UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549








FORM
20-F





(Mark One)


[  ]                      REGISTRATION STATEMENT PURSUANT TO
SECTION 12(b) or (g)


OF
THE SECURITIES EXCHANGE ACT OF 1934





OR





[X]                      ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934








For the
fiscal year ended December 31, 2007





OR





[  ]                      TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934





OR





[  ]                      SHELL COMPANY REPORT PURSUANT TO
SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934


Date of event requiring this shell
company report........................





For the
transition period from ________________ to _____________________





Commission
file number 1-33198








TEEKAY
OFFSHORE PARTNERS L.P.


(Exact
name of Registrant as specified in its charter)




Republic
of The Marshall Islands


(Jurisdiction
of incorporation or organization)





4th floor,
Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda


(Address
of principal executive offices)





Roy
Spires


4th floor,
Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda


Telephone:
(441) 298-2530


Fax:
(441) 292-3931


(Contact
Information for Company Contact Person)





Securities
registered or to be registered pursuant to Section 12(b) of the
Act.





Title
      of each class
            Name
      of each exchange on which registeredCommon
      Units
            New
      York Stock Exchange





Securities
registered or to be registered pursuant to Section 12(g) of the
Act.





None





Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act.





None








1





Indicate
the number of outstanding shares of each of the issuer's classes of capital or
common stock as of the close of the period covered by the annual
report.


9,800,000
Common Units


9,800,000
Subordinated Units





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.





Yes
[  ] No [X]





If this
report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.





Yes
[  ] No [X]





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.





Yes [X]
No [  ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.  (Check one):





Large
Accelerated Filer
[  ]                                                                           Accelerated
Filer
[X]                                                                Non-Accelerated
Filer [  ]








Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:
 
 U.S.
      GAAP [X]
              International
      Financial Reporting Standards as issued by the International Accounting
      Standards Board [  ]
              Other
      [  ]
 
 If
"Other" has been checked in response to the previous question, indicate by check
mark which financial statement item the registrant has elected to
follow:
 
 Item
17 [  ]Item 18[  ]
 
 If this
is an annual report, indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act).
 
 Yes
[  ] No [X]





2





TEEKAY
OFFSHORE PARTNERS L.P.


INDEX
TO REPORT ON FORM 20-F








PagePART
      I.Item
      1.
            Identity
      of Directors, Senior Management and
      Advisors
            Not
      applicableItem
      2.
            Offer
      Statistics and Expected
      Timetable
            Not
      applicableItem
      3.
            Key
      Information
            5Item
      4.
            Information
      on the
      Partnership
            20Item
      4A.
            Unresolved
      Staff
      Comments
            Not
      applicableItem
      5.
            Operating
      and Financial Review and
      Prospects
            36Item
      6.
            Directors,
      Senior Management and
      Employees
            53Item
      7.
            Major
      Unitholders and Related Party
      Transactions
            57Item
      8.
            Financial
      Information
            60Item
      9.
            The
      Offer and
      Listing
            62Item
      10.
            Additional
      Information
            62Item
      11.
            Quantitative
      and Qualitative Disclosures About Market
      Risk
            65Item
      12.
            Description
      of Securities Other than Equity
      Securities
            Not
      applicablePART
      II.Item
      13.
            Defaults,
      Dividend Arrearages and
      Delinquencies
            66Item
      14.
            Material
      Modifications to the Rights of Unitholders and Use of
      Proceeds
            66Item
      15.
            Controls
      and
      Procedures
            66Item
      16A.
            Audit
      Committee Financial
      Expert
            66Item
      16B.
            Code
      of
      Ethics
            67Item
      16C.
            Principal
      Accountant Fees and
      Services
            67Item
      16D.
            Exemptions
      from the Listing Standards for Audit
      Committees
            67Item
      16E.
            Purchases
      of Units by the Issuer and Affiliated
      Purchasers
            67PART
      III.Item
      17.
            Financial
      Statements
            Not
      applicableItem
      18.
            Financial
      Statements
            67Item
      19.
            Exhibits
            68Signatures
            
            69








3








PART
I




This
Annual Report should be read in conjunction with the consolidated financial
statements and accompanying notes included in this report.




In
addition to historical information, this Annual Report contains forward-looking
statements that involve risks and uncertainties. Such forward-looking statements
relate to future events and our operations, objectives, expectations,
performance, financial condition and intentions. When used in this Annual
Report, the words "expect," "intend," "plan," "believe," "anticipate,"
"estimate" and variations of such words and similar expressions are intended to
identify forward-looking statements. Forward-looking statements in this Annual
Report include, in particular, statements regarding:




·
            our
      ability to make cash distributions on our units or any increases in
      quarterly distributions;




·
            our
      future financial condition or results of operations and future revenues
      and expenses;





·
            growth
      prospects of the offshore and tanker
markets;




·
            offshore
      and tanker market fundamentals, including the balance of supply and demand
      in the offshore and tanker markets;




·
            the
      expected lifespan of a new shuttle tanker, floating storage and off-take
      (or FSO) unit and conventional
tanker;




·
            estimated
      capital expenditures and the availability of capital resources to fund
      capital expenditures;




·
            our
      ability to maintain long-term relationships with major crude oil
      companies;




·
            our
      ability to leverage to our advantage Teekay Corporation’s relationships
      and reputation in the shipping
industry;




·
            our
      continued ability to enter into fixed-rate time charters with
      customers;




·
            obtaining
      offshore projects that we or Teekay Corporation bid on or that Teekay
      Corporation is awarded;




·
            our
      ability to maximize the use of our vessels, including the re-deployment or
      disposition of vessels no longer under long-term time
    charter;




·
            the
      ability of the counterparties to our derivative contracts to fulfill their
      contractual obligations;




·
            our
      pursuit of strategic opportunities, including the acquisition of vessels
      and expansion into new markets
vessels;




·
            our
      expected financial flexibility to pursue acquisitions and other expansion
      opportunities;




·
            anticipated
      funds for liquidity needs and the sufficiency of cash
    flows;




·
            the
      expected cost of, and our ability to comply with, governmental regulations
      and maritime self regulatory organization standards applicable to our
      business;




·
            the
      expected impact of heightened environmental and quality concerns of
      insurance underwriters, regulators and
  charterers;





·
            anticipated
      taxation of our partnership and its
  subsidiaries;




·
            Teekay
      Corporation increasing its ownership interest in Teekay Petrojarl ASA
      (formally Petrojarl ASA) or offering to us additional interest in Teekay
      Offshore Operating L.P;




·
            our
      general and administrative expenses as a public company and expenses under
      service agreements with other affiliates of Teekay Corporation and for
      reimbursements of fees and costs of our general partner;
    and




·
            our
      business strategy and other plans and objectives for future
      operations.




Forward-looking
statements include, without limitation, any statement that may predict,
forecast, indicate or imply future results, performance or achievements, and may
contain the words believe, anticipate, expect, estimate, project, will be, will
continue, will likely result, or words or phrases of similar meanings. These
statements are necessarily estimates reflecting the judgment of senior
management, involve known and unknown risks and are based upon a number of
assumptions and estimates that are inherently subject to significant
uncertainties and contingencies, many of which are beyond our control. Actual
results may differ materially from those expressed or implied by such
forward-looking statements. Important factors that could cause actual results to
differ materially include, but are not limited to, those factors discussed below
in Item 3: Key Information—Risk Factors and other factors detailed from
time to time in other reports we file with the SEC.





4







We do not
intend to revise any forward-looking statements in order to reflect any change
in our expectations or events or circumstances that may subsequently arise. You
should carefully review and consider the various disclosures included in this
Annual Report and in our other filings made with the SEC that attempt to advise
interested parties of the risks and factors that may affect our business,
prospects and results of operations.





Item
1.  Identity of Directors, Senior Management and Advisors





Not
applicable.





Item
2.  Offer Statistics and Expected Timetable





Not
applicable.




Item
3.  Key Information


Selected
Financial Data





The
following tables present, in each case for the periods and as of the dates
indicated, summary:





·
              historical
      financial and operating data of Teekay Offshore Partners Predecessor (as
      defined below); and





·
              financial
      and operating data of Teekay Offshore Partners L.P. and its subsidiaries
      (sometimes referred to as the Partnership, we or us) since its initial
      public offering on December 19,
2006.





Prior to
the closing of the our initial public offering of common units on December 19,
2006, Teekay Corporation transferred eight Aframax conventional crude oil
tankers to a subsidiary of Norsk Teekay Holdings Ltd. (or Norsk Teekay) and one FSO
unit to Teekay Offshore Australia Trust. Teekay Corporation then transferred to
Teekay Offshore Operating L.P. (or OPCO) all of the outstanding
interests of four wholly-owned subsidiaries — Norsk Teekay, Teekay Nordic
Holdings Inc., Teekay Offshore Australia Trust and Pattani Spirit L.L.C. These
four wholly-owned subsidiaries, which include the eight Aframax conventional
crude oil tankers and the FSO unit, are collectively referred to as Teekay Offshore Partners
Predecessor or the Predecessor.





The
summary historical financial and operating data has been prepared on the
following basis:


·
                  the
      historical financial and operating data of Teekay Offshore Partners
      Predecessor as at and for the year ended December 31, 2003 is derived from
      the unaudited combined consolidated financial statements of Teekay
      Offshore Partners
Predecessor;
 ·
                      the
      historical financial and operating data of Teekay Offshore Partners
      Predecessor as at and for the years ended December 31, 2004 and 2005 are
      derived from the audited combined consolidated financial statements of
      Teekay Offshore Partners
Predecessor;
 ·
                          the
      historical financial and operating data of Teekay Offshore Partners
      Predecessor as at December 31, 2006 and for the period from
      January 1, 2006 to December 18, 2006 are derived from the audited
      combined consolidated financial statements of Teekay Offshore Partners
      Predecessor; and
 ·
                              the
      historical financial and operating data of Teekay Offshore Partners L.P.
      as at December 31, 2006 and 2007, for the period from December 19, 2006 to
      December 31, 2006, and for the year ended December 31, 2007, reflect our
      initial public offering and are derived from our audited consolidated
      financial statements.




Our
initial public offering and certain other transactions that occurred during 2006
and 2007 have affected our historical performance or will affect our future
performance. As a result, the following tables should be read together with, and
are qualified in their entirety by reference to, (a) “Item 5. Operating and
Financial Review and Prospects," included herein, and (b) the historical
consolidated financial statements and the accompanying notes and the Report of
Independent Registered Public Accounting Firm therein (which are included
herein), with respect to the consolidated financial statements for the years
ended December 31, 2007, 2006, and 2005 aggregated as follows:





Year ended December 31,
2007


·
            January
      1 to December 31, 2007





Year ended December 31,
2006


·
            January
      1 to December 18, 2006


·
            December
      19 to December 31, 2006





Year ended December 31,
2005


·
            January
      1 to December 31, 2005








5


GAAP


Year
      Ended December 31, 2006Years
      Ended December 31,
            
            
            January
      1
              to
              December
      18,
            
            
            December
      19,
              to
              December
      31,
            
            
            Year
      Ended December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2006
            
            
            2007(in
      thousands, except unit, per unit and fleet data)Income
      Statement Data:Voyage
      revenues
            
            $
            747,383
            
            
            $
            986,504
            
            
            $
            807,548
            
            
            $
            684,766
            
            
            $
            23,926
            
            
            $
            775,969Operating
      expenses:Voyage
      expenses (1)
            
            
            146,893
            
            
            
            118,819
            
            
            
            74,543
            
            
            
            91,321
            
            
            
            3,102
            
            
            
            151,583Vessel
      operating expenses(2)
            
            
            87,507
            
            
            
            105,595
            
            
            
            104,475
            
            
            
            102,311
            
            
            
            4,087
            
            
            
            143,247Time-charter
      hire expense
            
            
            235,976
            
            
            
            372,449
            
            
            
            373,536
            
            
            
            239,311
            
            
            
            5,641
            
            
            
            150,463Depreciation
      and amortization
            
            
            93,269
            
            
            
            118,460
            
            
            
            107,542
            
            
            
            98,386
            
            
            
            3,636
            
            
            
            122,415General
      and administrative
            
            
            33,968
            
            
            
            65,819
            
            
            
            85,856
            
            
            
            70,387
            
            
            
            2,129
            
            
            
            61,530Loss
      (gain) on sale of vessels, net of writedowns
            
            
            63
            
            
            
            (3,725
            )
            
            
            2,820
            
            
            
            (4,778
            )
            
            
            -
            
            
            
            -Restructuring
      charge
            
            
            -
            
            
            
            -
            
            
            
            955
            
            
            
            832
            
            
            
            -
            
            
            
            -Total
      operating expenses
            
            
            597,676
            
            
            
            777,417
            
            
            
            749,727
            
            
            
            597,770
            
            
            
            18,595
            
            
            
            629,238Income
      from vessel operations
            
            
            149,707
            
            
            
            209,087
            
            
            
            57,821
            
            
            
            86,996
            
            
            
            5,331
            
            
            
            146,731Interest
      expense
            
            
            (46,872
            )
            
            
            (43,957
            )
            
            
            (39,791
            )
            
            
            (67,225
            )
            
            
            (2,200
            )
            
            
            (79,768
            )Interest
      income
            
            
            1,278
            
            
            
            2,459
            
            
            
            4,605
            
            
            
            5,167
            
            
            
            191
            
            
            
            5,774Equity
      income from joint ventures
            
            
            5,047
            
            
            
            6,162
            
            
            
            5,199
            
            
            
            6,162
            
            
            
            -
            
            
            
            -Gain
      on sale of marketable securities
            
            
            517
            
            
            
            94,222
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Foreign
      currency exchange (loss) gain (3)
            
            
            (17,821
            )
            
            
            (37,910
            )
            
            
            34,178
            
            
            
            (66,574
            )
            
            
            (131
            )
            
            
            (12,144
            )Income
      tax (expense) recovery
            
            
            (30,035
            )
            
            
            (28,188
            )
            
            
            13,873
            
            
            
            (2,672
            )
            
            
            (99
            )
            
            
            10,924Other
      –
      net
            
            
            4,455
            
            
            
            14,064
            
            
            
            9,091
            
            
            
            8,360
            
            
            
            309
            
            
            
            10,403Net
      income (loss) before non-controlling
              interest
            
            
            66,276
            
            
            
            215,939
            
            
            
            84,976
            
            
            
            (29,786
            )
            
            
            3,401
            
            
            
            81,920Non-controlling
      interest
            
            
            (2,763
            )
            
            
            (2,167
            )
            
            
            (229
            )
            
            
            (3,777
            )
            
            
            (2,553
            )
            
            
            (62,248
            )Net
      income
      (loss)
            
            $
            63,513
            
            
            $
            213,772
            
            
            $
            84,747
            
            
            $
            (33,563
            )
            
            $
            848
            
            
            $
            19,672General
      partner’s interest in net income
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            17
            
            
            $
            393Limited
      partners’ interest:Net
      income (loss)
            
            
            63,513
            
            
            
            213,772
            
            
            
            84,747
            
            
            
            (33,563
            )
            
            
            831
            
            
            
            19,279Net
      income (loss) per:Common
      unit (basis and diluted) (4)
            
            
            5.04
            
            
            
            16,97
            
            
            
            6.73
            
            
            
            (2.66
            )
            
            
            0.05
            
            
            
            1.26Subordinated
      unit (basis and diluted) (4)
            
            
            5.04
            
            
            
            16.97
            
            
            
            6.73
            
            
            
            (2.66
            )
            
            
            0.04
            
            
            
            0.70Total
      unit (basis and diluted) (4)
            
            
            5.04
            
            
            
            16.97
            
            
            
            6.73
            
            
            
            (2.66
            )
            
            
            0.04
            
            
            
            0.99Cash
      distributions declared per unit
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1.14Balance Sheet Data (at
      end of period):Cash
      and marketable securities
            
            $
            160,957
            
            
            $
            143,729
            
            
            $
            128,986
            
            
            
            
            
            
            $
            113,986
            
            
            $
            121,224Vessels
      and equipment (5)
            
            
            1,431,947
            
            
            
            1,427,481
            
            
            
            1,300,064
            
            
            
            
            
            
            
            1,524,842
            
            
            
            1,662,865Total
      assets
            
            
            2,037,855
            
            
            
            2,040,642
            
            
            
            1,884,017
            
            
            
            
            
            
            
            2,041,321
            
            
            
            2,166,351Total
      debt (6)
            
            
            1,354,392
            
            
            
            1,210,998
            
            
            
            991,855
            
            
            
            
            
            
            
            1,320,303
            
            
            
            1,517,467Non-controlling
      interest
            
            
            15,525
            
            
            
            14,276
            
            
            
            11,859
            
            
            
            
            
            
            
            427,977
            
            
            
            391,645Total
      partners’/owner’s equity
            
            
            529,794
            
            
            
            659,212
            
            
            
            740,379
            
            
            
            
            
            
            
            138,942
            
            
            
            80,969Common
      units outstanding (4)
            
            
            2,800,000
            
            
            
            2,800,000
            
            
            
            2,800,000
            
            
            
            2,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000Subordinated
      units outstanding (4)
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000Cash
      Flow Data:Net
      cash provided by (used in):Operating
      activities (7)
            
            $
            224,237
            
            
            $
            240,245
            
            
            $
            143,069
            
            
            
            
            
            
            
            
            
            
            $
            55,931Financing
      activities (7)
            
            
            734,389
            
            
            
            (67,363
            )
            
            
            (191,936
            )
            
            
            
            
            
            
            
            
            
            
            51,422Investing
      activities (7)
            
            
            (837,423
            )
            
            
            (190,110
            )
            
            
            34,124
            
            
            
            
            
            
            
            
            
            
            
            (100,115
            )Other
      Financial Data:Net
      voyage revenues (8)
            
            $
            600,490
            
            
            $
            867,685
            
            
            $
            733,005
            
            
            $
            593,445
            
            
            $
            20,824
            
            
            $
            624,386EBITDA
      (9)
            
            
            232,411
            
            
            
            401,918
            
            
            
            213,602
            
            
            
            129,553
            
            
            
            6,592
            
            
            
            205,157Capital
      expenditures:Expenditures
      for vessels and equipment
            
            
            146,279
            
            
            
            170,630
            
            
            
            24,760
            
            
            
            31,079
            
            
            
            -
            
            
            
            210,339Expenditures
      for
      drydocking
            
            
            11,980
            
            
            
            9,174
            
            
            
            8,906
            
            
            
            31,255
            
            
            
            -
            
            
            
            39,626Fleet
      data:Average
      number of shuttle tankers (10)
            
            
            30.5
            
            
            
            37.9
            
            
            
            35.8
            
            
            
            33.9
            
            
            
            36.0
            
            
            
            36.7Average
      number of conventional tankers (10)
            
            
            27.4
            
            
            
            40.7
            
            
            
            41.2
            
            
            
            22.0
            
            
            
            10.0
            
            
            
            9.3Average
      number of FSO units10)
            
            
            2.2
            
            
            
            3.0
            
            
            
            3.0
            
            
            
            3.0
            
            
            
            3.0
            
            
            
            3.9


6





(1)
            Voyage
      expenses are all expenses unique to a particular voyage, including any
      bunker fuel expenses, port fees, cargo loading and unloading expenses,
      canal tolls, agency fees and
commissions.





(2)
            Vessel
      operating expenses include crewing, repairs and maintenance, insurance,
      stores, lube oils and communication
expenses.





(3)
            Substantially
      all of these foreign currency exchange gains and losses were unrealized
      and not settled in cash. Under U.S. accounting guidelines, all
      foreign currency-denominated monetary assets and liabilities, such as cash
      and cash equivalents, accounts receivable, accounts payable, advances from
      affiliates and deferred income taxes, are revalued and reported based on
      the prevailing exchange rate at the end of the period. For the periods
      prior to our initial public offering, our primary source of foreign
      currency gains and losses were our Norwegian Kroner-denominated advances
      from affiliates, which were settled by the Predecessor prior to December
      19, 2006.





(4)
            Net
      income (loss) per unit is determined by dividing net income (loss), after
      deducting the amount of net income (loss) allocated to our general
      partner’s interest for periods subsequent to our initial public offering
      on December 19, 2006, by the weighted-average number of units outstanding
      during the period. For periods prior to December 19, 2006, such units are
      deemed equal to the common and subordinated units received by Teekay
      Corporation in exchange for a 26.0% interest in OPCO in connection with
      our initial public offering.





(5)
            Vessels
      and equipment consists of (a) vessels, at cost less accumulated
      depreciation, (b) vessels under capital leases, at cost less
      accumulated depreciation, and (c) advances on
      newbuildings.





(6)
            Total
      debt includes long-term debt, capital lease obligations and advances from
      affiliates.





(7)
            For
      the year ended December 31, 2006, cash flow data provided by (used in)
      operating activities, financing activities and investing activities was
      $151,486, ($219,496) and $53,010,
respectively.





(8)
            Consistent
      with general practice in the shipping industry, we use net voyage revenues
      (defined as voyage revenues less voyage expenses) as a measure of equating
      revenues generated from voyage charters to revenues generated from time
      charters, which assists us in making operating decisions about the
      deployment of vessels and their performance. Under time charters and
      bareboat charters, the charterer typically pays the voyage expenses, which
      are all expenses unique to a particular voyage, including any bunker fuel
      expenses, port fees, cargo loading and unloading expenses, canal tolls,
      agency fees and commissions, whereas under voyage charter contracts and
      contracts of affreightment the shipowner typically pays the voyage
      expenses. Some voyage expenses are fixed, and the remainder can be
      estimated. If we or OPCO, as the shipowner, pay the voyage expenses, we or
      OPCO typically pass the approximate amount of these expenses on to the
      customers by charging higher rates under the contract or billing the
      expenses to them. As a result, although voyage revenues from different
      types of contracts may vary, the net revenues after subtracting voyage
      expenses, which we call net voyage revenues, are comparable across the
      different types of contracts. We principally use net voyage revenues, a
      non-GAAP financial measure, because it provides more meaningful
      information to us than voyage revenues, the most directly comparable GAAP
      financial measure. Net voyage revenues are also widely used by investors
      and analysts in the shipping industry for comparing financial performance
      between companies in the shipping industry to industry averages. The
      following table reconciles net voyage revenues with voyage
      revenues.






Year
      Ended December 31, 2006Years
      Ended December 31,
            
            
            January
      1
              to
              December
      18,
            
            
            December
      19
              to
              December
      31,
            
            
            Year
      Ended December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2006
            
            
            2007Voyage
      revenues
            
            $
            747,383
            
            
            $
            986,504
            
            
            $
            807,548
            
            
            $
            684,766
            
            
            $
            23,926
            
            
            $
            775,969Voyage
      expenses
            
            
            146,893
            
            
            
            118,819
            
            
            
            74,543
            
            
            
            91,321
            
            
            
            3,102
            
            
            
            151,583Net
      voyage
      revenues
            
            $
            600,490
            
            
            $
            867,685
            
            
            $
            733,005
            
            
            $
            593,445
            
            
            $
            20,824
            
            
            $
            624,386





(9)
            EBITDA.
      Earnings before interest, taxes, depreciation and amortization is used as
      a supplemental financial measure by management and by external users of
      our financial statements, such as investors, as discussed
      below:





•
            Financial and operating
      performance.EBITDA assists our management and investors by
      increasing the comparability of the fundamental performance of us from
      period to period and against the fundamental performance of other
      companies in our industry that provide EBITDA information. This increased
      comparability is achieved by excluding the potentially disparate effects
      between periods or companies of interest expense, taxes, depreciation or
      amortization, which items are affected by various and possibly changing
      financing methods, capital structure and historical cost basis and which
      items may significantly affect net income between periods. We believe that
      including EBITDA as a financial and operating measure benefits investors
      in (a) selecting between investing in us and other investment
      alternatives and (b) monitoring the ongoing financial and operational
      strength and health of us in assessing whether to continue to hold our
      common units.





•
            Liquidity.EBITDA
      allows us to assess the ability of assets to generate cash sufficient to
      service debt, make distributions and undertake capital expenditures. By
      eliminating the cash flow effect resulting from the existing
      capitalization of us and OPCO and other items such as drydocking
      expenditures, working capital changes and foreign currency exchange gains
      and losses (which may vary significantly from period to period), EBITDA
      provides a consistent measure of our ability to generate cash over the
      long term. Management uses this information as a significant factor in
      determining (a) our and OPCO’s proper capitalization (including
      assessing how much debt to incur and whether changes to the capitalization
      should be made) and (b) whether to undertake material capital
      expenditures and how to finance them, all in light of existing cash
      distribution commitments to unitholders. Use of EBITDA as a liquidity
      measure also permits investors to assess the fundamental ability of OPCO
      and us to generate cash sufficient to meet cash needs, including
      distributions on our common units.





7








EBITDA  should
not be considered an alternative to net income, operating income, cash flow from
operating activities or any other measure of financial performance or liquidity
presented in accordance with GAAP. EBITDA excludes some, but not all, items that
affect net income and operating income, and these measures may vary among other
companies. Therefore, EBITDA as presented below may not be comparable to
similarly titled measures of other companies.





Year
      Ended December 31, 2006Years
      Ended December 31,
            
            
            January
      1
              to
              December
      18,
            
            
            December
      19
              to
              December
      31,
            
            
            Year
      Ended December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2006
            
            
            2007Reconciliation
      of “EBITDA” to “Netincome
              (loss)”:Net
      income
      (loss)
            
            $
            63,513
            
            
            $
            213,772
            
            
            $
            84,747
            
            
            $
            (33,563
            )
            
            $
            848
            
            
            $
            19,672Depreciation
      and amortization
            
            
            93,269
            
            
            
            118,460
            
            
            
            107,542
            
            
            
            98,386
            
            
            
            3,636
            
            
            
            122,415Interest
      expense, net
            
            
            45,594
            
            
            
            41,498
            
            
            
            35,186
            
            
            
            62,058
            
            
            
            2,009
            
            
            
            73,994Provision
      (benefit) for income taxes
            
            
            30,035
            
            
            
            28,188
            
            
            
            (13,873
            )
            
            
            2,672
            
            
            
            99
            
            
            
            (10,924
            )EBITDA
      (1)
            
            $
            232,411
            
            
            $
            401,918
            
            
            $
            213,602
            
            
            $
            129,553
            
            
            $
            6,592
            
            
            $
            205,157Reconciliation
      of “EBITDA” to “Net
              operating
      cash flow”:Net
      operating cash flow
            
            $
            224,237
            
            
            $
            240,245
            
            
            $
            143,069
            
            
            $
            151,486
            
            
            $
            -
            
            
            $
            55,931Non-controlling
      interest
            
            
            (2,763
            )
            
            
            (2,167
            )
            
            
            (229
            )
            
            
            (3,777
            )
            
            
            (2,553
            )
            
            
            (62,248
            )Expenditures
      for drydocking
            
            
            11,980
            
            
            
            9,174
            
            
            
            8,906
            
            
            
            31,255
            
            
            
            -
            
            
            
            39,626Interest
      expense, net
            
            
            45,594
            
            
            
            41,498
            
            
            
            35,186
            
            
            
            62,058
            
            
            
            2,009
            
            
            
            73,994(Loss)
      gain on sale of vessels
            
            
            (63
            )
            
            
            3,725
            
            
            
            9,423
            
            
            
            6,928
            
            
            
            -
            
            
            
            -Gain
      on sale of marketablesecurities
            
            
            517
            
            
            
            94,222
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Loss
      on writedown of vessels andequipment
            
            
            -
            
            
            
            -
            
            
            
            (12,243
            )
            
            
            (2,150
            )
            
            
            -
            
            
            
            -Write-off
      of debt issuance costs
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,790
            )
            
            
            -
            
            
            
            -Equity
      income (net of dividends received)
            
            
            (1,234
            )
            
            
            (1,338
            )
            
            
            2,449
            
            
            
            160
            
            
            
            -
            
            
            
            -Change
      in working capital
            
            
            (10,602
            )
            
            
            37,709
            
            
            
            (22,951
            )
            
            
            (47,861
            )
            
            
            7,134
            
            
            
            31,588Distribution
      from subsidiaries to minorityowners
            
            
            3,060
            
            
            
            2,347
            
            
            
            9,618
            
            
            
            4,224
            
            
            
            -
            
            
            
            78,107Foreign
      currency exchange (loss) gainand
              other,net
            
            
            (38,315
            )
            
            
            (23,497
            )
            
            
            40,374
            
            
            
            (69,980
            )
            
            
            2
            
            
            
            (11,841
            )EBITDA
      (1)
            
            $
            232,411
            
            
            $
            401,918
            
            
            $
            213,602
            
            
            $
            129,553
            
            
            $
            6,592
            
            
            $
            205,157




(1)
            EBITDA
      is net of non-controlling interest expense of $2.8 million, $2.2 million,
      $0.2 million, $3.8 million, $2.6 million and $62.2 million for the years
      ended December 31, 2003, 2004 and 2005, and for the periods January 1 to
      December 18, 2006 and December 19 to December 31, 2006, and for the year
      ended December 31, 2007,
respectively.




EBITDA
also includes the following items:





Year
      Ended December 31, 2006Years
      Ended December 31,
            
            
            January
      1
              to
              December
      18,
            
            
            December
      19
              to
              December
      31,
            
            
            Year
      Ended December 31,2003
            
            
            2004
            
            
            2005
            
            
            2006
            
            
            2006
            
            
            2007(Loss)
      gain on sale of vessels and equipment,
              netof
      writedowns
            
            $
            (63
            )
            
            $
            3,725
            
            
            $
            (2,820
            )
            
            $
            4,778
            
            
            $
            -
            
            
            $
            -Gain
      on sale of marketablesecurities
            
            
            517
            
            
            
            94,222
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Loss
      on writedown of marketable securities
            
            
            (4,910
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Foreign
      currency exchange (loss) gain
            
            
            (17,821
            )
            
            
            (37,910
            )
            
            
            34,178
            
            
            
            (66,574
            )
            
            
            (131
            )
            
            
            (12,144
            )$
            (22,277
            )
            
            $
            60,037
            
            
            $
            31,358
            
            
            $
            (61,796
            )
            
            $
            (131
            )
            
            $
            (12,144
            )





(10)
            Average
      number of ships consists of the average number of owned and chartered-in
      vessels that were in our possession during a period (excluding the five
      vessels owned by OPCO’s 50% joint ventures for periods prior to December
      1, 2006). On December 1, 2006, the joint venture agreements for these five
      joint ventures were amended, resulting OPCO controlling the joint ventures
      and in their consolidation with OPCO in accordance with
    GAAP.








8







RISK
FACTORS


Our cash
flow depends
substantially on OPCO’s ability to make distributions to
its partners, including us.





Until
July 2007, our partnership interest in OPCO represented our only cash generating
asset. We still derive a substantial majority of our cash flow from OPCO’s
distributions to us as one of its partners. The amount of cash OPCO can
distribute to its partners principally depends upon the amount of cash it
generates from its operations, which may fluctuate from quarter to quarter based
on, among other things:





•
            the
      rates it obtains from its charters and contracts of affreightment (whereby
      OPCO carries an agreed quantity of cargo for a customer over a specified
      trade route within a given period of
time);





•
            the
      price and level of production of, and demand for, crude oil, particularly
      the level of production at the offshore oil fields OPCO services under
      contracts of affreightment;





•
            the
      level of its operating costs, such as the cost of crews and
      insurance;





•
            the
      number of off-hire days for its fleet and the timing of, and number of
      days required for, drydocking of its
vessels;





•
            the
      rates, if any, at which OPCO may be able to redeploy shuttle tankers in
      the spot market as conventional oil tankers during any periods of reduced
      or terminated oil production at fields serviced by contracts of
      affreightment;





•
            delays
      in the delivery of any newbuildings or vessels undergoing conversion and
      the beginning of payments under charters relating to those
      vessels;





•
            prevailing
      global and regional economic and political
  conditions;





•
            currency
      exchange rate
fluctuations; and





•
            the
      effect of governmental regulations and maritime self-regulatory
      organization standards on the conduct of its
  business.




The
actual amount of cash OPCO has available for distribution also depends on other
factors such as:





•
            the
      level of capital expenditures it makes, including for maintaining vessels
      or converting existing vessels for other uses and complying with
      regulations;





•
            its
      debt service requirements and restrictions on distributions contained in
      its debt instruments;





•
            fluctuations
      in its working capital needs;





•
            its
      ability to make working capital
  borrowings; and





•
            the
      amount of any cash reserves, including reserves for future maintenance
      capital expenditures, working capital and other matters, established by
      the Board of Directors of our general
partner.





OPCO’s
limited partnership agreement provides that it distributes its available cash
(as defined in the partnership agreement) to its partners on a quarterly basis.
OPCO’s available cash includes cash on hand less any reserves that may be
appropriate for operating its business. The amount of OPCO’s quarterly
distributions, including the amount of cash reserves not distributed, is
determined by the Board of Directors of our general partner on our
behalf.





The
amount of cash OPCO generates from operations may differ materially from its
profit or loss for the period, which will be affected by non-cash items. As a
result of this and the other factors mentioned above, OPCO may make cash
distributions during periods when it records losses and may not make cash
distributions during periods when it records net income.





We may not have
sufficient cash from operations to enable us to pay
the minimum quarterly distribution on our common units or
to maintain or increase distributions.





The
source of our earnings and cash flow consists nearly exclusively of cash
distributions from our subsidiaries, primarily OPCO. Therefore, the amount of
distributions we are able to make to our unitholders will fluctuate based on the
level of distributions made to us by our subisidiaries. Neither OPCO nor any
other subsidiaries may make quarterly distributions at a level that will permit
us to make distributions to our common unitholders at the minimum quarterly
distribution level set forth in our partnership agreement or to maintain or
increase our quarterly distributions in the future. In addition, while we would
expect to increase or decrease distributions to our unitholders if our
subsidiaries increase or decrease distributions to us, the timing and amount of
any such increased or decreased distributions will not necessarily be comparable
to the timing and amount of the increase or decrease in distributions made by
our subsidiaries to us.





Our
ability to distribute to our unitholders any cash we may receive from our
subsidiaries is or may be limited by a number of factors, including, among
others:





•
            interest
      expense and principal payments on any indebtedness we
    incur;





•
            restrictions
      on distributions contained in any of our current or future debt
      agreements;





•
            fees
      and expenses of us, our general partner, its affiliates or third parties
      we are required to reimburse or pay, including expenses we incur as a
      result of being a public
company; and





9











•
            reserves
      our general partner believes are prudent for us to maintain for the proper
      conduct of our business or to provide for future
      distributions.





Many of
these factors will reduce the amount of cash we may otherwise have available for
distribution. We may not be able to pay distributions, and any distributions we
do make may not be at or above our minimum quarterly distribution. The actual
amount of cash that is available for distribution to our unitholders will depend
on several factors, many of which are beyond the control of us or our general
partner.





Our ability to
grow may be adversely affected by our cash distribution
policy. OPCO’s ability to meet its financial needs and grow
may be adversely affected by its cash distribution
policy.





Our cash
distribution policy, which is consistent with our partnership agreement,
requires us to distribute all of our available cash (as defined in our
partnership agreement) each quarter. Accordingly, our growth may not be as fast
as businesses that reinvest their available cash to expand ongoing
operations.





OPCO’s
cash distribution policy requires it to distribute all of its available cash
each quarter. In determining the amount of cash available for distribution by
OPCO, the Board of Directors of our general partner, in making the determination
on our behalf, will approve the amount of cash reserves to set aside by OPCO,
including reserves for future maintenance capital expenditures, working capital
and other matters. OPCO also relies upon external financing sources, including
commercial borrowings, to fund its capital expenditures. Accordingly, to the
extent OPCO does not have sufficient cash reserves or is unable to obtain
financing, its cash distribution policy may significantly impair its ability to
meet its financial needs or to grow.





We
must make substantial capital expenditures to maintain the operating capacity of
our fleet, which will reduce cash available for distribution. In addition, each
quarter our general partner is required to deduct estimated maintenance capital
expenditures from operating surplus, which may result in less cash available to
unitholders than if actual maintenance capital expenditures were
deducted.





We must
make substantial capital expenditures to maintain, over the long term, the
operating capacity of our fleet. We intend to continue to expand our fleet,
which would increase the level of our maintenance capital expenditures.
Maintenance capital expenditures include capital expenditures associated with
drydocking a vessel, modifying an existing vessel or acquiring a new vessel to
the extent these expenditures are incurred to maintain the operating capacity of
our fleet. These expenditures could increase as a result of changes
in:





•       the
cost of labor and materials;





•       customer
requirements;





•       increases
in fleet size or the cost of replacement vessels;





•       governmental
regulations and maritime self-regulatory organization standards relating to
safety, security or the environment; and





•       competitive
standards.





In
addition, actual maintenance capital expenditures vary significantly from
quarter to quarter based on the number of vessels drydocked during that quarter.
Significant maintenance capital expenditures reduce the amount of cash that OPCO
has available to distribute to us and that we have available for distribution to
our unitholders.





Our
partnership agreement requires our general partner to deduct our estimated,
rather than actual, maintenance capital expenditures from operating surplus each
quarter in an effort to reduce fluctuations in operating surplus (as defined in
our partnership agreement). The amount of estimated maintenance capital
expenditures deducted from operating surplus is subject to review and change by
the conflicts committee of our general partner at least once a year. In years
when estimated maintenance capital expenditures are higher than actual
maintenance capital expenditures, the amount of cash available for distribution
to unitholders is lower than if actual maintenance capital expenditures were
deducted from operating surplus. If our general partner underestimates the
appropriate level of estimated maintenance capital expenditures, we may have
less cash available for distribution in future periods when actual capital
expenditures begin to exceed our previous estimates.





We require
substantial capital expenditures to
expand the size of our fleet. We generally are required to make significant
installment payments for acquisitions of
newbuilding vessels or for the conversion of existing vessels
prior to their delivery and generation of revenue.
Depending on whether we finance our expenditures through cash from
operations or by issuing debt or equity securities, our
ability to make cash distributions may be diminished or our
financial leverage may increase or our unitholders may
be diluted.





We make
substantial capital expenditures to increase the size of our fleet. In 2007, we
purchased from Teekay Corporation its interests in two shuttle tankers and one
FSO unit. Teekay Corporation is obligated to offer us its interests in
additional vessels.  Please read Item 4: Information on the
Partnership—Overview, History and Development, for information about these
recent and potential acquisitions.





Currently,
the total delivered cost for a shuttle tanker is approximately $60 to
$150 million, the cost of converting an existing tanker to an FSO unit is
approximately $20 to $50 million and an FPSO unit is approximately
$100 million to $1.5 billion, although actual costs vary significantly
depending on the market price charged by shipyards, the size and specifications
of the vessel, governmental regulations and maritime self-regulatory
organization standards.








10





We and
Teekay Corporation regularly evaluate and pursue opportunities to provide marine
transportation services for new or expanding offshore projects. Teekay
Corporation currently is seeking to provide transportation services for several
offshore projects. Under an omnibus agreement that we have entered into in
connection with our initial public offering, Teekay Corporation is required to
offer to us, within 365 days of their deliveries, certain shuttle tankers,
FSO units and FPSO units Teekay Corporation may acquire. Neither we nor Teekay
Corporation may be awarded charters or contracts of affreightment relating to
any of the projects we pursue or it pursues, and we may choose not to purchase
the vessels Teekay Corporation is required to offer to us under the omnibus
agreement. If we obtain from Teekay Corporation any offshore project, we will
incur significant capital expenditures to build the offshore vessels needed to
fulfill the project requirements.





We
generally are required to make installment payments on newbuildings prior to
their delivery. We typically must pay between 10% to 20% of the purchase price
of a shuttle tanker upon signing the purchase contract, even though delivery of
the completed vessel will not occur until much later (approximately three to
four years from the time the order is placed). If we finance these acquisition
costs by issuing debt or equity securities, we will increase the aggregate
amount of interest or minimum quarterly distributions we must make prior to
generating cash from the operation of the newbuilding.





To fund
the remaining portion of existing or future capital expenditures, we will be
required to use cash from operations or incur borrowings or raise capital
through the sale of debt or additional equity securities. Use of cash from
operations will reduce cash available for distribution to unitholders. Our
ability to obtain bank financing or to access the capital markets for future
offerings may be limited by our financial condition at the time of any such
financing or offering as well as by adverse market conditions resulting from,
among other things, general economic conditions and contingencies and
uncertainties that are beyond our control. Our failure to obtain the funds for
future capital expenditures could have a material adverse effect on our
business, results of operations and financial condition and on our ability to
make cash distributions. Even if we are successful in obtaining necessary funds,
the terms of such financings could limit our ability to pay cash distributions
to unitholders. In addition, incurring additional debt may significantly
increase our interest expense and financial leverage, and issuing additional
equity securities may result in significant unitholder dilution and would
increase the aggregate amount of cash required to meet our minimum quarterly
distribution to unitholders, which could have a material adverse effect on our
ability to make cash distributions.





Our substantial
debt levels may limit our flexibility in
obtaining additional financing, pursuing other business
opportunities and paying distributions to you.





If we are
awarded contracts for additional offshore projects, our consolidated debt may
significantly increase. As at December 31, 2007, our total debt was $1,517.5
million and we had the ability to borrow an additional $165.5 million under
our revolving credit facilities, subject to limitations in the credit
facilities. We may incur additional debt under these or future credit
facilities. Our level of debt could have important consequences to us,
including:





•
            our
      ability to obtain additional financing, if necessary, for working capital,
      capital expenditures, acquisitions or other purposes may be impaired or
      such financing may not be available on favorable
  terms;





•
            we
      will need a substantial portion of our cash flow to make principal and
      interest payments on our debt, reducing the funds that would otherwise be
      available for operations, future business opportunities and distributions
      to unitholders;





•
            our
      debt level may make us more vulnerable than our competitors with less debt
      to competitive pressures or a downturn in our industry or the economy
      generally; and





•
            our
      debt level may limit our flexibility in responding to changing business
      and economic conditions.





Our
ability to service our debt will depend upon, among other things, our future
financial and operating performance, which will be affected by prevailing
economic conditions and financial, business, regulatory and other factors, some
of which are beyond our control. If our operating results are not sufficient to
service our current or future indebtedness, we will be forced to take actions
such as reducing distributions, reducing or delaying our business activities,
acquisitions, investments or capital expenditures, selling assets, restructuring
or refinancing our debt, or seeking additional equity capital or bankruptcy
protection. We may not be able to effect any of these remedies on satisfactory
terms, or at all.





Financing
agreements containing operating and financial restrictions may
restrict our business and financing activities.





The
operating and financial restrictions and covenants in our financing arrangements
and any future financing agreements for us could adversely affect our ability to
finance future operations or capital needs or to engage, expand or pursue our
business activities. For example, the arrangements may restrict our or OPCO’s
ability to:





•
            incur
      or guarantee indebtedness;





•
            change
      ownership or structure, including mergers, consolidations, liquidations
      and dissolutions;





•
            make
      dividends or distributions;





•
            make
      certain negative pledges and grant certain
  liens;





•
            sell,
      transfer, assign or convey assets;





•
            make
      certain investments; and





•
            enter
      into a new line of business.








11





In
addition, two revolving credit facilities require OPCO to maintain a minimum
liquidity (cash, cash equivalents and undrawn committed revolving credit lines
with at least six months of maturity) of $75.0 million, with aggregate
liquidity of not less than 5.0% of the total consolidated debt of OPCO and its
subsidiaries. Another revolving credit facility is guaranteed by Teekay
Corporation and requires Teekay Corporation to maintain the greater of a minimum
liquidity of at least $50.0 million and 5.0% of its total consolidated
debt. Teekay Corporation’s, OPCO’s or our ability to comply with covenants and
restrictions contained in debt instruments may be affected by events beyond
their, its or our control, including prevailing economic, financial and industry
conditions. If market or other economic conditions deteriorate, compliance with
these covenants may be impaired. If restrictions, covenants, ratios or tests in
the financing agreements are breached, a significant portion of the obligations
may become immediately due and payable, and the lenders’ commitment to make
further loans may terminate. Neither Teekay Corporation, OPCO nor we might have,
or be able to obtain, sufficient funds to make these accelerated payments. In
addition, obligations under our credit facilities are secured by certain
vessels, and if we are unable to repay debt under the credit facilities, the
lenders could seek to foreclose on those assets.





Restrictions in
our debt agreements may prevent OPCO or us from paying
distributions.





The
payment of principal and interest on our debt reduces cash available for
distribution to us and on our units. In addition, our and OPCO’s financing
agreements prohibit the payment of distributions upon the occurrence of the
following events, among others:





•
            failure
      to pay any principal, interest, fees, expenses or other amounts when
      due;





•
            failure
      to notify the lenders of any material oil spill or discharge of hazardous
      material, or of any action or claim related
  thereto;





•
            breach
      or lapse of any insurance with respect to vessels securing the
      facilities;





•
            breach
      of certain financial covenants;





•
            failure
      to observe any other agreement, security instrument, obligation or
      covenant beyond specified cure periods in certain
  cases;





•
            default
      under other indebtedness;





•
            bankruptcy
      or insolvency events;





•
            failure
      of any representation or warranty to be materially
  correct;





•
            a
      change of control, as defined in the applicable
      agreement; and





•
            a
      material adverse effect, as defined in the applicable
      agreement.





We
derive a substantial majority of our revenues from a limited number of
customers, and the loss of any such customers could result in a significant loss
of revenues and cash flow.





We have
derived, and we believe we will continue to derive, a substantial majority of
revenues and cash flow from a limited number of customers. StatoilHydro ASA,
Teekay Corporation and Petrobras Transporte S.A. accounted for approximately
40%, 20% and 13%, respectively, of consolidated voyage revenues during
2007.  Teekay Corporation and StatoilHydro ASA accounted for
approximately 22% and 27%, respectively, of consolidated voyage revenues during
2006, and approximately 32% and 23%, respectively, of consolidated voyage
revenues during 2005. No other customer accounted for 10% or more of revenues
during any of these periods.





If we
lose a key customer, we may be unable to obtain replacement long-term charters
or contracts of affreightment and may become subject, with respect to any
shuttle tankers redeployed on conventional oil tanker trades, to the volatile
spot market, which is highly competitive and subject to significant price
fluctuations. If a customer exercises its right under some charters to purchase
the vessel, we may be unable to acquire an adequate replacement vessel. Any
replacement newbuilding would not generate revenues during its construction and
we may be unable to charter any replacement vessel on terms as favorable to us
as those of the terminated charter.





The loss
of any of our significant customers could have a material adverse effect on our
business, results of operations and financial condition and our ability to make
cash distributions.





We depend on
Teekay Corporation to assist us in operating
our businesses and competing in our markets.





We, OPCO
and operating subsidiaries of us and OPCO have entered into various services
agreements with certain subsidiaries of Teekay Corporation pursuant to which
those subsidiaries will provide to us and OPCO all of our and OPCO's
administrative services and to the operating subsidiaries substantially all of
their managerial, operational and administrative services (including vessel
maintenance, crewing, purchasing, shipyard supervision, insurance and financial
services) and other technical and advisory services. Our operational success and
ability to execute our growth strategy depends significantly upon the
satisfactory performance of these services by the Teekay Corporation
subsidiaries. Our business will be harmed if such subsidiaries fail to perform
these services satisfactorily or if they stop providing these services to us,
OPCO or the operating subsidiaries.








12





Our
ability to compete for offshore oil marine transportation, processing and
storage projects and to enter into new charters or contracts of affreightment
and expand our customer relationships depends largely on our ability to leverage
our relationship with Teekay Corporation and its reputation and relationships in
the shipping industry. If Teekay Corporation suffers material damage to its
reputation or relationships, it may harm our or OPCO’s ability to:





•
            renew
      existing charters and contracts of affreightment upon their
      expiration;





•
            obtain
      new charters and contracts of
affreightment;





•
            successfully
      interact with shipyards during periods of shipyard construction
      constraints;





•
            obtain
      financing on commercially acceptable
  terms; or





•
            maintain
      satisfactory relationships with suppliers and other third
      parties.





If our
ability to do any of the things described above is impaired, it could have a
material adverse effect on our business, results of operations and financial
condition and our ability to make cash distributions.





Our
operating subsidiaries may also contract with certain subsidiaries of Teekay
Corporation for the Teekay Corporation subsidiaries to have newbuildings
constructed or existing vessels converted on behalf of the operating
subsidiaries and to incur the construction-related financing. The operating
subsidiaries would purchase the vessels on or after delivery based on an
agreed-upon price. None of our operating subsidiaries currently has this type of
arrangement with Teekay Corporation or any of its affiliates.





Our growth
depends on continued growth in demand for offshore oil
transportation, processing and storage services.





Our
growth strategy focuses on expansion in the shuttle tanker, FSO and FPSO
sectors. Accordingly, our growth depends on continued growth in world and
regional demand for these offshore services, which could be negatively affected
by a number of factors, such as:





•
            decreases
      in the actual or projected price of oil, which could lead to a reduction
      in or termination of production of oil at certain fields we service or a
      reduction in exploration for or development of new offshore oil
      fields;





•
            increases
      in the production of oil in areas linked by pipelines to consuming areas,
      the extension of existing, or the development of new, pipeline systems in
      markets we may serve, or the conversion of existing non-oil pipelines to
      oil pipelines in those markets;





•
            decreases
      in the consumption of oil due to increases in its price relative to other
      energy sources, other factors making consumption of oil less attractive or
      energy conservation measures;




•
            availability
      of new, alternative energy
sources; and




•
            negative
      global or regional economic or political conditions, particularly in oil
      consuming regions, which could reduce energy consumption or its
      growth.





Reduced
demand for offshore marine transportation, processing or storage services would
have a material adverse effect on our future growth and could harm our business,
results of operations and financial condition.





Because payments
under our contracts of affreightment are based on the
volume of oil transported, utilization of our shuttle
tanker fleet and the success of our shuttle tanker business
depends upon continued production from existing or new oil fields
it services, which is beyond our control and generally declines naturally over
time. Any decrease in the volume of
oil transported under contracts of affreightment
could adversely affect our business and operating results.





A
majority of our shuttle tankers operate under contracts of affreightment.
Payments under these contracts of affreightment are based upon the volume of oil
transported, which depends upon the level of oil production at the fields we
service under the contracts. Oil production levels are affected by several
factors, all of which are beyond our control, including: geologic factors,
including general declines in production that occur naturally over time; the
rate of technical developments in extracting oil and related infrastructure and
implementation costs; and operator decisions based on revenue compared to costs
from continued operations. Factors that may affect an operator’s decision to
initiate or continue production include: changes in oil prices; capital budget
limitations; the availability of necessary drilling and other governmental
permits; the availability of qualified personnel and equipment; the quality of
drilling prospects in the area; and regulatory changes. In addition, the volume
of oil transported may be adversely affected by extended repairs to oil field
installations or suspensions of field operations as a result of oil spills or
otherwise.





The rate
of oil production at fields we service may decline from existing or future
levels, and may be terminated. If such a reduction or termination occurs, the
spot market rates, if any, in the conventional oil tanker trades at which we may
be able to redeploy the affected shuttle tankers may be lower than the rates
previously earned by the vessels under the contracts of affreightment, which
would reduce our results of operations and ability to make cash
distributions.








13





The duration of
many of our shuttle tanker and FSO contracts is the
life of the relevant oil field or is subject to extension by the
field operator or vessel charterer. If the oil field no longer
produces oil or is abandoned or the contract term is not
extended, we will no longer generate revenue under the related
contract and will need to seek to redeploy affected vessels.





Many of
our shuttle tanker contracts have a “life-of-field” duration, which means that
the contract continues until oil production at the field ceases. If production
terminates for any reason, we no longer will generate revenue under the related
contract. Other shuttle tanker and FSO contracts under which our vessels operate
are subject to extensions beyond their initial term. The likelihood of these
contracts being extended may be negatively affected by reductions in oil field
reserves, low oil prices generally or other factors. If we are unable to
promptly redeploy any affected vessels at rates at least equal to those under
the contracts, if at all, our operating results will be harmed. Any potential
redeployment may not be under long-term contracts, which may affect the
stability of our cash flow and our ability to make cash
distributions.





The results of
our shuttle tanker operations in the North Sea are
subject to seasonal fluctuations.





Due to
harsh winter weather conditions, oil field operators in the North Sea typically
schedule oil platform and other infrastructure repairs and maintenance during
the summer months. Because the North Sea is our primary existing offshore oil
market, this seasonal repair and maintenance activity contributes to
quarter-to-quarter volatility in our results of operations, as oil production
typically is lower in the second and third quarters in this region compared with
production in the first and fourth quarters. Because a significant portion of
our North Sea shuttle tankers operate under contracts of affreightment, under
which revenue is based on the volume of oil transported, the results of these
shuttle tanker operations in the North Sea under these contracts generally
reflect this seasonal production pattern. When we redeploy affected shuttle
tankers as conventional oil tankers while platform maintenance and repairs are
conducted, the overall financial results for the North Sea shuttle tanker
operations may be negatively affected as the rates in the conventional oil
tanker markets at times may be lower than contract of affreightment rates. In
addition, we seek to coordinate some of the general drydocking schedule of our
fleet with this seasonality, which may result in lower revenues and increased
drydocking expenses during the summer months.





Our growth
depends on our ability to expand relationships
with existing customers and obtain new customers, for which we will
face substantial competition.





One of
our principal objectives is to enter into additional long-term, fixed-rate time
charters and contracts of affreightment. The process of obtaining new long-term
time charters and contracts of affreightment is highly competitive and generally
involves an intensive screening process and competitive bids, and often extends
for several months. Shuttle tanker, FSO and FPSO contracts are awarded based
upon a variety of factors relating to the vessel operator,
including:





•       industry
relationships and reputation for customer service and safety;





•       experience
and quality of ship operations;





•       quality,
experience and technical capability of the crew;





•       relationships
with shipyards and the ability to get suitable berths;





•       construction
management experience, including the ability to obtain on-time delivery of new
vessels according to customer specifications;





•       willingness
to accept operational risks pursuant to the charter, such as allowing
termination of the charter for force majeure events; and





•       competitiveness
of the bid in terms of overall price.





