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Form 10-K
Table of Contents

 

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 year ended December 31, 2003

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number 1-16417

 

VALERO L.P.

(Exact name of registrant as specified in its charter)

 

Delaware   74-2956831
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

One Valero Place

San Antonio, Texas

(Address of principal executive offices)

 

78212

(Zip Code)

 

Telephone number: (210) 370-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: Common Units representing limited partnership interests listed on the New York Stock Exchange.

 

Securities registered pursuant to 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 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 the Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

 

As of June 30, 2003, the last day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of common units held by non-affiliates based on the last sales price as quoted on the New York Stock Exchange was $500.6 million.

 

The number of common and subordinated units outstanding as of February 1, 2004 was 13,442,072 and 9,599,322, respectively.

 



Table of Contents

TABLE OF CONTENTS

 

          Page

     PART I     

Items 1. & 2.

   Business and Properties    2
    

Segments

   2
    

Valero L.P.’s Relationship with Valero Energy

   8
    

Recent Developments

   10
    

Pipeline and Terminal Control Operations and Maintenance

   12
    

Competition

   12
    

Regulation

   13
    

Properties

   15
    

Employees

   15

Item 3.

   Legal Proceedings    15

Item 4.

   Submission of Matters to a Vote of Security Holders    15
     PART II     

Item 5.

   Market for Registrant’s Common Units and Related Unitholder Matters    16

Item 6.

   Selected Financial Data    18

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    22

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    39

Item 8.

   Financial Statements and Supplementary Data    40

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    73

Item 9A.

   Controls and Procedures    73
     PART III     

Item 10.

   Directors and Executive Officers of the Registrant    74

Item 11.

   Executive Compensation    77

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Unitholder Matters    83

Item 13.

   Certain Relationships and Related Transactions    85

Item 14.

   Principal Accountant Fees and Services    86
     PART IV     

Item 15.

   Exhibits, Financial Statement Schedules, and Reports on Form 8-K    87

Signatures

   93

 


Table of Contents

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

This Form 10-K contains certain estimates, predictions, projections, assumptions and other forward-looking statements that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect Valero L.P.’s current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested in this report. These forward-looking statements can generally be identified by the words “anticipates,” “believes,” “expects,” “plans,” “intends,” “estimates,” “forecasts,” “budgets,” “projects,” “will,” “could,” “should,” “may” and similar expressions. These statements reflect Valero L.P.’s current views with regard to future events and are subject to various risks, uncertainties and assumptions, including:

 

Any reduction in the quantities of crude oil and refined products transported in Valero L.P.’s pipelines or handled at Valero L.P.’s terminals and storage tanks;

 

Any significant decrease in the demand for refined products in the markets served by Valero L.P.’s pipelines and terminals;

 

Any material decline in production by any of Valero Energy’s (as defined below) McKee, Three Rivers, Corpus Christi East, Corpus Christi West, Texas City, Paulsboro, Benicia or Ardmore refineries;

 

Any downward pressure on market prices caused by new competing refined product pipelines that could cause Valero Energy to decrease the volumes transported in Valero L.P.’s pipelines;

 

Any challenges to Valero L.P.’s tariff rates or changes in the FERC’s ratemaking methodology;

 

Any changes in laws and regulations to which Valero L.P. is subject, including federal, state and local tax laws, safety, environmental and employment laws;

 

Overall economic conditions;

 

Any material decrease in the supply of or material increase in the price of crude oil available for transport through Valero L.P.’s pipelines and storage in Valero L.P.’s storage tanks;

 

Inability to expand Valero L.P.’s business and acquire new assets as well as to attract third party shippers;

 

Conflicts of interest with Valero Energy;

 

The loss of Valero Energy as a customer or a significant reduction in its current level of throughput and storage with Valero L.P.;

 

Any inability to borrow additional funds;

 

Any substantial costs related to environmental risks, including increased costs of compliance;

 

Any change in the credit ratings assigned to Valero Logistics’ (as defined below) indebtedness;

 

Any change in the credit rating assigned to Valero Energy’s indebtedness;

 

Any reductions in space allocated to Valero L.P. in interconnecting third party pipelines;

 

Any material increase in the price of natural gas;

 

Terrorist attacks, threats of war or terrorist attacks or political or other disruptions that limit crude oil production; and

 

Accidents or unscheduled shutdowns affecting Valero L.P.’s pipelines, terminals, machinery, or equipment, or those of Valero Energy.

 

If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, Valero L.P.’s actual results may vary materially from those described in any forward-looking statement. Readers are cautioned not to place undue reliance on this forward-looking information, which is as of the date of the Form 10-K. Valero L.P. does not intend to update these statements unless it is required by the securities laws to do so, and it undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

 

1


Table of Contents

PART I

 

ITEMS 1. & 2. BUSINESS AND PROPERTIES

 

Valero L.P.1 is a Delaware limited partnership formed in 1999 that completed its initial public offering of common units on April 16, 2001. Valero L.P.’s common units are traded on the New York Stock Exchange under the symbol “VLI.” Valero L.P.’s principal executive offices are located at One Valero Place, San Antonio, Texas 78212 and its telephone number is (210) 370-2000.

 

When used in this report, the terms “Valero L.P.” may refer, depending on the context, to Valero L.P., to one or more of its consolidated subsidiaries, or to all of them taken as a whole. Valero L.P.’s operations are conducted through a subsidiary entity, Valero Logistics Operations, L.P. (Valero Logistics). Valero L.P.’s operations are controlled and managed by Valero GP, LLC, the general partner of its general partner, Riverwalk Logistics, L.P. (Riverwalk Logistics), an indirect wholly owned subsidiary of Valero Energy Corporation. Valero Energy Corporation, a publicly traded Delaware corporation (New York Stock Exchange symbol “VLO”), also currently owns an aggregate 43.7% limited partner interest in Valero L.P. As used in this report, the term “Valero Energy” may refer, depending on the context, to Valero Energy Corporation, to one or more of its consolidated subsidiaries or to all of them taken as a whole, but excludes Valero L.P. and its subsidiaries.

 

Valero L.P.’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 are available free of charge on Valero L.P.’s website at http://www.valerolp.com as soon as reasonably practicable after Valero L.P. files such material with, or furnishes it to, the Securities and Exchange Commission (SEC).

 

Valero L.P. generates revenue by charging tariffs for transporting crude oil and refined products through its pipelines and by charging a fee for use of its terminals and the services provided by its crude oil storage tanks. Valero L.P.’s primary customer for its crude oil pipelines, refined product pipelines, refined product terminals and crude oil storage tank operations is Valero Energy, which accounted for 98% of Valero L.P.’s $181.5 million in revenues for the year ended December 31, 2003. Valero Energy is discussed further in this Item under the caption “Valero L.P.’s Relationship with Valero Energy.” Valero L.P.’s assets support eight of Valero Energy’s refineries, including the McKee, Three Rivers, Texas City, Corpus Christi East and Corpus Christ West refineries in Texas, the Paulsboro refinery in New Jersey, the Ardmore refinery in Oklahoma and the Benicia refinery in California.

 

Valero L.P.’s operations have grown significantly since 2001. Valero L.P.’s net income has increased 51.7% and its revenues have increased 83.6% from the year ended December 31, 2001 to the year ended December 31, 2003.

 

The term “throughput” as used in this document generally refers to the crude oil or refined product barrels, as applicable, that pass through each pipeline, even if those barrels are also transported in another of Valero L.P.’s pipelines (for which a separate tariff is charged).

 

SEGMENTS

 

Valero L.P.’s four reportable business segments are refined product pipelines, crude oil pipelines, crude oil storage tanks and refined product terminals.


1 On December 31, 2001, Valero Energy acquired Ultramar Diamond Shamrock Corporation (UDS), the parent company of Shamrock Logistics, L.P. (the name under which Valero L.P. was formed), and on January 1, 2002, Shamrock Logistics, L.P. changed its name to Valero L.P.

 

2


Table of Contents

REFINED PRODUCT PIPELINES

 

Valero L.P. has an ownership interest in 23 refined product pipelines with an aggregate length of 3,717 miles. Valero L.P. also owns a 25-mile-long crude hydrogen pipeline. Valero L.P.’s refined product pipelines transport refined products from Valero Energy’s McKee, Three Rivers, Corpus Christi East, Corpus Christi West and Ardmore refineries to Valero L.P.’s terminals or to interconnections with third-party pipelines for distribution in markets in Texas, Oklahoma, Colorado, New Mexico, Arizona and other mid-continent states. The refined products transported in these pipelines include gasoline, distillates (including diesel and jet fuel), natural gas liquids (such as propane and butane), blendstocks and petrochemicals such as toluene, xylene and raffinate. During the year ended December 31, 2003, gasoline and distillates represented approximately 69% and 23%, respectively, of the total throughput in Valero L.P.’s refined product pipelines. Valero L.P. charges tariffs for transporting refined products in its refined product pipelines.

 

The following table sets forth the average number of barrels of refined products Valero L.P. transported daily through its refined product pipelines, in the aggregate, in each of the years presented.

 

    

Aggregate Throughput

Years Ended December 31,


     2003

   2002

   2001

   2000

   1999

     (barrels/day)

Refined product

   392,145    295,456    308,047    309,803    297,397

 

The following table sets forth information about each of Valero L.P.’s refined product pipelines. In instances where Valero L.P. owns less than 100% of a pipeline, its ownership percentage is indicated, and the capacity, throughput and capacity utilization information reflects only its ownership interest in these pipelines.

 

                    

Year Ended

December 31, 2003


 

Origin and Destination


   Length

   Ownership

    Capacity

   Throughput

   Capacity
Utilization


 
     (miles)          (barrels/day)    (barrels/day)       

McKee to El Paso, TX

   408    67 %   40,000    38,121    95 %

McKee to Colorado Springs, CO (1)

   256    100 %   52,000    9,365    22 %

Colorado Springs, CO to Airport

   2    100 %   12,000    1,099    9 %

Colorado Springs, CO to Denver, CO

   101    100 %   32,000    2,132    7 %

McKee to Denver, CO

   321    30 %   12,450    10,286    83 %

McKee to Amarillo, TX (6”) (1)(2)

   49    100 %   51,000    30,720    79 %

McKee to Amarillo, TX (8”) (1)(2)

   49    100 %                

Amarillo to Abernathy, TX (1)(3)

   102    67 %   11,733    8,815    75 %

Amarillo, TX to Albuquerque, NM

   293    50 %   17,150    10,874    63 %

Abernathy to Lubbock, TX (1)(3)

   19    46 %   8,029    1,327    17 %

McKee to Skellytown, TX

   53    100 %   52,000    7,605    15 %

Skellytown to Mont Belvieu,TX

   572    50 %   26,000    14,947    57 %

McKee to Southlake, TX (3)

   375    100 %   27,300    9,015    33 %

Three Rivers to San Antonio, TX

   81    100 %   33,600    27,045    80 %

Three Rivers to Laredo, TX

   98    100 %   16,800    14,098    84 %

Three Rivers to Corpus Christi, TX

   72    100 %   15,000    6,537    44 %

Three Rivers to Pettus to San Antonio, TX (12”) (3)

   103    100 %   24,000    21,010    88 %

Three Rivers to Pettus to Corpus Christi, TX (8”) (3)

   89    100 %   15,000    8,483    57 %

Ardmore to Wynnewood, OK

   31    100 %   90,000    51,945    58 %

El Paso, TX to Kinder Morgan

   12    67 %   40,000    28,426    71 %

Corpus Christi to Pasadena, TX (3)

   208    100 %   105,000    73,832    70 %

Corpus Christi to Edinburg, TX (3)

   134    100 %   27,100    16,463    61 %

Other refined product pipeline (4)

   289    50 %   N/A    N/A    N/A  
    
        
  
      
     3,717          708,162    392,145    57 %
    
        
  
      

 

3


Table of Contents
(1) This pipeline transports barrels relating to two tariff routes, one of which begins at this pipeline’s origin and ends at this pipeline’s destination and one of which is a longer tariff route with an origin or destination on another pipeline of Valero L.P.’s that connects to this pipeline. Throughput disclosed above for this pipeline reflects only the barrels subject to the tariff route beginning at this pipeline’s origin and ending at this pipeline’s destination. To accurately determine the actual capacity utilization of the pipeline, as well as aggregate capacity utilization, all barrels passing through the pipelines have been taken into account.

 

(2) The throughput, capacity and capacity utilization information listed opposite the McKee to Amarillo, TX 6-inch pipeline includes both McKee to Amarillo, TX pipelines on a combined basis.

 

(3) During 2003, Valero L.P. acquired the following refined product pipelines:

 

  On March 18, 2003, the Corpus Christi to Pasadena, TX pipeline, the Corpus Christi to Edinburg, TX pipeline, the Pettus to San Antonio, TX pipeline and the Pettus to Corpus Christi, TX pipeline. Each of the Pettus pipelines acquired in 2003 connected to one of the Three Rivers to Pettus, TX pipelines that were already owned by Valero L.P. Subsequently, Valero L.P. filed revised tariffs for the entire tariff routes, which begin at Three Rivers and end at either San Antonio or Corpus Christi, TX.

 

  On May 1, 2003, an additional 28% undivided interest in the Amarillo to Abernathy, TX pipeline and a 46% undivided interest in the Abernathy to Lubbock, TX pipeline.

 

  Effective August 1, 2003, the McKee to Southlake, TX pipeline.

 

The throughput barrels in the above table represent the total throughput from the date of acquisition divided by 365 days.

 

(4) Represents the idled 6-inch Amarillo, TX to Albuquerque, NM refined product pipeline.

 

CRUDE OIL PIPELINES

 

Valero L.P. has an ownership interest in nine crude oil pipelines with an aggregate length of 783 miles. Valero L.P.’s crude oil pipelines deliver crude oil and other feedstocks, such as gas oil, from various points in Texas, Oklahoma, Kansas and Colorado to Valero Energy’s McKee, Three Rivers and Ardmore refineries. Also included in this segment are Valero L.P.’s five crude oil storage facilities in Texas and Oklahoma, which allow for crude oil to be stored and batched prior to shipment in the crude oil pipelines. Valero L.P. charges tariffs for transporting crude oil and other feedstocks in its crude oil pipelines. Valero L.P. does not generate any separate revenue from its crude oil storage facilities. Instead, the costs associated with the storage facilities are considered in establishing the tariffs charged for transporting crude oil from the storage facilities to the refineries.

 

The following table sets forth the average daily number of barrels of crude oil and other feedstocks Valero L.P. transported through its crude oil pipelines, in the aggregate, in each of the years presented:

 

    

Aggregate Throughput

Years Ended December 31,


     2003

   2002

   2001

   2000

   1999

     (barrels/day)

Crude oil and other feedstocks

   355,008    348,023    303,811    294,784    280,041

 

4


Table of Contents

The following table sets forth information about each of Valero L.P.’s crude oil pipelines.

 

                    

Year Ended

December 31, 2003


Origin and Destination


   Length

   Ownership

    Capacity

   Throughput

   Capacity
Utilization


     (miles)          (barrels/day)    (barrels/day)     

Cheyenne Wells, CO to McKee

   252    100 %   17,500    9,699    55%

Dixon, TX to McKee

   44    100 %   85,000    40,659    48%

Hooker, OK to Clawson, TX (1)

   31    50 %   22,000    17,380    79%

Clawson, TX to McKee (2)

   41    100 %   36,000    12,350    83%

Wichita Falls, TX to McKee

   272    100 %   110,000    76,157    69%

Corpus Christi, TX to Three Rivers

   70    100 %   120,000    73,790    61%

Ringgold, TX to Wasson, OK (2)

   44    100 %   90,000    37,485    56%

Healdton to Ringling, OK

   4    100 %   52,000    13,069    25%

Wasson, OK to Ardmore

   25    100 %   90,000    74,419    83%
    
        
  
    
     783          622,500    355,008    62%
    
        
  
    

 

(1) Valero L.P. receives 50% of the tariff with respect to 100% of the barrels transported in the Hooker, OK to Clawson, TX pipeline. Accordingly, the capacity, throughput and capacity utilization are given with respect to 100% of the pipeline.

 

(2) This pipeline transports barrels relating to two tariff routes, one of which begins at this pipeline’s origin and ends at its destination and one of which is a longer tariff route with an origin or destination on another pipeline of Valero L.P.’s which connects to this pipeline. Throughput disclosed above for this pipeline reflects only the barrels subject to the tariff route beginning at this pipeline’s origin and ending at this pipeline’s destination. To accurately determine the actual capacity utilization of the pipeline, as well as aggregate capacity utilization, all barrels passing through the pipelines have been taken into account.

 

The following table sets forth information about Valero L.P.’s crude oil storage facilities:

 

Location


   Capacity

   Number of
Tanks


  

Mode of

Receipt


  

Mode of

Delivery


  

Average

Throughput

Year Ended

December 31,

2003


     (barrels)                   (barrels/day)

Corpus Christi, TX (1)

   1,600,000    4    marine    pipeline    73,790

Dixon, TX

   240,000    3    pipeline    pipeline    40,659

Ringgold, TX (1)

   600,000    2    pipeline    pipeline    37,485

Wichita Falls, TX

   660,000    4    pipeline    pipeline    76,157

Wasson, OK

   226,000    2    pipeline    pipeline    74,419
    
  
            
     3,326,000    15              302,510
    
  
            

 

(1) Valero L.P. owns the Corpus Christi, TX and Ringgold, TX crude oil storage facilities but leases the underlying realty under a long-term operating lease.

 

5


Table of Contents

CRUDE OIL STORAGE TANKS

 

Valero L.P. owns 58 crude oil and intermediate feedstock storage tanks and related assets with aggregate storage capacity of approximately 11.0 million barrels. Valero L.P.’s crude oil storage tanks serve the needs of Valero Energy’s Benicia, Corpus Christi West and Texas City refineries. Valero L.P. acquired the crude oil storage tanks on March 18, 2003 from Valero Energy. The land underlying these tanks is subject to long-term operating leases with Valero Energy. Valero L.P. charges a fee for each barrel of crude oil or certain other feedstocks that it delivers to Valero Energy’s Benicia, Corpus Christi West and Texas City refineries.

 

The following table sets forth information about Valero L.P.’s crude oil storage tanks:

 

Location


   Capacity

   Number
of Tanks


  

Mode of

Receipt


  

Mode of

Delivery


  

Average

Throughput

Year Ended

December 31,

2003 (1)


     (barrels)                   (barrels/day)

Benicia, CA

   3,815,000    16    marine/pipeline    pipeline    112,480

Corpus Christi, TX (West)

   4,023,000    26    marine    pipeline    126,047

Texas City, TX

   3,199,000    16    marine    pipeline    128,459
    
  
            
     11,037,000    58              366,986
    
  
            

 

(1) The throughput barrels in the above table represent the total throughput from March 18, 2003, the date of acquisition, divided by 365 days.

 

REFINED PRODUCT TERMINALS

 

Valero L.P. owns 21 refined product terminals in Texas, Colorado, New Mexico, California, Oklahoma and New Jersey. These terminals have a total of 199 tanks with a combined capacity of 4.5 million barrels. Most of Valero L.P.’s refined product terminals have automated loading facilities and are available 24 hours a day. At its terminals, Valero L.P. charges a per-barrel handling fee, as well as a per-barrel fee for refined product blending or filtering.

 

The following table sets forth the average daily number of barrels of refined products Valero L.P. handled at its refined product terminals, in the aggregate, in each of the years presented.

 

     Aggregate Throughput
Years Ended December 31,


     2003

   2002

   2001

   2000

   1999

     (barrels/day)

Refined product

   225,426    175,559    176,771    165,653    161,340

 

6


Table of Contents

The following table sets forth information about each of Valero L.P.’s refined product terminals:

 

Location


   Capacity

   Number
of Tanks


  

Mode of
Receipt


  

Mode of
Delivery


  

Average

Throughput
Year Ended

December 31,
2003


     (barrels)                   (barrels/day)

Abernathy, TX

   171,000    11    pipeline    truck    8,788

Amarillo, TX

   271,000    14    pipeline    truck/pipeline    23,914

Albuquerque, NM

   193,000    10    pipeline    truck/pipeline    9,425

Catoosa, OK (asphalt) (1) (4)

   340,000    24    truck/rail/barge    truck/rail    N/A

Colorado Springs, CO (1)

   324,000    8    pipeline    truck/pipeline    9,453

Corpus Christi, TX (1)

   371,000    15    pipeline    marine/pipeline    8,243

Denver, CO

   111,000    10    pipeline    truck    17,829

Edinburg, TX (3)

   184,600    7    pipeline    truck    16,707

El Paso, TX (2)

   347,000    22    pipeline    truck/pipeline    40,522

Harlingen, TX (1)

   314,000    7    marine    truck    8,301

Houston, TX (Hobby Airport) (3)

   107,100    6    pipeline    truck/pipeline    3,432

Houston, TX (asphalt) (3)

   75,000    3    marine    truck    1,402

Laredo, TX

   203,000    6    pipeline    truck    14,098

Paulsboro, NJ (3)

   90,800    6    pipeline    truck    6,880

Pittsburg, CA (asphalt) (3)

   380,000    8    rail    truck    1,051

Placedo, TX (3)

   98,000    4    pipeline    truck    2,566

Rosario, NM (asphalt) (1) (4)

   160,000    8    rail    truck    N/A

San Antonio (east), TX(3)

   148,200    8    pipeline    truck/pipeline    15,723

San Antonio (south), TX

   221,000    10    pipeline    truck    17,041

Southlake, TX

   286,000    6    pipeline    truck    20,051

Almeda, TX (idle) (3)

   105,800    6    pipeline    truck    N/A
    
  
            
     4,501,500    199              225,426
    
  
            

 

(1) Valero L.P. owns the Colorado Springs, CO, Corpus Christi, TX, Harlingen, TX, Catoosa, OK and Rosario, NM refined product terminals; however, the land underlying these facilities is subject to long-term operating leases.

 

(2) Valero L.P. owns a 66.67% undivided interest in the El Paso refined product terminal. The capacity and throughput amounts represent the proportionate share of capacity and throughput attributable to Valero L.P.’s ownership interest. The throughput represents barrels distributed from the El Paso refined product terminal and delivered to a third-party refined product pipeline.

 

(3) During 2003, Valero L.P. acquired the following refined product terminals:

 

  On January 7, 2003, the Pittsburg, CA asphalt terminal.
  On March 18, 2003, the Edinburg, TX terminal, the Houston, TX (Hobby Airport) terminal, the Houston, TX (asphalt) terminal, the San Antonio (east), TX terminal, the Placedo, TX terminal and the Almeda, TX terminal, which is currently idle.
  On September 2, 2003, the Paulsboro, NJ terminal.

The throughput barrels in the above table represent the total throughput from the date of acquisition divided by 365 days.

 

(4) On February 20, 2004, Valero L.P. acquired the Catoosa, OK terminal and the Rosario, NM terminal.

 

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Table of Contents

VALERO L.P.’S RELATIONSHIP WITH VALERO ENERGY

 

Valero L.P.’s operations are strategically located within Valero Energy’s refining and marketing supply chain in Texas, Oklahoma, California, Colorado, New Jersey, New Mexico, Arizona and other mid-continent states in the United States. Valero L.P. itself does not own or operate any refining or marketing operations. Valero L.P. is dependent on Valero Energy to provide substantially all the throughput for Valero L.P.’s pipelines, terminals and storage tanks and the ability of Valero Energy’s refineries to maintain their production of refined products. Although Valero L.P. intends to pursue third-party business as opportunities arise, Valero L.P. expects to continue to derive most of its revenues from Valero Energy for the foreseeable future. During the year ended December 31, 2003, Valero Energy accounted for 98% of Valero L.P.’s revenues.

