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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, 2004
OR
[X] 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.
Yes X No
-------- --------
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.
Yes X No
-------- --------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
-------- --------
Aggregate market value of the voting shares held by non-affiliates of the
registrant: $309,666,530. This figure is estimated as of June 30, 2004, at which
date the closing price of the registrant's shares on the New York Stock Exchange
was $28.21 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 4, 2005:
11,696,129.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is filed herewith.
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.
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash. Under the
terms of that agreement, Valero L.P. is offering to purchase all of the
outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement, each
holder of units of limited partnership interests in KPP will receive a number of
Valero L.P. common units based on an exchange ratio that fluctuates within a
fixed range to provide $61.50 in value of Valero L.P. units for each unit of
KPP. The actual exchange ratio will be determined at the time of the closing of
the proposed merger and is subject to a fixed value collar of plus or minus five
percent of Valero L.P.'s per unit price of $57.25 as of October 7, 2004. Should
Valero L.P.'s per unit price fall below $54.39 per unit, the exchange ratio will
remain fixed at 1.1307 Valero L.P. units for each unit of KPP. Likewise, should
Valero L.P.'s per unit price exceed $60.11 per unit, the exchange ratio will
remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust Improvements
Act. The completion of the KSL Merger is also subject to completion of the KPP
Merger. All required shareholder and unitholder approvals have been obtained.
Upon completion of the mergers, the general partner of the combined partnership
will be owned by affiliates of Valero Energy Corporation and the Company and KPP
will become wholly owned subsidiaries of Valero L.P.
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 includes 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 1,082,555 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 KPP'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 currently 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 a portion of
which was leased back to Koch Nitrogen. 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, 2004, these three
systems combined transported a total of 3.8 million barrels of diesel fuel,
representing an aggregate of $1.55 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. During 2004 and 2003, the
Ammonia Pipeline shipped 1,122,618 tons and 1,156,549 tons, respectively, of
ammonia generating $19.6 million and $21.3 million, respectively, of revenue.
Year Ended December 31,
------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- -------------- ------------- --------------
Volume (1).................. 104,344 102,928 89,780 92,116 89,192
Barrel miles (2)............ 22,243 21,327 18,275 18,567 17,843
Revenues (3)................ $100,241 $98,329 $78,240 $74,976 $70,685
(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)
------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- -------------- ------------- --------------
Gasoline.................... 54,745 53,205 45,106 46,268 44,215
Diesel and fuel oil......... 46,223 46,072 40,450 42,354 41,087
Propane..................... 3,376 3,651 4,224 3,494 3,890
------------- ------------- -------------- ------------- --------------
Total....................... 104,344 102,928 89,780 92,116 89,192
============= ============= ============== ============= ==============
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 that of 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 Pipelines' rights-of-way and possible damage to
the Pipelines.
KPP uses 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 "STB"), 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 STB, 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, 2004, 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 12
storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson, Kansas,
with aggregate capacities of approximately 548,555 and 534,000 barrels,
respectively. During 2004, approximately 57.3%, 87.6% and 90.0% 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.
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 Pipelines. 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 2004 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 ConocoPhillips
Company, respectively. The NCRA and Frontier Refining refineries are connected
directly to the East Pipeline. The McPherson, Kansas refinery operated by NCRA
accounted for approximately 31.8% of the total amount of product shipped over
the East Pipeline in 2004. 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 overall nitrogen fertilizer use,
management practice, 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 Texas, then 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 48 shippers in 2004. The principal
shippers include integrated oil companies, refining companies, farm cooperatives
and a railroad. Transportation revenues attributable to the top 10 shippers were
$90.4 million, $86.6 million and $61.5 million, which accounted for 75%, 72% and
74% of total Pipeline revenues shipped for each of the years 2004, 2003 and
2002, 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. Seventeen 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
ConocoPhillips. 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 Texas, 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. Midwest
production 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, 2004, KPP's terminaling business accounted
for approximately 41% of KPP's revenues. As of December 31, 2004, ST operated 41
facilities in 20 states, with a total storage capacity of approximately 34.9
million barrels. ST also owns and operates seven terminals located in the United
Kingdom, having a total capacity of approximately 6.0 million barrels. In May
and September 2004, ST acquired terminals in Philadelphia, Pennsylvania and
Linden, New Jersey from Exxon-Mobil. In September 2004, ST acquired a chemical
and petroleum terminal in Grangemouth, Scotland. 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 2004, 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 barrels per day 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 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. In September 2004, ST, outside of the joint
venture, acquired an adjacent 375,000 barrel terminal from Exxon-Mobil.
