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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
Delaware 75-2931295
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
- ---------------------------------------- --------------------------
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (972) 699-4062
Securities registered pursuant to Section
12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------------- ----------------------------------------------
Shares New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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.
X Yes No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Subsection 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
X Yes No
------ -------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
X Yes No
------ -------
Aggregate market value of the voting shares held by non-affiliates of the
registrant: $318,093,909. This figure is estimated as of June 30, 2003, at which
date the closing price of the registrant's shares on the New York Stock Exchange
was $29.19 per share and assumes that only officers and directors of the
registrant were affiliates of the registrant.
Number of Shares of the Registrant outstanding at March 5, 2004:
11,549,120.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is incorporated by reference from portions of the Registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission not later than
120 days after the close of the fiscal year covered by this Report.
PART I
Item 1. Business
GENERAL
Kaneb Services LLC (the "Company") is a limited liability company
organized under the laws of the State of Delaware. The Company manages and
operates a refined petroleum products and anhydrous ammonia pipeline business
and the terminaling of petroleum products and specialty liquids terminal storage
business through the general partner interest owned by one of its subsidiaries
in Kaneb Pipe Line Partners, L.P., a Delaware limited partnership ("KPP"), which
in turn owns those systems and facilities through its subsidiaries.
KPP is a separate public entity whose limited partner units are traded
over the New York Stock Exchange (NYSE: KPP). The Company's wholly owned
subsidiary, Kaneb Pipe Line Company LLC, a Delaware limited liability company,
("KPL"), owns the general partner interest and 5.1 million limited partner units
of KPP. For financial statement purposes, the assets, liabilities and earnings
of KPP are included in the Company's consolidated financial statements, with the
public unitholders' interest reflected as interest of outside non-controlling
partners in KPP. For purposes of this report, the business, operations, revenues
and other information about KPP are presented as a whole, even though the
Company does not, directly or indirectly, own 100% of KPP. The Company's product
marketing services are conducted by Martin Oil LLC, a Delaware limited liability
company ("Martin"), a 100% owned subsidiary of KPL and, since KPP's acquisition
of Statia (see "Liquidity and Capital Resources"), by Statia which delivers
bunker fuel to ships in the Caribbean and Nova Scotia, Canada and sells bulk
petroleum products to various commercial interests. Martin provides wholesale
motor fuel marketing services throughout the Great Lakes and Rocky Mountain
regions.
PIPELINE BUSINESS
Introduction
KPP's pipeline business consists primarily of the transportation of
refined petroleum products as a common carrier in Kansas, Nebraska, Iowa, South
Dakota, North Dakota, Colorado, Wyoming and Minnesota. On December 24, 2002, KPP
acquired the Northern Great Plains Product System from Tesoro Refining and
Marketing Company for approximately $100 million. This product pipeline system
is now referred to as KPP's North Pipeline. On November 1, 2002, KPP acquired a
2,000 mile anhydrous ammonia pipeline from Koch Pipeline Company, LP and Koch
Fertilizer Storage and Terminal Company for approximately $139 million. KPP's
three refined petroleum products pipelines and the anhydrous ammonia pipeline
are described below.
East Pipeline
Construction of the East Pipeline commenced in 1953 with a line from
southern Kansas to Geneva, Nebraska. During subsequent years, the East Pipeline
was extended northward to its present terminus at Jamestown, North Dakota, west
to North Platte, Nebraska and east into the State of Iowa. The East Pipeline,
which moves refined products from south to north, now consists of 2,090 miles of
pipeline ranging in size from 6 inches to 16 inches.
The East Pipeline system also consists of 17 product terminals in
Kansas, Nebraska, Iowa, South Dakota and North Dakota with total storage
capacity of approximately 3.5 million barrels and an additional 23 product tanks
with total storage capacity of approximately 1,118,393 barrels at its tank farm
installations at McPherson and El Dorado, Kansas. The system also has six origin
pump stations in Kansas and 38 booster pump stations throughout the system.
Additionally, the system maintains various office and warehouse facilities, and
an extensive quality control laboratory.
The East Pipeline transports refined petroleum products, including
propane, received from refineries in southeast Kansas and other connecting
pipelines to its terminals along the system and to receiving pipeline
connections in Kansas. Shippers on the East Pipeline obtain refined petroleum
products from refineries connected to the East Pipeline or through other
pipelines directly connected to the pipeline system. Five connecting pipelines
can deliver propane for shipment through the East Pipeline from gas processing
plants in Texas, New Mexico, Oklahoma and Kansas.
Much of the refined petroleum products delivered through the East
Pipeline are ultimately used as fuel for railroads or in agricultural
operations, including fuel for farm equipment, irrigation systems, trucks used
for transporting crops and crop drying facilities. Demand for refined petroleum
products for agricultural use, and the relative mix of products required, is
affected by weather conditions in the markets served by the East Pipeline.
Government agricultural policies and crop prices also affect the agricultural
sector. Although periods of drought suppress agricultural demand for some
refined petroleum products, particularly those used for fueling farm equipment,
the demand for fuel for irrigation systems often increases during such times.
The mix of refined petroleum products delivered varies seasonally, with
gasoline demand peaking in early summer, diesel fuel demand peaking in late
summer and propane demand higher in the fall. In addition, weather conditions in
the areas served by the East Pipeline affect both the demand for and the mix of
the refined petroleum products delivered through the East Pipeline, although
historically any impact on total volumes shipped has been short-term. Tariffs
charged to shippers for transportation of products do not vary according to the
type of product delivered.
West Pipeline
KPP acquired the West Pipeline in February 1995, increasing KPP's
pipeline business in South Dakota and expanding it into Wyoming and Colorado.
The West Pipeline system includes approximately 550 miles of pipeline in
Wyoming, Colorado and South Dakota, four truck-loading terminals and numerous
pump stations situated along the system. The system's four product terminals
have a total storage capacity of over 1.7 million barrels.
The West Pipeline originates near Casper, Wyoming, where it serves as a
connecting point with Sinclair's Little America Refinery and the Seminoe
Pipeline which transports product from Billings, Montana area refineries. At
Douglas, Wyoming, a 6 inch pipeline branches off to serve KPP's Rapid City,
South Dakota terminal approximately 190 miles away. The 6 inch pipeline also
receives product from Wyoming Refining's pipeline at a connection located near
the Wyoming/South Dakota border. From Douglas, KPP's pipeline continues
southward through a delivery point at the Burlington Northern junction to
terminals at Cheyenne, Wyoming, the Denver metropolitan area and Fountain,
Colorado.
The West Pipeline system parallels KPP's East Pipeline to the west. The
East Pipeline's North Platte line terminates in western Nebraska, approximately
200 miles east of the West Pipeline's Cheyenne, Wyoming Terminal. The West
Pipeline serves Denver and other eastern Colorado markets and supplies jet fuel
to Ellsworth Air Force Base at Rapid City, South Dakota, as compared to the East
Pipeline's largely agricultural service area. The West Pipeline has a relatively
small number of shippers who, with few exceptions, are also shippers on the
Partnership's East Pipeline system.
North Pipeline
The North Pipeline, acquired by KPP in December 2002, runs from west to
east approximately 440 miles from its origin at the Tesoro Refining and
Marketing Company's Mandan, North Dakota refinery to the Minneapolis, Minnesota
area. It has four product terminals, one in North Dakota and three in Minnesota,
with a total tankage capacity of 1.3 million barrels. The North Pipeline crosses
KPP's East Pipeline near Jamestown, North Dakota where the two pipelines are
connected. The North Pipeline is presently supplied exclusively by the Mandan
refinery, however, it is capable of delivering or receiving products to or from
the East Pipeline.
Ammonia Pipeline
In November 2002, KPP acquired the anhydrous ammonia pipeline (the
"Ammonia Pipeline") from two Koch companies. Anhydrous ammonia is primarily used
as agricultural fertilizer through direct application. Other uses are as a
component of various types of dry fertilizer as well as use as a cleaning agent
in power plant scrubbers. The 2,000 mile pipeline originates in the Louisiana
delta area where it has access to three marine terminals on the Mississippi
River. It moves north through Louisiana and Arkansas into Missouri, where at
Hermann, Missouri, one branch splits going east into Illinois and Indiana, and
the other branch continues north into Iowa and then turning west into Nebraska.
KPP acquired a storage and loading terminal near Hermann, Missouri which was
leased back to Koch Nitrogen. The operations headquarters for the Ammonia
Pipeline is located in Hermann, Missouri. The Ammonia Pipeline is connected to
twenty-two other third party owned terminals and also has several industrial
facility delivery locations. Product is primarily supplied to the pipeline from
plants in Louisiana and foreign-source product delivered through the marine
terminals.
Other Systems
KPP also owns three single-use pipelines, located near Umatilla,
Oregon; Rawlins, Wyoming and Pasco, Washington, each of which supplies diesel
fuel to a railroad fueling facility. The Oregon and Washington lines are fully
automated, however the Wyoming line utilizes a coordinated startup procedure
between the refinery and the railroad. For the year ended December 31, 2003,
these three systems combined transported a total of 3.7 million barrels of
diesel fuel, representing an aggregate of $1.5 million in revenues.
Pipelines Products and Activities
The revenues for the East Pipeline, West Pipeline, North Pipeline,
Ammonia Pipeline and Other Pipelines (collectively, the "Pipelines") are based
upon volumes and distances of product shipped. The following table reflects the
total volume, barrel miles of refined petroleum products shipped and total
operating revenues earned by the Pipelines for each of the periods indicated,
but does not include any information on the Ammonia Pipeline. In addition
information on the North Pipeline system prior to 2003 is not included. During
the year of 2003, the Ammonia Pipeline shipped 1,155,160 tons of ammonia
generating $21.3 million of revenue.
Year Ended December 31,
------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- -------------- ------------- --------------
Volume (1).................. 102,928 89,780 92,116 89,192 85,356
Barrel miles (2)............ 21,327 18,275 18,567 17,843 18,440
Revenues (3)................ $98,329 $78,240 $74,976 $70,685 $67,607
(1) Volumes are expressed in thousands of barrels of refined petroleum product.
