MAGELLAN MIDSTREAM PARTNERS, LP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
We are a publicly traded limited partnership principally engaged in the transportation, storage and distribution of refined petroleum products and crude oil. As of
December 31, 2021, our asset portfolio, excluding assets associated with discontinued operations, consisted of:
• our refined products segment, comprised of our approximately 9,800 mile refined petroleum products pipeline system with 54 terminals and two marine storage terminals (one of which is owned through a joint venture); and
•our crude oil segment, comprised of approximately 2,200 miles of crude oil pipelines, a condensate splitter and 39 million barrels of aggregate storage capacity, of which approximately 29 million barrels are used for contract storage. Approximately 1,000 miles of these pipelines, the condensate splitter and 31 million barrels of this storage capacity (including 25 million barrels used for contract storage) are wholly-owned, with the remainder owned through joint ventures.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report on Form 10-K for the year ended
See section 1. Business for a detailed description of our business.
Resiliency and Recovery. Overall, 2021 was a year of resiliency and recovery for our nation and us. As the country moved toward reopening and resumed travel, economic and drilling activity, we benefited from a robust return of demand for gasoline, diesel fuel and aviation fuel. We are honored to serve our country by Moving What Moves America®, ensuring safe and reliable access to the essential fuels that enable our everyday lives. Efficiency and discipline remain key to our strategy. Through our ongoing business optimization efforts, we have identified significant cost savings and process improvements throughout the organization. Started in late 2019, this initiative has served us well to ensure we are operating as efficiently as possible, especially considering the current inflationary environment, while safeguarding the integrity of our assets. Improved refined products demand as well as our successes in improving efficiency contributed to the solid financial results we achieved this year. We also regularly review our asset portfolio for opportunities to unlock incremental value for investors. During 2021, we sold a portion of our interest in our
Pasadena, Texasmarine terminal joint venture, while retaining a meaningful position in this strategic export facility. We also agreed to sell our independent terminals network, comprised of 26 locations primarily in the southeastern United States. Though we still await regulatory approval for this sale, we expect to close by mid-2022. Disciplined Approach to Capital Allocation. We have a proven track record of delivering superior returns on invested capital. Although the current environment for new large-scale projects is challenging, we continue to assess additional capital investments to create future value for our investors. We currently plan to spend $50 millionin 2022 to complete projects already committed, including expansions of our pipeline system to transport additional refined products to New Mexicoand Colorado. Both of these expansions are fully underwritten by commitments from strong counterparties and provide attractive returns, underscoring the flexibility of our network to respond to changing market dynamics. We also delivered value to our investors with nearly $525 millionof equity repurchases during the year as well as an increase to our quarterly cash distribution. In total, we returned $1.4 billionto our investors during 2021 through a combination of consistent cash distributions and equity repurchases, an increase of 19% over 2020. 37 -------------------------------------------------------------------------------- Essential Services. Energy transition and the long-term outlook for petroleum products have become recent topics of interest. However, the global pandemic and mid-2021 fuel emergency resulting from a third-party U.S.pipeline cyberattack served as strong reminders that our nation and the world very much depend on an abundance of crude oil and refined petroleum products to function. People expect gasoline will be readily accessible for their daily commutes and family activities, that diesel fuel will be available for farmers to harvest crops and for truckers to transport retail goods. The well-being of our entire economy depends on these essential fuels. We expect our business to stay healthy for decades. Industry and government forecasts project petroleum products to remain essential to our nation's everyday lives for many years to come. The fundamental features of our business strategy are proven, and we will adapt as the needs of our customers and markets evolve. Living our Principles. Our most important social responsibility is to safely and reliably transport and store the fuels that our nation relies on every day. For two decades, we have focused on long-term, sustainable operations in all aspects of our business. Our dedicated workforce spends significant time and resources each year to ensure the integrity of our assets and to protect the communities where we live and work. Further, our employees are empowered to make decisions every day that align with our fundamental focus on safety to ensure our company's success. To reinforce the importance of this responsibility, our annual incentive program for all employees has been linked to key environmental and safety metrics since the very beginning. In addition, Magellan has designed a responsible governance structure, with an independent board elected by our investors, and fostered a culture considered to be an industry leader for integrity, trustworthiness and simply doing the right thing.
