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Frontier Oil Corporation (NYSE:FTO)

Q2 2010 Earnings Conference Call

August 5, 2010 11:00 AM ET

Executives

Kristine Boyd – Manager, IR

Mike Jennings – Chairman, President and CEO

Jim Stump – VP, Refining Operations

Doug Aron – EVP and CFO

Joey Purdy – VP, Refinery Supply

Bill Rigby – VP, Refinery Planning & Optimization

Nancy Zupan – VP and Chief Accounting Officer

Analysts

Edward Wesley (ph) – Credit Suisse

Paul Sherada (ph) – Bank of America

Jeff Dietert – Simmons

Ben Herr – Morgan Stanley

Paul Sankey – Deutsche Bank

Blake Fernandez – Howard Weil

Chi Chow – Macquarie Capital

Daniel Burke – Johnson Rice

Jacques Rousseau – RBC

Paul Cheng – Barclays Capital

Operator

Welcome to the second quarter 2010 earnings call. I will be your operator for today’s call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Kristine Boyd, Manager of Investor Relations. Kristine, you may begin.

Kristine Boyd

Good morning and thanks to all of you who are joining us this morning for our second quarter 2010 earnings call. Here with me this morning are Mike Jennings, Chairman, 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 in circumstances that are described in the company’s reports 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 Chairman, President and CEO, Mike Jennings.

Mike Jennings

Good morning everyone and thank you for joining our second quarter earnings call. Frontier reported second quarter net income of $66 million, equivalent to $0.63 per share. This represents the big step forward versus our first quarter results when we reported a loss of $40 million or $0.39 a share. The second quarter earnings came from three major areas. First, we had consistent and reliable operations with high throughput rates at both refineries. Second, diesel margins strengthened significantly while gasoline margins improved seasonally. And finally, we captured considerably better crude oil economics as both contango and the WTI forward curve and wider heavy sour differentials provided favorable feedstock pricing at both of our refineries.

Refinery gross margins before operating expenses showed improvement at both the plants with El Dorado stepping up from $3.56 in the first quarter to $9.94 in the second and Cheyenne advancing from $2.61 in the first to $11.38 in the second, all on a per sales barrel basis. Production was very strong through the quarter with average total product sales of 143,500 per day in El Dorado and 51,600 per day in Cheyenne.

Both refineries lowered operating cost through the quarter and I am pleased to see that our actions to reduce costs are flowing through to our quarterly financials. Refinery operating cost per sales barrel excluding depreciation were $3.43 in El Dorado and $4.97 at Cheyenne. This Cheyenne figure does not include the benefit of an additional $4.2 million reduction in an accrual for environmental penalties.

So for the quarter, we are showing a recurring expense level at Cheyenne of less than $5 a barrel for the first time in several years. Cheyenne had a good second quarter with the best gasoline and diesels yields in its history and was continuing this performance in July. And while there is never a good time for refinery fire, the incident on July 28 was particularly difficult given the progress being made in Cheyenne prior to this. We experienced a relatively large fire though it did not involve in explosion and damage to our production equipment was moderate. Most importantly there were no injuries to our employees or contractors.

The crude unit in Cheyenne will be shut down for what we currently estimate to be two to three weeks while repairs are completed. Jim Stump will provide more details on the status of Cheyenne later in this call. And I recognize the tendency to want to connect this incident to our recent rationalization efforts in Cheyenne. However, let me assure you the cause of this fire was absolutely unrelated to our cost cutting efforts of the past year and safety remains our highest priority at both plants. We will spend what is necessary to operate our plants safely.

Turning to the third quarter operating environment, we have seen higher refinery utilization rates overall and despite improved gasoline and diesel demand, national product inventories remain on the high side. Gasoline and diesel crack spreads have come down from May June levels, though with an approximately $10.211 in the Mid-Con and somewhat higher margins in the Rockies. Refinery margins are continuing what we believe will be a slow cycle of improvement along with the overall economy.

