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Executives

Louie Rubiola – Director, IR

Greg Goff – President and CEO

Scott Spendlove – CFO

Everett Lewis – EVP and COO

Analysts

Evan Calio – Morgan Stanley

Chi Chow – Macquarie Capital

Blake Fernandez – Howard Weil

Jacques Rousseau – RBC

Doug Leggate – Bank of America Merrill Lynch

Edward Westlake – Credit Suisse

Jeff Dietert – Simmons

Tesoro Corporation (TSO) Q4 2010 Earnings Call Transcript February 3, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 Tesoro Corporation’s earnings conference call. My name is Theresa and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of today’s conference. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Louie Rubiola, Director of Investor Relations. Please proceed.

Louie Rubiola

Thank you, Theresa. Good morning, everyone, and welcome to today's conference call to discuss our fourth 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.

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

Greg Goff

Thanks, Louie. Good morning, everyone, and thanks for taking the time to join us on the call today. You have our earnings release and Scott will go over some of the detailed results in a moment. But the key takeaway is that our results are significantly better for the same quarter last year. Certainly, industry spreads were up year-over-year for the quarter, but the margins we captured were up even more.

The fourth quarter average Tesoro Index gained $3 per barrel or nearly 80% over the same quarter last year. This improvement was driven primarily by diesel margins, which were up about 100% over last year. Gasoline margins were also up, gaining nearly 40% over the same quarter of last year. Global demand growth, especially for distillate remained strong. US refining margins generally have benefited from the growth in Asian demand and increased levels of US exports to Europe and South America. We are also beginning to see marginal improvements in US demand.

Capture rates throughout our system were significantly in the quarter, driven by stronger clean product yields resulting from increased reliability and less turnaround activity within our system. On the West Coast, we continue to capture wider discounts for foreign heavy crude oil relative to domestic alternative. In the Mid-Continent, increased domestic crude oil production as well as crude oil pipeline disruptions at the end of the third quarter increased the discounts for local crude oil relative to WTI.

For the quarter, excluding business interruption insurance proceeds, our realized gross margin was $11.15 per barrel. On a Tesoro Index, that averaged about $7.15 per barrel. Throughput rates during the quarter were down year-over-year, but up sequentially with the full restart of the Anacortes refinery in early November.

During the quarter, we received $55 million in cash proceeds from business interruption insurance claims, and we also accrued another $12 million in expected property damage claims. The business interruption proceeds were recorded in gross margin, the property damage claims to direct manufacturing costs. The $55 million in business interruption proceeds collected to date represent estimated losses through mid-August, net of the April and May 60-day deductable period. As a reminder, the full loss period is essentially April through October.

We expect to settle remaining property damage and business interruption claims related to the incident during the first half of this year. Excluding the $12 million pretax income from property damage insurance accruals, our manufacturing cost in the fourth quarter were flat relative to the third quarter of 2010. As we shared with you in December, we have targeted to reduce this amount by $70 million to $80 million in 2011 as we drive further operating efficiencies.

Retail marketing margins were strong during the quarter, but down both sequentially and year-over-year. This is typical in a rising crude environment where street prices tend to lag rapid increases in wholesale spot prices. As we mentioned in the earnings release, our pretax corporate unallocated cost for the quarter was $39 million before corporate depreciation and a $26 million in non-cash expenses related to our stock-based compensation.

Excluding a bonus accrual that we did not call out in the release, G&A expenses were down year-over-year for the quarter, in line with guidance and reflecting the cuts in overhead that we made earlier this year. Scott will talk about the non-cash stock-based compensation charges in more detail later.

Our capital expenditures for the full year – last year were $287 million. Turnaround spending was $140 million. We reaffirmed our guidance for 2011 at $380 million for capital spending, including regulatory, maintenance and income projects and an additional $116 million in turnaround spending.

As we look forward, we remain cautiously optimistic about improving market conditions, but continue to plan for a margin environment similar to last year. We see opportunities to drive significant shareholder value from our existing asset base. We have established strategic priorities that are focused on driving free cash flow, strengthening the position of the company, and increasing shareholder value.

Our 2010 results clearly demonstrate our ability to deliver fundamental improvements in the business. EBITDA for 2010 was just over $515 million. For 2009, EBITDA was just under $365 million. The year-over-year gain of $185 million, about 50% improvement, was realized despite a basically flat margin environment between the two years and with 12.5% lower throughput primarily as a result of the Anacortes incident. We realized the gain because we delivered on the improvement targets we set out at the 2009 Analyst Day presentation.

We reduced our feedstock cost, realized better yields, and improved the netbacks on finished products. We also launched initiatives to reduce our overhead cost. As we start this year, we have laid out plans and have set meaningful targets to further drive operational efficiency and effectiveness through increased reliability, further system improvements, and a focus on driving cost leadership without sacrificing our commitment to environmental safety or health performance.