We expect
substantial competition for providing services for potential shuttle tanker, FSO
and FPSO projects from a number of experienced companies, including
state-sponsored entities. OPCO’s Aframax conventional tanker business also faces
substantial competition from major oil companies, independent owners and
operators and other sized tankers. Many of our competitors have significantly
greater financial resources than do we, OPCO or Teekay Corporation, which also
may compete with us. We anticipate that an increasing number of marine
transportation companies — including many with strong reputations and
extensive resources and experience — will enter the FSO and FPSO sectors.
This increased competition may cause greater price competition for charters. As
a result of these factors, we may be unable to expand our relationships with
existing customers or to obtain new customers on a profitable basis, if at all,
which would have a material adverse effect on our business, results of
operations and financial condition and our ability to make cash
distributions.





Delays in
deliveries of newbuilding vessels or of conversions of
existing vessels could harm our operating results.





The
delivery of any newbuildings or vessel conversions we may order could be
delayed, which would delay our receipt of revenues under the charters or other
contracts related to the vessels. In addition, under some charters we may enter
into that are related to a newbuilding or conversion, if our delivery of the
newbuilding or converted vessel to our customer is delayed, we may be required
to pay liquidated damages during the delay. For prolonged delays, the customer
may terminate the charter and, in addition to the resulting loss of revenues, we
may be responsible for substantial liquidated damages.





The
completion and delivery of newbuildings or vessel conversions could be delayed
because of:





•       quality
or engineering problems, the risk of which may be increased with FPSO units due
to their technical complexity;





•       changes
in governmental regulations or maritime self-regulatory organization
standards;





•       work
stoppages or other labor disturbances at the shipyard;





•       bankruptcy
or other financial crisis of the shipbuilder;





14








•       a
backlog of orders at the shipyard;





•       political
or economic disturbances;





•       weather
interference or catastrophic event, such as a major earthquake or
fire;





•       requests
for changes to the original vessel specifications;





•       shortages
of or delays in the receipt of necessary construction materials, such as
steel;





•       inability
to finance the construction or conversion of the vessels; or





•       inability
to obtain requisite permits or approvals.





If
delivery of a vessel is materially delayed, it could adversely affect our
results of operations and financial condition and our ability to make cash
distributions.





Charter
rates for conventional oil tankers may fluctuate substantially over time and may
be lower when we are or OPCO is attempting to recharter conventional oil
tankers, which could adversely affect operating results. Any changes in charter
rates for shuttle tankers or FSO or FPSO units could also adversely affect
redeployment opportunities for those vessels.





Our
ability to recharter OPCO's conventional oil tankers following expiration of
existing time-charter contracts commencing in 2011 and the rates payable upon
any renewal or replacement charters will depend upon, among other things, the
state of the conventional tanker market. Conventional oil tanker trades are
highly competitive and have experienced significant fluctuations in charter
rates based on, among other things, oil and vessel demand. For example, an
oversupply of conventional oil tankers can significantly reduce their charter
rates. There also exists some volatility in charter rates for shuttle tankers
and FSO and FPSO units.





Six of
OPCO's fixed-term charters and eleven contracts of affreightment (representing
approximately 6% of OPCO's aggregate contract of affreightment volumes) are
scheduled to expire prior to December 31, 2008. If, upon expiration or
termination of these or other contracts, long-term recharter rates are lower
than existing rates, our earnings and cash flow under any new contracts could be
adversely affected.





Over
time, the value of our vessels may decline, which could adversely affect our
operating results.





Vessel
values for shuttle tankers, conventional oil tankers and FSO and FPSO units can
fluctuate substantially over time due to a number of different factors,
including:








•
            prevailing
      economic conditions in oil and energy markets;•
            a
      substantial or extended decline in demand for oil;•
            increases
      in the supply of vessel capacity; and•
            the
      cost of retrofitting or modifying existing vessels, as a result of
      technological advances in vessel design or equipment, changes in
      applicable environmental or other regulations or standards, or
      otherwise.





If
operation of a vessel is not profitable, or if we cannot re-deploy a vessel at
attractive rates upon termination of a time charter or contract of
affreightment, rather than continue to incur costs to maintain and finance the
vessel, we may seek to dispose of it. Our inability to dispose of the vessel at
a reasonable value could result in a loss on its sale and adversely affect our
results of operations and financial condition.  Further, if we
determine at any time that a vessel’s future useful life and earnings require us
to impair its value on our financial statements, we may need to recognize a
significant charge against our earnings.





We may be unable
to make or realize expected benefits from
acquisitions, and implementing our growth strategy through acquisitions may
harm our business, financial condition and operating
results.





Our
growth strategy includes selectively acquiring existing shuttle tankers and FSO
and FPSO units or businesses that own or operate these types of vessels.
Historically, there have been very few purchases of existing vessels and
businesses in the FSO and FPSO segments. Factors that may contribute to a
limited number of acquisition opportunities for FSO units and FPSO units in the
near term include the relatively small number of independent FSO and FPSO fleet
owners. In addition, competition from other companies, many of which have
significantly greater financial resources than do we or Teekay Corporation,
could reduce our acquisition opportunities or cause us to pay higher
prices.





Any
acquisition of a vessel or business may not be profitable at or after the time
of acquisition and may not generate cash flow sufficient to justify the
investment. In addition, our acquisition growth strategy exposes us to risks
that may harm our business, financial condition and operating results, including
risks that we may:





•
            fail
      to realize anticipated benefits, such as new customer relationships,
      cost-savings or cash flow
enhancements;





•
            be
      unable to hire, train or retain qualified shore and seafaring personnel to
      manage and operate our growing business and
  fleet;





•
            decrease
      our liquidity by using a significant portion of available cash or
      borrowing capacity to finance
acquisitions;





•
            significantly
      increase our interest expense or financial leverage if we incur additional
      debt to finance acquisitions;





15











•
            incur
      or assume unanticipated liabilities, losses or costs associated with the
      business or vessels
acquired; or





•
            incur
      other significant charges, such as impairment of goodwill or other
      intangible assets, asset devaluation or restructuring
    charges.





Unlike
newbuildings, existing vessels typically do not carry warranties as to their
condition. While we generally inspect existing vessels prior to purchase, such
an inspection would normally not provide us with as much knowledge of a vessel’s
condition as we would possess if it had been built for us and operated by us
during its life. Repairs and maintenance costs for existing vessels are
difficult to predict and may be substantially higher than for vessels we have
operated since they were built. These costs could decrease our cash flow and
reduce our liquidity.





Terrorist
attacks, increased hostilities or war could lead to further
economic instability, increased costs and disruption of
business.





Terrorist
attacks, and the current conflicts in Iraq and Afghanistan and other current and
future conflicts, may adversely affect our business, operating results,
financial condition, and ability to raise capital and future growth. Continuing
hostilities in the Middle East may lead to additional armed conflicts or to
further acts of terrorism and civil disturbance in the United States or
elsewhere, which may contribute further to economic instability and disruption
of oil production and distribution, which could result in reduced demand for our
services.





In
addition, oil facilities, shipyards, vessels, pipelines and oil fields could be
targets of future terrorist attacks. Any such attacks could lead to, among other
things, bodily injury or loss of life, vessel or other property damage,
increased vessel operational costs, including insurance costs, and the inability
to transport oil to or from certain locations. Terrorist attacks, war or other
events beyond our control that adversely affect the distribution, production or
transportation of oil to be shipped by us could entitle customers to terminate
the charters and impact the use of shuttle tankers under contracts of
affreightment, which would harm our cash flow and business.





Our substantial
operations outside the United States expose us to political, governmental and
economic instability, which could harm our
operations.





Because
our operations are primarily conducted outside of the United States, they may be
affected by economic, political and governmental conditions in the countries
where we engage in business or where our vessels are registered. Any disruption
caused by these factors could harm our business, including by reducing the
levels of oil exploration, development and production activities in these areas.
We derive some of our revenues from shipping oil from politically unstable
regions. Conflicts in these regions have included attacks on ships and other
efforts to disrupt shipping. Hostilities or other political instability in
regions where we operate or where we may operate could have a material adverse
effect on the growth of our business, results of operations and financial
condition and ability to make cash distributions. In addition, tariffs, trade
embargoes and other economic sanctions by the United States or other countries
against countries in Southeast Asia or elsewhere as a result of terrorist
attacks, hostilities or otherwise may limit trading activities with those
countries, which could also harm our business and ability to make cash
distributions. Finally, a government could requisition one or more of our
vessels, which is most likely during war or national emergency. Any such
requisition would cause a loss of the vessel and could harm our cash flow and
financial results.





Marine
transportation is inherently risky, particularly in the extreme
conditions in which many of our vessels operate. An
incident involving significant loss of product or environmental
contamination by any of our vessels could harm our reputation and
business.





Vessels
and their cargoes and oil production facilities we service are at risk of being
damaged or lost because of events such as:





•
            marine
      disasters;





•
            bad
      weather;





•
            mechanical
      failures;





•
            grounding,
      capsizing, fire, explosions and
collisions;





•
            piracy;





•
            human
      error; and





•
            war
      and terrorism.





Our
shuttle tanker fleet primarily operates in the North Sea. Harsh weather
conditions in this region (or other regions in which our vessels operate) may
increase the risk of collisions, oil spills, or mechanical
failures.





An
accident involving any of our vessels could result in any of the
following:





•
            death
      or injury to persons, loss of property or damage to the environment and
      natural resources;





•
            delays
      in the delivery of cargo;





•
            loss
      of revenues from charters or contracts of
  affreightment;





•
            liabilities
      or costs to recover any spilled oil or other petroleum products and to
      restore the eco-system where the spill
occurred;





•
            governmental
      fines, penalties or restrictions on conducting
  business;





•
            higher
      insurance rates; and





16




•
            damage
      to our reputation and customer relationships
  generally.





Any of
these results could have a material adverse effect on our business, financial
condition and operating results. In addition, any damage to, or environmental
contamination involving, oil production facilities serviced could suspend that
service and result in loss of revenues.





Insurance may be
insufficient to cover losses that may occur to our
property or result from our operations.





The
operation of shuttle tankers, conventional oil tankers and FSO and FPSO units is
inherently risky. All risks may not be adequately insured against, and any
particular claim may not be paid by insurance. In addition, substantially all of
our vessels are not insured against loss of revenues resulting from vessel
off-hire time, based on the cost of this insurance compared to our off-hire
experience. Any significant off-hire time of our vessels could harm our
business, operating results and financial condition.Any claims relating to
our operationscovered by insurance
would be subject to deductibles, and since it is possible that a large number of
claims may be brought, the aggregate amount of these deductibles could be
material. Certain insurance coverage is maintained through mutual protection and
indemnity associations, and as a member of such associations we may be required
to make additional payments over and above budgeted premiums if member claims
exceed association reserves.





We may be
unable to procure adequate insurance coverage at commercially reasonable rates
in the future. For example, more stringent environmental regulations have led in
the past to increased costs for, and in the future may result in the lack of
availability of, insurance against risks of environmental damage or pollution. A
catastrophic oil spill or marine disaster could exceed the insurance coverage,
which could harm our business, financial condition and operating results. Any
uninsured or underinsured loss could harm our business and financial condition.
In addition, the insurance may be voidable by the insurers as a result of
certain actions, such as vessels failing to maintain certification with
applicable maritime self-regulatory organizations.





Changes
in the insurance markets attributable to terrorist attacks may also make certain
types of insurance more difficult to obtain. In addition, the insurance that may
be available may be significantly more expensive than existing
coverage.





We may experience
operational problems with vessels that
reduce revenue and increase costs.





Shuttle
tankers are complex and their operation is technically challenging. To the
extent we acquire FPSO units, this complexity and challenge will increase.
Marine transportation operations are subject to mechanical risks and problems.
Operational problems may lead to loss of revenue or higher than anticipated
operating expenses or require additional capital expenditures. Any of these
results could harm our business, financial condition and operating
results.





The offshore
shipping and storage industry is subject to substantial
environmental and other regulations, which may significantly
limit operations or increase expenses.





Our
operations are affected by extensive and changing international, national and
local environmental protection laws, regulations, treaties and conventions in
force in international waters, the jurisdictional waters of the countries in
which our vessels operate, as well as the countries of our vessels’
registration, including those governing oil spills, discharges to air and water,
and the handling and disposal of hazardous substances and wastes. Many of these
requirements are designed to reduce the risk of oil spills and other pollution.
In addition, we believe that the heightened environmental, quality and security
concerns of insurance underwriters, regulators and charterers will lead to
additional regulatory requirements, including enhanced risk assessment and
security requirements and greater inspection and safety requirements on vessels.
We expect to incur substantial expenses in complying with these laws and
regulations, including expenses for vessel modifications and changes in
operating procedures.





These
requirements can affect the resale value or useful lives of our vessels, require
a reduction in cargo capacity, ship modifications or operational changes or
restrictions, lead to decreased availability of insurance coverage for
environmental matters or result in the denial of access to certain
jurisdictional waters or ports, or detention in, certain ports. Under local,
national and foreign laws, as well as international treaties and conventions, we
could incur material liabilities, including cleanup obligations, in the event
that there is a release of petroleum or other hazardous substances from our
vessels or otherwise in connection with our operations. We could also become
subject to personal injury or property damage claims relating to the release of
or exposure to hazardous materials associated with our operations. In addition,
failure to comply with applicable laws and regulations may result in
administrative and civil penalties, criminal sanctions or the suspension or
termination of our operations, including, in certain instances, seizure or
detention of our vessels.





The
United States Oil Pollution Act of 1990 (or OPA 90), for instance, allows
for potentially unlimited liability for owners, operators and bareboat
charterers for oil pollution and related damages in U.S. waters, which include
the U.S. territorial sea and the 200-nautical mile exclusive economic zone
around the United States, without regard to fault of such owners, operators and
bareboat charterers. OPA 90 expressly permits individual states to impose their
own liability regimes with regard to hazardous materials and oil pollution
incidents occurring within their boundaries. Coastal states in the United States
have enacted pollution prevention liability and response laws, many providing
for unlimited liability. Similarly, the International Convention on Civil
Liability for Oil Pollution Damage, 1969, as amended, which has been adopted by
many countries outside of the United States, imposes liability for oil pollution
in international waters. In addition, in complying with OPA 90, regulations of
the International Maritime Organization (or IMO), European Union
directives and other existing laws and regulations and those that may be
adopted, ship-owners may incur significant additional costs in meeting new
maintenance and inspection requirements, in developing contingency arrangements
for potential spills and in obtaining insurance coverage.





Various
jurisdictions are considering regulating the management of ballast water to
prevent the introduction of non-indigenous species considered to be invasive.
For example, the United States Clean Water Act prohibits the discharge of oil or
hazardous substances in U.S. navigable waters and imposes strict liability in
the form of penalties for unauthorized discharges. Certain exemptions
promulgated by the Environmental Protection Agency (or EPA) under the Clean Water
Act allow vessels in U.S. ports to discharge certain substances, including
ballast water, without obtaining a permit to do so. However, a U.S. district
court has invalidated the exemption. If the EPA does not successfully appeal the district
court decision, we may be s ubjectto ballast
water treatment obligations that could increase the costs of operating in theUnited States.





17







In
addition to international regulations affecting oil tankers generally, countries
having jurisdiction over North Sea areas also impose regulatory requirements
applicable to operations in those areas. Operators of North Sea oil fields
impose further requirements. As a result, we must make significant expenditures
for sophisticated equipment, reporting and redundancy systems on our shuttle
tankers. Additional regulations and requirements may be adopted or imposed that
could limit our ability to do business or further increase the cost of doing
business in the North Sea or other regions in which we operate or may operate in
the future.





Exposure
to currency exchange rate fluctuations results in fluctuations in cash flows and
operating results.





We
currently are paid partly in Norwegian Kroners under some of our time-charters
and contracts of affreightment. In addition, we, OPCO and our and its operating
subsidiaries have entered into services agreements with certain subsidiaries of
Teekay Corporation pursuant to which those subsidiaries provide to us and OPCO
administrative services and to our and OPCO's operating subsidiaries managerial,
operational and administrative services. Under the services agreements, the
applicable subsidiaries of Teekay Corporation are paid in U.S. dollars for
reasonable direct and indirect expenses incurred in providing the services. A
substantial majority of those expenses are in Norwegian Kroners. The Teekay
Corporation subsidiaries are paid under the services agreements based on a fixed
U.S. Dollar/Norwegian Kroner exchange rate until December 31, 2008.
Thereafter, the exchange rate is not fixed, which may result in increased
payments under the services agreements if the strength of the U.S. Dollar
declines relative to the Norwegian Kroner.





The
redeployment risk of FPSO units is high given their lack of alternative uses and
significant costs.





FPSO
units are specialized vessels that have very limited alternative uses and high
fixed costs. If we acquire FPSO units and they are not, as a result of contract
termination or otherwise, subject to a long-term profitable contract, we may be
required to bid for projects at unattractive rates in order to reduce our losses
relating to the vessels.





Many seafaring
employees are covered by collective bargaining
agreements and the failure to renew those agreements or any future
labor agreements may disrupt operations and adversely affect
our cash flows.





A
significant portion of Teekay Corporation’s seafarers that crew certain some of
our vessels and Norwegian-based onshore operational staff that provide services
to us are employed under collective bargaining agreements. Teekay Corporation
may become subject to additional labor agreements in the future. Teekay
Corporation may suffer labor disruptions if relationships deteriorate with the
seafarers or the unions that represent them. The collective bargaining
agreements may not prevent labor disruptions, particularly when the agreements
are being renegotiated. Salaries are typically renegotiated annually or
bi-annually for seafarers and annually for onshore operational staff and higher
compensation levels will increase our costs of operations. Although these
negotiations have not caused labor disruptions in the past, any future labor
disruptions could harm our operations and could have a material adverse effect
on our business, results of operations and financial condition and ability to
make cash distributions.




Teekay
Corporation may be unable to attract and retain qualified, skilled employees or
crew necessary to operate our business.
 
 Our
success depends in large part on Teekay Corporation’s ability to attract and
retain highly skilled and qualified personnel. In crewing our vessels, we
require technically skilled employees with specialized training who can perform
physically demanding work. Competition to attract and retain qualified crew
members is intense. We expect crew costs to increase in 2008. If we are not able
to increase our rates to compensate for any crew cost increases, our financial
condition and results of operations may be adversely affected. Any inability we
experience in the future to hire, train and retain a sufficient number of
qualified employees could impair our ability to manage, maintain and grow our
business.


Teekay
Corporation and its affiliates may engage in
competition with us.





Teekay
Corporation and its affiliates may engage in competition with us. Pursuant to an
omnibus agreement we entered into in connection with our initial public
offering, Teekay Corporation, Teekay LNG Partners L.P. (NYSE: TGP). and their
respective controlled affiliates (other than us, OPCO and its and our
subsidiaries) generally have agreed not to engage in, acquire or invest in any
business that owns, operates or charters (a) dynamically-positioned shuttle
tankers (other than those operating in the conventional oil tanker trade under
contracts with a remaining duration of less than three years, excluding
extension options), (b) FSO units or (c) FPSO units (collectively
offshore vessels)
without the consent of our general partner. The omnibus agreement, however,
allows Teekay Corporation, Teekay LNG Partners L.P. and any of such controlled
affiliates to:





•
            own,
      operate and charter offshore vessels if the remaining duration of the time
      charter or contract of affreightment for the vessel, excluding any
      extension options, is less than three
years;





•
            own,
      operate and charter offshore vessels and related time charters or
      contracts of affreightment acquired as part of a business or package of
      assets and operating or chartering those vessels if a majority of the
      value of the total assets or business acquired is not attributable to the
      offshore vessels and related contracts, as determined in good faith by
      Teekay Corporation’s Board of Directors or the conflicts committee of the
      Board of Directors of Teekay LNG Partners L.P.’s general partner, as
      applicable; however, if at any time Teekay Corporation or Teekay LNG
      Partners L.P. completes such an acquisition, it must, within 365 days
      of the closing of the transaction, offer to sell the offshore vessels and
      related contracts to us for their fair market value plus any additional
      tax or other similar costs to Teekay Corporation or Teekay LNG Partners
      L.P. that would be required to transfer the vessels and contracts to us
      separately from the acquired business or package of
      assets; or





•
            own,
      operate and charter offshore vessels and related time charters and
      contracts of affreightment that relate to tender, bid or award for a
      proposed offshore project that Teekay Corporation or any of its
      subsidiaries has submitted or received hereafter submits or receives;
      however, at least 365 days after the delivery date of any such
      offshore vessel, Teekay Corporation must offer to sell the vessel and
      related time charter or contract of affreightment to us, with the vessel
      valued (a) for newbuildings originally contracted by Teekay
      Corporation, at its “fully-built-up cost” (which represents the aggregate
      expenditures incurred (or to be incurred prior to delivery to us) by
      Teekay Corporation to acquire, construct and/or convert and bring such
      offshore vessel to the condition and location necessary for our intended
      use, plus project development costs for completed projects  and
      projects that were not completed but, if completed, would have been
      subject to an offer to us) and (b) for any other vessels, Teekay
      Corporation’s cost to acquire a newbuilding from a third party or the fair
      market value of an existing vessel, as applicable, plus in each case any
      subsequent expenditures that would be included in the “fully-built-up
      cost” of converting the vessel prior to delivery to
  us.





If we
decline the offer to purchase the offshore vessels and time charters described
in the immediately preceding two bullet points, Teekay Corporation or Teekay LNG
Partners L.P., as applicable, may own and operate the offshore vessels, but may
not expand that portion of its business.





In
addition, pursuant to the omnibus agreement, Teekay Corporation, Teekay LNG
Partners L.P. and any of their respective controlled affiliates (other than us
and our subsidiaries) may:





18











•
            acquire,
      operate and charter offshore vessels and related time charters and
      contracts of affreightment if our general partner has previously advised
      Teekay Corporation or Teekay LNG Partners L.P. that our general partner’s
      Board of Directors has elected, with the approval of its conflicts
      committee, not to cause us or our controlled affiliates to acquire or
      operate the vessels and related time charters and contracts of
      affreightment;





•
            acquire
      up to a 9.9% equity ownership, voting or profit participation interest in
      any publicly-traded company that engages in, acquires or invests in any
      business  that owns or operates or charters offshore vessels and
      related time charters and contracts of
  affreightment;





•
            provide
      ship management services relating to owning, operating or chartering
      offshore vessels and related time charters and contracts of
      affreightment; or





•
            own
      a limited partner interest in OPCO or own shares of Teekay Petrojarl ASA
      (formally Petrojarl ASA. And referred to herein as Petrojarl).





In
addition, Petrojarl has the right to continue to own, operate and charter its
four FPSOs and one shuttle tanker until such time, if ever, Teekay
Corporation acquires 100% of Petrojarl. If that happens, Teekay Corporation will
be required to offer to us certain of Petrojarl’s fleet and Petrojarl’s
interests in its joint venture projects with Teekay Corporation.  As
at March 31, 2008, Teekay Corporation owned 65% of Petrojarl.





If there
is a change of control of Teekay Corporation or of the general partner of Teekay
LNG Partners L.P., the non-competition provisions of the omnibus agreement may
terminate, which termination could have a material adverse effect on our
business, results of operations and financial condition and our ability to make
cash distributions.





Our general
partner and its other affiliates own a controlling
interest in us and have conflicts of interest and limited fiduciary
duties, which may permit them to favor their own interests to
those of unitholders.





Teekay
Corporation indirectly owns the 2.0% general partner interest and a 57.75%
limited partner interest in us and owns and controls our general partner, which
controls us. Although our general partner has a fiduciary duty to manage us in a
manner beneficial to us and our unitholders, the directors and officers of our
general partner have a fiduciary duty to manage our general partner in a manner
beneficial to Teekay Corporation. Furthermore, certain directors and officers of
our general partner are directors or officers of affiliates of our general
partner. Conflicts of interest may arise between Teekay Corporation and its
affiliates, including our general partner, on the one hand, and us and our
unitholders, on the other hand. As a result of these conflicts, our general
partner may favor its own interests and the interests of its affiliates over the
interests of our unitholders. These conflicts include, among others, the
following situations:





•
            neither
      our partnership agreement nor any other agreement requires Teekay
      Corporation or its affiliates (other than our general partner) to pursue a
      business strategy that favors us or utilizes our assets, and Teekay
      Corporation’s officers and directors have a fiduciary duty to make
      decisions in the best interests of the stockholders of Teekay Corporation,
      which may be contrary to our
interests;





•
            the
      Chief Executive Officer and Chief Financial Officer and three of the
      directors of our general partner also serve as executive officers or
      directors of Teekay Corporation and the general partner of Teekay LNG
      Partners L.P.;





•
            our
      general partner is allowed to take into account the interests of parties
      other than us, such as Teekay Corporation, in resolving conflicts of
      interest, which has the effect of limiting its fiduciary duty to our
      unitholders;





•
            our
      general partner has limited its liability and reduced its fiduciary duties
      under the laws of the Marshall Islands, while also restricting the
      remedies available to our unitholders and unitholders are treated as
      having agreed to the modified standard of fiduciary duties and to certain
      actions that may be taken by our general partner, all as set forth in our
      partnership agreement;





•
            our
      general partner determines the amount and timing of our asset purchases
      and sales, capital expenditures, borrowings, issuances of additional
      partnership securities and reserves, each of which can affect the amount
      of cash that is available for distribution to our
    unitholders;





•
            in
      some instances, our general partner may cause us to borrow funds in order
      to permit the payment of cash distributions, even if the purpose or effect
      of the borrowing is to make a distribution on the subordinated units or to
      make incentive distributions (in each case to affiliates of Teekay
      Corporation) or to accelerate the expiration of the subordination period
      relating to our subordinated units held by Teekay
    Corporation;





•
            our
      general partner determines which costs incurred by it and its affiliates
      are reimbursable by us;





•
            our
      partnership agreement does not restrict our general partner from causing
      us to pay it or its affiliates for any services rendered to us on terms
      that are fair and reasonable or entering into additional contractual
      arrangements with any of these entities on our
  behalf;





•
            our
      general partner intends to limit its liability regarding our contractual
      and other obligations;





•
            our
      general partner may exercise its right to call and purchase common units
      if it and its affiliates own more than 80.0% of our common
      units;





•
            our
      general partner controls the enforcement of obligations owed to us by it
      and its affiliates; and





•
            our
      general partner decides whether to retain separate counsel, accountants or
      others to perform services for us.








19





Although we
control OPCO through our ownership of its general partner,
OPCO’s general partner owes fiduciary duties to OPCO and OPCO’s
other partner, Teekay Corporation, which may
conflict with the interests of us and our unitholders.





Conflicts
of interest may arise as a result of the relationships between us and our
unitholders, on the one hand, and OPCO, its general partner and its other
limited partner, Teekay Corporation, on the other hand. Teekay Corporation owns
a 74.0% limited partner interest in OPCO and controls our general partner, which
appoints the directors of OPCO’s general partner. The directors and officers of
OPCO’s general partner have fiduciary duties to manage OPCO in a manner
beneficial to us, as such general partner’s owner. At the same time, OPCO’s
general partner has a fiduciary duty to manage OPCO in a manner beneficial to
OPCO’s limited partners, including Teekay Corporation. The Board of Directors of
our general partner may resolve any such conflict and has broad latitude to
consider the interests of all parties to the conflict. The resolution of these
conflicts may not be in the best interest of us or our unitholders.





For
example, conflicts of interest may arise in the following
situations:





•
            the
      allocation of shared overhead expenses to OPCO and
  us;





•
            the
      interpretation and enforcement of contractual obligations between us and
      our affiliates, on the one hand, and OPCO or its subsidiaries, on the
      other hand;





•
            the
      determination and timing of the amount of cash to be distributed to OPCO’s
      partners and the amount of cash to be reserved for the future conduct of
      OPCO’s business;





•
            the
      decision as to whether OPCO should make asset or business acquisitions or
      dispositions, and on what terms;





•
            the
      determination or the amount and timing of OPCO’s capital
      expenditures;





•
            the
      determination of whether OPCO should use cash on hand, borrow funds or
      issue equity to raise cash to finance maintenance or expansion capital
      projects, repay indebtedness, meet working capital needs or otherwise;
      and





•
            any
      decision we make to engage in business activities independent of, or in
      competition with, OPCO.





The fiduciary
duties of the officers and directors of our general
partner may conflict with those of the officers and directors of
OPCO’s general partner.





Our
general partner’s officers and directors have fiduciary duties to manage our
business in a manner beneficial to us and our partners. However, the Chief
Executive Officer and Chief Financial Officer and all of the non-independent
directors of our general partner also serve as executive officers or directors
of OPCO’s general partner and of Teekay Corporation and the general partner of
Teekay LNG Partners L.P., and, as a result, have fiduciary duties, among others,
to manage the business of OPCO in a manner beneficial to OPCO and its partners,
including Teekay Corporation. Consequently, these officers and directors may
encounter situations in which their fiduciary obligations to OPCO, Teekay
Corporation or Teekay LNG Partners L.P., on one hand, and us, on the other hand,
are in conflict. The resolution of these conflicts may not always be in the best
interest of us or our unitholders.





Item
4. Information on the Partnership





A.
Overview, History and Development





Overview
and History





We are an
international provider of marine transportation and storage services to the
offshore oil industry. We were formed as a Marshall Islands limited partnership
in August 2006 by Teekay Corporation (NYSE: TK), a leading provider of marine
services to the global oil and natural gas industries, to further develop its
operations in the offshore market. We plan to leverage the expertise,
relationships and reputation of Teekay Corporation and our controlled affiliates
to pursue growth opportunities in this market. As of December 31, 2007, Teekay
Corporation, which owns and controls our general partner, owned a 57.75% limited
partner interest in us.





We own a
26.0% interest in Teekay Offshore Operating L.P. (or OPCO), which owns and
operates the world’s largest fleet of shuttle tankers, in addition to floating
storage and offtake (or FSO) units and double-hull
conventional oil tankers. We control OPCO through our ownership of its general
partner, and Teekay Corporation owns the remaining 74.0% interest in
OPCO.





In July
2007, we directly acquired interests in two double-hull shuttle tankers and
related charters. These interests, which we acquired from Teekay Corporation,
include a 100% interest in the 2000-built Navion Bergen and a 50%
interest in the 2006-built Navion Gothenburg, together
with their respective 13-year, fixed-rate bareboat charters to a subsidiary of
Petrobras Transporte S.A., the shipping arm of Petroleo Brasileiro
S.A.





In
October 2007, we also directly acquired from Teekay Corporation one FSO unit,
the Dampier Spirit,
whichoperates
under a 7-year fixed-rate, time-charter to Apache Corporation of
Australia.








20





As of
December 31, 2007, our fleet consisted of:





•
            Shuttle
      Tankers.Our shuttle tanker fleet consists of 38 vessels that
      operate under fixed-rate contracts of affreightment, time charters and
      bareboat charters. Of the 38 shuttle tankers, 24 are owned by OPCO
      (including 5 through 50% controlled joint ventures), 12 are chartered-in
      by OPCO and 2 are owned by us (including one through a 50% controlled
      joint venture). All of the shuttle tankers operate under contracts of
      affreightment for various offshore oil fields or under fixed-rate time
      charter or bareboat charter contracts for specific oil field
      installations. The majority of the contracts of affreightment volumes are
      life-of-field, which have an estimated weighted-average remaining life of
      approximately 16 years. The time charters and bareboat charters have an
      average remaining contract term of approximately 5 years. As of December
      31, 2007, our shuttle tankers, which had a total cargo capacity of
      approximately 4.6 million deadweight tonnes (or dwt), represented
      approximately 65% of the total tonnage of the world shuttle tanker
      fleet.





•
            Conventional
      Tankers.OPCO has a fleet of nine Aframax conventional crude oil
      tankers. The conventional tankers all have fixed-rate time charters with
      Teekay Corporation, with an average remaining term of approximately
      7 years. As of December 31, 2007, our conventional tankers had a
      total cargo capacity of approximately 0.9 million
  dwt.





•
            FSO Units.We have a fleet of five FSO units. All of the FSO units operate
      under fixed-rate contracts, with an average remaining term of
      approximately 4 years. As of December 31, 2007, our FSO units had a
      total cargo capacity of approximately 0.6 million
  dwt.





We were
formed under the laws of the Republic of The Marshall Islands as Teekay Offshore
Partners L.P. and maintain our principal executive headquarters at 4th Floor,
Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda. Our telephone
number at such address is (441) 298-2530. Our principal operating office is
located at Suite 2000, Bentall 5, 550 Burrard Street, Vancouver, British
Columbia, Canada, V6C 2K2. Our telephone number at such address is (604)
683-3529.





Potential
Additional Shuttle Tanker, FSO and FPSO Projects





Pursuant
to an omnibus agreement we entered into in connection with our initial public
offering, Teekay Corporation is obligated to offer us certain shuttle tankers,
FSO units, and FPSO units it may acquire in the future, provided the vessels are
servicing contracts in excess of three years in length.





Teekay
Corporation has ordered four Aframax shuttle tanker newbuildings, which are
scheduled to deliver in 2010 and 2011, for a total delivered cost of
approximately $416.9 million. It is anticipated that these vessels will be
offered to us and will be used to service either new long-term, fixed-rate
contracts Teekay Corporation may be awarded prior to delivery or OPCO’s
contracts-of-affreightment in the North Sea.





The
omnibus agreement also obligates Teekay Corporation to offer to us (a) its
interest in certain future FPSO and FSO projects it may undertake through its
50%-owned joint venture with Teekay Petrojarl ASA and (b) if Teekay Corporation
obtains 100% ownership of Teekay Petrojarl ASA, the existing FPSO units owned by
Teekay Petrojarl ASA that are servicing contracts in excess of three years in
length. As at March 31, 2008, Teekay Corporation had a 65% ownership interest in
Teekay Petrojarl ASA.  Please see Item 5 - Major Unitholders and
Related Party Transactions.





B.
Business Overview





Shuttle
Tanker Segment





A shuttle
tanker is a specialized ship designed to transport crude oil and condensates
from offshore oil field installations to onshore terminals and refineries.
Shuttle tankers are equipped with sophisticated loading systems and dynamic
positioning systems that allow the vessels to load cargo safely and reliably
from oil field installations, even in harsh weather conditions. Shuttle tankers
were developed in the North Sea as an alternative to pipelines. The first cargo
from an offshore field in the North Sea was shipped in 1977, and the first
dynamically-positioned shuttle tankers were introduced in the early 1980s.
Shuttle tankers are often described as “floating pipelines” because these
vessels typically shuttle oil from offshore installations to onshore facilities
in much the same way a pipeline would transport oil along the ocean
floor.





Our
shuttle tankers are primarily subject to long-term, fixed-rate time-charter
contracts for a specific offshore oil field or under contracts of affreightment
for various fields. The number of voyages performed under these contracts of
affreightment normally depends upon the oil production of each field.
Competition for charters is based primarily upon price, availability, the size,
technical sophistication, age and condition of the vessel and the reputation of
the vessel's manager. Technical sophistication of the vessel is especially
important in harsh operating environments such as the North Sea. Although the
size of the world shuttle tanker fleet has been relatively unchanged in recent
years, conventional tankers could be converted into shuttle tankers by adding
specialized equipment to meet customer requirements. Shuttle tanker demand may
also be affected by the possible substitution of sub-sea pipelines to transport
oil from offshore production platforms.





As of
December 31, 2007, there were approximately 74 vessels in the world shuttle
tanker fleet (including newbuildings), the majority of which operate in the
North Sea. Shuttle tankers also operate in Brazil, Canada, Russia and Africa. As
of December 31, 2007, we owned 26 shuttle tankers and chartered-in an additional
12 shuttle tankers. Other shuttle tanker owners in the North Sea include Knutsen
OAS Shipping AS, JJ Ugland Group and Penny Ugland, which as of December 31, 2007
controlled fleets of two to ten shuttle tankers each. We believe that we have
significant competitive advantages in the shuttle tanker market as a result of
the quality, type and dimensions of our vessels combined with our market share
in the North Sea.





21


The
following tables provide additional information about our shuttle tankers as of
December 31, 2007:





__________





(1)
            “CoA”
      refers to contracts of
affreightment.





(2)
            The
      vessel is capable of loading from a submerged turret loading
      buoy.





(3)
            OPCO
      has options to extend the time charter or purchase the
    vessel.


22




(4)
              The
      time charter period is linked to the term of the transportation service
      agreement for the Heidrun field on the Norwegian continental shelf, which
      term is in turn linked to the production level at the
    field.
 
 (5)
              OPCO
      has options to extend the bareboat
lease.


(6)
            Not
      all of the contracts of affreightment customers utilize every ship in the
      contract of affreightment fleet.





(7)
            Owned
      through a 50% controlled joint venture. The parties share in the
      profits and losses of the joint venture in proportion to each party’s
      relative capital contributions. Teekay Corporation subsidiaries provide
      operational services for these
vessels.





(8)
            Charterer
      has an option to extend the time
charter.




(9)
              Charterer
      has the right to purchase the vessel at end of the bareboat
      charter.


(10)
            In
      June 2007, OPCO exercised its option to purchase this vessel. The vessel
      delivered in March 2008.





On the
Norwegian continental shelf, regulations have been imposed on the operators of
offshore fields related to vaporized crude oil that is formed and emitted during
loading operations and which is commonly referred to as “VOC.” To assist the oil
companies in their efforts to meet the regulations on VOC emissions from shuttle
tankers, OPCO and Teekay Corporation have played an active role in establishing
a unique co-operation among all of the approximately 26 owners of offshore
fields in the Norwegian sector. The purpose of the co-operation is to implement
VOC recovery systems on selected shuttle tankers and to ensure a high degree of
VOC recovery at a minimum cost followed by joint reporting to the authorities.
Currently, there are 12 VOC plants installed aboard shuttle tankers operated or
owned by OPCO. The oil companies that participate in the co-operation have
engaged OPCO to undertake the day-to-day administration, technical follow-up and
handling of payments through a dedicated clearing house function.





During
2007, approximately 76% of our net voyage revenues wereearned by the vessels in
the shuttle tanker segment, compared to approximately 73% in 2006 and 61% in
2005. Please read Item 5 – Operating and Financial Review and Prospects: Results
of Operations.





Historically,
the utilization of shuttle tankers in the North Sea is higher in the winter
months, as favorable weather conditions in the summer months provide
opportunities for repairs and maintenance to our vessels and to the offshore oil
platforms. Downtime for repairs and maintenance generally reduces oil production
and, thus, transportation requirements.




Conventional
Tanker Segment





Conventional
oil tankers are used primarily for transcontinental seaborne transportation of
oil. Conventional oil tankers are operated by both major oil companies
(including state-owned companies) that generally operate captive fleets, and
independent operators that charter out their vessels for voyage or time charter
use. Most conventional oil tankers controlled by independent fleet operators are
hired for one or a few voyages at a time at fluctuating market rates based on
the existing tanker supply and demand. These charter rates are extremely
sensitive to this balance of supply and demand, and small changes in tanker
utilization have historically led to relatively large changes in short-term
rates. Long-term, fixed-rate charters for crude oil transportation, such as
those applicable to OPCO’s conventional tanker fleet, are less typical in the
industry. As used in this discussion, “conventional” oil tankers exclude those
vessels that can carry dry bulk and ore, tankers that currently are used for
storage purposes and shuttle tankers.





Oil
tanker demand is a function of several factors, including the location of oil
production, refining and consumption and world oil demand and supply. Tanker
demand is based on the amount of crude oil transported in tankers and the
distance over which the oil is transported. The distance over which oil is
transported is determined by seaborne trading and distribution patterns, which
are principally influenced by the relative advantages of the various sources of
production and locations of consumption.





The
majority of crude oil tankers range in size from approximately 80,000 to
approximately 320,000 dwt. Aframax tankers are the mid-size of the various
primary oil tanker types, typically sized from 80,000 to 119,999 dwt. As of
December 31, 2007, the world Aframax tanker fleet consisted of approximately
726 vessels, of which 576 crude tankers and 150 coated tankers are termed
conventional tankers. As of December 31, 2007, there were approximately
287 conventional Aframax newbuildings on order for delivery through 2011.
Delivery of a vessel typically occurs within three to four years after
ordering.





As of
December 31, 2007, our Aframax conventional crude oil tankers had an average age
of approximately 11.0 years, compared to the average age of 9.5 years for
the world Aframax conventional tanker fleet. New Aframax tankers generally are
expected to have a lifespan of approximately 25 to 30 years, based on
estimated hull fatigue life. However, United States and international
regulations require the phase-out of double-hulled vessels by 25 years. All of
our Aframax tankers are double-hulled.





Because
all of the vessels in OPCO’s conventional Aframax fleet are subject to
long-term, fixed-rate charters, we do not expect to compete for deployment of
the Aframax vessels until the first charter is scheduled to end in December
2011. The shuttle tankers in OPCO’s contract of affreightment fleet may operate
in the conventional spot market during downtime or maintenance periods for oil
field installations or otherwise, which provides greater capacity utilization
for the fleet.





23








The
following table provides additional information about our conventional tankers
as of December 31, 2007:





Vessel
            Capacity
      (dwt)
            Built
            Ownership
            Contract
      Type
            Charterer
            Remaining
      Term (1)Kilimanjaro
      Spirit
            115,000
            2004
            100%
            Time
      charter
            Teekay
            11
      yearsFuji
      Spirit
            106,300
            2003
            100%
            Time
      charter
            Teekay
            11
      yearsHamane
      Spirit
            105,200
            1997
            100%
            Time
      charter
            Teekay
            8
      yearsPoul
      Spirit
            105,300
            1995
            100%
            Time
      charter
            Teekay
            7
      yearsGotland
      Spirit
            95,300
            1995
            100%
            Time
      charter
            Teekay
            7
      yearsTorben
      Spirit
            98,600
            1994
            100%
            Time
      charter
            Teekay
            5
      yearsScotia
      Spirit (2)
            95,000
            1992
            100%
            Time
      charter
            Teekay
            4
      yearsLeyte
      Spirit
            98,700
            1992
            100%
            Time
      charter
            Teekay
            4
      yearsLuzon
      Spirit
            98,600
            1992
            100%
            Time
      charter
            Teekay
            4
      yearsTotal
      capacity
            918,000


__________





(1)
            Charterer
      has options to extend each time charter on an annual basis for a total of
      five years after the initial term. Charterer also has the right to
      purchase the vessel beginning on the third anniversary of the contract at
      a specified price.





(2)
            This
      vessel has been equipped with FSO equipment and OPCO can terminate the
      charter upon 30-days notice if it has arranged an FSO project for the
      vessel.





During
2007, approximately 16% of our net voyage revenues wereearned by the vessels in
the conventional tanker segment, compared to approximately 24% in 2006 and 36%
in 2005. Please read Item 5 – Operating and Financial Review and Prospects:
Results of Operations.





FSO
Segment





FSO units
provide on-site storage for oil field installations that have no storage
facilities or that require supplemental storage. An FSO unit is generally used
in combination with a jacked-up fixed production system, floating production
systems that do not have sufficient storage facilities or as supplemental
storage for fixed platform systems, which generally have some on-board storage
capacity. An FSO unit is usually of similar design to a conventional tanker, but
has specialized loading and offtake systems required by field operators or
regulators. FSO units are moored to the seabed at a safe distance from a field
installation and receive the cargo from the production facility via a dedicated
loading system. An FSO unit is also equipped with an export system that
transfers cargo to shuttle or conventional tankers. Depending on the selected
mooring arrangement and where they are located, FSO units may or may not have
any propulsion systems. FSO units are usually conversions of older single-hull
conventional oil tankers. These conversions, which include installation of a
loading and offtake system and hull refurbishment, can generally extend the
lifespan of a vessel as an FSO unit by up to 20 years over the normal
conventional tanker lifespan of 25 years.





Our FSO
units are generally placed on long-term, fixed-rate time charters or bareboat
charters as an integrated part of the field development plan, which provides
more stable cash flow to us.





As of
December 2007, there were approximately 86 FSO units operating and ten FSO units
on order in the world fleet, and we had five FSO units. The major markets for
FSO units are Asia, the Middle East, West Africa, South America and the North
Sea. Our primary competitors in the FSO market are conventional tanker owners,
who have access to tankers available for conversion, and oil field services
companies and oil field engineering and construction companies who compete in
the floating production system market. Competition in the FSO market is
primarily based on price, expertise in FSO operations, management of FSO
conversions and relationships with shipyards, as well as the ability to access
vessels for conversion that meet customer specifications.





The
following table provides additional information about our FSO units as of
December 31, 2007:





Vessel
            Capacity
              (dwt)
            Built
            Ownership
            Field
      name and
              location
            Contract
      Type
            Charterer
            Remaining
              TermPattani
      Spirit
            113,800
            1988
            100%
            Platong,
      Thailand
            Bareboat
            Teekay
            6
      years (1)Nordic
      Apollo
            126,900
            1978
            89%
            Banff,
      U.K.
            Bareboat
            Teekay
            7
      years (2)Navion
      Saga
            149,000
            1991
            100%
            Volve,
      Norway
            Time
      charter
            StatoilHydro
            2
      years (3)Karratha
      Spirit
            106,600
            1988
            100%
            Legendre,
      Australia
            Time
      charter
            Woodside
            1
      year (3)Dampier
      Spirit
            106,700
            1987
            100%
            Stag,
      Australia
            Time
      charter
            Apache
            6
      year (3)Total
      capacity
            603,0000


________





(1)
            This
      vessel is on a back-to-back charter between Teekay and Unocol for a
      remaining term of six years.





(2)
            Charterer
      is required to charter the vessel for as long as a specified FPSO unit,
      the Petrojarl
      Banff, produces the Banff field in the North Sea, which could
      extend to 2014 depending on the field
operator.





(3)
            Charterer
      has option to extend the time charter after the initial fixed
      period.





24








During
2007 approximately 8% of our net voyage revenues wereearned by the vessels in
the FSO segment, compared to 3% in 2006 and 2005. Please read Item 5 – Operating
and Financial Review and Prospects: Results of Operations.





Business
Strategies





Our
primary business objective is to increase distributions per unit by executing
the following strategies:





•
            Expand
      global operations in high growth regions.We seek to expand our
      shuttle tanker and FSO unit operations into growing offshore markets such
      as Brazil and Australia. In addition, we intend to pursue opportunities in
      new markets such as Arctic Russia, Eastern Canada, the Gulf of Mexico,
      Asia and Africa.





•
            Pursue
      opportunities in the FPSO sector.We believe that Teekay
      Corporation’s control of Petrojarl will enable us to competitively pursue
      FPSO projects anywhere in the world by combining Petrojarl’s engineering
      and operational expertise with Teekay Corporation’s global marketing
      organization and extensive customer and shipyard
      relationships.





•
            Acquire
      additional vessels on long-term, fixed-rate contracts.We intend to
      continue acquiring shuttle tankers and FSO units with long-term contracts,
      rather than ordering vessels on a speculative basis, and we intend to
      follow this same practice in acquiring FPSO units. We believe this
      approach facilitates the financing of new vessels based on their
      anticipated future revenues and ensures that new vessels will be employed
      upon acquisition, which should stabilize cash flows. Additionally, we
      anticipate growing by acquiring additional limited partner interests in
      OPCO that Teekay Corporation may offer us in the
  future.





•
            Provide
      superior customer service by maintaining high reliability, safety,
      environmental
      and quality standards.Energy companies seek transportation
      partners that have a reputation for high reliability, safety,
      environmental and quality standards. We intend to leverage OPCO’s and
      Teekay Corporation’s operational expertise and customer relationships to
      further expand a sustainable competitive advantage with consistent
      delivery of superior customer
service.





•
            Manage our
      conventional tanker fleet to provide stable cash flows.We believe
      the fixed-rate time charters for these tankers will provide stable cash
      flows during their terms and a source of funding for expanding offshore
      operations. Depending on prevailing market conditions during and at the
      end of each existing charter, we may seek to extend the charter, enter
      into a new charter, operate the vessel on the spot market or sell the
      vessel, in an effort to maximize returns on the conventional fleet while
      managing residual risk.





Competitive
Strengths





We
believe that we are well positioned to execute our business strategies because
of the following competitive strengths:





•
            Leading
      position in the shuttle tanker sector.We are the world’s largest
      owner and operator of shuttle tankers, as we owned or operated 38 of the
      74 vessels in the world shuttle tanker fleet as at December 31, 2007.
      Our large fleet size enables us to provide comprehensive coverage of
      charterers’ requirements and provides opportunities to enhance the
      efficiency of operations and increase fleet
  utilization.





•
            Offshore
      operational expertise and enhanced growth opportunities through our
      relationship
      with Teekay Corporation.Teekay Corporation has achieved a global
      brand name in the shipping industry and the offshore market, developed an
      extensive network of long-standing relationships with major energy
      companies and earned a reputation for reliability, safety and excellence.
      Some benefits we believe we receive due to our relationship with Teekay
      Corporation include:





•
            access
      through services agreements to its comprehensive market intelligence and
      operational and technical sophistication gained from over 25 years of
      providing shuttle tanker services and FSO services to offshore energy
      customers. We believe this expertise will also assist us in successfully
      expanding into the FPSO sector through Teekay Corporation’s control of
      Petrojarl and our rights to participate in certain FPSO projects under the
      omnibus agreement;





•
            access
      to Teekay Corporation’s general commercial and financial core
      competencies, practices and systems, which we believe enhances the
      efficiency and quality of
operations;





•
            enhanced
      growth opportunities and added competitiveness in bidding for
      transportation requirements for offshore projects and in attracting and
      retaining long-term contracts throughout the world;
  and





•
            improved
      leverage with leading shipyards during periods of vessel production
      constraints, which are anticipated over the next few years, due to Teekay
      Corporation’s established relationships with these shipyards and the high
      number of newbuilding orders it
places.





•
            Cash flow
      stability from contracts with leading energy companies.We benefit
      from stability in cash flows due to the long-term, fixed-rate contracts
      underlying most of our business. We have been able to secure long-term
      contracts because our services are an integrated part of offshore oil
      field projects and a critical part of the logistics chain of the fields.
      Due to the integrated nature of our services, the high cost of field
      development and the need for uninterrupted oil production, contractual
      relationships with customers with respect to any given field typically
      last until the field is no longer
producing.





•
            Disciplined
      vessel acquisition strategy and successful project execution. Our
      fleet has been built through successful new project tenders and
      acquisitions, and this strategy has contributed significantly to our
      leading position in the shuttle tanker market. A significant portion of
      OPCO’s shuttle tanker fleet was established through the acquisition of
      Ugland Nordic Shipping AS in 2001 and Navion AS, StatoilHydro ASA’s
      shipping subsidiary, in 2003. In addition, we have increased the size of
      our fleet through customized shuttle tanker and FSO projects for major
      energy companies around the world.





25








•
            We have
      financial flexibility to pursue acquisitions and other expansion
      opportunities through additional debt borrowings and the issuance of
      additional partnership units. As of March 31, 2008, our existing
      revolving credit facilities provided us access to $115.5 million of
      undrawn financing for working capital and acquisition purposes. We believe
      that borrowings available under our revolving credit facilities, access to
      other bank financing facilities and the debt capital markets, and our
      ability to issue additional partnership units will provide us with
      financial flexibility to pursue acquisition and expansion
      opportunities.





Customers





We
provide marine transportation and storage services to energy and oil service
companies or their affiliates. Our most important customer measured by annual
voyage revenue excluding Teekay Corporation, is StatoilHydro ASA, which is
Norway’s largest energy company and one of the world’s largest producers of
crude oil. StatoilHydro created the shuttle tanker industry beginning in the
late 1970s and developed the current operating model in the North Sea.
StatoilHydro chose Teekay Corporation to purchase its shuttle tanker operations
in 2003, and Teekay Corporation and we continue to have a close working
relationship with StatoilHydro.





StatoilHydro,
Teekay Corporation and Petrobras Transporte S.A. accounted for approximately
40%, 20% and 13%, respectively, of our consolidated voyage revenues during the
year ended December 31, 2007. Teekay Corporation and StatoilHydro ASA accounted
for approximately 22% and 27%, respectively, of consolidated voyage revenues
during 2006, and approximately 32% and 23%, respectively, of combined
consolidated voyage revenues during 2005. No other customer accounted for 10% or
more of revenues during any of these periods.





Safety,
Management of Ship Operations and Administration




Safety
and environmental compliance are our top operational priorities. We operate our
vessels in a manner intended to protect the safety and health of our employees,
the general public and the environment. We seek to manage the risks inherent in
our business and are committed to eliminating incidents that threaten the safety
and integrity of our vessels. In 2007 Teekay Corporation introduced a
behavior-based safety program called “Safety in Action” to improve the safety
culture in our fleet. We are also committed to reducing our emissions and waste
generation.


Key
performance indicators facilitate regular monitoring of our operational
performance. Targets are set on an annual basis to drive continuous improvement,
and indicators are reviewed monthly to determine if remedial action is necessary
to reach the targets.





Teekay
Corporation, through certain of its subsidiaries, assists our operating
subsidiaries in managing their ship operations. Det Norske Veritas, the
Norwegian classification society, has approved Teekay Corporation’s safety
management system as complying with the International Safety Management Code (or
ISM Code), the
International Standards Organization’s (orISO) 9001 for Quality
Assurance, ISO 14001 for Environment Management Systems, and Occupational
Health and Safety Advisory Services (or OHSAS) 18001, and this
system has been implemented on all our ships. Australia’s flag administration
has approved this safety management system for our Australian-flagged vessel. As
part of Teekay Corporation’s ISM Code compliance, all the vessels’ safety
management certificates are being maintained through ongoing internal audits
performed by Teekay Corporation’s certified internal auditors and intermediate
external audits performed by Det Norske Veritas and Australia’s flag
administration. Subject to satisfactory completion of these internal and
external audits, certification is valid for five years.





