1999, the CPUC granted limited
rehearing of its August 1998 decision for the purpose of addressing the proper
ratemaking treatment for partnership tax expenses, the calculation of
environmental costs and the public utility status of SFPP's Sepulveda Line and
its Watson Station gathering enhancement facilities. In pursuing these rehearing
issues, complainants sought prospective rate reductions aggregating
approximately $10 million per year.
On March 16, 2000, SFPP filed an application with the CPUC seeking authority
to justify its rates for intrastate transportation of refined petroleum products
on competitive, market-based conditions rather than on traditional,
cost-of-service analysis.
On April 10, 2000, ARCO and Mobil filed a new complaint with the CPUC
asserting that SFPP's California intrastate rates are not just and reasonable
based on a 1998 test year and requesting the CPUC to reduce SFPP's rates
prospectively. The amount of the reduction in SFPP rates sought by the
complainants is not discernible from the complaint.
The rehearing complaint was heard by the CPUC in October 2000 and the April
2000 complaint and SFPP's market-based application were heard by the CPUC in
February 2001. All three matters stand submitted as of April 13, 2001, and
resolution of these submitted matters is anticipated within the third quarter of
2004.
The CPUC subsequently issued a resolution approving a 2001 request by SFPP to
raise its California rates to reflect increased power costs. The resolution
approving the requested rate increase also required SFPP to submit cost data for
2001, 2002, and 2003, and to assist the CPUC in determining whether SFPP's
overall rates for California intrastate transportation services are reasonable.
The resolution reserves the right to require refunds, from the date of issuance
of the resolution, to the extent the CPUC's analysis of cost data to be
submitted by SFPP demonstrates that SFPP's California jurisdictional rates are
unreasonable in any fashion. On February 21, 2003, SFPP submitted the cost data
required by the CPUC, which submittal was protested by Valero Marketing and
Supply Company, Ultramar Inc., BP West Coast Products LLC, Exxon Mobil Oil
Corporation and Chevron Products Company. Issues raised by the protest,
including the reasonableness of SFPP's existing intrastate transportation rates,
were the subject of evidentiary hearings conducted in December 2003 and are
expected to be resolved by the CPUC by the third quarter of 2004.
We currently believe the CPUC complaints seek approximately $15 million in
tariff reparations and prospective annual tariff reductions, the aggregate
average annual impact of which would be approximately $31 million. There is no
way to quantify the potential extent to which the CPUC could determine that
SFPP's existing California rates are unreasonable. With regard to the amount of
dollars potentially subject to refund as a consequence of the CPUC resolution
requiring the provision by SFPP of cost-of-service data, such refunds could
total about $6 million per year from October 2002 to the anticipated date of a
CPUC decision during the third quarter of 2004.
14
SFPP believes the submission of the required, representative cost data
required by the CPUC indicates that SFPP's existing rates for California
intrastate services remain reasonable and that no refunds are justified.
We believe that the resolution of such matters will not have a material
adverse effect on our business, financial position, results of operations or
cash flows.
Trailblazer Pipeline Company
Rate Case
As required by its last rate case settlement, Trailblazer Pipeline Company
made a general rate case filing at the FERC on November 29, 2002. The filing
provides for a small rate decrease and a number of non-rate tariff changes. By
an order issued December 31, 2002, the FERC effectively bifurcated the
proceeding. The FERC accepted the rate decrease effective January 1, 2003,
subject to refund and a hearing. The FERC suspended most of the non-rate tariff
changes until June 1, 2003, subject to refund and a technical conference
procedure.
Trailblazer sought rehearing of the FERC rate decrease order with respect to
the refund condition. On April 15, 2003, the FERC granted Trailblazer's
rehearing request to remove the refund condition that had been imposed in the
FERC's December 31, 2002 order. Certain intervenors have sought rehearing as to
the FERC's acceptance of certain non-rate tariff provisions.
The technical conference on non-rate tariff issues was held on February 6,
2003. The non-rate tariff issues include:
o capacity award procedures;
o credit procedures;
o imbalance penalties; and
o the maximum length of bid terms considered for evaluation in the right of
first refusal process.
Comments on the non-rate tariff issues as discussed at the technical
conference were filed by parties in March 2003. On May 23, 2003, the FERC issued
an order deciding non-rate tariff issues and denying rehearing of its prior
order. In the May 23, 2003 order, the FERC:
o accepted Trailblazer's proposed capacity award procedures with very limited
changes;
o accepted Trailblazer's credit procedures subject to very extensive changes,
consistent with numerous recent orders involving other pipelines;
o accepted a compromise agreed to by Trailblazer and the active parties under
which existing shippers must match competing bids in the right of first
refusal process for up to ten years (in lieu of the current five years); and
o accepted Trailblazer's withdrawal of daily imbalance charges.
More specifically, the May 23, 2003 order:
o allowed shortened notice periods for suspension of service, but required at
least thirty days notice for service termination;
o limited prepayments and any other assurance of future performance, such as a
letter of credit, to three months of service charges except for new
facilities;
15
o required the pipeline to pay interest on prepayments or allow those funds
to go into an interest-bearing escrow account; and
o required much more specificity about credit criteria and procedures in
tariff provisions.
Certain shippers and Trailblazer sought rehearing of the May 23, 2003 order.
Trailblazer made its compliance filing on June 20, 2003. The tariff changes
under the May 23, 2003 order were made effective as of May 23, 2003, except that
Trailblazer filed to make the revised credit procedures effective August 15,
2003. In an order issued July 13, 2004, the FERC accepted Trailblazer's
compliance filing of June 20, 2003, but required some minor changes, and denied
the rehearing requests.
With respect to the rate review portion of the case, direct testimony was
filed by the FERC Staff and the Indicated Shippers on May 22, 2003 and
cross-answering testimony was filed by the Indicated Shippers on June 19, 2003.
Trailblazer's answering testimony was filed on July 29, 2003.
On September 22, 2003, Trailblazer filed an offer of settlement with the FERC
with respect of the rate review portion of the case. Under the settlement,
Trailblazer's rate would be reduced effective January 1, 2004, from $0.12 to
$0.09 per dekatherm of natural gas, and Trailblazer would file a new rate case
to be effective January 1, 2010.
