**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| ý | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|--------|----------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended September 30, 2004**

**OR**

** **
| o | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|---|-----------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom             to           **

 

**Commission File Number 1-313345**

 

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**PACIFICENERGY PARTNERS, L.P.**

(Exact name of registrant as specified in its charter)

 
| **DELAWARE**                                                    | **68-0490580**                       |
|-----------------------------------------------------------------|--------------------------------------|
| (State or other jurisdiction

of incorporation or organization) | (I.R.S. Employer Identification No.) |

 

**5900 Cherry Avenue**

**Long Beach, CA 90805-4408**

(Address of principal executive offices)

 

**(562) 728-2800**

(Registrant’s telephone number, including area code)

 

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                Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

                Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes ý  No o

 

                There were 19,121,638 of theregistrant’s Common Units and 10,465,000 of the registrant’s Subordinated Unitsoutstanding at September 30, 2004.

 

 

 

 

**PACIFICENERGY PARTNERS, L.P.**

 

**FORM 10-Q**

 

**TABLE OF CONTENTS**

 
| **PART I.  FINANCIAL INFORMATION** |                                                                                                                                         |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                            | Financial Statements                                                                                                                         |   |
|                                    | Condensed  Consolidated Balance Sheets (Unaudited)—As of September 30, 2004 and  December 31, 2003                                 |   |
|                                    | Condensed  Consolidated Statements of Income (Unaudited)—For the Three and Nine Months  Ended September 30, 2004 and 2003               |   |
|                                    | Condensed  Consolidated Statement of Partners’ Capital (Unaudited)—For the Nine Months  Ended September 30, 2004                   |   |
|                                    | Condensed  Consolidated Statements of Comprehensive Income (Unaudited)—For the Three and  Nine Months Ended September 30, 2004 and 2003 |   |
|                                    | Condensed  Consolidated Statements of Cash Flows (Unaudited)—For the Nine Months Ended  September 30, 2004 and 2003                     |   |
|                                    | Notes  to Condensed Consolidated Financial Statements (Unaudited)                                                                            |   |
| Item 2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                  |   |
| Item 3.                            | Quantitative  and Qualitative Disclosures About Market Risk                                                                                  |   |
| Item 4.                            | Controls and  Procedures                                                                                                                     |   |
| **PART II. OTHER  INFORMATION**    |                                                                                                                                         |
| Item 1.                            | Legal Proceedings                                                                                                                            |   |
| Item 6.                            | Exhibits                                                                                                                                     |   |

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. Financial Statements**

 

**PACIFIC ENERGY PARTNERS,L.P. (Note 1)**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                       | ** ** | **September 30,  2004**          | ** ** | **December  31,   2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                       | ** ** | **(in thousands)   (unaudited)** | ** ** |
| **ASSETS**                                                                                                                       |       |                             |       |                          |       |
| Current assets:                                                                                                                  |       |                             |       |                          |       |
| Cash and cash equivalents                                                                                                        |       | $                                | 14,528     |                          | $          | 9,699 |   |
| Crude oil sales receivable                                                                                                       |       | 35,470                           |       | 33,766                        |       |
| Transportation and storage accounts receivable                                                                                   |       | 21,071                           |       | 16,828                        |       |
| Canadian value added tax receivable                                                                                              |       | 7,099                            |       | —                        |       |
| Crude oil inventory                                                                                                              |       | 10,637                           |       | 2,272                         |       |
| Spare parts inventory                                                                                                            |       | 1,637                            |       | 1,644                         |       |
| Prepaid expenses                                                                                                                 |       | 5,799                            |       | 4,182                         |       |
| Other                                                                                                                            |       | 1,736                            |       | 405                           |       |
| Total current assets                                                                                                             |       | 97,977                           |       | 68,796                        |       |
| Property and equipment, net                                                                                                      |       | 713,351                          |       | 567,954                       |       |
| Investment in Frontier                                                                                                           |       | 7,841                            |       | 6,886                         |       |
| Other assets                                                                                                                     |       | 48,771                           |       | 6,567                         |       |
|                                                                                                                             |       | $                                | 867,940    |                          | $          | 650,203 |   |
| **LIABILITIES AND PARTNERS’ CAPITAL**                                                                                       |       |                             |       |                          |       |
| Current liabilities:                                                                                                             |       |                             |       |                          |       |
| Accounts payable and accrued liabilities                                                                                         |       | $                                | 9,291      |                          | $          | 6,933 |   |
| Accrued crude oil purchases                                                                                                      |       | 32,443                           |       | 31,602                        |       |
| Accrued interest                                                                                                                 |       | 5,448                            |       | 2,690                         |       |
| Accrued insurance                                                                                                                |       | 3,428                            |       | 1,883                         |       |
| Due to related parties (note 6)                                                                                             |       | 374                              |       | 580                           |       |
| Derivatives liability—current portion                                                                                       |       | 2,537                            |       | 4,986                         |       |
| Other                                                                                                                            |       | 7,490                            |       | 1,317                         |       |
| Total current liabilities                                                                                                        |       | 61,011                           |       | 49,991                        |       |
| Senior notes and credit facilities, net of unamortized discount of  $4,278 at September 30, 2004 (note 3)                   |       | 341,493                          |       | 298,000                       |       |
| Deferred income taxes                                                                                                            |       | 36,641                           |       | —                        |       |
| Derivatives liability                                                                                                            |       | —                           |       | 622                           |       |
| Other liabilities                                                                                                                |       | 7,185                            |       | 6,523                         |       |
| Total liabilities and deferred income taxes                                                                                      |       | 446,330                          |       | 355,136                       |       |
| Commitments and contingencies (note 8)                                                                                      |       |                             |       |                          |       |
| Partners’ capital (note 5):                                                                                            |       |                             |       |                          |       |
| Common unitholders (19,121,638 and 14,441,763 units outstanding at  September 30, 2004 and December 31, 2003, respectively) |       | 364,702                          |       | 246,952                       |       |
| Subordinated unitholders (10,465,000 units outstanding at September  30, 2004 and December 31, 2003)                        |       | 43,631                           |       | 49,010                        |       |
| General Partner interest                                                                                                         |       | 6,389                            |       | 3,975                         |       |
| Undistributed employee long-term incentive compensation                                                                          |       | 957                              |       | 738                           |       |
| Accumulated other comprehensive income (loss)                                                                                    |       | 5,931                            |       | (5,608                        | )          |
| Net partners’ capital                                                                                                       |       | 421,610                          |       | 295,067                       |       |
|                                                                                                                             |       | $                                | 867,940    |                          | $          | 650,203 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

1

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**PACIFIC ENERGY PARTNERS,L.P. (Note 1)**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

 
| ** **                                                                                                                                                                                         | ** ** | **Three Months   Ended September 30,**                    | ** ** | **Nine Months   Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **2004**                                                  | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                                         | ** ** | **(in thousands, except per unit amounts)   (unaudited)** | ** ** |
| Pipeline transportation revenue                                                                                                                                                                    |       | $                                                         | 28,160     |                                  | $          | 25,501 |   | $ | 79,879 |   | $ | 76,579 |   |
| Storage and distribution revenue                                                                                                                                                                   |       | 8,391                                                     |       | 4,710                                 |       | 27,773 |   | 4,710 |   |
| Pipeline buy/sell transportation revenue                                                                                                                                                           |       | 7,972                                                     |       | —                                |       | 11,662 |   | — |   |
| Crude oil sales, net of purchases of $103,192 and $96,833 for the  three months ended September 30, 2004 and 2003 and $278,689 and $271,554 for  the nine months ended September 30, 2004 and 2003 |       | 3,568                                                     |       | 5,907                                 |       | 14,436 |   | 16,516 |   |
| Net revenue before operating expenses                                                                                                                                                              |       | 48,091                                                    |       | 36,118                                |       | 133,750 |   | 97,805 |   |
| Expenses:                                                                                                                                                                                          |       |                                                      |       |                                  |       |   |   |   |   |
| Operating                                                                                                                                                                                          |       | 22,589                                                    |       | 16,630                                |       | 62,189 |   | 43,622 |   |
| Transition costs                                                                                                                                                                                   |       | 199                                                       |       | —                                |       | 383 |   | 397 |   |
| General and administrative                                                                                                                                                                         |       | 3,762                                                     |       | 3,305                                 |       | 11,252 |   | 10,289 |   |
| Depreciation and amortization                                                                                                                                                                      |       | 6,821                                                     |       | 5,049                                 |       | 17,776 |   | 13,435 |   |
|                                                                                                                                                                                               |       | 33,371                                                    |       | 24,984                                |       | 91,600 |   | 67,743 |   |
| Share of net income of Frontier                                                                                                                                                                    |       | 406                                                       |       | 414                                   |       | 1,190 |   | 1,141 |   |
| Operating income                                                                                                                                                                                   |       | 15,126                                                    |       | 11,548                                |       | 43,340 |   | 31,203 |   |
| Interest expense                                                                                                                                                                                   |       | (5,234                                                    | )          | (4,782                                | )          | (13,743 | ) | (12,930 | ) |
| Write-off of deferred financing cost and interest rate swap  termination expense (note 4)                                                                                                     |       | —                                                    |       | —                                |       | (2,901 | ) | — |   |
| Other income                                                                                                                                                                                       |       | 219                                                       |       | 113                                   |       | 606 |   | 360 |   |
| Income before income taxes                                                                                                                                                                         |       | 10,111                                                    |       | 6,879                                 |       | 27,302 |   | 18,633 |   |
| Income tax expense:                                                                                                                                                                                |       |                                                      |       |                                  |       |   |   |   |   |
| Current                                                                                                                                                                                            |       | 118                                                       |       | —                                |       | 150 |   | — |   |
| Deferred                                                                                                                                                                                           |       | 103                                                       |       | —                                |       | 57 |   | — |   |
|                                                                                                                                                                                               |       | 221                                                       |       | —                                |       | 207 |   | — |   |
| Net income                                                                                                                                                                                         |       | $                                                         | 9,890      |                                  | $          | 6,879 |   | $ | 27,095 |   | $ | 18,633 |   |
| Net income for the general partner interest                                                                                                                                                        |       | $                                                         | 198        |                                  | $          | 138 |   | $ | 542 |   | $ | 373 |   |
| Net income for the limited partner interests                                                                                                                                                       |       | $                                                         | 9,692      |                                  | $          | 6,741 |   | $ | 26,553 |   | $ | 18,260 |   |
| Basic net income per limited partner unit                                                                                                                                                          |       | $                                                         | 0.33       |                                  | $          | 0.30 |   | $ | 0.95 |   | $ | 0.85 |   |
| Diluted net income per limited partner unit                                                                                                                                                        |       | $                                                         | 0.33       |                                  | $          | 0.30 |   | $ | 0.94 |   | $ | 0.84 |   |
| Weighted average limited partner units outstanding:                                                                                                                                                |       |                                                      |       |                                  |       |   |   |   |   |
| Basic                                                                                                                                                                                              |       | 29,574                                                    |       | 22,532                                |       | 28,008 |   | 21,470 |   |
| Diluted                                                                                                                                                                                            |       | 29,682                                                    |       | 22,725                                |       | 28,125 |   | 21,648 |   |
|                                                                                                                                                                                                    |            |                                                           |            |                                       |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to condensed consolidated financial statements.

 

2

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**PACIFIC ENERGY PARTNERS,L.P. (Note 1)**

 

**CONDENSEDCONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL**

 
| ** **                                                                      | ** ** | **Limited Partner Units**       | ** ** | **Limited Partner Amounts** | ** ** | **General Partner** | ** ** | **Undistributed Employee Long-Term Incentive** | ** ** | **Accumulated Other Comprehensive** | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|---------------------|------------|------------------------------------------------|------------|-------------------------------------|------------|------------------|------------|
| ** **                                                                      | ** ** | **Common**                      | ** ** | **Subordinated**            | ** ** | **Common**          | ** ** | **Subordinate**                                | ** ** | **Interest**                        | ** ** | **Compensation** | ** ** | **Income (Loss)** | ** ** | **Total** | ** ** |
| ** **                                                                      | ** ** | **(in thousands)  (unaudited)** | ** ** |
| Balance,  December 31, 2003                                                |       | 14,442                          |       | 10,465                      |       | $                   | 246,952    |                                           | $          | 49,010                              |       | $                | 3,975      |   | $ | 738 |   | $ | (5,608 | ) | $ | 295,067 |   |
| Net income                                                                      |       | —                          |       | —                      |       | 16,627              |       | 9,926                                          |       | 542                                 |       | —           |       | — |   | 27,095 |   |
| Distribution to  partners                                                       |       | —                          |       | —                      |       | (25,659             | )          | (15,305                                        | )          | (836                                | )          | —           |       | — |   | (41,800 | ) |
| Issuance of  common units, net of fees and offering expenses (note 5)      |       | 4,625                           |       | —                      |       | 125,881             |       | —                                         |       | —                              |       | —           |       | — |   | 125,881 |   |
| General partner  contribution related to issuance of common units (note 5) |       | —                          |       | —                      |       | —              |       | —                                         |       | 2,690                               |       | —           |       | — |   | 2,690 |   |
| Undistributed  employee compensation under long-term incentive plan             |       | —                          |       | —                      |       | —              |       | —                                         |       | —                              |       | 1,777            |       | — |   | 1,777 |   |
| Issuance of  common units pursuant to long-term incentive plan                  |       | 55                              |       | —                      |       | 901                 |       | —                                         |       | 18                                  |       | (1,558           | )          | — |   | (639 | ) |
| Foreign currency  translation adjustment                                        |       | —                          |       | —                      |       | —              |       | —                                         |       | —                              |       | —           |       | 7,742 |   | 7,742 |   |
| Change in fair  value of hedging derivatives                                    |       | —                          |       | —                      |       | —              |       | —                                         |       | —                              |       | —           |       | 3,797 |   | 3,797 |   |
| Balance,  September 30, 2004                                                    |       | 19,122                          |       | 10,465                      |       | $                   | 364,702    |                                           | $          | 43,631                              |       | $                | 6,389      |   | $ | 957 |   | $ | 5,931 |   | $ | 421,610 |   |
|                                                                                 |            |                                 |            |                             |            |                     |            |                                                |            |                                     |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to condensed consolidated financial statements.

 

 

3

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**PACIFIC ENERGY PARTNERS,L.P. (Note 1)**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

 
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | **(in thousands)   (unaudited)**      |
| Net income                                  |       | $                                     | 9,890      |                                 | $          | 6,879 |   | $ | 27,095 |   | $ | 18,633 |   |
| Change in fair value of hedging derivatives |       | (1,107                                | )          | 4,143                                |       | 3,797 |   | (845 | ) |
| Foreign currency translation adjustment     |       | 5,313                                 |       | —                               |       | 7,742 |   | — |   |
| Comprehensive income                        |       | $                                     | 14,096     |                                 | $          | 11,022 |   | $ | 38,634 |   | $ | 17,788 |   |
|                                             |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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**PACIFIC ENERGY PARTNERS,L.P. (Note 1)**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                              | ** ** | **Nine Months Ended  September 30,**        | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                                    | ** ** | **2003** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)  (unaudited)**             | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                    |       |                                        |       |   |   |
| Net income                                                                              |       | $                                           | 27,095     |   | $ | 18,633 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:      |       |                                        |       |   |   |
| Depreciation and amortization                                                           |       | 17,776                                      |       | 13,435 |   |
| Amortization of debt issue costs and accretion of bond discount                         |       | 1,100                                       |       | 745 |   |
| Write-off of deferred financing cost                                                    |       | 2,321                                       |       | — |   |
| Non-cash portion of employee compensation under long-term  incentive plan               |       | 1,120                                       |       | 1,955 |   |
| Deferred tax expense                                                                    |       | 57                                          |       | — |   |
| Share of net income of Frontier                                                         |       | (1,190                                      | )          | (1,141 | ) |
| Distributions from (Contributions to) Frontier, net                                     |       | (44                                         | )          | 1,777 |   |
|                                                                                    |       | 48,235                                      |       | 35,404 |   |
| Net changes in operating assets and liabilities:                                        |       |                                        |       |   |   |
| Crude oil sales receivable                                                              |       | (1,704                                      | )          | (3,519 | ) |
| Transportation and storage accounts receivable                                          |       | (3,318                                      | )          | (3,696 | ) |
| Other current assets and liabilities                                                    |       | (13,834                                     | )          | 970 |   |
| Accounts payable and other accrued liabilities                                          |       | 12,194                                      |       | 2,804 |   |
| Accrued crude oil purchases                                                             |       | 841                                         |       | 758 |   |
| Other non-current assets and liabilities                                                |       | (400                                        | )          | 680 |   |
|                                                                                    |       |        (6,221 | )          | (2,003 | )  |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                               |       | 42,014                                      |       | 33,401 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                    |       |                                        |       |   |   |
| Acquisitions                                                                            |       | (139,000                                    | )          | (159,939 | ) |
| Additions to property and equipment                                                     |       | (11,522                                     | )          | (2,320 | ) |
| Other                                                                                   |       | (621                                        | )          | 137 |   |
| NET CASH USED IN INVESTING ACTIVITIES                                                   |       | (151,143                                    | )          | (162,122 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                    |       |                                        |       |   |   |
| Issuance of common units, net of fees and offering expenses                             |       | 125,881                                     |       | 131,716 |   |
| Capital contributions from the general partner                                          |       | 2,708                                       |       | 1,955 |   |
| Redemption of common units held by the general partner, net of  underwriter’s fees |       | —                                      |       | (40,780 | ) |
| Net proceeds from senior notes offering                                                 |       | 241,086                                     |       | — |   |
| Repayment of term loan                                                                  |       | (225,000                                    | )          | — |   |
| Proceeds from bank credit facilities                                                    |       | 157,924                                     |       | 149,000 |   |
| Repayment of bank credit facilities                                                     |       | (145,453                                    | )          | (90,000 | ) |
| Deferred bank financing costs                                                           |       | (1,388                                      | )          | — |   |
| Distributions to partners                                                               |       | (41,800                                     | )          | (29,657 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                               |       | 113,958                                     |       | 122,234 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                    |       | 4,829                                       |       | (6,487 | ) |
| CASH AND CASH EQUIVALENTS, beginning of reporting period                                |       | 9,699                                       |       | 23,873 |   |
| CASH AND CASH EQUIVALENTS, end of reporting period                                      |       | $                                           | 14,528     |   | $ | 17,386 |   |
| Supplemental disclosures:                                                               |       |                                        |       |   |   |
| Cash paid for interest                                                                  |       | $                                           | 10,686     |   | $ | 11,716 |   |
| Non-cash financing and investing activities:                                            |       |                                        |       |   |   |
| Change in fair value of hedging derivatives                                             |       | $                                           | 3,797      |   | $ | (845 | ) |
| Foreign currency translation adjustment                                                 |       | $                                           | 7,742      |   | $ | — |   |
| Issuance of common units upon vesting pursuant to long-term incentive  plan             |       | $                                           | 1,558      |   | $ | 1,473 |   |
| Addition to equipment                                                                   |       | $                                           | —     |   | $ | 124 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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**PACIFIC ENERGY PARTNERS, L.P.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**September 30, 2004**

 

**(Unaudited)**

 

**1.     SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

**Basis of Presentation**

 

        Pacific Energy Partners,L.P. and its subsidiaries (the “Partnership”) are engaged principally in thebusiness of gathering, transporting, storing and distributing crude oil andrelated products in California and the Rocky Mountain region of the U.S. andCanada. The Partnership generates revenue primarily by transporting crude oilon its pipelines and by leasing storage capacity. The Partnership also buys,blends and sells crude oil, activities that are complementary to thePartnership’s pipeline transportation business. The Partnership operatesprimarily in California, Colorado, Montana, Wyoming and Utah in the UnitedStates, and in Alberta, Canada and conducts its business through two regionaloperating units: West Coast operations and Rocky Mountain operations.

