News Column

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

August 11, 2014

References in this report to the "Partnership," "we," "us," or "our" refer to Valero Energy Partners LP, one or more of its subsidiaries, or all of them taken as a whole for periods after December 16, 2013, the date the Partnership competed its initial public offering (the Offering) of 17,250,000 common units. For periods prior to the Offering, those terms refer to Valero Energy Partners LP Predecessor, our Predecessor for accounting purposes. References in this report to "Valero" refer collectively to Valero Energy Corporation and its subsidiaries, other than Valero Energy Partners LP, any of its subsidiaries, or its general partner. CAUTIONARY STATEMENT FOR THE PURPOSE OF SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Form 10-Q, including without limitation our disclosures below under the headings "OVERVIEW" and "OUTLOOK," includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify our forward-looking statements by the words "anticipate," "believe," "expect," "plan," "intend," "estimate," "project," "projection," "predict," "budget," "forecast," "goal," "guidance," "target," "could," "should," "may," and similar expressions. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to: the suspension, reduction, or termination of Valero's obligation under our



commercial agreements and our services and secondment agreement;

changes in global economic conditions and the effects of the global

economic downturn on Valero's business and the business of its suppliers,

customers, business partners, and credit lenders;

a material decrease in Valero's profitability;

disruptions due to equipment interruption or failure at our facilities,

Valero's facilities, or third-party facilities on which our business or Valero's business is dependent;



the risk of contract cancellation, non-renewal, or failure to perform by

Valero's customers, and Valero's inability to replace such contracts and/or customers;



Valero's ability to remain in compliance with the terms of its outstanding

indebtedness; the timing and extent of changes in commodity prices and demand for Valero's refined products;



actions of customers and competitors;

changes in our cash flows from operations;

state and federal environmental, economic, health and safety, energy, and

other policies and regulations, including those related to climate change

and any changes therein, and any legal or regulatory investigations, delays, or other factors beyond our control;



operational hazards inherent in refining operations and in transporting

and storing crude oil and refined products;

earthquakes or other natural disasters affecting operations;

changes in capital requirements or in execution of planned capital projects;

the availability and costs of crude oil, other refinery feedstocks, and

refined petroleum products; 16

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changes in the cost or availability of third-party vessels, pipelines, and

other means of delivering and transporting crude oil, feedstocks, and refined products; direct or indirect effects on our business resulting from actual or threatened terrorist incidents or acts of war;



weather conditions affecting our or Valero's operations or the areas in

which Valero markets its refined products;

seasonal variations in demand for refined petroleum products;

adverse rulings, judgments, or settlements in litigation or other legal or

tax matters, including unexpected environmental remediation costs in

excess of any accruals, which affect us or Valero;

risks related to labor relations and workplace safety;

changes in insurance markets impacting costs and the level and types of

coverage available; and

political developments.

Any one of these factors, or a combination of these factors, could materially affect our future results of operations and whether any forward-looking statements ultimately prove to be accurate. Our forward-looking statements are not guarantees of future performance, and actual results and future performance may differ materially from those suggested in any forward-looking statements. We do not intend to update these statements unless we are required by the securities laws to do so. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing. We undertake no obligation to publicly release any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. OVERVIEW We are a fee-based, traditional master limited partnership formed by Valero in July 2013 to own, operate, develop, and acquire crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets. On December 16, 2013, we completed the Offering of 17,250,000 common units at a price of $23.00 per unit and received net proceeds of $369.2 million after deducting underwriting fees, structuring fees, and other offering costs. As of June 30, 2014, our assets consisted of crude oil and refined petroleum products pipeline and terminal systems in the United States (U.S.) Gulf Coast and U.S. Mid-Continent regions that are integral to the operations of Valero's Port Arthur, McKee, and Memphis refineries. The results of operations for the three and six months ended June 30, 2014 represent our consolidated financial results, while the results of operations for the three and six months ended June 30, 2013 represent the financial results of our Predecessor. At the date of the Offering, we entered into new commercial agreements with Valero. Under these commercial agreements, the historical storage capacity lease arrangements were replaced with terminaling throughput fees. In addition, we began charging a terminaling throughput fee for crude oil delivered to our Lucas terminal for which we did not historically charge a throughput fee, and we revised the rates charged for transportation services provided by certain of our pipelines. Because of these new agreements, our future results of operations may not be comparable to our historical results of operations. For the second quarter of 2014, we reported net income of $12.2 million compared to net income of $11.6 million for the second quarter of 2013. Net income per limited partner unit was $0.21 for the second quarter of 2014. We did not report net income per limited partner unit for the second quarter of 2013 because we were wholly owned by Valero during that period. The increase in net income of $587,000 in the second 17

