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Executives

Bruce Smith - Chairman, President & Chief Executive Officer

Chuck Flag - Senior Vice President of System Optimization

Everett Lewis - Chief Operating Officer, Executive Vice President

Lynn Westfall - Senior Vice President, External Affairs & Chief Economist

Scott Phipps - Investor Relations

Analysts

Evan Calio - Morgan Stanley

Paul Sankey - Deutsche Bank

Jeff Dietert - Simmons & Company

Neil McMahon - Sanford Bernstein

Blake Fernandez - Howard Weil

Faisel Khan - Citigroup

Tesoro Corp. (TSO) Q3 2009 Earnings Call November 9, 2009 2:30 PM ET

Operator

Greetings and welcome to the Tesoro Corporation third quarter 2009 earnings conference call. (Operator Instructions)

It is now my pleasure to introduce your host, Scott Phipps. Thank you, you may begin.

Scott Phipps

Thanks Joe. Well, good morning everyone and good afternoon and thank you for joining us for today’s conference call to discuss our third quarter 2009 earnings. Our management will not be referencing slides during the call. We have posted additional financial and operational information on our website, which is filed earlier with the SEC. These details along with other financial information should help you in analyzing our results, it can be found on our website at www.tsocorp.com.

After reviewing this information, please feel free to contact me with any questions about this material or otherwise follow in today’s call. Please refer to the forward-looking statements in t slides which says that 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.

Since there are many factors that could cause results to defer from our expectations. Before I provide guidance for the fourth quarter of 2009 to those interested our management team will be hosting a presentation tomorrow at 4:30 eastern time at the Downtown Association in lower Manhattan.

This presentation till highlight our 2010 business plan capital budget and other business items. Due to the limited seating, reservations will be required. For those not already registered, you can do so by calling the Tesoro IR department at 210-626-4676. I’ll now provide fourth quarter guidance for modeling purposes.

We estimate regional throughput to be in the Pacific Northwest, 125,000 to a 135,000 barrels a day in the Mid Pacific, 60,000 to 70,000 barrels per day, in the mid continent, 95,000 to a 105,000 barrels per day and in California, 230,000 to 240,000 barrels per day.

OpEx guidance for the fourth quarter is as follows. In the Pacific Northwest, $4.25 per barrel. In the Mid pacific $3.10 per barrel. In the mid continent, $3.75 per barrel and in California, $8.10 per barrel. Our depreciation for refining is estimated at $90 million. Additional fourth quarter guidance items include corporate expense of $45 million and interest expense before interest income of $38 million.

I’ll now turn the call over to Bruce.

Bruce Smith

Well, thanks Scott, and good afternoon to everybody also. I appreciate you joining us this afternoon. Just a brief note, our conference call this year, this quarter is just a little bit later than usual we had some scheduling conflicts with our board. We don’t normally end up reporting at the end. As you saw today, it wasn’t because of any other thing than just scheduling problems.

I would also make one other observation since our peers have reported their financial results and most of them have talked about the third quarter market environment. I am only going to briefly summarize our third quarter financial results. I am also going to highlight some important operational information and then lastly, I will give you some color on the market conditions we experienced in the third quarter.

Then as Joe said, we’ll open up to brief Q&A period after we are finished. This morning we reported third quarter earnings of $0.24 per share and we also reported that we built $255 million of cash during the quarter. We were very pleased with these results given the market environment and I do want to take a moment to congratulate our employees for this accomplishment.

In part, our success is due to the fact that our employees have embraced the goal we announced earlier in the year to improve margin capture through non-capital initiatives, more effective capital expenditure management, improved energy and maintenance efficiencies in addition to cost controls and also by optimizing working capital.

Net income in the quarter was $33 million, which was well below the $259 million we posted a year ago, when we had much higher gross margins and consequently we had much higher throughput. The major operating income improvement in the quarter comparisons would be that we had lower energy cost due to price, volume and energy improvements.

I mentioned that cash increased in the quarter. Cash, in fact at the end of the third quarter totaled $534 million and that was driven primarily by $4 million barrel draw on inventory, which was part of our initiative to optimize working capital as we better matched supply with current demand.

