Introduction

The following discussion is intended to provide investors with an understanding of our financial condition and results of our operations, including periods prior to our initial public offering on May 5, 2010. Such analysis should be read in conjunction with the historical audited consolidated financial statements, and accompanying notes. For ease of reference, we refer to the historical financial results of PAA Natural Gas Storage, LLC ("PNGS") prior to our initial public offering as being "our" historical financial results. Unless the context otherwise requires, references to "we," "us," "our," and "the Partnership" are intended to mean the business and operations of PAA Natural Gas Storage, L.P. (the "Partnership" or "PNG") and its consolidated subsidiaries since May 5, 2010. When used in the historical context (i.e. prior to May 5, 2010), these terms are intended to mean the business and operations of PNGS. Unless the context indicates otherwise, for purposes of the following discussion "PAA" refers to Plains All American Pipeline, L.P. (the owner of our general partner) (NYSE: PAA) and its consolidated subsidiaries and affiliates other than the Partnership and its general partner and their respective subsidiaries.

For periods prior to our initial public offering, the historical consolidated financial statements are those of PNGS, our predecessor. Through the contribution of all of the equity interest of PNGS to us in connection with the closing of our initial public offering on May 5, 2010, all of the assets, liabilities and operations of PNGS were contributed directly or indirectly by PAA to the Partnership. For further discussion regarding the Partnership's initial public offering, please see Notes 1 and 9 to our consolidated financial statements.

Our discussion and analysis includes the following:

† Executive Summary

†          Company Overview



†          Overview of Operating Results, Capital Investments and Significant
Activities

† Critical Accounting Policies and Estimates

† Recent Accounting Pronouncements

† Results of Operations

† Outlook

† Liquidity and Capital Resources

Executive Summary

Company Overview

We are primarily a fee-based, growth-oriented Delaware limited partnership formed by Plains All American in January 2010 to own, operate and grow the natural gas storage business that PAA acquired in 2005 and has continuously operated since that time. In conjunction with our initial public offering in May 2010, PAA contributed the equity interest in the entities that owned its natural gas storage business to us. Our business consists of the acquisition, development, operation and commercial management of natural gas storage facilities.

As of December 31, 2012, we owned and operated three natural gas storage facilities located in Louisiana, Mississippi and Michigan that have an aggregate working gas storage capacity of approximately 93 Bcf and an aggregate peak injection and withdrawal capacity of 4.1 Bcf per day and 6.4 Bcf per day, respectively. Our Pine Prairie and Southern Pines facilities are recently constructed, high-deliverability salt cavern natural gas storage complexes located in Evangeline Parish, Louisiana and Greene County, Mississippi, respectively. Our Bluewater facility is a depleted reservoir natural gas storage complex located approximately 50 miles from Detroit in St. Clair County, Michigan. As of December 31, 2012, through these facilities, PNG had a total of nine operational salt storage caverns and two depleted reservoirs used for natural gas storage. Additionally, our dedicated commercial marketing group captures short-term market opportunities by utilizing a portion of our storage capacity for our own account and engaging in related commercial marketing activities.

Overview of Operating Results, Capital Investments and Significant Activities

Adjusted EBITDA for the year ended December 31, 2012 was $122.4 million, a 14% increase over Adjusted EBITDA of $107.2 million for the year ended December 31, 2011. This increase was primarily the result of the completion of the Southern Pines Acquisition on February 9, 2011, incremental revenues attributable to capacity expansions (including additional working gas of approximately 17 Bcf and 9 Bcf in the aggregate at our Pine Prairie and Southern Pines facilities during 2012 and 2011, respectively), a reduction in storage-related costs attributable to firm storage services activities and results of PNG Marketing, LLC (our commercial optimization company). See "- Results of Operations" for further discussion and analysis of our operating results. Expansion capital expenditures for 2012 were approximately $61.0 million. Such expenditures were principally associated with the ongoing development of our Pine Prairie and Southern Pines facilities.

