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Executives

Lynn Elsenhans - Chairman & Chief Executive Officer

Brian McDonald – Senior Vice President, Chief Financial Officer

Bill Diebold - Manger of Investor Relations

Analysts

Jeff Dietert - Simmons & Company

Arjun Murti – Goldman Sachs

Mark Gilman - Benchmark Company

Paul Cheng - Barclays Capital

Ann Kohler – Caris & Company

Evan Calio – Morgan Stanley

Paul Sankey - Deutsche Bank

Faisel Khan - Citigroup

Jacques Rousseau – Soleil, Black Bay Research

Sunoco Inc. (SUN) Q3 2009 Earnings Call November 5, 2009 5:30 PM ET

Operator

Welcome everyone to the Sunoco third quarter 2009 earnings conference call. (Operator Instructions) Thank you. I would now like to turn the call over to Ms. Lynn Elsenhans, Chairman and CEO of Sunoco. Ma’am, you may begin your conference.

Lynn Elsenhans

Thank you. Good evening. Welcome to Sunoco’s quarterly conference call where we will be discussing the company’s third quarter earnings that were reported this afternoon. With me today are Brian McDonald, our Chief Financial Officer and Bill Diebold, Manager of Investor Relations. I will start by making a few introductory comments and then Brian will address business results and comment on our overall financial position.

As part of today’s call I would like to direct you to our website, www.sunocoinc.com, where we have posted a number of presentation slides which may provide a useful reference as we progress through our remarks. For purposes of facilitating a good discussion, I would also like to refer you to the Safe Harbor statement referenced on slide 2 of the slide package, and is as indicated in this afternoon’s earnings release and Form 10-Q filing.

So, let’s begin. As shown on slide three we reported a quarterly net loss excluding special items of $34 million or negative $0.29 per share. A challenging market environment continued to impact both volume and margins in our petroleum and chemical businesses. In addition, planned maintenance activity at our Toledo and Philadelphia refineries limited production during the quarter.

In our non-refining businesses, however, we continue to generate good results with earnings improving to $102 million in the third quarter up from $78 million in the second quarter. Retail marketing earned $49 million as retail gasoline margins improved significantly in a more stable price environment. Logistics earned $19 million with steady contributions from Sunoco Logistics Partners LP and our coke segment earned $35 million.

As we consider the outlook for the rest of the year and into 2010 we do not anticipate significant improvement in the refining markets. However, as evidenced by our announcement last month we continue to take the appropriate steps to position our businesses for this environment by focusing on improving our competitive cost position and optimizing our portfolio and operational performance.

In early October we announced the indefinite idling of the Eagle Point Refinery in an effort to reduce losses in our refining business at a time when the recessionary economy, weak demand and increased level of refining capacity have created margin pressure on the entire refining industry. This effort will shift current Eagle Point production to our nearby refineries in Marcus Hook and Philadelphia which will operate at higher capacity utilization and allow us to reduce our breakeven costs.

This effort is proceeding on schedule and all of Eagle Point processing units have ceased production this week. By the end of the year we should be in full mothball mode and well on our way to achieving our $250 million annualized pre-tax cost savings target.

On September 30 we closed on the sale of our retail heating oil and propane distribution business. The sale of the business has generated $83 million in net proceeds and positioned us to focus on our core retail branded outlets. We also continue to pursue our cost reductions from our March 2009 business improvement initiatives and remain on target to reduce costs by more than $300 million on an annualized basis by end of the year.

Year-to-date versus prior year and excluding portfolio changes our operating expenses are lower by about $350 million. Of this about half is attributable to our cost reduction initiatives and the remaining amount is associated with lower volume and energy costs. Additionally, we have recently informed our employees of changes to our defined benefit pension plan and post-retirement medical coverage which will reduce our employee related costs and future cash needs to fund the plan.

All of these actions our combined focus on costs, the idling of the Eagle Point Refinery and the sale of the retail heating oil and propane distribution business demonstrate our continuing efforts to realign our portfolio of assets and represent steps towards improving our operating performance and competitiveness. Coupled with our focus on capital discipline and our previously announced dividend reduction in 2010 these initiatives will allow us to manage through this refining down cycle while retaining our financial flexibility and liquidity through 2010 and beyond.

Now let me turn it to Brian McDonald who will talk about our business results and our financial position.