At this time, we do not expect to see any significant change in our inventory levels in the coming months. However, as you know, we are in unchartered territory. So we are going to have to be flexible and we will be responsive to changing market conditions.

So as I said earlier, we began the year by announcing a goal to enhance margin capture through non-capital and capital EBITDA improvement programs. Through the third quarter, we’ve generated approximately $310 million of EBITDA from our non-capital initiatives and we’ve realized $55 million from our capital program.

Accordingly, at the end of the third quarter, we were only $5 million short of meeting the full year goal of $370 million. In addition, we continue to aggressively look for ways to improve our cost structure, particularly energy and maintenance. This year, we have pursued initiatives to make the corporation more efficient and year-to-date these have reduced operations costs by $50 million.

Our principal balance sheet initiative was to protect our capital structure by keeping capital spending within operating cash flow and year-to-date our operations cash flow of $669 million is well in excess of our $389 million capital spending which does include turnarounds.

This year like years passed, has been defined by new and unique challenges, but as we build our 2009 annual business plan, we knew the markets were going to be different from our plan, but we were confident that we would be able to adapt to the environment which would enable us to successfully capture value for our shareholders. We believe the focus of our initiatives was correct, and that our entrepreneurial culture has aided us in delivering good financial results.

Turning to operations, third quarter operating income of $89 million was $363 million lower than the third quarter a year ago. The decline was a result of lower distill up margins, compressed differentials between heavy and light grades of crude and also as I mentioned lower throughput.

Gross refining margins for the system averaged $9.50, which was $7 lower than a year ago. West Coast diesel margins averaged $24 a barrel a year ago, but those dropped to approximately $10 in the third quarter as a result of weak global demand and high inventories.

During the quarter, gasoline margins were almost double diesel margins, so we adjusted our production to yield 6% more gasoline. While heavy crude differentials widened in the third quarter versus the second quarter of 2009, they continued to be significantly below a year ago.

The [OENT] ANS crude differential was down 50% year-on-year averaging less than $7 a barrel. In response to narrowing of heavy light spreads and operational impacts in California we shifted 6% of our crude out of the heavy barrel and into lighter barrels and other feed stocks.

Throughput of 564,000 barrels per day was well below the 622,000 that we had in the third quarter of 2008. While we optimized supply demand fundamentals for the entire system, a large portion of the reduction occurred in California where we not only made adjustments for the economy but we also had Golden Eagle and Los Angeles Down Town.

Earlier Scott gave you guidance for the fourth quarter, which does include a hydrocracker turnaround at our Los Angeles refinery as well as the unplanned down time on the coker there. Additionally, as you also noted in the Pacific, North West and California regions, we expect to have lower throughput caused by lower than historical seasonal demand in those markets.

Operating expense of $248 million was roughly $50 million better than a year ago as a result of lower purchased energy cost and due to lower consumption as a result of our energy improvement initiatives. But these benefits were partially offset by higher repair and maintenance cost due to the down time in California.

Our wholesale marketing channels and branded retail continue to offer secure off takes for our products during these weak demand periods and in the quarter they positively impacted operating income. Rack and retail prices rose with spot product values through July and August and they didn’t trend down where the spot price declined in September.

Retail operating expense was $5 million lower than the prior year due to our initiatives to lower these expenses and we expect these to remain in the $50 million range. As a result of our expense reduction initiatives and good market conditions retail generated $53 million in operating income.

We believe there is a definitive advantage to having marketing assets in our markets and are very pleased with the contributions that our employees are making to optimize our marketing channels of trade. Consequently, we continue to seek opportunities to enhance this business; and before we take questions I want to briefly discuss several market factors that impacted the third quarter results.

In August and September tighter product inventories in PADD V, especially gasoline, combined with extended planned and unplanned refinery down time caused West Coast gasoline margins to outperform other regions of the US.

Gasoline cracks in the West Coast, which averaged roughly $5 a barrel above the Gulf Coast for the month of July widened steadily throughout the quarter at $15 per barrel in September. Unquestionably this benefit was temporary but the underlying fundamental is important and that is the West Coast market has the best domestic supply-demand balance.

