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Executives

Kristine Boyd - IR

Mike Jennings - President and CEO

Jim Stump - VP of Refining Operations

Doug Aron - EVP and CFO

Billy Rigby - Vice President of Refinery Planning and Optimization

Analysts

Jeff Dietert - Simmons

Paul Cheng - Barclays Capital

Blake Fernandez - Howard Weil

Daniel Burke - Johnson Rice

Jacques Rousseau - Back Bay Research

Frontier Oil Corporation (FTO) Q3 2009 Earnings Call November 5, 2009 11:00 AM ET

Operator

Welcome to the Third Quarter 2009 Earnings Call hosted by Frontier Oil Corporation. (Operator Instructions).

I will now turn the call over to the Manager of Investor Relations. Kristine Boyd.

Kristine Boyd

Good morning and thanks to all of you who are joining us this morning for our third quarter 2009 earnings call. Here with me this morning are Mike Jennings, President and CEO; Doug Aron, EVP and CFO; Jim Stump, VP of Refining Operations; and other members of our executive management team.

Before we get started, I would like to read our safe harbor statement. The primary purpose of this conference call is to describe the assets, operations and certain current and historical financial conditions associated with Frontier Oil Corporation. This information and associated comments made during the course of this conference call may include forward-looking statements concerning the company. These may include statements of plans and objectives for future operations, statements of future economic performance or assumptions or estimates. The accuracy of these forward-looking statements is subject to a wide range of business risks and changes and circumstances that are described in the company's report that are filed from time to time with the Securities and Exchange Commission. Actual results and outcomes often differ from expectations.

I would now like to turn the call over to our President and CEO, Mike Jennings.

Mike Jennings

As stated in our release this morning, Frontier reported a third quarter net loss of $15 million or $0.15 per share. This included a $6.8 million accrual for potential EPA fine at our Cheyenne refinery. Our FIFO inventory gain for the quarter was $8.6 million after taxes and we also recorded a hedging gain of $2.6 million after taxes. Net of these effects generated a loss in the third quarter of $20 million or $0.19 per share.

Weak refining fundaments persisted during the third quarter. Distillate margins, which had declined steeply in the first half of the year, remained depressed through the quarter. Gasoline margins weakened by several dollars a barrel during the quarter due to an unimpressive back half of the 2009 driving season.

A brighter spot in the quarter was some improvement in the Canadian crude differential, which gained a couple dollars a barrel and brought the heavy barrel back as a viable option, particularly in Cheyenne.

Looking forward, we don't expect refining fundamentals to rebound quickly. Inventories remain elevated with occasional draw-downs coming more as a result of lower throughputs or fewer imports than due to material improvements in customer demand. The combined effect of full product tankage and low utilization rates will likely push the recovery of refining margins well into 2010. The capacity recently removed from the system by several of our refining peers will accelerate this process and eventually profitable refining margins for the remaining refiners should return.

In the second quarter earnings call, we promised details about our strategic plans for the Cheyenne refinery. Cheyenne has historically been an excellent performer, generating refining gross margins, excluding FIFO effects, of $337 million in 2007 and $223 million in 2008. However, the light heavy differential has been a critical part of that historic profitability. Weakness in the differential this year has highlighted the need for us to become more efficient than Cheyenne.

We performed a comprehensive review of the refinery this year and have developed a plan to improve refining margins there by $3 to $4 a barrel by midyear 2011. These improvements will be achieved through a combination of operating cost reductions, yield and efficiency improvements and margin capture opportunities. In brief, we're not waiting for return of better markets in order to return the Cheyenne refinery to better profitability.

In the meantime, we continue to assess acquisition opportunities that we consider complementary to our existing asset, but thus far we're without success. We continue to believe that consolidation will be an important and necessary part of the improvement in US downstream margins, but these opportunities have been slow to develop for Frontier, partly due to our desire to acquire only high quality assets.

With that, I'll turn the conversation over to Jim Stump. Jim is our Vice President of Refining Operations and he will provide more detail on the Cheyenne efforts, as well as an overall review of our operations during the third quarter.

Jim Stump

Let me introduce myself briefly. I started my career with Frontier 19 years ago as an engineer in the Cheyenne refinery and I've had various managerial positions at both plants since then, most recently as Refiner Manager in El Dorado. Earlier this year, as Mike mentioned, I became VP of Refining Operations and I'm responsible for operations in both plants.

