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Jeff Beyersdorfer – SVP, Treasurer, Director of IR

Analysts

Western Refining Inc (WNR) Bank of America Merrill Lynch Leveraged Financial Conference December 5, 2012 8:50 AM ET

Unidentified Corporate Participant

-- Western Refining. And from Western we have Jeff Beyersdorfer. So Jeff, go ahead and take it away.

Jeff Beyersdorfer

Thanks, (Kelly). Good morning. So for about the next 20 minutes I want to – for those of you not familiar with the company – take you through a little bit of the asset base for Western and, more specifically, describe the current phenomena. Hopefully you're all familiar with the WTI (brand) phenomena and talk about what's going on with that and also address the balance sheet opportunities we have.

Also, we're in the process of constructing our balance sheet. I want to talk a little bit about that. So I'll primarily focus on those two areas over the next 20 minutes or so.

A quick overview of the asset base for those of you not familiar with the asset base, primarily in the southwest of the US, two refineries, one in El Paso, Texas, one in Gallup, New Mexico; total capacity of about 150,000 barrels a day.

We also have two distribution networks. One is a wholesale distribution network where we distribute about 70,000 barrels a day all the way through to end customers, including the big mining companies: (Freeport), (Macmaran), the railroad companies all the way down to the little landscaper in Tucson who owns fleet vehicles that he needs to fill up at our (Carlock) locations. That's one distribution area.

And the second is retail distribution. We own a series of convenience stores throughout the southwest, about 200 convenience stores under various brand names where we distribute gas and diesel on a retail basis to customers.

We do have the legacy of the Virginia refining assets. We did own a refinery in Virginia; closed it, sold the assets to (Plains), did a transaction with (Glencore) earlier this year to free up the working capital we have there.

So all we have left in Virginia is a marketing base business. We market about 25,000 or 30,000 barrels a day to our customers in the Virginia reason and we and (Glencore) are trying to grow that business.

So I mentioned a couple areas I want to talk about are primarily the crude dynamics and we'll spend a little bit of time on that on the next page, also touch on the products, talk about some of the opportunities that we have for growth and then the capital structure.

So primarily this page, on Page 6, the map, is where I'll spend a little bit of time and orient you, if you're not familiar with it, with what's going on in the Permian Basin.

So here's the Permian in the white outline. The blue is a Delaware Basin portion. Here's El Paso refinery. Here's our Gallup refinery. El Paso buys all of its crude on a Midland basis, meaning on a Midland pricing basis. Midland's there. We buy all of our crude based on that basis.

And for El Paso, we enjoy three differentials on crude to people that buy (brett)-based crudes, meaning all the coasts and the Gulf Coast, East Coast, West Coast. Those three differentials are the following.

One is the (brett) TI differential. So (brett) is down here in the Gulf Coast and Cushing is TI. TI is short for WTI. Cushing, (Nimex), WTI, that differential this morning was at about $22 or $23 a barrel.

The second differential that we enjoy at El Paso is this Cushing midland differential and that's been getting a lot of news lately because the crude production is more in the Permian Basin that can ship through this pipeline, these two pipelines, this basin pipeline, the centurion pipeline, to get to Cushing.

Because of that, crude is being backed up in Midland. Midland is selling at a significant discount to Cushing, about $8 or $9 a barrel on average in November. It has historically run about $0.50 to $1 differential. So again, not only are we enjoying this (brett) TI differential here, we're enjoying another $8 or $9 for the month of November as an example Cushing-Midland.

And then the final differential is what I'll call a discount differential, which I'll show you a page on in a couple of slides where we're building assets, logistics assets, pipeline in the Bone springs and Avalon area. To capture the location discount it costs producers call it $2 a barrel to get their crude from here to Midland. We think we can capture that differential also and incent those producers to bring their barrels to El Paso versus shipping them to Midland or Cushing or the Gulf Coast, wherever those barrels are going to produce.

So three differentials that we enjoy at El Paso today and we think that (brett) TI differential, the widest differential, ultimately is going to contract at some point in time once all these new pipelines get built out that I show here, that we show here, the dotted lines. That'll happen over '13 and '14.

Once all those get built out plus there's talk about rail coming into the area to solve the disposition logistics of that crude. Once all that happens, we think that (brett) WTI differential probably lands somewhere between transportation economics, the pipeline, which is $4 or $5 a barrel, and rail, which is somewhere between $8 and $10 a barrel. Somewhere in between there is where that (brett) WTI differential lands longer term.

