<PAGE>
FILED PURSUANT TO RULE NO. 424(a)
REGISTRATION NO. 333-36945
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 7, 1997
PROSPECTUS
2,200,000 CLASS A COMMON UNITS
LAKEHEAD PIPE LINE PARTNERS, L.P.
REPRESENTING CLASS A LIMITED PARTNER INTERESTS
--------
All 2,200,000 Class A Common Units ("Class A Common Units") representing
Class A limited partner interests in Lakehead Pipe Line Partners, L.P., a
Delaware limited partnership (the "Partnership"), offered hereby are being sold
by the Partnership.
The Partnership distributes to its partners, after the end of each calendar
quarter, all of its Available Cash. The Partnership's most recent quarterly
distribution was $0.78 per limited partner unit, or $3.12 on an annualized
basis.
The Class A Common Units are traded on the New York Stock Exchange under the
symbol "LHP." The last reported sale price of the Class A Common Units on the
New York Stock Exchange on October 6, 1997 was $47 7/16 per Class A Common
Unit.
PURCHASERS OF THE CLASS A COMMON UNITS SHOULD CONSIDER THE FACTORS DESCRIBED
UNDER "RISK FACTORS" BEGINNING ON PAGE 12 OF THIS PROSPECTUS IN EVALUATING AN
INVESTMENT IN THE CLASS A COMMON UNITS. SUCH FACTORS INCLUDE THE FOLLOWING:
. THE PARTNERSHIP'S PIPELINE SYSTEM IS DEPENDENT UPON ADEQUATE SUPPLIES OF
AND DEMAND FOR WESTERN CANADIAN CRUDE OIL.
. TARIFFS CHARGED BY THE PARTNERSHIP ARE SUBJECT TO REGULATION BY THE
FEDERAL ENERGY REGULATORY COMMISSION. THE PARTNERSHIP CONTEMPLATES FILING
A RATE INCREASE IN LATE 1998 OR EARLY 1999 TO REFLECT THE PROJECTED
INCREMENTAL COSTS AND THROUGHPUT RESULTING FROM THE PARTNERSHIP'S CURRENT
SYSTEM EXPANSION PROGRAM. AN UNFAVORABLE OUTCOME OF ANY FUTURE RATE
PROCEEDING COULD HAVE A MATERIAL ADVERSE EFFECT ON THE PARTNERSHIP AND ITS
ABILITY TO MAKE DISTRIBUTIONS TO ITS PARTNERS.
. IN MAY 1997, THE ILLINOIS COMMERCE COMMISSION DENIED THE PARTNERSHIP'S
APPLICATION FOR A CERTIFICATE THAT IS A NECESSARY STEP TOWARD RECEIVING
CONDEMNATION AUTHORITY IN ILLINOIS WITH RESPECT TO THE PARTNERSHIP'S
CURRENT SYSTEM EXPANSION PROGRAM. WITHOUT SUCH CONDEMNATION AUTHORITY, THE
COST TO OBTAIN RIGHTS OF WAY IN CONNECTION WITH SUCH PROGRAM COULD
INCREASE.
. THE PARTNERSHIP AGREEMENT LIMITS THE LIABILITY AND MODIFIES THE FIDUCIARY
DUTIES OF THE GENERAL PARTNER; HOLDERS OF CLASS A COMMON UNITS ARE DEEMED
TO HAVE CONSENTED TO CERTAIN ACTIONS AND CONFLICTS OF INTEREST THAT MIGHT
OTHERWISE BE DEEMED A BREACH OF FIDUCIARY OR OTHER DUTIES UNDER STATE LAW.
POTENTIAL CONFLICTS OF INTEREST COULD ARISE AS A RESULT OF THE GENERAL
PARTNER'S RELATIONSHIP WITH ITS AFFILIATES, ON THE ONE HAND, AND THE
PARTNERSHIP OR ANY PARTNER THEREOF, ON THE OTHER.
--------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS (1) PARTNERSHIP (2)
- -----------------------------------------------------------------
<S> <C> <C> <C>
Per Class A Common Unit $ $ $
- -----------------------------------------------------------------
Total (3) $ $ $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) For information regarding indemnification of the Underwriters, see
"Underwriting."
(2) Before deducting expenses estimated at $ payable by the Partnership.
(3) The Partnership has granted to the Underwriters a 30-day option to
purchase up to 330,000 additional Class A Common Units solely to cover
over-allotments, if any. See "Underwriting." If such option is exercised
in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Partnership will be $ , $ and $ ,
respectively.
--------
The Class A Common Units are being offered by the several Underwriters named
herein, subject to prior sale, when, as and if accepted by them and subject to
certain conditions. It is expected that certificates for the Class A Common
Units offered hereby will be available for delivery on or about , 1997 at
the offices of Smith Barney Inc., 333 West 34th Street, New York, New York
10001.
--------
SMITH BARNEY INC.
GOLDMAN, SACHS & CO.
MERRILL LYNCH & CO.
, 1997
<PAGE>
[MAP OF THE IPL/LAKEHEAD SYSTEM APPEARS HERE]
---------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON
UNITS. SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE
OFFERING, MAY BID FOR, AND PURCHASE CLASS A COMMON UNITS IN THE OPEN MARKET AND
MAY IMPOSE PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION..................................................... 4
INCORPORATION OF CERTAIN INFORMATION...................................... 4
PROSPECTUS SUMMARY........................................................ 5
FORWARD-LOOKING STATEMENTS................................................ 12
RISK FACTORS.............................................................. 12
Considerations Relating to the Partnership's Business................... 12
Considerations Relating to Partnership Structure and Relationship to
General Partner........................................................ 14
Considerations Relating to the Partnership's Indebtedness and Ability to
Distribute Cash........................................................ 16
Tax Considerations...................................................... 17
PARTNERSHIP STRUCTURE..................................................... 19
USE OF PROCEEDS........................................................... 20
CAPITALIZATION............................................................ 20
PRICE RANGE OF CLASS A COMMON UNITS AND DISTRIBUTIONS..................... 21
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA.......................... 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................................................... 23
General................................................................. 23
Results of Operations................................................... 24
Liquidity and Capital Resources......................................... 26
BUSINESS.................................................................. 28
General ................................................................ 28
Business Strategy ...................................................... 28
Description of the Lakehead System...................................... 30
SEP II Expansion Program................................................ 32
Deliveries from the Lakehead System..................................... 33
Sources of Shipments.................................................... 34
Supply of and Demand for Western Canadian Crude Oil..................... 34
Customers............................................................... 34
Competition............................................................. 35
Regulation.............................................................. 36
Tariffs................................................................. 37
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MANAGEMENT................................................................. 40
Directors and Executive Officers of the General Partner.................. 40
CASH DISTRIBUTIONS......................................................... 42
General.................................................................. 42
Quarterly Distributions of Available Cash................................ 43
Adjustment of the Target Distributions................................... 44
Distribution of Cash Upon Liquidation.................................... 44
CONFLICTS OF INTEREST AND FIDUCIARY RESPONSIBILITIES....................... 46
Restrictions on General Partner Activity................................. 47
Fiduciary Responsibilities of the General Partner........................ 48
TAX CONSIDERATIONS......................................................... 50
Legal Opinions and Advice................................................ 50
Partnership Status....................................................... 50
Limited Partner Status................................................... 51
Tax Consequences of Unit Ownership....................................... 52
Allocation of Partnership Income, Gain, Loss and Deduction............... 54
Tax Treatment of Operations.............................................. 55
Disposition of Class A Common Units...................................... 58
Entity-Level Collections................................................. 60
Uniformity of Class A Common Units....................................... 60
Tax-Exempt Organizations and Certain Other Investors..................... 61
Administrative Matters................................................... 62
Other Tax Considerations................................................. 64
INVESTMENT IN THE PARTNERSHIP BY EMPLOYEE BENEFIT PLANS.................... 65
UNDERWRITING............................................................... 66
VALIDITY OF CLASS A COMMON UNITS........................................... 67
EXPERTS.................................................................... 67
INDEPENDENT ACCOUNTANTS.................................................... 67
GLOSSARY OF DEFINED TERMS.................................................. A-1
</TABLE>
3
<PAGE>
AVAILABLE INFORMATION
The Partnership has filed with the Securities and Exchange Commission (the
"SEC") in Washington, D.C., a Registration Statement on Form S-3 (the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"), with respect to the securities offered by this Prospectus.
Certain of the information contained in the Registration Statement is omitted
from this Prospectus, and reference is hereby made to the Registration
Statement and exhibits relating thereto for further information with respect
to the Partnership and the securities offered by this Prospectus. The
Partnership is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports and other information with the SEC. Such reports and
other information are available for inspection at the public reference
facilities, and copies of such materials may be obtained upon payment of the
fees prescribed therefor by the rules and regulations of the SEC from the
Public Reference Section of the SEC at its principal offices located at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549,
and at the regional offices of the SEC located at Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661, and at 7 World Trade
Center, 13th Floor, New York, New York 10048. The SEC maintains a web site
(http://www.sec.gov) that contains reports, proxy and information statements
and other information regarding registrants, such as the Partnership, that
file electronically with the SEC. In addition, the Class A Common Units are
traded on the New York Stock Exchange, and such reports and other information
may be inspected at the office of the New York Stock Exchange, Inc., 20 Broad
Street, New York, New York 10005.
INCORPORATION OF CERTAIN INFORMATION
The following documents, or portions of documents, previously filed by the
Partnership with the SEC are incorporated by reference in this Prospectus:
(i) the Partnership's Annual Report on Form 10-K (File No. 1-10934) for the
fiscal year ended December 31, 1996;
(ii) the Partnership's Quarterly Reports on Form 10-Q for the quarters
ended March 31, 1997 and June 30, 1997;
(iii) the description of the Class A Common Units contained in the
Partnership's Registration Statement on Form 8-A, dated November 14,
1991, as amended by Amendment No. 1 on Form 8-A/A, dated December 9,
1991, and Amendment No. 2 on Form 8-A/A, dated May 2, 1997; and
(iv) the Partnership's Current Report on Form 8-K, dated September 25,
1997.
All documents filed by the Partnership pursuant to Section 13(a), 13(c), 14
or 15(d) of the Exchange Act, after the date of this Prospectus and prior to
the termination of the offering of the securities offered by this Prospectus,
shall be deemed to be incorporated by reference in this Prospectus and to be a
part hereof from the date of filing of such documents. Any statement contained
herein or in a document incorporated or deemed to be incorporated by reference
in this Prospectus shall be deemed to be modified or superseded for purposes
of this Prospectus to the extent that a statement contained in this
Prospectus, or in any other subsequently filed document that also is or is
deemed to be incorporated by reference herein modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Partnership undertakes to provide without charge to each person to whom
a copy of this Prospectus has been delivered, upon written or oral request of
any such person, a copy of any or all of the documents incorporated by
reference herein, other than exhibits to such documents, unless such exhibits
are specifically incorporated by reference into the information that this
Prospectus incorporates. Written or oral requests for such copies should be
directed to: Lakehead Pipe Line Partners, L.P., Lake Superior Place, 21 West
Superior Street, Duluth, Minnesota 55802, Attention: R. R. Karlen, Investor
Relations, telephone (800) 525-3999 or (218) 725-0100, Internet access:
http://www.lakehead.com.
4
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial and operating data appearing elsewhere in this
Prospectus and information incorporated herein by reference. For an explanation
of certain terms used in this Prospectus, please refer to the Glossary of
Defined Terms in this Prospectus. Unless otherwise indicated, all information
in this Prospectus assumes that the over-allotment option granted to the
Underwriters is not exercised. See "Underwriting." Unless the context otherwise
requires, references herein to the Partnership include the Partnership and its
subsidiary operating partnership, Lakehead Pipe Line Company, Limited
Partnership, a Delaware limited partnership (the "Operating Partnership").
References herein to "Units" include the Partnership's Class A Common Units and
its Class B Common Units ("Class B Common Units") representing Class B limited
partner interests in the Partnership.
THE PARTNERSHIP
GENERAL
Lakehead Pipe Line Partners, L.P. is a publicly held Delaware limited
partnership engaged in the regulated crude oil and natural gas liquids pipeline
business. The Partnership owns and operates the United States portion of the
world's longest liquids pipeline (the "System"), which traverses approximately
3,200 miles from western Canada through the upper and lower Great Lakes region
of the United States to eastern Canada. The United States portion of the System
(the "Lakehead System") traverses approximately 1,750 miles and serves all of
the major refining centers in the Great Lakes region of the United States, as
well as in Ontario, Canada. The Canadian portion of the System (the "IPL
System") is owned and operated by Interprovincial Pipe Line Inc. ("IPL"), a
direct wholly owned subsidiary of IPL Energy Inc. ("IPL Energy") and the parent
company of Lakehead Pipe Line Company, Inc. ("Lakehead" or the "General
Partner"). IPL Energy is a publicly traded company that is a North American
leader in energy services and delivery.
The Partnership transports crude oil and, to a lesser extent, natural gas
liquids ("NGLs") owned by others as a common carrier for a fee, which is based
on a schedule of tariffs filed by the Partnership with the FERC. Substantially
all of the crude oil and NGLs transported by the Lakehead System are received
initially into the System in western Canada and then transported to markets in
the United States and eastern Canada. Lakehead estimates that in 1996 the
System transported approximately 70% of all crude oil produced in western
Canada, of which approximately 90% was transported by the Lakehead System.
Deliveries of crude oil and NGLs on the Lakehead System averaged approximately
1.45 million barrels per day for 1996, up from approximately 1.25 million
barrels per day for 1992.
The Partnership believes that the System has certain advantages over other
transporters of crude oil with which it competes. The System is among the
lowest cost transporters of crude oil and NGLs in North America based on costs
per barrel mile transported. The Partnership's low cost structure is derived
primarily from the extensive length and configuration of the System. The length
of the System and its large diameter pipe provide economies of scale, while the
configuration of the System, which includes at various segments a number of
parallel lines rather than a single line, allows the System to transport
multiple grades of crude oil more efficiently. In addition, because of its
strategic location, the System supplies western Canadian crude oil to the
Midwest U.S., an area that is experiencing rising crude oil demand and
declining crude oil production. Deliveries to the Midwest U.S. have
historically provided producers of western Canadian crude oil with a premium
netback (i.e., sales price net of transportation costs) relative to other
available U.S. markets.
BUSINESS STRATEGY
A principal objective of the Partnership is to increase cash generated from
its operations and to distribute all of its Available Cash to its partners. The
Lakehead System, together with the IPL System, serves as a strategic
5
<PAGE>
link between the western Canadian oil fields and the markets of the Midwest
U.S. and eastern Canada and currently operates at or near capacity. In response
to the continuing trend of increasing supply of crude oil from western Canada
and the growth of demand in the markets of the Midwest U.S., the Partnership
plans not only to maintain the service capability of the Lakehead System but
also to expand its capacity where appropriate. To the extent allowed under
orders of the Federal Energy Regulatory Commission (the "FERC"), or by
agreement with customers, the Partnership anticipates filing for additional
tariff rate increases from time to time to reflect these ongoing expansions.
See "Business--Regulation" and "--Tariffs." This strategy has enabled the
Partnership to increase quarterly cash distributions to Unitholders from $0.59
per Unit in 1992 to $0.78 per Unit currently, an increase of approximately 32%.
Lakehead System Expansion Projects
In implementing its business strategy, the Partnership pursues opportunities
to maximize utilization of and to expand the Lakehead System. Certain key
completed, current and future expansion projects of the Partnership are
summarized below:
. 1994 Capacity Expansion Program -- This $130 million expansion program
increased the delivery capability of the Lakehead System to Superior,
Wisconsin by approximately 170,000 barrels per day and to Chicago,
Illinois area markets by approximately 145,000 barrels per day.
. System Expansion Program I ("SEP I") -- This 1996 expansion program
provided an additional 120,000 barrels per day of capacity on the
Lakehead System from Superior to Chicago area markets at a cost of $65
million.
. System Expansion Program II ("SEP II") -- This proposed expansion, which
began in 1996, is expected to provide an additional 170,000 barrels per
day of delivery capacity on the Lakehead System from Superior to Chicago.
Current constraints on the capacity of the System in western Canada,
however, will limit incremental volumes reaching the Lakehead System to
approximately 120,000 barrels per day. This project, which is expected to
cost approximately $370 million, was undertaken in response to
apportionment of the existing capacity on the System among suppliers of
western Canadian crude oil and NGLs. SEP II is being undertaken in
conjunction with a Cdn. $140 million capacity expansion of the IPL System
by IPL. SEP II is expected to be completed by late 1998. See "Business--
SEP II Expansion Program."
. Terrace Project -- In early 1997, the Partnership, in conjunction with
IPL, announced a preliminary outline of a four-stage expansion program to
increase western Canadian crude oil pipeline capacity. Subject to
continued industry support and receipt of regulatory approval, the
Partnership and IPL anticipate that this proposed project would be
completed in stages over the period 1998 through 2005.
IPL Energy Projects
IPL Energy is also engaged in North American crude oil pipeline projects that
are related to the System. The General Partner believes that certain of these
projects, even though they are not owned by the Partnership, will benefit the
Partnership since they may result in increased deliveries on the Lakehead
System. Such projects include: (i) the Mustang pipeline that connects the
Lakehead System to the Patoka/Wood River refinery area and pipeline hub south
of Chicago; (ii) a proposed new pipeline that would connect the Partnership's
facilities to a refinery in the Toledo, Ohio area; and (iii) a proposed new
pipeline for the delivery of heavy crude oil from the Athabasca oil sands
region near Fort McMurray, Alberta to Hardisty, Alberta. See "Business--
Business Strategy--IPL Energy Projects."
1996 SETTLEMENT AGREEMENT
In October 1996, the FERC approved a Settlement Agreement (the "Settlement
Agreement") between the Partnership and representatives of certain of the
Partnership's customers on all then outstanding contested tariff rates. The
Settlement Agreement also sets forth parameters governing the tariff increase
associated with SEP II, although such tariff increase has not been approved by
the FERC. See "Business--Tariffs--Rate Cases."
6
<PAGE>
THE OFFERING
Securities offered.............. 2,200,000 Class A Common Units. (2,530,000
Class A Common Units if the Underwriters'
over-allotment option is exercised in full.)
Units to be outstanding after
the offering................... 22,290,000 Class A Common Units and 3,912,750
Class B Common Units representing an
effective 83.4% and 14.6% limited partner
interest in the Partnership, respectively. If
the Underwriters' over-allotment option is
exercised in full, a total of 22,620,000
Class A Common Units and 3,912,750 Class B
Common Units will be outstanding,
representing an effective 83.5% and 14.5%
limited partner interest in the Partnership,
respectively.
Use of proceeds................. The net proceeds from the sale of the Class A
Common Units offered hereby are estimated to
be approximately $ million ($ million if
the Underwriters' over-allotment option is
exercised in full). The net proceeds will be
used by the Partnership to fund a portion of
the $370 million estimated cost of SEP II.
New York Stock Exchange
symbol......................... LHP
7
<PAGE>
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth, for the periods and at the dates indicated,
summary historical financial and operating data for the Partnership. The
summary historical financial data are derived from and should be read in
conjunction with the Partnership's historical consolidated financial statements
and notes thereto incorporated in this Prospectus by reference. See also
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
------------------------ ---------------
1994 1995(1) 1996(1) 1996(1) 1997
------ ------- ------- ------- ------
(UNAUDITED)
(DOLLARS IN MILLIONS, EXCEPT PER UNIT
AMOUNTS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Operating revenue.................... $246.0 $268.5 $274.5 $133.9 $135.6
------ ------ ------ ------ ------
Power, operating and administrative
expenses.......................... 128.3 134.3 128.7 61.1 63.5
Provision for prior years' rate re-
funds............................. -- 22.9 20.1 20.1 --
Depreciation....................... 31.4 38.0 38.3 19.9 19.5
------ ------ ------ ------ ------
Total operating expenses............. 159.7 195.2 187.1 101.1 83.0
------ ------ ------ ------ ------
Operating income..................... 86.3 73.3 87.4 32.8 52.6
Interest income...................... 4.1 7.1 9.6 4.6 5.1
Interest expense..................... (29.8) (40.3) (43.9) (24.3) (20.3)
Minority interest.................... (0.7) (0.5) (0.7) (0.2) (0.5)
------ ------ ------ ------ ------
Net income........................... $ 59.9 $ 39.6 $ 52.4 $ 12.9 $ 36.9
====== ====== ====== ====== ======
Net income per Unit(2)............... $ 2.61 $ 1.60 $ 2.11 $ 0.51 $ 1.46
====== ====== ====== ====== ======
Cash distributions paid per Unit(3).. $ 2.51 $ 2.56 $ 2.60 $ 1.28 $ 1.36
====== ====== ====== ====== ======
FINANCIAL POSITION DATA (AT PERIOD
END):
Property, plant and equipment, net... $727.6 $725.1 $763.5 $741.8 $776.9
Total assets......................... $868.6 $915.2 $975.9 $966.9 $958.5
Long-term debt....................... $364.0 $395.0 $463.0 $426.0 $463.0
Partners' capital.................... $434.4 $411.1 $399.6 $392.6 $402.9
CASH FLOW DATA:
Cash provided from operating activi-
ties................................ $108.1 $121.5 $ 93.9 $ 67.9 $ 41.3
Capital expenditures................. $136.9 $ 35.5 $ 76.7 $ 36.6 $ 32.9
OPERATING DATA:
Barrel miles (billions).............. 366 385 384 188 188
Deliveries (thousands of barrels per
day)
United States...................... 795 876 901 889 935
Eastern Canada..................... 531 533 550 535 544
------ ------ ------ ------ ------
Total............................ 1,326 1,409 1,451 1,424 1,479
====== ====== ====== ====== ======
</TABLE>
- --------
(1) Results for 1995 reflect the impact of the June 1995 FERC decision (Opinion
No. 397). Results for 1996 reflect the impact of the Settlement Agreement.
See "Business--Tariffs."
(2) The General Partner's allocation of net income has been deducted before
calculating net income per Unit.
(3) The Partnership distributes 100% of its Available Cash as of the end of
each calendar quarter on or about 45 days after the end of such quarter.
See "Price Range of Class A Common Units and Distributions" for quarterly
distribution per Unit data.
8
<PAGE>
RECALCULATED OPERATING RESULTS
In October 1996, the FERC approved the Settlement Agreement between the
Partnership and representatives of certain of the Partnership's customers on
all then outstanding contested tariff rates. The Settlement Agreement provided
for a tariff rate reduction of approximately 6% and total rate refunds and
interest of $120.0 million through the effective date of October 1, 1996, with
interest accruing thereafter on the unpaid balance. Even though the Partnership
had been recording a provision for a potential rate refund since 1992,
additional provisions related to rate refunds were required in 1995, with
respect to FERC Opinion No. 397, and in 1996, with respect to the Settlement
Agreement. Accordingly, to eliminate the retroactive impact of the additional
provisions and to facilitate comparison of period-to-period results, set forth
below are the operating results of the Partnership for the indicated periods
recalculated to reflect the retroactive impacts of the tariff rate reduction
provided for in the Settlement Agreement in each such period. There is no
retroactive impact from the Settlement Agreement on operating results for
periods after December 31, 1996.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------- ------------------
1994 1995 1996 1996 1997
------- ------- ------- -------- --------
(DOLLARS IN MILLIONS, EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C> <C> <C>
Operating reve-
nue(1)......... $ 237.0 $ 268.5 $ 274.5 $ 133.9 $ 135.6
Total operating
expenses(2).... 159.7 172.3 167.0 81.0 83.0
------- ------- ------- -------- --------
Operating in-
come........... 77.3 96.2 107.5 52.9 52.6
Interest in-
come........... 4.1 7.1 9.6 4.6 5.1
Interest ex-
pense(3)....... (30.9) (38.8) (40.7) (21.1) (20.3)
Minority inter-
est............ (0.6) (0.7) (0.9) (0.5) (0.5)
------- ------- ------- -------- --------
Net income...... $ 49.9 $ 63.8 $ 75.5 $ 35.9 $ 36.9
======= ======= ======= ======== ========
Net income per
Unit(4)........ $ 2.17 $ 2.60 $ 3.06 $ 1.46 $ 1.46
======= ======= ======= ======== ========
</TABLE>
- --------
(1) Recalculated operating revenue is reduced to reflect an additional rate
refund of $9.0 million for the year ended December 31, 1994.
(2) Recalculated total operating expenses exclude the retroactive provision of
$22.9 million for the year ended December 31, 1995 and the non-recurring
charge of $20.1 million for the year ended December 31, 1996 and the six
months ended June 30, 1996.
(3) Recalculated interest expense includes additional interest expense of $1.1
million for the year ended December 31, 1994. Recalculated interest expense
excludes the interest expense portion of the retroactive provision of $1.5
million for the year ended December 31, 1995 and the non-recurring charge
of $3.2 million for the year ended December 31, 1996 and the six months
ended June 30, 1996.
(4) The General Partner's allocation of net income has been deducted before
calculating net income per Unit.
9
<PAGE>
RISK FACTORS
Prospective purchasers of Class A Common Units should consider the following
factors in evaluating an investment in the Class A Common Units:
. The Lakehead System is dependent upon adequate supplies of and demand for
western Canadian crude oil.
. The Lakehead System's tariffs are subject to regulation by the FERC.
There is uncertainty surrounding the applicable regulatory standards for
establishing tariff rates for liquids pipelines. The Partnership
contemplates filing a rate increase in late 1998 or early 1999 to reflect
the projected incremental costs and throughput resulting from SEP II. In
the event the Partnership's rates are formally challenged, any resulting
FERC order requiring a reduction of tariff rates could require a refund
of a portion of revenue amounts previously collected and could have a
material adverse effect on the Partnership and its ability to make
distributions to its partners.
. In May 1997, the Illinois Commerce Commission (the "ICC") denied the
Partnership's application for a certificate that is a necessary step
toward receiving condemnation authority in Illinois with respect to SEP
II. Without such condemnation authority, the cost to obtain rights of way
in connection with SEP II could increase.
. The Partnership Agreement limits the liability and modifies the fiduciary
duties of the General Partner. Holders of Class A Common Units are deemed
to have consented to certain actions and conflicts of interest that might
otherwise be deemed a breach of fiduciary or other duties under state
law. Potential conflicts of interest could arise as a result of the
General Partner's relationship with its affiliates, on the one hand, and
the Partnership or any partner thereof, on the other.
See "Risk Factors" for a more detailed discussion of these and other factors
that should be considered by prospective purchasers of Class A Common Units.
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TAX CONSIDERATIONS
THE TAX CONSEQUENCES OF AN INVESTMENT IN CLASS A COMMON UNITS TO A PARTICULAR
INVESTOR WILL DEPEND IN PART ON THE INVESTOR'S OWN TAX CIRCUMSTANCES. EACH
PROSPECTIVE INVESTOR SHOULD THEREFORE CONSULT HIS OR HER OWN TAX ADVISOR ABOUT
THE FEDERAL, STATE AND LOCAL TAX CONSEQUENCES TO SUCH INVESTOR OF AN INVESTMENT
IN CLASS A COMMON UNITS.
For a discussion of the principal federal income tax considerations
associated with the operations of the Partnership and the purchase, ownership
and disposition of Class A Common Units, see "Tax Considerations."
RATIO OF TAXABLE INCOME TO DISTRIBUTIONS
The General Partner estimates that a purchaser of a Class A Common Unit in
the offering made hereby who holds such Class A Common Unit through the record
date for the distribution with respect to the final calendar quarter of 1997
(assuming for this purpose quarterly distributions on the Units with respect to
that period are equal to the most recent quarterly distribution rate of $0.78
per Unit) will be allocated an amount of federal taxable income for 1997 equal
to approximately 10% of the amount of cash distributed to such Unitholder with
respect to 1997. The General Partner further estimates that such a Class A
Common Unitholder who holds a Class A Common Unit through the record date for
the distribution with respect to the final calendar quarter of 2000 will be
allocated an amount of federal taxable income for 1998 and 1999 ranging from
10% to 25% and, for 2000, 50% to 70%, of the amount of cash distributed to such
Unitholder with respect to each such period (assuming for this purpose
quarterly distributions on the Units with respect to each such period are equal
to $0.78 per Unit).