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quarter of 2014 compared to the second quarter of 2013 is primarily due to a $795,000 increase in operating revenues due primarily to higher pipeline volumes in our Port Arthur logistics system, a $467,000 increase in other income, and a $1.2 million decrease in income tax expense, offset by a $1.7 million increase in costs and expenses. For the first six months of 2014, we reported net income of $22.7 million compared to net income of $26.1 million for the first six months of 2013. Net income per limited partner unit was $0.39 for the first six months of 2014. We did not report net income per limited partner unit for the first six months of 2013 because we were wholly owned by Valero during that period. The decrease in net income of $3.4 million in the first six months of 2014 compared to the first six months of 2013 is due primarily to a $5.4 million decrease in operating income caused by a $1.1 million decrease in operating revenues due primarily to lower pipeline and terminaling volumes in our Memphis logistics system and a $4.3 million increase in costs and expenses. This decrease in operating income was offset by a $1.1 million increase in other income and $1.2 million decrease in income tax expense. Additional analysis of the changes in the components of net income is provided below under "RESULTS OF OPERATIONS." Effective July 1, 2014, we acquired the Texas Crude Systems Business from Valero for total cash consideration of $154.0 million. In connection with this acquisition, we entered into various commercial agreements with Valero regarding transportation and terminaling services to be provided by us with respect to the crude oil and refined petroleum products systems described below, and we amended and restated our omnibus agreement with Valero. In addition, our general partner entered into an amended services and secondment agreement with Valero. The Texas Crude Systems Business is engaged in the business of transporting, terminaling, and storing crude oil and refined petroleum products through various pipeline and terminal systems. The Texas Crude Systems Business consists of: McKee Crude System. The McKee Crude System is a crude oil system that



supports Valero's McKee refinery located in Sunray, Texas. The system has

a throughput capacity of 72,000 barrels per day and consists of more than

200 miles of pipelines, 20 crude oil truck unloading sites with lease

automatic custody transfer units, and approximately 240,000 barrels of storage capacity.



Three Rivers Crude System. The Three Rivers Crude System, located in the

Eagle Ford shale region in South Texas, consists of 11 crude oil truck

unloading sites with lease automatic custody transfer units and a 1-mile,

12-inch pipeline with a capacity of 110,000 barrels per day. The system

delivers crude oil received from the truck unloading sites and pipeline

connections to tanks at Valero's Three Rivers refinery. The system also receives locally produced crude oil via connections to the Harvest Arrowhead pipeline system and the Plains Gardendale pipeline for processing at the Three Rivers refinery or for shipment through third-party pipelines to Valero's two refineries in Corpus Christi, Texas. Wynnewood Products System. The Wynnewood Products System is the primary



distribution outlet for Valero's Ardmore Refinery in Ardmore, Oklahoma.

The Wynnewood Products System consists of a 30-mile, 12-inch refined

petroleum products pipeline with 90,000 barrels per day of capacity and

two tanks with a total of 180,000 barrels of storage capacity. The system

connects Valero's Ardmore refinery to the Magellan refined products pipeline system. 18

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Table of Contents OUTLOOK Because our operating revenues are generated from fee-based arrangements with Valero, the amount of operating revenues we generate primarily depends on the volumes of crude oil and refined petroleum products that we transport through our pipelines and handle at our terminals. These volumes are primarily affected by refinery reliability and the supply of, and demand for, crude oil and refined petroleum products in the markets served by our assets. We expect that Valero will ship volumes in excess of its total minimum throughput commitments on our pipeline systems and will throughput volumes in excess of its total minimum throughput commitments at our terminals during the second half of 2014. 19 --------------------------------------------------------------------------------