An important difference from the fundamentals we experienced early this year is the resurgence of a meaningful Canadian heavy crude differential. WCS presently trading in Hardesty at a discount of about $19 off WTI, which landed at our refineries represents about 20% discount versus WTI. This improvement we believe stems from low worldwide residual fuel prices, lower regional asphalt demand, and reduced demand for Canadian line fill barrels. Coking economics are once again contributing to refinery profitability though we still benefit from the flexibility of running some local sweet crudes and picking up the related boost to gasoline and diesel yields. As always, flexibility, reliability and safety are the main stays of refinery profits.

Returning to Frontier in our second quarter, I am pleased with our financial performance as it demonstrates good earnings power, product yields and cost efficiency in what feels like a mid-cycle margin environment. Our quarter ending cash balance of $444 million exceeded debt by $97 million and we continue to believe that a strong balance sheet, a good liquidity are valuable assets to our company and its shareholders. Obviously, we are upset about the downtime in Cheyenne but we are equally committed to a quick recovery from this incident and a continuation of the performance improvement that was underway.

With that, I will turn it over to Jim Stump for a discussion of our quarterly operations.

Jim Stump

Thanks, Mike and good morning everyone. We are proud of the operations at each of our refineries for the second quarter. As Mike mentioned, both plants ran reliably and had excellent results and throughput production and operating cost.

In El Dorado for the second quarter, crude throughput averaged about 132,000 barrels per day, which is a record quarterly average for that refinery. Operating expenses averaged $3.43 per sales barrels or $44.8 million on an absolute basis, which was another record low since 2006. The expected third quarter average crude rate for El Dorado will be about 130,000 barrels per day and total charges including other feed and blend stocks about 142,000 barrels per day.

Expected operating cost for El Dorado’s third quarter is about $4 per sales barrel. The final phase of the El Dorado gasoil project, hydrotreater installation is still on schedule for the fourth quarter of this year with the short window of reduced rates required for the necessary tie-ins.

Cheyenne also had a very good second quarter. Crude throughput averaged about 46,000 barrels per day on a 70% light crude slate, improving further flexibility to capture the benefit of local crude options. Operating expenses averaged $4.09 per sales barrel, however for comparison purposes, we need to add back about $0.88 for the non-recurring benefit of the EPA fund reversal that Mike mentioned which reoccurred in the third quarter of 2009. Excluding this, on an absolute basis, Cheyenne’s operating costs were about $23.4 million for the second quarter, which is an excellent progress for refinery that averaged $28 million per quarter over the last four years.

For the third quarter, Cheyenne had a strong start which has now been impacted by unfortunate event last week. We are very thankful that nobody was hurt in the incident and as Mike mentioned damages were modest with no major equipment affected by the fire. The affected area was a pipe rack between our atmospheric and vacuum distillation columns and we believe repair cost will be less than $5 million. We will have lost opportunity in the third quarter due to the reduction in gasoline and diesel production during the crude unit outage.

At current margins, the impact of this lost production represents a refining gross margin loss of about $7 million assuming the three week outage. Crews are working round the clock to repair the necessary piping, electrical and instrumentation.

While we recover from the Cheyenne fire, we will also bring forward some maintenance on our naphtha reformer and diesel hydrotreater. We expect to offset our fire related production losses by about $2 million by performing this maintenance now and avoiding lost production that would have occurred in the spring of 2011. This rescheduled maintenance will accelerate about $1.5 million of operating expense into the third quarter.

Including the effects of the crude unit outage, Cheyenne’s expected third quarter average crude rate will be about 35,000 barrels per day and total charges including other feed and blend stocks of about 38,000 barrels per day. With wider crude differentials, we will be increasing the heavy crude in our slate to about 50% for the third quarter. Expected operating cost will be about $30 million for the third quarter, which includes about $4 million for fire repairs, about $1.5 million for accelerated maintenance that I mentioned and offset by approximately $0.5 million per quarter savings from the second phase of staffing reductions we announced in May.

We continue to progress on our profitability initiative in Cheyenne with the LPG recovery project still on track for completion in the late second quarter 2011 and the additional energy savings from a number of efficiency projects to be completed along with the LPG project.