The foregoing estimates are based upon numerous assumptions regarding the
business and operations of the Partnership (including assumptions as to
tariffs, capital expenditures, cash flows and anticipated cash distributions).
Such estimates and assumptions are subject to, among other things, numerous
business, economic, regulatory and competitive uncertainties that are beyond
the control of the General Partner or the Partnership and to certain tax
reporting positions (including estimates of the relative fair market values of
the assets of the Partnership and the validity of certain curative allocations)
that the General Partner has adopted or intends to adopt and with which the
Internal Revenue Service ("IRS") could disagree. Accordingly, no assurance can
be given that the estimates will prove to be correct. The actual percentages
could be higher or lower than as described above, and such differences could be
material. See "Tax Considerations--Tax Consequences of Unit Ownership--Ratio of
Taxable Income to Distributions."
OWNERSHIP OF CLASS A COMMON UNITS BY TAX-EXEMPT ENTITIES, REGULATED INVESTMENT
COMPANIES AND FOREIGN INVESTORS
Ownership of Class A Common Units by tax-exempt entities, regulated
investment companies and foreign investors raises issues unique to such
persons. See "Tax Considerations--Tax-Exempt Organizations and Certain Other
Investors."
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FORWARD-LOOKING STATEMENTS
This Prospectus contains, or incorporates by reference, forward-looking
statements and information that are based on the beliefs of the Partnership
and the General Partner, as well as assumptions made by, and information
currently available to, the Partnership and the General Partner. All
statements, other than statements of historical fact, included in this
Prospectus are forward-looking statements, including, but not limited to,
statements identified by the words "anticipate," "believe," "estimate,"
"expect," "forecast" and "project" and similar expressions and statements
regarding the Partnership's business strategy, plans and objectives for future
operations. Such statements reflect the current views of the Partnership and
the General Partner with respect to future events, based on what they believe
are reasonable assumptions; however, such statements are subject to certain
risks, uncertainties and assumptions, including, but not limited to, the risk
factors described in this Prospectus. If one or more of these risks or
uncertainties materialize, or if underlying assumptions prove incorrect,
actual results may vary materially from those in the forward-looking
statements. The Partnership does not intend to update these forward-looking
statements and information.
RISK FACTORS
Prospective purchasers of Class A Common Units should consider the following
factors in evaluating an investment in the Class A Common Units.
CONSIDERATIONS RELATING TO THE PARTNERSHIP'S BUSINESS
Dependence Upon Western Canadian Crude Oil Supply and the IPL System
The Lakehead System is dependent upon the level of supply of crude oil and
other liquid hydrocarbons from western Canada. Lakehead estimates that in
1996, the System transported approximately 70% of all crude oil produced in
western Canada, of which approximately 90% was transported by the Lakehead
System. If a decline in western Canadian crude oil production does occur, the
Partnership expects that throughput on the Lakehead System will also decline.
For a discussion of projections relating to long-term trends in the supply of
crude oil produced in western Canada, see "Business--Supply of and Demand for
Western Canadian Crude Oil."
The Lakehead System is dependent upon the utilization of the IPL System by
producers of western Canadian crude oil to reach markets in the United States
and eastern Canada. The diversion of western Canadian crude oil away from the
IPL System, whether by virtue of increased demand by western Canadian refiners
or the shipment of crude oil by other pipelines, would likely have a direct
impact on the volumes transported by the Lakehead System. Although the General
Partner believes that under FERC regulations the Partnership will periodically
be allowed to increase tariff rates to compensate for declines in throughput
which result in a substantial divergence between the Partnership's costs and
tariff rates, there can be no assurance that this will be the case. Even if
such tariff increases were allowed, the Partnership may suffer lower revenues
during the period before a tariff adjustment can be implemented. In addition,
reduced throughput on the IPL System as a result of testing, line repair,
reduced operating pressures or other causes could result in reduced throughput
on the Lakehead System. If the Partnership were not able to recoup lost
revenue related to such reduced throughput, cash distributions to the
Unitholders could be adversely impacted.
Reduced Demand Could Affect Shipments on the Lakehead System
The Partnership's business depends in part on the level of demand for crude
oil and NGLs (in particular, western Canadian crude oil and NGLs) in the
geographic areas in which deliveries are made by the Lakehead System and the
ability and willingness of shippers having access to the Lakehead System to
satisfy such demand by deliveries through the Lakehead System. Demand for
western Canadian crude oil and NGLs in the geographic areas served by the
Lakehead System is affected by the delivery of other supplies of crude oil and
refined products into such geographic areas. Existing pipeline capacity for
the delivery of crude oil to the Midwest U.S., the primary market served by
the Lakehead System, exceeds current refining capacity. In addition, IPL is
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currently proposing an alternative use for the portion of the IPL System from
Sarnia to Montreal, Quebec, involving a reversal of the line to bring crude
oil from Montreal to Sarnia. The reversal of the line would result in IPL or a
subsidiary of IPL becoming a competitor of the Partnership for supplying crude
oil to the Ontario market and is expected to reduce the deliveries of western
Canadian crude oil into the eastern Canadian markets served by the System. If
and when the reversal of the line is effective, quantities of crude oil
historically delivered by the System to the Ontario market are expected to be
redirected to existing U.S. markets served by the Partnership. The Partnership
cannot predict the impact of future economic conditions, fuel conservation
measures, alternative fuel requirements, governmental regulation or
technological advances in fuel economy and energy generation devices, all of
which could reduce the demand for crude oil and other liquid hydrocarbons in
the areas in which deliveries are made by the Lakehead System.
Uncertainty Arising From Ratemaking Methodologies
As an interstate common carrier, the Partnership's pipeline operations are
subject to regulation by the FERC under the Interstate Commerce Act, which
requires, among other things, that liquids pipeline rates be just and
reasonable and nondiscriminatory. The Interstate Commerce Act permits
challenges to proposed or changed rates and to rates that are already
effective by protest or complaint, respectively, by an interested person or
upon the FERC's own motion. Proposed or changed rates may be suspended by the
FERC for up to seven months and allowed to become effective subject to
investigation and potential refund. Rates that are already effective may be
ordered to be reduced for the future and, upon an appropriate showing,
reparations may be awarded for damages sustained by a complainant as a result
of such rates for up to two years prior to the commencement of an
investigation.
In October 1993, the FERC issued Order No. 561, which established a new
ratemaking methodology for liquids pipelines to be effective January 1, 1995.
This order allows for the annual indexing of rate ceilings based on changes in
the Producer Price Index for Finished Goods minus 1% ("PPIFG-1"). Rate
ceilings may increase or decrease depending upon the change in the Producer
Price Index for Finished Goods. The order also provides that, under certain
circumstances, pipelines or shippers may seek to establish cost-based or
market-based rates rather than indexed rates. To the extent this order limits
the ability of the Partnership to establish cost-based rates, or the indexing
methodology restricts or delays the Partnership's ability to implement rates
that reflect increased costs, the Partnership could be adversely affected.
Furthermore, no assurances can be given that inflationary rate increases
allowed under the FERC's indexing methodology will be sufficient to offset
increases in the Partnership's costs. In addition, if the Producer Price Index
for Finished Goods increases less than 1% or decreases, the FERC's indexing
methodology could result in a corresponding reduction in tariffs. See
"Business--Regulation--FERC Regulation."
Many of the ratemaking related issues contested in prior rate cases of the
Partnership, in particular the FERC's own Opinion 154-B methodology (the cost-
based alternative under Order No. 561), have not been reviewed by a federal
appellate court. Any decision ultimately rendered by the FERC on any Opinion
154-B/C rate case may be subject to judicial review. Judicial review could
result in alternative ratemaking methodologies that could have a material
adverse effect on the Partnership and its ability to make distributions to the
Unitholders. There is also pending at the FERC a proceeding in which the FERC
could alter its current application of the Opinion 154-B/C methodology. On
September 25, 1997, a FERC administrative law judge issued an initial decision
in that case addressing various technical issues involving the application of
the Opinion 154-B/C methodology. That initial decision is subject to review by
the FERC on appeal by any party or on the FERC's own motion. In such a review,
it is possible that the FERC could alter its current application of the
Opinion 154-B/C methodology in a way that could, if applied to the
Partnership, have a material adverse impact on the Partnership and its ability
to make distributions to the Unitholders.
The Partnership contemplates filing a rate increase in late 1998 or early
1999 to reflect the projected incremental costs and throughput resulting from
SEP II. The Settlement Agreement sets forth parameters governing the tariff
increase associated with SEP II, although such tariff increase has not been
approved by the FERC. In addition, certain details of implementation remain
subject to further discussions. Customers who are
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not parties to the Settlement Agreement may challenge any rate filing. See
"Business--Tariffs." Any challenge, if successful, could have a material
adverse effect on the Partnership and its ability to make distributions to the
Unitholders.
Lack of Condemnation Authority in Illinois
In May 1997, the ICC denied the Partnership's application for a certificate
that is a necessary step toward receiving condemnation authority in Illinois
with respect to SEP II. Without such condemnation authority, the cost to
obtain rights of way in connection with SEP II could increase.
Competition
Because pipelines have historically been the lowest cost method for
intermediate and long haul overland movement of crude oil, the System's most
significant existing competitors for the transportation of western Canadian
crude oil (other than indigenous consumption in western Canada) are other
pipelines. The System encounters competition in serving shippers to the extent
that shippers have alternate opportunities for transporting liquid
hydrocarbons from their sources to customers. The General Partner estimates
that the System transported approximately 70% of total western Canadian crude
oil production, of which approximately 90% was transported by the Lakehead
System. The remainder was refined in Alberta or Saskatchewan or transported
through other pipelines to British Columbia, Washington, Montana and other
states in the Northwest U.S. In the United States, the Lakehead System
encounters competition from other crude oil and refined product pipelines and
other modes of transportation delivering crude oil and refined products to the
refining centers of Minneapolis-St. Paul, Chicago, Detroit and Toledo and the
refinery market and pipeline hub located in the Patoka/Wood River area. See
"Business--Competition."
Risk of Environmental and Safety Costs and Liabilities
The operations of the Partnership are subject to federal and state laws and
regulations relating to environmental protection and operational safety.
Although the General Partner believes that the operations of the Lakehead
System are in substantial compliance with applicable environmental and safety
regulations, risks of substantial costs and liabilities are inherent in
pipeline operations, and there can be no assurance that such costs and
liabilities will not be incurred. Moreover, it is possible that other
developments, such as increasingly strict environmental and safety laws,
regulations and enforcement policies thereunder, and claims for damages to
property or persons resulting from the Partnership's operations, could result
in substantial costs and liabilities to the Partnership. If the Partnership
were not able to recover such resulting costs through insurance or increased
tariffs, cash distributions to Unitholders could be adversely affected.
Lakehead has agreed to indemnify the Partnership with respect to certain
liabilities (including liabilities relating to environmental matters)
associated with the assets contributed to the Partnership that relate to
operations prior to the transfer of such assets to the Partnership by Lakehead
in December 1991.
The General Partner has, from time to time, hydrostatically tested certain
portions of the Lakehead System. If additional hydrostatic testing is
determined necessary by the General Partner or were to be required by a
regulatory authority, such testing could result in significant, and perhaps
material, expense arising out of treatment and disposal of the hydrostatic
test water and downtime resulting in lost transportation revenues. While the
General Partner believes suitable alternatives to hydrostatically testing the
pipeline exist, no assurance can be given that future hydrostatic testing will
not be required on the System. Hydrostatic testing of the IPL System in Canada
potentially may decrease deliveries on the Lakehead System due to restrictions
on volumes received from western Canada.
CONSIDERATIONS RELATING TO PARTNERSHIP STRUCTURE AND RELATIONSHIP TO GENERAL
PARTNER
Conflicts of Interest
Certain conflicts of interest may arise as a result of the General Partner's
relationships with IPL and its affiliates, on the one hand, and the
Partnership or any partner thereof, on the other. Such conflicts may include,
among others, the following situations: (i) the General Partner's
determination of the amount and timing of any
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capital expenditures, borrowings and reserves; (ii) the General Partner's
determination of which expenditures constitute capital expenditures that are
necessary to maintain the service capability of the Lakehead System, thereby
reducing Cash from Operations from which quarterly distributions are made;
(iii) the issuance of additional Units or other equity securities or the
purchase of outstanding Units; (iv) payments to IPL or its affiliates for any
services rendered to or on behalf of the Partnership, subject to the
limitations described under "Conflicts of Interest and Fiduciary
Responsibilities;" (v) the General Partner's determination of which direct and
indirect costs are reimbursable by the Partnership; (vi) the enforcement by
the General Partner of obligations owed by the General Partner or its
affiliates to the Partnership; and (vii) the decision to retain separate
counsel, accountants or others to perform services for or on behalf of the
Partnership.
Such conflicts of interest may also arise if and when IPL and its affiliates
conduct business, either currently or in the future, that may be in
competition with the business then conducted by the Partnership. The
Distribution Support Agreement provides that IPL and its affiliates (other
than the General Partner and its subsidiaries) generally will not be
restricted from pursuing their own business interests, which interests may
include investments in and/or ownership and operation of pipelines in the U.S.
See "Business--Business Strategy--IPL Energy Projects." IPL and its
subsidiaries (other than the General Partner and its subsidiaries) are not
restricted by the terms of the Partnership Agreement or the Distribution
Support Agreement from engaging in the businesses in which they were engaged
at the inception of the Partnership in 1991, which are, or may be in the
future, in competition with the Partnership. Substantially all of the
shipments of crude oil and NGLs delivered by the Lakehead System originate in
the IPL System, and all scheduling of shipments (including routes and storage)
is handled by IPL in coordination with the General Partner. In addition, the
reversal of the portion of the IPL System from Sarnia to Montreal would result
in IPL or a subsidiary of IPL becoming a competitor of the Partnership for
supplying crude oil to the Ontario market. See "Business--Competition" and
"Conflicts of Interest and Fiduciary Responsibilities."
The Partnership Agreement provides that the General Partner may resolve any
conflicts of interest that may arise by, among other things, considering the
relative interests of all the parties to the conflict. Thus, unlike the strict
duty of a trustee who must refrain under state law from engaging in
transactions with its affiliates and must act solely in the best interests of
its beneficiary, the Partnership Agreement permits the General Partner to
consider the interests of all parties to any situation involving a conflict of
interest, including IPL and its affiliates. See "Conflicts of Interest and
Fiduciary Responsibilities."
The Partnership and the General Partner do not have any employees and rely
solely on employees of IPL and its affiliates. Although the General Partner
conducts no business other than acting as general partner of the Partnership
and the Operating Partnership, managing certain subsidiaries and engaging in
ancillary activities, IPL and its affiliates conduct business and activities
of their own in which the Partnership has no economic interest. There may be
competition between the Partnership and IPL and its affiliates for the time
and effort of those employees who provide services to the General Partner.
Modification of Fiduciary Duties
The General Partner is generally accountable to the Partnership and to the
Unitholders as a fiduciary. Consequently, the General Partner generally must
exercise good faith and integrity in handling the assets and affairs of the
Partnership. The Delaware Revised Uniform Limited Partnership Act (the
"Delaware Act") provides that Delaware limited partnerships may, in their
partnership agreements, modify the fiduciary duties that might otherwise be
applied by a court in analyzing the duty owed by general partners to limited
partners. The Partnership Agreement, as permitted by the Delaware Act,
contains various provisions that have the effect of restricting the fiduciary
duties that might otherwise be owed by the General Partner to the Partnership
and its partners. In addition, holders of Class A Common Units are deemed to
have consented to certain actions and conflicts of interest that might
otherwise be deemed a breach of fiduciary or other duties under state law.
Such modifications of state law standards of fiduciary duty may significantly
limit a Unitholder's ability to successfully challenge the actions of or
failure to act by the General Partner as being in breach of a fiduciary duty.
See "Conflicts of Interest and Fiduciary Responsibilities."
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Sales of Additional Units
The General Partner may cause the Partnership to issue an unlimited number
of additional Units or other equity securities of the Partnership, including,
without limitation, equity securities with rights as to distributions and
allocations or in liquidation ranking prior or senior to those of the Class A
Common Units. Any issuance of additional Units or other equity securities
would result in a corresponding decrease in the proportionate ownership
interest in the Partnership represented by, and could adversely affect the
market price of, Class A Common Units then outstanding. Additional issuances
of Units could reduce the amount of distributions paid on the Class A Common
Units.
Pursuant to the Partnership Agreement, the General Partner and its
affiliates have the right, upon the terms and subject to the conditions
therein, to cause the Partnership to register under the Securities Act the
offer and sale of any Units held by any such party, including the 3,912,750
Class B Common Units currently held by the General Partner. Subject to the
terms and conditions of the Partnership Agreement, such registration rights
allow the General Partner and its affiliates holding any Units to request
registration of any such Units and to include any such Units in a registration
by the Partnership of other Units. The General Partner has waived such rights
in connection with the offering of Class A Common Units made by this
Prospectus. In addition, the General Partner and its affiliates may sell their
Units in private transactions at any time, in accordance with applicable law.
Limited Voting Rights; Management and Control; Difficulty in Removing General
Partner
Unitholders have only limited voting rights on matters affecting the
Partnership and its business. The General Partner manages and controls the
activities of the Partnership. Unitholders have no right to elect the General
Partner on an annual or other ongoing basis. If the General Partner withdraws
or is removed, however, its successor may be elected by the holders of a
majority of the outstanding Units.
The General Partner may not be removed by the Unitholders unless such
removal is approved by the vote of the holders of not less than 66 2/3% of the
outstanding Units (excluding for this purpose Units held by the General
Partner and its affiliates), and provided that certain other conditions are
satisfied.
The General Partner may not withdraw voluntarily as general partner of the
Partnership prior to January 1, 2000 (with limited exceptions) without
violating the Partnership Agreement, unless such withdrawal is approved by the
vote of the holders of not less than 66 2/3% of the outstanding Units
(excluding for this purpose Units held by the General Partner and its
affiliates). The withdrawal or removal of the General Partner as general
partner of the Partnership would automatically result in the concurrent
withdrawal of the General Partner as general partner of the Operating
Partnership. However, there is no agreement to which the Partnership is a
party that restricts the ability of IPL to sell all or part of its ownership
of the General Partner to a third party or parties.
General Partner Has Limited Call Right on Class A Common Units
If at any time less than 15% of the outstanding Units are held by persons
other than the General Partner and its affiliates, the General Partner has the
right to purchase all of the outstanding Units.
Difficulty in Enforcing Civil Liabilities Against Officers, Directors and
Controlling Persons
Certain of the controlling persons of the Partnership, within the meaning of
the U.S. federal securities laws, and certain of the officers and directors of
the General Partner are not residents of the United States, and all or a
substantial portion of their assets are located outside the United States. As
a result, it may be difficult for Unitholders to effect service of process
within the United States with respect to such persons, officers and directors
predicated upon civil liabilities under the United States federal securities
laws. The Partnership has been advised by Canadian counsel that there is doubt
as to the enforceability against such persons in Canada, in original actions
or in actions for the enforcement of judgments of United States courts, of
liabilities predicated solely upon the federal securities laws of the United
States.
CONSIDERATIONS RELATING TO THE PARTNERSHIP'S INDEBTEDNESS AND ABILITY TO
DISTRIBUTE CASH
The Partnership had long-term debt of $463 million as of June 30, 1997. In
addition, the General Partner expects the Partnership to incur additional
indebtedness from time to time to fund a portion of the $370 million
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expected cost of SEP II and to fund a portion of its other expansion programs
and capital expenditures. To the extent not refinanced, principal payments on
any such indebtedness will reduce the cash available for distribution by the
Partnership. The $463 million of long-term debt as of June 30, 1997 consisted
of $310 million of the Partnership's first mortgage notes, which have no
principal payments due until 2002, and $153 million outstanding on the
Partnership's revolving bank credit facility (the "Revolving Credit
Facility"). The Revolving Credit Facility currently matures in September 2002,
with provisions for annual extensions of one year at the option of the banks.
If the banks elect not to extend the maturity date, the outstanding amount
under the Revolving Credit Facility will, subject to certain conditions, be
converted into a term loan, repayable in equal quarterly installments during
the period extending from the date of conversion to the then maturity date of
the Revolving Credit Facility. The Partnership Agreement does not place any
limitations on the ability of the Partnership or the Operating Partnership to
incur indebtedness. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
The agreements relating to the first mortgage notes and the Revolving Credit
Facility contain covenants restricting, among other things, (i) the ability of
the Operating Partnership to incur additional indebtedness and (ii) the
operations of the Operating Partnership, including placing certain
restrictions on the ability of the Operating Partnership to make distributions
to the Partnership and giving the banks the ability to require the
establishment of certain reserves. Because the Operating Partnership will be
the primary source of cash for the Partnership, restrictions on the ability of
the Operating Partnership to make distributions could have an adverse effect
on the ability of the Partnership to make distributions. In this regard,
distributions to the Partnership will generally be prohibited if a default
under the first mortgage notes or the Revolving Credit Facility has occurred
and is continuing.
In addition to debt service requirements on current and future indebtedness
of the Partnership that reduce Available Cash, the General Partner has broad
discretion in establishing cash reserves that are necessary or appropriate to
provide for the proper conduct of the business of the Partnership (including
cash reserves for future capital expenditures). The decisions of the General
Partner regarding reserves could have a significant impact on the amount of
cash available for distribution by the Partnership.
TAX CONSIDERATIONS
Partnership Status
Based in part on the accuracy of certain factual matters as to which the
General Partner has made representations, Andrews & Kurth L.L.P. ("Counsel"),
counsel to the Partnership, has rendered its opinion that, under current law,
the Partnership will be classified as a partnership for federal income tax
purposes. The opinion of Counsel that the Partnership will be classified as a
partnership for federal income tax purposes is based upon certain
representations of the General Partner as to factual matters, including the
nature of the Partnership's gross income, which, if not correct, could result
in the Partnership being classified as a corporation for federal income tax
purposes. See "Tax Considerations--Partnership Status."
If the Partnership were treated as a corporation in any taxable year, its
income, gains, losses, deductions and credits would be reflected only on its
tax return rather than being passed through to Unitholders, and its net income
would be taxed at corporate rates. Distributions made to Unitholders would be
treated as dividend income (to the extent of current or accumulated earnings
and profits), and, in the absence of earnings and profits, as a nontaxable
return of capital (to the extent of the Unitholder's tax basis in his Units),
or as capital gain (after the Unitholder's tax basis in his Units is reduced
to zero). Furthermore, losses realized by the Partnership would not flow
through to Unitholders.
Allocation of Taxable Income and Loss
The Partnership Agreement provides for certain curative allocations of
income, deduction, gain and loss of the Partnership to account for differences
between the tax basis and fair market value of property contributed to the
Partnership by the General Partner, and these allocations could be challenged
by the IRS. Counsel believes, however, that the curative allocations, if
respected, will prevent a shift from the General Partner to Class A
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Common Unitholders of precontribution gain attributable to assets contributed
to the Partnership by the General Partner and, thus, are consistent with the
principles of Section 704(c) of the Internal Revenue Code of 1986, as amended
(the "Code"), and with the principles of the applicable Treasury regulations.
A successful challenge by the IRS of the curative allocations would have the
effect of shifting to the Class A Common Unitholders the tax consequences
associated with the built-in gain of the properties contributed to the
Partnership by the General Partner or differences between the fair market
value and book basis of such assets existing at the time of this offering, a
result contrary to the policy of Section 704(c). Because such curative
allocations are consistent with Counsel's view of the purposes of Section
704(c) and the regulations thereunder, Counsel believes that it is unlikely
that the IRS will challenge the curative allocations. However, because the
application of the regulations under Section 704(c) is unclear in the context
of a publicly traded partnership existing prior to their promulgation, if the
IRS were to litigate the matter, it is uncertain whether the curative
allocations would be respected by a court. Counsel believes that there is
substantial authority (within the meaning of Section 6662 of the Code) for the
Partnership's tax reporting position, and that no penalties would be
applicable if the IRS were to litigate successfully against the curative
allocations. A failure by the IRS to respect the curative allocations would
result in ratios of taxable income to cash distributions received by the
holder of a Class A Common Unit that are materially higher than the estimates
set forth in "Prospectus Summary--Tax Considerations" and "Tax
Considerations--Tax Consequences of Unit Ownership--Ratio of Taxable Income to
Distributions."
Tax Liability Exceeding Cash Distributions or Proceeds from Dispositions of
Units
A Unitholder will be required to pay federal income tax and, in certain
cases, state and local income taxes on the Unitholder's allocable share of the
Partnership's income, whether or not the Unitholder receives cash
distributions from the Partnership. No assurance can be given that Unitholders
will receive cash distributions equal to the tax on their allocable share of
Partnership taxable income. Further, upon the sale or other disposition of
Units, a Unitholder may incur a tax liability in excess of the amount of cash
received if the Partnership has incurred substantial nonrecourse indebtedness.
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PARTNERSHIP STRUCTURE
The Partnership is a Delaware limited partnership formed in 1991 to acquire,
own and operate, through the Operating Partnership, the regulated crude oil
and natural gas liquids pipeline business of Lakehead. Lakehead is a wholly
owned subsidiary of IPL, and is the general partner of the Partnership. IPL is
a direct wholly owned subsidiary of IPL Energy.
Lakehead serves as the general partner of the Partnership and the Operating
Partnership and owns an effective 2% general partner interest in the
Partnership. The General Partner also owns 3,912,750 Class B Common Units in
the Partnership. The Partnership owns a 1% general partner interest in
Lakehead Services, Limited Partnership, a Delaware limited partnership (the
"Services Partnership") formed to facilitate the ongoing financing of the
Operating Partnership, and Lakehead owns a 99% limited partner interest in the
Services Partnership.
The 22,290,000 Class A Common Units to be outstanding following completion
of this offering, consisting of 20,090,000 Class A Common Units outstanding
prior to this offering and 2,200,000 Class A Common Units offered hereby
(assuming the Underwriters' over-allotment option is not exercised), will
represent an effective 83.4% limited partner interest in the Partnership.
The following chart depicts the organization and ownership of the
Partnership and the General Partner after giving effect to the sale of the
Class A Common Units offered hereby (assuming that the Underwriters' over-
allotment option is not exercised). The percentages reflected in the following
chart represent the approximate ownership interest in each of the Partnership
and the Operating Partnership, individually. Except in the following chart,
the ownership percentages referred to in this Prospectus reflect the
approximate effective ownership interest of the holders in the Partnership and
the Operating Partnership on a combined basis.
[FLOW CHART OF PARTNERSHIP STRUCTURE]
The principal executive offices of the Partnership and the General Partner
are located at Lake Superior Place, 21 West Superior Street, Duluth, Minnesota
55802 and the telephone number at such offices is (218) 725-0100.
19
<PAGE>
USE OF PROCEEDS
The net proceeds to the Partnership from the sale of the 2,200,000 Class A
Common Units offered hereby are estimated to be approximately $ million
($ million if the Underwriters' over-allotment option is exercised in
full). The net proceeds will be used to fund a portion of the $370 million
estimated cost of SEP II. See "Business--SEP II Expansion Program."
The General Partner estimates that approximately $67 million of the $370
million total estimated cost of SEP II will be expended through 1997, with the
remaining $303 million to be expended in 1998. Pending use of the net proceeds
from this offering to fund a portion of the cost of SEP II, the Partnership
will invest the net proceeds in investment grade, short-term debt securities.
CAPITALIZATION
The following table sets forth the capitalization of the Partnership as of
June 30, 1997 and the adjusted capitalization of the Partnership after giving
effect to the sale of the Class A Common Units offered hereby (assuming a
public offering price of $47 7/16 per Unit and assuming the Underwriters'
over-allotment option is not exercised) and the General Partner's contribution
related thereto. The following table should be read in conjunction with the
Partnership's historical consolidated financial statements and notes thereto
incorporated in this Prospectus by reference.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
----------------------
HISTORICAL AS ADJUSTED
---------- -----------
(UNAUDITED;
DOLLARS IN MILLIONS)
<S> <C> <C>
Long-term Debt
First Mortgage Notes................................... $310.0 $310.0
Revolving Credit Facility.............................. 153.0 153.0
------ ------
Total Long-term Debt................................. 463.0 463.0
------ ------
Total Partners' Capital.................................. 402.9 503.4
------ ------
Total Capitalization..................................... $865.9 $966.4
====== ======
</TABLE>
The Partnership intends to fund the portion of the cost of SEP II not paid
from the net proceeds of this offering, and other remaining 1997 and 1998
Lakehead System enhancements, with the proceeds from future equity and debt
offerings, bank borrowings, cash generated from operations and existing cash
and cash equivalent balances.
