UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 1-34722

PAA Natural Gas Storage, L.P.

(Exact name of registrant as specified in its charter)

Delaware		27-1679071
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
333 Clay Street, Suite 1500, Houston, Texas		77002
(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code)

     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. þ Yes o No

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o No

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

     As of November 2, 2010, there were 31,586,405 common units outstanding. The common units trade on the New York Stock Exchange under the ticker symbol “PNG.”

 

 

PAA NATURAL GAS STORAGE, L.P. AND SUBSIDIARIES

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION			3
Item 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:			3
Condensed Consolidated Balance Sheets: September 30, 2010 and December 31, 2009			3
Condensed Consolidated Statements of Operations: For the three and nine months ended September 30, 2010 (Successor) and for the periods September 3, 2009 through September 30, 2009 (Successor), July 1, 2009 through September 2, 2009 and January 1, 2009 through September 2, 2009 (Predecessor)			4
Condensed Consolidated Statement of Changes in Partners’ Capital and Members’ Capital: For the nine months ended September 30, 2010			5
Condensed Consolidated Statements of Cash Flows: For the nine months ended September 30, 2010 and for the periods September 3, 2009 through September 30, 2009 (Successor) and January 1, 2009 through September 2, 2009 (Predecessor)			6
Notes to the Condensed Consolidated Financial Statements:			7
1. Organization, Nature of Operations and Basis of Presentation			7
2. Recent Accounting Pronouncements			8
3. Derivative Instruments and Risk Management Activities			8
4. Debt			11
5. Commitments and Contingencies			11
6. Partners’ Capital and Distributions			12
7. Comprehensive Income			15
8. Net Income per Limited Partner Unit			16
9. Equity Compensation Plans			18
10. Related Party Transactions			20
11. Reporting Segment			21
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			23
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			34
Item 4. CONTROLS AND PROCEDURES			34
PART II. OTHER INFORMATION			35
Item 1. LEGAL PROCEEDINGS			35
Item 1A. RISK FACTORS			35
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			35
Item 3. DEFAULTS UPON SENIOR SECURITIES			35
Item 4. [REMOVED AND RESERVED]			35
Item 5. OTHER INFORMATION			35
Item 6. EXHIBITS			35
SIGNATURES			37
EX-10.9
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I. FINANCIAL INFORMATION

		Item 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PAA Natural Gas Storage, L.P. and Subsidiaries

Condensed Consolidated Balance Sheets
(unaudited)
(in thousands, except units)

		September 30,				December 31,
		2010				2009
ASSETS
Current assets
Cash and cash equivalents		$	429			$	3,124
Accounts receivable			8,023				6,439
Natural gas imbalance receivables			400				400
Other current assets			6,492				2,280
Total current assets			15,344				12,243
Property and equipment
Property and equipment			873,038				816,267
Less: Accumulated depreciation, depletion and amortization			(11,682	)			(3,004	)
Property and equipment, net			861,356				813,263
Other assets
Base gas			37,498				27,927
Goodwill and intangibles, net			47,880				46,974
Total other assets, net			85,378				74,901
Total assets		$	962,078			$	900,407
LIABILITIES, PARTNERS’ CAPITAL AND MEMBERS’ CAPITAL
Current liabilities
Accounts payable and accrued liabilities		$	10,591			$	14,034
Natural gas imbalance payables			400				400
Accrued income and other taxes			707				1,610
Total current liabilities			11,698				16,044
Long-term liabilities
Note payable to PAA			—				450,523
Long-term debt under credit facility			221,500				—
Other long-term liabilities			94				1,096
Total long-term liabilities			221,594				451,619
Total liabilities			233,292				467,663
Commitments and contingencies (Note 5)
Partners’ capital and members’ capital
Common unitholders (31,586,405 units issued and outstanding at September 30, 2010)			478,323				—
Subordinated unitholders (25,434,351 units issued and outstanding at September 30, 2010)			238,262				—
General partner			12,604				—
Members’ capital			—				432,744
Accumulated other comprehensive loss			(403	)			—
Total partners’ capital and members’ capital			728,786				432,744
Total liabilities, partners’ capital and members’ capital		$	962,078			$	900,407

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

PAA Natural Gas Storage, L.P. and Subsidiaries

Condensed Consolidated Statements of Operations
(unaudited)
(in thousands, except per unit data)

		Successor								Predecessor				Successor								Predecessor
						September 3, 2009				July 1, 2009								September 3, 2009				January 1, 2009
		Three Months Ended				through September				through September				Nine Months Ended				through September				through September
		September 30, 2010				30, 2009				2, 2009				September 30, 2010				30, 2009				2, 2009
		(See Note 1)								(See Note 1)				(See Note 1)								(See Note 1)
Revenues
Firm storage services		$	23,773			$	6,020			$	11,977			$	66,057			$	6,020			$	42,649
Hub services			689				343				482				3,625				343				2,988
Other			621				7				1				1,764				7				1,292
Total revenues			25,083				6,370				12,460				71,446				6,370				46,929
Costs and expenses
Storage related costs			5,101				1,002				2,124				16,624				1,002				8,792
Other operating costs (except those shown below)			1,720				896				1,252				5,144				896				4,820
Fuel expense			611				171				40				1,665				171				1,816
General and administrative expenses			3,409				1,383				781				11,163				1,383				3,562
Depreciation, depletion and amortization			3,867				770				1,887				10,323				770				8,054
Total costs and expenses			14,708				4,222				6,084				44,919				4,222				27,044
Operating income			10,375				2,148				6,376				26,527				2,148				19,885
Other income/(expense)
Interest expense, net of capitalized interest			(749	)			(1,140	)			(676	)			(6,540	)			(1,140	)			(4,352	)
Interest income			1				—				13				2				—				139
Income tax expense			—				—				(119	)			—				—				(473	)
Gain on interest rate swaps			—				—				—				—				—				336
Other income (expense)			(7	)			(2	)			(1	)			(14	)			(2	)			(17	)
Net income		$	9,620			$	1,006			$	5,593			$	19,975			$	1,006			$	15,518
Calculation of Limited Partner Interest in Net Income: (1)
Net income		$	9,620				n/a				n/a			$	14,547				n/a				n/a
Less general partner interest in net income			192				n/a				n/a				291				n/a				n/a
Limited partner interest in net income		$	9,428				n/a				n/a			$	14,256				n/a				n/a
Net income per limited partner unit (basic and diluted) (1)
Common and Series A subordinated units (2)		$	0.21				n/a				n/a			$	0.32				n/a				n/a
Limited partner units outstanding (1)
Common and Series A subordinated units (2) (Basic)			44,520				n/a				n/a				44,902				n/a				n/a
Common and Series A subordinated units (2) (Diluted)			44,525				n/a				n/a				44,907				n/a				n/a

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

PAA Natural Gas Storage, L.P. and Subsidiaries

Condensed Consolidated Statement of Changes in Partners’ Capital and Members’ Capital
(unaudited)
(in thousands)

						Partners’ Capital																Accumulated
						Limited Partners																Other
		Members’								Subordinated								General				Comprehensive
		Capital				Common				Series A				Series B				Partner				Loss				Total
Balance at December 31, 2009		$	432,744			$	—			$	—			$	—			$	—			$	—			$	432,744
Net income attributable to the period from January 1, 2010 through May 4, 2010			5,428				—				—				—				—				—				5,428
Extinguishment of related party note payable to PAA			16,375				—				—				—				—				—				16,375
Contribution of net assets to PAA Natural Gas Storage, L.P.			(454,547	)			205,422				158,088				78,888				12,149				—				—
Issuance of common units to public, net of offering and other costs			—				268,161				—				—				—				—				268,161
Modification of subordinated units			—				—				(22,903	)			22,903				—				—				—
Equity compensation expense			—				222				—				—				359				—				581
Modification of LTIP awards			—				1,181				—				—				—				—				1,181
Net income attributable to the period from May 5, 2010 through September 30, 2010			—				10,024				4,232				—				291				—				14,547
Distributions to unitholders			—				(6,677	)			(2,946	)			—				(196	)			—				(9,819	)
Distribution equivalent right payments			—				(10	)			—				—				—				—				(10	)
Contribution from general partner			—				—				—				—				1				—				1
Net deferred loss on cash flow hedges			—				—				—				—				—				(403	)			(403	)
Balance at September 30, 2010		$	—			$	478,323			$	136,471			$	101,791			$	12,604			$	(403	)		$	728,786

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

PAA Natural Gas Storage, L.P. and Subsidiaries

Condensed Consolidated Statements of Cash Flows
(unaudited)
(in thousands)