In addition, we have plans to drive additional EBITDA growth to our commercial excellence strategies, and we are increasing our investments in income-generating capital projects. In all, we have targeted well over $200 million in EBITDA growth from these efforts in 2011. Combine that with Anacortes being back on line for a full year and in a relatively flat margin environment we expect for 2011, we should be able to deliver significant EBITDA growth in 2011 versus last year. Full details of the 2011 business plan can be viewed in the December Analyst Day presentation posted on the Investor Relations section of our website.

With that, I’ll now turn the call over to Scott Spendlove, our CFO, for a more detailed discussion of our quarterly and annual results and to also provide some guidance for the first quarter of 2011. Scott?

Scott Spendlove

Thanks, Greg. As we reported last night, fourth quarter net income was $3 million or $0.02 per diluted share. Adjusted for special items, we are reporting an adjusted net loss of $19 million or $0.13 per diluted share. That compares to an adjusted net loss in the fourth quarter last year of $136 million or $0.99 per diluted share.

Special items that we are excluding from the quarterly results to get an adjusted net loss include after-tax $39 million in business interruption insurance proceeds and property damage claims accruals related to the Anacortes incident net of repair expenses, a $10 million accrual related to legal claims associated with refunds that we received in 2008 from the Trans Alaska Pipeline System, and $7 million for the write-off of goodwill at our Hawaii refinery. The accrual for the legal contingency and the write-off of goodwill are non-cash charges.

In 2008, we received net refunds of $15 million from the Trans Alaska Pipeline System to settle protested intrastate transportation rates. The competitor claimed that they were entitled to a share of the refunds, and a trial court recently ruled in their favor. We disagree with the ruling and have appealed the decision to the Alaska Supreme Court. Meanwhile, we have established a reserve for potential refunds related to the case.

Despite improvement plans for Hawaii and because our updated outlook for that system is not as robust as it was a year ago, we ran an impairment test, which resulted in the pretax write-off of $10 million of goodwill. Some of that write-off is not tax deductible, resulting a $7 million after-tax charge.

As Greg mentioned, despite the headline number, our G&A expenses are coming down and are in line with the guidance for the quarter. The $26 million in pretax charges related to stock-based compensation arise from the way stock appreciation rights or SARs and phantom stock awards are accounted for under GAAP. Unlike stock options, the restricted stock awards whose value of the time of issue is amortized evenly over the life of the award.

SARs are marked to market based on the Black-Scholes value of the awards. With the $5 run-up in the stock price during the fourth quarter and given the relatively low average strike price of recent awards, the Black-Scholes valuation of the awards resulted in $26 million in pretax non-cash charges.

Turning to the balance sheet, we ended the year with a cash balance of $648 million and $1.1 billion of availability on Tesoro’s revolving credit facility. We remained undrawn on that facility during the quarter. Our debt-to-cap at the end of the year was 38%. The change in cash for the quarter was over $300 million and reflects EBITDA of $163 million plus working capital sources of $279 million, partially offset by cash interest and taxes of $56 million and capital and turnaround spending of $77 million.

The significant gain in cash from working capital in the quarter is before inventory purchased and financed by our Tesoro Panama subsidiary and primarily reflects the impact of rising crude prices on our cash collection cycle. As crude prices rise, product prices generally rise also. Because we collect our receivables in under 10 days and payables in over 30 days, we collect rising revenues faster than we make payments for purchases and our cash balances increases.

To the extent that crude prices stabilize or decline, we would expect some of this excess cash to be temporary. Nonetheless we are well positioned with cash on the balance sheet and significant excess revolving credit capacity. During the quarter, our Tesoro Panama subsidiary borrowed $150 million on a separate non-recourse credit facility for the purchase of inventories to move through that pipeline and storage facility. Bad debt will be repaid as those inventories are sold during the first quarter.

Turning to our outlook for the first quarter of this year, this is typically a weak gasoline demand period, both nationally and in PADD 5, with demand typically following 1% to 2% from the already weak fourth quarter. Despite the seasonal decline we are seeing, gasoline demands for December on the West Coast was well in excess of levels seen a year ago. Corresponding supply reductions from plant turnarounds and reduced runs helped offset this decline in demand with PADD 5 crude runs down 10% from December 2010 and slightly lower than the same period last year.

Product inventories are running near five-year highs and will likely limit margin growth through the low demand period. We expect a normal seasonal demand recovery later in the quarter to work these inventories down. Although oil demand continues to grow with Asia demand increasing, this is providing better support for exports, especially during the winter months when less Asian exports compete for Latin American demand. This should also help keep inventory levels in check.

