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Tesoro Corporation (NYSE:TSO)

Q1 2009 Earnings Call Transcript

May 7, 2009 8:30 am ET

Executives

Scott Phipps – Director, IR

Bruce Smith – Chairman, President, and CEO

Greg Wright – EVP and CFO

Everett Lewis – EVP and COO

Lynn Westfall – SVP, External Affairs and Chief Economist

Dan Porter – SVP, Refining

Analysts

Paul Cheng – Barclays Capital

Chi Chow – Tristone Capital

Blake Fernandez [ph]

Jeff Dietert – Simmons

Mark Gilman – The Benchmark Company

Erik Mielke – Merrill Lynch

Mark Caruso – Millennium Partners

Operator

Good morning. My name is Laura, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Tesoro Corporation first quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Mr. Phipps, you may begin your conference.

Scott Phipps

Thank you, Laura. Well, good morning, everyone. And welcome to today’s conference call to discuss our first quarter 2009 earnings. As management will be referencing slides we filed earlier with the SEC, I encourage you to have these available as we progress to this morning’s call. These slides, along with other financial results, including the press release and supplemental quarterly data, can be found on our Web site at tsocorp.com.

As a review in this information, please feel free to contact me with any questions about this material or otherwise following today’s call. Please refer to the forward-looking statement in the earnings slides, which says statements made during this call that refer to management’s expectations and/or future predictions are forward-looking statements intended to be covered by the Safe Harbor Provisions of the Securities Act as there are any factors, which could cause results to differ from our expectations.

Before Bruce’s comments, I’d like to offer guidance for the second quarter of 2009. I’ll be starting with slide three. We estimate throughput to be in thousands of barrels per day, in the pacific North West, 135 to 145; in the mid pacific, 60 to 70; in the mid continent region, 105 to 115; and, in the California region, 255 to 265 thousand barrels per day.

OpEx guidance for the second quarter is as follows. In the Pacific North West region, $3.50 a barrel, which is $1.25 lower versus the first quarter of 2009 as a result of expected higher throughputs in the second quarter. In the Mid Pacific, $3.70 a barrel, which is roughly $1 higher than the first quarter based on lower throughput and as well as higher expenses due to a short surgical outage we incurred in the second quarter. In the mid continent, $3.30 a barrel. And in California, $6.35 a barrel, which is roughly $0.65 lower than the first quarter as a result of lower expected repair maintenance and energy costs, along with higher throughput in the first quarter.

Our depreciation for refining is estimated at $90 million. Additional second quarter guidance items include corporate expense of $40 million, interest expense before interest income of $30 million, and a marginal tax rate of 38%.

I will now turn the call over to Bruce.

Bruce Smith

Thanks, Scott. And I’ll add my good morning for everybody. In the first quarter, we saw the inverse of what we would normally expect to see in a first quarter margin environment. Normally, we see margins peak in March. But in January, we saw the high point in margins for the quarter as we realize historically high West Coast crack spreads, those declined in February. And by March, our cracks were below their historical average.

In today’s environment, certainly nothing surprises us. We anticipate the unexpected, but the financial results for the first quarter were certainly better than our expectation. Another first quarter achievement was a strong start in meeting our 2009 improvement initiatives, which I’ll talk about later.

Now turn to slide four. That slide shows that net income for the quarter was $51 million or $0.37 a share versus an $82 million or $0.60 per share loss a year ago. And that loss included an after tax benefit of $0.20 a share as a result of a settlement in the litigation over the Alaska pipeline tariff, which further magnifies the year-over-year difference.

Slide five, covers other key financial data. Cash totaled to $156 million. And our 32% debt to capitalization ratio was a dramatic improvement from the prior year’s 41%. At the end of the first quarter, we were un-borrowed on our revolving credit facility, compared to last year’s first quarter when we had $545 million of revolver borrowings and $66 million outstanding at the end of the year. The reduction in debt, combined with approximately $1 billion of availability, puts us in a materially stronger financial condition than we were last year.

