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Valero Energy Corp. (NYSE:VLO)

Q1 2009 Earnings Call

April 28, 2009 11.00 AM ET

Executives

Ashley Smith - Director, Investor Relations

Mike Ciskowski - Executive Vice President and Chief Financial Officer

Joe Gorder - Executive Vice President-Marketing and Supply

Bill Klesse - Chief Executive Officer, President and Chairman of the Board

Kim Bowers - Executive Vice President and General Counsel

Gene Edwards - Executive Vice President-Corporate Development and Strategic Planning

Rich Marcogliese - Executive Vice President and Chief Operating Officer

Analysts

Erik Mielke - Bank of America/Merrill Lynch

Mark Flannery - Credit Suisse

Roger Read - Natexis Bleichroeder, Inc.

Jeff Dietert - Simmons & Co.

Paul Sankey - Deutsche Bank

Michael LaMotte - J.P.M organ

Mark Gilman - Benchmark Company

Neil McMahon - Sanford Bernstein

Paul Cheng - Barclays Capital

Chi Chow - Tristone Capital

Blake Fernandez - Howard Weil

Faisel Khan - Citigroup

Jacques Rousseau - Back Bay Research, LLC

Operator

Good morning my name is Celeste and I will be your conference operator today. At this time, I would like to welcome everyone to the Valero Energy Corporation First Quarter 2009 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.

I would now like to introduce Executive Director of Investor Relations, Mr. Ashley Smith. Please go ahead sir.

Ashley Smith

Hey thank you Celeste. Good morning and welcome to Valero Energy Corporation's first quarter 2009 earnings conference call. With me today are Bill Klesse our Chairman and CEO; Mike Ciskowski our CFO and other members of our executive management team.

If you have not received the earnings release and would like a copy you can find one on our website at valero.com. Also attached earnings release our table that provides additional financial information on our business segment. If you have any questions after reviewing these tables please feel free to contact Investor Relations after the call.

Before we get started, I'd like to direct your attention to the forward-looking statements disclaimer contained in the press release. In summary, it says that statements in the press release and on this conference call that state the company's or management's expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provision under Federal Securities Laws. There are many factors that could cause actual results to differ from our expectations, including those we've described in our filings with the SEC.

Now I will turn the call over to Mike.

Mike Ciskowski

Thanks Ashley and thank you for joining us today. As noted in the release we reported first quarter 2009 net income of $309 million or $0.59 per share. This is a 23% increase in earnings per share over the $0.48 per share reported in the first quarter of 2008.

When you exclude the $0.12 per share benefit from an insurance recovery at McKee in the first quarter of 2008, first quarter 2009 earnings per share is 64% higher in the same quarter of last year. First quarter 2009 operating income was $507 million versus $472 million in the first quarter of 2008 or $371 million without the previously mentioned insurance recovery. The increase in operating income was mainly due to higher refining margins on gasoline and secondary products such as fuel oil, asphalt and petroleum coke.

For example, benchmark U.S. Gulf Coast's gasoline margins versus WTI of $8.14 per barrel were almost double before 23 per barrel in the first quarter of 2008. As a proxy for secondary products Gulf Coast margins on hi-sol (ph) for fuel oil improved 86% from $28.16 per barrel below the price of WTI in the first quarter of 2008 to $4 per barrel below WTI in the first quarter of this year.

Lower operating expenses also contributed to the increase in operating income versus the first quarter of 2008. The $117 million decline in refining operating expenses was due primarily to lower energy costs and then the absence of operating expenses at Krotz Springs Refinery which was sold in July of 2008; Somewhat offsetting the increase in the first quarter 2009 operating income was the significant decline in our sour crude oil discounts and lower diesel and jet fuel margins.

From the first quarter of 2008 to the first quarter of 2009, Maya heavy sour crude oil discounts versus WTI, decreased 73% to $4.46 per barrel and the Mars sour crude oil spreads decreased by 111% to a premium to WTI of $0.78 per barrel. Although, benchmark diesel margins in our regions averaged respectable levels in the low to mid teens per barrel in the first quarter of 2009, the decreases from the first quarter of 2008 were approximately 25% on the Gulf Coast and East Coast and in 31% on the West Coast and 44% in the Mid-Continent.

Our first quarter throughput volumes averaged 2.5 million barrels per day which was 142,000 barrels per day below the first quarter of 2008. This was primarily due to the reduction in capacity from the sale of the Krotz Springs Refinery and then downtime of several of our other refineries.

Refinery cash operating expenses were $4.49 per barrel, which were favorable to our guidance of $4.80 per barrel due mainly to lower than expected energy costs and higher than expected throughput volume.

General and administrative expenses excluding corporate depreciation were a $145 million in first quarter. The $7 million increase from the fourth quarter and $2 million increase from our guidance was primarily due to higher severance costs.

For the first quarter, total depreciation and amortization expense was $378 million below our guidance due to lower turnaround amortization expense. Interest expense net of capitalized interest was $79 million, slightly above our guidance due to the issuance of the $1 billion worth of notes in mid-March. The effective tax rate was 28%.

Regarding cash flows for the first quarter, the capital spending was $902 million which includes a $167 million of turnaround expenditures and we paid $77 billion in dividends on our common stock. In March, we received nearly $1 billion from our bond offering in which we issued 750 million of 10 notes and 250 million of 30 year notes.

The proceeds enabled us to pay-off 209 million of maturing debt that came due on April 1st, to fund our acquisition of the VeraSun ethanol plants and maintain our capital expenditure program.

Regarding the ethanol plants we are excited about our acquisition of the plants from VeraSun, for total capacity of 780 million gallons per year or 50,000 barrels per day we will pay a total of $477 million which is 30% of estimated replacement cost plus approximately $78 million for working capital.

We have closed on six of the plants and one development site and we expect to close on the last plant very soon. We consider these to be the best plants in VeraSun's system and some of the best in the industry due to their large size and advantage access to local feed stocks. This acquisition fits well with Valero's core business of manufacturing and marketing motor fuels.