20
<PAGE>
PRICE RANGE OF CLASS A COMMON UNITS AND DISTRIBUTIONS
The Class A Common Units are listed and traded on the New York Stock
Exchange under the symbol LHP. Prior to April 15, 1997, the Class A Common
Units were designated Preference Units.
The high and low sale prices for the Class A Common Units for the periods
indicated, as reported on the New York Stock Exchange Composite Tape, and the
amount of cash distributions paid on each outstanding Class A Common Unit and
Class B Common Unit in such periods, are presented below.
<TABLE>
<CAPTION>
DISTRIBUTIONS
HIGH LOW PAID (1)
------- ------- -------------
<S> <C> <C> <C>
1995
First Quarter................................... $29 1/4 $26 3/8 $0.64
Second Quarter.................................. 30 5/8 22 0.64
Third Quarter................................... 27 1/4 25 0.64
Fourth Quarter.................................. 27 1/2 24 0.64
1996
First Quarter................................... 29 25 1/2 0.64
Second Quarter.................................. 28 1/8 21 5/8 0.64
Third Quarter................................... 31 1/8 25 1/4 0.64
Fourth Quarter.................................. 34 7/8 30 3/8 0.68
1997
First Quarter................................... 38 3/4 33 0.68
Second Quarter.................................. 39 33 7/8 0.68
Third Quarter (through October 6, 1997)......... 47 3/4 38 0.78
</TABLE>
- --------
(1) The Partnership distributes 100% of its Available Cash as of the end of
each calendar quarter on or about 45 days after the end of such quarter.
See the cover page of this Prospectus for a recent last reported sale price
of the Class A Common Units on the New York Stock Exchange. As of September
23, 1997, the Partnership had 20,090,000 Class A Common Units outstanding. On
September 23, 1997, there were 3,354 holders of record of the Class A Common
Units.
21
<PAGE>
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA
The following table sets forth selected financial and operating data of the
Partnership as of the dates and for each of the periods indicated below. Such
data have been derived from the Partnership's consolidated financial
statements. The selected financial data as of and for each of the years ended
December 31, 1992, 1993, 1994, 1995 and 1996 have been derived from the
Partnership's financial statements audited by Price Waterhouse LLP,
independent accountants. The selected consolidated financial data as of June
30, 1996 and 1997 and for the six-month periods then ended are derived from
unaudited consolidated financial statements which, in the opinion of
management, include all adjustments (consisting of normal recurring
adjustments and a non-recurring adjustment recorded in the first quarter of
1996 to reflect the impact of the Settlement Agreement) necessary for a fair
presentation of such data. The results for the six-month period ended June 30,
1997 are not necessarily indicative of the results that may be expected for
the full fiscal year. The information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Partnership's historical consolidated
financial statements and notes thereto incorporated in this Prospectus by
reference.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------ ---------------
1992 1993 1994 1995(1) 1996(1) 1996(1) 1997
------ ------ ------ ------- ------- ------- ------
(UNAUDITED)
(DOLLARS IN MILLIONS, EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Operating revenue..... $222.2 $240.1 $246.0 $268.5 $274.5 $133.9 $135.6
------ ------ ------ ------ ------ ------ ------
Power, operating and
administrative
expenses........... 121.3 130.4 128.3 134.3 128.7 61.1 63.5
Provision for prior
years' rate re-
funds.............. -- -- -- 22.9 20.1 20.1 --
Depreciation........ 27.4 29.2 31.4 38.0 38.3 19.9 19.5
------ ------ ------ ------ ------ ------ ------
Total operating ex-
penses............... 148.7 159.6 159.7 195.2 187.1 101.1 83.0
------ ------ ------ ------ ------ ------ ------
Operating income...... 73.5 80.5 86.3 73.3 87.4 32.8 52.6
Interest income....... 3.5 3.1 4.1 7.1 9.6 4.6 5.1
Interest expense...... (29.4) (30.9) (29.8) (40.3) (43.9) (24.3) (20.3)
Minority interest..... (0.6) (0.7) (0.7) (0.5) (0.7) (0.2) (0.5)
------ ------ ------ ------ ------ ------ ------
Net income............ $ 47.0 $ 52.0 $ 59.9 $ 39.6 $ 52.4 $ 12.9 $ 36.9
====== ====== ====== ====== ====== ====== ======
Net income per
Unit(2).............. $ 2.13 $ 2.36 $ 2.61 $ 1.60 $ 2.11 $ 0.51 $ 1.46
====== ====== ====== ====== ====== ====== ======
Cash distributions
paid per Unit(3)..... $ 1.80(4) $ 2.36 $ 2.51 $ 2.56 $ 2.60 $ 1.28 $ 1.36
====== ====== ====== ====== ====== ====== ======
FINANCIAL POSITION DATA
(AT PERIOD END):
Property, plant and
equipment, net....... $615.7 $622.1 $727.6 $725.1 $763.5 $741.8 $776.9
Total assets.......... $722.3 $758.8 $868.6 $915.2 $975.9 $966.9 $958.5
Long-term debt........ $320.0 $344.0 $364.0 $395.0 $463.0 $426.0 $463.0
Partners' capital..... $366.9 $366.9 $434.4 $411.1 $399.6 $392.6 $402.9
CASH FLOW DATA:
Cash provided from op-
erating activities... $ 68.5 $ 92.5 $108.1 $121.5 $ 93.9 $ 67.9 $ 41.3
Capital expenditures.. $ 32.6 $ 35.6 $136.9 $ 35.5 $ 76.7 $ 36.6 $ 32.9
OPERATING DATA:
Barrel miles (bil-
lions)............... 353 358 366 385 384 188 188
Deliveries (thousands of
barrels per day)
United States....... 737 757 795 876 901 889 935
Eastern Canada...... 514 531 531 533 550 535 544
------ ------ ------ ------ ------ ------ ------
Total............. 1,251 1,288 1,326 1,409 1,451 1,424 1,479
====== ====== ====== ====== ====== ====== ======
</TABLE>
- -------
(1) Results for 1995 reflect the impact of the June 1995 FERC decision
(Opinion No. 397). Results for 1996 reflect the impact of the Settlement
Agreement. See "Business--Tariffs."
(2) The General Partner's allocation of net income has been deducted before
calculating net income per Unit.
(3) The Partnership distributes 100% of its Available Cash as of the end of
each calendar quarter on or about 45 days after the end of such quarter.
See "Price Range of Class A Common Units and Distributions" for quarterly
distribution per Unit data.
(4) Distributions paid in 1992 consist of $0.03 per Unit with respect to the
period from December 27, 1991 (the Partnership's inception) through
December 31, 1991 and $0.59 per Unit with respect to each of the first
three quarters of 1992.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the historical financial condition and results
of operations of the Partnership should be read in conjunction with the
Partnership's historical consolidated financial statements and notes thereto
incorporated in this Prospectus by reference.
GENERAL
The Partnership is primarily engaged in the interstate transportation of
crude oil and natural gas liquids through the Lakehead System. The revenue,
income and cash flows from the Lakehead System are sensitive to the oil
industry supply and demand in both Canada and the United States, to changes in
rate base, to inflation and to the regulatory environment.
The Lakehead System is operationally integrated with the IPL System, which
is owned by the General Partner's Canadian parent company, IPL. Consequently,
the Partnership's revenues are dependent upon the utilization of the IPL
System by producers of western Canadian crude oil to reach markets in the
United States and eastern Canada. The Partnership estimates that in 1996 the
System transported approximately 70% of the total crude oil produced in
western Canada, of which approximately 90% was transported by the Lakehead
System. This level of throughput has resulted in the System operating at or
near capacity for the past several years. SEP II is projected to enable the
Lakehead System to transport additional volumes from the Canadian border to
the Midwest U.S. markets served by the Partnership. The new pipeline to be
installed as part of SEP II is expected to be in service by late 1998.
Accordingly, SEP II will not make a significant contribution to 1997 or 1998
net income or cash flow but is expected to have a favorable impact on the
income and cash flow of the Partnership after 1998.
The Partnership has settled a series of rate cases pending before the FERC.
In October 1996, the FERC approved the Settlement Agreement between the
Partnership and representatives of certain of the Partnership's customers on
all then outstanding contested tariff rates. The Settlement Agreement provided
for a tariff rate reduction of approximately 6% and total rate refunds and
interest of $120.0 million through the effective date of October 1, 1996, with
interest accruing thereafter on the unpaid balance. Cash refunds of $41.8
million were made in the fourth quarter of 1996, with the remaining balance
($79.3 million at December 31, 1996) to be paid through a 10% reduction of
tariff rates after November 1, 1996. This reduction will continue until all
refunds have been made. Based on the $67.9 million remaining balance at June
30, 1997 and projected Lakehead System deliveries, the 10% refund credit is
expected to remain effective until sometime during the third or fourth quarter
of 1999. The Settlement Agreement also provides that the agreed tariff rates
will be subject to indexing as prescribed by FERC regulations and that the
Partnership's customer representatives that are parties to the Settlement
Agreement will not challenge any rates within the indexed ceiling for a period
of five years. See "Business--Tariffs" and "--Regulation."
The Partnership's net income and its ability to make distributions to its
Unitholders will remain sensitive to the level of tariffs established from
time to time under rules and regulations of the FERC. The Partnership
anticipates filing a rate increase in late 1998 or early 1999 to reflect the
projected incremental costs and throughput resulting from SEP II. The
Settlement Agreement sets forth parameters governing the tariff increase
associated with SEP II. See "Business--Tariffs" and "--SEP II Expansion
Program."
23
<PAGE>
RESULTS OF OPERATIONS
Recalculated Operating Results
In October 1996, the FERC approved the Settlement Agreement between the
Partnership and representatives of certain of the Partnership's customers on
all then outstanding contested tariff rates. The Settlement Agreement provided
for a tariff rate reduction of approximately 6% and total rate refunds and
interest of $120.0 million through the effective date of October 1, 1996, with
interest accruing thereafter on the unpaid balance. Even though the
Partnership had been recording a provision for a potential rate refund since
1992, additional provisions related to rate refunds were required in 1995,
with respect to FERC Opinion No. 397, and in 1996, with respect to the
Settlement Agreement. Accordingly, to eliminate the retroactive impact of the
additional provisions and to facilitate comparison of period-to-period
results, set forth below are the operating results of the Partnership for the
indicated periods recalculated to reflect the retroactive impacts of the
tariff rate reduction provided for in the Settlement Agreement in each such
year. There is no retroactive impact from the Settlement Agreement on
operating results for periods after December 31, 1996.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------- ------------------
1992 1993 1994 1995 1996 1996 1997
------ ------ ------ ------ ------ -------- --------
(DOLLARS IN MILLIONS, EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenue(1).... $218.5 $229.9 $237.0 $268.5 $274.5 $ 133.9 $ 135.6
Total operating ex-
penses(2).............. 148.7 159.6 159.7 172.3 167.0 81.0 83.0
------ ------ ------ ------ ------ -------- --------
Operating income........ 69.8 70.3 77.3 96.2 107.5 52.9 52.6
Interest income......... 3.5 3.1 4.1 7.1 9.6 4.6 5.1
Interest expense(3)..... (29.5) (31.2) (30.9) (38.8) (40.7) (21.1) (20.3)
Minority interest....... (0.6) (0.5) (0.6) (0.7) (0.9) (0.5) (0.5)
------ ------ ------ ------ ------ -------- --------
Net income.............. $ 43.2 $ 41.7 $ 49.9 $ 63.8 $ 75.5 $ 35.9 $ 36.9
====== ====== ====== ====== ====== ======== ========
Net income per Unit(4).. $ 1.96 $ 1.89 $ 2.17 $ 2.60 $ 3.06 $ 1.46 $ 1.46
====== ====== ====== ====== ====== ======== ========
</TABLE>
- --------
(1) Recalculated operating revenue is reduced to reflect additional rate
refunds of $3.7 million, $10.2 million and $9.0 million for the years
ended December 31, 1992, 1993 and 1994, respectively.
(2) Recalculated total operating expenses exclude the retroactive provision of
$22.9 million for the year ended December 31, 1995 and the non-recurring
charge of $20.1 million for the year ended December 31, 1996 and the six
months ended June 30, 1996.
(3) Recalculated interest expense includes additional interest expense of $0.1
million, $0.3 million and $1.1 million for the years ended December 31,
1992, 1993 and 1994, respectively. Recalculated interest expense excludes
the interest expense portion of the retroactive provision of $1.5 million
for the year ended December 31, 1995 and the non-recurring charge of $3.2
million for the year ended December 31, 1996 and the six months ended June
30, 1996.
(4) The General Partner's allocation of net income has been deducted before
calculating net income per Unit.
Six Months ended June 30, 1997 Compared with Six Months ended June 30, 1996
Recalculated net income for the first six months of 1996 was $35.9 million,
or $1.46 per Unit. Net income for the six months ended June 30, 1997 was
slightly higher than the recalculated amount for the same period in 1996 due
to higher operating revenue, lower interest expense and greater interest
income, partially offset by higher total operating expenses.
Operating revenue for the first six months of 1997 increased slightly over
the comparable period of 1996 primarily due to a greater proportion of heavy
crude oil deliveries, up 29% to 563,000 barrels per day. Because heavy crude
oil is more expensive to pump due to its higher viscosity, the tariff rate for
heavy crude oil is greater than that for lighter crude oils. Total deliveries
averaged 1,479,000 barrels per day for the first six months of 1997, up 4%
from the 1,424,000 barrels per day averaged for the first half of 1996. System
utilization, measured in barrel miles, was essentially unchanged from the
first six months of 1996, despite an increase in deliveries. This was due to a
higher proportion of shorter haul deliveries to the Midwest U.S. markets
served by the Partnership.
24
<PAGE>
Excluding the provision for prior years' rate refund ($20.1 million) from
the first six months of 1996, total operating expenses for the first six
months of 1997 were slightly higher than the same period of 1996 due to
increased power costs and oil loss expense. Oil loss expense increased as a
result of operational considerations and volatility in crude oil prices.
Depreciation expense decreased slightly despite growth in property, plant and
equipment, due to the impact of revised depreciation rates put into effect
July 1, 1996. The depreciation rates were revised to better represent the
expected service life of the pipeline system.
Excluding the provision for interest related to prior years' rate refund
($3.2 million) from the first six months of 1996, interest expense for the
first six months of 1997 was less than the same period of 1996 due to lower
interest rates and balances with respect to rate refunds payable, partially
offset by interest on increased borrowings under the Revolving Credit
Facility.
Year ended December 31, 1996 Compared with the Year ended December 31, 1995
and Year ended December 31, 1995 Compared with the Year ended December 31, 1994
The Partnership enjoyed strong operational performance in 1996 as full year
deliveries averaged a record 1,451,000 barrels per day, up 3% from the
1,409,000 barrels per day averaged in 1995. System utilization, measured in
barrel miles, remained relatively unchanged from 1995, reflecting a higher
proportion of shorter haul deliveries to the Midwest U.S. markets served by
the Partnership. Deliveries and barrel miles during 1995 were up 6% and 5%,
respectively, over 1994 as a result of the Partnership's 1994 capacity
expansion program.
Recalculated net income for 1996 was $11.7 million, or $0.46 per Unit,
higher than in 1995. A combination of higher operating revenue, lower total
operating expenses and greater interest income, partially offset by higher
interest expense, led to the increase. Recalculated net income for 1995
reflects the positive impact of the Partnership's 1994 capacity expansion
program and was $13.9 million, or $0.43 per Unit, greater than 1994. This
expansion resulted in higher 1995 operating revenue which was partially offset
by increased operating and interest expense.
Recalculated operating revenue is computed at the tariff rates implied in
the Settlement Agreement. These implied rates include an approximate 5%
increase on November 30, 1994 to reflect the additional costs associated with
the 1994 capacity expansion program, and an approximate 0.9% increase on July
1, 1996 allowed under the FERC's indexing methodology. Operating revenue for
1996 was $6.0 million higher than 1995 primarily due to a greater proportion
of heavy crude oil deliveries (up 29% to 471,000 barrels per day) and the 1996
tariff rate increase of 0.9%. The tariff rate for heavier crude oil is greater
than that for lighter crude oils primarily due to its higher viscosity which
requires more power to pump. The Partnership's current tariff rate for heavy
crude oil deliveries from the Canadian border to the Chicago area is
approximately 10% to 18% higher than that for lighter crude oils. Operating
revenue for 1995 was 13% above the 1994 recalculated amount of $237.0 million.
This increase was due to both the transportation of greater volumes and the
November 1994 tariff rate increase of 5%.
Total 1996 recalculated operating expenses were $5.3 million less than in
1995 primarily due to lower power costs ($2.2 million) and oil losses ($2.8
million). Efficiencies gained from the Partnership's power cost management
initiatives, partially offset by the transportation of greater amounts of
heavy crude oil, led to the decrease in power costs. Oil losses are impacted
by operational considerations, including changing customer delivery
requirements, and the volatility of crude oil prices, resulting in variances
in the level of oil losses from year to year. Despite growth in property,
plant and equipment, 1996 depreciation expense increased only slightly over
1995 due to the impact of new depreciation rates, effective July 1, 1996,
which were put into effect to better represent the expected service life of
the pipeline system. This change in depreciation rates, approved by the FERC,
resulted in 1996 depreciation expense being approximately $1.8 million lower
than it would have been utilizing the prior rates. Total 1995 recalculated
operating expenses were $12.6 million greater than in 1994 primarily due to a
combination of additional ongoing costs resulting from the 1994 capacity
expansion program (depreciation and property taxes--$9.6 million) and lower
overhead costs capitalized ($5.6 million), partially offset by lower oil
losses ($2.4 million) and maintenance costs ($2.3 million). Overhead costs
capitalized were greater in 1994 as a higher proportion of employee time was
spent on capital projects (as opposed to maintenance
25
<PAGE>
and repair projects) due to the 1994 capacity expansion program. Efficiencies
implemented with the 1994 capacity expansion, as well as management
initiatives, contributed to oil losses being less in 1995 than in 1994. A
reduction in periodic pipeline inspection costs led to lower maintenance costs
in 1995 as compared to 1994.
Interest income in 1996 increased over 1995 due to higher average investment
balances. Interest income in 1995 was greater than in 1994 due to both higher
average interest rates and higher investment balances.
Recalculated interest expense for 1996 was $1.9 million greater than in 1995
primarily due to the impact of additional borrowings under the Revolving
Credit Facility to finance enhancement capital expenditures. Recalculated
interest expense for 1995 increased $7.9 million over the previous year
primarily due to the impact of higher average balances and interest rates with
respect to accrued rate refunds ($2.8 million) and borrowings under the
Revolving Credit Facility ($2.3 million) to finance enhancement capital
expenditures. In addition, interest capitalized in 1995 was $2.8 million lower
than in 1994. Larger capital projects, primarily the 1994 capacity expansion
program, resulted in more interest being capitalized in 1994.
LIQUIDITY AND CAPITAL RESOURCES
Uses of Capital
The Partnership distributes quarterly all of its Available Cash, which is
generally defined in the Partnership Agreement to mean, with respect to any
calendar quarter, the sum of all of the cash receipts of the Partnership plus
net reductions to reserves less all of its cash disbursements and net
additions to reserves. These reserves are retained to provide for the proper
conduct of the Partnership's business, to stabilize distributions of cash to
the Unitholders and the General Partner and as necessary to comply with the
terms of any agreement or obligation of the Partnership.
As noted previously, in October 1996, the FERC approved the Settlement
Agreement between the Partnership and representatives of certain of the
Partnership's customers on all then outstanding contested tariff rates. The
agreement provided for a tariff rate reduction of approximately 6% and total
rate refunds and interest of $120.0 million through the effective date of
October 1, 1996, with interest accruing thereafter on the unpaid balance. Cash
refunds of $41.8 million were made in the fourth quarter of 1996, with the
remaining balance ($79.3 million at December 31, 1996) to be paid through a
10% reduction of tariff rates after November 1, 1996. This reduction will
continue until all refunds have been made. Based on the $67.9 million
remaining balance at June 30, 1997 and projected Lakehead System deliveries,
the 10% refund credit is expected to remain effective until sometime during
the third or fourth quarter of 1999.
In addition to providing for cash distributions, cash will be required for
ongoing capital expenditures, including SEP II. Through 1997, the Partnership
expects to make expenditures totaling approximately $67.0 million for SEP II.
The remaining $303.0 million of the $370.0 million total cost is expected to
be expended in 1998. In addition to SEP II, the Partnership anticipates
spending approximately $37.0 million, and $9.0 million, for other Lakehead
System enhancements, and $9.0 million and $10.0 million, for core maintenance
activities, in 1997 and 1998, respectively. Thereafter, ongoing capital
expenditures are expected to average approximately $12.0 million on an annual
basis (approximately 50% for enhancement of the Lakehead System and 50% for
core maintenance of the Lakehead System). In addition to these ongoing capital
expenditures, the Partnership anticipates it may incur other capital
expenditures. See "Business--Business Strategy--Lakehead System Expansion
Projects." Core maintenance activities, such as the replacement of equipment
that is completing its useful life and preventive maintenance programs, are
expected to be undertaken to enable the Lakehead System to continue to operate
at its maximum operating capacity. Enhancements to the Lakehead System, such
as renewal and replacement of pipe and other enhancements, are expected to
extend the life of the Lakehead System and permit the Partnership to respond
to developing industry and government standards and the changing service
expectations of its customers.
At June 30, 1997, the Partnership had outstanding $310.0 million aggregate
principal amount of first mortgage notes bearing interest at the rate of 9.15%
per annum, payable semi-annually. The notes are due and payable in ten equal
annual installments beginning in the year 2002.
26
<PAGE>
At June 30, 1997, the Partnership had $153.0 million of borrowings
outstanding under the Revolving Credit Facility. The Revolving Credit Facility
currently matures in September 2002, with provisions for annual extensions of
one year at the option of the banks. If the banks elect not to extend the
maturity date, the outstanding amount under the Revolving Credit Facility
will, subject to certain conditions, be converted into a term loan, repayable
in equal quarterly installments during the period extending from the date of
conversion to the then maturity date of the Revolving Credit Facility.
The Partnership is also subject to the risks of environmental costs and
liabilities that are inherent in pipeline operations. The General Partner has
agreed to indemnify the Partnership for environmental liabilities that are
attributable to operations prior to the transfer of the Lakehead System to the
Partnership and that are not recoverable through tariffs, other than any
liabilities resulting from a change in laws after the transfer. The General
Partner believes that the Partnership has adequate insurance coverage for both
business interruption and property damage relating to incidents.
Sources of Capital
At June 30, 1997, the Partnership had $147.7 million in cash, cash
equivalents and short-term investments. Of these amounts, $20.1 million was
set aside to provide for the cash distribution payable August 14, 1997,
leaving a balance of $127.6 million. This balance can be used by the General
Partner in its sole discretion to fund capital expenditures, distributions or
any other reasonable business needs. On a combined basis, cash, cash
equivalents and short-term investments at June 30, 1997 were $25.6 million
lower than at December 31, 1996 primarily due to significant capital
expenditures resulting from SEP II and other capital projects.
Subject to complying with certain financial covenants, the Partnership
expects to have the ability to borrow amounts under the Revolving Credit
Facility to finance capital expenditures up to a total maximum outstanding
amount of $205.0 million. At June 30, 1997, the Partnership was entitled to
borrow an additional $52.0 million under this facility.
The Partnership intends to fund the remaining portion of SEP II and other
remaining 1997 and 1998 Lakehead System enhancements with the proceeds from
this offering, future equity and debt offerings, bank borrowings, cash
generated from operations and existing cash and cash equivalent balances. The
Partnership intends to fund 1997 and 1998 core maintenance expenditures with
cash from operations. On an ongoing basis, the Partnership expects to be able
to finance capital expenditures through a combination of future equity and
debt offerings, bank borrowings, cash generated from operations, and existing
cash and cash equivalent balances.
Cash from operating activities for the six months ended June 30, 1997 was
$41.3 million. This was less than the $67.9 million for the six months ended
June 30, 1996 primarily due to the payment of rate refunds and interest ($13.3
million) in 1997 and the collection of operating revenue in 1996 that was
subject to refund.
Capital expenditures for the first six months of 1997 totaled $32.9 million,
of which $14.7 million related to SEP II.
In 1997, the Partnership has paid three quarterly distributions totaling
$53.6 million ($33.6 million through June 30, 1997).
27
<PAGE>
BUSINESS
GENERAL
The Partnership and IPL are engaged in the transportation of crude oil and
other liquid hydrocarbons through the System. The System is the primary
transporter of crude oil from western Canada to the United States and is the
only pipeline that transports crude oil from western Canada to eastern Canada.
The System serves all the major refining centers in the Great Lakes region of
the United States, as well as in Ontario and, through a connecting pipeline,
the Patoka/Wood River refinery market and pipeline hub in southern Illinois.
The System consists of the IPL System in Canada and the Lakehead System, which
is owned by the Partnership, in the United States.
The IPL System, which is owned and operated by IPL, extends approximately
1,200 miles from Edmonton, Alberta, across the Canadian prairies to the U.S.
border near Neche, North Dakota, and continues from the U.S. border near
Marysville, Michigan to Toronto, Ontario, and Montreal, Quebec, with lateral
lines to Nanticoke, Ontario, and Niagara Falls, Ontario. The IPL System
includes a pipeline which is owned and operated by Interprovincial Pipe Line
(NW) Ltd., a wholly owned subsidiary of IPL Energy. This pipeline extends
approximately 540 miles between Norman Wells, Northwest Territories and Zama,
Alberta and connects from Zama, through a system owned by others, to the IPL
System at Edmonton.
The Lakehead System traverses approximately 1,750 miles from the Canadian
border near Neche to the Canadian border near Marysville. The Lakehead System
consists of three separate lines extending from the Canadian border near Neche
to Superior, and a line from the Canadian border near Neche to Clearbrook,
Minnesota. At Superior, the pipeline continues as two separate and diverging
lines, one traversing through the upper Great Lakes region and the other
through the lower Great Lakes region of the United States, with both lines re-
entering Canada at a point near Marysville. The Lakehead System also includes
a lateral line from the Canadian border near Niagara Falls, Ontario to the
Buffalo, New York area. Crude oil and NGLs are received by the Lakehead System
at the Canadian border from the IPL System and, to a lesser extent, at a
number of other receipt points and are scheduled into the pipeline in
accordance with customer nominations. See "--Sources of Shipments."
All scheduling of shipments (including routes, storage, etc.) is handled by
IPL in coordination with the General Partner. The Lakehead System includes 16
connections to pipelines and refineries at various locations in the United
States, including the Chicago, Minneapolis-St. Paul, Detroit, Toledo and
Buffalo refining areas, and, through a connecting pipeline, the Patoka/Wood
River refinery market and pipeline hub. The Lakehead System currently has
approximately nine million barrels of tankage capacity at its three main
terminals at Clearbrook, Superior and Griffith, Indiana. The tankage capacity
is utilized both to gather crude oil prior to injection into the Lakehead
System and to provide tankage in order to facilitate more flexible oil
movements scheduling. At Superior, all crude oil is removed from the Lakehead
System, directed into tankage and then, when appropriate to meet the
requirements of batch movements, reinjected into the Lakehead System for
delivery through either the upper Great Lakes region or the lower Great Lakes
region.
Shipments tendered to the IPL System originate in oil fields in the western
Canadian provinces of Alberta, Saskatchewan, Manitoba and British Columbia and
in the Northwest Territories of Canada and reach the IPL System through
facilities owned and operated by third parties or affiliates of IPL.