		Successor								Predecessor
						September 3, 2009				January 1, 2009
		Nine Months Ended				through September				through September 2,
		September 30, 2010				30, 2009				2009
		(See Note 1)								(See Note 1)
Cash flows from operating activities
Net income		$	19,975			$	1,006			$	15,518
Adjustments to reconcile to cash flow from operations
Depreciation, depletion and amortization			10,323				770				8,054
Non-cash change in fair market value of derivative instruments			(370	)			(336	)			—
Non-cash interest expense on borrowings from parent, net			5,081				—				—
Change in assets and liabilities
Accounts receivable and other assets			(5,882	)			954				(2,166	)
Accounts payable and accrued liabilities			3,099				2,021				1,197
Net cash provided by operating activities			32,226				4,415				22,603
Cash flows from investing activities
Additions to property and equipment			(58,550	)			(8,365	)			(47,542	)
Cash paid for base gas			(9,488	)			(4,367	)			(11,193	)
Other investing activities			80				14,002				174
Net cash provided by (used in) investing activities			(67,958	)			1,270				(58,561	)
Cash flows from financing activities
Repayments on term loan agreement			—				(25,214	)			(1,225	)
Borrowings on revolving credit facility			256,900				—				59,400
Repayments of borrowings on revolving credit facility			(35,400	)			—				(29,900	)
Borrowings from parent			24,000				—				—
Repayment of borrowings from parent			(468,363	)			—				—
Net proceeds from issuance of common units			268,161				—				—
Costs incurred in connection with financing arrangements			(2,433	)			—				(4,639	)
Contribution from general partner			1				—				—
Distributions paid to limited partners			(9,623	)			—				—
Distributions paid to general partner			(196	)			—				—
Distribution equivalent right payments			(10	)			—				—
Contributions from members			—				—				8,500
Distributions to members			—				—				(8,500	)
Net cash provided by (used in) financing activities			33,037				(25,214	)			23,636
Net decrease in cash and cash equivalents			(2,695	)			(19,529	)			(12,322	)
Cash and cash equivalents
Beginning of period			3,124				20,328				32,650
End of period		$	429			$	799			$	20,328
Cash paid for interest, net of amounts capitalized		$	1,448			$	—			$	2,298
Cash paid for income taxes		$	—			$	—			$	795
Non-cash items
Change in non-cash asset purchases included in accounts payable		$	(6,855	)		$	(3,761	)		$	1,534
Non-cash interest capitalized on borrowings from parent		$	5,130			$	1,140			$	—

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

PAA Natural Gas Storage, L.P. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements
(unaudited)

1. Organization, Nature of Operations and Basis of Presentation

     PAA Natural Gas Storage, L.P. (the “Partnership” or “PNG”) is a Delaware limited partnership formed on January 15, 2010 to own the natural gas storage business of Plains All American Pipeline, L.P. (“PAA”). The Partnership is a fee-based, growth-oriented partnership engaged in the ownership, acquisition, development, operation and commercial management of natural gas storage facilities. We currently own and operate two natural gas storage facilities located in Louisiana and Michigan.

     Our Pine Prairie facility is a recently constructed, high-deliverability salt cavern natural gas storage complex located in Evangeline Parish, Louisiana. As of September 30, 2010, Pine Prairie had a total working gas storage capacity of approximately 24.0 billion cubic feet (“Bcf”) in three caverns. Our Bluewater facility is a depleted reservoir natural gas storage complex located approximately 50 miles from Detroit in St. Clair County, Michigan. As of September 30, 2010, Bluewater had a total working gas storage capacity of approximately 26 Bcf in two depleted reservoirs.

     As further discussed in Note 6, on May 5, 2010, the Partnership completed its initial public offering (“IPO”) pursuant to which PAA sold an approximate 23.0% limited partner interest in the Partnership to the public. Immediately prior to the closing of the IPO on May 5, 2010, PAA and certain of its consolidated subsidiaries contributed 100.0% of the equity interests in PAA Natural Gas Storage, LLC (“PNGS”), the predecessor of the Partnership, and its subsidiaries to the Partnership. For periods prior to our initial public offering, the accompanying condensed consolidated financial statements of PNG reflect the predecessor financial statements of the Partnership, which are based on the historical ownership percentages of PAA and its subsidiaries in the PNGS operations that were contributed to the Partnership in conjunction with the IPO. Prior to the IPO, the financial statements of the Partnership consisted of total assets of $1,000 and the Partnership had not conducted any activity since its formation on January 15, 2010. The accompanying condensed consolidated financial statements, to the extent they relate to periods prior to the IPO, have been prepared from the separate financial records maintained by PNGS or its predecessor, as applicable, and may not necessarily be indicative of the actual results of operations that might have occurred if the Partnership had operated separately during those periods. As of September 30, 2010, PAA owned approximately 77.0% of the equity interests in the Partnership including our 2.0% general partner interest and limited partner interests consisting of 18,106,529 common units, 11,934,351 Series A subordinated units and 13,500,000 Series B subordinated units.

     On September 3, 2009, PAA became the sole owner of PNGS by acquiring Vulcan Capital’s 50.0% interest in PNGS (“PAA Ownership Transaction”) for an aggregate purchase price of $215.0 million. Although PNGS continued as the same legal entity after the PAA Ownership Transaction, all of its assets and liabilities were adjusted to fair value at the time of the transaction in accordance with push-down accounting requirements. The remeasurement of PNGS’s assets and liabilities to fair value resulted in changes in carrying value for certain of PNGS’s assets and liabilities. The changes in carrying value are summarized as follows (in thousands):

PP&E, net		$	153,800
Base gas			(38,338	)
Goodwill			(61,398	)
Other long term assets			(4,546	)
		$	49,518

     As a result of the push-down accounting requirements applied in conjunction with the PAA Ownership Transaction, the financial information of PNG for periods preceding (designated as “Predecessor”) and succeeding (designated as “Successor”) the PAA Ownership Transaction have been prepared under two different cost bases of accounting. Where applicable, a vertical line separates financial information for periods preceding and succeeding the PAA Ownership Transaction to highlight the fact that such information was prepared under different bases of accounting.

     The accompanying condensed consolidated interim financial statements should be read in conjunction with the Partnership’s final prospectus dated April 29, 2010 (the “Final Prospectus”) included in our Registration Statement on Form S-1, as amended (SEC File No. 333-164492). These financial statements have been prepared in accordance with the instructions for interim reporting as prescribed by the Securities and Exchange Commission (the “SEC”). All adjustments (consisting only of normal recurring adjustments) that in the opinion of management were necessary for a fair statement of the results for interim periods have been reflected. The condensed balance sheet data as of December 31, 2009 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the three and nine months ended September 30, 2010 should not be taken as indicative of results to be expected for the full year.

     The accompanying condensed consolidated financial statements include the accounts of PNG and its subsidiaries, all of which are wholly owned. All significant intercompany transactions have been eliminated.

     As used in this document, the terms “we,” “us,” “our” and similar terms refer to the Partnership and its subsidiaries including its predecessors, where applicable, unless the context indicates otherwise.

Other Current Assets

     During the quarter ended June 30, 2010, we purchased approximately 1 Bcf of natural gas for approximately $4.6 million for use in the dewatering of our Pine Prairie facility. This gas, which was acquired for operational purposes, is reflected as a component of other current assets in our accompanying condensed consolidated balance sheet as of September 30, 2010. We anticipate that this gas will be sold during the fourth quarter of 2010. In July 2010, we entered into derivative instruments, which were designated as cash flow hedges, to manage our exposure to changes in natural gas prices associated with this anticipated sale.

2. Recent Accounting Pronouncements

     In June 2009, the Financial Accounting Standards Board (“FASB”) issued guidance that requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest(s) provide a controlling financial interest in a variable interest entity (“VIE”). This analysis identifies the primary beneficiary of a VIE as the enterprise that has (i) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the entity, or the right to receive benefits from the entity, that could potentially be significant to the VIE. This guidance also (i) requires such assessments to be ongoing, (ii) amends certain guidance for determining whether an entity is a VIE and (iii) enhances disclosures that will provide users of financial statements with more transparent information regarding an enterprise’s involvement in a VIE. We adopted this guidance as of January 1, 2010. Our adoption did not have any material impact on our financial position, results of operations or cash flows.

     In January 2010, the FASB issued guidance to enhance disclosures related to the existing fair value hierarchy disclosure requirements. A fair value measurement is designated as Level 1, 2 or 3 within the hierarchy based on the nature of the inputs used in the valuation process. Level 1 measurements generally reflect quoted market prices in active markets for identical assets or liabilities, Level 2 measurements generally reflect the use of significant observable inputs and Level 3 measurements typically utilize significant unobservable inputs. This new guidance requires additional disclosures regarding transfers into and out of Level 1 and Level 2 measurements and requires a gross presentation of activities within the Level 3 roll forward. This guidance was effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 roll forward, which is required for annual reporting periods beginning after December 15, 2010 and for interim reporting periods within those years. We adopted the guidance relating to Level 1 and Level 2 measurements as of January 1, 2010. Our adoption did not have any material impact on our financial position, results of operations or cash flows. We will adopt the guidance relating to Level 3 measurements on January 1, 2011. We do not expect that adoption of this guidance will have any material impact on our financial position, results of operations, or cash flows.

