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Tesoro Corp. (NYSE:TSO)

Q2 2009 Earnings Call

July 30, 2009; 8.30 am ET

Executives

Bruce Smith - Chairman, President & Chief Executive Officer

Chuck Flag - Senior Vice President of system optimization

Everett Lewis - Executive Vice President & Chief Operating Officer

Scott Phipps - Director of Investor Relations

Analysts

Jeff Dietert - Simmons

Ann Kohler - Caris & Company

Arjun Murti - Goldman Sachs

Chi Chow - Tristone Capital

Blake Fernandez - Howard Weil

Paul Cheng - Barclays Capital

Corey Garcia - Raymond James

Alex Inkster - Sanford Bernstein

Operator

Good morning. My name is Beth, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tesoro Corporation announces second quarter results 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 period. (Operator Instructions)

Mr. Phipps, you may begin your conference.

Scott Phipps

Thank you, Beth. Good morning, everyone and welcome to today’s conference call to discuss our second quarter 2009 results. As management will be references 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 quarterly financial results, can be found on our website at tsocorp.com. After 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 I provide guidance for the third quarter 2009, please note that we where reconciled second quarter throughput and OpEx guidance to actual in two slides in the appendix of the earnings slide deck. Text below the charts provides more detail for any significant variances. I’ll now provide third quarter guidance for modeling purposes.

I’ll be starting with slide three of the presentation deck. We estimate throughput to be in the California region 235,000 to 245,000 barrels per day. In the Pacific North West, 150,000 to 160,000 barrels per day, in the mid-pacific region, 60,000 to 70,000 barrels per day and in the mid-continent, 105,000 to 115,000 barrels per day.

OpEx guidance for the third quarter is as follows in California $7.20 a barrel, in the Pacific North West, $3.20 a barrel, in the mid-pacific region, $3.50 a barrel and in the mid-continent, $3.50 a barrel. Our depreciation for refining is estimated at $90 million. Additional second quarter, third quarter guidance items include corporate expense of $45 million and interest expense before interest income of $30 million.

I’ll now turn the call over to Bruce.

Bruce Smith

Thanks, Scot. I would like to say good morning also to everyone that’s on the phone and anybody that happens to be lives over the Internet. Last night, we reported a second quarter loss of $0.33 a share. These results and the reasons for our loss aren’t much different from what you would have expected.

The gasoline strength that we saw in the early part of the quarter evaporated during the quarter, although we did see an uplift in marketing margins late in the quarter, but that was not enough to offset the one two punch of depressed distill margins and heavy light crude differentials.

The combination of all these factors resulted in the gross margin that was lower than the second quarter of last year and when that was below the first quarter of this year. One piece of good news is that PADD V supply demand remained in better balance in other markets.

Although clean product inventory is compare actively low versus the five year average, unseasonably low demand for gasoline and lower diesel demand for transportation and industrial fuels, suppressed second quarter margins as the Tesoro index was below both the prior year and the prior quarter’s range.

Although there’s been some improve in the July index, the index is at the low ends of the historical range for this time of year. In this environment, we are continuing to reoptimize the individual processing units in our entire system. I assume that the industry is looking at very much the same thing. For example, with the narrowing of the heavy light crude differential, coking economics have been thin regardless of where the unit is located.

Turning to our financial results, slide four in the deck that has been distributed, shows a net loss for the quarter of $45 million or $0.33 a share, versus earnings of $4 million or $0.03 a share a year ago. The second quarter results did include a $12 million pre-tax charge to write-off equipment purchased as part of a long term capital project that was initiated in 2007.

Although this charge was negative, the reason we took the charge was driven by positive facts. As you may recall, when the West Coast margin environment changed, I challenged our capital management team to find ways to reduce regulatory capital spending and in this case, they found a much lower investment strategy that was planned by Shell that meets a regulatory compliance target that was imbedded in a lower in a larger project. Therefore its relatively easy decision, save cash and take a write-off.

On slide five, we’ve highlighted a few financial statistics. At the end of the quarter, our cash position includes $282 from our death issuance. We were and are using a revolving credit facility only to issue letter of credit and at the end of the quarter, we had over a $1 billion availability and as this table shows, even after issuing debt or debt to capital ratio was lower than it was a year ago. Segment operating income in the second quarter was $11 million versus $74 million a year ago.

