filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with Part I, Item 1, Business, our audited Consolidated Financial Statements and the Notes to Consolidated Financial Statements in this Annual Report.
RECENT DEVELOPMENTS
Please refer to the “Financial Results and Operating Information” and “Liquidity and Capital Resources” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Annual Report for additional information.
Magellan Acquisition - On September 25, 2023, we completed the Magellan Acquisition. The acquisition strategically diversifies our complementary asset base and allows for significant expected synergies. Pursuant to the Merger Agreement, each common unit of Magellan was exchanged for a fixed ratio of 0.667 shares of ONEOK common stock and $25.00 of cash, for a total consideration of $14.1 billion. In addition, we assumed Magellan's debt at the fair value of $4.0 billion. We issued approximately 135 million shares of common stock, with a fair value of approximately $9.0 billion as of the closing date of the Magellan Acquisition. We funded the cash portion of the acquisition with an underwritten public offering of $5.25 billion senior unsecured notes.
For additional information on the Magellan Acquisition, see Part II, Item 8, Note B of the Notes to Consolidated Financial Statements in this Annual Report. See Part 1, Item 1A “Risk Factors” for further discussion of risks related to the Magellan Acquisition. Additional information regarding the financial results and operating information of our Refined Products and Crude segment subsequent to the closing of the Magellan Acquisition is provided in “Financial Results and Operating Information.”
Market Condition - We experienced increased volumes across our system in 2023, compared with 2022, highlighting our extensive and integrated assets located in, and connected with, some of the most productive shale basins, refining regions and demand centers, in the United States.
Medford Incident - In January 2023, we reached an agreement with our insurers to settle all claims for physical damage and business interruption related to the Medford incident that occurred at our 210 MMbl/d Medford, Oklahoma, NGL fractionation facility in July 2022. Under the terms of the settlement agreement, we agreed to resolve the claims for total insurance payments of $930 million, $100 million of which was received in 2022. The remaining $830 million was received in the first quarter of 2023, resulting in a one-time settlement gain of $779 million. The proceeds serve as settlement for property damage, business interruption claims to the date of settlement and as payment in lieu of future business interruption insurance claims.
The Medford incident resulted in an increase in operating income and adjusted EBITDA of $663 million, from the settlement gain of $779 million, offset partially by $146 million of third-party fractionation costs compared with an approximately $30
million unfavorable impact of the 45-day waiting period in the year ended December 31, 2022. We expect our cash from operations in 2024 to be impacted by incurred costs resulting from the Medford incident for which we no longer receive business interruption proceeds.
For additional information on the Medford Incident, see Part II, Item 8, Note C of the Notes to Consolidated Financial Statements in this Annual Report.
Ethane Economics - Price differentials between ethane and natural gas can cause natural gas processors to recover ethane or leave it in the natural gas stream, known as ethane rejection. As a result of these ethane economics, ethane volumes on our system can fluctuate. Ethane volumes under long-term contracts delivered to our NGL system increased 25 MBbl/d to an average of 475 MBbl/d during 2023, compared with an average of 450 MBbl/d in 2022, due primarily to changes in ethane extraction economics. We estimate that there are approximately 250 MBbl/d of discretionary ethane, consisting of approximately 150 MBbl/d in the Rocky Mountain region and approximately 100 MBbl/d in the Mid-Continent region, that could be recovered and transported on our system.
Capital Projects - Our primary capital projects are outlined in the table below:
| Project | Scope | Approximate Costs (a) | Completion | ||||||||
| Natural Gas Liquids | (In millions) | ||||||||||
| MB-5 fractionator | 125 MBbl/d NGL fractionator in Mont Belvieu, Texas | $750 | Completed | ||||||||
| MB-6 fractionator | 125 MBbl/d NGL fractionator in Mont Belvieu, Texas | $550 | First Quarter 2025 | ||||||||
| West Texas NGL pipeline expansion | Increase capacity to 740 MBbl/d in the Permian Basin | $520 | First Quarter 2025 | ||||||||
| Elk Creek pipeline expansion | Increase capacity to 435 MBbl/d out of the Rocky Mountain region | $355 | First Quarter 2025 | ||||||||
| Natural Gas Pipelines | |||||||||||
| Viking compressor stations | Electrification and replacement of certain compressor assets | $110 | Completed | ||||||||
(a) - Excludes capitalized interest/AFUDC.
Debt Issuances - In August 2023, we completed an underwritten public offering of $5.25 billion senior unsecured notes consisting of $750 million, 5.55% senior notes due 2026; $750 million, 5.65% senior notes due 2028; $500 million, 5.80% senior notes due 2030; $1.5 billion, 6.05% senior notes due 2033; and $1.75 billion, 6.625% senior notes due 2053. The net proceeds, after deducting underwriting discounts, commissions and offering expenses, were $5.2 billion. The net proceeds were used to fund the cash consideration and other costs related to the Magellan Acquisition.
Debt Repayments - In 2023, we repurchased in the open market outstanding principal of certain of our senior notes in the amount of $322 million for an aggregate repurchase price of $280 million, including accrued and unpaid interest, with cash on hand. In connection with these open market repurchases, we recognized $41 million of net gains on extinguishment of debt.
In June 2023, we redeemed our $500 million, 7.5% senior notes due September 2023 at 100% of the principal amount, plus accrued and unpaid interest, with cash on hand.
In February 2023, we redeemed our $425 million, 5.0% senior notes due September 2023 at 100% of the principal amount, plus accrued and unpaid interest, with cash on hand.
Share Repurchase Program - In January 2024, our Board of Directors authorized a share repurchase program to buy up to $2.0 billion of our outstanding common stock and targets the program to be largely utilized over the next four years. We expect shares to be acquired from time to time in open-market transactions or through privately negotiated transactions at our discretion, subject to market conditions and other factors. We expect any purchases to be funded by cash on hand, cash flow from operations and short-term borrowings. The program will terminate upon completion of the repurchase of $2.0 billion of common stock or on January 1, 2029, whichever occurs first. As of February 20, 2024, no shares have been repurchased under the program.
Dividends - During 2023, we paid common stock dividends totaling $3.82 per share, an increase of 2% compared to the 2022 dividend of $3.74 per share. In February 2024, we paid a quarterly common stock dividend of $0.99 per share ($3.96 per share on an annualized basis), an increase of 3.7% compared with the same quarter in the prior year. Our dividend growth is primarily due to the increase in cash flows resulting from the growth of our operations.
FINANCIAL RESULTS AND OPERATING INFORMATION
How We Evaluate Our Operations
Management uses a variety of financial and operating metrics to analyze our performance. Our consolidated financial metrics include: (1) operating income; (2) net income; (3) diluted EPS; and (4) adjusted EBITDA. We evaluate segment operating results using adjusted EBITDA and our operating metrics, which include various volume and rate statistics that are relevant for the respective segment. These operating metrics allow investors to analyze the various components of segment financial results in terms of volumes and rate/price. Management uses these metrics to analyze historical segment financial results and as the key inputs for forecasting and budgeting segment financial results. For additional information on our operating metrics, see the respective segment subsections of this “Financial Results and Operating Information” section.