(2) Barrel miles are shown in millions. A barrel mile is the movement of one
barrel of refined petroleum product one mile.
(3) Revenues are expressed in thousands of dollars.
The following table sets forth volumes of propane and various types of
other refined petroleum products transported by the Pipelines during each of the
periods indicated:
Year Ended December 31,
(thousands of barrels)
------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- -------------- ------------- --------------
Gasoline.................... 53,205 45,106 46,268 44,215 41,472
Diesel and fuel oil......... 46,072 40,450 42,354 41,087 40,435
Propane..................... 3,651 4,224 3,494 3,890 3,449
------------- ------------- -------------- ------------- --------------
Total....................... 102,928 89,780 92,116 89,192 85,356
============= ============= ============== ============= ==============
Diesel and fuel oil are used in farm machinery and equipment,
over-the-road transportation, railroad fueling and residential fuel oil.
Gasoline is primarily used in over-the-road transportation and propane is used
for crop drying, residential heating and to power irrigation equipment. The mix
of refined petroleum products delivered varies seasonally, with gasoline demand
peaking in early summer, diesel fuel demand peaking in late summer and propane
demand higher in the fall. In addition, weather conditions in the areas served
by the East Pipeline affect both the demand for and the mix of the refined
petroleum products delivered through the East Pipeline, although historically
any overall impact on the total volumes shipped has been short-term. Tariffs
charged to shippers for transportation of products do not vary according to the
type of product delivered. Demand on the North Pipeline is mainly of the same
agricultural nature as the East Pipeline except for the Minneapolis terminal
area which is more metropolitan.
Maintenance and Monitoring
The Pipelines have been constructed and are maintained in a manner
consistent with applicable federal, state and local laws and regulations,
standards prescribed by the American Petroleum Institute and accepted industry
practice. Further, protective measures are taken and routine preventive
maintenance is performed on the Pipelines in order to prolong their useful
lives. Such measures include cathodic protection to prevent external corrosion,
inhibitors to prevent internal corrosion and periodic inspection of the
Pipelines. Additionally, the Pipelines are patrolled at regular intervals to
identify equipment or activities by third parties that, if left unchecked, could
result in encroachment upon the Pipeline's rights-of-way and possible damage to
the Pipelines.
KPP uses state-of-the-art Supervisory Control and Data Acquisition
remote supervisory control software programs to continuously monitor and control
the Pipelines from the Wichita, Kansas headquarters and from the Roseville,
Minnesota terminal for the North Pipeline. The system monitors quantities of
products injected in and delivered through the Pipelines and automatically
signals the Wichita or Roseville personnel upon deviations from normal
operations that requires attention.
Pipeline Operations
For pipeline operations, integrity management and public safety, the
East Pipeline, the West Pipeline, the North Pipeline and the Ammonia Pipeline
are subject to federal regulation by one or more of the following governmental
agencies or laws: the Federal Energy Regulatory Commission ("FERC"), the Surface
Transportation Board, the Department of Transportation, the Environmental
Protection Agency, and the Homeland Security Act. Additionally, the operations
and integrity of the Pipelines are subject to the respective state jurisdictions
along the route of the systems. See "Regulation."
Except for the three single-use pipelines and certain ethanol
facilities, all of KPP's pipeline operations constitute common carrier
operations and are subject to federal tariff regulation. In May 1998, KPP was
authorized by the FERC to adopt market-based rates in approximately one-half of
its markets on the East and West systems. Common carrier activities are those
for which transportation through KPP's Pipelines is available at published
tariffs filed, in the case of interstate petroleum product shipments, with the
FERC or, in the case of intrastate petroleum product shipments in Kansas,
Colorado, Wyoming and North Dakota, with the relevant state authority, to any
shipper of refined petroleum products who requests such services and satisfies
the conditions and specifications for transportation. The Ammonia Pipeline is
subject to federal regulation by the Surface Transportation Board, rather than
the FERC.
In general, a shipper on one of KPP's refined petroleum products
pipelines delivers products to the pipeline from refineries or third party
pipelines that connect to the Pipelines. The Pipelines' refined petroleum
products operations also include 25 truck-loading terminals through which
refined petroleum products are delivered to storage tanks and then loaded into
petroleum transport trucks. Five of the 25 terminals also receive propane into
storage tanks and then load it into transport trucks. The Ammonia Pipeline
receives product from anhydrous ammonia plants or from the marine terminals for
imported product. Tariffs for transportation are charged to shippers based upon
transportation from the origination point on the pipeline to the point of
delivery. Such tariffs also include charges for terminaling and storage of
product at the Pipeline's terminals. Pipelines are generally the lowest cost
method for intermediate and long-haul overland transportation of refined
petroleum products.
Each shipper transporting product on a pipeline is required to supply
KPP with a notice of shipment indicating sources of products and destinations.
All shipments are tested or receive refinery certifications to ensure compliance
with KPP's specifications. Petroleum shippers are generally invoiced by KPP
immediately upon the product entering one of the Petroleum Pipelines.
The following table shows the number of tanks owned by KPP at each
refined petroleum product terminal location at December 31, 2003, the storage
capacity in barrels and truck capacity of each terminal location.
Location of Number Tankage Truck
Terminals of Tanks Capacity Capacity(a)
- ---------------------------------------- -------- ------------- -----------
Colorado:
Dupont 18 692,000 6
Fountain 13 391,000 5
Iowa:
LeMars 9 103,000 2
Milford(b) 11 172,000 2
Rock Rapids 12 366,000 2
Kansas:
Concordia(c) 7 79,000 2
Hutchinson 9 161,000 2
Salina 10 98,000 3
Minnesota
Moorhead 17 498,000 3
Sauk Centre 11 114,000 2
Roseville 13 594,000 5
Nebraska:
Columbus(d) 12 191,000 2
Geneva 39 678,000 6
Norfolk 16 187,000 4
North Platte 22 197,000 5
Osceola 8 79,000 2
North Dakota:
Jamestown(e) 19 315,000 4
South Dakota:
Aberdeen 12 181,000 2
Mitchell 8 72,000 2
Rapid City 13 256,000 3
Sioux Falls 9 381,000 2
Wolsey 21 149,000 4
Yankton 25 246,000 4
Wyoming:
Cheyenne 15 345,000 2
------ -----------
Totals 349 6,545,000
====== ===========
(a) Number of trucks that may be simultaneously loaded.
(b) This terminal is situated on land leased through August 7, 2007 at an
annual rental of $2,400. KPP has the right to renew the lease upon its
expiration for an additional term of 20 years at the same annual rental
rate.
(c) This terminal is situated on land leased through the year 2060 for a total
rental of $2,000.
(d) Also loads rail tank cars.
(e) Two terminals
The East Pipeline also has intermediate storage facilities consisting
of 13 storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson,
Kansas, with aggregate capacities of approximately 584,393 and 534,000 barrels,
respectively. During 2003, approximately 56.7%, 91.7% and 85.5% of the
deliveries of the East, the West and the North Pipelines, respectively, were
made through their terminals, and the remainder of the respective deliveries of
such lines were made to other pipelines and customer owned storage tanks.
Storage of product at terminals pending delivery is considered by KPP
to be an integral part of the petroleum product delivery service of the
pipelines. Shippers generally store refined petroleum products for less than one
week. Ancillary services, including injection of shipper-furnished and generic
additives, are available at each terminal.
KPP owns 1,500 tons of ammonia storage at the terminal near Hermann,
Missouri. One half of the capacity is leased to Koch Nitrogen to support their
leased terminal obligations.
Demand for and Sources of Refined Petroleum Products
KPP's pipeline business depends in large part on the level of demand
for refined petroleum products in the markets served by the pipelines and the
ability and willingness of refiners and marketers having access to the pipelines
to supply such demand by deliveries through the pipelines.
Much of the refined petroleum products delivered through the East
Pipeline and the western three terminals on the North Pipeline is ultimately
used as fuel for railroads or in agricultural operations, including fuel for
farm equipment, irrigation systems, trucks used for transporting crops and crop
drying facilities. Demand for refined petroleum products for agricultural use,
and the relative mix of products required, is affected by weather conditions in
the markets served by the East and North Pipeline. The agricultural sector is
also affected by government agricultural policies and crop prices. Although
periods of drought suppress agricultural demand for some refined petroleum
products, particularly those used for fueling farm equipment, the demand for
fuel for irrigation systems often increases during such times.
While there is some agricultural demand for the refined petroleum
products delivered through the West Pipeline, as well as military jet fuel
volumes, most of the demand is centered in the Denver and Colorado Springs area.
Because demand on the West Pipeline and the Minneapolis area terminal of the
North Pipeline is significantly weighted toward urban and suburban areas, the
product mix on the West Pipeline and that terminal includes a substantially
higher percentage of gasoline than the product mix on the East Pipeline.
KPP's refined petroleum products pipelines are also dependent upon
adequate levels of production of refined petroleum products by refineries
connected to the Pipelines, directly or through connecting pipelines. The
refineries are, in turn, dependent upon adequate supplies of suitable grades of
crude oil. The refineries connected directly to the East Pipeline obtain crude
oil from producing fields located primarily in Kansas, Oklahoma and Texas, and,
to a much lesser extent, from other domestic or foreign sources. In addition,
refineries in Kansas, Oklahoma and Texas are also connected to the East Pipeline
through other pipelines. These refineries obtain their supplies of crude oil
from a variety of sources. The refineries connected directly to the West
Pipeline are located in Casper and Cheyenne, Wyoming and Denver, Colorado.
Refineries in Billings and Laurel, Montana are connected to the West Pipeline
through other pipelines. These refineries obtain their supplies of crude oil
primarily from Rocky Mountain sources. The North Pipeline is heavily dependent
on the Tesoro Mandan refinery which primarily operates on North Dakota crude oil
although it has the ability to access other crude oils. If operations at any one
refinery were discontinued, KPP believes (assuming unchanged demand for refined
petroleum products in markets served by the refined petroleum products
pipelines) that the effects thereof would be short-term in nature, and KPP's
business would not be materially adversely affected over the long term because
such discontinued production could be replaced by other refineries or by other
sources.
