The following discussion contains forward-looking statements that reflect our
future plans, estimates, beliefs and expected performance. The forward-looking
statements are dependent upon events, risks and uncertainties that may be
outside our control, including, among other things, the risk factors discussed
in "Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year ended
December 31, 2020 and this Quarterly Report on Form 10-Q. Our actual results
could differ materially from those discussed in these forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, market prices for oil and natural gas, production
volumes, capital expenditures, weather, economic and competitive conditions,
regulatory changes and other uncertainties, as well as those factors discussed
below and elsewhere in our Annual Report on Form 10-K for the year ended
December 31, 2020 and this Quarterly Report on Form 10-Q, all of which are
difficult to predict. In light of these risks, uncertainties, and assumptions,
the forward-looking events discussed may or may not occur. See "Cautionary
Remarks Regarding Forward-Looking Statements" in the front of this Quarterly
Report on Form 10-Q.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains a discussion of our business, including a general overview
of our properties, our results of operations, our liquidity and capital
resources, and our quantitative and qualitative disclosures about market risk
broken down into two segments: (1) our Inspection Services ("Inspection
Services") segment comprises the TIR Entities and; (2) our Water and
Environmental Services ("Environmental Services") segment comprises our water
treatment facilities. The financial information for the Inspection Services and
Environmental Services segments is included in "Item 2 - Management's Discussion
and Analysis of Financial Condition and Results of Operations" should be read in
conjunction with the interim financial statements and related notes included
elsewhere in this report and prepared in accordance with accounting principles
generally accepted in the United States of America and in our Consolidated
Financial Statements for the year ended December 31, 2020 included in our Annual
Report on Form 10-K for the year ended December 31, 2020.
Overview
We are a growth-oriented master limited partnership formed in September 2013. We
offer essential services that help protect the environment and ensure
sustainability. We provide a wide range of environmental services including
independent inspection, integrity, and support services for pipeline and energy
infrastructure owners and operators and public utilities. We also provide water
pipelines, hydrocarbon recovery, disposal, and water treatment services. The
Inspection Services segment comprises the operations of our TIR Entities. We
also provide water treatment and other water and environmental services to U.S.
onshore oil and natural gas producers and trucking companies through our
Environmental Services segment.
In September 2021 we discontinued the operations of Cypress Brown Integrity, LLC
("CBI"), which previously represented our Pipeline & Process Services segment.
We have classified the accounts of CBI within discontinued operations in the
accompanying Unaudited Condensed Consolidated Financial Statements.
Ownership
As of September 30, 2021, Holdings and its affiliates own 64% of our common
units. Holdings' ownership group also owns 100% of the General Partner and
certain incentive distribution rights (although no such incentive distributions
have been paid to date), and an affiliate of Holdings owns 100% of the preferred
units.
Omnibus Agreement
We are party to an omnibus agreement with Holdings and other related parties.
The omnibus agreement provides for, among other things, our right of first offer
on Holdings' and its subsidiaries' assets used in, and entities primarily
engaged in, providing water treatment and other water and environmental
services. So long as Holdings controls our General Partner, the omnibus
agreement will remain in full force and effect, unless we and Holdings agree to
terminate it sooner. If Holdings ceases to control our General Partner, either
party may terminate the omnibus agreement. We and Holdings may agree to further
amend the omnibus agreement; however, amendments that the General Partner
determines are adverse to our unitholders will also require the approval of the
Conflicts Committee of our Board of Directors.
Inspection Services
The Inspection Services segment generates revenue by providing essential
environmental services, including inspection and integrity services on a variety
of infrastructure assets, such as midstream pipelines, gathering systems, and
distribution systems. Services include nondestructive examination, in-line
inspection support, pig tracking, data gathering, and supervision of third-party
contractors. Our revenues in this segment are driven by the number of inspectors
who perform services for our customers and the fees that we charge for those
services, which depend on the type, skills, technology, equipment, and number of
inspectors used on a particular project, the nature of the project, and the
duration of the project. The number of inspectors engaged on projects is driven
by the type of project, the age and condition of customers' assets including
pipelines, gas plants, compression stations, storage facilities, and gathering
and distribution systems including the legal and regulatory requirements
relating to the inspection and maintenance of those assets. We also bill our
customers for per diem charges, mileage, and other reimbursement items. Revenue
and costs in this segment are subject to seasonal variations and interim
activity may not be indicative of yearly activity, considering many of our
customers develop yearly operating budgets and enter into contracts with us
during the winter season for work to be performed during the remainder of the
year. Additionally, inspection work throughout the United States during the
winter months (especially in the northern states) may be hampered or delayed due
to inclement weather. The first and fourth quarters of each year are typically
slower than the second and third quarters, due to weather conditions and
customers' budgeting cycles.