First, a few comments on operations. In El Dorado, for the third quarter, crude throughput averaged about 119,000 barrels per day. Operating expenses averaged about $4 per sales barrel. For the fourth quarter, El Dorado has been at reduced crude rates in the low 60s due to the ongoing cat and gofiner turnarounds which are both going well and on schedule to be complete in the next week or so. The majority of the gofiner project is being installed during the turnaround with the exception of the new reactor. The new reactor will be installed in the third quarter 2010.

The expected fourth quarter average crude rate for El Dorado will be about 79,000 barrels per day. Our expected operating costs for El Dorado's fourth quarter is about $6.50 per barrel, which is affected by the turnarounds and both turnaround related costs and lower production barrels.

In Cheyenne, for the third quarter, crude throughput averaged about 41,000 barrels per day and cash operating expense averaged $6.50 per barrel. We continue to identify and eliminate bottlenecks toward a lighter crude slate. In the third quarter, we ran a crude slate that averaged almost 60% light, sweet crude.

The fourth quarter crude rate in Cheyenne is expected to average about 43,000 barrels per day, with no major turnarounds planned until the cat turnaround in the fall of next year. We expect Cheyenne's fourth quarter operating expense to be down slightly at just under $6 per barrel.

One of my primary focuses in this job has been to coordinate a multi-departmental review of the Cheyenne refinery. Through this effort, a number of strategies have been identified to achieve the $3 to $4 per barrel margin improvement that Mike mentioned.

Reductions in operating costs are expected to account for between about $1 and $1.50 of this improvement, the first phase being the recently announced labor cuts that reduced Cheyenne's workforce by about 8%. This reduction resulted in about $4 million per year savings or about $0.25 per barrel.

The additional efforts on operating cost reductions involve various maintenance and operations efficiency improvements that are currently underway and have contributed greatly to the improvement in the fourth quarter costs. We're targeting to have about $1 per barrel operating costs reduction completed by the fall of 2010, with an additional energy savings component of about $0.50 realized through the end of 2011.

We also plan to improve gross margin at the plant by about $1.10 per barrel through a new LPG or liquefied petroleum gas recovery and fractionation project that will be submitted for final Board approval later this month. Cheyenne has the opportunity to capture liquid hydrocarbon values from these materials by improving recoveries at its [Lyden] plant.

Due to overly constrained processing equipment, a large portion of these liquids consisting of propane, butane [Appalachian unit feed] is lost at our refinery fuel gas. This project recovers and desulfurizes these LPGs to capture much higher values than they currently give us in fuel Btu content. Final cost estimates for this LPG recovery project are being reviewed. Project approval is still required from our Board, but our current cost estimates are about $40 million, with a targeted completion of second quarter 2011.

Finally, we have a long list of projects identified to improve product yield, product value, crude slate optimization and point of reliability that will contribute the remainder of the margin improvement. The results of these efforts will phase in throughout 2010. The heaviest focus in this area continues to be improving the flexibility of our refinery in Cheyenne and its ability to process a wide arrange of crude slates.

With that, Doug is going to wrap up our call.

Doug Aron

Let me start off by addressing the $6.8 million EPA fine in Cheyenne. In the last few days of the quarter we were assessed a penalty by the EPA related to waste management and wastewater handling in Cheyenne. Our environmental group was surprised by this action since we have worked hard with the EPA and state level, environmental officials for several years to identify improvements to these systems and have projects currently underway to resolve them.

At this time, we accrued the full amount of the potential fine, but we will be aggressively contesting the EPA's position and the amount of the fine. It's also worth pointing out, as I saw a few notes this morning that had questioned the higher operating expenses in Cheyenne, this fine was accrued and did show up in the operating expense. So, certainly not a normalized item there.

Regarding cash flows for the third quarter, capital spending was $45 million, bringing us to $122 million spent to far this year. We're still on track to come in at about $190 million for the year, slightly below the prior guidance of $200 million, but that $10 million difference is likely to be spent as carryover in the first quarter of next year.

We ended the quarter with a cash balance of $487 million, basically unchanged from the second quarter. In this quarter, we generated $22 million in operating cash flow before changes in working capital and paid $6 million in dividends.