Brian McDonald

Thanks Lynn. First let me comment on our quarterly net loss attributable to Sunoco shareholders and our special items. We reported a $312 million net loss attributable to Sunoco’s shareholders in Q3 which included $278 million of net unfavorable special items as detailed in our earnings release and on slide five of our web deck. We incurred $278 million provision for the indefinite idling of all processing units at Eagle Point Refinery of which $254 million represents non-cash charges.

We also reported a $14 million non-cash provision for pension and post retirement settlement losses and a $12 million write down of certain other assets in refining and supply. These charges were partially offset by a $26 million net gain on the sale of the retail heating oil and propane distribution business.

Before addressing some specific items regarding the operating results, in general I would say the quarterly results particularly in core refining reflect the continuation of market weakness as crack spreads deteriorated further from the second quarter. Our non-refining operations, however, continue to make positive contribution and we continue to aggressively take actions to improve the company’s cost structure and financial positioning for the future.

Now with respect to Q3 business unit results I direct you to slide six. Refining and supply had a loss of $118 million in Q3 as both gasoline and [inaudible] margins deteriorated from the prior quarter. Operationally true unit utilization across the system was 74% in Q3 with utilization rates affected by weak demand and planned maintenance at the Toledo Refinery and at a FTC unit here in the northeast.

With respect to our Q3 margin realizations I refer you to slides 7 and 8 for more detail on our refining system improved costs and product differentials versus our benchmark. First let me say we are disappointed with our margin realizations versus our benchmark margins. While most of the factors that affect our realizations versus our benchmarks are market related, we are identifying opportunities and taking actions to improve our margin capture.

In general our benchmarks were down $1.50 per barrel from the prior quarter and our realized margins moved lower with the benchmarks. Our crude cost for the quarter averaged about $0.90 per barrel above our weighted benchmark due to weaker differentials on lower quality crudes. On the product side our average differential was $1.95 per barrel lower than our weighted benchmark as product pricing, particularly for non-benchmark products continues to be weak in this difficult market environment.

Additionally, margins were affected by the cost of fuel consumed in our operations and lower yield gains due to maintenance work during the quarter. As we consider the outlook for the fourth quarter the Eagle processing units have ceased production this week and our overall production levels will reflect market conditions. We intend to increase our rate at Marcus Hook and Philadelphia such that our overall production will be consistent with recent periods.

Now let’s turn to the non-refining businesses which earned $102 million in total during the quarter as noted on slide nine. Retail marketing earned $49 million in Q3. Sales volumes were relatively flat versus the prior quarter and retail gasoline margins improved as wholesale prices were relatively stable in the third quarter.

As Lynn noted we divested our retail heating oil and propane business during the quarter which resulted in net proceeds of approximately $83 million and a $26 million after-tax gain that has been excluded from the operating results of the $49 million profit. This sale allows the company to focus on our core retail asset portfolio.

During the quarter we also continued to execute on our retail portfolio management program and generated approximately $47 million of proceeds and $5 million of after-tax gains on site sales through the sale of 55 sites primarily to Sunoco branded dealers and distributors. Year-to-date we have divested 96 sites and generated $76 million in proceeds. Approximately 80% of the sites continue to be in the Sunoco dealer or distribution portfolio. We will continue to use this program to enhance our overall return on capital employed in this business. We anticipate an additional $100 million of proceeds will be generated through 2011 as the timing of this program has been extended somewhat due to the weak economy and tough credit market conditions for potential purchasers.

In chemicals we reported a loss of $1 million in Q3 as results continue to reflect weakness in both polymers and phenol and the business continues to manage volumes and margins in this difficult market. We continue to progress through a formal sales process with respect to the chemicals business and by year-end we hope to have a decision as to whether a sale will occur or whether we will continue to run the business for cash.

Logistics earned $19 million as Sunoco Logistics posted another solid quarter. The business continues to have steady growth in income from its growing asset base although this quarter was negatively affected by lower lease acquisition results.

Coke posted another solid contribution earning $35 million in Q3, down from Q2. The decline is associated with a $6 million after-tax dividend from our Brazilian operations we recognized in the second quarter. However, the $35 million of profit reflects continued stability of earnings.

Given a firmer view for the remainder of the year we are narrowing our full-year 2009 earnings guidance to a range of $180-190 million which includes a one-time $41 million tax credit associated with our Granite City, Illinois facility in the fourth quarter. This facility at Granite City is currently in startup mode with its first coke being produced last week. Our earnings guidance through the remainder of the year is predicated upon a continued smooth startup of the Granite City facility.