Non-GAAP Financial Measures - Adjusted EBITDA is a non-GAAP measure of our financial performance. Adjusted EBITDA is defined as net income adjusted for interest expense, depreciation and amortization, noncash impairment charges, income taxes, noncash compensation expense and certain other noncash items. Following the Magellan Acquisition, we performed a review of our calculation methodology of adjusted EBITDA, and beginning in 2023, we updated our calculation to include the adjusted EBITDA related to our unconsolidated affiliates using the same recognition and measurement methods used to record equity in net earnings from investments. In prior periods, our calculation included equity in net earnings from investments. This change resulted in an additional $62 million of adjusted EBITDA in 2023, and we have not restated prior periods. Adjusted EBITDA from our unconsolidated affiliates is calculated consistently with the definition above and excludes items such as interest, depreciation, income taxes and other noncash items. Although the amounts related to our unconsolidated affiliates are included in the calculation of adjusted EBITDA, such inclusion should not be understood to imply that we have control over the operations and resulting revenues, expenses or cash flows of such unconsolidated affiliates.
We believe this non-GAAP financial measure is useful to investors because it and similar measures are used by many companies in our industry as a measurement of financial performance and is commonly employed by financial analysts and others to evaluate our financial performance and to compare financial performance among companies in our industry. Adjusted EBITDA should not be considered an alternative to net income, EPS or any other measure of financial performance presented in accordance with GAAP. Additionally, this calculation may not be comparable with similarly titled measures of other companies.
Consolidated Operations
Selected Financial Results - The following table sets forth certain selected financial results for the periods indicated:
| Years Ended December 31, | 2023 vs. 2022 | 2022 vs. 2021 | ||||||||||||||||||||||||||||||
| Financial Results | 2023 | 2022 | 2021 | $ Increase (Decrease) | ||||||||||||||||||||||||||||
| (Millions of dollars, except per share amounts) | ||||||||||||||||||||||||||||||||
| Revenues | ||||||||||||||||||||||||||||||||
| Commodity sales | $ | 15,614 | $ | 20,976 | $ | 15,180 | (5,362) | 5,796 | ||||||||||||||||||||||||
| Services | 2,063 | 1,411 | 1,360 | 652 | 51 | |||||||||||||||||||||||||||
| Total revenues | 17,677 | 22,387 | 16,540 | (4,710) | 5,847 | |||||||||||||||||||||||||||
| Cost of sales and fuel (exclusive of items shown separately below) | 11,929 | 17,910 | 12,257 | (5,981) | 5,653 | |||||||||||||||||||||||||||
| Operating costs | 1,535 | 1,149 | 1,067 | 386 | 82 | |||||||||||||||||||||||||||
| Depreciation and amortization | 769 | 626 | 622 | 143 | 4 | |||||||||||||||||||||||||||
| Transaction costs | 158 | — | — | 158 | — | |||||||||||||||||||||||||||
| Other operating income, net | (786) | (105) | (2) | 681 | 103 | |||||||||||||||||||||||||||
| Operating income | $ | 4,072 | $ | 2,807 | $ | 2,596 | 1,265 | 211 | ||||||||||||||||||||||||
| Equity in net earnings from investments | $ | 202 | $ | 148 | $ | 122 | 54 | 26 | ||||||||||||||||||||||||
| Interest expense, net of capitalized interest | $ | (866) | $ | (676) | $ | (733) | 190 | (57) | ||||||||||||||||||||||||
| Net income | $ | 2,659 | $ | 1,722 | $ | 1,500 | 937 | 222 | ||||||||||||||||||||||||
| Diluted EPS | $ | 5.48 | $ | 3.84 | $ | 3.35 | 1.64 | 0.49 | ||||||||||||||||||||||||
| Adjusted EBITDA | $ | 5,243 | $ | 3,620 | $ | 3,380 | 1,623 | 240 | ||||||||||||||||||||||||
| Capital expenditures | $ | 1,595 | $ | 1,202 | $ | 697 | 393 | 505 |
See reconciliation of net income to adjusted EBITDA in the “Non-GAAP Financial Measures” section.
Changes in commodity prices and sales volumes affect both revenues and cost of sales and fuel in our Consolidated Statements of Income and, therefore, the impact is largely offset between these line items.
2023 vs. 2022 - Operating income increased $1.3 billion primarily as a result of the following:
*•*Natural Gas Gathering and Processing - an increase of $227 million from higher volumes in the Rocky Mountain and Mid-Continent regions and an increase of $49 million due primarily to higher average fee rates;
*•*Natural Gas Liquids - an increase of $663 million related to the Medford incident and an increase of $303 million in exchange services;
*•*Natural Gas Pipelines - an increase of $43 million in transportation and storage services; and
- Refined Products and Crude - transportation and storage revenues of $535 million for the period of September 25, 2023, through December 31, 2023 due to the impact of the Magellan Acquisition; offset by
*•*Consolidated Operating, Depreciation and Transaction Costs - an increase of $290 million in operating costs and depreciation expense from our Refined Products and Crude segment, an increase of $158 million from transaction costs related to the Magellan Acquisition and an increase of $239 million due primarily to higher operating costs and depreciation expense in our Natural Gas Gathering and Processing, Natural Gas Liquids and Natural Gas Pipelines segments.
Net income and diluted EPS increased due primarily to the items discussed above, higher equity in net earnings from investments, higher interest income due to both higher cash balances and higher interest rates and net gains on extinguishment of debt related to open market repurchases. These increases were offset partially by higher income taxes and higher interest expense due to interest costs resulting from the Magellan Acquisition, which include acquired debt balances, our August 2023 $5.25 billion notes offering and commitment fees associated with our undrawn and terminated 364-day bridge loan facility.
Capital expenditures increased due primarily to our capital projects, including our MB-6 fractionator, NGL pipeline expansion projects and the Viking compression project.
Additional information regarding our financial results and operating information is provided in the following discussion for each of our four segments. In connection with the Magellan Acquisition, we reviewed our business segments in light of certain changes in the financial information regularly reviewed by our chief operating decision maker and other factors. Based on this review, we added the Refined Products and Crude segment. This change, which was effective as of September 25, 2023, had no impact on our consolidated financial statements for any periods.
Selected Financial Results and Operating Information for the Year Ended December 31, 2022 vs. 2021 - The consolidated and segment financial results and operating information for the year ended December 31, 2022, compared with the year ended December 31, 2021, are included in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2022 Annual Report on Form 10-K, which is available via the SEC’s website at www.sec.gov and our website at www.oneok.com.
Natural Gas Gathering and Processing
Capital Projects - Our Natural Gas Gathering and Processing segment invests in capital projects in NGL-rich areas where we operate.
For a discussion of our capital expenditure financing, see “Capital Expenditures” in the “Liquidity and Capital Resources” section.