Leadership Changes. On
January 25, 2022, Michael N. Mearsnotified the partnership of his decision to retire from his positions of President, Chief Executive Officer and Chairman of the Board of Directors effective on April 30, 2022. Our board elected Barry R. Pearl, currently the independent Lead Director, as Chairman of the Board and also elected Aaron L. Milfordas Chief Executive Officer and President effective May 1, 2022. Mr. Milfordcurrently serves as Chief Operating Officer and has served in such capacity since 2019. He served as Senior Vice President and Chief Financial Officer from 2015 to 2019 and various positions of increasing responsibility since joining us and our predecessor in 1995. Mark B. Roleswas elected by our board as Senior Vice President, Commercial - Refined Products, effective May 22, 2021. Mr. Roleshas held Vice President level positions since 2014 and various positions of increasing responsibilities in commercial and operations since joining us and our predecessor in 1998. Distribution. In January 2022, our board declared a quarterly distribution of $1.0375per unit for the period of October 1, 2021through December 31, 2021. This quarterly distribution was paid on February 14, 2022to unitholders of record on February 7, 2022. Equity Repurchase Program. In October 2021, our board expanded our unit repurchase program by $750 millionfor a total of $1.5 billionand extended the program through 2024. The expanded program allows unit repurchases in compliance with Securities Exchange Act Rules 10b-18, 10b5-1 or both. Discontinued Operations. In June 2021, we entered into an agreement to sell our independent terminals network comprised of 26 refined petroleum products terminals with approximately six million barrels of storage located primarily in the southeastern U.S.The sale is expected to close upon the receipt of required regulatory approval. The related results of operations, financial position and cash flows have been classified as discontinued operations for all periods presented. See Note 3 - Discontinued Operations and Assets Held for Sale under Item 8. Financial Statements and Supplementary Data of this report for further details. Sale of Partial Interest in MVP Terminalling, LLC. In April 2021, we sold nearly half of our membership interest in MVP and received proceeds of $272.1 million. Following the sale, we own approximately 25% of MVP and remain the operator of the facility. 38 --------------------------------------------------------------------------------
We believe that investors benefit from having access to the same financial measures utilized by management. Operating margin, which is presented in the following table, is an important measure used by management to evaluate the economic performance of our core operations. Operating margin is not a generally accepted accounting principles ("GAAP") measure, but the components of operating margin are computed using amounts that are determined in accordance with GAAP. A reconciliation of operating margin to operating profit, which is its nearest comparable GAAP financial measure, is included in the following table. Operating profit includes expense items, such as depreciation, amortization and impairment expense and general and administrative ("G&A") expense, which management does not focus on when evaluating the core profitability of our operating segments. Additionally, product margin, which management primarily uses to evaluate the profitability of our commodity-related activities, is provided in this table. Product margin is a non-GAAP measure but the components of product sales revenue and cost of product sales are determined in accordance with GAAP. Our gas liquids blending, fractionation and other commodity-related activities generate significant revenue. However, we believe the product margin from these activities, which takes into account the related cost of product sales, better represents its importance to our results of operations. 39 --------------------------------------------------------------------------------
Variance Year Ended December 31, Favorable (Unfavorable) 2020 2021 $ Change % Change Financial Highlights ($ in millions, except operating statistics) Transportation and terminals revenue: Refined products
$ 1,190.4 $ 1,338.5$ 148.1 12 Crude oil 559.5 466.2 (93.3) (17) Intersegment eliminations (6.6) (5.8) 0.8 12 Total transportation and terminals revenue 1,743.3 1,798.9 55.6 3 Affiliate management fee revenue 21.2 21.2 - - Operating expenses: Refined products 411.8 416.7 (4.9) (1) Crude oil 189.2 165.4 23.8 13 Intersegment eliminations (13.2) (12.4) (0.8) (6) Total operating expenses 587.8 569.7 18.1 3 Product margin: Product sales revenue 557.5 913.0 355.5 64 Cost of product sales 468.2 780.0 (311.8) (67) Product margin 89.3 133.0 43.7 49 Other operating income (expense) 0.1 2.8 2.7 2,700 Earnings of non-controlled entities 153.3 154.4 1.1 1 Operating margin 1,419.4 1,540.6 121.2 9 Depreciation, amortization and impairment expense 243.1 227.9 15.2 6 G&A expense 171.2 206.3 (35.1) (21) Operating profit 1,005.1 1,106.4 101.3 10 Interest expense (net of interest income and interest capitalized) 221.8 225.9 (4.1) (2) Gain on disposition of assets (12.9) (75.0) 62.1 481 Other (income) expense 5.2 20.9 (15.7) (302)