 

        The unaudited condensedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial reporting and with Securities and Exchange Commission (“SEC”)regulations. Accordingly, these statements have been condensed and do notinclude all of the information and footnotes required for complete financialstatements. These statements involve the use of estimates and judgments whereappropriate. In the opinion of management, all adjustments, consisting ofnormal recurring accruals considered necessary for a fair presentation, havebeen included. The results of operations for the three and nine months endedSeptember 30, 2004 and 2003 are not necessarily indicative of the results ofoperations for the full year. The financial data for the three and nine monthsended September 30, 2004 and 2003 is derived from the Partnership’s unauditedcondensed consolidated financial statements. The financial data as ofDecember 31, 2003 is derived from the Partnership’s audited consolidatedfinancial statements. All significant intercompany balances and transactionshave been eliminated during the consolidation process.

 

        These financial statementsshould be read in conjunction with the Partnership’s audited consolidatedfinancial statements and notes thereto included in the Partnership’s annualreport on Form 10-K for the year ended December 31, 2003.

 

**Revenue Recognition**

 

        During the second quarterof 2004, the Partnership completed the acquisition (see “Note 2 — Acquisitions”below) of the Rangeland Pipeline system and the Mid-Alberta pipeline (the “MAPLpipeline”).  Revenue from the RangelandPipeline system (including the MAPL pipeline) is recognized upon delivery ofthe crude oil, condensate and butane to the customer. Customers who wish totransport product on the Rangeland Pipeline system may either: (i) sellproduct at the inlet to the pipeline without repurchasing product; or(ii) sell product at an inlet point and repurchase such product at agreedupon delivery points for the price paid at the inlet to the pipeline plus anestablished location differential on a pre-arranged basis.

 

**Derivative Instruments**

 

        The Partnership uses, on alimited basis, certain derivative instruments (principally futures and options)to hedge its minimal exposure to market price volatility related to its crudeoil inventory or future sales of crude oil. Derivatives used to hedge marketprice volatility related to inventory are generally designated as fair valuehedges, and derivatives related to future sale of crude oil are generallydesignated as cash flow hedges. The Partnership does not engage in speculativederivative activities. Derivative instruments are included in other assets inthe accompanying consolidated balance sheets.

 

        Changes in the fair valueof the Partnership’s derivative instruments related to crude oil inventory arerecognized in net income. “Crude oil sales, net of purchases” were net of aloss of $1.7 million for the three months ended September 30, 2004 and animmaterial amount for 2003, and $2.3 million and $0.3 million for the ninemonths ended September 30, 2004 and 2003, respectively, reflecting changes inthe fair value of derivative instruments held for crude oil marketingactivities. Changes in the fair value of the Partnership’s derivativeinstruments related to the future sale of crude oil are deferred and 

 

6

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reflected in “accumulated other  comprehensive income,” a component of partners’capital, until the related revenue is included in the consolidated statementsof income. As of September 30, 2004, $1.8 million relating to the changesin the fair value of highly effective derivative instruments was included in “accumulatedother comprehensive income” and is expected to be reclassified to earnings in2004.

 

        In August andSeptember 2002, the Partnership entered into three interest rate swapagreements that were to mature in 2009, with notional amounts of$140.0 million, and two interest rate swap transactions that were to maturein 2007, with notional amounts of $30.0 million. The Partnershipdesignated these swaps as a hedge of its exposure to variability in future cashflows attributable to the LIBOR interest payments due on $170.0 millionoutstanding under the term loan facility. The average swap rate on this$170.0 million of debt was approximately 4.25%, resulting in an all-ininterest rate on the $170.0 million of debt of approximately 6.50%(including the applicable margin of 2.25%). In June 2004, in conjunctionwith the issuance of the 7.125% Senior Notes and the repayment of the termloan, the Partnership bought back the swaps for a loss of $0.6 million.

 

        In connection with theissuance of the 7.125% Senior Notes, the Partnership entered into interest rateswap agreements with an aggregate notional principal amount of$80.0 million to receive interest at a fixed rate of 7.125% and to payinterest at an average variable rate of six month LIBOR plus 1.6681% (set inadvance or in arrears depending on the swap transaction). The interest rateswaps mature June 15, 2014 and are callable at the same dates and terms asthe 7.125% Senior Notes. The Partnership designated these swaps as a hedge ofthe change in the Senior Notes fair value attributable to changes in the sixmonth LIBOR interest rate. Changes in fair values of the interest rate swapsare recorded into earnings each period. Similarly, changes in the fair value ofthe underlying $80.0 million of Senior Notes are recorded into earningseach period.  During the three months ended September 30,2004, we recognized reductions in interest expense of $0.7 million related tothe difference between the fixed rate and the floating rate of interest on theinterest rate swaps.  During the quarter ended September 30, 2004, we measuredthe hedge effectiveness of this interest rate swap and noted that no gain orloss from ineffectiveness was required to be recognized.  The fair valueof this interest rate swap was a gain of approximately $2.9 million atSeptember 30, 2004.

 

**Foreign Currency Translation**

 

        The financial statementsof operating subsidiaries in Canada are measured using the Canadian dollar asthe functional currency. Balance sheet amounts are translated at the end ofperiod exchange rate.  Income statementand cash flow amounts are translated at the average exchange rate for theperiod. Adjustments from translating these financial statements into U.S.dollars are accumulated in the equity section of the balance sheet under thecaption, “accumulated other comprehensive income (loss).”

 

**Income Taxes**

 

        The Partnership and itsU.S. subsidiaries are not taxable entities and are not subject to federal orstate income taxes as the tax effect of operations is accrued to itsunitholders. The Partnership’s Canadian subsidiaries are taxable entities inCanada and are subject to Canadian federal and provincial income taxes. Inaddition, monies repatriated from Canada into the U.S. may be subject towithholding taxes.

 

        Net income for financialstatement purposes may differ significantly from taxable income reportable tounitholders as a result of differences between the tax bases and financialreporting bases of assets and liabilities and the taxable income allocationrequirements under the Partnership’s First Amended and Restated Agreement ofLimited Partnership, as amended.

 

        Income taxes are accountedfor under the asset and liability method. Under this method, deferred taxassets and liabilities are recognized to reflect the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in net income inthe period that includes the enactment date.

 

        Pursuant to FASNo. 109, “Accounting for Income Taxes”, in the second quarter of 2004, thePartnership recorded a deferred tax liability of $33.9 million,representing the tax effect of the difference between the amounts paid forshares of certain entities that owned the assets that comprise the RangelandPipeline system (see “Note 2 — Acquisitions” below), and the underlying taxbasis of the assets.

 

 

7

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**Net Income per Unit**

 

        Basic net income perlimited partner unit is determined by dividing net income after deducting theamount allocated to the general partner interest, by the weighted averagenumber of outstanding limited partner units.

 

        Diluted net income perlimited partner unit is calculated in the same manner as basic net income perlimited partner unit except that the weighted average number of outstandinglimited partner units is increased to include the dilutive effect ofoutstanding unit options and restricted units by application of the treasury stockmethod.  Set forth below is areconciliation of the basic weighted average outstanding limited partner unitsto diluted weighted average outstanding limited partner units.

 
| ** **                                     | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **(in thousands)  (unaudited)**       | ** ** |
| Basic weighted average limited partner units   |       | 29,574                                |       | 22,532                               |       | 28,008 |   | 21,470 |   |
| Effect of restricted units                     |       | 93                                    |       | 181                                  |       | 102 |   | 170 |   |
| Effect of unit options                         |       | 15                                    |       | 12                                   |       | 15 |   | 8 |   |
| Diluted weighted average limited partner units |       | 29,682                                |       | 22,725                               |       | 28,125 |   | 21,648 |   |

 

**Reclassifications**

 

        Certain prior year balances in theaccompanying condensed consolidated financial statements have been reclassifiedto conform to the current year presentation.

 

**2.     ACQUISITIONS**

 

**Rangeland**

 

        On May 11, 2004, the Partnershipcompleted the acquisition of all of the outstanding shares of RangelandPipeline Company (“RPC”), Rangeland Marketing Company (“RMC”) and AuroraPipeline Company Ltd. (“APC”), the corporations that owned variouscomponents of the Rangeland Pipeline System and the related marketing businessfrom BP Canada Energy Company (“BP”). The Rangeland Pipeline System is locatedin the province of Alberta, Canada. The purchase price for the shares of RPC,RMC and APC was Cdn$130 million plus approximately Cdn$29 million forlinefill, working capital, transaction costs and transition capitalexpenditures. The aggregate purchase price was approximately U.S.$116 million and was funded through a combination of proceeds from the Partnership’sMarch 30, 2004 equity offering and a Cdn$45 million borrowing from anew Cdn$100 million revolving credit facility in Canada. The acquisitionwas accounted for as an acquisition of assets.

 

        The majority of the Rangeland PipelineSystem was constructed in 1966 with smaller portions being built as early as1955 and certain pump stations built as late as 1971. The Partnership isdepreciating the pipeline over forty years from the purchase date.

 

        Pursuant to a transportation serviceagreement between RMC, RPC and APC, RMC has contracted for the rights to theentire capacity of the Rangeland pipeline. Customers who wish to transportproduct on the Rangeland pipelines may, therefore, either: (i) sellproduct to RMC at the inlet to the pipeline without repurchasing product fromRMC; or (ii) sell product to RMC at an inlet point and repurchase suchproduct at agreed upon delivery points for the price paid at the inlet to thepipeline plus an established location differential. RMC owns the buy/sell contractswith customers, which were assumed with the purchase, but the marketingfunction was conducted by employees of BP to whom we were not able to and didnot offer employment.

 

        The Rangeland Pipeline System hashistorically been operated without regard to maximizing either pipelinethroughput or profitability; rather, it was operated as an integral part of alarger marketing and trading oriented enterprise. Similarly the MAPL Pipeline,which the Partnership also purchased (see “Mid Alberta Pipeline” below), wasnot operated with regard to maximizing pipeline operations or profitability; itwas operated as a cost center in a larger enterprise. The Partnership intendsto make significant changes to the revenue-generating capability of bothsystems by combining and integrating fully all of its Canadian and U.S. RockyMountain pipeline systems under common management, by expanding the throughputcapacity of

 

 

8

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 the MAPL system and by connecting into otherpipelines and establishing a new pump station and receiving terminal inEdmonton, Alberta. This new facility will be able to access additional sourcesof Canadian crude oil, which will allow the Partnership to participate intransporting the projected increase in production of Canadian synthetic crudeoil.

 

        In effect, the Partnership is convertingwhat has been primarily a gathering system for crude oil, condensate and butanein southern Alberta into a trunk line transportation system that will be ableto transport multiple grades of conventional and synthetic crude oils from theEdmonton oil hub to U.S. Rocky Mountain refining centers.

 

        Until April 2003, the assetscomprising the Rangeland Pipeline System were held by three legal entities: BP,APC and BP Canada Energy Resources Company (“BPR”). In April 2003, inorder to facilitate their sale, BPR formed RPC and RMC, and transferred theRangeland pipeline and marketing assets to the newly formed entities. APC,which contains only a short segment of pipeline and *de minimis* other assets, liabilities, revenues and expenses,remained unchanged. None of RPC, RMC or APC ever had any employees of theirown. All operations and administrative and technical support functionsassociated with the Rangeland pipeline system, including field services andoperations, executive management, marketing, engineering, environmental, riskmanagement, payroll, treasury, human resources and legal remained with BPR andBP. These included services provided by approximately 90 BP employees who alsoprovided varying amounts of support for BP’s other pipelines.

 

        Although the RPC and RMC legal entitieswere formed in April 2003, revenues, expenses, and other financialmeasures continued to be included within the financial statements of BPR andBP. Financial statements for RPC, RMC and Aurora were not maintained on acurrent basis.

 

        Upon closing of the purchasetransaction, BP terminated employees directly involved in the operation of theRangeland Pipeline System, including field-level supervisors, and thePartnership hired those who accepted an offer of employment. Except for oneformer marketing person (who had not been directly involved with marketing ofthe Rangeland Pipeline System for several years), no members of seniormanagement, and no financial, marketing or technical personnel who had beenassociated with the management and support of the Rangeland system were madeavailable by BP for possible employment with the Partnership following thecompletion of this acquisition. Consequently, the Partnership hired its ownmarketing, accounting and technical staffs, which are located in its newCalgary office or in Olds, Alberta. The Partnership also utilizes its existingexecutive and support staff in Long Beach, California and Denver, Colorado toprovide management oversight and administrative and technical support for theAlberta assets.

 

        The existing accounting software andcomputer hardware were not included with the assets purchased by thePartnership. The Partnership was able, however, to acquire as part of thetransaction, the Supervisory Control and Data Acquisition (SCADA) systemnecessary to operate the pipeline. Subsequent to the closing, the Partnershipacquired software associated with the complex task of volumetric and revenue accountingfrom the seller for no additional consideration. The Partnership will use itsexisting financial accounting software for other accounting functions.

 

**Mid Alberta Pipeline**

 

        On June 30, 2004, the Partnershipcompleted the acquisition of the MAPL Pipeline from Imperial Oil. The MAPLpipeline is located in Alberta, Canada. The purchase price for MAPL wasCdn$31.5 million, of which Cdn$5.0 million is payable June 30, 2007.In addition to the MAPL pipeline, the Partnership acquired linefill forCdn$5.0 million.  The aggregatepurchase price, including linefill, transaction costs and first-yearconstruction costs, was approximately U.S. $30 million, most of which wasfunded from the Partnership’s existing Canadian credit facility.

 

        The first section of MAPL pipeline wasconstructed in 1960 and other sections were constructed in 1985 and 1994. ThePartnership anticipates depreciating the pipeline over forty years from thedate of purchase.

 

        Imperial Oil did not make any of itsemployees available for possible employment with the Partnership following thecompletion of the acquisition. In connection with the purchase, the Partnershipentered into a two-year transitional services agreement with Imperial Oilwhereby Imperial Oil provides necessary services to operate the initiating pumpstation and the control center and software that control movements through theMAPL pipeline. The Partnership has the right to cancel the transitionalservices agreement at any time. The Partnership expects to assume all MAPL pipelineoperations and transfer MAPL operations to the Partnership’s Rangeland controlcenter after its initiation facilities in Edmonton are constructed andoperational.

 

 

9

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        The existing accounting software orcomputer hardware was not included with the assets purchased by thePartnership.  The task of volumetric andrevenue accounting has been consolidated with the accounting process for theRangeland Pipeline system. The Partnership uses its existing financialaccounting software for other accounting functions.

 

        The acquisition of MAPL was accountedfor as an acquisition of assets. Following the acquisition, the MAPL pipeline assets were integrated intoand will be operated as part of the Rangeland Pipeline system.

 

**Purchase Price Allocations**

 

        The acquisitions of Rangeland and MAPLhave been accounted for by the purchase method of accounting pursuant toStatement of Financial Accounting Standards (“FAS”) No. 141, “BusinessCombinations” and, accordingly the consolidated statements of income includethe results of Rangeland and MAPL from their acquisition dates. Based uponindependent appraisals of the fair values of the acquired assets, thePartnership is completing its review and determination of the fair values ofthe assets acquired and liabilities assumed. Accordingly, the allocation of thepurchase price is subject to revision. Based upon the preliminary estimates,the purchase price is being allocated to depreciable pipelines and relatedequipment, crude oil inventory, pipeline linefill, and rights of way, as wellas to amortizable intangible assets. In addition to the cash purchase price andrelated acquisition costs, the Partnership assumed an environmental liabilityof approximately $2.2 million, and pursuant to FAS 109, *Accounting for Income Taxes* thePartnership recorded a deferred tax liability of approximately$33.9 million, representing the tax effect of the difference between theamounts paid for shares of RPC, RMC and APC, and the underlying tax basis ofthe assets.

 

**3.     LONG-TERM DEBT**

 

        The Partnership’s long-term debtobligations at September 30, 2004 and December 31, 2003 are shown below:

 
| ** **                                          | ** ** | **September 30, 2004**     | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **(in thousands)  (unaudited)** | ** ** |
| Senior secured U.S. revolving credit facility       |       | $                               | 38,000     |                            | $          | 73,000 |   |
| Senior secured Canadian revolving credit facility   |       | 51,392                          |       | —                          |       |
| Senior notes, net of unamortized discount of $4,278 |       | 248,655                         |       | —                          |       |
| Senior secured term loan                            |       | —                          |       | 225,000                         |       |
| Future payment for MAPL assets                      |       | 3,446                           |       | —                          |       |
| Total                                               |       | 341,493                         |       | 298,000                         |       |
| Less current portion                                |       | —                          |       | —                          |       |
| Long-term debt                                      |       | $                               | 341,493    |                            | $          | 298,000 |   |

 

**Senior Secured U.S. Revolving Credit Facility and Term Loan**

 

        The revolving credit facility is a$200.0 million facility which matures on July 26, 2007 and is availablefor general partnership purposes, including working capital, letters of creditand distributions to unitholders, and to finance future acquisitions.Borrowings under the revolving credit facility are limited by various financialcovenants in the credit agreement. The revolving credit facility has aborrowing sublimit of $45.0 million for working capital, letters of creditand partnership distributions to unitholders.

 

        The revolving credit facility bearsinterest at the Partnership’s option, at either (i) the base rate, whichis equal to the higher of the prime rate as announced by Fleet National Bank orthe Federal Funds rate plus 0.50% or (ii) LIBOR plus an applicable marginranging from 0.75% to 2.00%. The applicable margins are subject to change basedon the credit rating of the revolving credit facility or, if is not rated, thecredit rating of the Partnership’s U.S. operating subsidiary, Pacific EnergyGroup LLC.  The Partnership incurs acommitment fee which ranges from 0.125% to 0.375% per annum on the unusedportion of the revolving credit facility.

 

        As of September 30, 2004, $38.0 millionwas outstanding under the revolving credit facility and $111 million ofundrawn credit was available under the credit facility.

 

        On June 16, 2004, the Partnershiprepaid all amounts outstanding under the term loan. Amounts under the term loanthat have been repaid may not be re-borrowed.

 

10

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**Canadian Revolving Credit Facility**

 

        On May 11, 2004, Rangeland PipelineCompany, a Canadian subsidiary of the Partnership, entered into a Canadianrevolving credit facility agreement which is guaranteed by certain Canadiansubsidiaries of the Partnership. The maximum amount available under theCanadian revolving credit facility is Cdn$75 million, which will befurther increased to Cdn$100 million after certain other conditions aresatisfied. The Canadian revolving credit facility is secured by liens on all ofthe property and assets of the Partnership’s Canadian subsidiaries.

 

        Indebtedness under the Canadianrevolving credit facility bears interest, at Rangeland Pipeline Company’soption, at either (i) the Canadian prime rate or the U.S. base rate (eachplus an applicable margin ranging from 1.00% to 1.625%, or (ii) Bankers’Acceptance discount rates, or LIBOR plus an applicable margin ranging from2.00% to 2.65%. The applicable margins are subject to change based on certainfinancial ratios.

 

        The Canadian revolving credit facilitymatures on May 11, 2007.  Amountsoutstanding under the credit facility may be repaid at any time prior tomaturity.