Our next scheduled major turnarounds will be the FCC and Alky units in Cheyenne during the fall of 2011 along with the El Dorado Alky unit also in the fall of 2011.

And with that, Doug is going to wrap up our call.

Doug Aron

Thanks, Jim and thanks to all of you for joining us this morning. Let me start off with a discussion of our cash flows for the second quarter. We generated $18 million in operating cash flows net of a $109 million increase to our working capital and spent $18 million on capital investments.

We ended the quarter with a cash balance of $444 million, which exceeded debt by $97 million. We have a remaining income tax receivable of $128 million related to our 2007 through 2009 tax returns. Of this, about $20 million was received in July, about $35 million is expected in the fourth quarter of this year with remainder expected sometime in 2011, probably the third or fourth quarter.

Our expected 2010 capital budget remains unchanged at approximately $115 million. During the second quarter, crude and product inventory changes had a material impact to raw material cost at each of our refineries under the LIFO inventory accounting method. In Cheyenne, increases in inventories reduced gross margin by about $1.15 per sales barrel. Our hedging results also contributed a benefit to the second quarter results in the amount of approximately $18 million after tax due to decline in crude prices during the quarter.

Finally, let me update you on our quarter-to-date crack spreads and crude oil differentials. Starting in Cheyenne, the gasoline crack spread averaged $11.30 for the month of July and is about $11 month-to-date in July. The diesel crack spread averaged $13 for July and is about $14 month-to-date in August. In the light/heavy differentials, which includes the transportation to our refinery averaged about $10 per barrel for July and $11 for August.

Moving now to El Dorado, the gasoline crack spread averaged $9.80 for July and about $7 month-to-date in August. The diesel crack spread averaged about $10.60 for July and $10 month-to-date in August. The WTI/WTF differential averaged about $2 for July and remains roughly the same so far in August. And finally, the light/heavy differentials again including transportation to the El Dorado refinery averaged about $8 for July and $9 for August.

And with that, I believe we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Edward Wesley (ph) from Credit Suisse.

Edward Wesley (ph) – Credit Suisse

On Cheyenne, you have about the sector, $0.5 million quarter for staffing. How low the costs can go on a quarterly basis and can you talk maybe a little bit about margin uplift project at the refinery as well as costs?

Mike Jennings

Our cost reduction targets at Cheyenne really are intended to get that plants to at or inside $5 a barrel. We have a little bit left to go particularly in the realm of energy efficiency but we are nearing the point where certainly from a staffing perspective, we have the right headcounts at that plant, which puts us approximately at 50th percentile in terms of solemn survey data, which is relevant to the refining industry.

In terms of margin improvement projects, the center piece of that obviously is the LPG project which comes on stream finally at the end of the second quarter of 2011. Impact of that is about $1.25 a barrel really in any price environment that we have seen in the last five years. So it’s very robust to differences in crude price and such, it’s determined principally by liquids prices versus gas prices.

So what we are looking at going forward is the effect of that project, some energy savings and some additional uplift projects that are principally commercial in orientation but it might add up to 25% to per sales barrel.

Operator

Our next question comes from Doug Leggate from Bank of America.

Paul Sherada (ph) – Bank of America

Hi, this is Paul Sherada filling in for Doug this morning. Just a couple of quick questions for you. You commented on your expected loss on both a business level and an opportunity cost from the Cheyenne fire. Could you just give us a little clarity on your insurance coverage related to the loss, both on a general level and any business interruption insurance you may carry?

Mike Jennings

Certainly. We carry a property coverage with $7.5 million deductible. We don’t expect to breach that through this. So this will come out of our pocket in terms of the repair cost. The business interruptions that we carry is significant in size but it requires a 45-day waiting period prior to kicking in. So we don’t anticipate recoveries under business interruption.

Paul Sherada (ph) – Bank of America

Just a follow-up on your comments about the widening light/heavy differentials in the quarter. Do you see this as a sustainable? Just your general clarity on that.