On January 23, 2004, the FERC issued an order approving, with modification,
the settlement that was filed on September 22, 2003. The FERC modified the
settlement to expand the scope of severance of contesting parties to present and
future direct interests, including capacity release agreements. The settlement
had provided the scope of the severance to be limited to present direct
interests. On February 20, 2004, Trailblazer filed a letter with the FERC
accepting the modifications to the settlement. As of March 1, 2004, all members
of the Indicated Shippers group opposing the settlement had filed to withdraw
their opposition. On April 9, 2004, the FERC accepted tariff sheets setting out
the settlement rates and, recognizing that the settlement is now unopposed,
dismissed the pending initial decision on Trailblazer's rates as moot. The
settlement rates were put into effect January 1, 2004. On March 26, 2004,
Trailblazer refunded approximately $0.9 million to shippers covering the period
January 1, 2004 through February 29, 2004 pursuant to the terms of the rate case
settlement. On July 13, 2004, the FERC issued an order requiring Trailblazer to
refund additional amounts to shippers previously contesting the settlement.
Trailblazer issued these additional refunds, totaling approximately $73,000 on
July 23, 2004.
Fuel Tracking Filing
On March 31, 2004, Trailblazer made its annual filing to revise its fuel
tracker percentage (its fuel rate) applicable to its expansion shippers. In the
filing, Trailblazer proposed to reduce its fuel rate from the previous level of
2.0% to 1.57%. On April 12, 2004, Marathon Oil Company filed a protest stating
that Trailblazer overstated projected volumes at the Station 601 compressor
facility and proposed that the volumes at the station be reduced, which would
result in a reduction of the fuel rate to 1.20%. On April 30, 2004, the FERC
issued an order allowing Trailblazer to place its proposed 1.57% fuel rate into
effect, subject to refund, on May 1, 2004. The order also established a comment
procedure, pursuant to which Trailblazer filed comments supporting its proposal
on May 20, 2004 and Marathon filed reply comments on June 1, 2004. On July 9,
2004, the FERC issued an order adopting Marathon's position. Pursuant to the
order, Trailblazer is to file revised tariff sheets adjusting its fuel rate to
1.20% and refund to its customers with interest any amounts it over collected.
FERC Order 637
Kinder Morgan Interstate Gas Transmission LLC
On June 15, 2000, Kinder Morgan Interstate Gas Transmission LLC made its
filing to comply with FERC's Orders 637 and 637-A. That filing contained KMIGT's
compliance plan to implement the changes required by the FERC dealing with the
way business is conducted on interstate natural gas pipelines. All interstate
natural gas pipelines were required to make such compliance filings, according
to a schedule established by the FERC. From October 2000 through June 2001,
KMIGT held a series of technical and phone conferences to identify issues,
obtain input, and modify its Order 637 compliance plan, based on comments
received from the FERC staff and other interested parties and shippers. On June
19, 2001, KMIGT received a letter from the FERC encouraging it to file
16
revised pro-forma tariff sheets, which reflected the latest discussions and
input from parties into its Order 637 compliance plan. KMIGT made such a revised
Order 637 compliance filing on July 13, 2001. The July 13, 2001 filing contained
little substantive change from the original pro-forma tariff sheets that KMIGT
originally proposed on June 15, 2000. On October 19, 2001, KMIGT received an
order from the FERC, addressing its July 13, 2001 Order 637 compliance plan. In
the FERC Order addressing KMIGT's July 13, 2001 compliance plan, KMIGT's plan
was accepted, but KMIGT was directed to make several changes to its tariff, and
to not place the revised tariff into effect until the FERC issues a further
order. KMIGT filed its compliance filing to the FERC's October 19, 2001 Order
and filed a request for rehearing/clarification of the FERC's October 19, 2001
Order. Several parties protested KMIGT's November 19, 2001 compliance filing.
KMIGT filed responses to those protests on December 14, 2001.
On May 22, 2003, the FERC issued an Order on Rehearing and Compliance Filing
(May 2003 Order) addressing KMIGT's November 19, 2001 compliance filing and
request for rehearing. The May 2003 Order granted in part and denied in part
KMIGT's request for rehearing, and directed KMIGT to file certain revised tariff
sheets consistent with the May 2003 Order's directives. On June 20, 2003, KMIGT
submitted its compliance filing reflecting revised tariff sheets in accordance
with the May 2003 Order's directives. Consistent with the May 2003 Order,
KMIGT's compliance filing reflected tariff sheets with proposed effective dates
of June 1, 2003 and December 1, 2003. Those sheets with a proposed effective
date of December 1, 2003 concern tariff provisions necessitating computer system
modifications.
On November 21, 2003, KMIGT received a Letter Order (November 21 Order) from
the FERC accepting the tariff sheets submitted in the June 20, 2003 compliance
filing. In accordance with the November 21 Order, KMIGT commenced full
implementation of Order No. 637 on December 1, 2003. KMIGT's actual operating
experience under the full requirements of Order No. 637 is limited. However, we
believe that these matters will not have a material adverse effect on our
business, financial position, results of operations or cash flows.
Trailblazer Pipeline Company
On August 15, 2000, Trailblazer Pipeline Company made a filing to comply with
the FERC's Order Nos. 637 and 637-A. Trailblazer's compliance filing reflected
changes in:
o segmentation;
o scheduling for capacity release transactions;
o receipt and delivery point rights;
o treatment of system imbalances;
o operational flow orders;
o penalty revenue crediting; and
o right of first refusal language.
On October 15, 2001, the FERC issued its order on Trailblazer's Order No. 637
compliance filing. The FERC approved Trailblazer's proposed language regarding
operational flow orders and rights of first refusal, but required Trailblazer to
make changes to its tariff related to the other issues listed above.
On November 14, 2001, Trailblazer made its compliance filing pursuant to the
FERC's October 15, 2001 order and also filed for rehearing of the October 15,
2001 order. On April 16, 2003, the FERC issued its order on Trailblazer's
compliance filing and rehearing order. The FERC denied Trailblazer's requests
for rehearing and approved its compliance filing subject to modifications that
must be made within 30 days of the order.