With respect to our balance sheet at the end of March, our total debt was $7.6 billion due to the timing of the bond offering, we ended the quarter with a cash balance of $1.7 billion and we had nearly $4.7 billion of additional liquidity available. Also at the end of quarter, our debt-to-cap ratio net of cash was 27.1% which remains far below the bank agreement threshold of 60%.

Regarding future uses of cash, we have made additional cuts to our estimate for the 2009 capital expenditures and turnaround costs considering the weak economic outlook. We now estimate capital spending will be 2.5 billion which is down 200 million from our most recent estimate. Regarding upcoming debt payments, we are required in October to offer to purchase 100 million of our bonds for the related indenture and in 2010 our maturities total only $30 million.

In summary, we are working diligently to manage our financial health in this weak economy. Realizing that we are not immune from the effects of the recession, we are reducing operating costs, overhead costs and capital expenditures. However, we will prudently continue to invest in growth opportunities that build long-term value for our shareholders.

Now, I'll turn it over to Ashley to cover the earnings models assumptions.

Ashley Smith

Thanks Mike. Okay, for modeling our second quarter operations we should expect the following refinery throughput volume. The Gulf Coast should average between 1.35 to 1.4 million barrels per day. Mid-Continent should average between 360,000 and 370,000 barrels per day. West Coast should average between 270,000 and 280,000 barrels per day and the North East should average in the range of 460,000 to 470,000 barrels per day.

Refinery cash operating expenses are expected to be about $4.40 per barrel which is down slightly from the first quarter due to higher expected throughput volume and continued low energy cost. Regarding our ethanol operation in the second quarter we expect total throughput volume of 1.5 to 1.6 million gallons per day and operating expenses should be in the range of $0.31 to $0.33 per gallon and that includes approximately $0.05 per gallon for non-cash costs such as depreciation and amortization expense.

With respect to some of the other items for the second quarter, we expect general and administrative expense excluding depreciation to be around $140 million. Net interest expense should be around $100 million. Total depreciation and amortization expense should be around $390 million and we expect a 31% effective tax rate.

We will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line, if I am pronouncing it correctly, Erik Mielke.

Erik Mielke - Bank of America/Merrill Lynch

Yes Erik Mielke from Merrill Lynch. I have two questions if I may. One is I guess its time the question to ask if you can give us an update on what you're seeing on demand for brief casting I guess also for diesel in the current environment.

And my second question relates to the commentary you had in the press release today of around different policy initiatives in D.C. If you can elaborate a little bit on what you expect to see come out of D.C. and what it might mean for your business I think particularly about cap and trade and other similar initiatives?

Joe Gorder

Well on gasoline demand, we realize it's weak. It's 2.5% from the same period last year which we saw, this demand is also weak, much weaker than gasoline and our own network though we've seen gasoline demand on retail operations actually increased. It's up 1% so in our markets we think it's with that (ph).

Erik Mielke - Bank of America/Merrill Lynch

What's the rate of change on the deficit side? Is it getting worse or is it starting to slowdown?

Joe Gorder

Well, it hasn't got any better. The story in it but of course is the export volumes and we continue to have an open arm Europe which we're taking advantage of. We're also seeing increased demand in South America. The winter's approaching there and then some of the traditional sources of supply just aren't available. So export volume is still strong, domestic volumes are weak.

Mike Ciskowski

I might add on our retail network. We're up 1% on gasoline but on distillate we're down about 10%. So, on an average when you weigh that we're pretty much flat for the year, of course this is the first quarter. Distillates or the diesel is only about 10% of our network sales volume. So we're flat.

Bill Klesse

On the Washington initiatives I think that Kim Bowers, who is our Executive Vice President and in-charge of government relations, but just keep in mind that we have and we're still auditing these numbers of about 36 million metric tones of CO2 emissions as she speaks.

Kim Bowers

Thanks Bill. Yes we're reviewing the Waxman Bill but there still so many details to work out that we haven't evaluated the impact. What they trying to chose credits whether they're going to be allocated or auctioned of all the details still need to be worked out with the Waxman Bill. So we're watching it very carefully, but still think and we still think that there are some unintended consequences that will result from this, pushing it's away from foreign crude oil to foreign products coming in and unfairly it's giving advantage to foreign competition over domestic competition here?

Bill Klesse

Obviously we think this is a bad idea. Also the devil is always in the details. Obviously, our government is looking for cash and so we'll see what happens on that. The other initiatives we've also spoken about is some of the tax consequences of eliminating LIFO just for energy companies, putting the super fund tax back in, which quite frankly we do collect from our customers I mean in reality corporations, you know we just collect taxes that we think composite (ph).

Also the manufacturer's credit which has been identified total back eliminating that also just for energy companies; so there is a effort here at the moment to raise money from a segment of the business that is just been to be able to pass. So those are only the few other things and as you read the newspaper like we do.

The major issue with CO2 is that the United States will in fact forced this. We'll have a department here that we'll track it, regulate it and file reports and we'll pay whatever we're told we have to pay. But in the rest of the world it would not be as rigorously enforced as it would be here. And thus it changes the global competitor situation.

So we need to be very careful.

Erik Mielke - Bank of America/Merrill Lynch

So, the document say the introduction of carbon pricing would add I am sorry, I am not asking to confirm or deny. But say that a dollar per pound to your overall cost base. If do you do not have an equivalent cost deployed to product imports, what would that do to your business?

Bill Klesse

Well, I have no idea. Except that as Joe mentioned, we are -- this is a global business, its very capital intensive business. By looking at our data our operating costs just say for this conversation $5 a barrel and if you add a $1 a barrel or $2 a barrel, you can see what its doing to your cost situation for a refinery. But as far as what the sensitivity or elasticity there for is I don't know.

Erik Mielke - Bank of America/Merrill Lynch

But are you I am thinking more about the pricing dynamics. If you, if it's prior to the import then presumably it'll be passed through consumer goods because its same for everyone. And whereas if its -- if it is not implied to import then, it becomes a question of who -- where the pricing power lies?