The majority of the refined petroleum product transported through the
East Pipeline in 2003 was produced at three refineries located at McPherson and
El Dorado, Kansas and Ponca City, Oklahoma, and operated by the National
Cooperative Refining Association ("NCRA"), Frontier Refining and
Conoco/Phillips, Inc. respectively. The NCRA and Frontier Refining refineries
are connected directly to the East Pipeline. The McPherson, Kansas refinery
operated by NCRA accounted for approximately 30.1% of the total amount of
product shipped over the East Pipeline in 2003. The East Pipeline also has
direct access by third party pipelines to four other refineries in Kansas,
Oklahoma and Texas and to Gulf Coast supplies of products through connecting
pipelines that receive products from pipelines originating on the Gulf Coast.
Five connecting pipelines can deliver propane from gas processing plants in
Texas, New Mexico, Oklahoma and Kansas to the East Pipeline for shipment.
The majority of the refined petroleum products transported through the
West Pipeline is produced at the Frontier Refinery located at Cheyenne, Wyoming,
the Valero Energy Corporation and Suncor Refineries located at Denver, Colorado,
and Sinclair's Little America Refinery located at Casper, Wyoming, all of which
are connected directly to the West Pipeline. The West Pipeline also has access
to three Billings, Montana, area refineries through a connecting pipeline.
Demand for and Sources of Anhydrous Ammonia
KPP's Ammonia Pipeline business depends on the level of demand for
direct application of anhydrous ammonia as a fertilizer for crop production
("Direct Application" or "DA"), the weather (DA is not effective if the ground
is too wet or too dry) and the price of natural gas (the primary component of
anhydrous ammonia).
The Ammonia Pipeline is the largest of three anhydrous ammonia
pipelines in the United States and the only one that has the capability of
receiving foreign production directly into the system and transporting anhydrous
ammonia into the nation's corn belt. This ability to receive either domestic or
foreign anhydrous ammonia is a competitive advantage over the next largest
ammonia system which originates in Oklahoma and extends into Iowa.
Corn producers have several fertilizer alternatives such as liquid, dry
or Direct Application. Liquid and dry fertilizers are both upgrades of anhydrous
ammonia and therefore are generally more costly but are less sensitive to
weather conditions during application. DA is the cheapest method of fertilizer
application but cannot be applied if the ground is too wet or extremely dry.
Principal Customers
KPP had a total of approximately 55 shippers in 2003. The principal
shippers include four integrated oil companies, four refining companies, three
large farm cooperatives and one railroad. Transportation revenues attributable
to the top 10 shippers were $86.6 million, $61.5 million and $51.5 million,
which accounted for 72%, 74% and 69% of total KPP revenues shipped for each of
the years 2003, 2002 and 2001, respectively.
Competition and Business Considerations
The East and North Pipelines' major competitor is an independent,
regulated common carrier pipeline system owned by Magellan Midstream Partners,
L.P. ("Magellan"), formerly the Williams Companies, Inc., that operates
approximately 100 miles east of and parallel to the East Pipeline and in close
proximity to the North Pipeline. The Magellan system is a substantially more
extensive system than the East and North Pipelines. Competition with Magellan is
based primarily on transportation charges, quality of customer service and
proximity to end users, although refined product pricing at either the origin or
terminal point on a pipeline may outweigh transportation costs. Twenty-one of
the East Pipeline's and all four of the North Pipeline's delivery terminals are
located within 2 to 145 miles of, and in direct competition with Magellan's
terminals.
The West Pipeline competes with the truck-loading racks of the Cheyenne
and Denver refineries and the Denver terminals of the Chase Terminal Company and
Conoco/Phillips. Valero L.P. terminals in Denver and Colorado Springs, connected
to a Valero L.P. pipeline from their Texas Panhandle Refinery, are major
competitors to the West Pipeline's Denver and Fountain Terminals, respectively.
Because pipelines are generally the lowest cost method for intermediate
and long-haul movement of refined petroleum products, KPP's more significant
competitors are common carrier and proprietary pipelines owned and operated by
major integrated and large independent oil companies and other companies in the
areas where KPP delivers products. Competition between common carrier pipelines
is based primarily on transportation charges, quality of customer service and
proximity to end users. KPP believes high capital costs, tariff regulation,
environmental considerations and problems in acquiring rights-of-way make it
unlikely that other competing pipeline systems comparable in size and scope to
KPP's Pipelines will be built in the near future, provided KPP's Pipelines have
available capacity to satisfy demand and its tariffs remain at reasonable
levels.
The costs associated with transporting products from a loading terminal
to end users limit the geographic size of the market that can be served
economically by any terminal. Transportation to end users from the loading
terminals of KPP is conducted principally by trucking operations of unrelated
third parties. Trucks may competitively deliver products in some of the areas
served by KPP's Pipelines. However, trucking costs render that mode of
transportation not competitive for longer hauls or larger volumes. KPP does not
believe that trucks are, or will be, effective competition to its long-haul
volumes over the long term.
Competitors of the Ammonia Pipeline include another anhydrous ammonia
pipeline which originates in Oklahoma and terminates in Iowa. The competitor
pipeline has the same DA demand and weather issues as the Ammonia Pipeline but
is restricted to domestically produced anhydrous ammonia. Barges and railroads
represent other forms of direct competition to the pipeline under certain market
conditions.
LIQUIDS TERMINALING BUSINESS
Introduction
KPP's terminaling business is conducted through the Support Terminal
Services operation ("ST Services" or "ST") and Statia Terminals International
N.V. ("Statia"). ST Services is one of the largest independent petroleum
products and specialty liquids terminaling companies in the United States.
Statia, acquired on February 28, 2002 for a purchase price of $178 million (net
of cash acquired), plus the assumption of $107 million of debt, owns and
operates KPP's two largest terminals and provides related value-added services,
including crude oil and petroleum product blending and processing, berthing of
vessels at their marine facilities, and emergency and spill response services.
In addition to its terminaling services, Statia sells bunkers, which is the fuel
marine vessels consume, and bulk petroleum products to various commercial
interests.
For the year ended December 31, 2003, KPP's terminaling business
accounted for approximately 41% of KPP's revenues. As of December 31, 2003, ST
operated 37 facilities in 20 states, with a total storage capacity of
approximately 33.9 million barrels. ST also owns and operates six terminals
located in the United Kingdom, having a total capacity of approximately 5.5
million barrels. In September 2002, ST acquired eight terminals in Australia and
New Zealand with a total capacity of approximately 1.2 million barrels for
approximately $47 million in cash. ST Services and its predecessors have a long
history in the terminaling business and handle a wide variety of liquids from
petroleum products to specialty chemicals to edible liquids. At the end of 2003,
Statia's tank capacity was 18.8 million barrels, including an 11.3 million
barrel storage and transshipment facility located on the Netherlands Antilles
island of St. Eustatius, and a 7.5 million barrel storage and transshipment
facility located at Point Tupper, Nova Scotia, Canada.
KPP's terminal facilities provide storage and handling services on a
fee basis for petroleum products, specialty chemicals and other liquids. KPP's
six largest terminal facilities are located on the Island of St. Eustatius,
Netherlands Antilles; in Point Tupper, Nova Scotia, Canada; in Piney Point,
Maryland; in Linden, New Jersey (50% owned joint venture); in Crockett,
California; and in Martinez, California.
Description of Largest Terminal Facilities
St. Eustatius, Netherlands Antilles
Statia owns and operates an 11.3 million barrel petroleum terminaling
facility located on the Netherlands Antilles island of St. Eustatius, which is
located at a point of minimal deviation from major shipping routes. This
facility is capable of handling a wide range of petroleum products, including
crude oil and refined products, and can accommodate the world's largest tankers
for loading and discharging crude oil. A two-berth jetty, a two-berth monopile
with platform and buoy systems, a floating hose station, and an offshore single
point mooring buoy with loading and unloading capabilities serve the terminal's
customers' vessels. The St. Eustatius facility has a total of 51 tanks. The fuel
oil and petroleum product facilities have in-tank and in-line blending
capabilities, while the crude tanks have tank-to-tank blending capability as
well as in-tank mixers. In addition to the storage and blending services at St.
Eustatius, the facility has the flexibility to utilize certain storage capacity
for both feedstock and refined products to support its atmospheric distillation
unit, which is capable of processing up to 15,000 BPD of feedstock, ranging from
condensates to heavy crude oil. Statia owns and operates all of the berthing
facilities at its St. Eustatius terminal and charges vessels a fee for their
use. Vessel owners or charterers may incur separate fees for associated services
such as pilotage, tug assistance, line handling, launch service, emergency
response services, and other ship services.
Point Tupper, Nova Scotia, Canada
Statia owns and operates a 7.5 million barrel terminaling facility
located at Point Tupper on the Strait of Canso, near Port Hawkesbury, Nova
Scotia, Canada, which is located approximately 700 miles from New York City, 850
miles from Philadelphia and 2,500 miles from Mongstad, Norway. This facility is
the deepest independent, ice-free marine terminal on the North American Atlantic
coast, with access to the East Coast and Canada as well as the Midwestern United
States via the St. Lawrence Seaway and the Great Lakes system. With one of the
premier jetty facilities in North America, the Point Tupper facility can
accommodate substantially all of the world's largest, fully-laden very large
crude carriers and ultra large crude carriers for loading and discharging crude
oil, petroleum products, and petrochemicals. The Point Tupper facility has a
total of 37 tanks. Its butane sphere is one of the largest of its kind in North
America. The facility's tanks were renovated in 1994 to comply with construction
standards that meet or exceed American Petroleum Institute, NFPA, and other
material industry standards. Crude oil and petroleum product movements at the
terminal are fully automated. Separate Statia fees apply for the use of the
jetty facility as well as associated services, including pilotage, tug
assistance, line handling, launch service, spill response services, and other
ship services. Statia also charters tugs, mooring launches, and other vessels to
assist with the movement of vessels through the Strait of Canso and the safe
berthing of vessels at Point Tupper and to provide other services to vessels.