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 37 other terminal facilities located throughout the United States,
seven facilities in the United Kingdom, four facilities in Australia and four
facilities 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, lube oils, potash and caustic solutions, as well as petroleum
products; Vancouver, Washington, which handles chemicals and fertilizer;
Eastham, United Kingdom, which handles chemicals and animal fats; Grangemouth,
United Kingdom, which handles chemicals and molasses as well as petroleum
products; 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 2,008,000 124 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,
caustic
Bremen, GA 182,000 9 Petroleum, jet fuel
Brunswick, GA 302,000 3 Fertilizer, pulp liquor
Columbus, GA 175,000 24 Petroleum, chemicals, fertilizers
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 Fertilizer
Indianapolis, IN 410,000 18 Petroleum
Westwego, LA 849,000 53 Molasses, fertilizer, caustic,
chemicals, lube oil
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
Linden, NJ 375,000 11 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
Philadelphia, PA 665,000 11 Petroleum
Texas City, TX 153,000 12 Chemicals, petrochemicals,
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 227,000 49 Chemicals, fertilizer, petroleum
Vancouver, WA 316,000 6 Petroleum, chemicals, fertilizer
Milwaukee, WI 308,000 7 Petroleum, ethanol
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 sulfur
Grangemouth, Scotland 530,000 46 Petroleum, chemicals and molasses
Glasgow, Scotland 344,000 16 Petroleum
Leith, Scotland 459,000 34 Petroleum, chemicals
Belfast, Northern Ireland 407,000 41 Petroleum
--------------- --------------
61,108,000 1,570
=============== ==============
(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, five 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, 2004, the product marketing segment's revenues,
gross margin and operating income were $676.1 million, $28.4 million and $17.3
million, respectively.
CAPITAL EXPENDITURES
Capital expenditures by KPP relating to its pipelines, including routine
maintenance and expansion expenditures, but excluding acquisitions, were $10.3
million, $9.6 million and $9.5 million for 2004, 2003 and 2002, respectively.
During these periods, adequate capacity existed on the Pipelines to accommodate
volume growth, and the expenditures required for environmental matters were not
material in amount. Capital expenditures, including routine maintenance and
expansion expenditures, but excluding acquisitions, by KPP relating to its
terminaling operations were $29.5 million, $34.6 million and $21.0 million for
2004, 2003 and 2002, respectively.
Capital expenditures of KPP during 2005, including routine maintenance and
expansion expenditures, but excluding acquisitions, are expected to be
approximately $40 million to $44 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. On July 20, 2004, the District of Columbia Court
of Appeals vacated the Commission's determination regarding the proper tax
allowance in that case and remanded the income tax allocation issue for further
FERC consideration. FERC has requested and received comments as to the issue. 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 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, and CF Industries
filed protests against the tariff filing. See "Item 3. Legal Proceedings,
Ammonia Pipeline Matters" for a description of those matters.
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 rights similar to 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 several matters
pending 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.
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, 2004, the Company, and its subsidiaries and affiliates
employed approximately 1,133 persons. Approximately 154 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
Richardson, 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 had 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 of 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 Services 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 Services 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. In June of 2004, the DOT issued a final
order reducing the penalty to $256,250 jointly against ST Services and PEPCO and
$74,000 against ST Services. On September 14, 2004, ST Services petitioned for
reconsideration of the order.
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 other 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.
Paulsboro Litigation. In 2003, Exxon Mobil filed a lawsuit in a New Jersey
state court against GATX Corporation, Kinder Morgan Liquid Terminals ("Kinder
Morgan"), the successor in interest to GATX Terminals Corporation ("GATX"), and
the Company's subsidiary, ST Services, seeking reimbursement for remediation
costs associated with the Paulsboro, New Jersey terminal. The terminal was owned
and operated by Exxon Mobil from the early 1950's until 1990 when purchased by
GATX. ST Services purchased the terminal in 2000 from GATX. GATX was
subsequently acquired by Kinder Morgan. As a condition to the sale to GATX in
1990, Exxon Mobil undertook certain remediation obligations with respect to the
site. In the lawsuit, Exxon Mobil is claiming that it has complied with its
remediation and contractual obligations and is entitled to reimbursement from
GATX Corporation, the parent company of GATX, Kinder Morgan, and ST Services for
costs in the amount of $400,000 that it claims are related to releases at the
site subsequent to its sale of the terminal to GATX. It is also alleging that
any remaining remediation requirements are the responsibility of GATX
Corporation, Kinder Morgan, or ST Services. Kinder Morgan has alleged that it
was relieved of any remediation obligations pursuant to the sale agreement
between its predecessor, GATX, and ST Services. ST Services believes that,
except for remediation involving immaterial amounts, GATX Corporation or Exxon
Mobil are responsible for the remaining remediation of the site. Costs of
completing the required remediation depend on a number of factors and cannot be
determined at the current time.
Ammonia Pipeline Matters. A subsidiary of KPP purchased the approximately
2,000-mile ammonia pipeline system from Koch Pipeline Company, L.P. and Koch
Fertilizer Storage and Terminal Company in 2002. The rates of the ammonia
pipeline are subject to regulation by the Surface Transportation Board (the
"STB"). The STB had issued an order in May 2000, prescribing maximum allowable
rates KPP's predecessor could charge for transportation to certain destination
points on the pipeline system. In 2003, KPP instituted a 7% general increase to
pipeline rates. On August 1, 2003, CF Industries, Inc. ("CFI") filed a complaint
with the STB challenging these rate increases. On August 11, 2004, STB ordered
KPP to pay reparations to CFI and to return CFI's rates to the levels permitted
under the rate prescription. KPP has complied with the order. The STB, however,
indicated in the order that it would lift the rate prescription in the event KPP
could show "materially changed circumstances." KPP has submitted evidence of
"materially changed circumstances," which specifically includes its capital
investment in the pipeline. CFI has argued that KPP's acquisition costs should
not be considered by the STB as a measure of KPP's investment base. The STB is
expected to decide the issue within the second quarter of 2005.