On slide six, we showed the significant variances between first quarter operating income. Our first quarter gross margin was $12.14 a barrel, $5.65 more than it was a year ago. But we captured $3 more of the available margin since the Tesoro index rose by only $2.65 a barrel. Said another way, our programs made a contribution roughly equal to what could be attributed to supply problems from both planned and unplanned industry downtime as well as historically low PADD V gasoline inventories. When production returned to the market in the late February, the index declined from its quarterly highs. Then as the West Coast market transitioned to summer grade gasoline, the index rose from its mid March lows, and averaged approximately $10 a barrel in April.

Declining crude prices help consumers as lower pump prices are now well below a year ago. In the first quarter of this year, gasoline in California averaged $1.20 a gallon lower than a year ago. It was over $2.30 below the July 2008 peak. Even though unemployment in California is almost doubled over the same time, lower pump prices appear to be stimulating some discretionary driving and we are seeing early signs that we may be reaching a plateau in demand.

In our own retail system, first quarter year-over-year volume decreased around 9%, which is indicative of a weak demand environment we’ve been seeing on the West Coast. However, the data points we monitor on a weekly and monthly basis are not always an accurate gauge of current market dynamics. Days of supplied for gasoline are well below the highs from a year ago. And they are more in line with levels seen in the last few years.

The West Coast has been able to accomplish this, primarily through decreased imports, increase export activities, and by refiners adjusting production to meet demand. As the demand data has become clearer, the refining complex has responded with appropriate and discipline supply adjustments.

Turning to our operational performance, in the quarter we successfully completed maintenance on the crude tower and other units at our Anacortes refinery. Additionally, we had downtime at both California refineries. The Los Angeles refinery had issues relating to the coker heater, which impacted both throughput and yields. And we had an additional downtime related to a decoking in March. At Golden Eagle, we also experienced coker downtime due to repair of a malfunctioning feed valve.

Currently, we are at a full turn around in Alaska, which began on April 21st. And that turnaround is expected to last about 20 days.

In January, we shifted production from lower value diesel to yield more gasoline at both California refineries, which averaged 51% gasoline in the fourth quarter. But gasoline production rose to 54% in the first quarter. One consequence of shifting our yield to optimize gasoline profitability will be that realizations on our index will now be more in lined with benchmark yields.

A year ago, the industry was maximizing distal yields. And we made adjustments, which made it possible for us to produce more diesel as those spreads relative to gasoline were very favorable. Ultimately, a shift like that contributed to the shorter gasoline supplies that we are seeing today, which has strengthened gasoline cracks.

Operating cost in the first quarter were $257 million, which was inline with our guidance, although our costs were higher on a per barrel basis due to lower than planned throughput. One of our expense focuses has been to reduce energy costs. And they were down year-over-year, both due to a combination of price as well as energy efficiency initiatives.

Reducing energy costs was one of the non-capital initiatives announced at our investor meeting last December. And slide seven summarizes this plan. As a reminder to you, this program was designed to improve the realization of the available margins. And year-to-date, we’ve realized $103 million from the non-capital program. These non-capital initiatives improved the weighted average of the Tesoro index by approximately $2.15 a barrel. These results are in line with our original improvement plan. And I expect us to realize the stated goal for both capital and non-capital initiatives, which totals $370 million for the year.

And those significant savings have been in a program that is designed to lower our crude cost by increasing crude flexibility. We do this mainly by taking advantage of our refinery's processing ability as well as the synergies associated with the proximity and makeup of our West Coast system. Another critical element is the flexibility and coordination exhibited by our refining supply and optimization departments.

For more than a year, we have been addressing the low demand issue created by the declining economy. In retrospect, we now know that California and other parts of the Western United States were at leading edge of the global economic problems that arrived in the fall of 2008. We reacted decisively beginning in late 2007 to address the issues of rapidly rising crude prices, the decline in product demand, and a poor margin environment by adjusting our utilization rates. We also began a program to conserve cash in order to rebuild our balance sheet. That plan was centered on lowering our capital spending and reducing excess inventory levels, which again, in retrospect, happened at very favorable prices.

Turning to slide eight, our 2009 improvement initiatives are designed to drive down our cash breakeven costs so we can be profitable when crack spreads are below what we experienced in 2008. In addition to this improvement program, we will make needed changes to using or investing cash, which means we will just our $600 million capital program as appropriate and to continue to have a sharp focus on optimal inventory levels. Notwithstanding, our strategic objective is to lower our costs and execute the sustainable pieces embedded in our improvement initiatives.