We also continue to work through permitting issues associated with our Middletown, Ohio coke making operations. Based on the extended permitting process we expect startup of this facility to be a 2011 event since construction will take about 15-18 months upon final resolution of the permits. We will provide new guidance for 2010 on our next quarterly conference call for the coke business.

Finally, let me take a few minutes to discuss our financial position as of the end of September. In conjunction with that I direct you to slides 10 and 11. Our third quarter net cash flow before debt activity was a use of $132 million for the quarter. From a balance sheet perspective our overall net debt position was approximately $2.4 billion up about $130 million from the second quarter. Of the $2.4 billion approximately $900 million was attributable to Sunoco Logistics. We ended the quarter with a net debt to capital ratio of 45%.

From a liquidity standpoint as of September 30 we had $178 million of cash and approximately $1.2 billion of available, committed borrowing capacity which includes approximately $200 million to Sunoco Logistics.

With regards to our capital program we have continued to reduce capital spending where possible in refining, marketing and chemical while making capital available for opportunities in Sunoco Logistics and Coke. Our full-year 2009 projected CapEx is just below $1 billion, down approximately $50 million from our most recent guidance. The mix of spending has changed to an ending year of approximately $150 million of reductions in refining and coke being partially offset by higher spending at Sunoco Logistics associated with growth opportunities.

As we look to 2010 we will continue to focus on capital discipline and anticipate spending to be lower sequentially. We will provide additional guidance after our board approves our budget for the 2010 fiscal year.

Turning to slide 12 as we look to the rest of 2009 and into 2010 we will continue to take appropriate actions that will assist us in maintaining our financial flexibility. We believe our proactive actions will improve performance in both the short and long-term and deliver increased value to shareholders. Together these actions are designed to enable the company to exit 2009 with a much more competitive cost structure across all of our businesses and reduced future capital calls.

We will continue to take prudent and appropriate steps that will enable Sunoco to face the future from a position of strength. With Sunoco’s significant refining presence in the northeast and Midwest, a more efficient cost structure, a strong branded retail network, significant ownership and overall control of the successful Logistics operation and a strong coke business we will be poised to capitalize on the eventual market recovery and take advantage of attractive opportunities for growth.

With that I will ask the operator to open the line up for any questions you have.

Question and Answer Session

Operator

(Operator instructions) The first question comes from the line of Jeff Dietert - Simmons & Company.

Jeff Dietert - Simmons & Company

On slide seven you go through the typical realized refining margin slide. That is a very helpful slide. I was hoping to get a little bit more color. The last two quarters your product differentials have been negative relative to the marker. Can you talk more specifically about the third quarter 2009 product realization and this $1.95 difference?

Brian McDonald

I would say in general we are not very happy with our performance around margin capture. We have a number of things we are doing internally to improve our capture rate. A couple of things we are looking at our operations processes, structure, etc. I think as we look at this on a go-forward basis we don’t have any specifics to talk about today but I would say this is an area of focus for us going forward.

Jeff Dietert - Simmons & Company

Is there something that has changed in the second quarter and third quarter of this year relative to prior operations or is this all market related?

Brian McDonald

I would say that some of it is market related. I would say some of it is our own execution. We are focused on improving our own execution in that component of it.

Jeff Dietert - Simmons & Company

Secondly, your chemicals segment gives you a view into demand for chemicals, economic recovery and also demand for crude. Can you talk about what you are seeing in the chemical segment? Is there a recovery in the products that you market?

Lynn Elsenhans

On the polypropylene side of the business we see some strengthening in demand. Phenol still is pretty weak. On the polypropylene if what I am saying to you doesn’t jive exactly what you see in our sales volumes, in part we have been impacted by lack of propylene supply.

Jeff Dietert - Simmons & Company

Did I read correctly you had McKenzie and Co. engaged in a cost cutting effort? If so is that the extent of their assignment or is it a broader assignment?

Lynn Elsenhans

We had asked McKenzie to help us with a benchmark approach to looking at our costs across the board. That is what we were calling the business improvement initiative and the guidance we had given was $300 million pre-tax annualized savings by year-end. We are on target to deliver that through seven months of when it was really initiated. We have about $175 million in reduced expenses, about $75 million of that in SG&A and about $100 million in other operating expenses and costs of goods sold.

Operator

The next question comes from the line of Arjun Murti – Goldman Sachs.