The West Coast refining complex has been rationally lowering both production and inventory levels to better target expected declining demand. And with low margins the absolute level of imports has slowed. California retail marketing heavily weighed to branded stations leaving few opportunities for significant sales into the spot market and CARBOB Gasoline remains a highly specialized product that is difficult for the global refining complex to produce.

Although the California market was hit early and hard by the economic downturn, the structure of the West Coast market hasn’t changed. The economic recovery maybe slow, but we believe long term industry fundamentals should be more positive, and that belief combined with our regional strengths and the stabilization of the West Coast product demand opens the door for us to begin to invest in our assets and start spending on the highest return projects from our in the hopper capital program.

These quick hit projects are designed to provide near term pay backs while maintaining the flexibility to start and stop as market conditions change. In 2010 we are budgeting $275 million for capital spending, and of this we intend to spend roughly $15 million in quicker capital

In our Q&A session today we won’t spend time discussing these projects or are really not going to spend any time on 2010, but we will provide additional detail along with other information concerning our future business plan during tomorrow’s investor presentation.

We continue to re-optimize unit, refinery and system utilizations as we see these market conditions change. The start to the fourth quarter is a good example as West Coast crack, spreads in October were about half of September. But we feel that our people assets and markets have positioned us well for growth and we believe it’s time to start reinvesting back in the business.

With that we are going to open it up to questions Joe.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Evan Calio - Morgan Stanley.

Evan Calio - Morgan Stanley

I had a question. I know in January California transitions under the low carbon fuel standard to a higher ethanol blend at 10%, I just had two questions for you guys. Number one, if you are on track for January compliance in terms of blending infrastructure investment etcetera.

Secondly, given current market conditions pricing and sending discretionary blending, I mean how do you estimate the current blend maybe in your system or overall in California. Meaning, I’m sure we are currently at some point between that 5, 7 and 10% today currently. Then I will follow up.

Chuck Flag

This is Chuck Flag. We are very definitely on track to begin to producing CARB 4 on the first of the year, and to the second part of your question if I understand it right,. we are going to be going up by about 4% ethanol in our blends which has the BTU equivalent of about little under 3% increase in production.

Evan Calio - Morgan Stanley

Right. But I mean there is incentivize to discretionary blend now, is that correct?

Chuck Flag

Earlier in the year there was an incentive to blend ethanol to gasoline, but right now there is not.

Evan Calio - Morgan Stanley

Okay. My second question, maybe if you could just walk us through a little bit more your decision to return with a modest discretionary spent in 2010. I mean is this marginally more bullish view take some of your cash cushion and reinvest it into the business, at the same time cracks on the screen, as well as your 4Q guidance looked challenging, if you can discuss what led to that time to reinvest decision Bruce.

Bruce Smith

I think first of all, I was reading my script just in case I misspoke. Scott says I said $275 million of capital, I should have said $675 million of capital, so just to make sure everybody has got the right number, we’ll eliminate question. I can’t get the spending down to $275 million although that would be a nice number, and particularly with $50 million of quick added capital.

I think that these projects have, and hopefully this will answer anybody’s question about this. But these projects have been under review for the better part beginning in mid part of 2008, we’ve been developing the concepts around this.

As we reviewed them with the board, it’s an outgrowth of so many different things and this is a slide that we used at the beginning, at the analyst meeting a year ago, when we said we have over 300 of these projects which is right, we have a large number over that and there’s split between refining projects and logistics and marketing projects and they range from very small amounts of money and we’ll get a little bit more detail tomorrow on that capital program.

But the basic question is sort of the outlook for I think in; we are looking at a point in time, where it would be very difficult for us to say that we’ll spend all this money if margins stay where they are. I think that it’s illogical to assume that margins are going to stay where they are. I think that our basic belief is, I am not quite sure, I can’t tell you why margins are where they are, and I couldn’t tell you many times when they are good why they are.