 

        The Canadian revolving credit facilityis available for general corporate purposes and also provides for the issuanceof letters of credit. Borrowings under this facility are limited by variousfinancial covenants that are set forth in the Canadian credit agreement. As ofSeptember 30, 2004, Rangeland Pipeline Company was in compliance with allcovenants under the Canadian agreement. At September 30, 2004, borrowings totalingCdn$65.0 million (U.S.$51.4 million) and letters of credit totalingCdn$5.0 million (U.S.$4.0 million) were outstanding under theCanadian revolving credit facility. As of September 30, 2004, the Partnershiphad available but undrawn credit of Cdn$5.0 million(U.S.$4.0 million) under its Canadian revolving credit facility.

 

        Rangeland Pipeline Company incurs acommitment or standby fee which ranges from 25% to 35% of the applicablemargin, based on the unused portion of the Canadian revolving credit facility.Under the Canadian credit agreement, Rangeland Pipeline Company is prohibitedfrom declaring dividends or making any other distributions or payments to itsparent or its affiliates if any default or event of default, as defined in theCanadian credit agreement, occurs or would result from such declaration orpayment, or if a material adverse effect, as defined in the Canadian creditagreement, would result from such declaration or payment, or if thedistributions and payments would exceed certain limits. The Canadian creditagreement also contains covenants requiring Rangeland Pipeline Company,including its subsidiaries and affiliates, to maintain specified financialratios. In addition, the Canadian credit agreement contains other restrictivecovenants. As of September 30, 2004, Rangeland Pipeline Company was incompliance with all covenants under the Canadian credit agreement.

 

**7.125% Senior Notes**

 

        On June 16, 2004, the Partnershipand its 100% owned subsidiary, Pacific Energy Finance Corporation, completedthe sale of $250 million of 7.125% senior notes due June 15, 2014(the “Senior Notes”).  The Senior Notes were sold in aprivate offering to qualified institutional buyers in reliance on Rule144A under the Securities Act of 1933 (the “Securities Act”) and tonon-U.S. persons under Regulation S under the Securities Act.  The Senior Notes were issuedat a discount of $4.4 million, resulting in an effective interest rate of7.375%. Interest payments are due on June 15 and December 15 of eachyear, beginning on December 15, 2004. At any time prior to June 15,2007, the Partnership has the option to redeem up to 35% of the aggregateprincipal amount of notes at a redemption price of 107.125% of the principalamount with the net cash proceeds of one or more equity offerings. ThePartnership has the option to redeem the Senior Notes, in whole or in part, atanytime on or after June 15, 2009 at the following redemption prices:

 
| **Year**            | ** ** | **Percentage** | ** ** |
|---------------------|------------|----------------|------------|
| 2009                |       | 103.563        | %          |
| 2010                |       | 102.375        | %          |
| 2011                |       | 101.188        | %          |
| 2012 and thereafter |       | 100.000        | %          |

 

        The Senior Notes are jointly andseverally guaranteed by certain of the Partnership’s subsidiaries, includingPacific Energy Group LLC, Pacific Marketing and Transportation LLC, RockyMountain Pipeline System LLC, Ranch Pipeline LLC, PEG Canada GP LLC and PEGCanada, L.P.

 

 

11

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        In addition, the indenture governing theSenior Notes contains certain covenants that, among other things, limit thePartnership’s ability and the ability of its restricted subsidiaries to incuror guarantee indebtedness or issue certain types of preferred equitysecurities; sell assets; pay distributions on, redeem or repurchase Partnershipunits; consolidate, merge or transfer all or substantially all of its assets.At September 30, 2004, the Partnership was in compliance with all suchcovenants.

 

        Net proceeds from the issuance of theSenior Notes were $241.1 million after deducting the $4.4 milliondiscount and offering expenses of $4.5 million. The net proceeds were usedprincipally to repay the Partnership’s $225 million term loan and to repay$14 million of indebtedness outstanding under the Partnership’s U.S.revolving credit facility.

 

        On September 2, 2004, the Partnershipfiled a Registration Statement on Form S-4 to register theSenior Notes.  On September 23, 2004, thePartnership commenced an exchange offer, which allowed the holders of theSenior Notes to exchange Senior Notes for new notes with materiallyidentical terms that have been registered under the Securities Act (the “NewNotes”).  The exchange offer expired onOctober 29, 2004, and all Senior Notes were exchanged for New Notes.  The New Notes are not listed on anysecurities exchange.

 

**        Future Paymentfor MAPL Assets**

 

        In connection with the purchase of theMAPL pipeline, the Partnership is obligated to pay the sellerCdn$5.0 million (U.S.$4.0 million) on June 30, 2007. The futurepayment was discounted at 5%. The carrying value of the future payment wasCdn$4.4 million (U.S.$3.4 million) at September 30, 2004.

 

**4.     WRITE OFF OF DEFERRED FINANCING COSTS ANDINTEREST RATE SWAP TERMINATION EXPENSE**

 

        On June 16, 2004, in connectionwith the repayment of its term loan, the Partnership had a $2.3 millionnon-cash write-down of deferred financing costs and incurred a$0.6 million cash expense to terminate related interest rate swaps.

 

**5.     PARTNERS’ CAPITAL**

 

        On March 30, 2004, the Partnershipissued and sold 4,200,000 common units in an underwritten public offering at aprice of $28.50. The common units sold in the offering were registered pursuantto the registration statement on SEC Form S-3 filed on August 1,2003. Net proceeds from the offering, including the Partnership’s generalpartner’s contribution of $2.4 million, totaled approximately $116.7 millionafter deducting underwriting fees and offering expenses of $5.4 million.The Partnership repaid approximately $10 million in borrowings under itsU.S. revolving credit facilities, which were incurred in the first quarter of2004 to fund the deposit on the Rangeland acquisition, and used approximately$76 million of the net proceeds to fund a portion of the aggregatepurchase price of the Rangeland and Mid Alberta pipeline acquisitions. ThePartnership utilized the remaining $31 million in net proceeds to repayborrowings under its U.S. revolving credit facility.

 

        On April 12, 2004, the underwritersexercised a portion of the over-allotment option granted in connection with theoffering of common units on March 30, 2004 and purchased an additional425,000 common units from the Partnership at a price of $28.50 per unit tocover over allotments. Including the related capital contribution of theGeneral Partner of $247,000, the Partnership received net proceeds of$11.8 million after underwriting fees. The Partnership used the$12 million in net proceeds from the exercise of the overallotment optionto reduce the balance outstanding under its U.S. revolving credit facility.

 

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**6.     RELATED PARTYTRANSACTIONS**

 

        In the ordinary course of itsoperations, the Partnership engages in various transactions with The AnschutzCorporation (“TAC”), the parent company of the Partnership’s general partner,and TAC’s affiliates. These transactions, which are more thoroughly describedbelow, are summarized in the following table for the three and nine monthsended September 30, 2004 and 2003:

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                              | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(in thousands)  (unaudited)**       | ** ** |
| Pipeline transportation revenue:        |       |                                  |       |                                 |       |   |   |   |   |
| The Anschutz Corporation and affiliates |       | $                                     | 342        |                                 | $          | 270 |   | $ | 1,003 |   | $ | 934 |   |
| General and administrative expense:     |       |                                  |       |                                 |       |   |   |   |   |
| The Anschutz Corporation and affiliates |       | $                                     | 54         |                                 | $          | 68 |   | $ | 325 |   | $ | 246 |   |

 

        Related party balances at September 30,2004 and December 31, 2003 were as follows:

 
| ** **                                  | ** ** | **September 30,  2004**         | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **(in thousands)  (unaudited)** | ** ** |
| Amounts included in accounts receivable:    |       |                            |       |                        |       |
| The Anschutz Corporation and affiliates     |       | $                               | 103        |                        | $          | 155 |   |
| Frontier Pipeline Company                   |       | $                               | 264        |                        | 64         |   |
| Amounts included in due to related parties: |       |                            |       |                        |       |
| Pacific Energy GP, Inc.                |       | $                               | 374        |                        | $          | 580 |   |

 

**Revenue from Related Parties**

 

        A subsidiary of TAC was a shipper on thePartnership’s Line 2000 and was charged the published tariff ratesapplicable to “participating shippers” until March 31, 2003, when anagreement between the TAC subsidiary and a third party, the performance ofwhich required the TAC subsidiary to ship on Line 2000, was assigned tothe Partnership for consideration equal to the value of transferred inventory.In addition, a subsidiary of TAC is a shipper on pipelines owned by RockyMountain Pipeline LLC (“RMPS”) a subsidiary of the Partnership, and is chargedpublished tariff rates.

 

        RMPS serves as the contract operator forcertain gas producing properties owned by a subsidiary of TAC in Wyoming andUtah, in exchange for which RMPS is reimbursed its direct costs of operationand is paid an annual fee of $0.3 million as compensation for the timespent by RMPS management and for other overhead services related to theiractivities. In addition, during 2003 and the first quarter of 2004, RMPS’strucking operation hauled water for a TAC subsidiary at rates equivalent tothose charged to third parties.

 

        RMPS also receives a management fee fromFrontier Pipeline Company (“Frontier”) in connection with time spent by RMPSmanagement and for other services related to Frontier’s pipeline’s activities.RMPS received $0.3 million and $0.1 million for the three months endedSeptember 30, 2004 and 2003 and $0.6 million and $0.4 million for the ninemonths ended September 30, 2004 and 2003, respectively.

 

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**Expenses Paid to Related Parties**

 

        **Generaland Administrative Expense:** In 2002, the Partnership began utilizing the financial accounting systemowned and provided by TAC under a shared services arrangement. In addition, thePartnership from time to time utilized the services of TAC’s risk managementpersonnel for acquiring the Partnership’s insurance, and the Partnership’ssurety bonds are issued under TAC’s bonding line. Beginning January 2003,TAC began charging the Partnership a fee of $0.1 million per year forthese services and continues to charge the Partnership for any out-of-pocketcosts it incurs. The fixed annual fee includes all license, maintenance andemployee costs associated with the Partnership’s use of the financialaccounting system.

 

        Beginning January 2003, and asamended in May 2004, the Partnership leases approximately 5,400 squarefeet of office space from an affiliate of TAC, for a term of five years at anannual cost of $0.1 million.

 

        **CostReimbursements:**  ThePartnership’s general partner, Pacific Energy GP, Inc. (“General Partner”),employs all U.S. based employees. All employee expenses incurred by the GeneralPartner on behalf of the Partnership are charged back to the Partnership.

 

        The operating and general andadministrative cost reimbursement amounts above exclude reimbursements forproperty, casualty and directors and officers’ insurance premiums paid by TACon behalf of the Partnership, until mid-2003. Beginning with the 2003-2004insurance policy period, the Partnership incurred these costs directly. Inaddition, out-of-pocket costs incurred by TAC for the benefit of thePartnership for computer consultants and surety bonds are also reimbursed bythe Partnership.

 

        **Other:**  The Partnership also reimburses TAC fortransportation services, based on a cost-based formula. For the nine monthsended September 30, 2004, the Partnership reimbursed TAC $0.1 million. An insignificantamount was incurred for the nine months ended September 30, 2003.

 

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**7.  SEGMENT INFORMATION**

 

        The Partnership’s business andoperations are organized into two regional operating units: West Coastoperations and Rocky Mountain operations. The West Coast operations include:(i) Pacific Pipeline System LLC, owner of Line 2000 and Line 63, (ii) PacificMarketing and Transportation LLC, owner of the PMT gathering and blendingsystem, and (iii) Pacific Terminals LLC, owner of the Pacific Terminals storageand distribution system (for the period from July 31, 2003 to September30, 2004). Rocky Mountain operations include: (i) Rocky Mountain PipelineSystem LLC, (ii) Ranch Pipeline LLC, and (iii) PEG Canada, L.P. and itsCanadian subsidiaries, which own and operate all of the Partnership’s Canadianassets (for the period from May 11, 2004 to September 30, 2004). Thereporting units comprising each segment have been aggregated to reflect how theassets are operated and managed. General and administrative costs, whichconsist of executive management, accounting and finance, human resources,information technology, investor relations, legal, and marketing and businessdevelopment, are not allocated to the individual segments. Informationregarding these two operating units is summarized below:

 
| ** **                                  | ** ** | **West Coast  Operations**      | ** ** | **Rocky  Mountain  Operations** | ** ** | **Intersegment   and  Intrasegment  Eliminations** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|----------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **(in thousands)  (unaudited)** | ** ** |
| **Three  months ended September 30,  2004** | ** ** | ** **                      | ** ** | ** **                      | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Segment revenue:                            |       |                            |       |                            |       |                                               |       |       |       |
| Pipeline transportation revenue             |       | $                               | 16,985     |                            | $          | 12,500                                             |       | $          | (1,325     | ) | $ | 28,160 |   |
| Storage and distribution revenue(1)         |       | 8,544                           |       | —                          |       | (153                                               | )          | 8,391      |       |
| Pipeline buy/sell transportation revenue(2) |       | —                          |       | 7,972                           |       |                                               |       | 7,972      |       |
| Crude oil sales, net of purchases(3)        |       | 3,568                           |       | —                          |       |                                               |       | 3,568      |       |
| Net revenue                                 |       | 29,097                          |       | 20,472                          |       |                                               |       | 48,091     |       |
| Expenses:                                   |       |                            |       |                            |       |                                               |       |       |       |
| Operating                                   |       | 14,309                          |       | 9,758                           |       | (1,478                                             | )          | 22,589     |       |
| Transition costs                            |       | —                          |       | 199                             |       |                                               |       | 199        |       |
| Depreciation and amortization               |       | 3,433                           |       | 3,388                           |       |                                               |       | 6,821      |       |
| Total expenses                              |       | 17,742                          |       | 13,345                          |       |                                               |       | 29,609     |       |
| Share of net income of Frontier             |       | —                          |       | 406                             |       |                                               |       | 406        |       |
| Operating income from segments(4)           |       | $                               | 11,355     |                            | $          | 7,533                                              |       |       |       | $ | 18,888 |   |
| Identifiable assets(5)                      |       | $                               | 507,459    |                            | $          | 330,830                                            |       |       |       | $ | 838,289 |   |
| Capital expenditures                        |       | $                               | 1,862      |                            | $          | 1,764                                              |       |       |       | $ | 3,626 |   |
|                                        |       |                            |       |                            |       |                                               |       |       |       |
| **Three months ended September 30,  2003**  |       |                            |       |                            |       |                                               |       |       |       |
| Segment revenue:                            |       |                            |       |                            |       |                                               |       |       |       |
| Pipeline transportation revenue             |       | $                               | 16,662     |                            | $          | 11,006                                             |       | $          | (2,167     | ) | $ | 25,501 |   |
| Storage and distribution revenue(1)         |       | 4,710                           |       | —                          |       |                                               |       | 4,710      |       |
| Pipeline buy/sell transportation revenue(2) |       | —                          |       | —                          |       |                                               |       | —     |       |
| Crude oil sales, net of purchases(3)        |       | 5,907                           |       | —                          |       |                                               |       | 5,907      |       |
| Net revenue                                 |       | 27,279                          |       | 11,006                          |       |                                               |       | 36,118     |       |
| Expenses:                                   |       |                            |       |                            |       |                                               |       |       |       |
| Operating                                   |       | 12,997                          |       | 5,800                           |       | (2,167                                             | )          | 16,630     |       |
| Transition costs                            |       | —                          |       | —                          |       |                                               |       | —     |       |
| Depreciation                                |       | 3,529                           |       | 1,520                           |       |                                               |       | 5,049      |       |
| Total expenses                              |       | 16,526                          |       | 7,320                           |       |                                               |       | 21,679     |       |
| Share of net income of Frontier             |       | —                          |       | 414                             |       |                                               |       | 414        |       |
| Operating income from segments(4)           |       | $                               | 10,753     |                            | $          | 4,100                                              |       |       |       | $ | 14,853 |   |
| Identifiable assets(5)                      |       | $                               | 499,127    |                            | $          | 124,473                                            |       |       |       | $ | 623,600 |   |
| Capital expenditures                        |       | $                               | 763        |                            | $          | 366                                                |       |       |       | $ | 1,129 |   |
|                                             |            |                                 |            |                                 |            |                                                    |            |            |            |  |  |  |  |  |  |

 

15

----

 
| ** **                                  | ** ** | **West Coast  Operations**      | ** ** | **Rocky Mountain  Operations** | ** ** | **Intersegment and  Intrasegment  Eliminations** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|--------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **(in thousands)  (unaudited)** | ** ** |
| **Nine  months ended September 30,  2004**  | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Segment revenue:                            |       |                            |       |                           |       |                                             |       |       |       |
| Pipeline transportation revenue             |       | $                               | 49,170     |                           | $          | 34,847                                           |       | $          | (4,138     | ) | $ | 79,879 |   |
| Storage and distribution revenue(1)         |       | 28,126                          |       | —                         |       | (353                                             | )          | 27,773     |       |
| Pipeline buy/sell transportation revenue(2) |       | —                          |       | 11,662                         |       |                                             |       | 11,662     |       |
| Crude oil sales, net of purchases(3)        |       | 14,436                          |       | —                         |       |                                             |       | 14,436     |       |
| Net revenue                                 |       | 91,732                          |       | 46,509                         |       |                                             |       | 133,750    |       |
| Expenses:                                   |       |                            |       |                           |       |                                             |       |       |       |
| Operating                                   |       | 43,197                          |       | 23,483                         |       | (4,491                                           | )          | 62,189     |       |
| Transition costs                            |       | —                          |       | 383                            |       |                                             |       | 383        |       |
| Depreciation and amortization               |       | 10,833                          |       | 6,943                          |       |                                             |       | 17,776     |       |
| Total expenses                              |       | 54,030                          |       | 30,809                         |       |                                             |       | 80,348     |       |
| Share of net income of Frontier             |       | —                          |       | 1,190                          |       |                                             |       | 1,190      |       |
| Operating income from segments(4)           |       | $                               | 37,702     |                           | $          | 16,890                                           |       |       |       | $ | 54,592 |   |
| Identifiable assets(5)                      |       | $                               | 507,459    |                           | $          | 330,830                                          |       |       |       | $ | 838,289 |   |
| Capital expenditures                        |       | $                               | 5,279      |                           | $          | 6,243                                            |       |       |       | $ | 11,522 |   |
|                                        |       |                            |       |                           |       |                                             |       |       |       |
| **Nine months ended September 30, 2003**    |       |                            |       |                           |       |                                             |       |       |       |
| Segment revenue:                            |       |                            |       |                           |       |                                             |       |       |       |
| Pipeline transportation revenue             |       | $                               | 51,550     |                           | $          | 30,726                                           |       | $          | (5,697     | ) | $ | 76,579 |   |
| Storage and distribution revenue(1)         |       | 4,710                           |       | —                         |       |                                             |       | 4,710      |       |
| Pipeline buy/sell transportation revenue(2) |       | —                          |       | —                         |       |                                             |       | —     |       |
| Crude oil sales, net of purchases(3)        |       | 16,516                          |       | —                         |       |                                             |       | 16,516     |       |
| Net revenue                                 |       | 72,776                          |       | 30,726                         |       |                                             |       | 97,805     |       |
| Expenses:                                   |       |                            |       |                           |       |                                             |       |       |       |
| Operating                                   |       | 32,793                          |       | 16,526                         |       | (5,697                                           | )          | 43,622     |       |
| Transition costs                            |       | —                          |       | 397                            |       |                                             |       | 397        |       |
| Depreciation                                |       | 9,210                           |       | 4,225                          |       |                                             |       | 13,435     |       |
| Total expenses                              |       | 42,003                          |       | 21,148                         |       |                                             |       | 57,454     |       |
| Share of net income of Frontier             |       | —                          |       | 1,141                          |       |                                             |       | 1,141      |       |
| Operating income from segments(4)           |       | $                               | 30,773     |                           | $          | 10,719                                           |       |       |       | $ | 41,492 |   |
| Identifiable assets(5)                      |       | $                               | 499,127    |                           | $          | 124,473                                          |       |       |       | $ | 623,600 |   |
| Capital expenditures                        |       | $                               | 1,480      |                           | $          | 840                                              |       |       |       | $ | 2,320 |   |

 

----

 

(1)          Includes therevenue of the Pacific Terminals storage and distribution system, which PacificTerminals acquired on July 31, 2003.