Arjun Murti – Goldman Sachs

I don’t mean this to be an unfair question and if it is I apologize. You all made the decision to sell your Tulsa refinery which I think you know Holly is now combining with the Sinclair facility. Can you make a comment on why that approach wasn’t exciting to you? I presume you must have considered it. It is really meant less of what do you think of Holly’s strategy than you are going to be left with now a kind of Northeast refining system, even if you cut costs to the degree you are talking about it is still a light sweet northeast refining system that you kind of wonder how competitive it is really going to be. Why not instead have taken that toehold in the midcontinent and chosen to focus more on building that area up?

Lynn Elsenhans

If I just take your first line of questioning around Tulsa, I say that particular facility of course required a major investment by us that we just felt we weren’t going to get a return on. Holly felt they would make that investment at a lower number than we felt we could make it at. You asked about combining with Sinclair. We looked at a number of options. Both from what I would call a contractual arrangement and also broader than contractual arrangements for intermediate supplies and processing. We weren’t able to come up with something there that made sense for us. I think overall our market view on the particular Tulsa area market is not as bullish as Holly’s.

In terms of the midcontinent in general we are bullish longer term on Toledo. We believe that Toledo is well positioned longer-term to have an upgrading facility there and be a part of what I believe will be a very important development of the oil pan going forward. We all know right now those projects have been either put on hold or extended in time because of the general crude oil price but that resource will be a very important resource to North America and I do believe it will be developed and it will make its way into the U.S. market and the midcontinent will be, I think, will be particularly well positioned as that occurs.

Arjun Murti – Goldman Sachs

You have taken a number of cost cutting and restructuring steps and clearly it makes sense to do that kind of stuff including idling Eagle Point and so forth. I guess I just wonder what the next phase of it is. Can Sunoco really be viable with its current assets or do you not need to have whether an acquisition or a merger but some meaningful other step to really change your assets beyond just the logical steps you are taking in cost cutting and I just don’t know that gets you to first quartile.

Lynn Elsenhans

I would agree with you that while the cost cutting measures we have taken are necessary steps that in the long-term they may not be sufficient steps. I think in the short to medium term the outlook are for relatively narrow light differentials. I would argue we aren’t at a particularly bad disadvantage running light sweet crude and in fact, many of the companies that are doing somewhat better are ones that are running light sweet. It doesn’t change the fact that we continue even in a bad environment to look at those opportunities to do the kinds of investments at a northeast facility and I have already talked about Toledo, that would increase our crude flexibility and increase our product out turn.

I think I have said this in investor meetings and conferences that we would anticipate that kind of investment would be of a size that would require us to do that with a partner. We are open to that.

Operator

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

Mark Gilman - Benchmark Company

I have a couple of specific things, two of which relate to comments made during your prepared remarks. I thought you said a few minutes ago that polypropylene sales volumes were constrained by propylene supply constraints? I guess I’m a little puzzled hearing that. What does that mean?

Lynn Elsenhans

We use propylene from the cat cracker at Marcus Hook and with the cat cracker cut back we aren’t making as much propylene and so it was not available at that time. We have some ability to bring in off-site propylene but that is limited and we have been looking for ways to increase that and work that issue over time.

Mark Gilman - Benchmark Company

I guess shutting down Eagle Point doesn’t help very much in that regard.

Lynn Elsenhans

We can’t get it from Eagle Point to markets [polymer]. Physically. We can’t do it.

Mark Gilman - Benchmark Company

There was also a comment made in the discussion of the results, higher cost of total fuel used. With natural gas prices where they are I guess I have a little bit of trouble understanding that. Could you clarify?

Bill Diebold

It is because of the maintenance and the turnaround activities that were going on during the quarter. We had different units down at different times and unfortunately you can’t optimize everything when you are doing that type of work.

Mark Gilman - Benchmark Company

A little bit more specifically, can you give us an idea of what the cash and income impacts are of the pension freeze?

Brian McDonald

Clearly these freezes which are effective July 1 next year, so there isn’t a full year impact next year, but clearly they are meant to cap the liabilities that the company has and to stop growth in those liabilities which these moves will do. As you know, there is a lot of variables between the asset returns and discount rate and the other factors around pension in particular, most of which are set in Q4, so we would plan to give a more specific update of the cash and expense impacts of these moves when we report our Q4 results.

Broadly speaking, this will reduce the cash requirements to fund pensions over time and to fund retiree healthcare over time and there will be some reduction in expense beginning next year although the full impact of expense reduction will really be in 2011 when it is a full year impact. Again, next year these moves are effective July 1 so there is only a half year impact next year.

