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Sunoco Inc. (NYSE:SUN)

Q3 FY08 Earnings Call

November 6, 2008, 3:00 PM ET

Executives

Terence P. Delaney - VP of IR and Planning

Thomas W. Hofmann - Sr. VP and CFO

Tom Harr - Manager of IR

Analysts

Jeffrey Dietert - Simmons & Company

Mark Flannery - Credit Suisse

Neil McMahon - Sanford Bernstein

Erik Mielke - Merrill Lynch

Paul Sankey - Deutsche Bank

Mark Gilman - The Benchmark Company

Paul Cheng - Barclays Capital

Chi Chow - Tristone Capital

Doug Leggate - Quadrum Capital

Operator

Good afternoon. My name is Kelly and I will be your conference operator today. At this time, I would like to welcome everyone to the Sunoco's Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions].

Thank you. Mr. Delaney, you may begin your conference.

Terence P. Delaney - Vice President of Investor Relations and Planning

Thank you, Kelly, and good afternoon. I apologize to everybody to be… being a few minutes late. We had some technical difficulties on our end, but welcome again to Sunoco's quarterly conference call where we will be discussing the company's third quarter earnings that were reported last evening.

With me today are Tom Hofmann, our Senior Vice President and Chief Financial Officer and Tom Harr, our Manager of Investor Relations. Lynn Elsenhans, our CEO and President had a previous commitment that had been scheduled prior to joining Sunoco that prevented her from being here this afternoon, but she does intend to participate in these calls in the future.

As part of today's call, I would direct you to our website www.sunocoinc.com, where we have posted a number of presentation slides. I will be making reference to a number of them today to help highlight and supplement some of the commentary and statistics that were included in our release. So if you haven't already done so, I would suggest that you go there now and be ready to refer to them as I progress through my remarks.

To start for purposes of facilitating a good discussion, I would refer you to the Safe Harbor statement referenced in slide 26 and as included in last nights earnings release. In the course of our remarks and in the subsequent Q&A, we may be making some forward-looking statements while we feel that the assumptions underlying these statements are reasonable. Our company and our businesses are subject to a variety of risks and uncertainties, which are highlighted there in slide 26.

Now, turning to the third quarter, last night, we reported quarterly income of $549 million, which included one unfavorable special item, $10 million after-tax provision to write-off capital expenditures incurred to date related to the now cancelled distillate hydrotreater project at our Tulsa refinery. Excluding this special item, Sunoco's income as noted in slide three was a record $559 million or $4.78 a share.

Our Refining and Supply segment earned $424 million as falling crude oil prices and industry supply constraints related to the Gulf Coast hurricane in September led to margins and earnings that were significantly improved from the first half of this year, despite continued lower year-over-year demand.

Our results were also significantly aided by our ability to reduce realized crude feedstock cost and optimize production in Refining and Supply during the quarter, which I'll discuss a bit more in a moment.

The non-refining businesses for Sunoco earned $140 million for the quarter, our highest total ever for these businesses. In the lower/falling crude cost environment of the third quarter, our Retail Marketing and Chemical margins were increased while Logistics and Coke continued to make steady contributions to our bottom-line.

Moving first to Refining and Supply, which as I said earned $424 million in the quarter. I refer you to slide 4. In considering the strong third quarter earnings for this business, in addition to the impacts of falling crude prices and the storms I previously mentioned, which helped margins for all refiners during the quarter, I'd like to highlight two factors more related to our own performance.

First, the mix of crude we purchased. As illustrated in slide 5 third quarter purchases of Nigerian-sourced crude oil were less than one third of our previous levels. We did this by expanding our slate of light-sweet crude oils to include a number of alternatives that traded at a discount for the premium Nigerian crude, we've historically run in more robust markets. The crude selection has been economically driven and during the third quarter helped improve our quality differential versus the benchmark by approximately $2 a barrel from second quarter 2008 levels.

Our crude cost also benefited significantly from the favorable five-day lag impact of how our crude prices versus the calendar day benchmark with about 2 million barrels to 3 million barrels of our purchases being priced during the first five days of October and much lower prices than the first five days of July. While the timing benefit was a direct result of the following price environment, our crude selection efforts should continue to benefit results in future quarters.

Second, from an operational perspective, we successfully optimized our production during the quarter to match the market opportunities. Crude unit utilization in the quarter was 88% of rated capacity and net refinery production was 82 million barrels. As economics and demand during [ph] much of the quarter continued to favor less than maximum production levels.

As shown in slide six, through July and August the market continued to favor the production of middle distillate products and our percentage yield of distillate during those months were on par with the high levels we achieved in the second quarter.

In September, when the margins for gasoline expanded, we were then able to adjust the operating plant to meaningfully increase our gasoline yield to meet market demand. These optimization successes have served us well in the last few quarters and will continue to be a critical focus for us as the markets continue to change.