Bill Klesse

You're not exactly right on freight (ph). If it comes gets into this and if it's a dollar as you just said, it would be $0.022 (ph) a gallon. So, but we'll just see what evolves; the thing that I say and I know this sounds a little bit like motherhood and apple pie, but we have good jobs in this industry. We pay a good wage; people who can work for us and own their home, educate their children and some of these initiatives and the social change agenda, will have a big impact on part of the backbone of our country with just with other of the manufacturing jobs.

Erik Mielke - Bank of America/Merrill Lynch

Nothing wrong with motherhood and apple pie. Thanks for your answer.

Bill Klesse

Thanks Erik.

Operator

Your next question comes from the line of Mark Flannery with Credit Suisse.

Mark Flannery - Credit Suisse

Thank you. Yeah I have a question on CapEx and how we should think about where the CapEx line is going. You got a another $200 million of it; should we infer from this that you are trying as best as you can to run cash neutral in 2009, in other words if things don't really kick-off over the summer, should we expect another 200 million to drop off that number as we enter the full? And am I thinking about it the wrong way?

Bill Klesse

No you can think of it that way. If you just look at the first call estimate, what we are trying to do is manage our business here, but we still have a very strong balance sheet. Apart of the thing we are doing all is getting our projects to a point where we can orderly stop them. For instance we have our large hydrocracker projects which our whole management team believes are good projects long-term.

But we're getting them to appoint if we stop here as we whether this storm that we're dealing with. But, if you go through first call and do all the adds and subtracts you can see that we're pretty close to being in balance at $2.5 billion.

Mark Flannery - Credit Suisse

Right. And last quarter I think you mentioned a $1.8 billion as a minimum CapEx number. Is that still a valid number or do you think we could chop away that little bit?

Mike Ciskowski

We still consider that to be the minimum expenditure level over the next couple of years when you consider turnaround expenditures reliability, safety projects and environmental capital. And environmental capital in particular for the next couple of years we have a couple of regulatory obligations that we have to meet, we have to reduce benzene and gasoline its known as the MSAT II Regulation. We have carry over projects that come out of our EPA 114 agreement, then we have a large air quality project in Benicia that we are completing. So we would still say that $1.8 billion represents a minimum level for the next few years.

Mark Flannery - Credit Suisse

Thanks. Thank you very much.

Bill Klesse

Thanks Mark.

Operator

Your next question comes from the line of Roger Read with Natexis Bleichroeder, Inc.

Roger Read - Natexis Bleichroeder, Inc.

Hey good morning gentlemen.

Bill Klesse

Good morning Roger.

Roger Read - Natexis Bleichroeder, Inc.

Just wanted to follow-up on the gasoline demand you're saying in your retail. Is that a year-over-year comparison the 1% and the 10% and if it is how would it compare say what you saw in the fourth quarter to the first quarter or currently even?

Mike Ciskowski

Okay. It is a that's a first quarter '09 versus the first quarter '08 comparison. In the fourth quarter we had -- we were up just a little bit compared to the first quarter. Not much difference though between the two quarters.

Roger Read - Natexis Bleichroeder, Inc.

All right, thanks. And then following on with the CapEx question, kind of last time we had an update, the expectation was the CapEx number would be may be more spend rather than less spend. Has something changed in the last lets say 60 days that lead you to be more conservative about that or something in your expectation, 60 days that is now not as bright as you thought then?

Bill Klesse

The only think I would tell you is we're looking at the economy just like you are and we have a lot of people that are telling us who see a recovery here may be at the end or year and we just look at the data. We no unemployment most likely going to continue to increase from 8.5 or if some numbers are high as 10.5, so we just look at the situation, we also don't see any stimulus money doing anything. We don't see a lot of things happening so we're just being a little more conservative.

Roger Read - Natexis Bleichroeder, Inc.

Okay. Thank you.

Operator

Your next question comes from the line of Jeff Dietert with Simmons.

Jeff Dietert - Simmons & Co.

Jeff Dietert with Simmons. Good morning.

Bill Klesse

Good morning.

Jeff Dietert - Simmons & Co.

First with stocks are up and the demand is pretty weak. Have you guys hedged some of your distillate going through the summer and if so is it significant?

Mike Ciskowski

We are always in these markets as I have said every time. We do a rate-ability when we buy oil, we have some forward sales in normal course of business. We have some pretty darn good treasures over there that our business for us. When it comes to strategic type decisions like significant sales or so, then and actually our entire management team gets involved and I am very involved in these things.

We have a strong main (ph), but to your question, we are in these markets all the time, some of you know a lot of this is my background and basically we are there, we have done some forward selling, but on the other hand this is competitive, its very competitive what our positions are and so Jeff I prefer not to get into too much detail. In 10-K that would be filed in a couple of weeks, there will be some disclosures.

Jeff Dietert - Simmons & Co.

Okay. Thank you. Now on the -- it seems the East Coast market has been more challenged in some of the other regions utilization rates have been much lower there and yet stocks are above average. Do you see that correcting overtime as the economy recovers or is that just a fundamentally more competitive market?

Bill Klesse

I think focusing on the East if I understand, we've taken our Delaware City Refinery down. We had a problem with the coker in February, and if you can think about that operation, a large fluid coker, we could not get it restarted when it came down. Thus, we wound up shutting down the entire refinery. We've had that refinery down here for the month of March and frankly for eight.

Now, we've done the repair work on the coker actually here the turnaround. We fixed our steam system because we took some of that down, things that you never fix. We've added some other steam; we have lost the boiler due to regulatory in Delaware and so we've actually had to bring in some temporary boilers because we decided we don't have enough steam.

So we have been doing things like this. Now the plant is scheduled to start up and we are in the process of starting back-up and thus you will see rates as based on Ashley's guidance till you hear in the second quarter. But the plant of Delaware City is starting up.

Now having said all of that, in this environment that we're in there is too much refining capacity, too much capability to make refine products and I said this very publicly the NSG needs to maintain discipline here during this environment until the economy picks up. If the industry does not maintain discipline then these margins are going to come down and it will be a lot tougher environment.