 

(2)          Includes therevenue of the Canadian subsidiaries, which were acquired on May 11, 2004.

 

(3)          The aboveamounts are net of purchases of $103,192 and $96,833 for the three months endedSeptember 30, 2004 and 2003 and $278,689 and $271,554 for the nine months endedSeptember 30, 2004, respectively.

 

16

----

 

 

(4)          The following is areconciliation of operating income as stated above to the statements of income:

 
| ** **                                                                       | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)  (unaudited)**       | ** ** |
| Income Statement Reconciliation                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Operating income from segments above:                                            |       |                                  |       |                                 |       |   |   |   |   |
| West Coast Operations                                                            |       | $                                     | 11,355     |                                 | $          | 10,753 |   | $ | 37,702 |   | $ | 30,773 |   |
| Rocky Mountain Operations                                                        |       | 7,533                                 |       | 4,100                                |       | 16,890 |   | 10,719 |   |
| Operating income from segments                                                   |       | 18,888                                |       | 14,853                               |       | 54,592 |   | 41,492 |   |
| Less: General and administrative expense                                         |       | 3,762                                 |       | 3,305                                |       | 11,252 |   | 10,289 |   |
| Operating income                                                                 |       | 15,126                                |       | 11,548                               |       | 43,340 |   | 31,203 |   |
| Interest expense                                                                 |       | (5,234                                | )          | (4,782                               | )          | (13,743 | ) | (12,930 | ) |
| Write-off of deferred financing cost and interest rate swap  termination expense |       | —                                |       | —                               |       | (2,901 | ) | — |   |
| Other income                                                                     |       | 219                                   |       | 113                                  |       | 606 |   | 360 |   |
| Income before income taxes                                                       |       | 10,111                                |       | 6,879                                |       | 27,302 |   | 18,633 |   |
| Income tax expense                                                               |       | 221                                   |       | —                               |       | 207 |   | — |   |
| Net income                                                                       |       | $                                     | 9,890      |                                 | $          | 6,879 |   | $ | 27,095 |   | $ | 18,633 |   |
|                                                                                  |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |

 

(5)          Identifiablesegment assets do not include assets related to the Partnership’s corporateactivity. As of September 30, 2004 and 2003, corporate related assets were$29,651 and $21,093, respectively.

 

**8.     COMMITMENTS ANDCONTINGENCIES**

 

        The Partnership is subject to numerousfederal (U.S. and Canadian), state, provincial and local laws which regulatethe discharge of materials into the environment or that otherwise relate to theprotection of the environment. At September 30, 2004, the Partnership hadaccrued for future environmental remediation liabilities of $7.5 million,including a current portion of $1.3 million, and right-of-way liabilitiesof $1.0 million, resulting from various acquisitions, which liabilities areclassified in the accompanying condensed consolidated balance sheets within “otherliabilities.” The actual future costs for environmental remediation activitieswill depend on, among other things, the identification of any additional sites,the determination of the extent of the contamination at each site, the timingand nature of required remedial actions, the technology available and requiredto meet the various existing legal requirements, the nature and extent offuture environmental laws, inflation rates and the determination of thePartnership’s liability at multi-party sites, if any, in light ofuncertainties with respect to joint and several liability, and the number,participation levels and financial viability of other potentially responsible parties.

 

        The Partnership is involved in variousother regulatory disputes, litigation and claims arising out of its operationsin the normal course of business. However, the Partnership is not currently aparty to any legal or regulatory proceedings, the resolution of which it couldbe expected to have a material adverse effect on its business, financialcondition or results of operations.

 

17

----

 

**9.  SUPPLEMENTALCONDENSED CONSOLIDATING FINANCIAL INFORMATION**

 

        Given that certain, but not allsubsidiaries are guarantors of our 7.125% Senior Notes, the Partnership isrequired to present the following supplemental condensed consolidatingfinancial information. For purposes of the following footnote, Pacific EnergyPartners, L.P. and its predecessor are referred to as “Parent.” Rocky MountainPipeline System LLC, Pacific Marketing and Transportation LLC, Ranch PipelineLLC, PEG Canada GP LLC, PEG Canada, L.P. and Pacific Energy Group LLC arecollectively referred to as the “Guarantor Subsidiaries” and Pacific PipelineSystem LLC and Pacific Terminals LLC are referred to as “Non-GuarantorSubsidiaries.”

 

        The following supplemental condensedconsolidating financial information reflects the Parent’s separate accounts,the combined accounts of the Guarantor Subsidiaries, the combined accounts ofthe Parent’s non-guarantor subsidiaries, the combined consolidating adjustmentsand eliminations and the Parent’s consolidated accounts for the dates andperiods indicated. For purposes of the following condensed consolidatinginformation, the Parent’s investments in its subsidiaries and the GuarantorSubsidiaries’ investments in their subsidiaries are accounted for under theequity method of accounting:

 
| ** **                                   | ** ** | **Balance Sheet  September 30, 2004** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **Parent**                            | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(in thousands)**

**(unaudited)**   | ** ** |
| Assets:                                      |       |                                  |       |   |   |   |   |   |   |   |   |
| Current assets                               |       | $                                     | 10,863     |   | $ | 89,944 |   | $ | 33,445 |   | $ | (36,275 | ) | $ | 97,977 |   |
| Property and equipment                       |       | —                                |       | 129,218 |   | 584,133 |   | — |   | 713,351 |   |
| Equity investments                           |       | 375,701                               |       | 195,624 |   | — |   | (563,484 | ) | 7,841 |   |
| Intercompany notes receivable                |       | 292,487                               |       | 335,861 |   | — |   | (628,348 | ) | — |   |
| Other assets                                 |       | 7,529                                 |       | 2,164 |   | 39,078 |   | — |   | 48,771 |   |
| Total assets                                 |       | $                                     | 686,580    |   | $ | 752,811 |   | $ | 656,656 |   | $ | (1,228,107 | ) | $ | 867,940 |   |
| Liabilities and partners’ capital:      |       |                                  |       |   |   |   |   |   |   |   |   |
| Current liabilities                          |       | $                                     | 16,315     |   | $ | 46,201 |   | $ | 34,770 |   | $ | (36,275 | ) | $ | 61,011 |   |
| Long-term debt                               |       | 248,655                               |       | 38,000 |   | 54,838 |   | — |   | 341,493 |   |
| Deferred income taxes                        |       | —                                |       | — |   | 36,641 |   | — |   | 36,641 |   |
| Intercompany notes payable                   |       | —                                |       | 292,487 |   | 335,861 |   | (628,348 | ) | — |   |
| Other liabilities                            |       | —                                |       | 422 |   | 6,763 |   | — |   | 7,185 |   |
| Total partners’ capital                 |       | 421,610                               |       | 375,701 |   | 187,783 |   | (563,484 | ) | 421,610 |   |
| Total liabilities and partners’ capital |       | $                                     | 686,580    |   | $ | 752,811 |   | $ | 656,656 |   | $ | (1,228,107 | ) | $ | 867,940 |   |
|                                              |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                   | ** ** | **Balance Sheet  December 31, 2003** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **Parent**                                | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating adjustments** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(in thousands)**

**(unaudited)**       | ** ** |
| Assets:                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Current assets                               |       | $                                         | 2,799      |   | $ | 63,905 |   | $ | 17,168 |   | $ | (15,076 | ) | $ | 68,796 |   |
| Property and equipment                       |       | —                                    |       | 126,216 |   | 441,738 |   | — |   | 567,954 |   |
| Equity investments                           |       | 292,268                                   |       | 165,815 |   | — |   | (451,197 | ) | 6,886 |   |
| Intercompany notes receivable                |       | —                                    |       | 276,400 |   | — |   | (276,400 | ) | — |   |
| Other assets                                 |       | —                                    |       | 4,957 |   | 1,610 |   | — |   | 6,567 |   |
| Total assets                                 |       | $                                         | 295,067    |   | $ | 637,293 |   | $ | 460,516 |   | $ | (742,673 | ) | $ | 650,203 |   |
| Liabilities and partners’ capital:      |       |                                      |       |   |   |   |   |   |   |   |   |
| Current liabilities                          |       | $                                         | —     |   | $ | 45,980 |   | $ | 19,087 |   | $ | (15,076 | ) | $ | 49,991 |   |
| Long-term debt                               |       | —                                    |       | 298,000 |   | — |   | — |   | 298,000 |   |
| Intercompany notes payable                   |       | —                                    |       | — |   | 276,400 |   | (276,400 | ) | — |   |
| Other liabilities                            |       | —                                    |       | 1,045 |   | 6,100 |   | — |   | 7,145 |   |
| Total partners’ capital                 |       | 295,067                                   |       | 292,268 |   | 158,929 |   | (451,197 | ) | 295,067 |   |
| Total liabilities and partners’ capital |       | $                                         | 295,067    |   | $ | 637,293 |   | $ | 460,516 |   | $ | (742,673 | ) | $ | 650,203 |   |
|                                              |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

----

 
| ** **                             | ** ** | **Statement of Income   Three Months Ended September 30, 2004** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                             | ** ** | **Parent**                                                      | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **(in thousands)**

**(unaudited)**                             | ** ** |
| Operating revenues                     |       | $                                                               | —     |   | $ | 16,068 |   | $ | 33,501 |   | $ | (1,478 | ) | $ | 48,091 |   |
| Operating expenses                     |       | —                                                          |       | (10,190 | ) | (14,076 | ) | 1,478 |   | (22,788 | ) |
| General and administrative expense(1)  |       | —                                                          |       | (3,311 | ) | (451 | ) | — |   | (3,762 | ) |
| Depreciation and amortization expense  |       | —                                                          |       | (1,668 | ) | (5,153 | ) | — |   | (6,821 | ) |
| Share of net income of Frontier        |       | —                                                          |       | 406 |   | — |   | — |   | 406 |   |
| Operating income                       |       | —                                                          |       | 1,305 |   | 13,821 |   | — |   | 15,126 |   |
| Interest expense                       |       | (3,894                                                          | )          | (489 | ) | (851 | ) | — |   | (5,234 | ) |
| Intercompany interest income (expense) |       | —                                                          |       | 5,946 |   | (5,946 | ) | — |   | — |   |
| Equity earnings                        |       | 13,798                                                          |       | 7,158 |   | — |   | (20,956 | ) | — |   |
| Interest and other income (expense)    |       | (14                                                             | )          | 151 |   | 82 |   | — |   | 219 |   |
| Income tax benefit (expense)           |       | —                                                          |       | (273 | ) | 52 |   | — |   | (221 | ) |
| Net income                             |       | $                                                               | 9,890      |   | $ | 13,798 |   | $ | 7,158 |   | $ | (20,956 | ) | $ | 9,890 |   |
|                                        |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          General and administrativeexpense is not currently allocated between guarantor and non-guarantorsubsidiaries for financial reporting purposes.

 
| ** **                              | ** ** | **Statement of Income   Three Months Ended September 30, 2003** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                              | ** ** | **Parent**                                                      | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **(in thousands)**

**(unaudited)**                             | ** ** |
| Operating revenues                      |       | $                                                               | —     |   | $ | 16,914 |   | $ | 21,371 |   | $ | (2,167 | ) | $ | 36,118 |   |
| Operating expenses and transition costs |       | —                                                          |       | (10,252 | ) | (8,545 | ) | 2,167 |   | (16,630 | ) |
| General and administrative expense(1)   |       | 6                                                               |       | (3,288 | ) | (23 | ) | — |   | (3,305 | ) |
| Depreciation and amortization expense   |       | —                                                          |       | (1,643 | ) | (3,406 | ) | — |   | (5,049 | ) |
| Share of net income of Frontier         |       | —                                                          |       | 414 |   | — |   | — |   | 414 |   |
| Operating income                        |       | 6                                                               |       | 2,145 |   | 9,397 |   | — |   | 11,548 |   |
| Interest expense                        |       | —                                                          |       | (4,782 | ) | — |   | — |   | (4,782 | ) |
| Intercompany interest income (expense)  |       | —                                                          |       | 2,876 |   | (2,876 | ) | — |   | — |   |
| Equity earnings                         |       | 6,869                                                           |       | 6,526 |   | — |   | (13,395 | ) | — |   |
| Interest and other income               |       | 4                                                               |       | 104 |   | 5 |   | — |   | 113 |   |
| Net income                              |       | $                                                               | 6,879      |   | $ | 6,869 |   | $ | 6,526 |   | $ | (13,395 | ) | $ | 6,879 |   |
|                                         |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          General and administrativeexpense is not currently allocated between guarantor and non-guarantorsubsidiaries for financial reporting purposes.

 

 

19

----

 

 
| ** **                                                                       | ** ** | **Statement of Income  Nine Months Ended September 30, 2004** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Parent**                                                    | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**

**(unaudited)**                           | ** ** |
| Operating revenues                                                               |       | $                                                             | —     |   | $ | 49,283 |   | $ | 88,958 |   | $ | (4,491 | ) | $ | 133,750 |   |
| Operating expenses and transition costs                                          |       | —                                                        |       | (29,928 | ) | (37,135 | ) | 4,491 |   | (62,572 | ) |
| General and administrative expense(1)                                            |       | —                                                        |       | (10,529 | ) | (723 | ) | — |   | (11,252 | ) |
| Depreciation and amortization expense                                            |       | —                                                        |       | (4,911 | ) | (12,865 | ) | — |   | (17,776 | ) |
| Share of net income of Frontier                                                  |       | —                                                        |       | 1,190 |   | — |   | — |   | 1,190 |   |
| Operating income                                                                 |       | —                                                        |       | 5,105 |   | 38,235 |   | — |   | 43,340 |   |
| Interest expense                                                                 |       | (4,648                                                        | )          | (7,909 | ) | (1,186 | ) | — |   | (13,743 | ) |
| Write-off of deferred  financing cost and interest rate swap termination expense |       | —                                                        |       | (2,901 | ) | — |   | — |   | (2,901 | ) |
| Intercompany interest income (expense)                                           |       | —                                                        |       | 14,564 |   | (14,564 | ) | — |   | — |   |
| Equity earnings                                                                  |       | 31,752                                                        |       | 22,732 |   | — |   | (54,484 | ) | — |   |
| Interest and other income (expense)                                              |       | (9                                                            | )          | 434 |   | 181 |   | — |   | 606 |   |
| Income tax benefit (expense)                                                     |       | —                                                        |       | (273 | ) | 66 |   | — |   | (207 | ) |
| Net income                                                                       |       | $                                                             | 27,095     |   | $ | 31,752 |   | $ | 22,732 |   | $ | (54,484 | ) | $ | 27,095 |   |
|                                                                                  |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          General and administrativeexpense is not currently allocated between guarantor and non-guarantorsubsidiaries for financial reporting purposes.

 

 
| ** **                              | ** ** | **Statement of Income  Nine Months Ended September 30, 2003** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                              | ** ** | **Parent**                                                    | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **(in thousands)**

**(unaudited)**                           | ** ** |
|                                    |       |                                                          |       |   |   |   |   |   |   |   |   |
| Operating revenues                      |       | $                                                             | —     |   | $ | 47,243 |   | $ | 56,259 |   | $ | (5,697 | ) | $ | 97,805 |   |
| Operating expenses and transition costs |       | —                                                        |       | (29,436 | ) | (20,280 | ) | 5,697 |   | (44,019 | ) |
| General and administrative expense(1)   |       | —                                                        |       | (10,215 | ) | (74 | ) | — |   | (10,289 | ) |
| Depreciation and amortization expense   |       | —                                                        |       | (4,549 | ) | (8,886 | ) | — |   | (13,435 | ) |
| Share of net income of Frontier         |       | —                                                        |       | 1,141 |   | — |   | — |   | 1,141 |   |
| Operating income                        |       | —                                                        |       | 4,184 |   | 27,019 |   | — |   | 31,203 |   |
| Interest expense                        |       | —                                                        |       | (12,930 | ) | — |   | — |   | (12,930 | ) |
| Intercompany interest income (expense)  |       | —                                                        |       | 6,484 |   | (6,484 | ) | — |   | — |   |
| Equity earnings                         |       | 18,616                                                        |       | 20,573 |   | — |   | (39,189 | ) | — |   |
| Interest and other income               |       | 17                                                            |       | 305 |   | 38 |   | — |   | 360 |   |
| Net income                              |       | $                                                             | 18,633     |   | $ | 18,616 |   | $ | 20,573 |   | $ | (39,189 | ) | $ | 18,633 |   |
|                                         |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          General and administrativeexpense is not currently allocated between guarantor and non-guarantorsubsidiaries for financial reporting purposes.