Now, let me turn to our non-refining businesses in slides seven and eight, where the earnings totaled as I said $140 million for the quarter. Retail Marketing earned just over half of that total with a $72 million contribution, as falling wholesale gasoline prices expanded retail gasoline margin.

Slide seven shows that wholesale gasoline prices fell by about $0.80 a gallon from the beginning to the end of the quarter. Despite this significant decline also seen in street [ph] prices we did continue to see evidence of weaker gasoline demand throughout our network. Total gasoline sales volumes were down about 5% versus the third quarter of last year with gasoline sales volumes at company operated and dealer locations what we would call 'open both years' down similarly.

In Chemicals, we earned $19 million in the third quarter, the business' best quarter since the third quarter of 2005, as again falling crude prices lead to a decline in feedstock costs and expansion in margins for both the polymers and phenol businesses.

As illustrated in slide seven again, after moving up in July, prices for refinery-grade propylene, which is a primary market indicator for the feedstock cost for our polypropylene business and along with benzene is also a key feedstock for our phenol business fell approximately $0.22 per pound from July to September.

Sales volumes, however were limited during the quarter due to continued weak economic conditions and some downtime at our Houston operations in September related to hurricane activity.

Turning to slide eight, Logistics and Coke, again made very strong contributions. Logistics earned $20 million driven by another strong quarter for Sunoco Logistics Partners LP. I think their earnings announcement and conference call last week provided a more detailed discussion of their performance, but in fact they benefited from increased pipeline fees, higher lease acquisition margins in its western pipeline system and higher earnings from its eastern pipeline system and terminalling operations as well.

Our Coke business earned, a record $29 million during the quarter, during which we completed construction and began operations at our second Coke plant in Haverhill, Ohio. Full operations at the plant, including full power production from the co-generation facility are expected by early 2009.

Regarding our other announced projects in Coke, construction on the Granite City, Illinois facility continues on schedule for targeted start-up by the end of 2009 and we are awaiting the final permit in Middletown, Ohio where we hope to begin construction by the end of the year, we targeted completion for that project in 2010.

Finishing out the non-refining discussion, Corporate was a net $2 million of after-tax income, due primarily to an $11 million reversal of an income tax consolidation adjustment made earlier in the year specifically in the first quarter of '08 and net financing expenses were $7 million after-tax, about the same as in the second quarter of this year. If I move now and look at the outlook for the current quarter, I would say some of the favorable market factors from our strong third quarter did continue into October.

In Refining and Supply, margins were strong in October, but they have declined throughout the month as Gulf Coast refining capacity came back online following the September hurricane. While the decline in crude oil prices has provided relief to fuel expenses and bottom-of-the-barrel product margins, the underlying demand for gasoline remains weak and the near-term outlook for refining margin is expected to weaken.

In our non-refining businesses, margins in Retail Marketing were very strong in October benefiting from the further sharp decline in wholesale gasoline prices. These stock costs in chemicals have also continued to decline, but sales volumes will likely be challenged as customer position their year-end inventories in the face of a weak global economy.

Logistics earnings should be comparable to third quarter levels and Coke results are projected to increase to meet our full year '08 guidance of about $110 million to $115 million of earnings.

Finally let me close with a few comments on our financial condition and related strategic matters. Financially, the balance sheet remains sound. We generated positive fund flow during the quarter and ended September with $327 million of cash on hand and a net debt-to-capital ratio of 30%.

At the Sunoco Inc level, we have $1.4 billion of available liquidity, primarily revolving credit agreements with strong bank sponsors. In addition Sunoco Logistics has revolving credit agreement s with approximately $400 million available at the end of the quarter.

We believe these factors provide the flexibility to meet our requirements and complete our capital program for 2008 which we now expect to be approximately $1.5 billion including estimated fourth quarter spending of approximately $600 million. If we exclude projected Logistics and Coke growth and acquisition capital, our base spending for 2008 is expected to be approximately $920 million or about $250 million lower than the original 2008 budget we presented last December.

I refer you to Slide 11 in our package for some additional detail on the business unit capital spending program for 2008. As we look to 2009, given the financial market conditions and the near-term outlook for economic growth and its impact on our businesses, we plan to maintain a particularly sharp focus on cost, capital spending and maintaining a strong balance sheet.

Consistent with that effort, we have elected not to proceed with the previously announced distillate hydrotreater project at our Tulsa refinery. This will reduce planned capital spending by approximately $375 million. We continue to evaluate our strategic option for the Tulsa refinery including a possible sale. Further while we have not yet finalized our 2009 capital program at this time, we do expect it to be materially lower than our latest estimate for 2008 spending.

We plan to host a meeting for security analysts and investors on Monday, December 15th here in Philadelphia. At that time, we will discuss the strategic outlook for each of our businesses, including an update on the specifics of our capital spending plan for 2009 and I would expect 2010.