Environmental Services
The Environmental Services segment owns and operates nine water treatment
facilities with ten EPA Class II injection wells in the Bakken shale region of
the Williston Basin in North Dakota. We wholly-own eight of these water
treatment facilities and we own a 25% interest in the other facility. These
water treatment facilities are connected to thirteen pipeline gathering systems,
including two that we developed and own. We specialize in the treatment,
recovery, separation, and disposal of waste byproducts generated during the
lifecycle of an oil and natural gas well to protect the environment and our
drinking water. All of the water treatment facilities utilize specialized
equipment and remote monitoring to minimize the facilities' downtime and
increase the facilities' efficiency for peak utilization. Revenue is generated
on a fixed-fee per barrel basis for receiving, separating, filtering,
recovering, processing, and injecting produced and flowback water. We also sell
recovered oil, receive fees for pipeline transportation of water, and receive
fees from a partially-owned water treatment facility for management and staffing
services.
Outlook
Overall
Our 2020 results were the worst in our short history following our best year in
2019. The financial results in 2020 were adversely affected by a significant
decline in oil prices, which was driven in part by increased supply from Russia,
Saudi Arabia, and other oil-producing nations as a result of a price war and in
part by a significant decrease in demand as a result of the COVID-19 pandemic.
The combination of these events led many of our customers to cancel planned
construction projects and to defer regular maintenance projects whenever
possible. The effects of these events placed significant financial pressures on
the vast majority of our customers to reduce costs, which led some of our
customers to aggressively pursue pricing concessions. We value our long-term
customer relationships and worked closely with them to address this reality,
which in turn required us to modify what pay we could offer to our valued
inspectors. Despite the COVID-19 pandemic, we continued our field operations
without any significant disruption in our service to our customers.
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Previously, OPEC started a price war for market share in November 2014 that led
to a downturn that lasted through 2017. The industry, our customers, and we
benefitted from a rebound in 2018 and 2019. In the years leading into 2020, many
companies had been active in constructing new energy infrastructure, such as
pipelines, gas plants, compression stations, pumping stations, and storage
facilities, which afforded us the opportunity to provide our inspection and
integrity services on these projects. The commodity price decline in 2020 led
our customers to change their budgets and plans, and to decrease their spending
on capital expenditures. This, in turn, had an impact on regular maintenance
work and the construction of new pipelines, gathering systems, and related
energy infrastructure. Lower exploration and production activity also affected
the midstream industry and led to delays and cancellations of projects. The
volatility in crude oil prices is illustrated in the chart below, which shows
the average monthly spot price for West Texas Intermediate crude oil from 2018
through September 2021:
[[Image Removed: img]]
Recognizing the impact of the COVID-19 pandemic, we took swift and decisive
actions in 2020 to reduce overhead and other costs through a combination of
salary reductions, reductions in workforce, and other cost-cutting measures. We
elected to defer some discretionary capital expenditures and we remained focused
on opportunities to reduce our working capital needs. In early 2021, we took
additional actions to further reduce our costs with some additional reductions
in workforce and furloughs. These actions have significantly lowered our general
and administrative costs. While reducing certain costs, we have also made
investments in personnel in our account management and business development
teams, to position ourselves to take advantage of the market's eventual
recovery. In addition, the challenging market conditions notwithstanding, in May
2021 we prospectively restored the salaries of certain key employees that had
accepted temporary salary reductions in 2020.
In light of the adverse market conditions, we made the difficult decision in
July 2020 to temporarily suspend payment of common unit distributions. This has
enabled us to retain more cash to manage our working capital and financing
requirements during these challenging market conditions. Our credit facility, as
amended in 2021, contains significant restrictions on our ability to pay cash
distributions to common and preferred unitholders. As a result, we expect to use
cash generated from operations for working capital to support revenue growth and
to pay down debt.
The vaccination process for COVID-19 has progressed, which has likely been a
leading factor in the recent recovery in demand for crude oil. The price of
crude oil has increased in 2021, with the average daily spot price for West
Texas Intermediate crude oil increasing from $48.35 per barrel at December 31,
2020 to $81.96 per barrel at November 8, 2021. We expect that a sustained
increase in crude oil prices would lead customers to increase their maintenance
and capital spending plans, although to this point, customers have been slow to
increase activity. We continue to focus on winning new customers while
supporting our existing customers.
