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BKEP > SEC Filings for BKEP > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for BLUEKNIGHT ENERGY PARTNERS, L.P.

Form 10-K for BLUEKNIGHT ENERGY PARTNERS, L.P.


12-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a publicly traded master limited partnership with operations in twenty-three states. We provide integrated terminalling, storage, gathering and transportation services for companies engaged in the production, distribution and marketing of crude oil and liquid asphalt cement. We manage our operations through four operating segments: (i) crude oil terminalling and storage services, (ii) crude oil pipeline services, (iii) crude oil trucking and producer field services, and (iv) asphalt services.

Recent Events

A time line of certain recent events is set forth below.

February 1, 2013 - We entered into an agreement with Advantage Pipeline to acquire approximately 30% ownership in a 70 mile crude oil pipeline project running from Pecos, Texas to Crane, Texas (the "Pecos River Pipeline"). The Pecos River Pipeline is a new 16" diameter pipeline that will enable west Texas producers to deliver crude oil to Gulf Coast markets through a pipeline connection at Crane, Texas. On September 17, 2013, commercial service started on Phase I of the system consisting of the Highway 18 Station near Grandfalls, Texas and 36 miles of pipeline connecting to the Longhorn Pipeline in Crane, Texas. We operate the pipeline under a long term agreement with Advantage Pipeline.

March 4, 2013 - We amended our credit facility to, among other things,
(i) eliminate the requirement that our consolidated total leverage ratio not exceed 4.00 to 1.00 for purposes of making distributions, (ii) increase our ability to make investments in joint ventures and subsidiaries without such joint ventures and subsidiaries becoming guarantors under our credit facility, and (iii) permit us to include projected EBITDA from material projects for purposes of calculating compliance with our credit facility's minimum consolidated interest coverage ratio and maximum consolidated total leverage ratio.

On June 28, 2013, the Partnership entered into an amended and restated credit agreement which consists of a $400.0 million revolving loan facility.

Our Revenues

Our revenues consist of (i) terminalling and storage revenues, (ii) gathering, transportation and producer field services revenues and (iii) fuel surcharge revenues. For the twelve months ended December 31, 2013, we derived approximately $51.8 million of our revenues from services we provided to Vitol and Advantage Pipeline L.L.C. ("Advantage Pipeline"), with the remainder of our services being provided to third parties.

Terminalling and storage revenues consist of (i) storage service fees from actual storage used on a month-to-month basis; (ii) storage service fees resulting from short-term and long-term contracts for committed space that may or may not be utilized by the customer in a given month; and (iii) terminal throughput service charges to pump crude oil to connecting carriers or to deliver asphalt product out of our terminals. Terminal throughput service charges are recognized as the crude oil exits the terminal and is delivered to the connecting crude oil carrier or third-party terminal and as the asphalt product is delivered out of our terminal. Storage service revenues are recognized as the services are provided on a monthly basis. We earn terminalling and storage revenues in two of our segments: (i) crude oil terminalling and storage services and (ii) asphalt services.

As of March 2014, we have approximately 5.6 million barrels of crude oil storage under service contracts with remaining terms of up to 22 months, including 4.1 million barrels under contract to Vitol. As of March 2014, 2.9 million barrels of crude oil storage contracts expire in 2014. We are in negotiations to contract additional storage capacity; however, there is no certainty that contracts will be renewed, or, if renewed, will be at the same or similar rates with the expiring contracts. If we are


unable to renew the majority of the expiring storage contracts, we may experience lower utilization of our assets which could have a material adverse effect on our business, cash flows, ability to make distributions to our unitholders, the price of our common units, results of operations and ability to conduct our business.

There are a number of market dynamics currently taking place at the Cushing Interchange, including a backwardated market for West Texas Intermediate crude oil, increased Cushing storage capacity, the reversal of Seaway pipeline and significant production increases in Kansas, Oklahoma and Texas. These trends are impacting demand for crude oil storage and putting downward pressure on storage rates. The current market environment places more importance on services and connectivity and, as a result, we plan to invest approximately $8.0 million in capital projects in Cushing in 2014 to enhance our connectivity and crude oil blending services. We believe our mix and delivery of services will differentiate us from competitors.