Jeff Dietert - Simmons & Co.

Thanks for your comments.

Operator

Your next question comes from the line of Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank

Hi good morning gentlemen. In the past you've been quite specific about merging acquisitions particularly in terms of disposal candidates, though could you talk a little about firstly, how you're viewing disposals.

Secondly, about acquisitions as well in the current market. And I am also thinking not just about refineries but also about ethanol and also based on what you just said on the potential for any international activity either disposal or acquisition. Thanks.

Bill Klesse

Sure. We still are looking for strategic options for Aruba refinery and we'll continue to do that as the world continues to evolve. But as a general statement, the markets have shifted dramatically as I said, you can buy assets for a lot less money and you can build. And this is kind of what we always expected and we're back to the market here where acquisitions, the proper hardware in the right location is attractive to us.

So to sum you detail on ethanol we've got a stake in the business, its got a critical math, it is policy in United States, we are still firm believer in sound science, but it is policy. And so all this is an extension for us, but I do not see us adding to our ethanol business through acquisitions unless it is absolutely a golden opportunity. We are also looking at little bits and pieces in what we'll call the second generation ethanol just like almost every company is.

On international acquisitions we are very interested, now that we see some plants coming on the market we continue to look at those. If we find one that we think, one, two or three that fits our situation we are interested in making an acquisition. It's got to be the right plant, the right location and the right price. What we would like to do is broaden our geographic face, but we need to do it in the right way.

Paul Sankey - Deutsche Bank

though it feels that as couple of refineries domestically they're kind of just not running any more, I mean is it fair to say that about Delaware for instance?

Bill Klesse

No, that's not fair to say. We're starting the plant up.

Paul Sankey - Deutsche Bank

Right. But I guess that was part of the very low throughput that you got for Q2 and...

Bill Klesse

Well, we've sorry Paul. We've lost one month obviously, so if you think about it, we're not starting up as to right and so that's the main reason. That refinery has a good configuration, but I am not going to deny. We've operated that refinery very poorly and we've have a major effort here to improve the operations of that.

Paul Sankey - Deutsche Bank

So, if I summarize basically, the existing if you like disposable candidate, is only Aruba and you are looking for international opportunities and you may very selectively add ethanol?

Bill Klesse

Yeah, I think the last thing you said is very, very selectively add ethanol. Is that what you said?

Paul Sankey - Deutsche Bank

Yeah.

Bill Klesse

Yeah. I would agree with that.

Paul Sankey - Deutsche Bank

And just to be clear, there's international account in Canada?

Bill Klesse

Oh Sure. I was thinking...

Paul Sankey - Deutsche Bank

But I guess you think...

Bill Klesse

I was thinking.... I thought you were asking me more about Europe.

Paul Sankey - Deutsche Bank

Yeah I know I was, but I just wanted to be quite clear. Okay, thanks a lot.

Bill Klesse

But to be honest with you, we already operate in Canada, so we are always interested in the current opportunity there.

Paul Sankey - Deutsche Bank

Yeah, okay. Thanks. That's great.

Operator

Your next question comes from the line of Michael LaMotte with J.P. Morgan.

Michael LaMotte - J.P.M organ

Thanks, good morning. If I could follow-up Ashley perhaps on the guidance for this quarter on ethanol. How does your current sort of wins balance and your petition to get a blender credit fit into that guidance? Can you give some update on those two things?

Joe Gorder

You want to ask -- I mean from let me just say from a product supply perspective, we deal with the compliance with the RFS on an ongoing basis. The acquisition of VeraSun for us is the acquisition of a standalone business and there will be opportunities I am sure for Valero to purchase ethanol from the VeraSun assets, our capacity (ph). But it is not the reason that we did the acquisition and we don't say the two being related to where you linked them in your question.

Michael LaMotte - J.P.M organ

Okay.

Mike Ciskowski

And utilization rates are just based on when we can acquire and get them up and running.

Michael LaMotte - J.P.M organ

Okay. Its helpful to think about it a sustainable business. Thank you for that. And then on the issue of cash management, how should we think about, how you are managing your inventory levels and can you give us an update as to how many days accrued there you are currently sitting on?

Mike Ciskowski

Cash management?

Michael LaMotte - J.P.M organ

No, I mean days accrued.

Bill Klesse

We still run our business in Illinois. We have about 115 million barrels of crude products and all kinds of things in our system. Our LIFO number at the end of last year was 114 million?

Mike Ciskowski

Yeah.

Bill Klesse

114 million if you look at. Obviously the markets in Calgary (ph) and so where we turn in the Mid-Continent we try very hard to take advantage of the Calgary just like you would expect us. We are not so and I have not gone out there and at least that the -- and we don't think that Calgary is quite enough.

However, we have had earlier in the year when the carry got out to be several bucks a lot more oil on the water and the sense of trying to capture the (ph). And its been difficult because in the Mid-Continent we thought we catch it some of the international stuff gets surprisingly of trouble capturing it, but we're trying that, but as a general statement we have that, we have brought crude on the water, we're buying more crude obviously Venezuela, the Rockies and some of the other places because the Mexican borrowings are down.

We have different numbers, we have a priced number which is actually a our price risk inventory and crude oil could be around 22, 23 days but then if you look at the supply functions its actually a different number, it tends to be slightly higher, because we buy a lot of the crude FOB. So it's hard for us to give you number except to say that we're basically around the business as we owns that. However, whereas not can go -- we are trying to get our inventories out of the refineries for instance and into the marketplace to generate the cash.

Michael LaMotte - J.P.M organ

That's helpful. Thank you.

Bill Klesse

It's a normal process for us.

Michael LaMotte - J.P.M organ

Yeah, yeah, okay. And normal as important I guess is sort of if I think about it year-on-year?

Bill Klesse

Yes, we have not like gone into a -- I mean we have a 115 million. We run our inventory situation same although we're watching it.