Sales and business development continue to be among our top priorities, and we
are bidding on many projects with both existing and prospective new customers.
The near-term recovery remains fragile, as market participants evaluate the
risks associated with new variants of the coronavirus. Our customers continue to
evaluate these changing circumstances. Historically, as commodity prices
increase, customers begin to increase their spending, which increases our
opportunities to provide services. Although higher commodity prices typically
benefit our business, we typically experience a lag between when commodity
prices increase and when our customers begin to increase their spending for our
services. We believe there will be significant long-term demand for our
services, and we continue our efforts to diversify our customer base. We have
continued to invest in talent in the areas of account management and business
development. We strive to position ourselves as a stable and reliable provider
of high-quality services to our customer base.
In 2020 we made the strategic decision to pursue new inspection markets to
diversify our inspection business to markets not tied to commodity prices. We
have the expertise and systems to offer inspection services into new markets
such as municipal water, sewer, bridges, electrical transmission, marine
coatings, wind, solar, and hydroelectric. We have been bidding inspection jobs
in these new markets and many of our inspectors and employees have the skills to
offer services to these new markets. Over the long term, we hope to have the
majority of our inspection revenue coming from these new services.
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We believe government regulation under the new administration will continue to
grow with a focus on protecting the environment. The U.S. Pipeline and Hazardous
Materials Safety Administration ("PHMSA") recently issued new rules that impose
several new requirements on operators of onshore gas transmission systems and
hazardous liquids pipelines. The new rules expand requirements to address risks
to pipelines outside of environmentally sensitive and populated areas. In
addition, the rules make changes to integrity management requirements, including
emphasizing the use of in-line inspection technology. The new rules took effect
on July 1, 2020 with various implementation phases over a period of years. We
remain optimistic about the long-term demand for environmental services such as
inspection services, integrity services, and water solutions, due to our
nation's aging pipeline infrastructure, and we believe we continue to be
well-positioned to capitalize on these opportunities. The following charts
summarize the age of pipelines in the United States, as developed from
independent research and government data:
[[Image Removed: img]]
In 2018, Holdings completed an acquisition to further broaden our collective
suite of environmental services. This acquisition provided entry into the
municipal water industry, whereby we can offer our traditional inspection
services, including corrosion and nondestructive testing services, as well as
in-line inspection ("ILI"). Holdings' next generation 5G ultra high-resolution
magnetic flux leakage ("MFL") ILI technology called EcoVision™ UHD, is capable
of helping pipeline owners and operators better manage the integrity of their
pipeline assets in both the municipal water and energy industries. We believe
Holdings is the only technology provider today capable of offering this service
to the large and diverse municipal water industry that provides drinking water
to our communities. Holdings has been investing in building tools to serve
pipelines of various sizes. At some point in the future, this business may be
offered to the Partnership when appropriate. We do not expect to acquire this
business in the near term, although we continue to use our affiliation with this
business as a cross-selling opportunity for our services.
Our parent company's ownership interests continue to remain fully aligned with
our unitholders, as our General Partner and insiders collectively own 76% of our
total common and preferred units.
In March 2021, we entered into an amendment to our credit facility that extended
the maturity date of the facility to May 2022, reduced the total borrowing
capacity under the facility from $110.0 million to $75.0 million, and made the
leverage ratio covenant temporarily less restrictive. In August 2021, we entered
into another amendment to the credit facility that, among other things, removed
certain financial statement ratio covenants for the remaining term of the
facility and reduced the total capacity under the facility from $75.0 million to
$70.0 million. We continue to have discussions with our lenders regarding our
financing options beyond the May 2022 maturity date of our credit facility. It
is possible that any future amendments, extensions, or replacements of the
credit facility could further reduce the borrowing capacity under the credit
facility, further limit our payment of distributions or add other new
restrictions, which could further limit our ability to borrow for working
capital to fund revenue growth and could also restrict our ability to borrow to
fund capital expenditures. Future amendments, extensions, or replacements of the
credit facility could also result in increased interest rates and bank fees. We
have incurred and expect to continue to incur additional advisory fees in
developing our financing plans. We can make no assurances that we will be able
to successfully extend the credit facility beyond the May 2022 maturity date. As
part of our efforts to reduce our outstanding debt and working capital needs, we
will consider asset sales, which could result in impairments to long-lived
assets in future periods. In September 2021, we discontinued the operations of
our Pipeline & Process Services segment, which is now reported within
discontinued operations in the accompanying Unaudited Condensed Consolidated
Financial Statements. In October 2021, we decided to wind down our survey
service line, which represented less than 1% of the total revenues of the
Inspection Services segment during the nine months ended September 30, 2021.