We have leases and storage agreements with third party customers relating to our 42 asphalt facilities. The majority of the leases and storage agreements related to these facilities have terms that expire between the end of 2016 and the end of 2018. We operate the asphalt facilities pursuant to the storage agreements while our contract counterparties operate the asphalt facilities that are subject to the lease agreements.

Gathering and transportation services revenues consist of service fees recognized for the gathering of crude oil for our customers and the transportation of crude oil to refiners, to common carrier pipelines for ultimate delivery to refiners or to terminalling and storage facilities owned by us and others. Revenue for the gathering and transportation of crude oil is recognized when the service is performed and is based upon regulated and non-regulated tariff rates and the related transport volumes. Producer field services revenue consists of a number of services ranging from gathering condensates from natural gas producers to hauling produced water to disposal wells. Revenue for producer field services is recognized when the service is performed. We earn gathering and transportation revenues in two of our segments:
(i) crude oil pipeline services and (ii) crude oil trucking and producer field services.

During the twelve months ended December 31, 2013, we transported approximately 55,000 Bpd on our pipelines, a decrease of 18% as compared to the twelve months ended December 31, 2012. Vitol accounted for 27% of volumes transported in 2013. In 2012, we evaluated our gathering systems located in Oklahoma and Texas to determine whether or not they were economically feasible to continue to operate after taking into consideration transported volumes, ongoing maintenance costs and risk. As a result we idled approximately 100 miles of gathering pipeline that we determined to not be economically viable and recognized a $1.0 million impairment charge related to these assets in the second quarter of 2012. We sold these and other idled gathering assets for $0.4 million in 2013. The majority of volumes that were displaced as a result of idling the pipeline has been retained by our crude oil transport trucks. We do not anticipate the idling of this gathering pipeline to have a significant impact on the overall future results of our operations.

For the twelve months ended December 31, 2013, we transported approximately 62,000 Bpd on our crude transport trucks, an increase of 13% as compared to the twelve months ended December 31, 2012. Vitol accounted for approximately 44% of volumes transported in 2013. We continue to see opportunity to increase the utilization of our crude oil trucking and producer field services assets due to high demand for our services in the markets we serve.

Fuel surcharge revenues are comprised of revenues recognized for the reimbursement of fuel and power consumed to operate our asphalt product storage tanks and terminals. We recognize fuel surcharge revenues in the period in which the related fuel and power expenses are incurred.

Our Expenses

Operating expenses increased by $10.9 million, or 9%, for 2013 as compared to 2012. This increase was primarily due to incremental costs incurred in connection with our trucking operations as a result of the increase in the volume of crude oil we transported for our customers. General and administrative expenses decreased $2.3 million, or 12%, in 2013 as compared to 2012. The decrease was driven by incremental compensation expense in the fourth quarter of 2012 related to the employment of our new Chief Executive Officer and costs associated with the departure of our former President and Chief Operating Officer and our former Executive Vice President - Products. Our interest expense decreased by $0.1 million during the twelve months ended December 31, 2013 as compared to the twelve months ended December 31, 2012 primarily as a result of the refinancing our credit facility in June 2013.

Income Taxes


As part of the process of preparing the consolidated financial statements, we are required to estimate the federal and state income taxes in each of the jurisdictions in which our subsidiary that is taxed as a corporation operates. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess, using all available positive and negative evidence, the likelihood that the deferred tax assets will be recovered from future taxable income. If we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, we must include an expense or reduction of expense within the tax provisions in the consolidated statement of operations.

Under ASC 740 - Accounting for Income Taxes, an enterprise must use judgment in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists (a) the more positive evidence is necessary and
(b) the more difficult it is to support a conclusion that a valuation allowance is not needed for some portion, or all of the deferred tax asset. Among the more significant types of evidence that we consider are:

taxable income projections in future years,

whether the carryforward period is so brief that it would limit realization of tax benefits,

future revenue and operating cost projections that will produce more than enough taxable income to realize the deferred tax asset based on existing service rates and cost structures, and

our earnings history exclusive of the loss that created the future deductible amount coupled with evidence indicating that the loss is an aberration rather than a continuing condition.

Given that our subsidiary that is taxed as a corporation has limited earnings history for purposes of determining the likelihood of realizing the benefits of the deferred tax assets, we have provided a full valuation allowance against our deferred tax asset as of December 31, 2013.