Mark Gilman - Benchmark Company

I just have one more that is considerably broader. There is something I don’t quite understand. You are running your system at 74% utilization. That is well below at least for the third quarter what the U.S. average was. It is well below in terms of operating rates anything else I have seen in terms of individual companies. Yet you operate in a market where your location is an advantage. You operate in an import price determined market. Why are the utilization rates so low? Why is it you believe your assets are so disadvantaged that particularly in an environment of narrower light, heavy, sweet and sour differentials you have got to carry the bulk of the burden in terms of the demand reductions that are in place?

Lynn Elsenhans

The reason we were lower than industry was because of the turnaround that was planned, the turnaround at Toledo that was fairly extensive in length and then planned turnaround at Philadelphia. So if we hadn’t had the turnaround effect in there, I didn’t do it down to the decimal point but I can tell you we would be at the industry type numbers if not a little better.

Mark Gilman - Benchmark Company

You were very low in the first quarter also.

Lynn Elsenhans

I don’t believe we were a lot lower than industry in that quarter.

Mark Gilman - Benchmark Company

I would tend to think given the factors which I cited that your utilization rates ought to exceed industry average such that it raises a question in my mind to how exactly you are going about trying to determine what an appropriate operating utilization rate is.

Lynn Elsenhans

Is that a comment or a question?

Mark Gilman - Benchmark Company

A little bit of both. How do you do it? Why are the numbers that you get to which are considered to be the right number for an environment? Is it a classical marginal barrel, marginal cost type of consideration?

Lynn Elsenhans

Yes. We run linear programs just like probably everybody else in the industry.

Operator

The next question comes from the line of Paul Cheng - Barclays Capital.

Paul Cheng - Barclays Capital

It looked like for the rest of 2009 and 2010 it depends on what your CapEx or if your CapEx is similar to what you previously discussed in the 1.1 or 1.2 billion, you are probably generating negative cash flow. For arguments sake if I am right, you generate negative cash flow what is the priority? Are you going to raise debt to fund it or are you going to cut back in the CapEx so that you [inaudible]. Or you are just going to sell more asset to make sure you can? I just want to understand what is the priority?

Brian McDonald

We haven’t reviewed our CapEx plan for next year with the board. We would be pushing CapEx pretty hard next year and we would expect it to be down next year versus this year.

Paul Cheng - Barclays Capital

What is the minimum requirement you need to just sustain the business without cutting into the muscle?

Brian McDonald

I don’t have an answer for that. I would say as we looked at the plan for next year we are focusing on capital and prioritizing capital and we don’t see any issues even in the market environment we are in today given the actions we have taken with Eagle Point and other things we have underway to be able to prioritize the growth capital that we have as well as the base capital.

Paul Cheng - Barclays Capital

I guess my question is in the event you don’t have sufficient cash are you going to raise that or will it result in more asset sales or are you going to cut back CapEx so that you are liquid in the meantime? I am just trying to understand what approach you are going to take.

Brian McDonald

I think that is a sort of hypothetical question and I think based upon what we see today we don’t face any issues to get through the CapEx program we are looking at next year. If cash is tight we may look at a mix of both, selling some assets and we already have some things we have been doing for awhile selling some retail stations and we could also look at the capital markets as well which are very much open for us. I don’t have an answer to your question because right now we have sort of looked at next year we think we can fund the CapEx we have coming at us.

Paul Cheng - Barclays Capital

Earlier you mentioned the cost cutting and how much you realize, versus the second quarter can you give us some idea by segment where the incremental savings have come from and by what magnitude?

Lynn Elsenhans

We are not disclosing that. We are not going into that amount of detail.

Paul Cheng - Barclays Capital

How about if you just give us a total company, what is the incremental spend or cost saving from the second to the third quarter?

Brian McDonald

$75 million. Last quarter on a year-to-date basis it was $100 million and this quarter it is $175 million roughly.

Paul Cheng - Barclays Capital

Is that an actual number or a run rate?

Brian McDonald

That is year-to-date versus 2008 year-to-date.

Paul Cheng - Barclays Capital

So that is the six month year-to-date versus the 9 month year-to-date?

Brian McDonald

No. Nine month last year versus nine month this year.

Paul Cheng - Barclays Capital

But the $100 million is the 6-month year-to-date versus…

Brian McDonald

Exactly.

Paul Cheng - Barclays Capital

Maybe you can help me to see if my math is right. When I look at your realization and when I looked from the second to third quarter it does appear your refining cash unit cost actually has been up maybe $0.50 to $0.60 per barrel. Two questions, one is that in the ballpark correct and secondly if it is I thought with the restructuring initiatives, mainly focused in refining we should see refining unit costs down not up. So I’m just trying to understand better.