Deliveries from the IPL System are currently made in the prairie provinces of
Canada and, through the Lakehead System, in the Great Lakes and Midwest
regions of the United States and the Province of Ontario, principally to
refineries, either directly or through connecting pipelines of other
companies.
BUSINESS STRATEGY
A principal objective of the Partnership is to increase cash generated from
its operations and to distribute all of its Available Cash to its partners.
The Lakehead System, together with the IPL System, serves as a strategic
28
<PAGE>
link between the western Canadian oil fields and the markets of the Midwest
U.S. and eastern Canada and currently operates at or near capacity. In
response to the continuing trend of increasing supply of crude oil from
western Canada and the growth of demand in the markets of the Midwest U.S.,
the Partnership plans not only to maintain the service capability of the
existing Lakehead System but also to expand its capacity where appropriate. To
the extent allowed under FERC orders, or by agreement with customers, the
Partnership anticipates filing for additional tariff increases from time to
time to reflect these ongoing expansions. See "--Regulation" and "--Tariffs."
This strategy has enabled the Partnership to increase quarterly cash
distributions to Unitholders from $0.59 per Unit in 1992 to $0.78 per Unit
currently, an increase of approximately 32%.
Lakehead System Expansion Projects
In implementing its business strategy, the Partnership pursues opportunities
to maximize utilization of and to expand the Lakehead System. Certain key
completed, current and future expansion projects of the Partnership are
summarized below:
. 1994 Capacity Expansion Program -- This $130 million expansion program
increased the delivery capability of the Lakehead System to Superior by
approximately 170,000 barrels per day and to Chicago area markets by
approximately 145,000 barrels per day. This project was completed in late
1994 at a cost of approximately $130 million and was undertaken in
conjunction with a Cdn. $256 million expansion of the IPL System by IPL.
. SEP I -- This 1996 expansion program provided an additional 120,000
barrels per day of capacity on the Lakehead System from Superior to
Chicago area markets (40,000 barrels of which are required to offset the
impact of increased heavy crude oil volumes on deliverability). This
expansion program, which has increased deliveries to Chicago area markets
by approximately 80,000 barrels per day, was completed in December 1996
at a cost of $65 million.
. SEP II -- This proposed expansion, which began in 1996, is expected to
provide an additional 170,000 barrels per day of delivery capacity on the
Lakehead System from Superior to Chicago. Current constraints on the
capacity of the System in western Canada, however, will limit incremental
volumes reaching the Lakehead System to approximately 120,000 barrels per
day. This project, which is expected to cost approximately $370 million,
was undertaken in response to apportionment of the existing capacity on
the System among suppliers of western Canadian crude oil and NGLs. SEP II
is being undertaken in conjunction with a Cdn. $140 million capacity
expansion of the IPL System by IPL. SEP II is expected to be completed by
late 1998. See "--SEP II Expansion Program."
. Terrace Project -- In early 1997, the Partnership, in conjunction with
IPL, announced a preliminary outline of a four-stage expansion program to
increase western Canadian crude oil pipeline capacity. Subject to
continued industry support and receipt of regulatory approval, the
Partnership and IPL anticipate that this proposed project would be
completed in stages over the period 1998 through 2005.
IPL Energy Projects
IPL Energy is also engaged in North American crude oil pipeline projects
which are related to the System. The General Partner believes that certain of
these projects, even though they are not owned by the Partnership, will
benefit the Partnership since they may result in increased deliveries on the
Lakehead System. Such projects are summarized below:
. Mustang -- In 1996, a U.S. subsidiary of IPL Energy entered into a
partnership ("Mustang Pipe Line Partners") with Mobil Illinois Pipe Line
Company, a subsidiary of Mobil Oil Corporation, to own and operate a
crude oil pipeline that connects the Lakehead System to the Patoka/Wood
River refinery area and pipeline hub south of Chicago. This connection
provides the Partnership's customers with additional access to heavy
crude oil markets south of Chicago. The Partnership has entered into a
joint tariff agreement with Mustang Pipe Line Partners covering shipments
of western Canadian crude oil over the Lakehead System and the Mustang
pipeline. The joint tariff agreement provides for lower transportation
costs to shippers desiring access to the Patoka/Wood River market area,
an incentive the General Partner believes complements SEP II.
29
<PAGE>
. Toledo -- IPL Energy is proposing the construction of a new pipeline
which, together with an existing pipeline to be leased by IPL Energy,
would connect the Partnership's facilities at Stockbridge, Michigan to a
refinery in the Toledo area.
. Wild Rose -- IPL Energy recently announced a project to construct a new
30-inch pipeline for the delivery of heavy crude oil from the Athabasca
oil sands region near Fort McMurray to Hardisty. At Hardisty, the Wild
Rose pipeline would access other pipeline systems including the IPL
System in western Canada. This project would provide new pipeline
capacity to accommodate anticipated growth in production in the Athabasca
oil sands region.
DESCRIPTION OF THE LAKEHEAD SYSTEM
The Lakehead System consists of approximately 2,600 miles of pipe with
diameters ranging from 12 inches to 48 inches, 57 main line pump station
locations with a total of approximately 551,000 installed horsepower and 54
tanks with an aggregate capacity of approximately nine million barrels. The
volume of liquid hydrocarbons in the Lakehead System that is required at all
times for operation amounts to approximately 12 million barrels, all of which
is owned by the shippers on the Lakehead System. The Lakehead System regularly
transports up to 35 different types of liquid hydrocarbons including light,
medium and heavy crude oil (including bitumen), condensate, synthetic crudes
and NGLs.
The Lakehead System is comprised of a number of separate segments as
follows:
(i) (a) the portion of Line 13 that extends from the Canadian border near
Neche to Clearbrook consisting of 18-inch pipe;
(b) the portions of Lines 1, 2, and 3 that extend from the Canadian
border near Neche to Superior consisting of 20- (18-inch from Clearbrook to
Superior), 26- and 34-inch pipe, respectively; Line 3 is looped with
approximately 120 miles of 48-inch pipe;
(ii) Line 5, a 30-inch line from Superior through the upper Great Lakes
region via the upper peninsula of Michigan and across the Straits of
Mackinac to the Canadian border near Marysville;
(iii) the portion of Line 6 that is a 34-inch line extending from
Superior to the Chicago area;
(iv) the portion of Line 6 that is a 30-inch line extending from the
Chicago area to the Canadian border near Marysville; and
(v) the portion of Line 10 that is a lateral line from the Canadian
border near Niagara Falls to the Buffalo area consisting of 12-inch pipe
and which is looped with a four-mile section of 20-inch pipe.
Estimated capacities of the various segments of the Lakehead System for 1997
are set forth below. The estimated capacities set forth below do not include
additional delivery capability to be added as a result of SEP II. See "--SEP
II Expansion Program."
<TABLE>
<CAPTION>
THOUSANDS OF
BARRELS PER DAY
-----------------
DESIGN ANNUAL
LINE SEGMENT CAPACITY CAPACITY
------------ -------- --------
<S> <C> <C>
Canadian border to Clearbrook............................... 1,729 1,452
Clearbrook to Superior...................................... 1,512 1,218
Superior to Canadian border near Marysville (through the up-
per Great Lakes region).................................... 566 509
Superior to Chicago area.................................... 782 704
Chicago area to Canadian border near Marysville............. 409 368
Canadian border near Niagara Falls to the Buffalo area...... 66 59
</TABLE>
Design capacity is the absolute theoretical system capacity and assumes that
all required horsepower is fully operational at all times. Annual capacity,
which takes into account receipt and delivery patterns and ongoing pipeline
maintenance, reflects achievable rates over long periods of time.
30
<PAGE>
The chart below depicts the System following the completion of SEP II and
describes the types of petroleum products transported through the various lines
in the System.
THE IPL/LAKEHEAD SYSTEM
[CHART OF THE IPL/LAKEHEAD SYSTEM APPEARS HERE]
31
<PAGE>
The General Partner believes that the Lakehead System has been constructed
and is maintained in accordance with applicable federal, state and local laws
and regulations, standards prescribed by the American Petroleum Institute and
accepted industry practice. To prolong the useful life of the Lakehead System,
pipeline crews perform scheduled maintenance and make repairs when necessary.
The Partnership attempts to control corrosion of the pipeline through the use
of pipe coatings and cathodic protection systems. The Partnership monitors the
integrity of the Lakehead System through a program of periodic internal
inspections using electronic instruments. In order to maintain the service
capability of the pipeline, periodic internal inspections will continue in
1998 and in the future, based on the judgment of the General Partner. On a bi-
weekly basis, the entire right of way is inspected from the air. Trained and
skilled operators use computerized monitoring systems to identify pressure
drops that might indicate potential disruptions in flow and operate remote
controlled valves and pumps that allow the Lakehead System to be shut down
quickly if required.
SEP II EXPANSION PROGRAM
The Partnership has commenced the SEP II expansion of the Lakehead System
consisting primarily of a new pipeline ("Line 14") from Superior to the
Chicago area. This expansion of the Lakehead System is being undertaken at the
request of western Canadian crude oil shippers to address System capacity
constraints and forecasted increases in the crude oil supply in western
Canada.
Increases in crude oil supply in western Canada are forecast to coincide
approximately with and partially to offset decreases in domestic crude oil
supply produced in the Rocky Mountain and Midwest U.S. areas. The Partnership
believes that this forecasted decrease in domestic supply, coupled with a
forecasted increase in demand for crude oil, supports the need for SEP II.
Furthermore, the Partnership believes that refineries located in the Midwest
U.S. are particularly well positioned to utilize the expected increases in
western Canadian heavy crude oil production since they are already the primary
consumers of western Canadian heavy crude oil. See "--Supply of and Demand for
Western Canadian Crude Oil."
SEP II involves estimated expenditures of $370 million to add approximately
450 miles of 24-inch pipeline from Superior to the Chicago area. The
additional pipeline, together with other pipeline system modifications, is
projected to provide approximately 170,000 additional barrels per day of
delivery capacity to the Midwest U.S. markets served by the Partnership.
However, it is anticipated that current constraints on the capacity of the
System in western Canada will limit incremental volumes reaching the Lakehead
System to approximately 120,000 barrels per day. In addition to the new
pipeline, the project includes the construction of six new pump stations along
the pipeline route and additional terminalling facilities in Superior and
Mokena, Illinois. Additional system modifications will be required on
facilities west of Superior to enhance the Lakehead System's existing delivery
capability. SEP II complements a Cdn. $140 million expansion of the IPL
System. While the new pipeline is expected to initially provide an additional
170,000 barrels per day of delivery capacity, it is being designed for an
ultimate potential capacity of 350,000 barrels per day to facilitate future
expansions through the installation of additional pumping units. Current
estimated costs for the major components of SEP II are as follows:
<TABLE>
<CAPTION>
DESCRIPTION $ MILLIONS
----------- ----------
<S> <C>
New pipeline facilities........................................ $300
Six new pump stations.......................................... 40
Additional terminalling facilities............................. 10
Existing system modifications.................................. 20
----
$370
====
</TABLE>
The Partnership contemplates filing a tariff rate increase in late 1998 or
early 1999 to reflect the projected incremental costs and throughput resulting
from SEP II. In accordance with the Settlement Agreement, the necessary rate
increase will be added to the Partnership's indexed tolls and therefore, will
not be subject to the index ceiling mechanism. The Settlement Agreement
requires further discussions with the other parties to the agreement with
respect to certain details of implementation. Although the FERC has generally
approved the Settlement Agreement, such approval does not constitute a ruling
or decision regarding the merits of future rate filings, including those
related to SEP II. See "--Tariffs--Rate Cases."
32
<PAGE>
In May 1997, the ICC denied the Partnership's application for a certificate
that is a necessary first step toward receiving condemnation authority in
Illinois with respect to SEP II. Without condemnation authority, the cost to
obtain rights of way in connection with SEP II could increase. However, as the
ICC does not have jurisdiction to decide whether or not the Partnership can
build Line 14 through Illinois, the Partnership is continuing with its plans
to build Line 14. At September 1, 1997, approximately 90% of the line's route
had been secured or contractually committed. The Partnership is currently
seeking and acquiring environmental and construction permits.
DELIVERIES FROM THE LAKEHEAD SYSTEM
Deliveries from the Lakehead System are made in the Great Lakes and Midwest
regions of the United States and in Ontario, principally to refineries, either
directly or through connecting pipelines of other companies. Major refining
centers within these regions are located near Sarnia, Nanticoke and Toronto,
Ontario; the Minneapolis-St. Paul area of Minnesota; Superior, Wisconsin; the
Chicago area of Illinois and Indiana; the Patoka/Wood River area of southern
Illinois; and the Detroit, Michigan, Toledo, Ohio, and Buffalo, New York
areas. Crude oil and NGLs transported by the Lakehead System are feedstock for
refineries and petrochemical plants.
The U.S. Government segregates the United States into five districts,
Petroleum Administration for Defense Districts ("PADD"), for purposes of its
strategic planning to ensure crude oil supply to key refining areas in the
event of a national emergency. The oil industry utilizes these districts in
reporting statistics regarding oil supply and demand. The Lakehead System
services, directly or through connecting lines, the northern tier of PADD II,
and U.S. governmental publications project that crude oil demand in this area
will remain relatively constant. In addition, such publications project the
total supply of crude oil from producing areas in the U.S. Southwest, Rocky
Mountains and Midwest that currently serve the entire PADD II market to
decline in the near term as reserves are depleted, resulting in a need for
additional supplies of crude oil to replace the continuing demand. See "--
Sources of Shipments."
The following table sets forth Lakehead System average deliveries per day
and barrel miles for each of the years in the five-year period ended December
31, 1996 and for the six months ended June 30, 1996 and 1997.
<TABLE>
<CAPTION>
DELIVERIES (THOUSANDS OF BARRELS PER DAY)
-----------------------------------------
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------- -----------
1992 1993 1994 1995 1996 1996 1997
----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
UNITED STATES
Light crude oil.................... 333 332 335 345 309 315 261
Medium and heavy crude oil......... 401 421 452 513 569 553 648
Natural gas liquids................ 3 4 8 18 23 21 26
----- ----- ----- ----- ----- ----- -----
Total United States.............. 737 757 795 876 901 889 935
----- ----- ----- ----- ----- ----- -----
EASTERN CANADA
Light crude oil.................... 335 333 321 332 348 328 357
Medium and heavy crude oil......... 83 97 108 96 102 109 87
Natural gas liquids................ 96 101 102 105 100 98 100
----- ----- ----- ----- ----- ----- -----
Total Eastern Canada............. 514 531 531 533 550 535 544
----- ----- ----- ----- ----- ----- -----
Total deliveries................. 1,251 1,288 1,326 1,409 1,451 1,424 1,479
===== ===== ===== ===== ===== ===== =====
BARREL MILES (billions per year)..... 353 358 366 385 384 188 188
===== ===== ===== ===== ===== ===== =====
</TABLE>
Deliveries to U.S. destinations as a percentage of total volumes shipped on
the Lakehead System have increased over the past five years and comprised 62%
of the total volumes shipped on the Lakehead System during 1996. Deliveries to
eastern Canada over the five-year period ended December 31, 1996 have also
increased, but to a lesser extent compared to deliveries to U.S. destinations.
Generally, over the period, higher shipments of medium and heavy crude oil and
NGLs contributed to the higher delivery total. Barrel miles and deliveries
both increased significantly in 1995 due to the completion of the 1994
capacity expansion program.
33
<PAGE>
SOURCES OF SHIPMENTS
Substantially all of the shipments delivered through the Lakehead System
originate in oil fields in the Canadian provinces of Alberta, Saskatchewan,
Manitoba and British Columbia and in the Northwest Territories of Canada. The
shipments reach the Lakehead System from the portion of the System located in
western Canada, which receives its shipments primarily through pipelines owned
and operated by other companies. The Lakehead System also receives U.S. and
Canadian production at Clearbrook (through a connection with Portal Pipe Line
Company, a subsidiary of IPL Energy); U.S. production at Stockbridge and
Lewiston, Michigan; and both U.S. and offshore production in the Chicago area.
Changes in supply from western Canada would directly affect movements through
the IPL System and, therefore, the supply available for transportation through
the Lakehead System.
SUPPLY OF AND DEMAND FOR WESTERN CANADIAN CRUDE OIL
Supply
IPL made application to the NEB in January 1996 to construct its System
Expansion Program Phase II ("IPL SEP II") facilities in Canada which would
complement the SEP II facilities to be constructed by the Partnership in the
United States. As part of that application, IPL submitted a forecast of supply
of western Canadian crude oil and a projection of the markets in which it
could be reasonably expected to be consumed. IPL's forecast, which is based
upon numerous assumptions many of which are beyond the control of IPL or the
Partnership, showed the supply of western Canadian crude oil in the year 2000
at 2,230,000 barrels per day, approximately 258,000 barrels per day above
estimated 1996 average daily production of western Canadian crude oil,
declining to 2,180,000 barrels per day by the year 2005. While acknowledging
the uncertainty associated with forecasts of the supply of crude oil and other
commodities shipped on the IPL System, the NEB accepted as reasonable the
forecasts of the supply of crude oil and other commodities submitted by IPL
and recommended that a certificate for construction be issued.
Demand
Rising crude oil demand and declining inland U.S. domestic production are
contributing to an increasing need for importing crude oil into the PADD II
market. The General Partner believes that PADD II will continue to provide an
excellent market for western Canadian shippers as long as netbacks remain
attractive and additional pipeline capacity is put in place. Moreover, the
General Partner believes that PADD II will remain the most attractive market
for western Canadian supply since it is currently the largest North American
processor of western Canadian heavy crude oil and has the greatest potential
for converting refining capacity from light to heavy crude. At the NEB hearing
at which the IPL SEP II expansion was approved, IPL projected that, with the
construction of the facilities, total western Canadian exports to the United
States would increase to 1,558,000 barrels per day in 2000 and 1,519,000
barrels per day in 2005, approximately 426,000 and 387,000 barrels per day,
respectively, higher than average 1996 exports. Of those exports, PADD II was
projected to receive 1,322,000 barrels per day in 2000 and 1,276,000 barrels
per day in 2005, approximately 452,000 and 406,000 barrels per day,
respectively, higher than average 1996 exports to PADD II.
In the NEB's decision in the IPL SEP II application, the NEB stated that it
was of the view that, with the removal of the market constraint for heavy
crude oil, the PADD II market could absorb additional volumes of western
Canadian crude oil in light of the available refining capacity and the
capability of refiners to process additional heavy crude oil. The NEB noted
that the significant level of support from shippers, provincial governments
and industry organizations demonstrates that markets are available and that
the IPL SEP II facilities will achieve high utilization levels. The NEB
acknowledged that current apportionment of the System indicates that there is
a need for additional capacity and that the new facilities will help to reduce
this apportionment.
CUSTOMERS
The Lakehead System conducts operations without the benefit of exclusive
franchises from government entities or long-term contractual arrangements with
shippers. During 1996, 44 shippers tendered crude oil and
34
<PAGE>
other liquid hydrocarbons for delivery through the Lakehead System. These
customers included integrated oil companies with production facilities in
western Canada and refineries in eastern Canada, major oil companies, refiners
and marketers. Shipments by the top ten shippers during 1996 accounted for
approximately 80% of total revenues during that period. Revenue from Amoco
Corporation (through affiliated companies), Mobil Oil Company of Canada Ltd.
and Imperial Oil Limited accounted for approximately 22%, 13% and 12%,
respectively, of total operating revenue generated by the Lakehead System
during 1996. The remaining shippers each accounted for less than 10% of such
revenue.
COMPETITION
Because pipelines have historically been the lowest cost method for
intermediate and long haul overland movement of crude oil, the System's most
significant existing competitors for the transportation of western Canadian
crude oil are other pipelines. Of the pipelines transporting western Canadian
crude oil out of Canada, the System provides approximately 75% of the total
pipeline design capacity. The remaining 25% of design capacity is shared by
five other pipelines transporting crude oil to British Columbia, Washington,
Montana and other states in the Northwest U.S.
Competition among common carrier pipelines is based primarily on
transportation charges, access to producing areas and proximity to end users.
The General Partner believes that high capital requirements, environmental
considerations and the difficulty in acquiring rights of way and related
permits make it unlikely that a competing pipeline system comparable in size
and scope to the System will be built in the foreseeable future.
Express Pipeline, a joint venture between Alberta Energy Company, Ltd. and
TransCanada Pipelines Limited, has constructed a 170,000 barrel per day
pipeline to carry western Canadian crude oil to the U.S. Rocky Mountain region
and the Patoka/Wood River market area. This pipeline began service in early
1997. The General Partner believes, however, that the System (including the
future Line 14) will be more attractive to western Canadian producers shipping
to the Chicago or Patoka/Wood River market area as it offers lower tolls and
shorter transit times than Express Pipeline and does not require shipper
volume commitments as are required by Express Pipeline.
The System encounters competition in serving shippers to the extent that
shippers have alternate opportunities for transporting liquid hydrocarbons
from their sources to customers. In selecting the destination for their
supplies of crude oil, sellers generally desire to use the alternative that
results in the highest netback to them. Generally, it is expected that
producers will receive the highest netback price from markets served by the
System, but alternate markets may, for periods of time, offer equal or better
returns for the producer. Such markets could potentially include the U.S.
Rocky Mountain region for sweet crude oil and the Washington State market for
light sour crude oil.
In the United States, the Lakehead System encounters competition from other
crude oil and refined product pipelines and other modes of transportation
delivering crude oil and refined products to the refining centers of
Minneapolis-St. Paul, Chicago, Detroit and Toledo and the refinery market and
pipeline hub located in the Patoka/Wood River area. The Lakehead System
transports approximately 45% of all crude oil deliveries into the Chicago
area, 75% of all crude oil deliveries into the Minneapolis-St. Paul area and
virtually all deliveries of crude oil to Ontario.
The IPL System includes a section which extends from Sarnia to Montreal (the
"Montreal Extension" or "Line 9"). The portion of the Montreal Extension from
Sarnia to North Westover, Ontario is currently in west to east service. The
section from North Westover to Montreal has been purged with nitrogen and
remains available for service. IPL and a group of refiners have developed the
Line 9 project so that crude oil imported into eastern Canada through
facilities of Portland Pipe Line Corporation and Montreal Pipe Line Limited
can be transported on Line 9 in an east to west direction from Montreal to the
major refining centers in Ontario. By application dated May 1, 1997, IPL has
petitioned the NEB for authorization to reverse the direction of flow of
35
<PAGE>
the Montreal Extension. A hearing regarding the Line 9 matter commenced in
August 1997, and a decision is expected in the fourth quarter of 1997. While a
reversal of the Montreal Extension would result in IPL or a subsidiary of IPL
becoming a competitor of the Lakehead System for supplying crude oil to the
Ontario market, such a reversal is expressly permitted by the agreements
entered into at the time of formation of the Partnership. A reversal of the
Montreal Extension is not anticipated to have a material adverse impact on the
Partnership, as displaced volumes are expected to be redirected to existing
U.S. markets served by the Partnership. See "Conflicts of Interest and
Fiduciary Responsibilities."
REGULATION
FERC Regulation
The interstate common carrier pipeline operations of the Partnership are
subject to rate regulation by the FERC under the Interstate Commerce Act. The
Interstate Commerce Act requires, among other things, that petroleum products
and crude oil pipeline rates be just, reasonable and nondiscriminatory, and
permits challenges to new, changed and existing rates through either a
"protest" or a "complaint." At the FERC, a protest normally applies only to a
proposed change in a pipeline's rates or practices and subjects the pipeline
to a forward-looking investigation and possible refund obligation if the FERC
chooses to suspend the proposed change. A complaint, by comparison, can apply
either to an existing rate or practice or a proposed change and subjects the
pipeline, in certain circumstances, to possible retroactive liability for past
rates or practices found to be unlawful.
The Energy Policy Act of 1992 required the FERC to issue rules establishing
a simplified and generally applicable ratemaking methodology for oil pipelines
and to streamline procedures in oil pipeline proceedings. In response, the
FERC issued Orders No. 561 and No. 561-A, which prescribe an indexing
methodology for setting rate ceilings beginning in 1995. Rates in effect at
December 31, 1994, if not subject to protest or complaint, became the base
rates for application of the indexing mechanism. The index selected for use is
PPIFG-1. On an ongoing basis, rate ceiling levels are increased or decreased
each July 1, and the PPIFG-1 for use on July 1, 1997 was approximately 1.6%.
Indexed rates are subject both to protests and to complaints, but in either
case, the FERC's existing regulations specify that the party challenging a
rate must show reasonable grounds for asserting that the amount of any rate
increase resulting from application of the index is so substantially in excess
of the actual cost increases incurred by the pipeline as to be unjust and
unreasonable (or that the amount of any rate decrease is so substantially less
than the actual cost decrease incurred by the pipeline that the rate is unjust
and unreasonable).
The Energy Policy Act further deemed certain oil pipeline rates to be "just
and reasonable." This applied to rates that were either in effect for the 365-
day period ended on the date of enactment of the Energy Policy Act or were in
effect on the 365th day preceding enactment and had not been subject to
complaint, protest or investigation during the 365-day period that began
October 25, 1991.
Prior to the indexing methodology, and since 1985, the propriety of crude
oil pipeline rates was generally assessed on the basis of a trended original
cost methodology (FERC Opinion No. 154-B/C). In general, under this cost-based
methodology, crude oil pipeline rates were permitted to generate operating
revenues, based on projected volumes, not greater than the total of the
following components: (i) operating expenses; (ii) depreciation and
amortization; (iii) federal and state income taxes; and (iv) an overall
allowed rate of return on the pipeline's rate base. During the period 1992 to
1996, the Partnership implemented several rate filings in accordance with the
methodology specified in Opinion 154-B/C. See "--Tariffs--Rate Cases."
In Orders No. 561 and No. 561-A, the FERC stated that, as a general rule,
pipelines must utilize the indexing methodology to change rates. The FERC
indicated, however, that it was retaining cost-based ratemaking, market-based
rates and settlements as alternatives to the indexing approach. A pipeline can
follow a cost-based approach when it can demonstrate that there is a
substantial divergence between its actual costs and the rates resulting from
application of the indexing methodology such that rates at the ceiling level
would preclude the pipeline from being able to charge a just and reasonable
rate. In addition, a pipeline can charge
36
<PAGE>
market-based rates if it first establishes that it lacks significant market
power in a particular relevant market, and a pipeline can establish rates
pursuant to a settlement if agreed upon by all current shippers. Initial rates
for new services can be established through a cost-based filing or through an
uncontested agreement between the pipeline and at least one shipper not
affiliated with the pipeline.
In May 1996, the United States Court of Appeals for the District of Columbia
Circuit denied the petitions for review of FERC Orders No. 561 and No. 561-A
filed by the Association of Oil Pipe Lines, the Canadian Association of
Petroleum Producers ("CAPP") and others. No further legal review of these
orders is pending.
Other Regulation
The Operating Partnership and the portion of the Lakehead System in Michigan
are, or may be, subject to the jurisdiction of the Michigan Public Service
Commission with respect to the construction and operation of the pipeline and
the issuance of the Partnership's securities in that state. The Michigan
Public Service Commission does not regulate the tariffs charged for
transportation on the Lakehead System.
International border crossing permits received from the U.S. Government
authorize the Partnership to make and maintain its pipeline crossings of the
international boundary between the United States and Canada. These permits
provide that they may be terminated or amended at the will of the U.S.
Government and that the pipelines they govern may be inspected by, or be
subject to orders issued by, federal or state government agencies.
The governments of the United States and Canada have, by treaty, agreed to
ensure nondiscriminatory treatment with respect to the passage of oil and gas
through the pipelines of one country across the territory of the other.
TARIFFS
Rate Cases
The Partnership had several rate cases pending before the FERC during the
period from 1992 to 1996. On April 1, 1992, the Partnership filed new tariffs
to become effective May 2, 1992. These tariffs were subsequently challenged by
Marysville Fractionation Partnership, CAPP and the Alberta Petroleum Marketing
Commission ("APMC"). The FERC Oil Pipeline Board issued an order suspending
the tariffs for one day and allowing the tariffs to become effective May 3,
1992, subject to investigation and potential refund with interest. Subsequent
to the first filing, the Partnership implemented several other rate changes,
all of which were suspended pending resolution of the first rate proceeding.