Table of Contents RESULTS OF OPERATIONS The following tables highlight our results of operations and our operating performance. The financial results for the three and six months ended June 30, 2014 represent our consolidated results of operations, while the financial results for the three and six months ended June 30, 2013 represent the results of operations of our Predecessor. The narrative following these tables provides an analysis of our results of operations. Results of Operations (in thousands, except per unit amounts) Three Months Ended June 30, 2014 2013 Change Operating revenues - related party $ 23,660$ 22,865$ 795 Costs and expenses: Operating expenses 5,738 5,551



187

General and administrative expenses 2,848 1,357 1,491 Depreciation expense 3,024 2,984 40 Total costs and expenses 11,610 9,892 1,718 Operating income 12,050 12,973 (923 ) Other income, net 491 24 467 Interest expense (221 ) (47 ) (174 ) Income before income taxes 12,320 12,950 (630 ) Income tax expense 120 1,337 (1,217 ) Net income 12,200 11,613 587 Less: Net income attributable to Predecessor - 11,613 (11,613 ) Net income attributable to partners 12,200 $ -



$ 12,200 Less: General partner's interest in net income 244 Limited partners' interest in net income $ 11,956

Net income per limited partner unit (basic and diluted): Common units $ 0.21 Subordinated units $ 0.21 Weighted average limited partner units outstanding (basic and diluted): Common units - public 17,250 Common units - Valero 11,540 Subordinated units - Valero 28,790 20

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Table of Contents Operating Highlights and Other Financial Information (in thousands, except throughput, per barrel, and per unit amounts) Three Months Ended June 30, 2014 2013 Change Operating highlights: Pipeline transportation: Pipeline transportation revenues $ 11,128$ 13,647$ (2,519 ) Pipeline transportation throughput (BPD) (a) 622,209 571,026 51,183 Average pipeline transportation revenue per barrel (b) $ 0.20$ 0.26$ (0.06 ) Terminaling: Terminaling revenues $ 12,532$ 4,293$ 8,239 Terminaling throughput (BPD) 499,424 132,962 366,462 Average terminaling revenue per barrel (b) $ 0.28$ 0.35$ (0.07 ) Storage revenues (c) $ - $ 4,925$ (4,925 ) Total operating revenues - related party $ 23,660$ 22,865$ 795 Capital expenditures: Maintenance $ 1,005$ 289$ 716 Expansion 1,355 700 655 Total capital expenditures $ 2,360$ 989$ 1,371 Other financial information: Quarterly distribution declared per unit $ 0.2225 n/a Distribution declared: Limited partner units - public $ 3,839 n/a Limited partner units - Valero 8,974 n/a General partner units - Valero 261 n/a Total distribution declared $ 13,074 n/a



______________

(a) Represents the sum of volumes transported through each separately tariffed

pipeline segment.

(b) Average revenue per barrel is calculated as revenue divided by throughput for

the period. Throughput is derived by multiplying the throughput barrels per

day (BPD) by the number of days in the period.

(c) Prior to the Offering, our Predecessor leased some of our refined petroleum

products and crude oil storage capacity to Valero. Subsequent to the

Offering, under our commercial agreements with Valero, these storage capacity

lease agreements were replaced with terminaling fees. 21

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Operating revenues increased $795,000, or 3 percent, for the second quarter of 2014 compared to the second quarter of 2013. The increase was due primarily to: An increase of $2.4 million at our Port Arthur logistics system primarily attributable to a 71 percent increase in pipeline volumes resulting from refinery expansion projects and improved refinery operations and our new



commercial agreement with Valero, which incorporates a terminal throughput

fee at our Lucas crude system.

A decrease of $1.6 million at our Memphis logistics system driven by lower

throughput volumes throughout the system. Crude oil throughput volumes in

the Collierville crude system decreased by 26 percent, and refined

petroleum product pipeline throughput volumes in the Memphis products

system decreased by 24 percent. The decreases in volumes were attributed

to a planned turnaround at Valero's Memphis refinery.