Teekay
Corporation provides, through certain of its subsidiaries, expertise in various
functions critical to the operations of our operating subsidiaries. We believe
this arrangement affords a safe, efficient and cost-effective operation. Teekay
subsidiaries also provide to us access to human resources, financial and other
administrative functions pursuant to administrative services
agreements.





Critical
ship management functions that certain subsidiaries of Teekay Corporation
provide to our operating subsidiaries through the Teekay Marine Services
division located in various offices around the world include:





•
            vessel
      maintenance;





•
            crewing;





•
            purchasing;





•
            shipyard
      supervision;





•
            insurance; and





•
            financial
      management services.





These
functions are supported by onboard and onshore systems for maintenance,
inventory, purchasing and budget management.





In
addition, Teekay Corporation’s day-to-day focus on cost control is applied to
our operations. In 2003, Teekay Corporation and two other shipping companies
established a purchasing alliance, Teekay Bergesen Worldwide, which leverages
the purchasing power of the combined fleets, mainly in such commodity areas as
lube oils, paints and other chemicals. Through our arrangements with Teekay
Corporation, we benefit from this purchasing alliance.





We
believe that the generally uniform design of some of our existing and
newbuilding vessels and the adoption of common equipment standards provides
operational efficiencies, including with respect to crew training and vessel
management, equipment operation and repair, and spare parts
ordering.





26








Risk
of Loss, Insurance and Risk Management





The
operation of any ocean-going vessel carries an inherent risk of catastrophic
marine disasters, death or injury of persons and property losses caused by
adverse weather conditions, mechanical failures, human error, war, terrorism,
piracy and other circumstances or events. The occurrence of any of these events
may result in loss of revenues or increased costs.





We carry
hull and machinery (marine and war risks) and protection and indemnity insurance
coverage to protect against most of the accident-related risks involved in the
conduct of our business. Hull and machinery insurance covers loss of or damage
to a vessel due to marine perils such as collisions, grounding and weather.
Protection and indemnity insurance indemnifies against other liabilities
incurred while operating vessels, including injury to the crew, third parties,
cargo loss and pollution. The current available amount of our coverage for
pollution is $1 billion per vessel per incident. We also carry insurance
policies covering war risks (including piracy and terrorism).





Under
bareboat charters, the customer is responsible to insure the vessel. We believe
that current insurance coverage is adequate to protect against most of the
accident-related risks involved in the conduct of our business and that we
maintain appropriate levels of environmental damage and pollution coverage.
However, we cannot assure that all covered risks are adequately insured against,
that any particular claim will be paid or that we will be able to procure
adequate insurance coverage at commercially reasonable rates in the future. More
stringent environmental regulations at times in the past have resulted in
increased costs for, and may result in the lack of availability of, insurance
against the risks of environmental damage or pollution. Substantially all of our
vessels are not insured against loss of revenues resulting from vessel off-hire
time, based on the cost of this insurance compared to our off-hire
experience.





We use in
our operations Teekay Corporation’s thorough risk management program that
includes, among other things, computer-aided risk analysis tools, maintenance
and assessment programs, a seafarers competence training program, seafarers
workshops and membership in emergency response organizations.





Classification,
Audits and Inspections





All of
our shuttle tankers and conventional oil tankers have been “classed” by one of
the major classification societies:  Det Norske Veritas, Lloyd’s
Register of Shipping or the American Bureau of Shipping.  Although FSO
and FPSO units are not required to be “classed”, each of our FSO units has been
inspected and certified as such.  The classification society certifies
that the vessel has been built and maintained in accordance with its rules and
complies with applicable rules and regulations of the country of registry,
although for some vessels this latter certification is obtained directly from
the relevant flag state authorities. Each vessel is inspected by a
classification society surveyor annually, with either the second or third annual
inspection being a more detailed survey (an Intermediate Survey) and the
fifth annual inspection being the most comprehensive survey (a Special Survey). The
inspection cycle resumes after each Special Survey. Vessels may be required to
be drydocked at each Intermediate and Special Survey for inspection of the
underwater area and fittings. However, many of our vessels have qualified with
their respective classification societies for drydocking every five years and
are no longer subject to the Intermediate Survey drydocking process. To qualify,
the resiliency of the underwater coatings of each vessel was enhanced and the
hull was marked to accommodate underwater inspections by divers.





In
addition to classification inspections:





•
            the
      vessel’s flag state, or the vessel’s classification society if nominated
      by the flag state, inspect the vessels to ensure they comply with
      applicable rules and regulations of the country of registry of the vessel
      and the international conventions of which that country is a
      signatory;





•
            port
      state control authorities, such as the U.S. Coast Guard and
      Australian Maritime Safety Authority, inspect vessels at regular
      intervals; and





•
            customers
      regularly inspect our vessels as a condition to chartering, and regular
      inspections are standard practice under long-term
  charters.





In
addition to third-party audits and inspections, our seafarers regularly inspect
their vessels and perform much of the necessary routine maintenance. Shore-based
operational and technical specialists also inspect the vessels at least twice a
year for conformity with established criteria. Upon completion of each
inspection, recommendations are made for improving the overall condition of the
vessel and its maintenance, safety and crew welfare. All recommendations are
monitored until they are completed.  The objective of these
inspections are to:




·
            ensure
      adherence to our operating
standards;




·
            maintain
      the structural integrity of the vessel is being
  maintained;




·
            maintain
      machinery and equipment to give full reliability in
    service;




·
            optimize
      performance in terms of speed and fuel consumption;
  and




·
            ensure
      the vessel’s appearance will support our brand and meet customer
      expectations.





To
achieve the vessel structural integrity objective, we use a comprehensive
“Structural Integrity Management System” developed by Teekay Corporation. This
system is designed to monitor the condition of the vessels closely and to ensure
that structural strength and integrity are maintained throughout a vessel’s
life.





Teekay
Corporation, which assists us in managing our ship operations through its
subsidiaries, has obtained approval for its safety management system as being in
compliance with the ISM Code. To maintain compliance, the system is audited
regularly by either the vessels’ flag state or, when nominated by the flag
state, a classification society. Certification is valid for five years subject
to satisfactorily completing internal and external audits.





27








Regulations





General





Our
business and the operation of our vessels are significantly affected by
international conventions and national, state and local laws and regulations in
the jurisdictions in which our vessels operate, as well as in the country or
countries of their registration. Because these conventions, laws and regulations
change frequently, we cannot predict the ultimate cost of compliance or their
impact on the resale price or useful life of the vessels. Additional
conventions, laws and regulations may be adopted that could limit our ability to
do business or increase the cost of doing business and that may materially
adversely affect operations. We are required by various governmental and
quasi-governmental agencies to obtain permits, licenses and certificates with
respect to our operations. Subject to the discussion below and to the fact that
the kinds of permits, licenses and certificates required for the operations of
the vessels we own will depend on a number of factors, we believe that we will
be able to continue to obtain all permits, licenses and certificates material to
the conduct of operations.





We
believe that the heightened environmental and quality concerns of insurance
underwriters, regulators and charterers will generally lead to greater
inspection and safety requirements on all vessels in the oil tanker markets and
will accelerate the scrapping of older vessels throughout these
markets.





Regulation —
International Maritime Organization (or IMO)





The IMO
is the United Nation’s agency for maritime safety. IMO regulations include the
International Convention for Safety of Life at Sea (or SOLAS), including amendments
to SOLAS implementing the International Security Code for Ports and Ships (or
ISPS), the ISM Code,
the International Convention on Prevention of Pollution from Ships (or the MARPOL Convention), the
International Convention on Civil Liability for Oil Pollution Damage of 1969,
the International Convention on Load Lines of 1966. The IMO Marine Safety
Committee has also published guidelines for vessels with dynamic positioning
(DP) systems, which
would apply to shuttle tankers and DP-assisted FSO units and FPSO units. SOLAS
provides rules for the construction of and equipment required for commercial
vessels and includes regulations for safe operation. Flag states which have
ratified the convention and the treaty generally employ the classification
societies, which have incorporated SOLAS requirements into their class rules, to
undertake surveys to confirm compliance.





SOLAS and
other IMO regulations concerning safety, including those relating to treaties on
training of shipboard personnel, lifesaving appliances, radio equipment and the
global maritime distress and safety system, are applicable to our operations.
Non-compliance with IMO regulations, including SOLAS, the ISM Code, ISPS and the
specific requirements for shuttle tankers, FSO units and FPSO units under the
NPD (Norway) and HSE (United Kingdom) regulations, may subject us to increased
liability or penalties, may lead to decreases in available insurance coverage
for affected vessels and may result in the denial of access to or detention in
some ports. For example, the Coast Guard and European Union authorities have
indicated that vessels not in compliance with the ISM Code will be prohibited
from trading in U.S. and European Union ports.





The ISM
Code requires vessel operators to obtain a safety management certification for
each vessel they manage, evidencing the shipowner’s compliance with requirements
of the ISM Code relating to the development and maintenance of an extensive
“Safety Management System.” Such a system includes, among other things, the
adoption of a safety and environmental protection policy setting forth
instructions and procedures for safe operation and describing procedures for
dealing with emergencies. Each of the existing vessels in our fleet currently is
ISM Code-certified, and we expect to obtain safety management certificates for
each newbuilding upon delivery.





Under IMO
regulations an oil tanker must be of double-hull construction, be of a mid-deck
design with double-side construction or be of another approved design ensuring
the same level of protection against oil pollution in the event that such
tanker:





•
            is
      the subject of a contract for a major conversion or original construction
      on or after July 6, 1993;





•
            commences
      a major conversion or has its keel laid on or after January 6,
      1994; or





•
            completes
      a major conversion or is a newbuilding delivered on or after July 6,
      1996.





In
December 2003, the IMO revised its regulations relating to the prevention of
pollution from oil tankers. These regulations, which became effective
April 5, 2005, accelerate the mandatory phase-out of single-hull tankers
and impose a more rigorous inspection regime for older tankers. All of our
shuttle and conventional oil tankers are double-hulled and were delivered after
July 6, 1996, so those tankers will not be affected directly by these IMO
regulations.





Shuttle
Tanker, FSO Unit and FPSO Unit Regulation





Our
shuttle tankers primarily operate in the North Sea. In addition to the
regulations imposed by the IMO, countries having jurisdiction over North Sea
areas impose regulatory requirements in connection with operations in those
areas, including HSE in the United Kingdom and NPD in Norway. These regulatory
requirements, together with additional requirements imposed by operators in
North Sea oil fields, require that we make further expenditures for
sophisticated equipment, reporting and redundancy systems on the shuttle tankers
and for the training of seagoing staff. Additional regulations and requirements
may be adopted or imposed that could limit our ability to do business or further
increase the cost of doing business in the North Sea. In Brazil, Petrobras
serves in a regulatory capacity and has adopted standards similar to those in
the North Sea.





Environmental
Regulations — The United States Regulations





The
United States has enacted an extensive regulatory and liability regime for the
protection and cleanup of the environment from oil spills, including discharges
of oil cargoes, bunker fuels or lubricants, primarily through the Oil Pollution
Act of 1990 (or OPA 90)
and the Comprehensive Environmental Response, Compensation and Liability Act (or
CERCLA). OPA 90 affects
all owners, bareboat charterers and operators whose vessels trade to the United
States or its territories or possessions or whose vessels operate in United
States waters, which include the U.S. territorial sea and 200-mile exclusive
economic zone around the United States.





28








Under OPA
90, vessel owners, operators and bareboat charterers are “responsible parties”
and are jointly, severally and strictly liable (unless the spill results solely
from the act or omission of a third party, an act of God or an act of war and
the responsible party reports the incident and reasonably cooperates with the
appropriate authorities) for all containment and clean-up costs and other
damages arising from discharges or threatened discharges of oil from their
vessels. These other damages are defined broadly to include:





§
            natural
      resources damages and the related assessment
  costs;





§
            real
      and personal property damages;





§
            net
      loss of taxes, royalties, rents, fees and other lost
    revenues;





§
            lost
      profits or impairment of earning capacity due to property or natural
      resources damage;





§
            net
      cost of public services necessitated by a spill response, such as
      protection from fire, safety or health hazards;
  and





§
            loss
      of subsistence use of natural
resources.





OPA 90
limits the liability of responsible parties. Effective as of October 9,
2006, the limit for double-hulled tank vessels was increased to the greater of
$1,900 per gross ton or $16 million per double-hulled tanker per
incident, subject to adjustment for inflation. These limits of liability would
not apply if the incident were proximately caused by violation of applicable
U.S. federal safety, construction or operating regulations, including IMO
conventions to which the United States is a signatory, or by the responsible
party’s gross negligence or willful misconduct, or if the responsible party
fails or refuses to report the incident or to cooperate and assist in connection
with the oil removal activities. In addition, CERCLA, which applies to the
discharge of hazardous substances (other than oil) whether on land or at sea,
contains a similar liability regime and provides for cleanup, removal and
natural resource damages.  Liability under CERCLA is limited to the
greater of $300 per gross ton or $5 million, unless the incident is caused
by gross negligence, willful misconduct, or a violation of certain regulations,
in which case liability is unlimited. We currently maintain for each vessel
pollution liability coverage in the maximum coverage amount of $1 billion
per incident. A catastrophic spill could exceed the coverage available, which
could harm our business, financial condition and results of
operations.





Under OPA
90, with limited exceptions, all newly built or converted tankers delivered
after January 1, 1994 and operating in U.S. waters must be built with
double-hulls.  All of our existing tankers are, and all of our
newbuildings will be, double-hulled.





In
December 1994, the U.S. Coast Guard (or Coast Guard) implemented
regulations requiring evidence of financial responsibility in the amount of
$1,500 per gross ton for tankers, coupling the then-applicable OPA
limitation on liability of $1,200 per gross ton with the CERCLA liability
limit of $300 per gross ton. The financial responsibility limits have not
been increased to comport with the amended statutory limits of OPA. However, the
Coast Guard has issued a notice of policy change indicating its intention to
change the financial responsibility regulations accordingly. Under the
regulations, such evidence of financial responsibility may be demonstrated by
insurance, surety bond, self-insurance, guaranty or an alternate method subject
to agency approval. Under OPA 90, an owner or operator of a fleet of vessels is
required only to demonstrate evidence of financial responsibility in an amount
sufficient to cover the tanker in the fleet having the greatest maximum limited
liability under OPA 90 and CERCLA.





The Coast
Guard’s regulations concerning certificates of financial responsibility (or
COFR) provide, in
accordance with OPA 90, that claimants may bring suit directly against an
insurer or guarantor that furnishes COFR. In addition, in the event that such
insurer or guarantor is sued directly, it is prohibited from asserting any
contractual defense that it may have had against the responsible party and is
limited to asserting those defenses available to the responsible party and the
defense that the incident was caused by the willful misconduct of the
responsible party. Certain organizations, which had typically provided COFR
under pre-OPA 90 laws, including the major protection and indemnity
organizations have declined to furnish evidence of insurance for vessel owners
and operators if they are subject to direct actions or required to waive
insurance policy defenses. The Coast Guard has indicated that it intends to
propose a rule that would increase the required amount of such COFRs to $2,200
per gross ton to reflect the higher limits on liability imposed by OPA 90,
as described above.





The Coast
Guard's financial responsibility regulations may also be satisfied by evidence
of surety bond, guaranty or by self-insurance. Under the self-insurance
provisions, the ship-owner or operator must have a net worth and working
capital, measured in assets located in the United States against liabilities
located anywhere in the world, that exceeds the applicable amount of financial
responsibility. We have complied with the Coast Guard regulations by obtaining
financial guarantees from a third-party. If other vessels in our fleet trade
into the United States in the future, we expect to obtain additional guarantees
from third-party insurers or to provide guarantees through
self-insurance.





OPA 90
and CERCLA permit individual states to impose their own liability regimes with
regard to oil or hazardous substance pollution incidents occurring within their
boundaries if the state’s regulations are equally or more stringent, and some
states have enacted legislation providing for unlimited strict liability for
spills. Several coastal states, including California, Washington and Alaska,
require state specific COFR and vessel response plans. We intend to comply with
all applicable state regulations in the ports where our vessels
call.





Owners or
operators of tank vessels operating in United States waters are required to file
vessel response plans with the Coast Guard, and their tank vessels are required
to operate in compliance with their Coast Guard approved plans. Such response
plans must, among other things:




§
            address
      a “worst case” scenario and identify and ensure, through contract or other
      approved means, the availability of necessary private response resources
      to respond to a “worst case
discharge”;




§
            describe
      crew training and drills; and




§
            identify
      a qualified individual with full authority to implement removal
      actions.





29








We have
filed vessel response plans with the Coast Guard for the vessels we own and have
received approval of such plans for all vessels in our fleet to operate in
United States waters. In addition, we conduct regular oil spill response drills
in accordance with the guidelines set out in OPA 90. The Coast Guard has
announced it intends to propose similar regulations requiring certain vessels to
prepare response plans for the release of hazardous substances.





Environmental
Regulation — Other Environmental Initiatives





Although
the United States is not a party, many countries have ratified and follow the
liability scheme adopted by the IMO and set out in the International Convention
on Civil Liability for Oil Pollution Damage, 1969, as amended (orCLC), and the Convention for the
Establishment of an International Fund for Oil Pollution of 1971, as amended.
Under these conventions, which are applicable to vessels that carry persistent
oil as cargo, a vessel's registered owner is strictly liable for pollution
damage caused in the territorial waters of a contracting state by discharge of
persistent oil, subject to certain complete defenses. Many of the countries that
have ratified the CLC have increased the liability limits through a 1992
Protocol to the CLC. The liability limits in the countries that have ratified
this Protocol are currently approximately $7.4 million plus approximately $1,040
per gross registered tonne above 5,000 gross tonnes with an approximate maximum
of $148 million per vessel and the exact amount tied to a unit of account which
varies according to a basket of currencies. The right to limit liability is
forfeited under the CLC when the spill is caused by the owner's actual fault or
privity and, under the 1992 Protocol, when the spill is caused by the owner's
intentional or reckless conduct. Vessels trading to contracting states must
provide evidence of insurance covering the limited liability of the owner. In
jurisdictions where the CLC has not been adopted, various legislative schemes or
common law govern, and liability is imposed either on the basis of fault or in a
manner similar to the CLC.





In
September 1997, the IMO adopted Annex VI to the International Convention for the
Prevention of Pollution from Ships (or Annex VI) to address air
pollution from ships. Annex VI, which became effective in May 2005, sets limits
on sulfur oxide and nitrogen oxide emissions from ship exhausts and prohibit
deliberate emissions of ozone depleting substances, such as halons,
chlorofluorocarbons, emissions of volatile compounds from cargo tanks and
prohibition of shipboard incineration of specific substances. Annex VI also
includes a global cap on the sulfur content of fuel oil and allows for special
areas to be established with more stringent controls on sulfur emissions. We
plan to operate our vessels in compliance with Annex VI. Additional or new
conventions, laws and regulations may be adopted that could adversely affect our
ability to manage our ships.





In
addition, the IMO, various countries and states, such as Australia, the United
States and the State of California, and various regulators, such as port
authorities, the U.S. Coast Guard and the U.S. Environmental Protection Agency,
have either adopted legislation or regulations, or are separately considering
the adoption of legislation or regulations, aimed at regulating the discharge of
ballast water and the discharge of bunkers as potential pollutants, and
requiring the installation on ocean-going vessels of pollution prevention
equipment such as oily water separators and bilge alarms.





The
United States Clean Water Act prohibits the discharge of oil or hazardous
substances in U.S. navigable waters and imposes strict liability in the form of
penalties for unauthorized discharges. The Clean Water Act also imposes
substantial liability for the costs of removal, remediation and damages and
complements the remedies available under OPA 90 and CERCLA discussed above.
Pursuant to regulations promulgated by the EPA in the early 1970s, the discharge
of sewage and effluent from properly functioning marine engines was exempted
from the permit requirements of the National Pollution Discharge Elimination
System. This exemption allowed vessels in U.S. ports to discharge certain
substances, including ballast water, without obtaining a permit to do so.
However, on March 30, 2005, a U.S. District Court for the Northern District
of California granted summary judgment to certain environmental groups and U.S.
states that had challenged the EPA regulations, arguing that the EPA exceeded
its authority in promulgating them. On September 18, 2006, the U.S.
District Court in that action issued an order invalidating the exemption in
EPA’s regulations for all discharges incidental to the normal operation of a
vessel as of September 30, 2008, and directing EPA to develop a system for
regulating all discharges from vessels by that date.





The EPA
has appealed this decision. Oral arguments on this appeal were heard by the
Ninth Circuit Court of Appeals on August 14, 2007. No decision has yet been issued.If the
exemption is repealed, we would be subject to the Clean Water Act permit
requirements that could include ballast water treatment obligations that could
increase the costs of operating in the United States. For example, this ruling
could require the installation of equipment on our vessels to treat ballast
water before it is discharged, require the implementation of other port facility
disposal arrangements or procedures at potentially substantial cost, and
otherwise restrict our vessels traffic in U.S. waters.





In
Norway, the Norwegian Pollution Control Authority requires the installation of
volatile organic compound emissions (or VOC equipment) on most
shuttle tankers serving the Norwegian continental shelf. Oil companies bear the
cost to install and operate the VOC equipment onboard the shuttle
tankers.





Vessel
Security Regulation





The ISPS
was adopted by the IMO in December 2002 in the wake of heightened concern over
worldwide terrorism and became effective on July 1, 2004. The objective of ISPS
is to enhance maritime security by detecting security threats to ships and ports
and by requiring the development of security plans and other measures designed
to prevent such threats. The United States implemented ISPS with the adoption of
the Maritime Transportation Security Act of 2002 (or MTSA), which requires vessels
entering U.S. waters to obtain certification of plans to respond to emergency
incidents there, including identification of persons authorized to implement the
plans. Each of the existing vessels in our fleet currently complies with the
requirements of ISPS and MTSA.





C.
Organizational Structure





Our sole
general partner is Teekay Offshore GP L.L.C., which is a wholly owned subsidiary
of Teekay Corporation.  Teekay Corporation also controls its public
subsidiaries Teekay LNG Partners L.P. (NYSE: TGP) and Teekay Tankers Ltd. (NYSE:
TNK).




30


Please
read Exhibit 8.1 to this Annual Report for a list of our significant
subsidiaries as of December 31, 2007





D.
Properties





Other
than our vessels and VOC plants mentioned above, we do not have any material
property.





E.
Taxation of the Partnership





United
States Taxation





This
discussion is based upon provisions of the U.S. Internal Revenue Code of
1986, as amended (or the Code) as in effect on the
date of this Annual Report, existing final and temporary regulations thereunder
(or Treasury
Regulations), and current administrative rulings and court decisions, as
in effect on the date of this Annual Report, all of which are subject to change,
possibly with retroactive effect. Changes in these authorities may cause the tax
consequences to vary substantially from the consequences described below. The
following discussion is for general information purposes only and does not
purport to be a comprehensive description of all of the U.S. federal income
tax considerations applicable to us.





Election to be
Taxed as a Corporation.We have elected to be taxed as a corporation for
U.S. federal income tax purposes. As such, we are subject to
U.S. federal income tax on our income to the extent it is from
U.S. sources or otherwise is effectively connected with the conduct of a
trade or business in the United States as discussed below.





Taxation of
Operating Income.We expect that substantially all of our gross income
will be attributable to the transportation of crude oil and related products.
For this purpose, gross income attributable to transportation (or Transportation Income)
includes income derived from, or in connection with, the use (or hiring or
leasing for use) of a vessel to transport cargo, or the performance of services
directly related to the use of any vessel to transport cargo, and thus includes
both time charter or bareboat charter income.





Transportation
Income that is attributable to transportation that begins or ends, but that does
not both begin and end, in the United States (or U.S. Source
International Transportation Income) will
be considered to be 50.0% derived from sources within the United States.
Transportation Income attributable to transportation that both begins and ends
in the United States (or U.S. Source Domestic Transportation
Income) will be considered to be 100.0% derived from sources within the
United States. Transportation Income attributable to transportation exclusively
between non-U.S. destinations will be considered to be 100% derived from
sources outside the United States. Transportation Income derived from sources
outside the United States generally will not be subject to U.S. federal
income tax.





Based on
our current operations, we expect substantially all of our Transportation Income
to be from sources outside the United States and not subject to
U.S. federal income tax. However, certain of our activities could give rise
to U.S. Source International Transportation Income, and future expansion of
our operations could result in an increase in the amount of U.S. Source
International Transportation Income, as well as give rise to U.S. Source
Domestic Transportation Income, all of which could be subject to
U.S. federal income taxation, unless the exemption from U.S. taxation
under Section 883 of the Code (or the Section 883 Exemption)
applies.





The
Section 883 Exemption.In general, the Section 883 Exemption
provides that if a non-U.S. corporation satisfies the requirements of
Section 883 of the Code and the Treasury Regulations thereunder (or the
Section 883
Regulations), it will not be subject to the net basis and branch taxes or
4.0% gross basis tax described below on its U.S. Source International
Transportation Income. The Section 883 Exemption only applies to U.S.
Source International Transportation Income. As discussed below, we believe that
under our current ownership structure, the Section 883 Exemption will apply
and we will not be taxed on our U.S. Source International Transportation
Income. The Section 883 Exemption does not apply to U.S. Source
Domestic Transportation Income.





A
non-U.S. corporation will qualify for the Section 883 Exemption
if it is organized in a jurisdiction outside the United States that grants
an equivalent exemption from tax to corporations organized in the United States
(or an Equivalent
Exemption), it meets one of three ownership tests (or the Ownership Test) described in
the Final Section 883 Regulations and it meets certain substantiation,
reporting and other requirements.





We are
organized under the laws of the Republic of the Marshall Islands. The
U.S. Treasury Department has recognized the Republic of the Marshall
Islands as a jurisdiction that grants an Equivalent Exemption. Consequently, our
U.S. Source International Transportation Income (including for this
purpose, any such income earned by our subsidiaries that have properly elected
to be treated as partnerships or disregarded as entities separate from us for
U.S. federal income tax purposes) will be exempt from U.S. federal
income taxation provided we meet the Ownership Test described in the Final
Section 883 Regulations. We believe that we should satisfy the Ownership Test
based upon the ownership of more than 50% of the value of us by Teekay
Corporation. However, the determination of whether we satisfy the Ownership Test
at any given time depends upon a multitude of factors, including Teekay
Corporation’s ownership of us, whether Teekay Corporation’s stock is publicly
traded, the concentration of ownership of Teekay Corporation’s own stock and the
satisfaction of various substantiation and documentation requirements. There can
be no assurance that we will satisfy these requirements at any given time and
thus that our U.S. Source International Shipping Income would be exempt
from U.S. federal income taxation by reason of Section 883 in any of
our taxable years.





The Net Basis Tax
and Branch Profits Tax.If we earn U.S. Source International
Transportation Income and the Section 883 Exemption does not apply, such
income may be treated as effectively connected with the conduct of a trade or
business in the United States (or Effectively Connected Income)
if we have a fixed place of business in the United States and substantially all
of our U.S. Source International Transportation Income is attributable to
regularly scheduled transportation or, in the case of bareboat charter income,
is attributable to a fixed placed of business in the United States. Based on our
current operations, none of our potential U.S. Source International
Transportation Income is attributable to regularly scheduled transportation or
is received pursuant to bareboat charters. As a result, we do not anticipate
that any of our U.S. Source International Transportation Income will be
treated as Effectively Connected Income. However, there is no assurance that we
will not earn income pursuant to regularly scheduled transportation or bareboat
charters attributable to a fixed place of business in the United States in the
future, which would result in such income being treated as Effectively Connected
Income.








31





U.S. Source
Domestic Transportation Income generally is treated as Effectively Connected
Income.





Any
income we earn that is treated as Effectively Connected Income would be subject
to U.S. federal corporate income tax (the highest statutory rate is
currently 35.0%). In addition, if we earn income that is treated as Effectively
Connected Income, a 30.0% branch profits tax imposed under Section 884 of
the Code generally would apply to such income, and a branch interest tax could
be imposed on certain interest paid or deemed paid by us.





On the
sale of a vessel that has produced Effectively Connected Income, we could be
subject to the net basis corporate income tax and to the 30.0% branch profits
tax with respect to our gain not in excess of certain prior deductions for
depreciation that reduced Effectively Connected Income. Otherwise, we would not
be subject to U.S. federal income tax with respect to gain realized on the
sale of a vessel, provided the sale is considered to occur outside of the United
States under U.S. federal income tax principles.





The 4.0% Gross
Basis Tax.If the Section 883 Exemption does not apply and the net
basis tax does not apply, we would be subject to a 4.0% U.S. federal income
tax on the U.S. source portion of our gross U.S. Source International
Transportation Income, without benefit of deductions.





Marshall
Islands Taxation





Because
we and our controlled affiliates do not, and we do not expect that we and our
controlled affiliates will, conduct business or operations in the Republic of
The Marshall Islands, neither we nor our controlled affiliates are subject to
income, capital gains, profits or other taxation under current Marshall Islands
law. As a result, distributions by OPCO or other controlled affiliates to us are
not subject to Marshall Islands taxation.





Norway
Taxation





The
following discussion is based upon the current tax laws of the Kingdom of Norway
and regulations, the Norwegian tax administrative practice and judicial
decisions thereunder, all as in effect as of the date of this Annual Report and
subject to possible change on a retroactive basis. The following discussion is
for general information purposes only and does not purport to be a comprehensive
description of all of the Norwegian income tax considerations applicable to
us.





Our
Norwegian subsidiaries are subject to taxation in Norway on their income
regardless of where the income is derived. The generally applicable Norwegian
income tax rate is 28.0%.





Taxation of
Norwegian Subsidiaries Engaged in Business
Activities.All of our Norwegian subsidiaries are subject to normal
Norwegian taxation. Generally, a Norwegian resident company is taxed on its
income realized for tax purposes. The starting point for calculating taxable
income is the company’s income as shown on its annual accounts, calculated under
generally accepted accounting principles and as adjusted for tax purposes. Gross
income will include capital gains, interest, dividends from certain corporations
and foreign exchange gains.





The
Norwegian companies also are taxed on any gains resulting from the sale of
depreciable assets. The gain on these assets is taken into income for Norwegian
tax purposes at a rate of 20.0% per year on a declining balance
basis.





Norway
does not allow consolidation of the income of companies in a corporate group for
Norwegian tax purposes. However, a group of companies that is ultimately owned
more than 90.0% by a single company can transfer its Norwegian taxable income to
another Norwegian resident company in the group by making a transfer to the
other company (this is referred to as making a “group contribution”). The
ultimate parent in the corporate group can be a foreign company.





Group
contributions are deductible for the contributing company for tax purposes and
are included in the taxable income of the receiving company in the income year
in which the contribution is made. Group contributions are subject to the same
rules as dividend distributions under the Norwegian Companies Act. In other
words, group contributions are restricted to the amount that is available to
distribute as dividends for corporate law purposes.





Taxation of
Dividends.Generally, dividends received by a Norwegian resident company
are exempt from Norwegian taxation. The exemption does not apply to dividends
from companies resident outside the European Economic Area if (a) the
country of residence is a low-tax country or (b) the ownership of shares in
the distributing company is considered to be a “portfolio investment” (i.e. less than 10.0% share
ownership or less than two years continuous ownership period). Dividends not
exempt from Norwegian taxation are subject to the general 28.0% income tax rate
when received by the Norwegian resident company. We believe that dividends
received by our Norwegian subsidiaries will not be subject to Norwegian
tax.





Correction Income
Tax.Our Norwegian subsidiaries may be subject to a tax, called correction income tax,on
their dividend distributions. Norwegian correction tax is levied if a dividend
distribution leads to the company’s balance sheet equity at year end being lower
than the company’s paid-in share capital (including share premium), plus a
calculated amount equal to 72.0% of the net positive temporary timing
differences between the company’s book values and tax values.





As a
result, correction tax is effectively levied if dividend distributions result in
the company’s financial statement equity for accounting purposes being reduced
below its equity calculated for tax purposes (i.e.when dividends are paid
out of accounting earnings that have not been subject to taxation in Norway). In
addition to dividend distributions, correction tax may also be levied on the
partial liquidation of the share capital of the company or if the company makes
group contributions that are in excess of taxable income for the
year.





Taxation of
Interest Paid by Norwegian Entities. Norway does not levy any tax or
withholding tax on interest paid by a Norwegian resident company to a company
that is not resident in Norway (provided that the interest rate and the
debt/equity ratio are based on arms-length principles). Therefore, any interest
paid by our Norwegian subsidiaries to companies that are not resident in Norway
will not be subject to Norwegian withholding tax.








32





Taxation on
Distributions by Norwegian Entities. Norway levies a 25.0% withholding
tax on non-residents of Norway that receive dividends from a Norwegian resident
company. However, if the recipient of the dividend is resident in a country that
has an income tax treaty with Norway or that is a member of the European
Economic Area, the Norwegian withholding tax may be reduced or eliminated. We
believe that distributions by our Norwegian subsidiaries will be subject to a
reduced amount of Norwegian withholding tax or not be subject to Norwegian
withholding tax.





Luxembourg
Taxation





The
following discussion is based upon the current tax laws of Luxembourg and
regulations, the Luxembourg tax administrative practice and judicial decisions
thereunder, all as in effect as of the date of this Annual Report and subject to
possible change on a retroactive basis. The following discussion is for general
information purposes only and does not purport to be a comprehensive description
of all of the Luxembourg income tax considerations applicable to
us.





Our
operating subsidiary, Teekay Offshore Partners L.P. owns all of the shares of
Norsk Teekay Holdings Ltd. (or Norsk Teekay), a Marshall
Islands company. Norsk Teekay owns all of the shares of Teekay European Holdings
S.a.r.l. (or TEHS), a
Luxembourg company. TEHS owns all of the shares of Teekay Netherlands European
Holdings BV (or Teekay
Netherlands), a Netherlands company.





TEHS was
primarily capitalized with a discounted loan from Norsk Teekay (the proceeds of
which TEHS used to purchase shares in Norsk Teekay, which were immediately then
contributed to Teekay Netherlands), which we believe were compliant with the
Luxembourg thin capitalization threshold and a fixed interest loan from OPCO.
Its only significant assets are shares of Teekay Netherlands and a fixed
interest loan to Navion Offshore Loading AS (or NOL).





TEHS is
considered a Luxembourg resident company subject to taxation in Luxembourg on
its income regardless of where the income is derived. The generally applicable
Luxembourg income tax rate is approximately 30%.





Taxation of
Interest Income.TEHS’ loans to NOL generate interest income. However,
this interest income is substantially offset by interest expense on the loan
made by OPCO to TEHS. Accordingly, at TEHS’ current level of indebtedness and
provided that TEHS does not bear any foreign exchange risk, TEHS should earn a
minimum level of net interest income equal to 0.09375% or less of the loan
balance to NOL, an immaterial amount that will be subject to taxation in
Luxembourg. The net interest income generated from the loans to NOL can also, to
the extent the interest due on the discounted loan from Norsk Teekay exceeds any
dividend income from Teekay Netherlands during the same year be offset by
interest expense on TEHS’ discounted loan payable to Norsk Teekay. The deduction
of interest expense on the discounted loan is subject to recapture in the
future, as discussed below.





Taxation of
Potential Foreign Currency Exchange Net Gain.TEHS holds it accounts in Euros, while the loan to NOL is denominated in
Norwegian Kroners. Regardless whether they are realized or unrealized, foreign
currency exchange gains are fully taxable in Luxembourg to the extent they are
reflected in the accounts (under Luxembourg GAAP). Foreign currency exchange
losses are in principle deductible from the taxable base of TEHS under the same
conditions. We minimized such foreign exchange exposure by having the loan from
OPCO also Norwegian Kroner denominated and with the exact same terms and
conditions (same principal amount and same effective date and maturity save for
a differential in the interest rates leading to the small net interest income
noted above) as the loan to NOL. Accordingly, we believe that the foreign
exchange net gain on the loan from OPCO and on the loan to NOL should be
minimized in Luxembourg.





Taxation of
Interest Payments.Luxembourg does not levy a withholding tax on interest
paid to non-residents of Luxembourg, such as Norsk Teekay and OPCO, unless the
interest represents a right to participate in profits of the interest-paying
entity and the debt has certain other characteristics or the interest payment
relates to the portion of debt used to acquire share capital, and the debt
exceeds a Luxembourg “thin capitalization” threshold, or the interest rate is
not regarded to be at arm’s length. We believe that the interest paid by TEHS on
the types of loans made to it by Norsk Teekay and OPCO does not represent a
right to participate in its profits and is consistent with Luxembourg transfer
pricing rules. Furthermore, we have capitalized TEHS to meet the “thin
capitalization” threshold. Accordingly, we believe that interest payments made
by TEHS to Norsk Teekay and OPCO are not subject to Luxembourg withholding
tax.





Taxation of
Dividends and Capital Gains. Pursuant to Luxembourg law, dividends
received by TEHS from Teekay Netherlands and capital gains realized on any
disposal of shares of Teekay Netherlands generally are exempt from Luxembourg
taxation if the following requirements are met:





•
            TEHS
      is a capital company resident in Luxembourg and fully subject to tax in
      this country;





•
            TEHS
      owns more than 10% of Teekay Netherlands, or alternatively, TEHS’
      acquisition price for the shares of Teekay Netherlands equals or exceeds
      Euro 1.2 million for purposes of the dividend exemption or Euro
      6.0 million for purposes of the capital gains
    exemption;





•
            At
      the time of the dividend or disposal of shares, TEHS has owned the shares
      for at least 12 months (or, alternatively in the case of dividends,
      TEHS commits to hold the shares for at least 12 months and in the
      case of capital gains, TEHS commits to continue to hold at least 10% of
      the shares of Teekay Netherlands for at least 12 months);
      and





•
            Teekay
      Netherlands is a resident of the Netherlands for Dutch tax purposes and is
      covered by the European Union Parent-Subsidiary
  Directive.





TEHS
meets the ownership threshold and has owned the shares in Teekay Netherlands for
at least 12 months. In addition, assuming that Teekay Netherlands is a
resident of the Netherlands for Dutch tax purposes and is fully subject to the
Dutch general corporate tax regime (even if it has subsidiaries that may be
subject to special shipping regimes), we believe that Teekay Netherlands is
covered by the European Union Parent-Subsidiary Directive. Therefore, we believe
that any dividend received on or any capital gain resulting from the disposition
of the shares of Teekay Netherlands will be exempt from taxation in
Luxembourg.








33





Notwithstanding
this exemption, Luxembourg law does not permit the deduction of interest expense
on loans used to purchase shares eligible for the dividend and capital gain
exemption noted above, to the extent of the dividend received. Similarly,
capital gains, although generally eligible for the exemption discussed above,
are subject to Luxembourg taxation to the extent of any such related interest
expense that has been deducted from TEHS’ taxable income (such as the net
interest income on loans to NOL), in the year of disposal and for any previous
year the shares have been held.





We intend
to operate TEHS such that it will not dispose of its shares in Teekay
Netherlands. Accordingly, we believe that TEHS will not be subject to Luxembourg
dividend or capital gains taxation, and, even if it were, it would only be
affected to the extent of the recapture of interest deductions discussed
above.





Taxation of TEHS
Dividends.Luxembourg levies a 15% withholding tax on dividends paid by a
Luxembourg company to a non-EU resident, absent an Income Tax Treaty, which
would apply to dividends paid by TEHS to Norsk Teekay. However, we currently do
not expect to cause TEHS to pay dividends, but to distribute all of its
available cash through the payment of interest and principal on its loans owing
to Norsk Teekay and/or OPCO. In addition, under current Luxembourg tax rules, it
is possible to releverage the Luxembourg operations with new debt, which would
allow a new Luxco to continue to distribute all of its available cash through
payments of interest and principal on the new debt.





Net Wealth Tax.Luxembourg companies are also subject to a net wealth tax, which normally
is based on the company’s net asset value. Capital stock held by a company that
qualifies for the dividend and capital gains exemption discussed above are
excluded from net asset value in calculating this tax. Liabilities related to
shareholdings excluded from the net wealth tax are not deductible from other
assets subject to the net wealth tax. Furthermore, cash amounts held on January
1 with respect to the payments of interest or dividends to TEHS are subject to
the net wealth tax. The cash balance on the last closed financial statements is
generally used to determine the cash amount. Because the shares of Teekay
Netherlands and the discounted loan from Norsk Teekay should be excluded from
the net asset value according to the above, and taking into account that the
loan to NOL should be offset by corresponding loan from OPCO, Luxco should be
required to pay a nominal amount of Luxembourg net wealth tax.





Netherlands
Taxation





The
following discussion is based upon the current tax laws of the Kingdom of the
Netherlands and regulations, the Dutch tax administrative practice and judicial
decisions thereunder, all as in effect as of the date of this Annual Report and
subject to possible change on a retroactive basis. The following discussion is
for general information purposes only and does not purport to be a comprehensive
description of all of the Dutch income tax considerations applicable to
us.





Teekay
Netherlands is capitalized solely with equity from TEHS. Its only significant
asset are the shares of Norsk Teekay AS, which is an intermediate holding
company and is the direct or indirect parent of various operating subsidiaries
in Norway and Singapore, including Teekay Norway AS, NOL and Teekay Offshore
Loading Pte Ltd.





Taxation of
Dividends and Capital Gains. Pursuant to Dutch law, dividends received by
Teekay Netherlands from Norsk Teekay AS and capital gains realized on any
disposal of the shares of Norsk Teekay AS generally will be exempt from Dutch
taxation (the participation
exemption) if the following conditions are met:





•
            Teekay
      Netherlands is a shareholder of at least 5.0% of the par value of the paid
      up share capital of Norsk Teekay
AS;





•
            Norsk
      Teekay AS is subject to Norwegian profits
tax;





•
            the
      shares are not held as stock in trade;
and





•
            the
      shares of Norsk Teekay AS are not held as a portfolio
      investment.





Since
Norsk Teekay AS is an intermediate holding company that fulfills a key position
between the activities of its parent companies and the activities of operational
subsidiaries, the shares in Norsk Teekay AS are not deemed to be held as a
portfolio investment. However, shares are deemed to be held as a portfolio
investment if the subsidiary is mainly involved in passive group financing. If
the activities of the subsidiaries of Teekay Netherlands consist mostly (more
than 50.0%) of direct or indirect financing of related entities, or the
financing of business assets of those entities, including providing for the use
or right to use those assets, the shares of the subsidiaries will be considered
a portfolio investment.





Teekay
Netherlands meets the ownership threshold, and we currently expect that Teekay
Netherlands will maintain its 100.0% ownership interest in Norsk Teekay AS for
the foreseeable future. In addition, assuming that Norsk Teekay AS is a resident
of Norway for Norwegian tax purposes, we expect Norsk Teekay AS to be fully
subject to the Norwegian general corporate tax regime. In addition, we expect
that the shares of Norsk Teekay AS will not be held as stock in trade or as a
portfolio investment. Therefore, we believe that any dividend received on or any
capital gain resulting from the disposition of the shares of Norsk Teekay AS
should be exempt from taxation in the Netherlands.





Capital
losses on a disposition of the shares of Norsk Teekay AS will not be tax
deductible.





Taxation of
Teekay Netherlands Dividends.In general, the Netherlands levies a 25.0%
withholding tax on dividends paid by a Dutch company. The withholding tax is
reduced to zero if the dividend is paid by Teekay Netherlands to TEHS, if TEHS
meets the conditions of the European Union Parent-Subsidiary Directive. The
Directive requires that TEHS hold at least 10.0% of the shares of Teekay
Netherlands for at least one year before the dividend distribution. TEHS has
owned the shares of Teekay Netherlands for at least 12 months. We currently
expect that TEHS will maintain its 100.0% ownership interest in Teekay
Netherlands for the foreseeable future. Therefore, we believe that Dutch
withholding tax will not apply to dividends paid by Teekay Netherlands to TEHS.
In addition, TEHS should not be liable to Dutch corporate income tax with
regards to the dividends received.








34





2007 Tax Reform
in the Netherlands.On November 28, 2006 the Dutch parliament passed the Corporate Income Tax
2007 Bill, which became effective on January 1, 2007. This new legislation
affects the participation exemption. Under the new law, the requirements for the
participation exemption include;





•
            Teekay
      Netherlands must be a shareholder of at least 5.0% of the par value of the
      paid up share capital of Norsk Teekay
  AS; and





•
            the
      shares in Norsk Teekay AS must not be considered a portfolio investment in
      a company that is not subject to an adequate profit
  tax.





Whether
or not a shareholder’s interest in a company is a “portfolio investment” is
determined by the consolidated assets of that company. If the consolidated
assets are predominantly free portfolio investments or consist predominantly of
assets used for group financing activities, the shares would in principle be
considered a portfolio investment. Accordingly, the assessment of the activities
of the subsidiaries (active or passive) would remain very significant. If the
“activities test” were not met, the participation exemption would not apply to
that entity, unless the profits of the entity were subjected to an adequate
profit tax. The taxation would be considered adequate if the profits are taxed
against an effective tax rate of at least 10.0% over a taxable base determined
according to Dutch standards.





Singapore
Taxation





Taxation of
Singapore Companies Operating Ships in International
Traffic.OPCO has one subsidiary that is incorporated and tax resident in
Singapore for Singapore tax purposes, Teekay Navion Offshore Loading Pte. Ltd.
(or TNOL).





Taxation of
Charter Income from Non-Singapore-Registered Ships.In respect of the
charter income that TNOL earns from its non-Singapore-registered ships, they are
currently exempt from Singapore tax under a tax incentive being enjoyed by TNOL.
TNOL was conferred the Singapore Approved International Shipping (or AIS) status with effect from
January 1, 2005. The AIS status was granted for an initial period of
10 years subject to a review at the end of the fifth year to ensure that
TNOL has complied with the qualifying conditions of the incentive. At the end of
the first 10 years, TNOL can apply for a further 10-year extension of the
incentive.





Under
Section 13F of the Singapore Income Tax Act and the terms of the AIS incentive
approval letter from the Maritime Port Authority of Singapore (or MPA) dated January 2005, the
types of income that would qualify for tax exemption include:




•
              charter
      hire/freight income from the operation of non-Singapore-registered vessels
      outside the limits of the port of Singapore;•
              dividends
      from approved shipping subsidiaries;•
              gains
      from the disposition of non-Singapore-registered ships for a period of
      5 years from January 1, 2004 to December 13, 2008;
      and•
              foreign
      exchange, interest rate swaps and other derivative gains would be
      automatically regarded as tax exempt hedging gains for a period
      of 5 years from January 1 2004 to December 31,
      2008.




The AIS
status awarded to TNOL is subject to TNOL meeting and continuing to meet the
following conditions:




•
            be a tax resident in
      Singapore;•
            own and operate a significant
      fleet of ships;•
            implement the business plan
      agreed with the MPA at the time of application of the incentive or such
      other modified plans as approved by the MPA;•
            the
      company’s shipping operations should be controlled and managed in
      Singapore;•
            incur
      directly attributable business spending in Singapore an average of S$4
      million a year or S$20 million over a 5 year period;•
            support
      and make significant use of Singapore’s trade infrastructure, such as
      banking, financial, business training, arbitration, and other ancillary
      services;•
            all
      ships chartered-in must be conducted on an arm's-length
      basis;•
            inform
      the MPA of any changes to its Group shareholdings and
      operations;•
            keep
      proper books and records and submit annual audited accounts to the MPA,
      together with an annual audited statement comparing the actual total
      business spending in Singapore against the projected amount within 3
      months of their completion; and•
            disclose
      such information to and permit such inspection of its premises by the
      Singapore Government, as required.




TNOL
intends to operate such that substantially all of its charter income will be
exempt from Singapore tax under the AIS incentive. It also intends to operate
and charter out all of its non-Singapore-registered ships in international
waters outside the limits of the port of Singapore. On this basis, it expects
that all of its income from the charter of its non-Singapore-registered ships
should be exempt from Singapore tax under Section 13F of the Singapore Income
Tax Act.





Taxation of
Investment Income. Any investment income earned by TNOL would be subject
to the normal corporate tax rules. With respect to the interest income earned
from deposits placed outside Singapore, the interest will be taxable in
Singapore at the prevailing corporate tax rate (currently 18.0%) when received
or deemed received in Singapore.





35








Taxation of Ship
Management Income.In addition to the above, since October 2006 TNOL has
provided ship management services to related and third party companies. Income
from such activities does not qualify for exemption under the AIS incentive.
Accordingly, the income derived from these activities is subject to tax at the
prevailing corporate tax rate of 18.0%.





Australian
Taxation





The
following discussion is based upon the current tax laws of Australia and
regulations, the Australian tax administrative practice and judicial decisions
thereunder, all as in effect as of the date of this Annual Report and subject to
possible change on a retroactive basis. The following discussion is for general
information purposes only and does not purport to be a comprehensive description
of all Australian income tax considerations applicable to us. This discussion
only considers Australia income tax.





Teekay
Offshore Australia Trust (or the “Trust”), which owns and
operates the Karratha
Spirit vessel in Australian waters, is treated as a company for
Australian tax purposes. OPCO is the beneficiary of the Trust.





As a
beneficiary of the Trust, OPCO is subject to Australian tax on the taxable
income of the Trust derived from Australian sources. Since the Trust only
operates one asset, the Karratha Spirit, it is
expected that all taxable income of the Trust has an Australian
source.





Since,
however, OPCO is not a resident of Australia, the trustee of the Trust is
required to pay the Australian tax due, on behalf of OPCO (the non-resident
beneficiary). This is at 30.0% of the taxable income of the Trust.





The Trust
is required to file an Australian tax return disclosing the taxable income
related to the Trust and receives a credit for the tax paid by the trustee.
Hence, no further Australian income tax should be due by the Trust. Generally,
the Trust will be taxable on its income attributable to its operations in
Australia calculated under generally accepted accounting principles, as adjusted
for tax purposes. Gross income will include capital gains, interest and realized
foreign exchange gains and losses.  Trusts are subject to capital
gains on the disposition of different classes of assets, including those which
are used to carry on a business in Australia, and land and buildings situated in
Australia. Capital gains can be offset by any capital losses incurred in the
current year, in addition to any carried forward capital losses. Net capital
gains generated by a trust are taxed at the general corporate rate of
30.0%.





Generally,
a Trust is allowed to deduct the expenses it incurs in a taxation year, to the
extent the expenses are incurred to earn the Australian sourced income. The
Australian operations of the Trust is partly financed by debt. As such, to the
extent the interest expense is allocable to the Australian sourced income it
should generate interest deductions, subject to thin capitalization
restrictions.





Teekay
Australia Offshore Holdings Pty Ltd. (or “TAOH”) was incorporated in
July of 2007 and is owned directly by the Partnership.  TAOH is the
sole member of Dampier Spirit LLC, which owns and operates the Dampier Spirit vessel in
Australian waters.  Together, TAOH and Dampier Spirit LLC form a tax
consolidated group for Australian tax reporting purposes.  The
consolidated group is taxed as a regular Australian company and is subject to
Australian domestic tax law.  The consolidated group is taxed on its
consolidated taxable income at the Australian corporate tax rate of 30% and is
required to file an Australian tax return.





Thin
capitalization measures apply which limit the deductibility of interest
expenditure incurred by non-residents carrying on a business in Australia. The
measures apply to the total debt of the Australian operations of multinational
groups such that interest deductions are denied to the extent that borrowings
exceed a safe harbor ratio or, alternatively, an arm’s length debt amount (as so
calculated under the provisions of the Australian income tax legislation).
Broadly, the safe harbor maximum amount of Australian debt for the Australian
operations of a non-resident is 75.0% of the accounting book value of the assets
of the Australian operation after being reduced by non-debt liabilities
(calculated on an average basis).





Taxation of
Interest Paid in Respect of the Australian
Operations.Australia levies withholding tax on interest paid to a
non-resident where the interest relates to Australian operations. Therefore, any
interest paid to non-residents will be subject to Australian withholding tax.
Withholding tax is levied on payments of interest made to non residents,
regardless of whether the interest deduction is allowed pursuant to other
provisions of the Australian tax legislation. The withholding tax rate on
interest is generally 10.0%, with the exception of certain interest payments to
U.S. and U.K. resident financial institutions, whereby the rate is reduced to
0.0%.





Item
4A.  Unresolved Staff Comments





Not
applicable.





Item
5.  Operating and Financial Review and Prospects





Management's
Discussion and Analysis of Financial Condition and Results of
Operations





OVERVIEW





We are an
international provider of marine transportation and storage services to the
offshore oil industry. We were formed in August 2006 by Teekay Corporation, a
leading provider of marine services to the global oil and natural gas
industries, to further develop its operations in the offshore market. Our growth
strategy focuses on expanding our fleet of shuttle tankers and FSO units under
long-term, fixed-rate time charters. We intend to continue our practice of
acquiring shuttle tankers and FSO units as needed for approved projects only
after the long-term charters for the projects have been awarded to us, rather
than ordering vessels on a speculative basis. We intend to follow this same
practice in acquiring FPSO units, which produce and process oil offshore in
addition to providing storage and offloading capabilities. We seek to capitalize
on opportunities emerging from the global expansion of the offshore
transportation, storage and production sectors by selectively targeting
long-term, fixed-rate time charters. We may enter into joint ventures and
partnerships with companies that may provide increased access to these
opportunities or may engage in vessel or business acquisitions. We plan to
leverage the expertise, relationships and reputation of Teekay Corporation and
its affiliates to pursue these growth opportunities in the offshore sectors and
may consider other opportunities to which our competitive strengths are well
suited. We view our conventional tanker fleet primarily as a source of stable
cash flow as we seek to expand our offshore operations.