Our balance sheet remains strong with a debt to cap ratio of 23%. In addition, we had $339 million of borrowing base availability at the end of the quarter. We will continue our cautious stance in regard to cash preservation in this weak market environment, particularly in the upcoming winter months, which we expect to be thin from a margin standpoint.

Lastly, I'll update you on the quarter-to-date crack spreads. For Cheyenne, the gasoline crack spread has averaged $3.73 for the month of October and $4.14 month-to-date in November. The diesel crack spread averaged $8.38 for October and $7.35 month-to-date in November.

For El Dorado, our gasoline crack spread was $4.51 in October and $4 month-to-date in November. The diesel crack spread was $6.87 for October and $6.31 month-to-date in November for El Dorado.

With that, Sandra, we're pleased to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from Jeff Dietert from Simmons.

Jeff Dietert - Simmons

You gave some statistics on light, sweet crude feedstocks for the third quarter. I would guess there was a fairly wide range of feedstock variance through the third quarter and then maybe even in October as the heavy, sour spreads change during that period. Could you give us a feel for your flexibility on the highest percentage of light, sweet versus lowest percentage of light, sweet at both Cheyenne and El Dorado?

Mike Jennings

Billy, do you have the monthly charge spreads there or differences by month for the two plants?

Billy Rigby

If we want to do it by month, I've got it by month here. I will grab it real quick.

Jeff Dietert - Simmons

Perhaps while we're waiting on that, I had a second question on the Keystone pipeline. Linefill expected to start later this quarter and that brings Canadian crudes into some incremental markets or at least incremental volumes. How do you expect that to influence Frontier's feedstock costs?

Mike Jennings

In the near term, there is a month of December expected injection date for the Keystone barrels. Quite honestly, it represents a lot of crude, I believe its 9 million total barrels. That probably has put some pressure on a differential given that incremental demand for the heavy crude. Through time, as that pipeline provides access, first, obviously, just to the Wood River plant, but ultimately to Cushing it's going to represent sort of an unconstrained feed of the Canadian heavy into our backyard. Longer term, I think that is good for Frontier, though in the immediate term the incremental demand for linefill is probably pressuring differentials to our detriment.

Mike Jennings

To answer your question, at Cheyenne, through the third quarter, our sweet crude and lighter crude percentage, we are working really hard to increase flexibility. We actually range from a high of 70% light and sweet crude in July or close to 70% to down to 56% as we worked to take advantage of those lighter, sweeter crudes. So our heavy did change quite a bit. In the fourth quarter, we actually have somewhat of an anecdotal opportunity to take advantage of more heavy crude as the Canadian heavy dip has widened for us. We've seen short term differentials for Canadian heavy out as wide as 1,350 off at Hardisty. So we are taking advantage in the short term in the fourth quarter of a slightly better Canadian heavy dip. So, we're moving our heavy percentages up to 40% or better simply because we've got that opportunity.

Frankly, as both Jim and Mike alluded to, our watchword for Cheyenne is flexibility. The refinery is historically configured as a heavy crude refinery, but we're simply trying to work very hard to make it more flexible. At El Dorado, our heavy percentage has been running between 10% and 20%. El Dorado's key advantage compared to other refiners is simply that it can dig so deep into that heavy barrel with the project that we implemented in 2008, and we've continued to take advantage of that project to run Canadian barrels, frankly, into worse differentials than I think other refiners can take advantage of because we yield so little bottoms off that Canadian barrel. So, El Dorado has advantages that I think many other refiners simply don't.

Operator

The next question is from Paul Cheng from Barclays Capital. Please go ahead.

Paul Cheng - Barclays Capital

Just two quick question. One, earlier you made the comment in the M&A fund there is no progress. I am wondering can you elaborate is it because there is a large gap between the bid/ask price, between the buyer and the seller in the marketplace, or that from you guys' standpoint there are just not good asset that fit into your portfolio that people are willing to depart for and is available for sale, which is the reason why we didn't see a transaction?

Mike Jennings

Paul, the two are linked. The fact is that people that hold the best of these assets in the geography we're interested in aren't willing to sell in what they consider to be a trough, okay? So there's an expectation there of improved refinery margins going forward. Generally, the assets just aren't available for sale. Given Frontier's price deck, which is effectively one of looking at public company comparables and concluding about valuation from what we see on the screen, we think that it is difficult to take a different view than the market as to forward margins.