Piney Point, Maryland
The largest domestic terminal currently owned by ST is located on
approximately 400 acres on the Potomac River. The facility was acquired as part
of the purchase of the liquids terminaling assets of Steuart Petroleum Company
and certain of its affiliates (collectively "Steuart") in December 1995. The
Piney Point terminal has approximately 5.4 million barrels of storage capacity
in 28 tanks and is the closest deep-water facility to Washington, D.C. This
terminal competes with other large petroleum terminals in the East Coast
water-borne market extending from New York Harbor to Norfolk, Virginia. The
terminal currently stores petroleum products consisting primarily of fuel oils
and asphalt. The terminal has a dock with a 36-foot draft for tankers and four
berths for barges. It also has truck-loading facilities, product-blending
capabilities and is connected to a pipeline which supplies residual fuel oil to
two power generating stations.
Linden, New Jersey
In October 1998, ST entered into a joint venture relationship with
Northville Industries Corp. ("Northville") to acquire a 50% ownership interest
in and the management of the terminal facility at Linden, New Jersey that was
previously owned by Northville. The 44-acre facility provides ST with deep-water
terminaling capabilities at New York Harbor and primarily stores petroleum
products, including gasoline, jet fuel and fuel oils. The facility has a total
capacity of approximately 3.9 million barrels in 22 tanks, can receive products
via ship, barge and pipeline and delivers product by ship, barge, pipeline and
truck. The terminal owns two docks and leases a third with draft limits of 35,
24 and 24 feet, respectively.
Crockett, California
The Crockett Terminal was acquired in January 2001 as a part of the
Shore acquisition. The terminal has approximately 3 million barrels of tankage
and is located in the San Francisco Bay area. The facility provides deep-water
access for handling petroleum products and gasoline additives such as ethanol.
The terminal offers pipeline connections to various refineries and pipelines. It
receives and delivers product by vessel, barge, pipeline and truck-loading
facilities. The terminal also has railroad tank car unloading capability.
Martinez, California
The Martinez Terminal, also acquired in January 2001 as a part of the
Shore acquisition, is located in the refinery area of San Francisco Bay. It has
approximately 3.1 million barrels of tankage and handles refined petroleum
products as well as crude oil. The terminal is connected to a pipeline and to
area refineries by pipelines and can also receive and deliver products by vessel
or barge. It also has a truck rack for product delivery.
KPP's facilities have been designed with engineered structural measures
to minimize the possibility of the occurrence and the level of damage in the
event of a spill or fire. All loading areas, tanks, pipes and pumping areas are
"contained" to collect any spillage and insure that only properly treated water
is discharged from the site.
Other Terminal Sites
In addition to the four major domestic facilities described above, ST
Services has 31 other terminal facilities located throughout the United States,
six facilities in the United Kingdom, four facilities in Australia and four in
New Zealand. These other facilities primarily store petroleum products for a
variety of customers, with the exception of the facilities in Texas City, Texas,
which handles specialty chemicals; Columbus, Georgia, which handles aviation
gasoline and specialty chemicals; Winona, Minnesota, which handles nitrogen
fertilizer solutions; Savannah, Georgia, which handles chemicals and caustic
solutions, as well as petroleum products; Vancouver, Washington, which handles
chemicals and fertilizer; Eastham, United Kingdom which handles chemicals and
animal fats; and Runcorn, United Kingdom, which handles molten sulphur, and the
Australian and New Zealand terminals which handle chemicals and animal fats and
oil. Overall, these facilities provide ST Services with locations which are
diverse geographically, in products handled and in customers served.
The following table outlines KPP's terminal locations, capacities,
tanks and primary products handled:
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- ------------------------------ ------------- ------------- ------------------------------
Major U. S. Terminals:
Piney Point, MD 5,403,000 28 Petroleum
Linden, NJ(a) 3,884,000 22 Petroleum
Crockett, CA 3,048,000 24 Petroleum, Ethanol
Martinez, CA 3,106,000 19 Petroleum
Jacksonville, FL 2,069,000 30 Petroleum
Texas City, TX 2,161,000 136 Chemicals, Petrochemicals,
Petroleum
Other U. S. Terminals:
Montgomery, AL(b) 162,000 7 Petroleum, Jet Fuel
Moundville, AL 310,000 6 Jet Fuel
Tucson, AZ(a) 174,000 7 Petroleum
Los Angeles, CA 597,000 20 Petroleum
Richmond, CA 617,000 25 Petroleum, Ethanol
Stockton, CA 706,000 32 Petroleum, Ethanol, Fertilizer
Bremen, GA 182,000 9 Petroleum, Jet Fuel
Brunswick, GA 302,000 3 Fertilizer, Pulp Liquor
Columbus, GA 175,000 24 Petroleum, Chemicals
Macon, GA(b) 307,000 10 Petroleum, Jet Fuel
Savannah, GA 903,000 28 Petroleum, Chemicals
Blue Island, IL 752,000 19 Petroleum, Ethanol
Chillicothe, IL(a) 270,000 6 Petroleum
Peru, IL 221,000 8 Petroleum, Fertilizer
Indianapolis, IN 410,000 18 Petroleum
Westwego, LA 849,000 53 Molasses, Fertilizer, Caustic,
Chemicals
Andrews AFB Pipeline, MD(b) 72,000 3 Jet Fuel
Baltimore, MD 832,000 50 Chemicals, Asphalt, Jet Fuel
Salisbury, MD 177,000 14 Petroleum
Winona, MN 267,000 8 Fertilizer
Reno, NV 107,000 7 Petroleum
Paulsboro, NJ 1,580,000 18 Petroleum
Alamogordo, NM(b) 120,000 5 Jet Fuel
Drumright, OK 315,000 4 Petroleum
Portland, OR 1,119,000 31 Petroleum
Philadelphia, PA 894,000 11 Petroleum
Dumfries, VA 554,000 16 Petroleum, Asphalt
Virginia Beach, VA(b) 40,000 2 Jet Fuel
Tacoma, WA 377,000 15 Petroleum
Vancouver, WA 543,000 55 Chemicals, Fertilizer, Petroleum
Milwaukee, WI 308,000 7 Petroleum
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- ------------------------------ ------------- ------------- ------------------------------
Foreign Terminals:
St. Eustatius, Netherlands
Antilles. 11,350,000 60 Petroleum, crude oil
Point Tupper, Canada 7,514,000 40 Petroleum, crude oil
Sydney, Australia 330,000 65 Chemicals, fats and oils
Melbourne, Australia 468,000 118 Specialty chemicals
Geelong, Australia 145,000 14 Specialty chemicals, petroleum
Adelaide, Australia 90,000 24 Chemicals, tallow, petroleum
Auckland, New Zealand (a) 74,000 44 Fats, oils and chemicals
New Plymouth, New Zealand 35,000 10 Fats, oils and chemicals
Mt. Maunganui, New Zealand 83,000 24 Fats, oils and chemicals
Wellington, New Zealand 50,000 13 Fats, oils and chemicals
Grays, England 1,945,000 53 Petroleum
Eastham, England 2,185,000 162 Chemicals, Petroleum, Animal Fats
Runcorn, England 146,000 4 Molten sulphur
Glasgow, Scotland 344,000 16 Petroleum
Leith, Scotland 459,000 34 Petroleum, Chemicals
Belfast, Northern Ireland 407,000 41 Petroleum
--------------- --------------
59,538,000 1,502
=============== ==============
(a) The terminal is 50% owned by ST.
(b) Facility also includes pipelines to U.S. government military base
locations.
Customers
Statia provides terminaling services for crude oil and refined
petroleum products to many of the world's largest producers of crude oil,
integrated oil companies, oil traders, and refiners. Statia's crude oil
transshipment customers include an oil producer that leases and utilizes 5.0
million barrels of storage at St. Eustatius, and a major international oil
company which leases and utilizes 3.6 million barrels of storage at Point
Tupper, both of which have long-term contracts with Statia. In addition, two
different international oil companies each lease and utilize 1.0 million barrels
of clean products storage at St. Eustatius and Point Tupper, respectively. Also
in Canada, a consortium consisting of major oil companies sends natural gas
liquids via pipeline to certain processing facilities on land leased from
Statia. After processing, certain products are stored at the Point Tupper
facility under a long-term contract. In addition, Statia's blending capabilities
have attracted customers who have leased capacity primarily for blending
purposes and who have contributed to Statia's bunker fuel and bulk product
sales.
The storage and transport of jet fuel for the U.S. Department of
Defense is an important part of ST's business. Eleven of ST's terminal sites are
involved in the terminaling or transport (via pipeline) of jet fuel for the
Department of Defense and four of the eleven locations have been utilized solely
by the U.S. Government. Of the eleven locations, six include pipelines which
deliver jet fuel directly to nearby military bases.
Competition and Business Considerations
In addition to the terminals owned by independent terminal operators,
such as KPP, many major energy and chemical companies own extensive terminal
storage facilities. Although such terminals often have the same capabilities as
terminals owned by independent operators, they generally do not provide
terminaling services to third parties. In many instances, major energy and
chemical companies that own storage and terminaling facilities are also
significant customers of independent terminal operators, such as KPP. Such
companies typically have strong demand for terminals owned by independent
operators when independent terminals have more cost effective locations near key
transportation links, such as deep-water ports. Major energy and chemical
companies also need independent terminal storage when their owned storage
facilities are inadequate, either because of size constraints, the nature of the
stored material or specialized handling requirements.
Independent terminal owners generally compete on the basis of the
location and versatility of terminals, service and price. A favorably located
terminal will have access to various cost effective transportation modes both to
and from the terminal. Transportation modes typically include waterways,
railroads, roadways and pipelines. Terminals located near deep-water port
facilities are referred to as "deep-water terminals" and terminals without such
facilities are referred to as "inland terminals"; although some inland
facilities located on or near navigable rivers are served by barges.