CAPP and APMC took several exceptions to the Partnership's tariff filing.
The issues raised included the applicability to the Partnership of the FERC's
Opinion 154-B/C trended original cost methodology, the entitlement of the
Partnership to a starting or transition rate base, and the Partnership's
entitlement to an income tax allowance in its cost of service. In addition,
Marysville Fractionation Partnership's protest challenged the Partnership's
rules and regulations governing the transportation of NGLs and the portion of
the Partnership's rates relating to NGL breakout tankage credits.
In June 1995, the FERC issued a decision ("Opinion No. 397") on the
Partnership's May 1992 tariff rate increase containing both favorable and
unfavorable rulings with respect to the May 1992 rate proceeding. In Opinion
No. 397 the FERC decided:
(1) as provided in FERC Opinion No. 154-B/C, the Partnership's use of the
trended original cost methodology is appropriate, and the Partnership
is entitled to a starting, or transition, rate base;
(2) the Partnership is not entitled to recover in cost of service a tax
allowance with respect to income attributable to individual limited
partners; and
(3) the Partnership's rates in effect on October 24, 1991 were deemed by
the FERC to have been subject to a complaint and are therefore not
deemed "just and reasonable" by the Energy Policy Act. However, for the
purposes of making refunds under Opinion No. 397, the Partnership is
obligated to do so only down to the level of its rates in effect
immediately preceding the May 1992 increase.
37
<PAGE>
The Partnership, CAPP and other parties requested FERC rehearing of Opinion
No. 397. In May 1996, the FERC issued Opinion No. 397-A, which denied the
parties' requests for rehearing of Opinion No. 397. In Opinion No. 397-A, the
FERC clarified several aspects of Opinion No. 397. Specifically, the FERC
further limited the income tax allowance by denying the Partnership's
entitlement to any income tax allowance in connection with "curative
allocations" which cause the General Partner's proportion of taxable income to
be greater than its share of the Partnership's net book income.
In October 1996, the FERC approved the Settlement Agreement between the
Partnership, CAPP and the Alberta Department of Energy ("ADOE") on all
outstanding contested tariff rates. The Settlement Agreement provided for a
tariff rate reduction of approximately 6% and total rate refunds and interest
of $120.0 million through the effective date of October 1, 1996, with interest
accruing thereafter on the unpaid balance. Cash refunds of $41.8 million were
made in the fourth quarter of 1996, with the remaining balance ($79.3 million
at December 31, 1996) to be paid through a 10% reduction of tariff rates after
November 1, 1996. This reduction will continue until all refunds have been
made. Based on the $67.9 million remaining balance at June 30, 1997 and
projected Lakehead System deliveries, the 10% refund credit is expected to
remain effective until sometime during the third or fourth quarter of 1999.
The Settlement Agreement also provides for the terms of an incremental
tariff rate surcharge for a period of 15 years to recover the cost of, and
allow a rate of return on the Partnership's investment in, SEP II. See "--SEP
II Expansion Program." The rate of return on this new line will be based on
the utilization level of the additional capacity constructed. As specified in
the Settlement Agreement, higher utilization will result in a greater rate of
return, subject to a minimum and maximum rate of return of 7.5% and 15.0%,
respectively. Although the FERC has generally approved the Settlement
Agreement, such approval does not constitute a ruling or decision regarding
the merits of future rate filings, including those related to SEP II.
The Settlement Agreement provides that the agreed tariff rates will be
subject to indexing as prescribed by FERC regulation and that CAPP and ADOE
will not challenge any rates within the indexed ceiling for a period of five
years or the 15-year incremental tariff rate surcharges adopted in connection
with SEP II. The Partnership's other customers are not parties to the
Settlement Agreement, and the Settlement Agreement does not prohibit those
customers from filing a protest or complaint against the Partnership's
tariffs.
Subsequent to the Settlement Agreement, the Partnership, CAPP and ADOE
withdrew appeals filed with the U.S. Court of Appeals for the District of
Columbia Circuit in response to the June 1995 FERC decision (Opinion No. 397)
on the Partnership's tariff rates as well as the related May 1996 FERC Opinion
No. 397-A.
Many of the ratemaking issues contested in the Partnership's rate cases, in
particular the FERC's own Opinion 154-B/C methodology, have not previously
been reviewed by a federal appellate court. Any decision ultimately rendered
by the FERC on any Opinion 154-B/C rate case may be subject to judicial
review. Any such judicial review could ultimately result in alternative
ratemaking methodologies that could have a material adverse effect on the
Partnership and its ability to make distributions to the Unitholders. There is
also pending at the FERC a proceeding (SFPP, L.P.) in which the FERC could
further limit its current position related to the tax allowance permitted in
the rates of publicly traded partnerships, as well as possibly altering the
FERC's current application of the Opinion 154-B/C rate methodology. On
September 25, 1997, the administrative law judge in that case issued an
initial decision addressing various aspects of the tax allowance issue as it
affects publicly traded partnerships, as well as various technical issues
involving the application of the Opinion 154-B/C methodology. The SFPP, L.P.
initial decision is subject to review by the FERC on appeal by any party or on
the FERC's own motion. In such a review, it is possible that the FERC could
alter its current rulings on the tax allowance issue or on the application of
the Opinion 154-B/C rate methodology in a way that could, if applied to the
Partnership, have a material adverse impact on the Partnership and its ability
to make distributions to the Unitholders.
38
<PAGE>
Current Tariffs
Under the published tariffs for transportation through the Lakehead System,
the rates for light crude oil from the Canadian border near Neche to principal
delivery points at July 1, 1997 are set forth below. As previously discussed,
the Partnership's published tariffs are subject to a 10% reduction, which will
continue until all rate refunds and interest thereon resulting from the
Settlement Agreement have been paid, which is expected to occur sometime
during the third or fourth quarter of 1999. The published tariffs for light
crude oil, less this 10% reduction, are also set forth below.
<TABLE>
<CAPTION>
PUBLISHED TARIFF PUBLISHED TARIFF PER BARREL
CANADIAN BORDER TO: PER BARREL LESS 10% REDUCTION
------------------- ---------------- ---------------------------
<S> <C> <C>
Clearbrook, Minnesota...... $0.147 $0.132
Superior, Wisconsin........ 0.275 0.248
Chicago, Illinois area..... 0.541 0.487
Canadian border near
Marysville................ 0.617 0.555
Buffalo, New York area..... 0.659 0.593
</TABLE>
The rates at July 1, 1997 for medium and heavy crude oils are higher, while
those for NGLs are lower, than the rates set forth in the above table to
compensate for differences in costs for shipping different grades of liquid
hydrocarbons.
The Partnership finalized an agreement with Mustang Pipe Line Partners in
October 1996 to provide for a joint tariff covering shipments of western
Canadian crude oil to the Patoka/Wood River market area south of Chicago.
These shipments travel on the Lakehead System to Chicago, and on to the
Patoka/Wood River market area through the Mustang pipeline system. The joint
tariff agreement provides for lower transportation costs to shippers desiring
access to the Patoka/Wood River market area, an incentive which the General
Partner believes complements the Partnership's future Line 14 from Superior to
Chicago. A reduction in the Partnership's tariff under the joint tariff
agreement will not become effective until the Partnership's refund obligation
under the Settlement Agreement is extinguished.
39
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS OF THE GENERAL PARTNER
The Registrant is a limited partnership and has no officers, directors or
employees. Set forth below is certain information concerning the directors and
executive officers of the General Partner. As the sole stockholder of the
General Partner, IPL elects the directors of the General Partner on an annual
basis. All officers of the General Partner serve at the discretion of the
directors of the General Partner.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH GENERAL PARTNER
---- --- -----------------------------
<S> <C> <C>
E. C. Hambrook........................... 60 Chairman and Director
P. D. Daniel............................. 51 President and Director
R. C. Sandahl............................ 46 Vice President and Director
F. W. Fitzpatrick........................ 64 Director
B. F. MacNeill........................... 58 Director
C. A. Russell............................ 63 Director
D. P. Truswell........................... 54 Director
J. R. Bird............................... 48 Treasurer
M. A. Maki............................... 33 Chief Accountant
P. W. Norgren............................ 44 Secretary
</TABLE>
Mr. Hambrook was elected a Director of the General Partner in January 1992
and has served as Chairman of the General Partner since July 1996. He also
serves on the Audit Committee. Mr. Hambrook is the President of Hambrook
Resources Inc.
Mr. Daniel has served as President and a Director of the General Partner
since July 1996. Mr. Daniel has served as Executive Vice President and Chief
Operating Officer--Energy Transportation Services of IPL Energy since
September 1, 1997. He served as Senior Vice President of IPL Energy from May
1994 to August 1997. Mr. Daniel served as President and Chief Executive
Officer of IPL from August 1996 to August 1997 and as President and Chief
Operating Officer of IPL from May 1994 to August 1996. Prior thereto, he
served as Vice President, Planning of IPL Energy.
Mr. Sandahl has served as Vice President and a Director of the General
Partner since July 1996. He served as Vice President, Operations of the
General Partner from May 1994 to August 1996. Prior thereto, he was employed
by IPL for six years where he served in various capacities, most recently as
Director of Engineering Services from June 1990 to May 1994.
Mr. Fitzpatrick was elected a Director of the General Partner in April 1993
and serves on the Audit Committee. He is also a Director of IPL Energy and
serves as Chairman of the Audit, Finance and Risk Committee of the Board of
IPL Energy.
Mr. MacNeill has served as a Director of the General Partner since May 1990
and previously served as Chairman and Chief Executive Officer of the General
Partner from May 1994 to July 1996. From May 1991 to May 1994, he served as
President and Chief Executive Officer of the General Partner. Mr. MacNeill has
served as Chief Executive Officer, President and a Director of IPL Energy
since December 1992 and as Chairman of IPL since August 1996. He was Chairman
and Chief Executive Officer of IPL from May 1994 to August 1996. Prior
thereto, he served as President and Chief Executive Officer of IPL from May
1991 to May 1994.
Mr. Russell was elected a Director of the General Partner in October 1985
and serves as the Chairman of the Audit Committee. Mr. Russell served as
Chairman and Chief Executive Officer of Norwest Bank Minnesota North, N.A. for
1995. Prior thereto, he served as President of Norwest Bank Minnesota North,
N.A. He also served as a Director of Minnesota Power and Light Co. until May
1996.
Mr. Truswell was elected a Director of the General Partner in May 1991 and
previously served as a Vice President of the General Partner from October 1991
to May 1994. Mr. Truswell has served as Senior Vice President and Chief
Financial Officer of IPL Energy since May 1994 and prior thereto, as Vice
President, Finance
40
<PAGE>
from 1992 to May 1994. Prior thereto, he served in various senior executive
capacities with IPL, including as Vice President, Finance from May 1991 to May
1994.
Mr. Bird has served as Treasurer of the General Partner since October 1996.
He has served as Senior Vice President--Corporate Planning and Development of
IPL Energy since September 1, 1997. He served as Vice President and Treasurer
of IPL Energy from February 1995 to August 1997. Prior thereto, Mr. Bird was
employed by Gulf Canada Resources Ltd. as Vice President, Treasury and
Corporate Development from April 1993 to January 1995. Prior thereto, he was
employed by GW Utilities Ltd. as Vice President and Controller.
Mr. Maki has served as Chief Accountant of the General Partner since June
1997. Prior thereto, he held supervisory and professional positions with the
General Partner or IPL Energy (U.S.A.) Inc. ("IPL Energy (USA)") in the areas
of Internal Audit, Rate Regulation and Accounting.
Mr. Norgren has served as Secretary of the General Partner since July 1996.
Prior thereto, he served as Assistant Secretary of the General Partner, from
May 1990 to July 1996, and as General Counsel of the General Partner, from
October 1992 to December 1995.
41
<PAGE>
CASH DISTRIBUTIONS
GENERAL
A principal objective of the Partnership is to generate cash from
Partnership operations and to distribute Available Cash to the Unitholders and
the General Partner in the manner described herein. "Available Cash" means
generally, with respect to any calendar quarter, the sum of all of the cash
receipts of the Partnership plus net reductions to reserves less all of its
cash disbursements and net additions to reserves. The full definition of
Available Cash is set forth in the Glossary of Defined Terms. The definition
of Available Cash permits the General Partner to establish cash reserves that
it determines are necessary or appropriate to provide for the proper conduct
of the business of the Partnership (including cash reserves for future capital
expenditures), to stabilize distributions of cash to the Unitholders and the
General Partner or as necessary to comply with the terms of any agreement or
obligation of the Partnership. The General Partner has broad discretion in
establishing reserves, and its decisions regarding reserves could have a
significant impact on the amount of Available Cash. The timing of additions
and reductions to reserves may impact the amount of incentive distributions
payable to the General Partner and may result in the realization of taxable
income by Unitholders in a year prior to that in which funds related thereto
are distributed.
The Partnership will distribute 100% of its Available Cash as of the end of
each calendar quarter on or about 45 days after the end of such calendar
quarter to Unitholders of record on the applicable record date, which will
generally be the last day of the month following the close of such calendar
quarter, and to the General Partner.
Cash distributions will be characterized as either distributions of Cash
from Operations or Cash from Interim Capital Transactions. This distinction
affects the amounts distributed to the Unitholders relative to the General
Partner. See "--Quarterly Distributions of Available Cash--Distributions of
Cash from Operations" and "--Quarterly Distributions of Available Cash--
Distributions of Cash from Interim Capital Transactions" below. Cash from
Operations, which is determined on a cumulative basis, generally refers to the
$54 million cash balance of the Partnership on the date the Partnership
commenced operations in 1991, plus all cash generated by the operations of the
Partnership's business, after deducting related cash expenditures, reserves
and certain other items. Cash from Interim Capital Transactions will generally
be generated only by (i) borrowings and sales of debt securities by the
Partnership (other than for working capital purposes and other than for items
purchased on open account in the ordinary course of business), (ii) sales of
equity interests in the Partnership for cash and (iii) sales or other
voluntary or involuntary dispositions of any assets of the Partnership for
cash (other than inventory, accounts receivable and other current assets and
assets disposed of in the ordinary course of business). References to the
Partnership in the foregoing summary definitions of Cash from Operations and
Cash from Interim Capital Transactions are to the Partnership and the
Operating Partnership on a combined basis. The full definitions of Cash from
Operations, Interim Capital Transactions and Cash from Interim Capital
Transactions are set forth in the Glossary of Defined Terms.
Amounts of cash distributed by the Partnership on any date from any source
will be treated as a distribution of Cash from Operations, until the sum of
all amounts so distributed to the Unitholders and to the General Partner
(including any incentive distributions) equals the aggregate amount of all
Cash from Operations from the date the Partnership commenced operations in
1991 ("Partnership Inception") through the end of the calendar quarter prior
to such distribution. Any amount of cash (irrespective of its source)
distributed on such date in excess of the aggregate amount of all Cash from
Operations from Partnership Inception through the calendar quarter prior to
such distribution will be deemed to constitute Cash from Interim Capital
Transactions and distributed accordingly. See "--Quarterly Distributions of
Available Cash--Distributions of Cash from Interim Capital Transactions" and
"--Adjustment of the Target Distributions." If cash that is deemed to
constitute Cash from Interim Capital Transactions is distributed in respect of
each Class A Common Unit offered hereby in an aggregate amount per Class A
Common Unit equal to $21.50 (the offering price of the Class A Common Units in
the Partnership's initial public offering in December 1991), the distinction
between Cash from Operations and Cash from Interim Capital Transactions will
cease, and all cash will, in general, be distributed as Cash from
42
<PAGE>
Operations. The General Partner does not anticipate that there will be
significant amounts of cash that are deemed to constitute Cash from Interim
Capital Transactions distributed to the Unitholders.
Capital expenditures that are necessary to maintain the service capability
of the Lakehead System will reduce the amount of Cash from Operations.
Therefore, if the General Partner were to determine that a substantial portion
of the Partnership's capital expenditures was of a nature necessary to
maintain the service capability of the Lakehead System, the amount of cash
distributions that are deemed to constitute Cash from Operations might
decrease and the amount of cash distributions that are deemed to constitute
Cash from Interim Capital Transactions might increase.
QUARTERLY DISTRIBUTIONS OF AVAILABLE CASH
The Partnership will make distributions to its Unitholders and the General
Partner with respect to each calendar quarter prior to liquidation in an
amount equal to 100% of its Available Cash for such quarter. Actual quarterly
distributions of Available Cash will depend on the Partnership's future
performance.
Distributions of Cash from Operations
Distributions by the Partnership of Available Cash constituting Cash from
Operations with respect to any calendar quarter will be made in the following
manner:
first, 98% to all Unitholders, pro rata, and 2% to the General Partner,
until all Unitholders have received distributions of $0.59 per Unit for
such quarter (the "First Target Distribution");
second, 85% to all Unitholders, pro rata, and 15% to the General Partner,
until all Unitholders have received distributions of $0.70 per Unit for
such quarter (the "Second Target Distribution");
third, 75% to all Unitholders, pro rata, and 25% to the General Partner,
until all Unitholders have received distributions of $0.99 per Unit for
such quarter (the "Third Target Distribution"); and
thereafter, 50% to all Unitholders, pro rata, and 50% to the General
Partner.
The following table illustrates the percentage allocation of Available Cash
among the Unitholders and the General Partner up to the various target
distribution levels.
<TABLE>
<CAPTION>
MARGINAL PERCENTAGE
INTEREST IN DISTRIBUTIONS
------------------------------
QUARTERLY DISTRIBUTION GENERAL
AMOUNT UP TO UNITHOLDERS PARTNER
---------------------- -------------- ------------
<S> <C> <C> <C>
First Target
Distribution........... $0.59 98% 2%
Second Target
Distribution........... $0.70 85% 15%
Third Target
Distribution........... $0.99 75% 25%
Thereafter.............. -- 50% 50%
</TABLE>
The Target Distributions are each subject to adjustment as described below
under "--Distributions of Cash from Interim Capital Transactions" and "--
Adjustment of the Target Distributions." Notwithstanding the foregoing, if the
Target Distributions have been reduced to zero as a result of distributions of
Available Cash constituting Cash from Interim Capital Transactions,
distributions will first be made 98% to all Class A Common Unitholders, pro
rata, and 2% to the General Partner until there has been distributed in
respect of each Class A Common Unit then outstanding (taking into account all
prior distributions of Available Cash constituting Cash from Operations)
Available Cash constituting Cash from Operations since Partnership Inception
in an amount equal to the First Target Distribution for all periods since
Partnership Inception.
Distributions of Cash from Interim Capital Transactions
Distributions on any date by the Partnership of Available Cash constituting
Cash from Interim Capital Transactions will be distributed 98% to all
Unitholders, pro rata, and 2% to the General Partner until a hypothetical
holder of a Class A Common Unit acquired at the time of the closing of the
Partnership's initial
43
<PAGE>
public offering in December 1991 has received with respect to such Class A
Common Unit distributions of Available Cash constituting Cash from Interim
Capital Transactions in an amount per Class A Common Unit equal to $21.50.
Thereafter, all distributions of Available Cash constituting Cash from Interim
Capital Transactions will be distributed as if they were Cash from Operations,
and because the Target Distributions will have been reduced to zero, as
described under "--Adjustment of the Target Distributions," the General
Partner's share of distributions of Available Cash will increase, in general,
to 50% of all distributions of Available Cash. Notwithstanding the foregoing,
if the Target Distributions have been reduced to zero as a result of
distributions of Available Cash constituting Cash from Interim Capital
Transactions, distributions will first be made 98% to all Class A Unitholders
and 2% to the General Partner until there has been distributed in respect of
each Class A Common Unit then outstanding (taking into account all prior
distributions of Available Cash constituting Cash from Operations) Available
Cash constituting Cash from Operations since Partnership Inception in an
amount equal to the First Target Distribution for all periods since
Partnership Inception.
Distributions of Cash from Interim Capital Transactions will not reduce
Target Distributions in the quarter in which they are distributed.
ADJUSTMENT OF THE TARGET DISTRIBUTIONS
The Target Distributions will be proportionately adjusted in the event of
any combination or subdivision of Units (whether effected by a distribution
payable in Units or otherwise) but not by reason of the issuance of additional
Units for cash. In addition, if a distribution is made of Available Cash
constituting Cash from Interim Capital Transactions, the Target Distributions
will be adjusted downward by multiplying each amount, as the same may have
been previously adjusted, by a fraction, the numerator of which is the
Unrecovered Initial Unit Price (as defined below) immediately after giving
effect to such repayment and the denominator of which is the Unrecovered
Initial Unit Price immediately prior to such repayment. The "Unrecovered
Initial Unit Price" is the amount by which $21.50 exceeds the aggregate per
Unit distributions of Cash from Interim Capital Transactions on the Class A
Common Units. If and when the Unrecovered Initial Unit Price is zero, the
Target Distributions each will have been reduced to zero.
The Target Distributions may also be adjusted if legislation is enacted that
causes the Partnership to become taxable as a corporation or otherwise
subjects the Partnership to taxation as an entity for federal income tax
purposes. In such event, the Target Distributions for each quarter thereafter
would be reduced to an amount equal to the product of (i) each of the Target
Distributions multiplied by (ii) one minus the sum of (x) the effective
federal income tax rate to which the Partnership is subject as an entity
(expressed as a fraction) plus (y) the effective overall state and local
income tax rate to which the Partnership is subject as an entity (expressed as
a fraction) for the taxable year in which such quarter occurs.
DISTRIBUTION OF CASH UPON LIQUIDATION
Following the commencement of the dissolution and liquidation of the
Partnership, assets will be sold or otherwise disposed of, and the partners'
capital account balances will be adjusted to reflect any resulting gain or
loss. The proceeds of such liquidation will, first, be applied to the payment
of creditors of the Partnership in the order of priority provided in the
Partnership Agreement and by law, and thereafter be distributed to the
Unitholders and the General Partner in accordance with their respective
capital account balances, as so adjusted.
Generally, the holders of Class A Common Units will have no preference over
the General Partner or holders of Class B Common Units upon the dissolution
and liquidation of the Partnership and will instead be entitled to share with
the General Partner and such holders in the remainder of the Partnership's
assets in proportion to their respective capital account balances in the
Partnership as so adjusted. The manner of such adjustment is as provided in
the Partnership Agreement. Any gain (or unrealized gain attributable to assets
distributed in kind) will be allocated to the partners as follows:
first, to each partner having a deficit balance in such partner's capital
account to the extent of and in proportion to such deficit balance;
44
<PAGE>
second, any remaining gain would be allocated 98% to all Unitholders, pro
rata, and 2% to the General Partner, until the capital account for each
Class A Common Unit is equal to the Unrecovered Capital in respect of such
Class A Common Unit;
third, any then remaining gain would be allocated 98% to the holders of
Class B Common Units, pro rata, and 2% to the General Partner until the
capital account for each Class B Common Unit is equal to the Unrecovered
Capital in respect of such Class B Common Unit;
fourth, any then remaining gain would be allocated 98% to all
Unitholders, pro rata, and 2% to the General Partner until the capital
account for each Unit is equal to the sum of the Unrecovered Capital in
respect of such Unit plus any cumulative arrearages then existing in the
First Target Distribution in respect of such Unit for each quarter of the
Partnership's existence;
fifth, any then remaining gain would be allocated 85% to all Unitholders,
pro rata, and 15% to the General Partner until the capital account for each
Unit is equal to the sum of (a) the Unrecovered Capital in respect of such
Unit, plus (b) any cumulative arrearages then existing in the First Target
Distribution in respect of such Unit, plus (c) the excess of the Second
Target Distribution over the First Target Distribution for each quarter of
the Partnership's existence, less (d) the amount of any distributions of
Available Cash constituting Cash from Operations in respect of such Unit in
excess of the First Target Distribution that were distributed 85% to the
Unitholders pro rata and 15% to the General Partner for each quarter of the
Partnership's existence ((b) plus (c) less (d) being the "Target Amount");
sixth, any then remaining gain would be allocated 75% to all Unitholders,
pro rata, and 25% to the General Partner, until the capital account for
each Unit is equal to the sum of (a) the Unrecovered Capital in respect of
each Unit, plus (b) the Target Amount, plus (c) the excess of the Third
Target Distribution over the Second Target Distribution for each quarter of
the Partnership's existence, less (d) the amount of any distributions of
Available Cash constituting Cash from Operations in respect of such Unit in
excess of the Second Target Distribution that were distributed 75% to the
Unitholders pro rata and 25% to the General Partner for each quarter of the
Partnership's existence; and
thereafter, any then remaining gain would be allocated 50% to all
Unitholders, pro rata, and 50% to the General Partner.
Unrecovered Capital with respect to a Unit means, in general, the amount
equal to the excess of (i) $21.50 over (ii) the aggregate per Unit
distributions of Cash from Interim Capital Transactions in respect of such
Unit. Any loss or unrealized loss will be allocated to the partners first in
proportion to the positive balances in the General Partner's and Unitholders'
capital accounts until all such balances are reduced to zero, and, thereafter,
to the General Partner.
45
<PAGE>
CONFLICTS OF INTEREST AND FIDUCIARY RESPONSIBILITIES
Certain conflicts of interest could arise as a result of the relationships
among IPL and its affiliates, the General Partner and the Partnership. The
General Partner makes all decisions relating to the Partnership. Some of the
officers of the General Partner who make such decisions may also be officers
of IPL and its affiliates. The Partnership does not have any employees. In
addition, IPL owns all of the capital stock of the General Partner. The
directors and officers of IPL have fiduciary duties to manage IPL, including
its investments in its subsidiaries (including the General Partner) and
affiliates, in a manner beneficial to the shareholders of IPL and its parent,
IPL Energy. In general, the General Partner has a fiduciary duty to manage the
Partnership in a manner beneficial to the Unitholders. However, the
Partnership Agreement contains provisions that allow the General Partner to
take into account the interests of parties in addition to the Partnership and
the Unitholders in resolving conflicts of interest and provisions that may
restrict the remedies available to Unitholders for actions taken that might
otherwise constitute breaches of fiduciary duty. The duty of the directors and
officers of the General Partner and IPL to their shareholders and affiliates
may, therefore, come into conflict with the duties of the General Partner to
the Unitholders.
Potential conflicts of interest could arise in the situations described
below, among others:
(a) Because of the definitions of Available Cash and Cash from Operations
set forth elsewhere herein, the amount of cash expenditures, borrowings and
reserves in any quarter may affect whether or the extent to which there is
sufficient Available Cash constituting Cash from Operations to make
distributions on the Units in such quarter or subsequent quarters. In
addition, the General Partner's determination whether to make, or which
portion of a capital expenditure constitutes, a capital expenditure that is
for the purpose of ongoing maintenance or that is necessary to maintain the
service capability of the Lakehead System may have the same effect.
Borrowings and issuances of additional Units also increase the amount of
Available Cash and, in the case of working capital borrowings, the amount
of Cash from Operations. The Partnership Agreement provides that any
borrowings by the Partnership or the Operating Partnership, or the approval
thereof by the General Partner, shall not constitute a breach of any duty
by the General Partner to the Partnership or the Unitholders, including
borrowings that have the purpose or effect, directly or indirectly, of
enabling the General Partner to receive incentive distributions. Further,
any actions taken by the General Partner consistent with the standards of
reasonable discretion set forth in the definitions of Available Cash, Cash
from Operations and Interim Capital Transactions will be deemed not to
breach any duty of the General Partner to the Partnership or the
Unitholders. See "Cash Distributions."
(b) Under the terms of the Partnership Agreement and the Amended and
Restated Agreement of Limited Partnership of the Operating Partnership (the
"Operating Partnership Agreement" and, together with the Partnership
Agreement, the "Partnership Agreements"), the General Partner will exercise
its discretion in managing the business of the Partnership and, as a
result, the General Partner is not restricted from paying IPL or its
affiliates for any services rendered on terms fair and reasonable to the
Partnership. In this connection, the General Partner will determine which
of its direct or indirect costs (including costs allocated to the General
Partner by IPL and its affiliates) are reimbursable by the Partnership.