 

20

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| ** **                                  | ** ** | **Statement of Comprehensive Income  Three Months Ended September 30, 2004** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Parent**                                                                   | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(in thousands)**

**(unaudited)**                                          | ** ** |
| Net income                                  |       | $                                                                            | 9,890      |   | $ | 13,798 |   | $ | 7,158 |   | $ | (20,956 | ) | $ | 9,890 |   |
| Change in fair value of hedging derivatives |       | (1,107                                                                       | )          | (1,107 | ) | — |   | 1,107 |   | (1,107 | ) |
| Foreign currency translation adjustment     |       | 5,313                                                                        |       | 5,313 |   | 5,313 |   | (10,626 | ) | 5,313 |   |
| Comprehensive income                        |       | $                                                                            | 14,096     |   | $ | 18,004 |   | $ | 12,471 |   | $ | (30,475 | ) | $ | 14,096 |   |
|                                             |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Statement of Comprehensive Income   ThreeMonths Ended September 30, 2003** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Parent**                                                                   | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(in thousands)**

**(unaudited)**                                          | ** ** |
| Net income                                  |       | $                                                                            | 6,879      |   | $ | 6,869 |   | $ | 6,526 |   | $ | (13,395 | ) | $ | 6,879 |   |
| Change in fair value of hedging derivatives |       | 4,143                                                                        |       | 4,143 |   | — |   | (4,143 | ) | 4,143 |   |
| Comprehensive income                        |       | $                                                                            | 11,022     |   | $ | 11,012 |   | $ | 6,526 |   | $ | (17,538 | ) | $ | 11,022 |   |
|                                             |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Statement of Comprehensive Income  Nine Months Ended September 30, 2004** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Parent**                                                                  | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(in thousands)**

**(unaudited)**                                         | ** ** |
| Net income                                  |       | $                                                                           | 27,095     |   | $ | 31,752 |   | $ | 22,732 |   | $ | (54,484 | ) | $ | 27,095 |   |
| Change in fair value of hedging derivatives |       | 3,797                                                                       |       | 3,797 |   | — |   | (3,797 | ) | 3,797 |   |
| Foreign currency translation adjustment     |       | 7,742                                                                       |       | 7,742 |   | 7,742 |   | (15,484 | ) | 7,742 |   |
| Comprehensive income                        |       | $                                                                           | 38,634     |   | $ | 43,291 |   | $ | 30,474 |   | $ | (73,765 | ) | $ | 38,634 |   |
|                                             |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                  | ** ** | **Statement of Comprehensive Income  Nine Months Ended September 30, 2003** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Parent**                                                                  | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(in thousands) (unaudited)**                                              | ** ** |
| Net income                                  |       | $                                                                           | 18,633     |   | $ | 18,616 |   | $ | 20,573 |   | $ | (39,189 | ) | $ | 18,633 |   |
| Change in fair value of hedging derivatives |       | (845                                                                        | )          | (845 | ) | — |   | 845 |   | (845 | ) |
| Comprehensive income                        |       | $                                                                           | 17,788     |   | $ | 17,771 |   | $ | 20,573 |   | $ | (38,344 | ) | $ | 17,788 |   |
|                                             |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

21

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| ** **                                                                         | ** ** | **Statement of Cash Flows  Nine Months Ended September 30, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **Parent**                                                        | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**

**(unaudited)**                               | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Net income                                                                         |       | $                                                                 | 27,095     |   | $ | 31,752 |   | $ | 22,732 |   | $ | (54,484 | ) | $ | 27,095 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                                              |       |   |   |   |   |   |   |   |   |
| Equity earnings                                                                    |       | (31,752                                                           | )          | (22,732 | ) | — |   | 54,484 |   | — |   |
| Distributions from subsidiaries                                                    |       | 41,800                                                            |       | 35,012 |   | — |   | (76,812 | ) | — |   |
| Depreciation, amortization and other                                               |       | 176                                                               |       | 8,127 |   | 12,837 |   | — |   | 21,140 |   |
| Net changes in operating assets and liabilities                                    |       | 4,550                                                             |       | (10,783 | ) | (6,893 | ) | 6,905 |   | (6,221 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                          |       | 41,869                                                            |       | 41,376 |   | 28,676 |   | (69,907 | ) | 42,014 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                               |       |                                                              |       |   |   |   |   |   |   |   |   |
| Acquisitions                                                                       |       | —                                                            |       | — |   | (139,000 | ) | — |   | (139,000 | ) |
| Additions to property and equipment and other                                      |       | —                                                            |       | (7,633 | ) | (4,510 | ) | — |   | (12,143 | ) |
| Intercompany                                                                       |       | (369,675                                                          | )          | (96,267 | ) | — |   | 465,942 |   | — |   |
| NET CASH USED IN INVESTING ACTIVITIES                                              |       | (369,675                                                          | )          | (103,900 | ) | (143,510 | ) | 465,942 |   | (151,143 | ) |
| NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                |       | 328,210                                                           |       | 63,622 |   | 118,161 |   | (396,035 | ) | 113,958 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               |       | 404                                                               |       | 1,098 |   | 3,327 |   | — |   | 4,829 |   |
| CASH AND CASH EQUIVALENTS, beginning of reporting period                           |       | 746                                                               |       | 8,603 |   | 350 |   | — |   | 9,699 |   |
| CASH AND CASH EQUIVALENTS, end of reporting period                                 |       | $                                                                 | 1,150      |   | $ | 9,701 |   | $ | 3,677 |   | $ | — |   | $ | 14,528 |   |

 

22

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| ** **                                                                         | ** ** | **Statement of Cash Flows  Nine Months Ended September 30, 2003** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **Parent**                                                        | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **Total** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**

**(unaudited)**                               | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Net income                                                                         |       | $                                                                 | 18,633     |   | $ | 18,616 |   | $ | 20,573 |   | $ | (39,189 | ) | $ | 18,633 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                                              |       |   |   |   |   |   |   |   |   |
| Equity earnings                                                                    |       | (18,616                                                           | )          | (20,573 | ) | — |   | 39,189 |   | — |   |
| Distributions from subsidiaries                                                    |       | 29,657                                                            |       | 28,177 |   | — |   | (57,834 | ) | — |   |
| Depreciation, amortization and other                                               |       | —                                                            |       | 7,885 |   | 8,886 |   | — |   | 16,771 |   |
| Net changes in operating assets and liabilities                                    |       | 42                                                                |       | 1,457 |   | 3,911 |   | (7,413 | ) | (2,003 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                          |       | 29,716                                                            |       | 35,562 |   | 33,370 |   | (65,247 | ) | 33,401 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                               |       |                                                              |       |   |   |   |   |   |   |   |   |
| Acquisitions                                                                       |       | —                                                            |       | — |   | (159,939 | ) | — |   | (159,939 | ) |
| Additions to property, equipment and other                                         |       | —                                                            |       | (948 | ) | (1,235 | ) | — |   | (2,183 | ) |
| Intercompany                                                                       |       | (92,891                                                           | )          | (160,000 | ) | — |   | 252,891 |   | — |   |
| NET CASH USED IN INVESTING ACTIVITIES                                              |       | (92,891                                                           | )          | 160,948 |   | (161,174 | ) | 252,891 |   | (162,122 | ) |
| NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                |       | 62,006                                                            |       | 126,748 |   | 121,124 |   | (187,644 | ) | 122,234 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               |       | (1,169                                                            | )          | 1,362 |   | (6,680 | ) | — |   | (6,487 | ) |
| CASH AND CASH EQUIVALENTS, beginning of reporting period                           |       | 2,394                                                             |       | 13,285 |   | 8,194 |   | — |   | 23,873 |   |
| CASH AND CASH EQUIVALENTS, end of reporting period                                 |       | $                                                                 | 1,225      |   | $ | 14,647 |   | $ | 1,514 |   | $ | — |   | $ | 17,386 |   |

 

**11.  SUBSEQUENT EVENT**

 

**        Cash Distribution**

 

        On October 22, 2004, the Partnershipannounced a cash distribution of $0.4875 per limited partner unit, payable onNovember 12, 2004, to unitholders of record as of November 1, 2004.  On October 27, 2004, the Partnershipannounced that it expects, subject to final board approval, to increase itsquarterly distribution rate to $0.50 per unit beginning with the fourth quarter2004 distribution payable in February 2005.

 

**        Pending Sale of TheAnschutz Corporation’s Interest in the Partnership**

 

        On October 29, 2004, the Partnershipannounced that The Anschutz Corporation had agreed to sell its 36.7% interestin the Partnership for an undisclosed amount to LB Pacific, LP, an entityformed by Lehman Brothers Merchant Banking Group (“Lehman Brothers MerchantBanking”).  The acquisition by LehmanBrothers Merchant Banking will include (i) a 100% ownership interest in theGeneral Partner, which owns the 2% general partner interest in the Partnershipand the incentive distribution rights and (ii) 10,465,000 subordinated units ofthe Partnership representing a 34.7% limited partner interest in the Partnership.  The transaction is expected to close in thefirst quarter of 2005, subject to certain conditions, including applicableregulatory approvals and other customary closing conditions.

 

 

 

 

23

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**ITEM 2.****Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

        References in thisquarterly report on Form 10-Q to “Pacific Energy Partners,” “Partnership,”“we,” “ours,” “us” or like terms refer to Pacific Energy Partners, L.P. and itssubsidiaries.

 

**Forward-Looking Statements**

 

        The information in this quarterly reporton Form 10-Q contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, and Section 21E of theSecurities Exchange Act of 1934. These forward-looking statements areidentified as any statements that do not relate strictly to historical orcurrent facts, including statements that use terms such as “anticipate,” “assume,”“believe,” “estimate,” “expect,” “forecast,” “intend,” “plan,” “position,” “predict,”“project,” or “strategy” or the negative connotation or other variations ofsuch terms or other similar terminology. In particular, statements,express or implied, regarding our future results of operations or our abilityto generate sales, income or cash flow or to make distributions to unitholdersare forward-looking statements. Forward-looking statements are notguarantees of performance. Such statements are based on management’s currentplans, expectations, estimates, assumptions and beliefs concerning futureevents impacting us and therefore involve risks and uncertainties. Futureactions, conditions or events and future results of operations may differmaterially from those expressed in these forward-looking statements. Manyof the factors that will determine these results are beyond our ability tocontrol or predict.

 

        We caution you that the forward-lookingstatements in this quarterly report on Form 10-Q are subject to all of therisks and uncertainties, many of which are beyond our control, incident togathering, transporting, storing, and distributing crude oil and other relatedproducts and buying, gathering, blending and selling crude oil. For a moredetailed description of these and other factors that may affect the forward-lookingstatements, please read “Risk Factors” contained in our universal shelfregistration statement on Form S-3 (SEC File No.: 333-107609), filedAugust 1, 2003, and declared effective by the Securities and ExchangeCommission (“SEC”) on August 8, 2003, and our annual report onForm 10-K for the year ended December 31, 2003, as well as otherfilings with the SEC. The risk factors could cause our actual results to differmaterially from those contained in any forward-looking statement. Youshould not put undue reliance on these forward-looking statements. Wedisclaim any obligation to announce publicly the result of any revision to anyof the forward-looking statements to reflect future events ordevelopments.

 

**Introduction**

 

        The following discussion of thefinancial condition and results of operations of Pacific Energy Partners, L.P.,the successor to Pacific Energy (Predecessor) (as defined below) should be readtogether with the condensed consolidated financial statements and the notes theretoset forth elsewhere in this report. The discussion set forth in this sectionpertains to the unaudited condensed consolidated balance sheet, statements ofincome and statements of cash flows of, as well as equity investment in, thePartnership and its 100% ownership interest in Pacific Energy Group LLC (“PEG”),whose subsidiaries consist of: (i) Pacific Pipeline System LLC (“PPS”),owner of Line 2000 and the Line 63 system, (ii) PacificTerminals LLC (“PT”), owner of the Pacific Terminals storage and distributionsystem, (iii) Pacific Marketing and Transportation LLC (“PMT”), owner ofthe PMT gathering and blending system, (iv) Rocky Mountain Pipeline SystemLLC (“RMPS”), owner of the Partnership’s interest in various pipelines thatmake up the Western Corridor system, the Salt Lake City Core system, and AREPIpipeline, and (v) Ranch Pipeline LLC (“RPL”), the owner of a 22.22%partnership interest in Frontier Pipeline Company (“Frontier”).

 

        The unaudited condensed consolidatedbalance sheet, statements of income and statements of cash flows of thePartnership also include our 100% ownership interest in PEG Canada GP LLC, thegeneral partner of PEG Canada, L.P. (“PEG Canada”), the holding company for ourCanadian subsidiaries. We own 100% of the limited partner interests in PEGCanada, whose 100%  owned subsidiariesconsist of (i) Rangeland Pipeline Company (“RPC”), which owns 100% ofAurora Pipeline Company Ltd. (“APC”) and a partnership interest inRangeland Pipeline Partnership (“RPP”), (ii) Rangeland Northern PipelineCompany (“RNPC”), which owns the remaining partnership interest in RPP, and(iii) Rangeland Marketing Company (“RMC”). RPP owns all of the assets thatmake up the Rangeland pipeline system except the Aurora pipeline, which isowned by APC.

 

        We also own 100% of Pacific EnergyFinance Corporation, co-issuer of our 7.125% Senior Notes.

 

 

 

24

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        PPS, PT and PMT comprise our West Coastoperations segment. RMPS, RPL, PEG Canada, RPC, APC, RPP, RNPC and RMC compriseour Rocky Mountain operations segment. Certain costs of PEG are also includedin each segment.

 

        The financial data included hereinreflects (i) the ownership and results of operations of the assets comprisingthe Pacific Terminals storage and distribution system for the period fromJuly 31, 2003 to September 30, 2004; (ii) the ownership and results ofoperations of Rangeland Pipeline system for the period from May 11, 2004to September 30, 2004; and (iii) the ownership of MAPL pipeline for the periodJune 30, 2004 to September 30, 2004.

 

        This report on Form 10-Q should beread in conjunction with our universal shelf registration statement onForm S-3 (SEC File No.: 333-107609), filed August 1, 2003, anddeclared effective by the Securities and Exchange Commission (“SEC”) onAugust 8, 2003, and our annual report on Form 10-K for the year endedDecember 31, 2003.

 

**Overview**

 

        We are a publicly traded partnershipengaged principally in the business of gathering, transporting, storing and distributingcrude oil and related products in California and the Rocky Mountain region,including Alberta, Canada. We generate revenue primarily by charging tariffrates for transporting crude oil on our pipelines and by leasing storagecapacity. We also buy, blend and sell crude oil, activities that arecomplementary to our pipeline transportation business. We operate primarily inCalifornia, Colorado, Montana, Wyoming and Utah in the United States and inAlberta, Canada, and conduct our business through two regional operating units:West Coast operations and Rocky Mountain operations.

 

        We are managed by our general partner,Pacific Energy GP, Inc., a wholly owned indirect subsidiary of TheAnschutz Corporation.

 

*West Coast Operations*

 

        Our West Coast operations are located inCalifornia and include the only common carrier pipelines that deliver crude oilproduced in California’s San Joaquin Valley and the two primary CaliforniaOuter Continental Shelf (“OCS”) producing fields, Point Arguello and the SantaYnez Unit, to refineries and terminal facilities in the Los Angeles Basin andin Bakersfield. In addition, we own and operate storage and distribution assetsservicing the Los Angeles Basin, which we believe strategicallyposition us to benefit from the projected increase in marine imports of crudeoil into this region. Our West Coast operations are headquartered in LongBeach, California, with a field office in Bakersfield.

 

        Our West Coast operations are comprisedof the following assets, all of which we operate and own 100%:

 

        *Line 2000:*  Line 2000 is an intrastate commoncarrier crude oil pipeline that consists of a 130-mile, insulated trunkpipeline with a permitted annual throughput capacity of 130,000 barrels per day(“bpd”) that transports crude oil produced in the San Joaquin Valley andCalifornia OCS to refineries and terminal facilities in the Los Angeles Basin.

 

        *Line 63System:*  The Line 63system is an intrastate common carrier crude oil pipeline system that consistsof a 107-mile trunk pipeline with a throughput capacity of approximately105,000 bpd, 60 miles of distribution pipelines, 156 miles ofgathering pipelines, and 22 storage tanks with a total of approximately1.2 million barrels of storage capacity. Most of these storage assets arelocated in the San Joaquin Valley and are primarily used to facilitate thetransportation of crude oil on our pipelines.

 

        *PMTGathering and Blending System:* The PMT gathering and blending system is a proprietary crude oilpipeline system located in the San Joaquin Valley that consists of103 miles of gathering pipelines and five storage and blending facilitieswith a total of approximately 0.25 million barrels of storage capacity andup to 51,000 bpd of blending capacity. The PMT gathering and blending system isinterconnected to our Line 63 system. PMT buys,blends and sells crude oil, activities that are complementary to our pipelinetransportation business.

 

        *PacificTerminals Storage and Distribution System:*  The Pacific Terminals storage and distributionsystem is a storage and pipeline distribution system located in the Los AngelesBasin that consists of 70 miles of distribution pipelines in activeservice and 34 storage tanks with a total of approximately 9.0 millionbarrels of storage capacity. Of this total approximately 6.7 millionbarrels are in active commercial service, 0.5 million barrels are usedprimarily for throughput to other storage tanks and do not generate revenueindependently, approximately 1.5 million barrels are idle but could bereconditioned and brought into service, and approximately 0.3 millionbarrels are in displacement oil service.

 

 

25

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*Rocky Mountain Operations*

 

        Our Rocky Mountain operations consist ofvarious interests in pipelines that transport crude oil produced in Canada andthe U.S. Rocky Mountain region to refineries in the states of Montana, Wyoming,Colorado and Utah, and in Canada. We deliver crude oil to these refineriesdirectly through our pipelines or indirectly through connections with third-partypipelines. Our Rocky Mountain operations are headquartered in Denver, Coloradoand Calgary, Alberta. We have five field offices in Wyoming and two in Alberta.

 

        Our Rocky Mountain operations arecomprised of the following assets, which form an integrated pipeline network:

 

*Rangeland Pipeline System:*  The Rangeland Pipeline system includesRangeland pipeline and Mid Alberta Pipeline (“MAPL”). The MAPL pipeline is a138-mile proprietary pipeline with a throughput capacity of approximately50,000 bpd if transporting light crude oil. MAPL pipeline originates atEdmonton, Alberta and terminates in Sundre, Alberta, where it connects to theRangeland Pipeline system. The Rangeland Pipeline system is a proprietarypipeline system that consists of approximately 800 miles of gathering andtrunk pipelines and is capable of transporting crude oil, condensate and butaneeither north to Edmonton, Alberta via third-party pipeline connections orsouth to the U.S.-Canadian border near Cutbank, Montana, where itconnects to the Western Corridor system. The trunk pipeline from Sundre,Alberta to the U.S.-Canadian border consists of approximately250 miles of trunk pipelines and has a current throughput capacity ofapproximately 85,000 bpd if transporting light crude oil. In 2003,approximately 47,000 barrels per day were transported on the trunk pipeline.The trunk system from Sundre, Alberta north to Rimbey, Alberta is abi-directional system that consists of three parallel trunk pipelines for lowsulfur crude oil, high sulfur crude oil, and for condensate and butane, eachapproximately 60 miles in length.

 

        Over the next year, we will construct anew initiating terminal facility with multiple pipeline connections inEdmonton, Alberta. In the interim, current volumes of approximately 5,000 bpdare expected to continue being transported on MAPL pipeline. The RangelandPipeline system will transport these volumes plus its own current volumes ofapproximately 40,000 bpd for a total volume of 45,000 bpd south to the UnitedStates. In addition, approximately 20,000 bpd will continue to be gathered andtransported north to Edmonton, Alberta.

 

        *WesternCorridor System:*  The WesternCorridor system is an interstate and intrastate common carrier crude oil pipelinesystem that consists of 1,012 miles of pipelines extending from dualorigination points at the U.S.-Canadian border near Cutbank, Montana,where it receives deliveries from the Rangeland system, and at Cutbank,Montana, where it receives deliveries from Cenex pipeline, and terminating atGuernsey, Wyoming with connections in Wyoming to Frontier pipeline, Suncor’spipeline, Platte pipeline and the Salt Lake City Core system. The WesternCorridor system consists of three contiguous trunk pipelines: Glacier pipeline,Beartooth pipeline and Big Horn pipeline. We own various undivided interests ineach of these three pipelines, which give us rights to a specified portion ofeach pipeline’s throughput capacity. Glacier and Beartooth pipelines provide uswith approximately 25,000 bpd of throughput capacity from the U.S.-Canadianborder to Elk Basin, Wyoming. Big Horn pipeline provides us with approximately33,900 bpd of throughput capacity from Elk Basin, Wyoming to Guernsey, Wyoming.We operate Beartooth and Big Horn pipelines. Conoco Pipe Line Company owns theremaining undivided interests in each pipeline and operates Glacier pipeline.We also own various undivided interests in 22 storage tanks that provide uswith a total of approximately 1.3 million barrels of storage capacity.