 

As of December 31, 2003, Valero Energy, through its wholly owned subsidiaries, owned 9,599,322 subordinated units, 679,226 common units and the 2% general partner interest in Valero L.P., representing an aggregate 45.7% ownership interest.

 

VALERO ENERGY’S BUSINESS

 

Valero Energy is one of the top three U.S. refining companies in terms of refining capacity. Valero Energy owns and operates 15 refineries in the United States, Canada and the island of Aruba, eight of which are served by Valero L.P.’s pipelines, terminals or storage assets. As of December 31, 2003, the total throughput capacity of each of those eight refineries was as follows:

 

Refinery


  

Location


  

Total
Throughput
Capacity


          (barrels/day)

Texas City

   Texas    243,000

Corpus Christi West

   Texas    225,000

Paulsboro

   New Jersey    195,000

Benicia

   California    175,000

McKee

   Texas    170,000

Corpus Christi East

   Texas    115,000

Three Rivers

   Texas      98,000

Ardmore

   Oklahoma      85,000

 

Valero Energy markets the refined products produced by these refineries primarily in Texas, Oklahoma, Colorado, New Mexico, Arizona, California, New Jersey and several other mid-continent states through a network of company-operated and dealer-operated convenience stores, as well as through other wholesale and spot market sales and exchange agreements.

 

MAJOR AGREEMENTS WITH VALERO ENERGY

 

Valero L.P.’s relationship with Valero Energy is governed by the following significant agreements.

 

Omnibus Agreement

 

The Omnibus Agreement governs potential competition between Valero Energy and Valero L.P. It contains the agreement by Valero Energy, subject to certain exceptions, not to engage in the business of transporting crude oil and refined petroleum products and to indemnify Valero L.P. for certain environmental liabilities that arose prior to April 16, 2001 related to the assets transferred to Valero L.P. in connection with Valero L.P.’s initial public offering.

 

Services Agreement

 

Under a Services Agreement with Valero Energy, employees of Valero Energy perform certain operational services on Valero L.P.’s behalf, and Valero Energy is reimbursed for those services. In addition, Valero L.P. pays Valero Energy and its affiliates an annual administrative fee of $5.2 million to perform and provide other services, including legal, accounting, treasury, engineering and information technology. The conflicts committee of the board of directors of Valero GP, LLC must approve any change to the Services Agreement fee. The Services Agreement will be amended effective April 1, 2004. The amendment is discussed below under the caption “Recent Developments-Amendment to Services Agreement in April ‘04.”

 

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Pipelines and Terminals Usage Agreement- McKee, Three Rivers and Ardmore

 

Under the terms of the Pipelines and Terminals Usage Agreement, Valero L.P. provides transportation services that support Valero Energy’s refining and marketing operations in the markets relating to the McKee, Three Rivers and Ardmore refineries. Under this agreement, Valero Energy has agreed through April 2008 to:

 

  use Valero L.P.’s crude oil pipelines to transport at least 75% of the aggregate volumes of the crude oil shipped to the McKee, Three Rivers and Ardmore refineries;

 

  use Valero L.P.’s refined product pipelines to transport at least 75% of the aggregate volumes of certain refined products shipped from these refineries; and

 

  use Valero L.P.’s refined product terminals for terminalling services for at least 50% of certain refined products Valero Energy ships from these refineries.

 

Valero Energy met and exceeded its obligations under the Pipelines and Terminals Usage Agreement during the year ended December 31, 2003. In addition, Valero Energy has agreed to remain the shipper for crude oil and refined products owned by it that are transported through Valero L.P.’s pipelines, and neither challenge, nor cause others to challenge, Valero L.P.’s interstate or intrastate tariffs for the transportation of crude oil and refined products through April 2008.

 

Crude Oil Storage Tank Agreements

 

In connection with the crude oil storage tank contribution described below in this Item under the caption “Recent Developments- Contribution Transactions,” Valero L.P. and Valero Energy entered into several agreements related to the operations of the crude oil storage tanks, including:

 

  a handling and throughput agreement pursuant to which Valero Energy agreed to pay Valero L.P. a fee, for an initial period of ten years, for all crude oil and certain other feedstocks delivered to each of the Corpus Christi West refinery, the Texas City refinery and the Benicia refinery and to use Valero L.P. for handling all deliveries to these refineries;

 

  services and secondment agreements pursuant to which Valero Energy agreed to provide to Valero L.P. for a fee personnel who perform operating and routine maintenance services related to the crude oil storage tank operations. The initial term of the services and secondment agreements is ten years and Valero L.P. has an option to extend for an additional five years; and

 

  lease and access agreements pursuant to which Valero Energy leases to Valero L.P. the real property on which the crude oil storage tanks are located for an aggregate of $0.7 million per year for an initial term of 25 years, subject to renewal.

 

South Texas Pipelines and Terminals Agreements

 

In connection with the South Texas Pipelines and Terminals contribution described below in this Item under the caption “Recent Developments-Contribution Transactions,” Valero L.P. and Valero Energy entered into agreements related to the operations of these assets, including:

 

  A throughput commitment agreement, having an initial period of seven years, pursuant to which Valero Energy agreed to:

 

  transport certain percentages of gasoline, distillate and raffinate production through the pipelines; and

 

  use specified terminals for certain percentages of refinery gasoline, distillate and asphalt production and refined product throughput.

 

Valero Energy will be required to make a cash payment based on the amount of any shortfall in committed volumes or usage.

 

  A terminalling agreement pursuant to which Valero Energy has agreed, during the initial period of five years, to pay a terminalling fee for each barrel of refined products stored or handled by or on behalf of Valero Energy at specified terminals, including an additive fee for gasoline additive blended at the terminals. At the Houston Hobby Airport terminal, Valero Energy will pay a filtering fee for each barrel of jet fuel stored or handled at the terminal.

 

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RECENT DEVELOPMENTS

 

AMENDMENT TO SERVICES AGREEMENT IN APRIL ‘04

 

Due to the significant growth of Valero L.P. over the past three years and the increased levels of service provided by Valero Energy for Valero L.P., Valero L.P. and Valero Energy have agreed to amend the terms of the Services Agreement, effective April 1, 2004, to change the annual services fee. Under the terms of the amended Services Agreement, the annual services fee will be $1.2 million. Each year over the next four years, the annual services fee will be increased by $1.2 million and by Valero Energy’s average percentage increase in salaries. The annual services fee may also be adjusted to account for changed service levels due to Valero L.P.’s acquisition, sale or construction of assets. Additionally, Valero L.P. will reimburse Valero Energy for the cost of corporate employees dedicated to Valero L.P. matters (currently estimated to be approximately $5.6 million a year, excluding employee bonus costs). The conflicts committee of the board of directors of Valero GP, LLC approved the amendment to the Services Agreement in March 2004.

 

AMENDMENTS TO PARTNERSHIP AGREEMENT IN MARCH ‘04

 

In March 2004, various amendments to Valero L.P.’s partnership agreement were approved. Effective March 11, 2004, the partnership agreement has been amended to reduce the percentage of the vote required to remove Valero L.P.’s general partner from 58% to a simple majority (excluding any units held by the general partner or its affiliates). In addition, the partnership agreement has been amended to lower the general partner’s incentive distribution rights with respect to distributions of available cash from 48% to 23% of the amount of any quarterly distribution that exceeds $0.90 per unit. The general partner also receives a 2% distribution with respect to its general partner interest. Cash distributions are discussed in Note 14 of Notes to Consolidated Financial Statements.

 

ROYAL TRADING

 

On February 20, 2004, Valero L.P. acquired two asphalt terminals located in Catoosa, Oklahoma (near Tulsa) and Rosario, New Mexico (near Santa Fe) from Royal Trading Company (Royal) for $28.1 million. These terminals have an aggregate storage capacity of 500,000 barrels in 32 tanks and six loading stations.

 

PAULSBORO REFINED PRODUCT TERMINAL ACQUISITION

 

In September 2003, Valero L.P. acquired a refined product terminal in Paulsboro, New Jersey, next to Valero Energy’s Paulsboro refinery, from ExxonMobil Oil Corporation for $14.1 million. This terminal has a storage capacity of 90,800 barrels.

 

SOUTHLAKE REFINED PRODUCT PIPELINE ACQUISITION

 

In August 2003, Valero L.P. acquired the Southlake refined product pipeline from Valero Energy for $29.9 million. This pipeline has a capacity of 27,300 barrels per day and extends 375 miles from Valero Energy’s McKee refinery to Valero L.P.’s Southlake refined product terminal near Dallas, Texas.

 

VALERO L.P. COMMON UNIT OFFERING

 

On August 11, 2003, Valero L.P. consummated a public offering of common units, selling 1,236,250 common units, which included 161,250 common units pursuant to the underwriter’s exercise of its over-allotment option, for net proceeds of $48.6 million. In order to maintain its 2% general partnership interest, Riverwalk Logistics made a cash contribution to Valero L.P. of $1.0 million.

 

SHELL PIPELINE ACQUISITION

 

In May 2003, Valero L.P. acquired Shell Pipeline Company, L.P.’s (Shell) 28% undivided interest in the Amarillo to Abernathy refined product pipeline and Shell’s 46% undivided interest in the Abernathy to Lubbock refined product pipeline for $1.6 million. After this acquisition, Valero L.P. owns a 67% undivided interest and ConocoPhillips owns the remaining 33% interest in the Amarillo to Abernathy refined product pipeline, and Valero L.P. owns a 46% undivided interest and ConocoPhillips owns the remaining 54% interest in the Abernathy to Lubbock refined product pipeline.

 

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CONTRIBUTION TRANSACTIONS

 

On March 18, 2003, Valero L.P. entered into contribution agreements with Valero Energy for certain crude oil storage tanks and for Valero Energy’s South Texas pipeline system. Valero Energy contributed 58 crude oil and intermediate feedstock storage tanks and related assets with aggregate storage capacity of approximately 11.0 million barrels to Valero L.P. for $200.2 million. These assets are located at Valero Energy’s Corpus Christi West, Texas City and Benicia refineries.

 

Valero Energy also contributed its South Texas pipeline system, comprised of the Houston pipeline system, the Valley pipeline system and the San Antonio pipeline system (together referred to as the South Texas Pipelines and Terminals) to Valero L.P. for $150.1 million. The three pipeline systems that make up the South Texas pipeline system are intrastate common carrier refined product pipelines that connect Valero Energy’s Corpus Christi East and Corpus Christi West refineries to the Houston and Rio Grande Valley, Texas markets and Valero Energy’s Three Rivers refinery to the San Antonio, Texas market and to Valero Energy’s Corpus Christi refineries. The three pipeline systems also include six refined product terminals located in Edinburg, Placedo, Houston (Hobby Airport and asphalt), San Antonio (east) and Almeda (idle).

 

VALERO L.P. COMMON UNIT OFFERINGS AND VALERO LOGISTICS SENIOR NOTES OFFERING

 

In connection with the contribution transactions described above, effective March 18, 2003, Valero L.P. issued 5,750,000 common units to the public and on April 16, 2003, Valero L.P. issued an additional 581,000 common units pursuant to the underwriters’ over-allotment option, for net proceeds of $222.8 million. Riverwalk Logistics made a $4.7 million capital contribution to Valero L.P. to maintain its 2% general partner interest.

 

Also on March 18, 2003, Valero Logistics issued $250.0 million of 6.05% senior notes due 2013 in a private placement to institutional investors. In July 2003, the 6.05% senior notes were exchanged for $250.0 million of 6.05% senior notes due 2013 that were registered under the Securities Act of 1933. The proceeds of the equity and debt offerings were used to finance the contributed assets and redemption of common units.

 

REDEMPTION OF COMMON UNITS OWNED BY VALERO ENERGY AND AMENDMENT TO VALERO L.P.’S PARTNERSHIP AGREEMENT

 

Common Unit Redemption: On March 18, 2003, immediately following Valero L.P.’s common unit offering and the offering by Valero Logistics of its 6.05% senior notes, Valero L.P. redeemed from Valero Energy 3,809,750 of Valero L.P.’s common units, for $134.1 million. Immediately following this redemption, Valero L.P. canceled the common units redeemed from Valero Energy and redeemed a corresponding portion of Riverwalk Logistics’ general partner interest for $2.9 million so that it maintained its 2% general partner interest.

 

Amendment to Partnership Agreement: Also on March 18, 2003, immediately upon the closing of the offerings, Valero L.P. amended its partnership agreement to reduce the percentage of the vote of holders of Valero L.P.’s outstanding common units and subordinated units necessary to remove Valero L.P’s general partner from 66 2/3% to 58% (excluding any vote by the general partner or its affiliates). Prior to this amendment, Valero Energy was allowed to vote its units and thus effectively block removal of the general partner. Valero L.P. further amended its partnership agreement to provide that the election of a successor general partner upon any such removal be approved by the holders of a majority of the common units, excluding the common units held by affiliates of Valero L.P.’s general partner. As a result of the partnership agreement changes and the issuance and redemption of Valero L.P. common units, Valero Energy ceased consolidation of Valero L.P. in its financial statements.

 

TELFER ASPHALT TERMINAL ACQUISITION

 

In January 2003, Valero L.P. purchased an asphalt terminal in Pittsburg, California from Telfer Oil Company (Telfer) for $15.3 million. The asphalt terminal assets include two storage tanks with a combined storage capacity of 350,000 barrels, six 5,000-barrel polymer modified asphalt tanks, a truck rack, rail facilities and various other tanks and equipment. In conjunction with the Telfer acquisition, Valero L.P. entered into a six-year terminal storage and throughput agreement with Valero Energy.

 

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PIPELINE AND TERMINAL CONTROL OPERATIONS AND MAINTENANCE

 

All of Valero L.P.’s crude oil and refined product pipelines are operated via satellite communication systems from one of two central control rooms located in San Antonio, Texas. Each control center can provide backup capability for the other, and each center is capable of monitoring and controlling the pipelines. The control centers operate with modern, state-of-the-art System Control and Data Acquisition systems (SCADA). The control centers are equipped with computer systems designed to continuously monitor real time operational data, including crude oil and refined product throughput, flow rates and pressures. In addition, the control centers monitor alarms and throughput balances. The control centers operate remote pumps, motors, engines and valves associated with the delivery of crude oil and refined products. The computer systems are designed to enhance leak-detection capabilities, sound automatic alarms if operational conditions outside pre-established parameters occur and provide for remote-controlled shutdown of pump stations on the pipelines. Pump stations, crude oil storage facilities and meter-measurement points along the pipelines are linked by satellite or telephone communication systems for remote monitoring and control.

 

A number of Valero L.P.’s crude oil storage facilities and refined product terminals are also operated through the central control centers. Other crude oil storage facilities and refined product terminals are modern, automated facilities but are locally controlled.

 

Billing of customers is electronic and the automatic system provides for control of allocations, credit and carrier certification by remote input of data by customers. All terminals have an electronic monitoring and control system that monitors the effectiveness of the ground protection and vapor control and will cause an automated shutdown of the terminal operations if necessary. For environmental and safety protection, all terminals have primary vapor control systems consisting of flares, vapor combustors or carbon absorption vapor recovery units.

 

Valero L.P. performs scheduled maintenance on all of its pipelines, terminals, crude oil tanks and related equipment and makes repairs and replacements when necessary or appropriate. Valero L.P. believes that all of its pipelines, terminals, crude oil tanks and related equipment have been constructed and are maintained in all material respects in accordance with applicable federal, state and local laws and the regulations and standards prescribed by the American Petroleum Institute, the Department of Transportation and accepted industry practice.

 

COMPETITION

 

As a result of Valero L.P.’s physical integration with Valero Energy’s refining and marketing operations and its contractual relationships with Valero Energy, management of Valero L.P. believes that it will not face significant competition for barrels of crude oil transported to, and barrels of refined products transported from, the various Valero Energy refineries serviced by Valero L.P.’s assets, particularly during the terms of the various agreements between Valero L.P. and Valero Energy described in this report.

 

However, Valero L.P. faces competition from other pipelines that may be able to supply Valero Energy’s end-user markets with refined products on a more competitive basis. If Valero Energy reduced its retail sales of refined products or its wholesale customers reduced their purchases of refined products, the volumes transported through Valero L.P.’s pipelines would be reduced, which would cause a decrease in cash and revenues generated from its operations.

 

Valero L.P. believes that high capital requirements, environmental and safety considerations and the difficulty in acquiring rights-of-way and related permits make it difficult for other entities to build competing pipelines in areas served by its pipelines. As a result, competing pipelines are likely to be built only in those cases in which strong market demand and attractive tariffs support additional capacity in an area.

 

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REGULATION

 

RATE REGULATION

 

Several of Valero L.P.’s pipelines are interstate common carrier pipelines, subject to regulation by the Federal Energy Regulatory Commission (FERC) under the Interstate Commerce Act (ICA). Additionally, the rates and practices for Valero L.P.’s intrastate common carrier pipelines are subject to regulation by state commissions. The applicable state statutes and regulations generally require that pipeline rates and practices be reasonable and nondiscriminatory.

 

Valero L.P.’s Pipelines Rates

 

Neither the FERC nor the state commissions have investigated Valero L.P.’s rates or practices. Valero L.P. does not believe that it is likely that there will be a challenge to its tariffs by a current shipper that would materially affect its revenues or cash flows because Valero Energy is the only current shipper in the majority of Valero L.P.’s pipelines. Valero Energy has committed not to challenge Valero L.P.’s tariffs until at least April 2008. Valero Energy has also agreed to be responsible for any ICA liabilities with respect to activities or conduct occurring during periods prior to April 16, 2001, and Valero L.P. will be responsible for ICA liabilities with respect to activities or conduct occurring after April 16, 2001. However, the FERC or a state regulatory commission could investigate Valero L.P.’s tariffs at the urging of a third party. Also, because Valero L.P.’s pipelines are common carrier pipelines, Valero L.P. may be required to accept new shippers who wish to transport in its pipelines. It is possible that any new shippers may decide to challenge Valero L.P.’s tariffs. If any tariff challenge or challenges are successful, cash available for distribution to unitholders could be materially reduced accordingly.

 

ENVIRONMENTAL AND SAFETY REGULATION

 

General

 

Valero L.P.’s operations are subject to extensive federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the environment, waste management and pollution prevention measures, and to environmental regulation by several federal, state and local authorities. The principal environmental risks associated with Valero L.P.’s operations relate to unauthorized emissions into the air and unauthorized releases into soil, surface water or groundwater. Valero L.P.’s operations are also subject to extensive federal and state health and safety laws and regulations, including those relating to pipeline safety. Compliance with these laws, regulations and permits increases Valero L.P.’s capital expenditures and its overall cost of business, and violations of these laws, regulations and/or permits can result in significant civil and criminal liabilities, injunctions or other penalties. Accordingly, Valero L.P. has adopted policies, practices and procedures in the areas of pollution control, product safety, occupational health and the handling, storage, use and disposal of hazardous materials in an effort to prevent material environmental or other damage, and to ensure the safety of its pipelines, its employees, the public and the environment. Future governmental action and regulatory initiatives could result in changes to expected operating permits, additional remedial actions or increased capital expenditures and operating costs that cannot be assessed with certainty at this time. In addition, contamination resulting from spills of crude oil and refined products occurs within the industry. Risks of additional costs and liabilities are inherent within the industry, and there can be no assurances that significant costs and liabilities will not be incurred in the future.

 

Water

 

The Federal Water Pollution Control Act of 1972, as amended, also known as the Clean Water Act, and analogous state statutes impose restrictions and strict controls regarding the discharge of pollutants into state waters or waters of the United States. The discharge of pollutants into state waters or waters of the United States is prohibited, except in accord with the terms of a permit issued by applicable federal or state authorities. The Oil Pollution Act, enacted in 1990, amends provisions of the Clean Water Act as they pertain to prevention and response to oil spills. Spill prevention control and countermeasure requirements of the Clean Water Act and some state laws require diking and similar structures to help prevent contamination of navigable waters in the event of overflow or release.

 

Air Emissions

 

Valero L.P.’s operations are subject to the Federal Clean Air Act and comparable state and local statutes. Numerous amendments to the Federal Clean Air Act were enacted in 1990. These amendments may result in the imposition over the next several years of certain pollution control requirements with respect to air emissions from the operations of Valero L.P.’s pipelines, storage tanks and terminals. The Environmental Protection Agency (EPA) is developing, over a period of many years, regulations to implement these requirements. Depending on the nature of those regulations, and upon requirements that may be imposed by state and local regulatory authorities, Valero L.P. may be required to incur certain capital expenditures over the next several years for air pollution control equipment in connection with maintaining or obtaining operating permits and approvals and addressing other air emission-related issues.

 

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Due to the broad scope of the issues involved and the complex nature of the regulations, full development and implementation of many Clean Air Act regulations have been delayed. Until such time as the new Clean Air Act requirements are implemented, Valero L.P. is unable to estimate the effect on net income or operations or the amount and timing of such required expenditures. At this time, however, Valero L.P. does not believe that it will be materially affected by any such requirements.

 

Solid Waste

 

Valero L.P. generates non-hazardous solid wastes that are subject to the requirements of the Federal Resource Conservation and Recovery Act (FRCRA) and comparable state statutes. FRCRA also governs the disposal of hazardous wastes. Valero L.P. is not currently required to comply with a substantial portion of FRCRA requirements because its operations generate minimal quantities of hazardous wastes. However, it is possible that additional wastes, which could include wastes currently generated during 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.

 

Hazardous Substances

 

The Comprehensive Environmental Response, Compensation and Liability Act, referred to as CERCLA and also known as Superfund, and analogous state laws, imposes liability, without regard to fault or the legality of the original act, on some 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 entities 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 that they incur. In the course of Valero L.P.’s ordinary operations, it may generate waste that falls within CERCLA’s definition of a “hazardous substance.” While Valero L.P. responsibly manages the hazardous substances that it controls, the intervening acts of third parties may expose Valero L.P. to joint and several liability under CERCLA for all or part of the costs required to clean up sites at which these hazardous substances have been disposed of or released into the environment.

 

Valero L.P. currently owns or leases, and has in the past owned or leased, properties where hydrocarbons are being or have been handled. Although Valero L.P. has utilized operating and disposal practices that were standard in the industry at the time, hydrocarbons or other wastes may have been disposed of or released on or under the properties owned or leased by Valero L.P. or on or under other locations where these wastes have been taken for disposal. In addition, many of these properties have been operated by third parties whose treatment and disposal or release of hydrocarbons or other wastes was not under Valero L.P.’s control. These properties and wastes disposed thereon may be subject to CERCLA, the Federal Resource Conservation and Recovery Act and analogous state laws. Under these laws, Valero L.P. could be required to remove or remediate previously disposed wastes (including wastes disposed of or released by prior owners or operators), to clean up contaminated property (including contaminated groundwater) or to perform remedial operations to prevent future contamination.

 

Pipeline Safety Improvement Act of 2002

 

The Pipeline Safety Improvement Act of 2002 (PSIA) requires pipeline operators to maintain qualification programs for key pipeline operating personnel, to review and update their existing pipeline safety public education programs and to provide information for the National Pipeline Mapping System. Some of PSIA’s requirements are effective immediately, while other requirements will become effective during 2004. While PSIA may affect Valero L.P.’s reliability capital expenditures and operating expenses, Valero L.P. believes that PSIA does not materially affect its competitive position and will not have a material effect on its financial condition or results of operations.