But certainly at this period of time, it’s hard to say that these margins are going to continue. If they did, we have to take a look at what our spending rate would be next year. Our basic view about the market right now sort of summarizing it is that, we’ve always tried to be ahead of the curve. I think the intent on the capital program is to be ahead of the curve.

When I look at the next several years, and we’ll talk about this, it’s all about year over year improvement. How do you generate that in a flat margin environment and this becomes the key driver for generating year over year earnings growth, some cost reductions, but really some of these low hanging fruit projects that we think will differentiate us over a period of time.

I think that the margin environment that we see today wouldn’t be something that would support a long term investment program, but I just don’t believe that we are going to see that as we get in the next year.

That said, they are easy to adjust, they are really sort of back end loaded because of the way the spending will occur next year. So, I think we will be able to review what we think that means tomorrow, but my feeling is we’ll be able to manage the capital and continue to have the right type of capital resources and balance sheet.

Operator

Your next question comes from Paul Sankey - Deutsche Bank.

Paul Sankey - Deutsche Bank

Bruce, I think this is the first question. You’ve said that we’ve gone through the market environment by virtue of the fact of the other results that we’ve had. But specific to California West Coast, it feels like we had better margins during Q3 despite weak demand on down time.

I wonder whether or not you think the reason that margins are so weak right now is predominantly because we’ve got refineries back and available or whether it remains, demand side is the chief concern? Knowing that you think strategically about these things with Lynn as well, I wonder whether you could just talk a little bit about what your outlook is for next year. I was particularly thinking about the unemployment rates and the fact that we’ve had kind of a GDP bounce here, but not an oil demand bounce. Thanks.

Lynn Westfall

Hey Paul, this is Lynn. I’ll try taking on some of that. Certainly, going into the fourth quarter, we typically see on the west coast, about a 4% decline in demand from the third quarter. Obviously, that setting is now early as well as with the vapor pressure change, we’ve automatically got more supply whether you are running refineries at the same rate or not.

I think looking maybe a little bit further ahead, what we saw in 2008 was a combination driving demand decline, about a third of it was due to unemployment and about two-thirds was due to the high prices we had in 2008. When I look at the data now for 2009, and probably going forward into next year, it’s all about unemployment. If you strip out the unemployment effect, you actually have growth in gasoline demand on the west coast.

So it’s all going to be about unemployment, but the only good news there from California is unemployment rate has been stable the last three months at about 12%, but when that’s going to come down, I think is anybody’s guess. But as I say, I think that’s going to be prime factor in demand increases next year.

Paul Sankey - Deutsche Bank

Okay and then thanks a lot, then if I could have a follow up. You talked about cost, cost control as being the key, one of the key elements that you can go after here. If I look at your guidance and your throughputs of Q3 against Q4 it seems that most of the OpEx guidance you have given could be attributed to lower throughputs.

I assume that’s why OpEx was guided to be up. With the exception of California where it seems that you have got around the same level of expected throughput but a higher OpEx. Can you talk a little bit about that thanks.

Scott Phipps

Hey Paul this is Scott. You’ve got, it’s about $20 million of expected increase in energy cost due to the price of purchase energy. Once you have additional cost associated with the unplanned down time for the Los Angeles Coker in your fourth quarter guidance.

Paul Sankey - Deutsche Bank

So we would expect that to revert for next years call looking forward, I know you probably don’t want to go too far down this road, but if you could just talk a little about how we would hope for those OpEx almost to shift over the full course of next year and the issues that we go with throughputs, thanks.

Scott Phipps

We are going to assess going to the non-income improvement initiatives around maintenance and energy reductions tomorrow as part of that.

Bruce Smith

Yes. I think we will get into a little bit more detail tomorrow. But we had so many different initiatives when we talk about cost reductions, and some of them are obviously OpEx reductions and we are making good improvements and we lost ground in our goals this year due to throughput, just the market changes where our throughput was lower than we thought it was going to be.

When we look at next year we still believe that there are really good improvements that we’ll make. And I think that the overall fact of where we think we still have room to make more significant improvements, when we think about the business itself is on the crude side.

