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Executives

Greg Goff - Chief Executive Officer, President and Director

Louie Rubiola -

G. Spendlove - Chief Financial Officer, Senior Vice President and Treasurer

Everett Lewis - Chief Operating Officer and Executive Vice President

Analysts

Jeffrey Dietert - Simmons & Company

Jacques Rousseau - RBC Capital Markets Corporation

Evan Calio - Morgan Stanley

Mark Gilman - The Benchmark Company, LLC

Paul Cheng

Chi Chow - Tristone Capital

Faisel Khan - Citigroup Inc

Douglas Leggate - BofA Merrill Lynch

Paul Sankey - Deutsche Bank AG

Blake Fernandez - Howard Weil Incorporated

Tesoro (TSO) Q3 2010 Earnings Call November 5, 2010 8:30 AM ET

Operator

Greetings, and welcome to the Tesoro Corporation Quarter Three 2010 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Louie Rubiola, Director of Investor Relations for Tesoro Corporation. Thank you. Mr. Rubiola, you may now begin.

Louie Rubiola

Thank you, Rob. Good morning, everyone, and welcome to today's conference call to discuss our third quarter 2010 earnings. Joining me today are Greg Goff, President and CEO; Everett Lewis, Executive Vice President and COO; and Scott Spendlove, Senior Vice President and CFO.

While we will not be referencing slides during the call, we do have a set of slides which was filed with the SEC today. These slides, along with other financial disclosure, should help you in analyzing our results and can be found on our website at tsocorp.com.

Please refer to the forward-looking statement in the earnings slides, which says statements made during this call that refer to management’s expectations and/or future predictions are forward-looking statements intended to be covered by the Safe Harbor provisions of the Securities Act, as there are many factors which could cause results to differ from our expectations.

Before I turn the call over to Greg, I'd like to take a minute to share some details regarding our 2010 Analyst Day event in New York. The event will be held Monday afternoon at 2:30 Eastern on December 13 at the New York Stock Exchange. Due to limited seating, reservations will be required. You may register by calling the Tesoro Investor Relations department at (210) 626-6861 or by sending us an e-mail at irelations@tsocorp.com. Reservations will be accepted until the close of business on Wednesday, December 8.

With that, I'll turn the call over to Greg.

Greg Goff

Thanks, Louie. Good morning, everyone, and thanks for joining us on the call today. We are pleased to report third quarter earnings of $0.39 per diluted share or $0.51 per diluted share excluding onetime expenses of $0.12. The onetime expenses are mainly attributable to our maintenance work at the Anacortes refinery. These earnings were achieved with Anacortes idled and Hawaii at reduced rates for a plant turnaround as both industry spreads and our capture rates improved during the quarter.

The Tesoro Index in the quarter was up 17% from the third quarter of last year. This improvement was driven by diesel spreads, which were up more than 50% over last year.

Demand for the distillate barrel is up globally, and we see this reflected in diesel exports, much of which is going to Latin America. In our markets in particular, we continue to see an increase in West Coast seaport traffic, which, during the quarter, reached levels not seen since late 2007. West Coast gasoline spreads meanwhile continued to suffer from weak demand as unemployment in California remains high.

Capture rates throughout our system were up significantly in the quarter, driven by strong clean product yields. Importantly, we were able to produce more diesel, allowing us to capture the stronger distillate margins.

We also saw an improvement in our feedstock costs as we ran an overall heavier diet of crude oil and captured improved light heavy differentials, specifically from Canadians and South American heavy crudes. Retail marketing margins were also strong during the quarter. Spot prices for light products, which generally follow the price of crude oil, fell more rapidly than street prices. However, throughput rates during the quarter were down significantly from last year's third quarter, as we repaired the Anacortes refinery and successfully completed the plant turnaround of our Hawaii refinery during the quarter.

As we reported in our press release, substantial progress has been made towards the restart of the Anacortes Washington refinery. Today, most of the refinery is operating, and we expect to be back to normal operations soon. In addition to completing repairs to the damaged units, we also accelerated extensive future inspection and maintenance work to take advantage of the plant downtime.

We hired a well-respected engineering firm immediately after the incident to conduct a refinery-wide review of equipment, specifically targeting High Temperature Hydrogen Attack or HTHA, which is what we believe was a source of the April 2 accident at Anacortes.

We also hired outside experts to conduct a review process of inspection records related to specific units in order to provide assurance that all of our processes are in accordance with standard industry practices, and they are.