Brian McDonald

I think you are directionally correct. I think one of the issues from a unit perspective was the fact we were running at lower rates because of the turnaround. Then also some of the maintenance cost creeps into the third quarter here and offsets.

Paul Cheng - Barclays Capital

Maintenance cost of both of them should be capitalized, right?

Brian McDonald

For the bulk of the turnaround in Toledo yes. But some of the work in Philadelphia was not.

Paul Cheng - Barclays Capital

Your run rate is down probably by about 5%. Your unit costs are up by about 15% nearly.

Brian McDonald

We can talk about it a little bit further but I think the real answer is the fact you have a little more cost from maintenance work and then you also have the lower rate.

Paul Cheng - Barclays Capital

Is it possible you can help quantify for us how much the maintenance in the third quarter has been expense, has been capitalized? Is there a number you can share?

Brian McDonald

We typically don’t get into a whole lot of detail on what was capitalized versus what was expensed from those types of activities.

Paul Cheng - Barclays Capital

On the quarter to date, if we are looking at in the third quarter you had your realized margin versus the benchmark both in the crude and the [inaudible] has been disadvantaged. In the fourth quarter so far on those two aspects is it getting better or getting worse?

Brian McDonald

We don’t give guidance but I think we did have the rate at which crude rose in October put some pressure on us clearly. We will see what plays out in November and December. Clearly in October the rate at which crude rose impacted us in a negative way.

Paul Cheng - Barclays Capital

So if I get it correctly the crude costs versus your benchmark in the third quarter is more expensive by $0.90 and so far, I am just saying actual I am not asking for projections, so far quarter to date is a pick up and the $0.90. Right? I also want to see whether the [inaudible] versus your weighted benchmark so far again not talking about projections, just talking about quarter to date, is it worse off than $1.95 or better than that?

Brian McDonald

I would just say that October wasn’t a great month for us given the way crude rose. I will kind of leave it at that.

Operator

The next question comes from the line of Ann Kohler – Caris & Company.

Ann Kohler – Caris & Company

Will the pension freezes affect all of your employees?

Brian McDonald

It affects the majority of employees. There are cases where employees either are not affected because they hit certain age and service triggers around healthcare and then we have some contractual situations where the employees are not affected. Broadly speaking the majority of employees are affected.

Ann Kohler – Caris & Company

Again you don’t have to negotiate with any unions or anything? Would it include those employees as well?

Brian McDonald

The changes we have made impact the employees we can impact at this time without any negotiations.

Ann Kohler – Caris & Company

Regarding the narrowing of the range for your coke operations, what is that attributable to and what type of impact will that have on guidance you provided for next year?

Brian McDonald

We have had this guidance range out there for a few quarters of $175-200 million and as we got to the end of the year we thought it was appropriate to narrow. We have more line of sight to the business. We have Granite City started up. We just felt we had better line of sight to where we were going to end up. When you work out the math and strip out the tax credit Q4 it would imply I think $39-49 million of profit for the coke business for Q4 so I think we are pretty pleased with the outlook.

Ann Kohler – Caris & Company

Is that a reflection of looking at your coal sales? Is that a large portion of the reduction or the narrowing of the range?

Brian McDonald

There is no reduction. It is just narrowing the range. As we have said before, coal prices are one of the bigger variables but this business doesn’t have a lot of variability in it in terms of the profitability we experience. We feel pretty comfortable about Q4. At our next earnings conference call we will provide some guidance for next year for the coke business.

Operator

The next question comes from the line of Evan Calio – Morgan Stanley.

Evan Calio – Morgan Stanley

I know you updated for the chemical sale process to be expected or some result of that process to be announced by year-end yet as bids were due in mid September is it safe to assume there is an ongoing negotiation, counter bid process on that activity?

Brian McDonald

Yes. I would say we got bids in September. People are going through the process and it is an active process with active interest. We are hopeful that we will have a decision by the end of the year.

Evan Calio – Morgan Stanley

Can you discuss the shifts in products to Philadelphia and Marcus Hook and Eagle Point. I know you are looking at that shift. Are you looking for that shift to be a direct shift or is it just based on an assumption of retaining market share? Higher utilization from that output?

Lynn Elsenhans

Well essentially what we have done is taken it from the crude distiller as the physical capability of those two plants because all three plants were running at reduced rates it may be somewhat serendipitous that we are actually able to fill the two that are left and just about offset what we were doing before with three running at reduced rates.