Earnings from continuing operations before provision for income taxes
791.0 934.6 143.6 18 Provision for income taxes 2.9 2.3 0.6 21 Income from continuing operations 788.1 932.3 144.2 18 Income from discontinued operations 28.9 49.7 20.8 72 Net income
$ 817.0 $ 982.0$ 165.0 20 Operating Statistics Refined products: Transportation revenue per barrel shipped $ 1.675 $ 1.715Volume shipped (million barrels): Gasoline 270.8 303.8 Distillates 175.5 205.6 Aviation fuel 21.6 30.5 Liquefied petroleum gases 0.9 0.9 Total volume shipped 468.8 540.8 Crude oil: Magellan 100%-owned assets: Transportation revenue per barrel shipped(1) $ 1.028 $ 0.815Volume shipped (million barrels)(1) 229.9 189.6 Terminal average utilization (million barrels per month) 25.2 24.9 Select joint venture pipelines: BridgeTex - volume shipped (million barrels)(2) 132.0 112.1 Saddlehorn - volume shipped (million barrels)(3) 61.6 77.6 (1) Includes shipments related to our crude oil marketing activities. (2) These volumes reflect total shipments for the BridgeTex pipeline, which is owned 30% by us. (3) These volumes reflect the total shipments for the Saddlehorn pipeline, which was owned 40% by us through January 31, 2020and 30% thereafter. 40 --------------------------------------------------------------------------------
Transportation and terminal revenues increased by
•an increase in refined products revenue of
$148.1 millionprimarily due to increased transportation revenue as a result of higher volumes versus the pandemic levels of 2020 due to the recovery in travel, economic and drilling activity as well as additional contributions from our Texaspipeline expansion projects. Revenues also benefited from an increase in the average tariff rate in the current period as a result of the 2020 and 2021 mid-year adjustments. These favorable items were partially offset by the absence of revenues in the current period associated with the three marine terminals we sold in March 2020and lower storage revenues due to lower utilization and lower rates following recent contract expirations; and •a decrease in crude oil revenue of $93.3 millionprimarily due to lower average tariff rates, less volume shipped and reduced storage revenues. Average tariff rates decreased primarily as a result of the late 2020 expiration of several higher-priced contracts on our Longhorn pipeline. In addition, deficiency revenue recognized in the year-ago period did not recur in 2021. Transportation volumes also declined partially due to those Longhorn contract expirations, with much of this volume replaced by activities of our marketing affiliate, as well as lower volumes shipped on our Houstondistribution system. Storage revenues decreased primarily due to the 2020 period benefiting from increased short-term storage utilization at higher rates with recent contract renewals at lower rates.
Operating expenses decreased
•an increase in refined products expenses of
$4.9 millionprimarily due to higher asset integrity spending related to the timing of maintenance work and higher compensation costs, partially offset by more favorable product overages and the absence of costs in the current period associated with the divested marine terminals; and •a decrease in crude oil expenses of $23.8 millionprimarily due to lower power costs as a result of our recent optimization efforts as well as gains on power hedges driven by the winter storm in first quarter 2021, lower fees paid to Seabrookfor ancillary services and lower integrity spending related to the timing of maintenance work. Product margin increased $43.7 millionprimarily due to higher margins and higher sales volume on our fractionator and refined over/short activities, the sale of a portion of the linefill related to our crude marketing activities, and lower losses recognized in the current year on futures contracts. See Note 14 - Derivative Financial Instruments in Item 8. Financial Statements and Supplementary Data, as well as Other Items - Commodity Derivative Agreements below, for more information about our futures contracts.
Other operating income was
Earnings of non-controlled entities increased
$1.1 millionprimarily due to increased earnings from Saddlehorn primarily due to higher volumes shipped and increased earnings from MVP due to a favorable revenue adjustment, partially offset by lower earnings from BridgeTex related to decreased uncommitted shipments based on unfavorable market conditions as well as lower earnings from Seabrook due to lower transportation and storage revenues and increased depreciation costs in the current period.
Depreciation and amortization allowances decreased
mainly due to the impairment of certain terminalling assets in 2020.