We inspected hundreds of vertical vessels and performed several thousand discrete examinations regarding appropriate alloy content of specific units. We replaced the heat exchangers on the naptha hydrotreater, with new units designed according to current industry standards. And then we also conducted inspections of units at all of our refineries that are in similar service.

While we remain saddened by the human cost of the Anacortes accident, we continue to expect that the overall financial impact of this incident, even taking into account the allegations made by the Washington regulatory agency, will be limited to our insurance deductibles and that we have adequate insurance coverage for this event.

As we've previously stated, our insurance deductibles are $10 million for property and $25 million for business interruption. In fact, as of this call, we have received $27 million in business interruption proceeds, net of the deductible for partial losses of income through June 30. We have filed additional business interruption and property damage claims, which we anticipate could be settled during the fourth quarter and first quarter of 2011. These are cash proceeds that will be reflected in higher net income.

I can't stress enough how thankful we are towards Tesoro employees at the Anacortes facility and throughout the organization, as they worked so hard to make the necessary repairs and successfully and safely restart the refinery.

Most of the investigations are now complete, and we are waiting the final results. The Chemical Safety Board has until April 2011 to issue the results of their investigation.

We filed a notice of appeal to all citations and penalties in response to the Washington State Department of Labor and Industries on October 22. While we disagree with the characterization of the department's allegations, we are encouraged that we may be able to work with the department to achieve a mutually satisfactory resolution to the citations.

As we look forward from here, we still see economic challenges and the effect of a weaker economy on product demand and margins. We're also disappointed that California voted against Proposition 23 that would have deferred implementation of AB 32 until unemployment rates in California dropped below 5.5%.

Regarding the potential costs of compliance with AB 32, we are not in a position to provide any details on the call today. Since the specifics of the regulations are being developed, it is premature to speculate on the impact at this point in time.

We are currently in the process of digesting carbs recent draft of the Cap-and-Trade Regulation. I would say that if you combine their initial credit allocation with our recent energy efficiency projects and those currently underway, we believe reaching the mandate of threshold on stationary sources will be attainable.

In summary, given these economic and regulatory challenges, we remain very focused on the things that we can do to improve our bottom line despite the lower margin environment. We're on track to realize our capital and non-capital improvement initiatives for this year, which we expect will add just under $200 million in EBITDA to this year's results. And our efforts to improve our cost structure are progressing as planned.

We'll discuss these and other initiatives and plans for 2011 and beyond at our Analyst Day event in December. I look forward to seeing many of you there.

With that, I'll turn the call over to Scott Spendlove, our CFO, for a more detailed discussion of our quarterly results and to provide guidance for the fourth quarter. Scott?

G. Spendlove

Thanks, Greg. As we reported last night for the third quarter, net income was $73 million or $0.51 per share before onetime after-tax expenses of $17 million or $0.12 per diluted share. The majority of these onetime items reflect after-tax expenses related to maintenance and repair work at our Anacortes refinery. About half of these expenses are attributable to the incident itself and will be part of our insurance claims.

The other half reflects acceleration of inspection and maintenance work plan for the future and completed while the refinery was idled. You can see these charges reflected in higher manufacturing expenses in our Pacific Northwest region.

Segment operating income was $178 million for the quarter, $201 million net of the special items, up significantly from the $137 million we reported for the quarter last year and driven by the margin and capture gains Greg described earlier.

Our manufacturing costs in the third quarter were $266 million, up $18 million from the second quarter of this year, driven primarily by the onetime cost I previously mentioned. Corporate and unallocated costs, net of depreciation, were $45 million for the quarter. Our guidance for the quarter was $37 million, reflecting expected reductions in overhead costs. What we realized in expenses was actually better than our guidance, but two additional non-cash charges took the final number to $45 million.

The first is a charge of $4 million relating to expenses incurred to sublease a portion of our corporate headquarters. The sublease will result in significant cash savings over the term of the lease but resulted in onetime charges in the period. The remaining amount of the difference relates to accruals for stock-based compensation. Our stock price gained nearly 14% during the period, leading to a higher accrual for stock-based compensation expense.

We ended the quarter with a cash balance of $339 million and had $827 million of availability on the revolving credit facility. Once again, we were undrawn on that facility during the quarter. At the end of the quarter, our debt-to-total cap was 37%.

Changing cash for the quarter was a build of $148 million, as EBITDA exceeded capital spending. Working capital was flat. We had no cash interest payments in the quarter, and we're currently not a cash taxpayer.

As Greg mentioned earlier, we spent $110 million on capital projects during the quarter. This was down from the second quarter because of less turnaround activities at our refineries. We have no additional plant turnaround work for the remainder of 2010. We continue to expect that capital spending, including turnarounds for 2010, will be in the $475 million to $500 million range.