Slide six shows the significant variances between 2009 and 2008. I want to focus on the year-to-year improvement from our optimization program, which we define is our performance against the Tesoro index. The goal of this program is to improve the amount of incremental margin that we capture as we attempt to maximize market opportunities.

Some examples in this quarter would be our successful effort to find and source new crude’s. We also effectively used system inventory to meet supply requirements during the turnarounds in Alaska and at Golden Eagle and then, finally, we shifted a refining production yields to better match demand.

During the second quarter, when gasoline prices traded over diesel, we reduced the amount of our distill production by 5% and increased gasoline production compared to the second quarter of last year when diesel was so strong. Additionally we took advantage of the comparatively higher gasoline margins in Southern California by moving gasoline blendstocks from Hawaii and Golden Eagle into Los Angeles.

Our plans to reduce operate costs have been helped by the decline in natural gas prices, which in the second quarter were roughly 70% lower than the same period a year ago. The overall benefit was higher than just the price benefit, due to our previously announced program that focused on reducing the volume metric consumption of energy. So in total we benefited from price, energy efficiency projects and lower utilization.

Another positive factor in our program is that we have been recording positive year-over-year same-store sales and in some markets sales are higher by 7% and as spot crude and product prices fell during the middle of June, as I mentioned earlier, we saw marketing margins rise. Although margins have recently narrowed a bit, we continue to see good margins in our marketing channels.

I return to slide six and talk about the improvements in operational performance, but these improvements were not adequate to offset the lower margin environment. I mentioned earlier that the Tesoro index was below both the prior year and prior quarter’s index.

Our benchmark Tesoro index was down $3 a barrel from the second quarter a year ago, and a significant amount of that change was caused by the narrowing heavy light crude differentials, as discounts for heavy sour crude grades to well below their historical average.

As noted in our press release discounts for this crude’s dropped by 45% from a year ago. This more significantly affected our California refineries that process heavier crude’s where our realized gross margin dropped by 42% from the second quarter of 2008. Diesel and jet sales continue to be affected by weak global economic conditions.

West Coast diesel margins averaged just under $9 a barrel, even though product supplies on the West Coast are in better balance to the weaker demand environment. U.S. distill at fundamentals don’t look particularly good since we have record inventories and very weak demand, so we are planning for continued near term pressure on distilled margins.

On the other hand, for most of the second quarter, gasoline margins were stronger than a year ago. During the last half of June, gasoline margin fell to almost half their quarterly average of $19 a barrel. In July, West Coast gasoline margins have been slightly better than the lows of the second quarter, averaging $12 a barrel, but that is still well below the average for the second quarter.

Finally, total system throughput was down 7% compared to last year, in part because Alaska’s entire plant was in turnaround and we had a higher crack turnaround at Golden Eagle. Also Alaska had a malfunction with their motor control center that brought their higher cracker down.

In third quarter guidance that Scott gave a little earlier, we don’t have any planned downtime, but it does it clown the current higher cracker downtime at Golden Eagle. Our operating plan for the quarter is to match our total system production to local product demand.

Back in December, we said that we expected lower margins in 2009 and we outlined a plan to enhance our competitive position in each market by improving energy efficiency and lowering our cash breakeven costs, mainly through non-cash initiatives. We do continue to deliver on this plan, even with the volatility that we’ve seen and worse that expected margins.

In slide seven you can see our 2009 improvement initiatives. To update you on our progress, we captured $225 million from this program through the first half of this year. When we laid out our plan, we said that as the market changes, our performance within each bucket would change.

However, as you might expect, the most significant realization is in the crude and feed stock bucket. This is a result of our long standing program to focus on crude flexibility, a practice which is now paying off in light of the current crude market dynamics. For the full year, we still anticipate that we will be able to deliver on our stated goal.

Looking ahead to the longer term, the industry is facing many new challenges that could impact both margins and our profitability. Those include, among other things, government legislation, consumer behavior, obviously the health of the global economy, and both local and global supply demand for petroleum products.