Michael LaMotte - J.P.M organ

And last one from me just on shipping rates as it relates particularly to the Arab window in Europe. How sensitive is that window to shipping rates and where do we stand within that?

Joe Gorder

No, it's a very sensitive point and we've had very inexpensive shipping here over the last several months. And it's started to tighten up a little bit, so it has chewed into the Arab, but the Arab remains open.

Michael LaMotte - J.P.M organ

So its still up. Okay.

Bill Klesse

The actual rates got down just a couple of pennies.

Joe Gorder

Yeah.

Bill Klesse

And so it's been as low as I've see in years and thus we've been enabled to chase the Arab when it's $0.04 or $0.05 a gallon. So that there's a buck profit in it for us a barrel to move stuff to Europe. So, but this is blowing rates that I have seen in a while, I am trying to remember when. So it does facilitate those type of trends.

Michael LaMotte - J.P.M organ

Okay. Thanks guys.

Operator

Our next question comes from the line of Mark Gilman with the Benchmark Company.

Mark Gilman - Benchmark Company

Good morning guys.

Bill Klesse

Hey Mark. Good morning Mark.

Mark Gilman - Benchmark Company

Hey Bill, I assume from your prior comments and also your answer to an earlier question regarding exploiting the deep first quarter contango. That there might be some fairly significant supply trading gains embedded in the first quarter results. Can you quantify what that is?

Bill Klesse

Yeah, we'll certainly tell you what we're doing contango Joe.

Mike Ciskowski

Yeah, Mark the number if you take into consideration all of domestic barrels is $150 million for the quarter. All right, and I think Bill answered the question what we're doing on inventories here pretty clearly just a minute ago. So anything else there?

Joe Gorder

Well Joe that's just the domestic number I am assuming that there might be another element to that as well.

Joe Gorder

Mark on the international book we may catch a little bit of a contango but not much and it varies by the crude that you're buying but the one thing that we need to keep in mind for example is this, that the way that the Middle Eastern oil priced and the way that the Mexican's priced Maya, it doesn't take into consideration the market structure and so you typically don't capture the contango unless you get something physically in storage at that point in time. And you as Bill mentioned that's really not the way we run our business. So you don't get it just by virtue of the fact that you're running it.

Mark Gilman - Benchmark Company

Yeah but Joe normally wouldn't you have taken inventories down the first quarter?

Joe Gorder

Pardon me.

Bill Klesse

Taking the course down the first quarter...

Joe Gorder

Did we?

Bill Klesse

Yeah.

Mark Gilman - Benchmark Company

No, you probably did not but....

Joe Gorder

They were up slightly I believe.

Bill Klesse

Hang on Mark, you'll then give you the right the answer here. Mike's going to give you the details.

Joe Gorder

They were 115.7 million barrels versus a 114 at year end. And crude was up one and products were just up a half.

Mark Gilman - Benchmark Company

Right. Then you said normal first quarter behavior for you?

Joe Gorder

Yeah, I don't think we did anything ordinary. I mean look we're running the system to satisfy our utilization rates too. So to the extent that they were different we'll have more would be with that than it would any kind of apply.

Mark Gilman - Benchmark Company

Okay. Let me shift gears for a second if I could. How you guys going to report the ethanol activities both operationally and financially, separate segment embedded in the regions, what are you going to do?

Mike Ciskowski

It would be a separate segment.

Mark Gilman - Benchmark Company

Okay. And implicit in Ashley's $0.32 per gallon operating cost second quarter guidance, what's the corn price that's embedded in that?

Ashley Smith

Well, there's not corn cost in that. That's just operating cost, just like in our refinery operating costs we don't repeat stock cost in that.

Mark Gilman - Benchmark Company

Okay.

Ashley Smith

I think it's 377.

Mike Ciskowski

Yeah, $0.03, that's right. That much.

Bill Klesse

$3.77. It's $3, just say $3.80 of those, how we're looking at it today.

Mark Gilman - Benchmark Company

Okay.

Bill Klesse

That order for the quarter.

Mark Gilman - Benchmark Company

Is that a hedged number Bill?

Bill Klesse

No, that is not. But in this business it is a lot different, we do a lot. There's a lot of forward buying, there's contract with the farmers and Gene do you want to comment?

Gene Edwards

Yeah. Mark we always try to keep things soft. So that where you're seeing spot price in the spot ethanol price everyday, similarly we run refining business. That mainly to trap the buying, spot are fixed priced contracts to the farmers and then you sell the back to convert it back to floating price until you run the corn.

Mark Gilman - Benchmark Company

Okay. Regarding the throughput numbers for the second quarter give me a rough idea, how much of that is maintenance, how much of that is economically oriented curtailment?

Gene Edwards

On the refinery?

Mark Gilman - Benchmark Company

Yeah.

Gene Edwards

I don't have that with me right now.

Mark Gilman - Benchmark Company

Okay. Last one for me, can you identify where the 200 million in CapEx reduction is going to hit on a project-by-project basis?

Bill Klesse

We can. We have gone through this in excruciating detail, as you can imagine we're all involved. But we are deferring some projects as we've been able to move turnaround from the forth quarter into the first quarter, because we're doing this full term work at St. Charles. So there are details, I think you should just expect from us that its been this we're in somewhere around 2.5 million.

Mark Gilman - Benchmark Company

Okay guys, thanks very much.

Bill Klesse

Mark, I want to answer the other question when you asked the normal behavior in the first quarter. It is normal behavior on the inventory management except for the fact that we did have contango and thus in the Mid-Continent where I mentioned to the earlier question we went ahead and tried where we have tankers and things like that to capture contango. If the market had been backward dated then we would have been pushing it the other way.

Mark Gilman - Benchmark Company

Okay. The benefit of that is captured in 150 million, I think that Joe quoted.

Bill Klesse

Yeah, it's all in Joe's numbers. We tried to calculate what that was all worth to us.

Mark Gilman - Benchmark Company

Okay. Thanks a lot.

Operator

Our next question comes from the line of Neil McMahon from Sanford Bernstein.