 

        *SaltLake City Core System:*  TheSalt Lake City Core system is an interstate and intrastate common carrier crudeoil pipeline system that consists of 914 miles of trunk pipelines with acombined throughput capacity of approximately 60,000 bpd to Salt Lake City,209 miles of gathering pipelines, and 30 storage tanks with a total ofapproximately 1.5 million barrels of storage capacity. This systemoriginates in Ft. Laramie, Wyoming, receives deliveries from the WesternCorridor system at Guernsey, Wyoming, and terminates in Salt Lake City and inRangely, Colorado. The Rangely terminus delivers to a ChevronTexaco pipelinethat serves refineries in Salt Lake City. Of the 60,000 bpd delivery capacityinto Salt Lake City, approximately 40,000 bpd is delivered directly through ourpipelines and approximately 20,000 bpd is delivered indirectly through aconnection to a ChevronTexaco pipeline. Since completion of a new connection inJuly 2004, the Salt Lake City Core system also receives deliveries fromFrontier pipeline at Frontier Station, Wyoming. We operate and own 100% of theSalt Lake City Core system.

 

        *AREPIPipeline:*  AREPI pipeline isan interstate common carrier crude oil pipeline that consists of a 42-miletrunk pipeline with a throughput capacity of approximately 52,500 bpd and threestorage tanks with a total of approximately 0.1 million barrels of storagecapacity. AREPI pipeline originates at Ranch Station, Utah, where it receivesdeliveries from Frontier pipeline, and terminates in Kimball Junction, Utah,where it delivers to a ChevronTexaco pipeline that serves

 

 

26

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 refineries in SaltLake City. We own and operate 100% of AREPI pipeline.

 

        *FrontierPipeline:*  Frontier pipelineis an interstate common carrier crude oil pipeline that consists of a 289-miletrunk pipeline with a throughput capacity of approximately 62,200 bpd and threestorage tanks with a total of approximately 274,000 barrels of storagecapacity. Frontier pipeline originates in Casper, Wyoming, receives deliveriesfrom the Western Corridor system and terminates south of Evanston, Wyoming atRanch Station, Utah. Frontier pipeline delivers crude oil to AREPI pipeline andto the Salt Lake City Core system for ultimate delivery to Salt Lake City. Weoperate Frontier pipeline and own a 22.22% partnership interest in FrontierPipeline Company, the general partnership that owns Frontier pipeline.Enbridge, Inc. owns the remaining partnership interest in Frontier PipelineCompany.

 

***Recent Developments***

 

***        PendingSale of The Anschutz Corporation’s Interest in thePartnership***

 

        On October 29, 2004, the Partnershipannounced that TAC had agreed to sell its 36.7% interest in the Partnership foran undisclosed amount to LB Pacific, LP, an entity formed by Lehman BrothersMerchant Banking Group (“Lehman Brothers Merchant Banking”).  The acquisition by Lehman Brothers MerchantBanking will include (i) a 100% ownership interest in the General Partner,which owns the 2% general partner interest in the Partnership and the incentivedistribution rights and (ii) 10,465,000 subordinated units of the Partnershiprepresenting a 34.7% limited partner interest in the Partnership.  The transaction is expected to close in thefirst quarter of 2005 and is subject to certain conditions, includingapplicable regulatory approvals and other customary closing conditions.

 

***        CanadianAcquisitions***

 

        *Rangeland Pipeline System Acquisition.*  On May 11, 2004, we completed theacquisition of the Rangeland Pipeline system from BP Canada Energy Company (“BP”).The Rangeland Pipeline system is located in Alberta, Canada. The purchase pricefor the Rangeland Pipeline system was Cdn$130 million plus approximatelyCdn$29 million for linefill, working capital, transaction costs andtransition capital expenditures for an aggregate purchase price ofCdn$159 million or US$116 million.

 

        *MAPL Pipeline Acquisition.*  On June 30, 2004, we completed theacquisition of MAPL pipeline, located in Alberta, Canada from Imperial Oil. Thepurchase price for MAPL was Cdn$31.5 million, of whichCdn$5.0 million is payable on June 30, 2007.  In addition, we acquired linefill forCdn$5.0 million.  The aggregatepurchase price including linefill, first year construction costs and transactioncosts is approximately US$30 million and was funded principally from ourCanadian credit facilities.

 

        *Integration and Transition.*  The Rangeland Pipeline system and MAPLpipeline have each historically been operated on a proprietary basis.  MAPL pipeline has, since its purchase, beenintegrated into the Rangeland Pipeline system, and we intend to makesignificant changes to the revenue-generating capability of these assetsby combining and integrating fully all of our Canadian and U.S. Rocky Mountainpipeline assets under common management, by expanding the throughput capacityof the Rangeland Pipeline system by establishing connections with otherpipelines, and by constructing a pump station and receiving terminal inEdmonton, Alberta. This new pump station and receiving terminal will be able toaccess multiple sources of Canadian crude oil, which will allow us toparticipate in the projected increase in production of synthetic crude oil. Theconstruction of the new connections on the Rangeland Pipeline system and thenew pump station and receiving terminal is expected to cost approximatelyCdn$6.5 million, and is expected to be completed in the third quarter of2005.

 

        *Financing.*  We funded the aggregate purchase price,including transaction costs, for the Rangeland Pipeline system and MAPLpipeline with a portion of the net proceeds from our March 2004 issuanceof common units and Cdn$65 million in borrowings under our newCdn$100 million revolving credit facility.

 

***        Pier 400***

 

        In February 2004, we completed afeasibility study for the development of a deepwater petroleum import terminalat Pier 400 and Terminal Island in the Port of Los Angeles (“POLA”) tohandle marine receipts of crude oil and refinery feedstocks. We are continuingwith the next phase of development of the Pier 400 terminal, commencingwith the environmental review, which is expected to be completed by late 2005.In connection with this next phase of development, we entered into a projectdevelopment agreement with two subsidiaries of Valero Energy Corporation (“Valero”)that defines the

 

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 facilities that we are to construct in thePOLA, and a terminalling services agreement that defines the ongoing commercialarrangement including a 30-year, 50,000 bpd volume commitment from Valero tosupport the terminal.  Each of theseagreements is subject to the satisfaction of various conditions, includingcompletion of a mutually satisfactory vessel emissions allocationagreement.  In addition, we and the POLAhave identified several possible sites for construction of storage facilitiesand have begun the review process required by the California EnvironmentalQuality Act.

 

        If the Pier 400 terminal receivesthe necessary governmental approvals and is successfully developed, a deepwaterberth, transfer infrastructure and storage tanks will be constructed atPier 400 and Terminal Island in the POLA and a pipeline distributionsystem will be constructed to connect the terminal’s storage tanks to Valero’sWilmington refinery and to our other customers’ facilities in the Los AngelesBasin through our Pacific Terminals storage and distribution system. We wouldconstruct the transfer infrastructure, including a large diameter pipelinesystem for receiving bulk petroleum liquids from marine vessels, storage tankswith an initial storage capacity of approximately 1.5 million barrels, anda pipeline distribution system, all at an estimated cost of approximately$130 million. The deepwater berth at Pier 400 would be constructed bythe POLA.  The ultimate cost of theproject will depend on its scope, which may increase depending on the level ofcustomer commitments, as well as on permit requirements.

 

        The Pier 400 terminal would providemarine receipt facilities with water depth of approximately 81 feet,capable of handling some of the largest tankers, and with the capacity toefficiently accommodate increasing volumes of waterborne imported crude oil andrefinery feedstocks. Initially, the Pier 400 terminal is expected tohandle marine receipts of approximately 100,000 bpd. However, the receiptfacilities are being designed, subject to permit limitations, to accommodate upto approximately 250,000 bpd. We expect construction of the Pier 400terminal to be completed and placed in service in early 2007.

 

        We spent approximately $5.3 million onthe Pier 400 terminal beginning in the second quarter of 2003 through the endof 2003 and $2.5 million in 2004 through September 30, 2004. We expect toincur additional capital expenditures of approximately $0.4 million duringthe remainder of 2004. We anticipate funding pre-construction costs throughlate-2005 from a portion of the proceeds from our March 2004 issuance ofcommon units. Construction of the Pier 400 terminal is expected to befinanced through a combination of debt and proceeds from the issuance ofadditional partnership units, including common units.

 

***        SaltLake City Expansion Project***

 

        We also recently expanded our pipelinesserving Salt Lake City by establishing a new delivery connection from Frontierpipeline to the Salt Lake City Core system at a cost of approximately $3million. Existing pipelines into Salt Lake City were previously prorated, orlimited by capacity, during the summer season. This connection increasesdelivery capacity to Salt Lake City refineries by approximately 8,000 to 9,000bpd.

 

***        Equityand Debt Offerings***

 

        On March 30, 2004, we issued andsold 4,200,000 common units in an underwritten public offering at a price of$28.50 per common unit before underwriting fees and offering expenses. OnApril 12, 2004, the underwriters exercised a portion of the over-allotmentoption and purchased an additional 425,000 common units to coverover-allotments at a price of $28.50 per common unit before underwriting feesand offering expenses. Net proceeds received from the offering, including thegeneral partner’s contribution of $2.7 million, totaled approximately$128.5 million after deducting underwriting fees and offering expenses. Weused $86 million of the net proceeds to finance the acquisition of theRangeland system and the balance of the net proceeds to repay borrowingsoutstanding under our U.S. revolving credit facility.

 

                OnJune 16, 2004, we completed the sale of $250 million of 7.125% SeniorNotes due June 15, 2014 (the “Senior Notes”). The Senior Notes were issuedat a discount of $4.4 million, resulting in an effective interest rate of7.375%. Net proceeds from the issuance of the Notes were $241.1 millionafter deducting the $4.4 million discount and offering expenses of$4.5 million. The net proceeds were used principally to repay our$225 million term loan and to repay $14 million of indebtednessoutstanding under our U.S. revolving credit facility.

 

On September 2, 2004, we filed a Registration Statementon Form S-4 to register our 7.125% Senior Notes, which were sold in aprivate offering to qualified institutional buyers in reliance on Rule144A under the Securities Act of 1933 (the “Securities Act”) and tonon-U.S. persons under Regulation S under the Securities Act.  OnSeptember 23, 2004, we commenced an exchange offer, which allowed theholders of the Senior Notes to exchange Senior Notes for newnotes with

 

 

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materially identical terms that have been registered underthe Securities Act (the “New Notes”). The exchange offer expired on October 29, 2004, and all Senior Noteswere exchanged for New Notes.  The New Notesare not listed on any securities exchange.

 

        In connection with the issuance of thenotes, we entered into interest rate swap agreements with an aggregate notionalprincipal amount of $80 million to receive interest at a fixed rate of7.125% and to pay interest at an average variable rate of six month LIBOR plus1.6681% (set in advance or in arrears depending on the swap transaction). Thenet impact of the notes offering, the related interest rate swap and the termloan repayment is that we expect our interest expense to remain largelyunchanged.

 

***Business Fundamentals***

 

*Pipeline Transportation*

 

        We generate pipeline transportationrevenue by charging tariff rates for transporting crude oil on our pipelines.The fundamental items impacting our pipeline transportation revenue are thevolume of crude oil, or throughput, we transport on our pipelines and ourtariff rates. Throughput on our pipelines fluctuates based on the volume ofcrude oil available for transport on our pipelines, the demand for refinedproducts, refinery downtime and the availability of alternate sources of crudeoil for the refineries we serve.

 

        Our shippers determine the amount ofcrude oil we transport on our pipelines, but we influence these volumes throughthe level and type of service we provide and the rates we charge. Our ratesneed to be competitive to transportation alternatives, which are mostly otherpipelines.

 

        The availability of crude oil fortransportation on our pipelines is dependent in part on the amount of drillingand enhanced recovery activity in the production fields we serve in our West Coastoperations and in parts of our Rocky Mountain operations. With the passage oftime, production of crude oil in an individual well naturally declines, whichcan in the short-term be offset in whole or in part by additional drilling orthe implementation of recovery enhancement measures. In the San Joaquin Valleyand in the California OCS, total production is generally declining.  In the third quarter of 2004, producers beganthe development of the Rocky Point field in the California OCS with thedrilling of the first of eight planned wells. The first well began production at the end of the third quarter of 2004,thereby increasing the supply of crude oil available to be transported by usinto the Los Angeles Basin.  Weanticipate that a significant portion of the Rocky Point production will betransported on our pipelines.

 

        In addition, Shell has announced that ithas extended the operation of its Bakersfield refinery through March 31, 2005,while it explores the possible sale of the refinery.  In late 2003, Shell had announced its plansto close the refinery October 1, 2004. Should Shell ultimately close the refinery, we continue to believe thiswould increase the supply of crude oil available to be transported by us to theLos Angeles Basin, offsetting some or all of the effects of production declinein the short-term.  In the event therefinery continues operating, we believe there may be an opportunity totransport additional volumes of crude oil to the refinery.

 

        In addition, we acquired the PacificTerminals storage and distribution assets and are developing the Pier 400terminal to participate in the marine import business, which is growing as aresult of the local production decline. In the Rocky Mountains, our pipelinesare connected to Canadian sources of crude oil, and we recently completed theacquisitions of pipeline systems giving us greater access to significantsupplies of Canadian crude oil, including synthetic crude oil, which we believewill replace any Rocky Mountain production decline and meet growing demand inthe Rocky Mountain region.

 

        The tariff rates we charge onLine 2000 and the Line 63 system are regulated by the CaliforniaPublic Utilities Commission (the “CPUC”). Tariffs on Line 2000 areestablished based on market considerations, subject to certain contractuallimitations. Tariffs on Line 63, which are cost-of-service based tariffs,are based upon the costs to operate and maintain the pipeline, as well ascharges for the depreciation of the capital investment in the pipeline and theauthorized rate of return. The tariff rates charged on our U.S. Rocky Mountainpipelines are regulated by either the FERC or the Wyoming Public ServiceCommission, generally under a cost-of-service approach.

 

        On May 1, 2004, we increased the tariffrates on Line 2000 by approximately 6%, based on a contractually agreed indexof cost changes plus a market adjustment. This index is reviewed annually. On October 1, 2004, we applied to the CPUC for a 9.5% cost of serviceincrease of the tariff rates on our Line 63 Pipeline system.  This increase, the first for Line 63 since2001, went into effect on November 1, 2004, subject to subsequent approval bythe CPUC and the obligation to refund, with interest, any portion of the tariffcharged after November 1, 2004 that is subsequently disallowed by the CPUC.

 

 

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*Storage and Distribution*

 

        We provide storage and distributionservices to refineries in the Los Angeles Basin. The fundamental itemsimpacting our storage and distribution revenue are the amount of storagecapacity we have under lease, the lease rates for that capacity and the lengthof each lease. Demand for crude oil storage capacity tends to be more stableover time and leases for crude oil storage capacity are usually long term (morethan one year). Demand for other dark products storagecapacity is less stable than for crude oil storage and varies depending on,among other things, refinery production runs and maintenance activities. Leasesfor dark products storage capacity are usually short term (less that one year).One of our business goals is to convert a number of other dark products tanksto more flexible crude oil service (which can also accommodate other darkproducts); we currently await permit approvals for one such tank conversion.

 

        While PT’s rates are regulated by theCPUC, the CPUC has authorized PT to establish its rates based on marketconditions through negotiated contracts.

 

*Pipeline Buy/Sell Transportation Revenue*

 

        The Rangeland Pipeline system, whichincludes the Rangeland and MAPL pipelines, operates as a proprietary systemand, therefore, we take title to the crude oil that is gathered andtransported. Pursuant to a transportation service agreement between RMC andRPC, RMC has contracted for the entire capacity of Rangeland pipeline.Customers who wish to transport product on Rangeland pipeline may either:(i) sell product to RMC at the inlet to the pipeline without repurchasingproduct from RMC; or (ii) sell product to RMC at an inlet point andrepurchase such product at agreed upon delivery points for the price paid atthe inlet to the pipeline plus an established location differential.

 

        Substantially all of the pipelines thatcomprise the Rangeland Pipeline system are subject to the jurisdiction of theAlberta Energy Utilities Board (“EUB”). The Canadian portion of the segment ofthe Rangeland Pipeline system that connects to the Western Corridor system atthe U.S.-Canadian border is subject to the Canadian National Energy Board(“NEB”). Neither the EUB nor the NEB will generally review rates set by a crudeoil pipeline operator unless it receives a complaint.

 

*Gathering and Blending*

 

        We purchase, gather, blend and resellcrude oil in our PMT operations. Our PMT gathering and blending system inCalifornia’s San Joaquin Valley is a proprietary intrastate operation that isnot regulated by the CPUC or the FERC. It is complementary to our West Coastpipeline transportation business. The gathering network effectively extends ourpipeline network to capture additional supplies of crude oil for transportationon our trunk pipelines to Los Angeles.

 

        The contribution of our PMT gatheringand blending operations is, for several reasons, a variable part of our income.First, it varies with the price differential between the cost of the varyinggrades of crude oil and natural gasoline PMT buys for use in its blendingoperations and the price of the blended crude oil it sells. Costs and salesprices are impacted by crude oil prices generally, as well as by local supplyand demand forces, including regulations affecting refined productspecifications. Second, it varies with the price differential between crude oilpurchased on one price basis and sold on a different price basis. Finally, itvaries with the volumes gathered and blended. We seek to control thesevariations through our risk management policy, which provides specificguidelines for our crude oil marketing and hedging activities and requiresoversight by our senior management.

 

        Our blending margins are a function ofthe cost of the heavy and light crude oils and natural gasoline that we buy andblend, relative to the price of the blended crude oil we sell.  Blending margins have exceeded theirhistorical averages in the first eight months of 2004.  In September 2004, blending marginsdeclined.  Foreign imports of crude oilinto the Los Angeles Basin were highly discounted relative to West TexasIntermediate (“WTI”) prices, which reduced demand for and prices of localCalifornia crude oil, including crude oil gathered and blended by us in the SanJoaquin Valley.  As the demand for andprice of our blended crude oil has fallen, we have taken action to cancelcertain purchase contracts beginning in the fourth quarter 2004, and to reducethe volume we gather, blend and sell.  Inaddition, margins on one particular contract declined as the difference betweenpurchases made on a WTI price basis and sales made on a West Coast price basisdeviated from historical norms.  Thissituation may continue in the fourth quarter of 2004, and perhaps through tothis contract’s maturity in the first quarter of 2005.

 

 

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*Acquisitions and New Projects*

 

        We intend to continue to pursueacquisitions and new projects for development of additional midstream assets,including pipeline, storage and terminal facilities that are accretive to ourcash flow and complement our existing business. We expect to fund acquisitionsand new projects with a combination of debt and additional Partnership units,including common units. We expect to maintain a debt to total capitalizationratio of approximately 50 percent over time.

 

*Operating Expenses*

 

        A substantial portion of the operatingexpenses we incur, including the cost of field and support personnel,maintenance, control systems, telecommunications, rights-of-way and insurance,varies little with changes in throughput. Certain of our costs, however, dovary with throughput, the most material being the cost of power used to run thevarious pump stations along our pipelines. Major maintenance costs can varydepending on a particular asset’s age and also with regulatory requirements,such as mandatory inspections at defined intervals. Unanticipated costs caninclude the costs of cleanup of any release of oil to the extent not covered byinsurance.

 

*Employees*

 

        We do not have any employees, except inCanada. Our general partner, which provides employees to conduct our U.S.operations, and our Canadian subsidiaries collectively employ approximately 300individuals who directly support our operations. Our general partner and ourCanadian subsidiaries consider their employee relations to be good. None ofthese employees are subject to a collective bargaining agreement. Our generalpartner does not conduct any business other than with respect to thePartnership. All expenses incurred by our general partner are charged to us.