General and administrative expenses increased
Interest expense, net of interest income and interest capitalized, increased
$4.1 millionin 2021 primarily due to higher outstanding debt. Otherwise, lower capitalized interest as a result of reduced ongoing expansion capital spending was more than offset by debt prepayment costs in the 2020 period. Our average outstanding debt increased 41 --------------------------------------------------------------------------------
Gain on disposition of assets was
$62.1 millionfavorable. We recognized a gain of $75.0 millionin 2021 primarily from the sale of a portion of our interest in MVP and a gain of $12.9 millionin 2020 due to the sale of a portion of our interest in Saddlehorn.
Other expenses were
Income from discontinued operations increased by
$20.8 milliondue to improved product margin for our independent terminals as a result of higher gas liquids blending volume sold at higher margins, as well as less depreciation now that the assets are classified as held for sale. For a comparative discussion of the years ended December 31, 2019and 2020, see Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" in our 2020 Annual Re port on Form 10-K . 42
Adjusted EBITDA, distributable cash flow and free cash flow
In the following tables, we present the financial measures of Adjusted EBITDA, Distributable Cash Flow ("DCF") and Free Cash Flow ("FCF"), which are non-GAAP measures. These measures include the results of our discontinued operations.
Adjusted EBITDA is an important metric used by management and the investment community to assess a company’s financial performance. A reconciliation of adjusted EBITDA to net income, the closest GAAP measure, is included in the table below.
Our partnership agreement requires that all of our available cash, less amounts reserved by our board, be distributed to our unitholders. DCF is used by management to determine the amount of cash that our operations generated, after maintenance capital spending, that is available for distribution to our unitholders, as well as a basis for recommending to our board the amount of distributions to be paid each period. We also use DCF as the basis for calculating our performance-based equity long-term incentive compensation. A reconciliation of DCF to net income, the nearest comparable GAAP measure, is included in the table below. FCF is a financial metric used by many investors and others in the financial community to measure the amount of cash generated by a company during a period after accounting for all investing activities, including both maintenance and expansion capital spending, as well as proceeds from divestitures. We believe FCF is important to the financial community as it reflects the amount of cash available for distributions, additional expansion capital opportunities, equity repurchases, debt reduction or other partnership uses. A reconciliation of FCF to net income and to net cash provided by operating activities, the nearest comparable GAAP measure, is included in the following tables.
Because the non-GAAP measures presented herein include adjustments unique to us, they may not be comparable to similarly titled measures of other companies.
-------------------------------------------------------------------------------- Adjusted EBITDA, DCF and FCF are non-GAAP measures. A reconciliation of each of these measures to net income for the years ended
December 31, 2020and 2021 is as follows (in millions): Year Ended December 31, 2020 2021 Net income $ 817.0 $ 982.0Interest expense, net 221.8 225.9 Depreciation, amortization and impairment(1) 254.6 233.9 Equity-based incentive compensation(2) (2.7) 15.6 Gain on disposition of assets(3) (10.5) (70.6)
Commodity-related adjustments: (gains) losses on derivatives recognized during the period associated with future transactions(4)
Gains (losses) on derivatives recognized in prior periods associated with transactions entered into during the period(4)
(20.9) (36.8) Inventory valuation adjustments(5) 5.8 2.1 Total commodity-related adjustments 14.2 (7.0) Distributions from operations of non-controlled entities in excess of earnings 54.2 38.9 Adjusted EBITDA 1,348.6 1,418.7
Interest expense, net, excluding amortization of debt issuance costs(6)
(205.4) (222.8) Maintenance capital(7) (98.7) (77.6) Distributable cash flow
$ 1,044.5 $ 1,118.3Expansion capital(8) (354.4) (73.0) Proceeds from disposition of assets(3) 334.9 270.7 Free cash flow 1,025.0 1,316.0 Distributions paid (927.1) (906.4) Free cash flow after distributions $ 97.9 $ 409.6(1) Depreciation, amortization and impairment expense is excluded from DCF to the extent it represents a non-cash expense. (2) Because we intend to satisfy vesting of unit awards under our equity-based long-term incentive compensation plan with the issuance of common units, expenses related to this plan generally are deemed non-cash and excluded for DCF purposes. The amounts above have been reduced by cash payments associated with the plan, which are primarily related to tax withholdings. (3) Gains on disposition of assets are excluded from DCF to the extent they are not related to our ongoing operations, while proceeds from disposition of assets exclude the related gains to the extent they are already included in our calculation of DCF. (4) Certain derivatives have not been designated as hedges for accounting purposes, and the mark-to-market changes of these derivatives are recognized currently in net income. We exclude the net impact of these derivatives from our determination of DCF until the transactions are settled and, where applicable, the related products are sold. (5) We adjust DCF for lower of average cost or net realizable value adjustments related to inventory and firm purchase commitments as well as market