Critical Accounting Policies and Estimates

Critical Accounting Policies

We have adopted various accounting policies to prepare our consolidated financial statements in accordance with GAAP. These critical accounting policies are discussed in Note 2 to our consolidated financial statements.

Critical Accounting Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities, at the date of the financial statements. Such estimates and assumptions may also affect the reported amounts of revenues and expenses during the reporting period. Although we believe these estimates are reasonable, actual results could differ from these estimates. The critical accounting estimates that we have identified are discussed below.

Fair Value of Assets and Liabilities Acquired and Identification of Associated Goodwill and Intangible Assets. In accordance with Financial Accounting Standards Board ("FASB") guidance regarding business combinations, with each acquisition, we allocate the cost of the acquired entity to the assets and liabilities assumed based on their estimated fair values at the date of acquisition. If the initial accounting for the business combination is incomplete when the combination occurs, an estimate will be recognized. Any subsequent adjustment to this estimate, if material, will be adjusted as if the amount was recognized when the combination occurred. We also expense the transaction costs as incurred in connection with each acquisition. In addition, we are required to recognize intangible assets separately from goodwill. Intangible assets with finite lives are amortized over their estimated useful lives as determined by management. Goodwill and intangible assets with indefinite lives are not amortized but instead are periodically assessed for impairment.

Impairment testing entails estimating future net cash flows relating to the asset, based on management's estimate of market conditions including pricing, demand, competition, operating costs and other factors. Determining the fair value of assets and liabilities acquired, as well as intangible assets that relate to such items as customer relationships, contracts, and industry expertise involves professional judgment and is ultimately based on acquisition models and management's assessment of the value of the assets acquired and, to the extent available, third-party assessments. Uncertainties associated with these estimates include assumptions regarding natural gas supply and demand, volatility and pricing of natural gas, economic obsolescence factors in the area and potential future sources of cash flow. Although the resolution of these uncertainties has not historically had a material impact on our results of operations or financial condition, we cannot provide assurance that actual amounts will not vary significantly from estimated amounts. We perform our goodwill impairment test annually (as of June 30) and when events or changes in circumstances indicate that the carrying value may not be recoverable. We did not have any goodwill impairments in 2012, 2011 or 2010.

Property and Equipment and Depreciation Expense. We compute depreciation using the straight-line method based on estimated useful lives. These estimates are based on various factors including condition, manufacturing specifications, technological advances and historical data concerning useful lives of similar assets. Uncertainties that impact these estimates include changes in laws and regulations relating to restoration and abandonment requirements, economic conditions and supply and demand in the area. When assets are put into service, we make estimates with respect to useful lives and salvage values that we believe are reasonable. However, subsequent events could cause us to change our estimates, thus impacting the future calculation of depreciation and amortization.

We also evaluate our property and equipment for impairment when events or circumstances indicate that the carrying value of these assets may not be recoverable. The impairment evaluation is highly dependent on the underlying assumptions of related cash flows. We consider the fair value estimate used to calculate impairment of property and equipment a critical accounting estimate. In determining the existence of an impairment in carrying value, we make a number of subjective assumptions as to:

† whether there is an indication of impairment;

† the grouping of assets;

† the intention of "holding" versus "selling" an asset;

† the forecast of undiscounted expected future cash flow over the asset's estimated useful life; and

† if an impairment exists, the fair value of the asset or asset group.

We did not have impairments of property and equipment in 2012, 2011 or 2010.