Paul Cheng - Barclays Capital

Right. So that means there is not so difficulty that the people will say, okay, those are the asset that I really want to keep, it's just that the price is not necessary where they're willing to depart.

Mike Jennings

I think that's a fair assessment. If you look at Jim Mulva's comments the other day in terms of what Conoco may or may not be willing to sell, I think you can read between the lines and conclude exactly that. They have desired dispositions of some $10 billion, but no expected refinery sales between now and 2012. What does that mean? It means that the prices are low right now and they expect an improvement in margins and valuations.

Paul Cheng - Barclays Capital

So the rest of the market is similar thinking, a lot of the other executive?

Mike Jennings

In terms of the people that hold the quality assets, that's correct. That's what we've encountered anyway.

Paul Cheng - Barclays Capital

Maybe a little bit more minor detail. I think you earlier talked about the oil throughput expectation for the fourth quarter, do you have a fixed start expectation or the total throughput expectation?

Mike Jennings

We do. Actually I think Jim Stump or Billy has that information.

Jim Stump

Fourth quarter in El Dorado, we're expecting to run about 79,000 barrels a day of total crude. In Cheyenne for the fourth quarter we're expecting to run about 43,000 barrels per day in total crude.

Billy Rigby

Total input would be about 45,000 of total charge at Cheyenne, and then at El Dorado, for the fourth quarter, total charge would be about 91,000 barrels a day of total charge, if that's what you were looking for.

Paul Cheng - Barclays Capital

Doug, you are very kind to give us the gasoline and diesel margin where they stand in October and November, can you give us a similarly (inaudible) in Cheyenne and El Dorado?

Mike Jennings

I don't have the latent values, but the market for heavy crude in Hardisty quarter-to-date has been about 1,200 to 1,250 off of WTI. The light crudes indigenous in the Cheyenne market have been in the range of $5 off traded at currency, and finally, the WTS barrel in the Mid-Con has been sort of $2, $2.25 off range during this quarter. All those are traded numbers and prior to transportation. So if you want, please follow-up with Kristine in terms of the transpiration costs from those market centers to our refineries, but I think we've given those in the past.

Paul Cheng - Barclays Capital

Kristine, if you don't mind, just send me an e-mail. That would be great. Thank you.

Kristine Boyd

Okay.

Operator

(Operator Instructions). The next question is from Blake Fernandez from Howard Weil.

Blake Fernandez - Howard Weil

My question is on the exemption that you are seeking from the low RVP regulations in Colorado. I'm just curious if you can give us an update there and the potential implications if you don't receive that exemption.

Billy Rigby

We currently provide 7.8 RVP gasoline during the mandated season for the Front Range area. Two more counties, the Northern counties in Colorado will opt into that program next season, as I understand. We will provide that fuel for those counties, Weldon and Larimer County for next season. Certainly, our marketing department will market their fuel appropriately and distribute fuel in other counties that do market 9 pounds in the region. So those counties that require 7.8, into which we market, we will provide that fuel as the regs require.

I'm not sure if your question is regarding further out potential regulation, which could be pointed toward lower RVP fuels, such as 7 pounds or even potential RFG, as far as I'm aware none of that has been finalized. So I'm not sure where your question might be going any further out than the currently promulgated 7.8 regulations.

Blake Fernandez - Howard Weil

Some of the press reports I had read suggest that the deadline would be by next summer and that maybe Frontier wouldn't reach that until some time in 2011, and that's where I was just curious what happens.

Billy Rigby

No. We do make 7.8 now. The Reg is being extended to two more counties next year. We are going to comply with that regulation and we will market fuel where it is required. So, we are meeting all current and immediately pending regulations and are watching further out regulatory landscape to see where it goes from there, if anywhere.

Blake Fernandez - Howard Weil

I wanted to confirm, is the $60 million tax refund still on target for fourth quarter '09?

Doug Aron

Actually only a portion of it at this point do we believe we'll see in the fourth quarter. We think we'll see about $15 million of that in the fourth quarter, probably sometime in mid December with the remaining $45 million collected sometime in the first quarter of next year.