Terminal versatility is a function of the operator's ability to offer
handling for diverse products with complex handling requirements. The service
function typically provided by the terminal includes, among other things, the
safe storage of the product at specified temperature, moisture and other
conditions, as well as receipt at and delivery from the terminal, all of which
must be in compliance with applicable environmental regulations. A terminal
operator's ability to obtain attractive pricing is often dependent on the
quality, versatility and reputation of the facilities owned by the operator.
Although many products require modest terminal modification, operators with
versatile storage capabilities typically require less modification prior to
usage, ultimately making the storage cost to the customer more attractive.
A few companies offering liquid terminaling facilities have
significantly more capacity than KPP. However, much of KPP's tankage can be
described as "niche" facilities that are equipped to properly handle "specialty"
liquids or provide facilities or services where management believes KPP enjoys
an advantage over competitors. As a result, many of KPP's terminals compete
against other large petroleum products terminals, rather than specialty liquids
facilities. Such specialty or "niche" tankage is less abundant in the U.S. and
"specialty" liquids typically command higher terminal fees than lower-price bulk
terminaling for petroleum products.
The main competition to crude oil storage at Statia's facilities is
from "lightering" which is the process by which liquid cargo is transferred to
smaller vessels, usually while at sea. The price differential between lightering
and terminaling is primarily driven by the charter rates for vessels of various
sizes. Lightering generally takes significantly longer than discharging at a
terminal. Depending on charter rates, the longer charter period associated with
lightering is generally offset by various costs associated with terminaling,
including storage costs, dock charges, and spill response fees. However,
terminaling is generally safer and reduces the risk of environmental damage
associated with lightering, provides more flexibility in the scheduling of
deliveries, and allows customers of Statia to deliver their products to multiple
locations. Lightering in U.S. territorial waters creates a risk of liability for
owners and shippers of oil under the U.S. Oil Pollution Act of 1990 and other
state and federal legislation. In Canada, similar liability exists under the
Canadian Shipping Act. Terminaling also provides customers with the ability to
access value-added terminal services.
In the bunkering business, Statia competes with ports offering bunker
fuels to which, or from which, each vessel travels or are along the route of
travel of the vessel. Statia also competes with bunker delivery locations around
the world. In the Western Hemisphere, alternative bunker locations include ports
on the U.S. East coast and Gulf coast and in Panama, Puerto Rico, the Bahamas,
Aruba, Curacao, and Halifax. In addition, Statia competes with Rotterdam and
various North Sea locations.
PRODUCT MARKETING SERVICES
In March 1998, the Company entered the product marketing business
through an acquisition by Martin, one of the Company's wholly owned
subsidiaries. For over 40 years, this operation and its predecessors have
engaged in the business of acquiring quantities of motor fuels and reselling
them at wholesale in smaller lots at truck racks located in terminal storage
facilities along pipelines primarily located throughout Colorado, Illinois,
Indiana, Ohio, Wisconsin and Wyoming. This business does not own any retail
outlets, pipelines or terminals. KPP's product sales, as discussed in "Liquids
Terminaling Business", delivers bunker fuels to ships in the Caribbean and Nova
Scotia, Canada, and sells bulk petroleum products to various commercial
customers at those locations. In the bunkering business, KPP competes with ports
offering bunker fuels along the route of the vessel. Vessel owners or charterers
are charged berthing and other fees for associated services such as pilotage,
tug assistance, line handling, launch service and emergency response services.
For the year ended December 31, 2003, the product marketing segment's revenues,
gross margin and operating income were $511.2 million, $24.9 million and $12.2
million, respectively.
CAPITAL EXPENDITURES
Capital expenditures by KPP relating to its pipelines, including
routine maintenance and expansion expenditures, but excluding acquisitions, were
$9.6 million, $9.5 million and $4.3 million for 2003, 2002 and 2001,
respectively. During these periods, adequate capacity existed on the Pipelines
to accommodate volume growth, and the expenditures required for environmental
and safety improvements were not material in amount. Capital expenditures,
including routine maintenance and expansion expenditures, but excluding
acquisitions, by KPP relating to its terminaling operations were $34.6 million,
$21.0 million and $12.9 million for 2003, 2002 and 2001, respectively.
Capital expenditures of KPP during 2004, including routine maintenance
and expansion expenditures, but excluding acquisitions, are expected to be
approximately $28 million to $32 million. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." Additional expansion-related capital expenditures will
depend on future opportunities to expand KPP's operations. Such future
expenditures, however, will depend on many factors beyond KPP's control,
including, without limitation, demand for refined petroleum products and
terminaling services in KPP's market areas, local, state and federal
governmental regulations, fuel conservation efforts and the availability of
financing on acceptable terms. No assurance can be given that required capital
expenditures will not exceed anticipated amounts during the year or thereafter
or that KPP will have the ability to finance such expenditures through
borrowings or choose to do so.
REGULATION
Interstate Regulation
The interstate common carrier petroleum product pipeline operations of
KPP are subject to rate regulation by FERC under the Interstate Commerce Act.
The Interstate Commerce Act provides, among other things, that to be lawful the
rates of common carrier petroleum pipelines must be "just and reasonable" and
not unduly discriminatory. New and changed rates must be filed with the FERC,
which may investigate their lawfulness on protest or its own motion. The FERC
may suspend the effectiveness of such rates for up to seven months. If the
suspension expires before completion of the investigation, the rates go into
effect, but the pipeline can be required to refund to shippers, with interest,
any difference between the level the FERC determines to be lawful and the filed
rates under investigation. Rates that have become final and effective may be
challenged by a complaint to FERC filed by a shipper or on the FERC's own
initiative. Reparations may be recovered by the party filing the complaint for
the two-year period prior to the complaint, if FERC finds the rate to be
unlawful.
The FERC allows for a rate of return for petroleum products pipelines
determined by adding (i) the product of a rate of return equal to the nominal
cost of debt multiplied by the portion of the rate base that is deemed to be
financed with debt and (ii) the product of a rate of return equal to the real
(i.e., inflation-free) cost of equity multiplied by the portion of the rate base
that is deemed to be financed with equity. The appropriate rate of return for a
petroleum pipeline is determined on a case-by-case basis, taking into account
cost of capital, competitive factors and business and financial risks associated
with pipeline operations.
Under Title XVIII of the Energy Policy Act of 1992 (the "EP Act"),
rates that were in effect on October 24, 1991 that were not subject to a
protest, investigation or complaint are deemed to be just and reasonable. Such
rates, commonly referred to as grandfathered rates, are subject to challenge
only for limited reasons. Any relief granted pursuant to such challenges may be
prospective only. Because KPP's rates that were in effect on October 24, 1991,
were not subject to investigation and protest at that time, those rates could be
deemed to be just and reasonable pursuant to the EP Act. KPP's current rates
became final and effective in July 2000, and KPP believes that its currently
effective tariffs are just and reasonable and would withstand challenge under
the FERC's cost-based rate standards. Because of the complexity of rate making,
however, the lawfulness of any rate is never assured.
On October 22, 1993, the FERC issued Order No. 561 which adopted a
simplified rate making methodology for future oil pipeline rate changes in the
form of indexation. Indexation, which is also known as price cap regulation,
establishes ceiling prices on oil pipeline rates based on application of a
broad-based measure of inflation in the general economy to existing rates. Rate
increases up to the ceiling level are to be discretionary for the pipeline, and,
for such rate increases, there will be no need to file cost-of-service or
supporting data. Moreover, so long as the ceiling is not exceeded, a pipeline
may make a limitless number of rate change filings. This indexing mechanism
calculates a ceiling rate. Rate decreases are required if the indexing mechanism
operates to reduce the ceiling rate below a pipeline's existing rates. The
pipeline may increase its rates to this calculated ceiling rate without filing a
formal cost based justification and with limited risk of shipper protests.
The indexation method is to serve as the principal basis for the
establishment of oil pipeline rate changes in the future. However, the FERC
determined that a pipeline may utilize any one of the following alternative
methodologies to indexing: (i) a cost-of-service methodology may be utilized by
a pipeline to justify a change in a rate if a pipeline can demonstrate that its
increased costs are prudently incurred and that there is a substantial
divergence between such increased costs and the rate that would be produced by
application of the index; and (ii) a pipeline may base its rates upon a
"light-handed" market-based form of regulation if it is able to demonstrate a
lack of significant market power in the relevant markets.
On September 15, 1997, KPP filed an Application for Market Power
Determination with the FERC seeking market based rates for approximately half of
its markets. In May 1998, the FERC granted KPP's application and approximately
half of the markets served by the East and West Pipelines subsequently became
subject to market force regulation.
In the FERC's Lakehead decision issued June 15, 1995, the FERC
partially disallowed Lakehead's inclusion of income taxes in its cost of
service. Specifically, the FERC held that Lakehead was entitled to receive an
income tax allowance with respect to income attributable to its corporate
partners, but was not entitled to receive such an allowance for income
attributable to partnership interests held by individuals. Lakehead's motion for
rehearing was denied by the FERC and Lakehead appealed the decision to the U.S.
Court of Appeals. Subsequently, the case was settled by Lakehead and the appeal
was withdrawn. In another FERC proceeding involving a different oil pipeline
limited partnership, various shippers challenged such pipeline's inclusion of an
income tax allowance in its cost of service. The FERC decided this case on the
same basis as its holding in the Lakehead case. If the FERC were to partially or
completely disallow the income tax allowance in the cost of service of the East
and West Pipelines on the basis set forth in the Lakehead order, KPL believes
that KPP's ability to pay distributions to the holders of the Units would not be
impaired; however, in view of the uncertainties involved in this issue, there
can be no assurance in this regard.
The Ammonia Pipeline rates are regulated by the Surface Transportation
Board (the "STB"). The STB was established in 1996 when the Interstate Commerce
Commission was terminated by the ICC Termination Act of 1995. The STB is headed
by Board Members appointed by the President and confirmed by the Senate and is
authorized to have three members. The STB jurisdiction generally includes
railroad rate and service issues, rail restructuring transactions and labor
matters related thereto; certain trucking company, moving van, and
non-contiguous ocean shipping company rate matters; and certain pipeline matters
not regulated by the FERC. In the performance of its functions, the STB is
charged with promoting, where appropriate, substantive and procedural regulatory
reform in the economic regulation of surface transportation, and with providing
an efficient and effective forum for the resolution of disputes. The STB seeks
to facilitate commerce by providing an effective forum for efficient dispute
resolution and facilitation of appropriate market-based business transactions.