Turning to the fourth quarter. The fourth quarter is typically a weak gasoline demand period, with PADD V demand declining more than 4% on average versus the third quarter. Supply reductions have supported margins in PADD V during October, but they weaken during the first part of November.

PADD V crude runs in October were 85,000 barrels a day or 4% lower relative to the same period last year, which was a record low. California gasoline production was down by more than 5%, relative to the same period last year.

And based on the latest Department of Energy data, PADD V gasoline inventories have declined to the five-year average unlike overall domestic markets, which remain above historical levels. This has led to relative margin strength in on West Coast in October where cracks have averaged just under $14 per barrel, down only slightly from September and well above the same period last year.

Additionally, the West Coast gasoline differentials to the NYMEX have averaged $0.15 per gallon, up $0.02 per gallon relative to both September and the same period last year.

So again, October was a good start to the fourth quarter, but we've seen a reduction in margins to this point in November.

Let me close with guidance for the fourth quarter for your modeling purposes. We estimate throughput in thousand of barrels per day to be 100 to 110 in the Pacific Northwest, 65 to 75 in the Mid-Pacific, 110 to 120 in the MidCon and 230 to 240 in the California region.

OpEx guidance for the third quarter in dollars per barrel is as follows, $5.85 in the Pacific Northwest, $3.25 in the mid-Pacific, $3.25 in the MidCon and $7.55 per barrel in the California region. Our depreciation for refining is estimated at $92 million. Additional fourth quarter guidance items include corporate expense, excluding depreciation, of $36 million and interest expense before interest income of $42 million.

With that, I'll turn the call back over to Greg for closing comments. Greg?

Greg Goff

As we have stated, before we recognized that excess capacity in the refining industry will continue to put pressure on refining margins. Although many believe we may have hit the bottom in the refining cycle, our focus and commitment is on strengthening the performance of our existing business.

We are committed to driving continued improvements in personal and process safety, lowering our cost structure, adding value with aggressive noncapital and small capital high return improvements and taking a disciplined approach to cash management that will also strengthen our balance sheet.

And with that, we'll now take questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question this morning is coming from the line of Doug Leggate of Merrill Lynch.

Douglas Leggate - BofA Merrill Lynch

I guess, one of them is accounting. If maintenance is an ongoing part of the business, and obviously, by your statement, you said that maintenance you took advantage of the downturn around the quarters. Why was it stripped out as a one-off? And my follow on is basically $7 million of declared impairments on the P&L, which seemingly was not stripped out, can you just explain the treatment of those two items and I have a follow-up?

Greg Goff

One, very early on after the incident at Anacortes, we made the decision to keep everyone fully employed and go back to work on the refinery. And so what we did is, in addition to going through and doing all of the necessary repair work and that, we also took advantage the time like I said in the call to really look at both future plans regarding both inspection and maintenance work and accelerated those to bring those forward. Things that we would have planned to do over the next couple of years, and that's why we've made that out as a special item. The second thing, around your question around the $7 million. That $7 million of asset write-off basically represents kind of spread across our system items, like tanks taken out of service and things like that, just your kind of a normal course of business, which we chose not to call off as a special item.

Douglas Leggate - BofA Merrill Lynch

I guess I'm a little confused, Greg, because accelerating stuff that you had to do as the normal course of business, how does that make it a nonrecurring item because this means you've accelerated the timing of it, but you still have to do it anyway. So I'm just kind of trying to understand. I understand it wouldn't all have been done at this time. But you had to spread out light expense out over the next couple of years where as now you've accelerated and taken that special. I'm not sure I really follow the accounting logic of that.

Greg Goff

Yes, I mean, what we've done, Doug, is we just, like I said, we have had an opportunity to do a lot of work that we have planned for future years, and we brought that work forward to do now and avoided doing in the future and allow us to do other things that we may choose to do as we get out into time.

Douglas Leggate - BofA Merrill Lynch

Let me do my follow on. So Hawaii, my understanding is the public advocate has come down in your site as it relates to the fuel renegotiation. Can you just give us an update, please, on where the buildup stands and whether or not as you understand things right now, you will be able to bite data in this all to what period?