Today is the $22, $23. Ultimately it'll go somewhere between $4 a barrel and $10 a barrel. But that's still pretty good potential EBITDA for Western.

Altogether, if you look at production estimates coming out of the Permian, there's about 1.8 million to 1.9 million barrels estimated to be produced out of the Permian by 2016. And you look at all this takeaway capacity, all these lines being built, all the refining demand in that area, that's about 1.8 million barrels.

The lines that I have up here, these pipelines, existing plus new plus all refining demand is about 1.8 million barrels. So if you believe those production estimates, the 1.8 million, the 1.9 million, we'll probably be in supply and demand equilibrium by 2016.

But if production estimates prove to be greater than that 1.8 million, 1.9 million barrels a day – today it's about 1 million barrels – then we could find ourselves perhaps in a supply-demand imbalance for perhaps a longer period of time.

One other thing I want to talk about on this page is up in the San Juan basis – this green area is the San Juan basin – it's northern New Mexico – that's a basin where we're starting to see some activity for some new crude, also shale crude.

There is a play called the (Menkos) shale crude play up in the San Juan basin that some producers such as BP and (Cana), Conoco are starting to drill up there. And while we haven't heard of any production estimates yet, this area is pipeline short, meaning this pipeline, this Tex New Mex line is the only pipeline to come out of that area, to take crude out of that area and we own it.

The only other way to get crude out of that area today is via trucking. So we've got an opportunity depending upon production up here of perhaps restarting this Tex New Mex line and maybe bringing crude down into the Permian. We'll see what happens with the production up in that area. It's early days but certainly Gallup, it's a 20,000 barrel a day refinery today. It'll swamp Gallup in terms of crude production. That crude needs to find a home somewhere else besides Gallup.

Question-and-Answer Session

Unidentified Corporate Participant

So is the proper basis for Midland and WTI do you think $0.50 as it's always been such that if you have – in 2016 it turns out that the infrastructure is balanced with the production, should it be $0.50 difference or what's that $0.50 difference based on?

Jeff Beyersdorfer

The question is is $0.50 historically between Midland and Cushing; what's the basis for that? That's the tariff on this pipeline, the basin pipeline between Midland and Cushing and it's always been around $0.50 a barrel and that differential has always been $0.50 a barrel.

So we expect that at some point in time, once this becomes in balance, it will most likely revert back to around that $0.50 a barrel give or take to ship from Midland to Cushing.

Unidentified Corporate Participant

So the $8 or $9, is that what it costs to truck it?

Jeff Beyersdorfer

The $8 or $9 is the – we don't know exactly what that's based on today. It's market. Primarily it's based on – we think that crude is being backed up here in Midland. There's not enough capacity to get crude to Cushing to the Gulf Coast. In short term, it's being driven by some of the operating issues that some of the other refineries in the area, some planned and unplanned downtime.

Unidentified Corporate Participant

But presumably it would be the cost to get it to another market, right?

Jeff Beyersdorfer

Correct.

Unidentified Corporate Participant

The marginal cost.

Jeff Beyersdorfer

Correct. And that's – these pipelines – that as you can see, these newly built pipelines aren't going to Cushing. That's not where the crude needs to get to ultimately. It's the Gulf Coast or somewhere else.

These new lines are being built to ship crude avoiding Cushing, taking it to the Gulf Coast directly. So this will all get resolved at some point in time but in the interim we'll still see some widening perhaps of differentials between WTI and (brett) and Cushing Midland.

Next page is on the product side. I won't spend as much time here but it's important for investors to understand that our product markets are pretty interesting also. So it's not only just a crude story. It's a product story.

Our product markets are basically the southwest and these are the southern markets that we primarily serve with Phoenix being our largest market for gasoline and diesel. We supply about 15%, 10% to 15% of Phoenix's gasoline, retail gasoline supply out of El Paso.

I also show – or we also show in here a highlight of some of the gasoline specs. As you may know, California has its own unique specification for gasoline, a very difficult blend to make.

Phoenix and Maricopa county, the county that Phoenix sits in, is probably the next level in terms of difficulty of gasoline spec to make, so not everybody can make that gasoline specification.

We can and a couple of other parties east of Phoenix can make that grade of gasoline and send it through this line to Phoenix. But like these markets we're in.

