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NGL ENERGY PARTNERS LP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

The following is a discussion of our financial condition and results of operations as of and for the three months ended June 30, 2014. The discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the historical consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014. Overview



We are a Delaware limited partnership formed in September 2010. NGL Energy Holdings LLC serves as our general partner. At June 30, 2014, our primary operations include:

† Our crude oil logistics business, the assets of which include owned and leased crude oil storage terminals, pipeline injection stations, a fleet of trucks, a fleet of leased and owned railcars, and a fleet of barges and towboats, and a 50% interest in a crude oil pipeline. Our crude oil logistics business purchases crude oil from producers and transports it for resale at owned and leased pipeline injection points, storage terminals, barge loading facilities, rail facilities, refineries, and other trade hubs. † Our water solutions business, the assets of which include water treatment and disposal facilities and a 27.5% interest in a water supply company. Our water solutions business generates revenues from the treatment and disposal of wastewater generated from crude oil and natural gas production operations, and from the sale of recycled water and recovered hydrocarbons. † Our liquids business, which supplies natural gas liquids to retailers, wholesalers, refiners, and petrochemical plants throughout the United States and in Canada, and which provides natural gas liquids terminaling services through its 22 terminals throughout the United States and railcar transportation services through its fleet of leased and owned railcars. Our liquids business purchases propane, butane, and other products from refiners, processing plants, producers, and other parties, and sells the product to retailers, refiners, and other participants in the wholesale markets. † Our retail propane business, which sells propane, distillates, and equipment and supplies to end users consisting of residential, agricultural, commercial, and industrial customers and to certain re-sellers in more than 20 states. † Our refined products and renewables marketing business, which purchases gasoline and diesel fuel from suppliers and typically sells these products in back-to-back contracts to customers at a nationwide network of third-party owned terminaling and storage facilities, and which purchases ethanol primarily at production facilities and transports the ethanol to refiners and blenders at various locations. We also purchase biodiesel from production facilities located in the Midwest and Houston, Texas, and transport the biodiesel via railcars for sale to refiners and blenders. We also own an 11% interest in an ethanol production facility in Nebraska. Crude Oil Logistics Our crude oil logistics business purchases crude oil from producers and transports it for resale at pipeline injection points, storage terminals, barge loading facilities, rail facilities, refineries, and other trade hubs. We attempt to reduce our exposure to price fluctuations by using back-to-back contracts whenever possible. In addition, we enter into forward contracts, financial swaps, and commodity spread trades as economic hedges of our physical forward sales and purchase contracts with our customers and suppliers. Most of our contracts to purchase or sell crude oil are at floating prices that are indexed to published rates in active markets, such as Cushing, Oklahoma. We seek to manage price risk by entering into purchase and sale contracts of similar volumes based on similar indexes and by entering into financial derivatives. We utilize our transportation assets to move crude oil from the wellhead to the highest value market. The spread between crude oil prices in different markets can fluctuate widely, which may expand or limit our opportunity to generate margins by transporting crude oil to different markets. We also seek to maximize margins by blending crude oil of varying properties.



The range of low and high spot prices per barrel of NYMEX West Texas Intermediate Crude Oil at Cushing, Oklahoma and the prices at period end were as follows:

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Table of Contents Spot Price Per Barrel Three Months Ended June 30, Low High At Period End 2014 $ 99.42$ 107.26$ 105.37 2013 86.68 98.44 96.56



We believe volatility in commodity prices will continue, and our ability to adjust to and manage this volatility may impact our financial results.

Water Solutions Our water solutions business generates revenues from the treatment and disposal of wastewater generated from oil and natural gas production operations, and from the sale of recycled water and recovered hydrocarbons. Our water processing facilities are strategically located near areas of high crude oil and natural gas production. A significant factor affecting the profitability of our water solutions segment is the extent of exploration and production in the areas near our facilities, which is based upon producers' expectations about the profitability of drilling new wells. The primary customers of our facility in Wyoming have committed to deliver a specified minimum volume of water to our facility under long-term contracts. The primary customers of our facilities in Colorado have committed to deliver to our facilities all wastewater produced at wells in a designated area. Most of the customers at our other facilities in Texas are not under volume commitments, other than one customer that has committed to deliver 50,000 barrels per day to our facilities. Liquids Our liquids business purchases propane, butane, and other products from refiners, processing plants, producers, and other parties, and sells the product to retailers, refiners, petrochemical plants, and other participants in the wholesale markets. Our liquids segment owns 22 terminals, operates a fleet of owned and leased railcars, and leases underground storage capacity. We attempt to reduce our exposure to the impact of price fluctuations by using back-to-back contracts and pre-sale agreements that allow us to lock in a margin on a percentage of our winter volumes. We also attempt to reduce our exposure to the impact of price fluctuations by entering into swap agreements whereby we agree to pay a floating rate and receive a fixed rate on a specified notional amount of product. We enter into these agreements as economic hedges against the potential decline in the value of a portion of our inventory. Our wholesale business is a "cost-plus" business that is affected both by price fluctuations and volume variations. We establish our selling price based on a pass-through of our product supply, transportation, handling, storage and capital costs plus an acceptable margin. The margins we realize in our wholesale business are substantially less on a per gallon basis than our retail propane business. Weather conditions and gasoline blending have a significant impact on the demand for propane and butane, and sales volumes and prices are typically higher during the colder months of the year. Consequently, our revenues, operating profits, and operating cash flows are typically lower in the first and second quarters of each fiscal year. The range of low and high spot propane prices per gallon at Conway, Kansas and Mt. Belvieu, Texas, two of our main pricing hubs, and the prices at period end were as follows: Conway, Kansas Mt. Belvieu, Texas Spot Price Per Gallon Spot Price Per Gallon Three Months Ended June 30, Low High At Period End