 

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PROPERTIES

 

Valero L.P.’s principal properties are described above under the caption “Segments.” Valero L.P. believes that it has satisfactory title to all of its assets. Although title to these properties is subject to encumbrances in some cases, such as customary interests generally retained in connection with acquisition of real property, liens related to environmental liabilities associated with historical operations, liens for current taxes and other burdens and minor easements, restrictions and other encumbrances to which the underlying properties were subject at the time of acquisition by Valero L.P. or its predecessors, Valero L.P. believes that none of these burdens will materially detract from the value of these properties or from its interest in these properties or will materially interfere with their use in the operation of Valero L.P.’s business. In addition, Valero L.P. believes that it has obtained sufficient right-of-way grants and permits from public authorities and private parties for it to operate its business in all material respects as described in this report.

 

EMPLOYEES

 

Riverwalk Logistics, the general partner of Valero L.P., is responsible for the management of Valero L.P. Valero GP, LLC, the general partner of Riverwalk Logistics, is responsible for managing the affairs of Riverwalk Logistics, and through it, the affairs of Valero L.P. and Valero Logistics. As of February 29, 2004, Valero GP, LLC employed approximately 207 individuals who perform services for Valero L.P.

 

ITEM 3. LEGAL PROCEEDINGS

 

Valero L.P. is a party to various claims and legal actions that have arisen in the ordinary course of its business. Valero L.P. believes it is unlikely that the final outcome of any claims or proceedings to which it is a party would have a material adverse effect on its financial position, results of operations or liquidity; however, due to the inherent uncertainty of litigation, the range of any possible loss cannot be estimated with a reasonable degree of precision and Valero L.P. cannot provide assurance that the resolution of any particular claim or proceeding would not have an adverse effect on its results of operations, financial position or liquidity.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of the unitholders, through solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 2003.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON UNITS AND RELATED UNITHOLDER MATTERS

 

Market Information, Holders and Distributions

 

Valero L.P.’s common units are listed and traded on the New York Stock Exchange under the symbol “VLI.” At the close of business on February 1, 2004, Valero L.P. had 107 holders of record of its common units. The high and low sales prices (composite transactions) by quarter for the years ended December 31, 2003 and 2002 were as follows:

 

    

Price Range of

Common Unit


     High

   Low

Year 2003

             

4th Quarter

   $ 50.25    $ 43.22

3rd Quarter

     44.80      40.75

2nd Quarter

     44.20      36.41

1st Quarter

     40.64      35.00

Year 2002

             

4th Quarter

   $ 39.85    $ 35.10

3rd Quarter

     37.65      32.00

2nd Quarter

     39.90      35.40

1st Quarter

     42.23      35.70

 

The cash distributions applicable to each of the quarters in the years ended December 31, 2003 and 2002 were as follows:

 

     Record Date

   Payment Date

   Amount
Per Unit


Year 2003

                

4th Quarter

   February 6, 2004    February 13, 2004    $ 0.75

3rd Quarter

   November 6, 2003    November 14, 2003      0.75

2nd Quarter

   August 5, 2003    August 14, 2003      0.75

1st Quarter

   May 6, 2003    May 15, 2003      0.70

Year 2002

                

4th Quarter

   February 5, 2003    February 14, 2003    $ 0.70

3rd Quarter

   November 1, 2002    November 14, 2002      0.70

2nd Quarter

   August 1, 2002    August 14, 2002      0.70

1st Quarter

   May 1, 2002    May 15, 2002      0.65

 

Valero L.P. has also issued 9,599,322 subordinated units, all of which are held by UDS Logistics, LLC, the limited partner of Riverwalk Logistics, for which there is no established public trading market. The issuance of subordinated units was exempt from registration with the SEC under Section 4(2) of the Securities Act of 1933. During the subordination period, the holders of the common units are entitled to receive each quarter a minimum quarterly distribution of $0.60 per unit ($2.40 annualized) prior to any distribution of available cash to holders of the subordinated units. The subordination period is defined generally as the period that will end on the first day of any quarter beginning after March 31, 2006 if (1) Valero L.P. has distributed at least the minimum quarterly distribution on all outstanding units with respect to each of the immediately preceding three consecutive, non-overlapping four-quarter periods and (2) Valero L.P.’s adjusted operating surplus, as defined in its partnership agreement, during such periods equals or exceeds the amount that would have been sufficient to enable it to distribute the minimum quarterly distribution on all outstanding units on a fully diluted basis and the related distribution on the 2% general partner interest during those periods. If the subordination period ends, the rights of the holders of subordinated units will no longer be subordinated to the rights of the holders of common units and the subordinated units may be converted into common units, on a one-for-one basis.

 

During the subordination period, Valero L.P.’s cash is distributed first 98% to the holders of common units and 2% to the general partner until there has been distributed to the holders of common units an amount equal to the minimum quarterly

 

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distribution and arrearages in the payment of the minimum quarterly distribution on the common units for any prior quarter. Secondly, cash is distributed 98% to the holders of subordinated units and 2% to the general partner until there has been distributed to the holders of subordinated units an amount equal to the minimum quarterly distribution. Thirdly, cash in excess of the minimum quarterly distributions is distributed to the unitholders and the general partner based on the percentages shown below.

 

The general partner, Riverwalk Logistics, is entitled to incentive distributions if the amount that Valero L.P. distributes with respect to any quarter exceeds specified target levels shown below:

 

     Percentage of Distribution

Quarterly Distribution Amount per Unit


   Unitholders

  General Partner

Up to $0.60

   98%     2%

Above $0.60 up to $0.66

   90%   10%

Above $0.66 up to $0.90

   75%   25%

Above $0.90

   50%   50%

 

The general partner’s incentive distributions for the years ended December 31, 2003 and 2002 totaled $2.6 million and $1.1 million, respectively. The general partner’s share of Valero L.P.’s net income for the years ended December 31, 2003 and 2002 was 5.7% and 4.0%, respectively, due to the impact of the incentive distributions.

 

Effective March 11, 2004, Valero L.P.’s partnership agreement has been amended to lower the general partner’s incentive distribution rights with respect to distributions of available cash from 48% to 23% of the amount of any quarterly distribution that exceeds $0.90 per unit. The general partner will continue to receive a 2% distribution with respect to its general partner interest.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

The following table provides selected financial data that was derived from the audited financial statements of Valero L.P. and its predecessor (as defined below), as well as selected operating data. The following table should be read together with the consolidated financial statements and accompanying notes included in Item 8. Financial Statements and Supplementary Data and with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Prior to July 1, 2000, Valero L.P.’s pipeline, terminalling and storage assets were owned and operated by Ultramar Diamond Shamrock Corporation (UDS, now part of Valero Energy), and such assets serviced UDS’ McKee and Three Rivers refineries located in Texas, and the Ardmore refinery located in Oklahoma. These assets and their related operations are referred to herein as the Ultramar Diamond Shamrock Logistics Business. Effective July 1, 2000, UDS transferred the Ultramar Diamond Shamrock Logistics Business along with certain liabilities to Shamrock Logistics Operations, L.P. (Shamrock Logistics Operations), a wholly owned subsidiary of Shamrock Logistics, L.P. (Shamrock Logistics). Shamrock Logistics was also wholly owned by UDS. Data in the following table prior to the July 1, 2000 transfer is indicated as “Predecessor” and data subsequent thereto is indicated as “Successor.”

 

On April 16, 2001, Shamrock Logistics completed its initial public offering of common units, which represented 26.4% of its outstanding partnership interests.

 

Effective on December 31, 2001, UDS merged with and into Valero Energy. This acquisition included the acquisition of UDS’ majority ownership interest in Shamrock Logistics and subsidiary. The consolidated balance sheet of Shamrock Logistics and subsidiary as of December 31, 2001 was not adjusted to fair value due to the significant level of public ownership interest in Shamrock Logistics. Effective January 1, 2002, Shamrock Logistics changed its name to Valero L.P., and Shamrock Logistics Operations changed its name to Valero Logistics Operations, L.P. (Valero Logistics).

 

The selected financial data and operating data for the year ended December 31, 1999, and for the six months ended June 30, 2000, reflect the operations of the Ultramar Diamond Shamrock Logistics Business (the predecessor to Shamrock Logistics Operations) as if it had existed as a single separate entity from UDS. The transfer of the Ultramar Diamond Shamrock Logistics Business to Shamrock Logistics Operations represented a reorganization of entities under common control and was recorded at historical cost. The selected financial data and operating data for the six months ended December 31, 2000, and for the years ended December 31, 2001, 2002 and 2003, represent the consolidated operations of Valero L.P. and Valero Logistics. The selected financial data as of December 31, 2001, includes the acquisition of the Wichita Falls Business, which Valero L.P. acquired on February 1, 2002 from Valero Energy. Because Valero L.P. and the Wichita Falls Business came under the common control of Valero Energy commencing on December 31, 2001, the acquisition represented a reorganization of entities under common control.

 

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Table of Contents
     Successor

    Predecessor

 
     Years Ended December 31,

   

Six

Months
Ended
December 31,

2000


   

Six

Months
Ended

June 30,

2000


   

Year Ended
December 31,

1999


 
     2003

    2002

    2001

       
     (in thousands, except per unit data and barrel/day information)  

Statement of Income Data:

                                                

Revenues (1)

   $ 181,450     $ 118,458     $ 98,827     $ 47,550     $ 44,503     $ 109,773  
    


 


 


 


 


 


Costs and expenses:

                                                

Operating expenses

     64,609       37,838       33,583       15,593       17,912       29,013  

General and administrative expenses

     7,537       6,950       5,349       2,549       2,590       4,698  

Depreciation and amortization

     26,267       16,440       13,390       5,924       6,336       12,318  
    


 


 


 


 


 


Total costs and expenses

     98,413       61,228       52,322       24,066       26,838       46,029  

Gain on sale of property, plant and equipment (2)

     —         —         —         —         —         2,478  
    


 


 


 


 


 


Operating income

     83,037       57,230       46,505       23,484       17,665       66,222  

Equity income from Skelly-Belvieu Pipeline Company

     2,416       3,188       3,179       1,951       1,926       3,874  

Interest expense, net

     (15,860 )     (4,880 )     (3,811 )     (4,748 )     (433 )     (777 )
    


 


 


 


 


 


Income before income tax (expense) benefit

     69,593       55,538       45,873       20,687       19,158       69,319  

Income tax (expense) benefit (3)

     —         (395 )     —         —         30,812       (26,521 )
    


 


 


 


 


 


Net income

   $ 69,593     $ 55,143     $ 45,873     $ 20,687     $ 49,970     $ 42,798  
    


 


 


 


 


 


Basic and diluted net income per unit applicable to limited partners (4)

   $ 3.02     $ 2.72     $ 1.82                          
    


 


 


                       

Cash distributions per unit applicable to limited partners

   $ 2.95     $ 2.75     $ 1.70                          
    


 


 


                       

Other Financial Data:

                                                

Net cash provided by operating activities

   $ 105,588     $ 77,656     $ 77,132     $ 1,870     $ 20,247     $ 54,054  

Net cash provided by (used in) investing activities

     (442,350 )     (80,607 )     (17,926 )     (1,736 )     (4,505 )     2,787  

Net cash provided by (used in) financing activities

     318,974       28,688       (51,414 )     (133 )     (15,742 )     (56,841 )

EBITDA (5)

     111,720       76,858       63,074       31,359       25,927       82,414  

Distributions from Skelly-Belvieu Pipeline Company

     2,803       3,590       2,874       2,352       2,306       4,238  

Reliability capital expenditures

     10,353       3,943       2,786       619       1,699       2,060  

Expansion capital expenditures

     21,208       1,761       4,340       1,518       3,186       7,313  

Acquisitions

     411,176       75,000       10,800       —         —         —    

Total capital expenditures

     442,737       80,704       17,926       2,137       4,885       9,373  

Operating Data (barrels/day):

                                                

Refined product pipeline throughput

     392,145       295,456       308,047       306,877       312,759       297,397  

Crude oil pipeline throughput

     355,008       348,023       303,811       295,524       294,037       280,041  

Refined product terminal throughput

     225,426       175,559       176,771       162,904       168,433       161,340  

Crude oil storage tank throughput

     366,986       —         —         —         —         —    

 

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Table of Contents
     Successor

   Predecessor

     December 31,

  

December 31,

1999


     2003

   2002

   2001

   2000

  
     (in thousands)

Balance Sheet Data:

                                  

Property, plant and equipment, net

   $ 765,002    $ 349,276    $ 349,012    $ 280,017    $ 284,954

Total assets

     827,557      415,508      387,070      329,484      308,214

Long-term debt, including current portion and debt due to parent

     354,192      109,658      26,122      118,360      11,102

Partners’ equity/net parent investment (6)

     438,163      293,895      342,166      204,838      254,807

 

(1) Effective January 1, 2000, the Ultramar Diamond Shamrock Logistics Business filed revised tariffs on many of its crude oil and refined product pipelines to reflect the total cost of the pipeline, the current throughput capacity, the current throughput utilization and other market conditions. If the revised tariffs had been implemented effective January 1, 1999, revenues for the year ended December 31, 1999 would have been $87.9 million, a decrease of $21.9 million from the historical revenues of $109.8 million.

 

(2) In August of 1999, the Ultramar Diamond Shamrock Logistics Business recognized a gain on the sale of an 8.33% interest in the McKee to El Paso refined product pipeline and the El Paso refined product terminal to ConocoPhillips.

 

(3) Income tax expense for the year ended December 31, 2002 represents income tax expense incurred by the Wichita Falls Business during the month ended January 31, 2002, prior to the acquisition of the Wichita Falls Business by Valero L.P. on February 1, 2002.

 

Effective July 1, 2000, UDS transferred the Ultramar Diamond Shamrock Logistics Business to Shamrock Logistics Operations. As a limited partnership, Shamrock Logistics Operations was not subject to federal or state income taxes. Due to this change in tax status, the deferred income tax liability of $38.2 million as of June 30, 2000 was written off in the statement of income of the Ultramar Diamond Shamrock Logistics Business for the six months ended June 30, 2000. The resulting income tax benefit of $30.8 million for the six months ended June 30, 2000, includes the write-off of the deferred income tax liability less the income tax expense of $7.4 million for the six months ended June 30, 2000. The income tax expense for periods prior to July 1, 2000 was based on the effective income tax rate for the Ultramar Diamond Shamrock Logistics Business of 38%. The effective income tax rate exceeds the U.S. federal statutory income tax rate due to state income taxes.

 

(4) Net income per unit applicable to limited partners is computed by dividing net income applicable to limited partners, after deduction of the general partner’s 2% interest and incentive distributions, by the weighted average number of limited partnership units outstanding for each class of unitholder. Basic and diluted net income per unit applicable to limited partners is the same. Net income per unit applicable to limited partners for the periods prior to April 16, 2001 is not shown as units had not been issued.

 

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Table of Contents
     Years Ended December 31,

   

For the
period

April 16, 2001
through

December 31,

2001


 
     2003

    2002

   
     (in thousands, except unit and per unit data)  

Net income

   $ 69,593     $ 55,143     $ 45,873  

Less net income applicable to the period January 1, 2001 through April 15, 2001

     —         —         (10,126 )

Less net income applicable to the Wichita Falls Business for the month ended January 31, 2002

     —         (650 )     —    

Less net income applicable to general partner’s interest, including incentive distributions

     (3,959 )     (2,187 )     (715 )
    


 


 


Net income applicable to limited partners’ interest

   $ 65,634     $ 52,306     $ 35,032  
    


 


 


Basic and diluted net income per unit applicable to limited partners

   $ 3.02     $ 2.72     $ 1.82  
    


 


 


Weighted average number of units outstanding, basic and diluted

     21,706,164       19,250,867       19,198,644  
    


 


 


 

(5) The following is a reconciliation of net income to earnings before interest, taxes, depreciation and amortization (EBITDA):

 

     Successor

   Predecessor

     Years Ended December 31,

  

Six

Months
Ended
December 31,

2000


  

Six
Months
Ended

June 30,

2000


   

Year Ended
December 31,

1999


     2003

   2002

   2001

       
     (in thousands)

Net income

   $ 69,593    $ 55,143    $ 45,873    $ 20,687    $ 49,970     $ 42,798

Plus income tax (expense) or less income tax benefit

     —        395      —        —        (30,812 )     26,521

Plus interest expense, net

     15,860      4,880      3,811      4,748      433       777

Plus depreciation and amortization

     26,267      16,440      13,390      5,924      6,336       12,318
    

  

  

  

  


 

EBITDA

   $ 111,720    $ 76,858    $ 63,074    $ 31,359    $ 25,927     $ 82,414
    

  

  

  

  


 

 

Valero L.P. utilizes the financial measure of EBITDA, which is not defined in United States generally accepted accounting principles. Management presents EBITDA in its filings under the Securities Exchange Act of 1934 and in its press releases. Management uses this financial measure because it is a widely accepted financial indicator used by some investors and analysts to analyze and compare partnerships on the basis of operating performance. EBITDA is not intended to represent cash flows for the period, nor is it presented as an alternative to operating income or net income. EBITDA should not be considered in isolation or as a substitute for a measure of performance prepared in accordance with United States generally accepted accounting principles. Valero L.P.’s method of computation for EBITDA may or may not be comparable to other similarly titled measures used by other partnerships.

 

(6) The partners’ equity amount as of December 31, 2001 includes $50.6 million of net parent investment resulting from Valero L.P.’s acquisition of the Wichita Falls Business on February 1, 2002, which represented a transfer between entities under common control and therefore required a restatement of the December 31, 2001 consolidated balance sheet of Valero L.P. to include the Wichita Falls Business as if it had been combined with Valero L.P. as of December 31, 2001. Upon execution of the acquisition on February 1, 2002, partners’ equity/net parent investment was reduced by $51.3 million.

 

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Table of Contents
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

Valero L.P.’s operations provide transportation and storage services to Valero Energy and other unrelated customers. Valero L.P. provides these services with its crude oil and refined product pipelines, refined product terminals and crude oil storage tanks located near or connected to eight of Valero Energy’s refineries. As a result of the significant relationship with Valero Energy, the operating results of Valero L.P. are affected by factors affecting the business of Valero Energy, including refinery utilization rates, refinery maintenance turnarounds, crude oil prices, the demand for refined products and industry refining capacity.

 

Since Valero L.P.’s initial public offering in 2001, Valero L.P. has more than doubled in size as a result of the acquisitions it has completed.

 

In 2001, after the initial public offering, Valero L.P. acquired the Southlake refined product terminal and the Ringgold crude oil storage facility connected to the Ringgold to Ardmore crude oil pipeline for a combined total cost of $10.8 million;

 

In 2002, Valero L.P. acquired the Wichita Falls to McKee crude oil pipeline and related Wichita Falls crude oil storage facility and the Texas City crude hydrogen pipeline for a combined total cost of $75.0 million; and

 

In 2003, Valero L.P. acquired the South Texas Pipelines and Terminals, the Crude Oil Storage Tanks, the Southlake refined product pipeline, the Telfer asphalt terminal, the Shell pipeline interest and the Paulsboro refined product terminal for a combined total cost of $411.2 million.

 

These acquisitions have resulted in an 83.6% increase in revenues and 51.7% increase in net income from the year ended December 31, 2001 to the year ended December 31, 2003.

 

To fund these acquisitions as well as the redemption of $134.1 million of common units (3,809,750 common units) in March 2003, Valero L.P. used a combination of debt and equity offerings as follows:

 

In 2002, Valero Logistics issued $100.0 million of 6.875% senior notes; and

 

In 2003, Valero Logistics issued $250.0 million of 6.05% senior notes and Valero L.P. issued 7,567,250 common units for $272.5 million, including general partner contributions.

 

In February 2004, Valero L.P. acquired the Royal asphalt terminals for $28.1 million and borrowed $38.0 million under the revolving credit facility to fund the Royal acquisition and to fund a portion of the Nuevo Laredo, Mexico propane terminal and related pipeline construction costs.

 

Management intends to further grow the asset base of Valero L.P. by completing additional acquisitions and/or expanding existing facilities in order to increase the cash distributions to unitholders. Since Valero L.P.’s initial public offering, the quarterly cash distribution paid to its limited partners has increased from $0.60 per unit for the second quarter of 2001 to $0.75 per unit for the fourth quarter of 2003. Total cash distributions paid to unitholders and the general partner have totaled $140.3 million for the period from April 16, 2001 through December 31, 2003.

 

Implementation of Segment Reporting

 

Prior to March 18, 2003, Valero L.P. was a consolidated subsidiary of Valero Energy and its operating performance was measured on an entity level basis. This measurement methodology was also used by UDS prior to Valero Energy’s acquisition of UDS on December 31, 2001. In addition, operational management of Valero L.P. reported to Valero Energy management as part of Valero Energy’s pipelines and terminals division. The historical organizational structure and method used to measure operating performance resulted in Valero L.P. having only one segment, an entity level segment.

 

On March 18, 2003, as a result of the common unit redemption transaction, the sale of additional common units to the public and certain changes to the partnership agreement, Valero Energy’s equity ownership in Valero L.P. was reduced to 49.5% and Valero Energy was deemed to no longer control Valero L.P. Accordingly, Valero L.P. was no longer consolidated into Valero Energy. At the same time that the ownership level of Valero L.P. was reduced, a new expanded management team was announced, which separated Valero L.P.’s business into four operating units. Based on these changes and the subsequent development of performance metrics for each operating unit, it was determined that Valero L.P. had four business segments in accordance with Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The four segments include the refined product pipelines segment, the crude oil pipelines segment, the refined product terminals segment and the crude oil storage tanks segment. Historical information for the years ended December 31, 2002 and 2001 has been restated to reflect the new segments.

 

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Table of Contents

Results of Operations

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

 

The results of operations for the year ended December 31, 2003 presented in the following table are derived from the consolidated statement of income for Valero L.P. and subsidiaries for the year ended December 31, 2003, which includes the results of operations of the South Texas Pipelines and Terminals and the Crude Oil Storage Tanks for the period from March 19, 2003 through December 31, 2003, the Telfer asphalt terminal from January 7, 2003 through December 31, 2003, the Shell pipeline interest from May 1, 2003 through December 31, 2003, the Southlake refined product pipeline from August 1, 2003 through December 31, 2003 and the Paulsboro refined product terminal from September 4, 2003 through December 31, 2003. The results of operations for the year ended December 31, 2002 presented in the following table are derived from the consolidated statement of income for Valero L.P. and subsidiaries, which includes the Wichita Falls Business for the month ended January 31, 2002 prior to its actual acquisition on February 1, 2002 and the results of operations of the crude hydrogen pipeline from June 1, 2002 through December 31, 2002.

 

     Years Ended
December 31,


 
     2003

    2002

 

Statement of Income Data:

     (in thousands)  

Revenues

   $ 181,450     $ 118,458  
    


 


Costs and expenses:

                

Operating expenses

     64,609       37,838  

General and administrative expenses

     7,537       6,950  

Depreciation and amortization

     26,267       16,440  
    


 


Total costs and expenses

     98,413       61,228  
    


 


Operating income

     83,037       57,230  

Equity income from Skelly-Belvieu Pipeline Company

     2,416       3,188  

Interest expense, net

     (15,860 )     (4,880 )
    


 


Income before income tax expense

     69,593       55,538  

Income tax expense

     —         (395 )
    


 


Net income

     69,593       55,143  

Less net income applicable to general partner

     (3,959 )     (2,187 )

Less net income related to the Wichita Falls Business for the month ended January 31, 2002

     —         (650 )
    


 


Net income applicable to the limited partners’ interest

   $ 65,634     $ 52,306  
    


 


     December 31,

 
     2003

    2002

 
     (in thousands)  

Balance Sheet Data:

                

Long-term debt, including current portion (1)

   $ 354,192     $ 109,658  

Partners’ equity (2)

     438,163       293,895  

Debt-to-capitalization ratio (1) / ((1) + (2))

     44.7 %     27.2 %

 

23


Table of Contents

Segment Operating Data for the Years Ended December 31, 2003 and 2002:

 

The following table reflects the results of operations for each of Valero L.P.’s operating segments and a reconciliation of the combined segments to the consolidated statements of income.