3. Derivative Instruments and Risk Management Activities

     From time to time, we may utilize derivative instruments to (i) manage our price exposure associated with anticipated purchases or sales of natural gas, (ii) economically hedge the value of our natural gas storage facilities and (iii) manage our exposure to interest rate risk. Our policy is to formally document all relationships between hedging instruments and hedged items, as well as our risk management objectives and strategy for undertaking hedges. This process includes specific identification of the hedging instrument and the hedged transaction, the nature of the risk being hedged and how the hedging instrument’s effectiveness will be assessed. Both at the inception of a hedge and on an ongoing basis, we assess whether the derivatives used in such hedging transactions are highly effective in offsetting changes in cash flows of hedged items. FASB guidance requires us to recognize changes in the fair value of derivative instruments currently in earnings unless the derivatives meet specific cash flow hedge accounting requirements, in which case the effective portion of changes in the fair value of cash flow hedges are deferred in accumulated other comprehensive income (“AOCI”) and reclassified into earnings when the underlying hedged transaction affects earnings.

Commodity Price Risk Hedging

     We use derivative financial instruments to hedge the following commodity risks inherent in our business:

     Anticipated Purchases and Sales of Natural Gas — Our gas storage facilities require minimum levels of base gas to operate. For our natural gas storage facilities that are under construction, we anticipate purchasing base gas in future periods as construction is completed. We use derivatives to hedge such anticipated purchases of natural gas. As of September 30, 2010, we have a long futures position of approximately 1 Bcf consisting of NYMEX futures and a long call option position of approximately 0.7 Bcf. Such positions were entered into during the first quarter of 2010. Additionally, we use derivatives to hedge anticipated sales of operational gas when that gas is no longer needed for cavern development purposes. As of September 30, 2010, we have a short futures position of approximately 1 Bcf consisting of NYMEX futures. Such positions were entered into during the third quarter of 2010. As of September 30, 2010, all of our outstanding derivatives entered into for purposes of hedging anticipated purchases and sales of natural gas have been designated as cash flow hedges.

Interest Rate Risk Hedging

     Prior to the PAA Ownership Transaction, we had previously entered into a series of interest rate swap agreements that were designated as cash flow hedges. These interest rate swaps were utilized to mitigate exposure to changes in cash flows associated with variable rate interest payments on certain debt obligations. In conjunction with the PAA Ownership Transaction, all of the associated debt obligations were settled and all of these interest rate swap agreements were terminated. Subsequent to the PAA Ownership Transaction, we have not entered into any additional interest rate swap agreements.

Summary of Financial Statement Impact

     Derivatives that qualify for hedge accounting are designated as cash flow hedges. Changes in fair value for the effective portion of the hedges are deferred to AOCI and recognized in earnings in the periods during which the underlying hedged transaction impacts earnings. Derivatives that do not qualify for hedge accounting and the ineffective portion of cash flow hedges are recognized in earnings each period. Cash settlements associated with our derivative activities are reflected as operating cash flows in our consolidated statements of cash flows.

     We recognized realized losses of approximately $0.8 million, of which approximately $0.4 million was incurred during the nine months ended September 30, 2010, associated with a natural gas calendar spread position, which was closed in June 2010 and did not qualify for hedge accounting. Such losses are reflected as a component of other revenues in our accompanying condensed consolidated statements of operations. During the three and nine months ended September 30, 2009, we did not have any derivative positions that did not qualify for hedge accounting.

     Our earnings were not impacted by derivatives that were classified as cash flow hedges during the three and nine months ended September 30, 2010.

     A summary of the impact of our derivative activities in cash flow hedging relationships recognized in earnings for the periods July 1, 2009 through September 2, 2009 and January 1, 2009 through September 2, 2009 is as follows (in thousands):

July 1, 2009 through

September 2, 2009

Amount of Gain/(Loss)

Amount of Gain/(Loss)

Reclassified from AOCI

Recognized in Income

into Income (Effective

on Derivatives

Location of Gain/(Loss)

Portion)(1)

(Ineffective Portion)(2)

Total

Interest Rate Derivatives

Interest expense

$

(2,081

)

$

—

$

(2,081

)

				January 1, 2009 through
				September 2, 2009
				Amount of Gain/(Loss)				Amount of Gain/(Loss)
				Reclassified from AOCI				Recognized in Income
				into Income (Effective				on Derivatives
		Location of Gain/(Loss)		Portion)(1)				(Ineffective Portion)(2)				Total
Interest Rate Derivatives		Interest expense		$	(6,613	)		$	—			$	(6,613	)
		Gain on interest rate swaps			—				336				336
Total				$	(6,613	)		$	336			$	(6,277	)

     The following table summarizes the derivative assets and liabilities on our condensed consolidated balance sheet on a gross basis as of September 30, 2010 (in thousands):

Asset Derivatives

Liability Derivatives

Balance Sheet

Balance Sheet

Location

Fair Value

Location

Fair Value

Commodity derivatives designated as hedging instruments

Accounts payable and

Accounts payable and

accrued liabilities

$

1,007

accrued liabilities

$

( 1,411

)

     The following table summarizes the derivative assets and liabilities on our condensed consolidated balance sheet on a gross basis as of December 31, 2009 (in thousands):

Asset Derivatives

Liability Derivatives

Balance Sheet

Balance Sheet

Location

Fair Value

Location

Fair Value

Commodity derivatives not designated as hedging instruments

Accounts payable and

Accounts payable and

Accrued liabilities

$

37

Accrued liabilities

$

(407

)

     As of September 30, 2010, there was a net loss of approximately $0.4 million deferred in AOCI (no amounts were deferred in AOCI as of December 31, 2009). The deferred loss in AOCI is expected to be reclassified to future earnings contemporaneously with the earnings recognition of the underlying hedged transactions. The underlying hedged transactions are for anticipated base gas purchases and anticipated sales of operational gas. As we account for base gas as a long-term asset, which is not subject to depreciation, amounts related to base gas will not be reclassified to future earnings until such gas is sold or in the event an impairment charge is recognized in the future. Approximately $1.4 million of deferred loss as of September 30, 2010 is associated with anticipated base gas purchases. We expect to reclassify the $1.0 million deferred gain as of September 30, 2010, associated with anticipated sales of operational gas, into earnings during the fourth quarter of 2010. Amounts deferred are based on market prices as of September 30, 2010, thus actual amounts to be reclassified will differ and could vary materially as a result of changes in market conditions. During 2010 and 2009, no amounts were reclassified from AOCI to earnings as a result of anticipated hedge transactions that were no longer considered to be probable of occurring.

     Our accounting policy is to offset fair value amounts associated with derivatives executed with the same counterparty when a master netting agreement exists. As of September 30, 2010 and December 31, 2009, we did not have an obligation to pay or a right to receive cash collateral associated with our derivatives. At September 30, 2010 and December 31, 2009, none of our outstanding derivatives contained credit-risk related contingent features that would result in a material adverse impact upon a change in our credit ratings.

     ASC 820, “Fair Value Measurements and Disclosures,” requires enhanced disclosures about assets and liabilities carried at fair value. As defined in ASC 820, fair value is the price that would be received from selling an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).

     The determination of fair value incorporates various factors. These factors include not only the credit standing of the counterparties involved and the impact of credit enhancements, but also the impact of potential nonperformance risk on our liabilities. As of September 30, 2010 and December 31, 2009, all of our derivatives consisted of exchange-traded instruments within active markets. We therefore consider all of our derivatives as of September 30, 2010 and December 31, 2009 to be Level 1 fair value measurements.

4. Debt

     In April 2010, subject to consummation of our initial public offering, we entered into a three-year, $400.0 million senior unsecured revolving credit facility that matures in May 2013. This credit facility, which bears interest based on LIBOR plus an applicable margin (approximately 2.8% in the aggregate as of September 30, 2010) determined based on funded debt-to-EBITDA levels (as defined in the credit agreement), may be expanded to $600.0 million, subject to additional lender commitments and with approval of the administrative agent for the credit facility.

     This credit facility restricts, among other things, the Partnership’s ability to make distributions of available cash to unitholders if any default or event of default, as defined in the credit agreement, exists or would result therefrom. In addition, the credit facility contains restrictive covenants, including those that restrict our ability to incur additional indebtedness, engage in certain transactions with affiliates, grant (or permit to exist) liens or enter into certain restricted contracts, make any material change to the nature of our business, make a disposition of all or substantially all of our assets or enter into a merger, consolidate, liquidate, wind up or dissolve. Also, the credit facility contains certain financial covenants which, among other things, requires us to maintain a debt-to-EBITDA coverage ratio that will not be greater than 4.75 to 1.00 on outstanding debt (5.50 to 1.00 on all outstanding debt during an acquisition period) and also requires that we maintain an interest-to-EBITDA coverage ratio that will not be less than 3.00 to 1.00, as such terms are defined in the credit agreement. As of September 30, 2010, we were in compliance with the covenants contained in our credit agreement.