Our Assets and Services

Our network of assets provides our customers the flexibility to access multiple points for the receipt and delivery of crude oil and the terminalling, storage and processing of crude oil and asphalt cement. Our operations have minimal direct exposure to changes in crude oil and asphalt cement prices, but the volumes of crude oil and asphalt cement we gather, transport, terminal or store are indirectly affected by commodity prices. We generate revenues by charging a fee for services provided at each transportation stage as crude oil is shipped from its origin at the wellhead to destination points such as the Cushing Interchange, to refineries in Oklahoma, Kansas and Texas or to pipelines and by charging a fee for services provided for the terminalling and storage of crude oil and asphalt cement.

Crude oil terminalling and storage assets and services. We provide crude oil terminalling and storage services at our terminalling and storage facilities located in Oklahoma and Texas. We currently own and operate an aggregate of approximately 7.8 million barrels of storage capacity. Of this storage capacity, approximately 6.6 million barrels are located at our terminal in Cushing, Oklahoma. Our Cushing terminal is strategically located within the Cushing Interchange, one of the largest crude oil marketing hubs in the United States and the designated point of delivery specified in all NYMEX crude oil futures contracts. Our terminals have a combined capacity to receive or deliver approximately 10.0 million barrels of crude oil per month. We also own approximately 26 acres of additional land within the Cushing Interchange where we can develop additional storage capacity.

Crude oil pipeline assets and services. We own and operate three pipeline systems, the Mid-Continent system, the East Texas system and the Eagle North system, collectively consisting of approximately 920 miles of pipelines that gather crude oil for our customers and transport it to refiners, to common carrier pipelines for ultimate delivery to refiners or to terminalling and storage facilities owned by us and others. Our pipeline gathering and transportation system located in Oklahoma and the Texas Panhandle, which we refer to as the Mid-Continent system, has a combined length of approximately 510 miles. Our second pipeline gathering and transportation system located in East Texas, which we refer to as the East Texas system, consists of approximately 210 miles of tariff-regulated crude oil gathering pipeline. Our third pipeline transportation system located in Oklahoma, which we refer to as the Eagle North Pipeline System, consists of approximately 200 miles of pipeline.

Crude oil trucking and producer field services. In addition to our pipelines, we use our approximately 170 owned or leased tanker trucks to gather crude oil in Kansas, Oklahoma, Texas, New Mexico and Colorado for our customers at remote wellhead locations generally not connected to pipeline and gathering systems and transport the


crude oil to aggregation points and storage facilities located along pipeline gathering and transportation systems. In connection with our gathering services, we also provide a number of producer field services, ranging from gathering condensates from natural gas producers to hauling production waste water to disposal wells. Our producer service fleet consists of approximately 130 trucks in a number of different sizes.
Asphalt Services. Our 42 asphalt cement terminals are located in 21 states and as such are well positioned to provide asphalt services in the market areas they serve throughout the continental United States. With our approximately 7.0 million barrels of total asphalt product and residual fuel oil storage capacity, we are able to provide our customers the ability to effectively manage their asphalt product storage and processing and marketing activities. We currently have storage contracts or leases with third party customers relating to our 42 asphalt facilities.

Factors That Will Significantly Affect Our Results

Commodity Prices. Although our current operations have minimal direct exposure to commodity prices, the volumes of crude oil and liquid asphalt cement we gather, transport, terminal or store are indirectly affected by commodity prices. Petroleum product prices may be contango (future prices higher than current prices) or backwardated (future prices lower than current prices) depending on market expectations for future supply and demand. Our terminalling and storage services benefit most from an increasing price environment, when a premium is placed on storage, and our gathering and transportation services benefit most from a declining price environment, when a premium is placed on prompt delivery.

Volumes. Our results of operations are dependent upon the volumes of crude oil we gather, transport, terminal and store and asphalt we terminal, store and/or process. An increase or decrease in the production of crude oil from the oil fields served by our pipelines or an increase or decrease in the demand for crude oil in the areas served by our pipelines and storage facilities will have a corresponding effect on the volumes we gather, transport, terminal and store. The production and demand for crude oil and liquid asphalt cement are driven by many factors, including the price for crude oil.