About 60% of our markets, if you were to draw a line from El Paso upwards, about this diagonal, all those markets are a Gulf Coast influenced market mainly because Gulf Coast providers can supply that market. All the markets west of that line, about 30%, as you can see here across the bottom, have a west coast influence.

West coast markets historically have performed better than Gulf Coast markets from a margin perspective, so we do have exposure of about 30% of our product to those west coast markets.

On Page 8, this is a little busy, but we show product prices both gasoline on the left, diesel on the right. For Phoenix grade gasoline, that's the gold that you see here and we also show Salt Lake, which is another good market and then some other indices West Coast, Gulf Coast and Mid-Con.

But you can see Phoenix grade gasoline and diesel has performed very well over the last 1.5 years versus all these others and so it's a market we're primarily in. Again, we like that market.

I mentioned the distribution networks we have, the wholesale and retail distribution networks. We are trying to grow those networks. We've expanded our retail distribution, the retail number of stores, by about 50% over the last 1.5 years.

We're also trying to grow our wholesale business. We have a card lock business. Card lock is an unmanned fuel distribution business that we primarily have in Arizona. We're trying to grow that business to service those fleet vehicles in the southwest.

Those are two businesses we like that help expand our distribution footprint for our refine product.

Where are we spending our money? We've been fortunate enough to generate a significant amount of cash. We've done a fair amount of deleveraging on the balance sheet. Where are we spending cash in 2013?

The first category is CapEx. We've got a budget in 2013 of about a little over $200 million in CapEx. $150 million or so of that is on discretionary CapEx. The second area is returning cash to shareholders, either via the dividend that we currently pay at $0.24 – or, sorry, $0.32 a share for 2012 on an annualized basis. And we pay a special dividend of $1 a share in the fourth quarter.

We also have a share buyback program that we're doing and we'll talk about that when we talk about the balance sheet why we're doing that share buyback.

And the final area for cash flow is no longer debt reduction but building cash on balance sheet. We're trying to build cash on balance sheet to weather the difficult times that we'll probably inevitably see at some point in time, so minimum cash we're trying to hold on our balance sheet is in the $300 million range.

On Page 11, we mentioned this earlier about the project we're doing. This is spending a little bit of our capital in 2013 where we're building a pipeline in the Permian Basin that ties into this Kinder Morgan line at Mason Station.

We're spending about $30 million doing this but this will facilitate the delivery of about 100,000 barrels a day of this new shale crude that we'll process at El Paso and back out the existing crude that we're running today that comes from the Eastern part of the Permian.

So today we're running about 20,000 to 25,000 barrels a day of that shale crude that's trucked to the refinery. Once we have this pipeline built permanently, that will help us facilitate the delivery of up to about 100,000 barrels a day.

We also understand that there's more holes being drilled west of here in the Permian and we think as that production grows we'll be able to build more infrastructure here, maybe replicate this pipeline to the west, again, directly to the field, piped directly to the well head to facilitate more of that crude coming to us or perhaps even to third parties, our third party refineries just because it's happening in our backyard.

So that's where we're spending a little bit of our money in '13 is on logistics assets.

Turning to the final point that I wanted to share with you is the balance sheet. The point that we're reconstructing the balance sheet to facilitate the new growth that we have in terms of logistics and to help facilitate the spend for our CapEx.

So I showed two points in time: December of 2010 and then September 2012 to show the material progress we've made on debt reduction and credit statistics.

So we've paid down a little over $1 billion of debt over the past 1.5 years or two years. And today debt stands at about $500 million and it's composed of a couple of different issues that we have an opportunity to address in the coming months.

The first issue is the 11.25 senior secured notes, the 305.2 that we show on here that are callable in June of 2013. We've looked at it pretty closely. We continue to evaluate whether it makes sense to tender for those bonds, balance that against the strength of the high yield market and trying to issue today in the high yield market.

We'll continue to evaluate that and, at a minimum, we'll most likely call those bonds in June of next year. But hopefully we'll find an opportunity perhaps tender for those bonds earlier and put a more permanent piece of capital in the capital structure on an unsecured basis.

What we'd like to do is a 10-year non-called (five) on an unsecured basis probably in the $300 million to $500 million range.

The other area is the convertible notes. They mature in 2014. They represent about 20 million common shares, so they are fairly dilutive to existing shareholders and that's the reason for the share repurchase program.

We're buying back common shares in the open market today with the intention of retiring those shares today but reissuing those shares upon the maturity to convert, thereby mitigating some of that dilution.

