The majority of the earnings from the oil and NGL logistics segment are
generated from volume-based fees for providing transportation of oil and NGL and
fractionation of NGL. However, many of the agreements with the customers on our
oil pipelines require that we purchase oil from the customer at the inlet of our
pipeline for an index price, less an amount that compensates us for
transportation services, and resell the oil to the customer at the outlet of our
pipeline at the same index price. We record these transactions based on the net
amount billed to our customers resulting in these transactions reflecting a fee
for transportation services. For these reasons, we feel that gross margin
(revenue less cost of natural gas and other products) provides a more accurate
and meaningful basis for analyzing operating results for this segment.
Margin is driven by product pricing for both oil and NGL and by volumes.
Both oil and NGL volumes are impacted by natural resource decline as well as
increases in new production. Volumes at our NGL fractionation plants are
significantly impacted by processing economics, which are driven by the
difference between natural gas prices and NGL prices.
Typhoon Oil Pipeline, a wholly owned subsidiary, has transportation
agreements with BHP and ChevronTexaco which provide that Typhoon Oil purchase
the oil produced at the inlet of its pipeline for an index price less an amount
that compensates Typhoon Oil for transportation services. At the outlet of its
pipeline, Typhoon Oil resells this oil back to these producers at the same index
price. As disclosed in our 2003 Annual Report on Form 10-K, as amended, we now
record revenue from these buy/sell transactions upon delivery of the oil based
on the net amount billed to the producers. For the quarter and six months ended
June 30, 2003, we reduced by $73.1 million and $121.9 million our revenues and
cost of natural gas and other products to conform to the current period
presentation. This revision had no effect on operating income, net income,
performance cash flows or partners' capital.
In July 2004, we completed our construction of the Marco Polo oil pipeline.
We now own interests in four offshore oil pipeline systems with a combined
capacity of approximately 755 MBbls/d, up from 635 MBbls/d, of oil with the
addition of pumps and the use of friction reducers.
Marco Polo Oil Pipeline
The Marco Polo oil pipeline is a 36-mile, 14-inch oil pipeline that
supports the Marco Polo TLP. The Marco Polo oil pipeline has a capacity of 120
MBbls/d and interconnects with our Allegheny oil pipeline in Green Canyon Block
164. We expect an increase in transportation revenues in the second half of 2004
derived from producer transportation on this system.
Front Runner Oil Pipeline
In July 2004, Poseidon, our 36 percent owned joint venture, completed
construction of its 36-mile, 14-inch Front Runner oil pipeline and first
production is anticipated in the fourth quarter of 2004. The new oil pipeline
has a capacity of 65 MBbls/d and connects the Front Runner platform with
Poseidon's existing system at Ship Shoal Block 332. In October 2003, Poseidon
began withholding distributions to fund its capital expenditures related to its
Front Runner project. Since Poseidon has completed its construction of the Front
Runner oil pipeline, we expect to start receiving distributions again in late
2004 or early 2005.
Cameron Highway Oil Pipeline
The Cameron Highway oil pipeline will be a 390-mile crude oil pipeline
system with a capacity of approximately 500 MBbls/d. In July 2003, we sold a 50
percent interest in our Cameron Highway oil pipeline to Valero Energy
Corporation (Valero) for $86 million, forming a joint venture with Valero.
Valero paid us approximately $70 million at closing, including $51 million
representing 50 percent of the capital investment expended through that date for
the pipeline project. Valero will pay us an additional $5 million once the
system is completed, which is expected in the fourth quarter of 2004. We expect
to reflect this amount as a gain from the sale of long-lived assets in the
fourth quarter of 2004. In addition, we will receive another $11 million by the
end of 2006. We expect to reflect this amount as a gain from the sale of
long-lived assets in the period it is earned. We do not expect to receive
distributions from Cameron Highway until 2006 due to the debt service covenants
on Cameron Highway's project finance facility.