We done know how these issues are going to play out, but I can tell shareholders that we’ve run various scenarios to assess their impact and have developed a variety of outcomes on our business. It’s obvious and we know the change is coming. We are confident that we will be prepared to meet those challenges and take advantage of the existing opportunities that occur.

With that operator, we’re ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jeff Dietert from Simmons. Your line is open.

Jeff Dietert – Simmons

Okay. I’m sorry. I had a question on capital spending. You’ve talked about managing your capital spending within; operating cash flow and I just wanted an update. We’re modeling about $570 million for this year and about $500 million for next year. Are those reasonable expectations? And what’s the range around those numbers, both in a good margin environment and in a weaker margin environment?

Bruce Smith

I can tell you that for the Jeff, for the current year, we think we’re on track. It will depend on timing differences, as always, as we get to end of the year. We announced we’re going to do $600 million I think that looking at where we are, we expect to be a little less than $600 million and it will depend on where invoices come out, sort of in probably the last month of the year as to exactly what that number is.

I don’t know whether that 570s is a number that’s good, but if we look historically, we think we’ll be less than 600. I think that those programs are pretty well baked for the year, what we’re doing right now is we’re rerunning, through these different scenarios, various capital programs for next year and obviously various operating plans for next year.

Our goal is try to figure out we’ve said that next years operating, or capital will be in sort of the $600 million range again. We are looking where we think cash flow is going to be our goal is still be to within cash flow. So, we’re looking at whether we can trim some other things and make some changes to be able to modify our capital program. There’s a very this active effort that we’ve had for about a year has gotten even more active.

The board meeting yesterday, we said exactly the same thing to the board. We said it’s certainly not going to be it’s one of those thins I can say it’s not going to be bigger than, and I think we’ll have a better handle on it probably in the next couple of months now. I don’t think you’re going to be far off of where the numbers going to be.

Jeff Dietert – Simmons

Very good, could you give us an update on what you’re seeing on the demand side in California?

Bruce Smith

Yes, I guess Chuck Flag, who is really driving our operating plan, I mean as I’ve reported; we’ve had a little bit of some very positive store year-over-year store sales. It’s the market has been dynamic to say the least, but I know Chuck, we think…

Chuck Flag

I think we’re beginning to see basically a flattening of the decline rate. In other words, demand for clean products is roughly flat. It appears we’ve seen a little bit of improvement on the gasoline side. However, the distillates are probably roughly equal to slightly negative from where they were year-on-year.

Jeff Dietert – Simmons

Thanks for your comments.

Operator

Your next question comes from the line of Ann Kohler, Caris & Co.

Ann Kohler - Caris & Co.

I had a question just follow upon, certainly you mentioned you were seeing pretty good year-over-year, I guess same-store improvement on the retail side?

Bruce Smith

Right.

Ann Kohler - Caris & Co.

What is that attributable to, the very good improvement?

Bruce Smith

Everett?

Everett Lewis

Sure. I think what we’re seeing on the retail side reflects a lot of what Chuck was talking about generally in California. The overall statistics show slight increases year-over-year in California gasoline. We’re seeing the same sort of pattern in our retail stores. So, I think it’s a broad thing, not necessarily specific to our stores.

Ann Kohler - Caris & Co.

Okay. So, there’s been no, like, promotionals or changes within the store, or your pricing arrangements, or pricing strategy?

Everett Lewis

Not that is driving that. Think we’re always trying to too better on our retail system, and we have a good system, but I think our same-store increases are more fundamental than that.

Ann Kohler - Caris & Co.

Okay. Great, and then my last question, is could you just provide a little bit of detail on how you viewed the heavy-light differential, kind of over the balance of the year and into next year, kind of what you expect for that?

Chuck Flag

Yes, Ann, this is Chuck Flag. It’s pretty hard to tell what that is going to be certainly what we seen over the past year have been substantial declines militia going from $21 down to about $5. The domestic, however has not fallen as much from roughly $15 down to $9.

There’s been so many factors that have influenced that. The increase in purchases of heavy crude from both India and China, certainly OPEC, as they’ve cut their total production has tended to cut the heavier grades being the lower revenue grades for them, as opposed to the lighter grades and we’ve seen a few cokers that are coming online.