Our ability to improve our cash position by over $600 million in a year is a testament to the ingenuity and efforts of our employees. One facet of our company’s culture is that we understand the need to anticipate and adapt the change that we believe this is particularly important in today's highly uncertain environment. For years, we have said our culture gives us the ability to be a strong – stronger competitor and it gives us the foundation to improve share holder returns.

While we witness better than expected margins in the first quarter, we know that there are challenges ahead. And we are prepared to operate with lower margins than we had in 2008. And we will continue to plan for that environment until we see a more positive and sustainable change in the market place. And with that, we're ready to take questions.

Scott Phipps

Laura?

Bruce Smith

Laura?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Paul Cheng of Barclays Capital. Mr. Cheng, your line is open.

Paul Cheng – Barclays Capital

Hey, guys. Good morning.

Bruce Smith

Good morning, Paul.

Paul Cheng – Barclays Capital

Just a number of quick balance sheet items. Do you have a working capital number on your inventory mark advantage in excess of the book value? And also the long-term component of the total debt?

Bruce Smith

Yes. I'll let Greg answer.

Paul Cheng – Barclays Capital

Hey, Greg.

Greg Wright

Paul, our working capital in the first quarter was increased less than $10 million. So working capital was about $215 million.

Paul Cheng – Barclays Capital

$215 million. Okay.

Greg Wright

Inventory excess market value over book was about 480 million.

Paul Cheng – Barclays Capital

$480 million. Okay.

Greg Wright

And you want a long-term debt?

Paul Cheng – Barclays Capital

Right.

Greg Wright

Just the long-term? You don’t want capital leases in there or you do?

Paul Cheng – Barclays Capital

No. Just the long-term debt.

Greg Wright

Okay. I'll have to look that one up.

Paul Cheng – Barclays Capital

If you don’t it then including long time leases. That’s fine.

Greg Wright

It's a $1.544 billion including–

Paul Cheng – Barclays Capital

$1.544 billion. Okay. And Greg, I didn't hear, in your result, you stayed at the inventory or (inaudible) or loss in the first quarter in the gross margin?

Greg Wright

Nominal.

Paul Cheng – Barclays Capital

Nominal. Okay. And can you tell us that what is the CMA Contango benefit in the mid-continent system for the quarter?

Greg Wright

The CMA that you’re talking about–

Bruce Smith

In the mid-continent system?

Paul Cheng – Barclays Capital

Yes. I mean, I assume that it's only the mid-continent system that you guys will benefit from the Contango.

Everett Lewis

We didn’t do any separate Contango plays around that. We do, do a lot of current monthly average pricing, but we don’t calculate the Contango benefit for that.

Paul Cheng – Barclays Capital

When you do the CMA by definition that you got the benefit from the Contango.

Everett Lewis

You do get some benefit because of your current monthly average price. We have not calculated the separate number for that.

Paul Cheng – Barclays Capital

Is that something that you guys may do or that you're not going to say, be part of it?

Everett Lewis

Well it’s not something we have done. We can’t certainly talk about whether we do it.

Paul Cheng – Barclays Capital

Okay. If you guys can share that number that would be interesting because in the first quarter, I think that the Contango was a quite dramatic. So most likely that backup benefit may not pull through in the second quarter. Bruce, it sounds like that – I'm sorry.

Bruce Smith

Go ahead.

Paul Cheng – Barclays Capital

Bruce, I think at this point, it sounds like that you do not have any plan to change the 2009 CapEx, so you're still in the $600 million?

Bruce Smith

That's correct.

Paul Cheng – Barclays Capital

Okay. And a final point on (inaudible). Do you have the turnaround – I thought that that one for the remaining of the year, are we still going to have any major turnarounds?

Bruce Smith

We do. We have a hydrographic turnaround at the Golden Eagle this quarter. And we have got a hydrographic turnaround at Los Angeles, which is I think is the third quarter – fourth quarter.

Paul Cheng – Barclays Capital

So a hydrocracker for the LA in fourth quarter. And Bruce, you mentioned earlier, I think that the coker in Golden Eagle was having some issue in the first quarter. Can you elaborate a little bit more because I thought that was a brand new one? So we need to not expect to have any problem. Is there anything serious, which should we consider?