Selected Financial Results and Operating Information - The following tables set forth certain selected financial results and operating information for our Natural Gas Gathering and Processing segment for the periods indicated:
| Years Ended December 31, | 2023 vs. 2022 | 2022 vs. 2021 | ||||||||||||||||||||||||||||||
| Financial Results | 2023 | 2022 | 2021 | $ Increase (Decrease) | ||||||||||||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||||||||||
| NGL and condensate sales | $ | 2,479 | $ | 3,690 | $ | 2,821 | (1,211) | 869 | ||||||||||||||||||||||||
| Residue natural gas sales | 1,398 | 2,674 | 1,484 | (1,276) | 1,190 | |||||||||||||||||||||||||||
| Gathering, compression, dehydration and processing fees and other revenue | 179 | 169 | 156 | 10 | 13 | |||||||||||||||||||||||||||
| Cost of sales and fuel (exclusive of depreciation and operating costs) | (2,364) | (5,117) | (3,226) | (2,753) | 1,891 | |||||||||||||||||||||||||||
| Operating costs, excluding noncash compensation adjustments | (448) | (386) | (351) | 62 | 35 | |||||||||||||||||||||||||||
| Adjusted EBITDA from unconsolidated affiliates (a) | 1 | — | — | 1 | — | |||||||||||||||||||||||||||
| Equity in net earnings from investments (a) | — | 5 | 4 | (5) | 1 | |||||||||||||||||||||||||||
| Other | (1) | 2 | 1 | (3) | 1 | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 1,244 | $ | 1,037 | $ | 889 | 207 | 148 | ||||||||||||||||||||||||
| Capital expenditures | $ | 448 | $ | 445 | $ | 275 | 3 | 170 |
(a) - Beginning in 2023, we updated our calculation methodology of adjusted EBITDA to include adjusted EBITDA from our unconsolidated affiliates, which resulted in an additional $3 million of adjusted EBITDA in 2023, and we have not restated prior periods. See reconciliation of net income to adjusted EBITDA in the “Non-GAAP Financial Measures” section.
Changes in commodity prices and sales volumes affect both revenue and cost of sales and fuel, and, therefore, the impact is largely offset between these line items.
2023 vs. 2022 - Adjusted EBITDA increased $207 million, primarily as a result of the following:
-
an increase of $227 million from higher volumes due primarily to increased producer activity in the Rocky Mountain and Mid-Continent regions, and the impact of winter weather in the Rocky Mountain region in the second and fourth quarters of 2022; and
-
an increase of $49 million due primarily to higher average fee rates and realized condensate prices, net of hedging, offset partially by lower realized NGL prices, net of hedging; offset by
-
an increase of $62 million in operating costs due primarily to higher employee-related costs, outside services and materials and supplies expense due primarily to the growth of our operations, and higher property insurance premiums.
Capital expenditures remained relatively unchanged for 2023, as compared to 2022, due primarily to increased expenditures in 2023 on various capital projects, offset by expenditures in 2022 on our Demicks Lake III project completed in the first quarter of 2023.
| Years Ended December 31, | ||||||||||||||||||||
| Operating Information (a) | 2023 | 2022 | 2021 | |||||||||||||||||
| Natural gas processed (BBtu/d) (b) | 2,995 | 2,612 | 2,515 | |||||||||||||||||
| Average fee rate ($/MMBtu) | $ | 1.17 | $ | 1.10 | $ | 1.04 |
(a) - Includes volumes for consolidated entities only.
(b) - Includes volumes we processed at company-owned and third-party facilities.
2023 vs. 2022 - Our natural gas processed volumes increased due primarily to increased producer activity in the Rocky Mountain and Mid-Continent regions and the impact of winter weather in the Rocky Mountain region in the second and fourth quarters of 2022.
Our average fee rate increased due primarily to increased contribution of volumes on higher fee contracts in the Williston Basin and inflation-based escalators in our contracts. Also, for certain fee with POP contracts, our contractual fees increased due to production volumes, delivery pressures or commodity prices relative to specified contractual thresholds.
Natural Gas Liquids
Capital Projects - Our Natural Gas Liquids segment invests in capital projects to transport, fractionate, store, deliver to market centers and receive NGL supply from shale and other resource development areas. Our growth strategy is focused around
connecting diversified supply basins from the Rocky Mountain region through the Mid-Continent region and the Permian Basin with demand for Purity NGLs from the petrochemical and refining industries and NGL exports in the Gulf Coast. We proactively monitor lead times on materials and equipment used in constructing capital projects, and we enter into procurement agreements for long-lead items for potential projects to plan for future growth. See “Capital Projects” in the “Recent Developments” section for more information on our capital projects.
In 2023, we connected two third-party natural gas processing plants in the Permian Basin and one affiliate natural gas processing plant in the Rocky Mountain region.
For a discussion of our capital expenditure financing, see “Capital Expenditures” in the “Liquidity and Capital Resources” section.
Selected Financial Results and Operating Information - The following tables set forth certain selected financial results and operating information for our Natural Gas Liquids segment for the periods indicated:
| Years Ended December 31, | 2023 vs. 2022 | 2022 vs. 2021 | ||||||||||||||||||||||||||||||
| Financial Results | 2023 | 2022 | 2021 | $ Increase (Decrease) | ||||||||||||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||||||||||
| NGL and condensate sales | $ | 13,666 | $ | 18,329 | $ | 13,653 | (4,663) | 4,676 | ||||||||||||||||||||||||
| Exchange service and other revenues | 559 | 558 | 559 | 1 | (1) | |||||||||||||||||||||||||||
| Transportation and storage revenues | 204 | 180 | 180 | 24 | — | |||||||||||||||||||||||||||
| Cost of sales and fuel (exclusive of depreciation and operating costs) | (11,592) | (16,546) | (11,940) | (4,954) | 4,606 | |||||||||||||||||||||||||||
| Operating costs, excluding noncash compensation adjustments | (637) | (549) | (499) | 88 | 50 | |||||||||||||||||||||||||||
| Adjusted EBITDA from unconsolidated affiliates (a) | 67 | — | — | 67 | — | |||||||||||||||||||||||||||
| Equity in net earnings from investments (a) | — | 35 | 21 | (35) | 14 | |||||||||||||||||||||||||||
| Other | 778 | 88 | (10) | 690 | 98 | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 3,045 | $ | 2,095 | $ | 1,964 | 950 | 131 | ||||||||||||||||||||||||
| Capital expenditures | $ | 818 | $ | 581 | $ | 307 | 237 | 274 |
(a) - Beginning in 2023, we updated our calculation methodology of adjusted EBITDA to include adjusted EBITDA from our unconsolidated affiliates which resulted in an additional $9 million of adjusted EBITDA in 2023, and we have not restated prior periods. See reconciliation of net income to adjusted EBITDA in the “Non-GAAP Financial Measures” section.
Changes in commodity prices and sales volumes affect both revenues and cost of sales and fuel and, therefore, the impact is largely offset between these line items.