However, we’ve also seen a few cokers in industry that have backed-off their throughput rate. So, there are so many variables in that. It’s kind of tough to tell, but we certainly don’t see a significant strengthening in those differentials to come.

Bruce Smith

I think just to comment a little bit more, Ann. We’re at another one of those inflection points. I mean as I said in my comments and others I’m sure are going to say about coker economics, they’re just awful and that’s in a comparative sense. So, you’re starting to see changes that are going to back out and you’re starting to see changes even what’s being put into, the feed stocks that are put into them.

So, does that end up backing starting to back out crudes? Well there’s some indication that certainly in the marketplace that activity is happening. We’ve seen some crudes recently that we haven’t seen. But there’s so much change that’s got to occur for that to really reverse itself,

It gets to be a little bit difficult to predict, but like most things in this business, the point I would make is that the industry, when you’re not making money and on as we report losses and as others look at the economics, the industry will make adjustments and those adjustments will cause market adjustments. We are planning in the near term for a continuation of many things, but I mean, I would tell you that is quickly as we say that. I think the adjustments will make changes in the market environment.

Ann Kohler - Caris & Co.

Okay. Great, thank you, Bruce.

Bruce Smith

Sure.

Operator

Your next question comes from the line of Arjun Murti, Goldman Sachs.

Arjun Murti - Goldman Sachs

It’s Arjun with Goldman.

Bruce Smith

Yes, Arjun, how are you?

Arjun Murti - Goldman Sachs

I’m doing alright. How are you?

Bruce Smith

Fine. Nice peace.

Arjun Murti - Goldman Sachs

Thank you. Bruce, I just had a question on how you’re thinking about your refining portfolio of assets, both in terms of whether it’s temporary or permanent shut downs. I know over the years, people have always asked about Alaska and Hawaii, but then on the other hand, their cannon will be distressed sellers out there, who don’t have good balance sheets.

Where do you stand in terms of any interest on the other side, as well in terms of potentially out into your portfolio in this challenging environment? Thank you.

Bruce Smith

Sure, Arjun. I don’t see us in the near term with the market like it is doing anything on the acquisition side. We’ve been very acquisitive and we’ve been fortunate to complete the system that we wanted to build and I think in this market, to the broader question, we feel pretty good about our system.

Not having it being spread out, which makes it much more difficult to manage and having it be in a concentrated area and I will say that, if there’s another piece of good news and all the bad news we’ve seen is that, the fact that we said many times that the West Coast was hurt early in this process. So, that we made adjustments and that’s really reflected in the supply-demand statistics, I think the industry produces, those markets are in better balance.

So, we’ve run a lot of scenarios to be able to look at a continuation of lower margins, things that impact them even more negatively. I think we feel that the system overall is strong. We’re looking individually. The assets have done well, with the exception of, we’ve had some downtimes and turnarounds it’s a little hard.

If you take a turn around, you always have an, you’ll say well, how much it will cost you and you take obviously the volumetric change and you take what would have happened in that price environment, but we all know there been more supply that wouldn’t have been the price environment.

So, it gets a little complicated to be able to actually determine what the normalized results would be in the quarter, but I think one to answer your question. We’re really not looking at acquisitions, right now. I mean, we’ve seen opportunities. That’s not what we think is in shareholders best interest, right now.

We think in focusing on the internal projects that we’ve got, ways to reduce costs. There are some real efficiencies that we think we can pursue. We want to aggressively try to minimize all of our regulatory capital to be able to do other things with the same amount of capital.

Then we’ll look at the market as it continues to evolve and make decisions relative to the assets, but overall even the niche assets are doing well on a cash basis and so we feel pretty fortunate both to be early in the process and with the assets that we’ve got.

Arjun Murti - Goldman Sachs

I guess that last point is critical, where even in the challenge or as you described it downside scenarios, your net cash margin inclusive of potential CapEx, you’re still comfortable with it kind of your overall system of refineries?

Bruce Smith

I think so, I mean if you look at the second quarter, the worst part of the environment was obviously our California refineries, partially because of downtime and partially because of the heavy crude processing and so, that we have confidence that those markets are going to come back and the rest of the business is doing, I mean not listen, we’re not going to stand up and say we had great results in those markets, but in the conditions that we’re in, as we reviewed those, we are fairly pleased with how they are performing.