Neil McMahon - Sanford Bernstein

Sanford Bernstein:} Hi good morning. I got a few questions; first one really just looking at your outlook for the summer in terms of gasoline imports coming from Europe to the U.S. given the really low diesel track in Europe and one presumes a falling utilization rate of European refineries. Just wondering if you're factoring that a toll in some of your thinking of overrun summer imports.

Bill Klesse

I don't think that we expect anything to be different this year than last year relative to gasoline imports from Europe.

Neil McMahon - Sanford Bernstein

Okay. And second one is on ethanol again and may be just more of a 50 point (ph) good question. I could see the logic why you've gone in and done this with VeraSun. Do you expect -- or oil companies to start doing this as well. Nothing that's been playing in this game already but a new entrant pass then may be some of the bigger integrated. And secondly can you see yourselves selling ethanol to however may be larger integrated companies?

Bill Klesse

For your first question I really don't know what the others will do. And for us as we've said with the VeraSun market was a good extension, remember we're an independent refiner and our whole businesses almost entirely motor fuels. So, to us it was a good extension. And then as far as selling, we will sell, we are going to run this separate business and so as Mike said its going to be segment recorded, we take advantage of synergies here in the office when you come to wake our management, accounting cash management the things that you would expect, but as far as the business itself, we're seller of ethanol. And I will sell to anybody that will pay our price and pays their bills.

Neil McMahon - Sanford Bernstein

Okay. Just a last, hopefully quick one; just back on the gasoline demand in the U.S. and though seen that from your stores that as you said you're up 1%. Are you getting any sense of geography where that is coming through? Are you seeing primarily the demand coming back in the West, relative to the rest of countries certainly miles probably in all the things and picked up in the West relative to the Central and Eastern parts of the U.S. May be you could give us some flavor of its faulty or is it you're actually seeing has some migration of demands picking up from West three?

Bill Klesse

Yeah, I'll just give you just a quick observation. I mean in California vehicles miles travel kicked off. And so where obviously volumes moved up a little better in California, and that just came out the other day some report on the vehicle miles travel.

But then in the South West here obviously in Texas, and remember we're talking where Mike spoke, he spoke that the company operated retail, which for barrel is a 100 -- is 1000 company operated stores and then the volumes stands for the first quarter at average somewhere around a 117 or 18,000 barrels a day of gasoline.

So when you look at it that way, you would just think about the size of the business, but South West year, you tend to have better volumes here in Texas, because the weather had been pretty nice. But as far as going East or so, we don't directly market there.

Neil McMahon - Sanford Bernstein

All right, great. Just looking for your overview.

Operator

Okay. Your next question comes from the line of Paul Cheng with Barclays Capital.

Paul Cheng - Barclays Capital

Hey guys, on you're earlier that you are talking about the Delaware City saying that you guys have not been running it, whereas you should be -- is that hardware issue or just the people issue?

Bill Klesse

Yes we had a hardware issue there. I'll let Rich speak.

Rich Marcogliese

Sure, Paul I think the plan has a good configuration but has one of our most complicated plans from a steam gas and utility management point of view which largely relates to the coal gas plant. We had an issue in late 2008 where we had a failure on one of two gas refining reactors which really affected the operation of that whole complex, to try to run it on one remaining gas refining reactor.

That in turn affected the utility system in the refinery and really you can trace some of that to the problem that we had in the middle of February, where we had large steam system up set that resulted in the shutdown of the coker. So my stance of this is we have got a very complicated plant configuration, we had an issue last year, we made to repair and gotten it behind us and I think you'll see improvement going forward.

Paul Cheng - Barclays Capital

Okay. I know but I think may be I missed you, have you guys say probably be the inventory or the trading gain in the quarter is 150 million?

Bill Klesse

That the number that Joe gave was the calculated contango benefit.

Paul Cheng - Barclays Capital

Totally the contango benefit.

Bill Klesse

So that shows up eventually in our crude costs.

Paul Cheng - Barclays Capital

Right. And that 150 million is so that means that you've seen your gross profit margin that would be a mutation, and that entered Mid-Continent system or they spread to other systems also?

Bill Klesse

Primarily the Mid-Continent somewhere in the Gulf Coast we're running domestic barrels.

Paul Cheng - Barclays Capital

Right. And is that including any of the potential trading gain?

Bill Klesse

No.

Paul Cheng - Barclays Capital

That is already included?

Bill Klesse

That does not include our activity where we do some spreads when you had the contango market obviously we traded some of the papers and things like that.

Paul Cheng - Barclays Capital

Right. So the 150 is the periodic to CMA adjustment or that's?

Bill Klesse

That's right. That's the way to look to at it Paul.

Paul Cheng - Barclays Capital

Okay. And given that the oil price actually, and the quarter above $5 higher than they stop the quarter. Do we have any inventory gain because I think that you have markdown as have some LIFO inventory markdown at the end of the year. Do we have any mark-up in the quarter?

Mike Ciskowski

No. It's not a material amount that goes through there...

Paul Cheng - Barclays Capital

It's not a material. And that Bill I know you saying that you don't want to disclose too much because of proprietary on the trading side. Can you give us a rough idea that how much have may have made in the quarter?

Bill Klesse

Well I'd prefer not to because its really an ongoing piece of the business for us. And we think people look at us. We're obviously still large; we're in the paper markets all the time. And we have a bunch of good guys that execute for us. But it has been a positive benefit to us and it's a positive benefit that has continued. We had some in the fourth quarter, third quarter of last year.

I believe the paper markets are key part of the business, the way we do business today and so we're very opted in those markets.

Paul Cheng - Barclays Capital

Okay. And a little earlier that you mentioned that for M&A, you're looking for potential acquisition you would interest? You said with the right location, right facility? Can you elaborate a little bit more in terms of what you will consider as the right location and what you consider as the right kind of configuration of facility?