Trailblazer made those modifications in a further compliance filing submitted
to the FERC on May 16, 2003. Certain shippers have filed a limited protest
regarding that compliance filing. The compliance filing is pending
17
FERC action. Under the FERC's orders, limited aspects of Trailblazer's plan
(revenue crediting) were effective as of May 1, 2003. The entire plan went into
effect on December 1, 2003.
On March 24, 2004, the FERC issued an order directing Trailblazer to make
relatively minor changes to its tariff filing of May 16, 2003. Trailblazer
submitted its further compliance filing on April 8, 2004. That filing is
pending FERC action, but Trailblazer's Order 637 compliance plan remains in
effect as stated in the prior paragraph.
Trailblazer anticipates no adverse impact on its business as a result of the
implementation of Order No. 637.
Standards of Conduct Rulemaking
On September 27, 2001, the FERC issued a Notice of Proposed Rulemaking in
Docket No. RM01-10 in which it proposed new rules governing the interaction
between an interstate natural gas pipeline and its affiliates. If adopted as
proposed, the Notice of Proposed Rulemaking could be read to limit
communications between Kinder Morgan Interstate Gas Transmission LLC,
Trailblazer and their respective affiliates. In addition, the Notice could be
read to require separate staffing of Kinder Morgan Interstate Gas Transmission
LLC and its affiliates, and Trailblazer and its affiliates. Comments on the
Notice of Proposed Rulemaking were due December 20, 2001. Numerous parties,
including Kinder Morgan Interstate Gas Transmission LLC, have filed comment on
the Proposed Standards of Conduct Rulemaking. On May 21, 2002, the FERC held a
technical conference dealing with the FERC's proposed changes in the Standard of
Conduct Rulemaking. On June 28, 2002, Kinder Morgan Interstate Gas Transmission
LLC and numerous other parties filed additional written comments under a
procedure adopted at the technical conference.
On July 25, 2003, the FERC issued a Modification to Policy Statement stating
that FERC regulated natural gas pipelines will, on a prospective basis, no
longer be permitted to use gas basis differentials to price negotiated rate
transactions. Effectively, we will no longer be permitted to use commodity price
indices to structure transactions on our FERC regulated natural gas pipelines.
Negotiated rates based on commodity price indices in existing contracts will be
permitted to remain in effect until the end of the contract period for which
such rates were negotiated. Price indexed contracts currently constitute an
insignificant portion of our contracts on our FERC regulated natural gas
pipelines; consequently, we do not believe that this Modification to Policy
Statement will have a material impact on our operations, financial results or
cash flows.
On November 25, 2003, the FERC issued Order No. 2004, adopting new Standards
of Conduct to become effective February 9, 2004. Every interstate pipeline was
required to file a compliance plan by that date and was required to be in full
compliance with the Standards of Conduct by June 1, 2004. The primary change
from existing regulation is to make such standards applicable to an interstate
pipeline's interaction with many more affiliates (referred to as "energy
affiliates"), including intrastate/Hinshaw pipelines (in general, a Hinshaw
pipeline is a pipeline that receives gas at or within a state boundary, is
regulated by an agency of that state, and all the gas it transports is consumed
within that state), processors and gatherers and any company involved in natural
gas or electric markets (including natural gas marketers) even if they do not
ship on the affiliated interstate pipeline. Local distribution companies are
excluded, however, if they do not make sales to customers not physically
attached to their system. The Standards of Conduct require, among other things,
separate staffing of interstate pipelines and their energy affiliates (but
support functions and senior management at the central corporate level may be
shared) and strict limitations on communications from an interstate pipeline to
an energy affiliate.
Kinder Morgan Interstate Gas Transmission LLC filed for clarification and
rehearing of Order No. 2004 on December 29, 2003. In the request for rehearing,
Kinder Morgan Interstate Gas Transmission LLC asked that intrastate/Hinshaw
pipeline affiliates not be included in the definition of energy affiliates. On
February 19, 2004, Kinder Morgan Interstate Gas Transmission LLC and Trailblazer
Pipeline Company filed exemption requests with the FERC. The pipelines seek a
limited exemption from the requirements of Order No. 2004 for the purpose of
allowing their affiliated Hinshaw and intrastate pipelines, which are subject to
state regulation and do not make any off-system sales, to be excluded from the
rule's definition of energy affiliate.
On April 16, 2004, the FERC issued Order No. 2004-A. The FERC extended the
effective date of the new Standards of Conduct from June 1, 2004, to September
1, 2004. Otherwise, the FERC largely denied rehearing of Order No. 2004, but
provided further clarification or adjustment in several areas. The FERC
continued the
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exemption for local distribution companies which do not make off-system sales,
but clarified that the local distribution company exemption still applies if the
local distribution company is also a Hinshaw pipeline. The FERC also clarified
that a local distribution company can engage in certain sales and other energy
affiliate activities to the limited extent necessary to support sales to
customers located on its distribution system, and sales necessary to remain in
balance under pipeline tariffs, without becoming an energy affiliate. The FERC
declined to exempt producers. The FERC also declined to exempt intrastate and
Hinshaw pipelines, processors and gatherers, but did clarify that such entities
will not be energy affiliates if they do not participate in gas or electric
commodity markets, interstate capacity markets (as capacity holder, agent or
manager), or in financial transactions related to such markets.
The separate exemption requests by our interstate pipelines as to their
intrastate affiliates remains pending. The FERC also clarified further the
personnel and functions which can be shared by interstate pipelines and their
energy affiliates, including senior officers and risk management personnel, and
the permissible role of holding or parent companies and service companies. The
FERC also clarified that day-to-day operating information can be shared by
interconnecting entities. Finally, the FERC clarified that an interstate
pipeline and its energy affiliate can discuss potential new interconnects to
serve the energy affiliate, but subject to very onerous posting and
record-keeping requirements.
On July 21, 2004, Trailblazer Pipeline Company and Kinder Morgan Interstate
Gas Transmission LLC filed additional requests for limited exemptions from
certain requirements of FERC Order 2004. These exemptions requested relief from
the independent functioning and information disclosure requirements of Order
2004. The exemption requests propose to treat as energy affiliates, within the
meaning of Order 2004, two groups of employees: individuals in the Choice Gas
Group within KMI's Retail operations and individuals in the Commodity sales and
purchase group within our Texas intrastate natural gas group. Order 2004
regulations governing relationships between interstate pipelines and their
energy affiliates would apply to relationships with these two groups. Under
these proposals, certain critical operating functions could continue to be
shared. We also requested an extension of time for full compliance with the
Standards of Conduct until 90 days after FERC acts on these exemption requests.