Arjun Murti - Goldman Sachs

That’s greater, thank you very much, Bruce.

Bruce Smith

Sure, Arjun.

Operator

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

Bruce Smith

Good morning, Chi.

Chi Chow - Tristone Capital

Good morning. How are you doing?

Bruce Smith

Alright.

Chi Chow - Tristone Capital

I got a few questions on California. First Golden Eagle, can you give us an update on the status of the hydrocrackers as far as the length and downtime impact on production?

Dan Porter

Yes, this is Dan Porter, Senior VP or Refining and the hydrocracker at Golden Eagle, we have just completed the mechanical work on that short outage and we’re now in the process of restarting the unit. So, wee would expect it to be up in about less than a week.

Chi Chow - Tristone Capital

What sort of impact on production have you had during the downtime?

Dan Porter

Well, again there we did have the hydrocracker down and a couple of other small units that are associated with that, but the overall impact is approximately a 10,000 barrel a day cut in overall throughput during that period of time. So, it’s relatively small during that period and we’ll run-off the feedstocks from the hyrdocracker, as well within our system.

Bruce Smith

I don’t think, do you have any idea we haven’t talked about it, but it means a lot of expense?

Dan Porter

No, it’s not.

Bruce Smith

So, it’s really, I mean minor. It’s really not going to be material to the quarter.

Chi Chow - Tristone Capital

Bruce, you talked about the weak coking economics, but when I look at your stats, it looks like in California you actually pushed through more heavy crudes in the second quarter than the prior two quarters, any explanation for that and how that’s going to trend going forward?

Chuck Flag

Yes, Chi, this is Chuck. While we did run essentially the same amount of heavy crude, maybe a little more of the grades of those crudes have changed very significantly and again, we continually look at our system and optimize our raw materials. We’re probably looking at similar levels of heavy crude running, however.

Again, our ability could be flexibility, based on the dock improvements we’ve made both in L.A. and at Golden Eagle allow us to switch back and forth between domestic heavies and foreign heavies, whichever are making more money for us at any particular point in time.

Chi Chow - Tristone Capital

So, in the second quarter, did you run more domestics versus international?

Chuck Flag

Directionally, we’ve headed that way, as well as even in different foreign sources of crudes as well.

Chi Chow - Tristone Capital

Any more detail you can provide on that?

Chuck Flag

Well, I think that’s about all we can give you.

Chi Chow - Tristone Capital

Okay, alright final question I have, it looks like California, the cash operating costs seem to be really swinging around the last few quarters and in particularly given your 3Q guidance. It seems like it swings like $20 million from quarter-to-quarter, any explanation for that?

Chuck Flag

Don’t forget Chi, when we had the turnaround in the last quarter and then this quarter’s cash operating costs include a much lower throughput rate than we’ve given in the past. So, there’s no real material change I think in the operation side. It’s just a matter of the throughput levels and the plant maintenance.

Chi Chow - Tristone Capital

Alright, thanks a lot.

Operator

Your next question comes from the line of Blake Fernandez from Howard Weil. Your line is open.

Blake Fernandez - Howard Weil

Thanks, good morning guys. I had two questions for you. One macro oriented and one a little more detailed. On the macro side it was really important penetration into PADD V.

Historically it seems like that’s been one of your real kind of competitive advantages, if you will seeing how it’s been somewhat inflated and I’m just wondering as we kind of move more toward a globally connected, more export oriented type of environment. I’m wondering if you could remind us of the kind of barriers to the West Coast. Is it the ports and is that expected to continue into the future?

Chuck Flag

Yes, Blake, this is Chuck. There certainly is, our export barriers based on the ability of the West Coast logistically to bring barrels in, the [orbs] have been closed into the West Coast. So, really we haven’t seen any significant importation of light products into the West Coast.

We have been exporting; I think as an industry distillates out of the West Coast, since demand for the distillates are down, primarily to Latin America, however not in the same quantities as prior year.

Blake Fernandez - Howard Weil

Okay. So any ideas as far as some of these additional global refineries coming online that are more export oriented, obviously it’s seems like with dodged a bullet with [Inaudible], any thoughts on future exports making their way into the West Coast? Do you feel like you’re still going to be pretty insulated?