Accruals and Contingent Liabilities. We record accruals or liabilities including, but not limited to, insurance claims, asset retirement obligations, property taxes and potential legal claims. Accruals are made when our assessment indicates that it is probable that a liability has occurred and the amount of liability can be reasonably estimated. Such accruals may include estimates and are based on all known facts at the time and our assessment of the ultimate outcome. Among the many uncertainties that impact our estimates are the necessary regulatory requirements for operating gas storage facilities, costs of medical care associated with worker's compensation and employee health insurance claims, and the possibility of legal claims. Our estimates for contingent liability accruals are increased or decreased as additional information is obtained or resolution is achieved. Presently, there are no material accruals in

these areas. Although the resolution of uncertainties has not historically had a material impact on our results of operations or financial condition, we cannot provide assurance that actual amounts will not vary significantly from estimated amounts.

Equity Compensation Plan Expense Recognitions. We recognize compensation expense for outstanding equity compensation awards granted under our Long Term Incentive Plan and similar plans sponsored by PAA. Under generally accepted accounting principles, we are required to estimate the fair value of our outstanding equity awards and recognize that fair value as compensation expense over the applicable service period. For awards that contain a performance condition, the fair value of the award is recognized as compensation expense only if the attainment of the performance condition is considered probable. See Note 13 to our consolidated financial statements for further discussion of our equity compensation plans.

Valuation of Derivative Financial Instruments. We are required to measure derivatives at fair value pursuant to FASB guidance, the estimates of derivative gains or losses for a particular period are unrealized and will most likely not reflect the realized derivative gain or loss upon settlement of the derivative. We estimate the fair value of our derivatives with quoted prices, internal records and information received from third parties. For derivatives that are not exchange traded, the estimates we derive are based on indicative broker quotations that are further validated with market observable inputs. Although the resolution of these uncertainties has not historically had a material impact on our results of operations or financial condition, we cannot provide assurance that actual amounts will not vary significantly from estimated amounts. See Note 10 to our consolidated financial statements for further discussion regarding our use of derivative financial instruments.

Realization of Benefits Under Tax Abatement Programs. We are party to specific agreements with certain taxing authorities that provide for the reduction, abatement or deferral of certain taxes other than income taxes (including ad valorem property taxes, sales and use taxes, inventory taxes and various assessments or charges) in exchange for certain payments or undertakings on our part. If future events result in these agreements not being honored by the applicable tax authorities or we are otherwise unable to realize the benefits we believe we are entitled to under these agreements, we may be (i) subject to additional and unanticipated cash payments and expenses, (ii) unable to recover previous payments made under these agreements (including any payments made to facilitate the enforcement of our rights under these agreements) and
(iii) required to recognize an impairment charge associated with all or a portion of our intangible assets related to such agreements. See Notes 3, 7 and 14 to our consolidated financial statements for further discussion regarding our tax abatement agreements and intangible assets associated with them.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements that will impact us, see Note 2 to our consolidated financial statements.

Results of Operations

Year ended December 31, 2012 and year ended December 31, 2011

The following table includes our operating results for years ended December 31, 2012 and 2011 (amounts in thousands, except for average working storage capacity and monthly operating metrics):

                                                                                          Favorable/(Unfavorable) Variance(1)
                                               Year Ended            Year Ended                       2012 - 2011
                                            December 31, 2012     December 31, 2011                $                       %

Revenues
Firm storage services                      $           143,810   $           136,181   $                   7,629                6 %
Hub services and merchant storage (2)                  239,963               202,837                      37,126               18 %
Other                                                    3,890                 3,946                         (56 )             (1 )%
Total revenues                                         387,663               342,964                      44,699               13 %

Storage-related costs - Hub services and
merchant storage (3)                                  (224,003 )            (191,893 )                   (32,110 )            (17 )%
Storage-related costs - Firm storage
services (4)                                           (13,599 )             (18,123 )                     4,524               25 %
Field operating costs                                  (12,368 )             (11,621 )                      (747 )             (6 )%
General and administrative expenses                    (19,148 )             (22,566 )                     3,418               15 %
Other income/(expense), net                                  5                     5
Equity compensation expense                              3,980                 4,046
Acquisition-related expense                                  -                 4,055
Insurance deductible related to property
damage                                                       -                   500
Mark-to-market of open derivative
positions                                                 (127 )                (138 )
Adjusted EBITDA                            $           122,403   $           107,229   $                  15,174               14 %