Greg Goff

You have to go back to your question. It's actually the Consumer Advocate who provides an opinion to the Public Utilities Commission regarding the agreement that we have with HECO regarding the increase in price on the fuel oil. And you're exactly right, sometime ago the Consumer Advocate provided their opinion to the Public Utilities Commission that they saw no disagreement with what had been negotiated between ourself and HECO and therefore gave their support to the Public Utilities Commission, which they'll need to take action on the increase for the fuel oil. And that has taken longer than we thought. I mean, part of it is that they are a politically appointed body and with the elections and that, we believe that there was probably some delay in taking action on that. But we expect that to happen very shortly. It's been a long process since we reached commercial agreements with HECO back at the very beginning part of the summer. So everything that we see so far, that should move forward there. What we're not certain of is when the amount of retro-activity that we will receive. We do know that our agreement with HECO on this specific contracts was reached in the early part of June, and we'll have to work and see if we received retro-activity back to June of this year. But that, we don't know as of this point in time.

Douglas Leggate - BofA Merrill Lynch

So it wouldn't be start of the year, correct?

Greg Goff

You know, Doug, we're not certain. There was an agreement between ourselves and HECO that it would be affected until then. But we'd have to see how the Public Utilities Commission views that agreement. We're probably have a higher probability of getting something back to when the formal agreement was signed, which was in June of this year.

Operator

Our next question is from the line of Blake Fernandez with Howard Weil.

Blake Fernandez - Howard Weil Incorporated

On the Pacific Northwest OpEx guidance, I'm assuming that's a bit elevated for 4Q due to and the quarter still kind of ramping up. Is it fair to think that, that kind of reduces going to the first quarter of next year?

Greg Goff

You're exactly right, Blake. I mean both your comments are. Yes.

Blake Fernandez - Howard Weil Incorporated

Secondly, on Mandan, just curious if you could talk a little bit about the end bridge outage, the potential impact of that and maybe any impact going into the fourth quarter if we should be thinking about maybe extended differentials or locking in contracts or anything like that, please?

Greg Goff

The crude supply from Mandan basically comes from the Bakken field right there, which is a very attractive, secure supply of crude oil. So the end bridge downtime did not materially impact what happened to our supply at Mandan. But the differentials have been attractive at Mandan and we don't see any big changes going into the fourth quarter.

Blake Fernandez - Howard Weil Incorporated

Yes, I guess I was thinking, as I understood it, the Bakken differentials had begun to expand a bit. And I didn't know if that may be created an opportunity but it doesn't sound like you've locked in any kind of contracts or any kind of material changes coming. Is that fair?

Greg Goff

Yes, there are no material changes, right.

Blake Fernandez - Howard Weil Incorporated

West Coast margins from third quarter clearly probably benefited from Anacortes being off-line. I'm just curious if that changes your thinking at all with regard to maybe capacity rationalization? Would it benefit the system as a whole to maybe remove some capacity, not necessarily just Anacortes. But just looking company-wide, does that change your thinking at all?

Greg Goff

There's no question that Anacortes being gone had an impact on West Coast margins when you take that amount of capacity out of the system, it's going to have an impact on the margins. And anyone could calculate and see what they may think that range is. But we continue to look at all of our operations and trying to capture the most value of how we can operate the facilities and try to match where our demand is when you have commitments to supply customers and meet that demand and then where there are other opportunities, whether it be in the export markets, or whatever to meet the marketplace requirement. So we're driven by really looking at our own systems and the integrated value that we can capture between our refining and marketing to target where we run our refineries. And that's what we'll continue to do.

Operator

Our next question is from the line of Evan Calio with Morgan Stanley.

Evan Calio - Morgan Stanley

First question is related to Anacortes. I note that and I appreciate the disclosure that you provided and I looked at the appeals in Washington and Department of Labor & Industries. Have any private lawsuits been filed yet? And maybe more importantly, can you discuss the liability standard that is protected within your insurance policy? Because there are various mentions of willful in that October filing there.

G. Spendlove

Well, Evan, actually can you restate that first question again?

Evan Calio - Morgan Stanley

You have insurance with regard to Anacortes, right? And I guess my question is, you haven't filed so we don't know what that insurance policy is. What kind of conduct by Tesoro is covered under your insurance policy?

G. Spendlove

Yes, I think you also asked if there'd been any lawsuits filed, and the answer to that question is no, not at this time. No, they're not have been any at this time. And from an insurance standpoint, we carry worker's compensation, insurance and other forms of insurance both for the planned and for business interruption and that. And we believe that all of our insurance policy will provide coverage for any potential claims that we have. And part of the way that the process works in the state of Washington with the labor and industry is that as they go through and everyone has seen publicly what the 44 citations that we received, 39 of them, which were considered by them to be willful valuations. It's the process that they you go through to basically categorize their assessment of the violations. And that's what, like I said in the call, that is one thing that we disagree with. And that's why we have filed an appeal to work with them basically on the characterization of those accusations. But at this point in time, we can't really comment on whether that has an impact one way or another on any potential litigation that may come from that because they characterize them as willful work. We're very hopeful that we can go back and work through with the L&I to go back and look at all of those violations.