Low High At Period End 2014 $ 0.96$ 1.13 $ 1.07 $ 0.99$ 1.13 $ 1.06 2013 0.77 0.91 0.80 0.81 0.97 0.85



The range of low and high spot butane prices per gallon at Mt. Belvieu, Texas and the prices at period end were as follows:

Spot Price Per Gallon Three Months Ended June 30, Low High At Period End 2014 $ 1.20$ 1.30 $ 1.30 2013 1.08 1.41 1.18



We believe volatility in commodity prices will continue, and our ability to adjust to and manage this volatility may impact our financial results.

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Table of Contents Retail Propane Our retail propane segment sells propane, distillates, and equipment and supplies to residential, agricultural, commercial, and industrial end users. Our retail propane segment purchases the majority of its propane from our liquids segment. Our retail propane segment generates margins based on the difference between the wholesale cost of product and the selling price of the product in the retail markets. These margins fluctuate over time due to supply and demand conditions. Weather conditions have a significant impact on our sales volumes and prices, as a significant portion of our sales are to residential customers who purchase propane and distillates for home heating purposes. A significant factor affecting the profitability of our retail propane segment is our ability to maintain our realized product margin on a cents per gallon basis. Product margin is the differential between our sales prices and our total product costs, including transportation and storage. Historically, we have been successful in passing on price increases to our customers. We monitor propane prices daily and adjust our retail prices to maintain expected margins by passing on the wholesale costs to our customers. We believe that volatility in commodity prices will continue, and our ability to adjust to and manage this volatility may impact our financial results. In periods of significant propane price increases we have experienced, and expect to continue to experience, conservation of propane used by our customers, which could result in a decline in our sales volumes, revenues and product margins. In periods of decreasing propane costs, we have typically experienced an increase in our product margin. The retail propane business is weather-sensitive and subject to seasonal volume variations due to propane's primary use as a heating source in residential and commercial buildings and for agricultural purposes. Typically, over 70% of our retail volume is sold during the peak heating season from October through March. Consequently, our revenues, operating profits, and operating cash flows are typically lower in the first and second quarters of each fiscal year.



Refined Products and Renewables

Our refined product marketing business purchases gasoline and diesel fuel primarily from eight suppliers and sells these products to over 300 customers. We purchase and sell these products at a nationwide network of third-party owned terminaling and storage facilities. We typically sell these products at the same time we purchase them in back-to-back transactions. This business was acquired as part of our purchase of Gavilon Energy. Our ethanol marketing business purchases ethanol primarily at production facilities and transports the ethanol for sale at various locations to refiners and blenders. We also transport and market ethanol owned by other unaffiliated entities in exchange for a service fee. Our biodiesel marketing business purchases biodiesel from production facilities located in the Midwest and in Houston, Texas, and transports the product on leased railcars for sale to refiners and blenders. We lease biodiesel storage at facilities located in Phoenix, Arizona and Deer Park, Texas. Recent Developments



We have continued to expand our operations through a number of business combinations, as summarized below.

TransMontaigne Inc. On July 1, 2014, we acquired TransMontaigne Inc. ("TransMontaigne") for $173.8 million of cash, net of cash acquired. As part of this transaction, we also purchased $346.9 million of inventory from the previous owner of TransMontaigne. The operations of TransMontaigne include the marketing of refined products and crude oil. As part of this transaction, we acquired the general partner interest and a 19.7% limited partner interest in TransMontaigne Partners L.P. ("TLP"), a publicly-traded partnership that conducts refined product and crude oil transportation and terminaling operations. On July 10, 2014, we submitted a non-binding proposal to the conflicts committee of the board of directors of TLP's general partner. Under this proposal, each outstanding unit of TLP would be exchanged for one of our common units. This proposed 44

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transaction is subject to the negotiation and execution of a definitive agreement, the approval of the conflicts committee of the board of directors of TLP's general partner, and any requisite unitholder approval under applicable law.