valuations of short positions recognized each period as these are non-cash items. In subsequent periods when we physically sell or purchase the related products, we adjust DCF for the valuation adjustments previously recognized. (6) Interest expense includes debt prepayment costs of $12.9 millionin 2020, which are excluded from DCF as they are financing activities and not related to our ongoing operations. (7) Maintenance capital expenditures maintain our existing assets and do not generate incremental DCF (i.e. incremental returns to our unitholders). For this reason, we deduct maintenance capital expenditures to determine DCF. (8) Includes additions to property, plant and equipment (excluding maintenance capital and capital-related changes in accounts payable and other current liabilities), acquisitions and investments in non-controlled entities, net of distributions from returns of investments in non-controlled entities and deposits from undivided joint interest third parties. 44 --------------------------------------------------------------------------------
A reconciliation of FCF to net cash provided by operating activities for the years ended
2020 2021 Net cash provided by operating activities
$ 1,107.5 $ 1,196.2Changes in operating assets and liabilities 37.1 9.7 Net cash provided (used) in investing activities (199.4) 118.1
Payments associated with the settlement of stock-based incentive compensation
Settlement cost, amortization of past service credit and actuarial loss
(6.7) (8.4) Changes in accrued capital items 79.7 7.8 Commodity-related adjustments(1) 14.2 (7.0) Other 7.3 5.8 Free cash flow 1,025.0 1,316.0 Distributions paid (927.1) (906.4) Free cash flow after distributions
$ 97.9 $ 409.6
(1) Please refer to the previous table for a description of these raw material adjustments.
Cash and capital resources
Cash flow and capital expenditure
Operating Activities. Net cash provided by operating activities was
$1,107.5 millionand $1,196.2 millionfor the years ended December 31, 2020and 2021, respectively. The $88.7 millionincrease from 2020 to 2021 was due to higher net income as previously described and changes in our working capital, partially offset by adjustments for non-cash items and distributions in excess of earnings of our non-controlled entities. Investing Activities. Net cash used by investing activities for the year ended December 31, 2020was $199.4 millionand net cash provided by investing activities for the year ended December 31, 2021was $118.1 million. During 2021, we used $148.6 millionfor capital expenditures. Also, during 2021, we sold a portion of our interest in MVP for cash proceeds of $272.1 million. During 2020, we used $424.1 millionfor capital expenditures, which included $0.2 millionfor undivided joint interest projects for which cash was received from a third party. Also, during 2020, we sold three marine terminals for cash proceeds of $251.8 millionand sold a portion of our interest in Saddlehorn for cash proceeds of $79.9 million. Additionally, we made net capital contributions of $94.6 millionto our joint ventures, which we account for as investments in non-controlled entities. Financing Activities. Net cash used by financing activities for the years ended December 31, 2020and 2021 was $970.3 millionand $1,327.7 million, respectively. During 2021, we paid distributions of $906.4 millionto our unitholders and made common unit repurchases of $523.1 million. Additionally, we had net commercial paper borrowings of $108.0 million. Also, in January 2021, our equity-based incentive compensation awards that vested December 31, 2020were settled by issuing 163,007 common units and distributing those units to the long-term incentive plan ("LTIP") participants, resulting in payments primarily associated with tax withholdings of $6.2 million. During 2020, we paid distributions of $927.1 millionto our unitholders and made common unit repurchases of $276.9 million. Additionally, we received net proceeds of $828.4 millionfrom the issuance of long-term senior notes, which were used to repay our $550.0 millionof 4.25% notes due 2021 and outstanding commercial paper borrowings at that time. Also, in January 2020, our equity-based incentive compensation awards that vested December 31, 2019were settled by issuing 284,643 common units and distributing those units to the LTIP participants, resulting in payments primarily associated with tax withholdings of $14.7 million. The quarterly distribution amount related to fourth-quarter 2021 earnings was $1.0375per unit, which was paid in February 2022. Based on the number of common units currently outstanding and our current quarterly 45 --------------------------------------------------------------------------------
distribution, the total distributions paid to our 2022 earnings-linked unitholders would be
For a discussion of cash flows for the year ended
December 31, 2019, see Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" in our 2020 Annual Report on Form 10-K . Capital Requirements
Our company’s capital expenditures consist primarily of:
•Maintenance capital expenditures. These expenditures include costs required to maintain equipment reliability and safety and to address environmental and other regulatory requirements rather than to generate incremental DCF; and •Expansion capital expenditures. These expenditures are undertaken primarily to generate incremental DCF and include costs to acquire additional assets to grow our business and to expand or upgrade our existing facilities and to construct new assets, which we refer to collectively as organic growth projects. Organic growth projects include, for example, capital expenditures that increase storage or throughput volumes or develop pipeline connections to new supply sources.