2023 vs. 2022 - Adjusted EBITDA increased $950 million primarily as a result of the following:
-
an increase of $663 million related to the Medford incident, due to the settlement gain of $779 million, offset partially by $146 million of third-party fractionation costs, compared with an approximately $30 million unfavorable impact of the 45-day waiting period in 2022;
-
an increase of $303 million in exchange services due primarily to higher volumes across the system, offset partially by narrower commodity price differentials;
-
an increase of $32 million in earnings from unconsolidated affiliates due primarily to higher volumes delivered to the Overland Pass pipeline and the change in calculation methodology in 2023;
-
an increase of $20 million due primarily to higher volumes on the ONEOK North System and higher storage revenue; and
*•*an increase of $12 million in optimization and marketing due primarily to higher earnings on sales of Purity NGLs held in inventory; offset by
- an increase of $88 million in operating costs due primarily to higher employee-related costs and higher outside services due to the growth of our operations, and higher property insurance premiums.
Capital expenditures increased in 2023 due primarily to capital projects, which includes our MB-6 fractionator and pipeline expansion projects.
| Years Ended December 31, | |||||||||||||||||||||||
| Operating Information | 2023 | 2022 | 2021 | ||||||||||||||||||||
| Raw feed throughput (MBbl/d) (a) | 1,359 | 1,237 | 1,198 | ||||||||||||||||||||
| Average Conway-to-Mont Belvieu OPIS price differential - ethane in ethane/propane mix ($/gallon) | $ | 0.04 | $ | 0.04 | $ | (0.01) | |||||||||||||||||
(a) - Represents physical raw feed volumes for which we provide transportation and/or fractionation services.
We generally expect ethane volumes to increase or decrease with corresponding increases or decreases in overall NGL production. However, ethane volumes may experience growth or decline greater than corresponding growth or decline in overall NGL production due to ethane economics causing producers to recover or reject ethane.
2023 vs. 2022 - Volumes increased due primarily to increased production in the Permian Basin and Rocky Mountain region and increased ethane volumes in the Mid-Continent region.
Natural Gas Pipelines
Capital Projects - Our Natural Gas Pipelines segment invests in capital projects that provide transportation and storage services to end users. In February 2024, the FERC approved our Saguaro Connector Pipeline, L.L.C.’s Presidential Permit application to construct and operate new international border-crossing facilities at the U.S. and Mexico border. The proposed border facilities would connect upstream with a potential intrastate pipeline, the Saguaro Connector pipeline. Additionally, the proposed border facilities would connect at the international boundary with a new pipeline under development in Mexico for delivery to a liquefied natural gas export facility on the west coast of Mexico. The final investment decision on the Saguaro Connector pipeline is expected by mid-year 2024.
In 2023, we completed an expansion of our injection capabilities of our Oklahoma natural gas storage facilities, which allowed us to utilize and subscribe an additional 4 Bcf of our existing storage capacity, which is fully subscribed through 2027 and 90% subscribed through 2029. We are reactivating previously idled storage facilities with 3 Bcf of working gas storage capacity in Texas, which is already fully subscribed on a firm basis. We are also further expanding our injection capabilities in Oklahoma to allow us to subscribe additional firm storage capacity.
See “Capital Projects” in the “Recent Developments” section for a discussion of our capital projects.
For a discussion of our capital expenditure financing, see “Capital Expenditures” in the “Liquidity and Capital Resources” section.
Selected Financial Results and Operating Information - The following tables set forth certain selected financial results and operating information for our Natural Gas Pipelines segment for the periods indicated:
| Years Ended December 31, | 2023 vs. 2022 | 2022 vs. 2021 | ||||||||||||||||||||||||||||||
| Financial Results | 2023 | 2022 | 2021 | $ Increase (Decrease) | ||||||||||||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||||||||||||||
| Transportation revenues | $ | 423 | $ | 409 | $ | 413 | 14 | (4) | ||||||||||||||||||||||||
| Storage revenues | 159 | 130 | 78 | 29 | 52 | |||||||||||||||||||||||||||
| Residue natural gas sales and other revenues | 41 | 40 | 116 | 1 | (76) | |||||||||||||||||||||||||||
| Cost of sales and fuel (exclusive of depreciation and operating costs) | (28) | (25) | (11) | 3 | 14 | |||||||||||||||||||||||||||
| Operating costs, excluding noncash compensation adjustments | (194) | (174) | (162) | 20 | 12 | |||||||||||||||||||||||||||
| Adjusted EBITDA from unconsolidated affiliates (a) | 160 | — | — | 160 | — | |||||||||||||||||||||||||||
| Equity in net earnings from investments (a) | — | 108 | 97 | (108) | 11 | |||||||||||||||||||||||||||
| Other | (2) | — | (3) | (2) | 3 | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 559 | $ | 488 | $ | 528 | 71 | (40) | ||||||||||||||||||||||||
| Capital expenditures | $ | 228 | $ | 123 | $ | 93 | 105 | 30 |
(a) - Beginning in 2023, we updated our calculation methodology of adjusted EBITDA to include adjusted EBITDA from our unconsolidated affiliates which resulted in an additional $42 million of adjusted EBITDA in 2023, and we have not restated prior periods. See reconciliation of net income to adjusted EBITDA in the “Non-GAAP Financial Measures” section.
2023 vs. 2022 - Adjusted EBITDA increased $71 million primarily as a result of the following:
*•*an increase of $43 million in transportation and storage services due primarily to higher storage rates on renegotiated contracts, higher storage volumes related to completed projects and higher firm and interruptible transportation volumes; and
*•*an increase of $42 million in earnings from unconsolidated affiliates due to the change in calculation methodology in 2023; offset by
- an increase of $20 million in operating costs due primarily to higher employee-related costs.
Capital expenditures increased in 2023 due primarily to capital projects, including the Viking compression project.
| Years Ended December 31, | ||||||||||||||||||||
| Operating Information (a) | 2023 | 2022 | 2021 | |||||||||||||||||
| Natural gas transportation capacity contracted (MDth/d) | 7,743 | 7,428 | 7,395 | |||||||||||||||||
| Transportation capacity contracted | 96 | % | 94 | % | 95 | % |
(a) - Includes volumes for consolidated entities only.
In April 2022, the FERC initiated a review of Guardian’s rates pursuant to Section 5 of the Natural Gas Act. In August 2022, Guardian reached a settlement in principle with the participants in the Section 5 rate case. The FERC approved the settlement in February 2023, which resulted in a reduction of rates starting in April 2023. The reduced rates did not have a material impact on our results of operations.
In July 2023, Viking filed a proposed increase in rates pursuant to Section 4 of the Natural Gas Act with the FERC. The FERC is currently reviewing the filing. While the ultimate outcome of the filing cannot be predicted, we do not expect it to materially impact our results of operations.
Refined Products and Crude
Capital Projects - Our Refined Products and Crude segment invests in capital projects to transport, store and distribute Refined Products and crude oil primarily throughout the central United States. Our growth strategy is focused on expanding our core business and marketing presence.
For a discussion of our capital expenditure financing, see “Capital Expenditures” in the “Liquidity and Capital Resources” section.