     We incurred approximately $2.4 million of costs, reflected as a component of goodwill and intangibles, net in our accompanying condensed consolidated balance sheet as of September 30, 2010, in connection with the establishment of our senior unsecured revolving credit facility. Such costs were capitalized and will be amortized over the term of the credit facility using the straight-line method of amortization. Amortization of debt issuance costs is reflected as a component of depreciation, depletion and amortization expenses in our accompanying condensed consolidated statements of operations. At September 30, 2010, we estimate that the carrying value of outstanding borrowings under our credit facility approximates fair value as interest rates reflect current market rates.

     Our credit facility includes the ability to issue letters of credit. As of September 30, 2010, we had no outstanding letters of credit.

     As of December 31, 2009, approximately $450.5 million was outstanding on a related party note payable to PAA, which was entered into in conjunction with the PAA Ownership Transaction. The note accrued interest and was payable in kind, at a rate of 6.5%. As discussed in Note 6, net proceeds of the IPO, along with borrowings under the new credit facility, were used to repay approximately $468.4 million of the related party note, which included additional borrowings and interest accrued through May 5, 2010. The remaining balance of approximately $16.4 million was extinguished and treated as a capital contribution by PAA as part of PAA’s initial investment in the Partnership.

     Capitalized interest for the three and nine months ended September 30, 2010, was $1.0 million and $6.5 million, respectively, and $1.3 million, $3.3 million and $10.2 million for the periods September 3, 2009 through September 30, 2009, July 1, 2009 through September 2, 2009 and January 1, 2009 through September 2, 2009, respectively.

5. Commitments and Contingencies

Environmental

     We may experience releases of natural gas, brine, crude oil or other contaminants into the environment, or discover past releases that were previously unidentified. Although we maintain an inspection program designed to prevent and, as applicable, to detect and address such releases promptly, damages and liabilities incurred due to any such releases from our assets may substantially affect our business. As of September 30, 2010, we have not identified any such material obligations.

     A natural gas storage facility, associated pipeline header system and gas handling and compression facilities may suffer damage as a result of an accident, natural disaster or terrorist activity. These hazards can cause personal injury and loss of life, severe damage to or destruction of property, base gas, or equipment, pollution or environmental damage, or suspension of operations. We maintain insurance under PAA’s insurance program, of various types that we consider adequate to cover our operations and properties. Such insurance covers our assets in amounts management considers reasonable. The insurance policies are subject to deductibles that we consider reasonable and not excessive. Our insurance does not cover every potential risk associated with operating natural gas storage facilities, associated pipeline header systems, and gas handling and compression facilities. The overall trend in the insurance industry appears to be a contraction in the breadth and depth of available coverage, while costs, deductibles and retention levels have increased. Absent a material favorable change in the insurance markets, we expect this trend to continue as we continue to grow and expand. Accordingly, we may elect to self-insure more of our activities or incorporate higher retention in our insurance arrangements.

     The occurrence of a significant event not fully insured, indemnified or reserved against, or the failure of a party to meet its indemnification obligations, could materially and adversely affect our operations and financial condition. We believe we are adequately insured for public liability and property damage to others with respect to our operations. With respect to all of our coverage, we may not be able to maintain adequate insurance in the future at rates we consider reasonable. In addition, although we believe that we have established adequate reserves to the extent that such risks are not insured, costs incurred in excess of these reserves may be higher and may potentially have a material adverse effect on our financial condition, results of operations or cash flows.

Litigation

     We, in the ordinary course of business, are a claimant and/or a defendant in various legal proceedings. To the extent we are able to assess the likelihood of a negative outcome for these proceedings, our assessments of such likelihood range from remote to probable. If we determine that a negative outcome is probable and the amount of loss is reasonably estimable, we accrue the estimated amount. We do not believe that the outcome of these legal proceedings, individually or in the aggregate, will have a materially adverse effect on our financial condition, results of operations or cash flows.

6. Partners’ Capital and Distributions

Initial Public Offering

     As discussed in Note 1, immediately prior to the closing of the IPO on May 5, 2010, PAA and its subsidiaries contributed 98.0% of the equity interests in PNGS to the Partnership in exchange for certain limited partner interests. In addition, PNGS GP LLC, the general partner of the Partnership and a subsidiary of PAA, contributed 2.0% of the equity interests in PNGS to the Partnership in exchange for a 2.0% general partner interest in the Partnership as well as all of our incentive distribution rights, which entitle our general partner to increasing percentages of the cash we distribute in excess of $0.3375 per quarter.

     On May 5, 2010, the Partnership issued approximately 13.5 million common units to the public, which included approximately 1.8 million common units issued pursuant to the full exercise of the underwriters’ over-allotment option, through an underwritten initial public offering representing an approximate 23.0% limited partner interest in us. Upon closing of the initial public offering and after giving effect to the exercise of the underwriters’ over-allotment option, PAA and its subsidiaries retained an approximate 77.0% equity interest in the Partnership, consisting of approximately 18.1 million common units, approximately 13.9 million Series A subordinated units, 11.5 million Series B subordinated units and a 2.0% general partner interest in us. Total proceeds of the initial public offering were approximately $289.8 million. After deducting underwriting discounts and commissions and direct offering expenses, net proceeds of the offering were approximately $268.2 million. Net proceeds of the offering, along with $200.0 million of borrowings under the Partnership’s new $400.0 million senior unsecured revolving credit facility, were used to repay intercompany indebtedness owed to PAA. The remaining balance of the intercompany indebtedness owed to PAA of approximately $16.4 million was extinguished and treated as a capital contribution and part of PAA’s initial investment in the Partnership.

Outstanding Units

     From the closing of our initial public offering on May 5, 2010 through September 30, 2010, changes in our issued and outstanding common, Series A subordinated and Series B subordinated units were as follows:

						Subordinated
		Common				Series A				Series B				Total
Balance, May 5, 2010			—				—				—				—
Initial public offering			31,584,529				13,934,351				11,500,000				57,018,880
Modification of subordinated units			—				(2,000,000	)			2,000,000				—
Vesting of LTIP awards			1,876				—				—				1,876
Balance, September 30, 2010			31,586,405				11,934,351				13,500,000				57,020,756

Modification of subordinated units

     In August 2010, our general partner amended and restated the Amended and Restated Agreement of Limited Partnership of the Partnership (the “Second Amended and Restated Agreement”) to increase our distribution coverage and growth profile of our common and Series A subordinated units and improve our posture with respect to potential acquisitions. The Second Amended and Restated Agreement reduced the number of Series A subordinated units held by PAA by 2.0 million units and increased the number of Series B subordinated units held by PAA by an equivalent amount. The Second Amended and Restated Agreement also established two additional tranches of Series B subordinated units. We accounted for this transaction as an exchange between entities under common control and accordingly, we reclassified approximately $22.9 million, the book value of 2.0 million Series A subordinated units at the time of the transaction, from the Series A subordinated unit limited partner capital account to the Series B subordinated unit limited partner capital account in our accompanying condensed consolidated statement of changes in partners’ capital and members’ capital.

Series A subordinated units

     All of our Series A subordinated units are owned by PAA. The principal difference between our common units and Series A subordinated units is that in any quarter during the subordination period, holders of the Series A subordinated units are not entitled to receive any distribution until the common units have received the minimum quarterly distribution plus any arrearages in the payment of the minimum quarterly distribution from prior quarters. Series A subordinated units will not accrue arrearages.

     At any time on or after June 30, 2013, the subordination period for the Series A subordinated units will end on the first business day following the quarter in respect of which we have, for each of three consecutive, non-overlapping four quarter periods (i) generated from distributable cash flow at least $1.35 (the minimum quarterly distribution on an annualized basis) on the weighted average number of outstanding common units and Series A subordinated units on a fully diluted basis, plus the corresponding distribution on our general partner’s 2.0% interest and (ii) paid from available cash at least $1.35 on all outstanding common units and Series A subordinated units, plus the corresponding distribution on our general partner’s 2.0% interest. Additionally, at any time on or after June 30, 2011, if we have, for a period of four consecutive quarters (i) generated from distributable cash flow at least $0.5063 per quarter (150.0% of the minimum quarterly distribution, which is approximately $2.03 on an annualized basis) on the weighted average number of outstanding common units and Series A subordinated units on a fully diluted basis, plus the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights and (ii) paid from available cash at least $0.5063 per quarter (150.0% of the minimum quarterly distribution, which is approximately $2.03 on an annualized basis) on all outstanding common units and Series A subordinated units, plus the corresponding distribution on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights, the subordination period will end.