Bill Klesse

Well we're one -- we always look for an asset that's on the water. We want the ability to trade barrels. We are firm believers here that this is a global business. On the north Atlantic Basin, its -- if you just look at the Basin, Europe's long gasoline short diesel. The U.S. today is long gasoline and I can admit and say -- I could say we're a little on diesel, but once the economy does recover, we will not be long diesel.

And so it's a natural play for us. That's why we had our hydrocracker projects at our big refineries, so that we could make more diesel, to service both the domestic market, as well as the European market. But we like the Atlantic Basin trade, you get draws in the South America, obviously Mexico continues to be an importer and Venezuela is an importer or used to be an exporter. Africa with all the issues that go on in Nigeria is a importer of gasoline.

So you see a lot of things that say to us that having assets that can back you up in your trading business in your North Atlantic is the way to go. And there's been a lot of companies who've made a lot of money over the years by doing that strategy.

Paul Cheng - Barclays Capital

So basically despite the market condition may have changed somewhat over the last 12 to 18 months, your overall view about what will quantify as a good location or a good asset configuration have not change, its the same?

Bill Klesse

No, and has not. We like assets as I said on the water; we like to have some size, we've said historically 150,000 barrels a day or more but the facts are its got - its really a location game. We want to ability to upgrade; we think that's a key part of Valero. You buy our stocks, you're buying a refinery in a capital intensive business. And we like the ability to try to work on these plans and improve them.

Paul Cheng - Barclays Capital

And Bill, if current market condition extends for the next say one to two years, is there any of your facility if you can't sell, you think may be candidly for impairment that is your thought?

Bill Klesse

Well I kind of got this question on the last call and I think somebody asked me if we can't make any money and if you can't sell it what'll you do with it? And I said well and you shut it down. We're in business to make money and that's our value. But today, we don't have any clients like that. And its always a big if, like if you can change a significant changes, we'd like to thank that we're going to have an economic recovery here at least by 2010 and if that happens our business provides fuels that's still fuel economy.

Paul Cheng - Barclays Capital

Very good. Thank you.

Bill Klesse

This is much different than the 1980's and our view is that a lot because I understand the 80's but the big difference this time is versus then if you think about the 80's the government controls all kinds of thinks going on that had put a lot of bias into the business. This time what's really affected us is yes its new construction, but its been this integration of demand and that's been because of economics. So if the economies pick-up I think you'll see our volumes pick-up.

Paul Cheng - Barclays Capital

Very good. Thank you.

Bill Klesse

Thanks Paul.

Operator

Our next question comes from the line of Chi Chow of Tristone Capital.

Chi Chow - Tristone Capital

Thanks. Hey Bill, just continuing on your thoughts there with Paul's question; I guess you may have answered this already but I have a broader question on your thoughts on the general independent refiner business model. I mean you talked at that front, excess global capacity that will likely get worse here in the near term. Unknown capital requirements related to carbon increasing our best mandates. Do you feel like long-term you need some sort of integration to the upstream or can you survive as the independent refiner for longer-term?

Bill Klesse

Well, I will say we can survive as an independent refiner. Sure, I'd like to lets not be foolish. I'd like to add more oil production, I mean if you give them but we don't, we're an independent refiner. In my particular case that made my entire career working for an independent refiner and so a lot of people listen to this call and so the facts are we can compete, but it is a tough business; we have to get our costs down, we have to be lean, mean and very, very efficient.

We can't afford some of the luxuries that the integrated natures can have; we just can't afford them and that's why we're so focused and on executing things. We've been reorganized in many of our departments here in a very systematic approach. To give you an example, we just completed our planning and economics group did a complete reorganization and we took costs out of our system.

And we continue to do that and we're going to continue to push it but you have to be lean, mean and very efficient and move quickly because that's the only way the business model can work in a highly competitive environment.

Chi Chow - Tristone Capital

Are you looking at possible JV opportunities with, with upstream players?

Bill Klesse

No.

Chi Chow - Tristone Capital

Sorry.

Bill Klesse

Go ahead.

Chi Chow - Tristone Capital

I guess, the other question I had was; it just seems like the capital requirements are coming in the few years or may be in next decade. You got a lot non-profit type capital where you need to spend specially on legislative tech items. How concerned are you on the returns, longer term in this business?

Bill Klesse

Well, I guess treat as very fine and fair approach. But all I would tell you that, that's how it always is. If you remember the Clean Air Act first in the 70's then in the 90's when it was amended. If you go back we have all that capital go in. Rich made the comment I am very against this scrubber that we're putting in Benicia. This scrubber itself is $450 million that has no return.

And MSAT II which is the benzene that Rich mentioned, we will spend 530 million the way we're approaching it. We are actually going to make a benzene product out of this so there is some economics in there. But you are exactly right and I have some other examples, of these type of things that this is our business. But if look at our business model and you go back to 30 years into the refining business, we make around a cost to capital way to return.

I know all the theories about how we destroy value and other things, but if you actually look at all the data, you can make a cost to capital way to return. You are not going to hear from Valero that the golden age of refining is around the corner again. We're down to the business as we as a management team know it and that is to slug it out. And that's what we're doing, but we will provide a good opportunity, things happen, we'll have some better years, and we'll have some years that aren't quite as good.

Last year for Valero and everybody said it's going to be a terrible year. We made over $5 a share and over $2.5 billion of profit. The reason we reported losses, we run off $4 billion of goodwill that had no tax effects, which gave us the $2 share loss. But we had a good year this -- last year and this year, we beat our first quarter from last year, and I think gasoline is going to surprise. We have very low prices for gasoline on a relative basis and it does give you an opportunity to get around. So, our business adds value as long as we add value we're part of the society here.

Chi Chow - Tristone Capital

Okay. And one final question, you bring up California, they just adopted this low carbon fuel standard. Just the scrubber at Benicia get you to those requirements and how much more would think you need to put into California I means the state requirement?

Bill Klesse

I mean..... all right.

Joe Gorder

Well, just first on the scrubber, that is for an air quality requirements to reduce sulphur emission, so that it is separated apart from the low carbon fuel standard.

Chi Chow - Tristone Capital

Okay.