We expect the one-time costs of compliance with the Order, assuming the request
to exempt intrastate pipeline affiliates is granted, to range from $600,000 to
$700,000, to be shared between us and KMI.
On August 2, 2004, the FERC issued Order No. 2004-B. In this order, the
FERC extended the effective date of the new Standards of Conduct from September
1, 2004 to September 22, 2004. Also in this order, among other actions, the FERC
denied the request for rehearing made by our interstate pipelines to clarify the
applicability of the LDC and Parent Company exemptions to them. The July 21,
2004 joint request for limited exemption from certain requirements described
above remains pending at the FERC.
On February 11, 2004, the FERC approved a final rule in Docket No. RM03-8-000
requiring jurisdictional entities to file quarterly financial reports with the
FERC. Electric utilities, natural gas companies, and licensees will file Form
3-Q, while oil pipeline companies will submit Form 6-Q. The final rule also
adopts some minimal changes to the annual financial reports filed with the FERC.
The final rule modifies the Notice of Proposed Rulemaking by eliminating the
management discussion and analysis section from both the quarterly and annual
reports, and eliminating the use of fourth quarter data in the annual report. In
addition, the final rule eliminates the cash management notification requirement
adopted in FERC Order No. 634-A. The FERC said it will also use the quarterly
financial information when reviewing the adequacy of traditional cost-based
rates. On June 22, 2004, the FERC issued an order granting an extension of time
for the filing of the quarterly financial reports for the first and second
quarters of 2004. The first quarter reports for major public utilities,
licensees and natural gas companies will be due on August 23, 2004, and the
second quarter reports will be due September 23, 2004. For non-major public
utilities, licensees, natural gas companies, and all oil pipeline companies, the
first quarter reports will be due on September 3, 2004, and the second quarter
reports will be due October 7, 2004. After the transition period, major public
utilities, licensees and natural gas companies will file quarterly reports 60
days after the end of the quarter; non-major public utilities, licensees,
natural gas companies, and all oil pipeline companies will file 70 days after
the end of the quarter.
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Other Regulatory
In addition to the matters described above, we may face additional challenges
to our rates in the future. Shippers on our pipelines do have rights to
challenge the rates we charge under certain circumstances prescribed by
applicable regulations. There can be no assurance that we will not face
challenges to the rates we receive for services on our pipeline systems in the
future. In addition, since many of our assets are subject to regulation, we are
subject to potential future changes in applicable rules and regulations that may
have an adverse effect on our business, financial position, results of
operations or cash flows.
On July 20, 2004, the United States Court of Appeals for the District of
Columbia Circuit issued its opinion in BP West Coast Products, LLC, v. Federal
Energy Regulatory Commission, No. 99-1020, On Petitions for Review of Orders of
the Federal Energy Regulatory Commission (Circuit opinion), addressing in part
the tariffs of SFPP, L.P. Among other things, the Circuit opinion vacated the
income tax allowance portion of the FERC opinion and order allowing recovery in
SFPP's rates for income taxes and remanded this and other matters for further
proceedings consistent with the Circuit opinion. By its terms, the opinion only
pertains to SFPP, L.P. and it is based on the record in that case.
Southern Pacific Transportation Company Easements
SFPP, L.P. and Southern Pacific Transportation Company are engaged in a
judicial reference proceeding to determine the extent, if any, to which the
rent payable by SFPP for the use of pipeline easements on rights-of-way held
by SPTC should be adjusted pursuant to existing contractual arrangements
(Southern Pacific Transportation Company vs. Santa Fe Pacific Corporation, SFP
Properties, Inc., Santa Fe Pacific Pipelines, Inc., SFPP, L.P., et al.,
Superior Court of the State of California for the County of San Francisco,
filed August 31, 1994). In the second quarter of 2003, the trial court set
the rent at approximately $5.0 million per year as of January 1, 1994. SPTC
has appealed the matter to the California Court of Appeals.
Carbon Dioxide Litigation
Kinder Morgan CO2 Company, L.P. and Cortez Pipeline Company are among the
named defendants in Celeste C. Grynberg, et al. v. Shell Oil Company, et al.,
No. 98-CV-43 (Colo. Dist. Ct., Montezuma County filed March 2, 1998). This case
involves claims by overriding royalty interest owners in the McElmo Dome and Doe
Canyon Units for underpayment of royalties on carbon dioxide produced from the
McElmo Dome Unit, failure to develop carbon dioxide reserves at the Doe Canyon
Unit, and failure to develop hydrocarbons at both McElmo Dome and Doe Canyon.
The plaintiffs also possess a small working interest at Doe Canyon. Plaintiffs
claim breaches of contractual and potential fiduciary duties owed by the
defendants and also allege other theories of liability including breach of
covenants, civil theft, conversion, fraud/fraudulent concealment, violation of
the Colorado Organized Crime Control Act, deceptive trade practices, and
violation of the Colorado Antitrust Act. In addition to actual or compensatory
damages, plaintiffs seek treble damages, punitive damages, and declaratory
relief relating to the Cortez Pipeline tariff and the method of calculating and
paying royalties on McElmo Dome carbon dioxide. Various motions for summary
judgment have been filed and are pending before the Court. The parties are
continuing to engage in discovery. No trial date is currently set.
Kinder Morgan CO2 Company, L.P., Kinder Morgan G.P., Inc., and Cortez Pipeline
Company are among the named defendants in Shores, et al. v. Mobil Oil Corp., et
al., No. GC-99-01184 (Statutory Probate Court, Denton County, Texas filed
December 22, 1999) and First State Bank of Denton, et al. v. Mobil Oil Corp., et
al., No. 8552-01 (Statutory Probate Court, Denton County, Texas filed March 29,
2001). These cases involve claims brought on behalf of classes of overriding
royalty interest owners (Shores) and royalty interest owners (Bank of Denton)
for underpayment of royalties on carbon dioxide produced from the McElmo Dome
Unit. The plaintiffs' claims include claims for breach of contractual duties and
covenants, breach of agency duties, civil conspiracy, and declaratory relief. In
addition to their claims for actual damages, plaintiffs seek an equitable
accounting, imposition of a constructive trust over the defendants' interests,
and punitive damages. After the trial court certified classes in both cases, the
Fort Worth Court of Appeals reversed and vacated the trial court's class
certification order in Shores because the trial court lacked jurisdiction to
certify a class. The court of appeals also ruled that most of the named
plaintiffs in Shores could not establish proper venue in Denton County and
dismissed those parties' claims. The trial court's class certification order in
Bank of Denton is currently on appeal to the Fort Worth Court of Appeals, but
the plaintiffs have filed a motion with the trial court to vacate its class
certification order, which was unopposed by the defendants. This motion was
granted in May 2004. The remaining claims in the Shores and Bank of Denton cases
are scheduled to go to trial on November 30, 2004.