     In addition, the subordination period will end upon the removal of our general partner other than for cause, if the units held by our general partner and its affiliates are not voted in favor of such removal.

     When the subordination period ends, all Series A subordinated units will convert into common units on a one-for-one basis, and all common units thereafter will no longer be entitled to arrearages.

Series B subordinated units

     All of our Series B subordinated units are owned by PAA. The Series B subordinated units will not be entitled to participate in our quarterly distributions until they convert into Series A subordinated units or common units.

     The Series B subordinated units will convert into Series A subordinated units upon satisfaction of the following operational and financial conditions:

•

2,600,000 Series B subordinated units will convert into Series A subordinated units on a one-for-one basis if (a) the aggregate amount of working gas storage capacity at Pine Prairie that has been placed into service totals at least 29.6 Bcf,

			(b) we generate distributable cash flow for two consecutive quarters sufficient to pay a quarterly distribution of at least $0.36 per unit (representing an annualized distribution of $1.44 per unit) on the weighted average number of outstanding common units and Series A subordinated units and all of such Series B subordinated units and (c) we make a quarterly distribution of available cash of at least $0.36 per quarter for two consecutive quarters on all outstanding common units and Series A subordinated units and the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights;
	•		2,833,333 Series B subordinated units will convert into Series A subordinated units on a one-for-one basis if (a) the aggregate amount of working gas storage capacity at Pine Prairie that has been placed into service totals at least 35.6 Bcf, (b) we generate distributable cash flow for two consecutive quarters sufficient to pay a quarterly distribution of at least $0.3825 per unit (representing an annualized distribution of $1.53 per unit) on the weighted average number of outstanding common units and Series A subordinated units and all of such Series B subordinated units and, if any, the Series B subordinated units described in the prior bullet, and (c) we make a quarterly distribution of available cash of at least $0.3825 per quarter for two consecutive quarters on all outstanding common units and Series A subordinated units and the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights;
	•		2,066,667 Series B subordinated units will convert into Series A subordinated units on a one-for-one basis if (a) the aggregate amount of working gas storage capacity at Pine Prairie that has been placed into service totals at least 41.6 Bcf, (b) we generate distributable cash flow for two consecutive quarters sufficient to pay a quarterly distribution of at least $0.4075 per unit (representing an annualized distribution of $1.63 per unit) on the weighted average number of outstanding common units and Series A subordinated units and all of such Series B subordinated units and, if any, the Series B subordinated units described in the prior two bullets, and (c) we make a quarterly distribution of available cash of at least $0.4075 per quarter for two consecutive quarters on all outstanding common units and Series A subordinated units and the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights;
	•		3,000,000 Series B subordinated units will convert into Series A subordinated units on a one-for-one basis if (a) the aggregate amount of working gas storage capacity at Pine Prairie that has been placed into service totals at least 48 Bcf, (b) we generate distributable cash flow for two consecutive quarters sufficient to pay a quarterly distribution of at least $0.4275 per unit (representing an annualized distribution of $1.71 per unit) on the weighted average number of outstanding common units and Series A subordinated units and all of such Series B subordinated units and, if any, the Series B subordinated units described in the prior three bullets, and (c) we make a quarterly distribution of available cash of at least $0.4275 per quarter for two consecutive quarters on all outstanding common units and Series A subordinated units and the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights; and
	•		3,000,000 Series B subordinated units will convert into Series A subordinated units on a one-for-one basis if (a) the aggregate amount of working gas storage capacity at Pine Prairie that has been placed into service totals at least 48 Bcf, (b) we generate distributable cash flow for two consecutive quarters sufficient to pay a quarterly distribution of at least $0.45 per unit (representing an annualized distribution of $1.80 per unit) on the weighted average number of outstanding common units and Series A subordinated units and all of such Series B subordinated units and, if any, the Series B subordinated units described in the prior four bullets, and (c) we make a quarterly distribution of available cash of at least $0.45 per quarter for two consecutive quarters on all outstanding common units and Series A subordinated units and the corresponding distributions on our general partner’s 2.0% interest and the related distributions on the incentive distribution rights.

     Before giving effect to the Second Amended and Restated Agreement, there were 4,600,000, 3,833,333 and 3,066,667 Series B subordinated units included in first, second and third tranches of Series B subordinated units, respectively.

     Our general partner will determine whether the in-service operational requirements set forth above have been satisfied. To the extent that the operational tests described above are satisfied prior to or during the two-quarter period applicable to the financial tests described above, the holder of the Series B subordinated units subject to conversion will be entitled to receive the quarterly distribution payable with respect to the second quarter of such two-quarter period. In all other circumstances, where the operational tests are satisfied following the two-quarter period applicable to the financial tests, the holder of the Series B subordinated units subject to conversion will be entitled to receive any distribution payable following the satisfaction of such operational tests.

     Any Series B subordinated units that remain outstanding as of December 31, 2018 will automatically be cancelled.

     Following conversion of any Series B subordinated units into Series A subordinated units, such converted Series B subordinated units will further convert into common units (together with any other outstanding Series A subordinated units) to the extent that the tests for conversion of the Series A subordinated units are satisfied. In determining whether such conversion tests have been satisfied, the Series B subordinated units that have converted into Series A subordinated units will be treated as Series A subordinated units from and after the date of their conversion into Series A subordinated units.

     If at the time the above operational and financial tests are satisfied, the subordination period has already ended and all outstanding Series A subordinated units have converted into common units, the Series B subordinated units will instead convert directly into common units on a one-for-one basis and participate in the quarterly distribution payable to common units.

Distributions

     Our partnership agreement requires that, within 45 days subsequent to the end of each quarter, beginning with the quarter ended June 30, 2010, we will distribute all of our available cash, as defined in our partnership agreement, to unitholders of record on the applicable record date.

     Our partnership agreement requires that we distribute all of our available cash each quarter in the following manner:

	•		first, 98.0% to the holders of common units and 2.0% to our general partner, until each common unit has received the minimum quarterly distribution of $0.3375, plus any arrearages from prior quarters; and
	•		second, 98.0% to the holders of Series A subordinated units and 2.0% to our general partner, until each Series A subordinated unit has received the minimum quarterly distribution of $0.3375.

     If cash distributions to our unitholders exceed $0.3375 per common unit and Series A subordinated unit in any quarter, our general partner will receive, in addition to distributions on its 2.0% general partner interest, incentive distributions in increasing percentages, up to 48.0%, of the cash we distribute in excess of that amount as follows:

		Total Quarterly Distributions
		per Common Unit and				Marginal Percentage
		Series A Subordinated Unit				Interest in Distributions
						Unitholders				General Partner
Minimum quarterly distribution			$ 0.3375				98.0	%			2.0	%
First target distribution			above $0.3375 up to $0.37125				85.0	%			15.0	%
Second target distribution			above $0.37125 up to $0.50625				75.0	%			25.0	%
Thereafter			above $0.50625				50.0	%			50.0	%

     Our general partner has the right, at any time when there are no Series A subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (48.0%) for each of the prior four consecutive fiscal quarters, to reset the initial target distribution levels at higher levels based on our cash distributions at the time of the exercise of the reset election.

     The following table details the distributions subsequent to our initial public offering (in millions, except per unit amounts):

				Distributions Paid
								Series A																Distributions
				Common				Subordinated				General Partner												per limited
Date Declared		Date Paid or To Be Paid		Units				Units				Incentive				2%				Total				partner unit
October 12, 2010		November 12, 2010 (1)		$	10.7			$	4.0			$	—			$	0.3			$	15.0			$	0.3375
July 13, 2010		August 13, 2010 (2)		$	6.7			$	2.9			$	—			$	0.2			$	9.8			$	0.2114

7. Comprehensive Income

     Comprehensive income includes net income and all other non-owner changes in equity. Components of comprehensive income (loss) are presented below (in thousands):

		Successor								Predecessor				Successor								Predecessor
						September 3, 2009				July 1, 2009								September 3, 2009				January 1, 2009
		Three Months Ended				through September				through September				Nine Months Ended				through September				through September
		September 30, 2010				30, 2009				2, 2009				September 30, 2010				30, 2009				2, 2009
		(See Note 1)								(See Note 1)				(See Note 1)								(See Note 1)
Net income		$	9,620			$	1,006			$	5,593			$	19,975			$	1,006			$	15,518
Net derivative gain/(loss) on cash flow hedges			(44	)			—				(627	)			(403	)			—				1,990
Total comprehensive income		$	9,576			$	1,006			$	4,966			$	19,572			$	1,006			$	17,508

8. Net Income per Limited Partner Unit

     Basic and diluted net income per unit is determined by dividing each class of limited partners’ interest in net income by the weighted average number of limited partner units for such class outstanding during the period. Pursuant to FASB guidance, the limited partners’ interest in net income is calculated by first reducing net income by the distribution pertaining to the current period’s net income, which is to be paid in the subsequent quarter (including the incentive distribution right in excess of the 2.0% general partner interest). Then, the remaining undistributed earnings or excess distributions over earnings, if any, are allocated to the general partner and limited partner interests in accordance with the contractual terms of the partnership agreement. Diluted earnings per limited partner unit, where applicable, reflects the potential dilution that could occur if securities or other agreements to issue additional units of a limited partner class, such as phantom unit awards, were exercised, settled or converted into such units.