We have been working on our crude flexibility program, we just said to the board this year we have processed 23 new crudes. We continue to be very active, we have a another asset that we are going to employ in that process next year and so we will talk a little more. But a bigger factor, when you look at saving a little bit here and a little bit there the biggest savings obviously could still be around crude, and we think that that’s a pretty powerful lever for us to pull up.

Operator

Your next question comes from Jeff Dietert - Simmons & Company.

Jeff Dietert - Simmons & Company

Good afternoon. I had a question on 3Q, specifically with California with cracks having falling a bit there. Your throughput on the surface looks to be similar in 4Q relative to 3Q, and yet cracks are down as you mentioned relative to where they were in 3Q.

How do you react to the lower margin environment? I assume you purchased all your November and most of your December crude. Can you react and produce less and therefore build crude inventories or do you run per the plan in November and December and plan on little runs next year, how do you think about that?

Bruce Smith

That’s a great question. I think that and I’ll let Chuck talk to you a little bit and I may give you just sort of the summary point. But chuck why don’t you share?

Chuck Flag

Sure. Jeff, in the third quarter we had a fair amount of down time, which had a big effect on the rates that we ran. In the fourth, similarly, we have about the same amount of down time in the system. As far as our ability to adjust this concern, we are constantly looking at matching our throughput to our product demand, and we are constantly considering alternative margin environments and what we would do in those environment.

So we have the means and have a well thought out plan as to how we would react to potential elongated period of low margins.

Bruce Smith

I think just to your point, which is really an important one more in a macro sense, and your statement that margins are down a little bit is a very gracious way of putting margin sort of lower.

When we started looking at third quarter operating plan, which Chuck’s group prepares, and again trying to be quick on our feet, we have actually started a whole process of looking at what we do here in the quarter, which is driven in part obviously the timing, which is driven in part as you point out by crude purchases that you have already made, and there are things you can do, there are things you can’t do.

But I think importantly as we look at the market today, I don’t think anybody would be factious of the facts where people would see their profit building in the fourth quarter is going to be difficult at best, and we expect that whole, the entire industry is at the point of looking what they can rationalize.

But with crude purchases we maybe a week, we maybe a couple of weeks from seeing what really is going to happen. But we expect that there is going to be a response, we don’t expect that you are just going to see people continue to pursue an operating plan that was designed a couple of months ago when margins were higher.

Jeff Dietert - Simmons & Company

Okay. And now on your capital spending you talked about 675 for next year including $50 million of income producing investments, but I would assume if the margin environment were weaker you can make more adjustment, some 625 is probably not your minimum spend next year if we were to see a weak environment, is that fair to say and can you?

Bruce Smith

That’s fair to say, it’s probably not 275. But I think, again, we have also showed sort of the timing of the expenditures tomorrow. But we have looked at that as to what we would do. Obviously the period of weakness that we think, if you look at any type of traditional patterns is going to be in the fourth and the first quarter. And so, we are certainly more sensitive to that and we have the ability to make adjustments.

Operator

Your next question comes from Neil McMahon - Sanford Bernstein.

Neil McMahon - Sanford Bernstein

I have got a few questions. The first one is really looking at California in the quarter, were you running any different types of crude into California in the quarter versus 3Q and a year ago?

Chuck Flag

Neil, this is Chuck Flag. I believe we probably were running a little less of some of the South American heavy crudes. There has been both a reduction in the production levels of some of those oils and an increase in the demand for those oils from among others, China. And so, directionally we probably run less of crude such as NAPO coming from Ecuador.

Neil McMahon - Sanford Bernstein

Okay, that’s great. And second to your, slightly more strategic, it looked like there was another reasonably weak result from Hawaii, and I just wonder how that’s looking strategically within the portfolio these days and any updates there?

Everett Lewis

This is Everett Lewis, I will comment on that. We did have a weaker performance in Hawaii, part of that is the old lag time on some of the pricing there where we have contracts that are priced out of phase with our crude. But, nonetheless, when you see weaker distilled price versus gasoline, and that pattern why it tends to show up weaker were also being impacted with crude prices there as a lot of our sweet crude is being priced out of the Asia market.