Employees of IPL and its affiliates currently provide services to the
General Partner for the benefit of the Partnership pursuant to a services
agreement (the "Services Agreement") between IPL, IPL Energy USA and the
General Partner. Substantially all of the shipments of crude oil and
natural gas liquids delivered by the Lakehead System originate in the IPL
System, and all scheduling of shipments (including routes and storage) is
handled by IPL in coordination with the General Partner.
(c) The General Partner has certain varying percentage interests and
priorities with respect to Available Cash. See "Cash Distributions." The
timing and amount of cash receipts may be affected by various
determinations made by the General Partner under the Partnership Agreements
(including, for example, those relating to the timing of any capital
transaction, the establishment and maintenance of reserves, the timing of
expenditures, the incurrence of debt and other matters).
(d) Neither of the Partnership Agreements nor any of the other
agreements, contracts and arrangements between the Partnership, on the one
hand, and the General Partner, IPL and its affiliates, on the other hand,
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were or will be the result of arm's-length negotiations. The interests of
the holders of the Class A Common Units have not been represented by
separate legal counsel in connection with the preparation of such
agreements, contracts or arrangements.
(e) The decision whether the Partnership or the General Partner should
purchase outstanding Units at any time may involve the General Partner or
IPL in a conflict of interest.
(f) IPL and its affiliates (other than Lakehead) are expressly permitted
by the terms of the Partnership Agreement to engage in any businesses and
activities, including in certain instances, those in direct competition
with the Partnership except as described below. In this connection, IPL is
currently proposing an alternative use for the portion of the IPL System
from Sarnia to Montreal, including a reversal of the line to transport
crude oil from Montreal to Sarnia. The reversal of the line would result in
IPL or an affiliate of IPL becoming a competitor for supplying crude oil to
the Ontario market. See "Business--Competition."
(g) The Partnership and the General Partner do not have any employees and
rely solely on employees of IPL Energy USA, and its affiliates, including
IPL. Although the General Partner conducts no business other than as
general partner of the Partnership and the Operating Partnership and
managing certain subsidiaries and ancillary activities, IPL, IPL Energy USA
and their other affiliates conduct business and activities of their own in
which the Partnership has no economic interest. There may be competition
between the Partnership and IPL and its affiliates for the time and effort
of a small number of employees who provide services to the General Partner.
(h) As a matter of practice and whenever possible, the General Partner
limits the liability under contractual arrangements of the Partnership to
all or particular assets of the Partnership, with the other party thereto
to have no recourse against the General Partner or its assets other than
its interest in the Partnership. In some circumstances, such action of the
General Partner may result in the terms of the transaction being less
favorable to the Partnership than would otherwise be the case. The
Partnership Agreement provides that such action does not constitute a
breach of the General Partner's fiduciary obligations.
(i) The General Partner generally must act as a fiduciary to the
Partnership and the Unitholders, and, therefore, must generally consider
the best interests of the Partnership when deciding whether to make capital
or operating expenditures or take other steps with respect to the business
of the Partnership.
(j) The Partnership is, and may from time to time in the future be, a
party to various agreements to which the General Partner and its
affiliates, including IPL, are also parties and that provide certain
benefits to the Partnership. However, these agreements do not grant to the
holders of the Class A Common Units, separate and apart from the
Partnership, the right to enforce the obligations of the General Partner or
of such affiliates in favor of the Partnership. Therefore, the General
Partner is primarily responsible for enforcing such obligations, including
obligations that it or such affiliates may owe to the Partnership.
RESTRICTIONS ON GENERAL PARTNER ACTIVITY
The General Partner is subject to certain restrictions on its activities.
The sole business of the General Partner is to act as general partner of the
Partnership and the Operating Partnership, to manage certain subsidiaries and
to undertake ancillary activities. Further, the Partnership Agreement provides
that no subsidiary of the General Partner will engage in or acquire any
business that is in direct material competition with the business of the
Partnership as conducted at the time of its formation in 1991, subject to the
exceptions set forth below. None of the instruments to which the Partnership
or the Operating Partnership is a party imposes any restriction on the ability
of IPL and its affiliates, other than the General Partner, to engage in any
business. IPL agreed, however, in the Distribution Support Agreement that so
long as an affiliate of IPL is the general partner of the Partnership and the
Operating Partnership, IPL and its other subsidiaries will not engage in or
acquire any business that is in direct material competition with the business
of the Partnership as conducted at the time of its formation in 1991, subject
to the following important exceptions:
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first, there is no restriction on the ability of IPL and its other
subsidiaries to continue to engage in businesses, including the normal
development of those businesses in the future, in which they were engaged
at the time of the Partnership's formation in 1991 and that are or may be
in the future in competition with the Partnership, including, without
limitation, the potential reversal of the Montreal Extension to transport
crude oil from Montreal to Sarnia (see "Business--Competition");
second, the scope of the competition restriction is limited
geographically to those routes and products in respect of which the
Partnership provided transportation as of December 1991. For example, IPL
and its other subsidiaries would be permitted to acquire a crude oil
pipeline business in which transportation is made over routes or involving
products not served by the Partnership as of December 1991;
third, IPL and its other subsidiaries may acquire any competitive
business as part of a larger acquisition so long as the majority of the
value of the business or assets acquired, in IPL's judgement, is not
attributable to such competitive business; and
fourth, IPL and its other subsidiaries may acquire any competitive
business if the same is first offered for acquisition to the Partnership
and the Partnership fails to approve, after submission to a Unitholder
vote, the making of such acquisition. The approval of the holders of a
majority of the outstanding Units (excluding for this purpose any Units
held by the General Partner or any of its affiliates) is required for the
Partnership to exercise its right to accept such an offer.
Except as specified above, IPL and its affiliates are not restricted by the
terms of the Distribution Support Agreement or the Partnership Agreements from
engaging in businesses that may be in competition with the Partnership. In
addition, the Partnership Agreement specifically states that it will not
constitute a breach of the General Partner's fiduciary duty for IPL or its
other subsidiaries to take advantage of any business opportunity in preference
to or to the exclusion of the Partnership, except as specifically limited by
the restrictions described above.
FIDUCIARY RESPONSIBILITIES OF THE GENERAL PARTNER
The General Partner is generally accountable to the Partnership and to the
Unitholders as a fiduciary. Consequently, the General Partner must exercise
good faith and integrity in handling the assets and affairs of the
Partnership. In contrast to the relatively well developed state of the law
concerning fiduciary duties owed by officers and directors to the shareholders
of a corporation, the law concerning the duties owed by general partners to
the other partners and to their partnerships is relatively undeveloped. The
Delaware Act provides that Delaware limited partnerships may, in their
partnership agreements, restrict or expand the fiduciary duties that might
otherwise be applied by a court in analyzing the standard of duty owed by
general partners to limited partners. The Partnership Agreement, as permitted
by the Delaware Act, contains various provisions that have the effect of
restricting the fiduciary duties that might otherwise be owed by the General
Partner to the Partnership and its partners. In addition, holders of Class A
Common Units are deemed to have consented to certain actions and conflicts of
interest that might otherwise be deemed a breach of fiduciary or other duties
under state law.
The Partnership Agreement provides that whenever a conflict of interest
arises between the General Partner or its affiliates, on the one hand, and the
Partnership or any Unitholder, on the other hand, the General Partner will be
authorized, in resolving such conflict or determining such action, to consider
the relative interests of the parties involved in such conflict or affected by
such action, any customary or accepted industry practices, if applicable,
generally accepted accounting or engineering practices or principles and such
additional factors as the General Partner determines in its sole discretion to
be relevant, reasonable or appropriate under the circumstances. The same
considerations will apply whenever the Partnership Agreement requires the
General Partner to act in a manner that is fair and reasonable to the
Partnership or the Unitholders. Thus, unlike the strict duty of a trustee who
must act solely in the best interests of his beneficiary, the Partnership
Agreement permits the General Partner to consider the interests of all parties
to a conflict of interest, including the interests of the General Partner and
its affiliates, including IPL. The Partnership Agreement also provides that in
certain
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circumstances the General Partner will act in its sole discretion, in good
faith or pursuant to other appropriate standards.
The Partnership Agreement also provides that any standard of care and duty
imposed thereby or any applicable law, rule or regulation will be modified,
waived or limited as required to permit the General Partner to act under the
Partnership Agreement, or any other agreement contemplated therein, and to
make any decision pursuant to the authority prescribed in the Partnership
Agreement so long as such action is reasonably believed by the General Partner
to be in the best interests of the Partnership. Further, the Partnership
Agreement provides that the General Partner will not be liable for monetary
damages to the Partnership, the Unitholders or assignees for errors of
judgement or for any other acts or omissions if the General Partner acted in
good faith. The Partnership is required, under the terms of the Partnership
Agreement, to indemnify the General Partner and its officers, directors,
employees and agents against liabilities, costs and expenses, if the General
Partner or such persons acted in good faith and in a manner they reasonably
believed to be in, or not opposed to, the best interests of the Partnership
and, with respect to any criminal proceeding, had no reasonable cause to
believe their conduct was unlawful. This indemnification provision could
include indemnification of the General Partner for its negligent acts.
The Delaware Act provides that a limited partner may institute legal action
on behalf of the partnership (a partnership derivative action) to recover
damages from a third party where the general partner has refused to institute
the action or where an effort to cause the general partner to do so is not
likely to succeed. In addition, the statutory or case law of certain
jurisdictions may permit a limited partner to institute legal action on behalf
of himself or all other similarly situated limited partners (a class action)
to recover damages from a general partner for violations of its fiduciary
duties to the limited partners.
The fiduciary obligations of general partners is a developing area of the
law. The provisions of the Delaware Act that allow the fiduciary duties of a
general partner to be waived or restricted by a partnership agreement have not
been tested in a court of law, and the General Partner has not obtained an
opinion of counsel covering the provisions set forth in the Partnership
Agreement that purport to waive or restrict fiduciary duties of the General
Partner. Unitholders should consult their own legal counsel concerning the
fiduciary responsibilities of the General Partner and its officers and
directors and the remedies available to Unitholders.
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TAX CONSIDERATIONS
This section is a summary of certain federal income tax considerations that
may be relevant to prospective Unitholders and, to the extent set forth below
under "--Legal Opinions and Advice," represents the opinion of Andrews & Kurth
L.L.P., counsel to the Partnership ("Counsel"), insofar as it relates to
matters of law and legal conclusions. This section is based upon current
provisions of the Internal Revenue Code of 1986, as amended ("Code"), existing
and (to the extent noted) proposed regulations thereunder and current
administrative rulings and court decisions, all of which are subject to
change. Subsequent changes may cause the tax consequences to vary
substantially from the consequences described below. Unless the context
otherwise requires, references in this section to "Partnership" are references
to both the Partnership and the Operating Partnership.
No attempt has been made in the following discussion to comment on all
federal income tax matters affecting the Partnership or the Unitholders.
Moreover, the discussion focuses on Unitholders who are individual citizens or
residents of the United States and has only limited applications to
corporations, estates, trusts or non-resident aliens. Accordingly, each
prospective Unitholder should consult, and should depend on, his own tax
advisor in analyzing the federal, state, local and foreign tax consequences to
him of the purchase, ownership or disposition of Units.
LEGAL OPINIONS AND ADVICE
Counsel has expressed its opinion that, based on the representations and
subject to the qualifications set forth in the detailed discussion that
follows, for federal income tax purposes, (i) the Partnership will be treated
as a partnership, and (ii) owners of Units (with certain exceptions, as
described in "--Limited Partner Status" below) will be treated as partners of
the Partnership (but not the Operating Partnership). In addition, all
statements as to matters of law and legal conclusions contained in this
section, unless otherwise noted, reflect the opinion of Counsel. Counsel has
also advised the General Partner that, based on current law, the following
addresses all material tax consequences to Unitholders who are individual
citizens or residents of the United States from the purchase, ownership and
disposition of Units.
PARTNERSHIP STATUS
An organization, such as a limited partnership, that is classified for
federal income tax purposes as a partnership is not a taxable entity and
incurs no federal income tax liability. Each partner is required to take into
account in computing his federal income tax liability his allocable share of
income, gains, losses, deductions and credits of the Partnership, regardless
of whether cash distributions are made. Distributions by a partnership to a
partner are generally not taxable unless the amount of the distribution is in
excess of the partner's adjusted tax basis in his partnership interest.
Counsel is of the opinion that, under current law and regulations, the
Partnership and the Operating Partnership and the Services Partnership will
each be classified as a partnership for federal income tax purposes. Counsel's
opinion with respect to periods before 1997 depended on different factual
matters which the General Partner believes are true. Counsel has rendered its
opinion as to taxable years beginning after 1996 relying on the accuracy of
the following factual matters as to which the General Partner has made
representations:
1. Neither the Partnership, the Operating Partnership nor the Services
Partnership will elect to be treated as an association or corporation.
2. The Partnership, the Operating Partnership and the Services
Partnership will be operated in accordance with applicable state
partnership statutes and the applicable Partnership Agreements and the
partnership agreement of the Services Partnership.
3. At least 90% of the Partnership's gross income for each taxable year
will consist of (i) income or gain derived from the exploration,
development, production, processing, refining, transportation or
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marketing of oil, gas or products thereof or (ii) other items of
"qualifying income" within the meaning of Section 7704(d) of the Code.
Counsel's opinion as to the classification of the Partnership is based on
the assumption that if the General Partner ceases to be a general partner, any
successor general partner (or general partners) will make and satisfy such
representations. In this regard, if the General Partner were to withdraw as a
general partner at a time when there is no successor general partner, or if
the successor general partner could not satisfy the above representations,
then the IRS might attempt to classify the Partnership as an association
taxable as a corporation.
Counsel's opinion as to the partnership status of the Partnership is based
principally upon its interpretation of Treasury regulations under Section 7701
of the Code and Section 7704 of the Code, and upon the continuing accuracy of
those matters as to which representations have been made by the General
Partner.
Section 7704 of the Code provides that publicly traded partnerships will, as
a general rule, be taxed as corporations. Section 7704 of the Code provides an
exception to its general rule (the "Natural Resource Exception") in the case
of a publicly traded partnership if 90% or more of its gross income for every
taxable year consists of "qualifying income." Whether the Partnership will
continue to meet the Natural Resource Exception is a matter to be determined
by the Partnership's operations and the facts existing at the time of
determination. However, the General Partner will use its best efforts to cause
the Partnership to operate in such fashion as necessary for the Partnership to
continue to meet the Natural Resource Exception.
If the Partnership fails to meet the Natural Resource Exception (other than
a failure determined by the IRS to be inadvertent which is cured within a
reasonable time after discovery), the Partnership will be treated as if it had
transferred all of its assets (subject to liabilities) to a newly formed
corporation (on the first day of the year in which it fails to meet the
Natural Resource Exception) in return for stock in such corporation, and then
distributed such stock to the partners in liquidation of their interest in the
Partnership. This contribution and liquidation should be tax-free to
Unitholders and the Partnership, so long as the Partnership, at such time,
does not have liabilities in excess of the basis of its assets. Thereafter,
the Partnership would be treated as a corporation.
If the Partnership is treated as a corporation, the Partnership will be
treated as a separate taxpayer and its income, gains, losses, deductions and
credits would be reported on its own return instead of being passed through
directly to Unitholders. The Partnership's net income would be subject to
federal income tax, under current law, at rates up to 35%. Distributions made
to Unitholders generally would be treated as either a taxable dividend of
current and accumulated earnings and profits or, in the absence of earnings
and profits, as a nontaxable return of capital (to the extent of the
Unitholder's basis in his Units) or as taxable capital gain (after the
Unitholder's basis in his Units is reduced to zero, and assuming that the
Units are held as capital assets). Accordingly, treatment of the Partnership
as a corporation would result in a material reduction in a Unitholder's cash
flow and after-tax return.
Counsel's own opinion is based upon currently applicable law and regulations
and, accordingly, it may be made inapplicable by future legislation or changes
in Treasury regulations.
The discussion below is based on the assumption that the Partnership, the
Operating Partnership and the Services Partnership will be classified as a
partnership for federal income tax purposes. If that assumption proves to be
erroneous, most, if not all, of the tax consequences described below would not
be applicable to Unitholders and distributions to Unitholders would be
materially reduced.
LIMITED PARTNER STATUS
Unitholders who become Limited Partners pursuant to the provisions of the
Partnership Agreement will be treated as partners of the Partnership for
federal income tax purposes.
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The IRS has publicly ruled that assignees of partnership interests who have
not been admitted to a partnership as partners will be treated as partners in
the partnership for federal income tax purposes where they exercise
substantial dominion and control over the assigned partnership interests. On
the basis of that ruling, except as otherwise described herein, (i) assignees
who have executed and delivered transfer applications and are awaiting
admission as limited partners and (ii) Unitholders whose Units are held in
street name or by another nominee will be treated as partners for federal
income tax purposes. As the ruling does not extend to assignees of Units who
are entitled to execute and deliver transfer applications and thereby become
entitled to direct the exercise of attendant rights, but who fail to execute
and deliver such transfer applications, the tax status of such Unitholders is
unclear. Income, gain, deductions, losses or credits would not appear to be
reportable by such a Unitholder, and any cash distributions received by such a
Unitholder would be fully taxable as ordinary income. Such holders should
consult their own tax advisors with respect to their status as partners in the
Partnership for federal income tax purposes. A purchaser or other transferee
of Units who does not execute and deliver a transfer application may not
receive certain federal income tax information or reports furnished to holders
of Units unless the Units are held in a nominee or street name account and the
nominee or broker has executed and delivered a transfer application with
respect to such Units.
A beneficial owner of Units whose Units have been transferred to a "short
seller" to complete a short sale would appear to lose his status as a partner
with respect to such Units for federal income tax purposes. See "--Tax
Treatment of Operations--Treatment of Units Loaned to Cover Short Sales."
TAX CONSEQUENCES OF UNIT OWNERSHIP
Flow-through of Taxable Income
No federal income tax will be paid by the Partnership. Instead, each
Unitholder will be required to report on his income tax return his allocable
share of the income, gains, losses and deductions of the Partnership without
regard to whether corresponding cash distributions are received by such
Unitholder. Consequently, a Unitholder may be allocated income from the
Partnership although he has not received a cash distribution in respect of
such income.
Treatment of Partnership Distributions
Distributions by the Partnership to a Unitholder generally will not be
taxable to the Unitholder for federal income tax purposes to the extent of his
basis in his Units immediately before the distribution. Cash distributions in
excess of a Unitholder's basis generally will be considered to be gain from
the sale or exchange of the Units, taxable in accordance with the rules
described under "Disposition of Class A Common Units" below. Any reduction in
a Unitholder's share of the Partnership's liabilities for which no partner,
including the General Partner, bears the economic risk of loss ("nonrecourse
liabilities") will be treated as a distribution of cash to such Unitholder. It
is not expected that the Partnership will incur any material amounts of
nonrecourse liabilities. To the extent that Partnership distributions cause a
Unitholder's "at risk" amount to be less than zero at the end of any taxable
year, he must recapture as income in the year of such distributions any losses
deducted in previous years. See "--Limitations on Deductibility of Partnership
Losses."
A non-pro rata distribution of money or property may result in ordinary
income to a Unitholder, regardless of his basis in his Units, if such
distribution reduces the Unitholder's share of the Partnership's "unrealized
receivables" (including depreciation recapture) and/or "substantially
appreciated inventory items" (both as defined in Section 751 of the Code)
(collectively, "Section 751 Assets"). The Partnership Agreement provides that
recapture income will be allocated, to the extent possible, to the Unitholders
who were allocated the deductions giving rise to the treatment of gain as
recapture income. Such allocations, if respected, along with allocations in
accordance with Section 704(c) principles, should minimize the risk of
recognition of ordinary income under Section 751(b) of the Code upon a non-pro
rata distribution of money or property. The IRS may contend, however, that
such a deemed exchange of Section 751 Assets has occurred and that therefore
ordinary income must be realized under Section 751(b) of the Code by
Unitholders on such a non-pro rata distribution of money or property.
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Ratio of Taxable Income to Distributions
The General Partner estimates that a purchaser of a Class A Common Unit in
the offering made hereby who holds such Class A Common Unit through the record
date for the distribution with respect to the final calendar quarter of 1997
(assuming for this purpose quarterly distributions on the Units with respect
to that period are equal to the most recent quarterly distribution rate of
$0.78 per Unit) will be allocated an amount of federal taxable income for 1997
equal to approximately 10% of the amount of cash distributed to such
Unitholder with respect to 1997. The General Partner further estimates that
such a Class A Common Unitholder who holds a Class A Common Unit through the
record date for distribution with respect to the final calendar quarter of
2000 will be allocated an amount of federal taxable income for 1998 and 1999
ranging from 10% to 25% and, for 2000, 50% to 70%, of the amount of cash
distributed to such Unitholder with respect to each such period (assuming for
this purpose quarterly distributions on the Units with respect to each such
period are equal to $0.78 per Unit).
The foregoing estimates are based upon numerous assumptions regarding the
business and operations of the Partnership (including assumptions as to
tariffs, capital expenditures, cash flows and anticipated cash distributions).
Such estimates and assumptions are subject to, among other things, numerous
business, economic, regulatory and competitive uncertainties that are beyond
the control of the General Partner or the Partnership and to certain tax
reporting positions (including estimates of the relative fair market values of
the assets of the Partnership and the validity of certain curative
allocations) that the General Partner has adopted or intends to adopt and with
which the IRS could disagree. See "--Allocation of Partnership Income, Gain,
Loss and Deduction." Accordingly, no assurance can be given that the estimates
will prove to be correct. The actual percentages could be higher or lower than
as described above and such differences could be material.
As provided in the Partnership Agreement, the Class A Common Unitholders may
be allocated amounts of gross income that would otherwise be allocated to the
Class B Common Unitholders (the "Special Allocation"). With respect to taxable
year 1997, the amount of the Special Allocation could be up to $9 million.
Thereafter, the Special Allocation to be made each year could increase by up
to $2 million every two years until the taxable year beginning with 2012, for
which the Special Allocation could be up to $25 million for that year and for
each taxable year thereafter. Notwithstanding the above, the Special
Allocation will not be made (or will be reduced) in any taxable year to the
extent that a purchaser of a Class A Common Unit in the Partnership's initial
public offering (previously called a Preference Unit) would be allocated an
amount of federal taxable income with respect to such taxable year that would
exceed 65% of the amount of cash distributed to such a Unitholder with respect
to that taxable year. However, there is no assurance that the ratio of taxable
income to cash distributed with respect to any taxable year will not exceed
65%. Based on the current level of distributions, the General Partner
anticipates that the Special Allocation will be used in its entirety for the
taxable years 1997 through 2000. To the extent that the Special Allocation is
not made in any year, it cannot be carried forward.
Basis of Units
A Unitholder's initial tax basis for his Unit will be the amount paid for
the Unit. The initial tax basis will be increased by the Unitholder's share of
Partnership income. The basis will be decreased (but not below zero) by
distributions from the Partnership, by the Unitholder's share of Partnership
losses and by the Unitholder's share of expenditures of the Partnership that
are not deductible in computing its taxable income and are not required to be
capitalized.
Limitations on Deductibility of Partnership Losses
The passive loss limitations generally provide that individuals, estates,
trusts and certain closely held corporations and personal service corporations
can only deduct losses from passive activities (generally activities in which
the taxpayer does not materially participate) that are not in excess of the
taxpayer's income from such passive activities or investments. The passive
loss limitations are to be applied separately with respect to each publicly
traded partnership. Consequently, losses generated by the Partnership, if any,
will only be available to offset future income generated by the Partnership
and will not be available to offset income from other passive
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activities or investments (including other publicly traded partnerships) or
salary or active business income. Passive losses which are not deductible
because they exceed the Unitholder's income generated by the Partnership may
be deducted in full when the Unitholder disposes of his entire investment in
the Partnership in a fully taxable transaction to an unrelated party. The
passive activity loss rules are applied after other applicable limitations on
deductions such as the at risk rules and the basis limitation.
A Unitholder's share of net income from the Partnership may be offset by any
suspended passive losses from the Partnership, but it may not be offset by any
other current or carryover losses from other passive activities, including
those attributable to other publicly-traded partnerships. The IRS has
announced that Treasury Regulations will be issued which characterize net
passive income from a publicly-traded partnership as investment income for
purposes of the limitations on the deductibility of investment interest.
To the extent losses are incurred by the Partnership, a Unitholder's share
of deductions for losses will be limited to the tax basis of the Unitholder's
Units or, in the case of an individual Unitholder or a corporate Unitholder,
if more than 50% of the value of its stock is owned directly or indirectly by
five or fewer individuals or certain tax-exempt organizations, to the amount
which the Unitholder is considered to be "at risk" with respect to the
Partnership's activities, if that is less than the Unitholder's basis. A
Unitholder must recapture as income in the year of such distributions losses
deducted in previous years to the extent that Partnership distributions cause
the Unitholder's at risk amount to be less than zero at the end of any taxable
year. Losses disallowed to a Unitholder or recaptured as a result of these
limitations will carry forward and will be allowable to the extent that the
Unitholder's basis or at risk amount (whichever is the limiting factor) is
increased.
In general, a Unitholder will be at risk to the extent of the tax basis of
his Units, excluding any position of the basis attributable to his share of
Partnership nonrecourse liabilities, reduced by any amount of money the
Unitholder borrows to acquire or hold his Units if the lender of such borrowed
funds owns an interest in the Partnership, is related to such a person, or can
look only to Units for repayment. A Unitholder's at risk amount will increase
or decrease as the basis of the Unitholder's Units increases or decreases
(other than tax basis increases or decreases attributable to increases or
decreases in his share of Partnership nonrecourse liabilities).
Limitations on Interest Deductions
The deductibility of a non-corporate taxpayer's "investment interest
expense" is generally limited to the amount of such taxpayer's "net investment
income." As noted, a Unitholder's net passive income from the Partnership will
be treated as investment income for this purpose. In addition, the
Unitholder's share of the Partnership's portfolio income will be treated as
investment income. Investment interest expense includes (i) interest on
indebtedness properly allocable to property held for investment, (ii) a
partnership's interest expense attributed to portfolio income, and (iii) the
portion of interest expense incurred to purchase or carry an interest in a
passive activity to the extent attributable to portfolio income. The
computation of a Unitholder's investment interest expense will take into
account interest on any margin account borrowing or other loan incurred to
purchase or carry a Unit, to the extent attributable to portfolio income of
the Partnership.
ALLOCATION OF PARTNERSHIP INCOME, GAIN, LOSS AND DEDUCTION
In general, if the Partnership has a net profit, items of income, gain, loss
and deduction will be allocated among the General Partner and the Unitholders
in accordance with their respective percentage interests in the Partnership.
If the Partnership has a net loss, items of income, gain, loss and deduction
generally for both book and tax purposes will be allocated, first, to the
General Partner and the Unitholders in accordance with their respective
percentage interests to the extent of their positive capital accounts (as
maintained under the Partnership Agreement), and second, to the General
Partner. In addition, the Class A Common Unitholders could be allocated, by
reason of the Special Allocation which is discussed above, amounts of gross
income with respect to taxable years of the Partnership that would otherwise
be allocated to the Class B Common Unitholders. Although the Partnership does
not expect that its operations will result in the creation of negative capital
accounts, if negative capital accounts nevertheless result, items of
Partnership income and gain will be allocated
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in an amount and manner sufficient to eliminate the negative balance as
quickly as possible. On a liquidating sale of assets, the Partnership
Agreement provides separate gain and loss allocations, designed to the extent
possible, (i) to eliminate a deficit in any Partner's capital account, and
(ii) to produce capital accounts which, when followed on liquidation, will
result in each Unitholder recovering the Unrecovered Capital, and his
distributive share of any additional value.
Notwithstanding the above, as required by Section 704(c) of the Code,
certain items of Partnership income, deduction, gain and loss will be
specially allocated for tax purposes to account for the difference between the
tax basis and fair market value of property contributed to the Partnership by
the General Partner ("Contributed Property"), and to account for the
difference between the fair market value of the Partnership's assets and their
carrying value on the Partnership's books at the time of the offering made
hereby. In addition, certain items of recapture income will be allocated, to
the extent possible, to the Partner allocated the deduction or curative
allocation (discussed below) giving rise to the treatment of such gain as
recapture income in order to minimize the recognition of ordinary income by
some Unitholders. These allocations may not be respected by the IRS. If these
allocations of recapture are not respected, the amount of the income or gain
allocated to a Unitholder will not change but instead a change in the
character of the income allocated to a Unitholder would result.