Bruce Smith

This is Bruce. I hope we get imports. That means the margins are a lot higher. I mean it’s sort of the good news, bad news, but I think that the problems of importing and exporting on the West Coast, it’s both sides of it, but it’s the limitation of terminals and port space, and it’s the basis reelections to see things move on the water, which probably is not going to change for a while, but with the amount of utilization that.

If you look at the stats for the West Coast, there’s plenty of ability to be able to expand and it just needs to be the margin environment that makes that possible, but today I think its reflective that there’s not much happening on the import side and I don’t know that imports at all, but on the export side we are moving some product out, which again as gives us the opportunity to take advantage of something that and not oversupply the West Coast.

So, anyway I guess my answer would be wouldn’t be bad to see some imports. So, we probably have much higher margins.

Blake Fernandez - Howard Weil

Great, okay. My next one is regarding your Mandan refinery. We hear a lot of commentary from the they’re a lot of commenter from the EMPs on the bock and differentials out there and I know expanding capacity probably isn’t a very popular topic right now, but I’m just wondering if there is an opportunity for capturing some of that crude from what I understand it sounds like, its pretty high quality crude and the differentials are really based on transportation costs.

Chuck Flag

Yes, Blake, this is Chuck. That is indeed correct. Recent fines in the area and there’s been a fine that’s slightly below, strata that’s below the bock and bodes very well for Mandan. We have been on essentially a pure North Dakota bock and field type of diet. So, with the logistical limitations in that area as production increases, we would expect the differentials to WTI to be at least maintained, if not strengthened.

Blake Fernandez - Howard Weil

Okay, but no plans or evaluations of expanding capacity there?

Chuck Flag

Not at this time.

Blake Fernandez - Howard Weil

Okay. Thanks a lot, guys, I appreciate it.

Chuck Flag

You’re welcome.

Operator

Your next question comes from the line of Paul Cheng, Barclays Capital. Your line is open.

Paul Cheng - Barclays Capital

Hi, guys, I have to apologize. I came in a little bit late, maybe you already talked about it, plus in the past you indicated a fair launch at the listed flows, I think if I settle maybe $50 million, $60 million. Can you tell me a little bit of the age of that and should we assume it’s going to continue?

Bruce Smith

Actually, you’re in first to ask. So, you didn’t miss anything Paul. Everett briefed the board on it yesterday. So, I will let Everett to answer that question.

Paul Cheng - Barclays Capital

Thank you.

Everett Lewis

Hi, Paul this is Everett. The derivative loss is associated with some physical activity we did in inventory. So, there’s two sides to the derivative position. As we’ve said before, we look at hedging when we take inventory positions that are increased over our basic minimums and what we saw this quarter were some opportunities to pick up distressed crudes early, to take advantage of some pricing basis differentials.

The result of that was to increase our inventories above minimum. So, we are putting in discretionary working capital. We didn’t want to take flat price risk on that. So, we hedged that flat price risk and that’s what shows on the derivative side, but the offset on the physical side is buried in the cost of goods and we would estimate the net benefit, if you look at physical and the derivative to be around $20 million for the quarter on the overall cost of goods.

Paul Cheng - Barclays Capital

Okay. So, what that means that is actually, if we look at some of a pay trade this is just a one side the equation and that this pay trade actually resulted in the gain, even though that as we put as a loss?

Everett Lewis

That’s right and it is opportunistic. So, it won’t necessarily be ratable every quarter, but we’ll continue to look at opportunities.

Paul Cheng - Barclays Capital

Okay and I think along that line, I mean, Bruce a lot of people, when they’re looking at the Contango market and start to seeing I think one of your competitor saying that, it look like there is an opportunity to pay the curve by storing inventory. Is that something that you guys are interested and pursue that to trying to do that also?

Chuck Flag

Paul, this is Chuck. We do take a look at that. We’ve tended to use some of the balance sheets of some others to accomplish that, such that we don’t tie up our own working capital, but still capture that Contango. We’ve also taken the opportunity to use some of our own assets in the form of storage to capture some of that Contango as well.