Mike Jennings

Let me direct that to Joey Purdy, who is in charge of our commercial operations.

Joey Purdy

I think we have got some, short, medium turns, depending on your definition. There is a forward market out there that’s shown about $18.50 for the fourth quarter, $17.50 for the first quarter. So certainly year-on-year comparisons, those are very good light/heavy differentials. So we see a good fourth quarter, first quarter coming up on the light/heavy side. Pass that, we don’t see a material amount of increased production coming out of Canada in 2011 versus 2010. So maybe it needed six months but not something blowing back out like we saw three or four years ago.

Operator

Our next question comes from Jeff Dietert from Simmons.

Jeff Dietert – Simmons

You guys at Cheyenne have worked to test the flexibility of your feed stocks and you shifted quite a bit towards lighter sweeter crudes in previous quarters when heavy sour discounts were weak. In second quarter, heavy crude was only about 30%. The feedstock, you talked about increasing that to 50%. Is that what your linear programs would suggest as optimal? Or given the improvement in coking economics, could you go higher, and it just takes time to get there?

Mike Jennings

First, the improvement in the differential, it’s run from $16 to $19 over the course of about a week. So our view has changed during that time. Bill, do you want additional color?

Bill Rigby

We will transition as our – the prices that are shown to us will dictate. We anticipate in the last four months of the year as heavy crude prices move to benefit the Cheyenne refinery heading toward 75% heavy crude run. So as these differentials as Joey suggested move in our favor, we will head in that direction.

So this is part of the flexibility that the Cheyenne refinery has been able to realize, the light crude and those prices benefit us, we will head that direction if the heavy crude comes back to us, we will go that way. So we haven’t given up anything on either end of the coin.

Mike Jennings

The one additional point, the local sweet barrel remains pretty attractive to us. When we see North Dakota light with its high liquid yields, that $4 off or so and potentially this Niobrara production which is a little bit heavier but probably carries more of a discount. The Canadian barrel has to compete. So it’s not a complete nobrainer but a differential as wide as $19 buys that heavy barrel into the refinery.

Jim Stump

This is Jim. I think I heard a question in there about timing of being able to change from light to heavy crude slate with our crude supply logistics and maintaining the refinery staffing and other issues, we can switch from that light to crude slate very quickly, not an issue at all.

Operator

Our next question comes from Ben Herr from Morgan Stanley.

Ben Herr – Morgan Stanley

I think most of my questions have been answered around Cheyenne. Maybe I can just go in a different direction and ask a little bit about cash and it’s always a favorite question to ask in the quarter, but looks like you have a strong cash balance sheet again, and I’m just kind of looking here, what are you planning to do with the cash? Are you continually keeping the cushion? We’ve obviously seen one of the smaller integrated companies come out and saying that they’re going to be selling their downstream assets. Does any of that stuff look interesting to you or is there anything else out there that looks interesting to you at this point?

Mike Jennings

There are always assets to interesting to a refiner. The problem is they are not for sale right now and I wouldn’t tell you that we are warehousing cash in anticipation of buying for cash another refinery. We have seen in the press that our cash is “debt” and I would refuse that. In front of us is the ability to pay dividends once we get past our little hurdle, which requires Doug, another what, $55 million of EBITDA or so.

So looking forward, I think we are back to paying dividends, we are hopeful about paying dividend through the – that represents those lost through the period of hiatus if you will. And beyond that, we continue to look out in the marketplace, we benefit daily from the ability to buy these long haul barrels, which is a pretty working capital intensive operation. But when that barrel is $5, $6 in the money for the El Dorado plant, it’s very beneficial to have the liquidity and the balance sheet strength to either pay for it or gain open credit to afford that barrel. So I think you’ll see us run with a more conservative balance sheet than most, $450 million is not the cash position that we anticipate keeping long term.

Ben Herr – Morgan Stanley

What is the cash position that you plan on keeping long term?

Mike Jennings

I think that number is around 200, maybe as high as 250 but somewhere in that range.

Ben Herr – Morgan Stanley

Okay, great. Thank you.