But we are constantly looking at other alternatives there, we have got some ideas on the crude side as Bruce mentioned there earlier that we are working on and we continue to look at what options we have.

Neil McMahon - Sanford Bernstein

Well, and for this moment there’s no.

Bruce Smith

I think the lag effect in that is always difficult for everybody. But, we just, again having just reviewed this with the board, in the quarter actually the operation was plus cash. And so, the booked income and what we actually do there is it’s a little hard for everybody to sort out, but there is a timing difference and obviously it continues to be more of a reporting problem.

We continue to look at all those operations in the crudes that we feed that particular facility, which is with long holds and with, fair to say higher price differentials to other markets, it’s going back to what I said with Paul is one of those focuses of how you really pull the big lever on Hawaii to be able to significantly alter its crude cost.

Neil McMahon - Sanford Bernstein

So, you mentioned it’s still making cash in the third quarter?

Bruce Smith

That’s true.

Neil McMahon - Sanford Bernstein

Okay, just a final question. Given what’s going on in the Balkan in terms of quick production, that’s always been an area where, in terms of, I don’t want to use the word monopoly, but you have certainly got a huge advantage up there so far in terms of your location.

Just going forward, lots of discussions amongst upstream operators about different export channels to get the crude out of Balkan, any views there on trying to do more of a little term contracts with some upstream players who have a good crude supply coming into the refinery?

Joe McCoy

Yes, this is Joe McCoy. We have in fact started negotiations and have arranged to enhance our gathering systems up in the Balkan and we’ve been successful in negotiating one additional term contract and are looking forward to another that would significantly term up a good portion of the Mandan feedstock requirements.

Operator

Your next question comes from Blake Fernandez - Howard Weil.

Blake Fernandez - Howard Weil

Bruce, my first question is on the dividend. Just want to gauge your stands on the dividend. Obviously you are reducing the dividend and increasing capital spend in the next year for some enhancements, if you will. And I am just curious, is there a chance that you would consider, potentially just eliminating the dividend altogether if you see better opportunity for investing that within the business?

Bruce Smith

We looked at our dividend obviously we had a lot of discussion around and we continue to have a lot of discussion about it. It’s not the first quarter that we have discussed the appropriate amount of pay out, but you are exactly right.

When we look at going forward and the amount of, again looking at tomorrow you will be able to see the numbers with what we think we can do by investing capital in another form rather than giving it back to shareholders in the form of a dividend. We really believe that there is a much better use of allocating capital to the high quick and high return projects.

We certainly debated whether just going to eliminate it. I mean, if you look at $50 million next year that’s $50 million of dividend. But we decided that it looked like right amount of yield, appropriate to what other companies are doing, and at this time felt that it would be inappropriate to go farther.

I think that we will have to look at the facts and circumstances as we move into 2010. But it’s not an indication that we think that that’s 100% makes use of capital, but on the other hand I will tell you that we are not sure these are hundreds of projects, which are going to require a high level of execution.

So, being able to complete all of these as quickly as you would want to complete them and to be able to have the right sequencing and priority, becomes a much more challenge probably than the funding. And so the long way of saying that we will continue to evaluate dividends, we will look at how the best way to be able to deliver those results back to shareholders.

Blake Fernandez - Howard Weil

Okay. I know you said you wanted to talk about 2010 CapEx tomorrow. But maybe I will just take a stab on this front. I see that the way you word the payback on these, say, a one to two year time frame, is it fair conceptually just to kind of look at this as $50 million of spending and just assume somewhat of a, say 50% rate of return on that capital, is that just kind of a back of the envelope fair way of looking at this?

Bruce Smith

I think that puts your thumb up and that probably gets you right about in the category.

Blake Fernandez - Howard Weil

Okay. Then the only other one from me is, I guess, at the beginning of this year there was significant amount of down time on the West Coast and I am just curious if you have any thoughts or understanding of what’s going on, as we head into 2010 are there any major projects or turnarounds that you are aware of industry wide?