 

     Years Ended December 31,

     2003

   2002

     (in thousands, except
barrel/day information)

Refined Product Pipelines:

             

Throughput (barrels/day)(a)

     392,145      295,456

Revenues

   $ 72,276    $ 52,302

Operating expenses

     28,914      16,202

Depreciation and amortization

     12,380      8,051
    

  

Segment operating income

   $ 30,982    $ 28,049
    

  

Crude Oil Pipelines:

             

Throughput (barrels/day)

     355,008      348,023

Revenues

   $ 50,741    $ 47,925

Operating expenses

     15,196      13,541

Depreciation and amortization

     5,379      5,618
    

  

Segment operating income

   $ 30,166    $ 28,766
    

  

Refined Product Terminals:

             

Throughput (barrels/day)(a)

     225,426      175,559

Revenues

   $ 31,269    $ 18,231

Operating expenses

     15,447      8,095

Depreciation and amortization

     3,508      2,771
    

  

Segment operating income

   $ 12,314    $ 7,365
    

  

Crude Oil Storage Tanks:

             

Throughput (barrels/day)(a)

     366,986      —  

Revenues

   $ 27,164      —  

Operating expenses

     5,052      —  

Depreciation and amortization

     5,000      —  
    

      

Segment operating income

   $ 17,112      —  
    

      

Consolidated Information:

             

Revenues

   $ 181,450    $ 118,458

Operating expenses

     64,609      37,838

Depreciation and amortization

     26,267      16,440
    

  

Segment operating income

     90,574      64,180

General and administrative expense

     7,537      6,950
    

  

Consolidated operating income

   $ 83,037    $ 57,230
    

  

 

(a) During the years ended December 31, 2003 and 2002, Valero L.P. completed several acquisitions as discussed above. The throughput related to these newly acquired assets included in the table above is calculated based on throughput for the period from the date of acquisition through December 31st, divided by 365 days.

 

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Table of Contents

Refined Product Pipelines

 

Revenues for the refined product pipelines increased $20.0 million and throughput increased 33% due primarily to the acquisition of the South Texas Pipelines on March 18, 2003 and the Southlake refined product pipeline on August 1, 2003. Revenues for the South Texas Pipelines and Southlake refined product pipeline were $22.5 million and throughput totaled 102,650 barrels per day, on a basis of 365 days, from date of acquisition through December 31, 2003. Partially offsetting the increased revenues related to the acquisitions was a $4.5 million decrease in revenues related to the McKee to Colorado Springs to Denver pipeline resulting from Valero Energy maximizing production at its Denver refinery and lower jet fuel sales by Valero Energy in Colorado Springs, resulting in lower throughput in this pipeline.

 

Operating expenses for the refined product pipelines increased $12.7 million or 78% due primarily to the expenses associated with the operations of the South Texas Pipelines and the Southlake refined product pipeline. Operating expenses for the South Texas Pipelines and Southlake refined product pipeline were $11.4 million from the date of acquisition through December 31, 2003. In addition, Valero L.P. incurred higher pipeline inspection and repair costs during 2003 as compared to 2002 primarily for the Amarillo to Albuquerque refined product pipeline and the Three Rivers to San Antonio refined product pipeline, and increased utility costs due to higher electricity rates as a result of higher natural gas prices during 2003.

 

Depreciation and amortization expense for the refined product pipelines increased 54% or $4.3 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002 due to the acquisitions completed during 2003.

 

Crude Oil Pipelines

 

Revenues for the crude oil pipelines increased $2.8 million due primarily to increased revenues for the Wichita Falls to McKee and the Corpus Christi to Three Rivers crude oil pipelines as a result of a combined 7% increase in throughput barrels. Revenues and throughput for Valero L.P.’s other crude oil pipelines for 2003 were comparable to 2002.

 

Operating expenses for the crude oil pipelines increased $1.7 million or 12% due to increased chemical expenses related to drag reducing agents to transport higher volumes of heavier sour crude oil and increased utility costs to transport the higher throughput in 2003 as compared to 2002. Utility costs were higher during 2003 due to higher electricity rates as a result of higher natural gas prices.

 

Depreciation and amortization expense for the crude oil pipelines for the year ended December 31, 2003 remained level with the amount recognized for the year ended December 31, 2002 due to no significant changes in the underlying property, plant and equipment balances.

 

Refined Product Terminals

 

Revenues for the refined product terminals increased $13.0 million and throughput increased 28% due primarily to the acquisitions of the Telfer asphalt terminal on January 7, 2003, the South Texas Terminals on March 18, 2003 and the Paulsboro refined product terminal on September 3, 2003. Revenues for the acquired terminals were $10.8 million and throughput totaled 47,761 barrels per day, on a basis of 365 days, from the date of acquisition through December 31, 2003. Revenues for the other refined product terminals increased $2.2 million due primarily to an increase in the additive blending fee from $0.04 per barrel to $0.12 per barrel effective January 1, 2003.

 

Operating expenses for the refined product terminals increased $7.4 million or 91% due primarily to the expenses associated with the operations of the South Texas Terminals, the Telfer asphalt terminal and the Paulsboro refined product terminal. Operating expenses for the South Texas Terminals, the Telfer asphalt terminal and the Paulsboro refined product terminal were $5.3 million from the date of acquisition through December 31, 2003. In addition, chemical expenses related to gasoline additives increased by $1.0 million, as a result of Valero L.P. purchasing the additives during 2003 versus customers supplying the additives in 2002.

 

Depreciation and amortization expense increased 27% or $0.7 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002 due to the acquisitions completed during 2003.

 

Crude Oil Storage Tanks

 

Revenues for the crude oil storage tanks represent revenues earned on the throughput barrels from the date of acquisition, March 18, 2003, through December 31, 2003. Operating expenses for the crude oil storage tanks consist primarily of the fees charged by Valero Energy for the personnel providing operating and routine maintenance services, and rent expense charged by Valero Energy under the lease and access agreements. Depreciation and amortization expense was recognized for the period from March 18, 2003 through December 31, 2003.

 

25


Table of Contents

General Partnership and Other

 

General and administrative expenses were as follows:

 

     Years Ended
December 31,


 
     2003

    2002

 
     (in thousands)  

Services Agreement with Valero Energy

   $ 5,200     $ 5,200  

Third party expenses

     1,953       1,650  

Compensation expense related to restricted common units and unit options

     910       721  

General and administrative expenses related to the Wichita Falls Business for the month ended January 31, 2002

     —         40  

Reimbursement from partners on jointly owned pipelines

     (526 )     (661 )
    


 


     $ 7,537     $ 6,950  
    


 


 

General and administrative expenses increased 8% or $0.6 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002 due primarily to an increase in third party expenses related to Valero L.P. being a publicly held entity and higher compensation expense related to the award of restricted common units and unit options to Valero GP, LLC employees, officers and directors providing services to Valero L.P. (see Note 13: Employee Benefit Plans). During 2003, as a result of doing business in New Jersey (the Paulsboro refined product terminal acquisition), Valero L.P. incurred $0.3 million of franchise taxes. The reimbursement from partners on jointly owned pipelines was lower in 2003 as a result of Valero L.P.’s purchase of Shell’s interest in the Amarillo to Abernathy and the Abernathy to Lubbock refined product pipelines.

 

Equity income from Skelly-Belvieu Pipeline Company decreased 24% or $0.8 million for the year ended December 31, 2003 as compared to the year ended December 31, 2002 due to an 11% decrease in throughput barrels in the Skellytown to Mont Belvieu refined product pipeline and higher integrity maintenance expenses incurred in 2003. The decreased throughput in 2003 is due to both Valero Energy and ConocoPhillips utilizing greater quantities of liquefied petroleum gases to run their refining operations instead of selling the gases to third parties in Mont Belvieu.

 

Interest expense for the year ended December 31, 2003 was $15.9 million, net of interest income of $0.2 million, capitalized interest of $0.1 million, and interest income related to the interest rate swaps of $4.9 million as compared to $4.9 million of net interest expense for the year ended December 31, 2002. Interest expense was higher in 2003 due to interest expense related to the $250.0 million of 6.05% senior notes issued in March 2003 to fund the redemption of common units owned by UDS Logistics, LLC, redeem a related portion of the general partner interest and fund a portion of the acquisitions. Partially offsetting the higher interest expense in 2003 is the effect of interest rate swaps entered into during the first four months of 2003. Valero Logistics entered into $167.5 million (notional amount) of interest rate swaps, which effectively convert $167.5 million of fixed-rate debt to variable-rate debt, reducing the effective interest rate on such debt by approximately 3% based on current rates.

 

Income tax expense for the year ended December 31, 2002 represents income tax expense incurred by the Wichita Falls Business during the month ended January 31, 2002, prior to the transfer of the Wichita Falls Business to Valero L.P.

 

Net income for the year ended December 31, 2003 was $69.6 million as compared to $55.1 million for the year ended December 31, 2002, an increase of 26%. This increase was primarily attributable to the additional operating income generated from the various acquisitions completed during 2003, partially offset by higher interest costs related to the debt incurred to fund a portion of the acquisition costs. On a per unit basis, net income per unit applicable to the limited partners’ interest increased 11% or $0.30 per unit for the year ended December 31, 2003 as compared to the year ended December 31, 2002. This per unit increase was also attributable to the acquisitions completed during the year ended December 31, 2003; however, the per unit amount was impacted by an increase in the number of common units outstanding as a result of the equity offerings completed in 2003 to fund a portion of the acquisition costs.

 

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Table of Contents

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

 

The results of operations for the year ended December 31, 2002 presented in the following table are derived from the consolidated statement of income for Valero L.P. and subsidiaries for the year ended December 31, 2002, which includes the Wichita Falls Business for the month ended January 31, 2002 prior to its actual acquisition on February 1, 2002 and the results of operations of the crude hydrogen pipeline from June 1, 2002 through December 31, 2002. The results of operations for the year ended December 31, 2001 presented in the following table are derived from the consolidated statement of income for Valero L.P. and subsidiaries for the period from April 16, 2001 through December 31, 2001 and the combined statement of income for Valero L.P. and Valero Logistics for the period from January 1, 2001 through April 15, 2001, which in this discussion are combined and referred to as the year ended December 31, 2001. Included in the results of operations for the period subsequent to April 15, 2001 are the results of operations of the Southlake refined product terminal from July 2, 2001 and the Ringgold crude oil storage facility from December 1, 2001.

 

     Years Ended
December 31,


 
     2002

    2001

 
     (in thousands)  

Statement of Income Data:

                

Revenues

   $ 118,458     $ 98,827  
    


 


Costs and expenses:

                

Operating expenses

     37,838       33,583  

General and administrative expenses

     6,950       5,349  

Depreciation and amortization

     16,440       13,390  
    


 


Total costs and expenses

     61,228       52,322  
    


 


Operating income

     57,230       46,505  

Equity income from Skelly-Belvieu Pipeline Company

     3,188       3,179  

Interest expense, net

     (4,880 )     (3,811 )
    


 


Income before income tax expense

     55,538       45,873  

Income tax expense

     (395 )     —    
    


 


Net income

     55,143       45,873  

Less net income applicable to general partner

     (2,187 )     (715 )

Less net income related to the Wichita Falls Business for the month ended January 31, 2002 and net income related to the period from January 1, 2001 through April 15, 2001

     (650 )     (10,126 )
    


 


Net income applicable to the limited partners’ interest

   $ 52,306     $ 35,032  
    


 


 

     December 31,

 
     2002

    2001

 
     (in thousands)  

Balance Sheet Data:

                

Long-term debt, including current portion (1)

   $ 109,658     $ 26,122  

Partners’ equity (2)

     293,895       342,166  

Debt-to-capitalization ratio (1) / ((1)+(2))

     27.2 %     7.1 %

 

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Table of Contents

Segment Operating Data for the Years Ended December 31, 2002 and 2001:

 

The following table reflects the results of operations for each of Valero L.P.’s operating segments and a reconciliation of the combined segments to the consolidated statements of income.

 

     Years Ended
December 31,


     2002

   2001

     (in thousands,
except barrel/day
information)

Refined Product Pipelines:

             

Throughput (barrels/day)

     295,456      308,047

Revenues

   $ 52,302    $ 53,479

Operating expenses

     16,202      18,582

Depreciation and amortization

     8,051      7,511
    

  

Segment operating income

   $ 28,049    $ 27,386
    

  

Crude Oil Pipelines:

             

Throughput (barrels/day)(a)

     348,023      303,811

Revenues

   $ 47,925    $ 27,438

Operating expenses

     13,541      7,311

Depreciation and amortization

     5,618      3,419
    

  

Segment operating income

   $ 28,766    $ 16,708
    

  

Refined Product Terminals:

             

Throughput (barrels/day)(a)

     175,559      176,771

Revenues

   $ 18,231    $ 17,910

Operating expenses

     8,095      7,690

Depreciation and amortization

     2,771      2,460
    

  

Segment operating income

   $ 7,365    $ 7,760
    

  

Consolidated Information:

             

Revenues

   $ 118,458    $ 98,827

Operating expenses

     37,838      33,583

Depreciation and amortization

     16,440      13,390
    

  

Segment operating income

     64,180      51,854

General and administrative expense

     6,950      5,349
    

  

Consolidated operating income

   $ 57,230    $ 46,505
    

  

 

(a) During the years ended December 31, 2002 and 2001, Valero L.P. completed several acquisitions as discussed above. The throughput related to these newly acquired assets included in the table above is calculated based on throughput for the period from the date of acquisition through December 31st, divided by 365 days.

 

Refined Product Pipelines

 

Revenues for the refined product pipelines decreased $1.2 million and throughput decreased 4% due primarily to decreased revenues for the McKee to Colorado Springs to Denver refined product pipeline due to a 16% decrease in throughput barrels resulting from reduced production at Valero Energy’s McKee refinery. During the first quarter of 2002, Valero Energy completed several planned refinery turnaround projects at the McKee refinery, which significantly reduced production and thus reduced throughput barrels. Partially offsetting the decrease in revenues for the McKee to Colorado Springs to Denver refined product pipeline were $0.8 million in revenues related to the crude hydrogen pipeline which was acquired on May 29, 2002.

 

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Table of Contents

Operating expenses for the refined product pipelines decreased $2.4 million due primarily to lower utility expenses as a result of lower natural gas prices, participation in Texas electricity deregulation, negotiating lower rates with utility providers and implementation of power optimization software.

 

Depreciation and amortization expense for the refined product pipelines increased 7% or $0.5 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001 due to the additional depreciation expense related to the crude hydrogen pipeline acquired on May 29, 2002.

 

Crude Oil Pipelines

 

Revenues for the crude oil pipelines increased $20.5 million and throughput increased 15% due primarily to the acquisition of the Wichita Falls to McKee crude oil pipeline effective January 1, 2002. Revenues for the Wichita Falls to McKee crude oil pipeline were $22.9 million for the year ended December 31, 2002. Partially offsetting the Wichita Falls to McKee crude oil pipeline revenues was a $2.4 million decrease in revenues for the Corpus Christi to Three Rivers crude oil pipeline due to a 13% decrease in throughput barrels, as a result of reduced production at the Three Rivers refinery. During the first half of 2002, Valero Energy initiated economic-based refinery production cuts at the Three Rivers refinery. In addition, during the first quarter of 2002, Valero Energy completed several refinery turnaround projects resulting in a partial shutdown of the refinery and reduced throughput barrels in Valero L.P.’s pipelines.

 

Operating expenses for the crude oil pipelines increased $6.2 million due primarily to the expenses associated with the operations of the Wichita Falls to McKee crude oil pipeline. Operating expenses for the Wichita Falls to McKee crude oil pipeline were $5.9 million for the year ended December 31, 2002.

 

Depreciation and amortization expense for the crude oil pipelines increased 64% or $2.2 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001 due to the additional depreciation expense related to the acquisition of the Wichita Falls to McKee crude oil pipeline effective January 1, 2002 and the Ringgold crude oil storage facility on December 1, 2001.

 

Refined Product Terminals

 

Revenues for the refined product terminals increased $0.3 million due primarily to the acquisition of the Southlake refined product terminal on July 1, 2001. Revenues for the Southlake refined product terminal were $1.0 million higher for the full year of 2002 as compared to the second half of 2001. Partially offsetting the Southlake refined product terminal revenues was a decrease in revenues of $0.6 million for the Corpus Christi refined product terminal. In 2002, as a result of Valero Energy’s economic-based refinery production cuts at the Three Rivers refinery, lower volumes of benzene, toluene and xylene were transported to Corpus Christi.

 

Operating expenses for the refined product terminals increased $0.4 million due primarily to the expenses associated with the operations of the Southlake refined product terminal. Operating expenses for the Southlake refined product terminal were $0.5 million higher in 2002 as compared to 2001, due to a full year of operating expenses in 2002.

 

Depreciation and amortization expense for the refined product terminals increased 13% or $0.3 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001 due to the additional depreciation expense related to the Southlake refined product terminal.

 

General Partnership and Other

 

General and administrative expenses were as follows:

 

     Years Ended
December 31,


 
     2002

    2001

 
     (in thousands)  

Services Agreement with Valero Energy

   $ 5,200     $ 5,200  

Third party expenses

     1,650       730  

Compensation expense related to restricted common units

     721       —    

General and administrative expenses related to the Wichita Falls Business for the month ended January 31, 2002

     40       —    

Reimbursement from partners on jointly owned pipelines

     (661 )     (581 )
    


 


     $ 6,950     $ 5,349  
    


 


 

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Table of Contents

General and administrative expenses increased 30% or $1.6 million for the year ended December 31, 2002 as compared to the year ended December 31, 2001 due primarily to an increase in third party expenses and the recognition of compensation expense related to the award of restricted common units to Valero GP, LLC employees, officers and directors providing services to Valero L.P. (see Note 13: Employee Benefit Plans). The increase in third party expenses was due to higher audit fees, increased costs for the unitholder annual report and income tax reports, and a full year of director fees in 2002.

 

Equity income from Skelly-Belvieu Pipeline Company for the year ended December 31, 2002 was comparable to equity income recognized in the year ended December 31, 2001 as throughput barrels in the Skellytown to Mont Belvieu refined product pipeline increased 2% during 2002.

 

Interest expense for the year ended December 31, 2002 was $4.9 million, net of interest income of $0.2 million and capitalized interest of $0.3 million, as compared to $3.8 million of net interest expense for 2001. Interest expense was higher in 2002 due to additional borrowings to fund the acquisitions. Included in interest expense for 2002 was interest expense related to the $100.0 million of 6.875% senior notes issued in July 2002, the proceeds of which were used to repay borrowings under the variable-rate revolving credit facility. Included in interest expense for 2001 was interest expense of $2.5 million for the period from January 1, 2001 through April 15, 2001 related to the $107.7 million of debt due to parent that Valero L.P. paid off on April 16, 2001 upon closing its initial public offering.

 

Net income for the year ended December 31, 2002 was $55.1 million as compared to $45.9 million for the year ended December 31, 2001, an increase of 20%. This increase in net income was primarily attributable to the additional operating income generated from the acquisitions completed during 2002, partially offset by higher interest costs related to the debt incurred to fund a portion of the acquisitions and lower throughput barrels in 2002 resulting from economic-based refinery production cuts at the three Valero Energy refineries served by Valero L.P.’s pipelines and terminals during 2002.

 

On a per unit basis, net income per unit applicable to the limited partners’ interest increased 49% or $0.90 per unit for the year ended December 31, 2002 as compared to the year ended December 31, 2001. This per unit increase was primarily attributable to Valero L.P.’s initial public offering occurring on April 16, 2001. Net income for the period January 1, 2001 to April 15, 2001 of $10.1 million was allocated entirely to the general partner and thus was not included in the determination of net income per unit applicable to limited partners.

 

Liquidity and Capital Resources

 

Valero L.P.’s primary cash requirements, in addition to normal operating expenses, are for capital expenditures (both reliability and expansion), business and asset acquisitions, distributions to partners and debt service. Valero L.P. expects to fund its short-term needs for such items as reliability capital expenditures and quarterly distributions to the partners from operating cash flows. Capital expenditures for long-term needs resulting from future expansion projects and acquisitions are expected to be funded by a variety of sources including cash flows from operating activities, borrowings under the revolving credit facility and the issuance of additional common units, debt securities and other capital market transactions.

 

Revolving Credit Facility

 

On March 6, 2003, Valero Logistics amended its December 2000 revolving credit facility, increasing its credit limit to $175.0 million. The revolving credit facility expires on January 15, 2006. At Valero Logistics’ option, borrowings under the revolving credit facility bear interest based on either an alternative base rate or LIBOR. Valero Logistics also incurs a facility fee on the aggregate commitments of lenders under the revolving credit facility, whether used or unused. Borrowings under the revolving credit facility may be used for working capital and general partnership purposes; however borrowings to fund distributions to unitholders are limited to $40.0 million. All borrowings designated as borrowings subject to the $40.0 million sublimit must be reduced to zero for a period of at least 15 consecutive days during each fiscal year. The revolving credit facility also allows Valero Logistics to issue letters of credit for an aggregate of $75.0 million. The borrowings under the revolving credit facility are unsecured and rank equally with all of Valero Logistics’ outstanding unsecured and unsubordinated debt. The revolving credit facility is irrevocably and unconditionally guaranteed by Valero L.P. Valero L.P.’s guarantee ranks equally with all of its existing and future unsecured senior obligations.

 

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Table of Contents

The revolving credit facility requires that Valero Logistics maintain certain financial ratios, as defined in the revolving credit facility, including a consolidated debt coverage ratio not to exceed 4.0 to 1.0 and a consolidated interest coverage ratio no less than 3.5 to 1.0. The revolving credit facility includes other restrictive covenants, including a prohibition on distributions by Valero Logistics to Valero L.P. if any default, as defined in the revolving credit facility, exists or would result from the distribution. The revolving credit facility also includes a change-in-control provision, which requires that Valero Energy continue to own, directly or indirectly, 51% of Valero L.P.’s general partner interest or Valero Energy and/or Valero L.P. own 100% of the general partner interest in Valero Logistics or 100% of the outstanding limited partner interests in Valero Logistics. Management believes that Valero Logistics is in compliance with all of these ratios and covenants.

 

On March 18, 2003, Valero Logistics borrowed $25.0 million under the revolving credit facility to partially fund the purchase of the South Texas Pipelines and Terminals from Valero Energy, which borrowings were repaid during the second quarter of 2003, primarily from proceeds from the common unit offerings completed by Valero L.P. During the first quarter of 2002, Valero Logistics borrowed $64.0 million under the revolving credit facility to purchase the Wichita Falls Business from Valero Energy and during the second quarter of 2002, Valero Logistics borrowed an additional $11.0 million to purchase a crude hydrogen pipeline from Valero Energy. During the third quarter of 2002, the outstanding balance under the revolving credit facility of $91.0 million was paid off with proceeds from the $100.0 million of 6.875% senior notes issued in July of 2002. As of December 31, 2003, Valero Logistics had no outstanding borrowings under the revolving credit facility.