Mike Jennings

Yes.

Operator

Our next question comes from Paul Sankey from Deutsche Bank. Please go ahead.

Paul Sankey – Deutsche Bank

Hi, guys.

Mike Jennings

Howdy.

Doug Aron

Good morning Paul.

Paul Sankey – Deutsche Bank

Mike, can I just clarify what you just said then, did you say that you’re going to aim to resume the dividend and pay the dividends you missed?

Mike Jennings

Well obviously we can’t pay the dividends we missed, but in an equivalent amount and subject to board approval, yes that’s our intention.

Paul Sankey – Deutsche Bank

So you would come back with a one off payment that would make up for the suspension?

Mike Jennings

That’s the current design, yes.

Paul Sankey – Deutsche Bank

Okay, I just wanted to be.

Mike Jennings

The point being Paul, we have lot of liquidity and some earnings through this period. We got hung up on covenant, partly of our own doing when we changed our accounting and the intention is not to be a non-dividend payer and we feel like this adds to the credibility of that argument.

Paul Sankey – Deutsche Bank

Yes, I couldn’t agree more.

Doug Aron

Paul, to be clear, we are as of the reporting of the second quarter results still in a restricted position as you’ll see in our Q, but as Mike mentioned it would require at least at the end of the third quarter and incremental of $55 million approximately of EBITDA to get past that hurdle and whether that’s at the end of the third quarter or into the fourth, I would say as you look forward our earnings and we had a really terrible fourth quarter in 2009, so that just based on the heavy differentials that really gave all the material we had this year borrowing us a serious deterioration in margins and heavy spreads. So we’re not there yet and want to make sure that we’re clear on that but as Mike has pointed out that would be certainly something that we’d like the board to consider.

Paul Sankey – Deutsche Bank

Yes, that’s great. And then I guess, by extension what you’re saying is that you’re kind of, although you’re looking at assets all the time – you’re kind of really stepping back from, if you like an aggressive pursuit of expansion.

Doug Aron

I think that’s right and I think we’ve got a lot to work on right into our company and we’ve made very big progress in Cheyenne, have a little left to do in El Dorado. Our designs on acquisitions are very regional and involve high quality assets that presently aren’t for sale. Most likely it would be pay for with stock or materially with stock. So the notion of warehousing cash for acquisitions isn’t in our lexicon.

Paul Sankey – Deutsche Bank

That’s great, I think that’s very encouraging. The – I think you’ve kind of covered the subject of crude availability. But just to really put the final nail in that one. Can you just talk about the dynamics that you’re seeing if you like longer term for example some of the controversy around is the pipelines coming from Canada. The impact that those have had as they’ve ramped up over the past quarters and how much more you would expect that to continue occurring, and also if there’s much to be said about the availability through the Gulf of Venezuela and in Mexico?

Jim Stump

More specifically the Canada, I’m not – heavies in the Gulf haven’t been in the money in the mid continental long time, medium soars are occasionally but it’s more of a Canadian issue. Certainly the land filling that went on in the first half of the year where it took a look a lot of money out of our pockets. So it’s nice to have that behind us.

In the longer term, effectively that improves El Dorado’s access to heavy crude and I would suspect we’re going to see El Dorado running substantially more Canadian crude after the Keystone lateral completes in the Cushing which right now is projected to be sometime I think in the first quarter or early quarter of next year. So we’re going to see some different crude dynamics on El Dorado next year.

From Cheyenne’s perspective, the more crude they can get out of the Rockies then we’ll do some differential from time to time, but that’s being at least partially offset by all the Bakken place and now the volumes aren’t material yet with the Niobrara play right around Cheyenne is also very encouragingly we’re going to get some upside on that as well.

Paul Sankey – Deutsche Bank

Yes and then if I was going to move on to the Bakken, because we’ve got Hess with the stated aim of going to 80,000 barrels a day there. I imagine that’s going to have at least a knock on effect directly into you guys having more price advantage crude available right?