Evan Calio - Morgan Stanley

And maybe it's a different take on the Anacortes outage and the impact on the West Coast system, I mean, can you refresh my memory, seasonally, Alaska typically runs lower in the winter. So the relative demand in the region should be a little bit tighter. And also, if you guys know the status of BP's turnaround in Washington. I think it's been delayed.

Greg Goff

Regarding BP's turnaround, you just have to get that from public information. All we know is what we would be read anywhere else we could pick it up just like yourself. So the answer is, we don't know anything additional regarding what their plans are. And yes, I mean, demand is down. I think like Scott even mentioned during his comments, demand for gasoline down in the West Coast, typically 4% fourth quarter versus third quarter. And we expect that to happen. So I think the point is as we run the refineries, we'll match it with what we can supply with all of our requirements in the marketplace not only in Washington but in California and Alaska.

Operator

Our next question is coming from the line of Jack Russo of RBC.

Jacques Rousseau - RBC Capital Markets Corporation

Just wanted to follow up on the Anacortes questions here. And my question is more about the timing of the restart here. As been discussed, we are heading into a seasonally soft period on the West Coast. And if I take a look at your Tesoro Index, it's showing Pacific Northwest margins pretty well at kind of 2009 levels. I mean, can Anacortes make money this quarter?

Greg Goff

Well, Anacortes has a very good cost structure. The cost structure of Anacortes is good. And when you've a plant down for as long as we have, which as everyone knows, it's slightly over six months before we started to bring the plant back up, it's important that we basically go through and start to get the operation running because after an incident like that, with what the people in the facility go through and then all of the additional working that's done, we strongly believe that we need to go back in and commence the operations and supply the customers that we have in the marketplace. And with our projections of that on Anacortes, with the additional costs in that, we have gone back in to run the plan at the projected levels that Scott mentioned in the forecast. And it will be -- We'll just see what happens to margins. I mean, you can do the calculations and see how it will be marginally profitable under these market conditions that we're in.

Jacques Rousseau - RBC Capital Markets Corporation

I know you made some introductory comments on Proposition 23 and A-B 32. I mean, all in all, do you guys view this as something that's going to be a significant hit to earnings on the West Coast? Or is this something you view as more of a minor number?

Greg Goff

One of the things that we need to do is we need to spend looking time looking at it. What we do know is as the regulations are written today, that over time, they become more demanding. So when you get out, particularly, you have to get out into the 2015 to 2020 timeframe, both with the low carbon fuel standard, which haven't been defined clearly going in and putting in transportation fuels in after 2015, it definitely puts a greater demand on the industry from that standpoint. Like I mentioned in the call, as far as the emission, the requirements to meet the emission, we were pretty favorably impressed with where the allocation came out to start with and feel pretty comfortable from that part of it. And so on the front-end of it, the costs don't seem to be a big factor. But as we learn more about that and as we get further out in time, there are greater demands to comply with A-B 32.

Operator

Our next question is coming from the line of Chi Chow with Macquarie Capital.

Chi Chow - Tristone Capital

I was wondering if I could go back maybe on Blake's question on the guidance on OpEx. So you mentioned that the P&W is probably going to be a little bit higher with Anacortes-related cost there. But when I plug in your guidance and kind of a midpoint on throughputs, I noticed that the West Coast or California is higher as well. So can you just go by maybe just region by region and let us know what are the assumptions in there? What's the onetime item and what's the guidance going forward from here?

Greg Goff

Chi, on the West Coast, we're doing some additional, in Golden Eagle, where doing additional work at, the Golden Eagle right now on some our conversion units. So the cost for Golden Eagle will be higher and we'll expect a reduction in throughput and kind of in the range where Scott gave guidance on for the California refineries. So that work on Golden Eagle has been going on and will be finished up sometime during November.

Chi Chow - Tristone Capital

And do you have kind of onetime amount for the quarter?

Greg Goff

At this point in time, because the work's going in, we don't have -- we're just doing the work right now. We don't have an estimate on the onetime amount to make available.

Chi Chow - Tristone Capital

Another question on costs. I noticed you had some recent corporate executive overhead cuts. Is that part of your $40 million to $50 million plan? Or is that something separate?