36











SIGNIFICANT
DEVELOPMENTS


Our
Initial Public Offering




On
December 19, 2006, we completed our initial public offering of 8.05 million
common units at a price of $21.00 per unit. The net proceeds from the offering
were $155.2 million. The offering included 1.05 million common units sold to the
underwriters in connection with the exercise of their over-allotment option. We
used the net proceeds to repay a $134.6 million promissory to Teekay Corporation
and to redeem 1.05 million common units from Teekay Corporation for $20.6
million.





Prior to
the closing of this offering, Teekay Corporation contributed entities owning and
operating a fleet of shuttle tankers, FSO units and Aframax conventional crude
oil tankers to Teekay Offshore Operating L.P. (or OPCO). Upon the closing of
our initial public offering, we acquired from Teekay Corporation a 26.0%
interest in OPCO. Teekay Corporation owns the remaining 74.0% interest in OPCO.
Prior to June 30, 2007, our 26.0% interest in OPCO represented our only
cash-generating asset. The results prior to our initial public offering
discussed below are the results of the entities that were contributed to OPCO,
which we refer to collectively as “Teekay Offshore Partners Predecessor”. The
entities contributed to OPCO do not own some of the assets and operations they
owned during the year ended December 31, 2007. References in this Item 5 -
Management’s Discussion and Analysis of Financial Condition and Results of
Operations to “OPCO” refer to Teekay Offshore Partners Predecessor for periods
prior to December 19, 2006 and to OPCO and its subsidiaries for periods on or
after December 19, 2006.





Acquisition
of Vessels in 2007





In July
2007, we directly acquired interests in two double-hull shuttle tankers and
related charters for a total cost of approximately $159.1 million, including
assumption of debt of $93.7 million. These interests, which we acquired from
Teekay Corporation, include a 100% interest in the 2000-built Navion Bergen and a 50%
interest in the 2006-built Navion Gothenburg, together
with their respective 13-year, fixed-rate bareboat charters to a subsidiary of
Petrobras Transporte S.A., the shipping arm of Petroleo Brasileiro
S.A.





On
October 1, 2007, we directly acquired one FSO unit, the Dampier Spirit, for a total
cost of approximately $30.3 million.  The Dampier Spiritoperates under
a 7-year fixed-rate, time-charter to Apache Corporation of
Australia.




Potential
Additional Shuttle Tanker, FSO and FPSO Projects


Pursuant
to an omnibus agreement we entered into in connection with our initial public
offering, Teekay Corporation is obligated to offer us certain shuttle tankers,
FSO units, and FPSO units it may acquire in the future, provided the vessels are
servicing contracts in excess of three years in length.





Teekay
Corporation has ordered four Aframax shuttle tanker newbuildings, which are
scheduled to deliver in 2010 and 2011, for a total delivered cost of
approximately $416.9 million. It is anticipated that these vessels will be
offered to us and will be used to service either new long-term, fixed-rate
contracts Teekay Corporation may be awarded prior to delivery or OPCO’s
contracts-of-affreightment in the North Sea.





The
omnibus agreement also obligates Teekay Corporation to offer to us (a) its
interest in certain future FPSO and FSO projects it may undertake through its
50%-owned joint venture with Teekay Petrojarl ASA and (b) if Teekay Corporation
obtains 100% ownership of Teekay Petrojarl ASA, the existing FPSO units owned by
Teekay Petrojarl ASA that are servicing contracts in excess of three years in
length. As at March 31, 2008, Teekay Corporation had a 65% ownership interest in
Teekay Petrojarl ASA.





Our
Contracts of Affreightment and Charters





We
generate revenues by charging customers for the transportation and storage of
their crude oil using our vessels. Historically, these services generally have
been provided under the following basic types of contractual
relationships:





•
            Contracts of
      affreightment, whereby we carry an agreed quantity of cargo for a
      customer over a specified trade route within a given period of
      time;





•
            Time charters, whereby
      vessels we operate and are responsible for crewing are chartered to
      customers for a fixed period of time at rates that are generally fixed,
      but may contain a variable component based on inflation, interest rates or
      current market rates;





•
            Bareboat charters,
      whereby customers charter vessels for a fixed period of time at rates that
      are generally fixed, but the customers operate the vessels with their own
      crews; and





•
            Voyage charters, which
      are charters for shorter intervals that are priced on a current, or
      “spot,” market rate.








37





The table
below illustrates the primary distinctions among these types of charters and
contracts:





Contract
      of
              Affreightment
            Time
      Charter
            Bareboat
      Charter
            Voyage Charter
      (1)Typical
      contract
      length
            One
      year or more
            One
      year or more
            One
      year or more
            Single
      voyageHire
      rate basis
      (2)
            Typically
      daily
            Daily
            Daily
            VariesVoyage
      expenses
      (3)
            We
      pay
            Customer
      pays
            Customer
      pays
            We
      payVessel
      operating expenses (3)
            We
      pay
            We
      pay
            Customer
      pays
            We
      payOff-hire
      (4)
            Customer
      typically does not pay
            Varies
            Customer
      typically pays
            Customer
      does not pay


__________





(1)
            Under
      a consecutive voyage charter, the customer pays for idle
    time.





(2)
            “Hire”rate refers to
      the basic payment from the charterer for the use of the
      vessel.





(3)
            Defined
      below under “Important Financial and Operational Terms and
      Concepts.”





(4)
            “Off-hire”refers to
      the time a vessel is not available for
service.





Important
Financial and Operational Terms and Concepts





We use a
variety of financial and operational terms and concepts. These include the
following:





Voyage Revenues.Voyage revenues primarily include revenues from contracts of
affreightment, time charters, bareboat charters and voyage charters. Voyage
revenues are affected by hire rates and the number of days a vessel operates.
Voyage revenues are also affected by the mix of business between contracts of
affreightment, time charters, bareboat charters and voyage charters. Hire rates
for voyage charters are more volatile, as they are typically tied to prevailing
market rates at the time of a voyage.





Voyage Expenses.Voyage expenses are all expenses unique to a particular voyage, including
any bunker fuel expenses, port fees, cargo loading and unloading expenses, canal
tolls, agency fees and commissions. Voyage expenses are typically paid by the
customer under time charters and bareboat charters and by the shipowner under
voyage charters and contracts of affreightment. When we pay voyage expenses,
they typically are added to the hire rates at an approximate cost.





Net Voyage
Revenues.Net voyage revenues represent voyage revenues less voyage
expenses incurred by us. Because the amount of voyage expenses we incur for a
particular charter depends upon the type of charter, we use net voyage revenues
to improve the comparability between periods of reported revenues that are
generated by the different types of charters. We principally use net voyage
revenues, a non-GAAP financial measure, because it provides more meaningful
information to us about the deployment of our vessels and their performance than
voyage revenues, the most directly comparable financial measure under accounting
principles generally accepted in the United States (or GAAP).





Vessel Operating
Expenses.Under all types of charters except for bareboat charters, the
shipowner is responsible for vessel operating expenses, which include crewing,
repairs and maintenance, insurance, stores, lube oils and communication
expenses. The two largest components of our vessel operating expenses are crews
and repairs and maintenance.





Expenses
for repairs and maintenance tend to fluctuate from period to period because most
repairs and maintenance typically occur during periodic drydockings. Please read
“Drydocking” below. We expect these expenses to increase as the fleet matures
and expands, particularly to the extent we acquire vessels directly through our
wholly owned subsidiaries rather than through OPCO.





Time Charter Hire
Expenses.Time charter hire expenses represent the cost to charter-in a
vessel for a fixed period of time.





Income from
Vessel Operations.To assist us in evaluating operations by segment, we
sometimes analyze the income we receive from each segment after deducting
operating expenses, but prior to the deduction of interest expense, taxes,
foreign currency exchange gains and losses and other income and
losses.





Drydocking.We must periodically drydock our shuttle tankers and conventional oil
tankers for inspection, repairs and maintenance and any modifications to comply
with industry certification or governmental requirements. We may drydock FSO
units if we desire to qualify them for shipping classification. Generally, each
shuttle tanker and conventional oil tanker is drydocked every two and a half to
five years, depending upon the type of vessel and its age. We capitalize a
substantial portion of the costs incurred during drydocking and amortize those
costs on a straight-line basis from the completion of a drydocking to the
estimated completion of the next drydocking. We expense as incurred costs for
routine repairs and maintenance performed during drydocking that do not improve
or extend the useful lives of the assets. The number of drydockings undertaken
in a given period and the nature of the work performed determine the level of
drydocking expenditures.





Depreciation and
Amortization.Depreciation and amortization expense typically consists
of:





•
            charges
      related to the depreciation of the historical cost of our fleet (less an
      estimated residual value) over the estimated useful lives of the
      vessels;





•
            charges
      related to the amortization of drydocking expenditures over the estimated
      number of years to the next scheduled
  drydocking; and





•
            charges
      related to the amortization of the fair value of contracts of
      affreightment where amounts have been attributed to those items in
      acquisitions; these amounts are amortized over the period in which the
      asset is expected to contribute to future cash
  flows.





38








Revenue Days.Revenue days are the total number of calendar days our vessels were in
our possession during a period, less the total number of off-hire days during
the period associated with major repairs, or drydockings. Consequently, revenue
days represent the total number of days available for the vessel to earn
revenue. Idle days, which are days when the vessel is available to earn revenue,
yet is not employed, are included in revenue days. We use revenue days to show
changes in net voyage revenues between periods.





Calendar-Ship-Days.Calendar-ship-days are equal to the total number of calendar days that
our vessels were in our possession during a period. We use calendar-ship-days
primarily to highlight changes in vessel operating expenses, time charter hire
expense and depreciation and amortization. For periods prior to our initial
public offering in December 2006, calendar-ship days are based on OPCO's
owned and chartered-in fleet, excluding vessels owned by OPCO's five 50% owned
joint ventures. For periods on or after our initial public offering,
calendar-ship days are based on our and OPCO's owned and chartered-in fleet,
including vessels owned by our 50% controlled joint ventures, as OPCO obtained
control of five of these joint ventures as of December 1, 2006, and we purchased
a 50% interest in one joint venture in July 2007.





VOC Equipment.We assemble, install, operate and lease equipment that reduces volatile
organic compound emissions (or VOC equipment) during
loading, transportation and storage of oil and oil products. Leasing of the VOC
equipment is accounted for as a direct financing lease, with lease payments
received being allocated between the net investment in the lease and other
income using the effective interest method so as to produce a constant periodic
rate of return over the lease term.





Items You
Should Consider When Evaluating Our Results





You
should consider the following factors when evaluating our historical financial
performance and assessing our future prospects:





§
            Our cash
      flow will be reduced by distributions on Teekay Corporation’s
      interest in OPCO.Following the closing of our initial public
      offering, Teekay Corporation has held a 74% limited partner interest in
      OPCO. OPCO’s partnership agreement requires it to distribute all of its
      available cash each quarter. In determining the amount of cash available
      for distribution, the Board of Directors of our general partner must
      approve the amount of cash reserves to be set aside, including reserves
      for future maintenance capital expenditures, working capital and other
      matters. Distributions to Teekay Corporation for periods following our
      initial public offering reduce our cash flow compared to historical
      results.





§
            On
      July 1, 2006, OPCO transferred certain assets to Teekay Corporation
      that are included in results of operation prior to that date.On
      July 1, 2006, and in anticipation of our initial public offering,
      OPCO transferred to Teekay Corporation a subsidiary of Norsk Teekay
      Holdings Ltd. (Navion Shipping Ltd.) that chartered-in approximately 25
      conventional tankers since 2004 and subsequently time-chartered the
      vessels back to Teekay Corporation at charter rates that provided for a
      1.25% fixed profit margin. In addition, OPCO transferred to Teekay
      Corporation a 1987-built shuttle tanker (the Nordic Trym), a
      1992-built in-chartered shuttle tanker (the Borga) and certain
      other assets (collectively with Navion Shipping Ltd., the Non-OPCO Assets). During 2006
      and 2005, the Non-OPCO Assets accounted for approximately 14.3% and 31.3%,
      respectively, of OPCO’s net voyage
revenues.





§
            Amendments
      to OPCO’s joint venture agreements in December 2006 have resulted in
      five 50% joint
      venture companies being consolidated with us under GAAP.Our
      results of operations prior to December 1, 2006 reflect OPCO’s investment
      in five 50% joint venture companies, accounted for using the equity
      method, whereby the investment is carried at the original cost plus OPCO’s
      proportionate share of undistributed earnings. On December 1, 2006, the
      operating agreements for these joint ventures were amended such that OPCO
      obtained control of these joint ventures, resulting in the consolidation
      of these five joint venture companies in accordance with GAAP. Although
      our net income did not change due to this change in accounting, the
      results of the joint ventures have been reflected in our income from
      operations since December 1, 2006. As noted above, this change also
      resulted in the five shuttle tankers owned by these joint ventures being
      included in the vessels used to calculate
    calendar-ship-days.





§
            The size of
      our fleet continues to change.Our results of operations reflect
      changes in the size and composition of our fleet due to certain vessel
      deliveries and vessel dispositions. For instance, in addition to the
      decrease in chartered-in vessels associated with the transfer of Navion
      Shipping Ltd. described above, the average number of owned vessels in our
      shuttle tanker fleet increased from 21 in 2006 to 25 in 2007, and our FSO
      segment increased from 3 in 2006 to 4 in 2007. Please read “— Results
      of Operations” below for further details about vessel dispositions and
      deliveries. Due to the nature of our business, we expect our fleet to
      continue to fluctuate in size and
composition.





§
            Our
      financial results of operations reflect different time charter terms for
      OPCO’s nine conventional tankers. On October 1, 2006, OPCO entered
      into new fixed-rate time charters with a subsidiary of Teekay Corporation
      for OPCO’s nine conventional tankers at rates we believed reflected
      then-prevailing market rates. Please read item 18 - Financial Statements:
      Note 10 “Related Party Transactions.”  At various times prior to
      October 2006, eight of these nine conventional tankers were employed on
      time charters with the same subsidiary of Teekay Corporation. However, the
      charter rates were generally lower than market-based charter rates, as
      they were based on the cash flow requirements of each vessel, which
      included operating expenses, loan principal and interest payments and
      drydock expenditures. The ninth conventional tanker was employed on voyage
      and bareboat charters. Under the terms of eight of the nine new
      time-charter contracts, OPCO is responsible for the bunker fuel expenses
      and the approximate amounts of these expenses are added to the daily hire
      rate.


§
                Our vessel
      operating costs are facing industry-wide cost
      pressures.The shipping industry is experiencing a
      global manpower shortage due to significant growth in the world fleet.
      This shortage has resulted in crewing wage increases during 2007, the
      effect of which is explained in our comparison of vessel operating
      expenses incurred in the year ended December 31, 2007 versus the year
      ended December 31, 2006. We expect a trend of increasing crew compensation
      to continue into 2008.


39




§
            Our financial results of
      operations are affected by fluctuations in currency exchange
      rates. Under US GAAP, all foreign currency-denominated monetary
      assets and liabilities, such as cash and cash equivalents, accounts
      receivable, accounts payable, advances from affiliates and deferred income
      taxes are revalued and reported based on the prevailing exchange rate at
      the end of the period. Most of our historical foreign currency gains and
      losses prior to our initial public offering are attributable to this
      revaluation in respect of our foreign currency denominated advances from
      affiliates. In addition, a substantial majority of OPCO’s crewing expenses
      historically have been denominated in Norwegian Kroner, which is primarily
      a function of the nationality of the crew. Fluctuations in the Norwegian
      Kroner relative to the U.S. Dollar have caused fluctuations in
      operating results. Prior to our initial public offering, OPCO settled its
      then-outstanding foreign currency denominated advances from affiliates and
      also entered into services agreements with subsidiaries of Teekay
      Corporation whereby the subsidiaries operate and crew the vessels. Under
      these service agreements, OPCO pays all vessel operating expenses in
      U.S. Dollars, and will not be subject to currency exchange
      fluctuations until 2009. Beginning in 2009, payments under the service
      agreements will adjust to reflect any change in Teekay Corporation’s cost
      of providing services based on fluctuations in the value of the Norwegian
      Kroner relative to the U.S. Dollar, which may result in increased
      payments under the services agreements if the strength of the U.S. Dollar
      declines relative to the Norwegian Kroner. At December 31, 2007, we were
      committed to foreign exchange contracts for the forward purchase of
      approximately Norwegian Kroner 255.7 million for U.S. Dollars at an
      average rate of Norwegian Kroner 5.64 per U.S. Dollar, maturing in
      2009.




§
            We are
      incurring additional general and administrative expenses.Prior to
      our initial public offering, general and administrative expenses were
      allocated based on OPCO’s proportionate share of Teekay Corporation’s
      total ship-operating (calendar) days for applicable periods presented. In
      connection with our initial public offering, we, OPCO and certain of its
      subsidiaries entered into services agreements with subsidiaries of Teekay
      Corporation, pursuant to which those subsidiaries provide certain
      services, including administrative, advisory and technical services and
      ship management. Our cost for these services depends on the amount and
      types of services provided during each period. The services are valued at
      an arm’s-length rate that include reimbursement of reasonable direct and
      indirect expenses incurred to provide the services. We also reimburse our
      general partner for all expenses it incurs on our behalf, including
      compensation and expenses of its executive officers and directors and we
      may grant equity compensation that would result in an expense to us. Since
      becoming a publicly traded limited partnership, we have also incurred
      costs associated with annual reports to unitholders and SEC filings,
      investor relations, NYSE annual listing fees and additional tax compliance
      expenses





§
            Our
      operations are seasonal.Historically, the utilization of shuttle
      tankers in the North Sea is higher in the winter months, as favorable
      weather conditions in the summer months provide opportunities for repairs
      and maintenance to our vessels and to the offshore oil platforms. Downtime
      for repairs and maintenance generally reduces oil production and, thus,
      transportation requirements.





We manage
our business and analyze and report our results of operations on the basis of
three business segments: the shuttle tanker segment, the conventional tanker
segment and the FSO segment.





Year
Ended December 31, 2007 versus Year Ended December 31,
2006





Shuttle
Tanker Segment





Our
shuttle tanker fleet consists of 38 vessels that operate under fixed-rate
contracts of affreightment, time charters and bareboat charters. Of the 38
shuttle tankers, 24 are owned by OPCO (including 5 through 50% controlled joint
ventures), 12 are chartered-in by OPCO and 2 are owned by us (including one
through a 50% controlled joint venture). All of these shuttle tankers provide
transportation services to energy companies, primarily in the North Sea and
Brazil.





The
following table presents our shuttle tanker segment’s operating results for the
years ended December 31, 2007 and 2006, and compares its net voyage revenues
(which is a non-GAAP financial measure) for the years ended December 31, 2007
and 2006 to voyage revenues, the most directly comparable GAAP financial
measure, for the same periods. The following table also provides a summary of
the changes in calendar-ship-days by owned and chartered-in vessels for our
shuttle tanker segment:





40








For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2007
            
            
            2006
            
            
            %
      ChangeVoyage
      revenues
            
            
            588,547
            
            
            
            535,972
            
            
            
            9.8Voyage
      expenses
            
            
            114,103
            
            
            
            88,446
            
            
            
            29.0Net
      voyage revenues
            
            
            474,444
            
            
            
            447,526
            
            
            
            6.0Vessel
      operating expenses
            
            
            103,444
            
            
            
            80,307
            
            
            
            28.8Time-charter
      hire expense
            
            
            150,463
            
            
            
            165,614
            
            
            
            (9.2
            )Depreciation
      and amortization
            
            
            85,885
            
            
            
            71,367
            
            
            
            20.3General
      and administrative (1)
            
            
            50,783
            
            
            
            51,921
            
            
            
            (2.2
            )Gain
      on sale of vessels and equipment - net of writedowns
            
            
            -
            
            
            
            (4,778
            )
            
            
            (100.0
            )Income
      from vessel operations
            
            
            83,869
            
            
            
            83,095
            
            
            
            0.9Calendar-Ship-DaysOwned
      Vessels
            
            
            9,104
            
            
            
            7,559
            
            
            
            20.4Chartered-in
      Vessels
            
            
            4,297
            
            
            
            4,824
            
            
            
            (10.9
            )Total
            
            
            13,401
            
            
            
            12,383
            
            
            
            8.2






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the shuttle tanker segment based on
      estimated use of corporate
resources).





The
average size of our owned shuttle tanker fleet increased for 2007 compared to
2006, primarily due to:





§
            the
      consolidation into our results of the five vessels owned by OPCO’s 50%
      controlled joint ventures, effective December 1, 2006 upon amendments to
      the applicable operating agreements that granted OPCO control of the joint
      ventures (the Consolidation of Joint
      Ventures); and





§
            the
      acquisition in July 2007 of the 2000-built shuttle tanker (the Navion Bergen) and a
      50% interest in the 2006-built shuttle-tanker (the Navion Gothenburg) (the
      2007 Shuttle Tanker
      Acquisitions);





partially
offset by





§
            the
      sale of a 1981-built shuttle tanker (the Nordic Laurita) in July
      2006 to a third party and the sale of a 1987-built shuttle tanker (the
      Nordic Trym) to
      Teekay Corporation in November 2006 (collectively, the 2006 Shuttle Tanker
      Dispositions).





The
average size of our chartered-in shuttle tanker fleet decreased in 2007 compared
to 2006, primarily due to:





§
            the
      redelivery of one chartered-in vessel back to its owner in April 2006;
      and





§
            the
      sale in July 2006 to Teekay Corporation of a time charter-in contract for
      a 1992-built shuttle tanker (the Borga).





Net Voyage Revenues.Net
voyage revenues increased for 2007 from 2006, primarily due to:





§
            an
      increase of $40.8 million due to the Consolidation of Joint
      Ventures;





§
            an
      increase of $10.2 million due to the 2007 Shuttle Tanker Acquisitions;
      and





§
            an
      increase of $3.6 million due to the renewal of certain vessels on time
      charter contracts at higher daily rates during
  2006;





partially
offset by





§
            a
      decrease of $13.6 million in revenues due to (a) fewer revenue days for
      shuttle tankers servicing contracts of affreightment during 2007 due to a
      decline in oil production from mature oil fields in the North Sea and (b)
      the redeployment of idle shuttle tankers servicing contracts of
      affreightment in the conventional spot market at a lower average charter
      rate during the fourth quarter of 2007 due to a weaker spot tanker
      market;





§
            a
      decrease of $7.6 million due to the 2006 Shuttle Tanker
      Dispositions;





§
            a
      decrease of $4.4 million due to the sale of the time charter-in contract
      for the Borga;
      and





§
            a
      decrease of $2.9 million from the redelivery of one chartered-in vessel to
      its owner in April 2006.





Vessel Operating Expenses.Vessel operating expenses increased for 2007 from 2006, primarily due
to:





§
            an
      increase of $17.3 million due to the Consolidation of Joint
      Ventures;





§
            an
      increase of $7.0 million in salaries for crew and officers primarily due
      to general wage escalations from the renegotiation of seafarer contracts,
      changes in crew composition and a change in the crew rotation system;
      and





41








§
            an
      increase of $1.9 million relating to an increase in services due to the
      rising cost of consumables, lubes, and freight during
  2007;





partially
offset by





§
            a
      decrease of $3.2 million due to the 2006 Shuttle Tanker
      Dispositions.





Time-Charter Hire Expense.Time-charter hire expense decreased for 2007 from 2006, primarily due to
the decrease in the average number of vessels chartered-in.





Depreciation and Amortization.Depreciation and amortization expense increased for 2007 from 2006,
primarily due to:





§
            an
      increase of $13.7 million due to the Consolidation of Joint
      Ventures;





§
            an
      increase of $3.5 million due to the 2007 Shuttle Tanker Acquisitions;
      and





§
            an
      increase of $3.9 million from the amortization of vessel upgrades and
      drydock costs incurred during 2006 and
2007;





partially
offset by





§
            a
      decrease of $5.7 million relating to the 2006 Shuttle Tanker
      Dispositions.





Gain on sale of vessels equipment -
net of writedowns. Gain on sale of vessels and
equipment - net of writedowns for 2006 was a net gain of $4.8 million,
which was comprised primarily of:





§
            a
      $6.4 million gain relating to the sale of a 1981-built shuttle tanker (the
      Nordic Laurita)
      in July 2006;





partially
offset by





§
            a
      $2.2 million writedown in 2006 of certain offshore equipment
      servicing a marginal oil field that was prematurely shut down in June 2005
      due to lower than expected oil production. This writedown occurred due to
      a reassessment of the estimated net realizable value of the equipment and
      follows a $12.2 million writedown in 2005 arising from the early
      termination of a contract for the equipment (some of this equipment was
      re-deployed on another field in October
2005).





Conventional
Tanker Segment





OPCO owns
nine Aframax conventional crude oil tankers, all of which operate under
fixed-rate time charters with Teekay Corporation.





The
following table presents our conventional tanker segment’s operating results for
the years ended December 31, 2007 and 2006, and compares its net voyage revenues
(which is a non-GAAP financial measure) for the years ended December 31, 2007
and 2006 to voyage revenues, the most directly comparable GAAP financial
measure, for the same periods. The following table also provides a summary of
the changes in calendar-ship-days by owned and chartered-in vessels for our
conventional tanker segment.





For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2007
            
            
            2006
            
            
            %
      ChangeVoyage
      revenues
            
            
            135,922
            
            
            
            150,070
            
            
            
            (9.4
            )Voyage
      expenses
            
            
            36,594
            
            
            
            4,892
            
            
            
            648.0Net
      voyage revenues
            
            
            99,328
            
            
            
            145,178
            
            
            
            (31.6
            )Vessel
      operating expenses
            
            
            24,175
            
            
            
            19,378
            
            
            
            24.8Time-charter
      hire expense
            
            
            -
            
            
            
            79,338
            
            
            
            100.0Depreciation
      and amortization
            
            
            21,324
            
            
            
            21,212
            
            
            
            0.5General
      and administrative (1)
            
            
            7,828
            
            
            
            18,886
            
            
            
            (58.6
            )Restructuring
      charge
            
            
            -
            
            
            
            832
            
            
            
            (100.0
            )Income
      from vessel operations
            
            
            46,001
            
            
            
            5,532
            
            
            
            731.6Calendar-Ship-DaysOwned
      Vessels
            
            
            3,405
            
            
            
            3,650
            
            
            
            (6.7
            )Chartered-in
      Vessels
            
            
            -
            
            
            
            4,395
            
            
            
            (100.0
            )Total
            
            
            3,405
            
            
            
            8,045
            
            
            
            (57.7
            )






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the conventional tanker segment
      based on estimated use of corporate
resources).








42





The
average size of the conventional crude oil tanker fleet (including vessels
chartered-in) decreased for 2007 compared to 2006, primarily due
to:





§
            the
      sale to Teekay Corporation during July 2006 of Navion Shipping Ltd., which
      chartered-in approximately 25 conventional tankers since 2004 and
      subsequently time-chartered the vessels back to Teekay Corporation at
      charter rates that provided for a 1.25% fixed profit margin (please read
      "– Items You Should Consider When
      Evaluating Our Results – On July 1, 2006, OPCO transferred certain assets
      to Teekay Corporation that are included in results of operations prior to
      that date"); and





§
            the
      transfer of the Navion
      Saga to the FSO segment as a result of the completion of its
      conversion to an FSO unit and commencing a three-year FSO time charter
      contract in early May 2007 (prior to the completion of the vessel’s
      conversion to an FSO unit, it was included as a conventional crude oil
      tanker within the conventional tanker
segment).





Net Voyage Revenues.Net
voyage revenues decreased for 2007 from 2006, primarily due to:





§
            a
      decrease of $80.0 million due to the sale of Navion Shipping
      Ltd.;





partially
offset by





§
            an
      increase of $33.9 million resulting from higher hire rates earned by
      the nine owned Aframax conventional tankers on time charters with a
      subsidiary of Teekay Corporation (please read “– Items You Should Consider When
      Evaluating Our Results – Our financial results of operations reflect
      different time charter terms for OPCO’s nine conventional
      tankers”).





Vessel Operating Expenses.Vessel operating expenses increased for 2007 from 2006, primarily due to
an increase in salaries for crew and officers as a result of general wage
escalations and an increase in services and repairs and maintenance. In
addition, one of the nine owned Aframax conventional tankers was employed to
Teekay Corporation during 2006 on a short-term bareboat-charter under which the
customer was responsible for vessel operating expenses, and was employed during
2007 on a time-charter contract under which we are responsible for vessel
operating expenses.





Time-Charter Hire Expense.Due to the sale of Navion Shipping Ltd to Teekay Corporation in July
2006, OPCO did not incur any time-charter hire expense for the conventional
tanker fleet during 2007 compared to $79.4 million incurred for
2006.





Depreciation and Amortization.Depreciation and amortization expense increased slightly for 2007 from
2006, primarily due to an increase from the amortization of drydock costs
incurred during 2007, partially offset by a $1.3 million decrease due to the
transfer of the Navion
Saga to the FSO segment in early May 2007.





FSO
Segment





We own
five FSO units that operate under fixed-rate time charters or fixed-rate
bareboat charters. FSO units provide an on-site storage solution to oil field
installations that have no oil storage facilities or that require supplemental
storage.





The
following table presents our FSO segment’s operating results for the years ended
December 31, 2007 and 2006, and compares its net voyage revenues (which is a
non-GAAP financial measure) for the years ended December 31, 2007 and 2006 to
voyage revenues, the most directly comparable GAAP financial measure, for the
same periods. The following table also provides a summary of the changes in
calendar-ship-days for our FSO segment:





For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2007
            
            
            2006
            
            
            %
      ChangeVoyage
      revenues
            
            
            51,500
            
            
            
            22,650
            
            
            
            127.4Voyage
      expenses
            
            
            886
            
            
            
            1,085
            
            
            
            (18.3
            )Net
      voyage revenues
            
            
            50,614
            
            
            
            21,565
            
            
            
            134.7Vessel
      operating expenses
            
            
            15,628
            
            
            
            6,713
            
            
            
            132.8Depreciation
      and amortization
            
            
            15,206
            
            
            
            9,443
            
            
            
            61.0General
      and administrative (1)
            
            
            2,919
            
            
            
            1,709
            
            
            
            70.8Income
      from vessel operations
            
            
            16,861
            
            
            
            3,700
            
            
            
            355.7Calendar-Ship-Days
            
            
            1,432
            
            
            
            1,095
            
            
            
            30.8






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the FSO segment based on estimated
      use of corporate resources).





During
2006, we operated three FSO units. A fourth FSO unit, the Navion Saga, was included as
a conventional crude oil tanker within the conventional tanker segment until May
2007, when its conversion to an FSO unit was completed and it commenced
operating under a three-year FSO time charter contract. In October 2007, we
acquired from Teekay Corporation our fifth FSO unit, the Dampier Spirit, together with
the related 7-year, fixed-rate time-charter to Apache Corporation of
Australiain
October 2007.





The
change in operating results for the FSO segment from 2006 to 2007 were primarily
due to the acquisition of  the Navion Saga and the Dampier Spirit.





43








Other
Operating Results





General and Administrative Expenses.General and administrative expenses decreased to $61.5 million for 2007,
from $72.5 million for 2006, were primarily due to:





§
            a
      decrease of $13.3 million primarily as a result of the sale of Navion
      Shipping Ltd. to Teekay Corporation in July 2006, which since 2004 had
      chartered-in approximately 25 conventional tankers (prior to our initial
      public offering, general and administrative expenses were allocated based
      on OPCO’s proportionate share of Teekay Corporation’s total ship-operating
      (calendar) days for each of the periods presented; since the initial
      public offering, we have incurred general and administrative expenses
      primarily through services agreements between us, OPCO and certain of its
      subsidiaries and subsidiaries of Teekay
  Corporation).





partially
offset by





§
            an
      increase of $2.4 million relating to additional expenses as a result of
      our being a publicly-traded limited partnership since our initial public
      offering in December 2006.





Interest Expense.Interest
expense increased to $79.8 million for 2007, from $69.4 million for 2006,
primarily due to:





§
            an
      increase of $35.9 million relating to a full year of interest incurred on
      debt under a revolving credit facility OPCO entered into during the fourth
      quarter of 2006;





§
            an
      increase of $11.3 million due to the Consolidation of Joint Ventures;
      and





§
            an
      increase of $3.4 million due to the assumption of debt relating to the
      2007Shuttle
      Tanker Acquisitions;





partially
offset by





§
            a
      decrease of $14.2 million in interest incurred on a Norwegian
      Kroner-denominated loan owing by a subsidiary of OPCO to Teekay
      Corporation from October 2006 until our initial public offering in
      December 2006 (Teekay Corporation sold this loan receivable to OPCO
      immediately before our initial public
offering);





§
            a
      decrease of $12.9 million relating to the settlement of interest-bearing
      advances from affiliates during the fourth quarter of
  2006;





§
            a
      decrease of $7.5 million relating to interest incurred under a revolving
      credit facility that was prepaid and cancelled prior to our initial public
      offering; and





§
            a
      decrease of $6.3 million relating to interest incurred by Teekay Offshore
      Partners Predecessor on one of its revolving credit facilities, which was
      not transferred to OPCO prior to our initial public
    offering.





Equity Income From Joint Ventures.Equity income from OPCO’s 50% joint ventures was $6.2 million for
2006. On December 1, 2006, the operating agreements for these joint ventures
were amended, resulting in OPCO obtaining control of these joint ventures and,
consequently, OPCO has consolidated these entities since December 1,
2006.





Foreign Currency Exchange
Losses. Foreign currency exchange loss was $12.1 million for 2007
compared to a $66.7 million loss for 2006. In 2006, the foreign currency
exchange loss of $66.7 million was primarily due to the revaluation of Norwegian
Kroner-denominated advances from affiliates prior to our initial public
offering. These foreign currency exchange losses and gains, substantially all of
which were unrealized, are due primarily to the relevant period-end revaluation
of Norwegian Kroner-denominated monetary assets and liabilities for financial
reporting purposes. Gains reflect a stronger U.S. Dollar against the Kroner on
the date of revaluation or settlement compared to the rate in effect at the
beginning of the period. Losses reflect a weaker U.S. Dollar against the Kroner
on the date of revaluation or settlement compared to the rate in effect at the
beginning of the period.





Income Tax Recovery (Expense).Income tax recovery was $10.9 million 2007 compared to an income tax
expense of $2.8 million for 2006. The $13.7 million increase to income tax
recoveries was primarily due to deferred income tax recoveries resulting from
the financial restructuring of our Norwegian shuttle tanker operations during
2006, partially offset by an increase in deferred income tax expense relating to
unrealized foreign exchange translation gains.





Other Income.Other income
for 2007 and 2006 was $10.4 million and $8.7 million, respectively, which
was primarily comprised of leasing income from our VOC equipment.





Year
Ended December 31, 2006 versus Year Ended December 31,
2005





Shuttle
Tanker Segment





The
following table presents our shuttle tanker segment’s operating results for the
years ended December 31, 2006 and 2005, and compares its net voyage revenues
(which is a non-GAAP financial measure) for the years ended December 31, 2006
and 2005 to voyage revenues, the most directly comparable GAAP financial
measure, for the same periods. The following table also provides a summary of
the changes in calendar-ship-days by owned and chartered-in vessels for our
shuttle tanker segment:





44











For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2006
            
            
            2005
            
            
            %
      ChangeVoyage
      revenues
            
            
            535,972
            
            
            
            516,758
            
            
            
            3.7Voyage
      expenses
            
            
            88,446
            
            
            
            68,308
            
            
            
            29.5Net
      voyage revenues
            
            
            447,526
            
            
            
            448,450
            
            
            
            (0.2
            )Vessel
      operating expenses
            
            
            80,307
            
            
            
            75,196
            
            
            
            6.8Time-charter
      hire expense
            
            
            165,614
            
            
            
            169,687
            
            
            
            (2.4
            )Depreciation
      and amortization
            
            
            71,367
            
            
            
            77,083
            
            
            
            (7.4
            )General
      and administrative (1)
            
            
            51,921
            
            
            
            55,010
            
            
            
            (5.6
            )Gain
      on sale of vessels and equipment - net of writedowns
            
            
            (4,778
            )
            
            
            2,820
            
            
            
            269.4Restructuring
      charge
            
            
            -
            
            
            
            955
            
            
            
            (100.0
            )Income
      from vessel operations
            
            
            83,095
            
            
            
            67,699
            
            
            
            22.7Calendar-Ship-DaysOwned
      Vessels
            
            
            7,559
            
            
            
            8,120
            
            
            
            (6.9
            )Chartered-in
      Vessels
            
            
            4,824
            
            
            
            4,963
            
            
            
            (2.8
            )Total
            
            
            12,383
            
            
            
            13,083
            
            
            
            (5.4
            )






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the shuttle tanker segment based on
      estimated use of corporate
resources).





The
average size of OPCO’s owned shuttle tanker fleet decreased in 2006 compared to
2005, primarily the result of:





§
            the
      sale of two older shuttle tankers in March and October 2005, respectively
      (or the2005 Shuttle
      Tanker Dispositions); and





§
            the
      2006 Shuttle Tanker Dispositions.





The
average size of OPCO’s chartered-in shuttle tanker fleet decreased in 2006
compared to 2005, primarily the result of:





§
            the
      redelivery of one chartered-in vessel back to its owner in April 2006;
      and





§
            the
      sale in July 2006 of the Borga to Teekay
      Corporation;





partially
offset by





§
            the
      inclusion of two additional chartered-in vessels commencing May and June
      2005.





In
addition, during March 2005 OPCO sold and leased back an older shuttle tanker.
This had the effect of increasing the average number of chartered-in vessels and
decreasing the average number of owned vessels during 2006 compared to
2005.





Net Voyage Revenues.Net
voyage revenues decreased slightly for 2006 from 2005, primarily due
to:





§
            a
      decrease of $5.9 million from the 2005 Shuttle Tanker
      Dispositions;





§
            a
      decrease of $4.5 million due to an extended drydocking of the Nordic Trymduring the
      second half of 2006;





§
            a
      decrease of $2.9 million from the redelivery of one chartered-in vessel to
      its owner in April 2006; and





§
            a
      decrease of $2.2 million from the 2006 Shuttle Tanker
      Dispositions;





partially
offset by





§
            an
      increase of $5.4 million from the 2006 transfer of certain of our
      shuttle tankers servicing contracts of affreightment to short-term
      time-charter contracts, which had higher average
  rates;





§
            an
      increase of $4.9 million due to the renewal of three vessels on time
      charter at higher daily rates during 2006;
and





§
            an
      increase of $3.8 million due to the change in accounting treatment
      resulting from the Consolidation of Joint
  Ventures.





Vessel Operating
Expenses.Vessel
operating expenses increased for 2006 from 2005, primarily due to:





§
            an
      increase of $5.8 million in salaries for crew and officers primarily
      due to a change in crew composition on one vessel upon the commencement of
      a new short-term time charter contract in 2005, a one-time bonus payment
      and general wage escalations;





§
            a
      total increase of $1.5 million relating to repairs and maintenance
      for certain vessels during 2006 and an increase in the cost of lubricants
      as a result of higher crude oil costs;
and





45




§
            an
      increase of $1.2 million from the Consolidation of Joint
      Ventures;





partially
offset by





§
            a
      decrease of $2.8 million from the 2005 Shuttle Tanker
      Dispositions.





Time-Charter Hire Expense.Time-charter hire expense decreased for 2006 from 2005, primarily due to
the decrease in the average number of vessels chartered-in;





Depreciation and Amortization.Depreciation and amortization expense decreased for 2006 from 2005,
primarily due to:





§
            a
      decrease of $4.3 million relating to the 2006 Shuttle Tanker
      Dispositions and the 2005 Shuttle Tanker Dispositions, the sale of the
      Nordic Trym in
      November 2006 and the sale and leaseback of one shuttle tanker in March
      2005; and





§
            a
      decrease of $2.8 million relating to a reduction in amortization from
      the expiration during 2005 of two contracts of affreightment and from the
      contracts of affreightment acquired as part of the purchase of Navion AS
      in 2003, which are being amortized over their respective lives, with the
      amount amortized each year being weighted based on the projected revenue
      to be earned under the contracts;





partially
offset by





§
            an
      increase of $1.2 million due to the Consolidation of Joint
      Ventures.





Gain on sale of vessels and
equipment - net of writedowns.Gain on sale of vessels and
equipment - net of writedowns for 2006 was a net gain of $4.8 million,
which was comprised primarily of:





§
            a
      $6.4 million gain relating to the sale of the Nordic Laurita in July
      2006;





partially
offset by





§
            a
      $2.2 million writedown of certain offshore equipment servicing a
      marginal oil field that was prematurely shut down in June 2005 due to
      lower than expected oil production. This writedown occurred due to a
      reassessment of the estimated net realizable value of the equipment and
      follows a $12.2 million writedown in 2005 arising from the early
      termination of a contract for the equipment (some of this equipment was
      re-deployed on another field in October
2005).





Gain on
sale of vessels and equipment - net of writedowns for 2005 was a net loss
of $2.8 million, which was comprised of:





§
            a
      $12.2 million write-down from the previously mentioned offshore
      equipment;





partially
offset by





§
            a
      $9.1 million gain on the 2005 Shuttle Tanker
      Dispositions.





Restructuring Charges.Restructuring charges of $1.0 million in 2005 relate to the closure
of our Sandefjord, Norway office. We incurred no restructuring charges in 2006
in the shuttle tanker segment





Conventional
Tanker Segment





The
following table presents our conventional tanker segment’s operating results for
the year ended December 31, 2006 and 2005, and compares its net voyage revenues
(which is a non-GAAP financial measure) for the years ended December 31, 2006
and 2005 to voyage revenues, the most directly comparable GAAP financial
measure, for the same periods. The following table also provides a summary of
the changes in calendar-ship-days by owned and chartered-in vessels for our
conventional tanker segment:





46








For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2006
            
            
            2005
            
            
            %
      ChangeVoyage
      revenues
            
            
            150,070
            
            
            
            266,593
            
            
            
            (43.7
            )Voyage
      expenses
            
            
            4,892
            
            
            
            5,419
            
            
            
            (9.7
            )Net
      voyage revenues
            
            
            145,178
            
            
            
            261,174
            
            
            
            (44.4
            )Vessel
      operating expenses
            
            
            19,378
            
            
            
            22,679
            
            
            
            (14.6
            )Time-charter
      hire expense
            
            
            79,338
            
            
            
            203,849
            
            
            
            (61.1
            )Depreciation
      and amortization
            
            
            21,212
            
            
            
            21,112
            
            
            
            0.5General
      and administrative (1)
            
            
            18,886
            
            
            
            29,026
            
            
            
            (34.9
            )Restructuring
      charge
            
            
            832
            
            
            
            -
            
            
            
            100.0Income
      from vessel operations
            
            
            5,532
            
            
            
            (15,492
            )
            
            
            (135.7
            )Calendar-Ship-DaysOwned
      Vessels
            
            
            3,650
            
            
            
            3,831
            
            
            
            (4.7
            )Chartered-in
      Vessels
            
            
            4,395
            
            
            
            11,204
            
            
            
            (60.8
            )Total
            
            
            8,045
            
            
            
            15,035
            
            
            
            (46.5
            )






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the conventional tanker segment
      based on estimated use of corporate
resources).





The
average size of the conventional crude oil tanker fleet (including vessels
chartered-in) decreased in 2006 compared to 2005, primarily due to:





§
            the
      sale of the Dania
      Spirit to a subsidiary of Teekay Corporation in June 2005 (or the
      2005 Conventional Tanker
      Disposition); and





§
            the
      sale of Navion Shipping Ltd. to Teekay Corporation during July 2006
      (please read "–
      Items You Should
      Consider When Evaluating Our Results – On July 1, 2006, OPCO transferred
      certain assets to Teekay Corporation that are included in results of
      operations prior to that
date");





Net Voyage Revenues.Net
voyage revenues decreased for 2006 from 2005, primarily due to:





§
            a
      decrease of $129.1 million from the sale of Navion Shipping Ltd.;
      and





§
            a
      decrease of $2.4 million relating to the 2005 Conventional Tanker
      Disposition;





partially
offset by





§
            an
      increase of $15.5 million relating to an increase in the hire rate
      earned by the nine owned Aframax conventional tankers on time charters
      with a subsidiary of Teekay Corporation (please read “– Items You Should Consider When
      Evaluating Our Results – Our financial results of operations reflect
      different time charter terms for OPCO’s nine conventional
      tankers”).





Vessel Operating Expenses.Vessel operating expenses decreased for 2006 from 2005, primarily due
to:





§
            a
      $2.3 million decrease relating to one of our conventional tankers, which
      was on a time-charter contract during 2005 and the first half of 2006 and
      on a bareboat contract during the second half of 2006 with a subsidiary of
      Teekay Corporation; and





§
            a
      $1.1 million decrease due to the 2005 Conventional Tanker
      Disposition.





Time-Charter Hire Expense.Time-charter hire expense decreased for 2006 from 2005 due to the sale of
Navion Shipping Ltd to Teekay Corporation in July 2006.





Depreciation and Amortization.Depreciation and amortization expense increased slightly for 2006 from
2005, primarily due to:





§
            an
      increase of $0.9 million in the amortization of drydock expenditures
      incurred during 2006 and 2005;





partially
offset by





§
            a
      decrease of $0.6 million relating to the 2005 Conventional Tanker
      Disposition.





Restructuring Charges.Restructuring
charges of $0.8 million in 2006 relate to the relocation of certain
operational functions to Singapore.





47








FSO
Segment





The
following table presents our FSO segment’s operating results for the year ended
December 31, 2006 and 2005, and compares its net voyage revenues (which is a
non-GAAP financial measure) for the years ended December 31, 2006 and 2005 to
voyage revenues, the most directly comparable GAAP financial measure, for the
same periods. The following table also provides a summary of the changes in
calendar-ship-days for our FSO segment:





For
      the Year Ended
              December
      31,(in
      thousands of U.S. dollars, except calendar-ship-days and
      percentages)
            
            2006
            
            
            2005
            
            
            %
      ChangeVoyage
      revenues
            
            
            22,650
            
            
            
            24,197
            
            
            
            (6.4
            )Voyage
      expenses
            
            
            1,085
            
            
            
            816
            
            
            
            33.0Net
      voyage revenues
            
            
            21,565
            
            
            
            23,381
            
            
            
            (7.8
            )Vessel
      operating expenses
            
            
            6,713
            
            
            
            6,600
            
            
            
            1.7Depreciation
      and amortization
            
            
            9,443
            
            
            
            9,347
            
            
            
            1.0General
      and administrative (1)
            
            
            1,709
            
            
            
            1,820
            
            
            
            (6.1
            )Income
      from vessel operations
            
            
            3,700
            
            
            
            5,614
            
            
            
            (34.1
            )Calendar-Ship-Days
            
            
            1,095
            
            
            
            1,095
            
            
            
            -






(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to the FSO segment based on estimated
      use of corporate resources).





During
2006 and 2005, OPCO operated three FSO units. Net voyage revenues decreased for
2006 from 2005, primarily due to a scheduled drydocking of one of our FSO units
during 2006. Vessel operating expenses and depreciation and amortization in 2006
remained substantially unchanged from 2005.





Other
Operating Results





General and Administrative Expenses.General and administrative expenses decreased to $72.5 million for 2006,
from $85.9 million for 2005, primarily due to:





§
            a
      decrease of $11.4 million in allocated general and administrative
      expenses, including employee stock compensation expense, from Teekay
      Corporation as a result of the sale of Navion Shipping Ltd. to Teekay
      Corporation in July 2006 (general and administrative expenses were
      allocated based on OPCO’s proportionate share of Teekay Corporation’s
      total ship-operating (calendar) days for each of 2005 and 2006);
      and





§
            a
      decrease of $2.1 million relating to a reduction in costs associated with
      our long-term employee bonus plan.





Interest Expense.Interest
expense increased to $69.4 million for 2006, from $39.8 million for 2005,
primarily due to:





§
            an
      increase of $14.2 million in interest incurred on a Norwegian
      Kroner-denominated loan owing by a subsidiary of OPCO to Teekay
      Corporation from October 2006 until our initial public offering in
      December 2006 (Teekay Corporation sold this loan receivable to OPCO
      immediately before our initial public
offering);





§
            an
      increase of $7.1 million relating to additional debt of $745 million
      from a revolving credit facility entered into during the fourth quarter of
      2006;





§
            an
      increase of $4.6 million due to a higher average balance for one of OPCO’s
      existing revolving credit facilities in 2006 compared to
    2005;





§
            an
      increase of $4.0 million relating to an increase in the
      weighted-average interest rate on OPCO’s floating-rate debt in 2006
      compared to 2005; and





§
            an
      increase of $1.4 million due to the Consolidation of Joint
      Ventures;





partially
offset by





§
            a
      decrease of $1.9 million relating to the settlement of
      interest-bearing advances from affiliates during
  2005.





Interest Income.Interest
income increased to $5.4 million for 2006, from $4.6 million for 2005, primarily
due to an increase in interest rates.





Equity Income From Joint Ventures.Equity income from joint ventures increased to $6.2 million for
2006, from $5.2 million for 2005, primarily due to a decrease in repair and
maintenance activity on the shuttle tankers owned by the joint ventures,
partially offset by the Consolidation of Joint Ventures.





48








Foreign Currency Exchange Gains
(Losses). Foreign currency exchange losses were $66.7 million for
2006, compared to foreign currency exchange gains of $34.2 million for
2005. Historically, OPCO’s foreign currency exchange gains and losses have been
due primarily to period-end revaluations of Norwegian Kroner-denominated
advances from affiliates. In 2006, the foreign currency exchange loss of $66.7
million was primarily due to the revaluation of Norwegian Kroner-denominated
advances from affiliates prior to our initial public offering. Gains reflect a
stronger U.S. Dollar against the Kroner on the date of revaluation or settlement
compared to the rate in effect at the beginning of the period. Losses reflect a
weaker U.S. Dollar against the Kroner on the date of revaluation or settlement
compared to the rate in effect at the beginning of the period. Please read
"– Items You Should Consider When
Evaluating Our Results – Our financial results of operations are affected by
fluctuations in currency exchange rates”.





Income Tax Recovery (Expense).Income tax expense was $2.8 million for 2006, compared to an income
tax recovery of $13.9 million for 2005. This $16.4 million increase in tax
expense was primarily due to a $25.1 million increase in deferred income
tax expense relating to unrealized foreign exchange translation gains
(losses) for 2006 and 2005, partially offset by a $4.7 million increase in
deferred income tax recovery from the financial restructuring of our Norwegian
shuttle tanker operations during 2006.





Other Income.Other income
for 2006 was $8.7 million, which was primarily comprised of
$11.4 million of leasing income from the VOC equipment, partially offset by
a $2.8 million write-off of unamortized capitalized loan costs from one of
OPCO’s revolving credit facilities that was prepaid and cancelled prior to our
initial public offering.





Other
income for 2005 was $9.1 million, which was primarily comprised of
$11.0 million of leasing income from the VOC equipment, partially offset by
$1.9 million primarily relating to fees for early termination of certain
ship management contracts.





Liquidity
and Capital Resources





Liquidity
and Cash Needs





As at
December 31, 2007, our total cash and cash equivalents were $121.2 million,
compared to $114.0 million at December 31, 2006. Our total liquidity,
including cash, cash equivalents and undrawn long-term borrowings, was
$286.7 million as at December 31, 2007, compared to $429.0 million as
at December 31, 2006. The decrease in liquidity was primarily the result of
our purchase of the Navion
Bergen LLC and Navion
Gothenburg LLC in July 2007 and the Dampier Spirit LLC in October 2007, the
payment of cash distributions by us and OPCO, and expenditures for vessels and
equipment, partially offset by cash generated by our operating activities during
2007.





In
addition to distributions on our equity interests, our primary short-term
liquidity needs are to fund general working capital requirements and drydocking
expenditures, while our long-term liquidity needs primarily relate to expansion
and investment capital expenditures and maintenance capital expenditures and
debt repayment. Expansion capital expenditures are primarily for the purchase or
construction of vessels to the extent the expenditures increase the operating
capacity of or revenue generated by our fleet, while maintenance capital
expenditures primarily consist of drydocking expenditures and expenditures to
replace vessels in order to maintain the operating capacity of or revenue
generated by our fleet. Investment capital expenditures are those capital
expenditures that are neither maintenance capital expenditures nor expansion
capital expenditures.





We
anticipate that our primary sources of funds for our short-term liquidity needs
will be cash flows from operations. We believe that cash flows from operations
will be sufficient to meet our existing liquidity needs for at least the next
12 months. Generally, our long-term sources of funds are from cash from
operations, long-term bank borrowings and other debt or equity financings, or a
combination thereof. Because we and OPCO distribute all of our and its available
cash, we expect that we and OPCO will rely upon external financing sources,
including bank borrowings and the issuance of debt and equity securities, to
fund acquisitions and expansion and investment capital expenditures, including
opportunities we may pursue under the omnibus agreement with Teekay Corporation
and other of its affiliates.





Cash Flows.The
following table summarizes our sources and uses of cash for the periods
presented:





Years
      Ended December 31,2007
              ($000’s)
            2006
              ($000’s)Net
      cash flow from operating activities
            55,931
            151,486Net
      cash flow from financing activities
            51,422
            (219,496)Net
      cash flow from investing activities
            (100,115)
            53,010





Operating Cash Flows. Net
cash flow from operating activities decreased to $55.9 million in 2007,
from $151.5 million in 2006, primarily reflecting a $73.9 million increase
in cash distributions paid by OPCO to its non-controlling interest owners, an
$8.4 million increase in expenditures for drydocking, and an increase in
interest expense resulting from the revolving credit facility we entered into
during the fourth quarter of 2006 as well as from  the increase in
debt due to our acquisition of the Navion Bergen and the Dampier Spirit and our 50%
interest in the Navion
Gothenburg, partially offset by an increase in cash flows from operations
due to an increase in the hire rate earned by our nine conventional tankers,
which are on time charters with a subsidiary of Teekay Corporation and the
inclusion of the results of the Navion Bergen and Navion Gothenburg since July
2007 and the Dampier
Spirit since October 2007. Net cash flow from operating activities
depends upon the timing and amount of drydocking expenditures, repairs and
maintenance activity, vessel additions and dispositions, foreign currency rates,
changes in interest rates, fluctuations in working capital balances and spot
market hire rates. The number of vessel drydockings tends to be uneven between
years.