Selected Financial Results and Operating Information - The following tables set forth certain selected financial results and operating information for our Refined Products and Crude segment for the period subsequent to the closing of the Magellan Acquisition:
| September 25 through December 31, 2023 | ||||||||
| Financial Results | ||||||||
| (Millions of dollars) | ||||||||
| Product sales | $ | 502 | ||||||
| Transportation revenues | 392 | |||||||
| Storage, terminals and other revenues | 177 | |||||||
| Cost of sales and fuel (exclusive of depreciation and operating costs) | (450) | |||||||
| Operating costs, excluding noncash compensation adjustments | (192) | |||||||
| Adjusted EBITDA from unconsolidated affiliates | 36 | |||||||
| Adjusted EBITDA | $ | 465 | ||||||
| Capital expenditures | $ | 52 |
See reconciliation of net income to adjusted EBITDA in the “Non-GAAP Financial Measures” section.
Changes in commodity prices and sales volumes affect both revenues and cost of sales and fuel in our Consolidated Statements of Income and, therefore, the impact is largely offset between these line items.
| Three Months Ended December 31, | ||||||||
| Operating Information (a) | 2023 | |||||||
| Refined Products volume shipped (MBbl/d) | 1,547 | |||||||
| Crude oil volume shipped (MBbl/d) | 808 |
(a) - Includes volumes for consolidated entities only.
NON-GAAP FINANCIAL MEASURES
The following table sets forth a reconciliation of net income, the nearest comparable GAAP financial performance measure, to adjusted EBITDA for the periods indicated:
| Years Ended December 31, | ||||||||||||||||||||
| (Unaudited) | 2023 | 2022 | 2021 | |||||||||||||||||
| Reconciliation of net income to adjusted EBITDA | (Millions of dollars) | |||||||||||||||||||
| Net income | $ | 2,659 | $ | 1,722 | $ | 1,500 | ||||||||||||||
| Interest expense, net of capitalized interest | 866 | 676 | 733 | |||||||||||||||||
| Depreciation and amortization | 769 | 626 | 622 | |||||||||||||||||
| Income taxes | 838 | 528 | 484 | |||||||||||||||||
| Adjusted EBITDA from unconsolidated affiliates (c) | 264 | — | — | |||||||||||||||||
| Equity in net earnings from investments (c) | (202) | — | — | |||||||||||||||||
| Noncash compensation expense and other | 49 | 68 | 41 | |||||||||||||||||
| Adjusted EBITDA (a)(b)(c) | $ | 5,243 | $ | 3,620 | $ | 3,380 | ||||||||||||||
| Reconciliation of segment adjusted EBITDA to adjusted EBITDA | ||||||||||||||||||||
| Segment adjusted EBITDA: | ||||||||||||||||||||
| Natural Gas Gathering and Processing | $ | 1,244 | $ | 1,037 | $ | 889 | ||||||||||||||
| Natural Gas Liquids (a) | 3,045 | 2,095 | 1,964 | |||||||||||||||||
| Natural Gas Pipelines | 559 | 488 | 528 | |||||||||||||||||
| Refined Products and Crude (d) | 465 | — | — | |||||||||||||||||
| Other (b) | (70) | — | (1) | |||||||||||||||||
| Adjusted EBITDA (a)(b)(c) | $ | 5,243 | $ | 3,620 | $ | 3,380 |
(a) - The year ended December 31, 2023, includes $633 million related to the Medford incident, including a settlement gain of $779 million, offset partially by $146 million of third-party fractionation costs.
(b) - The year ended December 31, 2023, primarily includes transaction costs related to the Magellan Acquisition of $158 million, offset partially by interest income of $49 million and net gains of $41 million on extinguishment of debt related to open market repurchases.
(c) - Beginning in 2023, we updated our calculation methodology of adjusted EBITDA to include adjusted EBITDA from our unconsolidated affiliates using the same recognition and measurement methods used to record equity in net earnings from investments. In prior periods, our calculation included equity in net earnings from investments. This change resulted in an additional $62 million of adjusted EBITDA in 2023, and we have not restated prior periods.
(d) - Includes segment adjusted EBITDA for the period September 25, 2023, through December 31, 2023.
CONTINGENCIES
See Note O of the Notes to Consolidated Financial Statements in this Annual Report for a discussion of environmental and legal matters.
Other Legal Proceedings - We are a party to various legal proceedings that have arisen in the normal course of our operations. While the results of these proceedings cannot be predicted with certainty, we believe the reasonably possible losses from such proceedings, individually and in the aggregate, are not material. Additionally, we believe the probable final outcome of such proceedings will not have a material adverse effect on our consolidated results of operations, financial position or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
General - Our primary sources of cash inflows are operating cash flows, proceeds from our commercial paper program and our $2.5 Billion Credit Agreement, debt issuances and the issuance of common stock for our liquidity and capital resources requirements.
In January 2023, we reached an agreement with our insurers to settle all claims for physical damage and business interruption related to the Medford incident. Under the terms of the settlement agreement, we agreed to resolve the claims for total insurance payments of $930 million, $100 million of which was received in 2022. The remaining $830 million was received in the first quarter of 2023. The proceeds serve as settlement for property damage, business interruption claims to the date of settlement and as payment in lieu of future business interruption insurance claims. We expect our cash from operations in 2024 to be impacted by incurred costs resulting from the Medford incident for which we no longer receive business interruption proceeds.
We expect our sources of cash inflows to provide sufficient resources to finance our operations, capital expenditures, quarterly cash dividends, maturities of long-term debt, share repurchases and contributions to unconsolidated affiliates. We believe we have sufficient liquidity due to our $2.5 Billion Credit Agreement, which expires in June 2027, and access to $1.0 billion available through our “at-the-market” equity program. As of the date of this report, no shares have been sold through our “at-the-market” equity program.
We may manage interest-rate risk through the use of fixed-rate debt, floating-rate debt, Treasury locks and interest-rate swaps. For additional information on our interest-rate swaps, see Note E of the Notes to Consolidated Financial Statements in this Annual Report.
Cash Management - At December 31, 2023, we had $338 million of cash and cash equivalents. We use a centralized cash management program that concentrates the cash assets of our nonguarantor operating subsidiaries in joint accounts for the purposes of providing financial flexibility and lowering the cost of borrowing, transaction costs and bank fees. Our centralized cash management program provides that funds in excess of the daily needs of our operating subsidiaries are concentrated, consolidated or otherwise made available for use by other entities within our consolidated group. Our operating subsidiaries participate in this program to the extent they are permitted pursuant to FERC regulations or their operating agreements. Under the cash management program, depending on whether a participating subsidiary has short-term cash surpluses or cash requirements, we provide cash to the subsidiary or the subsidiary provides cash to us.