Paul Cheng - Barclays Capital

Okay and the final one. I think I have asked that question in the past, Bruce. With the market conditions where we are and your expectation that it will remain pretty weak for a little bit longer. If you guys go back and re-look at all of your systems, in trying to identify whether that is a keeper, or that some of them maybe subject to other actions at this point I think…

Bruce Smith

I guess we talked a little bit about when Arjun asked this question. I mean we’ve taken a look at the entire portfolio. It’s not, just we look at the entire portfolio as part of the process every year, to ask ourselves whether there’s changes that would justify us divesting of an asset.

Obviously whether the market conditions are such that there’s something we should do that would change our need to acquire an asset and they’re sort of both sides of those opportunities that exist.

While we really right now, are not seeking to make any acquisitions. We’ve looked in the same way at opportunities to divest and I think that we’re relatively comfortable with our portfolio in the current environment. It’s each of the niche markets that we’ve played, lay into the system.

The system generates reasonable cash and I think the other side of that, of course, is you have to take a realistic look and say if you wanted to dispose of something, it would be a buyer and not to say there aren’t buyers and there aren’t prices that you would be willing to part with an asset.

So, I would say that the answer is, yes. We’ve looked at it. We don’t currently have any plans to pursue that, but we have, in the scenarios that we run and all of the stress that we put on the system. We have identified what we would need to do, if things got materially worse.

So, it’s going to be based on what we see and the changes in the markets going forward, the actions that we take. That will drive our capital plans. It will drive we’re going to put into the business. It will drive the timing of it.

It will drive anything that we would want to extract from the business and there may be some things that we would do to extract value from the business that wouldn’t necessarily involve the material portions of the system, but as relative to refineries, we just don’t have any plans today to be able to monetize one or more of the assets.

Paul Cheng - Barclays Capital

Yes, Bruce I have to apologize again that if you’ve already covered that. Have you guys disclosed. Is there any change in your outlook for the 2010 CapEx? I think, 2009 you’re saying it’s going to be less than 600, right?

Bruce Smith

Yes. 2009, we expect to be less than 600, Jeff asked about that. So less than 600 and are still public announcement for 600 next year stands.

Although we are looking at that number, because our goal is to really have capital be operating cash flow. Obviously, that will depend on what the market environment is, and we’ll have better idea. I think of that looks like in the third quarter, as we have a closer projection for really the fourth and the first quarters.

So probably, a couple a months away from being able to give a definitive answer for where we think we’re going to go for capital next year, but it won’t grow. That’s, I think a fair statement. It won’t be bigger than what we originally said we’re going to do, if anything would be smaller.

Paul Cheng - Barclays Capital

Bruce, is there any minimum number that you have to spend next year?

Bruce Smith

Sure, there’s a minimum, because there’s a turnaround that scheduled at Mandan earlier in the first half of the year. There is regulatory capital that we do need to complete. So there is a minimum number…

Paul Cheng - Barclays Capital

I know, I guess my question is there a number you can share with us, that was a minimum?

Bruce Smith

No, I can’t give you the breakdown. I just can’t do that, Paul.

Paul Cheng - Barclays Capital

Okay. My final question, I think that previously it was expected that by the end of this year that California is got more than four year is going to implement. Is there any change in that, given the economy and everything, or that the government is still going to push ahead and implement that?

Everett Lewis

Sorry, Paul you broke up. Can you repeat that one more time, please?

Paul Cheng - Barclays Capital

I think that previous schedule was that California, top four model will be implement at the beginning of next year, and given the economy and the state and everything going on. Is there any discussion that you postpone that or that is still going to go ahead?

Everett Lewis

As far as we know for proceeding.

Paul Cheng - Barclays Capital

Yes, I don’t know, Len you’re on the phone. Is there anything going on? I haven’t heard anything at all about the implementation of carb being delayed.

Bruce Smith

No, no talk at all. It will [Multiple Speakers] 31 of this year.

Paul Cheng - Barclays Capital

When the top four model, in the sense you changed the ethanol branding from 5.7% to 10%, does that mean the gasoline pool will expand by the 4.3% or do you have other offsets that need to be reduced?

Bruce Smith

No, there really is no other offset. It really is just a net addition. Now, remember quarters that the energy value of that incremental 4.6% is only two thirds of that because of the difference in energy content between ethanol and gasoline.