What products slate we end up making will be determined by the linear program on how to best optimize hydrocarbon based on our outlook. We might not have exactly the same product out turn we had before because even within the system of running all three it will move with the marketplace.

Operator

The next question comes from the line of Paul Sankey - Deutsche Bank.

Paul Sankey - Deutsche Bank

I thought I might try to sum up the answers if I could. On the first one which is really about your refining strategy it sounds to me as if your actions are really just to circle the wagons and stay defensive. You are not going to try and grow out of this situation. You are really more focused on getting smaller essentially?

Lynn Elsenhans

I wouldn’t call it smaller it is being able to generate the same amount of gross margins with fewer facilities in a marketplace that is challenged on the demand side. So on the other hand I would say the other part of your question is are we actively looking to increase our exposure to refining margins and I would say that conclusion is correct. I would add to that if the right kind of opportunity came about that we felt we could create value for our shareholders we certainly would look at it. We are not actively looking to increase our refining exposure. We are more looking to how do we take the assets we have and make them more competitive and better position those assets.

Paul Sankey - Deutsche Bank

You are essentially trying to reduce your debt as well?

Lynn Elsenhans

I think in general we have been very consistent in saying we want a very strong balance sheet. We have maintained capital discipline and put a lot of focus on maintaining that discipline and liquidity.

Brian McDonald

I would say the refining environment is obviously pretty tough and we are trying to work the assets we have to get the cash flow breakeven in this kind of environment. Obviously with the way the margins have been and running the assets we have, we have had some pretty negative cash flow. We want to stem that and hopefully get some help from margins here in the future that will allow us to show positive cash flow off.

Paul Sankey - Deutsche Bank

You mentioned we looked at slide seven a couple of times. I think what you said is that the margin environment has deteriorated in October to [inaudible] and there would not have been at all a narrowing of that differential. Is that correct?

Brian McDonald

I would just say October was tough which is generally true for us when crude rises rapidly. We will talk about the whole quarter when we close the books in January.

Paul Sankey - Deutsche Bank

A more general question, can you make any observations you have on the general Atlantic basin crude market? What is going on in Nigeria. Any incremental observations you have on the light sweet crude markets would be interesting.

Lynn Elsenhans

The only general comment I would make is the differential is in general collapsing. Meaning the discounts we used to get on the less expensive, lower quality crudes are not as wide as they once were.

Paul Sankey - Deutsche Bank

Which I guess goes back to the idea that these markets are behaving kind of in a financial way as opposed to a fundamental demand strength way? It is slightly disconnected from the reality of the U.S. oil market at a give point?

Lynn Elsenhans

I would have to think about that one.

Paul Sankey - Deutsche Bank

How long should I give you?

Operator

The next question comes from the line of Faisel Khan – Citigroup.

Faisel Khan - Citigroup

The write downs and the one-time items you took, the after tax items, is it fair to say all those after-tax items if I look at the consolidated statement of operations and the $511 million I see in the third quarter and that encompasses all those one-time items?

Brian McDonald

Yes.

Faisel Khan - Citigroup

If I was looking at SG&A sequentially or quarter-over-quarter can you help me understand the increase from second quarter to third quarter 174 to 192. What is driving that?

Brian McDonald

I think there is a little bit of pension noise in there year-over-year. You are saying quarter-over-quarter?

Faisel Khan - Citigroup

Quarter-over-quarter yes.

Bill Diebold

I guess there are a few items that have trickled in this quarter and kind of offset some of the savings that you would see. If you look at it on a year-to-date last year versus year-to-date this year you will see about $75 million of savings which gets muted because our pension expense is up about $60 million. I think really what we have been focusing on and emphasizing is there are costs coming out and they are coming out of SG&A as well as cost of products sold and operating expenses. SG&A may be muted a bit because our pension expense is higher.

Brian McDonald

What I would add to that is there is sort of a number of smaller things which unfortunately were negative items that were in Q3 versus Q2. There is nothing of note. There was a series of mostly one-time things that are relatively small about $1-2 million each that impacted Q3 versus Q2. That is why subsequently it looks a little out of place given the cost cutting we are getting here.

Faisel Khan - Citigroup

So generally speaking we should continue to see those costs trickle down over time. Is that correct?

Brian McDonald

Yes. As Bill mentioned this year versus last year the company had a pretty big headwind on pension expense. Given the actions we have taken on pension and healthcare going forward some of that headwind or most of that headwind will unwind itself over time. This year the company had a fairly big headwind on pension expenses versus 2008.