Also, on June 16, 2003, Dyno Nobel Inc. ("Dyno") filed a complaint with the
STB challenging the 2003 rate increase on the basis that (i) the rate increase
constitutes a violation of a contract rate, (ii) rates are discriminatory and
(iii) the rates exceed permitted levels. Dyno also intervened in the CFI
proceeding described above. Unlike CFI, Dyno's rates are not subject to a rate
prescription. As of December 31, 2004, Dyno would be entitled to approximately
$2 million in rate refunds, should it be successful. KPP believes, however, that
Dyno's claims are without merit.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of business.
Management believes, after consulting with 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 2004.
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 4, 2005, 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
------------------------------ ---------------------- --------------
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 31.47 28.98 .475
Second quarter 31.17 25.11 .495
Third quarter 31.42 27.28 .495
Fourth quarter 42.91 30.99 .495
2005:
First quarter 43.08 42.61 (a)
(through March 4, 2005)
(a) The cash distribution with respect to the first quarter of 2005 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,
--------------------------------------------------------------------------
2004 2003 2002 (a) 2001 2000
------------ ------------ ------------ ------------ -------------
Income Statement Data:
Revenues:
Services........................... $ 379,155 $ 354,591 $ 288,669 $ 207,796 $ 156,232
Products........................... 676,093 511,200 381,159 327,542 381,186
------------ ------------ ------------ ------------ -------------
$ 1,055,248 $ 865,791 $ 669,828 $ 535,338 $ 537,418
============ ============ ============ ============ =============
Operating income...................... $ 136,779 $ 128,504 $ 106,359 $ 79,791 $ 61,174
============ ============ ============ ============ =============
Income before gain on issuance of
units by KPP, income taxes and
cumulative effect of change in
accounting principle............... $ 27,603 $ 27,385 $ 24,931 $ 16,051 $ 15,467
Income tax benefit (expense) (b)...... (3,251) (4,887) (2,585) 2,413 (2,824)
Gain on issuance of units by KPP (c).. - 10,898 24,882 9,859 -
------------ ------------ ------------ ------------ -------------
Income before cumulative effect
of change in accounting principle.. 24,352 33,396 47,228 28,323 12,643
Cumulative effect of change in
accounting principle - adoption of
new accounting standard for asset
retirement obligations............. - (313) - - -
------------ ------------ ------------ ------------ -------------
Net income............................ $ 24,352 $ 33,083 $ 47,228 $ 28,323 $ 12,643
============ ============ ============ ============ =============
Per Share Data:
Earnings per share:
Basic:
Before cumulative effect of
change in accounting principle. $ 2.07 $ 2.89 $ 4.13 $ 2.57 $ 1.19
Cumulative effect of change in
accounting principle........... - (.03) - - -
------------ ------------ ------------ ------------ -------------
$ 2.07 $ 2.86 $ 4.13 $ 2.57 $ 1.19
============ ============ ============ ============ =============
Diluted:
Before cumulative effect of
change in accounting principle. $ 2.03 $ 2.84 $ 4.02 $ 2.46 $ 1.15
Cumulative effect of change in
accounting principle........... - (.03) - - -
------------ ------------ ------------ ------------ -------------
$ 2.03 $ 2.81 $ 4.02 $ 2.46 $ 1.15
============ ============ ============ ============ =============
Cash distributions declared
per share (d)...................... $ 1.96 $ 1.825 $ 1.65 $ 0.725 $ -
============ ============ ============ ============ =============
Weighted average diluted shares
outstanding........................ 11,981 11,792 11,755 11,509 11,029
============ ============ ============ ============ =============
Year Ended December 31,
--------------------------------------------------------------------------
2004 2003 2002 (a) 2001 2000
------------ ------------ ------------ ------------ -------------
Balance Sheet Data (at year end):
Property and equipment, net........... $ 1,148,612 $ 1,113,020 $ 1,092,276 $ 481,396 $ 321,448
Total assets.......................... 1,356,888 1,291,567 1,244,101 571,767 429,852
Long-term debt........................ 688,935 636,308 718,162 277,302 184,052
Shareholders' equity.................. 80,355 77,721 63,654 33,932 71,369
(a) See Note 4 to Consolidated Financial Statements regarding KPP acquisitions.
(b) Effective with the Distribution (See Note 1 to Consolidated Financial
Statements) the Company became a pass-through entity with its income, for
federal and state purposes, taxed at the shareholder level instead of the
Company paying such taxes. Additionally, in 2000 the Company recognized
expected benefits from prior years tax losses (change in valuation
allowance) of $4.6 million.
(c) See Note 3 to Consolidated Financial Statements regarding the 2003 and 2002
gains 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.
OVERVIEW
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, 2004) 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.
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash. Under the
terms of that agreement, Valero L.P. is offering to purchase all of the
outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed