20-F 1 c99335e20vf.htm 20-F 20-F
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
(Mark One)
     
o   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
     
o   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report                     
For the transition period from                      to                     
Commission file number 1- 32479
TEEKAY LNG PARTNERS L.P.
(Exact name of Registrant as specified in its charter)
Republic of The Marshall Islands
(Jurisdiction of incorporation or organization)
4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda
(Address of principal executive offices)
Roy Spires
4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda
Telephone: (441) 298-2530
Fax: (441) 292-3931
(Contact information for company contact person)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
     
Title of each class   Name of each exchange on which registered
Common Units   New York Stock Exchange
Securities registered or to be registered pursuant to Section 12(g) of the Act.
None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
44,972,563 Common Units
7,367,286 Subordinated Units
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o     No þ
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o     No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
         
Large Accelerated Filer o   Accelerated Filer þ   Non-Accelerated Filer o
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
         
U.S. GAAP þ   International Financial Reporting Standards
as issued by the International
Accounting Standards Board o
  Other o
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o     Item 18 o
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o     No þ
 
 

 

 


 

TEEKAY LNG PARTNERS L.P.
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3


 

PART I
This Annual Report should be read in conjunction with the consolidated financial statements and accompanying notes included in this report.
Unless otherwise indicated, references in this prospectus to “Teekay LNG Partners,” “we,” “us” and “our” and similar terms refer to Teekay LNG Partners L.P. and/or one or more of its subsidiaries, except that those terms, when used in this Annual Report in connection with the common units described herein, shall mean specifically Teekay LNG Partners L.P. References in this Annual Report to “Teekay Corporation” refer to Teekay Corporation and/or any one or more of its subsidiaries.
In addition to historical information, this Annual Report contains forward-looking statements that involve risks and uncertainties. Such forward-looking statements relate to future events and our operations, objectives, expectations, performance, financial condition and intentions. When used in this Annual Report, the words “expect,” “intend,” “plan,” “believe,” “anticipate,” “estimate” and variations of such words and similar expressions are intended to identify forward-looking statements. Forward-looking statements in this Annual Report include, in particular, statements regarding:
   
our ability to make cash distributions on our units or any increases in quarterly distributions;
   
the expected timing of the conversion of our subordinated units to common units;
   
our future financial condition and results of operations and our future revenues and expenses;
   
growth prospects of the liquefied natural gas (or LNG) and liquefied petroleum gas (or LPG) shipping and oil tanker markets;
   
LNG, LPG and tanker market fundamentals, including the balance of supply and demand in the LNG, LPG and tanker markets;
   
the expected lifespan of a new LNG carrier, LPG carrier and Suezmax tanker;
   
estimated capital expenditures and the availability of capital resources to fund capital expenditures;
   
estimated costs and timing of implementation of the EU Directive to burn only low sulphur fuel, and our ability to timely comply with this Directive;
   
our ability to maintain long-term relationships with major LNG and LPG importers and exporters and major crude oil companies;
   
our ability to leverage to our advantage Teekay Corporation’s relationships and reputation in the shipping industry;
   
our continued ability to enter into long-term, fixed-rate time-charters with our LNG and LPG customers;
   
the recent economic downturn and financial crisis in the global market, including disruptions in the global credit and stock markets and potential negative effects on our customers’ ability to charter our vessels and pay for our services;
   
obtaining LNG and LPG projects that we or Teekay Corporation bid on or that Teekay Corporation has been awarded;
   
the expected timing of Teekay Corporation’s offer of the Angola LNG project vessels to the Partnership;
   
our ability to maximize the use of our vessels, including the re-deployment or disposition of vessels no longer under long-term charter;
   
expected purchases and deliveries of newbuilding vessels and commencement of service of newbuildings under long-term contracts;
   
the expected timing, amount and method of financing for the purchase of five of our leased Suezmax tankers;
   
our expected financial flexibility to pursue acquisitions and other expansion opportunities;
   
the expected cost of, and our ability to comply with, governmental regulations and maritime self-regulatory organization standards applicable to our business;
   
the expected impact of heightened environmental and quality concerns of insurance underwriters, regulators and charterers;
   
the future valuation of goodwill;
   
anticipated taxation of our partnership and its subsidiaries; and
   
our business strategy and other plans and objectives for future operations.

 

4


 

Forward-looking statements involve known and unknown risks and are based upon a number of assumptions and estimates that are inherently subject to significant uncertainties and contingencies, many of which are beyond our control. Actual results may differ materially from those expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially include, but are not limited to those factors discussed in Item 3: Key Information – Risk Factors, and other factors detailed from time to time in other reports we file with or furnish to the U.S. Securities and Exchange Commission (or the SEC).
We do not intend to revise any forward-looking statements in order to reflect any change in our expectations or events or circumstances that may subsequently arise. You should carefully review and consider the various disclosures included in this Annual Report and in our other filings made with the SEC that attempt to advise interested parties of the risks and factors that may affect our business prospects and results of operations.
Item 1. Identity of Directors, Senior Management and Advisors
Not applicable.
Item 2. Offer Statistics and Expected Timetable
Not applicable.
Item 3. Key Information
Selected Financial Data
   
The following tables presents, in each case for the periods and as of the dates indicated, summary historical financial and operating data of Teekay LNG Partners L.P. and its subsidiaries since its initial public offering on May 10, 2005, in connection with which it acquired Teekay Luxembourg S.a.r.l. (or Luxco) from Teekay Corporation.
The summary historical financial and operating data has been prepared on the following basis:
   
the period from January 1, 2005 to May 9, 2005 (or the 2005 Pre-IPO Period) reflects the acquisition of Naviera F. Tapias S.A. and its subsidiaries (or Teekay Spain) in April 2004 by Teekay Corporation through Luxco and are derived from the consolidated financial statements of Luxco; and
   
the historical financial and operating data of Teekay LNG Partners as at December 31, 2005, 2006, 2007 and 2008, and for the periods from May 10, 2005 to December 31, 2005, and for the years ended December 31, 2006, 2007, 2008 and 2009 reflect its initial public offering and related acquisition of Luxco from Teekay Corporation and are derived from the audited consolidated financial statements of Teekay LNG Partners.
Our historical operating results include the historical results of Luxco for the 2005 Pre-IPO Period. During this period, Luxco had no revenues, expenses or income, or assets or liabilities, other than:
   
net interest expense related to the advances of $7.3 for the 2005 Pre-IPO Period;
   
a $23.8 million unrealized foreign exchange gain related to the advances for the 2005 Pre-IPO Period;
   
other expenses of $0.1 million for the respective period;
   
its ownership interest in Teekay Spain and certain purchase rights and obligations for Suezmax tankers operated by Teekay Spain under capital lease arrangements, which it acquired from Teekay Spain on December 30, 2004.
Luxco’s results relate solely to the financing of the acquisition of Teekay Spain and repayment of Teekay Spain debt by Teekay Corporation and do not relate to the historical results of Teekay Spain. In addition, because the capital stock of Luxco and the advances from Teekay Corporation were contributed to us in connection with our initial public offering, these advances and their related effects were eliminated on consolidation in the periods subsequent to May 9, 2005. Consequently, certain of our historical financial and operating data for the 2005 Pre-IPO Period may not be comparable to subsequent periods.
The following table should be read together with, and is qualified in its entirety by reference to, (a) “Item 5. Operating and Financial Review and Prospects,” included herein, and (b) the historical consolidated financial statements and the accompanying notes and the Report of Independent Registered Public Accounting Firm therein (which are included herein), with respect to the consolidated financial statements for the years ended December 31, 2009, 2008 and 2007.
In November 2005, we acquired three Suezmax tankers and related long-term fixed rate time-charter contracts from Teekay Corporation. In May 2005, Teekay Corporation contributed the Granada Spirit to the Partnership. In addition, please refer to Item 5 – Operating and Financial Review and Prospects: Results of Operations – Items You Should Consider When Evaluating Our Results of Operations for a discussion relating to the LPG carrier and the two LNG carriers we acquired from Teekay Corporation in January 2007 and April 2008, respectively. These transactions were deemed to be business acquisitions between entities under common control. Accordingly, we have accounted for these transactions in a manner similar to the pooling of interest method whereby our financial statements prior to the date these vessels were acquired by us are retroactively adjusted to include the results of these acquired vessels. The periods retroactively adjusted include all periods that we and the acquired vessels were both under the common control of Teekay Corporation and had begun operations. As a result, our statements of income (loss) for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 reflect the results of operations of these seven vessels, referred to herein as the Dropdown Predecessor, as if we had acquired them when each respective vessel began operations under the ownership of Teekay Corporation, which were September 26, 2003, November 10, 2003, and January 4, 2004 (the three Suezmax tankers); April 1, 2003 (the LPG carrier); December 13 and 14, 2007 (the two LNG carriers); and as if we had not sold the vessel to Teekay Corporation on December 6, 2004 (Granada Spirit).

 

5


 

The information presented in the following table and related footnotes has been adjusted to reflect the inclusion of the Dropdown Predecessor in our financial results for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 as the Company accounts for the acquisition of the seven vessels as business combinations between entities under common control.
Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (or GAAP).
                                                 
    January 1     May 10                          
    to     to     Year Ended     Year Ended     Year Ended     Year Ended  
    May 9,     December 31,     December 31,     December 31,     December 31,     December 31,  
    2005     2005     2006     2007     2008     2009  
    (in thousands, except per unit and fleet data)  
Income Statement Data:
                                               
Voyage revenues
  $ 67,575     $ 116,603     $ 192,353     $ 257,769     $ 314,404     $ 326,029  
 
                                   
Operating expenses:
                                               
Voyage expenses (1)
    1,934       639       2,036       1,197       3,253       1,902  
Vessel operating expenses (2)
    14,609       22,646       40,977       56,863       77,113       77,482  
Depreciation and amortization
    18,134       32,570       53,076       66,017       76,880       78,742  
General and administrative
    4,481       8,732       14,152       15,186       20,201       18,162  
Restructuring charge
                                  3,250  
Goodwill impairment
                            3,648        
 
                                   
Total operating expenses
    39,158       64,587       110,241       139,263       181,095       179,538  
 
                                   
Income from vessel operations
    28,417       52,016       82,112       118,506       133,309       146,491  
 
                                   
Interest expense
    (35,677 )     (33,442 )     (82,099 )     (145,073 )     (138,317 )     (59,281 )
Interest income
    9,098       14,098       40,162       68,329       64,325       13,873  
Realized and unrealized (loss) gain on derivative instruments (3)
    (12,891 )     (27,481 )     14,207       9,816       (99,954 )     (40,950 )
Foreign currency exchange gain (loss) (4)
    52,295       29,523       (39,590 )     (41,241 )     18,244       (10,835 )
Equity (loss) income (5)
                (38 )     (130 )     136       27,639  
Other (expense) income
    (17,159 )     3,045       (391 )     (1,284 )     1,045       (302 )
 
                                   
Net income (loss)
    24,083       37,759       14,363       8,923       (21,212 )     76,635  
 
                                   
Non-controlling interest in net income (loss) (6)
                3,234       (16,739 )     (40,698 )     29,310  
 
                                               
Dropdown Predecessor’s interest in net income (loss)
    3,383       1,588       (123 )     520       894        
General Partner’s interest in net income (loss)
          6,229       1,542       9,752       11,989       5,180  
Limited partners’ interest in net income (loss)
    20,700       29,942       9,710       15,390       6,603       42,145  
Limited partners’ interest in net income (loss) per:
                                               
Common unit (basic and diluted) (7)
    0.88       1.21       0.32       0.64       0.63       0.86  
Subordinated unit (basic and diluted) (7)
    0.88       1.06       0.32       0.66       (0.29 )     0.80  
Total unit (basic and diluted) (7)
    0.88       1.14       0.32       0.65       0.36       0.85  
Cash distributions declared per unit
          0.65       1.80       2.05       2.22       2.28  
Balance Sheet Data (at end of period):
                                               
Cash and cash equivalents
        $ 35,955     $ 29,288     $ 91,891     $ 117,641     $ 102,570  
Restricted cash (8)
          298,323       670,758       679,229       642,949       611,520  
Vessels and equipment (9)
          1,522,887       1,715,662       2,065,572       2,207,878       1,874,435  
Net investments in direct financing leases (10)
                                  421,441  
Total assets (8)
          2,085,634       2,928,422       3,818,616       3,432,849       3,362,354  
Total debt and capital lease obligations (8)
          1,266,281       1,854,654       2,582,991       2,199,952       2,133,342  
Total stockholder’s/partners’ equity (deficit)
          736,599       703,190       709,292       805,851       860,218  
Common units outstanding
    8,734,572       20,238,072       20,240,547       22,540,547       33,338,320       44,972,563  
Subordinated units outstanding
    14,734,572       14,734,572       14,734,572       14,734,572       11,050,929       7,367,286  
Cash Flow Data:
                                               
Net cash provided by (used in):
                                               
Operating activities
  $ 15,980     $ 59,726     $ 89,383     $ 115,450     $ 149,570     $ 164,496  
Financing activities
    (163,646 )     36,530       (266,048 )     630,395       403,262       (9,648 )
Investing activities
    18,758       (87,803 )     169,998       (683,242 )     (527,082 )     (169,919 )
Other Financial Data:
                                               
Net voyage revenues (11)
  $ 65,641     $ 115,964     $ 190,317     $ 256,572     $ 311,151     $ 324,127  
EBITDA (12)
    71,135       86,625       109,751       152,839       129,865       201,479  
Adjusted EBITDA (12)
    47,013       81,621       130,534       182,333       206,603       244,638  
Capital expenditures:
                                               
Expenditures for vessels and equipment (13)
    44,270       158,045       1,037       160,757       172,093       134,230  
Expenditures for drydocking
    371       3,494       3,693       3,724       11,966       9,729  
Liquefied Gas Fleet Data:
                                               
Calendar-ship-days (14)
    645       1,180       1,887       2,897       3,701       4,637  
Average age of our fleet (in years at end of period) (15)
    1.9       2.8       3.0       4.3       4.4       4.6  
Vessels at end of period (16)
    5       5       6       10       11       14  
Suezmax Fleet Data:
                                               
Calendar-ship-days (14)
    1,032       1,833       2,920       2,920       2,928       2,920  
Average age of our fleet (in years at end of period)
    4.3       3.0       4.0       4.5       5.5       6.5  
Vessels at end of period
    8       8       8       8       8       8  
     
(1)  
Voyage expenses are all expenses unique to a particular voyage, including any bunker fuel expenses, port fees, cargo loading and unloading expenses, canal tolls, agency fees and commissions.
 
(2)  
Vessel operating expenses include crewing, repairs and maintenance, insurance, stores, lube oils and communication expenses.

 

6


 

     
(3)  
We entered into interest rate swaps to mitigate our interest rate risk from our floating-rate debt, leases and restricted cash. Changes in the fair value of our derivatives are recognized immediately into income and are presented as realized and unrealized (loss) gain on derivative instruments in the statements of income (loss). Please see Item 18 – Financial Statements: Note 12 – Derivative Instruments.
 
(4)  
Substantially all of these foreign currency exchange gains and losses were unrealized and not settled in cash. Under GAAP, all foreign currency-denominated monetary assets and liabilities, such as cash and cash equivalents, accounts receivable, restricted cash, accounts payable, long-term debt and capital lease obligations, are revalued and reported based on the prevailing exchange rate at the end of the period. Our primary source for the foreign currency exchange gains and losses is our Euro-denominated term loans, which totaled 304.3 million Euros ($444.0 million) at December 31, 2007, 296.4 million Euros ($414.1 million) at December 31, 2008 and 288.0 million Euros ($412.4 million) at December 31, 2009.
 
(5)  
Equity (loss) income includes unrealized gain on derivative instruments of $10.9 million for the year ended December 31, 2009 and nil for all the preceding periods.
 
(6)  
In January 2009, we adopted an amendment to Financial Accounting Standards Board (or FASB) Accounting Standards Codification (or ASC) 810, Consolidations, which requires us to change the portion of net income (loss) that is attributable to the non-controlling interest. This change was not applied retroactively, please read Item 18 — Financial Statements: Note 1 - Adoption of New Accounting Pronouncements to see the 2009 pro forma net income (loss) attributable to the non-controlling interest had we not adopted FASB ASC 810.
 
(7)  
In January 2009, the we adopted an amendment to FASB ASC 260, Earnings Per Share, and based on this amendment, the General Partner’s, common unitholders’ and subordinated unitholder’s interests in net income (loss) are calculated as if all net income (loss), after deducting the amount of net income (loss) attributable to the Dropdown Predecessor, the non-controlling interest and the General Partner’s interest, was distributed according to the terms of the Partnership’s partnership agreement, regardless of whether those earnings would or could be distributed. This amendment was applied retrospectively to all periods presented. Please Read Item 18 Financial Statements: Note 15 — Total Capital and Net Income (Loss) Per Unit.
 
(8)  
We operate certain of our LNG carriers under tax lease arrangements. Under these arrangements, we borrow under term loans and deposit the proceeds into restricted cash accounts. Concurrently, we enter into capital leases for the vessels, and the vessels are recorded as assets on our consolidated balance sheets. The restricted cash deposits, plus the interest earned on the deposits, will equal the remaining amounts we owe under the capital lease arrangements, including our obligations to purchase the vessels at the end of the lease term where applicable. Therefore, the payments under our capital leases are fully funded through our restricted cash deposits, and our continuing obligation is the repayment of the term loans. However, under GAAP we record both the obligations under the capital leases and the term loans as liabilities, and both the restricted cash deposits and our vessels under capital leases as assets. This accounting treatment has the effect of increasing our assets and liabilities by the amount of restricted cash deposits relating to the corresponding capital lease obligations.
 
(9)  
Vessels and equipment consist of (a) our vessels, at cost less accumulated depreciation, (b) vessels under capital leases, at cost less accumulated depreciation, and (c) advances on our newbuildings.
 
(10)  
The external charters which commenced in 2009 under the Tangguh LNG project have been accounted for as direct financing leases and as a result, the two LNG vessels relating to this project are not included as part of vessels and equipment.
 
(11)  
Consistent with general practice in the shipping industry, we use net voyage revenues (defined as voyage revenues less voyage expenses) as a measure of equating revenues generated from voyage charters to revenues generated from time-charters, which assists us in making operating decisions about the deployment of our vessels and their performance. Under time-charters the charterer pays the voyage expenses, whereas under voyage charter contracts the ship owner pays these expenses. Some voyage expenses are fixed, and the remainder can be estimated. If we, as the ship owner, pay the voyage expenses, we typically pass the approximate amount of these expenses on to our customers by charging higher rates under the contract or billing the expenses to them. As a result, although voyage revenues from different types of contracts may vary, the net voyage revenues are comparable across the different types of contracts. We principally use net voyage revenues, a non-GAAP financial measure, because it provides more meaningful information to us than voyage revenues, the most directly comparable GAAP financial measure. Net voyage revenues are also widely used by investors and analysts in the shipping industry for comparing financial performance between companies and to industry averages. The following table reconciles net voyage revenues with voyage revenues.
                                                 
    January 1     May 10                          
    to     to     Year Ended     Year Ended     Year Ended     Year Ended  
    May 9,     December 31,     December 31,     December 31,     December 31,     December 31,  
    2005     2005     2006     2007     2008     2009  
 
                                               
Voyage revenues
  $ 67,575     $ 116,603     $ 192,353     $ 257,769     $ 314,404     $ 326,029  
 
     
Voyage expenses
    (1,934 )     (639 )     (2,036 )     (1,197 )     (3,253 )     (1,902 )
 
                                   
 
                                               
Net voyage revenues
  $ 65,641     $ 115,964     $ 190,317     $ 256,572     $ 311,151     $ 324.127  
 
                                   
     
(12)  
EBITDA and Adjusted EBIDTA is used as a supplemental financial measure by management and by external users of our financial statements, such as investors, as discussed below:
   
Financial and operating performance. EBITDA and Adjusted EBITDA assist our management and investors by increasing the comparability of our fundamental performance from period to period and against the fundamental performance of other companies in our industry that provide EBITDA and Adjusted EBITDA information. This increased comparability is achieved by excluding the potentially disparate effects between periods or companies of interest expense, taxes, depreciation or amortization and realized and unrealized gain (loss) on derivative instruments relating to interest rate swaps, which items are affected by various and possibly changing financing methods, capital structure and historical cost basis and which items may significantly affect net income between periods. We believe that including EBITDA and Adjusted EBITDA as financial and operating measures benefits investors in (a) selecting between investing in us and other investment alternatives and (b) monitoring our ongoing financial and operational strength and health in assessing whether to continue to hold our common units.

 

7


 

   
Liquidity. EBITDA and Adjusted EBITDA allows us to assess the ability of assets to generate cash sufficient to service debt, pay distributions and undertake capital expenditures. By eliminating the cash flow effect resulting from our existing capitalization and other items such as drydocking expenditures, working capital changes and foreign currency exchange gains and losses, EBITDA and Adjusted EBITDA provides a consistent measure of our ability to generate cash over the long term. Management uses this information as a significant factor in determining (a) our proper capitalization (including assessing how much debt to incur and whether changes to the capitalization should be made) and (b) whether to undertake material capital expenditures and how to finance them, all in light of our cash distribution policy. Use of EBITDA and Adjusted EBITDA as a liquidity measure also permits investors to assess the fundamental ability of our business to generate cash sufficient to meet cash needs, including distributions on our common units.
Neither EBITDA nor Adjusted EBITDA, which are non-GAAP measures, should be considered as an alternative to net income, income from vessel operations, cash flow from operating activities or any other measure of financial performance or liquidity presented in accordance with GAAP. EBITDA and Adjusted EBITDA exclude some, but not all, items that affect net income and operating income, and these measures may vary among other companies. Therefore, EBITDA and Adjusted EBITDA as presented in this Report may not be comparable to similarly titled measures of other companies.
The following table reconciles our historical consolidated EBITDA and Adjusted EBITDA to net income, and our historical consolidated Adjusted EBITDA to net operating cash flow.
                                                 
    January 1     May 10                          
    to     to     Year Ended     Year Ended     Year Ended     Year Ended  
    May 9,     December 31,     December 31,     December 31,     December 31,     December 31,  
    2005     2005     2006     2007     2008     2009  
 
                                               
Reconciliation of “EBITDA” and “Adjusted EBITDAto “Net income (loss)”:
                                               
Net income (loss)
  $ 24,083     $ 37,759     $ 14,363     $ 8,923     $ (21,212 )   $ 76,635  
Depreciation and amortization
    18,134       32,570       53,076       66,017       76,880       78,742  
Interest expense, net of interest income
    26,579       19,344       41,937       76,744       73,992       45,408  
Provision (benefit) for income taxes
    2,339       (3,048 )     375       1,155       205       694  
 
                                   
EBITDA
  $ 71,135     $ 86,625     $ 109,751     $ 152,839     $ 129,865     $ 201,479  
 
                                   
 
                                               
Restructuring charge
                                  3,250  
Foreign currency exchange (gain) loss
    (52,295 )     (29,523 )     39,590       41,241       (18,244 )     10,835  
Loss (gain) on sale of assets
    15,282       (186 )                        
Goodwill impairment
                            3,648        
Unrealized loss (gain) on derivative instruments
    8,071       20,860       (23,308 )     (10,941 )     84,546       3,788  
Realized loss (gain) on interest rate swaps
    4,820       3,845       4,501       (806 )     6,788       36,222  
Unrealized gain on interest rate swaps in joint venture
                                  (10,936 )
 
                                   
Adjusted EBITDA (i)
  $ 47,013     $ 81,621     $ 130,534     $ 182,333     $ 206,603     $ 244,638  
 
                                   
 
                                               
Reconciliation of “Adjusted EBITDA” to “Net operating cash flow”:
                                               
Net operating cash flow
  $ 15,980     $ 59,726     $ 89,383     $ 115,450     $ 149,570     $ 164,496  
Expenditures for drydocking
    371       3,494       3,693       3,724       11,966       9,729  
Interest expense, net of interest income
    26,579       19,344       41,937       76,744       73,992       45,408  
Change in operating assets and liabilities
    2,209       (4,763 )     (1,208 )     (12,313 )     (31,962 )     (29,537 )
Equity (loss) income from joint venture
                (38 )     (130 )     136       27,639  
Restructuring charge
                                  3,250  
Realized loss (gain) on interest rate swaps
    4,820       3,845       4,501       (806 )     6,788       36,222  
Unrealized gain on interest rate swaps in joint venture
                                  (10,936 )
Other, net
    (2,946 )     (25 )     (7,734 )     (336 )     (3,887 )     (1,633 )
 
                                   
Adjusted EBITDA
  $ 47,013     $ 81,621     $ 130,534     $ 182,333     $ 206,603     $ 244,638  
 
                                   
     
(13)  
Expenditures for vessels and equipment excludes non-cash investing activities. Please read Item 18 – Financial Statements: Note 14 – Supplemental Cash Flow Information.
 
(14)  
Calendar-ship-days are equal to the aggregate number of calendar days in a period that our vessels were in our possession during that period (including five vessels deemed to be in our possession for accounting purposes as a result of the impact of the Dropdown Predecessor prior to our actual acquisition of such vessels).
 
(15)  
Includes the newbuildings that have been consolidated in our balance sheets.
 
(16)  
Does not include four LNG carriers (or the RasGas 3 LNG Carriers) relating to our joint venture with QGTC Nakilat (1643-6) Holdings Corporation which are accounted for under the equity method following their deliveries between May and July of 2008.

 

8


 

RISK FACTORS
We may not have sufficient cash from operations to enable us to pay the current level of quarterly distributions on our common units following the establishment of cash reserves and payment of fees and expenses.
We may not have sufficient cash available each quarter to pay the current level of quarterly distributions on our common units. The amount of cash we can distribute on our common units principally depends upon the amount of cash we generate from our operations, which may fluctuate based on, among other things:
   
the rates we obtain from our charters;
   
the level of our operating costs, such as the cost of crews and insurance;
   
the continued availability of LNG and LPG production, liquefaction and regasification facilities;
   
the number of unscheduled off-hire days for our fleet and the timing of, and number of days required for, scheduled drydocking of our vessels;
   
delays in the delivery of newbuildings and the beginning of payments under charters relating to those vessels;
   
prevailing global and regional economic and political conditions;
   
currency exchange rate fluctuations; and
   
the effect of governmental regulations and maritime self-regulatory organization standards on the conduct of our business.
The actual amount of cash we will have available for distribution also will depend on factors such as:
   
the level of capital expenditures we make, including for maintaining vessels, building new vessels, acquiring existing vessels and complying with regulations;
   
our debt service requirements and restrictions on distributions contained in our debt instruments;
   
fluctuations in our working capital needs;
   
our ability to make working capital borrowings, including to pay distributions to unitholders; and
   
the amount of any cash reserves, including reserves for future capital expenditures and other matters, established by Teekay GP L.L.C., our general partner (or the General Partner) in its discretion.
The amount of cash we generate from our operations may differ materially from our profit or loss for the period, which will be affected by non-cash items. As a result of this and the other factors mentioned above, we may make cash distributions during periods when we record losses and may not make cash distributions during periods when we record net income.
We make substantial capital expenditures to maintain the operating capacity of our fleet, which reduce our cash available for distribution. In addition, each quarter our General Partner is required to deduct estimated maintenance capital expenditures from operating surplus, which may result in less cash available to unitholders than if actual maintenance capital expenditures were deducted.
We must make substantial capital expenditures to maintain, over the long term, the operating capacity of our fleet. These maintenance capital expenditures include capital expenditures associated with drydocking a vessel, modifying an existing vessel or acquiring a new vessel to the extent these expenditures are incurred to maintain the operating capacity of our fleet. These expenditures could increase as a result of changes in:
   
the cost of labor and materials;
   
customer requirements;
   
increases in the size of our fleet;
   
governmental regulations and maritime self-regulatory organization standards relating to safety, security or the environment; and
   
competitive standards.
Our significant maintenance capital expenditures reduce the amount of cash we have available for distribution to our unitholders.

 

9


 

In addition, our actual maintenance capital expenditures vary significantly from quarter to quarter based on, among other things, the number of vessels drydocked during that quarter. Our partnership agreement requires our General Partner to deduct estimated, rather than actual, maintenance capital expenditures from operating surplus (as defined in our partnership agreement) each quarter in an effort to reduce fluctuations in operating surplus. The amount of estimated maintenance capital expenditures deducted from operating surplus is subject to review and change by the conflicts committee of our General Partner’s board of directors at least once a year. In years when estimated maintenance capital expenditures are higher than actual maintenance capital expenditures — as we expect will be the case in the years we are not required to make expenditures for mandatory drydockings — the amount of cash available for distribution to unitholders will be lower than if actual maintenance capital expenditures were deducted from operating surplus. If our General Partner underestimates the appropriate level of estimated maintenance capital expenditures, we may have less cash available for distribution in future periods when actual capital expenditures begin to exceed our previous estimates.
We will be required to make substantial capital expenditures to expand the size of our fleet. We generally will be required to make significant installment payments for acquisitions of newbuilding vessels prior to their delivery and generation of revenue. Depending on whether we finance our expenditures through cash from operations or by issuing debt or equity securities, our ability to make required payments on our debt securities and cash distributions on our common units may be diminished or our financial leverage could increase or our unitholders could be diluted.
We make substantial capital expenditures to increase the size of our fleet. As of the date of this Report, we have agreed to purchase from Teekay Corporation its interests in two newbuilding Multigas vessels and from I.M. Skaugen ASA (or Skaugen) one LPG carrier. Teekay Corporation is obligated to offer to us its interests in additional vessels. Please read Item 5 – Operating and Financial Review and Prospects, for additional information about some of these pending and proposed acquisitions. In addition, we are obligated to purchase five of our leased Suezmax tankers upon the termination of the related capital leases, which will occur at various times in late 2011. On March 17, 2010 we acquired from Teekay Corporation, for a total purchase price of $160 million, two 2009-built Suezmax tankers and a 2007-built Handymax product tanker and the associated long-term charter contracts currently operating under 12 and 10 year fixed-rate contracts, respectively.
We and Teekay Corporation regularly evaluate and pursue opportunities to provide the marine transportation requirements for new or expanding LNG and LPG projects. The award process relating to LNG transportation opportunities typically involves various stages and takes several months to complete. Neither we nor Teekay Corporation may be awarded charters relating to any of the projects we or it pursues. If any LNG and LPG project charters are awarded to Teekay Corporation, it must offer them to us pursuant to the terms of an omnibus agreement entered into in connection with our initial public offering. If we elect pursuant to the omnibus agreement to obtain Teekay Corporation’s interests in any projects Teekay Corporation may be awarded, or if we bid on and are awarded contracts relating to any LNG and LPG project, we will need to incur significant capital expenditures to buy Teekay Corporation’s interest in these LNG and LPG projects or to build the LNG and LPG carriers.
To fund the remaining portion of existing or future capital expenditures, we will be required to use cash from operations or incur borrowings or raise capital through the sale of debt or additional equity securities. Use of cash from operations will reduce cash available for distributions to unitholders. Our ability to obtain bank financing or to access the capital markets for future offerings may be limited by our financial condition at the time of any such financing or offering as well as by adverse market conditions resulting from, among other things, general economic conditions and contingencies and uncertainties that are beyond our control. Our failure to obtain the funds for necessary future capital expenditures could have a material adverse effect on our business, results of operations and financial condition and on our ability to make cash distributions. Even if we are successful in obtaining necessary funds, the terms of such financings could limit our ability to pay cash distributions to unitholders. In addition, incurring additional debt may significantly increase our interest expense and financial leverage, and issuing additional equity securities may result in significant unitholder dilution and would increase the aggregate amount of cash required to maintain our level of quarterly distributions to unitholders, which could have a material adverse effect on our ability to make cash distributions.
A shipowner typically is required to expend substantial sums as progress payments during construction of a newbuilding, but does not derive any income from the vessel until after its delivery. If we were unable to obtain financing required to complete payments on any future newbuilding orders, we could effectively forfeit all or a portion of the progress payments previously made.
Our ability to grow may be adversely affected by our cash distribution policy.
Our cash distribution policy, which is consistent with our partnership agreement, requires us to distribute all of our available cash (as defined in our partnership agreement) each quarter. Accordingly, our growth may not be as fast as businesses that reinvest their available cash to expand ongoing operations.
Our substantial debt levels may limit our flexibility in obtaining additional financing and in pursuing other business opportunities.
As at December 31, 2009, our consolidated debt, capital lease obligations and advances from affiliates totaled $2.2 billion and we had the capacity to borrow an additional $0.38 billion under our credit facilities. These facilities may be used by us for general partnership purposes. If we are awarded contracts for new LNG or LPG projects, our consolidated debt and capital lease obligations will increase, perhaps significantly. We will continue to have the ability to incur additional debt, subject to limitations in our credit facilities. Our level of debt could have important consequences to us, including the following:
   
our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms;
   
we will need a substantial portion of our cash flow to make principal and interest payments on our debt, reducing the funds that would otherwise be available for operations, future business opportunities and distributions to unitholders;
   
our debt level may make us more vulnerable than our competitors with less debt to competitive pressures or a downturn in our industry or the economy generally; and
   
our debt level may limit our flexibility in responding to changing business and economic conditions.

 

10


 

Our ability to service our debt depends upon, among other things, our future financial and operating performance, which is affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing distributions, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt, or seeking additional equity capital or bankruptcy protection. We may not be able to effect any of these remedies on satisfactory terms, or at all.
Financing agreements containing operating and financial restrictions may restrict our business and financing activities.
The operating and financial restrictions and covenants in our financing arrangements and any future financing agreements for us could adversely affect our ability to finance future operations or capital needs or to engage, expand or pursue our business activities. For example, the arrangements may restrict our ability to:
   
incur or guarantee indebtedness;
   
change ownership or structure, including mergers, consolidations, liquidations and dissolutions;
   
make dividends or distributions when in default of the relevant loans;
   
make certain negative pledges and grant certain liens;
   
sell, transfer, assign or convey assets;
   
make certain investments; and
   
enter into a new line of business.
In addition, some of our financing arrangements require us to maintain a minimum level of tangible net worth and a minimum level of aggregate liquidity, a maximum level of leverage and require one of our subsidiaries to maintain restricted cash deposits. Our ability to comply with covenants and restrictions contained in debt instruments may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, compliance with these covenants may be impaired. If restrictions, covenants, ratios or tests in the financing agreements are breached, a significant portion of the obligations may become immediately due and payable, and the lenders’ commitment to make further loans may terminate. We might not have or be able to obtain sufficient funds to make these accelerated payments. In addition, our obligations under our existing credit facilities are secured by certain of our vessels, and if we are unable to repay debt under the credit facilities, the lenders could seek to foreclose on those assets.
Restrictions in our debt agreements may prevent us from paying distributions.
The payment of principal and interest on our debt and capital lease obligations reduces cash available for distribution to us and on our units. In addition, our financing agreements prohibit the payment of distributions upon the occurrence of the following events, among others:
   
failure to pay any principal, interest, fees, expenses or other amounts when due;
   
failure to notify the lenders of any material oil spill or discharge of hazardous material, or of any action or claim related thereto;
   
breach or lapse of any insurance with respect to vessels securing the facility;
   
breach of certain financial covenants;
   
failure to observe any other agreement, security instrument, obligation or covenant beyond specified cure periods in certain cases;
   
default under other indebtedness;
   
bankruptcy or insolvency events;
   
failure of any representation or warranty to be materially correct;
   
a change of control, as defined in the applicable agreement; and
   
a material adverse effect, as defined in the applicable agreement.

 

11


 

We derive a substantial majority of our revenues from a limited number of customers, and the loss of any customer, time-charter or vessel could result in a significant loss of revenues and cash flow.
We have derived, and believe that we will continue to derive, a significant portion of our revenues and cash flow from a limited number of customers. Please read Item 18 – Financial Statements: Note 4 Segment Reporting.
We could lose a customer or the benefits of a time-charter if:
   
the customer fails to make charter payments because of its financial inability, disagreements with us or otherwise;
   
the customer exercises certain rights to terminate the charter, purchase or cause the sale of the vessel or, under some of our charters, convert the time-charter to a bareboat charter (some of which rights are exercisable at any time);
   
the customer terminates the charter because we fail to deliver the vessel within a fixed period of time, the vessel is lost or damaged beyond repair, there are serious deficiencies in the vessel or prolonged periods of off-hire, or we default under the charter; or
   
under some of our time-charters, the customer terminates the charter because of the termination of the charterer’s sales agreement or a prolonged force majeure event affecting the customer, including damage to or destruction of relevant facilities, war or political unrest preventing us from performing services for that customer.
If we lose a key LNG or LPG time-charter, we may be unable to re-deploy the related vessel on terms as favorable to us due to the long-term nature of most LNG and LPG time-charters and the lack of an established LNG spot market. If we are unable to re-deploy an LNG carrier, we will not receive any revenues from that vessel, but we may be required to pay expenses necessary to maintain the vessel in proper operating condition. In addition, if a customer exercises its right to purchase a vessel, we would not receive any further revenue from the vessel and may be unable to obtain a substitute vessel and charter. This may cause us to receive decreased revenue and cash flows from having fewer vessels operating in our fleet. Any compensation under our charters for a purchase of the vessels may not adequately compensate us for the loss of the vessel and related time-charter.
If we lose a key Suezmax tanker customer, we may be unable to obtain other long-term Suezmax charters and may become subject to the volatile spot market, which is highly competitive and subject to significant price fluctuations. If a customer exercises its right under some charters to purchase or force a sale of the vessel, we may be unable to acquire an adequate replacement vessel or may be forced to construct a new vessel. Any replacement newbuilding would not generate revenues during its construction and we may be unable to charter any replacement vessel on terms as favorable to us as those of the terminated charter.
The loss of any of our customers, time-charters or vessels, or a decline in payments under our charters, could have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.
We depend on Teekay Corporation to assist us in operating our business, competing in our markets, and providing interim financing for certain vessel acquisitions.
Pursuant to certain services agreements between us and certain of our operating subsidiaries, on the one hand, and certain subsidiaries of Teekay Corporation, on the other hand, the Teekay Corporation subsidiaries provide to us administrative services and to our operating subsidiaries significant operational services (including vessel maintenance, crewing for some of our vessels, purchasing, shipyard supervision, insurance and financial services) and other technical, advisory and administrative services. Our operational success and ability to execute our growth strategy depend significantly upon Teekay Corporation’s satisfactory performance of these services. Our business will be harmed if Teekay Corporation fails to perform these services satisfactorily or if Teekay Corporation stops providing these services to us.
Our ability to compete for the transportation requirements of LNG, LPG and oil projects and to enter into new time-charters and expand our customer relationships depends largely on our ability to leverage our relationship with Teekay Corporation and its reputation and relationships in the shipping industry. If Teekay Corporation suffers material damage to its reputation or relationships it may harm our ability to:
   
renew existing charters upon their expiration;
   
obtain new charters;
   
successfully interact with shipyards during periods of shipyard construction constraints;
   
obtain financing on commercially acceptable terms; or
   
maintain satisfactory relationships with our employees and suppliers.
If our ability to do any of the things described above is impaired, it could have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.
Teekay Corporation is also incurring all costs for the construction and delivery of certain newbuildings, which we refer to as “warehousing.” Upon their delivery, we will purchase all of the interest of Teekay Corporation in the vessels at a price that will reimburse Teekay Corporation for these costs and compensate it for its average weighted cost of capital on the construction payments. We may enter into similar arrangements with Teekay Corporation or third parties in the future. If Teekay Corporation or any such third party fails to make construction payments for these newbuildings or other vessels warehoused for us, we could lose access to the vessels as a result of the default or we may need to finance these vessels before they begin operating and generating voyage revenues, which could harm our business and reduce our ability to make cash distributions.

 

12


 

Our main growth depends on continued growth in demand for LNG and LPG shipping.
Our growth strategy focuses on continued expansion in the LNG and LPG shipping sectors. Accordingly, our growth depends on continued growth in world and regional demand for LNG and LPG shipping, which could be negatively affected by a number of factors, such as:
   
increases in the cost of natural gas derived from LNG relative to the cost of natural gas generally;
   
increase in the cost of LPG relative to the cost of naphtha and other competing petrochemicals;
   
increases in the production of natural gas in areas linked by pipelines to consuming areas, the extension of existing, or the development of new, pipeline systems in markets we may serve, or the conversion of existing non-natural gas pipelines to natural gas pipelines in those markets;
   
decreases in the consumption of natural gas due to increases in its price relative to other energy sources or other factors making consumption of natural gas less attractive;
   
additional sources of natural gas, including shale gas;
   
availability of new, alternative energy sources, including compressed natural gas; and
   
negative global or regional economic or political conditions, particularly in LNG and LPG consuming regions, which could reduce energy consumption or its growth.
Reduced demand for LNG and LPG shipping would have a material adverse effect on our future growth and could harm our business, results of operations and financial condition.
Growth of the LNG market, and as a consequence, the LPG market, may be limited by infrastructure constraints and community environmental group resistance to new LNG infrastructure over concerns about the environment, safety and terrorism.
A complete LNG/LPG project includes production, liquefaction, regasification, storage and distribution facilities and LNG/LPG carriers. Existing LNG/LPG projects and infrastructure are limited, and new or expanded LNG/LPG projects are highly complex and capital-intensive, with new projects often costing several billion dollars. Many factors could negatively affect continued development of LNG/LPG infrastructure or disrupt the supply of LNG/LPG, including:
   
increases in interest rates or other events that may affect the availability of sufficient financing for LNG/LPG projects on commercially reasonable terms;
   
decreases in the price of LNG/LPG, which might decrease the expected returns relating to investments in LNG/LPG projects;
   
the inability of project owners or operators to obtain governmental approvals to construct or operate LNG/LPG facilities;
   
local community resistance to proposed or existing LNG/LPG facilities based on safety, environmental or security concerns;
   
any significant explosion, spill or similar incident involving an LNG/LPG facility or LNG carrier; and
   
labor or political unrest affecting existing or proposed areas of LNG/LPG production.
If the LNG/LPG supply chain is disrupted or does not continue to grow, or if a significant LNG/LPG explosion, spill or similar incident occurs, it could have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.
Our growth depends on our ability to expand relationships with existing customers and obtain new customers, for which we will face substantial competition.
One of our principal objectives is to enter into additional long-term, fixed-rate LNG, LPG and oil time-charters. The process of obtaining new long-term time-charters is highly competitive and generally involves an intensive screening process and competitive bids, and often extends for several months. Shipping contracts are awarded based upon a variety of factors relating to the vessel operator, including:
   
shipping industry relationships and reputation for customer service and safety;
   
shipping experience and quality of ship operations (including cost effectiveness);
   
quality and experience of seafaring crew;
   
the ability to finance carriers at competitive rates and financial stability generally;
   
relationships with shipyards and the ability to get suitable berths;
   
construction management experience, including the ability to obtain on-time delivery of new vessels according to customer specifications;
   
willingness to accept operational risks pursuant to the charter, such as allowing termination of the charter for force majeure events; and
   
competitiveness of the bid in terms of overall price.

 

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We compete for providing marine transportation services for potential energy projects with a number of experienced companies, including state-sponsored entities and major energy companies affiliated with the energy project requiring energy shipping services. Many of these competitors have significantly greater financial resources than we do or Teekay Corporation does. We anticipate that an increasing number of marine transportation companies — including many with strong reputations and extensive resources and experience — will enter the energy transportation sector. This increased competition may cause greater price competition for time-charters. As a result of these factors, we may be unable to expand our relationships with existing customers or to obtain new customers on a profitable basis, if at all, which would have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.
Delays in deliveries of newbuildings could harm our operating results and lead to the termination of related time-charters.
We have agreed to purchase various newbuilding vessels. The delivery of these vessels, or any other newbuildings we may order or otherwise acquire, could be delayed, which would delay our receipt of revenues under the time-charters for the vessels. In addition, under some of our charters if our delivery of a vessel to our customer is delayed, we may be required to pay liquidated damages in amounts equal to or, under some charters, almost double, the hire rate during the delay. For prolonged delays, the customer may terminate the time-charter and, in addition to the resulting loss of revenues, we may be responsible for additional, substantial liquidated damages.
Our receipt of newbuildings could be delayed because of:
   
quality or engineering problems;
   
changes in governmental regulations or maritime self-regulatory organization standards;
   
work stoppages or other labor disturbances at the shipyard;
   
bankruptcy or other financial crisis of the shipbuilder;
   
a backlog of orders at the shipyard;
   
political or economic disturbances where our vessels are being or may be built;
   
weather interference or catastrophic event, such as a major earthquake or fire;
   
our requests for changes to the original vessel specifications;
   
shortages of or delays in the receipt of necessary construction materials, such as steel;
   
our inability to finance the purchase of the vessels; or
   
our inability to obtain requisite permits or approvals.
If delivery of a vessel is materially delayed, it could adversely affect our results or operations and financial condition and our ability to make cash distributions.
We may have more difficulty entering into long-term, fixed-rate LNG time-charters if an active short-term or spot shipping market develops.
LNG shipping historically has been transacted with long-term, fixed-rate time-charters, usually with terms ranging from 20 to 25 years. One of our principal strategies is to enter into additional long-term, fixed-rate LNG time-charters. In recent years the number of spot and short term LNG charters which we defined as charters under four years has been increasing. In 2008 they accounted for approximately 18% of global LNG trade.
If an active spot or short-term market continues to develop, we may have increased difficulty entering into long-term, fixed-rate time-charters for our LNG vessels and, as a result, our cash flow may decrease and be less stable. In addition, an active short-term or spot LNG market may require us to enter into charters based on changing market prices, as opposed to contracts based on a fixed rate, which could result in a decrease in our cash flow in periods when the market price for shipping LNG is depressed or insufficient funds are available to cover our financing costs for related vessels.
Over time vessel values may fluctuate substantially and, if these values are lower at a time when we are attempting to dispose of a vessel, we may incur a loss.
Vessel values for LNG and LPG carriers and Suezmax tankers can fluctuate substantially over time due to a number of different factors, including:
   
prevailing economic conditions in natural gas, oil and energy markets;
   
a substantial or extended decline in demand for natural gas, LNG, LPG or oil;
   
increases in the supply of vessel capacity; and
   
the cost of retrofitting or modifying existing vessels, as a result of technological advances in vessel design or equipment, changes in applicable environmental or other regulation or standards, or otherwise.

 

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Vessel values have declined substantially during the last two years and may decline further. If a charter terminates, we may be unable to re-deploy the vessel at attractive rates and, rather than continue to incur costs to maintain and finance it, may seek to dispose of it. Our inability to dispose of the vessel at a reasonable value could result in a loss on its sale and adversely affect our results of operations and financial condition.
We may be unable to make or realize expected benefits from acquisitions, and implementing our growth strategy through acquisitions may harm our business, financial condition and operating results.
Our growth strategy includes selectively acquiring existing LNG carriers or LNG shipping businesses. Historically, there have been very few purchases of existing vessels and businesses in the LNG shipping industry. Factors that may contribute to a limited number of acquisition opportunities in the LNG/LPG industries in the near term include the relatively small number of independent LNG/LPG fleet owners and the limited number of LNG/LPG carriers not subject to existing long-term charter contracts. In addition, competition from other companies could reduce our acquisition opportunities or cause us to pay higher prices.
Any acquisition of a vessel or business may not be profitable to us at or after the time we acquire it and may not generate cash flow sufficient to justify our investment. In addition, our acquisition growth strategy exposes us to risks that may harm our business, financial condition and operating results, including risks that we may:
   
fail to realize anticipated benefits, such as new customer relationships, cost-savings or cash flow enhancements;
   
be unable to hire, train or retain qualified shore and seafaring personnel to manage and operate our growing business and fleet;
   
decrease our liquidity by using a significant portion of our available cash or borrowing capacity to finance acquisitions;
   
significantly increase our interest expense or financial leverage if we incur additional debt to finance acquisitions;
   
incur or assume unanticipated liabilities, losses or costs associated with the business or vessels acquired; or
   
incur other significant charges, such as impairment of goodwill or other intangible assets, asset devaluation or restructuring charges.
Unlike newbuildings, existing vessels typically do not carry warranties as to their condition. While we generally inspect existing vessels prior to purchase, such an inspection would normally not provide us with as much knowledge of a vessel’s condition as we would possess if it had been built for us and operated by us during its life. Repairs and maintenance costs for existing vessels are difficult to predict and may be substantially higher than for vessels we have operated since they were built. These costs could decrease our cash flow and reduce our liquidity.
Terrorist attacks, piracy, increased hostilities or war could lead to further economic instability, increased costs and disruption of our business.
Terrorist attacks, piracy, and the current conflicts in Iraq and Afghanistan and other current and future conflicts, may adversely affect our business, operating results, financial condition, ability to raise capital and future growth. Continuing hostilities in the Middle East may lead to additional armed conflicts or to further acts of terrorism and civil disturbance in the United States, Spain or elsewhere, which may contribute further to economic instability and disruption of LNG/LPG and oil production and distribution, which could result in reduced demand for our services.
In addition, LNG, LPG and oil facilities, shipyards, vessels, pipelines and oil and gas fields could be targets of future terrorist attacks and our vessels could be targets of pirates or hijackers. Any such attacks could lead to, among other things, bodily injury or loss of life, vessel or other property damage, increased vessel operational costs, including insurance costs, and the inability to transport LNG, LPG, natural gas and oil to or from certain locations. Terrorist attacks, war, piracy, hijacking or other events beyond our control that adversely affect the distribution, production or transportation of LNG, LPG or oil to be shipped by us could entitle our customers to terminate our charter contracts, which would harm our cash flow and our business.
Terrorist attacks, or the perception that LNG/LPG facilities and carriers are potential terrorist targets, could materially and adversely affect expansion of LNG/LPG infrastructure and the continued supply of LNG/LPG to the United States and other countries. Concern that LNG/LPG facilities may be targeted for attack by terrorists has contributed to significant community and environmental resistance to the construction of a number of LNG/LPG facilities, primarily in North America. If a terrorist incident involving an LNG/LPG facility or LNG/LPG carrier did occur, in addition to the possible effects identified in the previous paragraph, the incident may adversely affect construction of additional LNG facilities in the United States and other countries or lead to the temporary or permanent closing of various LNG/LPG facilities currently in operation.
Our substantial operations outside the United States expose us to political, governmental and economic instability, which could harm our operations.
Because our operations are primarily conducted outside of the United States, they may be affected by economic, political and governmental conditions in the countries where we are engaged in business or where our vessels are registered. Any disruption caused by these factors could harm our business. In particular, we derive a substantial portion of our revenues from shipping LNG and oil from politically unstable regions. Past political conflicts in these regions, particularly in the Arabian Gulf, have included attacks on ships, mining of waterways and other efforts to disrupt shipping in the area.
Future hostilities or other political instability in the Arabian Gulf or other regions where we operate or may operate could have a material adverse effect on the growth of our business, results of operations and financial condition and our ability to make cash distributions. In addition, tariffs, trade embargoes and other economic sanctions by Spain, the United States or other countries against countries in the Middle East, Southeast Asia or elsewhere as a result of terrorist attacks, hostilities or otherwise may limit trading activities with those countries, which could also harm our business and ability to make cash distributions.

 

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Marine transportation is inherently risky, and an incident involving significant loss of or environmental contamination by any of our vessels could harm our reputation and business.
Our vessels and their cargoes are at risk of being damaged or lost because of events such as:
   
marine disasters;
   
bad weather;
   
mechanical failures;
   
grounding, fire, explosions and collisions;
   
piracy;
   
human error; and
   
war and terrorism.
An accident involving any of our vessels could result in any of the following:
   
death or injury to persons, loss of property or environmental damage;
   
delays in the delivery of cargo;
   
loss of revenues from or termination of charter contracts;
   
governmental fines, penalties or restrictions on conducting business;
   
higher insurance rates; and
   
damage to our reputation and customer relationships generally.
Any of these results could have a material adverse effect on our business, financial condition and operating results.
Our insurance may be insufficient to cover losses that may occur to our property or result from our operations.
The operation of LNG and LPG carriers and oil tankers is inherently risky. Although we carry hull and machinery (marine and war risks) and protection and indemnity insurance, all risks may not be adequately insured against, and any particular claim may not be paid. In addition, we do not generally carry insurance on our vessels covering the loss of revenues resulting from vessel off-hire time based on its cost compared to our off-hire experience. Any claims covered by insurance would be subject to deductibles, and since it is possible that a large number of claims may be brought, the aggregate amount of these deductibles could be material. Certain of our insurance coverage is maintained through mutual protection and indemnity associations, and as a member of such associations we may be required to make additional payments over and above budgeted premiums if member claims exceed association reserves.
We may be unable to procure adequate insurance coverage at commercially reasonable rates in the future. For example, more stringent environmental regulations have led in the past to increased costs for, and in the future may result in the lack of availability of, insurance against risks of environmental damage or pollution. A catastrophic oil spill or marine disaster could result in losses that exceed our insurance coverage, which could harm our business, financial condition and operating results. Any uninsured or underinsured loss could harm our business and financial condition. In addition, our insurance may be voidable by the insurers as a result of certain of our actions, such as our ships failing to maintain certification with applicable maritime self-regulatory organizations.
Changes in the insurance markets attributable to terrorist attacks may also make certain types of insurance more difficult for us to obtain. In addition, the insurance that may be available may be significantly more expensive than our existing coverage.
The marine energy transportation industry is subject to substantial environmental and other regulations, which may significantly limit our operations or increase our expenses.
Our operations are affected by extensive and changing international, national and local environmental protection laws, regulations, treaties and conventions in force in international waters, the jurisdictional waters of the countries in which our vessels operate, as well as the countries of our vessels’ registration, including those governing oil spills, discharges to air and water, and the handling and disposal of hazardous substances and wastes. Many of these requirements are designed to reduce the risk of oil spills and other pollution. In addition, we believe that the heightened environmental, quality and security concerns of insurance underwriters, regulators and charterers will lead to additional regulatory requirements, including enhanced risk assessment and security requirements and greater inspection and safety requirements on vessels. We expect to incur substantial expenses in complying with these laws and regulations, including expenses for vessel modifications and changes in operating procedures.
These requirements can affect the resale value or useful lives of our vessels, require a reduction in cargo capacity, ship modifications or operational changes or restrictions, lead to decreased availability of insurance coverage for environmental matters or result in the denial of access to certain jurisdictional waters or ports, or detention in, certain ports. Under local, national and foreign laws, as well as international treaties and conventions, we could incur material liabilities, including cleanup obligations, in the event that there is a release of petroleum or other hazardous substances from our vessels or otherwise in connection with our operations. We could also become subject to personal injury or property damage claims relating to the release of or exposure to hazardous materials associated with our operations. In addition, failure to comply with applicable laws and regulations may result in administrative and civil penalties, criminal sanctions or the suspension or termination of our operations, including, in certain instances, seizure or detention of our vessels. For further information about regulations affecting our business and related requirements on us, please read Item 4 — Information on the Partnership: C. Regulations.

 

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Climate change and greenhouse gas restrictions may adversely impact our operations and markets.
Due to concern over the risk of climate change, a number of countries have adopted, or are considering the adoption of, regulatory frameworks to reduce greenhouse gas emissions. These regulatory measures include, among others, adoption of cap and trade regimes, carbon taxes, increased efficiency standards, and incentives or mandates for renewable energy. Compliance with changes in laws, regulations and obligations relating to climate change could increase our costs related to operating and maintaining our vessels and require us to install new emission controls, acquire allowances or pay taxes related to our greenhouse gas emissions, or administer and manage a greenhouse gas emissions program. Revenue generation and strategic growth opportunities may also be adversely affected.
Adverse effects upon the oil and gas industry relating to climate change may also adversely affect demand for our services. Although we do not expect that demand for oil and gas will lessen dramatically over the short term, in the long term climate change may reduce the demand for oil and gas or increased regulation of greenhouse gases may create greater incentives for use of alternative energy sources. Any long-term material adverse effect on the oil and gas industry could have a significant financial and operational adverse impact on our business that we cannot predict with certainty at this time.
Exposure to currency exchange rate fluctuations will result in fluctuations in our cash flows and operating results.
We are paid in Euros under some of our charters, and a majority of our vessel operating expenses and general and administrative expenses currently are denominated in Euros, which is primarily a function of the nationality of our crew and administrative staff. We also make payments under two Euro-denominated term loans. If the amount of our Euro-denominated obligations exceeds our Euro-denominated revenues, we must convert other currencies, primarily the U.S. Dollar, into Euros. An increase in the strength of the Euro relative to the U.S. Dollar would require us to convert more U.S. Dollars to Euros to satisfy those obligations, which would cause us to have less cash available for distribution. In addition, if we do not have sufficient U.S. Dollars, we may be required to convert Euros into U.S. Dollars for distributions to unitholders. An increase in the strength of the U.S. Dollar relative to the Euro could cause us to have less cash available for distribution in this circumstance. We have not entered into currency swaps or forward contracts or similar derivatives to mitigate this risk.
Because we report our operating results in U.S. Dollars, changes in the value of the U.S. Dollar relative to the Euro also result in fluctuations in our reported revenues and earnings. In addition, under U.S. accounting guidelines, all foreign currency-denominated monetary assets and liabilities such as cash and cash equivalents, accounts receivable, restricted cash, accounts payable, long-term debt and capital lease obligations, are revalued and reported based on the prevailing exchange rate at the end of the period. This revaluation historically has caused us to report significant non-monetary foreign currency exchange gains or losses each period. The primary source for these gains and losses is our Euro-denominated term loans.
Many of our seafaring employees are covered by collective bargaining agreements and the failure to renew those agreements or any future labor agreements may disrupt our operations and adversely affect our cash flows.
A significant portion of our seafarers, and the seafarers employed by Teekay Corporation and its other affiliates that crew some of our vessels, are employed under collective bargaining agreements. The collective bargaining agreement for our Filipino LNG tanker crew members (covering four Spanish LNG tankers) has been renewed. The collective bargaining agreement for our Spanish Suezmax Seafarers was extensively renegotiated in 2009. This agreement includes for a phased transfer from Spanish ratings to Filipino ratings, with the first vessel changing in November 2009, and further vessels in 2010 and 2011 when the agreement expires. We also renewed the Spanish LNG tanker officers collective bargaining agreement was renewed in 2009, and is valid through to the end of 2010. We may be subject to similar labor agreements in the future. Crew compensation levels under new or renegotiated collective bargaining agreements may exceed existing compensation levels, which would adversely affect our results of operations and cash flows. We may be subject to labor disruptions in the future if our relationships deteriorate with our seafarers or the unions that represent them. Our collective bargaining agreements may not prevent labor disruptions, particularly when the agreements are being renegotiated. Any labor disruptions could harm our operations and could have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.

 

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Teekay Corporation may be unable to attract and retain qualified, skilled employees or crew necessary to operate our business, or may have to pay substantially increased costs for its employees and crew.
Our success depends in large part on Teekay Corporation’s ability to attract and retain highly skilled and qualified personnel. In crewing our vessels, we require technically skilled employees with specialized training who can perform physically demanding work. Competition to attract and retain qualified crew members is intense. These costs have continued to increase to date in 2010, but to a lesser extent compared to 2009.
If we are not able to increase our rates to compensate for any crew cost increases, our financial condition and results of operations may be adversely affected. Any inability we experience in the future to hire, train and retain a sufficient number of qualified employees could impair our ability to manage, maintain and grow our business.
Due to our lack of diversification, adverse developments in our LNG, LPG or oil marine transportation businesses could reduce our ability to make distributions to our unitholders.
We rely exclusively on the cash flow generated from our LNG and LPG carriers and Suezmax oil tankers that operate in the LNG, LPG and oil marine transportation business. Due to our lack of diversification, an adverse development in the LNG, LPG or oil shipping industry would have a significantly greater impact on our financial condition and results of operations than if we maintained more diverse assets or lines of business.
Teekay Corporation and its affiliates may engage in competition with us.
Teekay Corporation and its affiliates, including Teekay Offshore Partners L.P. (or Teekay Offshore), may engage in competition with us. Pursuant to an omnibus agreement between Teekay Corporation, Teekay Offshore, us and other related parties, Teekay Corporation, Teekay Offshore and their respective controlled affiliates (other than us and our subsidiaries) generally have agreed not to own, operate or charter LNG carriers without the consent of our General Partner. The omnibus agreement, however, allows Teekay Corporation, Teekay Offshore or any of such controlled affiliates to:
   
acquire LNG carriers and related time-charters as part of a business if a majority of the value of the total assets or business acquired is not attributable to the LNG carriers and time-charters, as determined in good faith by the board of directors of Teekay Corporation or the board of directors of Teekay Offshore’s general partner; however, if at any time Teekay Corporation or Teekay Offshore completes such an acquisition, it must offer to sell the LNG carriers and related time-charters to us for their fair market value plus any additional tax or other similar costs to Teekay Corporation or Teekay Offshore that would be required to transfer the LNG carriers and time-charters to us separately from the acquired business; or
   
own, operate and charter LNG carriers that relate to a bid or award for a proposed LNG project that Teekay Corporation or any of its subsidiaries has submitted or hereafter submits or receives; however, at least 180 days prior to the scheduled delivery date of any such LNG carrier, Teekay Corporation must offer to sell the LNG carrier and related time-charter to us, with the vessel valued at its “fully-built-up cost,” which represents the aggregate expenditures incurred (or to be incurred prior to delivery to us) by Teekay Corporation to acquire or construct and bring such LNG carrier to the condition and location necessary for our intended use, plus a reasonable allocation of overhead costs related to the development of such a project and other projects that would have been subject to the offer rights set forth in the omnibus agreement but were not completed.
If we decline the offer to purchase the LNG carriers and time-charters described above, Teekay Corporation or Teekay Offshore may own and operate the LNG carriers, but may not expand that portion of its business.
In addition, pursuant to the omnibus agreement, Teekay Corporation, Teekay Offshore or any of their respective controlled affiliates (other than us and our subsidiaries) may:
   
acquire, operate or charter LNG carriers if our General Partner has previously advised Teekay Corporation or Teekay Offshore that the board of directors of our General Partner has elected, with the approval of the conflicts committee of its board of directors, not to cause us or our subsidiaries to acquire or operate the carriers;
   
acquire up to a 9.9% equity ownership, voting or profit participation interest in any publicly traded company that owns or operate LNG carriers; and
   
provide ship management services relating to LNG carriers.
If there is a change of control of Teekay Corporation or Teekay Offshore, the non-competition provisions of the omnibus agreement may terminate, which termination could have a material adverse effect on our business, results of operations and financial condition and our ability to make cash distributions.
Our General Partner and its other affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to those of unitholders.
Teekay Corporation, which owns and controls our General Partner, indirectly owns the 2% General Partner interest and as at March 1, 2010 owned a 48.2% limited partner interest in us. Conflicts of interest may arise between Teekay Corporation and its affiliates, including our General Partner, on the one hand, and us and our unitholders, on the other hand. As a result of these conflicts, our General Partner may favor its own interests and the interests of its affiliates over the interests of our unitholders. These conflicts include, among others, the following situations:
   
neither our partnership agreement nor any other agreement requires our General Partner or Teekay Corporation to pursue a business strategy that favors us or utilizes our assets, and Teekay Corporation’s officers and directors have a fiduciary duty to make decisions in the best interests of the stockholders of Teekay Corporation, which may be contrary to our interests;

 

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the executive officers and three of the directors of our General Partner also currently serve as executive officers or directors of Teekay Corporation;
   
our General Partner is allowed to take into account the interests of parties other than us, such as Teekay Corporation, in resolving conflicts of interest, which has the effect of limiting its fiduciary duty to our unitholders;
   
our General Partner has limited its liability and reduced its fiduciary duties under the laws of the Marshall Islands, while also restricting the remedies available to our unitholders, and as a result of purchasing common units, unitholders are treated as having agreed to the modified standard of fiduciary duties and to certain actions that may be taken by our General Partner, all as set forth in our partnership agreement;
   
our General Partner determines the amount and timing of our asset purchases and sales, capital expenditures, borrowings, issuances of additional partnership securities and reserves, each of which can affect the amount of cash that is available for distribution to our unitholders;
   
in some instances our General Partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make a distribution on our subordinated units or to make incentive distributions (in each case to affiliates to Teekay Corporation);
   
our General Partner determines which costs incurred by it and its affiliates are reimbursable by us;
   
our partnership agreement does not restrict our General Partner from causing us to pay it or its affiliates for any services rendered to us on terms that are fair and reasonable or entering into additional contractual arrangements with any of these entities on our behalf;
   
our General Partner controls the enforcement of obligations owed to us by it and its affiliates; and
   
our General Partner decides whether to retain separate counsel, accountants or others to perform services for us.
Certain of our lease arrangements contain provisions whereby we have provided a tax indemnification to third parties.
We and a joint venture partner are the lessee under 30-year capital lease arrangements with a third party for three LNG carriers. Under the terms of these capital lease arrangements, the lessor claims tax depreciation on the capital expenditures it incurred to acquire these vessels. As is typical in these leasing arrangements, tax and change of law risks are assumed by the lessee. The rentals payable under the lease arrangements are predicated on the basis of certain tax and financial assumptions at the commencement of the leases. If an assumption proves to be incorrect or there is a change in the applicable tax legislation, the lessor is entitled to increase the rentals so as to maintain its agreed after-tax margin. However, the terms of the lease arrangements enable us and our joint venture partner to terminate the lease arrangement on a voluntary basis at any time. In the event of an early termination of the lease arrangements, the joint venture may be obliged to pay termination sums to the lessor sufficient to repay its investment in the vessels and to compensate it for the tax effect of the terminations, including recapture of tax depreciation, if any.
In addition, the subsidiaries of another joint venture formed to service the Tangguh LNG project in Indonesia have entered into lease arrangements with a third party for two LNG carriers. We purchased Teekay Corporation’s interest in this joint venture in 2009.  The terms of the lease arrangements provide similar tax and change of law risk assumption by this joint venture as we have with the three LNG carriers above.
The continuation of recent economic conditions, including disruptions in the global credit markets, could adversely affect our results of operations.
The recent economic downturn and financial crisis in the global markets have produced illiquidity in the capital markets, market volatility, heightened exposure to interest rate and credit risks and reduced access to capital markets. If this economic downturn continues, we may face restricted access to the capital markets or secured debt lenders, such as our revolving credit facilities. The decreased access to such resources could have a material adverse effect on our business, financial condition and results of operations.
The recent economic downturn may affect our customers’ ability to charter our vessels and pay for our services and may adversely affect our business and results of operations.
The recent economic downturn in the global financial markets may lead to a decline in our customers’ operations or ability to pay for our services, which could result in decreased demand for our vessels and services. Our customer’s inability to pay could also result in their default on our current contracts and charters. The decline in the amount of services requested by our customers or their default on our contracts with them could have a material adverse effect on our business, financial condition and results of operations. We cannot determine whether the difficult conditions in the economy and the financial markets will improve or worsen in the near future.
The decision of the United States Court of Appeals for the Fifth Circuit in Tidewater Inc. v. United States creates greater uncertainty whether we will be classified as a partnership for U.S. federal income tax purposes.
In order for us to be classified as a partnership for U.S. federal income tax purposes, more than 90% of our gross income each year must be “qualifying income” under Section 7704 of the U.S. Internal Revenue Code of 1986, as amended (the Code). For this purpose, “qualifying income” includes income from providing marine transportation services to customers with respect to crude oil, natural gas and certain products thereof but may not include rental income from leasing vessels to customers.
The decision of the United States Court of Appeals for the Fifth Circuit in Tidewater Inc. v. United States, 565 F.3d 299 (5th Cir. 2009) held that income derived from certain time chartering activities should be treated as rental income rather than service income for purposes of a foreign sales corporation provision of the Code. After the Tidewater decision, there is greater uncertainty regarding the status of a significant portion of our income as “qualifying income” and therefore greater uncertainty whether we are classified as a partnership for federal income tax purposes. Please read “Item 4 – Information on the Partnership – F. Taxation of the Partnership — United States Taxation – Classification as a Partnership.”

 

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Some of our subsidiaries that are classified as corporations for U.S. federal income tax purposes might be treated as “passive foreign investment companies,” which could result in additional taxes to our unitholders.
Certain of our subsidiaries that are classified as corporations for U.S. federal income tax purposes could be treated as “passive foreign investment companies” (or PFICs) for U.S. federal income tax purposes. U.S. shareholders of a PFIC are subject to an adverse U.S. federal income tax regime with respect to the income derived by the PFIC, the distributions they receive from the PFIC, and the gain, if any, they derive from the sale or other disposition of their interests in the PFIC. Please read “Item 10 – Additional Information — Taxation to Unitholders – United States Tax Consequences – Consequences of Possible PFIC Classification.”
Teekay Corporation owns less than 50% of our outstanding equity interests, which could cause certain of our subsidiaries and us to be subject to additional tax.
Certain of our subsidiaries are classified as corporations for U.S. federal income tax purposes. As such, these subsidiaries will be subject to U.S. federal income tax on the U.S. source portion of our income attributable to transportation that begins or ends (but not both) in the United States if they fail to qualify for an exemption from U.S. federal income tax (the Section 883 Exemption). Teekay Corporation indirectly owns less than 50% of certain of our subsidiaries’ and our outstanding equity interests. Consequently, we expect these subsidiaries will fail to qualify for the Section 883 Exemption in 2010 and subsequent tax years. Any resulting imposition of U.S. federal income taxes will result in decreased cash available for distribution to common unitholders.
In addition, if we cease to be treated as a partnership for U.S. federal income tax purposes, we expect that we also would fail to qualify for the Section 883 Exemption in 2010 and subsequent tax years and that any resulting imposition of U.S. federal income taxes would result in decreased cash available for distribution to common unitholders. Please read “Item 4 – Information on the Partnership – F. Taxation of the Partnership – United States Taxation – Taxation of our Subsidiary Corporations: The Section 883 Exemption.”
The Internal Revenue Service (or IRS) may challenge the manner in which we value our assets in determining the amount of income, gain, loss and deduction allocable to the unitholders, which could adversely affect the value of the common units.
A unitholder’s taxable income or loss with respect to a common unit each year will depend upon a number of factors, including the nature and fair market value of our assets at the time the holder acquired the common unit, whether we issue additional units or whether we engage in certain other transactions, and the manner in which our items of income, gain, loss and deduction are allocated among our partners. For this purpose, we determine the value of our assets and the relative amounts of our items of income, gain, loss and deduction allocable to our unitholders and our general partner as holder of the incentive distribution rights by reference to the value of our interests, including the incentive distribution rights. The IRS may challenge any valuation determinations that we make, particularly as to the incentive distribution rights, for which there is no public market. In addition, the IRS could challenge certain other aspects of the manner in which we determine the relative allocations made to our unitholders and to the general partner as holder of our incentive distribution rights. A successful IRS challenge to our valuation or allocation methods could increase the amount of net taxable income and gain realized by a unitholder with respect to a common unit. Any such IRS challenge, whether or not successful, could adversely affect the value of our common units.
We may be subject to taxes, which reduces our cash available for distribution to you.
We or our subsidiaries are subject to tax in certain jurisdictions in which we or our subsidiaries are organized, own assets or have operations, which reduces the amount of our cash available for distribution. In computing our tax obligations in these jurisdictions, we are required to take various tax accounting and reporting positions on matters that are not entirely free from doubt and for which we have not received rulings from the governing authorities. We cannot assure you that upon review of these positions, the applicable authorities will agree with our positions. A successful challenge by a tax authority could result in additional tax imposed on us or our subsidiaries, further reducing the cash available for distribution. In addition, changes in our operations or ownership could result in additional tax being imposed on us or on our subsidiaries in jurisdictions in which operations are conducted. Also, jurisdictions in which we or our subsidiaries are organized, own assets or have operations may change their tax laws, or we may enter into new business transactions relating to such jurisdictions, which could result in increased tax liability and reduce the amount of our cash available for distribution.
Item 4. Information on the Partnership
A. Overview, History and Development
Overview and History
Teekay LNG Partners L.P. is an international provider of marine transportation services for LNG, LPG and crude oil. We were formed in 2004 by Teekay Corporation (NYSE: TK), the world’s largest owner and operator of medium sized crude oil tankers, to expand its operations in the LNG shipping sector. Our primary growth strategy focuses on expanding our fleet of LNG and LPG carriers under long-term, fixed-rate time-charters. We intend to continue our practice of acquiring LNG and LPG carriers as needed for approved projects only after the long-term charters for the projects have been awarded to us, rather than ordering vessels on a speculative basis. In executing our growth strategy, we may engage in vessel or business acquisitions or enter into joint ventures and partnerships with companies that may provide increased access to emerging opportunities from global expansion of the LNG and LPG sectors. We seek to leverage the expertise, relationships and reputation of Teekay Corporation and its affiliates to pursue these opportunities in the LNG and LPG sectors and may consider other opportunities to which our competitive strengths are well suited. We view our Suezmax tanker fleet primarily as a source of stable cash flow as we seek to continue to expand our LNG and LPG operations.
As of March 1, 2010, our fleet, excluding newbuildings, consisted of 15 LNG carriers (including the four RasGas 3 LNG Carriers which are accounted for under the equity method), eight Suezmax-class crude oil tankers and three LPG carriers, all of which are double-hulled. Our fleet is young, with an average age of approximately six years for our LNG carriers, approximately seven years for our Suezmax tankers, and approximately three years for our LPG carriers, compared to world averages of 10, 9 and 16 years, respectively, as of December 31, 2009. On March 17, 2010, we acquired from Teekay Corporation two additional Suezmax tankers and one Handymax product tanker, all of which operate under long-term, fixed-rate contracts.
Our vessels operate under long-term, fixed-rate time-charters with major energy and utility companies and Teekay Corporation. The average remaining term for these charters including the acquisitions on March 17, 2010, is approximately 18 years for our LNG carriers, approximately 11 years for our Conventional tankers (Suezmax and Handymax), and approximately 12 years for our LPG carriers, subject, in certain circumstances, to termination or vessel purchase rights.

 

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Our fleet of existing LNG carriers currently has approximately 2.3 million cubic meters of total capacity. The aggregate capacity of our Conventional tanker fleet, including our recently acquired tankers, is approximately 1.6 million deadweight tonnes (dwt). Upon delivery of the three remaining LPG newbuilding carriers, the total capacity of our fleet of LPG carriers will increase to approximately 60,000 cubic meters.
Our original fleet was established by Naviera F. Tapias S.A. (or Tapias), a private Spanish company founded in 1991 to ship crude oil. Tapias began shipping LNG with the acquisition of its first LNG carrier in 2002. Teekay Corporation acquired Tapias in April 2004 and changed its name to Teekay Shipping Spain S.L. (or Teekay Spain). As part of the acquisition, Teekay Spain retained its senior management, including its chief executive officer, and other personnel who continue to manage the day-to-day operations of Teekay Spain with input on strategic decisions from our General Partner. Teekay Spain also obtains strategic consulting, advisory, ship management, technical and administrative services from affiliates of Teekay Corporation.
We were formed in connection with our initial public offering. Upon the closing of that offering on May 10, 2005, we acquired Teekay Spain and other assets, and began operating as a publicly-traded limited partnership.
We are incorporated under the laws of the Republic of The Marshall Islands as Teekay LNG Partners L.P. and maintain our principal executive headquarters at 4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda. Our telephone number at such address is (441) 298-2530.
B. Operations
Our Charters
We generate revenues by charging customers for the transportation of their LNG, LPG and crude oil using our vessels. Historically, we generally have provided these services under the following basic types of contractual relationships:
   
Time-charters, where vessels are chartered to customers for a fixed period of time at rates that are generally fixed but may contain a variable component based on inflation, interest rates or current market rates; and
   
Voyage charters, which are charters for shorter intervals, usually a single round trip, that are priced on a current, or “spot,” market rate.
In the last several years, we have derived 100% of our revenues from time-charters. During these periods, all our vessels were employed on long-term time-charters. We do not anticipate earning revenues from voyage charters in the foreseeable future.
“Hire” rate refers to the basic payment from the customer for the use of a vessel. Hire is payable monthly, in advance, in U.S. Dollars or Euros, as specified in the charter. The hire rate generally includes two components – a capital cost component and an operating expense component. The capital component typically approximates the amount we are required to pay under vessel financing obligations and, for all but three of our existing Suezmax tankers, adjusts for changes in the floating interest rates relating to the underlying vessel financing. The operating component, which adjusts annually for inflation, is intended to compensate us for vessel operating expenses and provide us a profit.
The time-charters for three of our Suezmax tankers include a fixed monthly rate for their initial 12-year term, which increases for any extensions. These time-charters do not include separately identified capital or operating components or adjust for inflation.
For most of our charters, we earn a profit from a margin built into the operating component. Under other charters, this margin is built into the capital component.
In addition, we may receive additional revenues beyond the fixed hire rate when current market rates exceed specified amounts under our time-charter for one Suezmax tanker, the Teide Spirit.
Hire payments may be reduced or, under some charters, we must pay liquidated damages, if the vessel does not perform to certain of its specifications, such as if the average vessel speed falls below a guaranteed speed or the amount of fuel consumed to power the vessel under normal circumstances exceeds a guaranteed amount. Historically, we have had few instances of hire rate reductions and none that have had a material impact on our operating results.
When a vessel is “off-hire”—or not available for service—generally the customer is not required to pay the hire rate and we are responsible for all costs. Prolonged off-hire may lead to vessel substitution or termination of the time-charter. A vessel will be deemed to be off-hire if it is in drydock. We must periodically drydock each of our vessels for inspection, repairs and maintenance and any modifications to comply with industry certification or governmental requirements. In addition, a vessel generally will be deemed off-hire if there is a loss of time due to, among other things: operational deficiencies; equipment breakdowns; delays due to accidents, crewing strikes, certain vessel detentions or similar problems; or our failure to maintain the vessel in compliance with its specifications and contractual standards or to provide the required crew.
Liquefied Gas Segment
LNG Carriers
The LNG carriers in our liquefied gas segment compete in the LNG market. LNG carriers are usually chartered to carry LNG pursuant to time-charter contracts, where a vessel is hired for a fixed period of time, usually between 20 and 25 years, and the charter rate is payable to the owner on a monthly basis. LNG shipping historically has been transacted with long-term, fixed-rate time-charter contracts. LNG projects require significant capital expenditures and typically involve an integrated chain of dedicated facilities and cooperative activities. Accordingly, the overall success of an LNG project depends heavily on long-range planning and coordination of project activities, including marine transportation. Most shipping requirements for new LNG projects continue to be provided on a long-term basis, though the level of spot voyages (typically consisting of a single voyage) and short-term time-charters of less than 12 months duration have grown in the past few years.

 

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In the LNG market, we compete principally with other private and state-controlled energy and utilities companies that generally operate captive fleets, and independent ship owners and operators. Many major energy companies compete directly with independent owners by transporting LNG for third parties in addition to their own LNG. Given the complex, long-term nature of LNG projects, major energy companies historically have transported LNG through their captive fleets. However, independent fleet operators have been obtaining an increasing percentage of charters for new or expanded LNG projects as some major energy companies have continued to divest non-core businesses.
LNG carriers transport LNG internationally between liquefaction facilities and import terminals. After natural gas is transported by pipeline from production fields to a liquefaction facility, it is supercooled to a temperature of approximately negative 260 degrees Fahrenheit. This process reduces its volume to approximately 1/600th of its volume in a gaseous state. The reduced volume facilitates economical storage and transportation by ship over long distances, enabling countries with limited natural gas reserves or limited access to long-distance transmission pipelines to import natural gas. LNG carriers include a sophisticated containment system that holds and insulates the LNG so it maintains its liquid form. LNG is transported overseas in specially built tanks on double-hulled ships to a receiving terminal, where it is offloaded and stored in heavily insulated tanks. In regasification facilities at the receiving terminal, the LNG is returned to its gaseous state (or regasified) and then shipped by pipeline for distribution to natural gas customers.
Most new vessels, including all of our LNG carriers, are being built with a membrane containment system. These systems are built inside the carrier and consist of insulation between thin primary and secondary barriers that are designed to accommodate thermal expansion and contraction without overstressing the membrane. New LNG carriers are generally expected to have a lifespan of approximately 35 to 40 years. Unlike the oil tanker industry, there currently are no regulations that require the phase-out from trading of LNG carriers after they reach a certain age. As at December 31, 2009 our LNG carriers had an average age of approximately six years, compared to the world LNG carrier fleet average age of approximately 10 years. In addition, as at that date, there were approximately 338 vessels in the world LNG fleet and approximately 43 additional LNG carriers under construction or on order for delivery through 2012.

 

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The following table provides additional information about our LNG vessels as of December 31, 2009.
                         
                        Remaining
Vessel   Capacity     Delivery   Our Ownership   Charterer   Charter Term(1)
    (cubic meters)                  
 
     
Operating LNG carriers:
                       
Hispania Spirit
    140,500     2002   100%   Repsol YPF   13 years (3)
Catalunya Spirit
    138,000     2003   100%   Gas Natural SDG   14 years (3)
Galicia Spirit
    140,500     2004   100%   Uniòn Fenosa Gas   20 years (4)
Madrid Spirit
    138,000     2004   Capital lease (2)   Repsol YPF   15 years (3)
Al Marrouna
    140,500     2006   Capital lease (2)   Ras Laffan Liquefied
Natural Gas Company Ltd.
  17 years (5)
Al Areesh
    140,500     2007   Capital lease (2)   Ras Laffan Liquefied
Natural Gas Company Ltd.
  17 years (5)
Al Daayen
    140,500     2007   Capital lease (2)   Ras Laffan Liquefied
Natural Gas Company Ltd.
  17 years (5)
Tangguh Hiri
    155,000     2008   69%   The Tangguh Production
Sharing Contractors
  19 years
Tangguh Sago
    155,000     2009   69%   The Tangguh Production
Sharing Contractors
  19 years
Al Huwaila
    217,300     2008   40% (6)   Ras Laffan Liquefied
Natural Gas Company Ltd. (3)
  23 years (3)
Al Kharsaah
    217,300     2008   40% (6)   Ras Laffan Liquefied
Natural Gas Company Ltd. (3)
  23 years (3)
Al Shamal
    217,300     2008   40% (6)   Ras Laffan Liquefied
Natural Gas Company Ltd. (3)
  23 years (3)
Al Khuwair
    217,300     2008   40% (6)   Ras Laffan Liquefied
Natural Gas Company Ltd. (3)
  24 years (3)
Arctic Spirit
    89,880     1993   99%   Teekay Corporation   8 years (5)
Polar Spirit
    89,880     1993   99%   Teekay Corporation   8 years (5)
 
                     
Total Capacity:
    2,337,460                  
 
                     
     
(1)  
Each of our time-charters are subject to certain termination and purchase provisions.
 
(2)  
We lease the vessel under a tax lease arrangement. Please read Item 18 — Financial Statements: Note 5 – Leases and Restricted Cash.
 
(3)  
The charterer has two options to extend the term for an additional five years each.
 
(4)  
The charterer has one option to extend the term for an additional five years.
 
(5)  
The charterer has three options to extend the term for an additional five years each.
 
(6)  
The RasGas 3 LNG Carriers are accounted for under the equity method.
Repsol YPF and Gas Natural SDG accounted for 19% and 11% of our revenues in 2007, 18% and 9% of our revenues in 2008, and 16% and 9% of our revenues in 2009, respectively. We also derived 24%, 22% and 21% of our revenues in 2007, 2008 and 2009, respectively, from Ras Laffan Liquefied Natural Gas Company Ltd.; and in 2009 derived 10% of our revenues from the Tangguh Production Sharing Contractors; and in 2008 and 2009 derived 9% and 12% respectively, from Teekay Corporation. No other LNG customer accounted for 10% or more of our revenues during any of these periods. The loss of any significant customer or a substantial decline in the amount of services requested by a significant customer could harm our business, financial condition and results of operations.
Each LNG carrier that is owned by us (or that we have agreed to purchase from Teekay Corporation), is encumbered by a mortgage relating to the vessel’s financing. Each of the Madrid Spirit, Al Marrouna, Al Areesh and Al Daayen is considered to be a capital lease. Please read Item 18 – Financial Statements: Note 5 – Leases and Restricted Cash.
LPG Carriers
LPG shipping involves the transportation of three main categories of cargo: liquid petroleum gases including propane, butane and ethane; petrochemical gases including ethylene, propylene and butadiene; and ammonia.
As of December 31, 2009, the worldwide LPG tanker fleet consisted of approximately 1,149 vessels with an average age of approximately 16 years and approximately 136 additional LPG vessels were on order for delivery through 2011. LPG carriers range in size from approximately 500 to approximately 70,000 cubic meters. Approximately 55% of the worldwide fleet is less than 5,000 cubic meters (in terms of vessel numbers). New LPG carriers are generally expected to have a lifespan of approximately 30 to 35 years.
LPG carriers are mainly chartered to carry LPG on time-charters, on contracts of affreightment or spot voyage charters. The two largest consumers of LPG are residential users and the petrochemical industry. Residential users, particularly in developing regions where electricity and gas pipelines are not developed, do not have fuel switching alternatives and generally are not LPG price sensitive. The petrochemical industry, however, has the ability to switch between LPG and other feedstock fuels depending on price and availability of alternatives.

 

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The following table provides additional information about our LPG carriers as of December 31, 2009:
                         
            Delivery / Expected           Remaining
Vessel   Capacity     Delivery   Ownership   Charterer   Charter Term
    (cubic meters)                  
 
                       
Operating LPG carriers:
                       
Dania Spirit
    7,392     2000   100%   Statoil ASA   6 years
Norgas Pan (1)
    9,650     2009   100%   I.M. Skaguen ASA   14 years
Norgas Cathinka (1)
    9,650     2009   100%   I.M. Skaguen ASA   15 years
Newbuildings:
                       
Norgas Camilla (1)
    9,206     2010   100%   I.M. Skaguen ASA   15 years
Dingheng Jiangsu 1 (2)
    12,000     2011   100%   I.M. Skaguen ASA   15 years
Dingheng Jiangsu 2 (2)
    12,000     2011   100%   I.M. Skaguen ASA   15 years
 
                     
Total Capacity:
    59,898                  
 
                     
     
(1)  
In December 2006, we agreed to acquire three LPG carriers from Skaugen upon their deliveries for approximately $33 million per vessel. Two vessels were delivered in April and November 2009 and the last vessel is currently under construction and is scheduled to deliver mid-2010.
 
(2)  
On July 28, 2008 Teekay Corporation purchased two technically advanced 12,000-cubic meter newbuilding Multigas ships from Skaugen subsidiaries and we will acquire the vessels from Teekay Corporation upon their deliveries for approximately $47.0 million per vessel. Both vessels are expected to be delivered in 2011.
Suezmax Tanker Segment
Oil has been the world’s primary energy source for decades. Seaborne crude oil transportation is a mature industry. The two main types of oil tanker operators are major oil companies (including state-owned companies) that generally operate captive fleets, and independent operators that charter out their vessels for voyage or time-charter use. Most conventional oil tankers controlled by independent fleet operators are hired for one or a few voyages at a time at fluctuating market rates based on the existing tanker supply and demand. These charter rates are extremely sensitive to this balance of supply and demand, and small changes in tanker utilization have historically led to relatively large short-term rate changes. Long-term, fixed-rate charters for crude oil transportation, such as those applicable to our Suezmax tanker fleet, are less typical in the industry. As used in this discussion, “conventional” oil tankers exclude those vessels that can carry dry bulk and ore, tankers that currently are used for storage purposes and shuttle tankers that are designed to transport oil from offshore production platforms to onshore storage and refinery facilities.
Oil tanker demand is primarily a function of several factors, primarily the locations of oil production, refining and consumption and world oil demand and supply, while oil tanker supply is primarily a function of new vessel deliveries, vessel scrapping and the conversion or loss of tonnage.
The majority of crude oil tankers range in size from approximately 80,000 to approximately 320,000 dwt. Suezmax tankers, which typically range from 120,000 to 200,000 dwt, are the mid-size of the various primary oil tanker types. As of December 31, 2009, the world tanker fleet included 358 conventional Suezmax tankers, representing approximately 13% of worldwide oil tanker capacity, excluding tankers under 10,000 dwt.
As of December 31, 2009 our Suezmax tankers had an average age of approximately seven years, compared to the average age of nine years for the world Suezmax conventional tanker fleet. New Suezmax tankers generally are expected to have a lifespan of approximately 25 to 30 years, based on estimated hull fatigue life. However, United States and international regulations require the phase-out of double-hulled vessels by 25 years. All of our Suezmax tankers are double-hulled.
The following table provides additional information about our Suezmax oil tankers as of December 31, 2009.
                         
                        Remaining
Tanker   Capacity     Delivery   Our Ownership   Charterer   Charter Term
    (dwt)                  
 
                       
Operating Suezmax tankers:
                       
Tenerife Spirit
    159,500     2000   Capital lease (1)   CEPSA   11 years (2)
Algeciras Spirit
    159,500     2000   Capital lease (1)   CEPSA   11 years (2)
Huelva Spirit
    159,500     2001   Capital lease (1)   CEPSA   12 years (2)
Teide Spirit
    159,500     2004   Capital lease (1)   CEPSA   15 years (2)
Toledo Spirit
    159,500     2005   Capital lease (1)   CEPSA   16 years (2)
European Spirit
    151,800     2003   100%   ConocoPhillips   6 years (3)
African Spirit
    151,700     2003   100%   ConocoPhillips   6 years (3)
Asian Spirit
    151,700     2004   100%   ConocoPhillips   6 years (3)
 
                     
Total Capacity:
    1,252,700                  
 
                     

 

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(1)  
We are the lessee under a capital lease arrangement and are required to purchase the vessel after the end of their respective lease terms for a fixed price. The purchase of these vessels is expected to occur in late-2011. Please read Item 18 — Financial Statements: Note 5 – Leases and Restricted Cash.
 
(2)  
Compania Espanole de Petroleos, S.A. (or CEPSA) has the right to terminate the time-charter 13 years after the original delivery date, in which case we are generally expected to sell the vessel, subject to our right of first refusal to purchase the vessel.
 
(3)  
The term of the time-charter is 12 years from the original delivery date, which may be extended at the customer’s option for up to an additional six years. In addition, the customer has the right to terminate the time-charter upon notice and payment of a cancellation fee. Either party also may require the sale of the vessel to a third party at any time, subject to the other party’s right of first refusal to purchase the vessel.
CEPSA accounted for 22%, 21% and 14% of our 2007, 2008 and 2009 revenues, respectively. We also derived 11%, 9% and 9% of our revenues in 2007, 2008 and 2009, respectively, from ConocoPhillips. The loss of any significant customer or a substantial decline in the amount of services requested by a significant customer could harm our business, financial condition and results of operations.
On March 17, 2010, we acquired from Teekay Corporation two 2009-built 159,000 dwt Suezmax tankers, the Hamilton Spirit and Bermuda Spirit (or the Centrofin Suezmaxes) and a 2007-built 40,083 dwt Handymax product tanker, the Alexander Spirit, and the associated 12-year, 12-year and 10-year fixed-rate contracts, respectively. The remaining charter term for these vessels are 11 years, 11 years, and 10 years, respectively. We acquired the vessels from Teekay Corporation for a total purchase price of $160 million.
Business Strategies
Our primary business objective is to increase distributable cash flow per unit by executing the following strategies:
   
Acquire new LNG and LPG carriers built to project specifications after long-term, fixed-rate time-charters have been awarded for the LNG and LPG projects. Our LNG and LPG carriers are built or will be built to customer specifications included in the related long-term, fixed-rate time-charters for the vessels. We intend to continue our practice of acquiring LNG and LPG carriers as needed for approved projects only after the long-term, fixed-rate time-charters for the projects have been awarded, rather than ordering vessels on a speculative basis. We believe this approach is preferable to speculative newbuilding because it:
   
eliminates the risk of incremental or duplicative expenditures to alter our LNG and LPG carriers to meet customer specifications;
   
facilitates the financing of new LNG and LPG carriers based on their anticipated future revenues; and
   
ensures that new vessels will be employed upon acquisition, which should generate more stable cash flow.
   
Expand our LNG and LPG operations globally. We seek to capitalize on opportunities emerging from the global expansion of the LNG and LPG sector by selectively targeting:
   
long-term, fixed-rate time-charters wherever there is significant growth in LNG and LPG trade;
   
joint ventures and partnerships with companies that may provide increased access to opportunities in attractive LNG and LPG importing and exporting geographic regions; and
   
strategic vessel and business acquisitions.
   
Provide superior customer service by maintaining high reliability, safety, environmental and quality standards. LNG and LPG project operators seek LNG and LPG transportation partners that have a reputation for high reliability, safety, environmental and quality standards. We seek to leverage our own and Teekay Corporation’s operational expertise to create a sustainable competitive advantage with consistent delivery of superior customer service.
   
Manage our Suezmax tanker fleet to provide stable cash flows. The remaining terms for our existing long-term Suezmax tanker charters are 6 to 16 years. The Centrofin Suezmaxes and the one Handymax tankers that we acquired on March 17, 2010 have remaining terms of 11 years and 10 years, respectively. We believe the fixed-rate time-charters for our oil tanker fleet provide us stable cash flows during their terms and a source of funding for expanding our LNG and LPG operations. Depending on prevailing market conditions during and at the end of each existing charter, we may seek to extend the charter, enter into a new charter, operate the vessel on the spot market or sell the vessel, in an effort to maximize returns on our Suezmax fleet while managing residual risk.
Safety, Management of Ship Operations and Administration
Teekay Corporation, through its subsidiaries, assists us in managing our ship operations. Safety and environmental compliance are our top operational priorities. We operate our vessels in a manner intended to protect the safety and health of the employees, the general public and the environment. We seek to manage the risks inherent in our business and are committed to eliminating incidents that threaten the safety and integrity of our vessels, such as groundings, fires, collisions and petroleum spills. In 2007, Teekay Corporation introduced a behavior-based safety program called “Safety in Action” to further enhance the safety culture in our fleet. We are also committed to reducing our emissions and waste generation. In 2008, Teekay Corporation introduced the Quality Assurance and Training Officers (or QATO) Program to conduct rigorous internal audits of our processes and provide the seafarers with onboard training.
Teekay Corporation has achieved certification under the standards reflected in International Standards Organization’s (or ISO) 9001 for Quality Assurance, ISO 14001 for Environment Management Systems, Occupational Health and Safety Advisory Services 18001 for Occupational Health and Safety, and the IMO’s International Management Code for the Safe Operation of Ships and Pollution Prevention on a fully integrated basis. As part of Teekay Corporation’s compliance with the International Safety Management (or ISM) Code, all of our vessels’ safety management certificates are maintained through ongoing internal audits performed by our certified internal auditors and intermediate external audits performed by the classification society Det Norske Veritas. Subject to satisfactory completion of these internal and external audits, certification is valid for five years.

 

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We have established key performance indicators to facilitate regular monitoring of our operational performance. We set targets on an annual basis to drive continuous improvement, and we review performance indicators monthly to determine if remedial action is necessary to reach our targets.
In addition to our operational experience, Teekay Corporation’s in-house global shore staff performs, through its subsidiaries, the full range of technical, commercial and business development services for our LNG and LPG operations. This staff also provides administrative support to our operations in finance, accounting and human resources. We believe this arrangement affords a safe, efficient and cost-effective operation.
Critical ship management functions that Teekay Corporation provides to us through its Teekay Marine Services division located in various offices around the world include:
   
vessel maintenance;
   
crewing;
   
purchasing;
   
shipyard supervision;
   
insurance; and
   
financial management services.
These functions are supported by onboard and onshore systems for maintenance, inventory, purchasing and budget management.
In addition, Teekay Corporation’s day-to-day focus on cost control is applied to our operations. In 2003, Teekay Corporation and two other shipping companies established a purchasing alliance, Teekay Bergesen Worldwide, which leverages the purchasing power of the combined fleets, mainly in such commodity areas as lube oils, paints and other chemicals. Through our arrangements with Teekay Corporation, we benefit from this purchasing alliance.
We believe that the generally uniform design of some of our existing and newbuilding vessels and the adoption of common equipment standards provides operational efficiencies, including with respect to crew training and vessel management, equipment operation and repair, and spare parts ordering.
Risk of Loss, Insurance and Risk Management
The operation of any ocean-going vessel carries an inherent risk of catastrophic marine disasters, death or injury of persons and property losses caused by adverse weather conditions, mechanical failures, human error, war, terrorism, piracy and other circumstances or events. In addition, the transportation of LNG, LPG and crude oil is subject to the risk of spills and to business interruptions due to political circumstances in foreign countries, hostilities, labor strikes and boycotts. The occurrence of any of these events may result in loss of revenues or increased costs.
We carry hull and machinery (marine and war risks) and protection and indemnity insurance coverage to protect against most of the accident-related risks involved in the conduct of our business. Hull and machinery insurance covers loss of or damage to a vessel due to marine perils such as collisions, grounding and weather. Protection and indemnity insurance indemnifies us against liabilities incurred while operating vessels, including injury to our crew or third parties, cargo loss and pollution. The current available amount of our coverage for pollution is $1 billion per vessel per incident. We also carry insurance policies covering war risks (including piracy and terrorism) and, for some of our LNG carriers, loss of revenues resulting from vessel off-hire time due to a marine casualty. We believe that our current insurance coverage is adequate to protect against most of the accident-related risks involved in the conduct of our business and that we maintain appropriate levels of environmental damage and pollution insurance coverage. However, we cannot assure that all covered risks are adequately insured against, that any particular claim will be paid or that we will be able to procure adequate insurance coverage at commercially reasonable rates in the future. More stringent environmental regulations have resulted in increased costs for, and may result in the lack of availability of, insurance against risks of environmental damage or pollution.
We use in our operations Teekay Corporation’s thorough risk management program that includes, among other things, computer-aided risk analysis tools, maintenance and assessment programs, a seafarers competence training program, seafarers workshops and membership in emergency response organizations. We believe we benefit from Teekay Corporation’s commitment to safety and environmental protection as certain of its subsidiaries assist us in managing our vessel operations.
Classification, Audits and Inspections
The hull and machinery of all our vessels is “classed” by one of the major classification societies: Det Norske Veritas or Lloyd’s Register of Shipping, or American Bureau of Shipping. The classification society certifies that the vessel has been built and maintained in accordance with its rules. Each vessel is inspected by a classification society surveyor annually, with either the second or third annual inspection being a more detailed survey (or an Intermediate Survey) and the fifth annual inspection being the most comprehensive survey (or a Special Survey). The inspection cycle resumes after each Special Survey. Vessels also may be required to be drydocked at each Intermediate and Special Survey for inspection of the underwater parts of the vessel in addition to a more detailed inspection of the hull and machinery. Many of our vessels have qualified with their respective classification societies for drydocking every five years in connection with the Special Survey and are no longer subject to drydocking at Intermediate Surveys. To qualify, we were required to enhance the resiliency of the underwater coatings of each vessel and mark the hull to accommodate underwater inspections by divers.

 

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The vessel’s flag state, or the vessel’s classification society if nominated by the flag state, also inspects our vessels to ensure they comply with applicable rules and regulations of the country of registry of the vessel and the international conventions of which that country is a signatory. Port state authorities, such as the U.S. Coast Guard, also inspect our vessels when they visit their ports.
In addition to the classification inspections, many of our customers regularly inspect our vessels as a condition to chartering, and regular inspections are standard practice under long-term charters.
We believe that our relatively new, well-maintained and high-quality vessels provide us with a competitive advantage in the current environment of increasing regulation and customer emphasis on quality of service.
Our vessels are also regularly inspected by our seafaring staff, who perform much of the necessary routine maintenance. Shore-based operational and technical specialists also inspect our vessels at least twice a year. Upon completion of each inspection, action plans are developed to address any items requiring improvement. All plans are monitored until they are completed. The objectives of these inspections are to:
   
ensure adherence to our operating standards;
   
maintain the structural integrity of the vessel;
   
maintain machinery and equipment to give full reliability in service;
   
optimize performance in terms of speed and fuel consumption; and
   
ensure the vessel’s appearance will support our brand and meet customer expectations.
To achieve our structural integrity objective, we use a comprehensive “Structural Integrity Management System” developed by Teekay Corporation. This system is designed to closely monitor the condition of our vessels and to ensure that structural strength and integrity are maintained throughout a vessel’s life.
Teekay Corporation, which assists us in managing our ship operations through its subsidiaries, has obtained approval for its safety management system as being in compliance with the ISM Code. Our safety management system has also been certified as being compliant with ISO 9001, ISO 14001 and OSHAS 18001 standards. To maintain compliance, the system is audited regularly by either the vessels’ flag state or, when nominated by the flag state, a classification society. Certification is valid for five years subject to satisfactorily completing internal and external audits.
We believe that the heightened environmental and quality concerns of insurance underwriters, regulators and charterers will generally lead to greater inspection and safety requirements on all vessels in the LNG and LPG carrier and oil tanker markets and will accelerate the scrapping of older vessels throughout these markets.

 

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C. Regulations
General
Our business and the operation of our vessels are significantly affected by international conventions and national, state and local laws and regulations in the jurisdictions in which our vessels operate, as well as in the country or countries of their registration. Because these conventions, laws and regulations change frequently, we cannot predict the ultimate cost of compliance or their impact on the resale price or useful life of our vessels. Additional conventions, laws, and regulations may be adopted that could limit our ability to do business or increase the cost of our doing business and that may materially adversely affect our operations. We are required by various governmental and quasi-governmental agencies to obtain permits, licenses and certificates with respect to our operations. Subject to the discussion below and to the fact that the kinds of permits, licenses and certificates required for the operations of the vessels we own will depend on a number of factors, we believe that we will be able to continue to obtain all permits, licenses and certificates material to the conduct of our operations.
International Maritime Organization (or IMO)
The IMO is the United Nations’ agency for maritime safety. IMO regulations relating to pollution prevention for oil tankers have been adopted by many of the jurisdictions in which our tanker fleet operates. Under IMO regulations and subject to limited exceptions, a tanker must be of double-hull construction, be of a mid-deck design with double-side construction or be of another approved design ensuring the same level of protection against oil pollution. All of our tankers are double hulled.
Many countries, but not the United States, have ratified and follow the liability regime adopted by the IMO and set out in the International Convention on Civil Liability for Oil Pollution Damage, 1969, as amended (or CLC). Under this convention, a vessel’s registered owner is strictly liable for pollution damage caused in the territorial waters of a contracting state by discharge of persistent oil (e.g. crude oil, fuel oil, heavy diesel oil or lubricating oil), subject to certain defenses. The right to limit liability to specified amounts that are periodically revised is forfeited under the CLC when the spill is caused by the owner’s actual fault or when the spill is caused by the owner’s intentional or reckless conduct. Vessels trading to contracting states must provide evidence of insurance covering the limited liability of the owner. In jurisdictions where the CLC has not been adopted, various legislative regimes or common law governs, and liability is imposed either on the basis of fault or in a manner similar to the CLC.
IMO regulations also include the International Convention for Safety of Life at Sea (or SOLAS), including amendments to SOLAS implementing the International Security Code for Ports and Ships (or ISPS), the ISM Code, the International Convention on Load Lines of 1966, and, specifically with respect to LNG and LPG carriers, the International Code for Construction and Equipment of Ships Carrying Liquefied Gases in Bulk (the IGC Code). SOLAS provides rules for the construction of and equipment required for commercial vessels and includes regulations for safe operation. Flag states which have ratified the convention and the treaty generally employ the classification societies, which have incorporated SOLAS requirements into their class rules, to undertake surveys to confirm compliance.
SOLAS and other IMO regulations concerning safety, including those relating to treaties on training of shipboard personnel, lifesaving appliances, radio equipment and the global maritime distress and safety system, are applicable to our operations. Non-compliance with IMO regulations, including SOLAS, the ISM Code, ISPS and the IGC Code, may subject us to increased liability or penalties, may lead to decreases in available insurance coverage for affected vessels and may result in the denial of access to or detention in some ports. For example, the U.S. Coast Guard and European Union authorities have indicated that vessels not in compliance with the ISM Code will be prohibited from trading in U.S. and European Union ports. The ISM Code requires vessel operators to obtain a safety management certification for each vessel they manage, evidencing the shipowner’s development and maintenance of an extensive safety management system. Each of the existing vessels in our fleet is currently ISM Code-certified, and we expect to obtain safety management certificates for each newbuilding vessel upon delivery.
LNG and LPG carriers are also subject to regulation under the IGC Code. Each LNG and LPG carrier must obtain a certificate of compliance evidencing that it meets the requirements of the IGC Code, including requirements relating to its design and construction. Each of our LNG and LPG carriers is currently IGC Code certified, and each of the shipbuilding contracts for our LNG newbuildings, and for the LPG newbuildings that we have agreed to acquire from Skaugen and Teekay Corporation, requires IGC Code compliance prior to delivery.

 

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Annex VI to the IMO’s International Convention for the Prevention of Pollution from Ships (or Annex VI) became effective on May 19, 2005. Annex VI sets limits on sulfur oxide and nitrogen oxide emissions from ship exhausts and prohibits emissions of ozone depleting substances, emissions of volatile compounds from cargo tanks and the incineration of specific substances. Annex VI also includes a world-wide cap on the sulfur content of fuel oil and allows for special areas to be established with more stringent controls on sulfur emissions. Annex VI came into force in the United States on January 8, 2009. We operate our vessels in compliance with Annex VI.
In addition, the IMO has proposed that all tankers of the size we operate that are built starting in 2012 contain ballast water treatment systems, and that all other such tankers install treatment systems by 2016. When this regulation becomes effective, we estimate that the installation of ballast water treatment systems on our tankers may cost between $2 million and $3 million per vessel.
European Union (or EU)
Like the IMO, the EU has adopted regulations phasing out single-hull tankers. All of our tankers are double-hulled.
The EU has also adopted legislation that: bans manifestly sub-standard vessels (defined as vessels that have been detained twice by EU port authorities after July 2003) from European waters; creates obligations on the part of EU member port states to inspect at least 24% of vessels using these ports annually; provides for increased surveillance of vessels posing a high risk to maritime safety or the marine environment; and provides the European Union with greater authority and control over classification societies, including the ability to seek to suspend or revoke the authority of negligent societies. The EU is also considering the adoption of criminal sanctions for certain pollution events, including improper cleaning of tanks.
The EU Directive 33/2005 (or the Directive) came into force on January 1, 2010. Under this legislation, vessels are required to burn fuel with sulphur content below 0.1% while berthed or anchored in an EU port. Currently, the only grade of fuel meeting this low sulphur content requirement is low sulphur marine gas oil (or LSMGO). Certain modifications are necessary on our Suezmax tankers in order to optimize operation on LSMGO of equipment originally designed to operate on Heavy Fuel Oil (or HFO). The cost of such modifications will increase the capital expenditures of the relevant vessels in our fleet, which we estimate will total approximately $1 million. In addition, LSMGO is more expensive than HFO and this will impact the costs of operations. However, for vessels employed on fixed term business, all fuel costs, including any increases, are borne by the charterer. Given that the manufacturers of the equipment necessary to modify the vessels have not been able to supply parts and modification kits, the EU has issued a recommendation that member states adopt a phase in period for the first eight months of 2010 for vessel owners that have demonstrated actions to comply with the Directive. However, certain EU countries, including Sweden and Italy, are required under their national laws to either ban or impose fines on non-compliant vessels. We expect all vessels in our fleet trading to the EU will become compliant within the first eight months of 2010.
United States
The United States has enacted an extensive regulatory and liability regime for the protection and cleanup of the environment from oil spills, including discharges of oil cargoes, bunker fuels or lubricants, primarily through the Oil Pollution Act of 1990 (or OPA 90) and the Comprehensive Environmental Response, Compensation and Liability Act (or CERCLA). OPA 90 affects all owners, bareboat charterers, and operators whose vessels trade to the United States or its territories or possessions or whose vessels operate in United States waters, which include the U.S. territorial sea and 200-mile exclusive economic zone around the United States. CERCLA applies to the discharge of “hazardous substances” rather than “oil” and imposes strict joint and several liability upon the owners, operators or bareboat charterers of vessels for cleanup costs and damages arising from discharges of hazardous substances. We believe that petroleum products and LNG and LPG should not be considered hazardous substances under CERCLA, but additives to oil or lubricants used on LNG or LPG carriers might fall within its scope.
Under OPA 90, vessel owners, operators and bareboat charters are “responsible parties” and are jointly, severally and strictly liable (unless the oil spill results solely from the act or omission of a third party, an act of God or an act of war and the responsible party reports the incident and reasonably cooperates with the appropriate authorities) for all containment and cleanup costs and other damages arising from discharges or threatened discharges of oil from their vessels. These other damages are defined broadly to include:
   
natural resources damages and the related assessment costs;
   
real and personal property damages;
   
net loss of taxes, royalties, rents, fees and other lost revenues;
   
lost profits or impairment of earning capacity due to property or natural resources damage;
   
net cost of public services necessitated by a spill response, such as protection from fire, safety or health hazards; and
   
loss of subsistence use of natural resources.

 

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OPA 90 limits the liability of responsible parties in an amount it periodically updates. The liability limits do not apply if the incident was proximately caused by violation of applicable U.S. federal safety, construction or operating regulations, including IMO conventions to which the United States is a signatory, or by the responsible party’s gross negligence or willful misconduct, or if the responsible party fails or refuses to report the incident or to cooperate and assist in connection with the oil removal activities. Liability under CERCLA is also subject to limits unless the incident is caused by gross negligence, willful misconduct or a violation of certain regulations. We currently maintain for each of our vessel’s pollution liability coverage in the maximum coverage amount of $1 billion per incident. A catastrophic spill could exceed the coverage available, which could harm our business, financial condition and results of operations.
Under OPA 90, with limited exceptions, all newly built or converted tankers delivered after January 1, 1994 and operating in U.S. waters must be double-hulled. All of our existing tankers are double-hulled.
OPA 90 also requires owners and operators of vessels to establish and maintain with the United States Coast Guard (or Coast Guard) evidence of financial responsibility in an amount at least equal to the relevant limitation amount for such vessels under the statute. The Coast Guard has implemented regulations requiring that an owner or operator of a fleet of vessels must demonstrate evidence of financial responsibility in an amount sufficient to cover the vessel in the fleet having the greatest maximum limited liability under OPA 90 and CERCLA. Evidence of financial responsibility may be demonstrated by insurance, surety bond, self-insurance, guaranty or an alternate method subject to approval by the Coast Guard. Under the self-insurance provisions, the shipowner or operator must have a net worth and working capital, measured in assets located in the United States against liabilities located anywhere in the world, that exceeds the applicable amount of financial responsibility. We have complied with the Coast Guard regulations by using self-insurance for certain vessels and obtaining financial guaranties from a third party for the remaining vessels. If other vessels in our fleet trade into the United States in the future, we expect to provide guaranties through self-insurance or obtain guaranties from third-party insurers.
OPA 90 and CERCLA permit individual U. S. states to impose their own liability regimes with regard to oil or hazardous substance pollution incidents occurring within their boundaries, and some states have enacted legislation providing for unlimited strict liability for spills. Several coastal states, such as California, Washington and Alaska require state-specific evidence of financial responsibility and vessel response plans. We intend to comply with all applicable state regulations in the ports where our vessels call.
Owners or operators of tankers operating in U.S. waters are required to file vessel response plans with the Coast Guard, and their tankers are required to operate in compliance with their Coast Guard approved plans. Such response plans must, among other things:
   
address a “worst case” scenario and identify and ensure, through contract or other approved means, the availability of necessary private response resources to respond to a “worst case discharge”;
   
describe crew training and drills; and
   
identify a qualified individual with full authority to implement removal actions.
We have filed vessel response plans with the Coast Guard and have received its approval of such plans. In addition, we conduct regular oil spill response drills in accordance with the guidelines set out in OPA 90. The Coast Guard has announced it intends to propose similar regulations requiring certain vessels to prepare response plans for the release of hazardous substances.
OPA 90 and CERCLA do not preclude claimants from seeking damages resulting from the discharge of oil and hazardous substances under other applicable law, including maritime tort law. Such claims could include attempts to characterize the transportation of LNG or LPG aboard a vessel as an ultra-hazardous activity under a doctrine that would impose strict liability for damages resulting from that activity. The application of this doctrine varies by jurisdiction.
The United States Clean Water Act also prohibits the discharge of oil or hazardous substances in U.S. navigable waters and imposes strict liability in the form of penalties for unauthorized discharges. The Clean Water Act imposes substantial liability for the costs of removal, remediation and damages and complements the remedies available under OPA 90 and CERCLA discussed above.
Our vessels that discharge certain effluents, including ballast water, in U.S. waters must obtain a Clean Water Act permit from the Environmental Protection Agency (or EPA) titled the “Vessel General Permit” and comply with a range of best management practices, reporting, inspections and other requirements. The Vessel General Permit incorporates Coast Guard requirements for ballast water exchange and includes specific technology-based requirements for vessels. Several U.S. states have added specific requirements to the Vessel General Permit and, in some cases, may require vessels to install ballast water treatment technology to meet biological performance standards. We believe that the EPA may add requirements related to ballast water treatment technology to the Vessel General Permit requirements between 2012 and 2016 to correspond with the IMO’s adoption of similar requirements as discussed above.
Since 2009, several environmental groups and industry associations have filed challenges in U.S. federal court to the EPA’s issuance of the Vessel General Permit. These cases have not yet been resolved.

 

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Greenhouse Gas Regulation
In February 2005, the Kyoto Protocol to the United Nations Framework Convention on Climate Change (or the Kyoto Protocol) entered into force. Pursuant to the Kyoto Protocol, adopting countries are required to implement national programs to reduce emissions of greenhouse gases. In December 2009, more than 27 nations, including the United States, entered into the Copenhagen Accord. The Copenhagen Accord is non-binding, but is intended to pave the way for a comprehensive, international treaty on climate change. The IMO is evaluating various mandatory measures to reduce greenhouse gas emissions from international shipping, which may include market-based instruments or a carbon tax. The European Union also has indicated that it intends to propose an expansion of an existing EU emissions trading regime to include emissions of greenhouse gases from vessels, and individual countries in the EU may impose additional requirements. In the United States, the EPA issued an “endangerment finding” regarding greenhouse gases under the Clean Air Act. While this finding in itself does not impose any requirements on our industry, it authorizes the EPA to regulate directly greenhouse gas emissions through a rule-making process. In addition, climate change initiatives are being considered in the United States Congress and by individual states. Any passage of new climate control legislation or other regulatory initiatives by the IMO, European Union, the United States or other countries or states where we operate that restrict emissions of greenhouse gases could have a significant financial and operational impact on our business that we cannot predict with certainty at this time.
Vessel Security
The ISPS was adopted by the IMO in December 2002 in the wake of heightened concern over worldwide terrorism and became effective on July 1, 2004. The objective of ISPS is to enhance maritime security by detecting security threats to ships and ports and by requiring the development of security plans and other measures designed to prevent such threats. The United States implemented ISPS with the adoption of the Maritime Transportation Security Act of 2002 (or MTSA), which requires vessels entering U.S. waters to obtain certification by the Coast Guard of plans to respond to emergency incidents there, including identification of persons authorized to implement the plans. Each of the existing vessels in our fleet currently complies with the requirements of ISPS and MTSA.
D. Properties
Other than our vessels, we do not have any material property.
E. Organizational Structure
Our sole general partner is Teekay GP L.L.C., which is a wholly owned subsidiary of Teekay Corporation (NYSE: TK). Teekay Corporation also controls its public subsidiaries Teekay Offshore Partners L.P. (NYSE: TOO) and Teekay Tankers Ltd. (NYSE: TNK).
The following is a list of our significant subsidiaries as at March 1, 2010:
             
Name of Significant Subsidiary   Ownership     State or Jurisdiction of Incorporation
 
           
Teekay LNG Operating L.L.C.
    100 %   Marshall Islands
Naviera Teekay Gas, SL
    100 %   Spain
Naviera Teekay Gas II, SL
    100 %   Spain
Naviera Teekay Gas III, SL
    100 %   Spain
Naviera Teekay Gas IV, SL
    100 %   Spain
Single Ship Limited Liability Companies
    100 %   Marshall Islands
Teekay Luxembourg Sarl
    100 %   Luxembourg
Teekay Nakilat Holdings Corporation
    100 %   Marshall Islands
Teekay Nakilat Corporation
    70 %   Marshall Islands
Teekay Nakilat (II) Limited
    70 %   United Kingdom
Teekay Shipping Spain SL
    100 %   Spain
Teekay Spain SL
    100 %   Spain
Teekay II Iberia SL
    100 %   Spain
Teekay Nakilat (III) Holdings Corporation
    100 %   Marshall Islands
Teekay BLT Corporation
    69 %   Marshall Islands
Tangguh Hiri Finance Limited
    69 %   United Kingdom
Tangguh Sago Finance Limited
    69 %   United Kingdom
Teekay LNG Holdings L.P.
    99 %   United States
Teekay Tangguh Borrower L.L.C.
    99 %   Marshall Islands
Teekay LNG Holdco L.L.C.
    99 %   Marshall Islands
Teekay Tangguh Holdings Corporation
    99 %   Marshall Islands
F. Taxation of the Partnership
Marshall Islands Taxation
Because we and our subsidiaries do not, and we do not expect that we and our subsidiaries will, conduct business or operations in the Republic of The Marshall Islands, neither we nor our subsidiaries will be subject to income, capital gains, profits or other taxation under current Marshall Islands law. As a result, distributions by our subsidiaries to us will not be subject to Marshall Islands taxation.
United States Taxation
This section is based upon provisions of the U.S. Internal Revenue Code of 1986 (or the IRC) as in effect as of the date of this Annual Report, existing final, temporary and proposed regulations there under and current administrative rulings and court decisions, all of which are subject to change. Changes in these authorities may cause the tax consequences to vary substantially from the consequences described below. Unless the context otherwise requires, references in this section to “we”, “our” or “us” are references to Teekay LNG Partners L.P. and its direct or indirect wholly owned subsidiaries that have properly elected to be disregarded as entities separate from Teekay LNG Partners L.P. for U.S. federal tax purposes.
Classification as a Partnership  
For purposes of U.S. federal income taxation, a partnership is not a taxable entity, and although it may be subject to withholding taxes on behalf of its partners under certain circumstances, a partnership itself incurs no U.S. federal income tax liability. Instead, each partner of a partnership is required to take into account his share of items of income, gain, loss, deduction and credit of the partnership in computing his U.S. federal income tax liability, regardless of whether cash distributions are made to him by the partnership. Distributions by a partnership to a partner generally are not taxable unless the amount of cash distributed exceeds the partner’s adjusted tax basis in his partnership interest.  
Section 7704 of the Internal Revenue Code (or IRC) provides that publicly traded partnerships, as a general rule, will be treated as corporations for U.S. federal income tax purposes. However, an exception, referred to as the “Qualifying Income Exception,” exists with respect to publicly traded partnerships whose “qualifying income” represents 90% or more of their gross income for every taxable year. Qualifying income includes income and gains derived from the transportation and storage of crude oil, natural gas and products thereof, including LNG. Other types of qualifying income include interest (other than from a financial business), dividends, gains from the sale of real property and gains from the sale or other disposition of capital assets held for the production of qualifying income, including stock. We have received a ruling from the Internal Revenue Service (or IRS) that we requested in connection with our initial public offering that the income we derive from transporting LNG and crude oil pursuant to time-charters existing at the time of our initial public offering is qualifying income within the meaning of Section 7704. A ruling from the IRS, while generally binding on the IRS, may under certain circumstances be revoked or modified by the IRS retroactively.
As to income that is not covered by the IRS ruling, we will rely upon the opinion of Perkins Coie LLP with respect to whether the income is qualifying income.

 

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We estimate that less than 5% of our current income is not qualifying income; however, this estimate could change from time to time for various reasons. Because we have not received an IRS ruling or an opinion of counsel that (1) any income we derive from transporting LPG, petrochemical gases and ammonia pursuant to charters that we have entered into or will enter into in the future, (2) income we derive from transporting crude oil, natural gas and products thereof, including LNG, pursuant to bareboat charters or (3) income or gain we recognize from foreign currency transactions, is qualifying income, we are currently treating income from those sources as non-qualifying income. Under some circumstances, such as a significant change in foreign currency rates, the percentage of income or gain from foreign currency transactions or from interest rate swaps in relation to our total gross income could be substantial. We do not expect income or gains from these sources and other income or gains that are not qualifying income to constitute 10% or more of our gross income for U.S. federal income tax purposes. However, it is possible that the operation of certain of our vessels pursuant to bareboat charters could, in the future, cause our non-qualifying income to constitute 10% or more of our future gross income if such vessels were held in a pass-through structure. In order to preserve our status as a partnership for U.S. federal income tax purposes, we have received a ruling from the IRS that effectively allows us to conduct our bareboat charter operations, as well as our LPG operations, in a subsidiary corporation.
If we fail to meet the Qualifying Income Exception described previously with respect to our classification as a partnership for U.S. federal income tax purposes, other than a failure that is determined by the IRS to be inadvertent and that is cured within a reasonable time after discovery, we will be treated as a non-U.S. corporation for U.S. federal income tax purposes. Our change in status would be deemed to have been effected by our transfer of all of our assets, subject to liabilities, to a newly formed non-U.S. corporation, in return for stock in that corporation, and then our distribution of that stock to our unitholders and other owners in liquidation of their interests in us.
THE REMAINING DISCUSSION OF U.S. TAXATION IN THIS ITEM 4 (PART F) APPLIES ONLY IF WE BECOME CLASSIFIED AS A CORPORATION.
Potential Classification as a Corporation  
If we were treated as a corporation in any taxable year, either as a result of a failure to meet the Qualifying Income Exception or otherwise, our items of income, gain, loss, deduction and credit would not pass through to unitholders. Instead, we would be subject to U.S. federal income tax based on the rules applicable to foreign corporations, not partnerships, and such items would be treated as our own.
Taxation of Operating Income
We expect that substantially all of our gross income and the gross income of our corporate subsidiaries will be attributable to the transportation of LNG, LPG, crude oil and related products. For this purpose, gross income attributable to transportation (or Transportation Income) includes income derived from, or in connection with, the use (or hiring or leasing for use) of a vessel to transport cargo, or the performance of services directly related to the use of any vessel to transport cargo, and thus includes both time-charter or bareboat charter income.
Transportation Income that is attributable to transportation that begins or ends, but that does not both begin and end, in the United States will be considered to be 50% derived from sources within the United States (or U.S. Source International Transportation Income). Transportation Income attributable to transportation that both begins and ends in the United States will be considered to be 100% derived from sources within the United States (or U.S. Source Domestic Transportation Income). Transportation Income attributable to transportation exclusively between non-U.S. destinations will be considered to be 100% derived from sources outside the United States. Transportation Income derived from sources outside the United States generally will not be subject to U.S. federal income tax.
Based on our current operations and the operations of our subsidiaries, we expect substantially all of our Transportation Income to be from sources outside the United States and not subject to U.S. federal income tax. However, if we or any of our subsidiaries does earn U.S. Source International Transportation Income or U.S. Source Domestic Transportation, our income or our subsidiaries income may be subject to U.S. federal income taxation under one of two alternative tax regimes (the 4% gross basis tax or the net basis tax, as described below), unless the exemption from U.S. taxation under Section 883 of the Code (or the Section 883 Exemption) applies.
The Section 883 Exemption
In general, if a non-U.S. corporation satisfies the requirements of Section 883 of the Code and the regulations thereunder (or the Final Section 883 Regulations), it will not be subject to the 4% gross basis tax or the net basis tax and branch profits tax described below on its U.S. Source International Transportation Income.
A non-U.S. corporation will qualify for the Section 883 Exemption if, among other things, it satisfies the following three requirements:
(i) it is organized in a jurisdiction outside the United States that grants an equivalent exemption from tax to corporations organized in the United States (or an Equivalent Exemption);
(ii) it meets one of the following three tests: (1) the more than 50% ownership test (or the Ownership Test); (2) the publicly traded test (or the Publicly Traded Test); or (3) the controlled foreign corporation test (or the CFC Test); and
(iii) it meets certain substantiation, reporting and other requirements.
We are organized under the laws of the Republic of The Marshall Islands. The U.S. Treasury Department has recognized the Republic of The Marshall Islands as a jurisdiction that grants an Equivalent Exemption. Therefore, in the event we were treated as a corporation for U.S. federal income tax purposes, we would meet the first requirement for the Section 883 Exemption.

 

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Regarding the second requirement for the Section 883 Exemption, we do not believe that we would meet the CFC Test, as we do not expect to be a controlled foreign corporation (or CFC) if we were to be treated as a corporation for U.S. federal income tax purposes and we do not believe that we would meet the Publicly Traded Test due to Teekay Corporation’s indirect ownership of our general partner interests. Thus, in order to qualify for the Section 883 Exemption, we would need to satisfy the Ownership Test.
In order to satisfy the Ownership Test, a non-U.S. corporation must be able to substantiate that more than 50% of the value of its stock is owned, directly or indirectly applying attribution rules, by “qualified shareholders” for at least half of the number of days in the non-U.S. corporation’s taxable year, and the non-U.S. corporation must comply with certain substantiation and reporting requirements.
For this purpose, qualified shareholders are individuals who are residents (as defined for U.S. federal income tax purposes) of countries that grant an Equivalent Exemption, non-U.S. corporations that meet the Publicly Traded Test of the Final Section 883 Regulations and are organized in countries that grant an Equivalent Exemption, or certain foreign governments, non profit organizations and certain beneficiaries of foreign pension funds. Unitholders who are citizens or residents of the United States or are domestic corporations are not qualified shareholders.
In addition, a corporation claiming the Section 883 Exemption based on the Ownership Test must obtain statements from the holders relied upon to satisfy the Ownership Test, signed under penalty of perjury, including the owner’s name, permanent address and country where the individual is fully liable to tax, if any, a description of the owner’s ownership interest in the non-U.S. corporation, including information regarding ownership in any intermediate entities, and certain other information. In addition, we would be required to file a U.S. federal income tax return and list on our U.S. federal income tax return the name and address of each unitholder holding 5% or more of the value of our units who is relied upon to meet the Ownership Test.
For more than half of the number of days in our 2009 taxable year, Teekay Corporation indirectly owned approximately a 53% interest in us, including a 2% general partner interest. Based on information provided by Teekay Corporation, Teekay Corporation is organized in the Republic of The Marshall Islands and meets the Publicly Traded Test under current law and under the Final Section 883 Regulations. In addition, Teekay Corporation would be willing to provide us with such ownership statements as long as it is a qualified shareholder.
Therefore we believe that the requirements of Section 883 of the Code for 2009 were met and, if we were treated as a corporation for U.S. federal income tax purposes in 2009, our U.S. Source International Transportation Income (including for this purpose, any such income earned by our subsidiaries that have properly elected to be treated as partnerships or disregarded as entities separate from us for U.S. federal income tax purposes) for 2009 would be exempt from U.S. federal income taxation by reason of Section 883 of the Code.
Teekay Corporation, however, now owns less than 50% of the value of our outstanding equity interests. As such, we would need to look to our other non-U.S. unitholders to determine whether more than 50% of our units, by value, are owned by non-U.S. unitholders who are qualifying shareholders and certain non-U.S. unitholders may be asked to provide ownership statements, signed under penalty of perjury, with respect to their investment in our units in order for us to qualify for the Section 883 Exemption. We currently do not expect to be able to obtain ownership statements from non-U.S. unitholders holding, in the aggregate, more than 50% of the value of our units. Consequently, in the event we were treated as a corporation for U.S. federal income tax purposes, we anticipate that we would not be eligible to claim the Section 883 Exemption in 2010 and subsequent years.
The 4% Gross Basis Tax
If we were to be treated as a corporation and if the Section 883 Exemption and the net basis tax described below does not apply, we would be subject to a 4% U.S. federal income tax on our U.S. source Transportation Income, without benefit of deductions. We estimate that, in this event, we would be subject to less than $500,000 of U.S. federal income tax in 2010 and in each subsequent year (in addition to any U.S. federal income taxes on our subsidiaries, as described below) based on the amount of U.S. Source International Transportation Income we earned for 2009 and our expected U.S. Source International Transportation Income for subsequent years. The amount of such tax for which we would be liable for any year in which we were treated as a corporation for U.S. federal income tax purposes would depend upon the amount of income we earn from voyages into or out of the United States in such year, however, which is not within our complete control.
Net Basis Tax and Branch Profits Tax
We currently do not expect to have a fixed place of business in the United States. Nonetheless, if this were to change or we otherwise were treated as having such a fixed place of business involved in earning U.S. source Transportation Income, such Transportation Income may be treated as U.S. effectively connected income. Any income that we earn that is treated as U.S. effectively connected income would be subject to U.S. federal corporate income tax (the highest statutory rate currently is 35%), unless the Section 883 Exemption (as discussed above) applied. The 4% U.S. federal income tax described above is inapplicable to U.S. effectively connected income.
Unless the Section 883 Exemption applied, a 30% branch profits tax imposed under Section 884 of the Code also would apply to our earnings that result from U.S. effectively connected income, and a branch interest tax could be imposed on certain interest paid or deemed paid by us. Furthermore, on the sale of a vessel that has produced U.S. effectively connected income, we could be subject to the net basis corporate income tax and to the 30% branch profits tax with respect to our gain not in excess of certain prior deductions for depreciation that reduced U.S. effectively connected income. Otherwise, we would not be subject to U.S. federal income tax with respect to gain realized on sale of a vessel because it is expected that any sale of a vessel will be structured so that it is considered to occur outside of the United States and so that it is not attributable to an office or other fixed place of business in the United States.

 

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Taxation of Our Subsidiary Corporations: The Section 883 Exemption
Our subsidiaries Arctic Spirit L.L.C., Polar Spirit L.L.C. and Teekay Tangguh Holdco L.L.C. are classified as corporations for U.S. federal income tax purposes and are subject to U.S. federal income tax based on the rules applicable to foreign corporations described above under “Possible Classification as a Corporation—Taxation of Operating Income,” including, but not limited to, the 4% gross basis tax or the net basis tax if the Section 883 Exemption does not apply. We believe that the Section 883 Exemption would apply to our corporate subsidiaries to the extent that it would apply to us if we were to be treated as a corporation. As such, we believe that the Section 883 Exemption applied in 2009 and these subsidiaries were not be subject to either the 4% gross basis tax or the net basis tax in 2009. However, we anticipate that the subsidiaries will not be eligible to claim the Section 883 Exemption in 2010 and subsequent years and, therefore, the 4% gross basis tax will apply to our subsidiary corporations. In this regard, we estimate that we will be subject to approximately $500,000 or less of U.S. federal income tax in 2010 and in each subsequent year based on the amount of U.S. Source International Transportation Income these subsidiaries earned for 2009 and their expected U.S. Source International Transportation Income for 2010 and subsequent years. The amount of such tax for which they would be liable for any year will depend upon the amount of income they earn from voyages into or out of the United States in such year, which, however, is not within their complete control.
Other Taxation
We and our subsidiaries are subject to taxation in certain non-U.S. jurisdictions because we or our subsidiaries are either organized, or conduct business or operations, in such jurisdictions. We intend that our business and the business of our subsidiaries will be conducted and operated in a manner that minimizes taxes imposed upon us and our subsidiaries. However, we cannot assure this result as tax laws in these or other jurisdictions may change or we may enter into new business transactions relating to such jurisdictions, which could affect our tax liability. Please read Item 18 — Financial Statements: Note 20 — Income Taxes.

 

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Item 4A. Unresolved Staff Comments
Not applicable.
Item 5. Operating and Financial Review and Prospects
Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Teekay LNG Partners L.P. is an international provider of marine transportation services for LNG, LPG and crude oil. We were formed in 2004 by Teekay Corporation, the world’s largest owner and operator of medium sized crude oil tankers, to expand its operations in the LNG shipping sector. Our primary growth strategy focuses on expanding our fleet of LNG and LPG carriers under long-term, fixed-rate time-charters. We intend to continue our practice of acquiring LNG and LPG carriers as needed for approved projects only after the long-term charters for the projects have been awarded to us, rather than ordering vessels on a speculative basis. In executing our growth strategy, we may engage in vessel or business acquisitions or enter into joint ventures and partnerships with companies that may provide increased access to emerging opportunities from global expansion of the LNG and LPG sectors. We seek to leverage the expertise, relationships and reputation of Teekay Corporation and its affiliates to pursue these opportunities in the LNG and LPG sectors and may consider other opportunities to which our competitive strengths are well suited. We view our Suezmax tanker fleet primarily as a source of stable cash flow as we seek to expand our LNG and LPG operations.
Our primary goal is to increase our quarterly distributions to unitholders. During 2008, we increased distributions from $0.53 per unit for the first quarter of 2008 to $0.55 per unit effective for the second quarter of 2008 and to $0.57 per unit effective for the third quarter of 2008 and onwards.
SIGNIFICANT DEVELOPMENTS IN 2009
Equity Offerings and Conversion of Subordinated Units
On March 30, 2009, we completed a follow-on equity offering of 4.0 million common units at a price of $17.60 per unit, for gross proceeds of approximately $71.8 million (including Teekay GP L.L.C.’s (or the General Partner) proportionate capital contribution). As a result of this transaction, Teekay Corporation’s ownership of us was reduced from 57.7% to 53.0% (including its 2% percent General Partner interest). We used the total net proceeds from the offering of approximately $68.7 million to prepay amounts outstanding on two of our revolving credit facilities.
On May 19, 2009, 3.7 million subordinated units held by Teekay Corporation were converted into an equal number of common units as provided for under the terms of the partnership agreement and now participate pro rata with the other common units in distributions of available cash commencing with the August 2009 distribution. We anticipate that, pending confirmation of the results for the quarter ended March 31, 2010, the subordination period will end April 1, 2010 and the remaining subordinated units will convert to common units.
On November 20, 2009, we completed a follow-on equity offering of 3.5 million common units at a price of $24.40 per unit, for gross proceeds of approximately $87.2 million (including the General Partner’s 2% proportionate capital contribution). On November 25, 2009, the underwriters partially exercised their over-allotment option and purchased an additional 0.5 million common units for an additional $11.2 million in gross proceeds to us (including the General Partner’s 2% proportionate capital contribution). As a result of this offering, we raised gross proceeds of approximately $98.4 million (including our General Partner’s proportionate 2% capital contribution), and Teekay Corporation’s ownership of us was reduced from 53.1% to 49.2% (including its indirect 2% General Partner interest). The total net proceeds from the offering of approximately $93.9 million was used to prepay amounts outstanding under two of our revolving credit facilities.
Commencement of the Skaugen LPG Project
In December 2006, we agreed to acquire upon delivery three LPG carriers (or the Skaugen LPG Carriers) from subsidiaries of Skaugen each of which has a purchase price of approximately $33 million. The first two vessels delivered in 2009 and the remaining vessel is expected to deliver in mid-2010. Upon delivery, each vessel will be chartered at fixed rates for 15 years to Skaugen.
Tangguh LNG Project
In November 2006, we agreed to acquire from Teekay Corporation its 70% interest in a joint venture owning two 155,000 cubic meter LNG carriers (or the Tangguh LNG Carriers) and the related 20-year, fixed-rate time-charters to service the Tangguh LNG project in Indonesia. The remaining 30% interest in the joint venture relating to this project (or the Teekay Tangguh Joint Venture) is held by BLT LNG Tangguh Corporation, a subsidiary of PT Berlian Laju Tanker Tbk. The customer is The Tangguh Production Sharing Contractors, a consortium led by BP Berau Ltd., a subsidiary of BP plc.
The two Tangguh LNG carriers were delivered to the Teekay Tangguh Joint Venture in November 2008 and March 2009, respectively, and the related charters commenced in January 2009 and May 2009, respectively. On August 10, 2009, we acquired 99% of Teekay Corporation’s 70% interest in the Teekay Tangguh Joint Venture for $69.1 million net of assumed debt. Please read Item 18 – Financial Statements: Note 11(e) – Related Party Transactions.

 

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OTHER SIGNIFICANT PROJECTS
Acquisition of Three Conventional Tankers
On March 17, 2010, we acquired from Teekay Corporation for a total purchase price of $160 million two 2009-built 159,000 dwt Suezmax tankers, the Centrofin Suezmaxes, and a 2007-built 40,083 dwt Handymax product tanker, the Alexander Spirit, and the associated fixed-rate contracts. The remaining charter term for these vessels are 11 years and 10 years, respectively. We financed the acquisition by assuming $126 million of debt and by drawing $34 million from our existing revolvers. As a result of these acquisitions, our management plans to recommend to our Board of Directors an increase in our quarterly cash distribution by 3 cents per unit beginning with the first quarterly distribution to be paid in May 2010.
Agreement to Purchase Skaugen Multigas Carriers
On July 28, 2008, Teekay Corporation signed contracts for the purchase from Skaugen of two technically advanced 12,000-cubic meter newbuilding Multigas vessels (or the Skaugen Multigas Carriers) capable of carrying LNG, LPG or ethylene. We, in turn, agreed to acquire the vessels from Teekay upon delivery for a total cost of approximately $94 million. Both vessels are scheduled to be delivered in 2011. Upon delivery, each vessel will commence service under 15-year fixed-rate charters to Skaugen.
Angola LNG Project
In December 2007, a consortium in which Teekay Corporation has a 33% ownership interest agreed to charter four newbuilding 160,400-cubic meter LNG carriers for a period of 20 years to the Angola LNG Project. The Angola LNG Project is being developed by subsidiaries of Chevron Corporation, Sociedade Nacional de Combustiveis de Angola EP, BP Plc, Total S.A., and Eni SpA. The vessels will be chartered at fixed rates, subject to inflation adjustments, commencing in 2011. Mitsui & Co., Ltd. and NYK Bulkship (Europe) have 34% and 33% ownership interests in the consortium, respectively. Teekay Corporation is required to offer to us its 33% ownership interest in these vessels and related charter contracts not later than 180 days before delivery of the vessels. Deliveries of the vessels are scheduled for 2011 and 2012.
Important Financial and Operational Terms and Concepts
We use a variety of financial and operational terms and concepts when analyzing our performance. These include the following:
Voyage Revenues. Voyage revenues currently include revenues from time-charters accounted for under operating and direct financing leases. Voyage revenues are affected by hire rates and the number of calendar-ship-days a vessel operates. Voyage revenues are also affected by the mix of business between time and voyage charters. Hire rates for voyage charters are more volatile, as they are typically tied to prevailing market rates at the time of a voyage.
Voyage Expenses. Voyage expenses are all expenses unique to a particular voyage, including any bunker fuel expenses, port fees, cargo loading and unloading expenses, canal tolls, agency fees and commissions. Voyage expenses are typically paid by the customer under time-charters and by us under voyage charters.
Net Voyage Revenues. Net voyage revenues represent voyage revenues less voyage expenses. Because the amount of voyage expenses we incur for a particular charter depends upon the type of the charter, we use net voyage revenues to improve the comparability between periods of reported revenues that are generated by the different types of charters. We principally use net voyage revenues, a non-GAAP financial measure, because it provides more meaningful information to us about the deployment of our vessels and their performance than voyage revenues, the most directly comparable financial measure under GAAP.
Vessel Operating Expenses. We are responsible for vessel operating expenses, which include crewing, repairs and maintenance, insurance, stores, lube oils and communication expenses. The two largest components of vessel operating expenses are crews and repairs and maintenance.
Income from Vessel Operations. To assist us in evaluating our operations by segment, we sometimes analyze the income we receive from each segment after deducting operating expenses, but prior to the deduction of interest expense, taxes, foreign currency and interest rate swap gains or losses and other income and losses. For more information, please read Item 18 – Financial Statements: Note 4 – Segment Reporting.
Drydocking. We must periodically drydock each of our vessels for inspection, repairs and maintenance and any modifications required to comply with industry certification or governmental requirements. Generally, we drydock each of our vessels every five years. In addition, a shipping society classification intermediate survey is performed on our LNG and LPG carriers between the second and third year of a five-year drydocking period. We capitalize a portion of the costs incurred during drydocking and for the survey and amortize those costs on a straight-line basis from the completion of a drydocking or intermediate survey over the estimated useful life of the drydock. We expense as incurred costs for routine repairs and maintenance performed during drydocking or intermediate survey that do not improve operating efficiency or extend the useful lives of the assets. The number of drydockings undertaken in a given period and the nature of the work performed determine the level of drydocking expenditures.
Depreciation and Amortization. Our depreciation and amortization expense typically consists of the following three components:
   
charges related to the depreciation of the historical cost of our fleet (less an estimated residual value) over the estimated useful lives of our vessels;
   
charges related to the amortization of drydocking expenditures over the useful life of the drydock; and
   
charges related to the amortization of the fair value of the time-charters acquired in the 2004 Teekay Spain acquisition (over the remaining terms of the charters).

 

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Revenue Days. Revenue days are the total number of calendar days our vessels were in our possession during a period less the total number of off-hire days during the period associated with major repairs, drydockings or special or intermediate surveys. Consequently, revenue days represents the total number of days available for the vessel to earn revenue. Idle days, which are days when the vessel is available to earn revenue, yet is not employed, are included in revenue days. We use revenue days to explain some of the changes in our net voyage revenues between periods.
Calendar-Ship-Days. Calendar-ship-days are equal to the total number of calendar days that our vessels were in our possession during a period. As a result, we use calendar-ship-days primarily in explaining changes in vessel operating expenses and depreciation and amortization.
Utilization. Utilization is an indicator of the use of our fleet during a given period, and is determined by dividing our revenue days by our calendar-ship-days for the period.
Restricted Cash Deposits. Under capital lease arrangements for four of our LNG carriers, we (a) borrowed under term loans and deposited the proceeds into restricted cash accounts and (b) entered into capital leases, also referred to as “bareboat charters,” for the vessels. The restricted cash deposits, together with interest earned on the deposits, will equal the remaining amounts we owe under the lease arrangements, including our obligation to purchase the vessels at the end of the lease terms, where applicable. During vessel construction, we borrowed under the term loans and made restricted cash deposits equal to construction installment payments. For more information, please read Item 18 – Financial Statements: Note 5 – Leases and Restricted Cash.
RESULTS OF OPERATIONS
Items You Should Consider When Evaluating Our Results of Operations
Some factors that have affected our historical financial performance or will affect our future performance are listed below:
   
Our financial results reflect the results of the interests in vessels acquired from Teekay Corporation for all periods the vessels were under common control.  In April 2008, we acquired interests in two LNG carriers, the Arctic Spirit and the Polar Spirit (collectively, the Kenai LNG Carriers), from Teekay Corporation. This transaction was deemed to be a business acquisition between entities under common control. Accordingly, we have accounted for this transaction in a manner similar to the pooling of interest method whereby our financial statements prior to the date these vessels were acquired by us are retroactively adjusted to include the results of these acquired vessels. The periods retroactively adjusted include all periods that we and the acquired vessels were both under the common control of Teekay Corporation and had begun operations. As a result, our financial statements reflect these vessels and their results of operations referred to herein as the Dropdown Predecessor, as if we had acquired them when each respective vessel began operations under the ownership of Teekay Corporation, which were December 13 and 14, 2007 (the two Kenai LNG Carriers).
   
Our financial results reflect the consolidation of Teekay Tangguh, Teekay Nakilat (III), and the Skaugen Multigas Carriers prior to our purchase of interests in those entities. On November 1, 2006, we entered into an agreement with Teekay Corporation to purchase (a) its 100% interest in Teekay Tangguh Borrower LLC (or Teekay Tangguh), which owns a 70% interest in the Teekay Tangguh Joint Venture, and (b) its 100% interest in Teekay Nakilat (III) Holdings Corporation (or Teekay Nakilat (III)), which owns a 40% interest in Teekay Nakilat (III) Corporation (or the RasGas 3 Joint Venture). The Teekay Tangguh Joint Venture owns two Tangguh LNG carriers and related 20-year time-charters. The RasGas 3 Joint Venture owns the four RasGas 3 LNG Carriers and the related 25-year time-charters. We have been required to consolidate Teekay Tangguh in our consolidated financial statements since November 1, 2006, until we acquired this entity on August 10, 2009, as it was a variable interest entity and we were its primary beneficiary. We likewise consolidated in our financial statements Teekay Nakilat (III) as a variable interest entity of which we were the primary beneficiary from November 1, 2006 until we purchased it on May 6, 2008. After this purchase, Teekay Nakilat (III) was no longer a variable interest entity and we now equity account for Teekay Nakilat (III)’s investment in the RasGas 3 Joint Venture in our consolidated financial statements. On July 28, 2008, Teekay Corporation signed contracts for the purchase of the two Skaugen Multigas Carriers from subsidiaries of Skaugen. As described above, we have agreed to acquire the companies that own the Skaugen Multigas Carriers from Teekay Corporation upon delivery of the vessels. Since July 28, 2008, we have consolidated these ship-owning companies in our financial statements as variable interest entities as we are the primary beneficiary. Please read Item 18 — Financial Statements: Notes 11(e), 11(g), and 11(l) – Related Party Transactions and Note 13(a) — Commitments and Contingencies.
Subsidiaries of the Teekay Tangguh Joint Venture entered into a U.K. tax lease in December 2007. Upon delivery of the Tangguh LNG Carriers, subsidiaries of the Teekay Tangguh Joint Venture leased the vessels to Everest Leasing Company Limited (or Everest) for a period of 20 years under a tax lease arrangement. Simultaneously, Everest leased the vessels back to other subsidiaries of the Teekay Tangguh Joint Venture for a period of 20 years.
   
Our financial results are affected by fluctuations in the fair value of our derivative instruments. The change in fair value of our derivative instruments is included in our net income (loss) as our derivative instruments are not designated as hedges for accounting purposes. These changes may fluctuate significantly as interest rates and spot tanker rates fluctuate relating to our interest rate swaps and to the agreement we have with Teekay Corporation for the Toledo Spirit time-charter contract, respectively. Please read Item 18 – Financial Statements: Note 11(m) – Related Party Transactions and Note 12 – Derivative Instruments. The unrealized gains or losses relating to the change in fair value of our derivative instruments do not impact our cash flows.
   
Our financial results are affected by fluctuations in currency exchange rates. Under GAAP, all foreign currency-denominated monetary assets and liabilities, such as cash and cash equivalents, restricted cash, accounts receivable, accounts payable, advances from affiliates and long-term debt are revalued and reported based on the prevailing exchange rate at the end of the period. These foreign currency translations fluctuate based on the strength of the U.S. dollar relative mainly to the Euro and are included in our results of operations. The translation of all foreign currency-denominated monetary assets and liabilities are unrealized foreign currency exchange gains or losses and do not impact our cash flows.

 

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The size of our fleet will change. Our historical results of operations reflect changes in the size and composition of our fleet due to certain vessel deliveries. Please read “Liquefied Gas Segment” below and “Other Significant Projects” above for further details about certain prior and future vessel deliveries.
   
One of our Suezmax tankers earns revenues based partly on spot market rates. The time-charter for one Suezmax tanker, the Teide Spirit, contains a component providing for additional revenues to us beyond the fixed-hire rate when spot market rates exceed certain threshold amounts. Accordingly, even though declining spot market rates will not result in our receiving less than the fixed-hire rate, our results at the end of each fiscal year may continue to be influenced, in part, by the variable component of the Teide Spirit charter. During 2009, 2008 and 2007, we earned $0.6 million, $6.6 million and $1.9 million, respectively, in additional revenue from this variable component.
   
Our vessel operating costs are facing industry-wide cost pressures. The oil shipping industry is experiencing a global manpower shortage due to growth in the world fleet. This shortage resulted in significant crew wage increases during 2007, 2008, and to a lesser degree in 2009. We expect the trend of significant crew compensation increases to abate in the short term. However this could change if market conditions adjust. In addition, factors such as pressure on raw material prices and changes in regulatory requirements could also increase operating expenditures. We have taken various measures throughout 2009 in an effort to reduce costs, improve operational efficiencies, and mitigate the impact of inflation and price increases and will continue this effort during 2010.
   
The amount and timing of drydockings of our vessels can significantly affect our revenues between periods.  Our vessels are off-hire at various points of time due to scheduled and unscheduled maintenance. During the years ended December 31, 2009, 2008 and 2007, we had 70, 123 and 72 off-hire days relating to drydocking, respectively. The financial impact from these periods of off-hire, if material, is explained in further detail below. Five vessels are scheduled for drydocking in 2010.
Year Ended December 31, 2009 versus Year Ended December 31, 2008
Liquefied Gas Segment
Our fleet includes 15 LNG carriers (including the four RasGas 3 LNG Carriers, which are accounted for under the equity method, and the two Tangguh LNG Carriers which are held by Teekay Tangguh, (which was a variable interest entity until we acquired it from Teekay Corporation in August 2009) and three LPG carriers. All of our LNG and LPG carriers operate under long-term, fixed-rate time-charters. We expect our liquefied gas segment to increase due to the following:
   
As discussed above, we have agreed to acquire the third Skaugen LPG carrier for approximately $33 million upon its delivery scheduled for mid-2010. Please read Item 18 – Financial Statements: Note 13(b) – Commitments and Contingencies.
   
As discussed above, we have agreed to acquire upon delivery the Skaugen Multigas Carriers from Teekay Corporation for a total cost of approximately $94 million upon their deliveries, which are scheduled for 2011. Please read Item 18 – Financial Statements: Note 11(l) – Related Party Transactions and Note 13 – Commitments and Contingencies.
   
As discussed above, Teekay Corporation is required to offer to us its 33% ownership interest in the consortium relating to the Angola LNG Project not later than 180 days before the deliveries of the related four newbuilding LNG carriers, which are scheduled for 2011 and 2012. Please read Item 18 – Financial Statements: Note 16 – Other Information.
The following table compares our liquefied gas segment’s operating results for the years ended December 31, 2009 and 2008, and compares its net voyage revenues (which is a non-GAAP financial measure) for the years ended December 31, 2009 and 2008 to voyage revenues, the most directly comparable GAAP financial measure. The following table also provides a summary of the changes in calendar-ship-days and revenue days for our liquefied gas segment:
                         
(in thousands of U.S. dollars, except revenue   Year Ended December 31,        
days, calendar-ship-days and percentages)   2009     2008     % Change  
 
                       
Voyage revenues
    252,854       222,318       13.7  
Voyage expenses
    1,018       1,397       (27.1 )
 
                 
Net voyage revenues
    251,836       220,921       14.0  
Vessel operating expenses
    50,919       49,400       3.1  
Depreciation and amortization
    59,088       57,880       2.1  
General and administrative (1)
    11,033       11,247       (1.9 )
Restructuring charge
    1,381             100.0  
 
                 
Income from vessel operations
    129,415       102,394       26.4  
 
                 
 
                       
Operating Data:
                       
Revenue Days (A)
    4,491       3,631       23.7  
Calendar-Ship-Days (B)
    4,637       3,701       25.3  
Utilization (A)/(B)
    97 %     98 %        
     
(1)  
Includes direct general and administrative expenses and indirect general and administrative expenses (allocated to each segment based on estimated use of resources).

 

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Our liquefied gas segment’s operating results include 14 LNG and LPG carriers (not including the four RasGas 3 LNG Carriers delivered in 2008, which are accounted for under the equity method following their deliveries between May and July of 2008). During the first half of 2009, both Tangguh LNG Carriers were in operation. The Tangguh Hiri was delivered in November 2008 and its charter commenced in January 2009. The Tangguh Sago delivered to Teekay Corporation in March 2009 and its charter commenced in May 2009. The first two Skaugen LPG carriers, the Norgas Pan and Norgas Cathinka, delivered and commenced their charters in April and November 2009, respectively. As a result, our total calendar-ship-days increased by 25.3% to 4,637 days in 2009 from 3,701 days in 2008. In August 2009, we purchased from Teekay Corporation the Tangguh LNG Carriers. However, as Teekay Tangguh was a variable interest entity in which we were the primary beneficiary, it has been included in our results since November 2006.
During 2008 one of our LNG carriers, the Catalunya Spirit, was off-hire for approximately 6 days due to the loss of propulsion and 29 days for a scheduled drydock. The cost of the repairs was $0.7 million and we recovered $0.5 million under a protection and indemnity insurance policy. The vessel was repaired and resumed normal operations.
Net Voyage Revenues. Net voyage revenues increased during 2009 compared to 2008, primarily as a result of:
   
an increase of $32.2 million due to the commencement of the time-charters for the two Tangguh LNG Carriers in January and May 2009, respectively;
   
an increase of $3.5 million due to the commencement of the time-charters for the Norgas Pan and Norgas Cathinka in April and November 2009, respectively;
   
an increase of $3.1 million due to the Catalunya Spirit being off-hire for 34.3 days during 2008 for repairs;
   
an increase of $1.0 million due to the Polar Spirit being off-hire for 18.5 days during 2008 for a scheduled drydock; and
   
an increase of $0.4 million due to an escalation to the daily charter rates under the time-charter contracts for three LNG carriers;
partially offset by
   
a decrease of $3.8 million due to the effect on our Euro-denominated revenues from the weakening of the Euro against the U.S. Dollar compared to the same period last year;
   
a decrease of $2.1 million due to the Madrid Spirit being off-hire for 25.2 days during the third quarter of 2009 for a scheduled drydock;
   
a decrease of $1.9 million due to the Galicia Spirit being off-hire for 27.6 days during the third quarter of 2009 for a scheduled drydock; and
   
a decrease of $1.6 million due to a provision for crewing rate adjustment related to the time-charter contract for the two Kenai LNG Carriers.
Vessel Operating Expenses. Vessel operating expenses increased during 2009 compared to 2008, primarily as a result of:
   
an increase of $6.3 million from the deliveries of the Tangguh LNG Carriers in November 2008 and March 2009, respectively;
partially offset by
   
a decrease of $2.7 million relating to lower crew manning, insurance, and repairs and maintenance costs;
   
a decrease of $1.3 million relating to service costs associated with the Dania Spirit being off-hire for 15.5 days during 2008 for a scheduled drydock; and
   
a decrease of $0.8 million due to the effect on our Euro-denominated vessel operating expenses from the weakening of the Euro against the U.S. Dollar compared to the same period last year (a portion of our vessel operating expenses are denominated in Euros, which is primarily a function of the nationality of our crew).
Depreciation and Amortization. Depreciation and amortization increased during 2009 compared to 2008, primarily as a result of:
   
an increase of $1.3 million from the delivery of the Tangguh Sago in March 2009 prior to the commencement of the time-charter contract in May 2009 which is accounted for as a direct financing lease;
   
an increase of $1.0 million from the delivery of the Norgas Pan and the Norgas Cathinka in April and November 2009, respectively;
   
an increase of $0.2 million due to the amortization of costs associated with vessel cost expenditures during 2008; and
   
an increase of $0.2 million relating to amortization of drydock expenditures incurred during 2009;
partially offset by
   
a decrease of $1.0 million due to revised depreciation estimates; and
   
a decrease of $0.6 million from the commencement of the time-charter contract for the Tangguh Hiri in January 2009 which is accounted for as a direct financing lease.

 

39


 

Suezmax Tanker Segment
During 2009 and 2008, we operated eight Suezmax-class double-hulled conventional crude oil tankers. All of our Suezmax tankers operate under long-term, fixed-rate time-charters.
The following table compares our Suezmax tanker segment’s operating results for the year ended December 31, 2009 and 2008, and compares its net voyage revenues (which is a non-GAAP financial measure) for the year ended December 31, 2009 and 2008 to voyage revenues, the most directly comparable GAAP financial measure. The following table also provides a summary of the changes in calendar-ship-days and revenue days for our Suezmax tanker segment:
                         
(in thousands of U.S. dollars, except revenue   Year Ended December 31,        
days, calendar-ship-days and percentages)   2009     2008     % Change  
 
                       
Voyage revenues
    73,175       92,086       (20.5 )
Voyage expenses
    884       1,856       (52.4 )
 
                 
Net voyage revenues
    72,291       90,230       (19.9 )
Vessel operating expenses
    26,563       27,713       (4.1 )
Depreciation and amortization
    19,654       19,000       3.4  
General and administrative (1)
    7,129       8,954       (20.4 )
Goodwill impairment
          3,648       (100.0 )
Restructuring charge
    1,869             100.0  
 
                 
Income from vessel operations
    17,076       30,915       (44.8 )
 
                 
 
                       
Operating Data:
                       
Revenue Days (A)
    2,903       2,866       1.3  
Calendar-Ship-Days (B)
    2,920       2,928       (0.3 )
Utilization (A)/(B)
    99 %     98 %        
     
(1)  
Includes direct general and administrative expenses and indirect general and administrative expenses (allocated to each segment based on estimated use of corporate resources).
Net Voyage Revenues. Net voyage revenues decreased during 2009 compared to 2008, primarily as a result of:
   
a decrease of $7.7 million relating to lower revenues earned by the Toledo Spirit relating to the agreement between us and Teekay Corporation for the Toledo Spirit time charter contract (however, we had a corresponding decrease in our realized loss on derivatives; therefore this decrease and future increases or decreases related to this agreement did not and will not affect our cash flow or net income);
   
a decrease of $6.3 million due to interest-rate adjustments to the daily charter rates under the time-charter contracts for five Suezmax tankers (however, under the terms of these capital leases, we had corresponding decreases in our lease payments, which are reflected as decreases to interest expense; therefore, these and future interest rate adjustments do not and will not affect our cash flow or net income (loss));
   
a decrease of $6.0 million relating to lower revenues earned by the Teide Spirit due to market rates being lower than specified amounts under our time charter (the time charter for the Teide Spirit contains a component providing for additional revenues to us beyond the fixed hire rate when spot market rates exceed threshold amounts); and
   
a decrease of $0.4 million due to the Teide Spirit being off-hire for 16 days during 2009 for a scheduled drydock;
partially offset by
   
an increase of $0.6 million relating to lower bunker fuel expense incurred during vessel drydocking;
   
an increase of $0.6 million due to the European Spirit being off-hire for 24.1 days during 2008 for a scheduled drydock;
   
an increase of $0.5 million due to the African Spirit being off-hire for 19 days during 2008 for a scheduled drydock; and
   
an increase of $0.5 million due to the Asian Spirit being off-hire for 19.4 days during 2008 for a scheduled drydock.
The realized and unrealized loss of $10.6 million relating to the Toledo Spirit time-charter contract for 2008 was reclassified from voyage revenues to realized and unrealized gain (loss) on derivative instruments to conform to the presentation adopted for the current year.
Vessel Operating Expenses. Vessel operating expenses decreased during 2009 compared to 2008, primarily as a result of:
   
a decrease of $0.9 million due to the effect on our Euro-denominated vessel operating expenses from the weakening of the Euro against the U.S. Dollar during such period compared to the same periods last year (a portion of our vessel operating expenses are denominated in Euros, which is primarily a function of the nationality of our crew); and
   
a decrease of $0.1 million relating to lower crew manning, insurance, and repairs and maintenance costs.

 

40


 

Depreciation and Amortization. Depreciation and amortization increased during 2009 compared to 2008, primarily as a result of an increase of $0.6 million due to the amortization of costs associated with the scheduled drydockings during 2008 relating to the European Spirit, the Asian Spirit and the African Spirit.
Goodwill Impairment. During 2008, due to the decline in market conditions, we conducted an interim impairment review of our reporting units during 2008. The fair value of the reporting units was estimated using the expected present value of future cash flows. The fair value of the reporting units was then compared to its carrying values and it was determined that the fair value attributable our Suezmax tanker segment was less than its carrying value. As a result of our review, a goodwill impairment loss of $3.6 million was recognized in the Suezmax tanker reporting unit during 2008. In 2009, we conducted a goodwill impairment review of our liquefied gas segment and concluded that no impairment existed at December 31, 2009.
Other Operating Results
General and Administrative Expenses. General and administrative expenses decreased 10.1% to $18.2 million for 2009 from $20.2 for 2008. This decrease was primarily the result of:
   
a decrease of $2.5 million relating to lower annual long-term incentive plan accruals and the impact of our restructuring plan, which reduced the number of shore-based staff in our Spain office; and
   
a decrease of $0.5 million relating to lower corporate and office expenses;
partially offset by
   
an increase of $1.1 million associated with corporate services provided to us by subsidiaries of Teekay Corporation.
Restructuring Charge. During 2009, we restructured certain ship management functions from our office in Spain to a subsidiary of Teekay Corporation and the change of the nationality of some of the seafarers. During 2009, we incurred $3.3 million in connection with these restructuring plans.
Interest Expense. Interest expense decreased 57.1% to $59.3 million for 2009, from $138.3 million for 2008. Interest expense primarily reflects interest incurred on our capital lease obligations and long-term debt. This decrease was primarily the result of:
   
a decrease of $35.1 million as the debt relating to Teekay Nakilat (III) was novated to the RasGas 3 Joint Venture on December 31, 2008. Please read Item 18 – Financial Statements: Note 11(g) – Related Party Transactions (the interest expense on this debt is not reflected in our 2009 consolidated interest expense as the RasGas 3 Joint Venture is accounted for using the equity method);
   
a decrease of $20.0 million due to a decrease of LIBOR rates relating to the long-term debt in Teekay Nakilat Corporation (or Teekay Nakilat). Please read Item 18 – Financial Statements: Note 9 – Long-Term Debt;
   
a decrease of $15.4 million from the scheduled loan payments on the Catalunya Spirit, and scheduled capital lease repayments on the Madrid Spirit (the Madrid Spirit is financed pursuant to a Spanish tax lease arrangement, under which we borrowed under a term loan and deposited the proceeds into a restricted cash account and entered into a capital lease for the vessel; as a result, this decrease in interest expense from the capital lease is offset by a corresponding decrease in the interest income from restricted cash);
   
a decrease of $4.7 million from declining interest rates on our five Suezmax tanker capital lease obligations (however, as described above, under the terms of the time-charter contracts for these vessels, we received corresponding decreases in charter payments, which are reflected as a decrease to voyage revenues);
   
a decrease of $3.0 million relating to the interest expense attributable to the operations of the Kenai LNG Carriers that was incurred by Teekay Corporation and allocated to us as part of the results of the Dropdown Predecessor;
   
a decrease of $2.2 million relating to debt used to fund general corporate purposes; and
   
a decrease of $1.6 million due to the effect on our Euro-denominated debt from the weakening of the Euro against the U.S. Dollar during such period compared to the same periods last year;
partially offset by
   
an increase of $2.5 million relating to debt to finance the purchase of the Tangguh LNG Carriers as the interest on this debt was capitalized in 2008; and
   
an increase of $0.4 million due to amortization of deferred debt issuance costs.
Realized and unrealized losses incurred in 2008 of $265.9 million relating to interest rate swaps were reclassified from interest expense to realized and unrealized gain (loss) on derivative instruments to conform to the presentation adopted in the current period.

 

41


 

Interest Income. Interest income decreased 78.4% to $13.9 million for 2009, from $64.3 million for 2008. Interest income primarily reflects interest earned on restricted cash deposits that approximate the present value of the remaining amounts we owe under lease arrangements on four of our LNG carriers. This decrease was primarily the result of:
   
a decrease of $33.5 million relating to interest-bearing advances made by us to the RasGas 3 Joint Venture for shipyard construction installment payments repaid on December 31, 2008 when the debt was novated to the RasGas 3 Joint Venture;
   
a decrease of $13.4 million due to decreases in LIBOR rates relating to the restricted cash in Teekay Nakilat that is used to fund capital lease payments for the RasGas II LNG Carriers;
   
a decrease of $1.5 million relating to lower interest rates on our bank accounts compared to the same periods last year;
   
a decrease of $0.4 million due to the effect on our Euro-denominated deposits from the weakening of the Euro against the U.S. Dollar during such periods compared to the same period last year; and
   
a decrease of $0.3 million primarily from scheduled capital lease repayments on one of our LNG carriers which was funded from restricted cash deposits.
Realized and unrealized gains of $176.6 million recognized in 2008 relating to interest rate swaps were reclassified from interest income to realized and unrealized gain (loss) on derivative instruments to conform to the presentation adopted in the current period.
Realized and Unrealized Loss on Derivative Instruments. Net realized and unrealized losses on derivative instruments decreased 59.0% to $41.0 million in 2009 from $100.0 million in 2008 as detailed in the table below.
                 
    Year Ended December 31,  
    2009     2008  
(in thousands of U.S. dollars)   $     $  
Realized losses relating to:
               
Interest rate swaps
    (36,222 )     (6,788 )
Toledo Spirit time-charter derivative contract
    (940 )     (8,620 )
 
           
 
    (37,162 )     (15,408 )
 
           
 
               
Unrealized (losses) gains relating to:
               
Interest rate swaps
    (11,143 )     (82,543 )
Toledo Spirit time-charter derivative contract
    7,355       (2,003 )
 
           
 
    (3,788 )     (84,546 )
 
           
Total realized and unrealized losses on derivative instruments
    (40,950 )     (99,954 )
 
           
Foreign Currency Exchange (Losses) Gains. Foreign currency exchange losses were $10.8 million for 2009, compared to foreign currency exchange gains of $18.2 million for 2008. These foreign currency exchange gains and losses, substantially all of which were unrealized, are due primarily to the relevant period-end revaluation of Euro-denominated term loans and restricted cash for financial reporting purposes. Losses reflect a weaker U.S. Dollar against the Euro on the date of revaluation. Gains reflect a stronger U.S. Dollar against the Euro on the date of revaluation.
Equity Income (Loss). Equity income was $27.6 million for 2009, compared to a nominal loss for 2008. This change is primarily due to the operations of the four RasGas 3 LNG Carriers, which were delivered between May and July 2008, and RasGas 3 Joint Venture’s realized and unrealized gain on its interest rate swaps. The unrealized gain on its interest rate swaps included in equity income for 2009 and 2008 was $10.9 million and nil, respectively.
Year Ended December 31, 2008 versus Year Ended December 31, 2007
Liquefied Gas Segment
We operated eleven LNG and LPG carriers (excluding the four RasGas 3 LNG Carriers delivered in 2008, which are accounted for under the equity method following their deliveries between May and July of 2008) and eight LNG and LPG carriers during 2008 and 2007, respectively. We took delivery of the RasGas II LNG Carriers in January and February 2007, respectively (collectively, the 2007 RasGas II Deliveries), as well as one LPG carrier, the Dania Spirit, in January 2007. On April 1, 2008, we purchased from Teekay Corporation two Kenai LNG Carriers, the Arctic Spirit and the Polar Spirit; however, as they are included among the vessels constituting the Dropdown Predecessor, they have been included in our results as if they were acquired on December 13 and 14, 2007, respectively, when they began operations under the ownership of Teekay Corporation. On November 21, 2008, we took delivery of one LNG carrier, the Tangguh Hiri. As a result, our total calendar-ship-days increased by 27.8% to 3,701 days in 2008 from 2,897 days in 2007.

 

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The following table compares our liquefied gas segment’s operating results for the years ended December 31, 2008 and 2007, and compares its net voyage revenues (which is a non-GAAP financial measure) for the years ended December 31, 2008 and 2007 to voyage revenues, the most directly comparable GAAP financial measure. The following table also provides a summary of the changes in calendar-ship-days and revenue days for our liquefied gas segment:
                         
(in thousands of U.S. dollars, except revenue   Year Ended December 31,        
days, calendar-ship-days and percentages)   2008     2007     % Change  
 
                       
Voyage revenues
    222,318       172,822       28.6  
Voyage expenses
    1,397       109       1,181.7  
 
                 
Net voyage revenues
    220,921       172,713       27.9  
Vessel operating expenses
    49,400       32,696       51.1  
Depreciation and amortization
    57,880       45,986       25.9  
General and administrative (1)
    11,247       7,445       51.1  
 
                 
Income from vessel operations
    102,394       86,586       18.3  
 
                 
 
                       
Operating Data:
                       
Revenue Days (A)
    3,631       2,825       28.5  
Calendar-Ship-Days (B)
    3,701       2,897       27.8  
Utilization (A)/(B)
    98 %     98 %        
     
(1)  
Includes direct general and administrative expenses and indirect general and administrative expenses (allocated to each segment based on estimated use of resources).
Net Voyage Revenues. Net voyage revenues increased during 2008 compared to 2007, primarily as a result of:
   
an increase of $37.3 million due to full year operations in 2008 of the two Kenai LNG Carriers acquired by Teekay Corporation in 2007;
   
an increase of $6.0 million due to full year operations in 2008 of the RasGas II LNG Carriers delivered in 2007;
   
an increase of $4.7 million due to the effect on our Euro-denominated revenues from the strengthening of the Euro against the U.S. Dollar compared to the same period last year;
   
a relative increase of $2.0 million due to the Hispania Spirit being off-hire for 30.8 days for a scheduled drydock during July 2007; and
   
a net increase of $1.1 million due to the Madrid Spirit being off-hire during 2007;
partially offset by:
   
a decrease of $3.1 million due to the Catalunya Spirit being off-hire for 34.3 days during 2008, as discussed above;
   
a decrease of $0.3 million due to the Dania Spirit being off-hire for 15.5 days during 2008 for a scheduled drydock; and
   
a decrease of $0.4 million due to the delivery of the Tangguh Hiri in November 2008;
Vessel Operating Expenses. Vessel operating expenses increased during 2008 compared to 2007, primarily as a result of:
   
an increase of $11.5 million due to full year operations of the two Kenai LNG Carriers acquired by Teekay Corporation in 2007;
   
an increase of $2.3 million due to the effect on our Euro-denominated vessel operating expenses from the strengthening of the Euro against the U.S. Dollar during such periods compared to the same periods last year (a portion of our vessel operating expenses are denominated in Euros, which is primarily a function of the nationality of our crew);
   
an increase of $1.4 million relating to higher crew manning, insurance and repairs and maintenance costs;
   
an increase of $1.3 million relating to service costs associated with the Dania Spirit being off-hire for 15.5 days during 2008 for a scheduled drydock; and
   
an increase of $1.1 million from the delivery of Tangguh Hiri in November 2008;
partially offset by
   
a relative decrease of $0.8 million relating to the cost of the repairs completed on the Madrid Spirit during the second quarter of 2007 net of estimated insurance recoveries.
Depreciation and Amortization. Depreciation and amortization increased during 2008 compared to 2007, primarily as a result of:
   
an increase of $9.4 million due to full year operations in 2008 of the two Kenai LNG Carriers acquired by Teekay Corporation in 2007;
   
an increase of $1.7 million due to full year operations in 2008 of the RasGas II LNG Carriers delivered in 2007;
   
an increase of $0.6 million from the delivery of the Tangguh Hiri; and
   
an increase of $0.4 million relating to amortization of drydock expenditures incurred during 2008.

 

43


 

Suezmax Tanker Segment
During 2008 and 2007, we operated eight Suezmax-class double-hulled conventional crude oil tankers. All of our Suezmax tankers operate under long-term, fixed-rate time charters.
The following table compares our Suezmax tanker segment’s operating results for the year ended December 31, 2008 and 2007, and compares its net voyage revenues (which is a non-GAAP financial measure) for the year ended December 31, 2008 and 2007 to voyage revenues, the most directly comparable GAAP financial measure. The following table also provides a summary of the changes in calendar-ship-days and revenue days for our Suezmax tanker segment:
                         
(in thousands of U.S. dollars, except revenue   Year Ended December 31,        
days, calendar-ship-days and percentages)   2008     2007     % Change  
 
                       
Voyage revenues
    92,086       84,947       8.4  
Voyage expenses
    1,856       1,088       70.6  
 
                 
Net voyage revenues
    90,230       83,859       7.6  
Vessel operating expenses
    27,713       24,167       14.7  
Depreciation and amortization
    19,000       20,031       (5.1 )
General and administrative (1)
    8,954       7,741       15.7  
Goodwill impairment
    3,648             100.0  
 
                 
Income from vessel operations
    30,915       31,920       (3.1 )
 
                 
 
                       
Operating Data:
                       
Revenue Days (A)
    2,866       2,920       (1.8 )
Calendar-Ship-Days (B)
    2,928       2,920       0.3  
Utilization (A)/(B)
    98 %     100 %        
     
(1)  
Includes direct general and administrative expenses and indirect general and administrative expenses (allocated to each segment based on estimated use of corporate resources).
Net Voyage Revenues. Net voyage revenues increased during 2008 compared to 2007, primarily as a result of:
   
an increase of $6.7 million relating to higher revenues earned by the Toledo Spirit relating to the agreement between us and Teekay Corporation for the Toledo Spirit time charter contract (however, we had a corresponding increase in our realized loss on derivatives; therefore this increase and future increases or decreases related to this agreement did not and will not affect our cash flow or net income); and
   
an increase of $4.6 million relating to higher revenues earned by the Teide Spirit due to market rates exceeding specified amounts under our time charter (the time charter for the Teide Spirit contains a component providing for additional revenues to us beyond the fixed hire rate when spot market rates exceed threshold amounts);
partially offset by
   
a decrease of $2.6 million due to interest-rate adjustments to the daily charter rates under the time charter contracts for five Suezmax tankers (however, under the terms of these capital leases, we had corresponding decreases in our lease payments, which are reflected as decreases to interest expense; therefore, these and future interest rate adjustments do not and will not affect our cash flow or net income);
   
a decrease of $0.8 million relating to higher bunker fuel expense incurred during vessel drydocking;
   
a decrease of $0.6 million due to the European Spirit being off-hire for 24.1 days during 2008 for a scheduled drydock;
   
a decrease of $0.5 million due to the Asian Spirit being off-hire for 19.4 days during 2008 for a scheduled drydock; and
   
a decrease of $0.5 million due to the African Spirit being off-hire for 18.9 days during 2008 for a scheduled drydock.
The realized and unrealized (loss) gain of ($10.6) million and $12.2 million relating to the Toledo Spirit time-charter contract for 2008 and 2007, respectively, were reclassified from voyage revenues to realized and unrealized gain (loss) on derivative instruments to conform to the presentation adopted for the current period.
Vessel Operating Expenses. Vessel operating expenses increased during 2008 compared to 2007, primarily as a result of:
   
an increase of $2.7 million relating to higher crew manning, insurance, and repairs and maintenance costs; and
   
an increase of $1.0 million due to the effect on our Euro-denominated vessel operating expenses from the strengthening of the Euro against the U.S. Dollar during such period compared to the same periods last year (a portion of our vessel operating expenses are denominated in Euros, which is primarily a function of the nationality of our crew).

 

44


 

Depreciation and Amortization. Depreciation and amortization decreased during 2008 compared to 2007, primarily as a result of:
   
a decrease of $1.5 million due to an increase in salvage value estimates on our Suezmax tanker fleet;
partially offset by
   
an increase of $0.5 million due to the amortization of the costs associated with the scheduled drydockings during 2008 relating to the European Spirit, the Asian Spirit and the African Spirit.
Goodwill Impairment. Due to the decline in market conditions, we conducted an interim impairment review of our reporting units during 2008. The fair value of the reporting units was estimated using the expected present value of future cash flows. The fair value of the reporting units was then compared to its carrying values and it was determined that the fair value attributable our Suezmax tanker segment was less than its carrying value. As a result of our review, a goodwill impairment loss of $3.6 million was recognized in the Suezmax tanker reporting unit during 2008.
Other Operating Results
General and Administrative Expenses. General and administrative expenses increased 33% to $20.2 million for 2008, from $15.2 for 2007. This increase was primarily the result of:
   
an increase of $1.8 million associated with corporate services provided to us by Teekay Corporation subsidiaries;
   
an increase of $1.4 million relating to audit, legal and tax research costs, related primarily to the restatement of our financial results for the years 2003 through 2007 and first quarter of 2008;
   
an increase of $0.6 million relating to annual cost of living increases in salaries and benefits and long-term incentive plan accruals; and
   
an increase of $0.2 million associated with additional ship management services provided to us by Teekay Corporation subsidiaries relating to the deliveries of the RasGas II LNG Carriers, the first Tangguh LNG Carrier and the purchase of the Kenai LNG Carriers; and
Interest Expense. Interest expense decreased 4.7% to $138.3 million for 2008, from $145.1 million for 2007. Interest expense primarily reflects interest incurred on our capital lease obligations and long-term debt. This change was primarily the result of:
   
a decrease of $14.6 million relating to the decrease in interest rates and debt of Teekay Nakilat used to finance restricted cash deposits and repay advances from Teekay Corporation;
   
a decrease of $2.1 million from declining interest rates on our five Suezmax tanker capital lease obligations (however, as described above, under the terms of the time charter contracts for these vessels, we received corresponding decreases in charter payments, which are reflected as a decrease to voyage revenues);
   
a decrease of $2.1 million from the scheduled loan payments on the Catalunya Spirit, and scheduled capital lease repayments on the Madrid Spirit (the Madrid Spirit is financed pursuant to a Spanish tax lease arrangement, under which we borrowed under a term loan and deposited the proceeds into a restricted cash account and entered into a capital lease for the vessel; as a result, this decrease in interest expense from the capital lease is offset by a corresponding decrease in the interest income from restricted cash); and
   
a relative decrease of $0.6 million relating to the write-off of deferred debt issuance costs resulting from refinancing the Teekay Tangguh Joint Venture debt in December 2007;
partially offset by
   
an increase of $6.6 million relating to debt of Teekay Nakilat (III) used by the RasGas 3 Joint Venture to fund shipyard construction installment payments (as indicated below, a portion of this increase in interest expense is offset by a corresponding increase in interest income from advances to the joint venture);
   
an increase of $3.0 million relating to debt incurred to finance the acquisition of the Kenai LNG Carriers;
   
an increase of $2.2 million due to the effect on our Euro-denominated debt from the strengthening of the Euro against the U.S. Dollar during such period compared to the same period last year; and
   
an increase of $1.0 million due to amortization of deferred debt issuance costs.
Realized and unrealized losses in 2008 and 2007 of $265.9 and $22.8 million, respectively, relating to interest rate swaps were reclassified from interest expense to realized and unrealized gain (loss) on derivative instruments to conform to the presentation adopted in the current period.
Interest Income. Interest income decreased 5.9% to $64.3 million for 2008, from $68.3 million for 2007. Interest income primarily reflects interest earned on restricted cash deposits that approximate the present value of the remaining amounts we owe under lease arrangements on four of our LNG carriers. This change was primarily the result of:
   
a decrease of $10.1 million relating to a decrease in interest rates and restricted cash used to fund capital lease payments for the RasGas II LNG Carriers; and
   
a decrease of $1.1 million, primarily from scheduled capital lease repayments on one of our LNG carriers which was funded from restricted cash deposits;

 

45


 

partially offset by
   
an increase of $5.4 million relating to interest-bearing advances made by us to the RasGas 3 Joint Venture for shipyard construction installment payments;
   
an increase of $0.6 million due to the effect on our Euro-denominated deposits from the strengthening of the Euro against the U.S. Dollar during such period compared to the same period last year; and
   
an increase of $0.4 million relating to the interest earned on the refund of a re-investment tax credit received in the second quarter of 2008.
Realized and unrealized gains of in 2008 and 2007 of $176.6 million and $20.4 million, respectively, relating to interest rate swaps were reclassified from interest income to realized and unrealized (loss) gain on derivative instruments to conform to the presentation adopted in the current period.
Realized and Unrealized Loss on Derivative Instruments. Net realized and unrealized (losses) gains on derivative instruments decreased 59.0% to ($100.0) million in 2008 from $9.8 million in 2007 as detailed in the table below.
                 
    Year Ended December 31,  
    2008     2007  
(in thousands of U.S. dollars)   $     $  
Realized (losses) gains relating to:
               
Interest rate swaps
    (6,788 )     806  
Toledo Spirit time-charter derivative contract
    (8,620 )     (1,931 )
 
           
 
    (15,408 )     (1,125 )
 
           
 
               
Unrealized (losses) gains  relating to:
               
Interest rate swaps
    (82,543 )     (3,195 )
Toledo Spirit time-charter derivative contract
    (2,003 )     14,136  
 
           
 
    (84,546 )     10,941  
 
           
Total realized and unrealized (losses) gains on derivative instruments
    (99,954 )     9,816  
 
           
Foreign Currency Exchange Gains (Losses). Foreign currency exchange gains were $18.2 million for 2008, compared to foreign currency exchange losses of ($41.2) million for 2007. These foreign currency exchange gains and losses, substantially all of which were unrealized, are due substantially to the relevant period-end revaluation of Euro-denominated term loans for financial reporting purposes. Losses reflect a weaker U.S. Dollar against the Euro on the date of revaluation. Gains reflect a stronger U.S. Dollar against the Euro on the date of revaluation.
Equity Income (Loss). Equity income (loss) was a nominal amount for both 2008 and 2007. This is primarily due to the operations of the four RasGas 3 LNG Carriers which delivered between May and July 2008, which was partially offset by an increase in interest expense as interest expense was capitalized in 2007.
Liquidity and Cash Needs
As at December 31, 2009, our cash and cash equivalents was $102.6 million, compared to $117.6 million at December 31, 2008 (of which $22.9 million was only available to the Teekay Tangguh Joint Venture as it was a variable interest entity of which we were the primary beneficiary). Our total liquidity which consists of cash, cash equivalents and undrawn long-term borrowings, was $479.8 million as at December 31, 2009, compared to $491.8 million as at December 31, 2008. The decrease in liquidity was primarily the results of the acquisition of the Teekay Tangguh Joint Venture, the acquisition of the first two Skaugen LPG Carriers and expenditures for vessels and equipment, partially offset by the equity offerings in March and November 2009.
Our primary short-term liquidity needs are to pay quarterly distributions on our outstanding units and to fund general working capital requirements and drydocking expenditures, while our long-term liquidity needs primarily relate to expansion and maintenance capital expenditures and debt repayment. Expansion capital expenditures primarily represent the purchase or construction of vessels to the extent the expenditures increase the operating capacity or revenue generated by our fleet, while maintenance capital expenditures primarily consist of drydocking expenditures and expenditures to replace vessels in order to maintain the operating capacity or revenue generated by our fleet. We anticipate that our primary sources of funds for our short-term liquidity needs will be cash flows from operations, while our long-term sources of funds will be from cash from operations, long-term bank borrowings and other debt or equity financings, or a combination thereof.
We will need to use certain of our available liquidity or we may need to raise additional capital to finance existing capital commitments. We are required to purchase five of our Suezmax tankers, currently on capital lease arrangements, in 2011. We anticipate that we will purchase these tankers by assuming the outstanding financing obligations that relate to them. However, we may be required to obtain separate debt or equity financing to complete the purchases if the lenders do not consent to our assuming the financing obligations. In addition, as of December 31, 2009, we were also committed to acquiring the one remaining Skaugen LPG Carrier and the two Skaugen Multigas Carriers. These additional purchase commitments, scheduled to occur in 2010 and 2011, total approximately $127 million. We intend to finance these purchases with one or more of our existing revolving credit facilities, incremental debt, surplus cash balances, proceeds from the issuance of additional common units, or combinations thereof. Please read Item 18 – Financial Statements: Note 13 — Commitments and Contingencies.

 

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On March 17, 2010, we acquired three additional vessels from Teekay Corporation for $160 million. Please see Item 18 – Financial Statements: Note 21 – Subsequent Events.
As described under “Item 4—Information on the Company: C. Regulations—Other Environmental Initiatives,” passage of any climate control legislation or other regulatory initiatives that restrict emissions of greenhouse gases could have a significant financial and operational impact on our business, which we cannot predict with certainty at this time. Such regulatory measures could increase our costs related to operating and maintaining our vessels and require us to install new emission controls, acquire allowances or pay taxes related to our greenhouse gas emissions, or administer and manage a greenhouse gas emissions program. In addition, increased regulation of greenhouse gases may, in the long term, lead to reduced demand for oil and gas and reduced demand for our services.
Cash Flows. The following table summarizes our cash flow for the periods presented:
                 
    Years Ended December 31,  
(in thousands of U.S. dollars)   2009     2008  
 
               
Net cash flow from operating activities
    164,496       149,570  
Net cash flow from financing activities
    (9,648 )     403,262  
Net cash flow from investing activities
    (169,919 )     (527,082 )
Operating Cash Flows. Net cash flow from operating activities increased to $164.5 million in 2009 from $149.6 million in 2008, primarily reflecting the increase in operating cash flows from the purchase of the two Skaugen LPG Carriers in April 2009 and November 2009, the commencement of the time-charters relating to the Tangguh LNG Carriers in 2009, a decrease of drydocking expenditures and the timing of our cash receipts and payments. Net cash flow from operating activities depends upon the timing and amount of drydocking expenditures, repairs and maintenance activity, vessel additions and dispositions, foreign currency rates, changes in interest rates, fluctuations in working capital balances and spot market hire rates (to the extent we have vessels operating in the spot tanker market or our hire rates are partially affected by spot market rates). The number of vessel drydockings tends to be uneven between years.
Financing Cash Flows. Our investments in vessels and equipment are financed primarily with term loans and capital lease arrangements. Proceeds from long-term debt were $220.1 million and $937.0 million, respectively, for 2009 and 2008. From time to time we refinance our loans and revolving credit facilities. During 2009, we used $68.4 million of our proceeds from long-term debt primarily to fund LNG newbuilding construction payments in the Teekay Tangguh Joint Venture. The remainder of the proceeds were used to acquire the Teekay Tangguh Joint Venture and the first two Skaugen LPG Carriers.
On March 30, 2009, we completed a follow-on equity offering of 4.0 million common units at a price of $17.60 per unit, for net proceeds of approximately $68.7 million. In November, 2009, we completed a follow-on equity offering of 4.0 million common units at a price of $24.40 per unit, for net proceeds of approximately $93.9 million. Please read Item 18 – Financial Statements: Note 3 – Equity Offerings.
Cash distributions paid during 2009 increased to $114.5 million from $97.4 million for the same period last year. This increase was the result of:
   
an increase in our quarterly distribution ranging from $0.53 per unit to $0.57 per unit during 2008, and $0.57 per unit for all of 2009; and
   
an increase in the number of units eligible to receive the cash distribution as a result of equity offerings and a private placement of common units subsequent to March 31, 2008.
Subsequent to December 31, 2009, a cash distribution totaling $31.6 million was declared with respect to the fourth quarter of 2009, which was paid in February 2010.
Investing Cash Flows. During 2009, we incurred $134.2 million in expenditures for vessels and equipment. These expenditures represent construction payments for the two Skaugen Multigas newbuildings and one of the Tangguh LNG Carriers which delivered in March 2009.
Credit Facilities
As at December 31, 2009, we had three long-term revolving credit facilities available which provided for borrowings of up to $558.2 million, of which $377.2 million was undrawn. The amount available under the credit facilities reduces by $31.6 million (2010), $32.2 million (2011), $32.9 million (2012), $33.7 million (2013), $34.5 million (2014) and $393.3 million (thereafter). Interest payments are based on LIBOR plus a margin. All revolving credit facilities may be used by us to fund general partnership purposes and to fund cash distributions. We are required to repay all borrowings used to fund cash distributions within 12 months of their being drawn, from a source other than further borrowings. The revolving credit facilities are collateralized by first-priority mortgages granted on seven of our vessels, together with other related security, and include a guarantee from us or our subsidiaries of all outstanding amounts.
We have a U.S. Dollar-denominated term loan outstanding which, as at December 31, 2009, totaled $396.6 million, of which $228.4 million of the term loan bears interest at a fixed rate of 5.39% and has quarterly payments. The remaining $168.2 million bears interest based on LIBOR plus a margin and will require bullet repayments of approximately $56.0 million for each of three vessels due at maturity in 2018 and 2019. The term loan is collateralized by first-priority mortgages on the vessels, together with certain other related security and certain guarantees from us.

 

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We own a 69% interest in the Teekay Tangguh Joint Venture. The Teekay Tangguh Joint Venture has a U.S. Dollar-denominated term loan outstanding, which, as at December 31, 2009, provided for borrowings of up to $342.6 million. Interest payments on the loan are based on LIBOR plus margins. At December 31, 2009, the margins ranged between 0.30% and 0.625%. Following delivery of the Tangguh LNG Carriers in November 2008 and March 2009, interest payments on one tranche under the loan facility are based on LIBOR plus 0.30%, while interest payments on the second tranche are based on LIBOR plus 0.625%. Commencing three months after delivery of each vessel, one tranche (total value of $324.5 million) reduces in quarterly payments while the other tranche (total value of up to $190.0 million) correspondingly is drawn up with a final $95.0 million bullet payment per vessel due 12 years and three months from each vessel delivery date. As at December 31, 2009, this loan facility is collateralized by first-priority mortgages on the vessels to which the loan relates, together with certain other security and is guaranteed by us.
We have a U.S. Dollar-denominated demand loan outstanding owing to Teekay Nakilat’s joint venture partner, which, as at December 31, 2009, totaled $15.3 million, including accrued interest. Interest payments on this loan, which are based on a fixed interest rate of 4.84%, commenced in February 2008. The loan is repayable on demand no earlier than February 27, 2027.
We have two Euro-denominated term loans outstanding which, as at December 31, 2009 totaled 288.0 million Euros ($412.4 million). (These loans were used to make restricted cash deposits that fully fund payments under capital leases). Interest payments are based on EURIBOR plus margins. The term loans have varying maturities through 2023. These loans are collateralized by first-priority mortgages on the vessels to which the loans relate, together with certain other related security and guarantees from one of our subsidiaries.
On October 27, 2009, we entered into a new $122.0 million credit facility that will be secured by the Skaugen LPG Carriers and Skaugen Multigas Carriers. The facility amount is equal to the lower of $122.0 million and 60% of the aggregate purchase price of the vessels. The facility will mature, with respect to each vessel, seven years after each vessels’ first drawdown date. We expect to draw on this facility to repay a portion of the amount we borrowed to purchase the Skaugen LPG Carriers that delivered in April 2009 and November 2009. We will use the remaining available funds from the facility to assist in purchasing, or facilitate the purchase of, the third Skaugen LPG Carrier and the two Skaugen Multigas Carriers upon delivery of each vessel.
The weighted-average effective interest rates for our long-term debt outstanding at December 31, 2009 and 2008 were 1.7% and 3.6%, respectively. These rates do not reflect the effect of related interest rate swaps that we have used to hedge certain of our floating-rate debt. At December 31, 2009, the margins on our long-term debt ranged from 0.3% to 2.75%.
Our term loans and revolving credit facilities contain covenants and other restrictions typical of debt financing secured by vessels, including, but not limited to, one or more of the following that restrict the ship-owning subsidiaries from:
   
incurring or guaranteeing indebtedness;
   
changing ownership or structure, including mergers, consolidations, liquidations and dissolutions;
   
making dividends or distributions if we are in default;
   
making capital expenditures in excess of specified levels;
   
making certain negative pledges and granting certain liens;
   
selling, transferring, assigning or conveying assets;
   
making certain loans and investments; and
   
entering into a new line of business.
Certain loan agreements require that minimum levels of tangible net worth and aggregate liquidity be maintained; provide for a maximum level of leverage and require one of our subsidiaries to maintain restricted cash deposits. Our ship-owning subsidiaries may not, among other things, pay dividends or distributions if we are in default under our loan agreements and revolving credit facilities. Our capital leases do not contain financial or restrictive covenants other than those relating to operation and maintenance of the vessels. As at December 31, 2009, we were in compliance with all covenants in our credit facilities and capital leases.

 

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Contractual Obligations and Contingencies
The following table summarizes our long-term contractual obligations as at December 31, 2009:
                                         
                    2011     2013        
                    and     and     Beyond  
    Total     2010     2012     2014     2014  
    (in millions of U.S. Dollars)  
U.S. Dollar-Denominated Obligations:
                                       
Long-term debt (1)
    936.7       53.7       118.5       121.6       642.9  
Commitments under capital leases (2)
    221.6       23.7       197.9              
Commitments under capital leases (3)
    1,049.1       24.0       48.0       48.0       929.1  
Commitments under operating leases (4)
    482.7       25.1       50.1       50.1       357.4  
Purchase obligations (5)
    127.0       33.0       94.0              
 
                             
Total U.S. Dollar-denominated obligations
    2,817.1       159.5       508.5       219.7       1,929.4  
 
                             
 
                                       
Euro-Denominated Obligations: (6)
                                       
Long-term debt (7)
    412.4       13.0       234.7       16.2       148.5  
Commitments under capital leases (8)
    131.4       38.6       92.8              
 
                             
Total Euro-denominated obligations
    543.8       51.6       327.5       16.2       148.5  
 
                             
 
                                       
Totals
    3,360.9       211.1       836.0       235.9       2,077.9  
 
                             
     
(1)  
Excludes expected interest payments of $17.5 million (2010), $30.7 million (2011 and 2012), $25.0 million (2013 and 2014) and $42.3 million (beyond 2014). Expected interest payments are based on the existing interest rates (fixed-rate loans) and LIBOR at December 31, 2009, plus margins that ranged up to 2.75% (variable-rate loans). The expected interest payments do not reflect the effect of related interest rate swaps that we have used as an economic hedge of certain of our floating-rate debt.
 
(2)  
Includes, in addition to lease payments, amounts we are required to pay to purchase certain leased vessels at the end of the lease terms. We are obligated to purchase five of our existing Suezmax tankers upon the termination of the related capital leases, which will occur in 2011. The purchase price will be based on the unamortized portion of the vessel construction financing costs for the vessels, which we expect to range from $31.7 million to $39.2 million per vessel. We expect to satisfy the purchase price by assuming the existing vessel financing, although we may be required to obtain separate debt or equity financing to complete the purchases if the lenders do not consent to our assuming the financing obligations. We are also obligated to purchase one of our existing LNG carriers upon the termination of the related capital leases on December 31, 2011. The purchase obligation has been fully funded with restricted cash deposits. Please read Item 18 – Financial Statements: Note 5 – Leases and Restricted Cash.
 
(3)  
Existing restricted cash deposits of $479.4 million, together with the interest earned on the deposits, will be sufficient to repay the remaining amounts we currently owe under the lease arrangements.
 
(4)  
We have corresponding leases whereby we are the lessor and expect to receive approximately $448.0 million for these leases from 2010 to 2029.
 
(5)  
In December 2006, we entered into an agreement to acquire the three Skaugen LPG Carriers from Skaugen, for approximately $33 million per vessel upon their deliveries. The first vessel was delivered in April 2009, the second vessel delivered in November 2009 and the third vessel is scheduled for delivery by mid-2010. In July 2008, Teekay Corporation signed contracts for the purchase of two newbuilding Multigas carriers from Skaugen and we have agreed to purchase these vessels from Teekay Corporation for a total cost of approximately $94.0 million upon their delivery. Both vessels are scheduled to be delivered in 2011. Please read Item 18 – Financial Statements: Note 13 — Commitments and Contingencies.
 
(6)  
Euro-denominated obligations are presented in U.S. Dollars and have been converted using the prevailing exchange rate as of December 31, 2009.
 
(7)  
Excludes expected interest payments of $4.4 million (2010), $4.9 million (2011 and 2012), $3.4 million (2013 and 2014) and $9.5 million (beyond 2014). Expected interest payments are based on EURIBOR at December 31, 2009, plus margins that ranged up to 0.66%, as well as the prevailing U.S. Dollar/Euro exchange rate as of December 31, 2009. The expected interest payments do not reflect the effect of related interest rate swaps that we have used as an economic hedge of certain of our floating-rate debt.
 
(8)  
Existing restricted cash deposits of $120.8 million, together with the interest earned on the deposits, will be expected to equal the remaining amounts we owe under the lease arrangement, including our obligation to purchase the vessel at the end of the lease term.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. We are committed to acquire from Teekay Corporation the Skaugen Multigas Carriers upon delivery for a total cost of approximately $94 million.

 

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Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with GAAP, which require us to make estimates in the application of our accounting policies based on our best assumptions, judgments and opinions. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements, because they inherently involve significant judgments and uncertainties. For a further description of our material accounting policies, please read Item 18 – Financial Statements: Note 1 – Summary of Significant Accounting Policies.
Vessel Lives and Impairment
Description. The carrying value of each of our vessels represents its original cost at the time of delivery or purchase less depreciation or impairment charges. We depreciate our vessels on a straight-line basis over a vessel’s estimated useful life, less an estimated residual value. The carrying values of our vessels may not represent their fair market value at any point in time since the market prices of second-hand vessels tend to fluctuate with changes in charter rates and the cost of newbuildings. Both charter rates and newbuilding costs tend to be cyclical in nature. We review vessels and equipment for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. We measure the recoverability of an asset by comparing its carrying amount to future undiscounted cash flows that the asset is expected to generate over its remaining useful life.
Judgments and Uncertainties. Depreciation is calculated using an estimated useful life of 25 years for Suezmax tankers, 30 years for LPG Carriers and 35 years for LNG carriers, from the date the vessel was originally delivered from the shipyard. In the shipping industry, the use of a 25-year vessel life for Suezmax tankers has become the prevailing standard. In addition, the use of a 30 to 35 year vessel life for LPG carriers and a 35 to 40 year vessel life for LNG carriers is typical. However, the actual life of a vessel may be different, with a shorter life resulting in an increase in the depreciation and potentially resulting in an impairment loss. The estimates and assumptions regarding expected cash flows require considerable judgment and are based upon existing contracts, historical experience, financial forecasts and industry trends and conditions. We are not aware of any indicators of impairments nor any regulatory changes or environmental liabilities that we anticipate will have a material impact on our current or future operations.
Effect if Actual Results Differ from Assumptions. If we consider a vessel or equipment to be impaired, we recognize impairment in an amount equal to the excess of the carrying value of the asset over its fair market value. The new lower cost basis will result in a lower annual depreciation than before the vessel impairment. A one-year reduction in the estimated useful lives of our Suezmax tankers, our LPG carriers and our LNG carriers would result in an increase in our current annual depreciation by approximately $4.5 million, assuming this decrease did not also result in an impairment loss.
Drydocking Life
Description. We capitalize a portion of the costs we incur during drydocking and for an intermediate survey and amortize those costs on a straight-line basis over the useful life of the drydock. We expense costs related to routine repairs and maintenance incurred during drydocking that do not improve operating efficiency or extend the useful lives of the assets.
Judgments and Uncertainties. Amortization of capitalized drydock expenditures requires us to estimate the period of the next drydocking and useful life of drydock expenditures. While we typically drydock each LNG and LPG carrier and Suezmax tanker every five years and have a shipping society classification intermediate survey performed on our LNG and LPG carriers between the second and third year of the five-year drydocking period, we may drydock the vessels at an earlier date, with a shorter life resulting in an increase in the depreciation.
Effect if Actual Results Differ from Assumptions. If we change our estimate of the next drydock date for a vessel, we will adjust our annual amortization of drydocking expenditures. Amortization expense of capitalized drydock expenditures for 2009, 2008 and 2007 were $4.5 million, $3.6 million and $2.7 million, respectively. As at December 31, 2009 and 2008, our capitalized drydock expenditures were $9.7 million and $12.0 million, respectively. A one-year reduction in the estimated useful lives of capitalized drydock expenditures would result in an increase in our current annual depreciation by approximately $2.6 million
Goodwill and Intangible Assets
Description. We allocate the cost of acquired companies to the identifiable tangible and intangible assets and liabilities acquired, with the remaining amount being classified as goodwill. Certain intangible assets, such as time-charter contracts, are being amortized over time. Our future operating performance will be affected by the amortization of intangible assets and potential impairment charges related to goodwill. Accordingly, the allocation of purchase price to intangible assets and goodwill may significantly affect our future operating results. Goodwill and indefinite lived assets are not amortized, but reviewed for impairment annually, or more frequently if impairment indicators arise. The process of evaluating the potential impairment of goodwill and intangible assets is highly subjective and requires significant judgment at many points during the analysis. A fair value approach is used to identify potential goodwill impairment and, when necessary, measure the amount of impairment. We use a discounted cash flow model to determine the fair value of reporting units, unless there is a readily determinable fair market value.
Judgments and Uncertainties. The allocation of the purchase price of acquired companies to intangible assets and goodwill requires management to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate to value these cash flows. In addition, the process of evaluating the potential impairment of goodwill and intangible assets is highly subjective and requires significant judgment at many points during the analysis. The fair value of our reporting units was estimated based on discounted expected future cash flows using a weighted-average cost of capital rate. The estimates and assumptions regarding expected cash flows and the discount rate require considerable judgment and are based upon existing contracts, historical experience, financial forecasts and industry trends and conditions.

 

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Effect if Actual Results Differ from Assumptions. During 2008 due to the decline in market conditions, we conducted an interim impairment review of our reporting units during 2008. The fair value of the reporting units was estimated using the expected present value of future cash flows. The fair value of the reporting units was then compared to its carrying values and it was determined that the fair value attributable our Suezmax tanker segment was less than its carrying value. As a result of our review, a goodwill impairment loss of $3.6 million was recognized in the Suezmax tanker reporting unit during 2008. As of the date of this filing, we do not believe that there is a reasonable possibility that the goodwill relating to the liquefied gas segment might be impaired within the next year. However, certain factors that impact this assessment are inherently difficult to forecast and as such we cannot provide any assurances that an impairment will or will not occur in the future. An assessment for impairment involves a number of assumptions and estimates that are based on factors that are beyond our control. These are discussed in more detail in the following section entitled “Forward-Looking Statements”. Amortization expense of intangible assets for each of the years 2009, 2008 and 2007 was $9.1 million. If actual results are not consistent with our estimates used to value our intangible assets, we may be exposed to an impairment charge and a decrease in the annual amortization expense of our intangible assets.
Valuation of Derivative Instruments
Description. Our risk management policies permit the use of derivative financial instruments to manage interest rate risk. Changes in fair value of derivative financial instruments that are not designated as cash flow hedges for accounting purposes are recognized in earnings.
Judgments and Uncertainties. The fair value of our interest rate swap agreements is the estimated amount that we would receive or pay to terminate the agreements at the reporting date, taking into account current interest rates and the current credit worthiness of both us and the swap counterparties. The estimated amount is the present value of future cash flows. The process of determining credit worthiness is highly subjective and requires significant judgment at many points during the analysis. The fair value of our derivative instrument relating to the agreement between us and Teekay Corporation for the Toledo Spirit time-charter contract is the estimated amount that we would receive or pay to terminate the agreement at the reporting date. This amount is estimated using the present value of our projection of future spot market tanker rates, which has been derived from current spot market rates and long-term historical average rates.
Effect if Actual Results Differ from Assumptions. If our estimates of fair value are inaccurate, this could result in a material adjustment to the carrying amount of derivative asset or liability and consequently the change in fair value for the applicable period that would have been recognized in earnings. See Item 18 – Financial Statements: Note 12 – Derivative Instruments for the effects on the change in fair value of our derivative instruments on our statements of income (loss).
Taxes
Description. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. If we determined that we were able to realize a net deferred tax asset in the future, in excess of the net recorded amount, an adjustment to the deferred tax assets would typically increase our net income in the period such determination was made. Likewise, if we determined that we were not able to realize all or a part of our deferred tax asset in the future, an adjustment to the deferred tax assets would typically decrease our net income in the period such determination was made. In 2009 we recorded a valuation allowance of $2.0 million (2008 – $1.6 million).
Judgments and Uncertainties. The estimate of our tax contingencies reserve contains uncertainty because management must use judgment to estimate the exposures associated with our various filing positions.
Effect if Actual Results Differ from Assumptions. As of December 31, 2007, we had unrecognized tax benefits of 3.4 million Euros (approximately $5.4 million) relating to a re-investment tax credit related to a 2005 annual tax filing. During 2008, we received the refund on the re-investment tax credit and met the more-likely-than-not recognition threshold. As a result, we reflected this refund as a credit to equity as the original vessel sale transaction was a related party transaction reflected in equity. The relevant tax authorities are proposing to challenge the eligibility of this transaction for the re-investment tax credit. Given the uncertainty relating to meeting the more-likely-than-not threshold, we have reversed the benefit of the refund as of December 31, 2009, however we believe we have strong arguments to defend our position.
Recent Accounting Pronouncements
In January 2009, we adopted an amendment to FASB ASC 805, Business Combinations. This amendment requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This amendment also requires the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full fair values of the assets and liabilities as if they had occurred on the acquisition date. In addition, this amendment requires that all acquisition related costs be expensed as incurred, rather than capitalized as part of the purchase price, and those restructuring costs that an acquirer expected, but was not obligated to incur, be recognized separately from the business combination. The amendment applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Our adoption of this amendment did not have a material impact on our consolidated financial statements.
In January 2009, we adopted an amendment to FASB ASC 810, Consolidation, which requires us to make certain changes to the presentation of our financial statements. This amendment requires that non-controlling interests in subsidiaries held by parties other than the partners be identified, labeled and presented in the statement of financial position within equity, but separate from the partners’ equity. This amendment requires that the amount of consolidated net income (loss) attributable to the partners and to the non-controlling interest be clearly identified on the consolidated statements of income (loss). In addition, this amendment provides for consistency regarding changes in partners’ ownership including when a subsidiary is deconsolidated. Any retained non-controlling equity investment in the former subsidiary will be initially measured at fair value. Except for the presentation and disclosure provisions of this amendment, which were adopted retrospectively to the our consolidated financial statements, this amendment was adopted prospectively.

 

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In January 2009, we adopted an amendment to FASB ASC 820 Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Non-financial assets and non-financial liabilities include all assets and liabilities other than those meeting the definition of a financial asset or financial liability. Our adoption of this amendment did not have a material impact on our consolidated financial statements.
In January 2009, we adopted an amendment to FASB ASC 815 Derivatives and Hedging, which requires expanded disclosures about a company’s derivative instruments and hedging activities, including increased qualitative, and credit-risk disclosures. Please read Item 18 – Financial Statements: Note 12 – Derivative Instruments.
In January 2009, we adopted an amendment to FASB ASC 260, Earnings Per Share, which provides guidance on earnings-per-unit (or EPU) computations for all master limited partnerships (or MLPs) that distribute “available cash”, as defined in the respective partnership agreements, to limited partners, the general partner, and the holders of incentive distribution rights (or IDRs). MLPs will need to determine the amount of “available cash” at the end of the reporting period when calculating the period’s EPU. This amendment was applied retrospectively to all periods presented. Please read Item 18 – Financial Statements: Note 15 – Total Capital and Net Income (Loss) Per Unit.
In January 2009, we adopted an amendment to FASB ASC 350, Intangibles — Goodwill and Other, which amends the factors that should be considered in developing renewal or extension of assumptions used to determine the useful life of a recognized intangible asset. The adoption of the amendment did not have a material impact on our consolidated financial statements.
In January 2009, we adopted an amendment to FASB ASC 323, Investments — Equity Method and Joint Ventures, which addresses the accounting for the acquisition of equity method investments, for changes in value and changes in ownership levels. The adoption of this amendment did not have a material impact on our consolidated financial statements.
In April 2009, we adopted an amendment to FASB ASC 825, Financial Instruments, which requires disclosure of the fair value of financial instruments to be disclosed on a quarterly basis and that disclosures provide qualitative and quantitative information on fair value estimates for all financial instruments not measured on the balance sheet at fair value, when practicable, with the exception of certain financial instruments. Please read Item 18 – Financial Statements: Note 2 – Fair Value Measurements.
In April 2009, we adopted an amendment to FASB ASC 855, Subsequent Events, which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This amendment requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. This amendment is effective for interim and annual reporting periods ending after June 15, 2009. In February 2010, the FASB further amended FASB ASC 855 to require a SEC filer to evaluate subsequent events through the date the financial statements are issued and to exempt a SEC filer from disclosing the date through which subsequent events have been evaluated. The adoption of these amendments did not have a material impact on the consolidated financial statements. Please read Item 18 – Financial Statements: Note 21 – Subsequent Events.
In June 2009, the FASB issued the FASB Accounting Standards Update (or ASU) 2009-1 effective for financial statements issued for interim and annual periods ending after September 15, 2009. The ASU identifies the source of GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the ASU superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the ASU will become non-authoritative. We adopted the ASU on July 1, 2009 and incorporated it in our notes to the consolidated financial statements.
In October 2009, we adopted an amendment to FASB ASC 820 Fair Value Measurements and Disclosures, which clarifies the fair value measurement requirements for liabilities that lack a quoted price in an active market and provides clarifying guidance regarding the consideration of restrictions when estimating the fair value of a liability. The adoption of this amendment did not have a material impact on our consolidated financial statements.
Item 6. Directors, Senior Management and Employees
Management of Teekay LNG Partners L.P.
Teekay GP L.L.C., our General Partner, manages our operations and activities. Unitholders are not entitled to elect the directors of our General Partner or directly or indirectly participate in our management or operation.
Our General Partner owes a fiduciary duty to our unitholders. Our General Partner is liable, as general partner, for all of our debts (to the extent not paid from our assets), except for indebtedness or other obligations that are expressly nonrecourse to it. Whenever possible, our General Partner intends to cause us to incur indebtedness or other obligations that are nonrecourse to it.
The directors of our General Partner oversee our operations. The day-to-day affairs of our business are managed by the officers of our General Partner and key employees of certain of our operating subsidiaries. Employees of certain subsidiaries of Teekay Corporation provide assistance to us and our operating subsidiaries pursuant to services agreements. Please read Item 7 – Major Unitholders and Certain Relationships and Related Party Transactions.
The Chief Executive Officer and Chief Financial Officer of our General Partner, Peter Evensen, allocates his time between managing our business and affairs and the business and affairs of Teekay Corporation and its subsidiaries Teekay Offshore (NYSE: TOO) Teekay Tankers Ltd. (NYSE: TNK) (or Teekay Tankers). Mr. Evensen is the Executive Vice President and Chief Strategy Officer of Teekay Corporation, the Chief Executive Officer and Chief Financial Officer of Teekay Offshore’s General Partner and the Executive Vice President of Teekay Tankers. The amount of time Mr. Evensen allocates between our business and the businesses of Teekay Corporation, Teekay Offshore and Teekay Tankers varies from time to time depending on various circumstances and needs of the businesses, such as the relative levels of strategic activities of the businesses. We believe Mr. Evensen devotes sufficient time to our business and affairs as is necessary for their proper conduct.

 

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Officers of Teekay LNG Projects Ltd., a subsidiary of Teekay Corporation, allocate their time between providing strategic consulting and advisory services to certain of our operating subsidiaries and pursuing LNG and LPG project opportunities for Teekay Corporation, which projects, if awarded to Teekay Corporation, are offered to us pursuant to the non-competition provisions of the omnibus agreement. This agreement has previously been filed with the SEC. Please see Item 19 - Exhibits.
Officers of our General Partner and those individuals providing services to us or our subsidiaries may face a conflict regarding the allocation of their time between our business and the other business interests of Teekay Corporation or its affiliates. Our General Partner seeks to cause its officers to devote as much time to the management of our business and affairs as is necessary for the proper conduct of our business and affairs.
Directors, Executive Officers and Key Employees
The following table provides information about the directors and executive officers of our General Partner and key employees of our operating subsidiary Teekay Spain as of December 31, 2009. Directors are elected for one-year terms. The business address of each of our directors and executive officers listed below is 4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda. The business address of each of our key employees of Teekay Spain is Musgo Street 5—28023, Madrid, Spain.
             
Name   Age   Position
 
           
C. Sean Day
    60     Chairman
Bjorn Moller
    52     Vice Chairman and Director
Peter Evensen
    51     Chief Executive Officer, Chief Financial Officer and Director
Robert E. Boyd
    71     Director (1) (2)
Ida Jane Hinkley
    59     Director (1)
Ihab J.M. Massoud
    41     Director (2)
George Watson
    62     Director (1) (2)
Andres Luna
    53     Managing Director, Teekay Spain
Pedro Solana
    53     Director, Finance and Accounting, Teekay Spain (3)
     
(1)  
Member of Audit Committee and Conflicts Committee.
 
(2)  
Member of Corporate Governance Committee.
 
(3)  
Has left Teekay Spain in January 2010.
Certain biographical information about each of these individuals is set forth below:
C. Sean Day has served as Chairman of Teekay GP L.L.C. since it was formed in November 2004. Mr. Day has also served as Chairman of the Board for Teekay Corporation since September 1999, Teekay Offshore GP L.L.C. since it was formed in August 2006, and Teekay Tankers Ltd. since it was formed in October 2007. From 1989 to 1999, he was President and Chief Executive Officer of Navios Corporation, a large bulk shipping company based in Stamford, Connecticut. Prior to this, Mr. Day held a number of senior management positions in the shipping and finance industry. He is currently serving as a Director of Kirby Corporation and Chairman of Compass Diversified Holdings. Mr. Day is engaged as a consultant to Kattegat Limited, the parent company of Teekay’s largest shareholder, to oversee its investments, including that in the Teekay group of companies.
Bjorn Moller has served as the Vice Chairman and Director of Teekay GP L.L.C. since it was formed in November 2004. Mr. Moller is the President and Chief Executive Officer of Teekay Corporation - positions he has held since April 1998. He also serves as Vice Chairman and Director of Teekay Offshore GP L.L.C., formed in August 2006, and Chief Executive Officer and Director of Teekay Tankers Ltd., formed in October 2007. Mr. Moller has over 25 years experience in the shipping industry, and has served as Chairman of the International Tanker Owners Pollution Federation since 2006 and on the Board of American Petroleum Institute since 2000. He has held senior management positions with Teekay for more than 15 years, and has led Teekay’s overall operations since January 1997, following his promotion to the position of Chief Operating Officer. Prior to this, Mr. Moller headed Teekay’s global chartering operations and business development activities.
Peter Evensen has served as Chief Executive Officer and Chief Financial Officer of Teekay GP L.L.C. since it was formed in November 2004 and as a Director since January 2005. He has also served as Chief Executive Officer, Chief Financial Officer and a Director of Teekay Offshore GP L.L.C., formed in August 2006, respectively. Mr. Evensen is the Executive Vice President and Chief Strategy Officer of Teekay Corporation, and was appointed Executive Vice President and a Director of Teekay Tankers Ltd., formed in October 2007. He joined Teekay Corporation in May 2003 as Senior Vice President, Treasurer and Chief Financial Officer. He was appointed to his current positions with Teekay Corporation in February 2004. Mr. Evensen has over 20 years experience in banking and shipping finance. Prior to joining Teekay Corporation, Mr. Evensen was Managing Director and Head of Global Shipping at J.P. Morgan Securities Inc., and worked in other senior positions for its predecessor firms. His international industry experience includes positions in New York, London and Oslo.
Robert E. Boyd has served as a Director of Teekay GP L.L.C. since January 2005. From May 1999 until his retirement in March 2004, Mr. Boyd was employed as the Senior Vice President and Chief Financial Officer of Teknion Corporation, a company engaged in the design, manufacture and marketing of office systems and office furniture products. From 1991 to 1999, Mr. Boyd was employed by The Oshawa Group Limited, a company engaged in the wholesale and retail distribution of food products and real estate activities, where his positions included Executive Vice President-Financial and Chief Financial Officer. Prior to 1991, Mr. Boyd held senior financial positions with several major companies, including Gulf Oil Corporation.

 

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Ida Jane Hinkley has served as a Director of Teekay GP L.L.C. since January 2005. From 1998 to 2001, she served as Managing Director of Navion Shipping AS, a shipping company at that time affiliated with the Norwegian state-owned oil company Statoil ASA (and subsequently acquired by Teekay Corporation in 2003). From 1980 to 1997, Ms. Hinkley was employed by the Gotaas-Larsen Shipping Corporation, an international provider of marine transportation services for crude oil and gas (including LNG), serving as its Chief Financial Officer from 1988 to 1992 and its Managing Director from 1993 to 1997.
I. Joseph Massoud has serve’s as a Director of Teekay GP L.L.C. since January 2005. Mr. Massoud is also Managing Partner of Teekay Corporation affliliate Compass Group Management L.L.C., a position he has held since 1998. Since 2006, he has also served as Chief Executive Officer of Compass Diversified Holdings (CODI), a NASDAQ-listed company based in Westport, Connecticut. Prior to 1998, Mr. Massoud was employed by Petroleum Heat and Power, Inc., Colony Capital, Inc., and McKinsey & Company.
George Watson has served as a Director of Teekay GP L.L.C. since January 2005. He currently serves as Executive Chairman of Critical Control Solutions Inc. (formerly WNS Emergent), a provider of information control applications for the energy sector. He held the position of CEO of Critical Control from 2002 to 2007. From February 2000 to July 2002, he served as Executive Chairman at VerticalBuilder.com Inc. Mr. Watson served as President and Chief Executive Officer of TransCanada Pipelines Ltd. from 1993 to 1999 and as its Chief Financial Officer from 1990 to 1993.
Andres Luna has served as the Managing Director of Teekay Shipping Spain since April 2004. Mr. Luna joined Alta Shipping, S.A., a former affiliate company of Naviera F. Tapias S.A., in September 1992 and served as its General Manager until he was appointed Commercial General Manager of Naviera F. Tapias S.A. in December 1999. He also served as Chief Executive Officer of Naviera F. Tapias S.A. from July 2000 until its acquisition by Teekay Corporation in April 2004, when it was renamed Teekay Shipping Spain. Mr. Luna’s responsibilities with Teekay Spain have included business development, newbuilding contracting, project management, development of its LNG business and the renewal of its tanker fleet. He has been in the shipping business since his graduation as a naval architect from Madrid University in 1981.
Pedro Solana served as the Director, Finance and Accounting of Teekay Shipping Spain from August 2004 until his departure in January 2010. Mr. Solana joined Naviera F. Tapias S.A. in 1991 and served as Deputy Financial Manager until its acquisition by Teekay Corporation. Mr. Solana’s responsibilities with Teekay Shipping Spain included oversight of its accounting department and arranging for financing of its LNG carriers and crude oil tankers. He has been in the shipping business since 1980.
Reimbursement of Expenses of Our General Partner
Our General Partner does not receive any management fee or other compensation for managing us. Our General Partner and its other affiliates are reimbursed for expenses incurred on our behalf. These expenses include all expenses necessary or appropriate for the conduct of our business and allocable to us, as determined by our General Partner. During 2009, these expenses were comprised of a portion of compensation earned by the Chief Executive Officer and Chief Financial Officer of our General Partner, directors’ fees and travel expenses, as discussed below. Please read Item 18 – Financial Statements: Note 11(b) – Related Party Transactions.
Annual Executive Compensation
Because the Chief Executive Officer and Chief Financial Officer of our General Partner, Peter Evensen, is an employee of Teekay Corporation, his compensation (other than any awards under the long-term incentive plan described below) is set and paid by Teekay Corporation, and we reimburse Teekay Corporation for time he spends on partnership matters. Please read Item 7 — Major Unitholders and Certain Relationships and Related Party Transactions.
The Corporate Governance Committee of the board of directors of our General Partner establishes the compensation for certain key employees of our operating subsidiary Teekay Spain. Officers and employees of our General Partner or its affiliates may participate in employee benefit plans and arrangements sponsored by Teekay Corporation, including plans that may be established in the future.
The aggregate amount of (a) reimbursement we made to Teekay Corporation for time our Chief Executive Officer and Chief Financial Officer spent on our partnership matters and (b) compensation earned by the two key employees of Teekay Spain listed above (collectively, the Officers) for 2009 was $3.2 million. This amount includes base salary ($1.2 million), annual bonus ($0.4 million) and pension and other benefits ($1.5 million). These amounts were paid primarily in Canadian Dollars or in Euros, but are reported here in U.S. Dollars using an exchange rate of 1.14 Canadian Dollars for each U.S. Dollar and .72 Euro for each U.S. Dollar, the exchange rates on December 31, 2009. Teekay Corporation’s annual bonus plan, in which each of the officers participates, considers both company performance, through comparison to established targets and financial performance of peer companies, and individual performance.
Compensation of Directors
Officers of our General Partner or Teekay Corporation who also serve as directors of our General Partner do not receive additional compensation for their service as directors. During 2008, each non-management director received compensation for attending meetings of the Board of Directors, as well as committee meetings. Non-management directors received a director fee of $40,000 for the year and common units with a value of approximately $30,000 for the year. The Chairman received an annual fee of $65,000, members of the audit and conflicts committees each received a committee fee of $5,000 for the year, and the chairs of the audit committee and conflicts committee received an additional fee of $5,000 for serving in that role. In addition, each director is reimbursed for out-of-pocket expenses in connection with attending meetings of the board of directors or committees. Each director is fully indemnified by us for actions associated with being a director to the extent permitted under Marshall Islands law.
During 2009, the four non-employee directors and the Chairman received, in the aggregate, $280,000 in director and committee fees and reimbursement of $73,000 of their out-of-pocket expenses from us relating to their board service. During 2009, the board of directors of our General Partner authorized the award by us of 1,644 common units to each of the four non-employee directors with a value for each award of approximately $30,000. The Chairman was awarded 3,562 common units with a value of approximately $65,000. These common units were purchased by the Partnership in the open market in September 2009.

 

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2005 Long-Term Incentive Plan
Our General Partner adopted the Teekay LNG Partners L.P. 2005 Long-Term Incentive Plan for employees and directors of and consultants to our General Partner and employees and directors of and consultants to its affiliates, who perform services for us. The plan provides for the award of restricted units, phantom units, unit options, unit appreciation rights and other unit or cash-based awards. Other than the previously mentioned 10,138 common units awarded to our General Partner’s directors, we did not make any awards in 2009 under the 2005 long-term incentive plan.
Board Practices
Teekay GP L.L.C., our General Partner, manages our operations and activities. Unitholders are not entitled to elect the directors of our General Partner or directly or indirectly participate in our management or operation.
Our General Partner’s board of directors (or the Board) currently consists of seven members. Directors are appointed to serve until their successors are appointed or until they resign or are removed.
There are no service contracts between us and any of our directors providing for benefits upon termination of their employment or service.
The Board has the following three committees: Audit Committee, Conflicts Committee, and Corporate Governance Committee. The membership of these committees and the function of each of the committees are described below. Each of the committees is currently comprised of independent members and operates under a written charter adopted by the Board. The committee charters for the Audit Committee, the Conflicts Committee and the Corporate Governance Committee are available under “Other Information — Partnership Governance” in the Investor Centre of our web site at www.teekaylng.com. During 2009, the Board held five meetings. Each director attended all Board meetings, except for one Board meeting when one director was absent. Each committee member attended all applicable committee meetings, except for one audit committee meeting where one committee member was absent.
Audit Committee. The Audit Committee of our General Partner is composed of three or more directors, each of whom must meet the independence standards of the NYSE and the SEC. This committee is currently comprised of directors Robert E. Boyd (Chair), Ida Jane Hinkley and George Watson. All members of the committee are financially literate and the Board has determined that Mr. Boyd qualifies as an audit committee financial expert.
The Audit Committee assists the Board in fulfilling its responsibilities for general oversight of:
   
the integrity of our financial statements;
   
our compliance with legal and regulatory requirements;
   
the independent auditors’ qualifications and independence; and
   
the performance of our internal audit function and independent auditors.
Conflicts Committee. The Conflicts Committee of our General Partner is composed of the same directors constituting the Audit Committee, being George Watson (Chair), Robert E. Boyd and Ida Jane Hinkley. The members of the Conflicts Committee may not be officers or employees of our General Partner or directors, officers or employees of its affiliates, and must meet the heightened NYSE and SEC director independence standards applicable to audit committee membership and certain other requirements.
The Conflicts Committee:
   
reviews specific matters that the Board believes may involve conflicts of interest; and
   
determines if the resolution of the conflict of interest is fair and reasonable to us.
Any matters approved by the Conflicts Committee will be conclusively deemed to be fair and reasonable to us, approved by all of our partners, and not a breach by our General Partner of any duties it may owe us or our unitholders. The Board is not obligated to seek approval of the Conflicts Committee on any matter, and may determine the resolution of any conflict of interest itself.
Corporate Governance Committee. The Corporate Governance Committee of our General Partner is composed of at least two directors, a majority of whom must meet the director independence standards established by the NYSE. This committee is currently comprised of directors Ihab J.M. Massoud (Chair), Robert E. Boyd and George Watson.
The Corporate Governance Committee:
   
oversees the operation and effectiveness of the Board and its corporate governance;
   
develops and recommends to the Board corporate governance principles and policies applicable to us and our General Partner and monitors compliance with these principles and policies and recommends to the Board appropriate changes; and
 
   
oversees director compensation and the long-term incentive plan described above.

 

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Crewing and Staff
As of March 1, 2010, approximately 1,200 seagoing staff served on our vessels and approximately 14 staff served on shore in technical, commercial and administrative roles in various countries. Certain subsidiaries of Teekay Corporation employ the crews, who serve on the vessels pursuant to agreements with the subsidiaries, and Teekay Corporation subsidiaries also provide on-shore advisory, operational and administrative support to our operating subsidiaries pursuant to service agreements. Please read Item 7 – Major Unitholders and Certain Relationships and Related Party Transactions.
We regard attracting and retaining motivated seagoing personnel as a top priority. Like Teekay Corporation, we offer our seafarers competitive employment packages and comprehensive benefits and opportunities for personal and career development, which relates to a philosophy of promoting internally.
Teekay Corporation has entered into a Collective Bargaining Agreement with the Philippine Seafarers’ Union, an affiliate of the International Transport Workers’ Federation (or ITF), and a Special Agreement with ITF London, which cover substantially all of the officers and seamen that operate our Bahamian-flagged vessels. Our Spanish officers and seamen for our Spanish-flagged vessels are covered by two different collective bargaining agreements (one for Suezmax tankers and one for LNG carriers) with Spain’s Union General de Trabajadores and Comisiones Obreras, and the Filipino crewmembers employed on our Spanish-flagged LNG and Suezmax tankers are covered by the Collective Bargaining Agreement with the Philippine Seafarer’s Union. We believe Teekay Corporation’s and our relationships with these labor unions are good.
Our commitment to training is fundamental to the development of the highest caliber of seafarers for our marine operations. Teekay Corporation has agreed to allow our personnel to participate in its training programs. Teekay Corporation’s cadet training approach is designed to balance academic learning with hands-on training at sea. Teekay Corporation has relationships with training institutions in Canada, Croatia, India, Latvia, Norway, Philippines, Turkey and the United Kingdom. After receiving formal instruction at one of these institutions, our cadets’ training continues on board on one of our vessels. Teekay Corporation also has a career development plan that we follow, which was designed to ensure a continuous flow of qualified officers who are trained on its vessels and familiarized with its operational standards, systems and policies. We believe that high-quality crewing and training policies will play an increasingly important role in distinguishing larger independent shipping companies that have in-house or affiliate capabilities from smaller companies that must rely on outside ship managers and crewing agents on the basis of customer service and safety.
Unit Ownership
The following table sets forth certain information regarding beneficial ownership, as of March 31, 2010, of our units by all directors and officers of our General Partner and key employees of Teekay Spain as a group. The information is not necessarily indicative of beneficial ownership for any other purpose. Under SEC rules a person or entity beneficially owns any units that the person has the right to acquire as of May 30, 2010 (60 days after March 31, 2010) through the exercise of any unit option or other right. Unless otherwise indicated, each person has sole voting and investment power (or shares such powers with his or her spouse) with respect to the units set forth in the following table. Information for all persons listed below is based on information delivered to us.
                                         
                                    Percentage  
                            Percentage     of Total  
            Percentage             of     Common and  
    Common     of Common     Subordinated     Subordinated     Subordinated  
Identity of Person or Group   Units Owned     Units Owned     Units Owned     Units Owned     Units Owned (3)  
All executive officers, key employees and directors as a group (9 persons) (1) (2)
    204,243       0.45 %                 0.39 %
     
(1)  
Excludes units owned by Teekay Corporation, which controls us and on the board of which serve the following directors of our General Partner, C. Sean Day and Bjorn Moller. In addition, Mr. Moller is Teekay Corporation’s Chief Executive Officer, and Peter Evensen, our General Partner’s Chief Executive Officer, Chief Financial Officer and Director, is Teekay Corporation’s Executive Vice President and Chief Strategy Officer. Please read Item 7 – Major Shareholders and Related Party Transactions for more detail.
 
(2)  
Each director, executive officer and key employee beneficially owns less than one percent of the outstanding common and subordinated units.
 
(3)  
Excludes the 2% general partner interest held by our General Partner, a wholly owned subsidiary of Teekay Corporation.
Item 7. Major Unitholders and Certain Relationships and Related Party Transactions
Major Unitholders
                                         
                                    Percentage  
                            Percentage     of Total  
            Percentage             of     Common and  
    Common     of Common     Subordinated     Subordinated     Subordinated  
Identity of Person or Group   Units Owned     Units Owned     Units Owned     Units Owned     Units Owned  
Teekay Corporation (1)
    17,840,988       39.7 %     7,367,286       100.0 %     48.2 %
Neuberger Berman, Inc. and Neuberger Berman, L.L.C., as a group (2)
    4,242,370       9.5 %                 8.1 %

 

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The following table sets forth information regarding beneficial ownership, as of December 31, 2009, of our common and subordinated units by each person we know to beneficially own more than 5% of the outstanding common or subordinated units. The number of units beneficially owned by each person is determined under SEC rules and the information is not necessarily indicative of beneficial ownership for any other purpose. Under SEC rules a person beneficially owns any units as to which the person has or shares voting or investment power. In addition, a person beneficially owns any units that the person or entity has the right to acquire as of March 1, 2010 (60 days after December 31, 2009) through the exercise of any unit option or other right. Unless otherwise indicated, each unitholder listed below has sole voting and investment power with respect to the units set forth in the following table.
       
  (1)  
Excludes the 2% general partner interest held by our General Partner, a wholly owned subsidiary of Teekay Corporation.
 
  (2)  
Neuberger Berman, L.L.C. and Neuberger Berman Management Inc. serve as sub-advisor and investment manager, respectively, of Neuberger Berman Inc’s mutual funds. This information is based on the Schedule 13G/A filed by this group with the SEC on February 17, 2010.
Our majority unitholder has the same voting rights as our other unitholders. We are controlled by Teekay Corporation. We are not aware of any arrangements, the operation of which may at a subsequent date result in a change in control of us.
Related Party Transactions
  a)  
We have entered into an amended and restated omnibus agreement with Teekay Corporation, our General Partner, our operating company, Teekay LNG Operating L.L.C., Teekay Offshore and related parties. The following discussion describes certain provisions of the omnibus agreement.
Noncompetition. Under the omnibus agreement, Teekay Corporation and Teekay Offshore have agreed, and have caused their controlled affiliates (other than us) to agree, not to own, operate or charter LNG carriers. This restriction does not prevent Teekay Corporation, Teekay Offshore or any of their controlled affiliates (other than us) from, among other things:
   
acquiring LNG carriers and related time-charters as part of a business and operating or chartering those vessels if a majority of the value of the total assets or business acquired is not attributable to the LNG carriers and related time-charters, as determined in good faith by the board of directors of Teekay Corporation or the conflict committee of the board of directors of Teekay Offshore’s General Partner; however, if at any time Teekay Corporation or Teekay Offshore completes such an acquisition, it must offer to sell the LNG carriers and related time-charters to us for their fair market value plus any additional tax or other similar costs to Teekay Corporation or Teekay Offshore that would be required to transfer the LNG carriers and time-charters to us separately from the acquired business;
   
owning, operating or chartering LNG carriers that relate to a bid or award for a proposed LNG project that Teekay Corporation or any of its subsidiaries has submitted or hereafter submits or receives; however, at least 180 days prior to the scheduled delivery date of any such LNG carrier, Teekay Corporation must offer to sell the LNG carrier and related time-charter to us, with the vessel valued at its “fully-built-up cost,’’ which represents the aggregate expenditures incurred (or to be incurred prior to delivery to us) by Teekay Corporation to acquire or construct and bring such LNG carrier to the condition and location necessary for our intended use, plus a reasonable allocation of overhead costs related to the development of such project and other projects that would have been subject to the offer rights set forth in the omnibus agreement but were not completed; or
   
acquiring, operating or chartering LNG carriers if our General Partner has previously advised Teekay Corporation or Teekay Offshore that the board of directors of our General Partner has elected, with the approval of its conflicts committee, not to cause us or our subsidiaries to acquire or operate the carriers.
In addition, under the omnibus agreement we have agreed not to own, operate or charter crude oil tankers or the following “offshore vessels” – dynamically positioned shuttle tankers, floating storage and off-take units or floating production, storage and off-loading units, in each case that are subject to contracts with a remaining duration of at least three years, excluding extension options. This restriction does not apply to any of the Suezmax tankers in our current fleet, and the ownership, operation or chartering of any oil tankers that replace any of those oil tankers in connection with certain events. In addition, the restriction does not prevent us from, among other things:
   
acquiring oil tankers or offshore vessels and any related time-charters or contracts of affreightment as part of a business and operating or chartering those vessels, if a majority of the value of the total assets or business acquired is not attributable to the oil tankers and offshore vessels and any related charters or contracts of affreightment, as determined by the conflicts committee of our General Partner’s board of directors; however, if at any time we complete such an acquisition, we are required to promptly offer to sell to Teekay Corporation the oil tankers and time-charters or to Teekay Offshore the offshore vessels and time-charters or contracts of affreightment for fair market value plus any additional tax or other similar costs to us that would be required to transfer the vessels and contracts to Teekay Corporation or Teekay Offshore separately from the acquired business; or
   
acquiring, operating or chartering oil tankers or offshore vessels if Teekay Corporation or Teekay Offshore, respectively, has previously advised our General Partner that it has elected not to acquire or operate those vessels.
Rights of First Offer on Suezmax Tankers, LNG Carriers, and Offshore Vessels. Under the omnibus agreement, we have granted to Teekay Corporation and Teekay Offshore a 30-day right of first offer on any proposed (a) sale, transfer or other disposition of any of our Suezmax tankers, in the case of Teekay Corporation, or certain offshore vessels in the case of Teekay Offshore, or (b) re-chartering of any of our Suezmax tankers or offshore vessels pursuant to a time-charter or contract of affreightment with a term of at least three years if the existing charter expires or is terminated early. Likewise, each of Teekay Corporation and Teekay Offshore has granted a similar right of first offer to us for any LNG carriers it might own. These rights of first offer do not apply to certain transactions.

 

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  b)  
We and certain of our subsidiaries have entered into services agreements with subsidiaries of Teekay Corporation pursuant to which the Teekay Corporation subsidiaries have agreed to provide (a) certain non-strategic administrative services to us, (b) crew training, (c) advisory, technical and administrative services that supplement existing capabilities of the employees of our operating subsidiaries and (d) strategic consulting and advisory services to our operating subsidiaries relating to our business, unless the provision of those services would materially interfere with Teekay Corporation’s operations. These services are to be provided in a commercially reasonably manner and upon the reasonable request of our General Partner or our operating subsidiaries, as applicable. The Teekay Corporation subsidiaries that are parties to the services agreements may provide these services directly or may subcontract for certain of these services with other entities, including other Teekay Corporation subsidiaries. We pay a reasonable, arm’s-length fee for the services that include reimbursement of the reasonable cost of any direct and indirect expenses the Teekay Corporation subsidiaries incur in providing these services. During 2009, 2008 and 2007, we incurred $11.1 million, $9.4 million and $7.4 million of costs under these agreements. In addition, as a component of the services agreement, the Teekay Corporation subsidiaries provide us with all usual and customary crew management services in respect of our vessels. During 2009, 2008 and 2007, we incurred $24.0 million, $20.1 million and $10.8 million respectively, for crewing and manning costs.
On March 31, 2009, a subsidiary of Teekay Corporation paid $3.0 million to us for the right to provide certain ship management services to certain of our vessels. This amount is deferred and amortized on a straight-line basis until 2012 and is included as part of general and administrative expense in our consolidated statements of income (loss).
During 2009, 2008 and 2007, nil, $0.5 million and $0.1 million, respectively, of general and administrative expenses attributable to the operations of the Kenai LNG Carriers were incurred by Teekay Corporation and has been allocated to us as part of the results of the Dropdown Predecessor.
During December 31, 2009, 2008 and 2007, nil, $3.1 million and $0.5 million, respectively, of interest expense attributable to the operations of the Kenai LNG Carriers was incurred by Teekay Corporation and has been allocated to us as part of the results of the Dropdown Predecessor.
  c)  
We reimburse our General Partner for all expenses necessary or appropriate for the conduct of our business. During each of 2009, 2008 and 2007, we incurred $0.8 million of these costs for each of these three years.
  d)  
We had entered into an agreement with Teekay Corporation pursuant to which Teekay Corporation provided us with off-hire insurance for our LNG carriers. During 2009, 2008 and 2007, we incurred $0.5 million, $1.5 million and $1.5 million of these costs. We did not renew this off-hire insurance with Teekay Corporation, which expired during the second quarter of 2009. We currently obtain third-party off-hire insurance for certain LNG carriers.
  e)  
On August 10, 2009 we purchased 99% of Teekay Corporation’s 70% interest in the Teekay Tangguh Joint Venture for a purchase price (net of assumed debt) of $69.1 million. For more information, please read Item 18 – Financial Statements: Note 11(e) – Related Party Transactions.
  f)  
On May 6, 2008, we purchased Teekay Corporation’s 100% interest in Teekay Nakilat (III), which in turn owns 40% of the RasGas 3 Joint Venture, for a purchase price (net of assumed debt) of $110.2 million. For more information, please read Item 18 – Financial Statements: Note 11(g) – Related Party Transactions.
  g)  
In January 2007, we acquired a 2000-built LPG carrier, the Dania Spirit, from Teekay Corporation and the related long-term, fixed-rate time-charter for a purchase price of approximately $18.5 million. The purchase was financed with one of our existing revolving credit facilities. This vessel is chartered to the Norwegian state-owned oil company, Statoil ASA and has a remaining contract term of seven years.
  h)  
In March 2007, one of our LNG carriers, the Madrid Spirit, sustained damage to its engine boilers. The vessel was off-hire for approximately 86 days during 2007. Since Teekay Corporation provided us with off-hire insurance for our LNG carriers, our exposure was limited to 14 days of off-hire, of which seven days were recoverable from a third-party insurer. In July 2007, Teekay Corporation paid approximately $6.0 million to us for loss-of-hire relating to the vessel.
  j)  
In April 2008, we acquired the two Kenai LNG Carriers from Teekay Corporation for $230.0 million. We chartered the vessels back to Teekay Corporation at a fixed rate for a period of 10 years (plus options exercisable by Teekay Corporation to extend up to an additional 15 years). During 2009 and 2008 we recognized revenues of $38.9 and $29.6 million, respectively, from these charters.
  k)  
As at December 31, 2009 and 2008, non-interest bearing advances to affiliates totaled $20.7 million and $9.6 million (December 31, 2007 – nil) and non-interest bearing advances from affiliates totaled $111.1 million and $73.1 million (December 31, 2007 — $268.5 million) repectively. These advances are unsecured and have no fixed repayment terms, however, we expect these amounts will be repaid during 2010.
  l)  
On July 28, 2008, Teekay Corporation signed contracts for the purchase of two technically advanced 12,000-cubic meter newbuilding Multigas vessels from subsidiaries of Skaugen and we agreed to acquire the vessels from Teekay Corporation upon delivery. The vessels are scheduled to delivered in 2011 for a total cost of approximately $94 million. Each vessel will operate under 15-year fixed-rate charters to Skaugen.
  m)  
Our Suezmax tanker, the Toledo Spirit, which delivered in July 2005, operates pursuant to a time-charter contract that increases or decreases the fixed rate established in the charter, depending on the spot charter rates that we would have earned had we traded the vessel in the spot tanker market. We entered into an agreement with Teekay Corporation such that Teekay Corporation pays us any amounts payable to the charter party as a result of spot rates being below the fixed rate, and we pay Teekay Corporation any amounts payable to us as a result of spot rates being in excess of the fixed rate. During 2009, 2008 and 2007 we incurred $0.9 million, $8.6 million and $1.9 million, respectively, of amounts owing to Teekay Corporation as a result of this agreement.

 

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  n)  
C. Sean Day is the Chairman of our General Partner, Teekay GP L.L.C. He also is the Chairman of Teekay Corporation, Teekay Offshore GP L.L.C. (the General Partner of Teekay Offshore Partners L.P., a publicly held partnership controlled by Teekay Corporation) and Teekay Tankers Ltd. (a publicly held corporation controlled by Teekay Corporation).
Bjorn Moller is the Vice Chairman of Teekay GP L.L.C. and Teekay Offshore GP L.L.C. He also is the President and Chief Executive Officer and a director of Teekay Corporation as well as the Chief Executive Officer and a director of Teekay Tankers Ltd.
Peter Evensen is the Chief Executive Officer and Chief Financial Officer and a director of Teekay GP L.L.C. and Teekay Offshore GP L.L.C. He also is the Executive Vice President and Chief Strategy Officer of Teekay Corporation as well as the Executive Vice President and a director of Teekay Tankers Ltd.
Because Mr. Evensen is an employee of Teekay Corporation or another of its subsidiaries, his compensation (other than any awards under our long-term incentive plan) is set and paid by Teekay Corporation or such other applicable subsidiary. Pursuant to our partnership agreement, we have agreed to reimburse Teekay Corporation or its applicable subsidiary for time spent by Mr. Evensen on our management matters as our Chief Executive Officer and Chief Financial Officer.
  o)  
In December 2007, a consortium in which Teekay Corporation has a 33% ownership interest was awarded a contract to charter four newbuilding 160,400-cubic meter LNG carriers for a period of 20 years to the Angola LNG Project, which is being developed by subsidiaries of Chevron Corporation, Sociedade Nacional de Combustiveis de Angola EP, BP Plc, Total S.A., and Eni SpA. The vessels will be chartered at fixed rates, with inflation adjustments, commencing in 2011. The remaining members of the consortium are Mitsui & Co., Ltd. and NYK Bulkship (Europe) which hold 34% and 33% ownership interests in the consortium, respectively. In accordance with the omnibus agreement, Teekay Corporation is required to offer to us its 33% ownership interest in these vessels and related charter contracts not later than 180 days before delivery of the vessels.
  p)  
In June and November 2009, in conjunction with the acquisition of the two Skaugen LPG Carriers, Teekay Corporation novated interest rate swaps, each with a notional amount of $30.0 million, to us for no consideration. The transactions were concluded between related parties and thus the interest rate swaps were recorded at their carrying values which were equal to their fair values. The excess of the liabilities assumed over the consideration received amounting to $1.6 million and $3.2 million, respectively, were charged to equity.
  q)  
In November 2009, we sold 1% of our interest in the Kenai LNG Carriers to our General Partner for approximately $2.3 million in order to structure this project in a tax efficient manner for us.
Item 8. Financial Information
Consolidated Financial Statements and Notes
Please see Item 18 – Financial Statements below for additional information required to be disclosed under this Item.
Legal Proceedings
From time to time we have been, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of our business, principally personal injury and property casualty claims. These claims, even if lacking merit, could result in the expenditure of significant financial and managerial resources. We are not aware of any legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on us.
Cash Distribution Policy
Rationale for Our Cash Distribution Policy
Our partnership agreement requires us to distribute all of our available cash (as defined in our partnership agreement) within approximately 45 days after the end of each quarter. This cash distribution policy reflects a basic judgment that our unitholders are better served by our distributing our cash available after expenses and reserves rather than our retaining it. Because we believe we will generally finance any capital investments from external financing sources, we believe that our investors are best served by our distributing all of our available cash.
Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy
There is no guarantee that unitholders will receive quarterly distributions from us. Our distribution policy is subject to certain restrictions and may be changed at any time, including:
   
Our distribution policy is subject to restrictions on distributions under our credit agreements. Specifically, our credit agreements contain material financial tests and covenants that we must satisfy. Should we be unable to satisfy these restrictions under our credit agreements, we would be prohibited from making cash distributions to unitholders notwithstanding our stated cash distribution policy.
   
The board of directors of our General Partner has the authority to establish reserves for the prudent conduct of our business and for future cash distributions to our unitholders, and the establishment of those reserves could result in a reduction in cash distributions to unitholders from levels we anticipate pursuant to our stated distribution policy.
   
Even if our cash distribution policy is not modified or revoked, the amount of distributions we pay under our cash distribution policy and the decision to make any distribution is determined by our General Partner, taking into consideration the terms of our partnership agreement.

 

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Under Section 51 of the Marshall Islands Limited Partnership Act, we may not make a distribution to unitholders if the distribution would cause our liabilities to exceed the fair value of our assets.
   
We may lack sufficient cash to pay distributions to our unitholders due to increases in our general and administrative expenses, principal and interest payments on our outstanding debt, tax expenses, the issuance of additional units (which would require the payment of distributions on those units), working capital requirements and anticipated cash needs.
   
While our partnership agreement requires us to distribute all of our available cash, our partnership agreement, including provisions requiring us to make cash distributions, may be amended. Although during the subordination period (defined in our partnership agreement), with certain exceptions, our partnership agreement may not be amended without the approval of the public common unitholders, our partnership agreement can be amended with the approval of a majority of the outstanding common units, voting as a class (including common units held by affiliates of our General Partner) after the subordination period has ended.
Minimum Quarterly Distribution
Common unitholders are entitled under our partnership agreement to receive a minimum quarterly distribution of $0.4125 per unit, or $1.65 per year, prior to any distribution on our subordinated units to the extent we have sufficient cash from our operations after establishment of cash reserves and payment of fees and expenses, including payments to our General Partner. Our General Partner has the authority to determine the amount of our available cash for any quarter. This determination must be made in good faith. There is no guarantee that we will pay the minimum quarterly distribution on the common units in any quarter, and we will be prohibited from making any distributions to unitholders if it would cause an event of default, or an event of default is existing, under our credit agreements.
Our cash distributions were $0.4625 per unit in the first quarter of 2007. Our distributions were increased to $0.53 per unit effective the second quarter of 2007, then to $0.55 per unit effective for the second quarter of 2008, and to $0.57 per unit effective for the third quarter of 2008, which was maintained throughout 2009.
Subordination Period
During the subordination period, applicable to the subordinated units held by Teekay Corporation, the common units will have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. The purpose of the subordinated units is to increase the likelihood that during the subordination period there will be available cash to be distributed on the common units. On May 19, 2008, 25% of the subordinated units (3.7 million units) were converted into common units on a one-for-one basis as provided for under the terms of our partnership agreement and began participating pro rata with the other common units in distributions of available cash commencing with the August 2008 distribution. On May 19, 2009, an additional 3.7 million subordinated units were converted into an equal number of common units as provided for under the terms of the partnership agreement and participate pro rata with the other common units in distributions of available cash commencing with the August 2009 distribution. We anticipate that, pending confirmation of the results for the quarter ended March 31, 2010, the subordination period will end April 1, 2010 and the remaining subordinated units will convert to common units.
Incentive Distribution Rights
Incentive distribution rights represent the right to receive an increasing percentage of quarterly distributions of available cash from operating surplus (as defined in our partnership agreement) after the minimum quarterly distribution and the target distribution levels have been achieved. Our General Partner currently holds the incentive distribution rights, but may transfer these rights separately from its general partner interest, subject to restrictions in our partnership agreement.
The following table illustrates the percentage allocations of the additional available cash from operating surplus among the unitholders and our General Partner up to the various target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions’’ are the percentage interests of the unitholders and our General Partner in any available cash from operating surplus we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution Target Amount,’’ until available cash from operating surplus we distribute reaches the next target distribution level, if any. The percentage interests shown for the unitholders and our General Partner for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests shown for our General Partner include its 2% general partner interest and assume the General Partner has not transferred the incentive distribution rights.
                     
    Total Quarterly Distribution   Marginal Percentage Interest  
    Target Amount   in Distributions  
                General  
        Unitholders     Partner  
 
                   
Minimum Quarterly Distribution
  $0.4125     98 %     2 %
First Target Distribution
  up to $0.4625     98 %     2 %
Second Target Distribution
  above $0.4625 up to $0.5375     85 %     15 %
Third Target Distribution
  above $0.5375 up to $0.6500     75 %     25 %
Thereafter
  above $0.6500     50 %     50 %
Significant Changes
Please read Item 18 – Financial Statements: Note 21 – Subsequent Events

 

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Item 9. The Offer and Listing
Our common units are listed on the New York Stock Exchange (or NYSE) under the symbol “TGP”. The following table sets forth the high and low closing prices for our common units on the NYSE for each of the periods indicated.
                                         
    Dec. 31,     Dec. 31,     Dec. 31,     Dec. 31,     Dec. 31,  
Years Ended   2009     2008     2007     2006     2005(1)  
 
                                       
High
  $ 25.92     $ 31.69     $ 39.94     $ 34.23     $ 37.40  
Low
    13.97       9.96       28.76       28.65       24.30  
                                                                 
    Dec 31,     Sept 30,     June 30,     Mar. 31,     Dec. 31,     Sept. 30,     June 30,     Mar. 31,  
Quarters Ended   2009     2009     2009     2009     2008     2008     2008     2008  
 
                                                               
High
  $ 25.92     $ 23.99     $ 18.19     $ 17.99     $ 18.26     $ 26.52     $ 30.48     $ 31.69  
Low
    22.90       17.58       14.21       13.97       9.96       14.89       26.33       27.22  
                                                 
    March 31,     Feb. 28,     Jan. 31,     Dec. 31,     Nov. 30,     Oct. 31,  
Months Ended   2010     2010     2010     2009     2009     2009  
 
                                               
High
  $ 29.87     $ 29.80     $ 28.32     $ 25.92     $ 25.14     $ 25.46  
Low
    27.46       24.91       26.08       23.26       22.62       22.90  
     
(1)  
Period beginning May 5, 2005.
Item 10. Additional Information
Memorandum and Articles of Association
The information required to be disclosed under Item 10B is incorporated by reference to our Registration Statement on Form 8-A/A filed with the SEC on September 29, 2006.
Material Contracts
The following is a summary of each material contract, other than material contracts entered into in the ordinary course of business, to which we or any of our subsidiaries is a party, for the two years immediately preceding the date of this Annual Report, each of which is included in the list of exhibits in Item 19:
  (a)  
Agreement dated December 7, 2005, for a U.S. $137,500,000 Revolving Credit Facility between Asian Spirit L.L.C., African Spirit L.L.C., and European Spirit L.L.C., Den Norske Bank ASA and various other banks. This facility bears interest at LIBOR plus a margin of 0.50%. The amount available under the facility reduces by $4.4 million semi-annually, with a bullet reduction of $57.7 million on maturity in April 2015. The credit facility may be used for general partnership purposes and to fund cash distributions. Our obligations under the facility are secured by a first-priority mortgage on three of our Suezmax tankers and a pledge of certain shares of the subsidiaries operating the Suezmax tankers.
 
  (b)  
Amended and Restated Omnibus agreement with Teekay Corporation, Teekay Offshore, our General Partner and related parties Please read Item 7 – Major Unitholders and Certain Relationships and Related Party Transactions for a summary of certain contract terms.
 
  (c)  
We and certain of our operating subsidiaries have entered into services agreements with certain subsidiaries of Teekay Corporation pursuant to which the Teekay Corporation subsidiaries provide us and our operating subsidiaries with administrative, advisory, technical and strategic consulting services for a reasonable fee that includes reimbursement of the reasonable cost of any direct and indirect expenses they incur in providing these services. Please read Item 7 – Major Unitholders and Certain Relationships and Related Party Transactions for a summary of certain contract terms.
 
  (d)  
Pursuant to the Nakilat Share Purchase Agreement, we agreed to acquire from Teekay Corporation its 100% ownership interest in Teekay Nakilat Holdings Corporation. Please read Item 7 – Major Unitholders and Certain Relationships and Related Party Transactions for a summary of certain contract terms.
 
  (e)  
Syndicated Loan Agreement between Naviera Teekay Gas III, S.L. (formerly Naviera F. Tapias Gas III, S.A.) and Caixa de Aforros de Vigo Ourense e Pontevedra, as Agent, dated as of October 2, 2000, as amended. This facility was used to make restricted cash deposits that fully fund payments under a capital lease for one of our LNG carriers, the Catalunya Spirit. Interest payments are based on EURIBOR plus a margin. The term loan matures in 2023 with monthly payments that reduce over time.
 
  (f)  
Teekay LNG Partners L.P. 2005 Long-Term Incentive Plan. Please read Item 6 – Directors, Senior Management and Employees for a summary of certain plan terms.
 
  (g)  
Agreement dated August 23, 2006, for a U.S. $330,000,000 Secured Revolving Loan Facility between Teekay LNG Partners L.P., ING Bank N.V. and other banks. This facility bears interest at LIBOR plus a margin of 0.55%. The amount available under the facility reduces semi-annually by amounts ranging from $4.3 million to $8.4 million, with a bullet reduction of $188.7 million on maturity in August 2018. The revolver is collateralized by first-priority mortgages granted on two of our LNG carriers. The credit facility may be used for general partnership purposes and to fund cash distributions.

 

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  (h)  
Agreement dated June 30, 2008, for a U.S. $172,500,000 Secured Revolving Loan Facility between Arctic Spirit L.L.C., Polar Spirit L.L.C and DnB Nor Bank A.S.A. and other banks. This facility bears interest at LIBOR plus a margin of 0.80%. The amount available under the facility reduces by $6.1 million semi-annually, with a balloon reduction of $56.6 million on maturity in June 2018. The revolver is collateralized by first-priority mortgages granted on two of our LNG carriers. The credit facility may be used for general partnership purposes and to fund cash distributions.
 
  (i)  
Agreement dated October 27, 2009, for a U.S. $122.0 million credit facility that will be secured by the Skaugen LPG Carriers and the Skaugen Multigas Carriers. The facility amount is equal to the lower of $122.0 million and 60% of the aggregate purchase price of the vessels. The facility will mature, with respect to each vessel, seven years after each vessels’ first drawdown date. We expect to draw on this facility in 2010 to repay a portion of the amount we borrowed to purchase the Skaugen LPG Carriers that delivered in April 2009 and November 2009. We will use the remaining available funds from the facility to assist in purchasing, or facilitate the purchase of, the third Skaugen LPG Carrier and the two Skaugen Multigas Carriers upon delivery of each vessel.
Exchange Controls and Other Limitations Affecting Unitholders
We are not aware of any governmental laws, decrees or regulations, including foreign exchange controls, in the Republic of The Marshall Islands that restrict the export or import of capital, or that affect the remittance of dividends, interest or other payments to non-resident holders of our securities.
We are not aware of any limitations on the right of non-resident or foreign owners to hold or vote our securities imposed by the laws of the Republic of The Marshall Islands or our partnership agreement.
Taxation to Unitholders
Marshall Islands Tax Consequences. Because we and our subsidiaries do not, and we do not expect that we and our subsidiaries will, conduct business or operations in the Republic of The Marshall Islands, and because all documentation related to our initial public offering and follow-on offerings were executed outside of the Republic of the Marshall Islands, under current Marshall Islands law, no taxes or withholdings are imposed by the Republic of The Marshall Islands on distributions, including upon a return of capital, made to unitholders, so long as such persons do not reside in, maintain offices in, nor engage in business in the Republic of The Marshall Islands. Furthermore, no stamp, capital gains or other taxes are imposed by the Republic of The Marshall Islands on the purchase, ownership or disposition by such persons of our common units.
United States Tax Consequences. The following discussion of the material U.S. federal income tax considerations that may be relevant to common unitholders who are individual citizens or residents of the United States is based upon provisions of the U.S. Internal Revenue Code of 1986 (or the Internal Revenue Code) as in effect on the date of this prospectus, existing final, temporary and proposed regulations thereunder (or Treasury Regulations) and current administrative rulings and court decisions, all of which are subject to change. Changes in these authorities may cause the tax consequences to vary substantially from the consequences described below. This discussion does not comment on all U.S. federal income tax matters affecting the unitholders and does not address the tax consequences under U.S. state and local and other tax laws. Moreover, the discussion focuses on unitholders who are individual citizens or residents of the United States and hold their units as capital assets and has only limited application to corporations, estates, trusts, non-U.S. persons or other unitholders subject to specialized tax treatment, such as tax-exempt entities (including IRAs), regulated investment companies (mutual funds), real estate investment trusts (or REITs) and holders who directly or indirectly own a ten percent (10%) or greater interest in us. Accordingly, unitholders should consult their own tax advisors in analyzing the U.S. federal, state, local and non-U.S. tax consequences particular to him of the ownership or disposition of common units.
Classification as a Partnership. As discussed in Item 4 – Information on the Partnership: F. Taxation of the Partnership, we believe we will be classified as a partnership for U.S. federal income tax purposes.
Consequences of Unit Ownership
Flow-through of Taxable Income. Each unitholder is required to include in computing his taxable income his allocable share of our items of income, gains, loss, deductions and credit for our taxable year ending with or within his taxable year, without regard to whether we make corresponding cash distributions to him. Our taxable year ends on December 31. Consequently, we may allocate income to a unitholder as of December 31 of a given year, and the unitholder will be required to report this income on his tax return for his tax year that ends on or includes such date, even if he has not received a cash distribution from us as of that date.
Newly enacted legislation requires certain U.S. unitholders who are individuals, estates or trusts to pay a 3.8 percent tax on, among other things, a unitholder’s allocable share of our income and gain in taxable years beginning after December 31, 2012. U.S. unitholders should consult their tax advisors regarding the effect, if any, of this legislation on their ownership of our common units.
Treatment of Distributions. Distributions by us to a unitholder generally will not be taxable to the unitholder for U.S. federal income tax purposes to the extent of his tax basis in his common units immediately before the distribution. Our cash distributions in excess of a unitholder’s tax basis generally will be considered to be gain from the sale or exchange of the common units. Any reduction in a unitholder’s share of our liabilities for which no partner, including the general partner, bears the economic risk of loss, known as “nonrecourse liabilities,” will be treated as a distribution of cash to that unitholder. A decrease in a unitholder’s percentage interest in us because of our issuance of additional common units will decrease his share of our nonrecourse liabilities, and thus will result in a corresponding deemed distribution of cash. To the extent our distributions cause a unitholder’s “at risk” amount to be less than zero at the end of any taxable year, he must recapture any losses deducted in previous years.
A non-pro rata distribution of money or property may result in ordinary income to a unitholder, regardless of his tax basis in his common units, if the distribution reduces the unitholder’s share of our “unrealized receivables,” including depreciation recapture, and/or substantially appreciated “inventory items,” both as defined in the Internal Revenue Code (or, collectively, Section 751 Assets). To that extent, he will be treated as having been distributed his proportionate share of the Section 751 Assets and having exchanged those assets with us in return for the non-pro rata portion of the actual distribution made to him. This latter deemed exchange will generally result in the unitholder’s realization of ordinary income, which will equal the excess of (1) the non-pro rata portion of that distribution over (2) the unitholder’s tax basis for the share of Section 751 Assets deemed relinquished in the exchange.

 

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Basis of Common Units. A unitholder’s initial U.S. federal income tax basis for his common units will be the amount he paid for the common units plus his share of our nonrecourse liabilities. That basis will be increased by his share of our income and by any increases in his share of our nonrecourse liabilities. That basis will be decreased, but not below zero, by distributions from us, by the unitholder’s share of our losses, by any decreases in his share of our nonrecourse liabilities and by his share of our expenditures that are not deductible in computing taxable income and are not required to be capitalized. A unitholder will have no share of our debt that is recourse to the general partner, but will have a share, generally based on his share of profits, of our nonrecourse liabilities.
Limitations on Deductibility of Losses. The deduction by a unitholder of his share of our losses will be limited to the tax basis in his units and, in the case of an individual unitholder or a corporate unitholder, if more than 50% of the value of the corporate unitholder’s stock is owned directly or indirectly by five or fewer individuals or some tax-exempt organizations, to the amount for which the unitholder is considered to be “at risk” with respect to our activities, if that is less than his tax basis. A unitholder must recapture losses deducted in previous years to the extent that distributions cause his at risk amount to be less than zero at the end of any taxable year. Losses disallowed to a unitholder or recaptured as a result of these limitations will carry forward and will be allowable to the extent that his tax basis or at risk amount, whichever is the limiting factor, is subsequently increased. Upon the taxable disposition of a unit, any gain recognized by a unitholder can be offset by losses that were previously suspended by the at risk limitation but may not be offset by losses suspended by the basis limitation. Any excess suspended loss above that gain is no longer utilizable. In general, a unitholder will be at risk to the extent of the tax basis of his units, excluding any portion of that basis attributable to his share of our nonrecourse liabilities, reduced by any amount of money he borrows to acquire or hold his units, if the lender of those borrowed funds owns an interest in us, is related to the unitholder or can look only to the units for repayment.
The passive loss limitations generally provide that individuals, estates, trusts and some closely-held corporations and personal service corporations can deduct losses from a passive activity only to the extent of the taxpayer’s income from the same passive activity. Passive activities generally are corporate or partnership activities in which the taxpayer does not materially participate. The passive loss limitations are applied separately with respect to each publicly traded partnership. Consequently, any passive losses we generate only will be available to offset our passive income generated in the future and will not be available to offset income from other passive activities or investments, including our investments or investments in other publicly traded partnerships, or salary or active business income. Passive losses that are not deductible because they exceed a unitholder’s share of income we generate may be deducted in full when he disposes of his entire investment in us in a fully taxable transaction with an unrelated party. The passive activity loss rules are applied after other applicable limitations on deductions, including the at risk rules and the basis limitation.
Dual consolidated loss restrictions also may apply to limit the deductibility by a corporate unitholder of losses we incur. Corporate unitholders are urged to consult their own tax advisors regarding the applicability and effect to them of dual consolidated loss restrictions.
Limitations on Interest Deductions. The deductibility of a non-corporate taxpayer’s “investment interest expense” generally is limited to the amount of that taxpayer’s “net investment income.” Investment interest expense includes:
   
interest on indebtedness properly allocable to property held for investment;
   
our interest expense attributed to portfolio income; and
   
the portion of interest expense incurred to purchase or carry an interest in a passive activity to the extent attributable to portfolio income.
The computation of a unitholder’s investment interest expense will take into account interest on any margin account borrowing or other loan incurred to purchase or carry a unit. Net investment income includes gross income from property held for investment and amounts treated as portfolio income under the passive loss rules, less deductible expenses, other than interest, directly connected with the production of investment income, but generally does not include gains attributable to the disposition of property held for investment. The IRS has indicated that net passive income earned by a publicly traded partnership will be treated as investment income to its unitholders. In addition, the unitholder’s share of our portfolio income will be treated as investment income.
Entity-Level Collections. If we are required or elect under applicable law to pay any U.S. federal, state or local or foreign income or withholding taxes on behalf of any present or former unitholder or the general partner, we are authorized to pay those taxes from our funds. That payment, if made, will be treated as a distribution of cash to the partner on whose behalf the payment was made. If the payment is made on behalf of a person whose identity cannot be determined, we are authorized to treat the payment as a distribution to all current unitholders. We are authorized to amend the partnership agreement in the manner necessary to maintain uniformity of intrinsic tax characteristics of units and to adjust later distributions, so that after giving effect to these distributions, the priority and characterization of distributions otherwise applicable under the partnership agreement are maintained as nearly as is practicable. Payments by us as described above could give rise to an overpayment of tax on behalf of an individual partner, in which event the partner would be required to file a claim in order to obtain a credit or refund of tax paid.
Allocation of Income, Gain, Loss, Deduction and Credit. In general, if we have a net profit, our items of income, gain, loss, deduction and credit will be allocated among the general partner and the unitholders in accordance with their percentage interests in us. At any time that distributions are made to the common units in excess of distributions to the subordinated units, or incentive distributions are made to the general partner, gross income will be allocated to the recipients to the extent of these distributions. If we have a net loss for the entire year, that loss generally will be allocated first to the general partner and the unitholders in accordance with their percentage interests in us to the extent of their positive capital accounts and, second, to the general partner.
Specified items of our income, gain, loss and deduction will be allocated to account for any difference between the tax basis and fair market value of any property held by the partnership immediately prior to an offering of common units, referred to in this discussion as “Adjusted Property.” The effect of these allocations to a unitholder purchasing common units in an offering essentially will be the same as if the tax basis of our assets were equal to their fair market value at the time of the offering. In addition, items of recapture income will be allocated to the extent possible to the partner who was allocated the deduction giving rise to the treatment of that gain as recapture income in order to minimize the recognition of ordinary income by some unitholders. Finally, although we do not expect that our operations will result in the creation of negative capital accounts, if negative capital accounts nevertheless result, items of our income and gain will be allocated in an amount and manner to eliminate the negative balance as quickly as possible.

 

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An allocation of items of our income, gain, loss, deduction or credit, other than an allocation required by the Internal Revenue Code to eliminate the difference between a partner’s “book” capital account, which is credited with the fair market value of Adjusted Property, and “tax” capital account, which is credited with the tax basis of Adjusted Property, referred to in this discussion as the “Book-Tax Disparity,” generally will be given effect for U.S. federal income tax purposes in determining a partner’s share of an item of income, gain, loss, deduction or credit only if the allocation has substantial economic effect. In any other case, a partner’s share of an item will be determined on the basis of his interest in us, which will be determined by taking into account all the facts and circumstances, including:
   
this relative contributions to us;
   
the interests of all the partners in profits and losses;
   
the interest of all the partners in cash flow; and
   
the rights of all the partners to distributions of capital upon liquidation.
A unitholder’s taxable income or loss with respect to a common unit each year will depend upon a number of factors, including the nature and fair market value of our assets at the time the holder acquired the common unit, we issue additional units or we engage in certain other transactions, and the manner in which our items of income, gain, loss, deduction and credit are allocated among our partners. For this purpose, we determine the value of our assets and the relative amounts of our items of income, gain, loss, deduction and credit allocable to our unitholders and our general partner as holder of the incentive distribution rights by reference to the value of our interests, including the incentive distribution rights. The IRS may challenge any valuation determinations that we make, particularly as to the incentive distribution rights, for which there is no public market. Moreover, the IRS could challenge certain other aspects of the manner in which we determine the relative allocations made to our unitholders and to the general partner as holder of our incentive distribution rights. A successful IRS challenge to our valuation or allocation methods could increase the amount of net taxable income and gain realized by a unitholder with respect to a common unit.
Section 754 Election. We have made an election under Section 754 of the Internal Revenue Code to adjust a common unit purchaser’s U.S. federal income tax basis in our assets (or inside basis) to reflect the purchaser’s purchase price (or a Section 743(b) adjustment). The Section 743(b) adjustment belongs to the purchaser and not to other unitholders and does not apply to unitholders who acquire their common units directly from us. For purposes of this discussion, a unitholder’s inside basis in our assets will be considered to have two components: (1) his share of our tax basis in our assets (or common basis) and (2) his Section 743(b) adjustment to that basis.
In general, a purchaser’s common basis is depreciated or amortized according to the existing method utilized by us. A positive Section 743(b) adjustment to that basis generally is depreciated or amortized in the same manner as property of the same type that has been newly placed in service by us. A negative Section 743(b) adjustment to that basis generally is recovered over the remaining useful life of the partnership’s recovery property.
A Section 743(b) adjustment is advantageous if the purchaser’s tax basis in his units is higher than the units’ share of the aggregate tax basis of our assets immediately prior to the transfer. In that case, as a result of the adjustment, the purchaser would have, among other items, a greater amount of depreciation and amortization deductions and his share of any gain or loss on a sale of our assets would be less. Conversely, a Section 743(b) adjustment is disadvantageous if the purchaser’s tax basis in his units is lower than those units’ share of the aggregate tax basis of our assets immediately prior to the purchase. Thus, the fair market value of the units may be affected either favorably or unfavorably by the Section 743(b) adjustment. A basis adjustment is required regardless of whether a Section 754 election is made in the case of a transfer on an interest in us if we have a substantial built-in loss immediately after the transfer, or if we distribute property and have a substantial basis reduction. Generally, a built-in loss or a basis reduction is substantial if it exceeds $250,000.
The calculations involved in the Section 743(b) adjustment are complex and will be made on the basis of assumptions as to the value of our assets and in accordance with the Internal Revenue Code and applicable Treasury Regulations. We cannot assure you that the determinations we make will not be successfully challenged by the IRS and that the deductions resulting from them will not be reduced or disallowed altogether. Should the IRS require a different basis adjustment to be made, and should, in our judgment, the expense of compliance exceed the benefit of the election, we may seek consent from the IRS to revoke our Section 754 election. If such consent is given, a subsequent purchaser of units may be allocated more income than he would have been allocated had the election not been revoked.
Tax Treatment of Operations
Accounting Method and Taxable Year. We use the year ending December 31 as our taxable year and the accrual method of accounting for U.S. federal income tax purposes. Each unitholder will be required to include in income his share of our income, gain, loss, deduction and credit for our taxable year ending within or with his taxable year. In addition, a unitholder who disposes of all of his units must include his share of our income, gain, loss, deduction and credit through the date of disposition in income for his taxable year that includes the date of disposition, with the result that a unitholder who has a taxable year ending on a date other than December 31 and who disposes of all of his units following the close of our taxable year but before the close of his taxable year must include his share of more than one year of our income, gain, loss, deduction and credit in income for the year of the disposition.
Asset Tax Basis, Depreciation and Amortization. The tax basis of our assets will be used for purposes of computing depreciation and cost recovery deductions and, ultimately, gain or loss on the disposition of these assets. The U.S. federal income tax burden associated with any difference between the fair market value of our assets and their tax basis immediately prior to this offering will be borne by the general partner and the existing limited partners.

 

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To the extent allowable, we may elect to use the depreciation and cost recovery methods that will result in the largest deductions being taken in the early years after assets are placed in service. Property we subsequently acquire or construct may be depreciated using any method permitted by the Internal Revenue Code.
If we dispose of depreciable property by sale, foreclosure or otherwise, all or a portion of any gain, determined by reference to the amount of depreciation previously deducted and the nature of the property, may be subject to the recapture rules and taxed as ordinary income rather than capital gain. Similarly, a unitholder who has taken cost recovery or depreciation deductions with respect to property we own likely will be required to recapture some or all of those deductions as ordinary income upon a sale of his interest in us.
The U.S. federal income tax consequences of the ownership and disposition of units will depend in part on our estimates of the relative fair market values, and the tax bases, of our assets at the time the holder acquired the common unit, we issue additional units or we engage in certain other transactions. Although we may from time to time consult with professional appraisers regarding valuation matters, we will make many of the relative fair market value estimates ourselves. These estimates and determinations of basis are subject to challenge and will not be binding on the IRS or the courts. If the estimates of fair market value or basis are later found to be incorrect, the character and amount of items of income, gain, loss, deductions or credits previously reported by unitholders might change, and unitholders might be required to adjust their tax liability for prior years and incur interest and penalties with respect to those adjustments.
Disposition of Common Units
Recognition of Gain or Loss. In general, gain or loss will be recognized on a sale of units equal to the difference between the amount realized and the unitholder’s tax basis in the units sold. A unitholder’s amount realized will be measured by the sum of the cash, the fair market value of other property received by him and his share of our nonrecourse liabilities. Because the amount realized includes a unitholder’s share of our nonrecourse liabilities, the gain recognized on the sale of units could result in a tax liability in excess of any cash or property received from the sale.
Prior distributions from us in excess of cumulative net taxable income for a common unit that decreased a unitholder’s tax basis in that common unit will, in effect, become taxable income if the common unit is sold at a price greater than the unitholder’s tax basis in that common unit, even if the price received is less than his original cost. Except as noted below, gain or loss recognized by a unitholder on the sale or exchange of a unit generally will be taxable as capital gain or loss. Capital gain recognized by an individual on the sale of units held more than one year generally will be taxed at a maximum rate of 15% under current law.
A portion of a unitholder’s amount realized may be allocable to “unrealized receivables” or to “inventory items” we own. The term “unrealized receivables” includes potential recapture items, including depreciation and amortization recapture. A unitholder will recognize ordinary income or loss to the extent of the difference between the portion of the unitholder’s amount realized allocable to unrealized receivables or inventory items and the unitholder’s share of our basis in such receivables or inventory items. Ordinary income attributable to unrealized receivables, inventory items and depreciation or amortization recapture may exceed net taxable gain realized upon the sale of a unit and may be recognized even if a net taxable loss is realized on the sale of a unit. Thus, a unitholder may recognize both ordinary income and a capital loss upon a sale of units. Net capital losses generally may only be used to offset capital gains. An exception permits individuals to offset up to $3,000 of net capital losses against ordinary income in any given year.
The IRS has ruled that a partner who acquires interests in a partnership in separate transactions must combine those interests and maintain a single adjusted tax basis for all those interests. Upon a sale or other disposition of less than all of those interests, a portion of that tax basis must be allocated to the interests sold using an “equitable apportionment” method. Treasury Regulations under Section 1223 of the Internal Revenue Code allow a selling unitholder who can identify common units transferred with an ascertainable holding period to elect to use the actual holding period of the common units transferred. Thus, according to the ruling, a common unitholder will be unable to select high or low basis common units to sell as would be the case with corporate stock, but, according to the regulations, may designate specific common units sold for purposes of determining the holding period of units transferred. A unitholder electing to use the actual holding period of common units transferred must consistently use that identification method for all subsequent sales or exchanges of common units. A unitholder considering the purchase of additional units or a sale of common units purchased in separate transactions is urged to consult his tax advisor as to the possible consequences of this ruling and application of the regulations.
Allocations Between Transferors and Transferees. In general, our taxable income or loss will be determined annually, will be prorated on a monthly basis and will be subsequently apportioned among the unitholders in proportion to the number of units owned by each of them as of the opening of the applicable exchange on the first business day of the month. However, gain or loss realized on a sale or other disposition of our assets other than in the ordinary course of business will be allocated among the unitholders on the first business day of the month in which that gain or loss is recognized. As a result of the foregoing, a unitholder transferring units may be allocated income, gain, loss, deduction and credit realized after the date of transfer. A unitholder who owns units at any time during a calendar quarter and who disposes of them prior to the record date set for a cash distribution for that quarter will be allocated items of our income, gain, loss and deductions attributable to months within that quarter in which the units were held but will not be entitled to receive that cash distribution.
Transfer Notification Requirements. A unitholder who sells any of his units, other than through a broker, generally is required to notify us in writing of that sale within 30 days after the sale (or, if earlier, January 15 of the year following the sale). A unitholder who acquires units generally is required to notify us in writing of that acquisition within 30 days after the purchase, unless a broker or nominee will satisfy such requirement. We are required to notify the IRS of any such transfers of units and to furnish specified information to the transferor and transferee. Failure to notify us of a transfer of units may lead to the imposition of substantial penalties.
Constructive Termination. We will be considered to have been terminated for U.S. federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a 12-month period. A constructive termination results in the closing of our taxable year for all unitholders. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may result in more than 12 months of our taxable income or loss being includable in his taxable income for the year of termination. We would be required to make new tax elections after a termination, including a new election under Section 754 of the Internal Revenue Code, and a termination would result in a deferral of our deductions for depreciation. A termination could also result in penalties if we were unable to determine that the termination had occurred. Moreover, a termination might either accelerate the application of, or subject us to, tax legislation applicable to a newly formed partnership.

 

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Foreign Tax Credit Considerations
Subject to detailed limitations set forth in the Internal Revenue Code, a unitholder may elect to claim a credit against his liability for U.S. federal income tax for his share of foreign income taxes (and certain foreign taxes imposed in lieu of a tax based upon income) paid by us. Income allocated to unitholders likely will constitute foreign source income falling in the general foreign tax credit category for purposes of the U.S. foreign tax credit limitation. The rules relating to the determination of the foreign tax credit are complex and unitholders are urged to consult their own tax advisors to determine whether or to what extent they would be entitled to such credit. Unitholders who do not elect to claim foreign tax credits may instead claim a deduction for their shares of foreign taxes paid by us.
Functional Currency
We are required to determine the functional currency of any of our operations that constitute a separate qualified business unit (or QBU) for U.S. federal income tax purposes and report the affairs of any QBU in this functional currency to our unitholders. Any transactions conducted by us other than in the U.S. dollar or by a QBU other than in its functional currency may give rise to foreign currency exchange gain or loss. Further, if a QBU is required to maintain a functional currency other than the U.S. dollar, a unitholder may be required to recognize foreign currency translation gain or loss upon a distribution of money or property from a QBU or upon the sale of common units, and items or income, gain, loss or deduction allocated to the unitholder in such functional currency must be translated into the unitholder’s functional currency.
For purposes of the foreign currency rules, a QBU includes a separate trade or business owned by a partnership in the event separate books and records are maintained for that separate trade or business. The functional currency of a QBU is determined based upon the economic environment in which the QBU operates. Thus, a QBU whose revenues and expenses are determined in a currency other than the U.S. dollar will have a non-U.S. dollar functional currency. We believe our principal operations constitute a QBU whose functional currency is the U.S. dollar, but certain of our operations constitute separate QBUs whose functional currencies are other than the U.S. dollar.
Under proposed regulations (or the Section 987 Proposed Regulations), the amount of foreign currency translation gain or loss recognized upon a distribution of money or property from a QBU or upon the sale of common units will reflect the appreciation or depreciation in the functional currency value of certain assets and liabilities of the QBU between the time the unitholder purchased his common units and the time we receive distributions from such QBU or the unitholder sells his common units. Foreign currency translation gain or loss will be treated as ordinary income or loss. A unitholder must adjust the U.S. federal income tax basis in his common units to reflect such income or loss prior to determining any other U.S. federal income tax consequences of such distribution or sale. A unitholder who owns less than a five percent interest in our capital or profits generally may elect not to have these rules apply by attaching a statement to his tax return for the first taxable year the unitholder intends the election to be effective. Further, for purposes of computing his taxable income and U.S. federal income tax basis in his common units, a unitholder will be required to translate into his own functional currency items of income, gain, loss or deduction of such QBU and his share of such QBU’s liabilities. We intend to provide such information based on generally applicable U.S. exchange rates as is necessary for unitholders to comply with the requirements of the Section 987 Proposed Regulations as part of the U.S. federal income tax information we will furnish unitholders each year. However, a unitholder may be entitled to make an election to apply an alternative exchange rate with respect to the foreign currency translation of certain items. Unitholders who desire to make such an election should consult their own tax advisors.
Based upon our current projections of the capital invested in and profits of the non-U.S. dollar QBUs, we believe that unitholders will be required to recognize only a nominal amount of foreign currency translation gain or loss each year and upon their sale of units. Nonetheless, the rules for determining the amount of translation gain or loss are not entirely clear at present as the Section 987 Proposed Regulations currently are not effective. Please consult your own tax advisor for specific advice regarding the application of the rules for recognizing foreign currency translation gain or loss under your own circumstances. In addition to a unitholder’s recognition of foreign currency translation gain or loss, the U.S. dollar QBU will engage in certain transactions denominated in the Euro, which will give rise to a certain amount of foreign currency exchange gain or loss each year. This foreign currency exchange gain or loss will be treated as ordinary income or loss.
Information Returns and Audit Procedures
We intend to furnish to each unitholder, within 90 days after the close of each calendar year, specific U.S. federal income tax information, including a document in the form of IRS Form 1065, Schedule K-1, which sets forth his share of our items of income, gain, loss, deductions and credits as computed for U.S. federal income tax purposes for our preceding taxable year. In preparing this information, which will not be reviewed by counsel, we will take various accounting and reporting positions, some of which have been mentioned earlier, to determine his share of such items of income, gain, loss, deduction and credit. We cannot assure you that those positions will yield a result that conforms to the requirements of the Internal Revenue Code, Treasury Regulations or administrative interpretations of the IRS. We can not assure prospective unitholders that the IRS will not successfully contend that those positions are impermissible. Any challenge by the IRS could negatively affect the value of the units.
We will be obligated to file U.S. federal income tax information returns with the IRS for any year in which we earn any U.S. source income or U.S. effectively connected income. In the event we were obligated to file a U.S. federal income tax information return but failed to do so, unitholders would not be entitled to claim any deductions, losses or credits for U.S. federal income tax purposes relating to us. Consequently, we may file U.S. federal income tax information returns for any given year. The IRS may audit any such information returns that we file. Adjustments resulting from an IRS audit of our return may require each unitholder to adjust a prior year’s tax liability, and may result in an audit of his return. Any audit of a unitholder’s return could result in adjustments not related to our returns as well as those related to our returns. Any IRS audit relating to our items of income, gain, loss, deduction or credit for years in which we are not required to file and do not file a U.S. federal income tax information return would be conducted at the partner-level, and each unitholder may be subject to separate audit proceedings relating to such items.
For years in which we file or are required to file U.S. federal income tax information returns, we will be treated as a separate entity for purposes of any U.S. federal income tax audits, as well as for purposes of judicial review of administrative adjustments by the IRS and tax settlement proceedings. For such years, the tax treatment of partnership items of income, gain, loss, deduction and credit will be determined in a partnership proceeding rather than in separate proceedings with the partners. The Internal Revenue Code requires that one partner be designated as the “Tax Matters Partner” for these purposes. The partnership agreement names Teekay GP L.L.C. as our Tax Matters Partner.

 

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The Tax Matters Partner will make some U.S. federal tax elections on our behalf and on behalf of unitholders. In addition, the Tax Matters Partner can extend the statute of limitations for assessment of tax deficiencies against unitholders for items reported in the information returns we file. The Tax Matters Partner may bind a unitholder with less than a 1% profits interest in us to a settlement with the IRS with respect to these items unless that unitholder elects, by filing a statement with the IRS, not to give that authority to the Tax Matters Partner. The Tax Matters Partner may seek judicial review, by which all the unitholders are bound, of a final partnership administrative adjustment and, if the Tax Matters Partner fails to seek judicial review, judicial review may be sought by any unitholder having at least a 1% interest in profits or by any group of unitholders having in the aggregate at least a 5% interest in profits. However, only one action for judicial review will go forward, and each unitholder with an interest in the outcome may participate.
A unitholder must file a statement with the IRS identifying the treatment of any item on his U.S. federal income tax return that is not consistent with the treatment of the item on an information return that we file. Intentional or negligent disregard of this consistency requirement may subject a unitholder to substantial penalties
Possible Classification as a Corporation
If we fail to meet the Qualifying Income Exception described previously with respect to our classification as a partnership for U.S. federal income tax purposes, other than a failure that is determined by the IRS to be inadvertent and that is cured within a reasonable time after discovery, we will be treated as a non-U.S. corporation for U.S. federal income tax purposes. If previously treated as a partnership, our change in status would be deemed to have been effected by our transfer of all of our assets, subject to liabilities, to a newly formed non-U.S. corporation, in return for stock in that corporation, and then our distribution of that stock to our unitholders and other owners in liquidation of their interests in us. Unitholders that are U.S. persons would be required to file IRS Form 926 to report these deemed transfers and any other transfers they made to us while we were treated as a corporation and may be required to recognize income or gain for U.S. federal income tax purposes to the extent of certain prior deductions or losses and other items. Substantial penalties may apply for failure to satisfy these reporting requirements, unless the person otherwise required to report shows such failure was due to reasonable cause and not willful neglect.
If we were treated as a corporation in any taxable year, either as a result of a failure to meet the Qualifying Income Exception or otherwise, our items of income, gain, loss, deduction and credit would not pass through to unitholders. Instead, we would be subject to U.S. federal income tax based on the rules applicable to foreign corporations, not partnerships, and such items would be treated as our own. Any distribution made to a unitholder would be treated as taxable dividend income to the extent of our current or accumulated earnings and profits, a nontaxable return of capital to the extent of the unitholder’s tax basis in his common units, and taxable capital gain thereafter.
A non-U.S. entity treated as a corporation for U.S. federal income tax purposes will be a PFIC in any taxable year in which, after taking into account the income and assets of the corporation and certain subsidiaries pursuant to a “look through” rule, either: (i) at least 75.0% of its gross income is “passive” income; or (ii) at least 50.0% of the average value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For purposes of these tests, “passive income” includes dividends, interest, and gains from the sale or exchange of investment property and rents and royalties other than rents and royalties that are received from unrelated parties in connection with the active conduct of a trade or business. For purposes of these tests, income derived from the performance of services does not constitute “passive income.”
There are legal uncertainties involved in determining whether the income derived from our time chartering activities constitutes rental income or income derived from the performance of services, including the decision in Tidewater Inc. v. United States, 565 F.3d 299 (5th Cir. 2009), which held that income derived from certain time chartering activities should be treated as rental income rather than services income for purposes of a foreign sales corporation provision of the Code, and a recent unofficial IRS pronouncement issued to provide guidance to IRS field employees and examiners, which cites the Tidewater decision favorably in support of the conclusion that income derived by foreign taxpayers from time chartering vessels engaged in the exploration for, or exploitation of, natural resources on the Outer Continental Shelf in the Gulf of Mexico is characterized as leasing or rental income for purposes of the income sourcing provisions of the Code. However, we believe that the nature of our time chartering activities, as well as our time charter contracts, differ in certain material respects from those at issue in Tidewater. Consequently, based upon our and our subsidiaries’ current assets and operations, we intend to take the position that we would not be considered to be a PFIC if we were treated as a corporation. No assurance can be given, however, that the IRS, or a court of law, would accept this position or that we would not constitute a PFIC for any future taxable year if we were treated as a corporation and there were to be changes in our and our subsidiaries’ assets, income or operations.
If we were classified as a PFIC, for any year during which a unitholder owns units, he generally will be subject to special rules (regardless of whether we continue thereafter to be a PFIC) with respect to (1) any “excess distribution” (generally, any distribution received by a unitholder in a taxable year that is greater than 125% of the average annual distributions received by the unitholder in the three preceding taxable years or, if shorter, the unitholder’s holding period for the units) and (2) any gain realized upon the sale or other disposition of units. Under these rules:
(i) the excess distribution or gain will be allocated ratably over the unitholder’s holding period;
(ii) the amount allocated to the current taxable year and any taxable year prior to the taxable year we were first treated as a PFIC with respect to the unitholder would be taxed as ordinary income in the current taxable year;
(iii) the amount allocated to each of the other taxable years would be subject to U.S. federal income tax at the highest rate in effect for the applicable class of taxpayer for that year; and an interest charge for the deemed deferral benefit will be imposed with respect to the resulting tax attributable to each of these other taxable years.

 

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Certain elections, such as a qualified electing fund (or QEF) election or mark to market election, may be available to a unitholder if we were classified as a PFIC. If we determine that we are or will be a PFIC, we will provide unitholders with information concerning the potential availability of such elections.
U.S. holders of PFICs may be subject to additional reporting requirements.
Under current law, dividends received by individual citizens or residents of the United States from domestic corporations and qualified foreign corporations generally are treated as net capital gains and subject to U.S. federal income tax at reduced rates (currently 15%). However, if we were classified as a PFIC for our taxable year in which we pay a dividend, we would not be considered a qualified foreign corporation, and individuals receiving such dividends would not be eligible for the reduced rate of U.S. federal income tax.
Consequences of Possible Controlled Foreign Corporation Classification.
If more than 50% of either the total combined voting power of our outstanding units entitled to vote or the total value of all of our outstanding units were owned, actually or constructively, by citizens or residents of the United States, U.S. partnerships or corporations, or U.S. estates or trusts (as defined for U.S. federal income tax purposes), each of which owned, actually or constructively, 10% or more of the total combined voting power of our outstanding units entitled to vote (each a “10% U.S. shareholder”), we could be treated as a controlled foreign corporation (or CFC) at any such time as we are properly classified as a corporation for U.S. federal income tax purposes. If we were a CFC, the tax consequences of holding and disposing of units would be different than described above. However, we believe we are not a CFC.
Taxation of Our Subsidiary Corporations
Consequences of Possible PFIC Classification
As non-U.S. entities classified as corporations for U.S. federal income tax purposes, our subsidiaries Arctic Spirit L.L.C., Polar Spirit L.L.C. and Teekay Tangguh Holdco L.L.C. could be considered PFICs. We received a ruling from the IRS that our subsidiary Teekay Tangguh Holdco L.L.C. will be classified as a controlled foreign corporation (CFC) rather than a PFIC as long as it is wholly-owned by a U.S. partnership. On November 17, 2009 we restructured our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C. such that they are also owned by a U.S. partnership, and believe that these subsidiaries should be treated as CFCs rather than PFICs following the restructuring. However, if our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C. were to be treated as PFICs prior to the restructuring, those subsidiaries would continue to be treated as PFICs with respect to a unitholder who held our common units prior to the restructuring, unless certain elections described below are made by the unitholder or the U.S. partnership, as applicable.
As described above under “Possible Classification as a Corporation— Consequences of Possible PFIC Classification,” legal uncertainties are involved in the determination of whether our subsidiaries Artic Spirit L.L.C. and Polar Spirit L.L.C. will be considered PFICs prior to the restructuring. These legal uncertainties include the decision of the United States Court of Appeals for the Fifth Circuit in Tidewater, which held that income derived from certain time chartering activities should be treated as rental income rather than services income for purposes of a foreign sales corporation provision of the Code. However, we believe that the nature of the chartering activities, as well as the charter contracts, of our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C. as well as the chartering activities of Polarc L.L.C., a wholly owned subsidiary of Teekay Corporation and the charterer of the Arctic Spirit and the Polar Spirit, differ in certain material respects from those at issue in Tidewater. Consequently, based on the current assets and operations of these subsidiaries, we intend to take the position that neither Arctic Spirit L.L.C. nor Polar Spirit L.L.C. has ever been a PFIC. No assurance can be given, however, that the IRS, or a court of law, will accept this position or that either of these subsidiaries would not constitute a PFIC for any future taxable year if there were to be changes in its assets, income or operations.
As described above under “Possible Classification as a Corporation— Consequences of Possible PFIC Classification,” U.S. shareholders of a PFIC are subject to an adverse U.S. federal income tax regime with respect to the income derived by the PFIC, the distributions they receive from the PFIC, and the gain, if any, they derive from the direct or indirect sale or other disposition of their interests in the PFIC. If either of our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C were to be treated as a PFIC prior to the restructuring, a unitholder who held our common units prior to the restructuring would be considered to own directly the unitholder’s proportionate share of the equity of such subsidiary. In that event, the impact of the PFIC rules on a unitholder would depend on whether the unitholder has made a timely and effective election to treat the subsidiary as a qualified electing fund under Section 1295 of the Code (QEF Election) for the tax year that is the first year in the unitholder’s holding period of our units during which the subsidiary qualified as a PFIC by filing IRS Form 8621 with the unitholder’s U.S. federal income tax return.
Taxation of a Unitholder Subject to a QEF Election. If a unitholder who held our common units prior to the restructuring makes a timely QEF Election, the adverse tax regime described above under “Possible Classification as a Corporation— Consequences of Possible PFIC Classification” would not apply. Instead a unitholder must report each year for U.S. federal income tax purposes the unitholder’s pro rata share of the ordinary earnings and net capital gain, if any, of the subsidiary for their taxable year that ends with or within the unitholder’s taxable year, regardless of whether or not distributions from the subsidiary were received by the unitholder. The unitholder’s adjusted tax basis in the equity of the subsidiary would be increased to reflect taxed but undistributed earnings and profits. Distributions of earnings and profits that had been previously taxed would result in a corresponding reduction in the adjusted tax basis in the equity of the subsidiary and would not be taxed again once distributed.
If a unitholder has not made a timely QEF Election with respect to the first year in the unitholder’s holding period of our units during which our subsidiary Arctic Spirit L.L.C. or Polar Spirit L.L.C. qualified as a PFIC, the unitholder may be treated as having made a timely QEF Election by filing a QEF Election and, under the rules of Section 1291(d)(2) of the Code, a “deemed sale election” to include in income as an “excess distribution” the amount of any gain that the unitholder would otherwise recognize if the unitholder sold the unitholder’s equity in the subsidiary on the “qualification date.” The qualification date is the first day of the subsidiary’s first taxable year in which the subsidiary qualified as a “qualified electing fund” with respect to such unitholder. Further, following the restructuring the unitholder may be treated as having made a timely QEF Election by a QEF Election under the rules of Section 1291(d)(2) of the Code, a “deemed dividend election” to include in income as an “excess distribution” the unitholder’s share of the undistributed earnings and profits of the subsidiary as of the day before the “qualification date” attributable to the unitholder’s equity in the subsidiary held on the “qualification date.” There is considerable uncertainty, however, as to the availability of this election to our unitholders under the circumstances surrounding the restructuring, including whether a “deemed dividend” Purging Election (described below) is the exclusive “deemed dividend” election available to remove any PFIC taint with respect to our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C. In addition to the above rules, under very limited circumstances, a unitholder may make a retroactive QEF Election if such U.S. Holder failed to file the QEF Election documents in a timely manner.

 

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A unitholder’s QEF Election will not be an effective election unless we agree to annually provide the holder with certain information concerning the subsidiary’s income and gain, calculated in accordance with the Code to be included with the unitholder’s U.S. federal income tax return. We have not provided our unitholders with such information in prior taxable years and do not intend to provide such information in the current taxable year. Accordingly, you will not be able to make an effective QEF Election at this time, notwithstanding the present uncertainty regarding whether Arctic Spirit L.L.C. or Polar Spirit L.L.C. were PFICs prior to the restructuring. If we determine that either of our subsidiaries Arctic Spirit L.L.C. or Polar Spirit L.L.C. is or will be a PFIC for any taxable year, we will provide unitholders with all necessary information in order to make an effective QEF Election with respect to the equity of such subsidiary.
Taxation of a Unitholder Subject to a Purging Election. A unitholder who held our common units prior to the restructuring also may be entitled to treat the stock of the subsidiary as not being stock in a PFIC if the unitholder or the U.S. partnership files at any time within three years of the due date (including extensions) for the unitholder’s or the U.S. partnership’s U.S. income tax return for the taxable year that includes the restructuring, under the rules of Section 1298(b)(1) of the Code and Treasury Regulations Section 1.1297-3, either (i) a “deemed sale election” to include in income as an “excess distribution” any gain that the unitholder would otherwise recognize if the unitholder sold the unitholder’s equity in the subsidiary on the day immediately after the restructuring, or (ii) a “deemed dividend election” to include in income as an “excess distribution” the unitholder’s share of the undistributed earnings and profits of the subsidiary as of the close of the taxable year that includes the restructuring attributable to the unitholder’s equity in the subsidiary held on the day immediately after the restructuring (each, a Purging Election). There is considerable uncertainty, however, surrounding the application of the Purging Elections to the restructuring, including whether the unitholder or the U.S. partnership is eligible to file the elections. We have no present intention to cause the U.S. partnership to file either of the Purging Elections, but we may consider doing so in the future.
Unitholders are urged to consult their own tax advisors regarding the applicability, availability and advisability of, and procedure for, making QEF Elections, deemed sale elections, deemed dividend elections and other available elections with respect to our subsidiaries Arctic Spirit L.L.C. and Polar Spirit L.L.C., and the U.S. federal income tax consequences of making such elections.
Canadian Federal Income Tax Consequences. The following discussion is a summary of the material Canadian federal income tax consequences under the Income Tax Act (Canada) (or the Canada Tax Act), that we believe are relevant to holders of common units who for the purposes of the Canada Tax Act and the Canada-United States Tax Convention 1980 (or the Canada-U.S. Treaty) resident in the United States and entitled to all of the benefits of the Canada – U.S. Treaty, and who deal at arm’s length with us and Teekay Corporation (or U.S. Resident Holders). This discussion takes into account all proposed amendments to the Canada Tax Act and the regulations thereunder that have been publicly announced by or on behalf of the Minister of Finance (Canada) prior to the date hereof and assumes that such proposed amendments will be enacted substantially as proposed. However, no assurance can be given that such proposed amendments will be enacted in the form proposed or at all.
A U.S. Resident Holder will not be liable to tax under the Canada Tax Act on any income or gains allocated by us to the U.S. Resident Holder in respect of such U.S. Resident Holder’s common units, provided that for purposes of the Canada-U.S. Treaty, (a) we do not carry on business through a permanent establishment in Canada and (b) such U.S. Resident Holder does not hold such common units in connection a business carried on by such U.S. Resident Holder through a permanent establishment in Canada.
A U.S. Resident Holder will not be liable to tax under the Canada Tax Act on any income or gain from the sale, redemption or other disposition of such U.S. Resident Holder’s common units, provided that, for purposes of the Canada-U.S. Treaty, such common units do not, and did not at any time in the twelve-month period preceding the date of disposition, form part of the business property of a permanent establishment in Canada of such U.S. Resident Holder.
In this regard, we believe that our activities and affairs can be conducted in a manner that we will not be carrying on business in Canada and that U.S. Resident Holders should not be considered to be carrying on business in Canada for purposes of the Canada Tax Act or the Canada-U.S. Treaty solely by reason of the acquisition, holding, disposition or redemption of common units. We intend that this is the case, notwithstanding that certain services will be provided to us, indirectly through arrangements with a subsidiary of Teekay Corporation that is resident and based in Bermuda, by Canadian service providers. However, we cannot assure this result.
Documents on Display
Documents concerning us that are referred to herein may be inspected at our principal executive headquarters at 4th Floor, Belvedere Building, 69 Pitts Bay Road, Hamilton, HM 08, Bermuda. Those documents electronically filed via the SEC’s Electronic Data Gathering, Analysis, and Retrieval (or EDGAR) system may also be obtained from the SEC’s website at www.sec.gov, free of charge, or from the SEC’s Public Reference Section at 100 F Street, NE, Washington, D.C. 20549, at prescribed rates. Further information on the operation of the SEC public reference rooms may be obtained by calling the SEC at 1-800-SEC-0330.

 

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Item 11. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to the impact of interest rate changes primarily through our borrowings that require us to make interest payments based on LIBOR or EURIBOR. Significant increases in interest rates could adversely affect our operating margins, results of operations and our ability to service our debt. We use interest rate swaps to reduce our exposure to market risk from changes in interest rates. The principal objective of these contracts is to minimize the risks and costs associated with our floating-rate debt.
We are exposed to credit loss in the event of non-performance by the counterparties to the interest rate swap agreements. In order to minimize counterparty risk, we only enter into derivative transactions with counterparties that are rated A- or better by Standard & Poor’s or A3 by Moody’s at the time of the transactions. In addition, to the extent practical, interest rate swaps are entered into with different counterparties to reduce concentration risk.
The table below provides information about our financial instruments at December 31, 2009, that are sensitive to changes in interest rates. For long-term debt and capital lease obligations, the table presents principal payments and related weighted-average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted-average interest rates by expected contractual maturity dates.
Expected Maturity Date
                                                                         
                                                            Fair Value        
          Asset/        
    2010     2011     2012     2013     2014     There-after     Total     (Liability)     Rate(1)  
    (in millions of U.S. dollars, except percentages)  
 
     
Long-Term Debt:
                                                                       
Variable Rate ($U.S.) (2)
    27.0       32.8       35.9       35.9       35.9       524.4       691.9       (602.2 )     0.7 %
Variable Rate (Euro) (3) (4)
    13.0       227.4       7.3       7.8       8.4       148.5       412.4       (368.2 )     1.1 %
 
                                                                       
Fixed-Rate Debt ($U.S.)
    26.7       24.9       24.9       24.9       24.9       118.5       244.8       (235.7 )     5.4 %
Average Interest Rate
    5.4 %     5.4 %     5.4 %     5.4 %     5.4 %     5.3 %     5.4 %                
 
                                                                       
Capital Lease
Obligations
(5) (6)
                                                                       
Fixed-Rate ($U.S.) (7)
    9.6       185.5                               195.1       (195.1 )     7.4 %
Average Interest Rate (8)
    7.5 %     7.4 %                             7.4 %                
 
                                                                       
Interest Rate Swaps:
                                                                       
Contract Amount ($U.S.) (6) (9)
    17.9       18.4       18.9       19.6       19.8       530.3       624.9       (87.1 )     5.6 %
Average Fixed Pay Rate (2)
    5.6 %     5.5 %     5.5 %     5.5 %     5.6 %     5.6 %     5.6 %                
Contract Amount (Euro) (4) (10)
    13.0       227.4       7.3       7.8       8.4       148.5       412.4       (10.6 )     3.8 %
Average Fixed Pay Rate (3)
    3.8 %     3.8 %     3.8 %     3.7 %     3.7 %     3.7 %     3.8 %                
     
(1)  
Rate refers to the weighted-average effective interest rate for our long-term debt and capital lease obligations, including the margin we pay on our floating-rate debt and the average fixed pay rate for our interest rate swap agreements. The average interest rate for our capital lease obligations is the weighted-average interest rate implicit in our lease obligations at the inception of the leases. The average fixed pay rate for our interest rate swaps excludes the margin we pay on our floating-rate debt, which as of December 31, 2009 ranged from 0.3% to 2.75%. Please read Item 18 – Financial Statements: Note 9 – Long-Term Debt.
 
(2)  
Interest payments on U.S. Dollar-denominated debt and interest rate swaps are based on LIBOR.
 
(3)  
Interest payments on Euro-denominated debt and interest rate swaps are based on EURIBOR.
 
(4)  
Euro-denominated amounts have been converted to U.S. Dollars using the prevailing exchange rate as of December 31, 2009.
 
(5)  
Excludes capital lease obligations (present value of minimum lease payments) of 83.1 million Euros ($119.1 million) on one of our existing LNG carriers with a weighted-average fixed interest rate of 5.8%. Under the terms of this fixed-rate lease obligation, we are required to have on deposit, subject to a weighted-average fixed interest rate of 5.0%, an amount of cash that, together with the interest earned thereon, will fully fund the amount owing under the capital lease obligation, including a vessel purchase obligation. As at December 31, 2009, this amount was 84.3 million Euros ($120.8 million). Consequently, we are not subject to interest rate risk from these obligations or deposits.
 
(6)  
Under the terms of the capital leases for the RasGas II LNG Carriers (see Item 18 – Financial Statements: Note 5 – Leases and Restricted Cash), we are required to have on deposit, subject to a variable rate of interest, an amount of cash that, together with interest earned on the deposit, will equal the remaining amounts owing under the variable-rate leases. The deposits, which as at December 31, 2009 totaled $479.4 million, and the lease obligations, which as at December 31, 2009 totaled $470.1 million, have been swapped for fixed-rate deposits and fixed-rate obligations. Consequently, Teekay Nakilat is not subject to interest rate risk from these obligations and deposits and, therefore, the lease obligations, cash deposits and related interest rate swaps have been excluded from the table above. As at December 31, 2009, the contract amount, fair value and fixed interest rates of these interest rate swaps related to Teekay Nakilat’s capital lease obligations and restricted cash deposits were $455.4 million and $473.8 million, ($37.3) million and $36.7 million, and 4.9% and 4.8% respectively.

 

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(7)  
The amount of capital lease obligations represents the present value of minimum lease payments together with our purchase obligation, as applicable.
 
(8)  
The average interest rate is the weighted-average interest rate implicit in the capital lease obligations at the inception of the leases.
 
(9)  
The average variable receive rate for our U.S. Dollar-denominated interest rate swaps is set quarterly at 3-month LIBOR.
 
(10)  
The average variable receive rate for our Euro-denominated interest rate swaps is set monthly at 1-month EURIBOR.
Spot Market Rate Risk
One of our Suezmax tankers, the Toledo Spirit, operates pursuant to a time-charter contract that increases or decreases the otherwise fixed rate established in the charter depending on the spot charter rates that we would have earned had we traded the vessel in the spot tanker market. The remaining term of the time-charter contract is 16 years, although the charterer has the right to terminate the time-charter in July 2018. We have entered into an agreement with Teekay Corporation under which Teekay Corporation pays us any amounts payable to the charterer as a result of spot rates being below the fixed rate, and we pay Teekay Corporation any amounts payable to us from the charterer as a result of spot rates being in excess of the fixed rate. At December 31, 2009, the fair value of this derivative liability was $10.6 million and the change from reporting period to period has been reported in realized and unrealized (loss) gain on derivative instruments.
Foreign Currency Fluctuations
Our functional currency is U.S. dollars. Our results of operations are affected by fluctuations in currency exchange rates. The volatility in our financial results due to currency exchange rate fluctuations is attributed primarily to foreign currency revenues and expenses and our Euro-denominated loans and restricted cash deposits. A portion of our voyage revenues are denominated in Euros. A portion of our vessel operating expenses and general and administrative expenses are denominated in Euros, which is primarily a function of the nationality of our crew and administrative staff. We also have Euro-denominated interest expense and interest income related to our Euro-denominated loans and Euro-denominated restricted cash deposits, respectively. As a result, fluctuations in the Euro relative to the U.S. Dollar have caused, and are likely to continue to cause, fluctuations in our reported voyage revenues, vessel operating expenses, general and administrative expenses, interest expense and interest income.
Item 12. Description of Securities Other than Equity Securities
Not applicable.
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
None.
Item 14. Material Modifications to the Rights of Unitholders and Use of Proceeds
Not applicable.
Item 15. Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (or the Exchange Act)) that are designed to ensure that (i) information required to be disclosed in our reports that are filed or submitted under the Exchange Act, are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
We conducted an evaluation of our disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of December 31, 2009.
During 2009, there were no changes in our internal controls that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The Chief Executive Officer and Chief Financial Officer do not expect that our disclosure controls or internal controls will prevent all error and all fraud. Although our disclosure controls and procedures were designed to provide reasonable assurance of achieving their objectives, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within us have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

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Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining for us adequate internal controls over financial reporting.
Our internal controls were designed to provide reasonable assurance as to the reliability of our financial reporting and the preparation and presentation of the consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Our internal controls over financial reporting include those policies and procedures that: 1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; 2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made in accordance with authorizations of management and the directors; and 3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
We conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements even when determined to be effective and can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. However, based on the evaluation, management believes that we maintained effective internal control over financial reporting as of December 31, 2009.
Our independent auditors, Ernst & Young LLP, a registered public accounting firm has audited the accompanying consolidated financial statements and our internal control over financial reporting. Their attestation report on the effectiveness of our internal control over financial reporting can be found on page F-2 of this Annual Report.
Item 16A. Audit Committee Financial Expert
The board of directors of our General Partner has determined that director Robert E. Boyd qualifies as an audit committee financial expert and is independent under applicable NYSE and SEC standards.
Item 16B. Code of Ethics
We have adopted Standards of Business Conduct that include a Code of Ethics for all our employees and the employees and directors of our General Partner. This document is available under “Other Information — Partnership Governance” in the Investor Centre of our web site (www.teekaylng.com). We intend to disclose, under “Other Information — Partnership Governance” in the Investor Centre of our web site, any waivers to or amendments of our Code of Ethics for the benefit of any directors and executive officers of our General Partner.
Item 16C. Principal Accountant Fees and Services
Our principal accountant for 2009 and 2008 was Ernst & Young LLP, Chartered Accountants. The following table shows the fees we paid or accrued for audit services provided by Ernst & Young LLP for 2009 and 2008.
                 
Fees (in thousands of U.S. dollars)   2009     2008  
 
               
Audit Fees (1)
  $ 1,060     $ 1,376  
Audit-Related Fees (2)
    83       68  
Tax Fees (3)
    10        
 
           
Total
  $ 1,153     $ 1,444  
 
           
     
(1)  
Audit fees represent fees for professional services provided in connection with the audit of our consolidated financial statements and review of our quarterly consolidated financial statements and audit services provided in connection with other statutory or regulatory filings.
 
(2)  
Audit-related fees consisted primarily of accounting consultations and professional services in connection with the review of our regulatory filings for our shelf filings in 2008 and 2009.
 
(3)  
For 2009, tax fees relate primarily to corporate tax compliance fees.
The Audit Committee of our General Partner’s board of directors has the authority to pre-approve permissible audit-related and non-audit services not prohibited by law to be performed by our independent auditors and associated fees. Engagements for proposed services either may be separately pre-approved by the Audit Committee or entered into pursuant to detailed pre-approval policies and procedures established by the Audit Committee, as long as the Audit Committee is informed on a timely basis of any engagement entered into on that basis. The Audit Committee separately pre-approved all engagements and fees paid to our principal accountant in 2009.
Item 16D. Exemptions from the Listing Standards for Audit Committees
Not applicable.
Item 16E. Purchases of Units by the Issuer and Affiliated Purchasers
Not applicable.

 

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Item 16F. Change in Registrant’s Certifying Accountant
Not applicable.
Item 16G. Corporate Governance
There are no significant ways in which our corporate governance practices differ from those followed by domestic companies under the listing requirements of the New York Stock Exchange.
PART III
Item 17. Financial Statements
Not applicable.
Item 18. Financial Statements
The following financial statements, together with the related reports of Ernst & Young LLP, Independent Registered Public Accounting Firm thereon, are filed as part of this Annual Report:
         
    Page  
 
       
    F-1, F-2  
 
       
Consolidated Financial Statements
       
 
       
    F-3  
 
       
    F-4  
 
       
    F-5  
 
       
    F-6  
 
       
    F-7  
All schedules for which provision is made in the applicable accounting regulations of the SEC are not required, are inapplicable or have been disclosed in the Notes to the Consolidated Financial Statements and therefore have been omitted.

 

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Item 19. Exhibits
The following exhibits are filed as part of this Annual Report:
         
  1.1    
Certificate of Limited Partnership of Teekay LNG Partners L.P. (1)
  1.2    
First Amended and Restated Agreement of Limited Partnership of Teekay LNG Partners L.P., as amended (2)
  1.3    
Certificate of Formation of Teekay GP L.L.C. (1)
  1.4    
Second Amended and Restated Limited Liability Company Agreement of Teekay GP L.L.C. (3)
  4.1    
Agreement, dated February 21, 2001, for a U.S. $100,000,000 Revolving Credit Facility between Naviera Teekay Gas S.L., J.P. Morgan plc and various other banks (3)
  4.2    
Contribution, Conveyance and Assumption Agreement (4)
  4.3    
Teekay LNG Partners L.P. 2005 Long-Term Incentive Plan (3)
  4.4    
Amended and Restated Omnibus Agreement (5)
  4.5    
Administrative Services Agreement with Teekay Shipping Limited (3)
  4.6    
Advisory, Technical and Administrative Services Agreement (3)
  4.7    
LNG Strategic Consulting and Advisory Services Agreement (3)
  4.10    
Agreement to Purchase Nakilat Interest (3)
  4.11    
Syndicated Loan Agreement between Naviera Teekay Gas III, S.L. (formerly Naviera F. Tapias Gas III, S.A.) and Caixa de Aforros de Vigo Ourense e Pontevedra, as Agent, dated as of October 2, 2000, as amended (3)
  4.12    
Bareboat Charter Agreement between Naviera Teekay Gas III, S.L. (formerly Naviera F. Tapias Gas III, S.A.) and Poseidon Gas AIE dated as of October 2, 2000 (3)
  4.13    
Credit Facility Agreement between Naviera Teekay Gas IV, S.L. (formerly Naviera F. Tapias Gas IV, S.A.) and Chase Manhattan International Limited, as Agent, dated as of December 21, 2001, as amended (3)
  4.14    
Bareboat Charter Agreement between Naviera Teekay Gas IV, S.L. (formerly Naviera F. Tapias Gas IV, S.A.) and Pagumar AIE dated as of December 30, 2003 (3)
  4.15    
Agreement, dated December 7, 2005, for a U.S. $137,500,000 Secured Reducing Revolving Loan Facility Agreement between Asian Spirit L.L.C., African Spirit L.L.C., European Spirit L.L.C., DNB Nor Bank ASA and other banks (6)
  4.16    
Agreement, dated August 23, 2006, for a U.S. $330,000,000 Secured Revolving Loan Facility between Teekay LNG Partners L.P., ING Bank N.V. and other banks (7)
  4.17    
Purchase Agreement, dated November 2005, for the acquisition of Asian Spirit L.L.C., African Spirit L.L.C. and European Spirit L.L.C. (8)
  4.18    
Agreement, dated June 30, 2008, for a U.S. $172,500,000 Secured Revolving Loan Facility between Arctic Spirit L.L.C., Polar Spirit L.L.C. and DnB Nor Bank A.S.A. (9)
  4.19    
Credit Facility Agreement between Taizhou L.L.C. and DHJS L.L.C. and Calyon, as Agent, dated as of October 27, 2009.
  8.1    
List of Subsidiaries of Teekay LNG Partners L.P.
  12.1    
Rule 13a-15(e)/15d-15(e) Certification of Teekay LNG Partners L.P.’s Chief Executive Officer
  12.2    
Rule 13a-15(e)/15d-15(e) Certification of Teekay LNG Partners L.P.’s Chief Financial Officer
  13.1    
Teekay LNG Partners L.P. Certification of Peter Evensen, Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  15.1    
Consent of Ernst & Young LLP, as independent registered public accounting firm, for Teekay LNG Partners L.P. and Teekay GP L.L.C.
  15.2    
Consolidated Balance Sheet of Teekay GP L.L.C.
  15.3    
Consolidated Financial Statements of Teekay Nakilat (III) Corporation
 
     
(1)  
Previously filed as an exhibit to the Partnership’s Registration Statement on Form F-1 (File No. 333-120727), filed with the SEC on November 24, 2004, and hereby incorporated by reference to such Annual Report.
 
(2)  
Previously filed as an exhibit to the Partnership’s Report on Form 6-K filed with the SEC on August 17, 2006, and hereby incorporated by reference to such Report.
 
(3)  
Previously filed as an exhibit to the Partnership’s Amendment No. 3 to Registration Statement on Form F-1 (File No. 333-120727), filed with the SEC on April 11, 2005, and hereby incorporated by reference to such Registration Statement.
 
(4)  
Previously filed as an exhibit to the Partnership’s Amendment No. 4 to Registration Statement on Form F-1 (File No. 333-120727), filed with the SEC on April 21, 2005, and hereby incorporated by reference to such Registration Statement.
 
(5)  
Previously filed as an exhibit to the Partnership’s Annual Report on Form 20-F (File No. 1-32479), filed with the SEC on April 19, 2007 and hereby incorporated by reference to such report.
 
(6)  
Previously filed as an exhibit to the Partnership’s Annual Report on Form 20-F (File No. 1-32479), filed with the SEC on April 14, 2006 and hereby incorporated by reference to such report.
 
(7)  
Previously filed as an exhibit to the Partnership’s Report on Form 6-K (File No. 1-32479), filed with the SEC on December 21, 2006 and hereby incorporated by reference to such report.
 
(8)  
Previously filed as an exhibit to the Partnership’s Amendment No. 1 to Registration Statement on Form F-1 (File No. 333-129413), filed with the SEC on November 3, 2005, and hereby incorporated by reference to such Registration Statement.
 
(9)  
Previously filed as an exhibit to the Partnership’s Report on Form 6-K (File No. 1-32479), filed with the SEC on March 20, 2009 and hereby incorporated by reference to such report.

 

74


 

SIGNATURE
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
TEEKAY LNG PARTNERS L.P.
By: Teekay GP L.L.C., its General Partner
         
Dated: April 26, 2010    
 
       
By:
  /s/ Peter Evensen
 
Peter Evensen
Chief Executive Officer and Chief Financial Officer
(Principal Financial and Accounting Officer)
   

 

75


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Unitholders of
TEEKAY LNG PARTNERS L.P.
We have audited the accompanying consolidated balance sheets of Teekay LNG Partners L.P. (or the Partnership) as of December 31, 2009 and 2008, and the related consolidated statements of income (loss), changes in total equity and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Teekay LNG Partners L.P. at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in 2009, the Partnership adopted an amendment to FASB ASC 810 Consolidation, related to the accounting for non-controlling interests in the consolidated financial statements.
As discussed in Note 1 to the consolidated financial statements, in 2009, the Partnership changed its method of presentation for realized and unrealized gain (loss) on non-designated derivative instruments.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Teekay LNG Partners L.P.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 26, 2010 expressed an unqualified opinion thereon.
     
Vancouver, Canada
  /s/ ERNST & YOUNG LLP
April 26, 2010
  Chartered Accountants

 

F - 1


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Unitholders of
TEEKAY LNG PARTNERS L.P.
We have audited Teekay LNG Partners L.P.’s (or the Partnership’s) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Partnership’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Report on Internal Control over Financial Reporting in the accompanying Form 20-F. Our responsibility is to express an opinion on the Partnership’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
The Partnership’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Partnership’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Partnership; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Partnership are being made only in accordance with authorizations of management and directors of the Partnership; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Partnership’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Teekay LNG Partners L.P. has maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2009 consolidated financial statements of Teekay LNG Partners L.P., and our report dated April 26, 2010 expressed an unqualified opinion thereon.
     
Vancouver, Canada
  /s/ ERNST & YOUNG LLP
April 26, 2010
  Chartered Accountants

 

F - 2


 

TEEKAY LNG PARTNERS L.P. AND SUBSIDIARIES (Note 1)
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(in thousands of U.S. dollars, except unit and per unit data)
                         
    Year Ended     Year Ended     Year Ended  
    December 31,     December 31,     December 31,  
    2009     2008     2007  
    $     $     $  
 
                       
VOYAGE REVENUES (note 11)
    326,029       314,404       257,769  
 
                 
 
                       
OPERATING EXPENSES (note 11)
                       
Voyage expenses
    1,902       3,253       1,197  
Vessel operating expenses
    77,482       77,113       56,863  
Depreciation and amortization
    78,742       76,880       66,017  
General and administrative
    18,162       20,201       15,186  
Restructuring charge (note 17)
    3,250              
Goodwill impairment (note 6)
          3,648        
 
                 
Total operating expenses
    179,538       181,095       139,263  
 
                 
Income from vessel operations
    146,491       133,309       118,506  
 
                 
OTHER ITEMS
                       
Interest expense (notes 5 and 9)
    (59,281 )     (138,317 )     (145,073 )
Interest income
    13,873       64,325       68,329  
Realized and unrealized (loss) gain on derivative instruments (note 12)
    (40,950 )     (99,954 )     9,816  
Foreign currency exchange (loss) gain (note 9)
    (10,835 )     18,244       (41,241 )
Equity income (loss)
    27,639       136       (130 )
Other (expense) income — net (note 10)
    (302 )     1,045       (1,284 )
 
                 
Total other items
    (69,856 )     (154,521 )     (109,583 )
 
                 
Net income (loss)
    76,635       (21,212 )     8,923  
 
                 
Non-controlling interest in net income (loss)
    29,310       (40,698 )     (16,739 )
Dropdown Predecessor’s interest in net income (loss)
          894       520  
General Partner’s interest in net income (loss)
    5,180       11,989       9,752  
Limited partners’ interest in net income (loss)
    42,145       6,603       15,390  
Limited partners’ interest in net income (loss) per unit (note 15):
                       
Common unit (basic and diluted)
    0.86       0.63       0.64  
Subordinated unit (basic and diluted)
    0.80       (0.29 )     0.66  
Total unit (basic and diluted)
    0.85       0.36       0.65  
 
                 
Weighted-average number of units outstanding:
                       
Common units (basic and diluted)
    40,912,100       29,698,031       21,670,958  
Subordinated units (basic and diluted)
    8,760,006       12,459,973       14,734,572  
 
                 
Total units (basic and diluted)
    49,672,106       42,158,004       36,405,530  
 
                 
The accompanying notes are an integral part of the consolidated financial statements.

 

F - 3


 

TEEKAY LNG PARTNERS L.P. AND SUBSIDIARIES (Note 1)
CONSOLIDATED BALANCE SHEETS
(in thousands of U.S. dollars)
                 
    As at     As at  
    December 31,     December 31,  
    2009     2008  
    $     $  
ASSETS
               
Current
               
Cash and cash equivalents
    102,570       117,641  
Restricted cash — current (note 5)
    32,427       28,384  
Accounts receivable, including non-trade of $6,100 (2008 — $3,905)
    6,407       5,793  
Prepaid expenses
    5,505       5,329  
Other current assets
    2,090       7,266  
Current portion of derivative assets (note 12)
    16,337       13,078  
Current portion of net investments in direct financing leases (note 5)
    5,196        
Advances to affiliates (note 11k)
    20,715       9,583  
 
           
 
               
Total current assets
    191,247       187,074  
 
           
 
               
Restricted cash — long-term (note 5)
    579,093       614,565  
 
               
Vessels and equipment (note 9)
               
At cost, less accumulated depreciation of $157,579 (2008 — $121,233)
    913,484       1,078,526  
Vessels under capital leases, at cost, less accumulated depreciation of $138,569 (2008 — $106,975) (note 5)
    903,521       928,795  
Advances on newbuilding contracts (note 13)
    57,430       200,557  
 
           
Total vessels and equipment
    1,874,435       2,207,878  
 
           
Investment in and advances to joint venture (notes 11g and 18)
    93,319       64,382  
Net investments in direct financing leases (note 5)
    416,245        
Other assets
    23,915       27,266  
Derivative assets (note 12)
    15,794       154,248  
Intangible assets — net (note 6)
    132,675       141,805  
Goodwill (note 6)
    35,631       35,631  
 
           
 
               
Total assets
    3,362,354       3,432,849  
 
           
 
               
LIABILITIES AND EQUITY
               
Current
               
Accounts payable (includes $910 and $2,344 for 2009 and 2008, respectively, owing to related parties) (note 11a)
    4,587       10,838  
Accrued liabilities (includes $1,946 and $1,366 for 2009 and 2008, respectively, owing to related parties) (notes 8 and 11a)
    39,722       24,071  
Unearned revenue
    7,901       9,705  
Current portion of long-term debt (note 9)
    66,681       76,801  
Current obligations under capital lease (note 5)
    41,016       147,616  
Current portion of derivative liabilities (note 12)
    50,056       35,182  
Advances from joint venture partners (note 7)
    1,294       1,236  
Advances from affiliates (note 11k)
    111,104       73,064  
 
           
 
               
Total current liabilities
    322,361       378,513  
 
           
Long-term debt (note 9)
    1,282,391       1,305,810  
Long-term obligations under capital lease (note 5)
    743,254       669,725  
Other long-term liabilities
    56,373       44,668  
Derivative liabilities (note 12)
    83,950       225,420  
 
           
 
               
Total liabilities
    2,488,329       2,624,136  
 
           
Commitments and contingencies (notes 5, 9, 12 and 13)
               
 
               
Equity
               
Non-controlling interest
    13,807       2,862  
Partners’ equity
    860,218       805,851  
 
           
 
               
Total equity
    874,025       808,713  
 
           
 
               
Total liabilities and total equity
    3,362,354       3,432,849  
 
           
The accompanying notes are an integral part of the consolidated financial statements.

 

F - 4


 

TEEKAY LNG PARTNERS L.P. AND SUBSIDIARIES (Note 1)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of U.S. dollars)
                         
    Year Ended     Year Ended     Year Ended  
    December 31,     December 31,     December 31,  
    2009     2008     2007  
    $     $     $  
Cash and cash equivalents provided by (used for)
                       
 
                       
OPERATING ACTIVITIES
                       
Net income (loss)
    76,635       (21,212 )     8,923  
Non-cash items:
                       
Unrealized loss (gain) on derivative instruments (note 12)
    3,788       84,546       (10,941 )
Depreciation and amortization
    78,742       76,880       66,017  
Goodwill impairment (note 6)
          3,648        
Unrealized foreign currency exchange loss (gain)
    9,531       (17,746 )     41,450  
Equity based compensation
    361       369       375  
Equity (income) loss
    (27,639 )     (136 )     130  
Accrued interest and other — net
    3,270       3,225       907  
Change in operating assets and liabilities (note 14a)
    29,537       31,962       12,313  
Expenditures for drydocking
    (9,729 )     (11,966 )     (3,724 )
 
                 
 
                       
Net operating cash flow
    164,496       149,570       115,450  
 
                 
 
                       
FINANCING ACTIVITIES
                       
Excess of purchase price over the contributed basis of Teekay Nakilat (III) Holdings Corporation (note 11g)
          (28,192 )      
Excess deficit of purchase price over the contributed basis of Teekay Nakilat Holdings Corporation (note 11f)
                (13,844 )
Distribution to Teekay Corporation for the purchase of Kenai LNG Carriers (note 11j)
          (230,000 )      
Proceeds on sale of 1% interest in Kenai LNG Carriers (note 11o)
    2,300              
Distribution to Teekay Corporation for the purchase of Dania Spirit LLC (note 11h)
                (18,548 )
Proceeds from issuance of long-term debt
    220,050       936,988       1,021,615  
Debt issuance costs
    (1,281 )     (2,233 )     (5,345 )
Scheduled repayments of long-term debt
    (77,706 )     (73,613 )     (30,870 )
Prepayments of long-term debt
    (185,900 )     (321,000 )     (291,098 )
Scheduled repayments of capital lease obligations and other long-term liabilities
    (37,437 )     (33,176 )     (30,999 )
Proceeds from follow-on offering net of offering costs of $7,640 (2008 — $6,186, 2007 — $3,514) (note 3)
    162,559       202,519       85,975  
Advances from affiliates
    23,425       17,147       (2,788 )
Advances from joint venture partners
          621       44,185  
Repayment of joint venture partner advances
                (65,815 )
Decrease in restricted cash
    30,710       28,340       11,445  
Cash distributions paid
    (114,539 )     (97,420 )     (74,116 )
Excess of purchase price over the contributed basis of Teekay Tangguh Borrower LLC (note 11e)
    (31,829 )