In 2021, our maintenance capital expenditure was
During 2021, we spent
$67.4 millionfor our expansion capital projects, including $0.4 millionfor discontinued operations, and contributed $5.6 millionfor expansion capital projects in conjunction with our joint ventures. Based on the progress of expansion projects already underway, we expect to spend approximately $50 millionin 2022 to complete our current slate of expansion capital projects. Liquidity Cash generated from operations is a key source of liquidity for funding debt service, maintenance capital expenditures, quarterly distributions and repurchases of common units. Additional liquidity for purposes other than quarterly distributions, such as expansion capital expenditures, is available through borrowings under our commercial paper program and revolving credit facility, as well as from other borrowings or issuances of debt or common units (see Note 10 - Debt and Note 19 - Partners' Capital and Distributions in Item 8. Financial Statements and Supplementary Data of this report for detail of our borrowings and changes in partners' capital).
Off-balance sheet arrangements
Pipeline Tariff Changes. The
Federal Energy Regulatory Commission("FERC") regulates the rates charged on interstate common carrier pipelines. The tariff rates on approximately 30% of our refined products shipments have been regulated by the FERCprimarily through an annual index methodology, and nearly all the remaining rates are adjustable at our discretion based on market factors. The current 5-year FERCindex began July 1, 2021and was initially based on the change in the producer price index for finished goods ("PPI-FG") plus 0.78%. Upon rehearing the FERClowered the index to PPI-FG minus 0.21% effective March 1, 2022. Based on this methodology and preliminary PPI-FG estimates, we expect to increase our index rates by approximately 8.7% on July 1, 2022. While we continue to evaluate the remaining 70% of our refined products markets, we generally intend to increase rates in those markets by an average of 5%, resulting in an overall average refined products mid-year tariff increase of approximately 6%. Most of the tariffs on our long-haul crude oil pipelines are established at negotiated rates that generally provide for annual adjustments in line with changes in the FERCindex, subject to certain modifications. We expect to increase the rates on our long-haul crude oil pipelines between 2% and 5% in July 2022. Collective Bargaining Agreement. Approximately 13% of our employees are represented by the United Steel Workers("USW") and covered by a collective bargaining agreement that expired at the end of January 2022. We are operating under a 24-hour rolling extension of this agreement while negotiations for a new agreement continue. Management expects that we will be able to successfully negotiate a new long-term agreement with the USW; however, a prolonged work stoppage by a majority of these employees could have a material adverse effect on our business. Commodity Derivative Agreements. Certain of our business activities result in our owning various commodities, which exposes us to commodity price risk. We use forward physical commodity contracts and derivative instruments to hedge against changes in prices of commodities that we expect to sell or purchase in future periods. For further information regarding the quantities of refined products and crude oil hedged at December 31, 2021and the fair value of open hedge contracts at that date, please see Item 7A. Quantitative and Qualitative Disclosures about Market Risk. Related Party Transactions. See Note 18 - Related Party Transactions in Item 8. Financial Statements and Supplementary Data of this report for detail of our related party transactions. Critical Accounting Estimates Our management has discussed the development and selection of the following critical accounting estimates with the audit committee of our board, which has reviewed and approved these disclosures. Pension Obligations
We sponsor a pension plan for unionized employees and a pension plan for non-unionized employees. Various estimates and assumptions have a direct impact on the periodic net benefit expense and obligation of these plans. These estimates and assumptions include the expected long-term rate of return on plan assets, discount rates and the expected rate of compensation increase. Management reviews these assumptions annually and makes any necessary adjustments.