Details regarding that meeting which will be webcast on our internet site for the public will be forwarded shortly. So, with that, that closes my prepared remarks and I'll ask Kelly to open up the lines for any questions you may have.

Question and Answer

Operator

[Operator Instructions]. Your first question comes from Jeffrey Dietert with Simmons & Company.

Jeffrey Dietert - Simmons & Company

Good afternoon.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Good afternoon, Jeff.

Terence P. Delaney - Vice President of Investor Relations and Planning

Hi, Jeff.

Jeffrey Dietert - Simmons & Company

I guess Tom with your retirement December 1st, this will be your last call. So I want to tell you we appreciate you and appreciate your disciplined approach to being CFO of the Company

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Well, Jeff, thank you. I appreciate those kind words and I would just say to everybody out there I very much enjoyed my role here and I think the Company is in good shape as we go forward.

Jeffrey Dietert - Simmons & Company

Very good. On your Northeast feedstock, could you talk to us Terry about what markers we should try to track in replacement of some of the Nigerian crudes that would help us with the discounts certain to expect there?

Terence P. Delaney - Vice President of Investor Relations and Planning

Without getting too specific, Jeff, we replaced them for the most part with other West African crudes, with some Caspian crudes and with some Eastern Canadian crudes. I think as I've said in the prepared remarks this quarter… that's been kind of a differential of about $2 a barrel versus the Kayibo [ph] kind of crude that we would normally buy and then I would track it from there.

Jeffrey Dietert - Simmons & Company

Okay, very good. And one of the things… you mentioned in the strong Coke performance was a benefit from coal price increases. Do you have a metric that we can use to try to track changes in coal prices and the impact it would have on your Coke business?

Terence P. Delaney - Vice President of Investor Relations and Planning *

No I don't, Jeff, because really the spot kind of prices that you might see are not necessarily reflective of the contract market that's going to drive us. For the most part what's going on in 2008 are when certain coal suppliers back out of contracts and we can replace that with our own joule coal and get a spot price, but they're minimal volume.

The big area will be… and we'll be settling this we hope before the end of the year, the coal price that we will get for 2009. Generally most coal is sold on a year-to-year basis. So the big shift up in coal prices this year should be more beneficial to us next year, but we have not yet settled that price. We hope to have it done if not in time for our December 15th meeting, certainly by the end of the year.

Jeffrey Dietert - Simmons & Company

Very good. And one more question if I could. And give us an update on what you have seen retail volumes, same-store sales since the end of the third quarter. It seems like a number your peers are seeing some moderation and declines.

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes, I can't tell you that I'm seeing the same thing, but I haven't checked the numbers that closely, Jeff. So, that maybe real, it may be optimistic. I'm just not close enough to our numbers at this point.

Jeffrey Dietert - Simmons & Company

Okay. Thanks for your comments and Tom best of luck.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from Mark Flannery with Credit Suisse.

Mark Flannery - Credit Suisse

Great. Thanks. Could you maybe walk us through the five-day crude oil pricing effect? It's been a while since it was such a large potential contributor to the results and I just want to make sure that we are all understanding it properly.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

I think that I talked a little bit about this last quarter, Mark, because in the second quarter it was just the opposite because crude prices were running up so much on the end of March till the end of… into early July. Essentially what happens is when we buy crude, it prices five days after we take tidal and without getting into all the machinations, in effect what that means is that for us our crude purchasing and our crude pricing in the third quarter was more or like from July 5 to October 5 and in the prior quarter it was April 5 to July 5.

And when you compare that versus the calendar they benchmark, obviously that everybody is looking at and the calendar day is how we are selling our products. There's a little bit of a disconnect. So if you think of it in terms of it effects around 600,000 barrels a day is what we run in the Northeast. It's generally going to be 2 million to 3 million barrels that are priced out of period if you will versus a strict calendar day average and this quarter the difference between early July prices and early October prices is more or like $45 to $50 difference, just the opposite of where we were in the second quarter. Does that help you?

Mark Flannery - Credit Suisse

Yes, it does. Is there any particularly good reason why you do it that way or is it just an historic relic?

Terence P. Delaney - Vice President of Investor Relations and Planning

The good reason to do it I think, Mark, is that we want to remain consistent. It's the way we have bought it historically and the moment you change that is the moment you make a speculative bet. So, in this way we are in effect pricing crude and buying crude as close to calendar day, every day as we can and it just so happens that it's a little bit of a mismatch in any given quarter or any given year by those five days. But as soon as we would consider pulling off of that, like I said we would be off of that ratable model and it would be a speculative bet and that's not where we are headed at this point.

Mark Flannery - Credit Suisse

Great. Thanks a lot.