49








Financing Cash Flows.Prior
to our initial public offering in December 2006, advances under revolving credit
facilities, advances from Teekay Corporation and net cash flow from operations
were used to finance OPCO’s investments in vessels and equipment and direct
financing leases. In addition, advances under revolving credit facilities were
loaned to Teekay Corporation to temporarily finance vessel construction and for
other general corporate purposes. In effect, these revolving credit facilities
previously were used as corporate-related debt of Teekay Corporation. Net
proceeds from long-term debt, prepayments of long-term debt and net advances to
affiliates during the periods prior to our initial public offering reflect this
use. In connection with our initial public offering, OPCO settled its advances
from affiliates.





Scheduled
debt repayments were $17.3 million during 2007 compared to $119.9 million during
2006. Net proceeds from long-term debt of $247.2 million were used primarily to
make debt prepayments of $152.0 million during 2007 and to finance the
acquisition of the Navion
Bergenand theDampier
Spirit and our 50% interest in the Navion
Gothenburg.  Please read Item 18 – Financial Statements: Note 6
– Long-Term Debt.





Cash
distributions paid during 2007 totaled $22.7 million. Subsequent to December 31,
2007, cash distributions were declared and paid on February 14, 2008 for the
three months ended December 31, 2007 and totaled $8.0 million.





Investing Cash Flows.During
2007, we paid $95.7 million for the acquisition of the Navion Bergen, theDampier Spiritand our 50%
interest in the Navion
Gothenburg. During 2007
and 2006, we incurred expenditures of $21.0 million and $31.1 million,
respectively, for vessels and equipment, and paid $8.4 million and $13.3
million, respectively, related to investments in direct financing leases. During
2007 and 2006, we received $21.7 million and $19.3 million, respectively, in
scheduled repayments from the leasing of our VOC equipment. During 2007 and
2006, we received $3.2 million and $61.7 million, respectively, in proceeds from
the sale of certain offshore equipment and two older shuttle tankers,
respectively.





Credit
Facilities





As at
December 31, 2007, our total debt was $1,517.5 million, compared to $1,303.4
million as at December 31, 2006. As at December 31, 2007, we had three revolving
credit facilities available, which, as at such date, provided for borrowings of
up to $1,371.3 million, of which $165.5 million was undrawn. As at
December 31, 2007, each of our six 50% controlled joint ventures had an
outstanding term loan, which, in aggregate, totaled $311.7 million. The joint
venture term loans reduce in semi-annual payments with varying maturities
through 2017. Please read Item 18 – Financial Statements: Note 6 – Long-Term
Debt.





Our three
revolving credit facilities have the following terms:





§
            $455 Million Revolving Credit
      Facility. This 8-year reducing revolving credit facility allows
      OPCO and it subsidiaries to borrow up to $455 million (subject to
      scheduled reductions through 2014) and may be used for acquisitions and
      for general partnership purposes. Obligations under this credit facility
      are collateralized by first-priority mortgages on eight of OPCO’s vessels.
      Borrowings under the facility may be prepaid at any time in amounts of not
      less than $5.0 million.





§
            $940 Million Revolving Credit
      Facility. This 8-year reducing revolving credit facility allows for
      borrowing of up to $940 million (subject to scheduled reductions
      through 2014) and may be used for acquisitions and for general partnership
      purposes. Obligations under this credit facility are collateralized by
      first-priority mortgages on 19 of OPCO’s vessels. Borrowings under the
      facility may be prepaid at any time in amounts of not less than
      $5.0 million. This credit facility allows OPCO to incur working
      capital borrowings and loan the proceeds to us (which we could use to make
      distributions, provided that such amounts are paid down
      annually).





§
            $70 Million Revolving Credit
      Facility. This 10-year reducing revolving credit facility allows
      for borrowing of up to $70 million (subject to scheduled reductions
      through 2017) and may be used for general partnership purposes.
      Obligations under this credit facility are collateralized by a
      first-priority mortgage on one of our vessels. Borrowings under the
      facility may be prepaid at any time in amounts of not less than
      $5.0 million.





Two of
the revolving credit facilities contain covenants that require OPCO to maintain
the greater of a minimum liquidity (cash, cash equivalents and undrawn committed
revolving credit lines with at least six months of maturity) of at least
$75.0 million and 5.0% of OPCO’s total consolidated debt. The remaining
revolving credit facility is guaranteed by Teekay Corporation and contains
covenants that require Teekay Corporation to maintain the greater of a minimum
liquidity of at least $50.0 million and 5.0% of Teekay Corporation’s total
debt which is recoursed to Teekay Corporation. As at December 31, 2007, we, OPCO
and Teekay Corporation were in compliance with all of our covenants under these
credit facilities.





The term
loans of our 50% controlled joint ventures are collateralized by first-priority
mortgages on the vessels to which the loans relate, together with other related
collateral. As at December 31, 2007, we had guaranteed $103.8 million of these
term loans, which represents our 50% share of the outstanding vessel mortgage
debt in five of these 50% controlled joint venture companies. Teekay Corporation
and our joint venture partner have guaranteed the remaining $207.9
million.





Interest
payments on the revolving credit facilities and term loans are based on LIBOR
plus a margin. At December 31, 2007 and December 31, 2006, the margins ranged
between 0.45% and 0.80%.





All of
our vessel financings are collateralized by the applicable vessels. The term
loans used to finance the six 50% controlled joint venture shuttle tankers and
our three revolving credit facility agreements contain typical covenants and
other restrictions, including those that restrict the relevant subsidiaries
from:








•
            incurring
      or guaranteeing indebtedness (applicable to our term loans and the $70
      million revolving credit facility
only);





•
            changing
      ownership or structure, including by mergers, consolidations, liquidations
      and dissolutions;





•
            making
      dividends or distributions when in default of the relevant
      loans;





•
            making
      capital expenditures in excess of specified
  levels;





50











•
            making
      certain negative pledges or granting certain
  liens;





•
            selling,
      transferring, assigning or conveying
  assets; or





•
            entering
      into a new line of business.





We
conduct our funding and treasury activities within corporate policies designed
to minimize borrowing costs and maximize investment returns while maintaining
the safety of the funds and appropriate levels of liquidity for our
purposes.  We hold cash and cash equivalents primarily in U.S.
Dollars.





Contractual
Obligations and Contingencies





The
following table summarizes our long-term contractual obligations as at December
31, 2007:





Total
            
            
            2008
            
            
            2009
              and
              2010
            
            
            2011
              and
              2012
            
            
            Beyond
      2012(in
      millions of U.S. dollars)Long-term
      debt (1)
            
            
            1,517.5
            
            
            
            64.1
            
            
            
            222.6
            
            
            
            305.8
            
            
            
            925.0Chartered-in
      vessels (operating leases)
            
            
            480.4
            
            
            
            117.8
            
            
            
            168.3
            
            
            
            118.6
            
            
            
            75.7Purchase
      obligation(2)
            
            
            41.7
            
            
            
            41.7
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      contractual obligations
            
            
            2,039.6
            
            
            
            223.6
            
            
            
            390.9
            
            
            
            424.4
            
            
            
            1,000.7







(1)
            Excludes
      expected interest payments of $84.9 million (2008), $153.1 million
      (2009 and 2010), $122.6 million (2011 and 2012) and
      $87.2 million (beyond 2012). Expected interest payments are based on
      LIBOR, plus margins which ranged between 0.45% and 0.80% as at December
      31, 2007. The expected interest payments do not reflect the effect of
      related interest rate swaps that hedge certain of the floating-rate
      debt.





(2)
            In
      June 2007, we exercised our option to purchase a 2001-built shuttle
      tanker, which is currently part of our in-chartered shuttle tanker fleet.
      The vessel will be delivered to us in March
  2008.





Off-Balance
Sheet Arrangements





We have
no off-balance sheet arrangements that have or are reasonably likely to have, a
current or future material effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.





Critical
Accounting Estimates





We
prepare our consolidated financial statements in accordance with GAAP, which
require us to make estimates in the application of our accounting policies based
on our best assumptions, judgments and opinions. Management of our general
partner reviews our accounting policies, assumptions, estimates and judgments on
a regular basis to ensure that our consolidated financial statements are
presented fairly and in accordance with GAAP. However, because future events and
their effects cannot be determined with certainty, actual results will differ
from our assumptions and estimates, and such differences could be material.
Accounting estimates and assumptions discussed in this section are those that we
consider to be the most critical to an understanding of our financial statements
because they inherently involve significant judgments and uncertainties. For a
further description of our material accounting policies, please read Item 18 -
Financial Statements: Note 1 - Summary of Significant Accounting
Policies.





Revenue
Recognition





Description.We generate a
majority of our revenues from voyages servicing contracts of affreightment and
time charters and, to a lesser extent, bareboat charters and spot voyages.
Within the shipping industry, the two methods used to account for voyage
revenues and expenses are the percentage of completion and the completed voyage
methods. Most shipping companies, including us, use the percentage of completion
method. For each method, voyages may be calculated on either a load-to-load or
discharge-to-discharge basis. In other words, revenues are recognized ratably
either from the beginning of when product is loaded for one voyage to when it is
loaded for another voyage, or from when product is discharged (unloaded) at
the end of one voyage to when it is discharged after the next voyage. We
recognize revenues from time charters and bareboat charters daily over the term
of the charter as the applicable vessel operates under the charter. We do not
recognize revenues during days that the vessel is off-hire.





Judgments and Uncertainties.In applying the percentage of completion method, we believe that in most
cases the discharge-to-discharge basis of calculating voyages more accurately
reflects voyage results than the load-to-load basis. At the time of cargo
discharge, we generally have information about the next load port and expected
discharge port, whereas at the time of loading we are normally less certain what
the next load port will be. We use this method of revenue recognition for all
spot voyages. In the case of our shuttle tankers servicing contracts of
affreightment, a voyage commences with tendering of notice of readiness at a
field, within the agreed lifting range, and ends with tendering of notice of
readiness at a field for the next lifting. In all cases we do not begin
recognizing voyage revenue for any of our vessels until a charter has been
agreed to by the customer and us, even if the vessel has discharged its cargo
and is sailing to the anticipated load port on its next voyage.





Effect if Actual Results Differ
from Assumptions.Our revenues could be overstated or understated for any given period to
the extent actual results are not consistent with our estimates in applying the
percentage of completion method.





51








Vessel
Lives and Impairment





Description.The carrying
value of each of our vessels represents its original cost at the time of
delivery or purchase less depreciation or impairment charges. We depreciate our
vessels on a straight-line basis over each vessel’s estimated useful life, less
an estimated residual value. The carrying values of our vessels may not
represent their fair market value at any point in time because the market prices
of second-hand vessels tend to fluctuate with changes in charter rates and the
cost of newbuildings. Both charter rates and newbuilding costs tend to be
cyclical in nature. We review vessels and equipment for impairment whenever
events or changes in circumstances indicate the carrying amount of an asset may
not be recoverable. We measure the recoverability of an asset by comparing its
carrying amount to future undiscounted cash flows that the asset is expected to
generate over its remaining useful life.





Judgments and Uncertainties.Depreciation is calculated using an estimated useful life of
25 years for our vessels, commencing the date the vessel was originally
delivered from the shipyard, or a shorter period if regulations prevent us from
operating the vessels for 25 years. In the shipping industry, the use of a
25-year vessel life has become the prevailing standard. However, the actual life
of a vessel may be different, with a shorter life resulting in an increase in
the quarterly depreciation and potentially resulting in an impairment loss. The
estimates and assumptions regarding expected cash flows require considerable
judgment and are based upon existing contracts, historical experience, financial
forecasts and industry trends and conditions. We are not aware of any indicators
of impairments nor any regulatory changes or environmental liabilities that we
anticipate will have a material impact on our current or future
operations.





Effect if Actual Results Differ
from Assumptions.If we consider a vessel or equipment to be impaired, we recognize a loss
in an amount equal to the excess of the carrying value of the asset over its
fair market value. The new lower cost basis will result in a lower annual
depreciation expense than before the vessel impairment.





Drydocking





Description. We drydock each
of our shuttle tankers and conventional oil tankers periodically for inspection,
repairs and maintenance and for any modifications to comply with industry
certification or governmental requirements. We may drydock FSO units if we
desire to qualify them for shipping classification. We capitalize a substantial
portion of the costs we incur during drydocking and amortize those costs on a
straight-line basis from the completion of the drydocking to the estimated
completion of the next drydocking. We expense as incurred costs for routine
repairs and maintenance performed during drydocking that do not improve or
extend the useful lives of the assets.





Judgments and Uncertainties.Amortization of capitalized drydock expenditures requires us to estimate
the period of the next drydocking. While we typically drydock each shuttle
tanker and conventional oil tanker every two and a half to five years, we may
drydock the vessels at an earlier date.





Effect if Actual Results Differ
from Assumptions.A change in our estimate of the next drydock date will have a direct
effect on our annual amortization of drydocking expenditures.





Goodwill
and Intangible Assets





Description.We allocate the
cost of acquired companies to the identifiable tangible and intangible assets
and liabilities acquired, with the remaining amount being classified as
goodwill. Certain intangible assets, such as time charters, are amortized over
time. Our future operating performance will be affected by the amortization of
intangible assets and potential impairment charges related to goodwill.
Accordingly, the allocation of purchase price to intangible assets and goodwill
may significantly affect our future operating results. Goodwill is not
amortized, but reviewed for impairment annually, or more frequently if
impairment indicators arise.





Judgments and
Uncertainties.The
allocation of the purchase price of acquired companies to intangible assets and
goodwill requires management to make significant estimates and assumptions,
including estimates of future cash flows expected to be generated by the
acquired assets and the appropriate discount rate to value these cash flows. In
addition, the process of evaluating the potential impairment of goodwill and
intangible assets is highly subjective and requires significant judgment at many
points during the analysis. The fair value of our reporting units was estimated
based on discounted expected future cash flows using a weighted-average cost of
capital rate. The estimates and assumptions regarding expected cash flows and
the appropriate discount rates require considerable judgment and are based upon
existing contracts, historical experience, financial forecasts and industry
trends and conditions.





Effect if Actual Results Differ
from Assumptions.In the fourth quarter of 2007, we completed our annual impairment testing
of goodwill using the methodology described above, and determined there was no
impairment. If actual results are not consistent with assumptions and estimates,
we may be exposed to a goodwill impairment charge. As at December 31, 2007
and 2006, the net book value of goodwill was $127.1 million.





Amortization
expense of intangible assets for 2007 and 2006 was $11.1 million and
$12.1 million, respectively. If actual results are not consistent with our
estimates used to value our intangible assets, we may be exposed to an
impairment charge and a decrease in the annual amortization expense of our
intangible assets. As at December 31, 2007 and 2006, the net book value of
intangible assets was $55.4 million and $66.4 million,
respectively.





Recent
Accounting Pronouncements





In March
2008, the Financial Accounting Standards Board (or FASB)ratified a consensus
opinion reached by the Emerging Issues Task Force (or EITF) on EITF Issue No. 07-4,
Application of the Two-Class
Method under FASB Statement No. 128, Earnings per Share to Master Limited
Partnerships(or EITF
Issue No. 07-4). The guidance in EITF Issue No. 07-4 requires incentive
distribution rights in a master limited partnership, such as ourselves, to be
treated as participating securities for the purposes of computing earnings per
share and provides guidance on how earnings should be allocated to the various
partnership interests. EITF Issue No. 07-4 is effective for fiscal years
beginning after December 15, 2008. We are currently evaluating the
potential impact, if any, of the adoption of EITF Issue No.07-4 on our
consolidated results of operations and financial condition.





52











In
December 2007, the FASB issued SFAS No. 141(R): Business Combinations(or
SFAS 141(R)), which
replaces SFAS No. 141,
Business Combinations. This statement establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired.
SFAS 141(R) also establishes disclosure requirements to enable the
evaluation of the nature and financial effects of the business combination.
SFAS 141(R) is effective for fiscal years beginning after December 15,
2008. We are currently evaluating the potential impact, if any, of the adoption
of SFAS 141(R) on our consolidated results of operations and financial
condition.





In
December 2007, the FASB issued SFAS No. 160: Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of Accounting Research Bulletin
No. 51 (or SFAS
160). This statement establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent's ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS 160 is effective for fiscal
years beginning after December 15, 2008. We are currently evaluating the
potential impact, if any, of the adoption of SFAS 160 on our consolidated
results of operations and financial condition.





In
February 2007, the FASB issued SFAS No. 159: The Fair Value Option for Financial
Assets and Financial Liabilities Including an Amendment of SFAS No.115(or SFAS 159).
This statement permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. We are currently
evaluating the potential impact, if any, of the adoption of SFAS 159 on our
consolidated results of operations and financial condition.





In
September 2006, the FASB issued SFAS No. 157: Fair Value Measurements (or
SFAS 157). This
statement defines fair value, establishes a framework for measuring fair value
in GAAP, and expands disclosures about fair value measurements. This statement
applies under other accounting pronouncements that require or permit fair value
measurements, and accordingly, does not require any new fair value
measurements.  SFAS 157 is effective for fiscal years beginning after
November 15, 2007. In February 2008, the FASB delayed for one year the effective
date of adoption with respect to certain non-financial assets and liabilities.
We are currently evaluating the potential impact, if any, of the adoption of
SFAS 157 on our consolidated results of operations and financial
condition.





Item
6.   Directors, Senior Management and Employees





A. Directors and Senior Management





Management
of Teekay Offshore Partners L.P.





Teekay
Offshore GP L.L.C., our general partner, manages our operations and activities.
Unitholders are not entitled to elect the directors of our general partner or
directly or indirectly participate in our management or operation.





Our
general partner owes a fiduciary duty to our unitholders. Our general partner is
liable, as general partner, for all of our debts (to the extent not paid from
our assets), except for indebtedness or other obligations that are expressly
non-recourse to it. Whenever possible, our general partner intends to cause us
to incur indebtedness or other obligations that are non-recourse to
it.





The
directors of our general partner oversee our operations. The day-to-day affairs
of our business are managed by the officers of our general partner and key
employees of certain of our controlled affiliates, including OPCO. Employees of
certain subsidiaries of Teekay Corporation provide assistance to us and OPCO
pursuant to services agreements. Please see Item 7- Major Unitholders and
Related Party transactions.





The Chief
Executive Officer and Chief Financial Officer of our general partner, Peter
Evensen, allocates his time between managing our business and affairs and the
business and affairs of Teekay Corporation and its subsidiaries Teekay LNG
Partners L.P. (NYSE: TGP) (or TeekayLNG) and Teekay Tankers Ltd.
(NYSE: TNK) (or Teekay
Tankers). Mr. Evensen is the Executive Vice President and Chief
Strategy Officer of Teekay Corporation, and the Chief Executive Officer and
Chief Financial Officer of Teekay LNG’s general partner, and the Executive Vice
President of Teekay Tankers. The amount of time Mr. Evensen allocates among
our business and the businesses of Teekay Corporation, Teekay LNG and Teekay
Tankers varies from time to time depending on various circumstances and needs of
the businesses, such as the relative levels of strategic activities of the
businesses. We believe Mr. Evensen devotes sufficient time to our business
and affairs as is necessary for their proper conduct.





Teekay
Offshore Operating GP L.L.C., the general partner of OPCO, manages OPCO’s
operations and activities. The Board of Directors of Teekay Offshore GP L.L.C.,
our general partner, has the authority to appoint and elect the directors of
Teekay Offshore Operating GP L.L.C., who in turn appoint the officers of Teekay
Offshore Operating GP L.L.C. Some of the directors and officers of our general
partner also serve as directors or executive officers of OPCO’s general partner.
Any amendment to OPCO’s partnership agreement or to the limited liability
company agreement of OPCO’s general partner must be approved by the conflicts
committee of the Board of Directors of our general partner, Teekay Offshore GP
L.L.C. Other actions affecting OPCO, including, among other things, the amount
of its cash reserves, must be approved by our general partner’s Board of
Directors on our behalf.





Officers
of our general partner and those individuals providing services to us, OPCO or
our subsidiaries may face a conflict regarding the allocation of their time
between our business and the other business interests of Teekay Corporation or
its other affiliates. Our general partner intends to seek to cause its officers
to devote as much time to the management of our business and affairs as is
necessary for the proper conduct of our business and affairs.





53








Directors
and Executive Officers of Teekay Offshore GP L.L.C.





The
following table provides information about the directors and executive officers
of our general partner, Teekay Offshore GP L.L.C. Directors are elected for
one-year terms. The business address of each of our directors and executive
officers listed below is c/o 4th Floor, Belvedere Building, 69 Pitts Bay
Road, Hamilton, HM 08, Bermuda. Ages of the directors are as of December 31,
2007.





Name
            Age
            PositionC.
      Sean Day
            58
            Chairman
      (1)Bjorn
      Moller
            50
            Vice
      Chairman (1)Peter
      Evensen
            49
            Chief
      Executive Officer, Chief Financial Officer and DirectorDavid
      L. Lemmon
            65
            Director
      (2)Carl
      Mikael L.L. von Mentzer
            63
            Director
      (2)John
      J. Peacock
            64
            Director
      (2)





(1)  Member
of Corporate Governance Committee





(2)  Member
of Audit Committee and Conflicts Committee





Certain
biographical information about each of these individuals is set forth
below.





C. Sean Dayhas served as
Chairman of Teekay Offshore GP L.L.C. and of Teekay Offshore Operating GP L.L.C.
since they were formed in August and September 2006, respectively. Mr. Day
has served as Chairman of Teekay Corporation’s Board of Directors since 1999.
From 1989 to 1999, he was President and Chief Executive Officer of Navios
Corporation, a large bulk shipping company based in Stamford, Connecticut. Prior
to Navios, Mr. Day held a number of senior management positions in the
shipping and finance industries. Mr. Day has served as the Chairman of Teekay GP
L.L.C., the general partner of Teekay LNG, and of Teekay Tankers since they were
formed in November 2004 and October 2007, respectively. Mr. Day also serves as
the Chairman of Compass Diversified Trust and as a director of Kirby
Corporation.





Bjorn Mollerhas served as the
Vice Chairman of Teekay Offshore GP L.L.C. and of Teekay Offshore Operating GP
L.L.C. since they were formed in August and September 2006, respectively.
Mr. Moller is the President and Chief Executive Officer of Teekay
Corporation and has held those positions since April 1998. Mr. Moller has
over 25 years’ experience in the shipping industry and has served in senior
management positions with Teekay Corporation for more than 15 years. He has
headed its overall operations since January 1997, following his promotion to the
position of Chief Operating Officer. Prior to this, Mr. Moller headed
Teekay Corporation’s global chartering operations and business development
activities. Mr. Moller has also served as the Vice Chairman of Teekay GP
L.L.C. and as the Chief Executive Officer and as a director of Teekay Tankers
since they were formed in November 2004 and October 2007, respectively. In
December 2006, he was appointed Chairman of the International Tankers Owners
Pollution Federation.





Peter Evensenhas served as
the Chief Executive Officer and Chief Financial Officer and as a Director of
Teekay Offshore GP L.L.C. and of Teekay Offshore Operating GP L.L.C. since they
were formed in August and September 2006, respectively. Mr. Evensen is also
the Executive Vice President and Chief Strategy Officer of Teekay Corporation.
He joined Teekay Corporation in May 2003 as Senior Vice President, Treasurer and
Chief Financial Officer. He served as Executive Vice President and Chief
Financial Officer of Teekay Corporation from February 2004 until he was
appointed to his current role in November 2006. Mr. Evensen has also served
as Chief Executive Officer and Chief Financial Officer of Teekay GP L.L.C. since
it was formed in November 2004, as a director of Teekay GP L.L.C. since January
2005, and as the Executive Vice President and as a Director of Teekay Tankers
since it was formed in October 2007. Mr. Evensen has over 20 years’
experience in banking and shipping finance. Prior to joining Teekay Corporation,
Mr. Evensen was Managing Director and Head of Global Shipping at
J.P. Morgan Securities Inc. and worked in other senior positions for its
predecessor firms. His international industry experience includes positions in
New York, London and Oslo.





David L. Lemmon has served as
a Director of Teekay Offshore GP L.L.C. since December 2006. Mr. Lemmon
currently serves on the Board of Directors of Kirby Corporation and Deltic
Timber Corporation, positions he has held since April 2006 and February 2007,
respectively. He also served on the Board of Directors of Pacific Energy
Partners, L.P. from 2002 through 2006. Mr. Lemmon was President and Chief
Executive Officer of Colonial Pipeline Company from 1997 until his retirement
from that company in March 2006. Prior to joining Colonial Pipeline Company, he
served as President of Amoco Pipeline Company.





Carl Mikael L.L. von Mentzer
has served as a Director of Teekay Offshore GP L.L.C. since December 2006. Mr.
von Menzer has over 30 years' experience in the shipbuilding and offshore oil
industries. Since 1998, Mr. von Mentzer has served as a non-executive director
of Concordia Maritime AB in Gothenburg, Sweden and since 2002 has served as its
Deputy Chairman of its Board of Directors. Prior to this, Mr. von Mentzer served
in executive positions with various shipping and offshore oil companies,
including Gotaverken Ardenal AB and Safe Partners AB in Gothenburg, Sweden and
OAG Ltd. in Aberdeen, Scotland. He has also previously served as a director for
Northern Offshore Ltd., in Oslo, Norway, and GVA Consultants in Gothenburg,
Sweden.





John J. Peacock has served as
a Director of Teekay Offshore GP L.L.C. since December 2006. Mr. Peacock is
currently a director of the Fednav Group of companies, a Canadian ocean-going
dry-bulk shipowning and chartering group. He was the President, Chief Operating
Officer, Executive Vice-President and director of Fednav Limited from 1998 until
February 2007. Mr. Peacock joined Fednav Limited in 1979 as its Treasurer, and
in 1984 became Vice President, Finance. He has over 40 years' accounting
experience. Prior to joining the Fednav Group, Mr. Peacock was a partner with
Clarkson Gordon (now Ernst & Young) in Montreal, Canada.








54





Directors and Executive Officers of
Teekay Offshore Operating GP L.L.C.





The
following table provides information about the directors and executive officers
of Teekay Offshore Operating GP L.L.C., the general partner of OPCO. Directors
are appointed for one-year terms. The business address of each director and
executive officer of Teekay Offshore Operating GP L.L.C. listed below is
c/o 4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08,
Bermuda. Ages of the directors are as of December 31, 2007.





Name
            Age
            PositionC.
      Sean Day
            58
            ChairmanBjorn
      Moller
            50
            Vice
      ChairmanPeter
      Evensen
            49
            Chief
      Executive Officer, Chief Financial Officer and
  Director





As
described above, the directors and executive officers of Teekay Offshore
Operating GP L.L.C. also serve as directors or executive officers of Teekay
Offshore GP L.L.C. The business experience of these individuals is included
above.





B.
Compensation





Reimbursement
of Expenses of Our General Partner





Our
general partner does not receive any management fee or other compensation for
managing us. Our general partner and its other affiliates are reimbursed for
expenses incurred on our behalf. These expenses include all expenses necessary
or appropriate for the conduct of our business and allocable to us, as
determined by our general partner. During 2007, we reimbursed our general
partner for $0.8 million in expenses that it incurred on our behalf during the
year.  Our general partner did not incur any of such expenses during
2006.





Executive
Compensation





We and
our general partner were formed in August 2006. OPCO’s general partner was
formed in September 2006. Neither our general partner nor OPCO’s general partner
paid any compensation to its directors or officers or accrued any obligations
with respect to management incentive or retirement benefits for the directors
and officers prior to our initial public offering in December 2006. Because
Peter Evensen, the Chief Executive Officer and Chief Financial Officer of our
general partner and of OPCO’s general partner, is an employee of a subsidiary of
Teekay Corporation, his compensation (other than any awards under the long-term
incentive plan described below) is set and paid by the Teekay Corporation
subsidiary, and we reimburse the Teekay Corporation subsidiary for time he
spends on our partnership matters. Please read Item 7. Major Unitholders and
Related Party Transactions.





Compensation
of Directors





Officers
of our general partner or Teekay Corporation who also serve as directors of our
general partner or OPCO’s general partner do not receive additional compensation
for their service as directors. During 2007, each non-management director
received compensation for attending meetings of the Board of Directors, as well
as committee meetings. Non-management directors received a director fee of
$30,000 for the year and common units with an aggregate maximum value of
approximately $15,000 for the year. The Chairman received an additional annual
fee of $85,000, members of the audit and conflicts committees each received a
committee fee of $5,000 for the year, and the chairs of the audit committee
and conflicts committee received an additional fee of $5,000 for the year for
serving in that role. In addition, each director was reimbursed for
out-of-pocket expenses in connection with attending meetings of the Board of
Directors or committees. Each director is fully indemnified by us for actions
associated with being a director to the extent permitted under Marshall Islands
law.





During
2007, the four non-employee directors received, in the aggregate, $245,000 in
director and committee fees and reimbursement of $84,687 of their out-of-pocket
expenses from us relating to their board service. We reimbursed our general
partner for these expenses as they were incurred for the conduct of our
business. In March 2007, our general partner’s Board of Directors granted to
each of the four non-employee directors 714 units at $21.00 per unit. During
December 2007, the Board authorized the award by us to each of the four
non-employee directors of common units with a value of approximately $15,000 for
the 2008 year. These common units were purchased by us in the open market during
the first quarter of 2008.





2006
Long-Term Incentive Plan





Our
general partner adopted the Teekay Offshore Partners L.P. 2006 Long-Term
Incentive Plan for employees and directors of and consultants to our general
partner and employees and directors of and consultants to its affiliates, who
perform services for us. The plan provides for the award of restricted units,
phantom units, unit options, unit appreciation rights and other unit or
cash-based awards. Other than the previously mentioned 2,856 common units
awarded to our general partner’s non-employee directors, we did not make any
awards in 2007 under the 2006 Long-Term Incentive Plan.





C.
Board Practices





Teekay
Offshore GP L.L.C., our general partner, manages our operations and activities.
Unitholders are not entitled to elect the directors of our general partner or
directly or indirectly participate in our management or operation.





Our
general partner’s Board of Directors (or the Board) currently consists
of six members. Directors are appointed to serve until their successors are
appointed or until they resign or are removed.





There are
no service contracts between us and any of our directors providing for benefits
upon termination of their employment or service.





55








The Board
has the following three committees: Audit Committee, Conflicts Committee, and
Corporate Governance Committee. The membership of these committees and the
function of each of the committees are described below. Each of the committees
is currently comprised solely of independent members, except for the Corporate
Governance Committee, and operates under a written charter adopted by the Board,
other than the Conflicts Committee. The committee charters for the Audit
Committee, the Conflicts Committee and the Corporate Governance Committee are
available under “Other Information--Partnership Governance” in the Investor
Centre of our web site at www.teekayoffshore.com. During 2007, the Board held
five meetings. Each director attended all Board meetings and all applicable
committee meetings.





Audit Committee. The Audit
Committee of our general partner is composed of three or more directors, each of
whom must meet the independence standards of the NYSE, the SEC and any other
applicable laws and regulations governing independence from time to time. This
committee is currently comprised of directors John J. Peacock (Chair), David L.
Lemmon and Carl Mikael L.L. von Mentzer. All members of the committee are
financially literate and the Board has determined that Mr. Lemmon qualifies as
an audit committee financial expert.





The Audit
Committee assists the Board in fulfilling its responsibilities for general
oversight of:




·
            the
      integrity of our financial
statements;




·
            our
      compliance with legal and regulatory
  requirements;




·
            the
      qualifications and independence of our independent auditor;
      and




·
            the
      performance of our internal audit function and our independent
      auditor.





Conflicts Committee. The
Conflicts Committee of our general partner is composed of the same directors
constituting the Audit Committee, being David L. Lemmon  (Chair), John
J. Peacock, and Carl Mikael L.L. von Mentzer. The members of the Conflicts
Committee may not be officers or employees of our general partner or directors,
officers or employees of its affiliates, and must meet the heightened NYSE and
SEC director independence standards applicable to audit committee membership and
certain other requirements.





The
Conflicts Committee:


·
              reviews
      specific matters that the Board believes may involve conflicts of
      interest; and


·
                    determines
      if the resolution of the conflict of interest is fair and reasonable to
      us.


Any
matters approved by the Conflicts Committee will be conclusively deemed to be
fair and reasonable to us, approved by all of our partners, and not a breach by
our general partner of any duties it may owe us or our unitholders. The Board is
not obligated to seek approval of the Conflicts Committee on any matter, and may
determine the resolution of any conflict of interest itself.





Corporate Governance
Committee. The Corporate Governance Committee of our general partner
is composed of at least two directors. This committee is currently comprised of
directors C. Sean Day (Chair) and Bjorn Moller.





The
Corporate Governance Committee:


·
              oversees
      the operation and effectiveness of the Board and its corporate
      governance.·
              develops,
      updates and recommends to the Board corporate governance principles and
      policies applicable to us and our general partner and monitors compliance
      with these principles and policies; and   ·
                oversees
      director compensation and the long-term incentive plan described
      above.





D.
Employees





Crewing
and Staff





As of
December 31, 2007, approximately 2,100 seagoing staff served on our vessels and
approximately 200 staff served on shore in technical, commercial and
administrative roles in various countries. Certain subsidiaries of Teekay
Corporation employ the crews, who serve on the vessels pursuant to agreements
with the subsidiaries, and Teekay Corporation subsidiaries also provide on-shore
advisory, operational and administrative support to our operating subsidiaries
pursuant to service agreements. Please see Item 7- Major Unitholders and Related
Party transactions.





Teekay
Corporation regards attracting and retaining motivated seagoing personnel as a
top priority, and offers seafarers what we believe are highly competitive
employment packages and comprehensive benefits and opportunities for personal
and career development, which relates to a philosophy of promoting
internally.





Teekay
Corporation has entered into a Collective Bargaining Agreement with the
Philippine Seafarers’ Union, an affiliate of the International Transport
Workers’ Federation (or ITF), and a Special Agreement
with ITF London, which covers substantially all of the officers and seamen that
operate our and OPCO’s Bahamian-flagged vessels. Substantially all officers and
seamen for the Norway-flagged vessels are covered by a collective bargaining
agreement with Norwegian unions (Norwegian Maritime Officers’ Association,
Norwegian Union of Marine Engineers and the Norwegian Seafarers’ Union). We
believe Teekay Corporation’s relationships with these labor unions are
good.





56








Our
commitment to training is fundamental to the development of the highest caliber
of seafarers for marine operations. Teekay Corporation’s cadet training approach
is designed to balance academic learning with hands-on training at sea. Teekay
Corporation has relationships with training institutions in Canada, Croatia,
India, Norway, Philippines, , Turkey and the United Kingdom. After receiving
formal instruction at one of these institutions, cadet training continues on
board vessels. Teekay Corporation also has a career development plan that was
devised to ensure a continuous flow of qualified officers who are trained on its
vessels and familiarized with its operational standards, systems and policies.
We believe that high-quality crewing and training policies will play an
increasingly important role in distinguishing larger independent shipping
companies that have in-house or affiliate capabilities from smaller companies
that must rely on outside ship managers and crewing agents on the basis of
customer service and safety.





E.
Unit Ownership





The
following table sets forth certain information regarding beneficial ownership,
as of March 15, 2008, of our units by all directors and officers of our general
partner as a group. The information is not necessarily indicative of beneficial
ownership for any other purpose. Under SEC rules a person beneficially owns any
units that the person has the right to acquire as of May 14, 2008 (60 days after
March 15, 2008) through the exercise of any unit option or other right. Unless
otherwise indicated, each person has sole voting and investment power (or shares
such powers with his or her spouse) with respect to the units set forth in the
following table. Information for all persons listed below is based on
information delivered to us.





Identity of Person or
      Group
            Common Units
              Owned
            Percentage of
              Common Units
              Owned
            Subordinated Units
              Owned
            Percentage of
      Subordinated
              Units
      Owned
            Percentage
      of
              Total
      Common
              and
      Subordinated
              Units
      Owned(3)All
      directors and officers as a group (6 persons)(1) (2)
            292,725
            2.99%
            -
            -
            1.49%





(1)
            Excludes
      units owned by Teekay Corporation, which controls us and on the board of
      which serve the directors of our general partner, C. Sean Day and Bjorn
      Moller. In addition, Mr. Moller is Teekay Corporation’s President and
      Chief Executive Officer, and Peter Evensen, our general partner’s Chief
      Executive Officer and Chief Financial Officer and a Director, is Teekay
      Corporation’s Executive Vice President and Chief Strategy Officer. Please
      read Item 7: Major Shareholders and Related Party Transactions for more
      detail.





(2)
            Each
      director, executive officer and key employee beneficially owns less than
      one percent of the outstanding common and subordinated
    units.





(3)
            Excludes
      the 2% general partner interest held by our general partner, a wholly
      owned subsidiary of Teekay
Corporation.





Item
7.   Major Unitholders and Related Party
Transactions





A.
Major Unitholders





The
following table sets forth the beneficial ownership, as of March 15, 2008, of
our common and subordinated units by each person we know to beneficially own
more than 5% of the outstanding common or subordinated units. The number of
units beneficially owned by each person is determined under SEC rules and the
information is not necessarily indicative of beneficial ownership for any other
purpose. Under SEC rules a person beneficially owns any units as to which the
person has or shares voting or investment power. In addition, a person
beneficially owns any units that the person or entity has the right to acquire
as of May 14, 2008 (60 days after March 15, 2008) through the exercise of any
unit option or other right. Unless otherwise indicated, each unitholder listed
below has sole voting and investment power with respect to the units set forth
in the following table.





Identity of Person or
      Group
            Common
              Units
      Owned
            Percentage of
              Common Units
              Owned
            Subordinated Units
      Owned
            Percentage of
      Subordinated Units Owned
            Percentage of
              Total Commonand
              SubordinatedUnits
              OwnedTeekay
      Corporation(1)
            1,750,000
            17.9%
            9,800,000
            100.0%
            58.9%Luxor
      Capital Group, LP, Luxor
              Management, LLC, and Mr. Christian Leone, as a group (2)
            1,269,799
            13.0%
            -
            -
            6.5%Neuberger
      Berman, Inc. and Neuberger
              Berman,
      LLC, as a group (3)
            820,974
            8.4%
            -
            -
            4.2%





(1)
            Excludes
      the 2% general partner interest held by our general partner, a wholly
      owned subsidiary of Teekay
Corporation.





(2)
            Includes
      shared voting power and shared dispositive power as to 1,269,799 units.
      Luxor Capital Group, LP, Luxor Management, LLC, and Mr. Christian Leone
      all have shared voting and dispositive power. Luxor Capital Group, LP
      serves as an investment manager of Luxor Capital Group, LP’s mutual funds.
      This information is based on the Schedule 13G/A filed by this group with
      the SEC on February 14, 2008.





(3)
            Includes
      sole voting power as to 745,924 units and shared dispositive power as to
      820,974 units. Both Neuberger Berman, LLC and Neuberger Berman Inc. have
      shared dispositive power. Neuberger Berman, LLC and Neuberger Berman
      Management Inc. serve as sub-advisor and investment manager, respectively,
      of Neuberger Berman Inc.’s mutual funds. This information is based on the
      Schedule 13G filed by this group with the SEC on February 12,
      2008.





Our
majority unitholders have the same voting rights as our other unitholders. We
are controlled by Teekay Corporation. We are not aware of any arrangements, the
operation of which may at a subsequent date result in a change in control of
us.





57











B.
Related Party Transactions





a)
            On
      October 1, 2006, OPCO entered into time-charter contracts for its nine
      Aframax conventional tankers with a subsidiary of Teekay Corporation at
      then-prevailing market-based daily rates for terms of five to twelve
      years. Under the terms of eight of these nine time-charter contracts, OPCO
      is responsible for the bunker fuel expenses; however, OPCO adds the
      approximate amounts of these expenses to the daily hire rate. Pursuant to
      these time-charter contracts, OPCO earned voyage revenues of $128.4
      million during 2007.





b)
            Effective
      October 1, 2006, two of OPCO’s shuttle tankers commenced employment on
      long-term bareboat charters with a subsidiary of Teekay Corporation.
      Pursuant to these charter contracts, OPCO earned voyage revenues of $14.2
      million during 2007.





c)
            Two
      of OPCO’s FSO units were employed on long-term bareboat charters with a
      subsidiary of Teekay Corporation. Pursuant to these charter contracts,
      OPCO earned voyage revenues of $12.0 million during
  2007.





d)
            On
      October 1, 2006, a subsidiary of Teekay Corporation entered into a
      services agreement with a subsidiary of OPCO, pursuant to which the
      subsidiary of OPCO provides the Teekay Corporation subsidiary with ship
      management services. During 2007, OPCO earned management fees of $3.3
      million under the agreement.





e)
            Eight
      of OPCO’S Aframax conventional oil tankers and two FSO units are managed
      by subsidiaries of Teekay Corporation. Pursuant to the associated
      management services agreements, OPCO incurred general and administrative
      expenses of $4.4 million during
2007.





f)
            In
      December 2006, we, OPCO, and certain of our and its subsidiaries have
      entered into services agreements with certain subsidiaries of Teekay
      Corporation, pursuant to which the Teekay Corporation subsidiaries provide
      to us, OPCO, and our and its subsidiaries administrative, advisory and
      technical services and ship management.  These services are
      provided in a commercially reasonably manner and upon the reasonable
      request of our general partner or our or OPCO’s operating subsidiaries, as
      applicable. The Teekay Corporation subsidiaries that are parties to the
      services agreements provide these services directly or subcontract for
      certain of these services with other entities, including other Teekay
      Corporation subsidiaries. We pay an arm's-length fee for the services that
      include reimbursement of the reasonable cost of any direct and indirect
      expenses the Teekay Corporation subsidiaries incur in providing these
      services. During 2007, we incurred $52.7 million of costs under these
      agreements.





g)
            Pursuant
      to our partnership agreement, we reimburse our general partner for all
      expenses necessary or appropriate for the conduct of our business. During
      2007, we incurred $0.8 million of these
costs.





h)
            In
      July 2007, we acquired interests in two double-hull shuttle tankers from
      Teekay Corporation for a total cost of $159.1 million, including
      assumption of debt of $93.7 million and the related interest rate swap. We
      acquired Teekay Corporation's 100% interest in the 2000-built Navion Bergen and its 50%
      interest in the 2006-built Navion Gothenburg,
      together with their respective 13-year, fixed-rate bareboat charters to
      Petroleo Brasileiro S.A. We financed the purchases with one of our
      existing revolving credit facilities and the assumption of debt. The
      excess of the proceeds we paid over Teekay Corporation’s historical cost
      were accounted for as an equity distribution to Teekay Corporation of
      $27.8 million.





i)
            In
      October 2007, we acquired from Teekay Corporation an FSO unit, the Dampier Spirit, along
      with its 7-year fixed-rate time-charter to Apache Corporationfor a total cost
      of $30.3 million. We financed the purchase with one of our existing
      revolving credit facilities. The excess of the proceeds we paid over
      Teekay Corporation’s historical cost was accounted for as an equity
      distribution to Teekay Corporation of $13.9
  million.





j)
            In
      December 2007, Teekay Corporation contributed a $65.6 million, nine-year,
      4.98% interest rate swap (used to hedge the debt assumed in the purchase
      of the Navion
      Bergen) having a fair value liability of $2.6 million, to us for no
      consideration.





k)
            In
      December 2007, Teekay Corporation agreed to reimburse OPCO for certain
      costs relating to events which occurred prior to our initial public
      offering, totaling $4.8 million, including the settlement of a customer
      dispute in respect of vessels delivered prior to our initial public
      offering and other costs.





l)
            C.
      Sean Day is the Chairman of our general partner, Teekay Offshore GP
      L.L.C., and of Teekay Offshore Operating GP L.L.C., the general partner of
      OPCO. He also is the Chairman of Teekay Corporation, Teekay Tankers and
      Teekay GP L.L.C., the general partner of Teekay
  LNG.





Bjorn
Moller is the Vice Chairman of Teekay Offshore GP L.L.C., Teekay Offshore
Operating GP L.L.C. and Teekay GP L.L.C. He also is the President and Chief
Executive Officer and a director of Teekay Corporation and the Chief Executive
Officer and a director of Teekay Tankers.





Peter
Evensen is the Chief Executive Officer and Chief Financial Officer and a
director of Teekay Offshore GP L.L.C., Teekay Offshore Operating GP L.L.C. and
Teekay GP L.L.C. He also is the Executive Vice President and Chief Strategy
Officer of Teekay Corporation and the Executive Vice President and a director of
Teekay Tankers.





Because
Mr. Evensen is an employee of a subsidiary of Teekay Corporation, his
compensation (other than any awards under the long-term incentive plan) is set
and paid by the Teekay Corporation subsidiary. Pursuant to our partnership
agreement, we have agreed to reimburse the Teekay Corporation subsidiary for
time spent by Mr. Evensen on our management matters as our Chief Executive
Officer and Chief Financial Officer.





58








m)
            We
      have entered into an amended and restated omnibus agreement with our
      general partner, Teekay Corporation, Teekay LNG and related parties. The
      following discussion describes certain provisions of the omnibus
      agreement.




Noncompetition.Under
the omnibus agreement, Teekay Corporation and Teekay LNG have agreed, and have
caused their controlled affiliates (other than us) to agree, not to own, operate
or charter “offshore vessels” (i.e. dynamically positioned shuttle tankers
(other than those operating in the conventional oil tanker trade under contracts
with a remaining duration of less that three years, excluding extension
options), FSOs and FPSOs). This restriction does not prevent Teekay Corporation,
Teekay LNG or any of their other controlled affiliates from, among other
things:




§
            owning,
      operating or chartering offshore vessels if the remaining duration of the
      time charter or contract of affreightment for the vessel, excluding any
      extension options, is less than three
years;




§
            acquiring
      offshore vessels and related time charters or contracts of affreightment
      as part of a business or package of assets and operating or chartering
      those vessels if a majority of the value of the total assets or business
      acquired is not attributable to the offshore vessels and related
      contracts, as determined in good faith by the board of directors of Teekay
      Corporation or the board of directors of Teekay LNG’s general partner;
      however, if Teekay Corporation or Teekay LNG completes such an
      acquisition, it must, within one year after completing the acquisition,
      offer to sell the offshore vessels and related contracts  to us
      for their fair market value plus any additional tax or other similar costs
      to Teekay Corporation or Teekay LNG that would be required to transfer the
      offshore vessels and contracts to us separately from the acquired business
      or package of assets;




§
            owning,
      operating or chartering offshore vessels and related time charters and
      contracts of affreightment that relate to a tender, bid or award for a
      proposed offshore project that Teekay Corporation or any of its
      subsidiaries has submitted or hereafter submits or receives; however, at
      least one year after the delivery date of any such offshore vessel, Teekay
      Corporation must offer to sell the offshore vessel and related contract to
      us, with the vessel valued (i) for newbuildings originally contracted by
      Teekay Corporation, at its "fully-built-up cost'' (which represents the
      aggregate expenditures incurred (or to be incurred prior to delivery to
      us) by Teekay Corporation to acquire, construct, and/or convert and bring
      such offshore vessel to the condition and location necessary for our
      intended use, plus project development costs for completed projects and
      projects that were not completed but, if completed, would have been
      subject to an offer to us pursuant to the omnibus agreement) and (ii) for
      any other vessels, Teekay Corporation's cost to acquire a newbuilding from
      a third party or the fair market value of any existing vessel, as
      applicable, plus in each case any subsequent expenditures that would be
      included in the "fully-built-up cost" of converting the vessel prior to
      delivery to us;




§
            acquiring,
      operating or chartering offshore vessels if our general partner has
      previously advised Teekay Corporation or Teekay LNG that the board of
      directors of our general partner has elected, with the approval of its
      conflicts committee, not to cause us or our subsidiaries to acquire or
      operate the vessels; or




§
            owing
      a limited partner interest in OPCO or owning shares of Teekay Petrojarl
      ASA.




In
addition, unless Teekay Corporation acquires 100% of Teekay Petrojarl ASA,
Petrojarl may continue to own, operate and charter its current fleet. If Teekay
Corporation acquires 100% of Petrojarl, we have certain rights to acquire its
offshore vessels as described below.




In
addition, under the omnibus agreement we have agreed not to own, operate or
charter crude oil tankers or liquefied natural gas (or LNG) carriers. This
restriction does not apply to any of the Aframax tankers in our current fleet,
and the ownership, operation or chartering of any oil tankers that replace any
of those oil tankers in connection with certain events.  In addition,
the restriction does not prevent us from, among other things:




§
            acquiring
      oil tankers or LNG carriers and any related time charters as part of a
      business or package of assets and operating or chartering those vessels,
      if a majority of the value of the total assets or business acquired is not
      attributable to the oil tankers and LNG carriers and any related charters,
      as determined by the conflicts committee of our general partner's board of
      directors; however, if at any time we complete such an acquisition, we are
      required to promptly offer to sell to Teekay Corporation the oil tankers
      and time charters or to Teekay LNG the LNG carriers and time charters for
      fair market value plus any additional tax or other similar costs to us
      that would be required to transfer the vessels and contracts to Teekay
      Corporation or Teekay LNG separately from the acquired business or package
      of assets; or




§
            acquiring,
      operating or chartering oil tankers or LNG carriers if Teekay Corporation
      or Teekay LNG, respectively, has previously advised our general partner
      that it has elected not to acquire or operate those
    vessels.




Rights
of First Offer on Conventional Tankers, LNG Carriers, and Offshore
Vessels.Under the omnibus agreement, we have granted to
Teekay Corporation and Teekay LNG a 30-day right of first offer on certain (a)
sales, transfers or other dispositions of any of our Aframax tankers, in the
case of Teekay Corporation, or certain LNG carriers in the case of Teekay LNG,
or (b) re-charterings of any of our Aframax tankers or LNG carriers pursuant to
a time charter or contract of affreightment with a term of at least three years
if the existing charter expires or is terminated early. Likewise, each of Teekay
Corporation and Teekay LNG has granted a similar right of first offer to us for
any offshore vessels it might own that, at the time of the proposed offer, is
subject to a time charter or contract of affreightment with a remaining term,
excluding extension options, of at least three years. These rights of first
offer do not apply to certain transactions.




We also
have the right under the omnibus agreement to purchase, for fair market value,
Petrojarl existing offshore vessels and any of its joint venture interest (in
each case to the extent involving an offshore vessel subject to a time charter
or contract of affreightment with a remaining term of at least three years,
excluding extension options) if Teekay Corporation acquires 100% of Petrojarl.
Petrojarl has four FPSOs and one shuttle tanker.








59





Item
8.  Financial Information





A.
Consolidated Financial Statements and Other Financial Information





Consolidated
Financial Statements and Notes





Please
see Item 18 below for additional information required to be disclosed under this
Item.





Legal
Proceedings





From time
to time we have been, and expect to continue to be, subject to legal proceedings
and claims in the ordinary course of our business, principally personal injury
and property casualty claims. These claims, even if lacking merit, could result
in the expenditure of significant financial and managerial resources. We are not
aware of any legal proceedings or claims that we believe will have, individually
or in the aggregate, a material adverse effect on us.





Cash
Distribution Policy





Rationale
for Our Cash Distribution Policy





Our cash
distribution policy reflects a basic judgment that our unitholders are better
served by our distributing our cash available (as defined in our partnership
agreement and after deducting expenses, including estimated maintenance capital
expenditures and reserves) rather than our retaining it. Because we believe we
will generally finance any expansion capital expenditures from external
financing sources, we believe that our investors are best served by our
distributing all of our available cash. Our cash distribution policy is
consistent with the terms of our partnership agreement, which requires that we
distribute all of our available cash quarterly (after deducting expenses,
including estimated maintenance capital expenditures and reserves).





Limitations on
Cash Distributions and Our Ability to Change Our Cash
Distribution Policy





There is
no guarantee that unitholders will receive quarterly distributions from us. Our
distribution policy is subject to certain restrictions and may be changed at any
time, including:





•
            Our
      unitholders have no contractual or other legal right to receive
      distributions other than the obligation under our partnership agreement to
      distribute available cash on a quarterly basis, which is subject to our
      general partner’s broad discretion to establish reserves and other
      limitations.





•
            The
      Board of Directors of OPCO’s general partner, Teekay Offshore Operating GP
      L.L.C. (subject to approval by the Board of Directors of our general
      partner), has authority to establish reserves for the prudent conduct of
      OPCO’s business. The establishment of these reserves could result in a
      reduction in cash distributions.





•
            While
      our partnership agreement requires us to distribute all of our available
      cash, our partnership agreement, including provisions requiring us to make
      cash distributions contained therein, may be amended. Although during the
      subordination period (defined in our partnership agreement), with certain
      exceptions, our partnership agreement may not be amended without the
      approval of non-affiliated common unitholders, our partnership agreement
      can be amended with the approval of a majority of the outstanding common
      units after the subordination period has
ended.





•
            Even
      if our cash distribution policy is not modified or revoked, the amount of
      distributions we pay under our cash distribution policy and the decision
      to make any distribution is determined by the Board of Directors of our
      general partner, taking into consideration the terms of our partnership
      agreement.





•
            Under
      Section 51 of the Marshall Islands Limited Partnership Act, we may
      not make a distribution to unitholders if the distribution would cause our
      liabilities to exceed the fair value of our
  assets.