Dan Porter

No. We have some – this is Dan Porter. We have some minor issues around some of the decoking wire control for decoking the drums. It was relatively minor, those have been repaired and fix and is operating well.

Paul Cheng – Barclays Capital

I see. And Dan, how long is there – how'd you crack the turnaround going to be in the Golden Eagle in LA? And during that time, is that the whole facility going – whole unit is going to shut or is it just going to in the reduce smoke?

Dan Porter

The hydro cracker, and the reformer, and the hydrogen plant will be shut down during that period. And that will be approximately 39 days of oil-to-oil turnaround.

Paul Cheng – Barclays Capital

So for the Golden Eagle is 39 days. How about LA?

Dan Porter

LA is again is in the fourth quarter. It will be approximately 35 days.

Bruce Smith

They're about the same.

Paul Cheng – Barclays Capital

About the same. Perfect. Thank you.

Bruce Smith

You're welcome.

Operator

Your next question comes from the line of Chi Chow of Tristone Capital. Mr. Chow, your line is open.

Chi Chow – Tristone Capital

Okay. Thanks. Good morning.

Bruce Smith

Good morning, Chi.

Chi Chow – Tristone Capital

I was noticing in your refining segment, the line items and other expenses in SG&A seemed on the low end of the first quarter. Is there anything unusual in those numbers or that's a run rate going forward through the rest of the year?

Scott Phipps

I think you – chances that – you use this year's guidance as your run rate. There's always going to be some employee auctions and re-pricings that change it, but you should use the guidance going forward.

Bruce Smith

There's nothing that I could tell you that's unusual there, nothing that I’m aware of.

Chi Chow – Tristone Capital

Yes. Again, this is just specific to the refining segment. I know I think your guidance is more on corporate G&A. is that correct?

Scott Phipps

It is.

Bruce Smith

It is.

Chi Chow – Tristone Capital

Okay. Okay. Another question, what is your outlook on light-heavy differentials going forward the rest of this year?

Bruce Smith

That's a good question. I don’t know who wants to take that. Lynn, you want to–

Dan Porter

We can do it either way. I think we see some continuous pressure on the light heavy differentials. I mean there's additional demand for heavy crude. There's less light crude going in to topping facilities and the combination of those has compressed the light heavy differential. And we are planning on the basis that we’ll see some continued compression and light-heavy differentials this year.

Bruce Smith

Yes. For the rest of the year it’s a little harder. I think in the– my concern was from asking the question is what we think of the longer term. But in the shorter term, and in certainly all of our plans, we don’t anticipate that it’s going to change. I don’t know. Dan, do you have any other–?

Dan Porter

No. I think as well we’re starting to see some of the effect of the stimulus package from the president to make its way down into asphalt demand. And that’s certainly going to bid up the price of the heavier barrels. So I agree with everything that has been said here. We’re looking forward – we can’t see how it will widen out too much from where it is right now.

Bruce Smith

I mean, generally, if you look at the declines in what’s happening in heavy crude production and with – certainly those that have – that's those that just have heavy crude production. And when you look at the OPEC trying to maximize the value of their product and selling those, it’s just hard to see how we’re going to have just lower absolute crude price, the dynamics and the compress that. So again, you sort of look forward and say, what do you think about crude prices and you may see some expansion of that light – heavy-light differentials. But certainly in our second quarter planning, we’ve got it to be very narrow and are taking actions around that.

Chi Chow – Tristone Capital

Yes. Yes. How’s that impact to your crude purchasing decisions here?

Dan Porter

It’s affecting us like it is most. I think we’re all looking at our coker utilization. We’re all looking at the amount – the optimal amount of heavy crude we’re running, and we’re making adjustments around that.

Chi Chow – Tristone Capital

Okay. Thanks a lot.

Bruce Smith

Welcome.

Operator

Your next question comes from the line of Blake Fernandez [ph]. Mr. Fernandez, your line is open.

Blake Fernandez

Thanks. Good morning. Bruce, you eluded to the opportunities that you’re seeing for exports in the market. And that echoes commentary we heard from one of your competitors about a week ago. I was just wondering if you could elaborate a little bit on the order of magnitude or exactly what opportunities you see out there?