Jim Stump

I mean there is a lot projects to address the Bakken and there is a new one announced almost there every other day and lot of rail racks and pipeline projects. So I mean there is a lot of activity going on there, but the rig count continues to go up every month, we see 10 more rigs or something up there. So for the last six or eight months the prices have been relatively stable and production seems to be keeping up with takeaway capacity and again it’s been obviously positive for Cheyenne to a lesser extent for El Dorado as well.

Paul Sankey – Deutsche Bank

Okay, great. Okay, thanks guys.

Operator

Our next question comes from Blake Fernandez from Howard Weil. Please go ahead.

Blake Fernandez – Howard Weil

Hi guys, good morning. Most of my questions have already been answered, but I did have one for you on the WCS spread. You mentioned it’s about $19 a barrel, but obviously there is some opportunity cost lost as a result of Cheyenne being down. Are you able to lock in any of the current spreads, and if so, can you give us flavor for how much?

Mike Jennings

Lock-in in terms of forward trade, yes there is liquid forward market for CWS, I think Joey quoted it at $18.50 for the fourth quarter on average and $17.50 for the first and so we’re looking in that direction. Obviously we’re not running heavy crude in Cheyenne or any crude in Cheyenne right now. So there is clear opportunity lost. But the $19 a barrel that’s quoted is a September injector so it wouldn’t show up until late in the month or in October.

So we should see some pretty decent heavy crude economics at Cheyenne plant in our fourth quarter results, hard to harvest it immediately and particularly hard given our incident. Longer term Blake, and this is important, the direction we’re looking is towards, these kind of differentials in securing longer term crude supplies and that involves both the heavy barrel and light barrel, both of which are attractive in Cheyenne and are hoping that we underpin that refineries profitability into the future with some term crude deals that are beyond a quarter at a time.

Blake Fernandez – Howard Weil

Okay, but no specifics that we can put our finger on right now, as far as specific volumes?

Mike Jennings

Not yet, no.

Blake Fernandez – Howard Weil

Yes, okay, thanks a lot. That’s it.

Mike Jennings

Okay.

Operator

Our next question comes from Chi Chow from Macquarie Capital. Please go ahead.

Mike Jennings

Chi?

Chi Chow – Macquarie Capital

Hi, can you hear me?

Mike Jennings

Sure, we can.

Chi Chow – Macquarie Capital

Sorry about that, is the asphalt market limiting your heavy runs at this point at Cheyenne, or once you get the crude up?

Mike Jennings

Well in theory at the margins, yes we can run that plant very full of heavy crude and make some asphalt. The local market for the Cheyenne rack sales might be 300,000 barrels a day and our capacity is probably double that on a production side assuming a very heavy fleet. So yes, I think we have to be careful about pushing too hard just in order to be able to place the barrels.

Chi Chow – Macquarie Capital

What’s your outlook on the asphalt market here, and it seems like it’s been, certainly been a weak year so far?

Mike Jennings

It’s been an interesting year so far, as really what’s happened the Winterfield (ph) barrels were very active in the month of January, February. Those terminals got very long product and purchases ground to a halt in May, June. The real demand for asphalt in terms of paving is lower than we thought it would be given how active the Winterfield (ph) market was. So very strong start to the year has weakened some, but the local retail market around Cheyenne is still pretty good, as I said in limited quantities.

Chi Chow – Macquarie Capital

Okay, thanks. And back on Keystone you talked about the extension, but as far as the main line being turned on right now does that having any impacts you’re seeing on the local crude markets?

Jim Stump

I wouldn’t – I don’t think so, I mean it’s hard to tell, there is always a lot of moving parts, but so far we haven’t seen materially slack capacity on the other pipelines which you would expect once Keystone gets up and running full, I mean we think it’s running over a 100,000 barrels a day now but certainly not add its name play capacity. So frankly some of the heavy disruption, weakness in the heavy price now might just be uncertainty about how the flows are going to kind of fall out once Keystone is running at higher rate, but right now that’s a little bit in front of us still.

Chi Chow – Macquarie Capital

Okay, and any further thoughts on terming up some of the Bakken supply?