     The following table sets forth the computation of basic and diluted earnings per limited partner unit for the three months ended September 30, 2010 and the period from May 5, 2010 (the closing of our initial public offering) through September 30, 2010 (amounts in thousands, except per unit data):

		Three Months				May 5, 2010
		Ended				through
		September 30,				September 30,
		2010				2010
Net income		$	9,620			$	14,547
Less: General partner’s incentive distribution paid (1)			—				—
Less: General partner 2.0% ownership			192				291
Net income available to limited partners		$	9,428			$	14,256
Numerator for basic and diluted earnings per limited partner unit:
Allocation of net income amongst limited partner interests:
Net income allocable to common units		$	6,686			$	10,024
Net income allocable to Series A subordinated units			2,742				4,232
Net income allocable to Series B subordinated units (2)			—				—
Net income available to limited partners		$	9,428			$	14,256
Denominator:
Basic weighted average number of limited partner units outstanding: (2)(3)(4)
Common units			31,586				31,585
Series A subordinated units			12,934				13,317
Series B subordinated units			12,500				12,117
Diluted weighted average number of limited partner units outstanding: (2)(3)(4)
Common units			31,591				31,590
Series A subordinated units			12,934				13,317
Series B subordinated units			12,500				12,117
Basic and diluted net income per limited partner unit: (2)(3)(4)
Common units		$	0.21			$	0.32
Series A subordinated units		$	0.21			$	0.32
Series B subordinated units		$	—			$	—

9. Equity Compensation Plans

Long Term Incentive Plan (“LTIP”)

     On April 27, 2010, PNGS GP LLC, the general partner of the Partnership, adopted the PAA Natural Gas Storage, L.P. 2010 Long Term Incentive Plan (the “2010 LTIP Plan”) for the employees, directors and consultants of our general partner and its affiliates, including PAA, who perform services on our behalf. The 2010 LTIP Plan consists of restricted units, phantom units, unit options, unit appreciation rights and unit awards. The 2010 LTIP Plan limits the number of common units that may be delivered pursuant to awards under the plan to 3,000,000 units.

     During the second quarter of 2010, 658,500 phantom units were granted under the 2010 LTIP Plan to directors, officers and other employees, a portion of which were granted upon conversion of outstanding awards denominated in common units of PAA. Of this total, (i) 30,000 phantom units will vest annually in 25.0% increments and have an automatic re-grant feature such that as they vest, an equivalent amount is granted; (ii) 326,000 phantom units will vest in one-third increments upon the later of (a) the May 2012 distribution date and the date we pay a quarterly distribution of at least $0.3875, (b) the May 2013 distribution date and the date we pay a quarterly distribution of at least $0.4500, and (c) the May 2014 distribution date and the date we pay a quarterly distribution of at least $0.4750; and (iii) 302,500 phantom units will vest in 25.0% increments in connection with the conversion of our Series A subordinated units and the conversion of each of the first three tranches of our Series B subordinated units. Distribution equivalent rights were also awarded with respect to 342,500 of the phantom unit grants.

     In November 2010, our Board of Directors approved the modification (subject to agreement by the individual award recipients) of 302,500 LTIP awards originally granted in the second quarter of 2010 to more closely align the vesting of these awards to the conversion of our Series B subordinated units as a result of the modification of our subordinated units in August 2010 (see Note 6). Such awards now vest in 20% increments in connection with the conversion of our Series A subordinated units and the conversion of each of the first four tranches of our Series B subordinated units.

     Our LTIP activity for awards issued under the 2010 LTIP Plan is summarized in the following table (in thousands, except per unit data):

						Weighted Average
						Grant Date
		Units				Fair Value per Unit
Outstanding, May 5, 2010			—			$	—
Granted (1)			661				19.72
Vested			(2	)			19.72
Cancelled or forfeited			—				—
Outstanding, September 30, 2010			659			$	19.72

     Prior to our initial public offering and adoption of the 2010 LTIP Plan, certain of our officers and other individuals providing direct services on our behalf were granted LTIP awards under LTIP plans sponsored by PAA’s general partner (“PAA LTIP Awards”). Such awards, which allow settlement in cash or PAA common units upon vesting at the election of PAA’s general partner, generally contained performance conditions based on the attainment of certain annualized PAA distribution levels or the attainment of specific PNG EBITDA levels and vested upon the later of a certain date or the attainment of such levels. In connection with the second quarter grants under the 2010 LTIP Plan, substantially all of the then outstanding liability-classified PAA LTIP awards held by PNG management were converted to equity-classified PNG LTIP awards, which resulted in a reclassification to Partners’ capital of approximately $1.2 million of compensation expense recognized on such awards through the modification date. As of September 30, 2010, we are obligated to reimburse PAA, upon vesting, for approximately 20,000 currently outstanding PAA LTIP awards. We reimbursed PAA approximately $0.3 million and $0.5 million for PAA LTIP awards that vested during the three and nine months ended September 30, 2010, respectively.

     The fair value of our liability classified awards is calculated based on the closing price of the underlying PAA or PNG units as of each balance sheet date and adjusted for the present value of any distributions that are estimated to occur on the underlying units over the vesting period that will not be received by the award recipients. The fair value of our equity classified awards is calculated based on the closing price of our common units as of the respective grant dates and adjusted for the present value of any distributions that are estimated to occur on the underlying units over the vesting period that will not be received by the award recipient. The fair value of these awards is recognized as compensation expense over the service period. For awards with performance conditions, we recognize compensation expense only if the achievement of the performance condition is considered probable and amortize that expense over the service period. When awards with performance conditions that were not previously considered probable of occurring become probable

of occurring, we incur additional equity compensation expense necessary to adjust the life-to-date accrued expense associated with these awards. Substantially all of our equity compensation expense is reflected as a component of general and administrative expenses in our accompanying condensed consolidated statements of operations.

     Our accrued liability at September 30, 2010 related to all outstanding liability classified LTIP awards is approximately $1.3 million. We have also recognized $1.8 million in Partners’ capital related to all outstanding equity classified LTIP awards. Compensation expense recognized on 2010 LTIP Plan awards reflects our assessment that an annualized PNG distribution of $1.45 and the conversion of our Series A subordinated units and the first tranche of our Series B subordinated units are probable of occurring.

     Class B Awards of Our General Partner

     In July 2010, the Board of Directors of our general partner authorized the issuance of 165,000 Class B Units (“PNGS Class B Units”) of PNGS GP LLC (PNG’s general partner) in order to create long term incentives for our management. The entire economic burden of the PNGS Class B Units, which are equity classified, will be borne solely by our general partner and will not impact our cash or our units outstanding. We will recognize the grant date fair value of the PNGS Class B Units as compensation expense over the service period, with such expense recognized as a capital contribution. We will not be obligated to reimburse our general partner for such costs and any distributions made on the PNGS Class B Units will not reduce the amount of cash available for distribution to our unitholders.

     Approximately 98,000 PNGS Class B units were granted in July 2010 and the remaining units are reserved for future grants. The PNGS Class B Units earn the right to participate in distributions (i.e, become “earned”) in 25% increments 180 days following the payment by PNG of quarterly distributions that equate to annualized distribution levels of $2.00, $2.30, $2.50 and $2.70. When PNGS Class B Units become earned units, they will participate in quarterly distributions paid to our general partner in excess of $2,500,000. In addition, 50% of the applicable earned units vest immediately upon becoming earned units and the remaining 50% vest on the fifth anniversary of the date of grant. If PNGS Class B Units become earned units after the fifth anniversary of the date of grant, 100% of such units will vest immediately upon becoming earned units. Assuming all 165,000 PNGS Class B Units were granted and earned, the maximum participation rate would be 6% of PNG’s quarterly general partner distribution in excess of $2,500,000. No expense and corresponding capital contribution were recognized during the three months ended September 30, 2010 as it was not deemed probable that any of the performance conditions necessary for the PNGS Class B Units to become earned would be met.

     Awards Granted by PAA

     During September 2010, PAA entered into agreements with certain officers of PAA pursuant to which these individuals were granted approximately 375,000 awards denominated in PNG common units, Series A subordinated units, and Series B Subordinated units. The awards will vest upon the completion of the service period and certain performance conditions including the conversion of PNG’s Series A subordinated units into common units of PNG and the conversion of PNG’s Series B subordinated units into Series A subordinated units of PNG. Upon vesting, these awards will be settled with outstanding common or Series A subordinated units of PNG currently owned by PAA. The entire economic burden of these agreements will be borne solely by PAA and will not impact our cash or our units outstanding. Since these individuals also serve as officers of PNG and PNG benefits as a result of the services they provide, we will recognize the grant date fair value of these awards as compensation expense over the service period, with such expense recognized as a capital contribution. During the three months ended September 30, 2010, we recognized approximately $0.4 million of expense and a corresponding capital contribution associated with these awards.