Bruce Smith

I’m sorry. In my comments, it was just sort of a general West Coast comment, but there are – been some exports out, which have really adjusted inventory levels. We’re not – I don’t know. From our point of view, we hadn’t any significant exports out in –

Lynn Westfall

Well, the West Coast tends to be a little long and desolate, and we made some small exports on the West Coast. But it’s not a large program in any way.

Bruce Smith

I’m sorry if I mislead you there, Blake. Just to be clear, it was really an industry comment about what’s happened in PADD V. Trying to look at where are the inventories are, and part of that the lower inventory levels has been facilitated by industry exports out. And that’s where we are today with the very low inventory level.

Blake Fernandez

No. That’s great. That’s great. Thanks. The only other one I had for you. I know there’s an awfully lot of planned downtime on the West Coast through I guess, it’s May. And I’m just wondering, do you think once that planned downtime is complete, do you expect to significant ramp in utilization? Or do you think industry will maintain discipline and we’ll see depressed utilization rates ongoing out there?

Bruce Smith

I think that generally speaking, that everybody sees all the statistics today exactly the same way. I don’t talk to anybody that is overly optimistic about what’s happening right now. The real issue for us and this is what makes the second quarter now the most difficult as far as predicting and as far as planning. I’d expect that that production is going to come on and I expect it to be very disciplined. There’s absolutely no incentive at these levels. I think the biggest statistics we’d look at is we look on the West Coast it’s what’s happening with imports. And imports are virtually non-existent.

That’s sort of the good news and the bad news. You’d like to see a margin environment that where people feel like they could bring their product into the West Coast. So the data is fairly clear. What’s not clear is what’s going to happen in the driving season. We have seen – as I’ve said in my comments, we’ve seen a little bit of a plateauing over the last several months now in declining demand. Gassing prices are at a low level. And so I think a lot of it is going to be just trying to judge what the industries – I don’t think we’re any different from anybody else, trying to figure out whether there’s going to be a change in demand. And I think how that supplies matches up over compared to that demand over the second quarter is really going the telling for the profitability of the second quarter.

So I expect them – to answer your question, I expect the return of that, and you’re right, May. So by June that will come back, but I think it to be very disciplined. But then trying to read where demand is will be an important part of the second quarter profitability.

Blake Fernandez

Sure. Okay. Well, thanks a lot. Appreciate it.

Bruce Smith

You’re welcome.

Operator

Your next question comes from the line of Jeff Dietert of Simmons. Mr. Dietert, your line is open.

Jeff Dietert – Simmons

Good morning. I had a question on desolate inventories versus gasoline inventories. It looks like US gasoline imports have declined and the gasoline pool is looking a little better while desolate stocks are still very high. We’re seeing people talk about lower utilization on SCCs. How do you see this environment changing going forward? What we need to see higher FCC utilization and people back off on hydro-treating, or is that too simple?

Bruce Smith

That’s a general US question, but why don’t we talk about what people are going to do, Everett?

Everett Lewis

I think it’ a little bit like the coker question. As the dynamics of supply-and-demand and the inventories change, people are going to adjust accordingly. I mean, SCC economics actually for the gasoline season are looking better than they have. So I think if you’re going to see some SCC capacity come back, I think diesel inventories are very high so people are going to do what we’re doing. They are going to be cutting back on diesel production and chasing more of the gasoline market. And they’re going to have to balance overall utilizations with the overall demand picture however it develops, which I think is impaired by these, looking forward to seeing how that happens and will adjust accordingly.

Jeff Dietert – Simmons

Have you made really all the adjustments you can. You’ve made a pretty substantial improvement in gasoline yield and reduced diesel yield. Have you already maxed out that capability?

Everett Lewis

I think we saw some more room although our gasoline yields are back to what they sort of early ’08. So we’ve made a lot of the initial moves on gasoline. We certainly have, like everyone else, some additional gasoline capacity in our system should we choose to use it and should the market justify it.