•
            We
      may lack sufficient cash to pay distributions to our unitholders due to
      decreases in net voyage revenues or increases in operating expenses,
      principal and interest payments on outstanding debt, tax expenses, working
      capital requirements, maintenance capital expenditures or anticipated cash
      needs.





•
            Our
      distribution policy may be affected by restrictions on distributions under
      our and OPCO’s credit facility agreements, which contain material
      financial tests and covenants that must be satisfied. Should we or OPCO be
      unable to satisfy these restrictions included in the credit agreements or
      if we or OPCO is otherwise in default under the credit agreements, we or
      it would be prohibited from making cash distributions, which would
      materially hinder our ability to make cash distributions to unitholders,
      notwithstanding our stated cash distribution
  policy.





•
            If
      we make distributions out of capital surplus, as opposed to operating
      surplus (as such terms are defined in our partnership agreement), such
      distributions will constitute a return of capital and will result in a
      reduction in the minimum quarterly distribution and the target
      distribution levels under our partnership agreement. We do not anticipate
      that we will make any distributions from capital
  surplus.








60











Minimum
Quarterly Distribution





Common
unitholders are entitled under our partnership agreement to receive a minimum
quarterly distribution of $0.35 per unit, or $1.40 per unit per year, prior to
any distribution on our subordinated units to the extent we have sufficient cash
from our operations after establishment of cash reserves and payment of fees and
expenses, including payments to our general partner. Our general partner has the
authority to determine the amount of our available cash for any quarter. This
determination must be made in good faith. There is no guarantee that we will pay
the minimum quarterly distribution on the common units in any quarter, and we
will be prohibited from making any distributions to unitholders if it would
cause an event of default, or an event of default is existing, under our credit
agreements.





Commencing
after the date of our initial public offering until the third quarter of 2007,
cash distributions declared were $0.35 per unit per quarter.  For the
quarter ended December 31, 2006, cash distributions declared were prorated for
the period of December 19, 2006 to December 31, 2006.   Our cash
distributions were increased to $0.385 per unit and $0.40 per unit for
distributions effective for the third and fourth quarter of 2007,
respectively.





Subordination
Period





During
the subordination period applicable to the subordinated units held by Teekay
Corporation, the common units have the right to receive distributions of
available cash from operating surplus in an amount equal to the minimum
quarterly distribution, plus any arrearages in the payment of the minimum
quarterly distribution on the common units from prior quarters, before any
distributions of available cash from operating surplus may be made on the
subordinated units. The purpose of the subordinated units is to increase the
likelihood that during the subordination period there will be available cash to
be distributed on the common units.





Incentive
Distribution Rights





Incentive
distribution rights represent the right to receive an increasing percentage of
quarterly distributions of available cash from operating surplus (as defined in
our partnership agreement) after the minimum quarterly distribution and the
target distribution levels have been achieved. Our general partner currently
holds the incentive distribution rights, but may transfer these rights
separately from its general partner interest, subject to restrictions in our
partnership agreement. Except for transfers of incentive distribution rights to
an affiliate or another entity as part of our general partner's merger or
consolidation with or into, or sale of all or substantially all of its assets to
such entity, the approval of a majority of our common units (excluding common
units held by our general partner and its affiliates), voting separately as a
class, generally is required for a transfer of the incentive distributions
rights to a third party prior to December 31, 2016.





The
following table illustrates the percentage allocations of the additional
available cash from operating surplus among the unitholders and our general
partner up to the various target distribution levels. The amounts set forth
under "Marginal Percentage Interest in Distributions'' are the percentage
interests of the unitholders and our general partner in any available cash from
operating surplus we distribute up to and including the corresponding amount in
the column "Total Quarterly Distribution Target Amount,'' until available cash
from operating surplus we distribute reaches the next target distribution level,
if any. The percentage interests shown for the unitholders and our general
partner for the minimum quarterly distribution are also applicable to quarterly
distribution amounts that are less than the minimum quarterly distribution. The
percentage interests shown for our general partner include its 2% general
partner interest and assume the general partner has contributed any capital
necessary to maintain its 2.0% general partner interest and has not transferred
the incentive distribution rights.





Marginal
      Percentage Interestin DistributionsTotal QuarterlyDistribution Target
      Amount
            Unitholders
            General
      PartnerMinimum
      Quarterly Distribution
            $0.35
            98.0%
            2.0%First
      Target Distribution
            Up
      to $0.4025
            98.0%
            2.0%Second
      Target Distribution
            Above
      $0.4025 up to $0.4375
            85.0%
            15.0%Third
      Target Distribution
            Above
      $0.4375 up to $0.525
            75.0%
            25.0%Thereafter
            Above
      $0.525
            50.0%
            50.0%





B.
Significant Changes





No
significant changes have occurred since the date of the annual financial
statements included herein.








61





Item
9.  The Offer and Listing





Our
common units are traded on the NYSE under the symbol “TOO". The following table
sets forth the high and low closing sales prices for our common units on the
NYSE for each of the periods indicated.





Year
      Ended
            Dec.
      31,
              2007
            Dec.
      31,
              2006
      (1)High
            $37.45
            $26.77Low
            24.04
            21.00





Quarter
      Ended
            Dec.
      31,
              2007
            Sept.
      30,
              2007
            June
      30,
              2007
            Mar.
      31,
              2007
            Dec.
      31,
              2006
      (1)High
            $29.38
            $37.45
            $35.40
            $31.66
            $26.77Low
            24.04
            28.00
            29.79
            26.00
            21.00





Months
      Ended
            Mar.
      31,
              2008
            Feb.
      29,
              2008
            Jan.
      31,
              2008
            Dec.
      31,
              2007
            Nov.
      30,
              2007
            Oct.
      31,
              2007High
            $25.32
            $26.46
            $25.86
            $26.37
            $29.20
            $29.38Low
            20.71
            22.07
            22.75
            24.41
            24.04
            27.25





(1)
            Period
      beginning December 13, 2006.





Item
10.  Additional Information





Memorandum
and Articles of Association





The
information required to be disclosed under Item 10.B is incorporated by
reference to the following sections of the Rule 424(b) prospectus filed with the
SEC on December 14, 2006:  "The Partnership Agreement," "Description
of the Common Units – The Units," Conflicts of Interest and Fiduciary Duties"
and "Our Cash Distribution Policy and Restrictions on
Distributions."





Material
Contracts





The
following is a summary of each material contract, other than material contracts
entered into in the ordinary course of business, to which we or any of our
subsidiaries is a party, for the two years immediately preceding the date of
this Annual Report, each of which is included in the list of exhibits in Item
19:





a)
            Agreement,
      dated June 26, 2003, for a U.S. $455,000,000 Revolving Credit Facility
      between Norsk Teekay Holdings Ltd., Den Norske Bank ASA and various other
      banks. This facility bears interest at LIBOR plus a margin of 0.625%. The
      amount available under the facility reduces semi-annually, with a bullet
      reduction of $131.0 million on maturity in October 2014. The credit
      facility may be used for acquisitions and for general partnership
      purposes. Our obligations under the facility are secured by first-priority
      mortgages on seven shuttle tankers and one FSO
  unit.





b)
            Agreement,
      dated October 2, 2006, for a U.S. $940,000,000 Revolving Credit Facility
      between Teekay Offshore Operating L.P., Den Norske Bank ASA and various
      other banks. This facility bears interest at LIBOR plus a margin of
      0.625%. The amount available under the facility reduces semi-annually,
      with a bullet reduction of $350.0 million on maturity in October 2014. The
      credit facility may be used for acquisitions and for general partnership
      purposes. In addition, this facility allows OPCO to make working capital
      borrowings and loan the proceeds to us, which we could use to make
      distributions, provided that such amounts are paid down annually. Our
      obligations under the facility are secured by first-priority mortgages on
      11 shuttle tankers and eight conventional
  tankers.





c)
            Amended
      and Restated Omnibus Agreement, dated December 19, 2006, among us, our
      general partner, Teekay Corporation, Teekay LNG and related parties.
      Please read Item 7 – Major Unitholders and Related Party Transactions for
      a summary of certain contract
terms.





d)
            We,
      OPCO and certain of our and its operating subsidiaries have entered into
      services agreements with certain subsidiaries of Teekay Corporation
      pursuant to which the Teekay Corporation subsidiaries provide us, OPCO,
      and our and its operating subsidiaries with administrative, advisory,
      technical, strategic consulting services and ship management services for
      a reasonable fee that includes reimbursement of their direct and indirect
      expenses incurred in providing these services. Please read Item 7 – Major
      Unitholders and Related Party Transactions for a summary of certain
      contract terms.




e)
            Contribution,
      Conveyance and Assumption Agreement.  Pursuant to this
      agreement, prior to the closing of our initial public offering on December
      19, 2006, Teekay Corporation sold to us a 25.99% limited partner interest
      in OPCO and its subsidiaries and a 100% interest in Teekay Offshore
      Operating GP L.L.C., which owns the 0.01% general partner interest in
      OPCO, in exchange for (a) the issuance to Teekay Corporation of
      2,800,000 common units and 9,800,000 subordinated units in us and a $134.6
      million non-interest bearing promissory note and (b) the issuance of
      the 2.0% general partner interest in us and all of our incentive
      distribution rights to Teekay Offshore GP L.L.C., a wholly owned
      subsidiary of Teekay Corporation.




f)
            Teekay
      Offshore Partners L.P. 2006 Long-Term Incentive Plan. Please read Item 6 –
      Directors, Senior Management and Employees for a summary of certain plan
      terms.





62







Exchange
Controls and Other Limitations Affecting Unitholders





We are
not aware of any governmental laws, decrees or regulations, including foreign
exchange controls, in the Republic of The Marshall Islands that restrict the
export or import of capital, or that affect the remittance of dividends,
interest or other payments to non-resident holders of our
securities.





We are
not aware of any limitations on the right of non-resident or foreign owners to
hold or vote our securities imposed by the laws of the Republic of The Marshall
Islands or our partnership agreement.







Taxation


Teekay
Offshore Partners, L.P. was formed as a Marshall Islands limited partnership in
August 2006. The following provides information regarding taxes to which a U.S.
Holder of our common units may be subject to.





United States Tax
Consequences.We have elected to be
taxed as a corporation for U.S. federal income tax purposes. Subject to the
discussion of passive foreign investment companies (or PFICs) below, any
distributions made by us with respect to our common units to a U.S. Holder
generally will constitute dividends, which may be taxable as ordinary income or
“qualified dividend income” as described in more detail below, to the extent of
our current or accumulated earnings and profits, as determined under
U.S. federal income tax principles. Distributions in excess of our earnings
and profits will be treated first as a nontaxable return of capital to the
extent of the U.S. Holder’s tax basis in its common units on a
dollar-for-dollar basis and thereafter as capital gain. U.S. Holders that
are corporations generally will not be entitled to claim a dividends received
deduction with respect to any distributions they receive from us. Dividends paid
with respect to our common units generally will be treated as “passive category
income” or, in the case of certain types of U.S. Holders, “general category
income” for purposes of computing allowable foreign tax credits for
U.S. federal income tax purposes.




Dividends
paid on our common units to a U.S. Holder who is an individual, trust or
estate (or a U.S. Individual Holder)
will be treated as “qualified dividend income” that currently is taxable to such
U.S. Individual Holder at preferential capital gain tax rates provided
that: (i) our common units are readily tradable on an established
securities market in the United States (such as the New York Stock Exchange on
which our common units are traded); (ii) we are not a PFIC for the taxable
year during which the dividend is paid or the immediately preceding taxable year
(which we do not believe we are, have been or will be, as discussed below);
(iii) the U.S. Individual Holder has owned the common units for more
than 60 days in the 121-day period beginning 60 days before the date
on which the common units become ex-dividend; and (iv) the
U.S. Individual Holder is not under an obligation to make related payments
with respect to positions in substantially similar or related property. There is
no assurance that any dividends paid on our common units will be eligible for
these preferential rates in the hands of a U.S. Individual
Holder.  Any dividends paid on our common units not eligible for these
preferential rates will be taxed as ordinary income to a U.S. Individual
Holder. In the absence of legislation extending the term of the preferential tax
rates for qualified dividend income, all dividends received by a taxpayer in tax
years beginning on January 1, 2011 or later will be taxed at ordinary
graduated tax rates.




Special
rules may apply to any “extraordinary dividend” paid by us. An extraordinary
dividend is, generally, a dividend with respect to a share of stock if the
amount of the dividend is equal to or in excess of 10.0% of a stockholder’s
adjusted basis (or fair market value in certain circumstances) in such stock. If
we pay an “extraordinary dividend” on our common units that is treated as
“qualified dividend income,” then any loss derived by a U.S. Individual
Holder from the sale or exchange of such common units will be treated as
long-term capital loss to the extent of such dividend.





A
non-U.S. entity treated as a corporation for U.S. federal income tax
purposes will be a PFIC in any taxable year in which, after taking into account
the income and assets of the corporation and certain subsidiaries pursuant to a
"look through" rule, either: (i) at least 75.0% of its gross income is
"passive" income; or (ii) at least 50.0% of the average value of its assets
is attributable to assets that produce passive income or are held for the
production of passive income.





While
there are legal uncertainties involved in this determination, we do not believe
that we should be a PFIC based principally on the position that we derive at
least a majority of our gross income from our time and voyage charters (which
generally is not passive income).  Correspondingly, the assets that we
own and operate in connection with the production of such income, in particular
the vessels operating under time or voyage charters, should not constitute
passive assets for purposes of determining whether we are a
PFIC.  Legal authority concerning the characterization of income
derived from time charters, voyage charters and similar contracts for other tax
purposes supports this position.  Because there is no legal authority
specifically relating to the statutory provisions governing PFICs, the IRS or a
court could disagree with this position.  In addition, there is no
assurance that the nature of our assets, income and operations will remain the
same in the future.





If we
were classified as a PFIC, for any year during which a U.S. Holder owns
common units, such U.S. Holder generally will be subject to special rules
(regardless of whether we continue thereafter to be a PFIC) with respect to:
(i) any "excess distribution" (generally, any distribution received by a
unitholder in a taxable year that is greater than 125.0% of the average annual
distributions received by the unitholder in the three preceding taxable years
or, if shorter, the unitholder's holding period for the shares), and
(ii) any gain realized upon the sale or other disposition of units. Under
these rules:





•
            the
      excess distribution or gain will be allocated ratably over the
      unitholder's holding period;





•
            the
      amount allocated to the current taxable year and any year prior to the
      first year in which we were a PFIC will be taxed as ordinary income in the
      current year;





•
            the
      amount allocated to each of the other taxable years in the unitholder's
      holding period will be subject to U.S. federal income tax at the
      highest rate in effect for the applicable class of taxpayer for that
      year; and





•
            an
      interest charge for the deemed deferral benefit will be imposed with
      respect to the resulting tax attributable to each such other taxable
      year.





63




Certain
elections that would alter the tax consequences to a U.S. Holder, such as a
qualified electing fund election or mark to market election, may be available to
a U.S. Holder if we are classified as a PFIC. If we determine that we are
or will be a PFIC, we will provide unitholders with information concerning the
potential availability of such elections.





As
described above, current law provides that dividends received by a
U.S. Individual Holder from a qualified foreign corporation are subject to
U.S. federal income tax at preferential rates through 2010. However, if we
are classified as a PFIC for a taxable year in which we pay a dividend or the
immediately preceding taxable year, we would not be considered a qualified
foreign corporation, and a U.S. Individual Holder receiving such dividends
would not be eligible for the reduced rate of U.S. federal income
tax.





If more
than 50.0% of either the total combined voting power of our outstanding units
entitled to vote or the total value of all of our outstanding units were owned,
directly, indirectly or constructively, by citizens or residents of the United
States, U.S. partnerships or corporations, or U.S. estates or trusts
(as defined for U.S. federal income tax purposes), each of which owned,
directly, indirectly or constructively, 10.0% or more of the total combined
voting power of our outstanding units entitled to vote (each, a United States Stockholder),
we generally would be treated as a controlled foreign corporation (or CFC). United States
Stockholders of a CFC are treated as receiving current distributions of their
shares of certain income of the CFC (not including, under current law, certain
undistributed earnings attributable to shipping income) without regard to any
actual distributions and are subject to other burdensome U.S. federal
income tax and administrative requirements but generally are not also subject to
the requirements generally applicable to owners of a PFIC. Although we currently
are not a CFC, U.S. persons purchasing a substantial interest in us should
consult their tax advisors about the potential implications of being treated as
a United States Stockholder in the event we were to become a CFC in the
future.





Assuming
we do not constitute a PFIC for any taxable year, a U.S. Holder generally
will recognize taxable gain or loss upon a sale, exchange or other disposition
of our common units in an amount equal to the difference between the amount
realized by the U.S. Holder from such sale, exchange or other disposition
and the U.S. Holder’s tax basis in such units. Subject to the discussion of
extraordinary dividends above, such gain or loss will be treated as long-term
capital gain or loss if the U.S. Holder’s holding period is greater than
one year at the time of the sale, exchange or other disposition, and subject to
preferential capital gain tax rates. Such capital gain or loss will generally be
treated as U.S.-source gain or loss, as applicable, for U.S. foreign tax
credit purposes. A U.S. Holder’s ability to deduct capital losses is
subject to certain limitations. A disposition or sale of units by a shareholder
who owns, or has owned, 10.0% or more of the total voting power of us may result
in a different tax treatment under section 1248 of the Code.  U.S.
Holder’s purchasing a substantial interest in us should consult their tax
advisors.





Marshall
IslandsTax
Consequences. Because we and our subsidiaries do not, and we do not
expect that we and our subsidiaries will, conduct business or operations in the
Republic of The Marshall Islands, and because all documentation related to our
initial public offering was executed outside of the Republic of The Marshall
Islands, under current Marshall Islands law, no taxes or withholdings will be
imposed by the Republic of the Marshall Islands on distributions, including upon
a return of capital, made to unitholders, so long as such persons do not reside
in, maintain offices in, nor engage in business in the Republic of The Marshall
Islands. Furthermore, no stamp, capital gains or other taxes will be imposed by
the Republic of The Marshall Islands on the purchase, ownership or disposition
by such persons of our common units.





Canadian Federal
Income Tax Consequences. The following discussion is a summary of the
material Canadian federal income tax consequences under the Income Tax Act
(Canada) (or the Canada Tax
Act), that we believe are relevant to holders of common units who are, at
all relevant times, for the purposes of the Canada Tax Act and the Canada-United
States Tax Convention 1980 (or the Canada-U.S. Treaty)
resident in the United States and who deal at arm’s length with us and Teekay
Corporation (or U.S. Resident
Holders).





Under the
Canada Tax Act, no taxes on income (including taxable capital gains) are payable
by U.S. Resident Holders in respect of the acquisition, holding,
disposition or redemption of the common units, provided that we do not carry on
business in Canada and such U.S. Resident Holders do not, for the purposes
of the Canada-U.S. Treaty, otherwise have a permanent establishment or
fixed base in Canada to which such common units pertain and, in addition, do not
use or hold and are not deemed or considered to use or hold such common units in
the course of carrying on a business in Canada and, in the case of any
U.S. Resident Holders that carry on an insurance business in Canada and
elsewhere, such U.S. Resident Holders establish that the common units are
not effectively connected with their insurance business carried on in
Canada.





In this
connection, we believe that our activities and affairs and the activities and
affairs of OPCO, a Marshall Island Limited Partnership in which we own a 26.0%
limited partnership interest, are conducted in a manner that both we and OPCO
are not carrying on business in Canada. As a result, U.S. Resident Holders
should not be considered to be carrying on business in Canada for purposes of
the Canada Tax Act solely by reason of the acquisition, holding, disposition or
redemption of their common units. We intend that this is the case,
notwithstanding that certain services will be provided to Teekay Offshore
Partners L.P., OPCO and its operating subsidiaries indirectly through
arrangements with a subsidiary of Teekay Corporation that is resident and based
in Bermuda, by Canadian service providers.However we cannot assure
this result.





Documents
on Display





Documents
concerning us that are referred to herein may be inspected at our principal
executive headquarters at 4th Floor, Belvedere Building, 69 Pitts Bay Road,
Hamilton, HM 08, Bermuda. Those documents electronically filed via the SEC’s
Electronic Data Gathering, Analysis, and Retrieval (or EDGAR) system may also be
obtained from the SEC’s website at www.sec.gov,
free of charge, or from the SEC’s Public Reference Section at 100 F Street, NE,
Washington, D.C. 20549, at prescribed rates.  Further information on
the operation of the SEC public reference rooms may be obtained by calling the
SEC at 1-800-SEC-0330.








64





Item
11.  Quantitative and Qualitative Disclosures About Market
Risk





Interest
Rate Risk





We are
exposed to the impact of interest rate changes primarily through our unhedged
floating-rate borrowings. Significant increases in interest rates could
adversely affect operating margins, results of operations and our ability to
service debt. From time to time, we use interest rate swaps to reduce exposure
to market risk from changes in interest rates. The principal objective of these
contracts is to minimize the risks and costs associated with the floating-rate
debt. Changes in the fair value of our interest rate swaps are recognized in
other comprehensive income until the hedged item is recognized in income. The
ineffective portion of an interest rate swap’s change in fair value is
immediately recognized in income.





In order
to minimize counterparty risk, we only enter into derivative transactions with
counterparties that are currently rated A or better by Standard & Poor’s or
Aa3 by Moody’s. In addition, to the extent possible and practical, interest rate
swaps are entered into with different counterparties to reduce concentration
risk.





The
tables below provide information about financial instruments as at December 31,
2007 that are sensitive to changes in interest rates. For debt obligations, the
table presents principal payments and related weighted-average interest rates by
expected maturity dates. For interest rate swaps, the table presents notional
amounts and weighted-average interest rates by expected contractual maturity
dates.





Expected
      Maturity Date2008
            2009
            2010
            2011
            2012
            Thereafter
            Total
            Fair
      Value
              Asset/(Liability)
            Rate
      (1)(in
      millions of U.S. dollars, except percentages)Long-Term
      Debt:U.S
      Dollar- denominated (2)
            64.1
            115.6
            107.0
            164.0
            141.8
            925.0
            1,517.5
            (1,517.5)
            5.7%Interest Rate
      Swaps:Contract
      Amount (3)
            17.1
            552.6
            18.1
            18.7
            19.2
            723.7
            1,349.4
            (20.0)
            4.8%Average
      Fixed Pay Rate (2)
            4.9%
            4.7%
            4.9%
            4.9%
            4.9%
            4.8%
            4.8%


_________





(1)
            Rate
      refers to the weighted-average effective interest rate for OPCO’s debt,
      including the margin paid on our floating-rate debt and the average fixed
      pay rate for interest rate swaps. The average fixed pay rate for interest
      rate swaps excludes the margin paid on the floating-rate debt, which as of
      December 31, 2007 ranged from 0.50% to
0.80%.





(2)
            Interest
      payments on floating-rate debt and interest rate swaps are based on
      LIBOR.





(3)
            The
      average variable receive rate for interest rate swaps is set quarterly at
      the 3-month LIBOR or semi-annually at 6-month
  LIBOR.





Foreign
Currency Fluctuation Risk





Our
primary economic environment is the international shipping market. This market
utilizes the U.S. Dollar as its functional currency. Consequently,
virtually all of our revenues and most of our operating costs are in
U.S. Dollars. We incur certain vessel operating expenses and general and
administrative expenses in foreign currencies, the most significant of which is
the Norwegian Kroner and, to a lesser extent, Australian Dollars, Euros and
Singapore Dollars. For the years ended December 31, 2007 and 2006, approximately
52.6% and 44.1%, respectively, of vessel operating costs and general and
administrative expenses were denominated in Norwegian Kroner. There is a risk
that currency fluctuations will have a negative effect on the value of cash
flows.





On the
closing of our initial public offering, OPCO entered into new services
agreements with subsidiaries of Teekay Corporation whereby the subsidiaries
operate and crew OPCO’s vessels. Under these service agreements, OPCO pays all
vessel operating expenses in U.S. Dollars and will not be subject to
Norwegian Kroner exchange fluctuations until 2009. Beginning in 2009, payments
under the service agreements will adjust to reflect any change in Teekay
Corporation’s cost of providing services based on fluctuations in the value of
the Norwegian Kroner relative to the U.S. Dollar. At December 31, 2007, we
were committed to foreign exchange contracts for the forward purchase of
approximately Norwegian Kroner 255.7 million for U.S. Dollars at an average rate
of Norwegian Kroner 5.64 per U.S. Dollar, maturing in 2009. At December 31,
2007, we were also committed to foreign exchange contracts for the forward
purchase of approximately Australian Dollars 5.0 million, Euros 4.0 million, and
Singapore Dollars 4.1 million for U.S. Dollars at an average rate of Australian
Dollar 1.25 per U.S. Dollar, Euro 0.68 per U.S. Dollar and Singapore Dollar 1.44
per U.S. Dollar, all maturing in 2008. We may continue to seek to hedge these
currency fluctuation risks in the future





To the
extent the hedge is effective, changes in the fair value of the forward contract
are either offset against the fair value of assets or liabilities through
income, or recognized in other comprehensive income until the hedged item is
recognized in income. The ineffective portion of a forward contract's change in
fair value is immediately recognized in income.





Although
the majority of transactions, assets and liabilities are denominated in
U.S. Dollars, OPCO had Norwegian Kroner-denominated deferred income taxes
of approximately 386.1 million ($71.0 million) at December 31, 2007. Neither we
nor OPCO has entered into any forward contracts to protect against currency
fluctuations on any future taxes.





65











Item
12.  Description of Securities Other than Equity
Securities





Not
applicable.


PART
II





Item
13.  Defaults, Dividend Arrearages and Delinquencies





None.





Item
14.  Material Modifications to the Rights of Unitholders and Use of
Proceeds





None.





Item
15.  Controls and Procedures





We
conducted an evaluation of our disclosure controls and procedures under the
supervision and with the participation of the Chief Executive Officer and Chief
Financial Officer of our general partner. Based on the evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective as of December 31, 2007 to ensure that
information required to be disclosed by us in the reports we file or submit
under the Securities and Exchange Act of 1934 is accumulated and communicated to
our management, including the principal executive and principal financial
officers of our general partner, or persons performing similar functions, as
appropriate to allow timely decisions regarding required
disclosure.





During
2007 there was no change in our internal control over financial reporting that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.





The Chief
Executive Officer and Chief Financial Officer of our general partner do not
expect that our disclosure controls or internal controls will prevent all error
and all fraud. Although our disclosure controls and procedures were designed to
provide reasonable assurance of achieving their objectives, a control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the system are met. Further, the
design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs.  Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within us have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based partly on certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions.





Management’s
Report on Internal Control over Financial Reporting





Management
of our general partner is responsible for establishing and maintaining for us
adequate internal controls over financial reporting.





Our
internal controls were designed to provide reasonable assurance as to the
reliability of our financial reporting and the preparation and presentation of
the consolidated financial statements for external purposes in accordance with
accounting principles generally accepted in the United States. Our internal
controls over financial reporting includes those policies and procedures that,
1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of our assets; 2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of the financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made in
accordance with authorizations of management and the directors of our general
partnership; and 3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the our assets that
could have a material effect on the financial statements.





We
conducted an evaluation of the effectiveness of our internal control over
financial reporting based upon the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.  This evaluation included review of the documentation of
controls, evaluation of the design effectiveness of controls, testing of the
operating effectiveness of controls and a conclusion on this
evaluation.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements even when determined to be effective and can
only provide reasonable assurance with respect to financial statement
preparation and presentation.  Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies and procedures may deteriorate.  However, based on
the evaluation, management believes that we maintained effective internal
control over financial reporting as of December 31, 2007.





Our
independent auditors, Ernst & Young LLP, a registered public accounting firm
has audited the accompanying consolidated financial statements and our internal
control over financial reporting. Their attestation report on the effectiveness
of our internal control over financial reporting can be found on page F-2 of
this Form 20-F.





Item
16A.  Audit Committee Financial Expert





The Board
of Directors of our general partner has determined that director David L. Lemmon
qualifies as an audit committee financial expert and is independent under
applicable NYSE and SEC standards.








66





Item
16B.  Code of Ethics





Our
general partner has adopted Standards of Business Conduct that include a Code of
Ethics for all our employees and the employees and directors of our general
partner. This document is available under “Other Information - Partnership
Governance” in the Investor Centre of our web site (www.teekayoffshore.com).
We intend to disclose, under “Other Information - Partnership Governance” in the
Investor Centre of our web site, any waivers to or amendments of the Code of
Ethics for the benefit of any directors and executive officers of our general
partner.





Item
16C. Principal Accountant Fees and Services





Our
principal accountant for 2007 and 2006 was Ernst & Young LLP, Chartered
Accountants. The following table shows the fees we or our predecessor paid or
accrued for audit services provided by Ernst & Young LLP for 2007 and
2006.





Fees
            
            2007
            
            
            2006Audit
      Fees (1)
            
            $
            429,329
            
            
            $
            575,400Audit-Related
      Fees (2)
            
            
            8,500
            
            
            
            40,000Tax
      Fees (3)
            
            
            15,800
            
            
            
            144,300Total
            
            $
            453,600
            
            
            $
            759,700


________




(1)
            Audit
      fees represent fees for professional services provided in connection with
      the audit of our consolidated financial statements, review of our
      quarterly consolidated financial statements and audit services provided in
      connection with other statutory or regulatory filings, including
      professional services in connection with the review of our regulatory
      filings for our initial public offering of common units in December
      2006.






(2)
            Audit-related
      fees consisted primarily of accounting
  consultations.






(3)
            For
      2007 and 2006, respectively, tax fees principally included corporate tax
      compliance fees of $15,800 and $39,500. Tax fees in 2006 also included
      personal and expatriate tax services fees of $94,800 and international tax
      planning fees of $10,000.




The Audit
Committee of our general partner’s Board of Directors has the authority to
pre-approve permissible audit-related and non-audit services not prohibited by
law to be performed by our independent auditors and associated fees. Engagements
for proposed services either may be separately pre-approved by the Audit
Committee or entered into pursuant to detailed pre-approval policies and
procedures established by the Audit Committee, as long as the Audit Committee is
informed on a timely basis of any engagement entered into on that basis. The
Audit Committee separately pre-approved all engagements and fees paid to our
principal accountant in 2007.





Item
16D. Exemptions from the Listing Standards for Audit Committees





Not
applicable.





Item
16E. Purchases of Units by the Issuer and Affiliated Purchasers





Not
applicable.





PART
III





Item
17.  Financial Statements





Not
applicable.





Item
18.  Financial Statements





The
following financial statements, together with the related reports of Ernst &
Young LLP, Independent Registered Public Accounting Firm thereon, are filed as
part of this Annual Report:


PageReport
      of Independent Registered Public Accounting
      Firm
            F-1,
      F-2Consolidated
      Financial Statements
              Consolidated
      Statements of Income
      (Loss)
            F-3Consolidated
      Balance
      Sheets
            F-4Consolidated
      Statements of Cash
      Flows
            F-5Consolidated
      Statements of Changes in Partners’ Equity/Owner’s
      Equity
            F-6Notes
      to the Consolidated Financial
      Statements
            F-8





All
schedules for which provision is made in the applicable accounting regulations
of the SEC are not required, are inapplicable or have been disclosed in the
Notes to the Consolidated Financial Statements and therefore have been
omitted.





67





Item
19.  Exhibits





The
      following exhibits are filed as part of this Annual
  Report:





1.1
            Certificate
      of Limited Partnership of Teekay Offshore Partners L.P.
  (1)1.2
            First
      Amended and Restated Agreement of Limited Partnership of Teekay Offshore
      Partners L.P. (2)1.3
            Certificate
      of Formation of Teekay Offshore GP L.L.C. (1)1.4
            Amended
      and Restated Limited Liability Company Agreement of Teekay Offshore GP
      L.L.C.  (1)1.5
            Certificate
      of Limited Partnership of Teekay Offshore Operating L.P.
    (1)1.6
            Amended
      and Restated Agreement of Limited Partnership of Teekay Offshore Operating
      Partners L.P. (1)1.7
            Certificate
      of Formation of Teekay Offshore Operating GP L.L.C. (1)1.8
            Amended
      and Restated Limited Liability Company Agreement of Teekay Offshore
      Operating GP L.L.C.  (1)4.1
            Agreement,
      dated June 26, 2003, for a U.S $455,000,000 Revolving Credit Facility
      between Norsk Teekay Holdings Ltd., Den Norske Bank ASA and various other
      banks (1)4.2
            Agreement,
      dated October 2, 2006, for a U.S $940,000,000 Revolving Credit Facility
      between Teekay Offshore Operating L.P., Den Norske Bank ASA and various
      other banks (1)4.3
            Contribution,
      Conveyance and Assumption Agreement (1)4.4
            Teekay
      Offshore Partners L.P. 2006 Long-Term Incentive Plan
(1)4.5
            Amended
      and Restated Omnibus Agreement (1)4.6
            Administrative
      Services Agreement between Teekay Offshore Operating Partners L.P. and
      Teekay Limited (3)4.7
            Advisory,
      Technical and Administrative Services Agreement (3)4.8
            Administrative
      Services Agreement between Teekay Offshore Partners L.P. and Teekay
      Limited (3)8.1
            List
      of Subsidiaries of Teekay Offshore Partners L.P.12.1
            Rule
      13a-14(a)/15d-14(a) Certification of Teekay Offshore Partners L.P.’s Chief
      Executive Officer12.2
            Rule
      13a-14(a)/15d-14(a) Certification of Teekay Offshore Partners L.P.’s Chief
      Financial Officer13.1
            Teekay
      Offshore Partners L.P. Certification of Peter Evensen, Chief Executive
      Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350,
      as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.15.1
            Consent
      of Ernst & Young LLP, as independent registered public accounting
      firm.15.2
            Consolidated
      Balance Sheet of Teekay Offshore GP
L.L.C.





(1)
            Previously
      filed as an exhibit to the Partnership’s Registration Statement on Form
      F-1 (File No. 333-139116), filed with the SEC on December 4, 2006, and
      hereby incorporated by reference to such Registration
      Statement.





(2)
            Previously
      filed as Appendix A to the Partnership’s Rule 424(b)(4) Prospectus filed
      with the SEC on December 14, 2006, and hereby incorporated by reference to
      such Prospectus.





(3)
            Previously
      filed as an exhibit to the Partnership’s Amendment No. 1 to Registration
      Statement on Form F-1 (File No. 333-139116), filed with the SEC on
      December 8, 2006, and hereby incorporated by reference to such
      Registration Statement.





68





SIGNATURE





The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.








Dated:  April
      11, 2008
            TEEKAY
      OFFSHORE PARTNERS L.P.
              
              By: Teekay Offshore GP L.L.C., its general
      partner
              
              
              By: /s/ Peter
      Evensen
              Peter Evensen
              Chief Executive Officer and Chief Financial
      Officer
              (Principal Financial and Accounting
    Officer)
































69








REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To the
Board of Directors of Teekay Offshore GP L.L.C. and the Unitholders
of


TEEKAY
OFFSHORE PARTNERS L.P.





We have
audited the accompanying consolidated balance sheets of Teekay Offshore Partners L.P.(successor to Teekay Offshore Partners Predecessor) and subsidiaries(or the Partnership) as of December
31, 2007 and 2006, and the related consolidated statements of income (loss) for
the years ended December 31, 2007, 2006 and 2005 aggregated as
follows:





Year Ended December 31,
2007


·
            January
      1 to December 31, 2007





Year Ended December 31,
2006


·
            January
      1 to December 18, 2006


·
            December
      19 to December 31, 2006





Year Ended December 31,
2005


·
            January
      1 to December 31, 2005





We have
also audited the consolidated statements of the changes in partners’
equity/owner’s equity and cash flows for the three years ended December 31,
2007, 2006 and 2005. These financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
financial statements based on our audits.





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





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Teekay Offshore
Partners L.P. and subsidiaries at December 31, 2007 and 2006, and the
consolidated results of their operations and their cash flows for each of the
three years ended December 31, 2007 in conformity with U.S. generally accepted
accounting principles.





As
discussed in Note 1 to the consolidated financial statements, on January 1,
2006, the Partnership adopted the provisions of Statement of Financial
Accounting Standards No. 123(R), Share-Based
Payment.





As
discussed in Note 1 to the consolidated financial statements, on January 1,
2007, the Partnership adopted the provisions of Financial Accounting Standards
Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement No. 109.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Teekay Offshore Partner
L.P.’s internal control over financial reporting as of December 31, 2007, based
on criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 12, 2008 expressed an unqualified opinion thereon.













Vancouver,
      Canada
              March 12,
      2008
            /s/
      Ernst & Young LLP
              Chartered
      Accountants




























F-1





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To the
Board of Directors of Teekay Offshore GP L.L.C. and the Unitholders
of


TEEKAY
OFFSHORE PARTNERS L.P.





We have
audited Teekay Offshore Partners L.P.’s (or the Partnership’s) internal
control over financial reporting as of December 31, 2007, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (or the COSO criteria). Teekay
Offshore Partners L.P.’s management is responsible for maintaining effective
internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting included in the
accompanying Management’s Report on Internal Control over Financial Reporting.
Our responsibility is to express an opinion on the Partnership’s internal
control over financial reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Partnership are
being made only in accordance with authorizations of management and directors of
the Partnership; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
Partnership’s assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.





In our
opinion, Teekay Offshore Partners L.P. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007,
based on the COSO criteria.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Teekay
Offshore Partners L.P. as of December 31, 2007 and 2006, and the related
consolidated statements of income (loss), changes in partners’ equity/owner’s
equity and cash flows for each of the three years in the period ended December
31, 2007 of Teekay Offshore Partners L.P. and our report dated March 12, 2008
expressed an unqualified opinion thereon.











Vancouver,
      Canada
                March 12,
      2008
              /s/
      Ernst & Young LLP
                Chartered
      Accountants







F-2





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES (Note 1)


(Successor
to Teekay Offshore Partners Predecessor)


CONSOLIDATED
STATEMENTS OF INCOME (LOSS)


(in
thousands of U.S. dollars, except unit and per unit data)





Year Ended December
      31, 2006Year
      Ended
              December
      31,
              2007
              $
            
            
            January
      1
              to
              December
      18,
              2006
              $
            
            
            December
      19
              to
              December
      31,
              2006
              $
            
            
            Year
      Ended
              December
      31,
              2005
              $VOYAGE REVENUES($154,605, $154,198 and $254,080 for 2007, 2006 and 2005,
      respectively, from related parties – notes 10c, 10h, 10i, 10j, 10k,
      and 10l)
            
            
            775,969
            
            
            
            684,766
            
            
            
            23,926
            
            
            
            807,548OPERATING
      EXPENSESVoyage
      expenses
            
            
            151,583
            
            
            
            91,321
            
            
            
            3,102
            
            
            
            74,543Vessel
      operating expenses
            
            
            143,247
            
            
            
            102,311
            
            
            
            4,087
            
            
            
            104,475Time-charter
      hire expense
            
            
            150,463
            
            
            
            239,311
            
            
            
            5,641
            
            
            
            373,536Depreciation
      and amortization
            
            
            122,415
            
            
            
            98,386
            
            
            
            3,636
            
            
            
            107,542General
      and administrative ($54,662, $5,145 and $5,438  for 2007, 2006
      and 2005, respectively, from related parties – notes 10m, 10n, 10o, and
      10p)
            
            
            61,530
            
            
            
            70,387
            
            
            
            2,129
            
            
            
            85,856Gain
      on sale of vessels and equipment - net of writedowns (note
    15)
            
            
            -
            
            
            
            (4,778
            )
            
            
            -
            
            
            
            2,820Restructuring
      charge (note
      9)
            
            
            -
            
            
            
            832
            
            
            
            -
            
            
            
            955Total
      operating expenses
            
            
            629,238
            
            
            
            597,770
            
            
            
            18,595
            
            
            
            749,727Income
      from vessel operations
            
            
            146,731
            
            
            
            86,996
            
            
            
            5,331
            
            
            
            57,821OTHER
      ITEMSInterest
      expense (note 6,
      and $27,056 and $14,772 for 2006 and 2005, respectively, from
              relatedparties
      – notes 10f and
      10g)
            
            
            (79,768
            )
            
            
            (67,225
            )
            
            
            (2,200
            )
            
            
            (39,791
            )Interest
      income
            
            
            5,774
            
            
            
            5,167
            
            
            
            191
            
            
            
            4,605Equity
      income from joint ventures
            
            
            -
            
            
            
            6,162
            
            
            
            -
            
            
            
            5,199Foreign
      currency exchange (loss) gain
            
            
            (12,144
            )
            
            
            (66,574
            )
            
            
            (131
            )
            
            
            34,178Income
      tax recovery (expense) (note
12)
            
            
            10,924
            
            
            
            (2,672
            )
            
            
            (99
            )
            
            
            13,873Other
      income – net (note
      9)
            
            
            10,403
            
            
            
            8,360
            
            
            
            309
            
            
            
            9,091Total
      other items
            
            
            (64,811
            )
            
            
            (116,782
            )
            
            
            (1,930
            )
            
            
            27,155Net
      income (loss) before non-controlling interest
            
            
            81,920
            
            
            
            (29,786
            )
            
            
            3,401
            
            
            
            84,976Non-controlling
      interest
            
            
            (62,248
            )
            
            
            (3,777
            )
            
            
            (2,553
            )
            
            
            (229
            )Net
      income (loss)
            
            
            19,672
            
            
            
            (33,563
            )
            
            
            848
            
            
            
            84,747General
      partner’s interest in net income
            
            
            393
            
            
            
            -
            
            
            
            17
            
            
            
            -Limited
      partners’ interest (note
      16)Net
      income (loss)
            
            
            19,279
            
            
            
            (33,563
            )
            
            
            831
            
            
            
            84,747Net
      income (loss) per:•
      Common unit (basic and diluted)
            
            
            1.26
            
            
            
            (2.66
            )
            
            
            0.05
            
            
            
            6.73•
      Subordinated unit (basic and diluted)
            
            
            0.70
            
            
            
            (2.66
            )
            
            
            0.04
            
            
            
            6.73•
      Total unit (basic and diluted)
            
            
            0.99
            
            
            
            (2.66
            )
            
            
            0.04
            
            
            
            6.73Weighted-average
      number of units outstanding:•
      Common units (basic and diluted)
            
            
            9,800,000
            
            
            
            2,800,000
            
            
            
            9,800,000
            
            
            
            2,800,000•
      Subordinated units (basic and diluted)
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000
            
            
            
            9,800,000•
      Total units (basic and diluted)
            
            
            19,600,000
            
            
            
            12,600,000
            
            
            
            19,600,000
            
            
            
            12,600,000Cash
      distributions declared per unit
            
            
            1.14
            
            
            
            -
            
            
            
            -
            
            
            
            -





The
      accompanying notes are an integral part of the consolidated financial
      statements.








F-3





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES (Note 1)


(Successor
to Teekay Offshore Partners Predecessor)


CONSOLIDATED
BALANCE SHEETS


(in
thousands of U.S. dollars)





As
      at
              December
      31,
              2007
              $
            
            
            As
      at
              December
      31, 2006
              $ASSETSCurrent
              Cash
      and cash equivalents (note
6)
            
            
            121,224
            
            
            
            113,986Accounts
      receivable, net of allowance for doubtful accounts of $nil(December
      31, 2006 - $401)
            
            
            42,245
            
            
            
            24,635Net
      investment in direct financing leases – current
            
            
            22,268
            
            
            
            21,764Prepaid
      expenses
            
            
            34,219
            
            
            
            24,608Other
      current assets (notes
      10u and 10v)
            
            
            8,440
            
            
            
            7,732Total
      current assets
            
            
            228,396
            
            
            
            192,725Vessels and equipment
      (note
      6)
              At
      cost, less accumulated depreciation of $674,722 (December 31, 2006
      -  $567,563)
            
            
            1,662,865
            
            
            
            1,524,842Net
      investment in direct financing leases
            
            
            78,199
            
            
            
            92,018Other
      assets
            
            
            14,423
            
            
            
            38,198Intangible
      assets – net (note
      4)
            
            
            55,355
            
            
            
            66,425Goodwill
      - shuttle tanker segment
            
            
            127,113
            
            
            
            127,113Total
      assets
            
            
            2,166,351
            
            
            
            2,041,321LIABILITIES
      AND PARTNERS’ EQUITYCurrent
              Accounts
      payable
            
            
            12,076
            
            
            
            7,366Accrued
      liabilities (note
      5)
            
            
            38,464
            
            
            
            42,987Current
      portion of long-term debt (note
6)
            
            
            64,060
            
            
            
            17,656Advances
      from affiliate (note
      10v)
            
            
            -
            
            
            
            16,951Total
      current liabilities
            
            
            114,600
            
            
            
            84,960Long-term
      debt (note
      6)
            
            
            1,453,407
            
            
            
            1,285,696Deferred
      income taxes (note
      12)
            
            
            75,706
            
            
            
            71,583Other
      long-term liabilities (note
    11)
            
            
            50,024
            
            
            
            32,163Total
      liabilities
            
            
            1,693,737
            
            
            
            1,474,402Commitments
      and contingencies (notes
      7, 10 and 13)Non-controlling
      interest
            
            
            391,645
            
            
            
            427,977Partners’
      equityPartners’
      equity
            
            
            86,282
            
            
            
            133,642Accumulated
      other comprehensive (loss) income
            
            
            (5,313
            )
            
            
            5,300Total
      partners’ equity
            
            
            80,969
            
            
            
            138,942Total
      liabilities and partners’ equity
            
            
            2,166,351
            
            
            
            2,041,321





The
accompanying notes are an integral part of the consolidated financial
statements.











F-4





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES (Note 1)


(Successor
to Teekay Offshore Partners Predecessor)


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands of U.S. dollars)





Year
      Ended
              December
      31,
              2007
              $
            
            
            Year
      Ended December 31,
              2006
              $
            
            
            Year
      Ended December 31,
              2005
              $Cash
      and cash equivalents provided by (used for)

              OPERATING
      ACTIVITIESNet
      income (loss)
            
            
            19,672
            
            
            
            (32,715
            )
            
            
            84,747Non-cash
      items:Depreciation
      and amortization
            
            
            122,415
            
            
            
            102,022
            
            
            
            107,542Non-controlling
      interest
            
            
            62,248
            
            
            
            6,330
            
            
            
            229Gain
      on sale of vessels
            
            
            -
            
            
            
            (6,928
            )
            
            
            (9,423
            )Loss
      on writedown of vessels and equipment
            
            
            -
            
            
            
            2,150
            
            
            
            12,243Equity
      income (net of dividends received: December 31, 2006 – $6,002;
              December 31, 2005 - $2,750)
            
            
            -
            
            
            
            (160
            )
            
            
            (2,449
            )Deferred
      income tax (recovery) expense
            
            
            (10,924
            )
            
            
            2,771
            
            
            
            (14,202
            )Foreign
      currency exchange loss (gain) and other - net
            
            
            11,841
            
            
            
            72,768
            
            
            
            (40,045
            )Change
      in non-cash working capital items related to operating activities (note
14)
            
            
            (31,588
            )
            
            
            40,727
            
            
            
            22,951Distribution
      from subsidiaries to non-controlling interest owners
            
            
            (78,107
            )
            
            
            (4,224
            )
            
            
            (9,618
            )Expenditures
      for drydocking
            
            
            (39,626
            )
            
            
            (31,255
            )
            
            
            (8,906
            )Net
      operating cash flow
            
            
            55,931
            
            
            
            151,486
            
            
            
            143,069FINANCING
      ACTIVITIES
              Proceeds
      from issuance of long-term debt
            
            
            247,243
            
            
            
            1,290,750
            
            
            
            1,226,804Debt
      issuance costs
            
            
            -
            
            
            
            (6,178
            )
            
            
            (639
            )Scheduled
      repayments of long-term debt
            
            
            (17,328
            )
            
            
            (119,900
            )
            
            
            (29,884
            )Prepayments
      of long-term debt
            
            
            (152,000
            )
            
            
            (493,527
            )
            
            
            (1,382,140
            )Repayments
      of capital lease obligations
            
            
            -
            
            
            
            (34,245
            )
            
            
            (1,248
            )Prepayments
      of joint venture partner advances
            
            
            (1,000
            )
            
            
            -
            
            
            
            -Proceeds
      from issuance of common units
            
            
            (2,793
            )
            
            
            157,963
            
            
            
            -Net
      advances to affiliates
            
            
            -
            
            
            
            (786,816
            )
            
            
            (12,829
            )Equity
      distribution to Teekay Corporation
            
            
            -
            
            
            
            (226,816
            )
            
            
            -Investment
      in subsidiaries from non-controlling interest owners
            
            
            -
            
            
            
            -
            
            
            
            8,000Cash
      distribution paid
            
            
            (22,700
            )
            
            
            -
            
            
            
            -Other
            
            
            -
            
            
            
            (727
            )
            
            
            -Net
      financing cash flow
            
            
            51,422
            
            
            
            (219,496
            )
            
            
            (191,936
            )INVESTING
      ACTIVITIES
              Expenditures
      for vessels and equipment
            
            
            (20,997
            )
            
            
            (31,079
            )
            
            
            (24,760
            )Proceeds
      from sale of vessels and equipment
            
            
            3,225
            
            
            
            61,713
            
            
            
            73,220Investment
      in direct financing lease assets
            
            
            (8,378
            )
            
            
            (13,256
            )
            
            
            (23,708
            )Direct
      financing lease payments received
            
            
            21,677
            
            
            
            19,323
            
            
            
            12,440Cash
      assumed upon consolidation of joint ventures
            
            
            -
            
            
            
            17,055
            
            
            
            -Purchase
      of Navion Bergen LLC and Navion Gothenburg LLC (note
    10r)
            
            
            (65,389
            )
            
            
            -
            
            
            
            -Purchase
      of Dampier Spirit LLC (note
    10s)
            
            
            (30,253
            )
            
            
            -
            
            
            
            -Other
            
            
            -
            
            
            
            (746
            )
            
            
            (3,068
            )Net
      investing cash flow
            
            
            (100,115
            )
            
            
            53,010
            
            
            
            34,124Increase
      (decrease) in cash and cash equivalents
            
            
            7,238
            
            
            
            (15,000
            )
            
            
            (14,743
            )Cash
      and cash equivalents, beginning of the year
            
            
            113,986
            
            
            
            128,986
            
            
            
            143,729Cash
      and cash equivalents, end of the year
            
            
            121,224
            
            
            
            113,986
            
            
            
            128,986





Supplemental
cash flow disclosure (note
14)





The
accompanying notes are an integral part of the consolidated financial
statements.








F-5





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES (Note 1)


(Successor
to Teekay Offshore Partners Predecessor)


CONSOLIDATED
STATEMENTS OF CHANGES IN PARTNERS’ EQUITY/OWNER’S EQUITY


(in
thousands of U.S. dollars and units)





OWNER’S
      EQUITY (PREDECESSOR)Owner’s
              Equity
            
            
            Accumulated
      Other Comprehensive Income (Loss)
            
            
            Total
              Owner’s
              Equity$
            
            
            
            $
            
            
            
            $Balance
      as at December 31, 2004
            
            
            659,802
            
            
            
            (590
            )
            
            
            659,212Net
      income
            
            
            84,747
            
            
            
            
            
            
            
            84,747Other
      comprehensive income:Unrealized net gain on qualifying cash flow hedging instruments (note
11)
            
            
            
            
            
            
            792
            
            
            
            792Realized net gain on qualifying cash flow hedging instruments (note
11)
            
            
            
            
            
            
            (94
            )
            
            
            (94
            )Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            85,445Norwegian
      group tax contributions (note
    10a)
            
            
            (1,185
            )
            
            
            
            
            
            
            (1,185
            )Sale
      of Dania Spirit
      (note
      10b)
            
            
            (3,093
            )
            
            
            
            
            
            
            (3,093
            )Balance
      as at December 31,  2005
            
            
            740,271
            
            
            
            108
            
            
            
            740,379Net
      loss (January 1 to December 18, 2006)
            
            
            (33,563
            )
            
            
            
            
            
            
            (33,563
            )Other
      comprehensive income:Unrealized net gain on qualifying cash flow hedging instruments (note
11)
            
            
            
            
            
            
            21,981
            
            
            
            21,981Realized net gain on qualifying cash flow hedging instruments (note
11)
            
            
            
            
            
            
            (1,706
            )
            
            
            (1,706
            )Comprehensive
      loss
            
            
            
            
            
            
            
            
            
            
            (13,288
            )Sale
      of Navion Shipping Ltd. to Teekay Corporation (note
    10c)
            
            
            18,468
            
            
            
            
            
            
            
            18,468Sale
      of Norwegian subsidiaries to Teekay Corporation (note
    10e)
            
            
            23,260
            
            
            
            
            
            
            
            23,260Sale
      of theBorga to
      Teekay Corporation  (note
    10d)
            
            
            (11,900
            )
            
            
            
            
            
            
            (11,900
            )Equity
      distribution to Teekay Corporation (note 1)
            
            
            (226,816
            )
            
            
            
            
            
            
            (226,816
            )Purchase
      of a 26% interest in Teekay Offshore Operating L.P. (note 1)
            
            
            (134,629
            )
            
            
            
            
            
            
            (134,629
            )Reclassification
      adjustment for Teekay Corporation’s 74%non-controllinginterest
      in Teekay Offshore
              Operating L.P. (note
      1)
            
            
            (377,974
            )
            
            
            (15,083
            )
            
            
            (393,057
            )Stock
      compensation expense (note 1)
            
            
            1,048
            
            
            
            
            
            
            
            1,048Balance
      as at December 18, 2006
            
            
            (1,835
            )
            
            
            5,300
            
            
            
            3,465





The
accompanying notes are an integral part of the consolidated financial
statements.