Treasury regulations permit curative allocations similar to those provided
for by the Partnership Agreement. However, the application of those
regulations in the context of a publicly traded partnership existing at the
time of promulgation is unclear. Because such curative allocations are
consistent with Counsel's view of the purposes of Section 704(c) and with the
principles of the regulations, Counsel believes that it is unlikely that the
IRS will challenge the curative allocations. However, if the IRS were to
litigate the matter, it is uncertain whether the curative allocations would be
respected by a court. Counsel believes that there is substantial authority
(within the meaning of Section 6662 of the Code) for the Partnership's tax
reporting position, and that no penalties would be applicable if the IRS were
to litigate successfully against the curative allocations. Because the
Partnership has a relatively low tax basis in its properties, a successful
challenge by the IRS of the curative allocation would result in a ratio of
taxable income to cash distributions received by the holder of a Class A
Common Unit that is materially higher than the estimate set forth above under
"--Tax Consequences of Unit Ownership--Ratio of Taxable Income to
Distributions."
Counsel is of the opinion that, with the exception of the curative
allocations, the Special Allocations and the allocation of recapture income
discussed above, allocations under the Partnership Agreement will be given
effect for federal income tax purposes in determining a partner's distributive
share of an item of income, gain, loss or deduction. There are, however,
uncertainties in the Treasury Regulations relating to allocations of
partnership income, and investors should be aware that some of the allocations
in the Partnership Agreement may be successfully challenged by the IRS.
If an allocation contained in the Partnership Agreement is not given effect
for federal income tax purposes, notwithstanding the opinion of counsel, items
of income, gain, loss, deduction or credit will be reallocated to the
Unitholders and the General Partner in accordance with their respective
interests in such items. Such reallocation among the Unitholders and the
General Partner of such items of income, gain, loss, deduction or credit
allocated under the Partnership Agreement could result in additional taxable
income to the Unitholders. If the Special Allocations are not given effect,
the gross income subject to these allocations will be allocated to the Class B
Common Unitholders.
TAX TREATMENT OF OPERATIONS
Income and Deductions in General
Each Unitholder will be required to report on his income tax return, his
allocable share of income, gains, losses, deductions and credits of the
Partnership. Such items must be included on the Unitholder's federal income
tax return without regard to whether the Partnership makes a distribution of
cash to the Unitholder. A Unitholder is generally entitled to offset his
allocable share of the Partnership's passive income with his allocable share
of
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losses generated by the Partnership, if any. See"--Tax Consequences of Unit
Ownership--Limitations on Deductibility of Partnership Losses." No federal
income tax will be payable by the Partnership.
A Unitholder who owns Units at any time during a quarter and who disposes of
such Units prior to the record date set for a distribution with respect to
such quarter will be allocated items of Partnership income and gain
attributable to the months in such quarter during which such Units were owned
but will not be entitled to receive such cash distribution.
Accounting Method and Taxable Year
The Partnership will use the calendar year as its taxable year and uses the
accrual method of accounting for federal income tax purposes.
Initial Tax Basis, Depreciation and Amortization
The tax basis established for the various assets of the Partnership will be
used for purposes of computing depreciation and cost recovery deductions and,
ultimately, gain or loss on the disposition of such assets. The aggregate tax
basis established for the assets contributed to the Partnership by the General
Partner was initially equal to the tax basis of the General Partner in such
assets immediately before their contribution to the Partnership. See "--
Allocation of Partnership Income, Gain, Loss and Deduction."
The Partnership has both tangible assets of substantial value (including the
pipeline and related equipment) and rights of way of substantial value.
Amortization deductions in respect of such assets are based on determinations
as to their relative fair market values and useful lives by the Partnership.
The IRS may (i) challenge either the fair market values or the useful lives
assigned to such assets, or (ii) seek to characterize intangible assets as
nonamortizable goodwill. If any such challenge or characterization were
successful, the deductions allocated to a Unitholder in respect of such assets
would be reduced or eliminated and a Unitholder's share of taxable income from
the Partnership would be increased accordingly. Any such increase could be
material.
Section 754 Election
The Partnership has made the election permitted by Section 754 of the Code.
Such an election is irrevocable without the consent of the IRS. The election
generally permits a purchaser of Class A Common Units to adjust his share of
the basis in the Partnership's properties ("inside basis") pursuant to Section
743(b) of the Code to fair market value (as reflected by his Unit price). The
743(b) adjustment is attributed solely to a purchaser of Class A Common Units
and is not added to the bases of the Partnership's assets. (For purposes of
this discussion, a Partner's inside basis in the Partnership's assets will be
considered to have two components: (i) his share of the Partnership's actual
basis in such assets ("Common Basis"), and (ii) his Section 743(b) adjustment
allocated to each such asset).
Proposed Treasury Regulation Section 1.168-2(n) generally requires the
Section 743(b) adjustment attributable to recovery property to be depreciated
as if the total amount of such adjustment were attributable to newly acquired
recovery property placed in service when the Purchaser acquires the Class A
Common Units. Under Treasury Regulation Section 1.167(d)-1(a)(6), a Section
743(b) adjustment attributable to property subject to depreciation under
Section 167 of the Code rather than cost recovery deductions under Section 168
is generally required to be depreciated using either the straight-line method
or the 150% declining balance method. The depreciation and amortization
methods and useful lives associated with the Section 743(b) adjustment,
therefore, may differ from the methods and useful lives generally used to
depreciate the Common Bases in such properties. Pursuant to the Partnership
Agreement, the General Partner is authorized to adopt a convention to preserve
the uniformity of Units even if such convention is not consistent with
Treasury Regulation Section 1.167(c)-1(a)(6) or the legislative history of
Section 197 of the Code. See "--Uniformity of Class A Common Units" below.
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Although Counsel is unable to opine as to the validity of such an approach,
the Partnership intends to depreciate the portion of a Section 743(b)
adjustment attributable to unrealized appreciation in the value of Contributed
Property (to the extent of any unamortized Book-Tax Disparity) using a rate of
depreciation or amortization derived from the depreciation or amortization
method and useful life applied to the Common Basis of such property, despite
its inconsistency with Proposed Treasury Regulation Section 1.168-2(n) and
Treasury Regulation Section 1.167(c)-1(a)(6). To the extent such Section
743(b) adjustment is attributable to appreciation in value in excess of the
unamortized Book-Tax Disparity, the Partnership will apply the rules described
in the Regulations. If the Partnership determines that such position cannot
reasonably be taken, the Partnership may adopt a depreciation or amortization
convention under which all purchasers acquiring Units in the same month would
receive depreciation or amortization, whether attributable to Common Basis or
Section 743(b) basis, based upon the same applicable rate as if they had
purchased a direct interest in the Partnership's property. Such an aggregate
approach may result in lower annual depreciation or amortization deductions
than would otherwise be allowable to certain Unitholders. See "--Uniformity of
Class A Common Units" below.
The allocation of the Section 743(b) adjustment must be made in accordance
with the principles of Section 1060 of the Code. Based on these principles,
the IRS may seek to reallocate some or all of any Section 743(b) adjustment
not so allocated by the Partnership to goodwill, which, as an intangible asset
would be amortizable over a longer period of time than the Partnership's
tangible assets.
A Section 754 election is advantageous if the transferee's basis in his
Units is higher than such Units' share of the aggregate basis to the
Partnership of the Partnership's assets immediately prior to the transfer. In
such case, pursuant to the election, the transferee would take a new and
higher basis in his share of the Partnership's assets for purposes of
calculating, among other items, his depreciation deductions and his share of
any gain or loss on a sale of the Partnership's assets. Conversely, a Section
754 election is disadvantageous if the transferee's basis in such Units is
lower than such Units' share of the aggregate basis of the Partnership's
assets immediately prior to the transfer. Thus, the amount which a Unitholder
will be able to obtain upon the sale of his Units may be affected either
favorably or adversely by the election.
The calculations involved in the Section 754 election are complex and will
be made by the Partnership on the basis of certain assumptions as to the value
of Partnership assets and other matters. There is no assurance that the
determinations made by the Partnership will not be successfully challenged by
the IRS and that the deductions attributable to them will not be disallowed or
reduced. Should the IRS require a different basis adjustment to be made, and
should, in the General Partner's opinion, the expense of compliance exceed the
benefit of the election, the General Partner may seek permission from the IRS
to revoke the Section 754 election for the Partnership. If such permission is
granted, a purchaser of Units subsequent to such revocation probably will
incur increased tax liability.
Alternative Minimum Tax
Each Unitholder will be required to take into account his distributive share
of items of Partnership income, gain or loss for purposes of the alternative
minimum tax. A portion of the Partnership's depreciation deductions may be
treated as an item of tax preference for this purpose.
A Unitholder's alternative minimum taxable income derived from the
Partnership may be higher than his share of Partnership net income because the
Partnership may use accelerated methods of depreciation for purposes of
computing federal taxable income or loss.
Prospective Unitholders should consult with their tax advisors as to the
impact of an investment in Class A Common Units on their liability for the
alternative minimum tax.
Valuation of Partnership Property and Basis of Properties
The federal income tax consequences of the acquisition, ownership and
disposition of Units will depend in part on estimates by the General Partner
of the relative fair market values, and determinations of the initial tax
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basis of the assets of the Partnership. Although the General Partner may from
time to time consult with professional appraisers with respect to valuation
matters, many of the relative fair market value estimates will be made solely
by the General Partner. These estimates and determinations of basis are
subject to challenge and will not be binding on the IRS or the courts. If the
estimates of fair market value or determinations of basis are subsequently
found to be incorrect, the character and amount of items of income, gain,
loss, deductions or credits previously reported by Unitholders might change,
and Unitholders might be required to adjust their tax liability for prior
years.
Treatment of Units Loaned to Cover Short Sales
A Unitholder whose Units are loaned to a "short seller" to cover a short
sale of Units may be considered as having transferred beneficial ownership of
such Units. If so, he would no longer be a partner with respect to those Units
during the period of such loan. As a result, during such period, any
Partnership income, gain, deductions, losses or credits with respect to those
Units would appear not to be reportable by such Unitholder, any cash
distributions received by the Unitholder with respect to those Units would be
fully taxable and all of such distributions would appear to be treated as
ordinary income. Unitholders desiring to assure their status as partners
should modify their brokerage account agreements, if any, to prohibit their
brokers from borrowing their Units. The IRS has announced that it is actively
studying issues relating to the tax treatment of short sales of partnership
interests.
The Taxpayer Relief Act of 1997 (the "TRA of 1997") also contains provisions
affecting the taxation of certain financial products and securities, including
partnership interests, by treating a taxpayer as having sold an "appreciated"
partnership interest (one in which gain would be recognized if it were sold,
assigned or otherwise terminated at its fair market value) if the taxpayer or
related persons enter into a short sale of, an offsetting notional principal
contract with respect to or a futures or forward contract to deliver the same
or substantially identical property, or in the case of an appreciated
financial position that is a short sale or offsetting notional principal or
futures or forward contract, the taxpayer or related persons acquire, the same
or substantially identical property. The Secretary of Treasury is also
authorized to issue regulations that treat a taxpayer that enters into
transactions or positions that have substantially the same effect as the
preceding transactions as having constructively sold the financial position.
DISPOSITION OF CLASS A COMMON UNITS
Recognition of Gain or Loss
Gain or loss will be recognized on a sale of Units equal to the difference
between the amount realized and the Unitholder's tax basis for the Units sold.
A Unitholder's amount realized will be measured by the sum of the cash or the
fair market value of other property received plus that Unitholder's share of
Partnership nonrecourse liabilities. Since the amount realized includes a
Unitholder's share of Partnership nonrecourse liabilities, the gain recognized
on the sale of Units may result in a tax liability in excess of any cash
received from such sale.
Prior Partnership distributions in excess of cumulative net taxable income
in respect of a Class A Common Unit which decreased a Unitholder's tax basis
in such Class A Common Unit will, in effect, become taxable income if the
Class A Common Unit is sold at a price greater than the Unitholder's tax basis
in such Common Unit, even if the price is less than his original cost.
Gain or loss recognized by a Unitholder (other than a "dealer" in Units) on
the sale or exchange of a Unit will generally be taxable as capital gain or
loss, and gain on sale or exchange of a Unit held for more than eighteen
months will generally be subject to a maximum tax rate of 20%. A substantial
portion of this gain or loss, however, will be separately computed and taxed
as ordinary income or loss under Section 751 of the Code to the extent
attributable to assets giving rise to depreciation recapture or other
"unrealized receivables" or to "inventory items" owned by the Partnership. The
term "unrealized receivables" includes potential recapture items, including
depreciation recapture. Ordinary income attributable to unrealized
receivables, inventory items and depreciation recapture may exceed net taxable
gain realized upon the sale of the Unit and may be recognized
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even if there is a net taxable capital loss realized on the sale of the Unit.
Thus a Unitholder may recognize both ordinary income and a capital loss upon
disposition of Units. Net capital losses may offset no more than $3,000 of
ordinary income in the case of individuals and may only be used to offset
capital gain in the case of a corporation.
The IRS has ruled that a partner acquiring interests in a partnership in
separate transactions at different prices must maintain an aggregate adjusted
tax basis in a single partnership interest and that, upon sale or other
disposition of some of the interests, a portion of such aggregate tax basis
must be allocated to the interests sold on the basis of some equitable
apportionment method. The ruling is unclear as to how the holding period is
affected by this aggregation concept. If this ruling is applicable to the
holders of Class A Common Units, the aggregation of tax bases of a holder of
Class A Common Units effectively prohibits him from choosing among Class A
Common Units with varying amounts of unrealized gain or loss as would be
possible in a stock transaction. Thus, the ruling may result in an
acceleration of gain or deferral of loss on a sale of a portion of a
Unitholder's Class A Common Units. It is not clear whether the ruling applies
to publicly traded partnerships, such as the Partnership, the interests in
which are evidenced by separate interests and accordingly Counsel does not
opine as to the effect such ruling will have on the Unitholders. A Unitholder
considering the purchase of additional Units or a sale of Units purchased at
differing prices should consult his tax advisor as to the possible
consequences of that ruling.
Allocations Between Transferors and Transferees
In general, the Partnership's taxable income and losses will be determined
annually and will be prorated on a monthly basis and subsequently apportioned
among the Unitholders in proportion to the number of Units owned by them as of
the opening of the first business day of the month to which they relate.
However, gain or loss realized on a sale or other disposition of Partnership
assets other than in the ordinary course of business shall be allocated among
the Unitholders as of the opening of the New York Stock Exchange on the first
business day of the month in which such gain or loss is recognized. As a
result of this monthly allocation, a Unitholder transferring Units in the open
market may be allocated income, gain, loss, or deduction and credit accrued
after the transfer.
The use of the monthly conventions discussed above may not be permitted by
existing Treasury Regulations and accordingly, Counsel does not opine on the
validity of the method of allocating income and deductions between the
transferors and the transferees of Class A Common Units. If a monthly
convention is not allowed by the Treasury Regulations (or only applies to
transfers of less than all of the Unitholder's interest), taxable income or
losses of the Partnership might be reallocated among the Unitholders. The
General Partner is authorized to revise the Partnership's method of allocation
between the transferors and transferees (as well as among partners whose
interests otherwise vary during a taxable period) to conform to a method
permitted by future Treasury Regulations.
A Unitholder who owns Units at any time during a quarter and who disposes of
such Units prior to the record date set for a distribution with respect to
such quarter will be allocated items of Partnership income and gain
attributable to such quarter during which such Units were owned, but will not
be entitled to receive such cash distribution.
Notification Requirements
A Unitholder who sells or exchanges Units is required to notify the
Partnership in writing of such sale or exchange within 30 days of the sale or
exchange and in any event no later than January 15 of the year following the
calendar year in which the sale or exchange occurred. The Partnership is
required to notify the IRS of such transaction and to furnish certain
information to the transferor and transferee. However, these reporting
requirements do not apply with respect to a sale by an individual who is a
citizen of the United States and who effects such sale through a broker.
Additionally, a transferor and a transferee of a Unit will be required to
furnish statements to the IRS, filed with their income tax returns for the
taxable year in which the sale or exchange occurred, which set forth the
allocation of the amount of the consideration received for such Unit. Failure
to satisfy such reporting obligations may lead to the imposition of
substantial penalties.
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Constructive Termination
The Partnership and the Operating Partnership will be considered to have
been terminated if there is a sale or exchange of 50% or more of the total
interests in Partnership capital and profits within a 12-month period. A
termination of the Partnership will cause a termination of the Operating
Partnership. A termination of the Partnership will result in the closing of
the Partnership's taxable year for all Unitholders. In the case of a
Unitholder reporting on a taxable year other than a fiscal year ending
December 31, the closing of the Partnership's taxable year may result in more
than 12 months' taxable income or loss of the Partnership being includable in
his taxable income for the year of termination. New tax elections required to
be made by the Partnership, including a new election under Section 754 of the
Code, must be made subsequent to a termination, and a termination could result
in a deferral of Partnership deductions for depreciation. A termination could
also result in penalties if the Partnership were unable to determine that the
termination had occurred. Moreover, a termination might either accelerate the
application of, or subject the Partnership to, any tax legislation enacted
prior to the termination.
Under regulations, a termination of the Partnership would result in a deemed
transfer by the Partnership of its assets to a new partnership in exchange for
an interest in the new partnership followed by a deemed distribution of
interests in the new partnership to the Unitholders in liquidation of the
Partnership.
ENTITY-LEVEL COLLECTIONS
If the Partnership is required or elects under applicable law to pay any
federal, state or local income tax on behalf of any Partner or Former Partner,
the General Partner is authorized to pay such taxes from Partnership funds.
Such payments, if made, will be deemed current distributions of cash to the
Unitholders and the General Partner. The General Partner is authorized to
amend the Partnership Agreement in the manner necessary to maintain uniformity
of intrinsic tax characteristics of Units and to adjust subsequent
distributions so that after giving effect to such deemed distributions, the
priority and characterization of distributions otherwise applicable under the
Partnership Agreement is maintained as nearly as is practicable. Payments by
the Partnership as described above could give rise to an overpayment of tax on
behalf of an individual partner in which event, the partner could file a claim
for credit or refund.
UNIFORMITY OF CLASS A COMMON UNITS
Since the Partnership cannot match transferors and transferees of Class A
Common Units, uniformity of the economic and tax characteristics of the Class
A Common Units to a purchaser of such Class A Common Units must be maintained.
In the absence of uniformity, compliance with a number of federal income tax
requirements, both statutory and regulatory, could be substantially
diminished. A lack of uniformity can result from a literal application of
Proposed Treasury Regulations Section 1.168-2(n) and Treasury Regulation
Section 1.167(c)-1(a)(6). Any such non-uniformity could have a negative impact
on the value of a Unitholder's interest in the Partnership.
The Partnership intends to depreciate the portion of a Section 743(b)
adjustment attributable to unrealized appreciation in the value of Contributed
Property or Adjusted Property (to the extent of any unamortized Book-Tax
Disparity) using a rate of depreciation or amortization derived from the
depreciation method and useful life applied to the Common Basis of such
property, despite its inconsistency with Proposed Treasury Regulation Section
1.168-2(n) and Treasury Regulation Section 1.167(c)-1(a)(6). See "--Tax
Treatment of Operations--Section 754 Election" above. If the Partnership
determines that such position cannot reasonably be taken, the Partnership may
adopt a depreciation convention under which all purchasers acquiring Class A
Common Units in the same month would receive depreciation and amortization
deductions, whether attributable to common basis or Section 743(b) basis,
based upon the same applicable rate as if they had purchased a direct interest
in the
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Partnership's property. If such an aggregate approach is adopted, it may
result in lower annual depreciation and amortization of deductions than would
otherwise be allowable to certain Unitholders and risk the loss of
depreciation and amortization deductions not taken in the year that such
deductions are otherwise allowable. Such convention will not be adopted if the
Partnership determines that the loss of such depreciation and amortization
deductions will have a material adverse effect on the Unitholders. If the
Partnership chooses not to utilize this aggregate method, the Partnership may
use any other reasonable depreciation and amortization convention to preserve
the uniformity of the intrinsic tax characteristics of any Class A Common
Units that would not have a material adverse effect on the Unitholders. The
IRS may challenge any method of depreciating the Section 743(b) adjustment
described in this paragraph. If such a challenge were to be sustained, the
uniformity of Class A Common Units may be affected.
Because of the Special Allocations of gross income to the Class A Common
Units, the capital accounts underlying the Class A Common Units will likely
differ, perhaps materially, from the capital accounts underlying the Class B
Common Units. The Partnership Agreement contains a method by which the General
Partner may cause the capital accounts underlying the Class A Common Units to
equal the capital accounts underlying the Class B Common Units. The General
Partner must be reasonably assured, based on advice of counsel, that the Class
B Common Units and the Class A Common Units share the same intrinsic economic
and federal income tax characteristics, in all material respects, before the
Class A Common Units and the Class B Common Units will be treated as one class
of Units.
TAX-EXEMPT ORGANIZATIONS AND CERTAIN OTHER INVESTORS
Ownership of Units by employee benefit plans, other tax-exempt
organizations, nonresident aliens, foreign corporations, other foreign persons
and regulated investment companies raises issues unique to such persons and,
as described below, may have substantially adverse tax consequences.
Employee benefit plans and most other organizations exempt from federal
income tax (including individual retirement accounts and other retirement
plans) are subject to federal income tax on unrelated business taxable income.
Virtually all of the taxable income derived by such an organization from the
ownership of a Unit will be unrelated business taxable income and thus will be
taxable to such a Unitholder.
A regulated investment company or mutual fund is required to derive 90% or
more of its gross income from interest, dividends, gains from the sale of
stocks or securities or foreign currency or certain related sources. It is not
anticipated that any significant amount of the Partnership's gross income will
qualify as such income.
Nonresident aliens and foreign corporations, trusts or estates which acquire
Units will be considered to be engaged in business in the United States on
account of ownership of Units and as a consequence will be required to file
federal tax returns in respect of their distributive shares of Partnership
income, gain, loss, deduction or credit and pay federal income tax at regular
rates on such income. Under rules applicable to publicly traded partnerships,
the Partnership will withhold (currently at the rate of 39.6%) on actual cash
distributions made quarterly to foreign Unitholders. Each foreign Unitholder
must obtain a taxpayer identification number from the IRS and submit that
number to the Transfer Agent of the Partnership on a Form W-8 in order to
obtain credit for the taxes withheld. Subsequent adoption of Treasury
Regulations or the issuance of other administrative pronouncements may require
the Partnership to change these procedures.
Because a foreign corporation which owns Units will be treated as engaged in
a United States trade or business, such a Unitholder may be subject to United
States branch profits tax at a rate of 30%, in addition to regular federal
income tax, on its allocable share of the Partnership's earnings and profits
(as adjusted for changes in the foreign corporation's "U.S. net equity") which
are effectively connected with the conduct of a United States trade or
business. Such a tax may be reduced or eliminated by an income tax treaty
between the United States and the country with respect to which the foreign
corporate Unitholder is a "qualified resident." In addition, such a Unitholder
is subject to special information reporting requirements under Section 6038C
of the Code.
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Under a ruling of the IRS, a foreign Unitholder who sells or otherwise
disposes of a Unit will be subject to federal income tax on gain realized on
the disposition of such Unit to the extent that such gain is effectively
connected with a United States trade or business of the foreign Unitholder.
Apart from the ruling, a foreign Unitholder will not be taxed upon the
disposition of a Unit if that foreign Unitholder has held less than 5% in
value of the Units during the five-year period ending on the date of the
disposition and if the Units are regularly traded on an established securities
market at the time of the disposition.
ADMINISTRATIVE MATTERS
Partnership Information Returns and Audit Procedures
The Partnership intends to furnish each Unitholder, within 90 days after the
close of each calendar year, certain tax information, including a Schedule K-
1, which sets forth each Unitholder's allocable share of the Partnership's
income, gain, loss, deduction and credit for the preceding Partnership taxable
year. If the Partnership elects large partnership treatment under the
provisions of the TRA of 1997, this tax information will be provided to
Unitholders by March 15th for the preceding Partnership taxable year as
required. In preparing this information, which will generally not be reviewed
by counsel, the General Partner will use various accounting and reporting
conventions, some of which have been mentioned in the previous discussion, to
determine the respective Unitholder's allocable share of income, gain, loss,
deduction and credits. See "--Allocation of Partnership Income, Gain, Loss and
Deduction," "--Tax Treatment of Operations--Initial Tax Basis, Depreciation
and Amortization" and "--Tax Treatment of Operations--Section 754 Election"
and "--Disposition of Class A Common Units--Allocations Between Transferors
and Transferees." There is no assurance that any such conventions will yield a
result which conforms to the requirements of the Code, regulations or
administrative interpretations of the IRS. The General Partner cannot assure
prospective Unitholders that the IRS will not successfully contend in court
that such accounting and reporting conventions are impermissible.
The federal income tax information returns filed by the Partnership may be
audited by the IRS. Adjustments resulting from such audit may require each
Unitholder to file an amended tax return, and possibly may result in an audit
of the Unitholder's return. If the Partnership elects large partnership
treatment under the provisions of the TRA of 1997, partnership adjustments
would not result in Unitholders having to file amended returns. Instead, these
adjustments generally would flow through to the partners for the year in which
the adjustment takes effect. Thus, the current year partners' share of current
year partnership items of income, gains, losses, deductions or credits would
be adjusted to reflect partnership audit adjustments that take effect in that
year. In addition, in lieu of flowing adjustments through to its partners the
partnership may elect to pay an imputed underpayment. In either case,
Unitholders could bear significant economic burdens associated with tax
adjustments relating to periods predating their acquisition of Units. Any
audit of a Unitholder's return could result in adjustments of non-Partnership
as well as Partnership items.
Partnerships generally are treated as separate entities for purposes of
federal tax audits, judicial review of administrative adjustments by the IRS
and tax settlement proceedings. The tax treatment of partnership items of
income, gain, loss, deduction and credit is determined at the partnership
level in a unified partnership proceeding rather than in separate proceedings
with the partners. The Code provides for one partner to be designated as the
"Tax Matters Partner" for these purposes. The Partnership Agreement appoints
the General Partner as the Tax Matters Partner.
The Tax Matters Partner will make certain elections on behalf of the
Partnership and Unitholders and can extend the statute of limitations for
assessment of tax deficiencies against Unitholders with respect to Partnership
items. The Tax Matters Partner may bind any Unitholder with less than a 1%
profits interest in the Partnership to a settlement with the IRS unless the
Unitholder elects, by filing a statement with the IRS, not to give such
authority to the Tax Matters Partner. The Tax Matters Partner may seek
judicial review (to which all the Unitholders are bound) of a final
Partnership administrative adjustment and, if the Tax Matters Partner fails to
seek judicial review, such review may be sought by any Unitholder having at
least 1% interest in the profits of
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the Partnership and by Unitholders having, in the aggregate, at least a 5%
profits interest. However, only one action for judicial review will go
forward, and each Unitholder with an interest in the outcome may participate.
A Unitholder must file a statement with the IRS identifying the treatment of
any item on its federal income tax return that is not consistent with the
treatment of the item on the Partnership's return to avoid the requirement
that all items be treated consistently on both returns. Intentional or
negligent disregard of the consistency requirement may subject a Unitholder to
substantial penalties. Under the TRA of 1997, partners in a partnership
electing to be treated as a large partnership would be required to treat all
partnership items in a manner consistent with the partnership return.
Under the reporting provisions of the TRA of 1997, each partner of a
partnership electing to be treated as a large partnership would take into
account separately his share of the following items, determined at the
partnership level: (i) taxable income or loss from passive loss limitation
activities; (ii) taxable income or loss from other activities (such as
portfolio income or loss); (iii) net capital gains (or net capital loss) to
the extent allocable to passive loss limitation activities and other
activities; (iv) a net alternative minimum tax adjustment separately computed
for passive loss limitation activities and other activities; (v) general
credits; (vi) low-income housing credit; (vii) rehabilitation credit; (viii)
tax-exempt interests; (ix) for certain partnerships, foreign taxes paid and
foreign source partnership items; and (x) any other items designated by the
IRS to be separately treated.