The discount rate directly affects the measurement of the benefit obligations of our pension benefit plans. The objective of the discount rate is to determine the amount, if invested at the
December 31measurement date in a portfolio of high-quality fixed income securities, that would provide the necessary cash flows to make benefit payments when due. Decreases in the discount rate increase the obligation and generally increase the related expense, while increases in the discount rate have the opposite effect. Changes in general economic and market 47 -------------------------------------------------------------------------------- conditions that affect interest rates on long-term high-quality fixed income securities as well as the duration of our plans' liabilities affect our estimate of the discount rate. We estimate the long-term expected rate of return on plan assets using expectations of capital market results, which includes an analysis of historical results as well as forward-looking projections. We base these capital market expectations on a long-term period and on our investment strategy and asset allocation. We develop our estimates using input from several external sources, including consultation with our third-party independent investment consultant. We develop the forward-looking capital market projections using a consensus of expectations by economists for inflation and dividend yield, along with expected changes in risk premiums. Because our determined rate is an estimate of future results, it could be significantly different from actual results. The expected rate of return on plan assets are long-term in nature; therefore, short-term market performance does not significantly affect our estimated long-term expected rate of return. The expected rate of compensation increases represents average long-term salary increases. An increase in this rate causes the pension obligation and expense to increase.
The following table shows the estimated increase (decrease) in net employee benefit expenses and obligations that would result from a 1% change in the specified assumption (in millions):
Benefit Expense Benefit Obligation 1% Increase 1% Decrease 1% Increase 1% Decrease Pension benefits: Discount rate
$ (4.6) $ 5.5 $ (49.8) $ 61.9Expected long-term rate of return on plan assets $ (3.0) $ 3.0$ -
Rate of compensation increase
$ 5.1 $ (5.0) $ 30.2 $ (29.7)
The following table shows the increase (decrease) in our pension funding based on our current funding policy assuming a 1% change in the specified criterion (in millions):
1% Increase 1% Decrease Rate of compensation increase
Depreciation of fixed assets,
Impairment of Long-Lived Assets. Long-lived assets, including fixed assets and intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Such indicators include, among others, the nature of the asset, the projected future economic benefit of the asset, changes in regulatory and political environments and historical and future cash flow and profitability measurements. If the carrying value of an asset exceeds the future undiscounted cash flows expected from the asset, we recognize an impairment charge for the excess of carrying value of the asset over its estimated fair value.
Goodwill. The goodwill relating to each of our reporting units is tested for impairment annually as well as when an event or change in circumstances indicates an impairment may have occurred. Under GAAP, we have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of one of our reporting units is greater than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, we are not required to perform any further testing. However, if we conclude otherwise, we perform the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value. We have the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. 48 -------------------------------------------------------------------------------- For purposes of performing the impairment test for goodwill, our reporting units are our refined products and crude oil segments. In 2019 and 2020, we elected to perform the qualitative goodwill impairment test and concluded it was more likely than not that the fair value of each of our reporting units was greater than its carrying amount. In 2021, we elected to perform the quantitative goodwill impairment test and began with step one of the test as required by GAAP. Based on this assessment, we calculated that the fair value of each of our reporting units was greater than its carrying amount. Based on this assessment, we concluded goodwill was not impaired. Determination as to whether and how much goodwill or long-lived assets are impaired involves management estimates on highly uncertain matters such as future commodity prices, the effects of inflation and technology improvements on operating expenses and the outlook for national or regional market supply and demand conditions. We base the impairment reviews and calculations used in our impairment tests on assumptions that are consistent with our business plans and long-term investment decisions. See Note 6 - Property, Plant and Equipment, Goodwilland Other Intangibles in Item 8. Financial Statements and Supplementary Data for additional information regarding impairments of goodwill and long-lived assets. Investments. We evaluate investments in non-controlled entities for impairment whenever events or circumstances indicate that there is an other-than-temporary loss in value of the investment. When evidence of loss in value has occurred, we compare our estimate of fair value of the investment to the carrying value of the investment to determine whether an impairment has occurred. If the estimated fair value is less than the carrying value and we consider the decline in value to be other-than-temporary, the excess of the carrying value over the fair value is recognized in our consolidated financial statements as an impairment charge. 49
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