Acquisition Activities. We may pursue acquisition opportunities. These acquisition efforts may involve assets that, if acquired, would have a material effect on our financial condition, results of operations and cash flows. We can give no assurance that any such acquisition efforts will be successful or that any such acquisition will be completed on terms considered favorable to us.

Organic Expansion Activities. We may pursue opportunities to expand our existing asset base and consider constructing additional assets in strategic locations. The construction of additions or modifications to our existing assets, and the construction of new assets, involve numerous regulatory, environmental, political, legal and operational uncertainties beyond our control and may require the expenditure of significant amounts of capital.

Distributions to our Unitholders. We may make distributions to holders of our Preferred Units and common units as well as to our General Partner. To the extent that substantially all of our cash generated by our operations is used to make such distributions, we expect that we will rely upon external financing sources, including commercial bank borrowings and other debt and equity issuances, to fund our acquisition and expansion capital expenditures, as well as our working capital needs.

Vitol Storage Agreements

In March 2010, we entered into a crude oil storage services agreement with Vitol under which we began providing crude oil storage services to Vitol effective May 1, 2010 (the "2010 Vitol Storage Agreement"). The initial term of the 2010 Vitol Storage Agreement is five years commencing on May 1, 2010, subject to automatic renewal periods for successive one year periods until terminated by either party with ninety days prior notice. In March 2013, the 2010 Vitol Storage Agreement was amended to adjust the rates we charge Vitol for services provided under the agreement. We believe that the rates we charge Vitol under this agreement are fair and reasonable to us and our unitholders and are comparable with the rates we charge third parties. The Board's conflicts committee reviewed and approved this agreement, including the amendment thereto, in accordance with our procedures for approval of related party transactions and the provisions of the partnership agreement.

On June 1, 2012, the crude oil storage services agreement with Vitol previously entered into in 2008 expired according to its terms. In anticipation of such expiration, we entered into two new crude oil storage services agreements with Vitol under which we began providing additional crude oil storage services to Vitol effective June 1, 2012. Service revenues under the first agreement are based on the 1.0 million barrels of storage capacity of the crude oil storage tanks that are dedicated to Vitol under the agreement. The initial term of the first agreement was from June 1, 2012 through May 31, 2013. In March 2013, this agreement was amended to extend the term through March 31, 2014 and to adjust the rates we charge Vitol for services provided under the agreement.


Service revenues under the second agreement are based on the 0.5 million barrels of storage capacity of the crude oil storage tanks that are dedicated to Vitol under the agreement. The initial term of the second agreement was from June 1, 2012 through November 30, 2012 and automatically renewed twice before being amended in March 2013. The amendment extended the term through October 31, 2013 and adjusted the rates we charge Vitol for services provided under the agreement. In October 2013, this agreement was again amended to extend the term through March 31, 2014 and to adjust the rates we charge Vitol for services provided under the agreement. We believe that the rates we charge Vitol under these agreements are fair and reasonable to us and our unitholders and are comparable with the rates we charge third parties. The Board's conflicts committee reviewed and approved these agreements, including the amendments thereto, in accordance with our procedures for approval of related party transactions and the provisions of the partnership agreement. During the third quarter of 2012, we entered into another 6-month storage agreement with Vitol effective September 1, 2012 (the "Vitol September 2012 Storage Agreement"). Service revenues under the Vitol September 2012 Storage Agreement are based on the 0.5 million barrels of storage capacity of the crude oil storage tanks that are dedicated to Vitol under the agreement. The initial term of the Vitol September 2012 Storage Agreement was from September 1, 2012 to February 28, 2013. In March 2013, the Vitol September 2012 Storage Agreement was amended to extend the term through October 31, 2013 and to adjust the rates we charge Vitol for services provided under the agreement. In October 2013, the Vitol September 2012 Storage Agreement was again amended to extend the term through March 31, 2014 and to adjust the rates we charge Vitol for services provided under the agreement. We believe that the rates we charge Vitol under this agreement are fair and reasonable to us and our unitholders and are comparable with the rates we charge third parties. The Board's conflicts committee reviewed and approved this agreement, including the amendments thereto, in accordance with our procedures for approval of related party transactions and the provisions of the partnership agreement.

We are currently negotiating with Vitol on the potential renewal of the contracts expiring in March 2014, however, there is no certainty that contracts will be renewed, or, if renewed, will be at the same or similar rates with the expiring contracts.