 

Senior Notes

 

On March 18, 2003, Valero Logistics issued, in a private placement to institutional investors, $250.0 million of 6.05% senior notes, due March 15, 2013, with interest payable in arrears on March 15 and September 15 of each year beginning September 15, 2003. The net proceeds of $247.3 million were used to redeem 3,809,750 common units held by UDS Logistics, LLC ($134.1 million), redeem a related portion of the general partner interest ($2.9 million) and partially fund the South Texas Pipelines and Terminals acquisition cost. On July 10, 2003, Valero Logistics exchanged all of the $250.0 million of privately issued 6.05% senior notes for a like principal amount of 6.05% senior notes that were registered under the Securities Act of 1933.

 

On July 15, 2002, Valero Logistics issued $100.0 million of 6.875% senior notes due July 15, 2012 with interest payable in arrears on January 15 and July 15 of each year. The net proceeds were used to repay the $91.0 million then outstanding under the revolving credit facility.

 

Neither series of senior notes have sinking fund requirements. The 6.05% senior notes rank equally with all other existing senior unsecured indebtedness of Valero Logistics, including indebtedness under the revolving credit facility and the 6.875% senior notes. Both series of senior notes contain restrictions on Valero Logistics’ ability to incur secured indebtedness unless the same security is also provided for the benefit of holders of the senior notes. In addition, the senior notes limit Valero Logistics’ ability to incur indebtedness secured by certain liens and to engage in certain sale-leaseback transactions. Also, both series of senior notes are irrevocably and unconditionally guaranteed on a senior unsecured basis by Valero L.P. The guarantee by Valero L.P. ranks equally with all of its existing unsecured and unsubordinated indebtedness and is required to rank equally with any future unsecured and unsubordinated indebtedness. At the option of Valero Logistics, each of the series of senior notes may be redeemed in whole or in part at any time at a redemption price, which includes a make-whole premium, plus accrued and unpaid interest to the redemption date.

 

The senior notes also include change-in-control provisions, which require that an investment grade entity own and control the general partner of Valero L.P. and Valero Logistics. Otherwise, Valero Logistics must offer to purchase the senior notes at a price equal to 100% of their outstanding principal balance plus accrued interest through the date of purchase.

 

Interest Rate Swaps

 

During the first four months of 2003, Valero Logistics entered into interest rate swap agreements to manage its exposure to changes in interest rates. The interest rate swap agreements have an aggregate notional amount of $167.5 million, of which $60.0 million is tied to the maturity of the 6.875% senior notes and $107.5 million is tied to the maturity of the 6.05% senior notes. Under the terms of the interest rate swap agreements, Valero Logistics will receive a fixed rate (6.875% and 6.05%, respectively) and will pay a variable rate based on LIBOR plus a percentage that varies with each agreement. Valero Logistics accounts for the interest rate swaps as fair value hedges, with changes in the fair value of each swap and the related debt instrument recorded as an adjustment to interest expense in the consolidated statements of income.

 

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Table of Contents

Common Unit Offerings

 

On March 18, 2003, Valero L.P. closed on a public offering of 5,750,000 common units for net proceeds of $204.6 million, including a $4.3 million general partner contribution from Riverwalk Logistics to maintain its 2% general partner interest. Valero L.P. used the net proceeds primarily to fund the acquisition of the Crude Oil Storage Tanks. On April 16, 2003, Valero L.P. closed on the exercise of a portion of the underwriters’ over-allotment option, by selling 581,000 common units for net proceeds of $20.9 million, including a $0.5 million general partner contribution. Valero L.P. used the net proceeds to pay down the then outstanding balance due under the revolving credit facility.

 

On August 11, 2003, Valero L.P. closed on a public offering of 1,236,250 common units, which included 161,250 common units related to an over-allotment option, for net proceeds of $49.3 million, including a $1.0 million general partner contribution. Valero L.P. used the net proceeds primarily to fund the acquisitions of the Southlake refined product pipeline and the Paulsboro refined product terminal.

 

On April 16, 2001, Valero L.P. closed its initial public offering of 5,175,000 common units for net proceeds of $111.9 million. In addition, Valero Logistics borrowed $20.5 million under the revolving credit facility. Valero L.P. used the net proceeds to repay $107.7 million of debt due to parent, reimburse affiliates of UDS $20.5 million for previous capital expenditures and pay $0.4 million of debt issuance costs. The remaining net proceeds of $3.8 million were used for working capital and general partnership purposes.

 

Shelf Registration Statement

 

On October 2, 2003, Valero L.P. and Valero Logistics filed a $750.0 million universal shelf registration statement with the SEC covering the issuance of an unspecified amount of common units or debt securities or a combination thereof. Valero L.P. may, in one or more offerings, offer and sell common units representing limited partner interests in Valero L.P. Valero Logistics may, in one or more offerings, offer and sell debt securities, which will be fully and unconditionally guaranteed by Valero L.P. The full balance of the $750.0 million universal shelf registration statement is available. The remaining balance of $116.5 million related to the previously filed $500.0 million universal shelf registration statement was cancelled.

 

Distributions

 

Valero L.P.’s partnership agreement, as amended, sets forth the calculation to be used to determine the amount and priority of cash distributions that the common unitholders, subordinated unitholders and the general partner will receive. During the subordination period, if there is sufficient available cash, the holders of Valero L.P.’s common units are entitled to receive each quarter a minimum quarterly distribution of $0.60 per unit ($2.40 annualized) prior to any distribution of available cash to holders of Valero L.P.’s subordinated units. In addition, the general partner is entitled to incentive distributions, as defined below, if the amount Valero L.P. distributes with respect to any quarter exceeds $0.60 per unit.

 

The following table reflects the allocation of the total cash distributions to the general and limited partners applicable to the period in which the distributions are earned:

 

     Years Ended
December 31,


   April 16
through
December 31,


     2003

   2002

   2001

     (in thousands, except per unit data)

General partner interest

   $ 1,404    $ 1,103    $ 667

General partner incentive distribution

     2,620      1,103      —  
    

  

  

Total general partner distribution

     4,024      2,206      667

Limited partners’ distribution

     66,179      52,969      32,692
    

  

  

Total cash distributions

   $ 70,203    $ 55,175    $ 33,359
    

  

  

Cash distributions per unit applicable to limited partners

   $ 2.95    $ 2.75    $ 1.70
    

  

  

 

 

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Table of Contents

The distributions for the year ended December 31, 2001, represent the minimum quarterly distribution for the period subsequent to Valero L.P.’s initial public offering, the period from April 16, 2001 through December 31, 2001. On February 13, 2004, Valero L.P. paid a quarterly cash distribution of $0.75 per unit for the fourth quarter of 2003.

 

Capital Requirements

 

The petroleum pipeline and terminalling industry is capital-intensive, requiring significant investments to maintain, upgrade or enhance existing operations and to comply with environmental and safety laws and regulations. Valero L.P.’s capital expenditures consist primarily of:

 

reliability capital expenditures (formerly referred to as maintenance capital expenditures), such as those required to maintain equipment reliability and safety and to address environmental and safety regulations; and

 

expansion capital expenditures, such as those to expand and upgrade pipeline capacity and to construct new pipelines, terminals and storage tanks. In addition, expansion capital expenditures may include acquisitions of pipelines, terminals or storage tank assets.

 

During the year ended December 31, 2003, Valero L.P. incurred reliability capital expenditures of $10.4 million primarily related to pipeline replacements along the Corpus Christi to Pasadena refined product pipeline, tank and pipeline pump station upgrades at several locations and system automation projects related to terminal and pipeline management software. Expansion capital expenditures of $21.2 million were primarily related to the construction of the Nuevo Laredo, Mexico propane terminal and related pipeline, the addition of new pumps on the Wichita Falls to McKee crude oil pipeline and the expansion of the Corpus Christi to Edinburg refined product pipeline. Also during 2003, Valero L.P. completed $411.2 million of acquisitions, which included the following:

 

South Texas Pipelines and Terminals from Valero Energy for $150.1 million,

 

Crude Oil Storage Tanks from Valero Energy for $200.2 million,

 

Southlake refined product pipeline from Valero Energy for $29.9 million,

 

Telfer asphalt terminal from Telfer Oil Company for $15.3 million,

 

Paulsboro refined product terminal from ExxonMobil Oil Corporation for $14.1 million, and

 

Shell pipeline interest from Shell Pipeline Company, LP for $1.6 million.

 

During the year ended December 31, 2002, Valero L.P. incurred reliability capital expenditures of $3.9 million primarily related to tank and automation upgrades at both the refined product terminals and the crude oil storage facilities and corrosion protection and automation upgrades for refined product pipelines. Expansion capital expenditures of $1.8 million were primarily related to the completion of the Amarillo to Albuquerque refined product pipeline expansion, which is net of ConocoPhillips’ 50% share of costs. Also during 2002, Valero L.P. completed $75.0 million of acquisitions, which included the following:

 

Wichita Falls Business (consisting of the Wichita Falls to McKee crude oil pipeline and related storage facility) from Valero Energy for $64.0 million, and

 

Crude hydrogen pipeline from Valero Energy for $11.0 million.

 

During the year ended December 31, 2001, Valero L.P. incurred reliability capital expenditures of $2.8 million primarily related to tank and automation upgrades at the refined product terminals and cathodic (corrosion) protection and automation upgrades for both refined product and crude oil pipelines. Expansion capital expenditures of $4.3 million included $1.8 million for rights-of-way related to the expansion of the Amarillo to Albuquerque refined product pipeline, which is net of ConocoPhillips’ 50% share of such costs. Also during 2001, Valero L.P. completed $10.8 million of acquisitions, which included the following:

 

Southlake refined product terminal from Valero Energy for $5.6 million, and

 

Ringgold crude oil storage facility from Valero Energy for $5.2 million.

 

On February 20, 2004, Valero L.P. purchased two asphalt terminals from Royal for $28.1 million, which was funded with proceeds from borrowings under the revolving credit facility. The two asphalt terminals have a combined storage capacity of 500,000 barrels and are located in Catoosa, Oklahoma and Rosario, New Mexico. In conjunction with the Royal acquisition, Valero L.P. entered into a five-year Terminal Storage and Throughput Agreement with Valero Energy, which requires Valero Energy to utilize the two terminals for at least 18.5% of its combined asphalt production at the McKee and Ardmore refineries.

 

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Table of Contents

For 2004, Valero L.P. expects to incur approximately $33.5 million of capital expenditures, including $12.4 million for reliability capital projects (primarily pipeline replacements and automation upgrades) and $21.1 million for expansion capital projects. The 2004 expansion capital projects include $14.2 million related to the Nuevo Laredo, Mexico propane terminal and related pipeline and $1.6 million related to the expansion of the Corpus Christi to Edinburg refined product pipeline. Valero L.P. expects to fund its expansion capital expenditures with borrowings under its revolving credit facility and its reliability capital expenditures from cash provided by operations.

 

Valero L.P. believes it generates sufficient cash from its current operations to fund its day-to-day operating and general and administrative expenses and reliability capital expenditures. Valero L.P. also has available, borrowing capacity under Valero Logistics’ revolving credit facility and, to the extent necessary, it can raise additional funds from time to time through equity or debt offerings under the $750.0 million universal shelf registration statement. However, there can be no assurance regarding the availability of any future financings or whether such financings can be made available on terms acceptable to Valero L.P.

 

Long-Term Contractual Obligations

 

The following table presents long-term contractual obligations and commitments of Valero L.P. and the related payments due, in total and by period, as of December 31, 2003. Valero L.P. has no unconditional purchase obligations as of December 31, 2003.

 

     Payments Due by Period

     Less Than
1 Year


   1-3
Years


   4-5
Years


   Over 5
Years


   Total

     (in thousands)

Long-term debt (stated maturities)

   $ 935    $ 1,701    $ 1,373    $ 350,183    $ 354,192

Operating leases

     1,372      4,062      1,724      13,809      20,967

Right-of-way payments

     27      81      54      317      479

 

The operating lease amounts in the above table include minimum rentals due under the various land leases for the refined product terminals, the Corpus Christi crude oil storage facility and the crude oil storage tanks.

 

Valero L.P. does not have any long-term contractual obligations related to its investment in the Skelly-Belvieu Pipeline Company, other than the requirement to operate the pipeline on behalf of the members and to fund Valero L.P.’s 50% share of capital expenditures as they arise. Skelly-Belvieu Pipeline Company does not have any outstanding debt as of December 31, 2003.

 

Related Party Transactions

 

In addition to owning a combined 45.7% general and limited partner interest in Valero L.P., Valero L.P. and Valero Energy have entered into a number of operating agreements, which govern the required services provided to and from Valero Energy. Most of the operating agreements include adjustment provisions, which allow Valero L.P. to increase the handling, storage and throughput fees charged by Valero L.P. to Valero Energy based on a Consumer Price Index. In addition, the pipeline tariffs charged by Valero L.P. are reviewed annually and adjusted based on an inflation index and may also be adjusted to take into consideration additional costs incurred to provide the transportation services. The following is a summary of the significant requirements of the individual agreements.

 

Services Agreement

 

Valero L.P. does not have any employees. Under the Services Agreement, employees of Valero Energy perform services on Valero L.P.’s behalf, and Valero L.P. reimburses Valero Energy for the services rendered, including salary, wages and employee benefit costs. In addition, Valero Energy provides certain corporate functions of legal, accounting, treasury, engineering, information technology and other services to Valero L.P. for an annual fee of $5.2 million. The Services Agreement has a term that extends to June 2008. Due to the significant growth of Valero L.P. over the past three years and the increased levels of service provided by Valero Energy for Valero L.P., Valero L.P. and Valero Energy have agreed to amend the terms of the Services Agreement, effective April 1, 2004, to change the annual services fee. Under the terms of the amended Services Agreement, the annual services fee will be $1.2 million. Each year over the next four years, the annual services fee will be increased by $1.2 million and by Valero Energy’s average percentage increase in salaries. The annual services fee may also be adjusted to account for changed service levels due to Valero L.P.’s acquisition, sale or construction of assets. Additionally, Valero L.P. will reimburse Valero Energy for the cost of corporate employees dedicated to Valero L.P. matters (currently estimated to be approximately $5.6 million per year, excluding employee bonus costs). The conflicts committee of the board of directors of Valero GP, LLC approved the amendment to the Services Agreement in March 2004.

 

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Pipelines and Terminals Usage Agreement - McKee, Three Rivers and Ardmore

 

Under the terms of the Pipelines and Terminals Usage Agreement, Valero L.P. provides transportation services that support Valero Energy’s refining and marketing operations relating to the McKee, Three Rivers and Ardmore refineries. Pursuant to the agreement, Valero Energy has agreed through April 2008:

 

To transport in Valero L.P.’s crude oil pipelines at least 75% of the aggregate volumes of crude oil shipped to the McKee, Three Rivers and Ardmore refineries;

 

To transport in Valero L.P.’s refined product pipelines at least 75% of the aggregate volumes of refined products shipped from the McKee, Three Rivers and Ardmore refineries; and

 

To use Valero L.P.’s refined product terminals for terminalling services for at least 50% of the refined products shipped from the McKee, Three Rivers and Ardmore refineries.

 

In the event Valero Energy does not transport in Valero L.P.’s pipelines or use Valero L.P.’s terminals to handle the minimum volume requirements and if its obligation has not been suspended under the terms of the agreement, Valero Energy will be required to make a cash payment determined by multiplying the shortfall in volume by the applicable weighted-average pipeline tariff or terminal fee. During the year ended December 31, 2003, Valero Energy exceeded its obligations under the Pipelines and Terminals Usage Agreement. Additionally, Valero Energy has agreed not to challenge, or cause others to challenge Valero L.P.’s interstate or intrastate tariffs for the transportation of crude oil and refined products until at least April 2008.

 

Crude Oil Storage Tanks Agreements

 

In connection with the crude oil storage tank contribution, Valero L.P. and Valero Energy entered into the following agreements related to the operations of the crude oil storage tanks.

 

Handling and Throughput Agreement – Valero Energy has agreed to pay Valero L.P. a fee, for an initial period of ten years, for all crude oil and certain other feedstocks delivered to each of the Corpus Christi West refinery, the Texas City refinery and the Benicia refinery and to use Valero L.P. for handling all deliveries to these refineries. The throughput fees are adjustable annually, generally based on 75% of the regional consumer price index applicable to the location of each refinery. The agreement may be extended by Valero Energy for up to an additional five years.

 

Services and Secondment Agreements – Valero Energy has agreed to provide to Valero L.P. personnel who perform operating and routine maintenance services related to the crude oil storage tank operations. The annual reimbursement for services is an aggregate $3.5 million for the initial year and is subject to adjustment based on the actual expenses incurred and increases in the regional consumer price index. The initial term of the Services and Secondment Agreements is ten years with a Valero L.P. option to extend for an additional five years. In addition to the fees Valero L.P. has agreed to pay, Valero L.P. is responsible for operating expenses and specified capital expenditures related to the tank assets that are not addressed in the agreement. These operating expenses and capital expenditures include tank safety inspections, maintenance and repairs, certain environmental expenses, insurance premiums and ad valorem taxes.

 

Lease and Access Agreements – Valero L.P. leases from Valero Energy the real property on which the crude oil storage tanks are located for an aggregate of $0.7 million per year. The initial term of each lease is 25 years, subject to automatic renewal for successive one-year periods thereafter.

 

South Texas Pipelines and Terminals Agreements

 

In connection with the South Texas Pipelines and Terminals contribution, Valero L.P. and Valero Energy entered into the following agreements related to the operations of the pipelines and terminals:

 

A terminalling agreement pursuant to which Valero Energy agreed, during the initial period of five years, to pay a terminalling fee for each barrel of refined product stored or handled by or on behalf of Valero Energy at the terminals, including an additive fee for gasoline additive blended at the terminals. At the Houston Hobby Airport terminal, Valero Energy agreed to pay a filtering fee for each barrel of jet fuel stored or handled at the terminal.

 

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A throughput commitment agreement pursuant to which Valero Energy agreed, for an initial period of seven years:

 

to transport in the Houston and Valley pipeline systems an aggregate of 40% of the Corpus Christi refineries’ gasoline and distillate production but only if the combined throughput in these pipelines is less than 110,000 barrels per day;

 

to transport in the Pettus to San Antonio refined product pipeline 25% of the Three Rivers refinery gasoline and distillate production and in the Pettus to Corpus Christi refined product pipeline 90% of the Three Rivers refinery raffinate production;

 

to use the Houston asphalt terminal for an aggregate of 7% of the asphalt production of the Corpus Christi refineries;

 

to use the Edinburg refined product terminal for an aggregate of 7% of the gasoline and distillate production of the Corpus Christi refineries, but only if the throughput at this terminal is less than 20,000 barrels per day; and

 

to use the San Antonio east terminal for 75% of the throughput in the Pettus to San Antonio refined product pipeline.

 

In the event Valero Energy does not transport in Valero L.P.’s pipelines or use Valero L.P.’s terminals to handle the minimum volume requirements and if its obligation has not been suspended under the terms of the agreement, it will be required to make a cash payment determined by multiplying the shortfall in volume by the applicable weighted-average pipeline tariff or terminal fee. Valero Energy has indicated to Valero L.P. that the segment of the Corpus Christi to Edinburg refined product pipeline that runs approximately 60 miles south from Corpus Christi to Seeligson Station may require repair and, in some places, replacement. Valero Energy has agreed to indemnify Valero L.P. for any costs Valero L.P. incurs to repair and replace this segment in excess of $1.5 million, excluding costs to upgrade the size of the pipe, which will be Valero L.P.’s responsibility. Valero Energy also agreed to allow Valero L.P. to increase its tariff to compensate for any revenue shortfall in the event Valero L.P. has to curtail throughput in the Corpus Christi to Edinburg refined product pipeline as a result of repair and replacement activities.

 

Other Agreements

 

A hydrogen tolling agreement, which provides that Valero Energy will pay Valero L.P. minimum annual revenues of $1.4 million for transporting crude hydrogen from BOC’s chemical facility in Clear Lake, Texas to Valero Energy’s Texas City refinery.

 

A terminal storage and throughput agreement related to the Pittsburg asphalt terminal, which provides that Valero Energy will pay Valero L.P. a monthly lease fee of $0.2 million, a minimum annual throughput fee of $0.4 million and will reimburse Valero L.P. for utility costs.

 

Equity Ownership

 

As of December 31, 2003, UDS Logistics, LLC, an indirect wholly owned subsidiary of Valero Energy, owns 614,572 of Valero L.P.’s outstanding common units and all 9,599,322 of Valero L.P.’s outstanding subordinated units. In addition, Valero GP, LLC, also an indirect wholly owned subsidiary of Valero Energy, owns 64,654 of Valero L.P.’s outstanding common units. As a result, Valero Energy owns a 43.7% limited partner interest in Valero L.P. and the 2% general partner interest held by Riverwalk Logistics.

 

Environmental, Health and Safety

 

Valero L.P. is subject to extensive federal, state and local environmental and safety laws and regulations, including those relating to the discharge of materials into the environment, waste management, pollution prevention measures, pipeline integrity and operator qualifications. Because environmental and safety laws and regulations are becoming more complex and stringent and new environmental and safety laws and regulations are continuously being enacted or proposed, the level of future expenditures required for environmental, health and safety matters is expected to increase.

 

Valero Energy has agreed to indemnify Valero L.P. for a period of approximately 10 years, for pre-acquisition environmental liabilities related to the assets transferred or otherwise acquired by Valero L.P. from Valero Energy. These indemnifications do not include liabilities that result from a change in environmental law subsequent to acquisition. As an operator or owner of the assets, Valero L.P. could be held liable for pre-acquisition environmental liabilities should Valero Energy be unable to fulfill its obligation. However, Valero L.P. believes that such a situation is remote given Valero Energy’s financial condition. As of December 31, 2003, Valero L.P. has accrued $0.1 million for environmental matters, which is expected to be spent over the next two years. As of December 31, 2002, Valero L.P. had not incurred any material environmental liabilities.

 

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Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with United States generally accepted accounting principles requires management to select accounting policies and to make estimates and assumptions related thereto that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The following summary provides further information about Valero L.P.’s critical accounting policies and should be read in conjunction with Note 2: Summary of Significant Accounting Policies, which summarizes Valero L.P.’s significant accounting policies.

 

Revenue Recognition

 

Revenues are derived from interstate and intrastate pipeline transportation of crude oil and refined products, the storage and throughput of crude oil and the terminalling and blending of refined products. Transportation revenues are based on pipeline tariffs that are subject to extensive federal and/or state regulation. Terminalling and blending revenues are based on fees which Valero L.P. believes are market based. Reductions to the current pipeline tariffs or terminalling and blending fees charged could have a material adverse effect on Valero L.P.’s results of operations. For the year ended December 31, 2003, 98% of Valero L.P.’s revenues were derived from Valero Energy and Valero Energy has agreed not to challenge certain of Valero L.P.’s pipeline tariffs or terminalling fees until at least April 2008. See Note 12: Related Party Transactions for a discussion of Valero L.P.’s relationship with Valero Energy.

 

Depreciation

 

Depreciation expense is calculated using the straight-line method over the estimated useful lives of Valero L.P.’s property, plant and equipment. Because of the expected long useful lives of the property, plant and equipment, Valero L.P. depreciates its property over periods ranging from 3 years to 40 years. Changes in the estimated useful lives of the property, plant and equipment could have a material adverse effect on Valero L.P.’s results of operations.

 

Impairment of Long-Lived Assets and Goodwill

 

Long-lived assets are required to be tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Goodwill must be tested for impairment annually or more frequently if events or changes in circumstances indicate that the related asset might be impaired. An impairment loss should be recognized only if the carrying amount of the asset/goodwill is not recoverable and exceeds its fair value.