Greg Goff

The recent changes that you're referring to is that we continue to look at our organization and we're really focused on trying to both improve the effectiveness and simplify our organizational structure. And as a result of that, we made some changes in our structure that are part of our efforts to continue to drive efficiencies and improvements to our cost structure. And so those other changes are in addition to what we've already announced earlier this summer.

Chi Chow - Tristone Capital

Do you have a total cost savings associated with the recent changes?

Greg Goff

Those changes right now are kind of minor as we continue to work through our organizational structure. They're not a material impact.

Chi Chow - Tristone Capital

And then one final question on your insurance coverage. Do you have a deductible on the liability portion of your policy?

Greg Goff

Which liability are you referring to?

Chi Chow - Tristone Capital

I guess, like a general liability policy that's away from DI and away from property damage?

G. Spendlove

This is Scott. Yes, it's about $1 million. I mean it's fairly de minimis.

Operator

Our next question is coming from the line of Paul Cheng of with Barclays Capital.

Paul Cheng

Scott, in the $27 million net of the deductible that you guys received, is that all in the DI or the part of them is in property damage?

G. Spendlove

It's all beyond BI so far, Paul. We're still working the property damage claim.

Paul Cheng

From an accounting standpoint, will you treat that in the fourth quarter as a special item or will there just don't allow you to go through into the margin and treat you as ongoing result?

G. Spendlove

It'll be a special item. You'll see it. It'll be a net income item.

Paul Cheng

Yes, a net income but you will put into a special item?

G. Spendlove

Yes.

Paul Cheng

In the fourth quarter, when I looking at your Pacific Northwest footprint guidance, it does look like that entire -- you don't expect anybody go back to full production probably towards the end of the quarter you said. is that a fair assumption the interpretation?

Greg Goff

Well, Anacortes should be back to the rates that we have targeted to run by the latter part of next week.

Paul Cheng

And you're still going to only have 100 to 110 [thousand barrels per day] because Alaska you said, should be running at about probably around 35,000, 40,000. So it seems a bit low then. So your target rate for Anacortes is only what 85%, 90%?

Everett Lewis

Paul, this is Everett. As you've probably seen in past years when we get into the winter months. And further to what Greg has said, we start watching where the market demand goes. And we match our throughputs to our market positions in both Alaska and the Northwest. So we see lower rates, typically in the winter months for both of those facilities than we do in the summer months. So your assumption's correct. While we have the capability to run Anacortes at higher rates, we won't be running at full rates through the winter time.

Paul Cheng

Since I got you here, can you share with us what is your scheduled turnaround activity through first half of next year?

Everett Lewis

I think we're going to share our turnaround activity more when we do the Analyst Day thing. We don't have anything scheduled for the rest of this year in terms of major turnarounds. We have a couple of them scheduled in California for next year. I think we'd shared the details of that on the Analyst Day.

Paul Cheng

And how much of the net income, do you need to earn before you will go back into the cash taxpayer?

G. Spendlove

Well, it's not going to be for a couple of more years, Paul. Our current expectation will be within those feelings. That's what's there.

Paul Cheng

Right, I mean, it seems that no one really know what is the margin assumption or where is the margin going to be. Can you give me the rough number seeing that? Is that the $100 million you ned to earn, $200 million, what more kind of income numbers so we can make our own guess.

G. Spendlove

Why don't we have Louie follow you up on that one, Paul.

Operator

Our next question is from the line of Jeff Dietert.

Jeffrey Dietert - Simmons & Company

You guys have been experimenting with the Expo crude on the West Coast and I wondered you can make some comments on how that crude runs in your facilities, and if you're considering locking up some of that crude under medium or longer-term contracts?

Greg Goff

Jeff, you're right, Jeff. We have run Expo crude on the West Coast. And as everyone knows, there's some similarity take between Expo and A&S. and the yields on Expo is attractive in our finery. So we do continue to look at that. And when the economics are favorable, run it in the system. But we're not going to comment on how we structure our commercial arrangements, whether it be short term or longer term, other than we be continue. Like we have always said, we have the capability to process a lot of different crudes. And we're very active looking at the crudes to give us the best advantage from both a cost standpoint and a yield.

Jeffrey Dietert - Simmons & Company

On the product exports side, you mentioned in your opening remarks some of the benefits of exporting. Are you seeing that -- did you see that in the third quarter from your portfolio? Or are you expecting that to be a consistent aspect of your product distribution and marketing effort?

Everett Lewis

This is Everett. We did some exports, and we always look at exports off the West Coast particularly the South America during the quarter. And there have been demands in South America and Mexico that we've been accessing as their economic. But it's something we look at, and those move up and down depending on our economics and the competitive economics of the West Coast versus the Gulf Coast.