Operating expenses increased $187,000, or 3 percent, for the second quarter of 2014 compared to the second quarter of 2013 due to higher insurance expense of $545,000 as a result of us acquiring our own insurance policies. Prior to being a separate publicly traded limited partnership, we were allocated a portion of Valero's insurance costs. The increased insurance expense was partially offset by a charge for sales taxes of $312,000 during the second quarter of 2013 related to the settlement of a Texas sales tax audit that did not recur. General and administrative expenses increased $1.5 million, or 110 percent, for the second quarter of 2014 compared to the second quarter of 2013 due primarily to higher costs following the Offering due to being a separate publicly traded limited partnership. During the second quarter of 2014, we incurred incremental costs of $629,000 related to the management fee charged to us by Valero as compared to amounts allocated by Valero to our Predecessor for the second quarter of 2013, and $554,000 of additional incremental costs of being a separate publicly traded limited partnership. In the second quarter of 2014, we also incurred $308,000 in costs related to the July 1, 2014 acquisition of the Texas Crude Systems Business. "Other income, net" increased $467,000 for the second quarter of 2014 compared to the second quarter of 2013 due primarily to interest income (net of bank fees) of $258,000 earned on our cash and cash equivalents and incremental income of $177,000 from the sale of scrap metal and right-of-way fees collected during the second quarter of 2014. Prior to the Offering, our Predecessor participated in Valero's centralized cash management system; therefore, it held no cash or cash equivalents, and no interest income was allocated to our Predecessor by Valero. Interest expense increased $174,000 for the second quarter of 2014 compared to the second quarter of 2013 due primarily to commitment fees of $133,000 related to our revolving credit facility, which we entered into in connection with the Offering. Our income tax expense is associated with the Texas margin tax. Our effective tax rate was 1 percent during the second quarter of 2014 compared to 10 percent during the second quarter of 2013. The decrease was due primarily to deferred tax expense recorded in 2013 in connection with the initial recognition of a deferred tax liability associated with a change in the law with respect to the Texas margin tax. Because this was a one-time item associated with a law change, our effective tax rate returned to previous levels. 22 -------------------------------------------------------------------------------- Table of Contents Results of Operations (in thousands, except per unit amounts) Six Months Ended June 30, 2014 2013 Change Operating revenues - related party $ 45,191$ 46,343$ (1,152 ) Costs and expenses: Operating expenses 11,464 9,847



1,617

General and administrative expenses 5,443 2,414 3,029 Depreciation expense 6,082 6,453 (371 ) Total costs and expenses 22,989 18,714 4,275 Operating income 22,202 27,629 (5,427 ) Other income, net 1,139 50 1,089 Interest expense (449 ) (102 ) (347 ) Income before income taxes 22,892 27,577 (4,685 ) Income tax expense 210 1,444 (1,234 ) Net income 22,682 26,133 (3,451 ) Less: Net income attributable to Predecessor - 26,133 (26,133 ) Net income attributable to partners 22,682 $ -



$ 22,682 Less: General partner's interest in net income 454 Limited partners' interest in net income $ 22,228

Net income per limited partner unit (basic and diluted): Common units $ 0.39 Subordinated units $ 0.39 Weighted average limited partner units outstanding (basic and diluted): Common units - public 17,250 Common units - Valero 11,540 Subordinated units - Valero 28,790 23

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Table of Contents Operating Highlights and Other Financial Information (in thousands, except throughput, per barrel, and per unit amounts) Six Months Ended June 30, 2014 2013 Change Operating highlights: Pipeline transportation: Pipeline transportation revenues $ 21,608$ 27,853$ (6,245 ) Pipeline transportation throughput (BPD) (a) 598,492 581,307



17,185

Average pipeline transportation revenue per barrel (b) $ 0.20$ 0.26$ (0.06 ) Terminaling: Terminaling revenues $ 23,583$ 8,490$ 15,093 Terminaling throughput (BPD) 469,297 132,603 336,694



Average terminaling revenue per barrel (b) $ 0.28$ 0.35

$ (0.07 ) Storage revenues (c) $ - $ 10,000$ (10,000 )



Total operating revenues - related party $ 45,191$ 46,343

$ (1,152 ) Capital expenditures: Maintenance $ 1,869$ 547$ 1,322 Expansion 1,355 1,607 (252 ) Total capital expenditures $ 3,224$ 2,154$ 1,070 Other financial information: Quarterly distribution declared per unit $ 0.4350 n/a Distribution declared: Limited partner units - public $ 7,506 n/a Limited partner units - Valero 17,544 n/a General partner units - Valero 511 n/a Total distribution declared $ 25,561 n/a



______________

(a) Represents the sum of volumes transported through each separately tariffed

pipeline segment.