 

In order to test for recoverability, management must make estimates of projected cash flows related to the asset which include, but are not limited to, assumptions about the use or disposition of the asset, estimated remaining life of the asset, and future expenditures necessary to maintain the asset’s existing service potential. In order to determine fair value, management must make certain estimates and assumptions including, among other things, an assessment of market conditions, projected cash flows, investment rates, interest/equity rates and growth rates, that could significantly impact the fair value of the long-lived asset or goodwill. Due to the subjectivity of the assumptions used to test for recoverability and to determine fair value, significant impairment charges could result in the future, thus affecting Valero L.P.’s future reported net income.

 

Asset Retirement Obligation

 

An entity is required to recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. If a reasonable estimate cannot be made in the period the asset retirement obligation is incurred, the liability should be recognized when a reasonable estimate of fair value can be made.

 

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In order to determine fair value, management must make certain estimates and assumptions including, among other things, projected cash flows, a credit-adjusted risk-free rate, and an assessment of market conditions that could significantly impact the estimated fair value of the asset retirement obligation. These estimates and assumptions are very subjective. Valero L.P. has determined that it is obligated by contractual or regulatory requirements to remove assets or perform other remediation upon retirement of certain assets. However, the fair value of the asset retirement obligation cannot currently be reasonably estimated because the settlement dates are indeterminate. Valero L.P. will record an asset retirement obligation in the periods in which it can reasonably determine the settlement dates.

 

Income Allocation

 

Valero L.P.’s net income for each quarterly reporting period is first allocated to the general partner in an amount equal to the general partner’s incentive distribution declared for the respective reporting period. The remaining net income is allocated among the limited and general partners in accordance with their respective 98% and 2% interests.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The principal market risk (i.e., the risk of loss arising from adverse changes in market rates and prices) to which Valero L.P. is exposed is interest rate risk on Valero Logistics’ debt. Valero Logistics manages its debt considering various financing alternatives available in the market and manages its exposure to changing interest rates principally through the use of a combination of fixed-rate debt and variable-rate debt. In addition, Valero Logistics utilizes interest rate swap agreements to manage a portion of the exposure to changing interest rates by converting certain fixed-rate debt to variable-rate debt.

 

Borrowings under the revolving credit facility expose Valero Logistics to increases in the benchmark interest rate underlying its variable-rate revolving credit facility. As of December 31, 2003, Valero Logistics’ fixed-rate debt consisted of the $250.0 million of 6.05% senior notes, the $100.0 million of 6.875% senior notes and the 8.0% Port of Corpus Christi Authority note payable. As of December 31, 2002, Valero Logistics’ fixed-rate debt consisted of the $100.0 million of 6.875% senior notes and the 8% Port of Corpus Christi Authority note payable.

 

The following table provides information about Valero Logistics’ long-term debt and interest rate derivative instruments,

all of which are sensitive to changes in interest rates. For long-term debt, principal cash flows and related weighted-average interest rates by expected maturity dates are presented. For interest rate swaps, the table presents notional amounts and weighted-average interest rates by expected (contractual) maturity dates. Weighted-average variable rates are based on implied forward interest rates in the yield curve at the reporting date.

 

     December 31, 2003

 
     Expected Maturity Dates

             
     2004

    2005

    2006

    2007

    2008

   

There-

after


    Total

   

Fair

Value


 
     (in thousands, except interest rates)  

Long-term Debt:

                                                                

Fixed rate

   $ 935     $ 524     $ 566     $ 611     $ 660     $ 356,364     $ 359,660     $ 377,217  

Average interest rate

     8.0 %     8.0 %     8.0 %     8.0 %     8.0 %     6.3 %     6.3 %        

Variable rate

   $  —       $  —       $  —       $  —       $  —       $ —       $ —       $ —    

Average interest rate

     —         —         —         —         —         —         —            

Interest Rate Swaps Fixed to Variable:

                                                                

Notional amount

   $  —       $  —       $  —       $  —       $  —       $ 167,500     $ 167,500     $ (4,553 )

Average pay rate

     3.5 %     5.0 %     6.0 %     6.8 %     7.1 %     7.7 %     6.7 %        

Average receive rate

     6.3 %     6.3 %     6.3 %     6.3 %     6.3 %     6.5 %     6.4 %        

 

     December 31, 2002

     Expected Maturity Dates

           
     2003

    2004

    2005

    2006

    2007

   

There-

after


    Total

   

Fair

Value


                 (in thousands, except interest rates)            

Long-term Debt:

                                                              

Fixed rate

   $ 747     $ 485     $ 524     $ 566     $ 611     $ 107,025     $ 109,958     $ 109,922

Average interest rate

     8.0 %     8.0 %     8.0 %     8.0 %     8.0 %     6.9 %     7.0 %      

Variable rate

   $  —       $  —       $  —       $  —       $  —       $ —       $ —       $ —  

Average interest rate

     —         —         —         —         —         —         —          

 

Prior to 2003, Valero L.P. did not engage in interest rate hedging transactions.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Report of Independent Auditors

 

To the Board of Directors of Valero GP, LLC and Unitholders of Valero L.P.

 

We have audited the accompanying consolidated balance sheets of Valero L.P. and subsidiaries (a Delaware limited partnership, “the Partnership”) as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows and partners’ equity for the years then ended. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of the Partnership for the year ended December 31, 2001 were audited by other auditors who have ceased operations and whose report dated May 14, 2002 expressed an unqualified opinion on those financial statements before the restatement adjustments described in Notes 2 and 15.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Valero L.P. and subsidiaries as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

 

As discussed above, the consolidated financial statements of the Partnership for the year ended December 31, 2001 were audited by other auditors who have ceased operations. As described in Notes 2 and 15, the 2001 consolidated financial statements have been revised. Our audit procedures with respect to the adjustments that were applied to restate the disclosures for reportable segments reflected in the 2001 financial statements included (a) agreeing the adjusted amounts of segment revenues, operating income and assets to the Partnership’s underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliations of segment amounts to the consolidated financial statements. In our opinion, the disclosures for 2001 in Notes 2 and 15 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 statement of income, cash flow and partners’ equity of the Partnership other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 statement of income, cash flows and partners’ equity taken as a whole.

 

/s/ ERNST & YOUNG LLP

 

San Antonio, Texas

March 11, 2004

 

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THIS IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH THEIR AUDITS OF VALERO L.P. AS OF DECEMBER 31, 2001 AND 2000 AND FOR THE THREE YEARS ENDED DECEMBER 31, 2001. THIS AUDIT REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP AS THEY HAVE CEASED OPERATIONS. THE “(as restated—see Note 2)” REFERENCE BELOW RELATES TO THE RESTATEMENT OF THE DECEMBER 31, 2001 BALANCE SHEET FOR THE WICHITA FALLS BUSINESS ACQUISITION DISCLOSED IN NOTE 4 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

 

Report of Independent Public Accountants

 

To the Board of Directors and Unitholders of Valero L.P.:

 

We have audited the accompanying consolidated and combined balance sheets of Valero L.P., formerly Shamrock Logistics, L.P. (a Delaware limited partnership) and Valero Logistics Operations, L.P., formerly Shamrock Logistics Operations, L.P. successor to the Ultramar Diamond Shamrock Logistics Business (a Delaware limited partnership) (collectively, the Partnerships) as of December 31, 2001 and 2000 (successor), and the related consolidated and combined statements of income, cash flows (as restated – see Note 2), partners’ equity/net parent investment for the year ended December 31, 2001 and the six months ended December 31, 2000 (successor) and the related combined statements of income, cash flows (as restated – see Note 2), partners’ equity/net parent investment for the six months ended June 30, 2000 and the year ended December 31, 1999 (predecessor). These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated and combined financial position of the Partnerships as of December 31, 2001 and 2000, and the results of their operations and their cash flows (as restated) for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.

 

/s/ ARTHUR ANDERSEN LLP

 

San Antonio, Texas

May 14, 2002

 

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VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     December 31,

 
     2003

    2002

 
Assets                 

Current assets:

                

Cash and cash equivalents

   $ 15,745     $ 33,533  

Receivable from Valero Energy

     15,781       8,482  

Accounts receivable

     5,333       1,502  

Other current assets

     1,275       177  
    


 


Total current assets

     38,134       43,694  
    


 


Property, plant and equipment

     928,886       486,939  

Less accumulated depreciation and amortization

     (163,884 )     (137,663 )
    


 


Property, plant and equipment, net

     765,002       349,276  

Goodwill, net of accumulated amortization of $1,279

     4,715       4,715  

Investment in Skelly-Belvieu Pipeline Company

     15,703       16,090  

Other noncurrent assets, net of accumulated amortization of $1,040 and $250

as of 2003 and 2002, respectively

     4,003       1,733  
    


 


Total assets

   $ 827,557     $ 415,508  
    


 


Liabilities and Partners’ Equity                 

Current liabilities:

                

Current portion of long-term debt

   $ 935     $ 747  

Payable to Valero Energy

     9,849       —    

Accounts payable and accrued liabilities

     16,145       8,133  

Taxes other than income taxes

     4,441       3,797  
    


 


Total current liabilities

     31,370       12,677  
    


 


Long-term debt, less current portion

     353,257       108,911  

Other long-term liabilities

     4,767       25  

Commitments and contingencies (see note 9)

                

Partners’ equity:

                

Common units (13,442,072 and 9,654,572 outstanding as of 2003 and 2002, respectively)

     310,589       170,655  

Subordinated units (9,599,322 outstanding as of 2003 and 2002)

     118,005       117,042  

General partner’s equity

     9,569       6,198  
    


 


Total partners’ equity

     438,163       293,895  
    


 


Total liabilities and partners’ equity

   $ 827,557     $ 415,508  
    


 


 

See accompanying notes to consolidated financial statements.

 

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VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except unit and per unit data)

 

     Years Ended December 31,

 
     2003

    2002

    2001

 

Revenues

   $ 181,450     $ 118,458     $ 98,827  
    


 


 


Costs and expenses:

                        

Operating expenses

     64,609       37,838       33,583  

General and administrative expenses

     7,537       6,950       5,349  

Depreciation and amortization

     26,267       16,440       13,390  
    


 


 


Total costs and expenses

     98,413       61,228       52,322  
    


 


 


Operating income

     83,037       57,230       46,505  

Equity income from Skelly-Belvieu Pipeline Company

     2,416       3,188       3,179  

Interest expense, net

     (15,860 )     (4,880 )     (3,811 )
    


 


 


Income before income tax expense

     69,593       55,538       45,873  

Income tax expense

     —         (395 )     —    
    


 


 


Net income

   $ 69,593     $ 55,143     $ 45,873  
    


 


 


Allocation of net income:

                        

Net income

   $ 69,593     $ 55,143     $ 45,873  

Less net income applicable to the period January 1, 2001 through April 15, 2001

     —         —         (10,126 )

Less net income applicable to the Wichita Falls Business for the month ended January 31, 2002

     —         (650 )     —    
    


 


 


Net income applicable to the general and limited partners’ interest

     69,593       54,493       35,747  

General partner’s interest in net income

     (3,959 )     (2,187 )     (715 )
    


 


 


Limited partners’ interest in net income

   $ 65,634     $ 52,306     $ 35,032  
    


 


 


Basic and diluted net income per unit applicable to limited partners

   $ 3.02     $ 2.72     $ 1.82  
    


 


 


Weighted average number of basic and diluted units outstanding

     21,706,164       19,250,867       19,198,644  
    


 


 


 

See accompanying notes to consolidated financial statements.

 

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VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Years Ended December 31,

 
     2003

    2002

    2001

 

Cash Flows from Operating Activities:

                        

Net income

   $ 69,593     $ 55,143     $ 45,873  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation and amortization

     26,267       16,440       13,390  

Equity income from Skelly-Belvieu Pipeline Company

     (2,416 )     (3,188 )     (3,179 )

Distributions of equity income from Skelly-Belvieu Pipeline Company

     2,416       3,493       2,874  

Changes in operating assets and liabilities:

                        

Decrease (increase) in receivable from Valero Energy

     (7,299 )     (2,666 )     16,532  

Decrease (increase) in accounts receivable

     (3,831 )     1,353       (469 )

Decrease (increase) in other current assets

     (1,098 )     (177 )     3,528  

Increase in payable to Valero Energy

     9,849       —         —    

Increase in accounts payable and accrued liabilities

     8,012       3,958       1,359  

Increase (decrease) in taxes other than income taxes

     644       2,369       (2,394 )

Other, net

     3,451       931       (382 )
    


 


 


Net cash provided by operating activities

     105,588       77,656       77,132  
    


 


 


Cash Flows from Investing Activities:

                        

Reliability capital expenditures

     (10,353 )     (3,943 )     (2,786 )

Expansion capital expenditures

     (21,208 )     (1,761 )     (4,340 )

Acquisitions

     (411,176 )     (75,000 )     (10,800 )

Distributions in excess of equity income from Skelly-Belvieu Pipeline Company

     387       97       —    
    


 


 


Net cash used in investing activities

     (442,350 )     (80,607 )     (17,926 )
    


 


 


Cash Flows from Financing Activities:

                        

Proceeds from 6.05% senior note offering, net of discount and issuance costs

     247,297       —         —    

Proceeds from 6.875% senior note offering, net of discount and issuance costs

     —         98,207       —    

Proceeds from other long-term debt borrowings

     25,000       75,000       25,506  

Repayment of long-term debt

     (25,298 )     (91,164 )     (10,068 )

Distributions to unitholders and general partner

     (65,916 )     (52,843 )     (21,571 )

Redemption of common units held by UDS Logistics, LLC

     (134,065 )     —         —    

General partner contributions, net of redemption

     2,930       —         —    

Proceeds from sale of common units to the public, net of issuance costs

     269,026       —         111,912  

Distribution to Valero Energy and affiliates (UDS in 2001), including

reimbursement of capital expenditures

     —         (512 )     (49,517 )

Repayment of debt due to parent

     —         —         (107,676 )
    


 


 


Net cash provided by (used in) financing activities

     318,974       28,688       (51,414 )
    


 


 


Net (decrease) increase in cash and cash equivalents

     (17,788 )     25,737       7,792  

Cash and cash equivalents as of the beginning of year

     33,533       7,796       4  
    


 


 


Cash and cash equivalents as of the end of year

   $ 15,745     $ 33,533     $ 7,796  
    


 


 


Non-Cash Activities – Adjustment related to the transfer of the Wichita

Falls Business to Valero L.P. by Valero Energy:

                        

Property, plant and equipment

   $ —       $ 64,160     $ (64,160 )

Accrued liabilities and taxes other than income taxes

     —         (382 )     382  

Deferred income tax liabilities

     —         (13,147 )     13,147  

Net parent investment

     —         (50,631 )     50,631  

 

See accompanying notes to consolidated financial statements.

 

44


Table of Contents

VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF PARTNERS’ EQUITY

Years Ended December 31, 2003, 2002 and 2001

(in thousands)

 

     Limited Partners

   

General

Partner


   

Net

Parent

Investment


   

Total

Partners’

Equity


 
     Common

    Subordinated

       

Balance as of January 1, 2001

   $ 202,790     $ —       $ 2,048     $ —       $ 204,838  

Net income applicable to the period January 1, 2001 through April 15, 2001

     10,025       —         101       —         10,126  

Distributions to affiliates of Ultramar Diamond Shamrock Corporation of net income applicable to the period July 1, 2000 through April 15, 2001

     (28,710 )     —         (290 )     —         (29,000 )

Distribution to affiliates of Ultramar Diamond Shamrock Corporation for reimbursement of capital expenditures

     (20,517 )     —         —         —         (20,517 )

Issuance of 4,424,322 common and 9,599,322 subordinated units for the contribution of Valero Logistics’ limited partner interest

     (113,141 )     109,453       3,688       —         —    

Sale of 5,175,000 common units to the public

     111,912       —         —         —         111,912  

Net income applicable to the period from April 16, 2001 through December 31, 2001

     17,516       17,516       715       —         35,747  

Cash distributions to partners

     (10,570 )     (10,570 )     (431 )     —         (21,571 )

Adjustment for the Wichita Falls Business transaction

     —         —         —         50,631       50,631  
    


 


 


 


 


Balance as of December 31, 2001

     169,305       116,399       5,831       50,631       342,166  

Net income

     26,225       26,081       2,187       650       55,143  

Cash distributions to partners

     (25,585 )     (25,438 )     (1,820 )     —         (52,843 )

Adjustment resulting from the acquisition of the Wichita Falls Business on February 1, 2002

     —         —         —         (51,281 )     (51,281 )

Other

     710       —         —         —         710  
    


 


 


 


 


Balance as of December 31, 2002

     170,655       117,042       6,198     $ —         293,895  
                            


       

Net income

     36,832       28,802       3,959               69,593  

Cash distributions to partners

     (34,559 )     (27,839 )     (3,518 )             (65,916 )

Sales of 7,567,250 common units to the public in March, April and August of 2003 and related general partner interest contributions

     269,026       —         5,787               274,813  

Redemption of 3,809,750 common units held by UDS Logistics, LLC and related general partner interest redemption

     (134,065 )     —         (2,857 )             (136,922 )

Other

     2,700       —         —                 2,700  
    


 


 


         


Balance as of December 31, 2003

   $ 310,589     $ 118,005     $ 9,569             $ 438,163  
    


 


 


         


 

See accompanying notes to consolidated financial statements.

 

45


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2003, 2002 and 2001

 

NOTE 1: Organization, Operations and Significant Organizational Transactions

 

Organization

 

Valero L.P., a Delaware limited partnership, through its wholly owned subsidiary, Valero Logistics Operations, L.P. (Valero Logistics), owns and operates crude oil and refined product pipeline and terminalling assets that serve Valero Energy Corporation’s (Valero Energy) McKee, Three Rivers, Corpus Christi East and Corpus Christi West refineries located in Texas, the Paulsboro refinery located in New Jersey and the Ardmore refinery located in Oklahoma. Valero Logistics also owns and operates crude oil storage tanks that serve Valero Energy’s Corpus Christi West and Texas City refineries located in Texas and the Benicia refinery located in California. The pipeline, terminalling and storage tank assets provide for the transportation of crude oil and other feedstocks to the refineries and the transportation of refined products from the refineries to terminals or third-party pipelines for further distribution. Revenues of Valero L.P. and its subsidiaries are earned primarily from providing these services to Valero Energy (see Note 12: Related Party Transactions).

 

As used in this report, the term Valero L.P. may refer, depending on the context, to Valero L.P., Valero Logistics, or both of them taken as a whole. Riverwalk Logistics, L.P., a wholly owned subsidiary of Valero Energy, is the 2% general partner of Valero L.P. Valero Energy, through various affiliates, is also a limited partner in Valero L.P., resulting in a combined limited partner ownership of 43.7%. The remaining 54.3% limited partnership interest is held by public unitholders.

 

Valero Energy is an independent refining and marketing company. As of December 31, 2003, its operations consisted of 14 refineries with a combined crude oil and other feedstock throughput capacity of over 2.0 million barrels per day and an extensive network of company-operated and dealer-operated convenience stores. Valero Energy’s refining operations rely on various logistics assets (pipelines, terminals, marine dock facilities, bulk storage facilities, refinery delivery racks and rail car loading equipment) that support its refining and retail operations, including the logistics assets owned and operated by Valero L.P. Valero Energy markets the refined products produced at its McKee, Three Rivers, Corpus Christi East, Corpus Christi West, Texas City, Benicia, Paulsboro and Ardmore refineries primarily in Texas, Oklahoma, Colorado, New Mexico, Arizona, California, New Jersey and several other mid-continent states through a network of company-operated and dealer-operated convenience stores, as well as through other wholesale and spot market sales and exchange agreements.

 

Valero L.P.’s Operations

 

Valero L.P.’s operations include interstate and intrastate pipelines, which are subject to extensive federal and state environmental and safety regulations. In addition, the pipeline tariffs and practices under which Valero L.P. offers interstate and intrastate transportation services with its pipelines are subject to regulation by the Federal Energy Regulatory Commission (FERC), the Texas Railroad Commission or the Colorado Public Utility Commission, depending on the location of the pipeline. Tariffs and practices for each pipeline are required to be filed with the respective commission upon completion of a pipeline and when a tariff is being revised. In addition, the regulations include annual reporting requirements for each pipeline.

 

Valero L.P. has an ownership interest in 23 refined product pipelines with an aggregate length of 3,717 miles and a 25-mile crude hydrogen pipeline. Valero L.P. also has an ownership interest in 9 crude oil pipelines with an aggregate length of 783 miles and 5 crude oil storage facilities with a total storage capacity of 3.3 million barrels that are connected to the crude oil pipelines. Valero L.P. operates all but three of the pipelines.

 

Valero L.P. owns 21 refined product terminals with a total storage capacity of 4.5 million barrels in 199 tanks. Valero L.P. also owns 3 crude oil storage tank operations with a total storage capacity of 11.0 million barrels in 58 tanks.

 

46


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Significant Organizational Transactions

 

On April 16, 2001, Shamrock Logistics, L.P. (renamed Valero L.P. effective January 1, 2002) closed on an initial public offering of its common units, which represented 26.4% of its outstanding partnership interests at that time.

 

On December 31, 2001, Valero Energy acquired Ultramar Diamond Shamrock Corporation (UDS) under the terms of an Agreement and Plan of Merger for total consideration of approximately $4.3 billion and the assumption of approximately $2.0 billion of debt. This acquisition included the acquisition of UDS’s majority ownership interest in Shamrock Logistics, L.P.

 

On February 1, 2002, Valero L.P. acquired the Wichita Falls Crude Oil Pipeline and Storage Business (the Wichita Falls Business) from Valero Energy for $64.0 million. The consolidated balance sheet as of December 31, 2001 has been restated to reflect the acquisition of the Wichita Falls Business because Valero L.P. and the Wichita Falls Business came under the common control of Valero Energy commencing on that date and thus, represented a reorganization of entities under common control. Similarly, the statements of income and cash flows for the year ended December 31, 2002 reflect the operations of the Wichita Falls Business for the entire year.

 

On March 31, 2003, Valero Logistics and its general partner, Valero GP, Inc., formed Valero Internacional, S .de R.L. de C.V., a Mexican limited liability company, to ultimately own and operate a propane terminal in Nuevo Laredo, Mexico. The propane terminal is currently under construction and is expected to become operational in the second quarter of 2004.

 

NOTE 2: Summary of Significant Accounting Policies

 

Consolidation: The accompanying consolidated financial statements represent the consolidated operations of Valero L.P. and its subsidiaries. All interpartnership transactions have been eliminated in consolidation. In addition, the operations of certain crude oil and refined product pipelines and refined product terminals, in which Valero L.P. owns an undivided interest, are proportionately consolidated in the accompanying consolidated financial statements.

 

Use of Estimates: The preparation of consolidated financial statements in accordance with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates, including those related to commitments, contingencies and environmental liabilities, based on currently available information. Changes in facts and circumstances may result in revised estimates.

 

Cash and Cash Equivalents: All highly liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents.

 

Property, Plant and Equipment: Property, plant and equipment is stated at cost. Additions to property, plant and equipment, including reliability and expansion capital expenditures and capitalized interest, are recorded at cost. Reliability capital expenditures represent capital expenditures to replace partially or fully depreciated assets to maintain the existing operating capacity of existing assets and extend their useful lives. Expansion capital expenditures represent capital expenditures to expand the operating capacity of existing assets, whether through construction or acquisition. Repair and maintenance expenses associated with existing assets that are minor in nature and do not extend the useful life of existing assets are charged to operating expenses as incurred. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets. When property, plant and equipment is retired or otherwise disposed of, the difference between the carrying value and the net proceeds is recognized as gain or loss in the consolidated statement of income in the year retired.