On May 13, 2004, William Armor, one of the former plaintiffs in the Shores
matter whose claims were dismissed for improper venue by the Court of Appeals,
filed a new case alleging the same claims against the same defendants as he had
previously asserted in the Shores case. Armor v. Shell Oil Company, et al, No.
04-03559 (14th Judicial
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District, Dallas County Court). Defendants filed their answers and special
exceptions on June 4, 2004. Trial, if necessary, has been scheduled for
July 25, 2005.
Shell CO2 Company, Ltd., predecessor in interest to Kinder Morgan CO2 Company,
L.P., is among the named counter-claim defendants in Shell Western E&P Inc. v.
Gerald O. Bailey and Bridwell Oil Company; No. 98-28630 (215th Judicial District
Court, Harris County, Texas filed June 17, 1998) (the "SWEPI Action"). The
counter-claim plaintiffs are overriding royalty interest owners in the McElmo
Dome Unit and have sued for underpayment of royalties on carbon dioxide produced
from the McElmo Dome Unit. The counter-claim plaintiffs have asserted claims for
fraud/fraudulent inducement, real estate fraud, negligent misrepresentation,
breach of fiduciary duty, breach of contract, negligence, negligence per se,
unjust enrichment, violation of the Texas Securities Act, and open account.
Counter-claim plaintiffs seek actual damages, punitive damages, an accounting,
and declaratory relief. The trial court granted a series of summary judgment
motions filed by counter-claim defendants on all of plaintiffs' counter-claims
except for the fraud-based claims. The parties agreed to abate the case pending
settlement efforts. While the agreed abatement period has lapsed, no current
trial date is set.
On March 1, 2004, Bridwell Oil Company, one of the named
defendants/counter-claim plaintiffs in the SWEPI Action filed a new matter in
which it asserts claims which are virtually identical to the counterclaims it
asserts in the SWEPI Action against virtually the same parties. Bridwell Oil
Co. v. Shell Oil Co. et al, No. 160,199-B (78th Judicial District, Wichita
County Court). On June 25, 2004, defendants filed answers, special
exceptions, pleas in abatement and motions to transfer venue back to the
Harris County District Court, which motions are currently pending.
RSM Production Company, et al. v. Kinder Morgan Energy Partners, L.P., et al.
Cause No. 4519, in the District Court, Zapata County Texas, 49th Judicial
District. On October 15, 2001, Kinder Morgan Energy Partners, L.P. was served
with the First Supplemental Petition filed by RSM Production Corporation on
behalf of the County of Zapata, State of Texas and Zapata County Independent
School District as plaintiffs. Kinder Morgan Energy Partners, L.P. was sued in
addition to 15 other defendants, including two other Kinder Morgan affiliates.
Certain entities we acquired in the Kinder Morgan Tejas acquisition are also
defendants in this matter. The Petition alleges that these taxing units relied
on the reported volume and analyzed heating content of natural gas produced from
the wells located within the appropriate taxing jurisdiction in order to
properly assess the value of mineral interests in place. The suit further
alleges that the defendants undermeasured the volume and heating content of that
natural gas produced from privately owned wells in Zapata County, Texas. The
Petition further alleges that the County and School District were deprived of ad
valorem tax revenues as a result of the alleged undermeasurement of the natural
gas by the defendants. On December 15, 2001, the defendants filed motions to
transfer venue on jurisdictional grounds. On June 12, 2003, plaintiff served
discovery requests on certain defendants. On July 11, 2003, defendants moved to
stay any responses to such discovery.
United States of America, ex rel., Jack J. Grynberg v. K N Energy
Civil Action No. 97-D-1233, filed in the U.S. District Court, District of
Colorado. This action was filed on June 9, 1997 pursuant to the federal False
Claim Act and involves allegations of mismeasurement of natural gas produced
from federal and Indian lands. The Department of Justice has decided not to
intervene in support of the action. The complaint is part of a larger series of
similar complaints filed by Mr. Grynberg against 77 natural gas pipelines
(approximately 330 other defendants). Certain entities we acquired in the Kinder
Morgan Tejas acquisition are also defendants in this matter. An earlier single
action making substantially similar allegations against the pipeline industry
was dismissed by Judge Hogan of the U.S. District Court for the District of
Columbia on grounds of improper joinder and lack of jurisdiction. As a result,
Mr. Grynberg filed individual complaints in various courts throughout the
country. In 1999, these cases were consolidated by the Judicial Panel for
Multidistrict Litigation, and transferred to the District of Wyoming. The
multidistrict litigation matter is called In Re Natural Gas Royalties Qui Tam
Litigation, Docket No. 1293. Motions to dismiss were filed and an oral argument
on the motion to dismiss occurred on March 17, 2000. On July 20, 2000, the
United States of America filed a motion to dismiss those claims by Grynberg that
deal with the manner in which defendants valued gas produced from federal
leases, referred to as valuation claims. Judge Downes denied the defendant's
motion to dismiss on May 18, 2001. The United States' motion to dismiss most of
plaintiff's valuation claims has been granted by the court. Grynberg has
appealed that dismissal to the 10th Circuit, which has requested briefing
regarding its jurisdiction over that appeal. Discovery to
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determine issues related to the Court's subject matter jurisdiction, arising out
of the False Claims Act is complete and briefing is underway. On May 7, 2003,
Grynberg sought leave to file a Third Amended Complaint, which adds allegations
of undermeasurement related to CO2 production. Defendants have filed briefs
opposing leave to amend.