Terence P. Delaney - Vice President of Investor Relations and Planning

All right, Mark.

Operator

Your next question comes from Neil McMahon with Sanford Bernstein.

Neil McMahon - Sanford Bernstein

Hi. I've got a few questions, and good luck, Tom.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you. First of all looking at your margins you've made from the different parts of the barrels [ph] during the quarter, where did you see some of the biggest growth in margins and the lubes or petrochem, asphalt maybe you could just walk through in case there were some really big jumps that added to the overall Northeast margin.

Tom Harr - Manager of Investor Relations

Yeah, Neil, it's Tom Harr. Not so much in the Northeast, a lot of the benefit in the mid-continent from the bottom of the barrel or the non-crude price related did come from some of the lubes in petrochemicals lubricant margins and we produce about 1 million barrels a quarter or so of lubricants out of our Tulsa refinery were significantly higher in the third quarter than they were in the first and the second that's to be expected with a falling crude price environment and, not quite the same magnitude, but you also saw that with some of the refinery petrochemicals and the other more resin [ph] like products that we sell out of that region as well.

Neil McMahon - Sanford Bernstein

Tom what sort of order of magnitude are we talking about between the second quarter and third quarter?

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Lubricant margins were probably two to three times what they were earlier in the year.

Neil McMahon - Sanford Bernstein

Okay, great. Was there… or what impact was there on the inventory drawdown on the refining earnings in the quarter?

Terence P. Delaney - Vice President of Investor Relations and Planning

Not much really Neil. We drew down some barrels during the quarter but nothing in a material way that affected our results here. As I said really when I think of this quarter it's the positive impact of rapidly falling crude prices on everybody's margins, but then the two things unique to us were really the shifting to slightly cheaper light-sweet crude in our Northeast system and the timing effect that I talked through for mark.

Neil McMahon - Sanford Bernstein

Okay, and just a final one which may be way too early to say. Just wondering about the outlook for the steel industry and what potential impact that might have on the Coke business if at all.

Terence P. Delaney - Vice President of Investor Relations and Planning

Probably too early to tell Neil. Again for us our contracts are take or pay, so that provides us some security. Obviously depends on how long and how deep the downturn is in the steel industry, we will try to work constructively with our customers, but as I said our contracts are really take or pay. I think on the two projects that are in progress, they still are in good plants, they have good economics and they are still cheaper than other alternatives for Coke, so we think we should be okay.

Neil McMahon - Sanford Bernstein

Great. Thanks a lot.

Operator

Your next question comes from Erik Mielke with Merrill Lynch.

Erik Mielke - Merrill Lynch

Good afternoon. I have two questions. Firstly on the crude sourcing and just to make sure that I understand this correctly. The $2 savings that you highlighted, that was for the roughly 200,000 barrels per day that it's applied to?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes. From a pure quality standpoint versus our dated benchmark.

Erik Mielke - Merrill Lynch

And are you seeing a similar level of saving in the fourth quarter?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes.

Erik Mielke - Merrill Lynch

And to what extent, do you think this is repeatable going forward?

Terence P. Delaney - Vice President of Investor Relations and Planning

I don't know Erik. That would be effective. There is always some differential in these products but I think the weaker the demand gets and the weaker the flat price gets, the more that… perhaps that differential comes in. And again we'll re-jigger our economics and always look at what's most optimal but unless we're in a max crude kind of environment or unless these differentials come in significantly, we're probably going to be [inaudible] to run these kind of crudes for the foreseeable future.

Erik Mielke - Merrill Lynch

Thank you. Secondly on the variability of yield during the quarter and thanks for giving that monthly slide, that's very helpful in trying to understand the capture. Can you help us understand the amount of flexibility that you have and what are the relative economics that dictate whether you switch from one mode to the other? Obviously it's a function of relative products cranks, but could you mention one distillate yield constantly at 38.5% if you so chose to?

Terence P. Delaney - Vice President of Investor Relations and Planning

We've been able to achieve that for certain quarters. Again, I think with optimal operations and the right crude mix yes. One of the things we did this quarter was we started up an idle reformer in September to maximize our gasoline production during that period. That was very beneficial to us, so if we have the right foresight and the right crudes and the equipments running well, specifically to your question on distillate, we can probably do percentages like we did in the second quarter, which was our best ever, but there are limitations.

Erik Mielke - Merrill Lynch

Okay, thanks and good luck with your retirement, Tom.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from with Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank

It's Paul Sunoco for a second.

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes, all right.

Paul Sankey - Deutsche Bank

Tom congratulations and it was a pleasure working with you. Thank you.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you.

Paul Sankey - Deutsche Bank

First question on the crude… the dramatic crude shift that you guys had. I was wondering… I mean at your last analyst meeting you outlined the fact that there was a growing supply of sweet crude from the places that you've highlighted that are the alternative sources, but I was wondering quite how you managed to achieve such a step down in the quarter. I guess why you didn't do that sooner.