 

Impairment of Long-Lived Assets: Long-lived assets, including property, plant and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The evaluation of recoverability is performed using undiscounted estimated net cash flows generated by the related asset. If an asset is deemed to be impaired, the amount of impairment is determined as the amount by which the net carrying value exceeds discounted estimated net cash flows.

 

47


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Goodwill: Goodwill represents the excess of cost over the fair value of net assets acquired in 1997. Valero L.P. adopted Financial Accounting Standards Board (FASB) Statement No. 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002, resulting in the cessation of goodwill amortization beginning January 1, 2002. For the year ended December 31, 2001, goodwill amortization expense totaled $0.3 million or approximately $0.02 per unit assuming 19,198,644 common and subordinated units outstanding. In addition to the cessation of amortization, Statement No. 142 requires that goodwill be tested initially upon adoption and annually thereafter to determine whether an impairment has occurred. An impairment occurs when the carrying amount exceeds the fair value of the recognized goodwill asset. If impairment has occurred, the difference between the carrying value and the fair value is recognized as a loss in the consolidated statement of income in that period. Based on the results of the impairment tests performed upon initial adoption of Statement No. 142 as of January 1, 2002, and the annual impairment tests performed as of October 1, 2003 and 2002, no impairment had occurred.

 

Investment in Skelly-Belvieu Pipeline Company, LLC: Formed in 1993, the Skelly-Belvieu Pipeline Company, LLC (Skelly-Belvieu Pipeline Company) owns a liquefied petroleum gas pipeline that begins in Skellytown, Texas and extends to Mont Belvieu, Texas near Houston. Skelly-Belvieu Pipeline Company is owned 50% by Valero L.P. and 50% by ConocoPhillips. Valero L.P. accounts for this investment under the equity method of accounting as required by APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock,” including any impairment thereof.

 

Deferred Financing Costs: Deferred financing costs are amortized using the effective interest method and are included in other noncurrent assets in the consolidated balance sheets.

 

Environmental Remediation Costs: Environmental remediation costs are expensed and an associated accrual established when site restoration and environmental remediation and cleanup obligations are either known or considered probable and can be reasonably estimated. Accrued liabilities are not discounted to present value and are not reduced by possible recoveries from third parties. Environmental costs include initial site surveys, costs for remediation and restoration and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Adjustments to initial estimates are recorded, from time to time, to reflect changing circumstances and estimates based upon additional information developed in subsequent periods.

 

Revenue Recognition: Revenues are derived from interstate and intrastate pipeline transportation of refined products and crude oil, terminalling, blending and filtering of refined products, the movement of crude oil and other refinery feedstocks through the crude oil storage tank operations and, in the case of asphalt terminals, revenues are also based on storage capacity (see Note 12: Related Party Transactions).

 

Transportation revenues (based on pipeline tariffs) are recognized as refined product or crude oil is delivered through the pipelines. In the case of crude oil pipelines, the cost of the storage facility operations are included in the crude oil pipeline tariffs.

 

Terminalling revenues (based on a terminalling fee) are recognized as refined products move through the terminal and as additives are blended with refined products. Effective January 7, 2003, Valero L.P. began charging a storage capacity fee at the Pittsburg asphalt terminal in addition to a throughput fee. Effective March 18, 2003, Valero L.P. began charging a filtering fee for jet fuel terminalled at the Houston Hobby Airport terminal.

 

Crude oil storage tank revenues are recognized as crude oil and certain other refinery feedstocks are received by the related refinery.

 

Operating Expenses: Operating expenses consist primarily of fuel and power costs, telecommunication costs, labor costs of pipeline field and support personnel, maintenance, utilities, insurance and taxes other than income taxes. Such expenses are recognized as incurred (see Note 12: Related Party Transactions and Note 13: Employee Benefit Plans).

 

48


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

General and Administrative Expenses: General and administrative expenses consist primarily of the annual service fee charged by Valero Energy to Valero L.P. for corporate services and third party expenses such as audit fees, unitholder annual report costs, director fees and costs for the preparation and mailing of income tax reports to unitholders (see Note 12: Related Party Transactions and Note 13: Employee Benefit Plans).

 

Federal and State Income Taxes: Valero L.P. and Valero Logistics are limited partnerships and are not subject to federal or state income taxes. Accordingly, the taxable income or loss of Valero L.P. and Valero Logistics, which may vary substantially from income or loss reported for financial reporting purposes, is generally includable in the federal and state income tax returns of the individual partners. For transfers of publicly held units subsequent to the initial public offering, Valero L.P. has made an election permitted by section 754 of the Internal Revenue Code to adjust the common unit purchaser’s tax basis in Valero L.P.’s underlying assets to reflect the purchase price of the units. This results in an allocation of taxable income and expense to the purchaser of the common units, including depreciation deductions and gains and losses on sales of assets, based upon the new unitholder’s purchase price for the common units.

 

The Wichita Falls Business was included in UDS’ (now Valero Energy’s) consolidated federal and state income tax returns. Deferred income taxes were computed based on recognition of future tax expense or benefits, measured by enacted tax rates that were attributable to taxable or deductible temporary differences between financial statement and income tax reporting bases of assets and liabilities. No recognition was given to federal or state income taxes associated with the Wichita Falls Business for financial statement purposes for periods subsequent to its acquisition by Valero L.P. The deferred income tax liabilities related to the Wichita Falls Business as of February 1, 2002 were retained by Valero Energy and were credited to net parent investment upon the transfer of the Wichita Falls Business to Valero L.P.

 

Partners’ Equity: Valero L.P.’s partners’ equity consists of common units, primarily held by public unitholders, subordinated units held by UDS Logistics, LLC, an affiliate of Valero Energy, and a 2% general partner interest held by Riverwalk Logistics, L.P. In addition, Valero GP, LLC, the general partner of Riverwalk Logistics, L.P. and an affiliate of Valero Energy, holds common units to settle awards of restricted common units previously issued to employees, officers and directors of Valero GP, LLC. The common units held by the public represent a 54.3% ownership interest in Valero L.P. as of December 31, 2003.

 

Net Parent Investment: The net parent investment as of December 31, 2001 represents the historical cost to Valero Energy, net of deferred income tax liabilities and certain other accrued liabilities, related to the Wichita Falls Business. The Wichita Falls Business was consolidated with Valero L.P. as of December 31, 2001 as a result of a reorganization of entities under common control in connection with the acquisition of the Wichita Falls Business by Valero L.P. (see Note 1: Organization, Operations and Significant Organizational Transactions).

 

Income Allocation: Valero L.P.’s net income for each quarterly reporting period is first allocated to the general partner in an amount equal to the general partner’s incentive distribution declared for the respective reporting period. The remaining net income is allocated among the limited and general partners in accordance with their respective 98% and 2% interests.

 

Net Income per Unit Applicable to Limited Partners: The computation of net income per unit applicable to limited partners is based on the weighted-average number of common and subordinated units outstanding during the year. Net income per unit applicable to limited partners is computed by dividing net income applicable to limited partners, after deducting the general partner’s 2% interest and incentive distributions, by the weighted-average number of limited partnership units outstanding. Basic and diluted net income per unit applicable to limited partners is the same because Valero L.P. has no potentially dilutive securities outstanding. The general partner’s incentive distribution allocation for the years ended December 31, 2003 and 2002 was $2.6 million and $1.1 million, respectively, and there were no incentive distributions for the period April 16, 2001 through December 31, 2001. In addition, Valero L.P. generated sufficient net income such that the amount of net income per unit allocated to common units was equal to the amount allocated to the subordinated units (see Note 14: Partners’ Equity, Allocations of Net Income and Cash Distributions).

 

49


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Segment Disclosures: Prior to March 18, 2003, Valero L.P. was a consolidated subsidiary of Valero Energy and its operating performance was measured on an entity level basis. This measurement methodology was also used by UDS prior to Valero Energy’s acquisition of UDS on December 31, 2001. In addition, operational management of Valero L.P. reported to Valero Energy management as part of Valero Energy’s pipelines and terminals division. The historical organizational structure and method used to measure operating performance resulted in Valero L.P. having only one segment, an entity level segment.

 

On March 18, 2003, as a result of the common unit redemption transaction, the sale of additional common units to the public and certain changes to the partnership agreement, Valero Energy’s equity ownership of Valero L.P. was reduced to 49.5% and Valero Energy was deemed to no longer control Valero L.P. Accordingly, Valero Energy no longer consolidates Valero L.P. At the same time that the ownership level of Valero L.P. was reduced, a new expanded management team was announced, which separated Valero L.P.’s business into four operating units. Based on these changes and the subsequent development of performance metrics for each operating unit, it was determined that Valero L.P. has four business segments in accordance with FASB Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The four segments include the refined product pipelines segment, the crude oil pipelines segment, the refined product terminals segment and the crude oil storage tanks segment. Historical information for the years ended December 31, 2002 and 2001 has been restated to reflect the new segments (see Note 15: Segment Information).

 

Risk Management Activities: Beginning in 2003, Valero Logistics entered into interest rate swap agreements for the purpose of hedging the interest rate risk associated with a portion of its fixed-rate senior notes. In accordance with FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, Valero Logistics accounts for the interest rate swaps as fair value hedges and recognizes the fair value of each interest rate swap in the consolidated balance sheet as either an asset or liability. Changes in the fair value of the interest rate swaps, along with the offsetting gain or loss on the debt that is being hedged, are recognized currently in net income as an adjustment to interest expense.

 

Recent Accounting Pronouncements:

 

FASB Interpretation No. 46

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 requires the consolidation of a variable interest entity (VIE) in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interest in the entity. Prior to the issuance of FIN 46, an entity was generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority voting interest in the entity.

 

FIN 46 was applicable to VIEs created after January 31, 2003, and to VIEs in which an enterprise obtained an interest after that date. However, for VIEs created before February 1, 2003, FIN 46 first became applicable as of the first fiscal year or interim period beginning after June 15, 2003 (July 1, 2003 for Valero L.P.). In October 2003, the FASB issued FASB Staff Position 46-6, which deferred the applicable implementation date of FIN 46 for VIEs created before February 1, 2003 from the third quarter to the fourth quarter of 2003. Valero L.P. holds a variable interest in a VIE that was created prior to February 1, 2003, but it has not obtained any new variable interest during the year ended December 31, 2003. As such, FIN 46 first applies to Valero L.P. effective December 31, 2003.

 

50


Table of Contents

VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

As of December 31, 2003, Valero L.P. participates in a joint venture (Skelly-Belvieu Pipeline Company) with ConocoPhillips, and Valero L.P.’s share of this joint venture is 50%. The joint venture owns and operates a liquefied petroleum gas pipeline that is only used by each venture partner. The joint venture was created by a contribution of capital from each partner in the form of cash and/or property equal to its proportional share in the venture. In addition, each venture partner shares in all profits and losses equal to its proportional share in the joint venture, and there are no limits on the exposure to losses or on the ability to share in returns. Valero L.P. provides management services to the joint venture for which it receives an administrative fee. Valero L.P. does not control this joint venture, and it records its proportional share of the venture’s operating results using the equity method. Under FIN 46, Valero L.P.’s joint venture interest and its other contractual relationships with the joint venture represent variable interests in the joint venture; however, Valero L.P. is not the primary beneficiary of the joint venture. As a result, Valero L.P. will not consolidate the joint venture, but will continue to account for its joint venture interest under the equity method.

 

FASB Statement No. 143

 

In June 2001, the FASB issued Statement No. 143, “Accounting for Asset Retirement Obligations.” This statement establishes standards for accounting for an obligation associated with the retirement of a tangible long-lived asset. An asset retirement obligation should be recognized in the financial statements in the period in which it meets the definition of a liability as defined in FASB Concepts Statement No. 6, “Elements of Financial Statements.” The amount of the liability would initially be measured at fair value. Subsequent to initial measurement, an entity would recognize changes in the amount of the liability resulting from (a) the passage of time and (b) revisions to either the timing or amount of estimated cash flows. Statement No. 143 also establishes standards for accounting for the cost associated with an asset retirement obligation. It requires that, upon initial recognition of a liability for an asset retirement obligation, an entity capitalize that cost by recognizing an increase in the carrying amount of the related long-lived asset. The capitalized asset retirement cost would then be allocated to expense using a systematic and rational method.

 

Valero L.P. adopted the provisions of Statement No. 143 effective January 1, 2003 and has determined that it is obligated by contractual or regulatory requirements to remove assets or perform other remediation upon retirement of certain of its assets. Determination of the amounts to be recognized upon adoption is based upon numerous estimates and assumptions, including expected settlement dates, future retirement costs, future inflation rates and the credit-adjusted risk-free interest rate. However, the fair value of the asset retirement obligation cannot be reasonably estimated as of December 31, 2003, because the settlement dates are indeterminate. Valero L.P. will record an asset retirement obligation in the periods in which it can reasonably determine the settlement dates. Accordingly, the adoption of Statement No. 143 did not have an impact on Valero L.P.’s financial position or results of operations.

 

NOTE 3: Equity and Debt Offerings, Redemption of Common Units and Related Transactions

 

April 2001 Initial Public Offering

 

On April 16, 2001, Valero L.P. completed its initial public offering of common units by selling 5,175,000 common units to the public at $24.50 per unit, before underwriters’ discount of $1.715 per unit or $8.9 million. Net proceeds were $117.9 million before offering costs of $6.0 million. Concurrent with the closing of the initial public offering, Valero Logistics borrowed $20.5 million under its revolving credit facility. The net proceeds from the initial public offering and the borrowings under the revolving credit facility were used to repay the $107.7 million of debt due to parent, make a $20.5 million distribution to affiliates of UDS for reimbursement of previous capital expenditures incurred with respect to the assets transferred to Valero L.P., and for working capital purposes.

 

March 2003 Common Unit Offering

 

On March 18, 2003, Valero L.P. consummated a public offering of common units, selling 5,750,000 common units to the public at $36.75 per unit, before underwriters’ discount of $1.56 per unit. Net proceeds were $202.3 million, or $35.19 per unit, before offering expenses of $2.0 million. In order to maintain a 2% general partner interest, Riverwalk Logistics, L.P. contributed $4.3 million to Valero L.P. The net proceeds of the common unit offering and the general partner contribution were primarily used to fund the acquisition of the Crude Oil Storage Tanks (see Note 4: Acquisitions).

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

On April 16, 2003, Valero L.P. closed on the exercise of a portion of the underwriters’ over-allotment option, by selling 581,000 common units at $35.19 per unit. Net proceeds from this sale were $20.4 million and Riverwalk Logistics, L.P. contributed $0.5 million to maintain its 2% general partner interest. The common unit proceeds and general partner contribution were used to pay down the outstanding balance on the revolving credit facility.

 

Private Placement of 6.05% Senior Notes and Revolving Credit Facility

 

Also on March 18, 2003, concurrent with the closing of the common unit offering, Valero Logistics issued, in a private placement to institutional investors, $250.0 million of 6.05% senior notes, at a price of 99.719% before consideration of debt issuance costs of $2.0 million. In addition, Valero Logistics borrowed $25.0 million under its $175.0 million revolving credit facility. The net proceeds from the 6.05% senior notes and borrowings under the revolving credit facility were used to redeem common units held by UDS Logistics, LLC, redeem a related portion of the general partner interest and partially fund the acquisition of the South Texas Pipelines and Terminals (see Note 4: Acquisitions).

 

Redemption of Common Units and Amendment to Partnership Agreement

 

On March 18, 2003, subsequent to the common unit offering and private placement of 6.05% senior notes discussed above, Valero L.P. redeemed from UDS Logistics, LLC, a wholly owned subsidiary of Valero Energy, 3,809,750 common units at a total cost of $134.1 million, or $35.19 per unit. In order to maintain a 2% general partner interest, Valero L.P. redeemed a portion of Riverwalk Logistics, L.P.’s general partner interest at a total cost of $2.9 million. In addition to the redemption transaction, Valero L.P. amended its partnership agreement to reduce the vote required to remove the general partner from 66 2/3% to 58% of its outstanding units and to exclude from participating in such a vote the common and subordinated units held by affiliates of the general partner.

 

August 2003 Common Unit Offering

 

On August 11, 2003, Valero L.P. consummated a public offering of common units, selling 1,236,250 common units, which included 161,250 common units related to the underwriter’s over-allotment option, to the public at $41.15 per unit, before underwriter’s discount of $1.85 per unit. Net proceeds were $48.6 million, or $39.30 per unit, before offering expenses of $0.3 million. In order to maintain its 2% general partner interest, Riverwalk Logistics, L.P. contributed $1.0 million to Valero L.P. The net proceeds of the common unit offering and the general partner contribution were primarily used to fund the acquisitions of the Southlake refined product pipeline and the Paulsboro refined product terminal (see Note 4: Acquisitions).

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Summary of 2003 Transactions

 

The net proceeds from the 2003 common unit offerings, the private placement of 6.05% senior notes and the borrowings under the revolving credit facility were used to redeem common units held by UDS Logistics, LLC, repay the outstanding balance under the revolving credit facility and pay for asset and business acquisitions completed during 2003. A summary of the proceeds received and use of proceeds is as follows (in thousands):

 

Proceeds received:

        

March, April and August sales of common units to the public, including underwriters’ over-allotment options

   $ 271,372  

Private placement of 6.05% senior notes

     249,298  

Borrowings under the revolving credit facility

     25,000  

General partner contributions

     5,787  
    


Total proceeds

     551,457  
    


Use of proceeds:

        

South Texas Pipelines and Terminals

     150,115  

Crude Oil Storage Tanks

     200,198  

Southlake Refined Product Pipeline

     29,911  

Paulsboro Refined Product Terminal

     14,055  

Redemption of common units

     134,065  

Repayment of the borrowings under the revolving credit facility

     25,000  

Redemption of general partner interest

     2,857  

Professional fees and other costs of equity issuance

     2,346  

Debt issuance costs

     2,001  
    


Total use of proceeds

     560,548  
    


Net cash on hand paid out

   $ (9,091 )
    


 

NOTE 4: Acquisitions

 

Completed During 2003

 

Telfer Asphalt Terminal

 

On January 7, 2003, Valero L.P. completed its acquisition of Telfer Oil Company’s (Telfer) Pittsburg, California asphalt terminal for $15.3 million. The asphalt terminal includes two storage tanks with a combined storage capacity of 350,000 barrels, six 5,000-barrel polymer modified asphalt tanks, a truck rack, rail facilities and various other tanks and equipment. In conjunction with the Telfer acquisition, Valero L.P. entered into a six-year Terminal Storage and Throughput Agreement with Valero Energy. A portion of the purchase price represented payment to the principal owner of Telfer for a non-compete agreement and for the lease of certain facilities adjacent to the terminal operations.

 

South Texas Pipelines and Terminals

 

On March 18, 2003, Valero Energy contributed a South Texas pipeline system to Valero L.P. for $150.1 million, including transaction costs. The South Texas pipeline system is comprised of the Houston pipeline system, the Valley pipeline system and the San Antonio pipeline system (together referred to as the South Texas Pipelines and Terminals) as follows:

 

The Houston pipeline system is a 208-mile refined product pipeline originating in Corpus Christi, Texas and ending in Pasadena, Texas at the Houston ship channel. The pipeline has the capacity to transport 105,000 barrels per day of refined products produced at Valero Energy’s Corpus Christi East and Corpus Christ West refineries and third party refineries located in Corpus Christi. The pipeline system includes four refined product terminals (Houston Hobby Airport, Placedo, Houston asphalt and Almeda, which is currently idle) with a combined storage capacity of 310,900 barrels of refined products and 75,000 barrels of asphalt.

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The Valley pipeline system is a 134-mile refined product pipeline originating in Corpus Christi, Texas and ending in Edinburg, Texas. The pipeline has the capacity to transport 27,100 barrels per day of refined products. Currently, the pipeline transports refined products produced at Valero Energy’s Corpus Christi East and Corpus Christi West refineries. The pipeline system includes a refined product terminal in Edinburg with a storage capacity of 184,600 barrels.

 

The San Antonio pipeline system is comprised of two segments: the north segment, which runs from Pettus, Texas to San Antonio, Texas and the south segment which runs from Pettus, Texas to Corpus Christi, Texas. The north segment is 74 miles long and has a capacity of 24,000 barrels per day. The south segment is 60 miles long and has a capacity of 15,000 barrels per day and ends at Valero Energy’s Corpus Christi East refinery. The pipeline system includes a refined product terminal in east San Antonio with a storage capacity of 148,200 barrels.

 

In conjunction with the South Texas Pipelines and Terminals acquisition, Valero L.P. entered into several agreements with Valero Energy (see Note 12: Related Party Transactions).

 

Pro Forma Financial Information

 

The following unaudited pro forma financial information assumes that the South Texas Pipelines and Terminals acquisition was funded with $111.0 million of net proceeds from the issuance of the 6.05% senior notes, $25.0 million of borrowings under the revolving credit facility, $6.7 million of net proceeds from the issuance of 185,422 common units and the related general partner capital contribution and $7.4 million of available cash.

 

The unaudited pro forma financial information for the years ended December 31, 2003 and 2002, assumes that the transaction occurred on January 1, 2003 and 2002, respectively.

 

     Years Ended December 31,

     2003

   2002

     (in thousands, except per unit data)

Revenues

   $ 187,294    $ 146,355

Operating income

     85,028      63,072

Net income

     69,930      53,500

Net income per unit applicable to limited partners

     3.03      2.61

 

Crude Oil Storage Tanks

 

On March 18, 2003, Valero Energy contributed 58 crude oil storage tanks and related assets (the Crude Oil Storage Tanks) to Valero L.P. for $200.2 million, including transaction costs. The Crude Oil Storage Tanks consist of certain tank shells, foundations, tank valves, tank gauges, pressure equipment, temperature equipment, corrosion protection, leak detection, tank lighting and related equipment located at the following Valero Energy refineries:

 

Corpus Christi West refinery, which has a total capacity to process 225,000 barrels per day of crude oil and other feedstocks;

 

Texas City refinery, which has a total capacity to process 243,000 barrels per day of crude oil and other feedstocks; and

 

Benicia refinery, which has a total capacity to process 175,000 barrels per day of crude oil and other feedstocks.

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Historically, the Crude Oil Storage Tanks were operated as part of Valero Energy’s refining operations and, as a result, no separate fee was charged related to these assets and, accordingly, no revenues were recorded by Valero Energy. The Crude Oil Storage Tanks were not accounted for separately by Valero Energy and were not operated as an autonomous business unit. As a result, the purchase of the Crude Oil Storage Tanks represented an asset acquisition and, therefore, no pro forma impact of this transaction has been included above. In conjunction with the Crude Oil Storage Tanks acquisition, Valero L.P. entered into several agreements with Valero Energy (see Note 12: Related Party Transactions).

 

Shell Pipeline Interest

 

On May 1, 2003, Valero L.P. acquired Shell Pipeline Company, LP’s (Shell) 28% undivided interest in the Amarillo to Abernathy refined product pipeline and Shell’s 46% undivided interest in the Abernathy to Lubbock refined product pipeline for $1.6 million. After this acquisition, Valero L.P. owns a 67% undivided interest and ConocoPhillips owns the remaining 33% undivided interest in the Amarillo to Abernathy refined product pipeline and Valero L.P. owns a 46% undivided interest and ConocoPhillips owns the remaining 54% undivided interest in the Abernathy to Lubbock refined product pipeline.

 

Southlake Refined Product Pipeline

 

Effective August 1, 2003, Valero L.P. acquired the Southlake refined product pipeline from Valero Energy for $29.9 million. The pipeline, which has a capacity of 27,300 barrels per day, is a 375-mile pipeline connecting Valero Energy’s McKee refinery to Valero L.P.’s Southlake refined product terminal near Dallas, Texas.