 

*Impact of Foreign Exchange Rates*

 

        The cash flow of our Canadian operationsis based on the U.S. dollar equivalent of such amounts measured in Canadiandollars. Assets and liabilities of our Canadian subsidiaries are translated toU.S. dollars using the applicable exchange rate as of the end of a reportingperiod. Revenues, expenses and cash flow are translated using the averageexchange rate during the reporting period. The results of our Canadianoperations and distributions from our Canadian subsidiaries to the Partnershipmay vary based on fluctuations in currency exchange rates irrespective of ourCanadian subsidiaries’ underlying operating results.

 

**Critical Accounting Policies and Estimates**

 

        Our condensed consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States, which require management to make estimates andassumptions that affect the reported amounts of the assets and liabilities anddisclosures of contingent assets and liabilities as of the date of the balancesheet as well as the reported amounts of revenue and expenses during thereporting period. We routinely make estimates and judgments about the carryingvalue of our assets and liabilities that are not readily apparent from othersources. Such estimates and judgments are evaluated and modified as necessaryon an ongoing basis. We believe that of our significant accounting policies(see “Note 1—Summary of Significant Accounting Policies”, to ourconsolidated financial statements in our annual report on Form 10-K forthe year ended December 31, 2003) and estimates, the following may involvea higher degree of judgment and complexity:

 

•                  We routinelyapply the provisions of purchase accounting when recording our acquisitions.Application of purchase accounting requires that we estimate the fair value ofthe individual assets acquired and liabilities assumed. Determining the fairvalue of the assets involves a number of judgments and estimates. In our majoracquisitions to date, we have engaged an outside valuation firm to provide uswith an appraisal report, which we utilize in determining the purchase priceallocation. The allocation of the purchase price to different asset classesimpacts the depreciation expense we subsequently record. The principal assetswe have acquired to date are property, pipelines, storage tanks and equipment.

 

•                  We depreciatethe components of our property and equipment on a straight-line basis over theestimated useful lives of the assets. The estimates of the assets’ useful livesrequire our judgment and our knowledge of the assets being depreciated. Whennecessary, the assets’ useful lives are revised and the impact on depreciationis treated on a prospective basis.

 

•                  We accrue anestimate of the undiscounted costs of environmental remediation for work atidentified sites where an assessment has indicated it is probable that cleanupcosts are or will be required and may be reasonably estimated. In 

 

 

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making theseestimates, we consider information that is currently available, existingtechnology, enacted laws and regulations, and our estimates of the timing ofthe required remedial actions. We use outside environmental consultants toassist us in making these estimates. In addition, generally accepted accountingprinciples in the United States of America require us to establish liabilitiesfor the costs of asset retirement obligations when the retirement date isdeterminable. We will record such liabilities only when such date isdeterminable.

 

 

•                  From time totime, a shipper or group of shippers may initiate a regulatory proceeding orother action challenging the tariffs we charge or have charged. In such cases,we assess the proceeding on an ongoing basis as to its likely outcome and as tothe dollar amounts involved in order to determine whether to accrue for afuture expense. We use outside regulatory lawyers and financial experts toassist us in these assessments.

 

•                  Our inventoryof displacement oil, pipeline linefill and minimum tank volumes is carried inour accounts at the lower of cost and market value. This inventory is held forour long-term use and for the operation of our pipelines and storage facilitiesand as such is recorded in our property and equipment balance. We are exposedto the potential for a write-down to market value. A write-down will likelyoccur in future years as oil prices tend to be cyclical. However, such awrite-down would be a non-cash expense but would not be realized, if at all,until we were to sell such inventory for a price less than our cost.

 

**Results of Operations**

 

*Three Months Ended September 30, 2004 Compared to ThreeMonths Ended September 30, 2003*

 

        *Summary*

 
| ** **                                                                | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------|
| ** **                                                                | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                                                | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                |       | $                                         | 9,890      |       | $ | 6,879 |   | $ | 3,011 |   | 44 | % |
| Net income per limited partner unit

    Basic and diluted |       | $                                         | 0.33       |       | $ | 0.30 |   | $ | 0.03 |   | 10 | % |

 

        The results of the three months endedSeptember 30, 2004 reflect three acquisitions: Pacific Terminals, which wasacquired on July 31, 2003; the Rangeland Pipeline system, which was acquired onMay 11, 2004; and the MAPL pipeline, which was acquired on June 30, 2004.  Pacific Terminals experienced an increase instorage and distribution revenues due to increased storage capacity and higherutilization.  The period also reflectsthe benefit of increased volumes and revenue on our Rocky Mountainpipelines.  These increases werepartially offset by lower margins in our West Coast gathering and blendingoperations. There were approximately 31% more weighted average limited partnerunits outstanding in the three months ended September 30, 2004 due to the saleof additional common units to partially fund the acquisitions of the PacificTerminals storage and distribution system, the Rangeland Pipeline system andthe MAPL pipeline.

 

*        SegmentInformation*

 
| ** **                                                    | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|------------|
| ***West  Coast***                                             | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Operating income                                              |       | $                                         | 11,355     |       | $ | 10,753 |   | $ | 602 |   | 6 | % |
| Operating data:

    Pipeline throughput (bpd) |       | 139.7                                     |       | 146.4      |   | (6.7 | ) | -5 | % |
|                                                               |            |                                           |            |            |  |  |  |  |  |  |  |  |  |

 

        The increase in West Coast operatingincome was primarily due to the acquisition of the Pacific Terminals storageand distribution system on July 31, 2003. This increase was partially offset by lower margins in the gathering andblending operations. Margins in the gathering and blending operations wereadversely affected by competitive pricing pressures as a result of steeplydiscounted foreign crude entering the West Coast markets. In addition, a changein refined products specifications reduced demand for PMT’s blended crude.  Throughput during the third quarter of thisyear was reduced by 

 

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lower OCS volumes due to naturalproduction declines and lower SJV light crude volumes due to natural fielddecline.  Throughput was also reduced byhigher light crude runs at Bakersfield area refineries which reduces thevolumes available to move south to Los Angeles. The impact of lower volumes was offset by increased tariff rates and amore favorable tariff mix.

 

 
| ** **                                      | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|------------|
| ***Rocky Mountains***                           | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Operating income                                |       | $                                         | 7,533      |       | $ | 4,100 |   | $ | 3,433 |   | 84 | % |
| Operating data (bpd): Rangeland pipeline system |       |                                      |       |       |   |   |   |   |   |
| Sundre—North                               |       | 21.8                                      |       | —     |   | n.a. |   | n.a. |   |
| Sundre—South                               |       | 46.8                                      |       | —     |   | n.a. |   | n.a. |   |
| Western Corridor system                         |       | 23.1                                      |       | 17.7       |   | 5.4 |   | 31 | % |
| Salt Lake City Core system                      |       | 75.2                                      |       | 68.3       |   | 6.9 |   | 10 | % |
| AREPI pipeline                                  |       | 47.4                                      |       | 47.8       |   | (0.4 | ) | -1 | % |
| Frontier pipeline                               |       | 51.4                                      |       | 47.9       |   | 3.5 |   | 7 | % |
|                                                 |            |                                           |            |            |  |  |  |  |  |  |  |  |

 

        Operating income increased due to highervolumes on the Western Corridor system, increased volumes on our systems thattransport oil into the Salt Lake City area, and the benefit of a full quarter’soperations of the Rangeland Pipeline system. The increase into Salt Lake Cityreflects increased demand and the benefit of the 9,000 bpd expansion that wascompleted in the second quarter of 2004.

 

*         Statement ofIncome—Discussion and Analysis*

 

***        Revenues***

 
| ** **                               | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|------------|
| ** **                               | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                               | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Pipeline transportation revenue          |       | $                                         | 28,160     |       | $ | 25,501 |   | $ | 2,659 |   | 10 | % |
| Storage and distribution revenue         |       | 8,391                                     |       | 4,710      |   | 3,681 |   | 78 | % |
| Pipeline buy/sell transportation revenue |       | 7,972                                     |       | —     |   | 7,972 |   | — |   |
| Crude oil sales, net of purchases:       |       |                                      |       |       |   |   |   |   |   |
| Crude oil sales                          |       | 106,760                                   |       | 102,740    |   | 4,020 |   | 4 | % |
| Crude oil purchases                      |       | (103,192                                  | )          | (96,833    | ) | 6,359 |   | 7 | % |
| Crude oil sales, net of purchases        |       | 3,568                                     |       | 5,907      |   | (2,339 | ) | -40 | % |
| Net revenue before operating expenses    |       | $                                         | 48,091     |       | $ | 36,118 |   | $ | 11,973 |   | 33 | % |
|                                          |            |                                           |            |            |  |  |  |  |  |  |  |  |  |

 

        Pipeline transportation revenues werehigher mainly due to higher volumes on the Western Corridor system andincreased demand by Salt Lake City area refineries, as well as higher tariffsand a more favorable tariff mix in California.

 

        Increased storage and distributionrevenue reflects a full quarter of operations of the Pacific Terminals storageand distribution system, which was acquired on July 31, 2003.

 

        Pipeline buy/sell transportationrevenues of $8.0 million relate to a full quarter of operations of theRangeland pipeline system, which was acquired on May 11, 2004.

 

        The decrease in our West Coast gatheringand blending unit’s crude oil sales, net of purchases, for the three monthsended September 30, 2004, was primarily the result of lower margins in ourblending activities resulting from lower blending volumes due to a change inrefined products specifications, as well as from competitive pricing pressuresdue to steeply discounted foreign crude entering the West Coast markets. Weconsider this gathering and blending activity to be complementary to ourpipeline transportation operations.

 

 

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***        Expenses***

 
| ** **                    | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|------------|
| ** **                    | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                    | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Operating expenses            |       | $                                         | 22,589     |       | $ | 16,630 |   | $ | 5,959 |   | 36 | % |
| Transition costs              |       | 199                                       |       | —     |   | 199 |   | — |   |
| General and administrative    |       | 3,762                                     |       | 3,305      |   | 457 |   | 14 | % |
| Depreciation and amortization |       | 6,821                                     |       | 5,049      |   | 1,772 |   | 35 | % |
|                          |       | $                                         | 33,371     |       | $ | 24,984 |   | $ | 8,387 |   | 34 |  % |

 

        The increase in operating expense wasrelated primarily to the acquisition of the Rangeland pipeline system inMay 2004 and the MAPL pipeline on June 30, 2004, as well as a full quarterof operations of the Pacific Terminals storage and distribution system that wasacquired on July 31, 2003. We also experienced higher field operating andmaintenance costs in the Rocky Mountains as a result of the timing of internaltank inspections, repairs resulting from internal line inspections andincreased expenditures on flow improver this quarter to improve pipelinethroughput capacity.

 

        Transition costs were incurred fortransition services provided by the sellers of the Rangeland and MAPL Pipelinesystems, as well as for consulting and other out-of-pocket costs incurred inconnection with the integration of these systems.

 

        The increase in general andadministrative expense was mainly attributable to personnel and administrationcosts associated with marketing, accounting and administrative supportfunctions in our new regional Calgary office, following the acquisition of theRangeland pipeline system in May 2004.

 

        The increase in depreciation andamortization includes $1.8 million for depreciation on the Rangeland pipelinesystem.

 

***        OtherIncome and Expenses***

 
| ** **                      | ** ** | **Three Months**

**Ended September 30,** | ** ** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|------------|
| ** **                      | ** ** | **2004**                                  | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                      | ** ** | **(In thousands)**

**(unaudited)**       | ** ** | ** ** | ** ** | ** ** |
| Share of net income of Frontier |       | $                                         | 406        |       | $ | 414 |   | $ | (8 | ) | -2 | % |
|                            |       |                                      |       |       |   |   |   |   |   |
| Interest expense                |       | $                                         | 5,234      |       | $ | 4,782 |   | $ | 452 |   | 9 | % |
|                            |       |                                      |       |       |   |   |   |   |   |
| Income tax expense              |       | $                                         | 221        |       | — |   | $ | 221 |   | — |   |
|                                 |            |                                           |            |            |  |  |  |  |  |  |  |  |  |

 

 

        Our weighted average borrowings duringthe three months ended September 2004 were $335 million compared to$295 million in the corresponding period in 2003. The 2004 period averageincludes borrowings for our Canadian acquisition. The 2003 period averagereflects the acquisition of Pacific Terminals on July 31, 2003.  The effect of the increase in averageborrowings was partly offset by a lower weighted average interest rate of 5.8%for the three months ended September 30, 2004 compared to a weighted averageinterest rate of 6.5% in 2003. The decrease in the average interest rate wasdue in part to renegotiation of interest rates in December 2003 under ourcredit facilities, and also to lower market interest rates.

 

        The income tax expense for the periodended September 30, 2004 relates to the income of the Rangeland pipeline systemacquired in May 2004.  Our Canadiansubsidiaries are taxable entities and the repatriation of funds into the U.S.is subject to Canadian withholding tax.

 

 

34

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*Nine Months Ended September 30, 2004 Compared to Nine MonthsEnded September 30, 2003*

 

        ***Summary***

 
| ** **                                    | ** ** | **Nine Months**

**Ended September 30,** | ** ** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|------------|
| ** **                                    | ** ** | **2004**                                 | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                    | ** ** | **(In thousands)**

**(unaudited)**      | ** ** | ** ** | ** ** | ** ** |
| Net income                                    |       | $                                        | 27,095     |       | $ | 18,633 |   | $ | 8,462 |   | 45 | % |
| Net income per limited partner unit           |       |                                     |       |       |   |   |   |   |   |
| Basic                                         |       | $                                        | 0.95       |       | $ | 0.85 |   | $ | 0.10 |   | 12 | % |
| Diluted                                       |       | $                                        | 0.94       |       | $ | 0.84 |   | $ | 0.10 |   | 12 | % |
| Recurring net income(1)                       |       | $                                        | 29,996     |       | $ | 18,633 |   | $ | 11,363 |   | 61 | % |
| Recurring net income per limited partner unit |       |                                     |       |       |   |   |   |   |   |
| Basic                                         |       | $                                        | 1.05       |       | $ | 0.85 |   | $ | 0.20 |   | 24 | % |
| Diluted                                       |       | $                                        | 1.05       |       | $ | 0.84 |   | $ | 0.21 |   | 25 | % |
|                                               |            |                                          |            |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Recurring income excludes anexpense of $2.9 million incurred in connection with the repayment of ourterm loan, including a $2.3 million non-cash write-off of deferredfinancing costs and a $0.6 million cash expense for related interest rateswap terminations.

 

                Net income for the nine monthsended September 30, 2004 includes the operations of the Pacific Terminalsstorage and distribution system following the acquisition of these assets onJuly 31, 2003 and the operations of Rangeland Pipeline system afteracquiring these assets on May 11, 2004. Net income for the 2004 periodalso reflects a $2.9 million expense incurred in connection with therepayment of our term loan, which includes a $2.3 non-cash write-down ofpreviously deferred financing costs and a $0.6 million charge to terminateinterest rate swap agreements.  Theseexpenses are considered non-recurring. Accordingly, we exclude these amounts in reporting recurring net income.

 

        The increase in recurringnet income reflects the benefit of (i) the operation, since July 31,2003, of Pacific Terminals storage and distribution system, (ii) highervolumes and revenue on the Rocky Mountain pipelines, and (iii) theoperations of the Rangeland Pipeline system acquired in May 2004. Theseincreases were partially offset by lower volumes and revenue from the WestCoast pipelines and lower West Coast gathering and blending margins. There wereapproximately 30% more weighted average limited partner units outstanding inthe nine months ended September 30, 2004 due to the sale of additional commonunits to partially fund the acquisitions of the Pacific Terminals storage anddistribution system, the Rangeland Pipeline system and the MAPL pipeline.

 

                ***Segment Information***

 
| ** **                                                    | ** ** | **Nine Months**

**Ended September 30,** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------|------------|------------|
| ***West Coast***                                              | ** ** | **2004**                                 | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**

**(unaudited)**      | ** ** | ** ** | ** ** | ** ** |
| Operating income                                              |       | $                                        | 37,702     |       | $ | 30,773 |   | $ | 6,929 |   | 23 | % |
| Operating data:

    Pipeline throughput (bpd) |       | 137.6                                    |       | 154.0      |   | (16.4 | ) | -11 | % |
|                                                               |            |                                          |            |            |  |  |  |  |  |  |  |  |

 

        The increase in West Coast operatingincome was primarily due to the acquisition of the Pacific Terminals storageand distribution system.  This increasewas offset by a reduction in pipeline transportation revenue and lower marginsin our gathering and blending operations. Average daily pipeline throughputdecreased to 137,600 barrels per day for the nine months ended September 30,2004, compared to 154,000 barrels per day for the corresponding period of theprior year. Throughput during the first nine months of this year was adverselyaffected by refinery maintenance activities. In addition, OCS volumes werelower due to natural field decline.  Ahigher tariff beginning May 1, 2004 on Line 2000 partially offset the effectsof lower volumes.  The lower gatheringand blending margins resulted from lower blending volumes due to a change inrefined products specifications, which reduced demand for our blended crudeoil, as well as competitive pricing pressures due to steeply discounted foreigncrude oil entering the West Coast markets. We consider this gathering andblending activity to be complementary to our pipeline transportationoperations.

 

 

35

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| ** **                                      | ** ** | **Nine Months Ended**

**September 30,** | ** ** | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|------------|
| ***Rocky Mountains***                           | ** ** | **2004**                                 | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | **(In thousands)**

**(unaudited)**      | ** ** | ** ** | ** ** | ** ** |
| Operating income                                |       | $                                        | 16,890     |       | $ | 10,719 |   | $ | 6,171 |   | 58 | % |
| Operating data (bpd): Rangeland pipeline system |       |                                     |       |       |   |   |   |   |   |
| Sundre—North                               |       | 21.6                                     |       | —     |   | n.a. |   | n.a. |   |
| Sundre—South                               |       | 47.6                                     |       | —     |   | n.a. |   | n.a. |   |
| Western Corridor system                         |       | 19.7                                     |       | 16.2       |   | 3.5 |   | 22 | % |
| Salt Lake City Core system                      |       | 70.3                                     |       | 65.9       |   | 4.4 |   | 7 | % |
| AREPI pipeline                                  |       | 45.8                                     |       | 41.6       |   | 4.2 |   | 10 | % |
| Frontier pipeline                               |       | 48.5                                     |       | 41.5       |   | 7.0 |   | 17 | % |
|                                                 |            |                                          |            |            |  |  |  |  |  |  |  |  |

 

        The increase in Rocky Mountainsoperating income was primarily due to increased demand by refineries in theSalt Lake City area this year, compared to 2003 when demand was lower due torefinery turnarounds. In addition, we acquired the Rangeland pipeline system onMay 11, 2004.

 

*Statement of Income—Discussion and Analysis*

 

***        Revenue***

 
| ** **                               | ** ** | **Nine Months**

**Ended September 30,** | ** ** | ** ** |
|------------------------------------------|------------|------------------------------------------|------------|------------|
| ** **                               | ** ** | **2004**                                 | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                               | ** ** | **(In thousands)**

**(unaudited)**      | ** ** | ** ** | ** ** | ** ** |
| Pipeline transportation revenue          |       | $                                        | 79,879     |       | $ | 76,579 |   | $ | 3,300 |   | 4 | % |
| Storage and distribution revenue         |       | 27,773                                   |       | 4,710      |   | 23,063 |   | 490 | % |
| Pipeline buy/sell transportation revenue |       | 11,662                                   |       | —     |   | 11,662 |   | — |   |
| Crude oil sales, net of purchases:       |       |                                     |       |       |   |   |   |   |   |
| Crude oil sales                          |       | 293,125                                  |       | 288,070    |   | 5,055 |   | 2 | % |
| Crude oil purchases                      |       | (278,689                                 | )          | (271,554   | ) | 7,135 |   | 3 | % |
| Crude oil sales, net of purchases        |       | 14,436                                   |       | 16,516     |   | (2,080 | ) | -13 | % |
| Net revenue before operating expenses    |       | $                                        | 133,750    |       | $ | 97,805 |   | $ | 35,945 |   | 37 | % |
|                                          |            |                                          |            |            |  |  |  |  |  |  |  |  |  |

 

        Higher Rocky Mountain pipeline revenuedue to increased demand by Salt Lake City area refineries was partially offsetby lower West Coast pipeline revenue due to lower volumes as described above.