Mel R. Sweatman and Paz Gas Corporation v. Gulf Energy Marketing, LLC, et
al.
On July 25, 2002, we were served with this suit for breach of contract,
tortious interference with existing contractual relationships, conspiracy to
commit tortious interference and interference with prospective business
relationship. Mr. Sweatman and Paz Gas Corporation claim that, in connection
with our acquisition of Tejas Gas, LLC, we wrongfully caused gas volumes to be
shipped on our Kinder Morgan Texas Pipeline system instead of our Kinder Morgan
Tejas system. Mr. Sweatman and Paz Gas Corporation allege that this action
eliminated profit on Kinder Morgan Tejas, a portion of which Mr. Sweatman and
Paz Gas Corporation claim they are entitled to receive under an agreement with a
subsidiary of ours acquired in the Tejas Gas acquisition. We filed a motion to
remove the case from venue in Dewitt County, Texas to Harris County, Texas, and
our motion was denied in a venue hearing in November 2002.
In a Second Amended Original Petition, Sweatman and Paz assert new and
distinct allegations against us, principally that we were a party to an alleged
commercial bribery committed by us, Gulf Energy Marketing, and Intergen inasmuch
as we, in our role as acquirer of Kinder Morgan Tejas, allegedly paid Intergen
to not renew the underlying Entex contracts belonging to the Tejas/Paz joint
venture. Moreover, new and distinct allegations of breach of fiduciary and
bribery of a fiduciary are also raised in this amended petition for the first
time.
The parties have engaged in some discovery and depositions. At this stage of
discovery, we believe that our actions were justified and defensible under
applicable Texas law and that the decision not to renew the underlying gas sales
agreements was made unilaterally by persons acting on behalf of Entex. The
plaintiffs have moved for summary judgment asking the court to declare that a
fiduciary relationship existed for purposes of Sweatman's claims. We have moved
for summary judgment on the grounds that:
o there is no cause-in-fact of the gas sales nonrenewals attributable to
us; and
o the defense of legal justification applies to the claims for tortuous
interference.
In September 2003 and then again in November 2003, Sweatman and Paz filed
their third and fourth amended petitions, respectively, asserting all of the
claims for relief described above. In addition, the plaintiffs asked that the
court impose a constructive trust on (i) the proceeds of the sale of Tejas and
(ii) any monies received by any Kinder Morgan entity for sales of gas to any
Entex/Reliant entity following June 30, 2002 that replaced volumes of gas
previously sold under contracts to which Sweatman and Paz had a participating
interest pursuant to the joint venture agreement between Tejas, Sweatman and
Paz. In October 2003, the court granted, and then rescinded its order after a
motion to reconsider heard on February 13, 2004, a motion for partial summary
judgment on the issue of the existence of a fiduciary duty. We believe this suit
is without merit and we intend to defend the case vigorously. We have moved for
summary judgment on all of Sweatman's claims, asserting that even in the light
most favorable to Sweatman's assertions, there is no issue of material fact on
whether Sweatman even owned an interest in the underlying gas sales agreements
in dispute. That motion is presently set for hearing on August 13, 2004. Trial
of the case is set preferentially for January 17, 2005.
Maher et ux. v. Centerpoint Energy, Inc. d/b/a Reliant Energy,
Incorporated, Reliant Energy Resources Corp., Entex Gas Marketing Company,
Kinder Morgan Texas Pipeline, L.P., Kinder Morgan Energy Partners, L.P.,
Houston Pipeline Company, L.P. and AEP Gas Marketing, L.L.C., No. 30875
(District Court, Wharton County Texas).
On October 21, 2002, Kinder Morgan Texas Pipeline, L.P. and Kinder Morgan
Energy Partners, L.P. were served with the above-entitled Complaint. A First
Amended Complaint was served on October 23, 2002, adding additional
defendants Kinder Morgan G.P., Inc., Kinder Morgan Tejas Pipeline GP, Inc.,
Kinder Morgan Texas Pipeline GP, Inc., Tejas Gas, LLC and HPL GP, LLC. The
First Amended Complaint purports to bring a class action on behalf of those
Texas residents who purchased natural gas for residential purposes from the
so-called "Reliant Defendants" in Texas at any time during the period
encompassing "at least the last ten years."
The Complaint alleges that Reliant Energy Resources Corp., by and through its
affiliates, has artificially inflated the price charged to residential consumers
for natural gas that it allegedly purchased from the non-Reliant defendants,
including the above-listed Kinder Morgan entities. The Complaint further alleges
that in exchange for
22
Reliant Energy Resources Corp.'s purchase of natural gas at above market prices,
the non-Reliant defendants, including the above-listed Kinder Morgan entities,
sell natural gas to Entex Gas Marketing Company at prices substantially below
market, which in turn sells such natural gas to commercial and industrial
consumers and gas marketers at market price. The Complaint purports to assert
claims for fraud, violations of the Texas Deceptive Trade Practices Act, and
violations of the Texas Utility Code against some or all of the Defendants, and
civil conspiracy against all of the defendants, and seeks relief in the form of,
inter alia, actual, exemplary and statutory damages, civil penalties, interest,
attorneys' fees and a constructive trust ab initio on any and all sums which
allegedly represent overcharges by Reliant and Reliant Energy Resources Corp.
On November 18, 2002, the Kinder Morgan defendants filed a Motion to Transfer
Venue and, Subject Thereto, Original Answer to the First Amended Complaint. The
parties are currently engaged in preliminary discovery. Based on the information
available to date and our preliminary investigation, the Kinder Morgan
defendants believe that the claims against them are without merit and intend to
defend against them vigorously.