 

Paulsboro Refined Product Terminal

 

On September 3, 2003, Valero L.P. acquired the Paulsboro refined product terminal from ExxonMobil Oil Corporation for $14.1 million. The Paulsboro refined product terminal is located in Paulsboro, New Jersey, next to Valero Energy’s Paulsboro refinery. The terminal has a storage capacity of 90,800 barrels.

 

Purchase Price Allocations for 2003 Acquisitions

 

The Telfer, South Texas Pipelines and Terminals, Crude Oil Storage Tanks, Shell, Southlake and Paulsboro acquisitions were accounted for using the purchase method. The purchase price for each acquisition has been initially allocated based on the estimated fair values of the individual assets acquired and liabilities assumed at the date of acquisition based on each asset’s anticipated contribution to Valero L.P., pending completion of final purchase price allocations.

 

The South Texas Pipelines and Terminals and the Crude Oil Storage Tanks acquisitions were approved by the conflicts committee of the board of directors of Valero GP, LLC, the general partner of Riverwalk Logistics, L.P., based in part on an opinion from its independent financial advisor that the consideration paid by Valero L.P. was fair, from a financial point of view, to Valero L.P. and its public unitholders. The conflicts committee also approved the acquisition of the Southlake refined product pipeline by Valero L.P. from Valero Energy. The following summarizes the assets acquired in 2003:

 

     Property,
plant and
equipment


   Intangible
assets


   Total

     (in thousands)

Telfer (Pittsburg) Asphalt Terminal

   $ 15,047    $ 250    $ 15,297

South Texas Pipelines and Terminals

     149,575      540      150,115

Crude Oil Storage Tanks

     200,198      —        200,198

Shell Pipeline Interest

     1,600      —        1,600

Southlake Refined Product Pipeline

     29,911      —        29,911

Paulsboro Refined Product Terminal

     14,055      —        14,055
    

  

  

Total Purchase Price Allocations

   $ 410,386    $ 790    $ 411,176
    

  

  

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Completed During 2002

 

Wichita Falls Business

 

On February 1, 2002, Valero L.P. acquired the Wichita Falls Business from Valero Energy for a total cost of $64.0 million, which Valero L.P. had an option to purchase pursuant to the Omnibus Agreement between Valero L.P. and Valero Energy (see Note 12: Related Party Transactions). The purchase price was funded with borrowings under Valero Logistics’ revolving credit facility.

 

The Wichita Falls Business consists of the following assets:

 

A 272-mile crude oil pipeline originating in Wichita Falls, Texas and ending at Valero Energy’s McKee refinery in Dumas, Texas. The pipeline has the capacity to transport 110,000 barrels per day of crude oil gathered or acquired by Valero Energy at Wichita Falls. The Wichita Falls crude oil pipeline connects to third party pipelines that originate along the Texas Gulf Coast.

 

Four crude oil storage tanks located in Wichita Falls, Texas with a total capacity of 660,000 barrels.

 

Since the acquisition of the Wichita Falls Business represented the transfer of a business between entities under the common control of Valero Energy, the consolidated balance sheet as of December 31, 2001 and the statements of income and cash flows for the month ended January 31, 2002 (preceding the acquisition date) were restated to include the Wichita Falls Business.

 

The balance sheet of the Wichita Falls Business as of December 31, 2001, which is included in the consolidated balance sheet of Valero L.P. as of December 31, 2001, is summarized below, as well as, a reconciliation to the adjustment recorded when the acquisition was consummated on February 1, 2002.

 

    

Wichita Falls

Business


 
     (in thousands)  

Balance Sheet as of December 31, 2001:

        

Property, plant and equipment

   $ 64,160  

Accounts payable and accrued liabilities

     (131 )

Taxes other than income taxes

     (251 )

Deferred income tax liabilities

     (13,147 )
    


Net parent investment as of December 31, 2001

     50,631  

Net income for the month ended January 31, 2002

     650  
    


Adjustment resulting from the acquisition of the Wichita Falls Business on February 1, 2002

   $ 51,281  
    


 

Crude Hydrogen Pipeline

 

In May of 2002, Valero Energy completed the construction of a 30-mile pure hydrogen pipeline, which originates at Valero Energy’s Texas City refinery and ends at Praxair, Inc.’s La Porte, Texas plant. The total cost to construct the pipeline was $11.0 million.

 

On May 29, 2002, Valero L.P. acquired the 30-mile pure hydrogen pipeline from Valero Energy for $11.0 million, which was funded with borrowings under Valero Logistics’ revolving credit facility. Valero L.P. then exchanged, on May 29, 2002, this 30-mile pure hydrogen pipeline for Praxair, Inc.’s 25-mile crude hydrogen pipeline, which originates at BOC’s (successor to Celanese Ltd.) chemical facility in Clear Lake, Texas and ends at Valero Energy’s Texas City refinery in Texas City, Texas, under an exchange agreement previously negotiated between Valero Energy and Praxair, Inc. In conjunction with the exchange, Valero L.P. entered into an operating agreement with Praxair, Inc. whereby Praxair, Inc. will operate the pipeline for an annual fee of $0.1 million, plus reimbursement of repair, replacement and relocation costs.

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Valero Energy owns the crude hydrogen transported in the pipeline, and the transportation services provided by Valero L.P. to Valero Energy are subject to a hydrogen tolling agreement. The hydrogen tolling agreement provides that Valero Energy will pay Valero L.P. minimum annual revenues of $1.4 million for transporting crude hydrogen.

 

Completed During 2001

 

Southlake Refined Product Terminal and Ringgold Crude Oil Storage Facility

 

On July 2, 2001, Valero L.P. acquired the Southlake refined product terminal located near Dallas, Texas from UDS for $5.6 million, which was funded with available cash on hand. On December 1, 2001, Valero L.P. acquired the crude oil storage facility at Ringgold, Texas from UDS for $5.2 million, which was funded with borrowings under the revolving credit facility. Valero L.P. had options to purchase both of these assets pursuant to the Omnibus Agreement between Valero L.P. and UDS (see Note 12: Related Party Transactions).

 

NOTE 5: Property, Plant and Equipment

 

Property, plant and equipment, at cost, consisted of the following:

 

     Estimated
Useful
Lives


   December 31,

 
        2003

    2002

 
     (years)    (in thousands)  

Land

      $ 6,151     $ 820  

Land and leasehold improvements

   20      341       99  

Buildings

   35      10,319       5,647  

Pipeline and equipment

   3 – 40      828,247       442,650  

Rights of way

   20 – 35      50,087       29,860  

Construction in progress

        33,741       7,863  
         


 


Total

          928,886       486,939  

Accumulated depreciation and amortization

          (163,884 )     (137,663 )
         


 


Property, plant and equipment, net

        $ 765,002     $ 349,276  
         


 


 

Capitalized interest costs included in property, plant and equipment were $0.1 million, $0.3 million and $0.3 million for the years ended December 31, 2003, 2002 and 2001, respectively.

 

NOTE 6: Investment in Skelly-Belvieu Pipeline Company

 

The following presents summarized unaudited financial information related to Skelly-Belvieu Pipeline Company as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001:

 

     Years Ended December 31,

     2003

   2002

   2001

     (in thousands)

Statement of Income Information:

                    

Revenues

   $ 11,613    $ 12,849    $ 12,287

Income before income tax expense

     4,062      5,605      5,587

Valero L.P.’s share of net income

     2,416      3,188      3,179

Valero L.P.’s share of distributions

     2,803      3,590      2,874

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

     December 31,

     2003

   2002

     (in thousands)

Balance Sheet Information:

             

Current assets

   $ 1,712    $ 1,572

Property, plant and equipment, net

     47,254      48,739
    

  

Total assets

   $ 48,966    $ 50,311
    

  

Current liabilities

   $ 351    $ 150

Members’ equity

     48,615      50,161
    

  

Total liabilities and members’ equity

   $ 48,966    $ 50,311
    

  

 

The excess of Valero L.P.’s 50% share of members’ equity over the carrying value of its investment is attributable to the step-up in basis to fair value of property, plant and equipment of the initial contribution to Skelly-Belvieu Pipeline Company. This excess, which totaled $8.6 million as of December 31, 2003 and $9.0 million as of December 31, 2002, is being accreted into income over 33 years.

 

NOTE 7: Long-term Debt

 

Long-term debt consisted of the following:

 

     December 31,

 
     2003

    2002

 
     (in thousands)  

6.05% senior notes due 2013, net of unamortized discount of $647 and
a fair value adjustment of $2,759

   $ 246,594     $ —    

6.875% senior notes due 2012, net of unamortized discount of $268 in 2003
and $300 in 2002 and a fair value adjustment of $1,794 in 2003

     97,938       99,700  

Port Authority of Corpus Christi note payable

     9,660       9,958  

Revolving credit facility

     —         —    
    


 


Total debt

     354,192       109,658  

Less current portion

     (935 )     (747 )
    


 


Long-term debt, less current portion

   $ 353,257     $ 108,911  
    


 


 

The long-term debt repayments are due as follows (in thousands):

 

2004

   $ 935  

2005

     524  

2006

     566  

2007

     611  

2008

     660  

Thereafter

     356,364  
    


Total repayments

     359,660  

Less unamortized discount and fair value adjustment

     (5,468 )
    


Total debt

   $ 354,192  
    


 

Interest payments totaled $15.7 million, $2.0 million and $1.6 million for the years ended December 31, 2003, 2002 and 2001, respectively.

 

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VALERO L.P. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Valero L.P. has no operations and its only asset is its investment in Valero Logistics, which owns and operates pipelines, terminals and storage tanks. Valero L.P. has fully and unconditionally guaranteed the senior notes issued by Valero Logistics and any obligations under Valero Logistics’ revolving credit facility.

 

6.05% Senior Notes

 

On March 18, 2003, Valero Logistics completed the sale of $250.0 million of 6.05% senior notes, issued in a private placement to institutional investors, for total proceeds of $249.3 million, before debt issuance costs of $2.0 million. The 6.05% senior notes do not have sinking fund requirements. Interest on the 6.05% senior notes is payable semiannually in arrears on March 15 and September 15 of each year beginning September 15, 2003.

 

The 6.05% senior notes issued on March 18, 2003 were not registered under the Securities Act of 1933 or any other securities laws and consequently the 6.05% senior notes were originally subject to transfer and resale restrictions. The 6.05% senior notes included registration rights which provided that Valero Logistics would use its best efforts to file, within 90 days of issuance, a registration statement for the exchange of the 6.05% senior notes for new notes of the same series that generally would be freely transferable, and to consummate the exchange offer within 210 days. In July of 2003, Valero Logistics closed on the exchange of the outstanding $250.0 million 6.05% senior notes that were not registered under the Securities Act of 1933 for $250.0 million of 6.05% senior notes that have been registered under the Securities Act of 1933.

 

6.875% Senior Notes

 

On July 15, 2002, Valero Logistics completed the sale of $100.0 million of 6.875% senior notes, issued under the $500.0 million shelf registration statement, for total proceeds of $99.7 million before debt issuance costs of $1.5 million. The net proceeds were used to repay the $91.0 million then outstanding under the revolving credit facility. The 6.875% senior notes do not have sinking fund requirements. Interest on the 6.875% senior notes is payable semiannually in arrears on January 15 and July 15 of each year.

 

Both Series of Senior Notes

 

The 6.05% senior notes rank equally with all other existing senior unsecured indebtedness of Valero Logistics, including indebtedness under the revolving credit facility and the 6.875% senior notes. Both series of senior notes contain restrictions on Valero Logistics’ ability to incur secured indebtedness unless the same security is also provided for the benefit of holders of the senior notes. In addition, the senior notes limit Valero Logistics’ ability to incur indebtedness secured by certain liens and to engage in certain sale-leaseback transactions. Also, both series of senior notes are irrevocably and unconditionally guaranteed on a senior unsecured basis by Valero L.P. The guarantee by Valero L.P. ranks equally with all of its existing unsecured and unsubordinated indebtedness and is required to rank equally with any future unsecured and unsubordinated indebtedness. At the option of Valero Logistics, each of the series of senior notes may be redeemed in whole or in part at any time at a redemption price, which includes a make-whole premium, plus accrued and unpaid interest to the redemption date.

 

The senior notes also include a change-in-control provision, which requires that an investment grade entity own and control the general partner of Valero L.P. and Valero Logistics. Otherwise, Valero Logistics must offer to purchase the senior notes at a price equal to 100% of their outstanding principal balance plus accrued interest through the date of purchase.

 

Revolving Credit Facility

 

On December 15, 2000, Valero Logistics entered into a $120.0 million revolving credit facility. The revolving credit facility expires on January 15, 2006 and borrowings under the revolving credit facility bear interest based on either an alternative base rate or LIBOR at the option of Valero Logistics. Valero Logistics also incurs a facility fee on the aggregate commitments of lenders under the revolving credit facility, whether used or unused. Borrowings under the revolving credit facility may be used for working capital and general partnership purposes. Borrowings to fund distributions to unitholders, however, were originally limited to $25.0 million with such borrowings required to be reduced to zero for a period of at least 15 consecutive days during each fiscal year.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

On March 6, 2003, Valero Logistics entered into an amended revolving credit facility with the various banks included in the existing revolving credit facility and with a group of new banks to increase the revolving credit facility to $175.0 million. In addition, the amount that may be borrowed to fund distributions to unitholders was increased from $25.0 million to $40.0 million. In addition, the “Total Debt to EBITDA Ratio” as defined in the revolving credit facility was changed such that the ratio may not exceed 4.0 to 1.0 (as opposed to 3.0 to 1.0 in the original facility), and Valero L.P. is now guaranteeing the revolving credit facility. The amounts available under the revolving credit facility are not subject to a borrowing base computation; therefore as of December 31, 2003, the entire $175.0 million was available.

 

The revolving credit facility requires that Valero Logistics maintain certain financial ratios and includes other restrictive covenants, including a prohibition on distributions by Valero Logistics if any default, as defined in the revolving credit facility, exists or would result from the distribution. The revolving credit facility also includes a change-in-control provision, which requires that Valero Energy continue to own, directly or indirectly, 51% of Valero L.P.’s general partner interest or Valero Energy and/or Valero L.P. own 100% of the general partner interest in Valero Logistics or 100% of the outstanding limited partner interest in Valero Logistics. Management believes that Valero Logistics is in compliance with all of these ratios and covenants.

 

Port Authority of Corpus Christi Note Payable

 

The proceeds from the original $12.0 million note payable due to the Port of Corpus Christi Authority of Nueces County, Texas (Port Authority of Corpus Christi) were used for the construction of a crude oil storage facility in Corpus Christi, Texas. The note payable is due in annual installments of $1.2 million through December 31, 2015 and is collateralized by the crude oil storage facility. Interest on the unpaid principal balance accrues at a rate of 8% per annum. The land on which the crude oil storage facility was constructed is leased from the Port Authority of Corpus Christi (see Note 9: Commitments and Contingencies).

 

Interest Rate Swaps

 

During the first four months of 2003, Valero Logistics entered into interest rate swap agreements to manage its exposure to changes in interest rates. The interest rate swap agreements have an aggregate notional amount of $167.5 million, of which $60.0 million is tied to the maturity of the 6.875% senior notes and $107.5 million is tied to the maturity of the 6.05% senior notes. Under the terms of the interest rate swap agreements, Valero Logistics will receive a fixed rate (6.875% and 6.05% for the $60.0 million and $107.5 million of interest rate swap agreements, respectively) and will pay a variable rate based on LIBOR plus a percentage that varies with each agreement. As of December 31, 2003, the weighted average effective interest rate for the interest rate swaps was 3.1%. As of December 31, 2003, the aggregate estimated fair value of the interest rate swaps was $4.6 million and is included in other long-term liabilities in the consolidated balance sheet.

 

NOTE 8: Environmental, Health and Safety Matters

 

Valero L.P.’s operations are subject to extensive federal, state and local environmental and safety laws and regulations. Although Valero L.P. believes its operations are in substantial compliance with applicable environmental and safety laws and regulations, risks of additional costs and liabilities are inherent in pipeline, terminalling and storage operations, and there can be no assurance that significant costs and liabilities will not be incurred. Moreover, it is possible that other developments, such as increasingly stringent environmental and safety laws, regulations and enforcement policies thereunder, and claims for damages to property or persons resulting from the operations, could result in substantial costs and liabilities. Accordingly, Valero L.P. has adopted policies, practices and procedures in the areas of pollution control, pipeline integrity, operator qualifications, public relations, product safety, occupational health and the handling, storage, use and disposal of hazardous materials that are designed to prevent material environmental or other damage, and to limit the financial liability which could result from such events. However, some risk of environmental or other damage is inherent in pipeline, terminalling and storage operations, as it is with other entities engaged in similar businesses.

 

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Valero Energy has agreed to indemnify Valero L.P., for a period of 10 years from the date of acquisition, for pre-acquisition environmental liabilities related to assets transferred or otherwise acquired by Valero L.P. from Valero Energy or UDS. Excluded from this indemnification are liabilities that result from a change in environmental law after the date of acquisition.

 

Additionally, ExxonMobil has agreed to indemnify Valero L.P. for environmental liabilities in connection with off-site disposal activities performed prior to September 4, 2003 related to the Paulsboro refined product terminal acquisition (see Note 4: Acquisitions). As an operator or owner of the assets, Valero L.P. could be held liable for pre-acquisition environmental liabilities should Valero Energy or ExxonMobil be unable to fulfill their obligation. However, Valero L.P. believes that such a situation is remote given Valero Energy’s and ExxonMobil’s financial condition.

 

Environmental exposures and liabilities are difficult to assess and estimate due to unknown factors such as the magnitude of possible contamination, the timing and extent of remediation, the determination of Valero L.P.’s liability in proportion to other parties, improvements in cleanup technologies and the extent to which environmental laws and regulations may change in the future. Although environmental and safety costs may have a significant impact on the results of operations for any single period, Valero L.P. believes that such costs will not have a material adverse effect on its financial position. During the year ended December 31, 2003, Valero L.P. incurred $0.5 million of environmental remediation costs, including $0.1 million accrued for future remediation related to two matters, for which the current portion is included in accounts payable and accrued liabilities and the long-term portion is included in other long-term liabilities. As of December 31, 2002, Valero L.P. had not incurred any material environmental liabilities.

 

NOTE 9: Commitments and Contingencies

 

Valero L.P.’s predecessors previously entered into several agreements with the Port Authority of Corpus Christi including a crude oil dock user agreement, a land lease agreement and a note agreement. The crude oil dock user agreement, which renews annually in May, allows Valero L.P. to operate and manage a crude oil dock in Corpus Christi. Valero L.P. shares use of the crude oil dock with two other users, and operating costs are split evenly among the three users. The crude oil dock user agreement requires that Valero L.P. collect wharfage fees, based on the quantity of barrels offloaded from each vessel, and dockage fees, based on vessels berthing at the dock. These fees are remitted to the Port Authority of Corpus Christi. The wharfage and one-half of the dockage fees that Valero L.P. pays for the use of the crude oil dock reduces the annual amount it owes to the Port Authority of Corpus Christi under the note agreement discussed in Note 7: Long Term Debt. The wharfage and dockage fees for Valero L.P.’s use of the crude oil dock totaled $1.2 million, $1.1 million and $1.4 million for the years ended December 31, 2003, 2002 and 2001, respectively.

 

Valero L.P.’s predecessors previously entered into a refined product dock user agreement, which renews annually in April, with the Port Authority of Corpus Christi to use a refined product dock. Valero L.P. shares use of the refined product dock with one other user, and operating costs are split evenly between the two users. The refined product dock user agreement requires that Valero L.P. collect and remit the wharfage and dockage fees to the Port Authority of Corpus Christi. The wharfage and dockage fees for Valero L.P.’s use of the refined product dock totaled $0.2 million for each of the years ended December 31, 2003, 2002 and 2001.

 

The crude oil and the refined product docks provide Valero Energy’s Three Rivers refinery access to marine facilities to receive crude oil and deliver refined products. For the years ended December 31, 2003, 2002 and 2001, the Three Rivers refinery received 81%, 86% and 92%, respectively, of its crude oil requirements from crude oil received at the crude oil dock. Also, for the years ended December 31, 2003, 2002 and 2001, 7%, 6% and 6%, respectively, of the refined products produced at the Three Rivers refinery were transported via pipeline to the Corpus Christi refined product dock.

 

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Valero L.P. has the following land leases related to refined product terminals, crude oil storage facilities and the crude oil storage tank operations:

 

Corpus Christi crude oil storage facility: a 20-year noncancellable operating lease through 2014, at which time the lease is renewable every five years, for a total of 20 renewable years.

 

Corpus Christi refined product terminal: a five-year noncancellable operating lease through 2006, and a five-year noncancellable operating lease through 2007, at which time the agreements are renewable for at least two five-year periods.

 

Harlingen refined product terminal: a 13-year noncancellable operating lease through 2008, and a 30-year noncancellable operating lease through 2008.

 

Colorado Springs airport terminal: a 50-year noncancellable operating lease through 2043, at which time the lease is renewable for another 50-year period.

 

Corpus Christi West crude oil storage tanks: a 25-year operating lease through 2027, at which time the lease is renewable for successive one-year periods thereafter.

 

Texas City crude oil storage tanks: a 25-year operating lease through 2027, at which time the lease is renewable for successive one-year periods thereafter.

 

Benicia crude oil storage tanks: a 25-year operating lease through 2027, at which time the lease is renewable for successive one-year periods thereafter.

 

All of Valero L.P.’s land leases require monthly payments totaling $0.1 million. Future minimum rental payments applicable to all noncancellable operating leases as of December 31, 2003, are as follows (in thousands):

 

2004

   $ 1,372

2005

     1,372

2006

     1,358

2007

     1,332

2008

     862

Thereafter

     14,671
    

Future minimum lease payments

   $ 20,967
    

 

Rental expense for all operating leases totaled $0.9 million, $0.3 million and $0.3 million for the years ended December 31, 2003, 2002 and 2001, respectively.

 

Valero L.P. is involved in various lawsuits, claims and regulatory proceedings incidental to its business. In the opinion of management, the outcome of such matters will not have a material adverse effect on Valero L.P.’s financial position or results of operations.

 

NOTE 10: Income Taxes

 

As discussed in Note 2: Summary of Significant Accounting Policies, Valero L.P. and Valero Logistics are limited partnerships and are not subject to federal or state income taxes. However, the Wichita Falls Business was subject to federal and state income taxes prior to its acquisition on February 1, 2002. The $0.4 million of income tax expense included in the consolidated statement of income for the year ended December 31, 2002 represents the Wichita Falls Business’ income tax expense for the month ended January 31, 2002, which was calculated as if the Wichita Falls Business filed a separate federal and state income tax return.

 

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NOTE 11: Risk Management Activities

 

Interest Rate Risk

 

The estimated fair value of Valero L.P.’s fixed-rate debt as of December 31, 2003 and 2002 was $377.2 million and $109.9 million, respectively, as compared to the carrying value of $354.2 million and $109.7 million, respectively. These fair values were estimated using discounted cash flow analysis, based on Valero L.P.’s current incremental borrowing rates for similar types of borrowing arrangements.

 

Valero L.P. is exposed to market risk for changes in interest rates related to its long-term debt obligations. Interest rate swap agreements, which were entered into during the first four months of 2003, are used to manage a portion of the exposure to changing interest rates by converting certain fixed-rate debt to variable-rate debt. Interest rates on borrowings under the revolving credit facility float with market rates and thus the carrying amount approximates fair value.