Bill Klesse

On low carbon fuel I think we need to look at the detail, there is a movement for low carbon fuels, but they have several provisions where they are talking about some of this land used and trying to go all the way back or taking land stay out of pasture and putting it in the corn and trying to calculate this. I think this is a far bigger issue; there is going to be a lot more politics involved. So this the doubles in the details on this.

Kim Bowers

And the most longer term picture is a 20-20 reduction, 10% by 20-20. there is still a lot of work to be done and evaluation to be done.

Chi Chow - Tristone Capital

Okay. Well great thanks for your thoughts Bill, I appreciate.

Operator

Our next question comes from the line of

Blake Fernandez - Howard Weil

Good morning gentlemen. I know I got in late in the call so I'll just ask my two questions here briefly if I could. The first one is on the tax rate it came in well below what we were expecting, I was wondering if you could provide any color on the key drivers there?

And then secondly, essentially on the refinery utilization process, just trying to understand exactly how that is managed, just want to know if its based on a short-term rate of return process, in other words, a $9 or $10 Gulf Coast crack generates a sufficient rate of return. Does that prompt you to increase utilization or you taking more of longer term approach in trying to manage the inventory balance? Thanks.

Mike Ciskowski

Okay first place on the tax rate. We were lower than guidance that was due to on a proportional basis Aruba and Canada made a greater percentage of the income so, if there are lot of tax rate, obviously no tax in Aruba so we had came in lower on our tax rate.

Blake Fernandez - Howard Weil

Okay.

Mike Ciskowski

The refining utilization?

Joe Gorder

Yeah I mean, we look at our utilization and on an ongoing basis and we have planning economics group which Bill mentioned earlier that run VLP model and we're continuously adjusting based on what the market does so, we look at the whole picture though. We look at utilization rates in the context of economics that the economic of course are affected by the inventory values and then cash requirements. So it all gets balanced, but bottom line is it's a dynamic eroding process that goes on all the time.

Blake Fernandez - Howard Weil

Okay. Is that to suggest that maybe....

Bill Klesse

We could give you a little more. We do basically we've got almost like a three month look when you think about it. We do a monthly business plan, what we call an operations plan. That gets coordinated through all the groups; gets done before the end of the month. And there's got a lot of current pricing we make price calls just like you would make price call and we run our model, and we'll put a hurdle in there on margin. And depending on seasonality other factors and some judgment that hurdle rate can move around.

Blake Fernandez - Howard Weil

Okay, that's great. Thanks a lot for color.

Operator

Our next question comes from the line of Faisel Khan with Citigroup.

Faisel Khan - Citigroup

Good afternoon.

Bill Klesse

Good afternoon.

Faisel Khan - Citigroup

One question on the ethanol acquisitions do you expect those -- that acquisition to be accretive to earnings this year and how do you expect that to be going forward?

Gene Edwards

Based on current pricing, this is Gene Edwards, ethanol about a $1.66 probably it goes to corn and just under $3.80 of virtual. This plans our cash flow in positive right now. But we really think the real upside is probably 2010 when the RFS accept another 90,000 barrels a day or so, its really going to tighten its wide demand in further.

And that's the assumption as we use when we're buying the plants. We figure that this year would probably more or less cash flow neutral fund deposited. Last venture is still down; but our plans to invest in advantage locations in the core build which allow us to be cash flow positive while other industry are still struggling.

Faisel Khan - Citigroup

Okay. On a GAAP basis are you saying that it will be neutral or it will be a loss like....

Mike Ciskowski

I think its going to be a neutral. Neutral for us.

Faisel Khan - Citigroup

Got you. And then in your prepared remarks you guys talked about the narrowing sour differentials in the quarter versus last year? Can you us, what you guys expect going forward for the rest of this year, given the OPEC pricing to be in full effect?

Joe Gorder

Yeah, you know the factors and when we've got the OPEC cover the declining Maya productions we've got the weakness in the front WTI and we got relatively tight fuel our markets which have affected heavy sour discounts. So really I think, our view going forward to be that until demand grows, we're probably going to see discount stay in this general range.

Nothing is expected to change unless we get demand back, which of course would then stimulate the runs, it would pull suite crude things stored, at the storage rates of the price there and then we would get a discount of that.

Faisel Khan - Citigroup

Fair enough. Thank you for the color. I appreciate it.

Operator

Our next question comes from the line of Jacques Rousseau with Back Bay Research, LLC.

Jacques Rousseau - Back Bay Research, LLC

Most of my questions have been answered just wanted to try one more. Have you got any idea of the gasoline demand for April at your 1000, how its comparing to last year?

Mike Ciskowski

I think its pretty much flat in April I believe the advantage is pretty much flat from the first quarter.

Jacques Rousseau - Back Bay Research, LLC

From the first quarter or from April 2008?

Mike Ciskowski

I was referring to the first quarter.

Jacques Rousseau - Back Bay Research, LLC

Do you have any color versus year ago?

Mike Ciskowski

I don't have that for April of 2008.

Jacques Rousseau - Back Bay Research, LLC

Okay, thank you.

Operator

Our next question comes from the line of Mark Gilman with The Benchmark Company.

Mark Gilman - Benchmark Company

Hey guys, real quickly how much natural gas do you consume system wide?

Unidentified Company Speaker

We're using 400 now. It's when we back cast back into our energy consumption, its around 400,000 MMBtu per day of natural gas activity. But that includes all energy that's not just a natural gas but most of our energy, the power all that stuff is fired by natural gas as we think today. As well as hydrogen and steam its all basically driven also by natural gas.

Mark Gilman - Benchmark Company

Thanks Eric.

Unidentified Company Speaker

Sure.

Operator

Again we have no further questions. Mr. Smith, do you have any closing remarks.

Ashley Smith

We appreciate you shareholders listening to our call. If you have any questions call Investor Relations or check in with our website. Thank you.

Operator

This concludes today's Valero Energy Corp. first quarter 2009 earnings conference call. You may now disconnect.

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Source: Valero Energy Q1 2009 Earnings Call Transcript

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