Reconciliation to net income
Adjusted EBITDA                            $           122,403   $           107,229   $                  15,174               14 %
Depreciation, depletion and amortization               (37,546 )             (33,714 )                    (3,832 )            (11 )%
Interest expense, net of capitalized
interest                                                (7,701 )              (5,354 )                    (2,347 )            (44 )%
Equity compensation expense                             (3,980 )              (4,046 )
Acquisition-related expense                                  -                (4,055 )
Insurance deductible related to property
damage                                                       -                  (500 )
Mark-to-market of open derivative
positions                                                  127                   138
Net income                                 $            73,303   $            59,698   $                  13,605               23 %

Operating Data:
Net revenue margin (5)                     $           149,934   $           132,810   $                  17,124               13 %
Field operating costs/ G&A/ Other                      (27,531 )             (25,581 )                    (1,950 )             (8 )%
Adjusted EBITDA                            $           122,403   $           107,229   $                  15,174               14 %

Average working storage capacity (Bcf)                      84                    71                          13               18 %

Monthly Operating Metrics ($/Mcf)
Net revenue margin (5)                     $              0.15   $              0.16   $                   (0.01 )             (6 )%
Field operating costs/ G&A /Other                        (0.03 )               (0.03 )                         -                -
Adjusted EBITDA                            $              0.12   $              0.13   $                   (0.01 )             (8 )%

(2) Includes revenues associated with sales of natural gas through commercial marketing activities.

(3) Includes costs associated with natural gas sold through commercial marketing activities and storage-related costs (including fuel expense) attributable to hub services and merchant storage revenues.

(4) Includes storage-related costs (including fuel expense) attributable to firm storage services revenues.

(5) Net revenue margin equals total revenues less storage-related costs and excludes the impact, if any, of mark-to-market adjustments (unrealized gains and losses) on open derivative positions.

Revenues, Volumes and Related Costs. As noted in the table above, our total revenues and storage-related costs increased during the year ended December 31, 2012 (the "2012 period") when compared to the year ended December 31, 2011 (the "2011 period"). The primary reasons for such increases are the completion of the Southern Pines Acquisition on February 9, 2011, results of our commercial optimization company, and incremental revenues attributable to the expansion of our working gas capacity at our Pine Prairie and Southern Pines facilities. These and other significant variances related to these periods are discussed in more detail below:

† Firm storage services - Firm storage services revenues increased in the 2012 period as compared to the 2011 period primarily due to the completion of the Southern Pines Acquisition and incremental revenues attributable to the expansion of our working gas capacity at our Pine Prairie and Southern Pines facilities. These increases were partially offset by decreased storage rates on contracts executed to replace expiring contracts on existing capacity and lower fuel in kind revenues, both of which resulted from lower natural gas prices throughout 2011 and into 2012. Also, additional working storage capacity was retained for use by our commercial optimization company in the 2012 period as compared to the 2011 period. Revenues generated through the use of storage capacity by our commercial optimization company are reflected as merchant storage revenues when natural gas we own is withdrawn from storage and sold.

† Hub services and merchant storage - Hub services and merchant storage revenues (which includes revenues from sales of natural gas by our commercial optimization company) increased in the 2012 period as compared to the 2011 period. Our hub services activities are generally short-term in nature and their timing is influenced by weather, operating disruptions, import activities and other conditions that result in temporary disruptions in supply and demand. The primary reason for the increase in the 2012 period as compared to the 2011 period is due to an increase in volumes of natural gas sold by our commercial optimization company, partially offset by a decline in natural gas prices in the 2012 period as compared to the 2011 period. The volume and timing of natural gas sales by our commercial optimization company are largely driven by market opportunities.