Terence P. Delaney - Vice President of Investor Relations and Planning

Well, the economics largely driven… drove when we did it and recognizing of course that we're buying these crudes, six weeks ahead of time with perfect hindsight maybe we would have done it a quarter or so earlier, but it is a function as you alluded to Paul of availability and the differential and our projection of what product is going to be at the highest margin and the highest yield for us.

So I think what this is meant to do is demonstrate what we can do now, given what's available on the crude side and what we can do with our hardware, but environment we're in, it has been very helpful.

Paul Sankey - Deutsche Bank

So, theoretically you could have done it sooner, but [inaudible] hindsight is the best trader in the market. It wasn't a sudden flip of the switch that we saw?

Terence P. Delaney - Vice President of Investor Relations and Planning

I think theoretically, Paul… for most of prior to this year… anyway for most of '05 '06 and '07 we were doing the right thing by running maximum levels of crude and running these kind of… and running even the premium priced Nigerian. That was the best slate for us, so when we back off, some of that stuff we are now, it does give us some more bottom of the barrel some more resid [ph] and that depends on the margin environment for everything, but I do think for most of 5, 6 and 7 I wouldn't say that we should have been running lots of this but we might have looked earlier in 2008 if we had… like you said that kind of perfect hindsight we might have done some.

Paul Sankey - Deutsche Bank

Yes, okay, and then there's every reason to believe, given the trends that you've outlined at the last analyst meeting that you can keep running like this. So it's arguably a sustainable rather than Erik was saying, it's a sustainable change in the price of your crude essentially that you've got here unless you go back to very high utilization rates? Is that okay?

Terence P. Delaney - Vice President of Investor Relations and Planning

It's an option. It's now a demonstrated option.

Paul Sankey - Deutsche Bank

Right, great. On ethanol penetration, I was wondering given what you said about your same-store sales, if I wanted to back out the ethanol rate of change within that 5% decline, how much of that would you say is in there? How much ethanol held for sales would there be last year versus this year's volumes?

Terence P. Delaney - Vice President of Investor Relations and Planning

Year-on-year, Paul, I think we probably were….Tom will have to get back on this, but maybe 75% of our retail gasoline last year had ethanol in it and maybe 90% this year. That's the relative percentages I would say. So we've increased ethanol in our retail gasoline by maybe about that percent.

Paul Sankey - Deutsche Bank

Yeah, then there's no trick for me to calculate the volume, I just take your sales obviously and then look at the rate of change here?

Terence P. Delaney - Vice President of Investor Relations and Planning

Right.

Paul Sankey - Deutsche Bank

That's great. And then finally for me the steel industry has had a bit of a turn for the worst. What are the implications for your Coke business, if indeed there are any? Thanks.

Terence P. Delaney - Vice President of Investor Relations and Planning

Okay, I think Erik had just asked that same question and again what I would say is the implications are as a reminder we do have take or pay contracts and they provide us with some security. Our technology and our offering should be advantaged and not be the first choice for cuts and but we will have to work constructively with our customers where we can if there are slowdowns that are necessary, but for us it's the take or pay contracts that are most important.

Paul Sankey - Deutsche Bank

Yes, I apologize. I must have missed that. So that basically means there's no impact for 2009, but that might be for the longer term?

Terence P. Delaney - Vice President of Investor Relations and Planning

We'll see. It might slowdown the pace. It depends on how long and how deep you think this slowdown will be, but I think the overall appeal of what we're offering is still very strong.

Paul Sankey - Deutsche Bank

Yes, thank you very much and thanks again, Tom.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Okay. Thank you, Paul.

Operator

Your next question comes from Mark Gilman with Benchmark Company.

Mark Gilman - The Benchmark Company

Guys, good afternoon and Tom Hofmann, congratulations to you. We'll miss you.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you, Mark.

Mark Gilman - The Benchmark Company

Back to this Nigerian crude thing, again if we could, since our discussion on the last conference call on the subject I guess I've tracked cracking yields on [inaudible] versus the alternatives you mentioned a little bit more closely and I noticed, Terry, that you were very careful to say that there was a crude cost reduction, but it has appeared to me over the period as if from a cracking yield standpoint, factoring in the crude cost, there was really not much of any difference and as a practical matter it's my understanding the [inaudible] is very attractive crude because of its high distillate yield.

Could you comment on that for a minute?

Terence P. Delaney - Vice President of Investor Relations and Planning

I don't know what I could add to that, Mark. You've probably done more LP kind of work than I have this quarter. What I can comment on is I do know that directly as a result of buying these kinds of crudes we save $2 a barrel on relative quality differentials versus dated brand.

Mark Gilman - The Benchmark Company

Yes, but what I'm saying is that the net back might have been off by $2 a barrel also in which case it was a non-event.