Guarantees - In December 2023, ONEOK assumed the debt obligations of Magellan under its previous debt indentures and Magellan provided a guarantee of the outstanding notes. As of December 31, 2023, Magellan no longer had debt obligations outstanding. We guarantee certain debt securities of ONEOK Partners, and ONEOK Partners, the Intermediate Partnership and Magellan guarantee certain of our debt securities. The guarantees in place for our and ONEOK Partners’ indebtedness are full, irrevocable, unconditional and absolute joint and several guarantees to the holders of each series of outstanding securities. Liabilities under the guarantees rank equally in right of payment with all existing and future senior unsecured indebtedness. The Intermediate Partnership holds all of ONEOK Partners’ interests and equity in its subsidiaries, which are nonguarantors, and substantially all the assets and operations reside with nonguarantor operating subsidiaries. Magellan holds interests in its subsidiaries, which are nonguarantors, and substantially all the assets and operations reside with nonguarantor operating subsidiaries. Therefore, as allowed under Rule 13-01, we have excluded the summarized financial information for each issuer and guarantor as the combined financial information of the subsidiary issuers and parent guarantor, excluding our ownership of all the interests in ONEOK Partners and Magellan, reflect no material assets, liabilities or results of operations, apart from the guaranteed indebtedness. For additional information on our and ONEOK Partners’ indebtedness, please see Note H of the Notes to Consolidated Financial Statements in this Annual Report.
Short-term Liquidity - Our principal sources of short-term liquidity consist of cash generated from operating activities, distributions received from our equity-method investments, proceeds from our commercial paper program and our $2.5 Billion Credit Agreement. As of December 31, 2023, we had no borrowings under our $2.5 Billion Credit Agreement and we are in compliance with all covenants.
We had working capital (defined as current assets less current liabilities) deficits of $344 million and $503 million as of December 31, 2023, and December 31, 2022, respectively due primarily to current maturities of long-term debt. Generally, our working capital is influenced by several factors, including, among other things: (i) the timing of (a) debt and equity issuances, (b) the funding of capital expenditures, (c) scheduled debt repayments, and (d) accounts receivable and payable; and (ii) the volume and cost of inventory and commodity imbalances. We may have working capital deficits in future periods as our long-term debt becomes current. We do not expect a working capital deficit of this nature to have a material adverse impact to our cash flows or operations.
For additional information on our $2.5 Billion Credit Agreement, see Note H of the Notes to Consolidated Financial Statements in this Annual Report.
Long-term Financing - In addition to our principal sources of short-term liquidity discussed above, we expect to fund our longer-term financing requirements by issuing long-term notes, as needed. Other options to obtain financing include, but are not limited to, issuing common stock, loans from financial institutions, issuance of convertible debt securities or preferred equity securities, asset securitization and the sale and lease-back of facilities.
We may, at any time, seek to retire or purchase our or ONEOK Partners’ outstanding debt through cash purchases and/or exchanges for equity or debt, in open-market repurchases, privately negotiated transactions or otherwise. Such repurchases and exchanges, if any, will be on such terms and prices as we may determine, and will depend on prevailing market conditions, or liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Debt Issuances - In August 2023, we completed an underwritten public offering of $5.25 billion senior unsecured notes consisting of $750 million, 5.55% senior notes due 2026; $750 million, 5.65% senior notes due 2028; $500 million, 5.80% senior notes due 2030; $1.5 billion, 6.05% senior notes due 2033; and $1.75 billion, 6.625% senior notes due 2053. The net proceeds, after deducting underwriting discounts, commissions and offering expenses, were $5.2 billion. The net proceeds were used to fund the cash consideration and other costs related to the Magellan Acquisition. In connection with the underwritten public offering, we terminated the undrawn commitment letter for the $5.25 billion unsecured 364-day bridge loan facility.
Debt Repayments - In 2023, we repurchased in the open market outstanding principal of certain of our senior notes in the amount of $322 million for an aggregate repurchase price of $280 million, including accrued and unpaid interest, with cash on hand. In connection with these open market repurchases, we recognized $41 million of net gains on extinguishment of debt.
In November 2023, we made an equity contribution of $91 million to Northern Border, which in combination with an equal contribution from our joint venture partner, was used to partially repay the outstanding balance of its revolving credit facility and fund capital projects.
In June 2023, we redeemed our $500 million, 7.5% senior notes due September 2023 at 100% of the principal amount, plus accrued and unpaid interest, with cash on hand.
In June 2023, we made an equity contribution of $105 million to Roadrunner, which, in combination with an equal contribution from our joint venture partner, was used to repay Roadrunner’s outstanding debt.
In February 2023, we redeemed our $425 million, 5.0% senior notes due September 2023 at 100% of the principal amount, plus accrued and unpaid interest, with cash on hand.
Equity Issuances - On September 25, 2023, we completed the Magellan Acquisition. Pursuant to the Merger Agreement, each common unit of Magellan was exchanged for a fixed ratio of 0.667 shares of ONEOK common stock and $25.00 of cash, for a total consideration of $14.1 billion. We issued approximately 135 million shares of common stock, with a fair value of approximately $9.0 billion as of the closing date of the Magellan Acquisition.
Share Repurchase Program - In January 2024, our Board of Directors authorized a share repurchase program to buy up to $2.0 billion of our outstanding common stock and targets the program to be largely utilized over the next four years. We expect shares to be acquired from time to time in open-market transactions or through privately negotiated transactions at our discretion, subject to market conditions and other factors. We expect any purchases to be funded by cash on hand, cash flow from operations and short-term borrowings. The program will terminate upon completion of the repurchase of $2.0 billion of common stock or on January 1, 2029, whichever occurs first. As of February 20, 2024, no shares have been repurchased under the program.
Material Commitments - We have material cash commitments related to our capital expenditures, senior notes and corresponding interest payments, which we expect to fund through our sources of cash inflows discussed above. Our senior notes and interest payments are discussed in Note H of the Notes to Consolidated Financial Statements in this Annual Report. We also have cash commitments related to transportation, storage and other commercial contracts, as well as our financial and physical derivative obligations, which we expect to fund with cash from operations.
Capital Expenditures - We proactively monitor lead times on materials and equipment used in constructing capital projects, and we enter into procurement agreements for long-lead items for potential projects to plan for future growth. Our capital expenditures are financed typically through operating cash flows and short- and long-term debt.
The following table sets forth our capital expenditures, excluding AFUDC, for the periods indicated:
| Capital Expenditures | 2023 | 2022 | 2021 | |||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||
| Natural Gas Gathering and Processing | $ | 448 | $ | 445 | $ | 275 | ||||||||||||||
| Natural Gas Liquids | 818 | 581 | 307 | |||||||||||||||||
| Natural Gas Pipelines | 228 | 123 | 93 | |||||||||||||||||
| Refined Products and Crude (a) | 52 | — | — | |||||||||||||||||
| Other | 49 | 53 | 22 | |||||||||||||||||
| Total capital expenditures | $ | 1,595 | $ | 1,202 | $ | 697 |
(a) - Includes capital expenditures for the period September 25, 2023, through December 31, 2023.
Capital expenditures increased in 2023, compared with 2022, due primarily to our capital projects, including our MB-6 fractionator, NGL pipeline expansion projects and the Viking compression project. See discussion of our announced capital projects in the “Recent Developments” section.