Jim Stump

We’ve done some quarterly. I think we’ve done a little bit of 12 months term volume and there’s still a lot of uncertainty about Bakken pricing. I mean, one of the things you could expect from Keystone is, it’s going to open up Platte, east of Guernsey.

And so a lot of people are waiting in the Bakken market to kind of see how that’s going to affect pricing, right? Once Keystone gets to running it higher rates and we see how pipeline inflows are going to settle out, I think we may find that we can find more willing whatever you want to call it partners in some longer-term contract.

Chi Chow – Macquarie Capital

Okay, great. Thanks a lot.

Mike Jennings

Thank you, Chi.

Operator

Our next question comes from Daniel Burke from Johnson Rice. Please go ahead.

Daniel Burke – Johnson Rice

Good morning, everyone.

Mike Jennings

Hi Daniel.

Daniel Burke – Johnson Rice

I wanted to return to the LPG recovery project, Mike. You mentioned how consistent the economics are there. I think there’s at least a perception that NGL and LPG pricing relative to crude might – you might see a little bit of a bigger discount there emerging. Could that be sufficient enough to dampen the EBITDA contribution you’ve anticipated you’d receive from the LPG recovery project?

Mike Jennings

Well, the truth is, this year’s for pro forma numbers are substantially better than the previous four, five years that we used in our project evaluation. So it can trade it that being the value of the propanes and butanes a bit before or even back to our $18 million, $19 million a year of incremental EBITDA.

Yes, clearly, the gas drillers are now liquids drillers and that could have an effect. There’s a certain regional component to it and we’re just going to have to see how that works out. But how you want haircut or handicap that is really very subjective, we don’t have a market view right now that says, it’s going to be, “LPG’s trading it 10% below their historical or 5%”. It’ll be interesting to see how it works out.

Jim Stump

One other dynamic in the project is some of the liquids you recover are olefins, which are Alky fee for us, and so the project also increases gasoline production. And if NGLs do drop the price, that makes isobutane cheaper. And with the olefin recovery and the alkylation economics that that would drive, it’s another way the project makes money for us.

Mike Jennings

Sounds like Mr. Stump has covered both sides of the bet.

Daniel Burke – Johnson Rice

Thanks for that. You mentioned long-term pricing arrangements. Right now, is it – how are you thinking about the structure? Are you back to bickering with people on percent of TI pricing or are there other pricing structures that are potential looking ahead here?

Mike Jennings

I think it’s really a focus on the differential and the market seems to have moved to a dollar base differential as opposed to a percentage based that’s easily hedged through the NYMEX. But I – Joey you have additional comments?

Joey Purdy

That’s the market.

Mike Jennings

Yes.

Joey Purdy

You can’t fix the [inaudible] percentage and most deals are done on a fixed basis.

Mike Jennings

Yes.

Daniel Burke – Johnson Rice

Okay, that’s useful. And then, Mike, last one. You mentioned – I was just kind of curious that Q2 felt like a mid-cycle margin environment. And I was curious if you were implying that the margins you saw in Q2 felt like mid-cycle for Q2 or for a full year?

Mike Jennings

Devil is in the detail, isn’t it?

Daniel Burke – Johnson Rice

Yes, it is.

Mike Jennings

That’s hard to say. What I would say is that that we had good product demand, double-digit crack spreads. And in the summertime, that’s sort of what we would expect. Inventory levels in our jurisdictions are down to within the five-year range sort of slightly above the midpoint. So I’m careful about any kind of new normal discussion, because we don’t know where this is going, but the economy is improving, light oils demand is improving, and the crack spreads are showing that.

Daniel Burke – Johnson Rice

I appreciate that comments. Thanks.

Mike Jennings

Thanks Daniel.

Operator

Our next question comes from Jacques Rousseau from RBC. Please go ahead.

Jacques Rousseau – RBC

Good morning.

Mike Jennings

Howdy Jacques.

Jacques Rousseau – RBC

Hi. Just wanted to make sure I was following the change in working capital, about a $100 million. Now was that going to line fill, did you say?