(b) Average revenue per barrel is calculated as revenue divided by throughput for

the period. Throughput is derived by multiplying the throughput barrels per

day (BPD) by the number of days in the period.

(c) Prior to the Offering, our Predecessor leased some of our refined petroleum

products and crude oil storage capacity to Valero. Subsequent to the

Offering, under our commercial agreements with Valero, these storage capacity

lease agreements were replaced with terminaling fees. 24

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Operating revenues decreased $1.2 million, or 2 percent, for the first six months of 2014 compared to the first six months of 2013. The decrease was due primarily to: A decrease of $4.3 million at our Memphis logistics system driven by lower



throughput volumes throughout the system. Refined petroleum product

pipeline and terminal throughput volumes in the Memphis products system

decreased by 33 percent and 10 percent, respectively, and crude oil throughput volumes in the Collierville crude system decreased by 25 percent. The decreases in volumes were attributed to harsh winter weather conditions during the early part of 2014, which affected the supply of crude oil, and therefore production, at Valero's Memphis refinery. In addition, volumes were negatively impacted by a planned



turnaround at the Memphis refinery during the first six months of 2014.

An increase of $3.1 million at our Port Arthur logistics system primarily

attributable to a 49 percent increase in pipeline volumes resulting from refinery expansion projects and improved refinery operations and our new



commercial agreement with Valero, which incorporates a terminal throughput

fee at our Lucas crude system.

Operating expenses increased $1.6 million, or 16 percent, for the first six months of 2014 compared to the first six months of 2013 due primarily to an increase of $1.1 million in insurance expense as a result of us acquiring our own insurance policies. Prior to being a separate publicly traded limited partnership, we were allocated a portion of Valero's insurance costs. In addition, maintenance expense increased $622,000 due primarily to work at our Collierville crude system, which included repair of a crude prover and tank inspection, cleaning, and repair work for regulatory and compliance purposes. General and administrative expenses increased $3.0 million, or 125 percent, for the first six months of 2014 compared to the first six months of 2013 due primarily to higher costs following the Offering due to being a separate publicly traded limited partnership. During the first six months of 2014, we incurred incremental costs of $1.6 million related to the management fee charged to us by Valero as compared to amounts allocated by Valero to our Predecessor for the first six months of 2013, and $1.2 million in additional incremental costs of being a separate publicly traded limited partnership. We also incurred $308,000 in costs related to the July 1, 2014 acquisition of the Texas Crude Systems Business. Depreciation expense decreased $371,000, or 6 percent, for the first six months of 2014 compared to the first six months of 2013 due primarily to the write off of the remaining net book value of $306,000 in 2013 associated with a tank at our Lucas crude system that was no longer in service. "Other income, net" increased $1.1 million for the first six months of 2014 compared to the first six months of 2013 due primarily to interest income (net of bank fees) of $556,000 earned on our cash and cash equivalents and incremental income of $522,000 from the sale of scrap metal and right-of-way fees collected during the first six months of 2014. Prior to the Offering, our Predecessor participated in Valero's centralized cash management system; therefore, it held no cash or cash equivalents, and no interest income was allocated to our Predecessor by Valero. Interest expense increased $347,000 for the first six months of 2014 compared to the first six months of 2013 due primarily to commitment fees of $264,000 related to our revolving credit facility, which we entered into in connection with the Offering. Our income tax expense is associated with the Texas margin tax. Our effective tax rate was 1 percent during the first six months of 2014 compared to 5 percent during the first six months of 2013. The decrease was due primarily to deferred tax expense recorded in 2013 in connection with the initial recognition of a deferred 25