Terence P. Delaney - Vice President of Investor Relations and Planning

Right. Well our folks would say that's not the case but I don't know… I'm not sure that your LP would be exactly aligned with what our Northeast refining configuration is, but you've done more work than I have on that Mark.

Mark Gilman - The Benchmark Company

Okay let me try another one if I could. Guys, it was my understanding that there was linkage between the distillate hydrotreater at Tulsa and the environmentally mandated spending program at that refinery and by canceling the hydrotreater at least to some degree you were probably impairing what was otherwise the mitigated economics associated with the mandatory spend. Am I wide at the mark with that?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes. The distillate hydrotreater was in line with mandatory spending. We continue to operate the refinery under a hardship waiver and we continue to keep the EPA in our discussion as to what the future options are for the refinery.

Mark Gilman - The Benchmark Company

Well, I think, you've indicated that your intent is to go ahead with the mandatory spend.

Terence P. Delaney - Vice President of Investor Relations and Planning

No, I did no, did I? I don't recall indicating that. we are not doing the distillate hydrotreater project. We are continuing to just pursue the sale of the facility and in the meantime we are continuing to operate Tulsa under the hardship waiver.

Mark Gilman - The Benchmark Company

Doesn't that ability expire after a period of time?

Terence P. Delaney - Vice President of Investor Relations and Planning

We continue to have discussions with the EPA on that and we continue to operate it under that waiver.

Mark Gilman - The Benchmark Company

Okay. Let me try one on the ethanol gasoline situation that I know Tom Harr is expecting from me. Given what my understanding is of how you've managed this issue in a period where ethanol and gasoline prices do what they did in the third quarter with particular reference to the outright collapse in gasoline it seems to me there would have to be a huge derivative gain on your short position in gasoline. Is that accurate and if so can you give me a rough idea what it was?

Terence P. Delaney - Vice President of Investor Relations and Planning

One, no that is not accurate because we do not take flat price risks on ethanol when we buy it. We hedge it and what we lock in, Mark, is a differential to gasoline. And the hedging is matched with the physical as we draw that down because we are buying the ethanol on let's say six month contracts. So, we are not benefiting or getting hurt by changes in ethanol flat price, even relative to gasoline because we have locked in a certain differential.

Mark Gilman - The Benchmark Company

Yes, but when that differential changes as it did so dramatically, just as there were detriments when it was going the other way in prior periods. There's a benefit when it goes your way as it did in the third quarter. Isn't that not correct?

Terence P. Delaney - Vice President of Investor Relations and Planning

At the end of the day, Mark, I think where we go to market is whatever we buy ethanol at and again it's going to be at a certain differential versus gasoline, that's what most other retailers are doing the same thing. The spot market is actually very thin. So, at the end of the day we go to the retail market and maybe we bought ethanol better, maybe we bought ethanol worse, but the majority of that market is done on term contracts, not on spot contracts.

I think it's a little bit of… looking at the spot is a little bit overstating what's really happening in that market.

Mark Gilman - The Benchmark Company

Okay, we will take that one offline. Well just one more for me. I noticed in addition to the changes, Terry, you describe in terms of product yield between distillate and gasoline that there was also an uptick in the RFG portion of your gasoline production and a similar uptick in the ULSD or on road diesel portion of the distillate. How did you achieve it and can you sustain that?

Terence P. Delaney - Vice President of Investor Relations and Planning

I'd have to ask Vince a little bit on that one, Mark, as to the particular details on that. I don't have… how much… I don't know that it was… it were like a percent more in RFG from the second into the third quarter?

Mark Gilman - The Benchmark Company

Yes a couple of percent in each case.

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes. I'll have to ask Jim about that. As I said… I know we brought on a reformer… and I don't know what else they did there, Mark, but I would think it's redo-able. I don't know about whether it's sustainable if we get the same market, but we have demonstrated we can do it.

Mark Gilman - The Benchmark Company

Okay, guys, thanks very much and Tom Hofmann, again my best.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Great. Thank you, Mark. Appreciate it.

Operator

Your next question comes from Paul Cheng with Barclays Capital.

Paul Cheng - Barclays Capital

Hi guys.

Terence P. Delaney - Vice President of Investor Relations and Planning

Hi, Paul.

Paul Cheng - Barclays Capital

Well, first, Tom, we appreciate over the years, the help. Best of luck.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thank you, Paul. I've enjoyed working with all of you guys.

Paul Cheng - Barclays Capital

Yes, we'll miss you. Terry, a number of quick questions. Can you tell me what is the inventory over the book value, the market value of your inventory over the book?

Terence P. Delaney - Vice President of Investor Relations and Planning

Geez, I knew you were going to ask that one, Paul. I have that. It's 4.1 billion.