Marie Snyder, et al v. City of Fallon, United States Department of the Navy,
Exxon Mobil Corporation, Kinder Morgan Energy Partners, L.P., Speedway Gas
Station and John Does I-X, No. cv-N-02-0251-ECR-RAM (United States District
Court, District of Nevada)("Snyder"); Frankie Sue Galaz, et al v. United States
of America, City of Fallon, Exxon Mobil Corporation, Kinder Morgan Energy
Partners, L.P., Berry Hinckley, Inc., and John Does I-X, No.
cv-N-02-0630-DWH-RAM (United States District Court, District of Nevada)("Galaz
I"); Frankie Sue Galaz, et al v. City of Fallon, Exxon Mobil Corporation,;
Kinder Morgan Energy Partners, L.P., Kinder Morgan G.P., Inc., Kinder Morgan Las
Vegas, LLC, Kinder Morgan Operating Limited Partnership "D", Kinder Morgan
Services LLC, Berry Hinkley and Does I-X, No. CV03-03613 (Second Judicial
District Court, State of Nevada, County of Washoe) ("Galaz II); Frankie Sue
Galaz, et al v. The United States of America, the City of Fallon, Exxon Mobil
Corporation,; Kinder Morgan Energy Partners, L.P., Kinder Morgan G.P., Inc.,
Kinder Morgan Las Vegas, LLC, Kinder Morgan Operating Limited Partnership "D",
Kinder Morgan Services LLC, Berry Hinkley and Does I-X, No.CVN03-0298-DWH-VPC
(United States District Court, District of Nevada)("Galaz III)
On July 9, 2002, we were served with a purported Complaint for Class Action in
the Snyder case, in which the plaintiffs, on behalf of themselves and others
similarly situated, assert that a leukemia cluster has developed in the City of
Fallon, Nevada. The Complaint alleges that the plaintiffs have been exposed to
unspecified "environmental carcinogens" at unspecified times in an unspecified
manner and are therefore "suffering a significantly increased fear of serious
disease." The plaintiffs seek a certification of a class of all persons in
Nevada who have lived for at least three months of their first ten years of life
in the City of Fallon between the years 1992 and the present who have not been
diagnosed with leukemia.
The Complaint purports to assert causes of action for nuisance and "knowing
concealment, suppression, or omission of material facts" against all defendants,
and seeks relief in the form of "a court-supervised trust fund, paid for by
defendants, jointly and severally, to finance a medical monitoring program to
deliver services to members of the purported class that include, but are not
limited to, testing, preventative screening and surveillance for conditions
resulting from, or which can potentially result from exposure to environmental
carcinogens," incidental damages, and attorneys' fees and costs.
The defendants responded to the Complaint by filing Motions to Dismiss on the
grounds that it fails to state a claim upon which relief can be granted. On
November 7, 2002, the United States District Court granted the Motion to Dismiss
filed by the United States, and further dismissed all claims against the
remaining defendants for lack of Federal subject matter jurisdiction. Plaintiffs
filed a Motion for Reconsideration and Leave to Amend, which was denied by the
Court on December 30, 2002. Plaintiffs filed a Notice of Appeal to the United
States Court of Appeals for the 9th Circuit. On March 15, 2004, the 9th Circuit
affirmed the dismissal of this case.
On December 3, 2002, plaintiffs filed an additional Complaint for Class Action
in the Galaz I matter asserting the same claims in the same Court on behalf of
the same purported class against virtually the same defendants, including us. On
February 10, 2003, the defendants filed Motions to Dismiss the Galaz I Complaint
on the grounds that it also fails to state a claim upon which relief can be
granted. This motion to dismiss was granted as to all defendants on April 3,
2003. Plaintiffs have filed a Notice of Appeal to the United States Court of
Appeals for the 9th Circuit. On November 17, 2003, the 9th Circuit dismissed the
appeal, upholding the District Court's dismissal of
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the case.
On June 20, 2003, plaintiffs filed an additional Complaint for Class Action
(the "Galaz II" matter) asserting the same claims in Nevada State trial court on
behalf of the same purported class against virtually the same defendants,
including us (and excluding the United States Department of the Navy). On
September 30, 2003, the Kinder Morgan defendants filed a Motion to Dismiss the
Galaz II Complaint along with a Motion for Sanctions. On April 13, 2004,
plaintiffs' counsel voluntarily stipulated to a dismissal with prejudice of the
entire case in State Court. The Court has accepted the stipulation and the
parties are awaiting a final order from the Court dismissing the case with
prejudice.
Also on June 20, 2003, the plaintiffs in the Galaz matters filed yet another
Complaint for Class Action in the United States District Court for the District
of Nevada (the "Galaz III" matter) asserting the same claims in United States
District Court for the District of Nevada on behalf of the same purported class
against virtually the same defendants, including us. The Kinder Morgan
defendants filed a Motion to Dismiss the Galaz III matter on August 15, 2003. On
October 3, 2003, the plaintiffs filed a Motion for Withdrawal of Class Action,
which voluntarily drops the class action allegations from the matter and seeks
to have the case proceed on behalf of the Galaz family only. On December 5,
2003, the District Court granted the Kinder Morgan defendants' Motion to
Dismiss, but granted plaintiff leave to file a second Amended Complaint.
Plaintiff filed a Second Amended Complaint on December 13, 2003, and a Third
Amended Complaint on January 5, 2004. The Kinder Morgan defendants filed a
Motion to Dismiss the Third Amended Complaint on January 13, 2004. The Motion to
Dismiss was granted with prejudice on April 30, 2004. On May 7, 2004, Plaintiff
filed a Notice of Appeal in the United States Court of Appeals for the 9th
Circuit, which appeal is currently pending.
Richard Jernee, et al v. Kinder Morgan Energy Partners, et al, No.
CV03-03482 (Second Judicial District Court, State of Nevada, County of
Washoe) ("Jernee").
On May 30, 2003, a separate group of plaintiffs, individually and on behalf of
Adam Jernee, filed a civil action in the Nevada State trial court against us and
several Kinder Morgan related entities and individuals and additional unrelated
defendants ("Jernee"). Plaintiffs in the Jernee matter claim that defendants
negligently and intentionally failed to inspect, repair and replace unidentified
segments of their pipeline and facilities, allowing "harmful substances and
emissions and gases" to damage "the environment and health of human beings."
Plaintiffs claim that "Adam Jernee's death was caused by leukemia that, in turn,
is believed to be due to exposure to industrial chemicals and toxins."
Plaintiffs purport to assert claims for wrongful death, premises liability,
negligence, negligence per se, intentional infliction of emotional distress,
negligent infliction of emotional distress, assault and battery, nuisance,
fraud, strict liability, and aiding and abetting, and seek unspecified special,
general and punitive damages. The Kinder Morgan defendants filed Motions to
Dismiss the complaint on November 20, 2003, which Motions are currently pending.