Other Consolidated Equity Compensation Information

     The table below summarizes the expense recognized and the value of vested awards related to our equity compensation plans (in thousands):

		Three Months Ended
		September 30, 2010
		Liability Awards				Equity Awards
Equity compensation expense		$	230			$	441
LTIP cash settled vestings		$	317			$	—
Distribution equivalent right payments		$	—			$	10

		Nine Months Ended
		September 30, 2010
		Liability Awards				Equity Awards
Equity compensation expense		$	933			$	581
LTIP cash settled vestings		$	471			$	—
Distribution equivalent right payments		$	—			$	10

     Based on the September 30, 2010 fair value measurement and probability assessment regarding future distributions, we expect to recognize approximately $3.5 million of additional expense over the estimated service period of our outstanding awards related to the remaining unrecognized fair value. For our liability classified awards, this estimate is based on the fair value of the outstanding awards as of September 30, 2010. For our equity classified awards, this estimate is based on the grant date fair value of such awards. Actual amounts may materially differ as a result of a change in the market price of our units and/or probability assessment regarding future distributions. We estimate that the remaining fair value will be recognized in expense as shown below (in thousands):

		Equity Compensation
		Plan Fair Value
Year		Amortization(1),(2)
2010 (3)		$	315
2011			1,699
2012			916
2013 and thereafter			561
Total		$	3,491

10. Related Party Transactions

     We do not directly employ any personnel to manage or operate our business. These functions are provided by employees of Plains All American GP LLC (“GP LLC”), the general partner of Plains AAP, L.P. which is the sole member of PAA GP LLC, PAA’s general partner. References to PAA, unless the context otherwise requires, include GP LLC. We reimburse PAA for all direct and indirect expenses it incurs or payments it makes on our behalf and all other expenses allocable to us or otherwise incurred by PAA in connection with the operation of our business. These expenses are recorded in general and administrative expenses and other operating costs on our income statement and include salary, bonus, incentive compensation and other amounts paid to persons who perform services for us or on our behalf. We record these costs on the accrual basis in the period in which PAA’s general partner incurs them. We reimburse PAA for costs related to equity-based compensation awards upon vesting of the awards. Our agreement with PAA provides that PAA will determine the expenses allocable to us in any reasonable manner determined by PAA in its sole discretion. Total costs reimbursed by us to PAA for the three and nine months ended September 30, 2010, were approximately $4.6 million and $16.0 million, respectively; and $0.9 million, $1.5 million and $7.9 million for the periods September 3, 2009 through September 30, 2009, July 1, 2009 through September 2, 2009 and January 1, 2009 through September 2, 2009, respectively. Of these amounts approximately $0.8 million and $2.6 million and $0.1 million, $0.3 million and $1.0 million, during the three and nine month periods ended September 30, 2010 and the periods September 3, 2009 through September 30, 2009, July 1, 2009 through September 2, 2009 and January 1, 2009 through September 2, 2009, respectively, were allocated personnel costs for shared services and the remainder consisted of direct costs that PAA paid on our behalf along with our allocation of insurance premiums for participation in PAA’s insurance program. As of September 30, 2010 and December 31, 2009, PNG had a liability to PAA of approximately $1.0 million and $0.8 million, respectively, included in accounts payable and accrued liabilities on our accompanying condensed consolidated balance sheet.

     As of September 30, 2010 and December 31, 2009, PNG’s obligation for unvested equity-based compensation awards for which we are required to reimburse PAA upon vesting and settlement was approximately $1.3 million and $1.8 million, respectively. Approximately $1.2 million and $0.7 million of such amounts were reflected in accounts payable and accrued liabilities in our accompanying condensed consolidated balance sheets as of September 30, 2010 and December 31, 2009, respectively, with the remaining balances included as a component of other long-term liabilities at each respective date.

Omnibus Agreement

     In conjunction with our initial public offering in May 2010, we entered into an omnibus agreement with PAA and certain of its affiliates, pursuant to which we agreed upon certain aspects of our relationship with them, including, among other things (1) the

provision by PAA’s general partner to us of certain general and administrative services and our agreement to reimburse PAA’s general partner for such services, (2) the provision by PAA’s general partner of such personnel as may be necessary to operate and manage our business, and our agreement to reimburse PAA’s general partner for the expenses associated with such personnel, (3) certain indemnification obligations, and (4) our use of the name “PAA” and related marks. Under this agreement, PAA indemnifies us against certain environmental liabilities, tax matters, and title or permitting defects generally for a period of three years after the closing of our initial public offering. The environmental indemnifications are subject to a cap of $15.0 million and require us to pay the first $250 thousand of costs incurred. In addition, we have indemnified PAA against any losses, costs or damages incurred by PAA or its general partner that are attributable to the ownership and operation of our assets following the close of the initial public offering.

Tax Sharing Agreement

     In conjunction with our initial public offering in May 2010, we entered into a tax sharing agreement with PAA, pursuant to which we and PAA agreed on the method of allocation among us and our subsidiaries, on the one hand, and PAA and its subsidiaries (other than us and our subsidiaries) on the other, of the responsibilities, liabilities and benefits relating to any taxes for which a combined return is filed for taxable periods including or beginning on May 5, 2010. Subsequent to the PAA Ownership Transaction, income tax expense allocated to us under applicable allocation methodologies has not been material.

Relationship with our general partner

     Except as previously disclosed, we are not party to any material transactions with our general partner or any of its affiliates. Additionally, our general partner is not obligated to provide any direct or indirect financial assistance to us or to increase or maintain its capital investment in us.

11. Reporting Segment

     We manage our operations through two operating segments, Bluewater and Pine Prairie. We have aggregated these operating segments into one reporting segment, Gas Storage. Our Chief Operating Decision Maker (our Chief Executive Officer) evaluates segment performance based on a variety of measures including adjusted EBITDA, volumes, adjusted EBITDA per thousand cubic feet (“mcf”) and maintenance capital investment. We have aggregated our two operating segments into one reportable segment based on the similarity of their economic and other characteristics, including the nature of services provided, methods of execution and delivery of services, types of customers served and regulatory requirements. We define adjusted EBITDA as earnings before interest expense, taxes, depreciation, depletion and amortization, equity compensation plan charges, gains and losses from derivative activities and selected items that are generally unusual or non-recurring. The measure above excludes depreciation and amortization as we believe that depreciation and amortization are largely offset by repair and maintenance capital investments. Maintenance capital consists of expenditures for the replacement of partially or fully depreciated assets in order to maintain the operating capability, service capability, and/or functionality of our existing assets.

The following table reflects certain financial data for our reporting segment for the periods indicated (in thousands):

		Successor								Predecessor				Successor								Predecessor
						September 3, 2009				July 1, 2009								September 3, 2009				January 1, 2009
		Three Months Ended				through September				through September				Nine Months Ended				through September				through September
		September 30, 2010				30, 2009				2, 2009				September 30, 2010				30, 2009				2, 2009
		(See Note 1)								(See Note 1)				(See Note 1)								(See Note 1)
Revenues (1)		$	25,083			$	6,370			$	12,460			$	71,446			$	6,370			$	46,929
Adjusted EBITDA		$	14,907			$	3,849			$	8,275			$	37,982			$	3,849			$	28,701
Maintenance capital		$	75			$	2			$	170			$	292			$	2			$	384
Long-lived assets (1), (2)		$	946,734			$	872,605			$	—			$	946,734			$	872,605			$	—
Total assets (2)		$	962,078			$	881,079			$	—			$	962,078			$	881,079			$	—

     The following table reconciles Adjusted EBITDA to consolidated net income (in thousands):

		Successor								Predecessor				Successor								Predecessor
						September 3, 2009				July 1, 2009								September 3, 2009				January 1, 2009
		Three Months Ended				through September				through September				Nine Months Ended				through September				through September
		September 30, 2010				30, 2009				2, 2009				September 30, 2010				30, 2009				2, 2009
		(See Note 1)								(See Note 1)				(See Note 1)								(See Note 1)
Adjusted EBITDA		$	14,907			$	3,849			$	8,275			$	37,982			$	3,849			$	28,701
Selected items impacting Adjusted EBITDA:
Equity compensation charge			(671	)			(933	)			—				(1,514	)			(933	)			(304	)
Mark-to-market of open derivative positions			—				—				—				370				—				—
Depreciation, depletion and amortization			(3,867	)			(770	)			(1,887	)			(10,323	)			(770	)			(8,054	)
Interest expense			(749	)			(1,140	)			(676	)			(6,540	)			(1,140	)			(4,352	)
Income tax expense			—				—				(119	)			—				—				(473	)
Net Income		$	9,620			$	1,006			$	5,593			$	19,975			$	1,006			$	15,518