We expect total capital expenditures, excluding AFUDC and capitalized interest, of $1.75-$1.95 billion in 2024.
Credit Ratings - Our long-term debt credit ratings as of February 20, 2024, are shown in the table below:
| Rating Agency | Long-Term Rating | Short-Term Rating | Outlook | ||||||||
| Moody’s | Baa2 | Prime-2 | Stable | ||||||||
| S&P | BBB | A-2 | Stable | ||||||||
| Fitch | BBB | F2 | Stable |
Our credit ratings, which are investment grade, may be affected by our leverage, liquidity, credit profile or potential transactions. In April 2023, Moody’s upgraded the rating on our long-term debt to Baa2 from Baa3, the rating on our short-term debt to Prime-2 from Prime-3 and changed the outlook to stable from positive. The most common criteria for assessment of our credit ratings are the debt-to-EBITDA ratio, interest coverage, business risk profile and liquidity. If our credit ratings were downgraded, our cost to borrow funds under our $2.5 Billion Credit Agreement could increase and a potential loss of access to the commercial paper market could occur. In the event that we are unable to borrow funds under our commercial paper program and there has not been a material adverse change in our business, we would continue to have access to our $2.5 Billion Credit Agreement, which expires in 2027. An adverse credit rating change alone is not a default under our $2.5 Billion Credit Agreement.
In the normal course of business, our counterparties provide us with secured and unsecured credit. In the event of a downgrade in our credit ratings or a significant change in our counterparties’ evaluation of our creditworthiness, we could be required to provide additional collateral in the form of cash, letters of credit or other negotiable instruments as a condition of continuing to conduct business with such counterparties. We may be required to fund margin requirements with our counterparties with cash, letters of credit or other negotiable instruments.
Dividends - Holders of our common stock share equally in any common stock dividends declared by our Board of Directors, subject to the rights of the holders of outstanding preferred stock. In 2023, we paid common stock dividends totaling $3.82 per share, an increase of 2% compared to the 2022 dividend of $3.74 per share. In February 2024, we paid a quarterly common stock dividend of $0.99 per share ($3.96 per share on an annualized basis), an increase of 3.7% compared with the same quarter in the prior year.
Our Series E Preferred Stock pays quarterly dividends on each share of Series E Preferred Stock, when, as and if declared by our Board of Directors, at a rate of 5.5% per year. In 2023, we paid dividends for the Series E Preferred Stock of $1 million for the series E preferred stock. In February 2024, we paid quarterly dividends totaling $0.3 million for the Series E Preferred Stock.
For the year ended December 31, 2023, our cash flows from operations exceeded dividends paid by $2.6 billion, due in part to the insurance proceeds received from the Medford settlement in 2023. We expect our cash flows from operations to continue to sufficiently fund our cash dividends. To the extent operating cash flows are not sufficient to fund our dividends, we may utilize cash on hand from other sources of short- and long-term liquidity to fund a portion of our dividends.
CASH FLOW ANALYSIS
We use the indirect method to prepare our Consolidated Statements of Cash Flows. Under this method, we reconcile net income to cash flows provided by operating activities by adjusting net income for those items that affect net income but do not result in actual cash receipts or payments during the period and for operating cash items that do not impact net income. These reconciling items can include depreciation and amortization, deferred income taxes, impairment charges, allowance for equity funds used during construction, gain or loss on sale of assets, net undistributed earnings from equity-method investments, share-based compensation expense, other amounts and changes in our assets and liabilities not classified as investing or financing activities.
The following table sets forth the changes in cash flows by operating, investing and financing activities for the periods indicated:
| Years Ended December 31, | ||||||||||||||||||||
| 2023 | 2022 | 2021 | ||||||||||||||||||
| (Millions of dollars) | ||||||||||||||||||||
| Total cash provided by (used in): | ||||||||||||||||||||
| Operating activities | $ | 4,421 | $ | 2,906 | $ | 2,546 | ||||||||||||||
| Investing activities | (6,404) | (1,139) | (665) | |||||||||||||||||
| Financing activities | 2,101 | (1,693) | (2,259) | |||||||||||||||||
| Change in cash and cash equivalents | 118 | 74 | (378) | |||||||||||||||||
| Cash and cash equivalents at beginning of period | 220 | 146 | 524 | |||||||||||||||||
| Cash and cash equivalents at end of period | $ | 338 | $ | 220 | $ | 146 |
Operating Cash Flows - Operating cash flows are affected by earnings from our business activities and changes in our operating assets and liabilities. Changes in commodity prices and demand for our services or products, whether because of general economic conditions, changes in supply, changes in demand for the end products that are made with our products or increased competition from other service providers, could affect our earnings and operating cash flows. Our operating cash flows can also be impacted by changes in our inventory balances, which are driven primarily by commodity prices, supply, demand and the operation of our assets.
2023 vs. 2022 - Cash flows from operating activities, before changes in operating assets and liabilities increased $1.1 billion for the year ended December 31, 2023, compared with the same period in 2022, due primarily to higher operating income resulting from higher volumes from increased production and higher average fee rates in our Natural Gas Gathering and Processing segment, higher exchange services in our Natural Gas Liquids segment, higher transportation and storage services in our Natural Gas Pipelines segment and an increase due to the impact of the Magellan Acquisition in our Refined Products and Crude segment; and insurance proceeds received from the Medford settlement. Please see “Financial Results and Operating Information” for a discussion of operating results.
The changes in operating assets and liabilities increased operating cash flows $358 million for the year ended December 31, 2023, compared with a decrease of $58 million for the same period in 2022. This change is due primarily to changes in accounts receivable resulting from the timing of receipt of cash from counterparties and from inventory, both of which vary from period to period, and with changes in commodity prices; offset partially by changes in risk management assets and liabilities.
Investing Cash Flows
2023 vs. 2022 - Cash used in investing activities for the year ended December 31, 2023, increased $5.3 billion, compared with the same period in 2022, due primarily to the $5.0 billion of cash paid for the Magellan Acquisition.
Financing Cash Flows
2023 vs. 2022 - Cash from financing activities for the year ended December 31, 2023, increased $3.8 billion compared with the same period in 2022, due primarily to the issuance of $5.25 billion senior unsecured notes associated with the Magellan Acquisition.
Cash Flow Analysis for the Year Ended December 31, 2022 vs. 2021 - The cash flow analysis for the year ended December 31, 2022, compared with the year ended December 31, 2021, is included in Part II, Item 7, Management’s
Discussion and Analysis of Financial Condition and Results of Operations of our 2022 Annual Report on Form 10-K, which is available via the SEC’s website at www.sec.gov and our website at www.oneok.com.
IMPACT OF NEW ACCOUNTING STANDARDS
Information about the impact of new accounting standards is included in Note A of the Notes to Consolidated Financial Statements in this Annual Report.
CRITICAL ACCOUNTING ESTIMATES
The preparation of our Consolidated Financial Statements and related disclosures in accordance with GAAP requires us to make estimates and assumptions with respect to values or conditions that cannot be known with certainty that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements. These estimates and assumptions also affect the reported amounts of revenue and expenses during the reporting period. Although we believe these estimates and assumptions are reasonable, actual results could differ from our estimates.