Blake Fernandez - Howard Weil

I just noticed in the recent DoE numbers, it looks like gasoline inventories in Pad 4 are noticeably tight. I was just curious if there was any update or any commentary you might have on what's going on out there.

Mike Jennings

The Pad 4 numbers have benefited from some throughput restraint and some unplanned downtime, particularly on the Salt Lake side of the divide. That market has traded through the third quarter at a significant premium to Denver. Presently, Cheyenne is above Denver, Denver is above the Mid-Con. So you have a relative shortage of product, not a shortage but rather a better balance than we have had through the last nine months or so.

What it looks to us like is gasoline inventories are coming better into line with demand in the Rockies. Diesel inventories still a little bit high, but being worked off. A good portion of that, we believe, has come through some refinery downtime as well as possible production restraint.

Operator

The next question is from Daniel Burke from Johnson Rice.

Daniel Burke - Johnson Rice

Thanks for the detail on the Cheyenne program. I had trouble keeping up. It sounded like $1 a barrel on OpEx, another $0.50 a barrel on energy saving and then $1.10 maybe associated with the LPG capital project. From there bridging the gap to the total target of $3 to $4 a barrel, could you give me little more detail on what you all plan to do?

Jim Stump

LPG recovery is worth about $1.10. Our total OpEx goal is nearer $1.50, including energy cost savings. I would point out that we've achieved a significant portion of that already. Our light crude and flexibility opportunity in Cheyenne we believe is worth at least $0.50 a barrel, potentially more than that. We've completed a light crude test run recently where we showed a greater flexibility in that plan, so much of that is very attainable.

We've got several other small pieces, maybe about seven or eight that all are in about the $0.25 per barrel range, including things like improved yields, some cat cracker operational issues and just general margin improvement projects.

Daniel Burke - Johnson Rice

In terms of looking ahead to 2010 on a full year basis, some of these have already been implemented, do you think you'll have $1 a barrel out of Cheyenne's OpEx on average during 2010 or that is too quick to assume that could happen?

Jim Stump

We believe we'll be there faster than that. Right now, between operating cost reductions and the flexibility we've already proved out, I think we're at about $1 a barrel at this point in time. Our forecast right now would be about this time next year to be in about the $2.75 per barrel improvement region.

Daniel Burke - Johnson Rice

That's useful. My only other question would be, with the intense scrutiny that you all look to place on Cheyenne, I mean is it reasonable to assume now that there's going to be some focus over at El Dorado as well?

Mike Jennings

There is focus in every nook and cranny in our business, as you might expect. These are challenging times and we're really working hard to try to improve efficiency and make money. Jim, can you talk about yield improvements, in particular, in El Dorado.

Jim Stump

The long and short of that is we've kind of wore out some of those opportunities. Many of the projects we've done in the last two or three years and especially the new vacuum tower and crude project we did along with the new coke drum project, took advantage of a lot of the opportunities that El Dorado had. There are still some out there. We are also looking at some LPG recovery opportunities in El Dorado and have a much smaller project scoped and budgeted for next year.

Like Mike said, we always look for opportunities. The other place we work pretty hard for next year at El Dorado was operating expenses. We definitely went through budgets with a fine-toothed comb, and in both plants we have very aggressive but achievable operating budgets.

Operator

(Operator Instructions). The next question is from Jacques Rousseau from Back Bay Research.

Jacques Rousseau - Back Bay Research

With the LPG project announced, what should we think about for the capital budget for 2010, 2011?

Mike Jennings

We're looking to spend $100 million in cash in 2010. Doug referenced probably $10 million of spillover from 2009. So, 110 total assuming 190 in 2009. 2011, I'll tell you it's a little early, but we see a maintenance capital budget for the company in the $40 million range. Apart from the yield improvement type projects that we're doing, there is going to be a little bit of environmental spending, but in this margin environment, it's is going to be a skinny capital budget.

Jacques Rousseau - Back Bay Research

Any comments on demand in your markets?

Mike Jennings

We're able to place product that we make. We don't have issues in terms of full terminals, full product pipelines. I wouldn't say there has been a resurgence in consumer demand for either gasoline or diesel. So there is balance, but in looking at the margins, it's not driven by strong demand growth.

Operator

There are no further questions at this time.

Mike Jennings

Great. Thank you today for joining our call. We look forward to speaking with you again soon. Have a good day.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may all disconnect.

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