F-6





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES (Note 1)


(Successor
to Teekay Offshore Partners Predecessor)


CONSOLIDATED
STATEMENTS OF CHANGES IN PARTNERS’ EQUITY/OWNER’S EQUITY


(in
thousands of U.S. dollars and units)





PARTNERS’
      EQUITYLimited
      PartnersOwner’s
              Equity
              (Predecessor)
            
            
            Common
            
            
            Subordinated
            
            
            General
      Partner
            
            
            Accumulated
              Other
              Comprehensive
              Income
      (Loss)
            
            
            Total$
            
            
            Units
            
            
            
            $
            
            
            Units
            
            
            
            $
            
            
            
            $
            
            
            
            $
            
            
            
            $Balance
      as at
              December
      18, 2006
            
            
            3,465
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,465Allocation
      of Predecessor’s equity
              to unitholders(note
      1)
            
            
            (3,465
            )
            
            
            2,800
            
            
            
            (400
            )
            
            
            9,800
            
            
            
            (1,398
            )
            
            
            (37
            )
            
            
            5,300
            
            
            
            -Proceeds
      from initial public offering of limited partnership interests,
              net of offering costs of $13,788
              (note
      2)
            
            
            
            
            
            
            8,050
            
            
            
            155,262
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            155,262Redemption
      of common units from Teekay Corporation (note 2)
            
            
            
            
            
            
            (1,050
            )
            
            
            (20,633
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (20,633
            )Net
      income (December 19  – 31, 2006)
            
            
            
            
            
            
            
            
            
            
            485
            
            
            
            
            
            
            
            346
            
            
            
            17
            
            
            
            
            
            
            
            848Balance
      as at
              December
      31,  2006
            
            
            -
            
            
            
            9,800
            
            
            
            134,714
            
            
            
            9,800
            
            
            
            (1,052
            )
            
            
            (20
            )
            
            
            5,300
            
            
            
            138,942Net
      income (January 1 – December 31, 2007)
            
            
            
            
            
            
            
            
            
            
            12,374
            
            
            
            
            
            
            
            6,905
            
            
            
            393
            
            
            
            
            
            
            
            19,672Other
      comprehensive income:Unrealized
      net loss on qualifying cash flow hedging
      instruments    (note
11)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (9,117
            )
            
            
            (9,117
            )Realized
      net gain on qualifying
              cash flow hedging instruments
              (note
      11)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,496
            )
            
            
            (1,496
            )Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,059Offering
      costs from public offering
              of limited  partnership interests
            
            
            
            
            
            
            
            
            
            
            (93
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (93
            )Purchase
      of Navion Bergen LLC
              and Navion Gothenburg LLC
              from Teekay Corporation
              (note
      10r)
            
            
            
            
            
            
            
            
            
            
            (13,638
            )
            
            
            
            
            
            
            (13,638
            )
            
            
            (557
            )
            
            
            
            
            
            
            (27,833
            )Purchase
      of Dampier Spirit LLC
              from Teekay Corporation
              (note
      10s)
            
            
            
            
            
            
            
            
            
            
            (6,789
            )
            
            
            
            
            
            
            (6,789
            )
            
            
            (278
            )
            
            
            
            
            
            
            (13,856
            )Purchase
      of derivative instrument from Teekay Corporation
              (note
      10t)
            
            
            
            
            
            
            
            
            
            
            (1,249
            )
            
            
            
            
            
            
            (1,249
            )
            
            
            (52
            )
            
            
            
            
            
            
            (2,550
            )Cash
      distributions
            
            
            
            
            
            
            
            
            
            
            (11,123
            )
            
            
            
            
            
            
            (11,123
            )
            
            
            (454
            )
            
            
            
            
            
            
            (22,700
            )Balance
      as at
              December
      31,  2007
            
            
            -
            
            
            
            9,800
            
            
            
            114,196
            
            
            
            9,800
            
            
            
            (26,946
            )
            
            
            (968
            )
            
            
            (5,313
            )
            
            
            80,969





The
accompanying notes are an integral part of the consolidated financial
statements.








F-7





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





1.      Summary
of Significant Accounting Policies





Basis
of presentation





During
August 2006, Teekay Corporation formed Teekay Offshore Partners L.P., a Marshall
Islands limited partnership (the Partnership), as part of its
strategy to expand in the marine transportation, processing and storage sectors
of the offshore oil industry and for the Partnership to acquire, in connection
with the Partnership’s initial public offering of its common units, a 26.0%
interest in Teekay Offshore Operating L.P. (or OPCO), consisting of a 25.99%
limited partner interest to be held directly by the Partnership and a 0.01%
general partner interest to be held through the Partnership’s ownership of
Teekay Offshore Operating GP L.L.C., OPCO’s sole general partner.





Prior to
the closing of the Partnership’s initial public offering on December 19, 2006,
Teekay Corporation transferred eight Aframax conventional crude oil tankers to a
subsidiary of Norsk Teekay Holdings Ltd. (or Norsk Teekay) and one
floating storage and offtake (or FSO) unit to Teekay Offshore
Australia Trust. Teekay Corporation then transferred to OPCO all of the
outstanding interests of four wholly-owned subsidiaries — Norsk Teekay,
Teekay Nordic Holdings Inc., Teekay Offshore Australia Trust and Pattani Spirit
L.L.C. These four wholly-owned subsidiaries, the assets of which include the
eight Aframax conventional crude oil tankers and the FSO unit, are collectively
referred to as Teekay Offshore
Partners Predecessor or the Predecessor. The excess of
the price paid by the Partnership over the book value of these assets was $226.8
million and was accounted for as an equity distribution to Teekay Corporation.
Immediately prior to the closing of the Partnership’s initial public offering,
Teekay Corporation sold to the Partnership the 25.99% limited partner interest
in OPCO and its subsidiaries and a 100% interest in Teekay Offshore Operating GP
L.L.C., which owns the 0.01% general partner interest in OPCO, in exchange for
(a) the issuance to Teekay Corporation of 2,800,000 common units and
9,800,000 subordinated units of the Partnership and a $134.6 million
non-interest bearing promissory note and (b) the issuance of the 2.0%
general partner interest in the Partnership and all of the Partnership’s
incentive distribution rights to Teekay Offshore GP L.L.C., a wholly owned
subsidiary of Teekay Corporation (or the General Partner). The
Partnership controls OPCO through its ownership of OPCO’s general partner, and
Teekay Corporation owns the remaining 74.0% interest in OPCO. These transfers
represented a reorganization of entities under common control and were recorded
at historical cost. Immediately preceding the public offering, the net book
equity of the Partnership’s 26% share of these assets was $3.5
million.





The
consolidated financial statements for the periods prior to the initial public
offering reflect the combined consolidated financial position, results of
operations and cash flows of the Predecessor and its subsidiaries. In the
preparation of these combined consolidated financial statements, general and
administrative expenses were not identifiable as relating solely to the vessels.
General and administrative expenses (consisting primarily of salaries and other
employee related costs, office rent, legal and professional fees, and travel and
entertainment) were allocated based on the Predecessor’s proportionate share of
Teekay Corporation’s total ship-operating (calendar) days for each of the
periods presented prior to December 19, 2006. Management believes this
allocation reasonably presents the general and administrative expenses of the
Predecessor.





The
consolidated financial statements have been prepared in conformity with United
States generally accepted accounting principles (or GAAP).  They
include the accounts of the Predecessor and its subsidiaries for periods prior
to December 19, 2006. For the period commencing December 19, 2006, the
consolidated financial statements include the accounts of Teekay Offshore
Partners L.P. and its subsidiaries. In addition, the consolidated financial
statements include the accounts of the Predecessor’s and the Partnership’s
controlled joint ventures from December 1, 2006. Significant intercompany
balances and transactions have been eliminated upon consolidation. The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results may
differ from those estimates.





Certain
of the comparative figures have been reclassified to conform with the
presentation adopted in the current period. Distributions from subsidiaries to
non-controlling interest owners have been reclassified from financing activities
to operating activities in the consolidated statement of cash flows for the
years ended December 31, 2006 and 2005.




Reporting
currency





The
consolidated financial statements are stated in U.S. dollars.  The
functional currency of the Partnership is U.S. dollars because the Partnership
operates in international shipping markets, the Partnership’s primary economic
environment, which typically utilize the U.S. dollar as the functional
currency. Transactions involving other currencies during the year are converted
into U.S. dollars using the exchange rates in effect at the time of the
transactions. At the balance sheet dates, monetary assets and liabilities that
are denominated in currencies other than the U.S. dollar are translated to
reflect the year-end exchange rates. Resulting gains or losses are reflected
separately in the accompanying consolidated statements of income
(loss).





Operating
revenues and expenses





The
Partnership recognizes revenues from time charters and bareboat charters daily
over the term of the charter as the applicable vessel operates under the
charter. The Partnership does not recognize revenue during days that the vessel
is off-hire. Shuttle tanker voyages servicing contracts of affreightment with
offshore oil fields commence with tendering of notice of readiness at a field,
within the agreed lifting range, and ends with tendering of notice of readiness
at a field for the next lifting. All other voyage revenues from voyage charters
are recognized on a percentage of completion method. The Partnership uses a
discharge-to-discharge basis in determining percentage of completion for all
spot voyages, whereby it recognizes revenue ratably from when product is
discharged (unloaded) at the end of one voyage





F-8





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





to when
it is discharged after the next voyage. The Partnership does not begin
recognizing voyage revenue until a charter has been agreed to by the customer
and the Partnership, even if the vessel has discharged its cargo and is sailing
to the anticipated load port on its next voyage.
The consolidated balance sheets reflect the deferred portion of revenues and
expenses, which will be earned and incurred, respectively, in subsequent
periods. As at December 31, 2007 and 2006, there was no deferred revenue. As at
December 31, 2007 and 2006, the deferred portion of expenses, which are
included in prepaid expenses, was $25.4 million and $16.4 million,
respectively.





Voyage
expenses are all expenses unique to a particular voyage, including bunker fuel
expenses, port fees, cargo loading and unloading expenses, canal tolls, agency
fees and commissions. Vessel operating expenses include crewing, repairs and
maintenance, insurance, stores, lube oils and communication expenses. Voyage
expenses and vessel operating expenses are recognized when incurred. For periods
prior to October 1, 2006, the Predecessor recognized voyage expenses ratably
over the length of each voyage. The impact of recognizing voyage expenses
ratably over the length of each voyage was not materially different on a
quarterly and annual basis from a method of recognizing such costs as
incurred.





Cash
and cash equivalents





The
Partnership classifies all highly liquid investments with a maturity date of
three months or less when purchased as cash and cash equivalents.





Accounts
receivable and allowance for doubtful accounts





Accounts
receivable are recorded at the invoiced amount and do not bear interest. The
allowance for doubtful accounts is the Partnership’s best estimate of the amount
of probable credit losses in existing accounts receivable. The Partnership
determines the allowance based on historical write-off experience and customer
economic data. The Partnership reviews the allowance for doubtful accounts
regularly and past due balances are reviewed for collectibility. Account
balances are charged off against the allowance when the Partnership believes
that the receivable will not be recovered.





Vessels
and equipment





All
pre-delivery costs incurred during the construction of newbuildings, including
interest, supervision and technical costs, are capitalized. The acquisition cost
and all costs incurred to restore used vessels purchased by the Partnership to
the standards required to properly service the Partnership’s customers are
capitalized.





Depreciation
is calculated on a straight-line basis over a vessel’s estimated useful life,
less an estimated residual value. Depreciation is calculated using an estimated
useful life of 25 years, commencing from the date the vessel is delivered
from the shipyard, or a shorter period if regulations prevent the Partnership
from operating the vessel for 25 years. Depreciation of vessels and
equipment for the year ended December 31, 2007, the periods from December 19,
2006 to December 31, 2006, and from January 1, 2006 to December 18, 2006 and the
year ended December 31, 2005 totaled $97.0 million, $2.9 million, $78.9 million,
and $86.0 million, respectively. Depreciation and amortization includes
depreciation on all owned vessels and amortization of vessels accounted for as
capital leases.





Generally,
the Partnership drydocks each shuttle tanker and conventional oil tanker every
two and a half to five years. FSO units are generally not drydocked. The
Partnership capitalizes a substantial portion of the costs incurred during
drydocking and amortizes those costs on a straight-line basis from the
completion of a drydocking to the estimated completion of the next drydocking.
The Partnership expenses as incurred costs related to routine repairs and
maintenance performed during drydocking that do not improve or extend the useful
lives of the assets. When significant drydocking expenditures occur prior to the
expiration of the original amortization period, the remaining unamortized
balance of the original drydocking cost are expensed in the month of the
subsequent drydocking. Amortization of drydocking expenditures for the year
ended December 31, 2007, the periods from December 19, 2006 to December 31,
2006, January 1, 2006 to December 18, 2006 and the year ended December 31, 2005
totaled $14.3 million, $0.3 million, $7.8 million and $6.7 million,
respectively.





Vessels
and equipment that are “held and used” are assessed for impairment when events
or circumstances indicate the carrying amount of the asset may not be
recoverable. If the asset’s net carrying value exceeds the net undiscounted cash
flows expected to be generated over its remaining useful life, the carrying
amount of the asset is reduced to its estimated fair value. Estimated fair value
is determined based on discounted cash flows or appraised values depending on
the nature of the asset.





Direct
financing leases





The
Partnership assembles, installs, operates and leases equipment that reduces
volatile organic compound emissions (or VOC equipment) during
loading, transportation and storage of oil and oil products. Leasing of the VOC
equipment is accounted for as a direct financing lease with lease payments
received by the Partnership being allocated between the net investment in the
lease and other income using the effective interest method so as to produce a
constant periodic rate of return over the lease term.





Investment
in joint ventures





Investments
in companies over which the Partnership exercises significant influence but does
not consolidate are accounted for using the equity method, whereby the
investment is carried at the Partnership’s original cost plus its proportionate
share of undistributed earnings. The excess carrying value of the Partnership’s
investment over its underlying equity in the net assets is included in the
consolidated balance sheet as investment in joint ventures. On December 1, 2006,
the operating agreements for the five 50%-owned joint ventures, each of which
owns





F-9





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





one
shuttle tanker, were amended. These amendments resulted in the Partnership
obtaining control of these joint ventures and, consequently, the Partnership has
consolidated these entities effective December 1, 2006. As at December 31, 2007,
the Partnership had a 50% controlling interest in six joint
ventures.





Debt
issuance costs





Debt
issuance costs, including fees, commissions and legal expenses, are presented as
other assets and capitalized and amortized on a straight-line basis over the
term of the relevant loan. Amortization of debt issuance costs is included in
interest expense.





Goodwill
and intangible assets





Goodwill
is not amortized, but reviewed for impairment annually, or more frequently if
impairment indicators arise. A fair value approach is used to identify potential
goodwill impairment and, when necessary, measure the amount of impairment. The
Partnership uses a discounted cash flow model to determine the fair value of
reporting units, unless there is a readily determinable fair market value.
Intangible assets with finite lives are amortized over their useful
lives.





The
Partnership’s intangible assets, which consist of contracts of affreightment
acquired as part of the Predecessor’s purchase of Navion AS in 2003, are
amortized over their respective lives, with the amount amortized each year being
weighted based on the projected revenue to be earned under the
contracts.





Derivative
instruments





All
derivative instruments are initially recorded at cost as either assets or
liabilities in the accompanying consolidated balance sheets and subsequently
remeasured to fair value, regardless of the purpose or intent for holding the
derivative. The method of recognizing the resulting gain or loss is dependent on
whether the derivative contract is designed to hedge a specific risk and also
qualifies for hedge accounting. The Partnership generally designates its
interest rate swap agreements and foreign exchange forward contracts as cash
flow hedges for accounting purposes.





When a
derivative is designated as a cash flow hedge, the Partnership formally
documents the relationship between the derivative and the hedged item. This
documentation includes the strategy and risk management objective for
undertaking the hedge and the method that will be used to assess the
effectiveness of the hedge. Any hedge ineffectiveness is recognized immediately
in earnings, as are any gains and losses on the derivative that are excluded
from the assessment of hedge effectiveness. The Partnership does not apply hedge
accounting if it is determined that the hedge was not effective or will no
longer be effective, the derivative was sold or exercised, or the hedged item
was sold or repaid.





For
derivative financial instruments designated and qualifying as cash flow hedges,
changes in the fair value of the effective portion of the derivative financial
instruments are initially recorded as a component of accumulated other
comprehensive income in partners’ equity. In the periods when the hedged items
affect earnings, the associated fair value changes on the hedging derivatives
are transferred from partners’ equity to the corresponding earnings line item.
The ineffective portion of the change in fair value of the derivative financial
instruments is immediately recognized in earnings. If a cash flow hedge is
terminated and the originally hedged items may still possibly affect earnings,
the gains and losses initially recognized in partners’ equity remain until the
hedged item impacts earnings, at which point they are transferred to the
corresponding earnings line item (i.e. interest expense). If the hedged items
may no longer affect earnings, amounts recognized in partners’ equity are
immediately transferred to earnings.





For
derivative financial instruments that are not designated or that do not qualify
as hedges under Statement of Financial Accounting Standards (or SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, the changes in the fair value of the
derivative financial instruments are recognized in earnings.





Gains and
losses from the Partnership’s interest rate swaps that hedge long-term debt are
recorded in interest expense. Gains and losses from the Partnership’s foreign
exchange forward contracts are recorded in vessel operating expenses and general
and administrative expense.





Income
taxes





The
Partnership’s Norwegian subsidiaries and Australian subsidiary are subject to
income taxes. Deferred income taxes were $75.7 million and $71.6 million as
at December 31, 2007 and 2006, respectively. The Partnership accounts for
such taxes using the liability method pursuant to SFAS No. 109, Accounting for Income Taxes(orSFAS
109).





In July
2006, the Financial Accounting Standards Board (or FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement No. 109 (or FIN 48). This interpretation
clarifies the accounting for uncertainty in income taxes recognized in financial
statements in accordance with SFAS 109. FIN 48 requires companies to determine
whether it is more-likely-than-not that a tax position taken or expected to be
taken in a tax return will be sustained upon examination, including resolution
of any related appeals or litigation processes, based on the technical merits of
the position. If a tax position meets the more-likely-than-not recognition
threshold, it is measured to determine the amount of benefit to recognize in the
financial statements based on guidance in the interpretation.








F-10





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





The
Partnership adopted FIN 48 as of January 1, 2007. The adoption of FIN 48 did not
have a significant impact on the Partnership’s financial position and results of
operations. As of January 1 and December 31, 2007, the Partnership did not have
any material unrecognized tax benefits or material accrued interest and
penalties relating to taxes. The Partnership does not expect any material
changes to its unrecognized tax positions within the next twelve
months.





The
Partnership recognizes interest and penalties related to uncertain tax positions
in income tax expense. The 2006 and 2007 tax years remain open to
examination by the major taxing jurisdiction to which the Partnership is
subject.





Accounting
for stock-based compensation





Effective
January 1, 2006, the Predecessor adopted the fair value recognition
provisions of SFAS No. 123(R), Share-Based Payment(orSFAS 123(R)), using the
“modified prospective” method. Under this transition method, compensation cost
is recognized in the consolidated financial statements beginning with the
effective date for all share-based payments granted after January 1, 2006
and for all awards granted to employees prior to, but not yet vested as of
January 1, 2006. Accordingly, prior period amounts have not been
restated.





As a
result of adopting SFAS 123(R) on January 1, 2006, the Predecessor’s
net income for 2006 is $1.0 million lower than if it had continued to account
for share-based compensation under the recognition and measurement provision of
APB Opinion No. 25 (or APB No. 25), Accounting for Stock Issued to
Employees.





Prior to
January 1, 2006, the Predecessor accounted for stock options under
APB No. 25, using the intrinsic value method, as permitted by SFAS No. 123,
Accounting for Stock-Based
Compensation. As the exercise price of the Predecessor’s employee stock
options equals the market price of underlying stock on the date of grant, no
compensation expense was recognized under APB No. 25.





Certain
employees of the Predecessor participate in the stock option plan of the
Partnership’s parent, Teekay Corporation. Stock options granted under this plan
have a 10-year term and vest equally over three years from the grant date. All
outstanding options expire between May 28, 2006 and March 7, 2016, ten
years after the date of each respective grant.





During
the fourth quarter of 2006, substantially all of the Predecessor’s employees
were transferred to subsidiaries of Teekay Corporation, and, subsequently,
stock-based compensation has been allocated to the Partnership through a service
agreement with a subsidiary of Teekay Corporation (Note 10(o)).





Recent
Accounting Pronouncements





In March
2008, the FASB ratified a consensus opinion reached by the Emerging Issues Task
Force (or EITF) on EITF
Issue No. 07-4, Application of
the Two-Class Method under FASB Statement No. 128, Earnings per Share to Master
Limited Partnerships(or EITF Issue No. 07-4). The
guidance in EITF Issue No. 07-4 requires incentive distribution rights in a
master limited partnership, such as the Partnership, to be treated as
participating securities for the purposes of computing earnings per share and
provides guidance on how earnings should be allocated to the various partnership
interests. EITF Issue No. 07-4 is effective for fiscal years beginning
after December 15, 2008. The Partnership is currently evaluating the
potential impact, if any, of the adoption of EITF Issue No.07-4 on its
consolidated results of operations and financial condition.





In
December 2007, the FASB issued SFAS No. 141(R): Business Combinations(or
SFAS 141(R)), which
replaces SFAS No. 141,
Business Combinations. This statement establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired.
SFAS 141(R) also establishes disclosure requirements to enable the
evaluation of the nature and financial effects of the business combination.
SFAS 141(R) is effective for fiscal years beginning after December 15,
2008. The Partnership is currently evaluating the potential impact, if any, of
the adoption of SFAS 141(R) on its consolidated results of operations and
financial condition.





In
December 2007, the FASB issued SFAS No. 160: Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of Accounting Research Bulletin
No. 51 (or SFAS
160). This statement establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent's ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS 160 is effective for fiscal
years beginning after December 15, 2008. The Partnership is currently
evaluating the potential impact, if any, of the adoption of SFAS 160 on its
consolidated results of operations and financial condition.





In
February 2007, the FASB issued SFAS No. 159: The Fair Value Option for Financial
Assets and Financial Liabilities Including an Amendment of SFAS No.115(or SFAS 159).
This statement permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. The Partnership is
currently evaluating the potential impact, if any, of the adoption of
SFAS 159 on its consolidated results of operations and financial
condition.











F-11





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





In
September 2006, the FASB issued SFAS No. 157: Fair Value Measurements (or
SFAS 157). This
statement defines fair value, establishes a framework for measuring fair value
in GAAP, and expands disclosures about fair value measurements. This statement
applies under other accounting pronouncements that require or permit fair value
measurements, and accordingly, does not require any new fair value
measurements.  SFAS 157 is effective for fiscal years beginning after
November 15, 2007. In February 2008, the FASB delayed for one year the effective
date of adoption with respect to certain non-financial assets and liabilities.
The Partnership is currently evaluating the potential impact, if any, of the
adoption of SFAS 157 on its consolidated results of operations and
financial condition.





2.
            Initial
      Public Offering





On
December 19, 2006, the Partnership completed its initial public offering (or the
Offering) of 8.05
million common units at a price of $21.00 per unit. This included 1.05 million
common units sold to the underwriters in connection with the exercise of their
over-allotment option. The proceeds received by the Partnership from the
Offering and the use of those proceeds are summarized as follows:





Proceeds
      received:Sale
      of 8,050,000 common units at $21.00 per unit
            
            $
            169,050Use
      of proceeds from sale of common units:Underwriting
      and structuring fees.
            
            $
            11,088Professional
      fees and other offering expenses to third parties
            
            
            2,793Repayment
      of promissory notes and redemption of 1.05 million common units from
      Teekay Corporation
            
            
            155,169$
            169,050





3.      Segment
Reporting





The
Partnership is engaged in the international marine transportation of crude oil
through the operation of its oil tankers and FSO units. The Partnership’s
revenues are earned in international markets.





The
Partnership has three reportable segments: its shuttle tanker segment; its
conventional tanker segment; and its FSO segment. The Partnership’s shuttle
tanker segment consists of shuttle tankers operating primarily on fixed-rate
contracts of affreightment, time-charter contracts or bareboat charter
contracts. The Partnership’s conventional tanker segment consists of
conventional oil tankers primarily operating on fixed-rate time-charter
contracts. The Partnership’s FSO segment consists of its FSO units subject to
fixed-rate time-charter contracts or bareboat charter contracts. Segment results
are evaluated based on income from vessel operations. The accounting policies
applied to the reportable segments is the same as those used in the preparation
of the Partnership’s consolidated financial statements.





The
following table presents voyage revenues and percentage of consolidated voyage
revenues for customers that accountedfor
more than 10.0% of the Partnership’s consolidated voyage revenues during the
periods presented.





Year
      Ended December 31, 2006Year
      Ended
                December
      31,
                2007
              January
      1
                to
                December
      18,
                2006
              December
      19
                to
                December
      31,
                2006
              Year
      Ended
                December
      31,
                2005(U.S.
      dollars in millions)StatoilHydro
      ASA (1)
      (2)
              $309.6
      or 40%
              $187.6
      or 27%
              $6.9
      or 29%
              $184.7
      or 23%Teekay
      Corporation (3).
              $154.6
      or 20%
              $148.9
      or 22%
              $5.3
      or 22%
              $254.1
      or 32%Petrobras
      Transporte S.A (1)
      (2).
              $100.8
      or 13%
              -
              -
              -


(1)
            Shuttle
      tanker segment.


(2)
            Statoil
      ASA and Petrobras Transporte S.A. are international oil
      companies.


(3)
            Shuttle
      tanker, conventional tanker and FSO
segments.








F-12





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)




The
following tables include results for these segments for the periods presented in
these consolidated financial statements.


Part
C


Year
      Ended December 31, 2007Shuttle
      Tanker Segment
              $
            
            
            Conventional
              Tanker
      Segment
              $
            
            
            FSO
              Segment
              $
            
            
            Total
              $Voyage
      revenues
            
            
            588,547
            
            
            
            135,922
            
            
            
            51,500
            
            
            
            775,969Voyage
      expenses
            
            
            114,103
            
            
            
            36,594
            
            
            
            886
            
            
            
            151,583Vessel
      operating expenses
            
            
            103,444
            
            
            
            24,175
            
            
            
            15,628
            
            
            
            143,247Time
      charter hire expense
            
            
            150,463
            
            
            
            -
            
            
            
            -
            
            
            
            150,463Depreciation
      and amortization
            
            
            85,885
            
            
            
            21,324
            
            
            
            15,206
            
            
            
            122,415General
      and administrative(1)
            
            
            50,783
            
            
            
            7,828
            
            
            
            2,919
            
            
            
            61,530Income
      from vessel operations
            
            
            83,869
            
            
            
            46,001
            
            
            
            16,861
            
            
            
            146,731Expenditures
      for vessels and equipment
            
            
            167,047
            
            
            
            1,998
            
            
            
            41,294
            
            
            
            210,339






Year
      Ended December 31, 2006January
      1 to December 18, 2006
            
            
            December
      19 to December 31, 2006Shuttle
      Tanker Segment
              $
            
            
            Conventional
              Tanker
      Segment
              $
            
            
            FSO
              Segment
              $
            
            
            Total
              $
            
            
            Shuttle
      Tanker Segment
              $
            
            
            Conventional
              Tanker
      Segment
              $
            
            
            FSO
              Segment
              $
            
            
            Total
              $Voyage
      revenues
            
            
            516,187
            
            
            
            146,687
            
            
            
            21,892
            
            
            
            684,766
            
            
            
            19,785
            
            
            
            3,383
            
            
            
            758
            
            
            
            23,926Voyage
      expenses
            
            
            85,451
            
            
            
            4,841
            
            
            
            1,029
            
            
            
            91,321
            
            
            
            2,995
            
            
            
            51
            
            
            
            56
            
            
            
            3,102Vessel
      operating expenses
            
            
            77,085
            
            
            
            18,754
            
            
            
            6,472
            
            
            
            102,311
            
            
            
            3,222
            
            
            
            624
            
            
            
            241
            
            
            
            4,087Time
      charter hire expense
            
            
            159,973
            
            
            
            79,338
            
            
            
            -
            
            
            
            239,311
            
            
            
            5,641
            
            
            
            -
            
            
            
            -
            
            
            
            5,641Depreciation
      and amortization
            
            
            68,784
            
            
            
            20,507
            
            
            
            9,095
            
            
            
            98,386
            
            
            
            2,583
            
            
            
            705
            
            
            
            348
            
            
            
            3,636General
      and administrative(1)
            
            
            50,058
            
            
            
            18,668
            
            
            
            1,661
            
            
            
            70,387
            
            
            
            1,863
            
            
            
            218
            
            
            
            48
            
            
            
            2,129Gain
      on sale of vessels and equipment - net of writedowns
            
            
            (4,778
            )
            
            
            -
            
            
            
            -
            
            
            
            (4,778
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Restructuring  charge
            
            
            -
            
            
            
            832
            
            
            
            -
            
            
            
            832
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Income
      from vessel operations
            
            
            79,614
            
            
            
            3,747
            
            
            
            3,635
            
            
            
            86,996
            
            
            
            3,481
            
            
            
            1,785
            
            
            
            65
            
            
            
            5,331Equity
      income from joint ventures
            
            
            6,162
            
            
            
            -
            
            
            
            -
            
            
            
            6,162
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Expenditures
      for vessels and equipment
            
            
            25,055
            
            
            
            6,024
            
            
            
            -
            
            
            
            31,079
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -









F-13





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)






Year
      Ended December 31, 2005Shuttle
      Tanker Segment
              $
            
            
            Conventional
              Tanker
      Segment
              $
            
            
            FSO
              Segment
              $
            
            
            Total
              $Voyage
      revenues
            
            
            516,758
            
            
            
            266,593
            
            
            
            24,197
            
            
            
            807,548Voyage
      expenses
            
            
            68,308
            
            
            
            5,419
            
            
            
            816
            
            
            
            74,543Vessel
      operating expenses
            
            
            75,196
            
            
            
            22,679
            
            
            
            6,600
            
            
            
            104,475Time
      charter hire expense
            
            
            169,687
            
            
            
            203,849
            
            
            
            -
            
            
            
            373,536Depreciation
      and amortization
            
            
            77,083
            
            
            
            21,112
            
            
            
            9,347
            
            
            
            107,542General
      and administrative(1)
            
            
            55,010
            
            
            
            29,026
            
            
            
            1,820
            
            
            
            85,856Gain
      on sale of vessels and equipment - net of writedowns
            
            
            2,820
            
            
            
            -
            
            
            
            -
            
            
            
            2,820Restructuring  charge
            
            
            955
            
            
            
            -
            
            
            
            -
            
            
            
            955Income
      from vessel operations
            
            
            67,699
            
            
            
            (15,492
            )
            
            
            5,614
            
            
            
            57,821Equity
      income from joint ventures
            
            
            5,235
            
            
            
            (36
            )
            
            
            -
            
            
            
            5,199Investments
      in joint ventures
            
            
            33,907
            
            
            
            495
            
            
            
            -
            
            
            
            34,402Expenditures
      for vessels and equipment
            
            
            22,760
            
            
            
            2,000
            
            
            
            -
            
            
            
            24,760





(1)
            Includes
      direct general and administrative expenses and indirect general and
      administrative expenses (allocated to each segment based on estimated use
      of corporate resources).





A
reconciliation of total segment assets to total assets presented in the
accompanying consolidated balance sheets is as follows:





December
      31, 2007
              $
            
            
            December
      31, 2006
              $Shuttle
      tanker segment
            
            
            1,559,261
            
            
            
            1,445,830Conventional
      tanker segment
            
            
            255,460
            
            
            
            310,699FSO
      segment
            
            
            131,080
            
            
            
            75,633Cash
      and cash equivalents
            
            
            121,224
            
            
            
            113,986Accounts
      receivable and other assets
            
            
            99,326
            
            
            
            95,173Consolidated
      total assets
            
            
            2,166,351
            
            
            
            2,041,321





4.
            Intangible
      Assets





As at
December 31, 2007 and 2006, intangible assets consisted of:





December
      31, 2007
            
            
            December
      31, 2006Weighted-Average
              Amortization
      Period
              (years)
            
            
            Gross
              Carrying
      Amount
              $
            
            
            Accumulated
              Amortization
              $
            
            
            Net
              Carrying
      Amount
              $
            
            
            Gross
              Carrying
      Amount
              $
            
            
            Accumulated
              Amortization
              $
            
            
            Net
              Carrying
      Amount
              $Contracts
      of affreightment
            
            
            10.2
            
            
            
            124,250
            
            
            
            (68,895
            )
            
            
            55,355
            
            
            
            124,250
            
            
            
            (57,825
            )
            
            
            66,425





Aggregate
amortization expense of intangible assets for the year ended December 31, 2007
was $11.1 million ($12.1 million – 2006, $14.9 million – 2005). Amortization of
intangible assets for the five fiscal years subsequent to December 31, 2007 is
expected to be $10.1 million (2008), $9.1 million (2009), $8.1 million (2010),
$7.0 million (2011) and $6.0 million (2012).





5.    Accrued
Liabilities





December
      31, 2007
              $
            
            
            December
      31, 2006
              $Voyage
      and vessel
            
            
            26,015
            
            
            
            29,825Interest
            
            
            10,932
            
            
            
            6,717Payroll
      and benefits
            
            
            1,517
            
            
            
            6,44538,464
            
            
            
            42,987








F-14





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





6.
            Long-Term
      Debt


December
      31, 2007
              $
            
            
            December
      31, 2006
              $U.S.
      Dollar-denominated Revolving Credit Facilities due through
      2017
            
            
            1,205,808
            
            
            
            1,080,000U.S.
      Dollar-denominated Term Loans due through
      2017
            
            
            311,659
            
            
            
            223,3521,517,467
            
            
            
            1,303,352Less
      current
      portion
            
            
            64,060
            
            
            
            17,656Total
            
            
            1,453,407
            
            
            
            1,285,696


As at
December 31, 2007, the Partnership had three long-term revolving credit
facilities (collectively, the Revolvers), which, as at such
date, provided for borrowings of up to $1,371.3 million, of which
$165.5 million was undrawn. The total amount available under the Revolvers
reduces by $101.8 million (2008), $108.2 million (2009),
$114.9 million (2010), $122.0 million (2011), $129.7 million
(2012) and $794.7 million (thereafter). Two of the Revolvers are
guaranteed by certain subsidiaries of the Partnership for all outstanding
amounts and contain covenants that require OPCO to maintain the greater of a
minimum liquidity (cash, cash equivalents and undrawn committed revolving credit
lines with at least six months to maturity) of at least $75.0 million and
5.0% of the OPCO’s total consolidated debt. The remaining revolving credit
facility is guaranteed by Teekay Corporation and contains covenants that require
Teekay Corporation to maintain the greater of a minimum liquidity of at least
$50.0 million and 5.0% of Teekay Corporation’s total consolidated debt
which is recoursed to Teekay Corporation. The Revolvers are collateralized by
first-priority mortgages granted on 28 of the Partnership’s vessels, together
with other related collateral.




As at
December 31, 2007, each of the Partnership’s six 50% controlled joint ventures
had an outstanding term loan, which in the aggregate totaled $311.7 million. The
term loans have varying maturities through 2017 and semi-annual payments that
reduce over time. All term loans are collateralized by first-priority mortgages
on the vessels to which the loans relate, together with other related
collateral. As at December 31, 2007, OPCO had guaranteed $103.8 million of these
term loans, which represents its 50% share of the outstanding vessel mortgage
debt of five of these 50% controlled joint venture companies. Teekay Corporation
and the Partnership’s joint venture partner have guaranteed the remaining $207.9
million.





Interest
payments on the Revolvers and the term loans are based on LIBOR plus a margin.
At December 31, 2007 and December 31, 2006, the margins ranged between 0.45% and
0.80%. The weighted-average effective interest rate on the Partnership’s
long-term debt as at December 31, 2007 was 5.7% (December 31,
2006 — 6.0%). This rate does not reflect the effect of our interest rate
swaps (Note 11).





The
aggregate annual long-term debt principal repayments required to be made
subsequent to December 31, 2007 are $64.1 million (2008),
$115.6 million (2009), $107.0 million (2010), $164.0 million
(2011), $141.8 million (2012), and $925.0 million
(thereafter).





7.    Leases




Charters-out
and Direct Financing Lease
 
 Time
charters and bareboat charters of the Partnership’s vessels to customers are
accounted for as operating leases. The carrying amount of the vessels employed
on operating leases at December 31, 2007 was $1.3 billion (2006 - $1.1 billion).
Leasing of the VOC equipment is accounted for as direct financing leases. As at
December 31, 2007, the minimum lease payments receivable under the direct
financing leases approximated $125.6 million, including unearned income of
$25.1 million.
  As at
December 31, 2007, minimum scheduled future revenues under time charters
and bareboat charters and future scheduled payments under the direct financing
leases, to be received by the Partnership, then in place were approximately
$1,846.2 million, comprised of $366.1 million (2008),
$292.1 million (2009), $218.4 million (2010), $166.6 million
(2011), $155.2 million (2012) and $647.8 million (thereafter).
 The
minimum scheduled future revenues should not be construed to reflect total
charter hire revenues for any of the years.
  Charters-in
 
 As at
December 31, 2007, minimum commitments owing by the Partnership under
vessel operating leases by which the Partnership charters-in vessels were
approximately $480.4 million, comprised of $117.8 million (2008)
$87.4 million (2009), $80.9 million (2010), $61.8 million (2011),
$56.8 million (2012) and $75.7 million (thereafter). The Partnership recognizes
the expense from these charters, which is included in time-charter hire expense,
on a straight-line basis over the firm period of the
charters.





8.
            Fair
      Value of Financial Instruments





The
following methods and assumptions were used to estimate the fair value of each
class of financial instrument:





Cash and cash equivalents-The fair
value of the Partnership’s cash and cash equivalents approximate their carrying
amounts reported in the accompanying consolidated balance sheets.





Derivative instruments – The
fair value of the Partnership’s derivative instruments is the estimated amount
that the Partnership would receive or pay to terminate the agreements at the
reporting date, taking into account current interest rates, foreign exchange
rates and the current credit worthiness of the swap counterparties.







F-15





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





The
estimated fair value of the Partnership’s financial instruments is as
follows:











December
      31, 2007
              
              
              December
      31, 2006Carrying
                Amount
                $
              
              
              Fair
                Value
                $
              
              
              Carrying
                Amount
                $
              
              
              Fair
                Value
                $Cash
      and cash
      equivalents
              
              
              121,224
              
              
              
              121,224
              
              
              
              113,986
              
              
              
              113,986Advances
      to (from) affiliate (note
    10v)
              
              
              796
              
              
              
              796
              
              
              
              (16,951
              )
              
              
              (16,951
              )Long-term
      debt
              
              
              (1,517,467
              )
              
              
              (1,517,467
              )
              
              
              (1,303,352
              )
              
              
              (1,303,352
              )Derivative
      instruments(1)
      (note
      11)Interest
      rate swap
      agreements
              
              
              (20,050
              )
              
              
              (20,050
              )
              
              
              22,440
              
              
              
              22,440Foreign
      currency
      contracts
              
              
              1,122
              
              
              
              1,122
              
              
              
              -
              
              
              
              -


(1)
            The
      Partnership transacts all of its derivative instruments through
      investment-grade rated financial institutions and requires no collateral
      from these institutions.






9.  
Restructuring Charge and Other Income – Net





Year Ended December 31,
2006Year
      Ended December 31,
              2007
              $
            
            
            January
      1
              to
              December
      18,
              2006
              $
            
            
            December
      19
              to
              December
      31,
              2006
              $
            
            
            Year
      Ended December 31,
              2005
              $Volatile
      organic compound emissions plant lease income
            
            
            10,960
            
            
            
            11,037
            
            
            
            408
            
            
            
            11,001Miscellaneous
            
            
            (557
            )
            
            
            (2,677
            )
            
            
            (99
            )
            
            
            (1,910
            )Other
      income – net
            
            
            10,403
            
            
            
            8,360
            
            
            
            309
            
            
            
            9,091





During
the year ended December 31, 2006, the Predecessor relocated certain operational
functions to Singapore. As a result, the Predecessor incurred $0.8 million of
restructuring costs during 2006. During the year ended December 31, 2005, the
Predecessor relocated certain operational functions within Norway and closed its
office in Sandefjord, Norway. As a result, the Predecessor incurred $1.0 million
of restructuring costs during 2005.





10.
            Related
      Party Transactions





a.
            During
      2005, rate-effected income tax losses of $1.2 million that were
      generated by the Predecessor’s Norwegian subsidiaries were transferred to
      the Norwegian subsidiaries of Teekay Corporation. The transfer of these
      income tax losses was accounted for as an equity
    distribution.





b.
            During
      2005, the Predecessor sold the Dania Spirit,a 2000-built
      liquid petroleum gas carrier, to a subsidiary of Teekay Corporation for
      $18.0 million. The resulting $3.1 million loss on sale has been
      accounted for as an equity
distribution.





c.
            On
      July 1, 2006, the Predecessor sold Navion Shipping Ltd. to a subsidiary of
      Teekay Corporation for $53.7 million. The resulting gain on sale of $18.5
      million was accounted for as an equity contribution by Teekay Corporation.





During
the first half of 2006 and the year ended December 31, 2005, the Predecessor
earned $84.8 million and $205.9 million, respectively, of time charter
revenue pursuant to this agreement with Navion Shipping Ltd.





During
the first half of 2006 and the year ended December 31, 2005, the Predecessor
earned $5.1 million and $8.2 million, respectively, of management fees from
ship management services provided to a subsidiary of Teekay Corporation,
relating to the vessels chartered from Navion Shipping Ltd.








F-16





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





d.
            During
      2006, the Predecessor paid $11.9 million to Teekay Corporation for it to
      assume the time-charter contract for one of the Predecessor’s in-chartered
      shuttle tankers, the Borga. The resulting
      $11.9 million loss on sale was accounted for as an equity distribution to
      Teekay Corporation.





e.
            In
      2006, prior to the Offering, the Predecessor sold to Teekay Corporation
      certain subsidiaries and fixed assets for $64.7 million. The
      resulting $23.3 million gain on sale was accounted for as an equity
      contribution by Teekay Corporation.





f.
            Prior
      to the Offering, the Predecessor settled its Norwegian Kroner-denominated
      demand promissory note of 1.1 billion Norwegian Kroner ($166.3 million)
      and its Australian Dollar-denominated demand promissory note of 25.5
      million Australian Dollars ($19.2 million) owing to Teekay Corporation.
      Interest expense incurred on these demand promissory notes for the period
      prior to the Offering (January 1 to December 18, 2006) and for the year
      ended December 31, 2005 were $12.9 million and $14.8 million,
      respectively.





g.
            In
      October 2006, Teekay Corporation loaned 5.6 billion Norwegian Kroner
      ($863.0 million) to a subsidiary of OPCO primarily for the purchase of
      eight Aframax conventional crude oil tankers from Teekay Corporation.
      Immediately preceding the Offering, this interest-bearing loan was sold to
      OPCO. The interest expense incurred on this loan prior to its sale to OPCO
      was $14.2 million.





h.
            OPCO’s
      shuttle tankers, which are typically employed on long-term time-charters,
      previously were employed on short-term time charters with a subsidiary of
      Teekay Corporation when there were periods between the ending of one
      long-term time-charter and the beginning of another long-term
      time-charter. Pursuant to these short-term time-charters, OPCO earned
      voyage revenues of $1.2 million during the year ended December 31,
      2005.





i.
            On
      October 1, 2006, OPCO entered into time-charter contracts for its nine
      Aframax conventional tankers with a subsidiary of Teekay Corporation at
      then-prevailing market-based daily rates for terms of five to twelve
      years.  Under the terms of eight of these nine time-charter
      contracts, OPCO is responsible for the bunker fuel expenses; however, OPCO
      adds the approximate amounts of these expenses to the daily hire rate.
      Pursuant to these time-charter contracts, OPCO earned voyage revenues of
      $128.4 million and $22.3 million for the year ended December 31, 2007 and
      the three months ended December 31, 2006,
  respectively.





During
the first nine months of 2006 and the year ended December 31, 2005, seven of
these nine tankers were employed on time-charter contracts with a subsidiary of
Teekay Corporation. The rates earned by each vessel, which were generally lower
than market rates, depended upon the cash flow requirements of each vessel,
which included operating expenses, loan principal and interest payments and
drydock expenditures. Pursuant to these time-charter contracts, the Predecessor
earned voyage revenues of $24.6 million and $27.9 million during the first
nine months of 2006 and the year ended December 31, 2005,
respectively.





j.
            One
      of OPCO’s FSO units and one of OPCO’s conventional tankers were employed
      on short-term bareboat charters with a subsidiary of Teekay Corporation
      during the last half of 2006. Pursuant to these charter contracts, OPCO
      earned voyage revenues of $3.4 million revenues during the last half of
      2006.





k.
            Effective
      October 1, 2006, two of OPCO’s shuttle tankers have been employed on
      long-term bareboat charters with a subsidiary of Teekay Corporation.
      Pursuant to these charter contracts, OPCO earned voyage revenues of $14.2
      million and $3.6 million during the year ended December 31, 2007 and the
      three months ended December 31, 2006,
  respectively.





l.
            Two
      of OPCO’s FSO units were employed on long-term bareboat charters with a
      subsidiary of Teekay Corporation. Pursuant to these charter contracts,
      OPCO earned voyage revenues of $12.0 million, $10.2 million and
      $10.8 million during the years ended December 31, 2007, 2006 and
      2005, respectively.





m.
            On
      October 1, 2006, a subsidiary of Teekay Corporation entered into a
      services agreement with a subsidiary of OPCO, pursuant to which the
      subsidiary of OPCO provides the Teekay Corporation subsidiary with ship
      management services.  During the year ended December 31, 2007
      and the three months ended December 31, 2006, OPCO earned management fees
      of $3.3 million and $0.5 million, respectively, under the
      agreement.





n.
            Eight
      of OPCO’S Aframax conventional oil tankers and two FSO units were managed
      by subsidiaries of Teekay Corporation. Pursuant to the associated
      management services agreements, OPCO incurred general and administrative
      expenses of $4.4 million, $5.4 million and $5.4 million during the
      years ended December 31, 2007, 2006, and 2005,
      respectively.





o.
            The
      Partnership, OPCO and certain of OPCO’s operating subsidiaries have
      entered into services agreements with certain subsidiaries of Teekay
      Corporation in connection with the initial public offering, pursuant to
      which Teekay Corporation subsidiaries provide the Partnership, OPCO and
      its operating subsidiaries with administrative, advisory and technical
      services and ship management services. During the year ended December 31,
      2007 and the period from December 19, 2006 to December 31, 2006, the
      Partnership incurred $52.7 million and $0.3 million, respectively, of
      these costs. Prior to the Offering, the shore-based staff who provided
      these services to the Predecessor were transferred to a subsidiary of
      Teekay Corporation.








F-17





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





p.
            Pursuant
      to the Partnership's partnership agreement, the Partnership reimburses the
      General Partner for all expenses incurred by the Partnership that are
      necessary or appropriate for the conduct of the Partnership’s business.
      During the year ended December 31, 2007, the Partnership incurred $0.8
      million of these costs





q.
            The
      Partnership has entered into an omnibus agreement with Teekay Corporation,
      Teekay LNG Partners L.P., the General Partner and others governing, among
      other things, when the Partnership, Teekay Corporation and Teekay LNG
      Partners L.P. may compete with each other and certain rights of first
      offering on liquefied natural gas carriers, oil tankers, shuttle tankers,
      FSO units and floating production, storage and offloading units.





r.
            In
      July 2007, the Partnership acquired interests in two double-hull shuttle
      tankers from Teekay Corporation for a total cost of $159.1 million,
      including assumption of debt of $93.7 million and the related interest
      rate swap. The Partnership acquired Teekay Corporation's 100% interest in
      the 2000-built Navion Bergen and its 50%
      interest in the 2006-built Navion Gothenburg,
      together with their respective 13-year, fixed-rate bareboat charters to
      Petroleo Brasileiro S.A. The purchases were financed with one of the
      Partnership’s existing Revolvers and the assumption of debt. The excess of
      the proceeds paid by the Partnership over Teekay Corporation’s historical
      cost was accounted for as an equity distribution to Teekay Corporation of
      $27.8 million.





s.
            In
      October 2007, the Partnership acquired from Teekay Corporation an FSO
      unit, the Dampier
      Spirit, along with its 7-year fixed-rate time-charter to Apache
      Corporationfor a total cost
      of $30.3 million. The purchase was financed with one of the Partnership’s
      existing Revolvers. The excess of the proceeds paid by the Partnership
      over Teekay Corporation’s historical cost was accounted for as an equity
      distribution to Teekay Corporation of $13.9
  million.





t.
            In
      December 2007, Teekay Corporation contributed a $65.6 million, nine-year,
      4.98% interest rate swap (used to hedge the debt assumed in the purchase
      of the Navion
      Bergen) having a fair value liability of $2.6 million (Note 11), to
      the Partnership for no
consideration.





u.
            In
      December 2007, Teekay Corporation agreed to reimburse OPCO for certain
      costs relating to events which occurred prior to the Offering, totalling
      $4.8 million, including the settlement of a customer dispute in respect of
      vessels delivered prior to the Offering and other costs. This amount is
      included in other current assets.





v.
            At
      December 31, 2007 and 2006, advances to and from affiliates
      totaled $0.8 million and $17.0 million, respectively. Advances to and
      from affiliates are non-interest bearing and unsecured. The balance
      as at December 31, 2007 is included in other current
      assets.




11.
            Derivative
      Instruments and Hedging Activities





The
Partnership uses derivatives only for hedging purposes. The following summarizes
the Partnership's risk strategies with respect to market risk from foreign
currency fluctuations and changes in interest rates.





The
Partnership hedges portions of its forecasted expenditures denominated in
foreign currencies with foreign exchange forward contracts.  These
foreign exchange forward contracts are designated as cash flow hedges of
forecasted foreign currency expenditures. Where such instruments are designated
and qualify as cash flow hedges, the effective portion of the changes in their
fair value is recorded in accumulated other comprehensive income (loss), until
the hedged item is recognized in earnings. At such time, the respective amount
in accumulated other comprehensive income (loss) is released to earnings and is
recorded within operating expenses, based on the nature of the expense being
hedged.





As at
December 31, 2007, the Partnership was committed to the following foreign
exchange contracts for the forward purchase of foreign currency:


Contract
      amount in
            
            
            Average
            
            
            Expected
      maturityforeign
      currency
            
            
            forward
      rate
            
            
            2008
            
            
            2009(millions)
            
            
            
            
            
            (in
      millions of U.S. Dollars)Norwegian
      Kroner
            
            
            255.7
            
            
            
            5.64
            
            
            
            -
            
            
            $
            45.4Australian
      Dollar
            
            
            5.0
            
            
            
            1.25
            
            
            $
            4.0
            
            
            
            -Singapore
      Dollar
            
            
            4.1
            
            
            
            1.44
            
            
            $
            2.9
            
            
            
            -Euro
            
            
            4.0
            
            
            
            0.68
            
            
            $
            5.8
            
            
            
            -





The
Partnership enters into interest rate swaps which exchange a receipt of floating
interest for a payment of fixed interest to reduce the Partnership’s exposure to
interest rate variability on its outstanding floating rate debt. The
Partnership’s interest rate swaps are designated as cash flow hedges and mature
over various periods through 2026. The net gains or loss on the swaps has been
reported in a separate component of accumulated other comprehensive income
(loss), in the accompanying consolidated balance sheets and statements of
changes in partners’ equity to the extent the hedges are effective. The amount
recorded in accumulated other comprehensive income (loss) will subsequently be
reclassified into earnings in the same period as the hedged items affect
earnings.








F-18





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





As at
December 31, 2007, the Partnership was committed to the following interest rate
swap agreements related to its LIBOR-based debt, whereby certain of the
Partnership’s floating-rate debt was swapped with fixed-rate
obligations:





Interest
              Rate
              Index
            Principal
      Amount
              $
            Fair
      Value /
              Carrying
              Amount
      of
              Liability
              $
            Weighted-
              Average
              Remaining
              Term
              (years)
            Fixed
      Interest
              Rate
              (%)(1)U.S.
      Dollar-denominated interest rate swaps
            LIBOR
            935,000
            (8,374)
            6.5
            4.7U.S.
      Dollar-denominated interest rate swaps(2)
      (3)
            LIBOR
            414,373
            (11,676)
            13.3
            5.0







(1)
            Excludes
      the margin the Partnership pays on its variable-rate debt, which as at
      December 31, 2007, ranged from 0.50% and 0.80%.(2)
            Principal
      amount reduces quarterly or semiannually.(3)
            Included
      in the principal amount and fair value of the interest rate swaps is $65.6
      million and ($2.9) million, respectively, related to the portion of the
      derivative instrument that the Partnership has not designated as a cash
      flow hedge.







The
Partnership is exposed to credit loss in the event of non-performance by the
counter-parties to the foreign exchange forward contracts and the interest rate
swap agreements; however, the Partnership does not anticipate non-performance by
any of the counter-parties.





Changes
in the fair value of derivatives in economic hedges are recognized in earnings.
To the extent the cash flow hedges are effective, changes in the fair value of
the Partnership’s derivatives are recognized in other comprehensive income. The
ineffective portion of these derivative instruments is presented as interest
expense and foreign exchange gains and losses. During the year ended December
31, 2007, the Partnership recognized a net gain of $0.5 million, (2006 – net
gain of $0.1 million; 2005 – net loss of $0.2 million), relating to the
ineffective portion of its interest rate swap agreements and foreign currency
forward contracts.