Mike Jennings

No, I don’t think. I think maybe those were two comments that got talked about there. One, our line fill comment was that that was what contributed to a weaker light/heavy differential through most of the first six months of the year as KeyStone was filling and you saw additional demand for those barrels.

For Frontier, who doesn’t have any commuted space on KeyStone, we continue to ship our heavy crude to El Dorado through the spearhead pipeline. But what we did see was some incremental heavy runs and additional inventory builds during the quarter that would have contributed to that working capital build, plus a higher crude oil price, particularly towards the end of the quarter Jacques.

Jacques Rousseau – RBC

So is that something we should just assume is going to stay at the inventories now that you’re running at higher rates?

Mike Jennings

I think so, yes. I mean, for one thing, we’re replacing less Texas barrels with Canadian barrels as we see and I’d love North Dakota into that pot. But that crude is making its way to the Mid-Con and to our El Dorado refinery, and this is proving to be pretty attractively priced. Obviously, there’s a longer haul involved and a net working capital investment. We ensure that anytime we invest in that type of line fill, we’ve got more than our cost of capital covered by the incremental refining economics.

Jacques Rousseau – RBC

Okay, one more for you. What’s a general rule of thumb we should be using for your hedging from quarter-to-quarter?

Mike Jennings

We tend to be short about 2 million barrels on the NYMEX and that’s reflective of principally those long haul barrels trying to preserve their economics to the point of refinery entry.

Jacques Rousseau – RBC

Okay. And what type of timeframe should we use for – is that from the price from the beginning of the quarter, the end of the quarter, or how –?

Mike Jennings

It’s fairly continuous, Jacques. I mean, we’ll vary in amounts marginally through the quarter. But the amount hedge tends to be pretty consistent.

Jacques Rousseau – RBC

Okay, thank you.

Doug Aron

Hi Jacques, the only other thing I would add to that is that you may look at that number for the last quarter and say, “Gosh, it sure seems like you had a bigger hedging gain and that would have reflected.” And that is really reflective of the contango in the market. When you have contango and particularly in Q2 where we had almost $2 and one point, as a seller of forward barrels, you get the benefit of that so.

Jacques Rousseau – RBC

Okay, thank you.

Doug Aron

Yes.

Operator

(Operator Instructions). Our next question comes from Paul Cheng from Barclays Capital. Please go ahead.

Paul Cheng – Barclays Capital

Hi, guys. Two quick questions. Can you tell us what is the market revenue in excess of the – for the inventory?

Mike Jennings

Actually, Nancy Zupan has that information for us.

Nancy Zupan

Hi, Paul.

Paul Cheng – Barclays Capital

Hi.

Nancy Zupan

At the end of the second quarter, that difference is about $260 million of market value over book.

Paul Cheng – Barclays Capital

$260 million. Okay, great.

Nancy Zupan

Yes.

Paul Cheng – Barclays Capital

Great. And then under Cheyenne – I have to apologize, you may have already covered it, I came in a bit late. With the cooling unit incident, so that means you’re not going to run that for the next several weeks, how’s that it’s going to impact on your product yield during that period of time?

Mike Jennings

Well, for the first three days or so, we had – on average, we had intermediates to continue to produce gasoline and diesel at that sort of historical levels. Thereafter, we have generally run drive intermediates with some exceptions we’re trying to keep our cat cracker running. But I think it’s a fair statement that for 19 – 18 or 19 out of the 21 odd days, the product yields are approximately zero.

Paul Cheng – Barclays Capital

Okay. So that for 18 days to 19 days, your light product yield is close to zero, you say?

Mike Jennings

Yes.

Paul Cheng – Barclays Capital

Okay, very good. Thank you.

Mike Jennings

Okay.

Operator

We have no further questions at this time.

Mike Jennings

Great. Well, thank you all so much for joining us on the call, and we look forward to speaking with you again at the end of the third quarter.

Operator

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

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Frontier Oil Corporation Q2 2010 Earnings Call Transcript

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