So think about our share repurchase today being debt reduction in disguise because that's what we're doing is trying to buy back some of that convert via this common stock buyback.

Ultimately where we'd like to take this balance sheet – you heard me say it's in construction mode right now or reconstruction mode. Ultimately where we'd like to take it is an ABL revolver that we have today led by Bank of America. It's $1 billion in size. We like that size of the revolver.

So we'll have that ABL revolver and then we'll have a senior unsecured piece of high yield paper in the $300 million to $500 million range. Those are the two pieces of debt longer term we'd like to have on the balance sheet to finance this asset base as is today.

We're also doing some hedging. You know that we've tried or we have been successful at doing some crack split hedging over the last two years or so. We continue to do that, meaning that we're selling forward our production in the outer years to provide some cash flow visibility for '13, '14 and '15.

So our goal is to hedge about a third of our production and you can see on this chart where we are in terms of our gasoline production on the left hand side and our diesel production on the right hand side, the green being the volume of production per quarter, the right access and the red dots being the level of where we hedge that in terms of dollars per barrel for gasoline cracks and diesel cracks.

So again, you heard me say upfront that this crack split differential is not going to last forever. We don't know when it's going to go away. We know it will contract at some point in time and we're hedging some of our production forward to ensure that that cash flow is there regardless of what happens to that crack spread environment.

The last thing I'll talk about is the rating agencies. We continue to be in discussion around them given the continued improvement on the balance sheet. We're currently a B2, B+ rated entity and we're lobbying both agencies for upgrades.

And as we continue to improve the balance sheet, push out maturities, we believe we'll see some progress on the balance sheet.

So again, short term, CapEx is the primary goal. We're increasing the size of the discretionary capital we're spending. We're fortunate enough to be in this environment and have these assets to take advantage of the differential between (brett) and WTI generating a significant amount of cash.

So we're using that cash to lock in these differentials longer term through these logistics projects and returning some cash to shareholders and fixing the balance sheet. So that's short term what we're doing with the company. Any questions?

Unidentified Analyst

(inaudible – off mike) You sell your products through them, so they're from your refineries? I'm just asking about …

Jeff Beyersdorfer

The question was we have a couple brands, Shell, Conoco, for a retail group. Do we sell through them or do we own the – we own some of the stores. We lease some of the stores. We brand fuel through some of the majors, so we well under that brand but we also have a giant brand for the actual (C) store, so it depends upon what areas we're talking about. We're not trying to build a western brand on the retail side, though.

Unidentified Analyst

Yes, I was trying to figure out if this is one of the sources of your end products is going to your own stores and that is part of the margin structure.

Jeff Beyersdorf

It is. We sell about 15,000 barrels a day of gas to our retail stores, 15,000 to 20,000 barrels a day of gasoline to our retail stores. You heard me say that we've been expanding our retail distribution network. The goal of that is to try to bring more retail stores in the fold to sell our products, yes.

Unidentified Analyst

That's a conscious strategy, then.

Jeff Beyersdorf

Yes, it is.

Unidentified Analyst

(inaudible – off mike)

Jeff Beyersdorf

(From out of the) brand though. It is our production.

Unidentified Analyst

So your Shell station that you control is actually selling western gas.

Jeff Beyersdorf

Well, it's not a Shell station. It's a station that we own that we sell fuel through branded by Shell. It's just a brand that we're putting as a fuel.

Unidentified Analyst

I didn't know if there was some uniqueness to have …

Jeff Beyersdorf

I don't think there's anything unique about what we're doing versus what others are doing now.

Unidentified Analyst

Just trying to clarify. There's just the two refineries here. Did I understand that?

Jeff Beyersdorf

That's correct.

Unidentified Analyst

Is there an opportunity to – obviously you would never build a Greenfield refinery in this environment. That's a fair statement?

Jeff Beyersdorf

That's a fair statement, permitting being the issue, yes.

Unidentified Analyst

Is there an opportunity for additional consolidation? Is there another geographic area that's unique like you have that would be interesting for you to acquire by making it a (poly) or something like that?

Jeff Beyersdorf

We like – so the question is – the broader question, if I understood it correctly, is acquisitions, what markets geographically are you guys liking or do you like or would you look at?

We like the markets we're in currently. If we were to do an acquisition, we probably wouldn't look east of the Mississippi. It would be just west of the Mississippi most likely and probably not Gulf Coast either, so probably the Rockies, the mid continent and the west coast would be the areas that we like and we currently sell into some of those markets today.