As at
December 31, 2007, the Partnership estimated, based on then-existing
interest rates, that it would reclassify approximately $1.3 million of net
loss on derivative instruments from accumulated other comprehensive loss to
earnings during the next 12 months due to the payment of interest expense
associated with the Partnership’s floating-rate debt and the payment of
expenditures denominated in foreign currencies.





As at
December 31, 2007, the Partnership’s accumulated other comprehensive loss
of $5.3 million consisted of unrealized losses on derivative
instruments.  As at December 31, 2006, the Partnership’s accumulated
other comprehensive income of $5.3 million consisted of unrealized gains on
derivative instruments.





12.
            Income
      Taxes





The
significant components of the Partnership’s deferred tax liabilities and assets
are as follows:





December
      31,
              2007
              $
            
            
            December
      31,
              2006
              $Deferred
      tax liabilities:Vessels and equipment
            
            
            84,077
            
            
            
            58,824Goodwill and intangible assets
            
            
            266
            
            
            
            -Long-term debt
            
            
            94,071
            
            
            
            35,854Total
      deferred tax liabilities
            
            
            178,414
            
            
            
            94,678Deferred
      tax assets:Goodwill and intangible assets
            
            
            -
            
            
            
            368Provisions
            
            
            1,012
            
            
            
            1,012Tax losses carried forward (1)
            
            
            101,696
            
            
            
            21,715Total
      deferred tax assets
            
            
            102,708
            
            
            
            23,095Net
      deferred tax liabilities
            
            
            75,706
            
            
            
            71,583Current portion
            
            
            -
            
            
            
            -Long-term
      portion of net deferred tax liabilities
            
            
            75,706
            
            
            
            71,583





(1) The
net operating loss carryfowards are available to offset future taxable income in
the respective jurisdictions, and can be carried forward
indefinitely.





Substantially
all of the Partnership’s net income (loss) resulted from the operations of
companies that were subject to income taxes in their countries of
incorporation.








F-19





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





The
components of the provision for income taxes are as follows:





Year Ended December 31,
2006Year
      Ended
              December
      31,
              2007
              $
            
            
            January
      1
              to
              December
      18,
              2006
              $
            
            
            December
      19
              to
              December
      31,
              2006
              $
            
            
            Year
      Ended
              December
      31,
              2005
              $Current
            
            
            -
            
            
            
            (176
            )
            
            
            (7
            )
            
            
            (3,546
            )Deferred
            
            
            10,924
            
            
            
            (2,496
            )
            
            
            (92
            )
            
            
            17,419Income
      tax recovery (expense)
            
            
            10,924
            
            
            
            (2,672
            )
            
            
            (99
            )
            
            
            13,873




Reconciliations
of the actual income tax rate attributable to pretax income and the applicable
statutory income tax rate are as follows:





Year Ended December 31,
2006Year
      Ended
              December
      31,
              2007
              %
            
            
            January
      1
              to
              December
      18,
              2006
              %
            
            
            December
      19
              to
              December
      31,
              2006
              %
            
            
            Year
      Ended
              December
      31,
              2005
              %Actual
      income tax provision (credit) rate
            
            
            (16.2
            )
            
            
            (8.9
            )
            
            
            2.9
            
            
            
            (19.6
            )Income
      not subject to income taxes
            
            
            44.2
            
            
            
            36.9
            
            
            
            25.1
            
            
            
            47.6Applicable
      statutory income tax provision rate
            
            
            28.0
            
            
            
            28.0
            
            
            
            28.0
            
            
            
            28.0





13.
            Commitments
      and Contingencies





In June
2007, the Partnership exercised its option to purchase a 2001-built shuttle
tanker, which is currently part of the Partnership’s in-chartered shuttle tanker
fleet.  As of December 31, 2007, the Partnership was committed to
acquiring this vessel for $41.7 million.  The vessel will be delivered
to the Partnership in March 2008 and the Partnership financed the purchase
through one of its revolving credit facilities.





14.  Supplemental
Cash Flow Information





a)
              The
      changes in non-cash working capital items related to operating activities
      for the years ended December 31, 2007, 2006 and 2005 are as
      follows:


Year
      Ended
              December
      31,
              2007
              $
            
            
            Year
      Ended
              December
      31,
              2006
              $
            
            
            Year
      Ended
              December
      31,
              2005
              $Accounts
      receivable
            
            
            (15,808
            )
            
            
            3,214
            
            
            
            13,129Prepaid
      expenses and other
      assets
            
            
            (1,842
            )
            
            
            4,134
            
            
            
            (17,471
            )Accounts
      payable and accrued
      liabilities
            
            
            (4,521
            )
            
            
            2,098
            
            
            
            5,429Advances
      (to) from
      affiliate
            
            
            (9,417
            )
            
            
            31,281
            
            
            
            21,864(31,588
            )
            
            
            40,727
            
            
            
            22,951





b)
              Cash
      interest paid during the years ended December 31, 2007, 2006 and 2005
      totaled $73.9 million, $44.0 million and $38.1 million,
      respectively.





c)
              No
      taxes were paid for the years ended December 31, 2007 and December 31,
      2006. Taxes paid during the year ended December 31, 2005 totaled $6.5
      million.





15.
            Vessel Sales and Write-downs on
      Vessels and Equipment





a)
            Vessel
    Sales





During
2006, the Predecessor sold a 1981-built shuttle tanker. The Predecessor recorded
a gain of $6.4 million and a minority interest expense of $3.2 million relating
to the sale.





During
2005, the Predecessor sold two shuttle tankers built in 1981 and 1986. The
results for the year ended December 31, 2005 include a gain on sale from
these vessels totaling $9.1 million. In addition, the Predecessor sold and
leased back, under an operating lease, a 1991-built shuttle tanker. The sale
generated a $2.8 million gain, which has been deferred and is being amortized
over the 6.5 year term of the lease.





F-20





TEEKAY
OFFSHORE PARTNERS L.P. AND SUBSIDIARIES


(Successor
to Teekay Offshore Partners Predecessor)


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS- (Cont’d)


(all
tabular amounts stated in thousands of U.S. dollars, except unit and per unit
data or unless otherwise indicated)





b)
            Equipment  Writedowns





During
2006, the Predecessor incurred a $2.2 million write-down of certain offshore
equipment. This writedown occurred due to a reassessment of the estimated net
realizable value of this equipment and follows a $12.2 million write-down in
2005 arising from the early termination of a contract for the
equipment.





16.
            Net
      Income (Loss) Per Unit





Net
income (loss) per unit is determined by dividing net income (loss), after
deducting the amount of net income (loss) allocated to the General Partner’s
interest from the issuance date of the common units of December 19, 2006, by the
weighted-average number of units outstanding during the applicable period. For
periods prior to December 19, 2006, such units are deemed equal to the common
and subordinated units received by Teekay Corporation in exchange for net assets
contributed to the Partnership, or 12,600,000 units.





As
required by Emerging Issues Task Force Issue No. 03-6, Participating Securities and
Two-Class Method under FASB Statement No. 128, Earnings Per Share, the
interests of the General Partner, common unit holders and subordinated
unitholders in net income are calculated as if all net income for periods
subsequent to December 19, 2006 was distributed according to the terms of the
Partnership’s partnership agreement, regardless of whether those earnings would
or could be distributed. The partnership does not provide for the distribution
of net income; rather, it provides for the distribution of available cash, which
is a contractually defined term that generally means all cash on hand at the end
of each quarter after establishment of cash reserves. Unlike available cash, net
income is affected by non-cash items such as depreciation and amortization, and
foreign currency translation gains (losses).





Under the
partnership agreement, the holder of the incentive distribution rights in the
Partnership, which is currently the General Partner, has the right to receive an
increasing percentage of cash distributions after the minimum quarterly
distribution. Assuming there are no cumulative arrearages on common unit
distributions, the target distribution levels entitle the General Partner to
receive 2% of quarterly cash distributions up to $0.4025 per unit, 15% of
quarterly cash distributions between $0.4025 and $0.4375 per unit, 25% of
quarterly cash distributions between $0.4375 and $0.525 per unit, and 50% of
quarterly cash distributions in excess of $0.525 per unit. During the four
quarters that comprise the year ended December 31, 2007, net income did not
exceed $0.4025 per unit and, consequently, the assumed distribution of net
income did not result in the use of the increasing percentages to calculate the
General Partner’s interest in net income.





Under the
partnership agreement, during the subordination period applicable to the
Partnership’s subordinated units, the common units have the right to receive
distributions of available cash from operating surplus in an amount equal to the
minimum quarterly distribution of $0.35 per quarter, plus any arrearages in the
payment of the minimum quarterly distribution on the common units from prior
quarters, before any distributions of available cash from operating surplus may
be made on the subordinated units. During the first three quarters of 2007, net
income did not exceed the minimum quarterly distribution of $0.35 per unit and,
consequently, the assumed distribution of net income resulted in an unequal
distribution of net income between the subordinated unit holders and common unit
holders. During the fourth quarter of 2007, net income exceeded the minimum
quarterly distribution of $0.35 per unit and, consequently, the assumed
distribution of net income resulted in a minimum equal distribution of net
income between the subordinated unit holders and common unit
holders.





17.
            Valuation
      and Qualifying Accounts





Balance
      at beginning
              of
      year
              $
            
            Balance
      at end
              of
      year
              $Allowance
      for bad debts:Year
      ended December 31, 2006
            
            
            987
            
            
            
            401Year
      ended December 31, 2007
            
            
            401
            
            
            
            -Restructuring
      cost accrual:Year
      ended December 31, 2006
            
            
            955
            
            
            
            71Year
      ended December 31, 2007
            
            
            71
            
            
            
            -







F-21
  
 EXHIBIT
8.1
 
 LIST
OF SIGNIFICANT SUBSIDIARIES
 
 The
      following is a list of Teekay Offshore Partners L.P.'s significant
      subsidiaries as at December 31,
2007:
  Name of Significant
      Subsidiary
              
              State
      or
                Jurisdiction of
      Incorporation
              
              Proportion
      of
                Ownership
                InterestTEEKAY
      AUSTRALIA OFFSHORE HOLDINGS PTY LTD.
              
              AUSTRALIA
              
              
              100
              %NAVION
      BERGEN L.L.C.
              
              MARSHALL
      ISLANDS
              
              
              100
              %NAVION
      GOTHENBURG L.L.C.
              
              MARSHALL
      ISLANDS
              
              
              50
              %NAVION
      OFFSHORE LOADING AS.
              
              NORWAY
              
              
              26
              %NORSK
      TEEKAY AS.
              
              NORWAY
              
              
              26
              %NORSK
      TEEKAY HOLDINGS LTD.
              
              MARSHALL
      ISLANDS
              
              
              26
              %TEEKAY
      EUROPEAN HOLDINGS S.A.R.L.
              
              LUXEMBOURG
              
              
              26
              %TEEKAY
      NAVION OFFSHORE LOADING PTE. LTD.
              
              SINGAPORE
              
              
              26
              %TEEKAY
      NETHERLANDS EUROPEAN HOLDINGS BV.
              
              NETHERLANDS
              
              
              26
              %TEEKAY
      NORDIC HOLDINGS INC.
              
              MARSHALL
      ISLANDS
              
              
              26
              %TEEKAY
      NORWAY AS.
              
              NORWAY
              
              
              26
              %TEEKAY
      OFFSHORE OPERATING L.P.
              
              MARSHALL
      ISLANDS
              
              
              26
              %UGLAND
      NORDIC SHIPPING AS.
              
              NORWAY
              
              
              26
              %
 
 
  F-22


EXHIBIT
12.1





CERTIFICATION





I, Peter
Evensen, certify that:





1.      I
have reviewed this Annual Report on Form 20-F of Teekay Offshore Partners, L.P.
(the "Registrant");





2.
            Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a material fact necessary to make the
      statements made, in light of the circumstances under which such statements
      were made, not misleading with respect to the period covered by this
      report;





3.
            Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of
      the Registrant as of, and for, the periods presented in this
      report;





4.
            I
      and the Registrant's other certifying officer (which is also myself) are
      responsible for establishing and maintaining disclosure controls and
      procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
      internal control over financial reporting (as defined in Exchange Act
      Rules 13a-15(f) and 15d-15(f)) for the Registrant and
  have:





a)
            Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the Registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;





b)
            Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;





c)
            Evaluated
      the effectiveness of the Registrant’s disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation;
  and





d)
            Disclosed
      in this report any change in the Registrant’s internal control over
      financial reporting that occurred during the Registrant's most recent
      fiscal quarter (the fourth fiscal quarter in the case of an annual report)
      that has materially affected, or is reasonably likely to materially
      affect, the Registrant’s internal control over financial reporting;
      and





5.
            I
      and the Registrant's other certifying officer (which is also myself) have
      disclosed, based on our most recent evaluation of internal control over
      financial reporting, to the Registrant’s auditors and the audit committee
      of the board of directors of the Registrant's general partner (or persons
      performing the equivalent
functions):





a)
            All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the Registrant's ability to record,
      process, summarize and report financial information;
  and





b)
            Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the Registrant’s internal control
      over financial reporting.








Dated:  April
      11, 2008
            By:
      /s/ Peter
      Evensen
              Peter Evensen
              Chief Executive
  Officer












F-23








EXHIBIT
12.2


CERTIFICATION





I, Peter
Evensen,  certify that:





1.
            I
      have reviewed this Annual Report on Form 20-F of Teekay Offshore Partners,
      L.P. (the"Registrant");





2.
            Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a material fact necessary to make the
      statements made, in light of the circumstances under which such statements
      were made, not misleading with respect to the period covered by this
      report;





3.
            Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of the
      Registrant as of, and for, the periods presented in this
      report;





4.
            I
      and the Registrant's other certifying officer (which is also myself) are
      responsible for establishing and maintaining disclosure controls and
      procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
      internal control over financial reporting (as defined in Exchange Act
      Rules 13a-15(f) and 15d-15(f)) for the Registrant and
  have:





a)
            Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the Registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;





b)
            Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;





c)
            Evaluated
      the effectiveness of the Registrant’s disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation;
  and





d)
            Disclosed
      in this report any change in the Registrant’s internal control over
      financial reporting that occurred during the Registrant's most recent
      fiscal quarter (the fourth fiscal quarter in the case of an annual report)
      that has materially affected, or is reasonably likely to materially
      affect, the Registrant’s internal control over financial reporting;
      and





5.
            I
      and the Registrant's other certifying officer (which is also myself) have
      disclosed, based on our most recent evaluation of internal control over
      financial reporting, to the Registrant’s auditors and the audit committee
      of the board of directors of the Registrant's general partner (or persons
      performing the equivalent
functions):





a)
            All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the Registrant's ability to record,
      process, summarize and report financial information;
  and





b)
            Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the Registrant’s internal control
      over financial reporting.














Dated:  April
      11, 2008
            By:
      /s/ Peter
      Evensen
              Peter Evensen
              Chief Financial
  Officer









F-24











EXHIBIT
      13.1





CERTIFICATION
PURSUANT TO


18
U.S.C. SECTION 1350,


AS
ADOPTED PURSUANT TO SECTION 906


OF
THE SARBANES-OXLEY ACT OF 2002





In
connection with the Annual Report of Teekay Offshore Partners L.P. (the "Partnership")
on Form 20-F for the year ended December 31, 2007 as filed with the
Securities and Exchange Commission on the date hereof (the "Form
20-F"), I, Peter Evensen, Chief Executive Officer and Chief Financial
Officer of the Partnership, certify, pursuant to 18 U.S.C. §1350, as adopted
pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:





(1)
            The
      Form 20-F fully complies with the requirements of Section 13(a) or 15(d)
      of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d));
      and





(2)
            The
      information contained in the Form 20-F fairly presents, in all material
      respects, the financial condition and results of operations of the
      Partnership.





Dated:
April 11, 2008








By: /s/ Peter
Evensen


Peter
Evensen


Chief
Executive Officer and Chief Financial Officer












































F-25





Exhibit
15.1





CONSENT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





We
consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-147682) pertaining to the Teekay Offshore Partners L.P. 2006 Long
Term Incentive Plan of our reports dated March 12, 2008, with respect to the
consolidated financial statements of Teekay Offshore Partners L.P. and its
subsidiaries, the effectiveness of internal control over financial reporting of
Teekay Offshore Partners L.P., and the consolidated balance sheet of Teekay
Offshore GP L.L.C., included in the Annual Report (Form 20-F) for the year ended
December 31, 2007.











Vancouver,
      Canada
              April 11,
      2008
            /s/ ERNST
      & YOUNG LLP
              Chartered
Accountants



















F-26








Exhibit
15.2








CONSOLIDATED
BALANCE SHEET


OF


TEEKAY
OFFSHORE GP L.L.C.





F-27





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Member of


TEEKAY OFFSHORE GP
L.L.C.





We have
audited the accompanying consolidated balance sheet of Teekay Offshore GP L.L.C.
as of December 31, 2007. The balance sheet is the responsibility of the
Company’s management. Our responsibility is to express an opinion on this
consolidated balance sheet based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the balance
sheet is free of material misstatement. We were not engaged to perform an audit
of the Company’s internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statements presentation. We believe that our
audit provides a reasonable basis for our opinion.





In our
opinion, the consolidated balance sheet referred to above presents fairly, in
all material respects, the financial position of Teekay Offshore GP L.L.C. at
December 31, 2007 in conformity with U.S. generally accepted accounting
principles.











Vancouver,
      Canada
              March 12, 2008
            /s/
      Ernst & Young LLP
              Chartered
Accountants
















F-28





TEEKAY
OFFSHORE GP L.L.C. (Note 1)


CONSOLIDATED
BALANCE SHEET


(in
thousands of U.S. dollars)





As
      at
              December
      31,
              2007
              $ASSETSCurrent
              Cash
      and cash equivalents (note
6)
            
            
            121,506Accounts
      receivable, net of allowance for doubtful accounts of $nil
            
            
            42,245Net
      investment in direct financing leases – current
            
            
            22,268Prepaid
      expenses
            
            
            34,219Other
      current assets (notes
      9f)
            
            
            8,613Total
      current assets
            
            
            228,851Vessels and equipment
      (note
      6)
              At
      cost, less accumulated depreciation of $674,722
            
            
            1,662,865Net
      investment in direct financing leases
            
            
            78,199Other
      assets
            
            
            14,423Intangible
      assets – net (note
      4)
            
            
            55,355Goodwill
      - shuttle tanker segment
            
            
            127,113Total
      assets
            
            
            2,166,806LIABILITIES
      AND MEMBER’S EQUITYCurrent
              Accounts
      payable
            
            
            12,076Accrued
      liabilities (note
      5)
            
            
            38,464Current
      portion of long-term debt (note
6)
            
            
            64,060Total
      current liabilities
            
            
            114,600Long-term
      debt (note
      6)
            
            
            1,453,407Deferred
      income taxes (note
      11)
            
            
            75,706Other
      long-term liabilities (note
    10)
            
            
            50,024Total
      liabilities
            
            
            1,693,737Commitments
      and contingencies (notes
      7, 9 and 12)Non-controlling
      interest
            
            
            470,995Member’s
      equityMember’s
      equity
            
            
            2,181Accumulated
      other comprehensive loss
            
            
            (107
            )Total
      member’s equity
            
            
            2,074Total
      liabilities and member’s equity
            
            
            2,166,806





The
accompanying notes are an integral part of the Consolidated Balance
Sheet.











F-29





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





1.      Summary
of Significant Accounting Policies





Basis
of presentation




Teekay
Offshore GP L.L.C. (the Companyor theGeneral Partner), a Marshall
Islands limited liability company, was formed on August 25, 2006 to become the
general partner of Teekay Offshore Partners L.P. (the Partnership).  The
Company is a wholly owned subsidiary of Teekay Corporation. On August 25, 2006,
Teekay Corporation contributed $1,000 to the Company in exchange for a 100%
ownership interest. The Company has invested $20 in the Partnership for its 2%
general partner interest.





During
August 2006, Teekay Corporation formed the Partnership, a Marshall Islands
limited partnership, as part of its strategy to expand in the marine
transportation, processing and storage sectors of the offshore oil industry and
for the Partnership to acquire, in connection with the Partnership’s initial
public offering of its common units, a 26.0% interest in Teekay Offshore
Operating L.P. (or OPCO), consisting of a 25.99%
limited partner interest to be held directly by the Partnership and a 0.01%
general partner interest to be held through the Partnership’s ownership of
Teekay Offshore Operating GP L.L.C., OPCO’s sole general partner.





Prior to
the closing of the Partnership’s initial public offering on December 19, 2006,
Teekay Corporation transferred eight Aframax conventional crude oil tankers to a
subsidiary of Norsk Teekay Holdings Ltd. (or Norsk Teekay) and one
floating storage and offtake (or FSO) unit to Teekay Offshore
Australia Trust. Teekay Corporation then transferred to OPCO all of the
outstanding interests of four wholly-owned subsidiaries — Norsk Teekay,
Teekay Nordic Holdings Inc., Teekay Offshore Australia Trust and Pattani Spirit
L.L.C. These four wholly-owned subsidiaries, the assets of which include the
eight Aframax conventional crude oil tankers and the FSO unit, are collectively
referred to as Teekay Offshore
Partners Predecessor or the Predecessor.





Immediately
prior to the closing of the Partnership’s initial public offering, Teekay
Corporation sold to the Partnership the 25.99% limited partner interest in OPCO
and its subsidiaries and a 100% interest in Teekay Offshore Operating GP L.L.C.,
which owns the 0.01% general partner interest in OPCO. In exchange for the
equity interests, Teekay Corporation received 2,800,000 common units and
9,800,000 subordinated units from the Partnership and a $134.6 million
non-interest bearing promissory note. The Company received a 2.0% general
partner interest and all of the incentive distribution rights in the
Partnership.





This
consolidated balance sheet has been prepared in accordance with United States
generally accepted accounting principles (or GAAP). Effective January 1,
2007, we began consolidating the Partnership on a prospective basis in
accordance with Emerging Issues Task Force Issue No. 04-5, “Determining Whether
a General Partner, of the General Partners as a Group, Controls a Limited
Partnership or Similar Entity When the Limited Partners Have Certain Rights”
(EITF 04-5). EITF 04-5 presumes that a general partner controls a limited
partnership and therefore should consolidate the partnership in the financial
statements of the general partner. Significant intercompany balances and
transactions have been eliminated upon consolidation. The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in the balance sheet
and accompanying notes. Actual results may differ from those
estimates.





Reporting
currency




The
consolidated balance sheet and accompanying notes are stated in
U.S. dollars. The functional currency of the Partnership is U.S. dollars
because the Partnership operates in international shipping markets, the
Partnership’s primary economic environment, which typically utilize the
U.S. dollar as the functional currency. Transactions involving other
currencies during the year are converted into U.S. dollars using the
exchange rates in effect at the time of the transactions. At the balance sheet
dates, monetary assets and liabilities that are denominated in currencies other
than the U.S. dollar are translated to reflect the year-end exchange
rates.


Operating
revenues and expenses





The
Partnership recognizes revenues from time charters and bareboat charters daily
over the term of the charter as the applicable vessel operates under the
charter. The Partnership does not recognize revenue during days that the vessel
is off-hire. Shuttle tanker voyages servicing contracts of affreightment with
offshore oil fields commence with tendering of notice of readiness at a field,
within the agreed lifting range, and ends with tendering of notice of readiness
at a field for the next lifting. All other voyage revenues from voyage charters
are recognized on a percentage of completion method. The Partnership uses a
discharge-to-discharge basis in determining percentage of completion for all
spot voyages, whereby it recognizes revenue ratably from when product is
discharged (unloaded) at the end of one voyage to when it is discharged
after the next voyage. The Partnership does not begin recognizing voyage revenue
until a charter has been agreed to by the customer and the Partnership, even if
the vessel has discharged its cargo and is sailing to the anticipated load port
on its next voyage. The consolidated balance sheets reflect the deferred portion
of revenues and expenses, which will be earned and incurred, respectively, in
subsequent periods. As at December 31, 2007, there was no deferred revenue. As
at December 31, 2007, the deferred portion of expenses, which are included
in prepaid expenses, was $25.4 million.





Voyage
expenses are all expenses unique to a particular voyage, including bunker fuel
expenses, port fees, cargo loading and unloading expenses, canal tolls, agency
fees and commissions. Vessel operating expenses include crewing, repairs and
maintenance, insurance, stores, lube oils and communication expenses. Voyage
expenses and vessel operating expenses are recognized when
incurred.





F-30





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





Cash
and cash equivalents





The
Partnership classifies all highly liquid investments with a maturity date of
three months or less when purchased as cash and cash equivalents.





Accounts
receivable and allowance for doubtful accounts





Accounts
receivable are recorded at the invoiced amount and do not bear interest. The
allowance for doubtful accounts is the Partnership’s best estimate of the amount
of probable credit losses in existing accounts receivable. The Partnership
determines the allowance based on historical write-off experience and customer
economic data. The Partnership reviews the allowance for doubtful accounts
regularly and past due balances are reviewed for collectibility. Account
balances are charged off against the allowance when the Partnership believes
that the receivable will not be recovered.





Vessels
and equipment





All
pre-delivery costs incurred during the construction of newbuildings, including
interest, supervision and technical costs, are capitalized. The acquisition cost
and all costs incurred to restore used vessels purchased by the Partnership to
the standards required to properly service the Partnership’s customers are
capitalized.





Depreciation
is calculated on a straight-line basis over a vessel’s estimated useful life,
less an estimated residual value. Depreciation is calculated using an estimated
useful life of 25 years, commencing from the date the vessel is delivered
from the shipyard, or a shorter period if regulations prevent the Partnership
from operating the vessel for 25 years.





Generally,
the Partnership drydocks each shuttle tanker and conventional oil tanker every
two and a half to five years. FSO units are generally not drydocked. The
Partnership capitalizes a substantial portion of the costs incurred during
drydocking and amortizes those costs on a straight-line basis from the
completion of a drydocking to the estimated completion of the next drydocking.
The Partnership expenses as incurred costs related to routine repairs and
maintenance performed during drydocking that do not improve or extend the useful
lives of the assets. When significant drydocking expenditures occur prior to the
expiration of the original amortization period, the remaining unamortized
balance of the original drydocking cost are expensed in the month of the
subsequent drydocking.





Vessels
and equipment that are “held and used” are assessed for impairment when events
or circumstances indicate the carrying amount of the asset may not be
recoverable. If the asset’s net carrying value exceeds the net undiscounted cash
flows expected to be generated over its remaining useful life, the carrying
amount of the asset is reduced to its estimated fair value. Estimated fair value
is determined based on discounted cash flows or appraised values depending on
the nature of the asset.





Direct
financing leases





The
Partnership assembles, installs, operates and leases equipment that reduces
volatile organic compound emissions (or VOC equipment) during
loading, transportation and storage of oil and oil products. Leasing of the VOC
equipment is accounted for as a direct financing lease with lease payments
received by the Partnership being allocated between the net investment in the
lease and other income using the effective interest method so as to produce a
constant periodic rate of return over the lease term.





Investment
in joint ventures





Investments
in companies over which the Partnership exercises significant influence but does
not consolidate are accounted for using the equity method, whereby the
investment is carried at the Partnership’s original cost plus its proportionate
share of undistributed earnings. The excess carrying value of the Partnership’s
investment over its underlying equity in the net assets is included in the
consolidated balance sheet as investment in joint ventures. On December 1, 2006,
the operating agreements for the five 50%-owned joint ventures, each of which
owns one shuttle tanker, were amended. These amendments resulted in the
Partnership obtaining control of these joint ventures and, consequently, the
Partnership has consolidated these entities effective December 1, 2006. As at
December 31, 2007, the Partnership had a 50% controlling interest in six joint
ventures.





Debt
issuance costs





Debt
issuance costs, including fees, commissions and legal expenses, are presented as
other assets and capitalized and amortized on a straight-line basis over the
term of the relevant loan. Amortization of debt issuance costs is included in
interest expense.





Goodwill
and intangible assets





Goodwill
is not amortized, but reviewed for impairment annually, or more frequently if
impairment indicators arise. A fair value approach is used to identify potential
goodwill impairment and, when necessary, measure the amount of impairment. The
Partnership uses a discounted cash flow model to determine the fair value of
reporting units, unless there is a readily determinable fair market value.
Intangible assets with finite lives are amortized over their useful
lives.














F-31





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





The
Partnership’s intangible assets, which consist of contracts of affreightment
acquired as part of the Predecessor’s purchase of Navion AS in 2003, are
amortized over their respective lives, with the amount amortized each year being
weighted based on the projected revenue to be earned under the
contracts.





Derivative
instruments





All
derivative instruments are initially recorded at cost as either assets or
liabilities in the accompanying consolidated balance sheet and subsequently
remeasured to fair value, regardless of the purpose or intent for holding the
derivative. The method of recognizing the resulting gain or loss is dependent on
whether the derivative contract is designed to hedge a specific risk and also
qualifies for hedge accounting. The Partnership generally designates its
interest rate swap agreements and foreign exchange forward contracts as cash
flow hedges for accounting purposes.





When a
derivative is designated as a cash flow hedge, the Partnership formally
documents the relationship between the derivative and the hedged item. This
documentation includes the strategy and risk management objective for
undertaking the hedge and the method that will be used to assess the
effectiveness of the hedge. Any hedge ineffectiveness is recognized immediately
in earnings, as are any gains and losses on the derivative that are excluded
from the assessment of hedge effectiveness. The Partnership does not apply hedge
accounting if it is determined that the hedge was not effective or will no
longer be effective, the derivative was sold or exercised, or the hedged item
was sold or repaid.





For
derivative financial instruments designated and qualifying as cash flow hedges,
changes in the fair value of the effective portion of the derivative financial
instruments are initially recorded as a component of accumulated other
comprehensive income in partners’ equity. In the periods when the hedged items
affect earnings, the associated fair value changes on the hedging derivatives
are transferred from partners’ equity to the corresponding earnings line item.
The ineffective portion of the change in fair value of the derivative financial
instruments is immediately recognized in earnings. If a cash flow hedge is
terminated and the originally hedged items may still possibly affect earnings,
the gains and losses initially recognized in partners’ equity remain until the
hedged item impacts earnings, at which point they are transferred to the
corresponding earnings line item (i.e. interest expense). If the hedged items
may no longer affect earnings, amounts recognized in partners’ equity are
immediately transferred to earnings.





For
derivative financial instruments that are not designated or that do not qualify
as hedges under Statement of Financial Accounting Standards (or SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, the changes in the fair value of the
derivative financial instruments are recognized in earnings.





Gains and
losses from the Partnership’s interest rate swaps that hedge long-term debt are
recorded in interest expense. Gains and losses from the Partnership’s foreign
exchange forward contracts are recorded in vessel operating expenses and general
and administrative expense.





Income
taxes





The
Partnership’s Norwegian subsidiaries and Australian subsidiary are subject to
income taxes. Deferred income taxes were $75.7 million as at December 31,
2007. The Partnership accounts for such taxes using the liability method
pursuant to SFAS No. 109, Accounting for Income Taxes(orSFAS
109).





In July
2006, the Financial Accounting Standards Board (or FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement No. 109 (or FIN 48). This interpretation
clarifies the accounting for uncertainty in income taxes recognized in financial
statements in accordance with SFAS 109. FIN 48 requires companies to determine
whether it is more-likely-than-not that a tax position taken or expected to be
taken in a tax return will be sustained upon examination, including resolution
of any related appeals or litigation processes, based on the technical merits of
the position. If a tax position meets the more-likely-than-not recognition
threshold, it is measured to determine the amount of benefit to recognize in the
financial statements based on guidance in the interpretation.





The
Partnership adopted FIN 48 as of January 1, 2007. The adoption of FIN 48 did not
have a significant impact on the Partnership’s financial position and results of
operations. As of January 1 and December 31, 2007, the Partnership did not have
any material unrecognized tax benefits or material accrued interest and
penalties relating to taxes. The Partnership does not expect any material
changes to its unrecognized tax positions within the next twelve
months.





The
Partnership recognizes interest and penalties related to uncertain tax positions
in income tax expense. The 2006 and 2007 tax years remain open to
examination by the major taxing jurisdiction to which the Partnership is
subject.





Recent
Accounting Pronouncements





In March
2008, the FASB ratified a consensus opinion reached by the Emerging Issues Task
Force (or EITF) on EITF
Issue No. 07-4, Application of
the Two-Class Method under FASB Statement No. 128, Earnings per Share to Master
Limited Partnerships(or EITF Issue No. 07-4). The
guidance in EITF Issue No. 07-4 requires incentive distribution rights in a
master limited partnership, such as the Partnership, to be treated as
participating securities for the purposes of computing earnings per share and
provides guidance on how earnings should be allocated to the various partnership
interests. EITF Issue No. 07-4 is effective for fiscal years beginning
after December 15, 2008. The Partnership is currently evaluating the
potential impact, if any, of the adoption of EITF Issue No.07-4 on its
consolidated results of operations and financial condition.








F-32








TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





In
December 2007, the FASB issued SFAS No. 141(R): Business Combinations(or
SFAS 141(R)), which
replaces SFAS No. 141,
Business Combinations. This statement establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired.
SFAS 141(R) also establishes disclosure requirements to enable the
evaluation of the nature and financial effects of the business combination.
SFAS 141(R) is effective for fiscal years beginning after December 15,
2008. The Partnership is currently evaluating the potential impact, if any, of
the adoption of SFAS 141(R) on its consolidated results of operations and
financial condition.





In
December 2007, the FASB issued SFAS No. 160: Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of Accounting Research Bulletin
No. 51 (or SFAS
160). This statement establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent's ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS 160 is effective for fiscal
years beginning after December 15, 2008. The Partnership is currently
evaluating the potential impact, if any, of the adoption of SFAS 160 on its
consolidated results of operations and financial condition.





In
February 2007, the FASB issued SFAS No. 159: The Fair Value Option for Financial
Assets and Financial Liabilities Including an Amendment of SFAS No.115(or SFAS 159).
This statement permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. The Partnership is
currently evaluating the potential impact, if any, of the adoption of
SFAS 159 on its consolidated results of operations and financial
condition.





In
September 2006, the FASB issued SFAS No. 157: Fair Value Measurements (or
SFAS 157). This
statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. This statement applies under other accounting
pronouncements that require or permit fair value measurements, and accordingly,
does not require any new fair value measurements.  SFAS 157 is
effective for fiscal years beginning after November 15, 2007. In February 2008,
the FASB delayed for one year the effective date of adoption with respect to
certain non-financial assets and liabilities. The Partnership is currently
evaluating the potential impact, if any, of the adoption of SFAS 157 on its
consolidated results of operations and financial condition.




2.    Initial
Public Offering




On
December 19, 2006, the Partnership completed its initial public offering (or the
Offering) of 8.05
million common units at a price of $21.00 per unit. This included 1.05 million
common units sold to the underwriters in connection with the exercise of their
over-allotment option. The proceeds received by the Partnership from the
Offering and the use of those proceeds are summarized as follows:





Proceeds
      received:Sale
      of 8,050,000 common units at $21.00 per
      unit
            
            $
            169,050Use
      of proceeds from sale of common units:Underwriting
      and structuring
      fees.
            
            $
            11,088Professional
      fees and other offering expenses to third
      parties
            
            
            2,793Repayment
      of promissory notes and redemption of 1.05 million common units from
      Teekay Corporation
            
            
            155,169$
            169,050





3.      Segment
Reporting





The
Partnership has three reportable segments: its shuttle tanker segment; its
conventional tanker segment; and its FSO segment. The Partnership’s shuttle
tanker segment consists of shuttle tankers operating primarily on fixed-rate
contracts of affreightment, time-charter contracts or bareboat charter
contracts. The Partnership’s conventional tanker segment consists of
conventional oil tankers primarily operating on fixed-rate time-charter
contracts. The Partnership’s FSO segment consists of its FSO units subject to
fixed-rate time-charter contracts or bareboat charter contracts. Segment results
are evaluated based on income from vessel operations. The accounting policies
applied to the reportable segments is the same as those used in the preparation
of the Partnership’s consolidated financial statements.





F-33





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





A
reconciliation of total segment assets to total assets presented in the
Company’s accompanying consolidated balance sheet is as follows:





December
      31, 2007
              $Shuttle
      tanker
      segment
            
            
            1,559,261Conventional
      tanker
      segment
            
            
            255,460FSO
      segment
            
            
            131,080Cash
      and cash
      equivalents
            
            
            121,506Accounts
      receivable and other
      assets
            
            
            99,499Consolidated
      total
      assets
            
            
            2,166,806





4.
            Intangible
      Assets





As at
December 31, 2007, intangible assets consisted of:





December
      31, 2007Weighted-
              Average
              Amortization
              Period
              (years)
            Gross
              Carrying
              Amount
              $
            Accumulated
              Amortization
              $
            Net
      C
              arrying
              Amount
              $Contracts
      of
      affreightment
            10.2
            124,250
            (68,895)
            55,355





Amortization
of intangible assets for the five fiscal years subsequent to December 31, 2007
is expected to be $10.1 million (2008), $9.1 million (2009), $8.1 million
(2010), $7.0 million (2011) and $6.0 million (2012).





5.    Accrued
Liabilities





December
      31, 2007
              $Voyage
      and
      vessel
            
            
            26,015Interest
            
            
            10,932Payroll
      and
      benefits
            
            
            1,51738,464





6.
            Long-Term
      Debt




December
      31, 2007
              $U.S.
      Dollar-denominated Revolving Credit Facilities due through
      2017
            
            
            1,205,808U.S.
      Dollar-denominated Term Loans due through
      2017
            
            
            311,6591,517,467Less
      current
      portion
            
            
            64,060Total
            
            
            1,453,407




As at
December 31, 2007, the Partnership had three long-term revolving credit
facilities (collectively, the Revolvers), which, as at such
date, provided for borrowings of up to $1,371.3 million, of which
$165.5 million was undrawn. The total amount available under the Revolvers
reduces by $101.8 million (2008), $108.2 million (2009),
$114.9 million (2010), $122.0 million (2011), $129.7 million
(2012) and $794.7 million (thereafter). Two of the Revolvers are
guaranteed by certain subsidiaries of the Partnership for all outstanding
amounts and contain covenants that require OPCO to maintain the greater of a
minimum liquidity (cash, cash equivalents and undrawn committed revolving credit
lines with at least six months to maturity) of at least $75.0 million and
5.0% of the OPCO’s total consolidated debt. The remaining revolving credit
facility is guaranteed by Teekay Corporation and contains covenants that require
Teekay Corporation to maintain the greater of a minimum liquidity of at least
$50.0 million and 5.0% of Teekay Corporation’s total consolidated debt
which is recoursed to Teekay Corporation. The Revolvers are collateralized by
first-priority mortgages granted on 28 of the Partnership’s vessels, together
with other related collateral.


As at
December 31, 2007, each of the Partnership’s six 50% controlled joint ventures
had an outstanding term loan, which in the aggregate totaled $311.7 million. The
term loans have varying maturities through 2017 and semi-annual payments that
reduce over time. All term loans are collateralized by first-priority mortgages
on the vessels to which the loans relate, together with other related
collateral. As at December 31, 2007, OPCO had guaranteed $103.8 million of these
term loans, which represents its 50% share of the outstanding vessel mortgage
debt of five of these 50% controlled joint venture companies. Teekay Corporation
and the Partnership’s joint venture partner have guaranteed the remaining $207.9
million.





F-34





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





Interest
payments on the Revolvers and the term loans are based on LIBOR plus a margin.
At December 31, 2007, the margins ranged between 0.45% and 0.80%. The
weighted-average effective interest rate on the Partnership’s long-term debt as
at December 31, 2007 was 5.7%. This rate does not reflect the effect of our
interest rate swaps (Note 10).





The
aggregate annual long-term debt principal repayments required to be made
subsequent to December 31, 2007 are $64.1 million (2008),
$115.6 million (2009), $107.0 million (2010), $164.0 million
(2011), $141.8 million (2012), and $925.0 million
(thereafter).





7.    Leases




Charters-out
and Direct Financing Lease
 
 Time
charters and bareboat charters of the Partnership’s vessels to customers are
accounted for as operating leases. The carrying amount of the vessels employed
on operating leases at December 31, 2007 was $1.3 billion (2006 - $1.1 billion).
Leasing of the VOC equipment is accounted for as direct financing leases. As at
December 31, 2007, the minimum lease payments receivable under the direct
financing leases approximated $125.6 million, including unearned income of
$25.1 million.
 
 As at
December 31, 2007, minimum scheduled future revenues under time charters
and bareboat charters and future scheduled payments under the direct financing
leases, to be received by the Partnership, then in place were approximately
$1,846.2 million, comprised of $366.1 million (2008),
$292.1 million (2009), $218.4 million (2010), $166.6 million
(2011), $155.2 million (2012) and $647.8 million (thereafter).
 
 The
minimum scheduled future revenues should not be construed to reflect total
charter hire revenues for any of the years.
 
 Charters-in
 
 As at
December 31, 2007, minimum commitments owing by the Partnership under
vessel operating leases by which the Partnership charters-in vessels were
approximately $480.4 million, comprised of $117.8 million (2008)
$87.4 million (2009), $80.9 million (2010), $61.8 million (2011),
$56.8 million (2012) and $75.7 million (thereafter). The Partnership recognizes
the expense from these charters, which is included in time-charter hire expense,
on a straight-line basis over the firm period of the charters.


8.
            Fair
      Value of Financial Instruments





The
following methods and assumptions were used to estimate the fair value of each
class of financial instrument:





Cash and cash equivalents-The fair
value of the Company’s cash and cash equivalents approximate their carrying
amounts reported in the accompanying consolidated balance sheet.





Derivative instruments – The
fair value of the Partnership’s derivative instruments is the estimated amount
that the Partnership would receive or pay to terminate the agreements at the
reporting date, taking into account current interest rates, foreign exchange
rates and the current credit worthiness of the swap counterparties.





The
estimated fair value of the Company’s financial instruments is as
follows:








December
      31, 2007Carrying
              Amount
              $
            
            
            Fair
              Value
              $Cash
      and cash
      equivalents
            
            
            121,506
            
            
            
            121,506Advances
      to (from) affiliate (note
    10v)
            
            
            969
            
            
            
            969Long-term
      debt
            
            
            (1,517,467
            )
            
            
            (1,517,467
            )Derivative
      instruments(1)
      (note
      11)Interest
      rate swap
      agreements
            
            
            (20,050
            )
            
            
            (20,050
            )Foreign
      currency
      contracts
            
            
            1,122
            
            
            
            1,122






(1)
            The
      Partnership transacts all of its derivative instruments through
      investment-grade rated financial institutions and requires no collateral
      from these institutions.












F-35





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





9.
            Related
      Party Transactions





a.
            The
      Partnership has entered into an omnibus agreement with Teekay Corporation,
      Teekay LNG Partners L.P. and others governing, among other things, when
      the Partnership, Teekay Corporation and Teekay LNG Partners L.P. may
      compete with each other and certain rights of first offering on liquefied
      natural gas carriers, oil tankers, shuttle tankers, FSO units and floating
      production, storage and offloading
units.





b.
            In
      July 2007, the Partnership acquired interests in two double-hull shuttle
      tankers from Teekay Corporation for a total cost of $159.1 million,
      including assumption of debt of $93.7 million and the related interest
      rate swap. The Partnership acquired Teekay Corporation's 100% interest in
      the 2000-built Navion Bergen and its 50%
      interest in the 2006-built Navion Gothenburg,
      together with their respective 13-year, fixed-rate bareboat charters to
      Petroleo Brasileiro S.A. The purchases were financed with one of the
      Partnership’s existing Revolvers and the assumption of
    debt.





c.
            In
      October 2007, the Partnership acquired from Teekay Corporation an FSO
      unit, the Dampier
      Spirit, along with its 7-year fixed-rate time-charter to Apache
      Corporationfor a total cost
      of $30.3 million. The purchase was financed with one of the Partnership’s
      existing Revolvers.





d.
            In
      December 2007, Teekay Corporation contributed a $65.6 million, nine-year,
      4.98% interest rate swap (used to hedge the debt assumed in the purchase
      of the Navion
      Bergen) having a fair value liability of $2.6 million (Note 10), to
      the Partnership for no
consideration.





e.
            In
      December 2007, Teekay Corporation agreed to reimburse OPCO for certain
      costs relating to events which occurred prior to the Offering, totalling
      $4.8 million, including the settlement of a customer dispute in respect of
      vessels delivered prior to the Offering and other costs. This amount is
      included in other current assets.





f.
            At
      December 31, 2007, advances to affiliates totaled $1.0 million.
      Advances to affiliates are non-interest bearing and unsecured.
       This amount is included in other current
  assets.





10.
            Derivative
      Instruments and Hedging Activities





The
Partnership uses derivatives only for hedging purposes. The following summarizes
the Partnership's risk strategies with respect to market risk from foreign
currency fluctuations and changes in interest rates.





The
Partnership hedges portions of its forecasted expenditures denominated in
foreign currencies with foreign exchange forward contracts.  These
foreign exchange forward contracts are designated as cash flow hedges of
forecasted foreign currency expenditures. Where such instruments are designated
and qualify as cash flow hedges, the effective portion of the changes in their
fair value is recorded in accumulated other comprehensive income (loss), until
the hedged item is recognized in earnings. At such time, the respective amount
in accumulated other comprehensive income (loss) is released to earnings and is
recorded within operating expenses, based on the nature of the expense being
hedged.





As at
December 31, 2007, the Partnership was committed to the following foreign
exchange contracts for the forward purchase of foreign currency:


Contract
      amount in
            
            
            Average
            
            
            Expected
      maturityforeign
      currency
            
            
            forward
      rate
            
            
            2008
            
            
            2009(millions)
            
            
            
            
            
            (in
      millions of U.S. Dollars)Norwegian
      Kroner
            
            
            255.7
            
            
            
            5.64
            
            
            
            -
            
            
            $
            45.4Australian
      Dollar
            
            
            5.0
            
            
            
            1.25
            
            
            $
            4.0
            
            
            
            -Singapore
      Dollar
            
            
            4.1
            
            
            
            1.44
            
            
            $
            2.9
            
            
            
            -Euro
            
            
            4.0
            
            
            
            0.68
            
            
            $
            5.8
            
            
            
            -





The
Partnership enters into interest rate swaps which exchange a receipt of floating
interest for a payment of fixed interest to reduce the Partnership’s exposure to
interest rate variability on its outstanding floating rate debt. The
Partnership’s interest rate swaps are designated as cash flow hedges and mature
over various periods through 2026. The net gains or loss on the swaps has been
reported in a separate component of accumulated other comprehensive income
(loss), in the accompanying consolidated balance sheet to the extent the hedges
are effective. The amount recorded in accumulated other comprehensive income
(loss) will subsequently be reclassified into earnings in the same period as the
hedged items affect earnings.





F-36





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)





As at
December 31, 2007, the Partnership was committed to the following interest rate
swap agreements related to its LIBOR-based debt, whereby certain of the
Partnership’s floating-rate debt was swapped with fixed-rate
obligations:





Interest
              Rate
              Index
            Principal
              Amount
              $
            Fair
      Value /
              Carrying
              Amount
      of
              Liability
              $
            Weighted-
              Average
              Remaining
              Term
              (years)
            Fixed
      Interest
              Rate
              (%)
      (1)U.S.
      Dollar-denominated interest rate swaps
            LIBOR
            935,000
            (8,374)
            6.5
            4.7U.S.
      Dollar-denominated interest rate swaps(2)
      (3)
            LIBOR
            414,373
            (11,676)
            13.3
            5.0









(1)
            Excludes
      the margin the Partnership pays on its variable-rate debt, which as at
      December 31, 2007, ranged from 0.50% and 0.80%.(2)
            Principal
      amount reduces quarterly or semiannually.(3)
            Included
      in the principal amount and fair value of the interest rate swaps is $65.6
      million and ($2.9) million, respectively, related to the portion of the
      derivative instrument that the Partnership has not designated as a cash
      flow hedge.







The
Partnership is exposed to credit loss in the event of non-performance by the
counter-parties to the foreign exchange forward contracts and the interest rate
swap agreements; however, the Partnership does not anticipate non-performance by
any of the counter-parties.





Changes
in the fair value of derivatives in economic hedges are recognized in earnings.
To the extent the cash flow hedges are effective, changes in the fair value of
the Partnership’s derivatives are recognized in other comprehensive income. The
ineffective portion of these derivative instruments is presented as interest
expense and foreign exchange gains and losses.





As at
December 31, 2007, the Partnership estimated, based on then-existing
interest rates, that it would reclassify approximately $1.3 million of net
loss on derivative instruments from accumulated other comprehensive loss to
earnings during the next 12 months due to the payment of interest expense
associated with the Partnership’s floating-rate debt and the payment of
expenditures denominated in foreign currencies.





As at
December 31, 2007, the Company’s accumulated other comprehensive loss of
$0.1 million consisted of unrealized losses on derivative
instruments.




11.
            Income
      Taxes





The
significant components of the deferred tax liabilities and assets are as
follows:





December
      31,
              2007
              $Deferred
      tax liabilities:Vessels and
      equipment
            
            
            84,077Goodwill and intangible
      assets
            
            
            266Long-term
      debt
            
            
            94,071Total
      deferred tax liabilities
            
            
            178,414Deferred
      tax assets:Provisions
            
            
            1,012Tax losses carried forward (1)
            
            
            101,696Total
      deferred tax
      assets
            
            
            102,708Net
      deferred tax
      liabilities
            
            
            75,706Current
      portion
            
            
            -Long-term
      portion of net deferred tax
      liabilities
            
            
            75,706





(1) The
net operating loss carryfowards are available to offset future taxable income in
the respective jurisdictions, and can be carried forward
indefinitely.





12.
            Commitments
      and Contingencies





In June
2007, the Partnership exercised its option to purchase a 2001-built shuttle
tanker, which is currently part of the Partnership’s in-chartered shuttle tanker
fleet.  As of December 31, 2007, the Partnership was committed to
acquiring this vessel for $41.7 million.  The vessel will be delivered
to the Partnership in March 2008 and the Partnership financed the purchase
through one of its revolving credit facilities.





F-37





TEEKAY
OFFSHORE GP L.L.C.


NOTES
TO THE CONSOLIDATED BALANCE SHEET  - (Cont'd)


(all
tabular amounts stated in thousands of U.S. dollars, unless otherwise
indicated)








13.
            Valuation
      and Qualifying Accounts





Balance
      at beginning
              of
      year
              $
            
            Balance
      at end
              of
      year
              $Allowance
      for bad debts:Year
      ended December 31, 2007
            
            
            401
            
            
            
            -Restructuring
      cost accrual:Year
      ended December 31, 2007
            
            
            71
            
            
            
            -





14.
            Supplemental
      information





The
following balance sheet shows the consolidation of the Teekay Offshore GP L.L.C.
balance sheet on a stand-alone basis with the balance sheet of Teekay Offshore
Partners L.P., as of December 31, 2007.





Teekay
      Offshore G.P. L.L.C.
              Stand-alone
            
            
            Consolidation
      of Teekay Offshore Partners L.P.
            
            
            Teekay
      Offshore G.P. L.L.C.
              ConsolidatedASSETSCurrent
              Cash
      and cash equivalents
            
            
            282
            
            
            
            121,224
            
            
            
            121,506Accounts
      receivable, net of allowance for doubtful accounts of $nil
            
            
            -
            
            
            
            42,245
            
            
            
            42,245Net
      investment in direct financing leases – current
            
            
            -
            
            
            
            22,268
            
            
            
            22,268Prepaid
      expenses
            
            
            -
            
            
            
            34,219
            
            
            
            34,219Other
      current assets
            
            
            173
            
            
            
            8,440
            
            
            
            8,613Total
      current assets
            
            
            455
            
            
            
            228,396
            
            
            
            228,851Vessels and
      equipment
              At
      cost, less accumulated depreciation of $693,338
            
            
            -
            
            
            
            1,662,865
            
            
            
            1,662,865Net
      investment in direct financing leases
            
            
            -
            
            
            
            78,199
            
            
            
            78,199Other
      assets
            
            
            3,046
            
            
            
            11,377
            
            
            
            14,423Intangible
      assets – net
            
            
            -
            
            
            
            55,355
            
            
            
            55,355Goodwill
      - shuttle tanker segment
            
            
            -
            
            
            
            127,113
            
            
            
            127,113Total
      assets
            
            
            3,501
            
            
            
            2,163,305
            
            
            
            2,166,806LIABILITIES
      AND MEMBER’S/PARTNERS’ EQUITYCurrent
              Accounts
      payable
            
            
            -
            
            
            
            12,076
            
            
            
            12,076Accrued
      liabilities
            
            
            -
            
            
            
            38,464
            
            
            
            38,464Current
      portion of long-term debt
            
            
            -
            
            
            
            64,060
            
            
            
            64,060Total
      current liabilities
            
            
            -
            
            
            
            114,600
            
            
            
            114,600Long-term
      debt
            
            
            -
            
            
            
            1,453,407
            
            
            
            1,453,407Deferred
      income taxes
            
            
            -
            
            
            
            75,706
            
            
            
            75,706Other
      long-term liabilities
            
            
            -
            
            
            
            50,024
            
            
            
            50,024Total
      liabilities
            
            
            -
            
            
            
            1,693,737
            
            
            
            1,693,737Non-controlling
      interest
            
            
            -
            
            
            
            470,995
            
            
            
            470,995Member’s/Partners’
      equityMember’s/Partners’
      equity
            
            
            3,501
            
            
            
            (1,320
            )
            
            
            2,181Accumulated
      other comprehensive loss
            
            
            -
            
            
            
            (107
            )
            
            
            (107
            )Total
      member’s/partners’ equity
            
            
            3,501
            
            
            
            (1,427
            )
            
            
            2,074Total
      liabilities and member’s/partners’ equity
            
            
            3,501
            
            
            
            2,163,305
            
            
            
            2,166,806






F-38