KPP issued a STB tariff that became effective April 1, 2003. The tariff
filing combined the STB interstate tariff and the Louisiana intrastate tariff
into one document and standardized the tariff regulation between the two
regulatory bodies. The tariff filing modified the capacity allocation procedures
and established a minimum tariff rate of $5.00 per ton. The tariff filing
implemented a 7% tariff increase across all tariff rates. Another modification
was the removal of the "Industrial User" classification which effectively
increases the tariff rates actually paid for transportation to certain shippers
by more than 7%. Dyno Nobel, an industrial user in Missouri, has filed a protest
against the tariff filing. Dyno's protest centered on basically two issues.
First, it questioned KPP's ability to file a tariff without first obtaining
approval from the STB. Second, it questioned the amount of effective increase on
its particular situation on a cost justification basis. CF Industries also filed
a protest questioning KPP's ability to file a tariff without first obtaining
approval from the STB. KPP believes it has regulatory precedent in making the
tariff filing and can cost justify the tariff rate change. Initial data requests
have been submitted and answered, and summary judgment has been requested on the
issue of KPP's ability to file a tariff change. The cost justification portion
of the Dyno protest will go forward after the resolution of the tariff filing
issue.
Intrastate Regulation
The intrastate operations of the East Pipeline in Kansas are subject to
regulation by the Kansas Corporation Commission, the intrastate operations of
the West Pipeline in Colorado and Wyoming are subject to regulation by the
Colorado Public Utility Commission and the Wyoming Public Service Commission,
respectively, and the intrastate operations of the North Pipeline are subject to
regulation by the North Dakota Public Utility Commission. Like the FERC, the
state regulatory authorities require that shippers be notified of proposed
intrastate tariff increases and have an opportunity to protest such increases.
KPP also files with such state authorities copies of interstate tariff changes
filed with the FERC. In addition to challenges to new or proposed rates,
challenges to intrastate rates that have already become effective are permitted
by complaint of an interested person or by independent action of the appropriate
regulatory authority.
The intrastate operations of the Ammonia Pipeline in Louisiana are
subject to regulation by the Louisiana Public Service Commission. Shippers under
the Louisiana intrastate tariff have similar rights as those mentioned in the
paragraph above.
ENVIRONMENTAL MATTERS
General
The operations of KPP are subject to federal, state and local laws and
regulations relating to the protection of the environment in the United States
and to the environmental laws and regulations of the host countries in regard to
the terminals acquired overseas. Although KPP believes that its operations are
in general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and liabilities
will not be incurred by KPP. Moreover, it is possible that other developments,
such as increasingly strict environmental laws, regulations and enforcement
policies thereunder, and claims for damages to property or persons resulting
from the operations of KPP, past and present, could result in substantial costs
and liabilities to KPP.
See "Item 3 - Legal Proceedings" for information concerning two
lawsuits against certain subsidiaries of KPP involving claims for environmental
damages.
Water
The Oil Pollution Act ("OPA") was enacted in 1990 and amends provisions
of the Federal Water Pollution Control Act of 1972 and other statutes as they
pertain to prevention and response to oil spills. The OPA subjects owners of
facilities to strict, joint and potentially unlimited liability for removal
costs and certain other consequences of an oil spill, where such spill is into
navigable waters, along shorelines or in the exclusive economic zone. In the
event of an oil spill into such waters, substantial liabilities could be imposed
upon KPP. Regulations concerning the environment are continually being developed
and revised in ways that may impose additional regulatory burdens on KPP.
Contamination resulting from spills or releases of refined petroleum
products is not unusual within the petroleum pipeline and liquids terminaling
industries. The East Pipeline and ST Services have experienced limited
groundwater contamination at various terminal and pipeline sites resulting from
various causes including activities of previous owners. Remediation projects are
underway or under construction using various remediation techniques. The costs
to remediate contamination at several ST terminal locations are being borne by
the former owners under indemnification agreements. Although no assurances can
be made, KPP believes that the aggregate cost of these remediation efforts will
not be material.
The EPA has promulgated regulations that may require KPP to apply for
permits to discharge storm water runoff. Storm water discharge permits also may
be required in certain states in which KPP operates. Where such requirements are
applicable, KPP has applied for such permits and, after the permits are
received, will be required to sample storm water effluent before releasing it.
KPP believes that effluent limitations could be met, if necessary, with minor
modifications to existing facilities and operations. Although no assurance in
this regard can be given, KPP believes that the changes will not have a material
effect on KPP's financial condition or results of operations.
Aboveground Storage Tank Acts
A number of the states in which KPP operates in the United States have
passed statutes regulating aboveground tanks containing liquid substances.
Generally, these statutes require that such tanks include secondary containment
systems or that the operators take certain alternative precautions to ensure
that no contamination results from any leaks or spills from the tanks. Although
there is not total federal regulation of all above ground tanks, the DOT has
adopted an industry standard that addresses tank inspection, repair, alteration
and reconstruction. This action requires pipeline companies to comply with the
standard for tank inspection and repair for all tanks regulated by the DOT. KPP
is in substantial compliance with all above ground storage tank laws in the
states with such laws. Although no assurance can be given, KPP believes that the
future implementation of above ground storage tank laws by either additional
states or by the federal government will not have a material adverse effect on
KPP's financial condition or results of operations.
Air Emissions
The operations of KPP are subject to the Federal Clean Air Act and
comparable state and local statutes. KPP believes that the operations of KPP's
pipelines and terminals are in substantial compliance with such statutes in all
states in which they operate.
Amendments to the Federal Clean Air Act enacted in 1990 require or will
require most industrial operations in the United States to incur future capital
expenditures in order to meet the air emission control standards that have been
and are to be developed and implemented by the EPA and state environmental
agencies. Pursuant to these Clean Air Act Amendments, those Partnership
facilities that emit volatile organic compounds ("VOC") or nitrogen oxides are
subject to increasingly stringent regulations, including requirements that
certain sources install maximum or reasonably available control technology. In
addition, the 1999 Federal Clean Air Act Amendments include a new operating
permit for major sources ("Title V Permits"), which applies to some of KPP's
facilities. Additionally, new dockside loading facilities owned or operated by
KPP in the United States will be subject to the New Source Performance Standards
that were proposed in May 1994. These regulations require control of VOC
emissions from the loading and unloading of tank vessels.
Although KPP is in substantial compliance with applicable air pollution
laws, in anticipation of the implementation of stricter air control regulations,
KPP is taking actions to substantially reduce its air emissions. KPP plans to
install bottom loading and vapor recovery equipment on the loading racks at
selected terminal sites along the East Pipeline that do not already have such
emissions control equipment. These modifications will substantially reduce the
total air emissions from each of these facilities. Having begun in 1993, this
project is being phased in over a period of years.
Solid Waste
KPP generates non-hazardous solid waste that is subject to the
requirements of the Federal Resource Conservation and Recovery Act ("RCRA") and
comparable state statutes in the United States. The EPA is considering the
adoption of stricter disposal standards for non-hazardous wastes. RCRA also
governs the disposal of hazardous wastes. At present, KPP is not required to
comply with a substantial portion of the RCRA requirements because KPP's
operations generate minimal quantities of hazardous wastes. However, it is
anticipated that additional wastes, which could include wastes currently
generated during pipeline operations, will in the future be designated as
"hazardous wastes". Hazardous wastes are subject to more rigorous and costly
disposal requirements than are non-hazardous wastes. Such changes in the
regulations may result in additional capital expenditures or operating expenses
by KPP.
At the terminal sites at which groundwater contamination is present,
there is also limited soil contamination as a result of the aforementioned
spills. KPP is under no present requirements to remove these contaminated soils,
but KPP may be required to do so in the future. Soil contamination also may be
present at other Partnership facilities at which spills or releases have
occurred. Under certain circumstances, KPP may be required to clean up such
contaminated soils. Although these costs should not have a material adverse
effect on KPP, no assurance can be given in this regard.
Superfund
The Comprehensive Environmental Response, Compensation and Liability
Act ("CERCLA" or "Superfund") imposes liability, without regard to fault or the
legality of the original act, on certain classes of persons that contributed to
the release of a "hazardous substance" into the environment. These persons
include the owner or operator of the site and companies that disposed or
arranged for the disposal of the hazardous substances found at the site. CERCLA
also authorizes the EPA and, in some instances, third parties to act in response
to threats to the public health or the environment and to seek to recover from
the responsible classes of persons the costs they incur. In the course of its
ordinary operations, KPP may generate waste that may fall within CERCLA's
definition of a "hazardous substance". KPP may be responsible under CERCLA for
all or part of the costs required to clean up sites at which such wastes have
been disposed.
Environmental Impact Statement
The United States National Environmental Policy Act of 1969 (the
"NEPA") applies to certain extensions or additions to a pipeline system. Under
NEPA, if any project that would significantly affect the quality of the
environment requires a permit or approval from any United States federal agency,
a detailed environmental impact statement must be prepared. The effect of the
NEPA may be to delay or prevent construction of new facilities or to alter their
location, design or method of construction.
Indemnification
KPL has agreed to indemnify KPP against liabilities for damage to the
environment resulting from operations of the East Pipeline prior to October 3,
1989. Such indemnification does not extend to any liabilities that arise after
such date to the extent such liabilities result from change in environmental
laws or regulations. Under such indemnity, KPL is presently liable for the
remediation of contamination at certain East Pipeline sites. In addition, KPP
was wholly or partially indemnified under certain acquisition contracts for some
environmental costs. Most of such contracts contain time and amount limitations
on the indemnities. To the extent that environmental liabilities exceed the
amount of such indemnity, KPP has affirmatively assumed the excess environmental
liabilities.