 

        Higher storage and distribution revenuein 2004 reflects nine months of operations of the Pacific Terminals storage anddistribution system that was acquired on July 31, 2003.

 

        Pipeline buy/sell transportation revenueof $11.7 million relates to the operations of the Rangeland pipelinesystem, which was acquired on May 11, 2004.

 

        The decrease in net crude oil sales for2004 was primarily the result of lower West Coast blending volumes due to achange in refined products specifications, which reduced demand for our blendedcrude oil, as well as competitive pricing pressures due to steeply discountedforeign crude oil entering the West Coast markets. We consider this gatheringand blending activity to be complementary to our pipeline transportationoperations.

 

 

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***        Expenses***

 
| ** **                    | ** ** | **Nine Months**

**Ended September 30,** | ** ** | ** ** |
|-------------------------------|------------|------------------------------------------|------------|------------|
| ** **                    | ** ** | **2004**                                 | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                    | ** ** | **(In thousands)**

**(unaudited)**      | ** ** | ** ** | ** ** | ** ** |
| Operating expenses            |       | $                                        | 62,189     |       | $ | 43,622 |   | $ | 18,567 |   | 43 | % |
| Transition costs              |       | 383                                      |       | 397        |   | (14 | ) | -4 | % |
| General and administrative    |       | 11,252                                   |       | 10,289     |   | 963 |   | 9 | % |
| Depreciation and amortization |       | 17,776                                   |       | 13,435     |   | 4,341 |   | 32 | % |
|                          |       |                                     | $          | 91,600     |   | $ | 67,743 |   | $ | 23,857 |   | 35 |  % |
|                               |            |                                          |            |            |  |  |  |  |  |  |  |  |  |

 

        The increase in operating expense wasrelated primarily to the acquisition of the Pacific Terminals storage anddistribution assets on July 31, 2003 and the Rangeland pipeline system on May11, 2004. We also experienced higher field operating and maintenance costs andhigher power costs in the Rocky Mountains as a result of timing of internalline inspections, increased expenditure on flow improver and increased volumesand higher natural gas prices. This was offset by lower maintenance and powercosts in the West Coast.

 

        Transition costs in 2003 consisted ofemployee transition bonus payments related to our purchase of the WesternCorridor and Salt Lake City Core systems in 2002. Transition costs in 2004 wereincurred for transition services provided by the sellers of the Rangeland andMAPL pipeline systems, as well as for consulting and other out-of-pocket costsincurred in connection with the integration of these systems.

 

        The increase in general andadministrative expense was in part due to the acquisition of the Rangelandpipeline system in May 2004, increased personnel costs related to companygrowth and increased costs for regulatory compliance.

 

        The increase in depreciation andamortization includes $1.9 million for depreciation on the Pacific Terminalsstorage and distribution system and $2.4 million for depreciation on theRangeland pipeline system.

 

***        OtherIncome and Expenses***

 
| ** **                                                                        | ** ** | **Nine Months  Ended September 30,** | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------|
| ** **                                                                        | ** ** | **2004**                             | ** ** | **2003**   | ** ** | **Change** | ** ** | **Percent** | ** ** |
| ** **                                                                        | ** ** | **(In thousands)**

**(unaudited)**  | ** ** | ** ** | ** ** | ** ** |
| Share of net income of Frontier                                                   |       | $                                    | 1,190      |       | $ | 1,141 |   | $ | 49 |   | 4 | % |
| Interest expense                                                                  |       | $                                    | 13,743     |       | $ | 12,930 |   | $ | 813 |   | 6 | % |
| Write-off of deferred financing costs and interest rate swap  termination expense |       | $                                    | 2,901      |       | — |   | $ | 2,901 |   | — |   |
| Income tax expense                                                                |       | $                                    | 207        |       | — |   | $ | 207 |   | — |   |
|                                                                                   |            |                                      |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

        Our increased share of Frontier netincome was attributable to increased volumes on Frontier pipeline, offset byincreased expenses for flow improver.

 

        The increase in interest cost was due toborrowings incurred to partially fund the acquisition of Pacific Terminalsstorage and distribution system and the Rangeland Pipeline system.  Our weighted average borrowings during thenine months ended September 30, 2004 were $304 million compared to $248 millionin the corresponding period in 2003.  Theeffect of this increase was partially offset by a decrease in interest expenseassociated with a renegotiation of interest rates in December 2003 underour credit facilities and lower market interest rates.  The combination of lower renogiated interestrates and lower market rates led to a lower weighted average interest rate of5.8% for the first nine months in 2004 compared to a weighted average interestrate of 7.0% in 2003.

 

        Write-off of deferred financing costsand interest rate swap termination expense relate to deferred financing costsof $2.3 million incurred in connection with the repayment of our term loan and$0.6 million of expense incurred to terminate related interest rate swaps.

 

 

37

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        The income tax expense for the periodended September 30, 2004 relates to the income of the Rangeland pipeline systemacquired in May 2004.  Our Canadiansubsidiaries are taxable entities and the repatriation of funds into the U.S.is subject to Canadian withholding tax.

 

**Liquidity and Capital Resources**

 

        We believe that cash generated fromoperations, together with our cash balance and our unutilized borrowingcapacity, will be sufficient to meet our planned distributions, our workingcapital requirements, anticipated sustaining capital expenditures and scheduleddebt payments in the next three years.

 

        The financing plan for the construction ofour proposed Pier 400 Project is under development, but will likelyinclude both proceeds from debt and the issuance of additional Partnershipunits. The final structure will depend on market conditions.

 

        On August 1, 2003, the Partnership,PEG and certain subsidiaries of PEG filed a universal shelf registrationstatement on Form S-3 with the SEC to register the issuance and sale, fromtime to time and in such amounts as determined by the market conditions andneeds of the Partnership, of up to $550.0 million of common units of thePartnership and debt securities of both the Partnership and PEG. The SECdeclared the registration statement effective on August 8, 2003. Duringthe nine months ended September 30, 2004, we issued 4.6 million Partnershipunits pursuant to the registration statement. At September 30, 2004, we haveapproximately $280 million of remaining availability under thisregistration statement.

 

        We intend to draw down on this shelfregistration statement and use proceeds from borrowings under our existing andplanned revolving credit facilities to finance our future acquisitions anddevelopment projects, including the Pier 400 Project. We expect tomaintain a debt to total capitalization ratio of approximately 50 percentover time.

 

        Our ability to satisfy our debt serviceobligations, fund planned capital expenditures, make acquisitions, developprojects and pay distributions to our unitholders will depend upon our futureoperating performance. Our operating performance is primarily dependent on thevolume of crude oil transported through our pipelines and the capacity leasedin our storage tanks as described in “Overview” above. Our operatingperformance is also affected by prevailing economic conditions in the crude oilindustry and financial, business and other factors, some of which are beyondour control, which could significantly impact future results.

 

*Operating, Investing and Financing Activities*

 
| ** **                                | ** ** | **Nine Months Ended September 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|------------|------------|
| ** **                                | ** ** | **2004**                            | ** ** | **2003**   | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **(In thousands)**

**(unaudited)** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities |       | $                                   | 42,014     |       | $          | 33,401 |   | $ | 8,613 |   |
| Net cash used in investing activities     |       | (151,143                            | )          | (162,122   | )          | (10,979 | ) |
| Net cash provided by financing activities |       | 113,958                             |       | 122,234    |       | (8,276 | ) |
|                                           |            |                                     |            |            |            |  |  |  |  |  |

 

        *Netcash provided by operating activities*

 

        The increase in the net cash fromoperating activities of $8,613 million, or 26%, was the result of higheroperating income, partially offset by an increase in cash used for workingcapital.

 

*        Net cash usedin investing activities*

 

        The amount in 2004 relates primarily toour acquisition and development activities. The 2004 period includes$139.0 million related to the acquisition of the Rangeland Pipeline andMAPL Pipeline systems. Capital expenditures were $11.5 million in 2004, ofwhich $1.5 million related to sustaining capital projects,$1.2 million related to the primarily to the transition of the PacificTerminals storage and distribution system and our Canadian assets, and $6.3 millionrelated to expansion. Additionally, we continue to develop the Pier 400Project, for which we capitalized $2.5 million for the nine months endedSeptember 30, 2004.

 

 

38

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        In 2003, net cash used in investingactivities includes $159.9 million paid to date for the acquisition of thePacific Terminals storage and distribution system assets on July 31, 2003.  Additionally, capital expenditures were$2.3 million, of which $1.3 million related to sustaining capitalprojects, $0.9 million related to expansion projects, and$0.1 million related to transition projects.

 

*        Net cashprovided by financing activities*

 

        The amount in 2004 of$114.0 million includes net proceeds of $128.6 million from ourequity offerings completed in March and April, 2004, which were usedprincipally to partly fund our Rangeland Pipeline and MAPL Pipelineacquisitions, $241.1 million net proceeds from our 7.125% unsecured seniornotes offering which were used, in part, to repay our $225 million termloan, net proceeds of $11.1 million under our revolving credit facilities,and $41.8 million in distributions to the limited and general partnerinterests.

 

        Net cash provided by financingactivities in 2003 includes proceeds of $149.0 million under the revolvingcredit facility which were used to fund, in part, the acquisition of thePacific Terminals storage and distribution system.  It also includes net proceeds and relatedcontribution from our general partner of $133.7 million from our sale of additionalcommon units, which were used to repay $90.0 million of debt under ourrevolving credit facility and to redeem 1.7 million outstanding common unitstotaling $40.8 million held by our general partner, which were cancelled afterredemption.  Distributions to our limitedpartners and our general partner were $29.7 million.

 

*Capital Requirements*

 

        Generally, our crude oil transportationand storage operations require investment to upgrade or enhance existingoperations and to meet environmental and operational regulations. Our capitalrequirements consist primarily of:

 

•                  sustainingcapital expenditures to replace partially or fully depreciated assets in orderto maintain the existing operating capacity or efficiency of our assets andextend their useful lives;

 

•                  transitional capitalexpenditures to integrate acquired assets into our existing operations; and

 

•                  expansioncapital expenditures to expand or increase the efficiency of the existingoperating capacity of our assets, whether through construction or acquisition,such as placing new storage tanks in service to increase our storagecapabilities and revenue, and adding new pump stations or pipeline connectionsto increase our transportation throughput and revenue.

 

        We have forecasted total capitalexpenditures of $16 million in 2004, including $11 million forexpansion projects, $3 million for transition capital projects and$2 million for sustaining capital projects.

 

*Debt Obligations*

 

        At September 30, 2004, our debtobligations include: (i) $38.0 million on our U.S. revolving creditfacility (ii) Cdn$65 million (U.S.$51.4 million) on our seniorsecured Canadian revolving credit facility, (iii) $248.7 million onour 7.125% senior unsecured notes, and (iv) Cdn$4.3 million(U.S.$3.4 million) payable to the seller of the MAPL assets. For furtherdiscussion of these debt obligations see “Footnote 5—Long-term Debt” to thefinancial statements.

 

***        Off-BalanceSheet Arrangements***

 

        The Partnership has no off-balance sheetarrangements.

 

**Accounting Pronouncements**

 

        See discussion ofnewly issued accounting pronouncements in “Note 1—Summary of SignificantAccounting Policies” in the accompanying condensed consolidated financialstatements.

 

 

39

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**ITEM 3.****Quantitative and Qualitative Disclosures About MarketRisk**

 

        Market risk is the risk of loss arisingfrom adverse changes in market rates and prices. The principal market risks towhich we are exposed are interest rate risk, crude oil price risk and currencyexchange rate risk. We utilize various derivative instruments to manage ourexposure to our principal market risks. Our risk management policies andprocedures are designed to monitor interest rates, currency exchange rates,NYMEX and over-the-counter commodity positions, and physical volumes, grades, locationsand delivery schedules to ensure that our hedging activities address our marketrisks.

 

        We have interest rate swap agreementswith an aggregate notional principal amount of $80.0 million to receiveinterest at a fixed rate of 7.125% and to pay interest at an average variablerate of six month LIBOR plus 1.6681% (set in advance or in arrears depending onthe swap transaction). The interest rate swaps mature June 15, 2014 andare callable at the same dates and terms as our 7.125% Senior Notes. We electedto apply hedge accounting to account for the interest rate swaps. Changes infair values of the interest rate swaps are recorded into earnings each period.Similarly, changes in the fair value of $80 million of the 7.125% SeniorNotes are recorded into earnings each period. During the three months ended September 30, 2004, werecognized reductions in interest expense of $0.7 million related to thedifference between the fixed rate and the floating rate of interest on theinterest rate swaps.  During the three months ended September 30, 2004, wemeasured the hedge effectiveness of these interest rate swaps and noted that nogain or loss from ineffectiveness was required to be recognized.  The fairvalue of these interest rate swaps was a gain of approximately $2.9 million atSeptember 30, 2004.

 

        We are subject to risks resulting frominterest rate fluctuations as the interest cost on $169.4 million of ouroutstanding debt is based on variable rates. If the LIBOR or Canadian Bankers’Acceptance discount rates were to increase 1.0% for the remainder of 2004, ourinterest expense would increase approximately $0.4 million based on theoutstanding debt at September 30, 2004.

 

        We use, on a limited basis, certainderivative instruments (principally futures and options) to hedge our minimalexposure to market price volatility related to our inventory or future sales ofcrude oil. We do not enter into speculative derivative activities of any kind.Derivative instruments are included in other assets in the accompanyingcondensed consolidated balance sheets. In our PMT operations we purchase crude oil for subsequent blending,transportation and resale primarily in the Los Angeles Basin. Changes in thefair value of our derivative instruments related to crude oil inventory arerecognized in net income. For the nine months ended September 30, 2004 and2003, “crude oil sales, net of purchases” were net of $2.3 million and$0.3 million, respectively, reflecting changes in the fair value of PMT’sderivative instruments for its marketing activities. In addition, changes inthe fair value of our derivative instruments related to the future sale ofcrude oil are deferred and reflected in “accumulated other comprehensiveincome,” a component of partners’ capital, until the related revenue isreflected in the consolidated statements of income. As of September 30, 2004,$1.8 million relating to the changes in the fair value of derivativeinstruments was included in “accumulated other comprehensive income.”

 

**ITEM 4.****Controlsand Procedures**

 

***        DisclosureControls and Procedures***

 

        As of the end of the quarterly periodended September 30, 2004, Irvin Toole, Jr., Chief Executive Officer of ourGeneral Partner, and Gerald A. Tywoniuk, Chief Financial Officer of ourGeneral Partner, evaluated the effectiveness of our disclosure controls andprocedures. Based on this evaluation, they believe that:

 

•                  our disclosurecontrols and procedures were effective in ensuring that information required tobe disclosed by us in the reports we file or submit under the SecuritiesExchange Act of 1934 was recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms; and

 

•                  our disclosurecontrols and procedures were effective in ensuring that material informationrequired to be disclosed by us in the report we file or submit under theSecurities Exchange Act of 1934 was accumulated and communicated to ourmanagement, including the Chief Executive Officer and the Chief FinancialOfficer of our General Partner, as appropriate to allow timely decisionsregarding required disclosure.

 

***        InternalControl Over Financial Reporting***

 

        There has not been any change in ourinternal control over financial reporting that occurred during our quarterlyperiod ended September 30, 2004 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

 

 

40

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**PART II. OTHER INFORMATION**

 

**ITEM 1.Legal Proceedings**

 

        See discussion of legal proceedings in “Note 8—Commitmentsand Contingencies” in the accompanying condensed consolidated financialstatements.

 

**ITEM 6.Exhibits**

 

        The following documents are filed as exhibitsto this quarterly filing:

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                              |
|-------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Exhibit 31.1      |       | Certification  of Principal Executive Officer of Pacific Energy GP, Inc., General  Partner of Pacific Energy Partners, L.P., as required by Rule 13a-14(a)  of the Securities Exchange Act of 1934 |
| *Exhibit 31.2      |       | Certification  of Principal Financial Officer of Pacific Energy GP, Inc., General  Partner of Pacific Energy Partners, L.P., as required by Rule 13a-14(a)  of the Securities Exchange Act of 1934 |
| †Exhibit 32.1 |       | Certification  of Chief Executive Officer of Pacific Energy GP, Inc., General Partner  of Pacific Energy Partners, L.P., pursuant to 18 U.S.C. §1350                                          |
| †Exhibit 32.2 |       | Certification  of Chief Financial Officer of Pacific Energy GP, Inc., General Partner  of Pacific Energy Partners, L.P., pursuant to 18 U.S.C. §1350                                          |

 

----

*                 Filed herewith.

 

†                  Not considered to be “filed” for purposes ofSection 18 of the Securities Exchange Act of 1934 or otherwise subject tothe liabilities of that section.

 

 

41

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**SIGNATURES**

 

                Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Partnership has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
| ** **              | **PACIFIC ENERGY PARTNERS, L.P.** |
|-------------------------|-----------------------------------|
| ** **              | **By:**                           | **PACIFIC ENERGY GP, INC.  its General Partner** |
|                    |                              | By: | /s/ IRVIN TOOLE, JR. |
|                    |                              |   | Irvin Toole, Jr.*President and Chief Executive Officer  (Principal Executive Officer)* |
|                    |                              |   |   |
| November  2,  2004 |                              |   |   |
|                    |                              | By: | /s/ GERALD A. TYWONIUK  |
|                    |                              |   | Gerald A. Tywoniuk*Senior Vice President, Chief Financial  Officer and Treasurer  (Principal Financial Officer)* |
| November  2, 2004       |                              |   |   |

 

 

42

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**EXHIBIT INDEX**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                   |
|-------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *Exhibit 31.1      |       | Certification  of Principal Executive Officer of Pacific Energy GP, Inc., General  Partner of Pacific Energy Partners, L.P., as required by Rule 13a-14(a) of  the Securities Exchange Act of 1934 |
|                    |       |                                                                                                                                                                                                              |
| *Exhibit 31.2      |       | Certification  of Principal Financial Officer of Pacific Energy GP, Inc., General  Partner of Pacific Energy Partners, L.P., as required by Rule 13a-14(a) of  the Securities Exchange Act of 1934 |
|                    |       |                                                                                                                                                                                                              |
| †Exhibit 32.1 |       | Certification  of Chief Executive Officer of Pacific Energy GP, Inc., General Partner  of Pacific Energy Partners, L.P., pursuant to 18 U.S.C. §1350                                               |
|                    |       |                                                                                                                                                                                                              |
| †Exhibit 32.2 |       | Certification  of Chief Financial Officer of Pacific Energy GP, Inc., General Partner  of Pacific Energy Partners, L.P., pursuant to 18 U.S.C. §1350                                               |

 

----

*                 Filed herewith.

 

†                  Not considered to be “filed” for purposes ofSection 18 of the Securities Exchange Act of 1934 or otherwise subject tothe liabilities of that section.

 

 

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