Paul Cheng - Barclays Capital

Sure, but I mean still that increase, you don’t have ethanol offset?

Bruce Smith

2%. No, there aren’t any offset.

Paul Cheng - Barclays Capital

I see, okay. Thank you.

Operator

Your next question comes from the line of Corey Garcia from Raymond James. Your line is open.

Corey Garcia - Raymond James

Thanks, guys. Good morning.

Bruce Smith

Good morning.

Corey Garcia - Raymond James

Just one quick question, I guess I’ve been looking at margin realizations in the mid-continent have been consistently higher than your reported Tesoro Index. I’m just wondering if you could provide any color as to what’s really been driving that and fits something that could be transferred to the other refineries within your system?

Chuck Flag

Corey, this is Chuck Flag. The margins in the mid-continent, we see very high capture rates relative to the industries. It’s primarily due to the discount, but we’re seeing on the domestic crude’s in those markets. As we talked about before largely logistically based as far as those premiums concerned, we also see premiums on our local products relative to group three spot market prices, again, due to the, niche advantage we have from the perspective of the logistics.

Corey Garcia - Raymond James

Okay. That’s helpful. Thank you.

Operator

Your next question comes from the line of Alex Inkster - Sanford Bernstein. Your line is open.

Alex Inkster - Sanford Bernstein

Hi, guys.

Bruce Smith

Alex, how are you?

Alex Inkster - Sanford Bernstein

I’m very good. How are you?

Bruce Smith

Good.

Alex Inkster - Sanford Bernstein

Just one quick question, are you expecting to raise more debt this year, and where do you see gearing at year end?

Bruce Smith

No, we’re not going to raise more debt. We don’t have any plans to raise debt. We don’t have any plans to raise equity. We’re just, I don t know, so if you tell me exactly where earnings are coming out I’ll give you, but I think it’s going to be relatively unchanged. I don’t think much happens. I think just an overall comment about the third quarter that their conditions are, we’re about to wrap up July.

The heavy light crude differential is sort of what it is. We’ve bought a lot of those crude’s for the quarter, so, you know, I think the, for the quarter is getting more and more defined that’s not to say that we won’t have some margin change and improvement, which is certainly possible and maybe even more probable, but a lot of it’s going to, this quarter is going to depend on what happens on the margin side.

In the fourth quarter, we may start to see some improvements relative to some of the crude’s, and that will determine what happens in the fourth quarter. I think the third and fourth quarter are going to be driven by factors that are probably not so much pure demand, that is really more on the supply side. We’re still continuing to see supply side adjustments, and I think those ultimately will translate into higher margins.

I think gearing remains relatively unchanged. I think that that’s to we’re sort of at a steady floor right now, and our goal is to try to figure out how we can reduce, continue to reduce costs, to re-optimize the units and I feel that we’re right on track.

We’re very active in doing that, but we’ve been at it now for a year and a half, in this market and the plan is very flexible for the third quarter, as to what we’re going to do, and to what the changes that we’ll make will involve is almost on a weekly basis here. So I don’t think there’s going to be a lot of change in gearing to answer your question.

Alex Inkster - Sanford Bernstein

Okay. Thank you.

Bruce Smith

You’re welcome.

Operator

There are no further questions at this time. Are there any further remarks?

Bruce Smith

No, I just I want to thank everybody for joining us. Obviously, it’s not as much fun to have a conference call where we’re producing negative results, and I know there are a lot of reasons for it, but I do believe that as I just said, that there are some positive, there’s some positive facts out there that have the ability to impact both the third quarter and obviously things going forward.

I think that the third quarter is going to be a challenge that we’re looking at it at being a very difficult challenge. I think that our goal continues to be the same, which is to just conserve cash, to make smart decisions about capital, to be able to and look that’s with capital this year, as well as the capital planning for next year.

So I think by the end of the third quarter, we’ll have a much better handle on the year. I think we’ll also be in a position to really more fully talk about what our expectations are going forward, and so we’ll be anxious to have everybody join us for the third quarter conference call. Again, thanks for being with us today.

Operator

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

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Source: Tesoro Corporation Q2 2009 Earnings Call Transcript
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