SAFETY REGULATION
KPP's Pipelines are subject to regulation by the United States
Department of Transportation (the "DOT") under the Hazardous Liquid Pipeline
Safety Act of 1979 ("HLPSA") relating to the design, installation, testing,
construction, operation, replacement and management of their pipeline
facilities. The HLPSA covers anhydrous ammonia, petroleum and petroleum products
pipelines and requires any entity that owns or operates pipeline facilities to
comply with such safety regulations and to permit access to and copying of
records and to make certain reports and provide information as required by the
Secretary to Transportation. The Federal Pipeline Safety Act of 1992 amended the
HLPSA to include requirements of the future use of internal inspection devices.
KPP does not believe that it will be required to make any substantial capital
expenditures to comply with the requirements of HLPSA as so amended.
On November 3, 2000, the DOT issued new regulations intended by the DOT
to assess the integrity of hazardous liquid pipeline segments that, in the event
of a leak or failure, could adversely affect highly populated areas, areas
unusually sensitive to environmental impact and commercially navigable
waterways. Under the regulations, an operator is required, among other things,
to conduct baseline integrity assessment tests (such as internal inspections)
within seven years, conduct future integrity tests at typically five-year
intervals and develop and follow a written risk-based integrity management
program covering the designated high consequence areas. KPP does not believe
that the increased costs of compliance with these regulations will materially
affect KPP's results of operations.
KPP is subject to the requirements of the United States Federal
Occupational Safety and Health Act ("OSHA") and comparable state statutes that
regulate the protection of the health and safety of workers. In addition, the
OSHA hazard communication standard requires that certain information be
collected regarding hazardous materials used or produced in operations and that
this information be provided to employees, state and local authorities and
citizens. KPP believes that it is in general compliance with OSHA requirements,
including general industry standards, record keeping requirements and monitoring
of occupational exposure to benzene.
The OSHA hazard communication standard, the EPA community right-to-know
regulations under Title III of the Federal Superfund Amendment and
Reauthorization Act, and comparable state statutes require KPP to organize
information about the hazardous materials used in its operations. Certain parts
of this information must be reported to employees, state and local governmental
authorities, and local citizens upon request. In general, KPP expects to
increase its expenditures during the next decade to comply with more stringent
industry and regulatory safety standards such as those described above. Such
expenditures cannot be accurately estimated at this time, although they are not
expected to have a material adverse impact on KPP.
EMPLOYEES
At December 31, 2003, the Company, and its subsidiaries and affiliates
employed approximately 1,078 persons. Approximately 152 persons at seven
terminal locations in the United States and Canada were subject to
representation by labor unions and collective bargaining or similar contracts at
that date. The Company considers relations with its employees to be good.
AVAILABLE INFORMATION
The Company files annual, quarterly, and other reports and other
information with the Securities and Exchange Commission ("SEC") under the
Securities Exchange Act of 1934 (the "Exchange Act"). You may read and copy any
materials that the Company files with the SEC at the SEC's Public Reference Room
at 450 Fifth Street, NW, Washington, DC 20549. You may obtain additional
information about the Public Reference Room by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy information statements, and
other information regarding issuers that file electronically with the SEC.
The Company also makes available free of charge on or through the
Company's Internet site (http://www.kaneb.com) the Company's Annual Report on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and
other information statements and, if applicable, amendments to those reports
filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as
reasonably practicable after the reports and other information is electronically
filed with, or furnished to, the SEC.
Item 2. Properties
The properties owned or utilized by the Company and its subsidiaries
are generally described in Item 1 of this Report. Additional information
concerning the obligations of the Company and KPP for lease and rental
commitments is presented under the caption "Commitments and Contingencies" in
Note 9 to the Company's consolidated financial statements. Such descriptions and
information are hereby incorporated by reference into this Item 2.
The properties used in the operations of KPP's Pipelines are owned by
KPP, through its subsidiary entities, except for KPL's operational headquarters,
located in Wichita, Kansas, which is held under a lease that expires in 2009.
Statia's facilities are owned through subsidiaries and the majority of ST's
facilities are owned, while the remainder, including some of its terminal
facilities located in port areas and its operational headquarters, located in
Dallas, Texas, are held pursuant to lease agreements having various expiration
dates, rental rates and other terms.
Item 3. Legal Proceedings
Grace Litigation. Certain subsidiaries of KPP were sued in a Texas
state court in 1997 by Grace Energy Corporation ("Grace"), the entity from which
KPP acquired ST Services in 1993. The lawsuit involves environmental response
and remediation costs allegedly resulting from jet fuel leaks in the early
1970's from a pipeline. The pipeline, which connected a former Grace terminal
with Otis Air Force Base in Massachusetts (the "Otis pipeline" or the
"pipeline"), ceased operations in 1973 and was abandoned before 1978, when the
connecting terminal was sold to an unrelated entity. Grace alleged that
subsidiaries of KPP acquired the abandoned pipeline, as part of the acquisition
of ST Services in 1993 and assumed responsibility for environmental damages
allegedly caused by the jet fuel leaks. Grace sought a ruling from the Texas
court that these subsidiaries are responsible for all liabilities, including all
present and future remediation expenses, associated with these leaks and that
Grace has no obligation to indemnify these subsidiaries for these expenses. In
the lawsuit, Grace also sought indemnification for expenses of approximately
$3.5 million that it incurred since 1996 for response and remediation required
by the State of Massachusetts and for additional expenses that it expects to
incur in the future. The consistent position of KPP's subsidiaries has been that
they did not acquire the abandoned pipeline as part of the 1993 ST Services
transaction, and therefore did not assume any responsibility for the
environmental damage nor any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis pipeline
and any liabilities associated with the pipeline were transferred to them as
well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created
an automatic stay against actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued an
order staying all proceedings of the appeal because of the bankruptcy. Once that
stay is lifted, KPP's subsidiaries that are party to the lawsuit intend to
resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military
Reservation ("MMR Site"), which has been declared a Superfund Site pursuant to
CERCLA. The MMR Site contains a number of groundwater contamination plumes, two
of which are allegedly associated with the Otis pipeline, and various other
waste management areas of concern, such as landfills. The United States
Department of Defense, pursuant to a Federal Facilities Agreement, has been
responding to the Government remediation demand for most of the contamination
problems at the MMR Site. Grace and others have also received and responded to
formal inquiries from the United States Government in connection with the
environmental damages allegedly resulting from the jet fuel leaks. KPP's
subsidiaries voluntarily responded to an invitation from the Government to
provide information indicating that they do not own the pipeline. In connection
with a court-ordered mediation between Grace and KPP's subsidiaries, the
Government advised the parties in April 1999 that it has identified two spill
areas that it believes to be related to the pipeline that is the subject of the
Grace suit. The Government at that time advised the parties that it believed it
had incurred costs of approximately $34 million, and expected in the future to
incur costs of approximately $55 million, for remediation of one of the spill
areas. This amount was not intended to be a final accounting of costs or to
include all categories of costs. The Government also advised the parties that it
could not at that time allocate its costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the Texas state court judgment, which in the DOJ's view, held
that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation. KPP does not
believe this matter will have a materially adverse effect on its financial
condition, although there can be no assurances as to the ultimate outcome.
PEPCO Litigation. On April 7, 2000, a fuel oil pipeline in Maryland
owned by Potomac Electric Power Company ("PEPCO") ruptured. Work performed with
regard to the pipeline was conducted by a partnership of which ST Services is
general partner. PEPCO has reported that it has incurred total cleanup costs of
$70 million to $75 million. PEPCO probably will continue to incur some cleanup
related costs for the foreseeable future, primarily in connection with EPA
requirements for monitoring the condition of some of the impacted areas. Since
May 2000, ST Services has provisionally contributed a minority share of the
cleanup expense, which has been funded by ST Services' insurance carriers. ST
Services and PEPCO have not, however, reached a final agreement regarding ST
Services' proportionate responsibility for this cleanup effort, if any, and
cannot predict the amount, if any, that ultimately may be determined to be ST
Services' share of the remediation expense, but ST believes that such amount
will be covered by insurance and therefore will not materially adversely affect
KPP's financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims have been
settled for immaterial amounts with ST Services' portion of such settlements
provided by its insurance carrier.
PEPCO and ST Services agreed with the federal government and the State
of Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST have each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. ST Services does not anticipate any
further hearings on the subject and is still awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO has also reached a
settlement of these claims with the State of Maryland. Accordingly, KPP believes
that this matter will not have a material adverse effect on its financial
condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among things, a declaratory judgment as to ST
Services' legal obligations, if any, to reimburse PEPCO for costs of the oil
spill. On December 16, 2002, PEPCO sued ST Services in the United States
District Court for the District of Maryland, seeking recovery of all its costs
for remediation of and response to the oil spill. Pursuant to an agreement
between ST Services and PEPCO, ST Services' suit was dismissed, subject to
refiling. ST Services has moved to dismiss PEPCO's suit. ST Services is
vigorously defending against PEPCO's claims and is pursuing its own
counterclaims for return of monies ST Services has advanced to PEPCO for
settlements and cleanup costs. KPP believes that any costs or damages resulting
from these lawsuits will be covered by insurance and therefore will not
materially adversely affect KPP's financial condition. The amounts claimed by
PEPCO, if recovered, would trigger an excess insurance policy which has a
$600,000 retention, but KPP does not believe that such retention, if incurred,
would materially adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting
from litigation, claims and commitments incident to the ordinary course of
business. Management believes, based on the advice of counsel, that the ultimate
resolution of such contingencies will not have a materially adverse effect on
the financial position, results of operations or liquidity of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not hold a meeting of shareholders or otherwise submit
any matter to a vote of security holders in the fourth quarter of 2003.
PART II
Item 5. Market for the Registrant's Shares and Related Shareholder Matters
The Company's shares ("Shares") were listed and began trading on the
New York Stock Exchange (the "NYSE") effective June 29, 2001, under the symbol
"KSL." At March 5, 2004, there were approximately 4,000 shareholders of record
for the Company. Set forth below are prices on the NYSE and cash distributions
for the periods indicated for such Shares.