Operator

Our next question is coming from the line of Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank AG

Greg, I was just wondering, you may not be able to say a whole lot about this with the analyst meeting coming up, but I was just wondering now that you've been in the longer, really what you're thinking in terms of the strategic potential that you have beyond the sort of, I guess, relatively obvious cost-cutting approach. I mean, what I'm really thinking about is how you feeling about other asset disposition, acquisitions or JVs particularly?

Greg Goff

Well, Paul, I think, one, I'd prefer to address more details of that question when we get together in December. But I can say that an important part of our strategy going forward will be to create additional value, significant value, actually, with our existing business, which is managing our costs and improving our cost structure is only one part of it. We also see other opportunities that will really enhance our value going forward, which is kind of what you've been hearing from us in the last little bit here. But other things around the portfolio and that, we'll just talk more in December when we can have everyone together and do that.

Paul Sankey - Deutsche Bank AG

Do you think the potential's there for you to be more specific on what would be portfolio actions, I guess, at the December meeting? I mean do you anticipate announcements about a more proactive, if you like, that's not quite the right word, perhaps, but a more asset-changing type strategy?

Greg Goff

We'll be able to give directional ideas of what we're looking at and where we see opportunities to do things with the assets.

Operator

Our next question is from the line of Mark Gilman of Benchmark company.

Mark Gilman - The Benchmark Company, LLC

Greg, you mentioned in the release that you ran a little bit more Canadian and South America Heavy crudes. What crudes did you back out as part of doing that?

Greg Goff

Well, it's not a matter, Mark, I think of what we backed out as much as just how we alter our crude slate late in that, as we look at the differentials on the crude in that, so it's -- I mean, it's hard to say, we didn't really back out anything because it kind of moves all of the time. We just took advantage of the differentials because with the South American and the Canadian crudes.

Mark Gilman - The Benchmark Company, LLC

Well, Greg, something had to give if you're running more of one thing, you're running less of something else.

Greg Goff

Yes.

Mark Gilman - The Benchmark Company, LLC

Let me try another one. Our indicators are suggesting that the Bakken discounts over the course of the last month or so appeared to have narrowed. Are you seeing the same kind of thing?

Greg Goff

Yes, the discounts have narrowed in the last little bit in Bakken.

Mark Gilman - The Benchmark Company, LLC

I wanted to ask about the announcement, I guess, it was probably several weeks ago regarding your having been taking down what seemed to be a pretty sizable nonrecourse [ph] line of credit in support of your activities in Panama. And I wondered if you can spend a minute discussing what that's about and whether it's a reflection of an interest in taking a more active trading role?

Greg Goff

Yes, Mark, what we've done there is a while back, the company committed to capacity along the pipeline and storage in Panama. And in April of this year, as I think we mentioned earlier, that contract came into effect so that we have commitments to move a certain amount of volume across the pipeline and access to the tankage. The purpose of that, there's three or four things that we're trying to do there. One of the them is it allows us to supply, to source of crudes, South American crudes into our West Coast systems. So that when we see opportunities to acquire crudes that will fit into our system, that gives us some operational flexibility to do that. The second thing is because of the commitments that we have around the pipelines and the tankage, it allows us to -- when there are opportunities with the market structure, if we want to be able to store crudes, either for our own system, for future running or to resell in the marketplace to companies that we have commercial relationships, it allow us to do that. It allows us to manage the freight economics between the pipeline, as well as what other companies may do by go in and not using the pipeline. It allows us to go in and take advantage of blending opportunities. So the whole purpose is really, to take commercially position ourselves from a crude supply standpoint as well as other commercial opportunities to move primarily South American crudes.

Mark Gilman - The Benchmark Company, LLC

Okay, Greg. So it's not by any means any indication that you're getting more active freighting but rather just a normal extension of the supply function taking into consideration the commitments you made regarding the Panama pipeline?

Greg Goff

Yes, Mark. One, it is driven by doing that, and we will do some additional activity because of the advantage we have with the assets. Like I said there's a market structure that's attractive to us, to start crude oil because it contained oil in the market or blending different crudes because of the tankage in that, we will extend that a little bit. But the primary purpose is to be able to go in and manage it within our system.

Mark Gilman - The Benchmark Company, LLC

Your deal regarding the Shell brand and the distributor outlets that you've picked up. First, was there any upfront costs to you on that transaction? And secondly, can you give a rough idea of how much incremental volume you expect to be able to move from an unbranded to a branded channel?