† Other - Other revenues did not have a significant impact on the comparability of our operating results between the 2012 and the 2011 periods.

† Storage-related costs - Hub services and merchant storage - Hub services and merchant storage-related costs (which includes costs associated with natural gas sold by our commercial optimization company) increased in the 2012 period as compared to the 2011 period. The primary reason for the increase in the 2012 period as compared to the 2011 period is due to an increase in volumes of natural gas sold by our commercial optimization company, partially offset by a decline in natural gas prices in 2012 as compared to 2011.

† Storage-related costs - Firm storage services - Firm storage services related costs decreased in the 2012 period as compared to the 2011 period. The decrease in the 2012 period as compared to the 2011 period is primarily due to a reduction in storage and transportation capacity leased from third parties along with lower fuel costs resulting from a decline in natural gas prices in 2012 as compared to 2011.

Other Costs and Expenses. The significant variances are discussed further below:

† Field operating costs - Field operating costs increased in the 2012 period as compared to the 2011 period. The increase is primarily related to the Southern Pines Acquisition and the increase in working gas capacity in-service in the 2012 period as compared to the 2011 period as a result of our expansion efforts at our Pine Prairie and Southern Pines facilities. The 2011 period includes approximately $0.5 million of expense for the property insurance deductible related to the January 2011 operational incident and fire at our Bluewater facility.

† General and administrative expenses - General and administrative expenses decreased in the 2012 period as compared to the 2011 period. The 2011 period includes approximately $4.1 million of acquisition-related expenses associated with the Southern Pines Acquisition. Also, the 2012 period reflects an increase in costs associated with the continued expansion of our business and growth in personnel costs, including equity compensation costs. Additionally, we recognized approximately $1.2 million and $2.7 million of equity compensation expense associated with transaction awards granted by PAA during the 2012 and 2011 periods, respectively. Although we will not bear the economic burden of these awards, we benefit from the services underlying these awards.

† Depreciation, depletion and amortization - Depreciation, depletion and amortization expense increased in the 2012 period as compared to the 2011 period. The increase resulted primarily from an increased amount of depreciable assets resulting from the Southern Pines acquisition and our internal capital expansion projects at our Pine Prairie and Southern Pines facilities. Additionally, amortization of intangible assets acquired in conjunction with the Southern Pines Acquisition was approximately $16.4 million and $14.7 million during the 2012 and 2011 periods, respectively.

† Interest expense, net of capitalized interest - Interest expense, net of capitalized interest, increased in the 2012 period when compared to the 2011 period. Interest expense, on a gross basis, decreased to approximately $15.0 million in the 2012

period as compared to approximately $16.3 million in the 2011 period due to lower average interest rates and was partially offset by higher average debt balances in the 2012 period as compared to the 2011 period. Capitalized interest decreased from approximately $10.9 million in the 2011 period to approximately $7.3 million in the 2012 period. The decrease was primarily the result of lower average interest rates and an increase in assets in-service.

Year ended December 31, 2011 and year ended December 31, 2010

The following table includes our operating results for years ended December 31, 2011 and 2010 (amounts in thousands, except for average working storage capacity and monthly operating metrics):

                                                                                        Favorable/(Unfavorable) Variance(1)
                                              Year Ended            Year Ended                      2011 - 2010
                                           December 31, 2011     December 31, 2010             $                     %
Revenues
Firm storage services                     $           136,181   $            90,965   $            45,216                  50 %
Hub services and merchant storage (2)                 202,837                 6,190               196,647               3,177 %
Other                                                   3,946                 3,132                   814                  26 %
Total revenues                                        342,964               100,287               242,677                 242 %

Storage-related costs - Hub services
and merchant storage (3)                             (191,893 )             (10,035 )            (181,858 )            (1,812 )%
Storage-related costs - Firm storage
services (4)                                          (18,123 )             (15,798 )              (2,325 )               (15 )%
. . .