Paul Cheng - Barclays Capital

Next time, you can have that. So maybe you can put that into the press release then.

Terence P. Delaney - Vice President of Investor Relations and Planning

I thought… I know you've been on four or five calls already, but it's very deep in our 10-Q. I thought you would have had it by now.

Paul Cheng - Barclays Capital

No, I don't have the 10-Q yet.

Terence P. Delaney - Vice President of Investor Relations and Planning

All right

Paul Cheng - Barclays Capital

Okay and let me see.. for 2009, you indicated it's going to be substantially less than the $1.5 billion. What is the minimum or what is already committed you have to spend in 2009?

Terence P. Delaney - Vice President of Investor Relations and Planning

Paul, why don't we table that one till we do the… a more fulsome discussion of capital in the December meeting?

Paul Cheng - Barclays Capital

All right. And even rough idea that do you need the minimum, say 800 million or a $1 billion, some rough number?

Terence P. Delaney - Vice President of Investor Relations and Planning

Really I'd rather not do that now. Like I said, we are not that far away from that. As I indicated, I think in my remarks it's material. It's not insignificant, but let us talk about the whole program when it is really finalized because it's just not finalized at this point.

Paul Cheng - Barclays Capital

Let me ask you in another way. I think in the past that we were talking about the sustainable capital for the corporation is somewhere in the $600 million or so… wondering is that still a good number?

Terence P. Delaney - Vice President of Investor Relations and Planning

You are persistent, but I'll have to say let's, let that go until December 15th?

Paul Cheng - Barclays Capital

Okay fair enough. On Tulsa. Do you, guys, know of any refinery already have… get a waiver from the EPA, so that they don't have to comply or they can remain under the hardship beyond 2010?

Terence P. Delaney - Vice President of Investor Relations and Planning

Not that I'm aware of, Paul. I bet… we wouldn't necessarily be privy to all of those discussions either, but…

Paul Cheng - Barclays Capital

Okay and that [inaudible] and I know that it's early day. You're in negotiations, I am not saying that I want to know what they are going to give you a waiver or not, but let's assume that you cannot get a waiver. If that means that the whole facility cannot run or that you only need to shut down a portion of the facility and the portion can still be run?

Terence P. Delaney - Vice President of Investor Relations and Planning

Well, I'd rather not speculate on where we go from there. As I said I'd like to leave it for here as we continue to operate under the hardship waiver. We continue to keep the EPA in our discussions and we continue to pursue the sale option for the facility and that's really all I want to say.

Paul Cheng - Barclays Capital

Okay then let me make the two final ones simple. Quarter to date, when you are looking at the crude defense oil [ph] versus the third quarter and also the part of defense oil versus the third quarter. Are we seeing material differences?

Terence P. Delaney - Vice President of Investor Relations and Planning

No, not particularly. The one… again the one flywheel I will tell people to at least keep in mind here is that timing lag. And keep in mind that there will probably be two to three million barrels that rise in the first five days of January as opposed to the first five days of October. But absent that the kind of quality differentials we are seeing, the kind of transportation we are seeing is… costs we are seeing are relatively similar, maybe a little bit favorable actually compared to the third quarter.

Paul Cheng - Barclays Capital

Okay so that's on the crude side. How about on the product side?

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

No, at this point, Paul, I wouldn't say very much different. There's so many moving parts on the product side, but the overall market I wouldn't tell you to think of it any differently than the third quarter.

Terence P. Delaney - Vice President of Investor Relations and Planning

I mean in general the falling crude prices, probably help some of the bottom of the barrel, but it will continue to be most driven by obviously gasoline and distillate margins quarter-on-quarter.

Paul Cheng - Barclays Capital

Sure, and final one on the refinery run for the fourth quarter, any kind of comment you can make versus the third quarter level?

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Nothing more than conditions feel pretty much like the third quarter from an overall operating standpoint.

Paul Cheng - Barclays Capital

And you shouldn't have any major turnaround in the fourth quarter; right?

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Correct.

Paul Cheng - Barclays Capital

Okay, very good. Thank you.

Terence P. Delaney - Vice President of Investor Relations and Planning

Thanks, Paul.

Operator

Your next question comes from Chi Chow with Tristone Capital.

Chi Chow - Tristone Capital

Thanks. Tom, it's been a pleasure working with you and best wishes to you.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Thanks, again Chi.

Chi Chow - Tristone Capital

Got a question on the… back on the crude issue. Did you take advantage of any distressed cargos from the hurricane disruptions during the quarter or were the crude savings strictly based on your crude slate changes, you described?

Terence P. Delaney - Vice President of Investor Relations and Planning

They were on the crude slate change Chi.

Chi Chow - Tristone Capital

Okay. Great and then second question on your CapEx for '08, you're showing a $200 million plus decline in refining CapEx, relative to the analyst meeting presentation. Could you go through some details on what was either cancelled or deferred on that end on refining?