Inspection Services
Revenues of our Inspection Services segment decreased from $41.9 million during
the three months ended September 30, 2020 to $31.5 million during the three
months ended September 30, 2021, a decrease of 25%. Gross margins in this
segment decreased from $5.1 million during the three months ended September 30,
2020 to $3.9 million during the three months ended September 30, 2021, a
decrease of 24%. At the end of the first quarter of 2020, the outbreak of the
COVID-19 pandemic, combined with a significant decrease in crude oil prices
resulting from reduced demand and an anticipated increase in supply from Saudi
Arabia and Russia, led many of our customers to reduce their spending on capital
expenditures and maintenance projects. Most projects that were already in
process continued, despite the COVID-19 pandemic. However, many customers
announced reductions in their capital expansion budgets and deferrals of planned
construction projects, which significantly reduced our opportunities to generate
revenue from inspection services. The lower level of activity continued into
2021, and many of our customers have not yet resumed significant spending on
capital expansion. We are beginning to see signs of a market upcycle driven by
much higher commodity prices, which we expect to benefit many of our customers
in the energy industry.
The macroeconomic fundamentals have strengthened recently with a recovery in
demand for oil, natural gas, and refined products. Absent a recession or
pandemic-related economic setback, these positive dynamics are expected to
benefit our industry. The development by our customers of large expansion
projects typically lags behind increases in commodity prices, due to the time
required to plan, permit, and initiate large-scale projects.
In 2021, a large majority of our revenues have been generated from services to
utility customers and maintenance services to our customers in the energy
industry, rather than from new construction projects. Services to public utility
customers have represented over 50% of the Inspection Services segment's
revenues in 2021. We have seen modest improvement during 2021, as our average
monthly inspector headcount increased from 436 in January 2021 to 462 in
September 2021.
We expect customers to continue to conduct maintenance activities, many of which
are government-mandated. However, many clients are deferring maintenance work
whenever possible if they have the option. We believe our reputation developed
over 18 years will give us a competitive advantage during this challenging
industry downturn when some of our competitors may not survive.
21
We continue to bid on new inspection opportunities, including in new markets
such as electrical transmission and municipal water. We operate in a very large
market, with more than 3,000 customer prospects who require federally and/or
state-mandated inspection and integrity services. Our focus remains on
maintenance and integrity work on existing pipelines, as well as work on new
projects. The majority of our clients are large public companies with long
planning cycles that lead to healthy backlogs of new long-term projects when
market conditions warrant and existing pipeline networks that also require
inspection and integrity services. We believe that regulatory requirements,
coupled with the aging pipeline infrastructure, mean that our customers will
require our inspection services regardless of commodity prices. However, any
prolonged downturn in oil and natural gas prices could lead to reduced demand
for our services.
We are currently reviewing our inspector remuneration programs to address a
longstanding industry practice whereby inspectors are provided with fixed
reimbursements based on estimates of their out-of-pocket expenditures. We plan
to reduce these reimbursements to our inspectors and to make corresponding
increases in their wages and benefits. We have also continued our process of
converting inspector compensation from day rates to hourly rates. We believe
these changes should be welcomed by our customers and inspectors; however, these
changes could lead to the loss of inspectors who prefer the historical
practices, as inspectors could choose to switch to competitors that maintain
such historical remuneration practices.
Occupational Safety and Health Administration ("OSHA") released federal
regulations implementing a workplace COVID-19 vaccination mandate, effective
January 4, 2022. Employers with 100 or more employees would be required to
establish, implement, and enforce a policy that either ensures their workers are
fully vaccinated or requires all unvaccinated workers to wear a mask and submit
to weekly COVID-19 testing. We are still evaluating the potential impact of
these new regulations on our field personnel and inspectors. Additionally,
various state employment laws may impact us. These policies could lead to the
departure of inspectors, to the extent that inspectors refuse to accept the
mandates of such policies, and these departures could result in the loss of
revenue and/or additional cost to find new inspectors.