In addition, plaintiffs and the defendant City of Fallon have appealed the Trial
Court's ruling on initial procedural matters concerning proper venue. On March
29, 2004, the Nevada Supreme Court stayed the action pending resolution of these
procedural matters on appeal.
Floyd Sands, et al v. Kinder Morgan Energy Partners, et al, No. CV03-05326
(Second Judicial District Court, State of Nevada, County of Washoe) ("Sands").
On August 28, 2003, a separate group of plaintiffs, represented by the counsel
for the plaintiffs in the Jernee matter, individually and on behalf of Stephanie
Suzanne Sands, filed a civil action in the Nevada State trial court against us
and several Kinder Morgan related entities and individuals and additional
unrelated defendants ("Sands"). Plaintiffs in the Sands matter claim that
defendants negligently and intentionally failed to inspect, repair and replace
unidentified segments of their pipeline and facilities, allowing "harmful
substances and emissions and gases" to damage "the environment and health of
human beings." Plaintiffs claim that Stephanie Suzanne Sands' death was caused
by leukemia that, in turn, is believed to be due to exposure to industrial
chemicals and toxins. Plaintiffs purport to assert claims for wrongful death,
premises liability, negligence, negligence per se, intentional infliction of
emotional distress, negligent infliction of emotional distress, assault and
battery, nuisance, fraud, strict liability, and aiding and abetting, and seek
unspecified special, general and punitive damages. The Kinder Morgan defendants
were served with the Complaint on January 10, 2004. On February 26, 2004, the
Kinder Morgan defendants filed a Motion to Dismiss and a Motion to Strike, which
motions are currently pending. In addition, plaintiffs and the defendant City of
Fallon have appealed the Trial Court's ruling on initial procedural matters
concerning proper
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venue and a peremptory challenge of the trial judge by the plaintiffs. On April
27, 2004, the Nevada Supreme Court stayed the action pending resolution of these
procedural matters on appeal.
Based on the information available to date, our own preliminary investigation,
and the positive results of investigations conducted by State and Federal
agencies, we believe that the claims against us in these matters are without
merit and intend to defend against them vigorously.
Marion County, Mississippi Litigation
In 1968, Plantation discovered a release from its 12-inch pipeline in Marion
County, Mississippi. The pipeline was immediately repaired. In 1998 and 1999, 62
lawsuits were filed on behalf of 263 plaintiffs in the Circuit Court of Marion
County, Mississippi. The majority of the claims are based on alleged exposure
from the 1968 release, including claims for property damage and personal injury.
A settlement has been reached between most of the plaintiffs and Plantation.
It is anticipated that all of the proceedings to complete the settlement will be
completed by the end of the third quarter of 2004. We believe that the ultimate
resolution of these Marion County, Mississippi cases will not have a material
effect on our business, financial position, results of operations or cash flows.
Exxon Mobil Corporation v. GATX Corporation, Kinder Morgan Liquids
Terminals, Inc. and ST Services, Inc.
On April 23, 2003, Exxon Mobil Corporation filed the Complaint in the Superior
Court of New Jersey, Gloucester County. We filed our answer to the Complaint on
June 27, 2003, in which we denied ExxonMobil's claims and allegations as well as
included counterclaims against ExxonMobil. The lawsuit relates to environmental
remediation obligations at a Paulsboro, New Jersey liquids terminal owned by
ExxonMobil from the mid-1950s through November 1989, by GATX Terminals Corp.
from 1989 through September 2000, and owned currently by ST Services, Inc. Prior
to selling the terminal to GATX Terminals, ExxonMobil performed an environmental
site assessment of the terminal required prior to sale pursuant to state law.
During the site assessment, ExxonMobil discovered items that required
remediation and the New Jersey Department of Environmental Protection issued an
order that required ExxonMobil to perform various remediation activities to
remove hydrocarbon contamination at the terminal. ExxonMobil, we understand, is
still remediating the site and has not been removed as a responsible party from
the state's cleanup order; however, ExxonMobil claims that the remediation
continues because of GATX Terminals' storage of a fuel additive, MTBE, at the
terminal during GATX Terminals' ownership of the terminal. When GATX Terminals
sold the terminal to ST Services, the parties indemnified one another for
certain environmental matters. When GATX Terminals was sold to us, GATX
Terminals' indemnification obligations, if any, to ST Services may have passed
to us. Consequently, at issue is any indemnification obligations we may owe to
ST Services in respect to environmental remediation of MTBE at the terminal. The
Complaint seeks any and all damages related to remediating MTBE at the terminal,
and, according to the New Jersey Spill Compensation and Control Act, treble
damages may be available for actual dollars incorrectly spent by the successful
party in the lawsuit for remediating MTBE at the terminal. The parties have
recently completed discovery. We intend to take depositions of several key ST
Services personnel who were involved in the transaction with GATX Terminals.
Once the depositions are complete, the parties will discuss the effectiveness of
various methods of alternative dispute resolutions in an effort to resolve the
case.
Exxon Mobil Corporation v. Enron Gas Processing Co., Enron Corp., as party
in interest for Enron Helium Company, a division of Enron Corp., Enron
Liquids Pipeline Co., Enron Liquids Pipeline Operating Limited Partnership,
Kinder Morgan Operating L.P. "A," and Kinder Morgan, Inc., No. 2000-45252
(189th Judicial District Court, Harris County, Texas)
On September 1, 2000, Plaintiff Exxon Mobil Corporation filed its Original
Petition and Application for Declaratory Relief against Kinder Morgan
Operating L.P. "A," Enron Liquids Pipeline Operating Limited Partnership
n/k/a Kinder Morgan Operating L.P. "A," Enron Liquids Pipeline Co. n/k/a
Kinder Morgan G.P., Inc., Enron Gas Processing Co. n/k/a ONEOK Bushton
Processing, Inc., and Enron Helium Company. Plaintiff added Enron Corp. as
party in interest for Enron Helium Company in its First Amended Petition and
added Kinder Morgan, Inc. as a Defendant. The claims against Enron Corp.
were severed into a separate cause of action. Plaintiff's claims are based
on a Gas Processing Agreement entered into on September 23, 1987 between
Mobil Oil Corp. and Enron Gas Processing Company relating to gas produced in
the Hugoton Field in Kansas and processed at
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