Faisel Khan - Citigroup

Given the asset write down is it fair to say that the depreciation rate you were showing in the third quarter of $124 million is that the right rate going forward or will that come down?

Brian McDonald

I don’t want to get specific on that but I would say because we have taken this write down in Eagle Point and we have taken the book value down there fairly substantially the depreciation on the remaining assets will be lower, absolutely.

Faisel Khan - Citigroup

On the product differential, I just want to make sure I understand it, in the third quarter the products versus the benchmark you said higher costs of total fuel used. Is that the crude you consumed in the refining process? Am I thinking about that the right way?

Bill Diebold

That is exactly right.

Faisel Khan - Citigroup

So the higher prices mean higher cost of fuel?

Bill Diebold

Exactly.

Operator

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

Mark Gilman - Benchmark Company

If I remember correctly when we talked about working capital in the second quarter I believe that at the time it was said that part of the reason we did not see a source of working capital in the second quarter in a rising price environment was the fact there was an attempt to exploit some of the benefits of the contango in place. So my expectation I guess was with the narrowing in the contango a lot of that would have been unwound. So go forward into a third quarter environment which is also a rising price environment which given your leverage to payables should generate a source of working capital and we are essentially breakeven. What do I have wrong?

Brian McDonald

I wasn’t here in the second quarter but let me give you a couple of things. One, the third quarter inventory was higher than we had planned and wanted primarily because of some of the turnaround activity and the contango I believe is primarily coming down as we go into Q4. So, we have a lot of pressure on inventory and would hope to see improvement there in Q4 versus Q3.

Mark Gilman - Benchmark Company

So would it be fair all things being equal let’s say the markets stay where they are to expect fairly significant working capital liquidation in the fourth quarter?

Brian McDonald

I think it depends how you define significant but we would certainly expect to have improvement in working capital in Q4 versus Q3.

Mark Gilman - Benchmark Company

I want to go back to this product differentials and margin capture on the product side for just one second if I could. Is any of the effect that has been discussed by many questions up to this point associated at all either with derivative activity or with what you are or not doing vis a vie ethanol?

Lynn Elsenhans

No.

Mark Gilman - Benchmark Company

None of it Lynn?

Lynn Elsenhans

Neither.

Operator

The next question comes from the line of Jacques Rousseau – Soleil, Black Bay Research.

Jacques Rousseau – Soleil, Black Bay Research

A question on the coke segment. Does the delay in the timing of the Middletown plant change your thought process on when your segment might be spun off?

Bill Diebold

I think we have said we would be open to a sale or a spin but we have never talked about a specific plan or timeline. I think we are focused on the operations we have and getting Middletown up and running. I think we have a very nice business now. We make $180-190 million this year and we are very happy with that business, where it is in the cycle and the opportunities we have to grow it from here.

Jacques Rousseau – Soleil, Black Bay Research

If I remember correctly what has been said in the past was you wanted to wait until these plants were completed before you would consider doing something. So I guess my question is now this plant has been delayed about a year does that push everything back a year?

Lynn Elsenhans

I think what you are referring to is in response to some questions I received at conferences about a spin, what would it take to look like that was a viable option, we would feel the business would have to stand alone and the amount of EBITDA the business generates once Granite City and Middletown are on stream it puts it more in the likelihood that was the case. That is the context of the comments you are referring to. To the extent that Middletown comes on later, then we wouldn’t be generating that amount of cash flow until a later time.

Jacques Rousseau – Soleil, Black Bay Research

So that statement still holds then?

Lynn Elsenhans

I will reiterate what Brian said. While we have gotten a number of questions on whether we would be willing to spin this business we have always maintained that if it creates value for our shareholders we could certainly be willing to do it but we have no definitive plans to do so.

Operator

The next question comes from the line of Paul Cheng - Barclays Capital.

Paul Cheng - Barclays Capital

Can you tell me what is the amount of value in excess of the [coke] value in the third quarter on inventory.

Brian McDonald

$2.5 billion.

Paul Cheng - Barclays Capital

Also can you just refresh my memory what is the expected CapEx for Middletown for 2010, or since the timing it is a little bit unclear we really don’t know at this point?

Brian McDonald

The whole project I think is $350 million. We have spent a little bit already and then we put it on hold but we haven’t given any specific guidance as far as how much we will have next year.

Operator

There are no further audio questions at this time.

Brian McDonald

We will say goodnight and thank you to everyone. Myself and Bill will be available for any further questions or follow-up this evening and tomorrow. Thank you operator.

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