Certain of our current and former inspectors who were compensated on a day rate
have filed lawsuits and arbitration claims against us, alleging that they were
entitled to hourly wages with overtime under the Fair Labor Standards Act. Such
inspectors have, in certain circumstances, also sued our customers, asserting
that the customers were co-employers, and certain of those customers have made
indemnification claims against us related to such litigation. Many of our
competitors are experiencing similar claims, and certain of our competitors have
entered into settlement agreements with the Department of Labor involving the
payment of significant fees. The strategies of the plaintiffs' counsel have
continued to evolve and have included various creative legal theories. We have
incurred $1.3 million of legal fees during the nine months ended September 30,
2021 and we have spent a significant amount of time defending against these
claims. These costs include defending numerous arbitration claims from
individual inspectors, defending our rights to enforce the arbitration
provisions in employment agreements with inspectors, assisting customers in
their defense of the claims, and monitoring various lawsuits unrelated to us
that could create precedents that could affect the claims against us and our
customers. We expect to continue to incur significant legal defense costs. We
have paid approximately $0.2 million to settle certain claims and we have
accrued $0.3 million for certain other claims on which we have offered a
settlement. We could incur significant additional costs associated with future
settlements, including costs associated with indemnification claims from
customers that choose to settle litigation against them. Our insurance policies
generally do not offer coverage to us for these types of claims.
Environmental Services
Revenues of our Environmental Services segment decreased from $1.4 million
during the three months ended September 30, 2020 to $0.9 million during the
three months ended September 30, 2021, a decrease of 34%. Gross margins
decreased from $0.9 million during the three months ended September 30, 2020 to
$0.4 million during the three months ended September 30, 2021, a decrease of
52%. Beginning in March 2020, volatility in commodity prices and market
uncertainty due to the COVID-19 pandemic led to a significant reduction in
activity by producers in North Dakota.
Bakken Clearbrook oil pricing was under intense pressure during 2020, along with
WTI oil prices. WTI oil prices decreased throughout the first half of 2020
before gradually increasing in the second half of the year. Pipeline capacity
and storage constraints also adversely affected this market. Several prominent
exploration and production customers elected to shut in their production instead
of selling oil at the low market prices. According to a published rig count as
of December 31, 2020, the Williston basin of the Bakken totaled 11 rigs, down
82% from its peak in 2019 of 61 rigs. WTI oil prices began increasing in
December 2020 and continued to increase throughout 2021, reaching $75.22 per
barrel at September 30, 2021. According to a published rig count, the number of
rigs in the Williston basin increased modestly from 11 rigs at December 31, 2020
to 23 rigs at September 30, 2021. We expect this increase in oil prices in 2021
to lead to an increase in exploration and production activity in the Bakken,
although to this point, producers have been slow to increase production.
In July 2020, in relation to an ongoing lawsuit challenging various federal
authorizations for the Dakota Access Pipeline ("DAPL"), a federal court ordered
that the DAPL be shut down and drained of oil by August 5, 2020. The owners of
the pipeline appealed the decision, and a federal appeals court stayed the July
2020 order to close the pipeline and ordered further briefing on the issue. The
DAPL is allowed to continue operating until the United States Army Corps of
Engineers completes its environmental assessment, which is planned to be
completed by March 2022. The DAPL transports approximately 40% of the crude oil
that is produced in the Bakken region. The closure of the pipeline would likely
have an adverse effect on overall production in the Bakken, which would likely
reduce the volume of water delivered to our facilities. In addition, the
uncertainty associated with this litigation may reduce E&P companies' incentive
to invest in new production in the Bakken.
We are in discussions with several customers regarding their drilling plans and
the potential to use our facilities for the water treatment services that will
be required from these new wells. Although market conditions have been adverse,
we continue to benefit from the fact that 99% of our water in 2021 was produced
water from existing wells (rather than flowback water from new wells) and 57% of
our water in 2021 was from pipelines. We also took steps to reduce our operating
costs.
During late 2020, the largest customer of one of our highest-volume facilities
notified us of its decision to build its own facility and began sending most of
its water to that facility in February 2021.
In October 2020 a public energy company connected one of its pipelines to one of
our water treatment facilities, which benefitted our revenues in the first half
of 2021. In the third quarter of 2021, this pipeline was taken out of service
for repairs, which had an adverse effect on our revenues. We expect the pipeline
to return to service in the first quarter of 2022.
We generate a portion of our revenue from a contract to operate a facility that
we own a 25% interest in. The majority owner of the facility has notified us of
its intention to reopen negotiations over the pricing of this contract when the
contract expires in November 2022.
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