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tax liability associated with a change in the law with respect to the Texas margin tax. Because this was a one-time item associated with a law change, our effective tax rate returned to previous levels. CAPITAL RESOURCES AND LIQUIDITY Historically, our sources of liquidity included cash generated from operations and funding from Valero, and we participated in Valero's centralized cash management system. Our cash receipts were deposited in Valero's bank accounts and all cash disbursements were made from those accounts. Because we maintained no bank accounts dedicated solely to our assets, our Predecessor financial statements reflect a zero cash balance. In conjunction with the Offering, we established separate bank accounts, but Valero will continue to provide treasury services on our general partner's behalf under our omnibus agreement. We expect our ongoing sources of liquidity to include the net proceeds from the Offering, cash generated from operations, borrowings under our revolving credit facility, and issuances of additional debt and equity securities. We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements and long-term capital expenditure requirements, and to make quarterly cash distributions. On July 15, 2014, the board of directors of our general partner declared a distribution of $0.2225 per unit applicable to the second quarter of 2014, which equates to $13.1 million based on the number of common, subordinated, and general partner units outstanding as of June 30, 2014. This quarterly distribution per unit is more than the minimum quarterly distribution of $0.2125 per unit. We do not have a legal obligation to pay this minimum quarterly distribution. Our distributions are declared subsequent to quarter end. The table below summarizes the quarterly distributions related to our quarterly financial results: Total Quarterly Quarterly Total Cash Period Distribution Distribution Date of Record Date of Ended (Per Unit) (In Thousands) Declaration Date Distribution December 31, 2013 $ 0.037 $ 2,174 January 20, 2014 January 31, 2014 February 12, 2014 March 31, 2014 0.2125 12,487 April 17, 2014 May 1, 2014 May 14, 2014 June 30, 2014 0.2225 13,074 July 15, 2014 August 1, 2014 August 13, 2014 Revolving Credit Facility In connection with the Offering, we entered into a $300.0 million senior unsecured revolving credit facility that matures on December 31, 2018. The facility includes sub-facilities for swingline loans and letters of credit. As of June 30, 2014, no amounts were outstanding under this facility. See Note 4 of Condensed Notes to Consolidated Financial Statements for a description of our revolving credit facility. 26

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Table of Contents Cash Flows Summary Components of our cash flows are set forth below (in thousands): Six Months Ended June 30, 2014 2013 Cash flows provided by (used in): Operating activities $ 29,382$ 33,563 Investing activities (3,224 ) (2,154 ) Financing activities (19,461 ) (31,409 )



Increase in cash and cash equivalents $ 6,697 $ -

Operating Activities Our operations generated $29.4 million in cash for the first six months of 2014 compared to $33.6 million for the first six months of 2013. The decline in cash flows from operating activities was attributable to a reduction in net income and was driven primarily by a decrease in our operating revenues, an increase in maintenance costs, and an increase in incremental costs associated with being a separate publicly traded limited partnership as discussed above under "RESULTS OF OPERATIONS." Investing Activities Our investing activities were solely related to capital expenditures of $3.2 million and $2.2 million for the six months ended June 30, 2014 and 2013, respectively. See "Capital Expenditures" below for a discussion of the various maintenance and expansion projects. Financing Activities Our net cash used in financing activities for the first six months of 2014 was $19.5 million compared to $31.4 million for the first six months of 2013. Cash used for financing activities in 2014 consisted primarily of payments of $14.7 million for distributions paid to limited partners and our general partner, $3.2 million of offering costs related to the Offering, and $1.1 million of debt issuance costs related to the $300.0 million senior unsecured revolving credit facility we entered into in connection with the Offering. For the first six months of 2013, our financing activities consisted primarily of net transfers to Valero as a result of participating in Valero's centralized cash management system. Capital Expenditures Our operations can be capital intensive, requiring investments to expand, upgrade, or enhance existing operations and to meet environmental and operational regulations. Our capital requirements consist of maintenance capital expenditures and expansion capital expenditures as those terms are defined in our partnership agreement. Examples of maintenance capital expenditures are those made to replace partially or fully depreciated assets, to maintain the existing operating capacity of our assets and to extend their useful lives, or other capital expenditures that are incurred in maintaining existing system volumes and related cash flows. In contrast, examples of expansion capital expenditures include those made to expand and upgrade our systems and facilities and to construct or acquire new systems or facilities to grow our business. 27 --------------------------------------------------------------------------------