The TRA of 1997 also makes a number of changes to the tax compliance and
administrative rules relating to partnerships that elect large partnership
treatment. One provision would require that each partner in a large
partnership take into account his share of any adjustments to partnership
items in the year such adjustments are made. Under current law, adjustments
relating to partnership items for a previous taxable year are taken into
account by those persons who were partners in the previous taxable year.
Alternatively, under the TRA of 1997, a partnership could elect to or, in some
circumstances, could be required to, directly pay the tax resulting from any
such adjustments. In either case, therefore, Unitholders could bear
significant economic burdens associated with tax adjustments relating to
periods predating their acquisition of Units. The partnership has not
determined at this time whether it will make the election to be treated as a
large partnership.
Nominee Reporting
Persons who hold an interest in the Partnership as a nominee for another
person are required to furnish to the Partnership: (i) the name, address and
taxpayer identification number of the beneficial owners and the nominee; (ii)
whether the beneficial owner is (a) a person that is not a United States
person, (b) a foreign government, an international organization or any wholly
owned agency or instrumentality of either of the foregoing, or (c) a tax-
exempt entity; (iii) the amount and description of the Units held, acquired or
transferred for the beneficial owners; and (iv) certain information including
the dates of acquisitions and transfers, means of acquisitions and transfers
and acquisition cost for purchases, as well as the amount of the net proceeds
from sales. Brokers and financial institutions are required to furnish
additional information, including whether they are a United States person and
certain information on Partnership Units they acquire, hold or transfer for
their own account. A penalty of $50 per failure (up to a maximum of $100,000
per calendar year) is imposed by the Code for failure to report such
information to the Partnership. The nominee is required to supply the
beneficial owner of the Units with the information furnished to the
Partnership.
Registration as a Tax Shelter
The Code requires that "tax shelters" be registered with the Secretary of
the Treasury. The temporary Treasury Regulations interpreting the tax shelter
registration provisions of the Code are extremely broad. It is arguable that
the Partnership will not be subject to the registration requirement on the
basis that it will not constitute a tax shelter. However, the General Partner,
as principal organizer of the Partnership, has registered the Partnership as a
tax shelter with the IRS in the absence of assurance that the Partnership will
not be subject to tax shelter registration and in light of the substantial
penalties which might be imposed if registration is required and not
undertaken. The IRS has issued the following shelter registration number to
the Partnership: 92008000124. ISSUANCE OF THE REGISTRATION NUMBER DOES NOT
INDICATE THAT AN
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INVESTMENT IN THE PARTNERSHIP OR THE CLAIMED TAX BENEFITS HAVE BEEN REVIEWED,
EXAMINED OR APPROVED BY THE IRS. The Partnership must furnish the registration
number to the Unitholders, and a Unitholder who sells or otherwise transfers a
Unit in a subsequent transaction must furnish the registration number to the
transferee. The penalty for failure of the transferor of a Unit to furnish
such registration number to the transferee is $100 for each such failure. The
Unitholders must disclose the tax shelter registration number of the
Partnership on Form 8271 to be attached to the tax return on which any
deduction, loss, credit or other benefit generated by the Partnership is
claimed or income of the Partnership is included. A Unitholder who fails to
disclose the tax shelter registration number on his return, without reasonable
cause for such failure, will be subject to a $250 penalty for each such
failure. Any penalties discussed herein are not deductible for federal income
tax purposes.
Accuracy--Related Penalties
An additional tax equal to 20% of the amount of any portion of an
underpayment of tax that is attributable to one or more of certain listed
causes, including negligence or disregard of rules or regulations, substantial
understatements of income tax and substantial valuation misstatements, is
imposed by the Code. No penalty will be imposed, however, with respect to any
portion of an underpayment if it is shown that there was a reasonable cause
for such portion and that the taxpayer acted in good faith with respect to
such portion.
A substantial understatement of income tax in any taxable year exists if the
amount of the understatement exceeds the greater of 10% of the tax required to
be shown on the return for the taxable year or $5,000 ($10,000 for most
corporations). The amount of any understatement subject to penalty generally
is reduced if any portion is attributable to a position adopted on the return
with respect to which there is, or was, "substantial authority" or as to which
there is reasonable basis and the pertinent facts are disclosed on the return.
Certain more stringent rules apply to "tax shelters," a term that does not
appear to include the Partnership. If any Partnership item of income, gain,
loss, deduction or credit included in the distributive shares of the
Unitholders might result in such an "understatement" of income for which no
"substantial authority" exists, the Partnership must disclose the pertinent
facts on its return. In addition, the Partnership will make a reasonable
effort to furnish sufficient information for Unitholders to make adequate
disclosure on their returns to avoid liability for this penalty.
A substantial valuation misstatement exists if the value of any property (or
the adjusted basis of any property) claimed on a tax return is 200% or more of
the amount determined to be the correct amount of such valuation or adjusted
basis. No penalty is imposed unless the portion of the underpayment
attributable to a substantial valuation misstatement exceeds $5,000 ($10,000
for most corporations). If the valuation claimed on a return is 400% or more
than the correct valuation, the penalty imposed increases to 40%.
OTHER TAX CONSIDERATIONS
Prospective investors should consider state and local tax consequences of an
investment in the Partnership. The Partnership anticipates owning property or
doing business in Illinois, Indiana, Michigan, Minnesota, New York, North
Dakota and Wisconsin. The Unitholder will likely be required to file state
income tax returns and/or to pay such taxes in such states and may be subject
to penalties for failure to comply with such requirements. Some of the states
may require that a partnership withhold a percentage of income from amounts
that are to be distributed to a partner that is not a resident of the state.
The amounts withheld, which may be greater or less than a particular partner's
income tax liability to the state, generally do not relieve the non-resident
partner from the obligation to file a state income tax return. In addition, an
obligation to file tax returns or to pay taxes may arise in other states.
It is the responsibility of each prospective Unitholder to investigate the
legal and tax consequences, under the laws of pertinent states or localities,
of his investment in the Partnership. Further, it is the responsibility of
each Unitholder to file all state and local, as well as federal, tax returns
that may be required of such Unitholder. Counsel has not rendered an opinion
on the state and local tax consequences of an investment in the Partnership.
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INVESTMENT IN THE PARTNERSHIP BY EMPLOYEE BENEFIT PLANS
An investment in the Partnership by an employee benefit plan is subject to
certain additional considerations because persons with discretionary control
of assets of such plans (a "fiduciary") are subject to the fiduciary
responsibility provisions of the Employee Retirement Income Security Act of
1974, as amended ("ERISA"), and transactions are subject to restrictions
imposed by Section 4975 of the Code. As used herein, the term "employee
benefit plan" includes, but is not limited to, qualified pension, profit-
sharing and stock bonus plans, Keogh plans, Simplified Employee Pension Plans,
and tax deferred annuities or Individual Retirement Accounts ("IRAs")
established or maintained by an employer or employee organization. Among other
things, consideration should be given to (i) whether such investment is
prudent under Section 404(a)(1)(B) of ERISA; (ii) whether in making such
investment such plan will satisfy the diversification requirement of Section
404(a)(1)(C) of ERISA; and (iii) whether such investment will result in
recognition of unrelated business taxable income by such plan. See "Tax
Considerations--Tax-Exempt Organizations and Certain Other Investors."
Fiduciaries should determine whether an investment in the Partnership is
authorized by the appropriate governing instrument and is an appropriate
investment for such plan.
In addition, a fiduciary of an employee benefit plan should consider whether
such plan will, by investing in the Partnership, be deemed to own an undivided
interest in the assets of the Partnership, with the result that the General
Partner would also be a fiduciary of such plan and the Partnership would be
subject to the regulatory restrictions of ERISA, including its prohibited
transaction rules, as well as the prohibited transaction rules of the Code.
Section 406 of ERISA and Section 4975 of the Code (which also applies to
Individual Retirement Accounts that are not considered part of an employee
benefit plan; i.e., IRAs established or maintained by individuals rather than
an employer or employee organization) prohibit an employee benefit plan from
engaging in certain transactions involving "plan assets" with parties who are
"parties in interest" under ERISA or "disqualified persons" under the Code
with respect to the plan. Under Department of Labor regulations the assets of
an entity in which employee benefit plans acquire equity interests would not
be deemed "plan assets" if, among other things, (i) the equity interests
acquired by employee benefit plans are publicly offered securities--i.e., the
equity interests are widely held by 100 or more investors independent of the
issuer and each other, freely transferable and registered pursuant to certain
provisions of the federal securities law, (ii) the entity is an "operating
company"--i.e., it is primarily engaged in the production or sale of a product
or service other than the investment of capital, or (iii) there is no
significant investment by benefit plan investors, which is defined to mean
that less than 25% of the value of each class of equity interest is held by
the employee benefit plans referred to above, IRAs and other employee benefit
plans not subject to ERISA (such as government plans). The Partnership's
assets are not expected to be considered "plan assets" under these regulations
because it is expected that the investment will satisfy the requirements in
(i) above, and may also satisfy the requirements in (ii) and (iii).
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UNDERWRITING
Upon the terms and subject to the conditions contained in the Underwriting
Agreement dated the date hereof (the "Underwriting Agreement"), the
Partnership has agreed to sell to each of the underwriters named below (the
"Underwriters"), and each of the Underwriters has severally agreed to purchase
from the Partnership, the number of Class A Common Units set forth opposite
the name of such Underwriter below:
<TABLE>
<CAPTION>
NUMBER OF
CLASS A
UNDERWRITER COMMON UNITS
----------- ------------
<S> <C>
Smith Barney Inc..............................................
Goldman, Sachs & Co...........................................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated............................................
---------
Total....................................................... 2,200,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters to pay for and accept delivery of the Class A Common Units are
subject to approval of certain legal matters by counsel and to certain other
conditions. The Underwriters are obligated to take and pay for all Class A
Common Units offered hereby (other than those covered by the over-allotment
option described below) if any such Class A Common Units are taken.
The Underwriters, for whom Smith Barney Inc., Goldman, Sachs & Co. and
Merrill Lynch, Pierce, Fenner & Smith Incorporated are acting as
representatives, initially propose to offer part of the Class A Common Units
offered hereby directly to the public at the public offering price set forth
on the cover page of this Prospectus and part of such Class A Common Units to
certain dealers at such price less a concession not in excess of $ per Class
A Common Unit. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $ per Class A Common Unit to certain other
dealers.
The Partnership and the General Partner have agreed that, for a period of 90
days from the date of this Prospectus, they will not, without the prior
written consent of Smith Barney Inc., sell, contract to sell or otherwise
dispose of, any Class A Common Units or Class B Common Units or any securities
substantially similar to, convertible into or exercisable or exchangeable for,
Class A Common Units or Class B Common Units or grant any options or warrants
to purchase any Class A Common Units or Class B Common Units or any such
securities.
The Partnership has granted the Underwriters an option, exercisable for 30
days from the date of this Prospectus, to purchase up to 330,000 additional
Class A Common Units at the public offering price set forth on the cover page
of this Prospectus minus the underwriting discounts and commissions. The
Underwriters may exercise such option solely for the purpose of covering over-
allotments, if any, incurred in connection with the sales of the Class A
Common Units offered hereby. To the extent such option is exercised, each
Underwriter will be obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional Class A Common Units as
the number of Class A Common Units set forth opposite each Underwriter's name
in the preceding table bears to the total number of Class A Common Units
listed in such table.
Because the National Association of Securities Dealers, Inc. ("NASD") views
the Class A Common Units offered hereby as interests in a direct participation
program, the offering is being made in compliance with Rule 2810 of the NASD's
Conduct Rules. The Underwriters do not intend to confirm sales to any accounts
over which they exercise discretionary authority without the prior written
approval of the transaction by the customer.
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In connection with the offering of the Class A Common Units offered hereby
and in compliance with applicable law, the Underwriters may engage in
transactions which stabilize, maintain or otherwise affect the market price of
the Class A Common Units at levels above those which might otherwise prevail
in the open market. Specifically, the Underwriters may over-allot in
connection with the offering creating a short position in the Class A Common
Units for their own account. For the purposes of covering a syndicate short
position or pegging, fixing or maintaining the price of the Class A Common
Units, the Underwriters may place bids for the Class A Common Units or effect
purchases of the Class A Common Units in the open market. A syndicate short
position may also be covered by exercise of the over-allotment option
described above. Finally, the Underwriters may impose a penalty bid on certain
Underwriters and dealers. This means that the underwriting syndicate may
reclaim selling concessions allowed to an Underwriter or a dealer for
distributing Class A Common Units in the offering if the syndicate repurchases
previously distributed Class A Common Units in transactions to cover syndicate
short positions, in stabilization transactions or otherwise. The Underwriters
are not required to engage in any of these activities and any such activities,
if commenced, may be discontinued at any time.
The Partnership, the Operating Partnership and the General Partner have
agreed to indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act.
VALIDITY OF CLASS A COMMON UNITS
The validity of the Class A Common Units is being passed upon by Andrews &
Kurth L.L.P., as counsel for the General Partner and the Partnership. Certain
legal matters in connection with the Class A Common Units will be passed upon
for the Underwriters by Baker & Botts, L.L.P., as counsel for the
Underwriters.
EXPERTS
The consolidated financial statements of Lakehead Pipe Line Partners, L.P.
as of December 31, 1996 and 1995 and for each of the three years in the period
ended December 31, 1996 incorporated in this Prospectus by reference to the
Annual Report on Form 10-K for the year ended December 31, 1996, have been so
incorporated in reliance on the report of Price Waterhouse LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.
The balance sheet of Lakehead Pipe Line Company, Inc. as of December 31,
1996, incorporated in this Prospectus by reference to the Current Report on
Form 8-K of Lakehead Pipe Line Partners, L.P. dated September 25, 1997, has
been so incorporated in reliance on the report of Price Waterhouse LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
INDEPENDENT ACCOUNTANTS
The firm of Price Waterhouse LLP has been approved by the General Partner as
the Partnership's independent accountants for 1997 and serves as the
independent accountants for Lakehead. In addition, Price Waterhouse serves as
independent accountants in Canada for IPL Energy and IPL.
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EXHIBIT A
GLOSSARY OF DEFINED TERMS
The following terms used in this Prospectus shall have the following
respective meanings:
"Adjusted Property" means any property the carrying values of which have
been adjusted pursuant to the terms and provisions of the Partnership
Agreement, which generally permit the adjustment of capital accounts to
reflect the revaluation of existing partnership property to fair market value
upon a contribution or distribution of money or other property in
consideration for the acquisition or relinquishment of an interest in the
Partnership.
"Assignee" means a Non-citizen Assignee or a person to whom one or more
Units have been transferred in a manner permitted under the Partnership
Agreement and who has executed and delivered a transfer application as
required by the Partnership Agreement, but who has not become a substituted
Limited Partner.
"Available Cash" means, with respect to any calendar quarter, (i) the sum of
(a) all cash receipts of the Partnership during such quarter from all sources
(including distributions of cash received from the Operating Partnership) and
(b) any reduction in cash reserves established in prior quarters (either by
reversal or utilization), less (ii) the sum of (aa) all cash disbursements of
the Partnership during such quarter (excluding cash distributions to
Unitholders and to the General Partner) and (bb) any cash reserves established
in such quarter in such amounts as the General Partner shall determine to be
necessary or appropriate in its reasonable discretion (x) to provide for the
proper conduct of the business of the Partnership (including cash reserves for
possible rate refunds or future capital expenditures) or (y) to provide funds
for distributions with respect to any of the next four quarters and (cc) any
other cash reserves established in such quarter in such amounts as the General
Partner determines in its reasonable discretion to be necessary because the
distribution of such amounts would be prohibited by applicable law or by any
loan agreement, security agreement, mortgage, debt instrument or other
agreement or obligation to which the Partnership is a party or by which it is
bound or its assets are subject. Taxes paid by the Partnership on behalf of,
or amounts withheld with respect to, all or less than all of the Unitholders
shall not be considered cash disbursements of the Partnership that reduce
"Available Cash," but the payment or withholding thereof shall be deemed to be
a distribution of Available Cash to such Unitholders. Alternatively, in the
discretion of the General Partner, such taxes (if pertaining to all
Unitholders) may be considered to be cash disbursements of the Partnership
that reduces "Available Cash," but the payment or withholding thereof shall
not be deemed to be a distribution of Available Cash to Unitholders.
Notwithstanding the foregoing, "Available Cash" shall not include any cash
receipts or reductions in reserves or take into account any disbursements made
or reserves established after commencement of the dissolution and liquidation
of the Partnership.
"barrel mile" means a measurement of how fully a pipeline is used over its
length, calculated by multiplying individual deliveries (barrels) by their
distances shipped (miles) and summing the product of such multiplication.
"bitumen" means a naturally occurring viscous mixture, mainly of
hydrocarbons, that in its naturally occurring viscous state is not recoverable
at a commercial rate through a well, absent steam injection, and also includes
hydrocarbons produced as a result of mining oil-impregnated rock or sand.
"Book-Tax Disparity" means, with respect to any item of Contributed Property
or Adjusted Property, the difference between the carrying value of such
property and the adjusted basis thereof for federal income tax purposes, i.e.,
the difference between the partner's book capital account and a pure tax
capital account, arising from a revaluation of any such property.
"CAPP" means the Canadian Association of Petroleum Producers.
"Cash from Interim Capital Transactions" means cash distributed by the
Partnership in excess of the cumulative amount that is Cash from Operations.
"Cash from Operations" means, at any date but prior to the commencement of
the dissolution and liquidation of the Partnership, on a cumulative basis, the
cash balance of the Partnership at Partnership Inception
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(excluding any cash on hand at Partnership Inception from the exercise of the
Underwriters' over-allotment option), plus all cash receipts of the
Partnership from its operations (excluding any cash proceeds from Interim
Capital Transactions) during the period since Partnership Inception through
such date less the sum of (a) all cash operating expenditures of the
Partnership, including, without limitation, taxes paid by the Partnership as
an entity after Partnership Inception, (b) all cash debt service payments of
the Partnership during such period (other than payments or prepayments of
principal and premium required by reason of loan agreements (including
covenants and default provisions therein) or by lenders, in each case in
connection with sales or other dispositions of assets or made in connection
with refinancing or refunding of indebtedness, provided that any payment or
prepayment of principal, whether or not then due, shall be determined at the
election and in the discretion of the General Partner to be refunded or
refinanced by any indebtedness incurred or to be incurred by the Partnership
simultaneously with or within 180 days prior to or after such payment or
prepayment to the extent of the principal amount of such indebtedness so
incurred), (c) all cash capital expenditures of the Partnership during such
period necessary to maintain the service capability of the Lakehead System,
(d) an amount equal to the incremental revenues collected pursuant to a rate
increase that are, at such date, subject to possible refund and for which the
General Partner has established a cash reserve, (e) any cash reserves
outstanding as of such date that the General Partner determines in its
reasonable discretion to be necessary or appropriate to provide for the future
cash payment of items of the type referred to in (a) through (c) above, and
(f) any cash reserves outstanding as of such date that the General Partner
determines to be necessary or appropriate in its reasonable discretion to
provide funds for distributions with respect to any one or more of the next
four quarters, all as determined on a consolidated basis after elimination of
intercompany items and Lakehead's general partner interest in the Operating
Partnership. Taxes paid by the Partnership on behalf of, or amounts withheld
with respect to, all or less than all of the Unitholders shall not be
considered cash operating expenditures of the Partnership that reduce "Cash
from Operations," but the payment or withholding thereof shall be deemed to be
a distribution of Available Cash to such Unitholders. Alternatively, in the
discretion of the General Partner, such taxes (if pertaining to all
Unitholders) may be considered to be cash disbursements of the Partnership
that reduces "Cash from Operations," but the payment or withholding thereof
shall not be deemed to be a distribution to Unitholders.
"Cdn. $" means Canadian dollars.
"Code" means the United States Internal Revenue Code of 1986, as amended,
and as interpreted by the applicable regulations thereunder.
"Contributed Property" means each property or other asset, in such form as
may be permitted by the Delaware Act, but excluding cash, contributed to the
Partnership by the General Partner.
"Delaware Act" means the Delaware Revised Uniform Limited Partnership Act, 6
Del. C. 17-101, et seq., as it may be amended from time to time, and any
successor to such statute.
"deliveries" means the amount of liquid hydrocarbons delivered by a pipeline
to certain points along the system.
"Distribution Support Agreement" means the agreement between the
Partnership, the General Partner and IPL which specifies certain business
opportunities that the General Partner and its affiliates are prohibited from
engaging in.
"employee benefit plans" include qualified pension, profit-sharing and stock
bonus plans, Keogh plans, Simplified Employee Pension Plans, and tax deferred
annuities or Individual Retirement Accounts.
"Energy Policy Act" means the Energy Policy Act of 1992.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Exchange Act" means the Securities Exchange Act of 1934, as amended, and
any successor to such statute.
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"FERC" means the United States Federal Energy Regulatory Commission.
"First Target Distribution" means $0.59 per Unit per calendar quarter,
subject to downward adjustment under certain circumstances including
distributions of capital to Unitholders.
"General Partner" means Lakehead Pipe Line Company, Inc., a Delaware
corporation. The General Partner is sometimes referred to herein as
"Lakehead."
"Interim Capital Transactions" means in general, extraordinary transactions
that have an impact on the capital of the Partnership, which are defined in
the Partnership Agreement to be (a) borrowings and sales of debt securities
(other than for working capital purposes and other than for items purchased on
open account in the ordinary course of business) by the Partnership, (b) sales
of equity interests by the Partnership and (c) sales or other voluntary or
involuntary dispositions of any assets of the Partnership (other than (x)
sales or other dispositions of inventory in the ordinary course of business,
(y) sales or other dispositions of other current assets including accounts
receivable or (z) sales or other dispositions of assets as part of normal
retirements or replacements), in each case prior to the commencement of the
dissolution and liquidation of the Partnership.
"IPL" means Interprovincial Pipe Line Inc., a Canadian corporation that is a
subsidiary of IPL Energy and the parent of Lakehead.
"IPL Energy" means IPL Energy Inc., a Canadian corporation and the parent of
IPL.
"IPL Energy USA" means IPL Energy (U.S.A.) Inc., a U.S. corporation and
subsidiary of IPL Energy.
"IPL System" means the portion of the System that is in Canada.
"IRS" means the United States Internal Revenue Service.
"Lakehead" means Lakehead Pipe Line Company, Inc., a Delaware corporation
and the General Partner of the Partnership.
"Lakehead System" means the portion of the System that is in the United
States.
"Limited Partner" means each person holding a limited partner interest
(which includes Class A Common Units and Class B Common Units) in the
Partnership who has been admitted to the Partnership as a partner.
"Montreal Extension" means the portion of the IPL System running from
Sarnia, Ontario to Montreal, Quebec.
"NEB" means the National Energy Board, the Canadian regulatory authority
that governs the interprovincial transportation of liquid hydrocarbons by the
IPL System.
"netback" means the price received by a seller for a barrel of crude oil or
NGLs, less the cost of transportation.
"NGLs" means those hydrocarbon components transported on the Lakehead System
that include the following natural gas liquids: propane, butanes, pentanes
plus and condensate with certain vapor pressures.
"Operating Partnership" means Lakehead Pipe Line Company, Limited
Partnership, a Delaware limited partnership.
"Operating Partnership Agreement" means the Amended and Restated Agreement
of Limited Partnership of the Operating Partnership.
"Order No. 561" means FERC Order No. 561 issued on October 22, 1993.
A-3
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"Partnership" means Lakehead Pipe Line Partners, L.P., a Delaware limited
partnership.
"Partnership Agreement" means the Amended and Restated Agreement of Limited
Partnership of the Partnership (and together with the Operating Partnership
Agreement, the "Partnership Agreements").
"Producer Price Index for Finished Goods" means the Producer Price Index for
Finished Goods published by the U.S. Department of Labor, Bureau of Labor
Statistics.
"SEC" means the United States Securities and Exchange Commission.
"Second Target Distribution" means initially $0.70 per Unit per calendar
quarter, subject to downward adjustment under certain circumstances including
distributions of capital to Unitholders.
"Section 751 Assets" means the Partnership's "unrealized receivables"
(including depreciation recapture) and "substantially appreciated inventory
items," both as defined in Section 751 of the Code.
"Securities Act" means the Securities Act of 1933, as amended, and any
successor to such statute.
"SEP II" means the capacity expansion program undertaken by the Partnership
expected to be completed in late 1998.
"Services Agreement" means the agreement between IPL, or IPL Energy USA and
Lakehead, whereby IPL provides certain services to Lakehead.
"Services Partnership" means Lakehead Services, Limited Partnership, a
Delaware limited partnership which is not part of the operating business of
the System, but in which the Partnership holds a 1% general partner interest
and Lakehead owns a 99% limited partner interest.
"Settlement Agreement" means the Settlement Agreement between the
Partnership and representatives of certain of the Partnership's customers on
all then outstanding contested tariff rates, which agreement was approved by
the FERC in October 1996.
"Special Allocation" means the allocation, beginning with the 1995 taxable
year of the Partnership, of amounts of gross income to the Class A Common
Unitholders that would otherwise be allocated to the Class B Common Unitholder
as provided in the Partnership Agreement.
"System" means the 3,200-mile liquids pipeline that extends from western
Canada though the upper and lower Great Lakes region of the United States to
eastern Canada.
"tariff" means the charge to transport liquid hydrocarbons from a receipt
point to a delivery point.
"Third Target Distribution" means initially $0.99 per Unit per calendar
quarter, subject to downward adjustment under certain circumstances including
distributions of capital to Unitholders.
"throughput" means the amount of liquid hydrocarbons flowing at a given
point on the Lakehead System or the IPL System.
"Unitholder" means a person who is the holder of a Class A Common Unit or a
Class B Common Unit on the records of the Partnership.
"Units" means a partnership interest of a Limited Partner or Assignee in the
Partnership (including Class A Common Units and Class B Common Units)
representing a fractional part of the partnership interest of all Limited
Partners and Assignees.
"Unrecovered Capital" means, at any time, with respect to a Unit, the
Unrecovered Initial Unit Price.
"Unrecovered Initial Unit Price" with respect to a Unit means, in general,
the amount by which (i) $21.50 exceeds (ii) the aggregate per Unit
distributions of Cash from Interim Capital Transactions in respect of such
Unit.
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- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AU-
THORIZED BY THE PARTNERSHIP OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CON-
STITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN
OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE CLASS A COMMON
UNITS OFFERED HEREBY IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT
IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANC-
ES, CREATE AN IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET
FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE PARTNERSHIP SINCE THE DATE
HEREOF.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information.................................................... 4
Incorporation of Certain Information..................................... 4
Prospectus Summary....................................................... 5
Forward-Looking Statements............................................... 12
Risk Factors............................................................. 12
Partnership Structure.................................................... 19
Use of Proceeds.......................................................... 20
Capitalization........................................................... 20
Price Range of Class A Common Units and Distributions.................... 21
Selected Historical Financial and Operating Data......................... 22
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 23
Business................................................................. 28
Management............................................................... 40
Cash Distributions....................................................... 42
Conflicts of Interest and Fiduciary Responsibilities..................... 46
Tax Considerations....................................................... 50
Investment in the Partnership by Employee Benefit Plans.................. 65
Underwriting............................................................. 66
Validity of Class A Common Units......................................... 67
Experts.................................................................. 67
Independent Accountants.................................................. 67
Glossary of Defined Terms................................................ A-1
</TABLE>
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2,200,000
CLASS A COMMON UNITS
LAKEHEAD
PIPE LINE
PARTNERS, L.P.
REPRESENTING CLASS A
LIMITED PARTNER INTERESTS
--------
PROSPECTUS
, 1997
--------
SMITH BARNEY INC.
GOLDMAN, SACHS & CO.
MERRILL LYNCH & CO.
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