Chuck Flag

Yes Blake, this is Chuck Flag. There are in fact some pretty significant turnarounds particularly in the January-February time frame of 2010.

Blake Fernandez - Howard Weil

Chuck, do you happen to have any order of magnitude there or?

Chuck Flag

I really can’t talk about our competitors, but I would say something on the order of 150,000 to 200,000 barrels a day coming off.

Operator

(Operator Instructions) Your next question comes from Faisel Khan - Citigroup.

Faisel Khan - Citigroup

I just had a question on the realizations in specific North West; you guys seem to out perform your Tesoro index this quarter. I’m just wondering what drove that. I guess you put in $9.08 I think the index was something like $7.3?

Everett Lewis

We get the benefit, you have to remember we have the Canadian crude pricing, which we get the benefit for quarter over quarter as well. I think we had pretty decent retail realizations on the product side as well in Alaska which also contributes to the out performance over the basic spot marker that you see that’s embedded in the index.

Chuck Flag

One of the other things Faisel is blending ethanol, the ethanol prices were extremely well during the third quarter and we benefited from blending more ethanol into gasoline which is not in our index.

Faisel Khan - Citigroup

Okay. So you have more discretionary blending capabilities over there than the rest of your competitors?

Chuck Flag

Yes.

Faisel Khan - Citigroup

Got you. Can you talk a little bit about, you had the reverse, the Panama pipeline that reversed I think in August, can you talk about any benefits that you guys were able to derive from that in September and October?

Chuck Flag

Faisel that system doesn’t really come on line until the latter part of the first quarter.

Faisel Khan - Citigroup

Okay, there is not going to be any benefits from that until next year.

Chuck Flag

Right.

Faisel Khan - Citigroup

Got you. Can you talk a little bit more about, you guys mentioned that right now you believe the demand is right now tied towards California unemployment data. Are you saying that you think that that sort of figure has stabilized, do you see the demand has stabilized or do you think if it does get worse we could see the demand get worse in California.

Bruce Smith

Yes, well what we are saying is that the people in California who are driving appear to be driving more than they have been on year over year. But its people that are off the road, people that are unemployed that were keeping the demand numbers down overall.

So yes, I would say it’s totally related to the unemployment. If that goes higher although from 12% it’s hard to imagine how it could go too much higher. But if it does we would expect to see overall demand declines. If it stabilizes where it is now hopefully we will start to see some improvement.

Faisel Khan - Citigroup

Okay. got you. Just last question. On Hawaii, you said you see your free cash flow positive out there, is that after CapEx too or is that on an operative basis.

Bruce Smith

That is just an operating. I mean it is pure operating numbers, and I don’t mean to day, the significance of the number is not so important is I’m just, I want to because of the way the contracts work over there and the lag that exists, it’s a little misleading when you see the numbers. But we continue to look at all of these businesses to make sure that on balance it’s something that we want to continue to operate, to feed, what the run rate should be and my only point there is it’s a little bit misleading.

Faisel Khan - Citigroup

Is there an opportunity to kind of renegotiate that contract when you move that lag than it hurt you from quarter to quarter?

Bruce Smith

That’s been our focus. I mean, if the contract works very effectively, just from an accounting point of view, it doesn’t. It’s indexed and we have got a few things that we’ve been talking about with our customers there, but I can’t tell you that we are going to be able to be successful doing that.

Operator

There are no further questions in queue. I would like to turn the call back over to Bruce Smith for closing remarks.

Bruce Smith

Well, I want to thank you all for being on the call, again it’s late in the reporting quarter, we are really pleased with what we’ve done. I know there are going to be a lot of interesting questions tomorrow, we will start getting that information out about our capital program and we are really excited to see everybody tomorrow afternoon.

Thanks for your participation and we’ll see some of you tomorrow and those of you who we don’t see, if you have follow-up questions, you can call Brad or Scott, otherwise we’ll plan on looking forward to report the fourth quarter. Thank you.

Operator

This concludes the teleconference. You may disconnect your lines. Thank you for your participation.

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Source: Tesoro Corp. Q3 2009 Earnings Call Transcript.
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