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion analyzes the financial condition and results of operations of the Partnership, including periods prior to our initial public offering on May 5, 2010. Such analysis should be read in conjunction with the historical audited financial statements, and the notes thereto, included in the final prospectus dated April 29, 2010 (the “Final Prospectus”) included in our Registration Statement on Form S-1, as amended (SEC File No. 333-164492). For ease of reference, we refer to the historical financial results of PAA Natural Gas Storage, LLC (“PNGS”) prior to our initial public offering as being “our” historical financial results. Unless the context otherwise requires, references to “we,” “us,” “our,” and “the Partnership” are intended to mean the business and operations of PAA Natural Gas Storage, L.P. (the “Partnership” or “PNG”) and its consolidated subsidiaries since May 5, 2010. When used in the historical context (i.e. prior to May 5, 2010), these terms are intended to mean the business and operations of PNGS. Unless the context indicates otherwise, for purposes of the following discussion “PAA” refers to Plains All American Pipeline, L.P. (the owner of our general partner) (NYSE: PAA) and its consolidated subsidiaries and affiliates other than the Partnership and its general partner and their respective subsidiaries.

     For periods prior to our initial public offering, the historical condensed consolidated financial statements included in this Quarterly Report on Form 10-Q are those of PNGS. Through the contribution of all of the equity interest of PNGS to us in connection with the closing of our initial public offering on May 5, 2010, all of the assets, liabilities and operations of PNGS were contributed directly or indirectly by PAA to the Partnership. For further discussion regarding the Partnership’s initial public offering, please see Notes 1 and 6 to the condensed consolidated financial statements.

     As further discussed in Note 1 to the condensed consolidated financial statements, PNGS became a wholly owned subsidiary of PAA on September 3, 2009 when PAA acquired an additional 50.0% interest in PNGS from Vulcan Capital (the “PAA Ownership Transaction”). Application of push-down accounting from PAA to PNGS resulted in a change in carrying value for certain assets and liabilities of PNGS. Accordingly, the following discussion refers to Predecessor and Successor periods, which relate to the accounting periods preceding and succeeding the PAA Ownership Transaction. In the presentation set forth below, the historical Predecessor and Successor periods of 2009 have been separated by a vertical line in order to highlight the fact that the financial information for such periods was prepared under two different cost bases of accounting.

Overview of Operating Results, Capital Spending and Significant Activities

     In October 2010, we filed with the Federal Energy Regulatory Commission (FERC) for expansion of our Pine Prairie facility. The filing contemplates construction of an additional 32 Bcf of working gas storage capacity, including two new 12 Bcf caverns and the expansion of existing permitted capacity by 8 Bcf. Receipt of FERC approval of the proposed expansions would increase Pine Prairie’s permitted capacity from 48 Bcf to 80 Bcf.

     During the second quarter of 2010, we received the necessary regulatory approvals and placed our third cavern into service at our Pine Prairie facility. This 10 Bcf cavern increases the Partnership’s working gas storage capacity at Pine Prairie by approximately 70.0% from 14 Bcf to 24 Bcf and increases the Partnership’s aggregate working capacity by 25.0% from 40 Bcf to approximately 50 Bcf.

     During the second quarter of 2010, we established a commercial optimization group. Without altering our basic commercial strategy of committing a high percentage of our storage capacity under multi-year firm storage contracts at attractive rates, our dedicated commercial marketing group will capture short-term market opportunities by leasing a portion of our owned or leased storage capacity engaging in related commercial marketing activities. Consistent with PAA’s experience in marketing crude oil and refined products, we believe a dedicated commercial marketing group that has a consistent presence in our markets will enhance our ability to properly price our storage and hub service offerings and will increase our cash flow by capitalizing on volatility and inefficiencies in the natural gas markets. We will conduct these commercial activities within pre-defined risk parameters, and our general policy will be (i) to purchase natural gas only in situations where we have a market for such gas, (ii) to utilize physical natural gas inventory and financial derivatives to manage and optimize seasonal and spread risks inherent in our operations and commercial management activities and to structure our transactions so that commodity price fluctuations will not have a material adverse impact on our cash flow and (iii) not to acquire or hold natural gas, futures contracts or other derivative products for the purpose of speculating on outright commodity price changes.

Results of Operations (in thousands, except per storage capacity and monthly operating metrics data)

     The tables below summarize our results of operations for the periods indicated. Due to the change in accounting basis that occurred as a result of the PAA Ownership Transaction, combining results of operations for periods in 2009 prior and subsequent to the transaction for purposes of comparison to 2010 results without making appropriate adjustments may not necessarily facilitate a

meaningful analysis and would be inconsistent with relevant accounting and financial reporting authoritative guidance applicable to similar circumstances. As a result, we have elected to present pro forma results of operations for the three and nine month periods ended September 30, 2009 which have been prepared as if the PAA Ownership Transaction had occurred on January 1, 2009. This pro forma information should be read in conjunction with the “Unaudited Pro Forma Condensed Combined Financial Statements” contained in the Final Prospectus.

     The pro forma information is based on assumptions that we believe are reasonable under the circumstances and are intended for illustrative purposes only. While not necessarily indicative of the results of the actual or future operations that would have been achieved had the PAA Ownership Transaction occurred on January 1, 2009, we believe this information provides a more meaningful basis of comparison for purposes of discussion of current period results as information is presented on a comparable accounting basis for complete fiscal periods. Pro forma adjustments reflected in the pro forma results for the three and nine month periods ended September 30, 2009 impacted general and administrative expenses, interest expense and depreciation, depletion and amortization. Revenues and expense categories, other than those previously noted, were not materially impacted by the change in basis and amounts on a pro forma basis for the applicable 2009 period are the summation of activity for the applicable 2009 historical periods. Further discussion of the nature of the pro forma adjustments made is included as a part of this analysis.

		Successor				Pro Forma				Successor					Predecessor
										September 3, 2009					July 1, 2009				Favorable/(Unfavorable)
		Three Months Ended				Three Months Ended				through September					through September				Variance(2)
		September 30, 2010				September 30, 2009				30, 2009					2, 2009				$				%
Revenues
Firm Storage Services
Reservation fees		$	22,487			$	16,854			$	5,638				$	11,216			$	5,633				33	%
Cycling fees and fuel-in-kind			1,286				1,143				382					761				143				13	%
Hub Services			689				825				343					482				(136	)			-16	%
Other			621				8				7					1				613				7663	%
Total revenue			25,083				18,830				6,370					12,460				6,253				33	%
Storage related costs			(5,101	)			(3,126	)			(1,002	)				(2,124	)			(1,975	)			-63	%
Other operating costs (except those shown below)			(1,720	)			(2,148	)			(896	)				(1,252	)			428				20	%
Fuel expense			(611	)			(211	)			(171	)				(40	)			(400	)			-190	%
General and administrative expenses			(3,409	)			(2,474	)			(1,383	)				(781	)			(935	)			-38	%
Interest income and other income (expense), net			(6	)			10				(2	)				12				(16	)			-160	%
Equity compensation expense			671				933				933					—
Mark-to-market of open derivative positions			—				—				—					—
Adjusted EBITDA		$	14,907			$	11,814			$	3,849				$	8,275			$	3,093				26	%
							—
Reconciliation to net income
Depreciation, depletion and amortization			(3,867	)			(2,584	)			(770	)				(1,887	)			(1,283	)			-50	%
Interest expense, net of capitalized interest			(749	)			(2,675	)			(1,140	)				(676	)			1,926				72	%
Income tax expense			—				(119	)			—					(119	)			119				100	%
Equity compensation expense			(671	)			(933	)			(933	)				—
Mark-to-market of open derivative positions			—				—				—					—
Net income		$	9,620			$	5,503			$	1,006				$	5,593			$	4,117				75	%
Operating Data:
Net revenue margin (1)			19,982				15,704				5,368					10,336				4,278				27	%
Other operating expenses / G&A / Other			(5,075	)			(3,890	)			(1,519	)				(2,061	)			(1,185	)			-30	%
Adjusted EBITDA		$	14,907			$	11,814			$	3,849				$	8,275			$	3,093				26	%
Average working storage capacity (Bcf)			50.0				40.0				40.0					40.0				10.0				25	%
Monthly Operating Metrics ($/Mcf)
Net Revenue Margin		$	0.13			$	0.13			$	0.13				$	0.13				—				0	%
Operating expenses / G&A / Other		$	(0.03	)		$	(0.03	)		$	(0.04	)			$	(0.03	)			—				0	%
Adjusted EBITDA		$	0.10			$	0.10			$	0.09				$	0.10				—				0	%