Share Prices Per Share Cash
Year High Low Distributions
------ ----------------------- -----------------
2002:
First quarter $22.35 $18.10 $.4125
Second quarter 23.98 19.80 .4125
Third quarter 21.25 16.21 .4125
Fourth quarter 21.39 17.51 .4125
2003:
First quarter 21.11 18.35 .4375
Second quarter 29.35 20.90 .4375
Third quarter 29.70 24.99 .475
Fourth quarter 32.31 26.81 .475
2004:
First quarter 33.78 30.77 (a)
(through March 5, 2004)
(a) The cash distribution with respect to the first quarter of 2004 has not yet
been declared.
Under the terms of its financing agreements, the Company is prohibited
from declaring or paying any distribution if a default exists thereunder.
Item 6. Summary Historical Financial and Operating Data
The following table sets forth, for the periods and at the dates
indicated, certain selected historical consolidated financial data for Kaneb
Services LLC and its subsidiaries (the "Company"). The data in the table (in
thousands, except per share amounts) should be read in conjunction with the
Company's audited financial statements. See also "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Year Ended December 31,
--------------------------------------------------------------------------
2003 2002 (a) 2001 (a) 2000 1999
------------ ------------ ------------ ------------ -------------
Income Statement Data:
Revenues:
Services........................... $ 354,591 $ 288,669 $ 207,796 $ 156,232 $ 158,028
Products........................... 511,200 381,159 327,542 381,186 212,298
------------ ------------ ------------ ------------ -------------
$ 865,791 $ 669,828 $ 535,338 $ 537,418 $ 370,326
============ ============ ============ ============ =============
Operating income...................... $ 128,504 $ 106,359 $ 79,791 $ 61,174 $ 64,911
============ ============ ============ ============ =============
Income before gain on issuance of
units by KPP, income taxes and
cumulative effect of change in
accounting principle............... $ 27,385 $ 24,931 $ 16,051 $ 15,467 $ 17,999
Income tax benefit (expense) (b)...... (4,887) (2,585) 2,413 (2,824) 9,494
Gain on issuance of units by KPP (c).. 10,898 24,882 9,859 - 16,764
------------ ------------ ------------ ------------ -------------
Income before cumulative effect
of change in accounting principle.. 33,396 47,228 28,323 12,643 44,257
Cumulative effect of change in
accounting principle - adoption of
new accounting standard for asset
retirement obligations............. (313) - - - -
------------ ------------ ------------ ------------ -------------
Net income............................ $ 33,083 $ 47,228 $ 28,323 $ 12,643 $ 44,257
============ ============ ============ ============ =============
Per Share Data:
Earnings per share:
Basic:
Before cumulative effect of
change in accounting principle. $ 2.89 $ 4.13 $ 2.57 $ 1.19 $ 4.22
Cumulative effect of change in
accounting principle........... (.03) - - - -
------------ ------------ ------------ ------------ -------------
$ 2.86 $ 4.13 $ 2.57 $ 1.19 $ 4.22
============ ============ ============ ============ =============
Diluted:
Before cumulative effect of
change in accounting principle. $ 2.84 $ 4.02 $ 2.46 $ 1.15 $ 4.06
Cumulative effect of change in
accounting principle........... (.03) - - - -
------------ ------------ ------------ ------------ -------------
$ 2.81 $ 4.02 $ 2.46 $ 1.15 $ 4.06
============ ============ ============ ============ =============
Cash distributions declared
per share (d)...................... $ 1.825 $ 1.65 $ 0.725 $ - $ -
============ ============ ============ ============ =============
Weighted average diluted shares
outstanding........................ 11,792 11,755 11,509 11,029 10,897
============ ============ ============ ============ =============
Year Ended December 31,
--------------------------------------------------------------------------
2003 2002 (a) 2001 (a) 2000 1999
------------ ------------ ------------ ------------ -------------
Balance Sheet Data (at year end):
Property and equipment, net........... $ 1,113,020 $ 1,092,276 $ 481,396 $ 321,448 $ 316,956
Total assets.......................... 1,291,567 1,244,101 571,767 429,852 427,608
Long-term debt........................ 636,308 718,162 277,302 184,052 167,028
Shareholders' equity.................. 77,721 63,654 33,932 71,369 86,833
(a) See Note 3 to Consolidated Financial Statements regarding KPP acquisitions.
(b) See Note 4 to Consolidated Financial Statements regarding 2001 benefit for
change in tax status. Additionally, in 2000 and 1999, the Company
recognized expected benefits from prior years tax losses (change in
valuation allowance) of $4.6 million and $23.3 million, respectively.
(c) See Note 2 to Consolidated Financial Statements regarding the 2003 and 2002
gains on issuance of units by KPP and Note 3 regarding 2001 gain on
issuance of units by KPP.
(d) The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability company agreement, to the common
shareholders of record on the applicable record date, within 45 days after
the end of each quarter. Available cash consists generally of all the cash
receipts of the Company, less all cash disbursements and reserves.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion should be read in conjunction with the consolidated
financial statements of the Company and the notes thereto and the summary
historical financial and operating data included elsewhere in this report.
GENERAL
On November 27, 2000, the Board of Directors of Kaneb Services, Inc.
authorized the distribution of its pipeline, terminaling and product marketing
businesses (the "Distribution") to its stockholders in the form of a new limited
liability company, Kaneb Services LLC (the "Company"). On June 29, 2001, the
Distribution was completed, with each stockholder of Kaneb Services, Inc.
receiving one common share of the Company for each three shares of Kaneb
Services, Inc.'s common stock held on June 20, 2001, the record date for the
Distribution, resulting in the distribution of 10.85 million shares of the
Company. On August 7, 2001, the stockholders of Kaneb Services, Inc. approved an
amendment to its certificate of incorporation to change its name to Xanser
Corporation ("Xanser").
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), now a wholly
owned subsidiary of the Company, formed Kaneb Pipe Line Partners, L.P. ("KPP")
to own and operate its refined petroleum products pipeline business. KPL manages
and controls the operations of KPP through its general partner interests and an
18% (at December 31, 2003) limited partner interest. KPP operates through Kaneb
Pipe Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which
KPP holds a 99% interest as limited partner. KPL owns a 1% interest as general
partner of KPP and a 1% interest as general partner of KPOP.
KPP's petroleum pipeline business consists primarily of the
transportation, as a common carrier, of refined petroleum products in Kansas,
Nebraska, Iowa, South Dakota, North Dakota, Colorado, Wyoming, and Minnesota.
Common carrier activities are those under which transportation through the
pipelines is available at published tariffs filed, in the case of interstate
shipments, with the Federal Energy Regulatory Commission (the "FERC"), or in the
case of intrastate shipments with the relevant state authority, to any shipper
of refined petroleum products who requests such services and satisfies the
conditions and specifications for transportation. The petroleum pipelines
primarily transport gasoline, diesel oil, fuel oil and propane. Substantially
all of the petroleum pipeline operations constitute common carrier operations
that are subject to federal or state tariff regulations. KPP also owns an
approximately 2,000-mile anhydrous ammonia pipeline system acquired from Koch
Pipeline Company, L.P. in November of 2002 (see "Liquidity and Capital
Resources"). The fertilizer pipeline originates in southern Louisiana, proceeds
north through Arkansas and Missouri, and then branches east into Illinois and
Indiana and north and west into Iowa and Nebraska. KPP's petroleum pipeline
business depends on the level of demand for refined petroleum products in the
markets served by the pipelines and the ability and willingness of refineries
and marketers having access to the pipelines to supply such demand by deliveries
through the pipelines. KPP's pipeline revenues are based on volumes shipped and
the distance over which such volumes are transported.
KPP's terminaling business is conducted through Support Terminal
Services ("ST Services") and Statia Terminals International N.V. ("Statia"). ST
Services is one of the largest independent petroleum products and specialty
liquids terminaling companies in the United States. In the United States, ST
Services operates 37 facilities in 20 states. ST Services also owns and operates
six terminals located in the United Kingdom and eight terminals in Australia and
New Zealand. ST Services and its predecessors have a long history in the
terminaling business and handle a wide variety of liquids from petroleum
products to specialty chemicals to edible liquids. Statia, acquired on February
28, 2002 ("see "Liquidity and Capital Resources"), owns a terminal on the Island
of St. Eustatius, Netherlands Antilles and a terminal at Point Tupper, Nova
Scotia, Canada. Independent terminal owners generally compete on the basis of
the location and versatility of the terminals, service and price. Terminal
versatility is a function of the operator's ability to offer handling for
diverse products with complex handling requirements. The service function
typically provided by the terminal includes the safe storage of product at
specified temperatures and other conditions, as well as receipt and delivery
from the terminal. The ability to obtain attractive pricing is dependent largely
on the quality, versatility and reputation of the facility. Terminaling revenues
are earned based on fees for the storage and handling of products.
KPL owns a petroleum product marketing business which provides
wholesale motor fuel marketing services in the Great Lakes and Rocky Mountain
regions. KPP's product sales business delivers bunker fuels to ships in the
Caribbean and Nova Scotia, Canada, and sells bulk petroleum products to various
commercial customers at those locations. In the bunkering business, KPP competes
with ports offering bunker fuels along the route of the vessel. Vessel owners or
charterers are charged berthing and other fees for associated services such as
pilotage, tug assistance, line handling, launch service and emergency response
services.
OVERVIEW
In 2003, The Company integrated the major acquisitions completed in
2002 and focused on the performance of those operations, as well as its core
business, to generate increased cash flow. The Company's success in this effort
enabled it to increase cash distributions twice in 2003. On an annualized basis,
the Company raised its distributions $0.10 in May 2003 and another $0.15 in
November 2003. The Company had a very strong year as revenues increased 29%,
operating income increased 21% and net income before gain on issuance of units
by KPP, income taxes and cumulative effect of change in accounting principle,
increased 10%. Reflecting the Company's two major assets - the 5.1 million KPP
units it owns and the general partner incentive, the Company's distributions
from KPP increased 17% .
In 2003, KPP completed the financing for the $600 million of
acquisitions it made in 2002, which were financed half with equity and half with
debt. In March 2003, KPP sold approximately three million units - the larges