Terence P. Delaney - Vice President of Investor Relations and Planning

I don't have all that detail right with me, Chi. I think it is a mixture of perhaps some early SEL [ph] income improvement projects, but it's also long-tailed maintenance programs that have been pushed out a bit. It's a combination of the different categories for the most part. Some of it is also though not spending on the distillate hydrotreater a little bit anyway although the majority of that was in our '09-'10 program to begin with.

Chi Chow - Tristone Capital

Okay. Of the $680 million, or so you're projecting for '08, how much is environmental regulatory related?

Terence P. Delaney - Vice President of Investor Relations and Planning

I'm not sure off hand Chi.

Chi Chow - Tristone Capital

Okay. Well, maybe I'll follow-up.

Terence P. Delaney - Vice President of Investor Relations and Planning

Sure.

Operator

[Operator Instructions]. Your next question comes from Mark Gilman with Benchmark Company.

Mark Gilman - The Benchmark Company

Guys, if my math is correct, there was something like a $380 million working capital increase in the third quarter, which in the falling price environment strikes me, as being somewhat counterintuitive. Is that accurate, and if so can you explain what happened?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes, it probably is accurate and in a falling price environment, Mark we loose crude payables and as it turned out, we had a lower crude payable balance at the end of September than we did at the end of June, both from power standpoint, but also from a price standpoint. So that's the majority… the biggest moving parts usually in our working capital is what goes on with crude payable barrels and prices, so falling price environment drains us a bit.

Mark Gilman - The Benchmark Company

And I guess it more than offset what would be reductions in accounts receivable and things on the other side of the balance sheet?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes, we're much more leveraged to the crude payable than receivable.

Mark Gilman - The Benchmark Company

Okay, thanks

Terence P. Delaney - Vice President of Investor Relations and Planning

All right.

Operator

Your next question comes from Doug Leggate with Quadrum Capital.

Doug Leggate - Quadrum Capital

Hi, I wanted to jump on also to wish Tom all the very best in your retirement, but Terry I also wanted to ask, did the comments you made about utilization rates in the third quarter, can you give us some idea, as to what we should expect, as you put it in this challenging environment and more importantly on the operating cost side given that natural gas prices have come down quite a bit?

Terence P. Delaney - Vice President of Investor Relations and Planning

On the utilization rates, Doug I'll repeat. I think at least for the fourth quarter outlook what I would suggest is that you look for the rates that are similar to what we just completed in the third quarter. That that's pretty much the operating mode that we have been in at least this far into the quarter and given the… where margins are now, I would expect that that's… we wouldn't be ramping up from here.

On the cost side maybe, Tom can give you some more detail on that particular model. Certainly our fuel costs will go down and our bottom-of-the-barrel product margins go up as the commodities come down.

But they're interesting for modeling purposes, but at the end of the day obviously as I said before it will be gasoline and distillate margins that drive, but Tom can give you perhaps… did you ask specifically on natural gas?

Doug Leggate - Quadrum Capital

No, just really thinking about operating costs because obviously one of the things I guess that… on the way up on crude prices and gas prices for that model was the cash operating costs. So I'm just trying to get an idea as to what the magnitude of any improvement or reduction in that might be as we look forward do I see over the next couple of quarters?

Terence P. Delaney - Vice President of Investor Relations and Planning

Yes, I think… yes let us talk to Tom, but you're right. Directionally, those kind of expenses go down. But on the other hand, a lot of the other utilities and other costs that still remain relatively high, so, but you're right. That one component and it's… for us it's really only natural gas purchase fuel that makes its way into our expenses that you'll see trending down a bit quarter-to-quarter.

Doug Leggate - Quadrum Capital

I guess a related question, Terry, if you don't mind we are hearing from a number of your competitors and some of your peers that they're starting to cut back the reformers and basically minimize gasoline production to really just to satisfy hydrogen requirements. Could you give any kind of color as to what kind of operating mode you're in, not so much on the crude unit, but within the conversion units as to how you might be reacting right now to this environment?

Terence P. Delaney - Vice President of Investor Relations and Planning

I think we are all reacting to the same environment to the extent that we can with the hardware we have. So we are… we would also be operating in that mode, I would think, Doug, as well.

Doug Leggate - Quadrum Capital

Okay, great stuff. Thanks again.

Terence P. Delaney - Vice President of Investor Relations and Planning

Thanks.

Operator

At this time, there's no further questions.

Thomas W. Hofmann - Senior Vice President and Chief Financial Officer

Okay, I want to thank everyone for listening in and participating after a long day of a number of refining conference calls. I appreciate your interest and Tom and I will both be around to take any further questions. Thank you.

Operator

Thank you. This concludes today's conference call. You may now disconnect. .

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