Bruce Smith

I think, excuse me, you can probably first say that collectively, when we look at the quarter, we’re probably looking still at more adjustments overall, not just to that one factor. But we’re tending to do during the quarter. I think going back to the earlier question that Blake asked, Jeff, in the data is now getting about what’s going to happen in the second quarter and we’re going to make adjustments. And I think this feels almost like the first quarter to me, which is a way of saying that when I think traditionally, not like I’ve said at my comments that the first quarter went in reverse, went from high to low rather than from low to high.

I think we made it look in the second quarter being somewhat the same as what we would traditionally think about the first quarter with the adjustment starting to occur now. And of course you just don’t turn things on a dime. People are going to looking at the data, making adjustments. And I think that the real emphasis is going to be probably toward late May and June profitability and that’s going to determine really where the quarter is. So I think we’re doing a lot right now with looking at what we’re going to do to make adjustments to inputs and outputs for the quarter.

Jeff Dietert – Simmons

Thanks, Bruce and Everett.

Operator

Your next question comes from the line of Mark Gilman of The Benchmark Company. Mr. Gillman, your line is open.

Mark Gilman – The Benchmark Company

Good morning, guys. A couple of questions about California, versus the fourth quarter, did the crude slate change at all? I noticed that in conjunction with the increase in the gasoline yield, the result yield is also higher. Is there any relationship there that you might be able to talk about?

Everett Lewis

Generally speaking, I think we’ve been running a slightly heavier crude slate and of course the prices of the fuel oil had improved as everybody is looking at different peat stocks with their cokers. So it’s not surprising that fuel oil yields would be up and heavy crude rounds would be up a bit. But beyond that, I don’t have good data.

Mark Gilman – The Benchmark Company

But no significant changes on the crude slate 4Q versus 1Q in California?

Everett Lewis

No, I don’t think so.

Mark Gilman – The Benchmark Company

Okay. And in the mid-continent area, were you running any Syncrude in the quarter?

Everett Lewis

Yes. We ran some Syncrude as the marginal (inaudible) in Salt Lake, but not very much. The real advantage crude there are the Rocky Mountain crude and the Bakken.

Mark Gilman – The Benchmark Company

Any Canadian light in the mid-continent?

Everett Lewis

Lewis

Not the terms. Primarily it’s been in the Rocky Mountain crude, a little bit of the Syncrude over Salt Lake, as I indicated.

Mark Gilman – The Benchmark Company

But I mean minor amount?

Everett Lewis

Yes. In the case of the Canadian light crude it would be a minor amount, if any.

Mark Gilman – The Benchmark Company

Okay, just one more for me and in a way for clarification. I thought I heard Greg say that there was a $10 million increase in first quarter working capital in response to a prior question. If that was true, I guess I’m still looking for about $100 million from a cash flow, funds flow perspective. Could you confirm that that $10 million increase in working capital that I heard was indeed correct and help me to reconcile the funds for that?

Everett Lewis

It is correct.

Mark Gilman – The Benchmark Company

Any other material changes from a cash flow perspective in the first quarter?

Everett Lewis

No. I’d like to give it with Scott after the call and you guys can work it out.

Bruce Smith

Okay there’s nothing we could point you out right of the bat here.

Mark Gilman – The Benchmark Company

Okay, guys. Thanks a lot.

Operator

The next question comes from the line of Erick Mielke of Merrill Lynch. You’re line is open.

Erik Mielke – Merrill Lynch

Okay, good morning. I have two questions. First, is relating to natural gas pricing and how it may impact your operating cost. Can you give us an update on where we are with that? And also, in reference to the cash breakeven side that you have, can you confirm what sort of a gas pricing you’ve incorporated in that? And is it the same number for 2008 and the 2009 projection?

Everett Lewis

For the slide Erik, we’ve held the gas price constant so the improvement that you’ve seen on the energy efficiency would be immaterial of price. And the guidance that we’ve given of the Street is a $1 change in BTU is worth roughly $9 million a quarter for our system.

Erik Mielke – Merrill Lynch

And what was the natural gas price breakeven into the cash breakeven price

Everett Lewis

$5.75. $5.65.