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Our capital expenditures were as follows (in thousands):

Six Months Ended June 30, 2014 2013 Maintenance $ 1,869$ 547 Expansion 1,355 1,607 Total capital expenditures $ 3,224$ 2,154



Our capital expenditures for the first six months of 2014 were primarily associated with the construction of: an interconnection with TransCanada's Cushing MarketLink pipeline;

improvements in pipeline and tank monitoring systems at our Lucas crude

system;



the enhancement of pipeline and terminal monitoring systems at our Memphis

products system; and



additive blending system improvements at our Memphis truck rack.

Our capital expenditures for the first six months of 2013 were primarily directed toward the following activities: biodiesel blending system improvements at our Memphis truck rack;

an interconnection with TransCanada's Cushing MarketLink pipeline; and

installation of metering equipment on our Port Arthur products system

pipelines and a pipeline connection to Oiltanking's Beaumont marine

terminal.

For the full year 2014, we expect to incur capital expenditures of approximately $14.0 million, which includes approximately $6.4 million primarily related to an expansion project associated with the Texas Crude Systems Business that was acquired on July 1, 2014. Included in our 2014 budget is $7.4 million for expansion capital expenditures and $6.6 million for maintenance capital expenditures. We continuously evaluate our capital budget and make changes as conditions warrant. We anticipate that these capital expenditures will be funded from cash flows from operations and $3.5 million in prefunding from Valero for certain projects pursuant to our omnibus agreement. The capital expenditure estimate excludes expenditures related to strategic business acquisitions, which we expect to rely primarily upon external financing sources to fund, including borrowings under our revolving credit facility and the issuance of debt and equity securities. Contractual Obligations As of June 30, 2014, our contractual obligations included capital lease obligations, operating leases, purchase obligations, and other long-term liabilities. There were no material changes outside the ordinary course of business with respect to these contractual obligations during the six months ended June 30, 2014. 28

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Table of Contents Regulatory Matters Rate and Other Regulations Our interstate common carrier crude oil and refined petroleum products pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission (FERC) under the Interstate Commerce Act (ICA) and Energy Policy Act (EPAct). Our pipelines and terminal operations are also subject to safety regulations adopted by the Department of Transportation (DOT), as well as to state regulations. For more information on federal and state regulations affecting our business, please read our annual report on Form 10-K for the year ended December 31, 2013. Environmental Matters and Compliance Costs We are subject to extensive federal, state, and local environmental laws and regulations. These laws, which change frequently, regulate the discharge of materials into the environment or otherwise relate to protection of the environment. Compliance with these laws and regulations may require us to remediate environmental damage from any discharge of petroleum or chemical substances from our facilities or require us to install additional pollution control equipment on our equipment and facilities. Our failure to comply with these or any other environmental or safety-related regulations could result in the assessment of administrative, civil, or criminal penalties, the imposition of investigatory and remedial liabilities, and the issuance of injunctions that may subject us to additional operational constraints. As of June 30, 2014, there were no significant changes to our environmental matters and compliance costs since the date our annual report on Form 10-K for the year ended December 31, 2013 was filed. CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. As of June 30, 2014, there were no significant changes to our critical accounting estimates since the date our annual report on Form 10-K for the year ended December 31, 2013 was filed. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk of loss arising from adverse changes in market rates and prices. Because we do not take ownership of or receive any payments based on the value of the crude oil or refined petroleum products that we handle and do not engage in the trading of any commodities, we have no direct exposure to commodity price fluctuations. Our commercial agreements with Valero are indexed to inflation to mitigate our exposure to increases in the cost of labor and materials used in our business. Any debt that we incur under our revolving credit facility will bear interest at a variable rate and will expose us to interest rate risk. Unless interest rates increase significantly in the future, our exposure to interest rate risk should be minimal. There were no borrowings or letters of credit outstanding under our revolving credit agreement as of June 30, 2014. 29 --------------------------------------------------------------------------------



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