Unidentified Analyst

(inaudible – off mike)

Jeff Beyersdorf

There are a few other independent plus privately held companies, refining companies in those markets today, yes.

Unidentified Analyst

The strategy on the sum properties in (Philly) that I think it's (inaudible) got involved in, are they just basically turning that into a depot for shale, (inaudible) and things of that nature? Is that what that's all about or is that really a regular (run) refinery?

Jeff Beyersdorf

From what I read from the public disclosure, (Carlisle) plans to run it as a typical refinery but I don't know anything more than that. I haven't heard anything other than that.

Unidentified Analyst

You don't think you can make any money in those refineries, I assume.

Jeff Beyersdorf

I can't speculate on that, no.

Unidentified Analyst

(Inaudible – off mike)

Jeff Beyersdorf

Again, our focus is the west of the Mississippi, yes.

Unidentified Analyst

Can you give us an idea of how big that buyback program is and would you continue it at – the size of the buyback program and will you continue it to next year and how big do you think it could be in the future?

Jeff Beyersdorf

We are doing the buyback program with the sole purpose being to mitigate the (rution) of the convert. We, depending upon cash flow, may revisit the size of that in 2013 but right now it's at $200 million and, as we disclosed in our Q, we've completed about $80 million of stock buybacks of that $200 million, so we've got another $120 million-ish to go on the stock buyback.

We may, as I said, revisit it depending upon cash flow. But the sole intention will be to address the convert maturity in 2014.

Unidentified Analyst

How do you think about – you laid out pretty well what you want the balance sheet to look like – I presume that's based on your view of how differentials are sorted – will sort out and how your cash flow will look like under that environment and I don't know when, a few years out. But can you give us a little bit of thought on …

Jeff Beyersdorf

Yes, so the balance sheet – the question is how did you construct what the ideal balance sheet looks like? And there is some thought behind that. The thinking is we'd like to have double the flat credit metrics.

And if you look, that BB credit metrics for us through mid cycle market conditions. And through mid cycle market conditions, we think that's probably Gulf Coast three, two, one crack spread in the range of $12 to $14 a barrel give or take.

We generate about $400 million to $500 million of annual EBITDA. And the metrics associated with that are about a one times leverage to get a BB flat credit, so that's how we get to the $500 million of funded debt.

Unidentified Corporate Participant

(Inaudible – off mike)

Jeff Beyersdorf

The question is is there a normalized crack spread that we think we'll end up with? Your guess is as good as mine. I'm not in the crack spread projection opportunity. But it will come in at some point once all these logistics get built out.

Where it comes to, again, we don't know. We can speculate and we think based on fundamentals, again, it'll come in somewhere between pipeline economics and rail economics, between that $4 and $10 a barrel.

But as an example today it's at $22. We cannot tell you why it's trading at $22 differential today. On the fundamentals, the fundamentals don’t support that today. We don’t understand why it's …

Unidentified Analyst

So $10 is worth to you in terms of EBITDA.

Jeff Beyersdorf

For every dollar differential between (brett) and WTI for El Paso, that represents about $35 million to $40 million of annualized EBITDA, for every $1.

Unidentified Analyst

(Inaudible – off mike)

Jeff Beyersdorf

$10, yes. That's correct.

Unidentified Analyst

(Inaudible – off mike)

Jeff Beyersdorf

Oh, no. When the spread – the question was do the economics of this plant disappear when the spread decreases? When spreads were zero this plant was making money. So if they settle of $6 or $7 a barrel, this plant will make more money than it did in 2010 if it operates.

Unidentified Analyst

(Inaudible – off mike)

Jeff Beyersdorf

Yes, the costs are $3.75 to $4 a barrel, the fixed cost, both operating – both variable and fixed. So anything above $4 a barrel, we're making money. One more question.

Unidentified Analyst

A bunch of your competitors have done – some of your competitors have done the MLP (rude) and turned to unlocked value. What are your thoughts on that? And I know you're investing in some pipeline assets, so it would probably fit the MLP structure.

Jeff Beyersdorf

Yes, the question is MLP, you guys have sights on that. Certainly it would make sense for us. We do have existing assets that generate EBITDA that qualifies for MLP status. We're also constructing some assets that qualify for MLP status.

So yes, we're looking at it and it's bubbling up to the surface as a priority within the company, yes. Thank you again for your time. We appreciate your attendance.

Unidentified Corporate Participant

Jeff, thank you very much.

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