Investment in Grassland Water Solutions LLC

In June 2014, we acquired a 27.5% interest in a water supply company that expands our water solutions business in the DJ Basin in Colorado.

Gavilon, LLC In December 2013, we acquired the ownership interests of Gavilon, LLC ("Gavilon Energy"). Gavilon Energy's assets include crude oil terminals in Oklahoma, Texas and Louisiana, a 50% ownership interest in Glass Mountain Pipeline, LLC ("Glass Mountain"), which owns a crude oil pipeline that originates in western Oklahoma and terminates in Cushing, Oklahoma, and an 11% interest in an ethanol production facility in Nebraska. Other operations of Gavilon Energy include the marketing of crude oil, refined products, ethanol, biodiesel, and natural gas liquids and owned and leased crude oil storage in Cushing, Oklahoma.



Coastal Plains Disposal #1, LLC ("Coastal")

In September 2013, we acquired the ownership interests in three water disposal facilities in the Eagle Ford Basin in Texas, and an option to acquire an additional facility which we exercised in March 2014.

Oilfield Water Lines LP ("OWL")

In August 2013, we acquired the ownership interests in four water disposal facilities and a fleet of approximately 55 water transportation vehicles located in the Eagle Ford Basin in Texas.

High Roller Wells Big Lake SWD No. 1 Ltd. ("Big Lake")

In July 2013, we acquired a water disposal facility located in the Permian Basin in Texas. As part of this transaction, we entered into a five-year development agreement that provides us with the option to operate and then purchase additional disposal facilities that may be constructed by the sellers.



Crescent Terminals, LLC and Cierra Marine, LP

In July 2013, we acquired the operating assets of Crescent Terminals, LLC ("Crescent"), which operates a leased crude oil storage and dock facility in Port Aransas, Texas. In addition, we also purchased the ownership interests of Cierra Marine, LP ("Cierra Marine"), whereby we acquired a fleet of four towboats and seven crude oil barges operating in the intercoastal waterways of Texas.



Summary Discussion of Operating Results for the Three Months ended June 30, 2014

During the three months ended June 30, 2014, we generated an operating loss of $20.6 million, compared to an operating loss of $7.3 million during the three months ended June 30, 2013. Our crude oil logistics business generated operating income of $1.5 million during the three months ended June 30, 2014, compared to operating income of $6.6 million during the three months ended June 30, 2013. Spreads between the price of crude oil in different markets remained narrow, which reduced our opportunity to generate increased margins by transporting crude oil from lower-price markets to higher-price markets. Our water solutions business generated an operating loss of $0.9 million during the three months ended June 30, 2014. compared to operating income of $3.0 million during the three months ended June 30, 2013. Operating income during the three months ended June 30, 2014 was reduced by $6.2 million of unrealized losses on derivatives. During the three months ended June 30, 2013, operating income was increased by $0.6 million of unrealized gains on derivatives. Our liquids business generated an operating loss of $0.9 million during the three months ended June 30, 2014, compared to an operating loss of $2.1 million during the three months ended June 30, 2013. Due to the seasonal nature of demand for natural gas liquids, sales volumes of our liquids segment are typically lower during the first and second quarters of the fiscal year than during the third and fourth quarters of the fiscal year. 45 --------------------------------------------------------------------------------



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Our retail propane business generated an operating loss of $1.6 million during the three months ended June 30, 2014, compared to an operating loss of $1.5 million during the three months ended June 30, 2013. Due to the seasonal nature of demand for propane, sales volumes of our retail propane business typically are lower during the first and second quarters of the fiscal year than during the third and fourth quarters of the fiscal year. Our refined products business generated operating income of $0.4 million during the three months ended June 30, 2014. Our refined products segment began when we acquired Gavilon Energy in December 2013. Our renewables business generated an operating loss of $1.7 million during the three months ended June 30, 2014. Our renewables segment began when we acquired Gavilon Energy in December 2013. Ethanol prices decreased during May and June 2014, which had an unfavorable impact on product margins. Demand for biodiesel has been impacted by uncertainty regarding the requirements for biodiesel usage, as the United States Environmental Protection Agency (the "EPA") has not yet issued its final mandate for 2014 usage. The low demand had an unfavorable impact on our biodiesel volumes and product margins during the three months ended June 30, 2014.



We recorded $2.6 million of earnings from our equity method investments, which were acquired in our December 2013 acquisition of Gavilon Energy.

We incurred interest expense of $20.5 million during the three months ended June 30, 2014. This was higher than interest expense of $10.6 million during the three months ended June 30, 2013, due primarily to borrowings to finance acquisitions.


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Source: Edgar Glimpses


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