The following is a summary of our most critical accounting estimates, which are defined as those estimates most important to the portrayal of our financial condition and results of operations and requiring management’s most difficult, subjective or complex judgment, particularly because of the need to make estimates concerning the impact of inherently uncertain matters. We have discussed the development and selection of our critical accounting estimates with the Audit Committee of our Board of Directors. See Note A of the Notes to Consolidated Financial Statements in this Annual Report for the description of our accounting policies.
Fair Value Estimates in Business Combination Accounting - Business combination accounting requires that assets and liabilities be recorded at their estimated fair value in connection with the initial recognition of the transaction. Estimating the fair value of assets and liabilities in connection with business combination accounting requires management to make estimates, assumptions and judgments, and in some cases management may also utilize third-party specialists to assist and advise on those estimates.
In order to estimate the fair value of assets acquired and liabilities assumed, we utilized widely accepted valuation techniques that included discounted cash flow and cost methods. The discounted cash flow method utilizes assumptions that include, but are not limited to, estimated future cash flows, discount rates applied to estimated future cash flows, estimated rates of return and estimated customer attrition rates. Cost methods estimate the fair value of assets based on the estimated construction cost of the assets, and requires the use of various inputs and assumptions. While we believe we have made reasonable assumptions to estimate the fair value, these assumptions are inherently uncertain. An estimate of the sensitivity to changes in our assumptions is not practicable given the numerous assumptions, and their interdependence, that can materially affect our estimates.
The purchase price allocation recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available.
See Note B of the Notes to Consolidated Financial Statements in this Annual Report for additional discussion of the business combination.
Derivatives and Risk-Management Activities - We utilize derivatives to reduce our market-risk exposure to commodity price and interest-rate fluctuations and to achieve more predictable cash flows. The accounting for changes in the fair value of a derivative instrument depends on whether it qualifies and has been designated as part of a hedging relationship. When possible, we implement effective hedging strategies using derivative financial instruments that qualify as hedges for accounting purposes. We have not used derivative instruments for trading purposes. For a derivative designated as a cash flow hedge, the gain or loss from a change in fair value of the derivative instrument is deferred in accumulated other comprehensive loss until the forecasted transaction affects earnings, at which time the fair value of the derivative instrument is reclassified into earnings.
We assess hedging relationships at the inception of the hedge, and periodically thereafter, to determine whether the hedging relationship is, and is expected to remain, highly effective. We do not believe that changes in our fair value estimates of our derivative instruments have a material impact on our results of operations, as the majority of our derivatives are accounted for as effective cash flow hedges. However, if a derivative instrument is ineligible for cash flow hedge accounting or if we fail to appropriately designate it as a cash flow hedge, changes in fair value of the derivative instrument would be recorded currently
in earnings. Additionally, if a cash flow hedge ceases to qualify for hedge accounting treatment because it is no longer probable that the forecasted transaction will occur, the change in fair value of the derivative instrument would be recognized in earnings. For more information on commodity price sensitivity and a discussion of the market risk of pricing changes, see Item 7A, Quantitative and Qualitative Disclosures about Market Risk.
See Notes A, D and E of the Notes to Consolidated Financial Statements in this Annual Report for additional discussion of fair value measurements and derivatives and risk-management activities.
Impairment of Goodwill, Long-Lived Assets, Including Intangible Assets and Equity Method Investments - We assess our goodwill for impairment at least annually as of July 1, unless events or changes in circumstances indicate an impairment may have occurred before that time. As part of our goodwill impairment test, we may first assess qualitative factors (including macroeconomic conditions, industry and market considerations, cost factors and overall financial performance) to determine whether it is more likely than not that the fair value of each of our reporting units with goodwill was less than its carrying amount. If further testing is necessary or a quantitative test is elected, we perform a Step 1 analysis for goodwill impairment.
In a Step 1 analysis, an assessment is made by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying value of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
We assess our long-lived assets, including intangible assets, for impairment whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable. An impairment is indicated if the carrying amount of a long-lived asset exceeds the sum of the undiscounted future cash flows expected to result from the use and eventual disposition of the asset. If an impairment is indicated, we record an impairment loss equal to the difference between the carrying value and the fair value of the long-lived asset.
We evaluate equity method investments in unconsolidated affiliates for impairment whenever events or circumstances indicate that there is an other-than-temporary loss in value of the investment. When evidence of loss in value has occurred, we compare our estimate of fair value of the investment to the carrying value of the investment to determine whether an impairment has occurred. If the estimated fair value is less than the carrying value and we consider the decline in value to be other-than-temporary, the excess of the carrying value over the fair value is recognized in our consolidated financial statements as an impairment charge.
Our impairment tests require the use of assumptions and estimates, such as industry economic factors and the profitability of future business strategies. To estimate undiscounted future cash flows of long-lived assets we may apply a probability-weighted approach that incorporates different assumptions and potential outcomes related to the underlying long-lived assets. The evaluation is performed at the lowest level for which separately identifiable cash flows exist. To estimate the fair value of these assets, we use two generally accepted valuation approaches, an income approach and a market approach. Under the income approach, our discounted cash flow analysis includes the following inputs that are not readily available: a discount rate reflective of industry cost of capital, our estimated contract rates, volumes, operating margins, operating and maintenance costs and capital expenditures. Under the market approach, our inputs include EBITDA multiples, which are estimated from recent peer acquisition transactions, and forecasted EBITDA, which incorporates inputs similar to those used under the income approach. If actual results are not consistent with our assumptions and estimates or our assumptions and estimates change due to new information, we may be exposed to future impairment charges.
See Notes A, F, G and N of the Notes to Consolidated Financial Statements in this Annual Report for additional discussion of goodwill and intangible assets, long-lived assets and investments in unconsolidated affiliates.
Depreciation Methods and Estimated Useful Lives of Property, Plant and Equipment - Our property, plant and equipment are depreciated using the straight-line method that incorporates management assumptions regarding useful economic lives and residual values. As we place additional assets in service or acquire assets as a result of an acquisition or asset purchase, our estimates related to depreciation expense have become more significant and changes in estimated useful lives of our assets could have a material effect on our results of operations. At the time we place our assets in service, we believe such assumptions are reasonable; however, circumstances may develop that would cause us to change these assumptions, which would change our depreciation expense prospectively. Examples of such circumstances include changes in (i) competition, (ii) laws and regulations that limit the estimated economic life of an asset, (iii) technology that render an asset obsolete, (iv) expected salvage values, (v) results of rate cases or rate settlements on regulated assets and (vi) forecasts of the remaining economic life for the resource basins where our assets are located, if any. For the fiscal years presented in this Form 10-K, no changes were made to the determinations of useful lives that would have a material effect on the timing of depreciation expense in future periods.
See Note F of the Notes to Consolidated Financial Statements in this Annual Report for additional discussion of property, plant and equipment.
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