Results of Operations

Non-GAAP Financial Measures

To supplement our financial information presented in accordance with GAAP, management uses additional measures that are known as "non-GAAP financial measures" in its evaluation of past performance and prospects for the future. The primary measure used by management is operating margin excluding depreciation and amortization.

Management believes that the presentation of such additional financial measures provides useful information to investors regarding our performance and results of operations because these measures, when used in conjunction with related GAAP financial measures, (i) provide additional information about our core operating performance and ability to generate and distribute cash flow, (ii) provide investors with the financial analytical framework upon which management bases financial, operational, compensation and planning decisions and (iii) present measurements that investors, rating agencies and debt holders have indicated are useful in assessing us and our results of operations. These additional financial measures are reconciled to the most directly comparable measures as reported in accordance with GAAP, and should be viewed in addition to, and not in lieu of, our Consolidated Financial Statements and footnotes.

The table below summarizes our financial results for the twelve months ended December 31, 2011, 2012 and 2013, reconciled to the most directly comparable GAAP measure:


                                       For the twelve months                   Favorable/(Unfavorable)
Operating Results                        ended December 31,                 2011-2012            2012-2013
(in thousands)                     2011         2012         2013          $          %         $          %
Operating Margin, excluding
depreciation and amortization
Crude oil terminalling and
storage operating margin        $ 34,120     $ 31,867     $ 27,079      (2,253 )     (7 )%   (4,788 )    (15 )%
Crude oil pipeline services
operating margin                   4,370        2,801        6,909      (1,569 )    (36 )%    4,108      147  %
Crude oil trucking and producer
field services operating margin    5,462        7,658       10,067       2,196       40  %    2,409       31  %
Asphalt services operating
margin                            37,006       36,600       40,968        (406 )     (1 )%    4,368       12  %
Total operating margin,
excluding depreciation and
amortization                      80,958       78,926       85,023      (2,032 )     (3 )%    6,097        8  %

Depreciation and amortization     22,496       22,824       23,962        (328 )     (1 )%   (1,138 )     (5 )%
General and administrative
expenses                          17,311       19,795       17,482      (2,484 )    (14 )%    2,313       12  %
Asset impairment expense             867        1,942          524      (1,075 )   (124 )%    1,418       73  %
Gain on sale of assets             3,008        7,271        1,073       4,263      142  %   (6,198 )    (85 )%

Operating income:                 43,292       41,636       44,128      (1,656 )     (4 )%    2,492        6  %

Other income (expense)
Equity loss in unconsolidated
entity                                 -            -         (502 )         -       NA        (502 )     NA
Interest expense                 (32,898 )    (11,705 )    (11,615 )    21,193      (64 )%       90       (1 )%
Change in fair value of
embedded derivative within
convertible debt                  20,224            -            -     (20,224 )   (100 )%        -       NA
Change in fair value of rights
offering liability                 1,883            -            -      (1,883 )   (100 )%        -       NA
Income tax expense                  (287 )       (318 )       (593 )       (31 )     11  %     (275 )     86  %
Net income from continuing
operations                        32,214       29,613       31,418      (2,601 )     (8 )%    1,805        6  %
Income (loss) from discontinued
operations                         1,261        1,951       (3,383 )       690       55  %   (5,334 )   (273 )%
Net Income                      $ 33,475     $ 31,564     $ 28,035      (1,911 )     (6 )%   (3,529 )    (11 )%

Total operating margin excluding depreciation and amortization increased from 2012 to 2013 due to several factors including a $6.9 million sale of crude oil related to accumulated pipeline loss allowances on our Eagle North and East Texas pipeline systems, a 13% increase in the number of barrels of crude oil transported in our trucking and field services segment and increased product throughput, short-term storage service agreements, and contractual rate escalations on certain asphalt facilities. These increases were offset by decreases in our storage and terminalling segment as changes in market demand for crude oil storage services led to decreases in the rates we charged our customers for those services.

Total operating margin excluding depreciation and amortization for 2012 decreased slightly as compared to 2011 due to a decrease in our storage and terminalling segment as changes in market demand for crude oil storage services led to decreases in the rates we charged our customers for those services and as a result of a $1.6 million decrease in our pipeline transportation segment due primarily to increased compensation costs. These decreases were partially offset . . .

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