Greg Goff

Yes, the deal with Shell that you're referencing, Mark, is there are no upfront costs associated with doing that. It really kind of stems from the relationship we have with Shell in Southern California, where we were able to go in and target the market areas that we talked about that are both around the Salt Lake City and the Mandan refineries, where we have good commercial terms to gain access to the Shell brand and place volume in the market. Our intent is to be able to go out and increase our marketing outlets by using the Shell brand around both of those refineries in that. So the volume, we do have some volume growth that we'll talk about more when we get together with the analyst meeting for both those two systems in December.

Mark Gilman - The Benchmark Company, LLC

Is there a significant unbranded channel or significant amount of barrels moving on an unbranded basis currently, Greg, from those units?

Greg Goff

In those areas, there is. When you talk about our system and you look at our branded volumes in that market, it's not major. So there is unbranded volumes moving to those systems. And the Shell volumes will probably allow us to pick up about 13,000 barrels a day of volume that we can convert to the Shell brand. And Mark, I'd like to just go back and talk when you asked about the crudes, I mean it's pretty dynamic the crudes that we backed out of the crudes late. If anything that we ran less of, that would have been the California heavy crudes on a relative basis to everything else. But I mean, there's a lot of moving parts there.

Operator

[Operator Instructions] Our next question is from the line of Faisel Khan of Citigroup.

Faisel Khan - Citigroup Inc

Going back to the Panama pipeline for a second. Were you able to utilize that pipeline in the quarter? And was there a material benefit to your margin in California?

Greg Goff

Faisel, like I mentioned earlier, our contractual obligations started in April this year. And we've kind of been ramping up our use of the pipeline over time, and it's in the tankage also not just the pipeline. And we had been using it. Our use of those assets have been increasing. They are not material at this point in time to what we're doing though.

Faisel Khan - Citigroup Inc

And with the Canadian discounts that we saw in the quarter, how much of that situation were you guys be able to take advantage of in the quarter? I guess, you would recognize those discounted Canadian volumes through your California system, is that correct?

Greg Goff

I'm sorry, can you state the question again, Faisal?

Faisel Khan - Citigroup Inc

We saw material discounts of Canadian Heavy crude in the quarter. I know you guys have some opportunity to move those volumes to the West Coast. I'm just curious, how you guys were able to take advantage of that situation on the West Coast?

Greg Goff

Yes, we were able to take additional barrels because of the discounts with the pipeline problems and then through the Vancouver dock into our system during the quarter. So we did take some advantage of that.

Faisel Khan - Citigroup Inc

And was that a material uplift to your margins for the quarter?

Greg Goff

It was helpful to the margins. That's like we talked about in the front end when we look at our capture rate. Our capture rate was improved, and it helped our capture rate pretty significantly.

Faisel Khan - Citigroup Inc

If you could clarify for me on the business interruption insurance, from what time to what time does that insurance cover? What's the time period the Insurance covers the downtime? Is it the entire time from when the facility comes up, or is it sometime before that?

Greg Goff

Well, the actual policy, the period is from when it went down until mechanic completion, excluding the deductible, which the deductible we talked about earlier was the $25 million so, or 60 days really.

Faisel Khan - Citigroup Inc

So by 60 days?

Greg Goff

No, the Deductible is based upon 60 days or $25 million. And then the policy, the coverage ends once mechanical completion is declared on the refinery, then the policy ends. So it's that period of time from the incident, excluding the deductible period until mechanical completion.

Operator

Our next question is a follow-up from the line of Doug Leggate with Merrill Lynch.

Douglas Leggate - BofA Merrill Lynch

About a month or so, Greg, we had dinner together and I asked you this question and I wanted to just get your latest thoughts on it. First, when he was in the chair, he always said that the pipeline business of your portfolio was too small to be MLPd, and you did not necessarily share that opinion. I was just wondering if you could reiterate your view or give us an update as to how you see the possibility of potentially using that as a value release for the stock?

Greg Goff

Doug, our views aren't different than when we spoke the last time. We are looking very comprehensively at all of our assets, whether it be our pipeline in determining assets or how the refineries, the integration between refining and marketing and everything. So the views that we've said about the use of those assets isn't really any different. And we'll share strategically what we're trying to do with the business as we go forward when we meet in December.

Douglas Leggate - BofA Merrill Lynch

So just to be clear, you do think it's big enough or you don't?

Greg Goff

I mean you can go back in and look at the size of our pipeline assets and then in our assets relative to what other people are on a comparable basis to what other people have done that have created MLPs with our assets. So our asset base is not significantly smaller than what other people have done.

Operator

There are no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Greg Goff

No closing comments. We're appreciate everyone's questions. Thank you very much.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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