Erik Mielke – Merrill Lynch

Great Second question for me is just sorting up on your comments earlier on what’s happening to demand. If you look at the official government statistics, I know that we dictated (inaudible) on a monthly date, but it doesn’t appear that in March and April we saw bit of a double dip both for gasoline and for distillate. And gasoline in part is driven by higher crude prices and therefore higher pump prices. Is that data consistent with what you’ve seen in March and April, and into May?

Everett Lewis

Excuse me, I think what you’re seeing is going on now is that during the last half of last year, we had two things going for us on the demand side, which showed some pretty good increases. We had prices coming down I think from peak $2.40 a gallon and unemployment had really taken off. I think what we’re starting to see now though is a reversal of those two things.

Prices on the street are now up above $0.40 since in the beginning of the year. And as you are well aware, we’re starting to see unemployment go up from 8.5% in January to 9% now in March. So it’s a little difficult going forward to see where demand is going to end out. We’re certainly not getting help from prices. So I think it’s going to take a levelling off of the unemployment before we could start seeing increases again. Did that help?

Erik Mielke – Merrill Lynch

It does indeed. Thank you.

Operator

Your next question comes from the line of Mark Caruso of Millennium Partners. Your line is open.

Mark Caruso – Millennium Partners

Good morning. I got in late so I apologize if you already made the comments on this, but one was – I didn't hear – I know you guys gave the guidance on the 2Q looking at the slides, but I just didn't know. Did you give your thoughts on the industry and I know Bruce had said that pricing was a little bit weaker and you haven’t seen demand make a big uptake. I just want to know if that was your general comments on 2Q. And the second question is just a follow-up to Eric’s question. I missed it. Was the 565 gas on the annual or the 2Q guidance for a cost?

Everett Lewis

We don't give guidance for what we expect natural gas will be at. That's just for the estimated breakeven anticipation for the $2.50.

Mark Caruso – Millennium Partners

Okay.

Bruce Smith

Yes. I think on the other side of it. I hate to go backwards here, but don't mean to – sorry? Hello?

Mark Caruso – Millennium Partners

Hello?

Bruce Smith

What happened? The general outlook for the – took me a long time to go through this first I had to summarize it quickly. Demand is really the key to the 2nd quarter and we've got supply that's going to be coming back on, has been noted by their participants. Expect that demand to be disciplined, but trying to guess where supply is going to be in the second quarter, both those factors are going to be significant in determining profitability along with one of the other participant said, which was what's going to happen relative to some of the inputs in the 2nd quarter with the very narrow heavy-light differentials we're seeing.

So a combination of factors we don't – we think that it's going to be a challenging quarter across the board. I’ve said that I think that it's going to be somewhat inversed that is going to be really about late May and June to determine the entire profitability. So we're making adjustments today, I think everybody else is going to be making adjustments. And I think that with the lag that occurs when people at data, it's really the later part of the second quarter before we can really determine where profitability is going to be.

And then continuing in the third quarter, it's going to depend on the strength of the demand. But with low prices, I think there's a good chance that we're going to see improvements. And demand was down, we think we're down at sort of the base level and from here it’s more upside potential than downside.

Mark Caruso – Millennium Partners

Thanks. I just have one follow up. As far as the Bakken differentials go, I know in the first quarter they were in a more advantage. Can you give us a sense of update now because some of the producers are talking about renting back up production? I just want to see how you guys see that impact in the opportunity there.

Bruce Smith

I think the Bakken crude in our situation and (inaudible) continues to be a healthy one for us and we tend to – and we continue to get performance there. The Bakken crude producers are going up and down a bit. I think generally, the new exploration is down. And there'll be some downward pressure on supply at these prices. But we do see the ups and downs you're talking about and we continue to see that as an attractive feedstock for our refinery.

Mark Caruso – Millennium Partners

Great. Thanks so much.

Bruce Smith

You're welcome.

Operator

There are no further questions at this time. I'll now return the call over to Mr. Bruce Smith for his closing remarks.

Bruce Smith

I just want to thank you for participating. It's like what we’ve said, it’s going to be an interesting quarter. And so we look forward to talking to you at the end of the second quarter. If you have any follow up questions, obviously we'll be more than happy to address those and talk to you as the quarter goes on. So again, thank you for being with us today.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect, and have a great day.

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Source: Tesoro Corporation Q1 2009 Earnings Call Transcript
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