With gains in demand from a year ago, both domestically and globally, margins so far in 2011 are up significantly over where they were at this time last year. On the West Coast, for example, the three-to-one crack spread has averaged over $11 per barrel, up $5 per barrel over January of last year.

I’ll close with guidance for the first quarter modeling purposes. We estimate throughput to be in thousands of barrels per day; 125 to 135 in the Pacific Northwest, 65 to 75 in the Mid-Pacific, 100 to 110 in the Mid-Continent, and 245 to 255 in the California region. The Mid-Continent throughput guidance includes the effect of slightly reduced run rates at our Mandan refinery, following a first fire on the alkylation unit. The fire was quickly contained and no one was injured.

OpEx guidance for the fourth quarter in dollars per barrel is as follows. $4.30 in the Pacific Northwest, $3.30 in the Mid-Pacific, $3.65 in the Mid-Continent, and $6.55 in the California region. Our depreciation for refining is estimated at $95 million. Additional first quarter guidance items include estimated corporate expense, including depreciation of $38 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

Thanks, Scott. It’s been about six weeks since we presented our 2011 business plan on our Analyst Day event in New York. Since that time, we have really shifted our focus to the execution of that plan. We are very confident that our strategic priorities will drive incremental free cash flow, strengthen the competitive position of the company, and increase shareholder value. We believe that our 2010 results clearly demonstrate our ability to deliver these improvements. We look forward, as the year progresses, to really updating you about the progress that we are making.

With that, we’ll now, between Scott, Everett and myself, entertain your questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Evan Calio of Morgan Stanley. Please proceed.

Evan Calio – Morgan Stanley

Good morning, guys. One question is on Mandan. And I heard the update on the fire. I was wondering when the refinery will be back on line. And maybe a broader strategic question. I mean, it’s clearly feedstock advantaged asset to its location in the Bakken? Are there other debottlenecking opportunities, or even broader, are there any potential expansion projects that make sense? I mean, on that context, if we look at logistic problems out of PADD 2, some type of upstream, downstream joint ventures seems very analogous to oilsands joint ventures. And clearly different from a hardware perspective, but their barrels that will ultimately competing in the Mid-Con. I’m wondering if you have any thoughts you could share there. And then I have a follow-up please.

Greg Goff

Good morning, Evan. Several good questions there. I’ll let Everett respond to those questions.

Everett Lewis

Hi, Evan, this is Everett. Regarding the fire at Mandan, it really had a pretty minimal effect on our throughput. At this time of year, we can blend butane to gasoline. So the impact of an alkylation outage is really minor. On our gasoline capability, the real issue is containing the LPG, which we’re working at. So we were running last weekend at nearly 58, which is above our plans. And if we’re limited by anything really right now, it’s the weather getting our crude gathering and crude into the refinery more than it is the effects of that incident. So the effect is pretty minimal. We expect to have that furnace coil repaired by mid-March and be back to fully normal operations at that point.

Concerning the broader question on the Bakken, if you look at our fourth quarter results, we set a record on throughput on Mandan in the fourth quarter. So we agree with your idea that we should be taking advantage of the Bakken discounts to the extent we possibly can. And we’re looking at all kinds of ways doing that. In fact, we do have some very low capital quick ways to further increase our throughput at the Mandan location. It’s also affecting the Canadian crudes because they are seeing the same kind of pressure in the Mid-Con. So we’re looking at max-ing the volumes we can get at the Canadian crudes that are going west towards Anacortes. And that’s helping us there as well. And we continue to look at other ways to take advantage elsewhere in our system of the Mid-Con crude pricing.

Evan Calio – Morgan Stanley

Any thoughts on the local product market’s ability to absorb incremental demand? Meaning, if you – if there was more of an expansion there, you wouldn’t be trading an inability to move crude with an inability to move product, would you?

Everett Lewis

Well, we are trying to work on both in tandem actually. If you remember, we did a deal with Shell around some additional retail outlets in the Mid-Con area, and that turned out to be good timing because we’re using that additional retail capacity to match up with our throughput capacity at Mandan. That’s one of the reasons we’re able to go to the record levels. So we continue to try to move them in tandem. It’s a good point, because running more crude in the region when the market isn’t expanding can limit you just on the other side. So we see that. We’re working both ends.

Evan Calio – Morgan Stanley

Okay. And my second question, if I may, it’s also strategic, but BP announced the sell process for Carson City, big LA refinery. How do you think about that asset and the context to your portfolio or –? I mean, even broader, are there any scenarios where Tesoro to consider operating the asset for a third-party buyer, particularly if it was some NOC that didn’t want to operate that asset? Thanks.

Greg Goff

Evan, we’ve been doing a lot of work. As we talked about at our Analyst Day presentation, we have gone through our portfolio very, very thoroughly and we are looking at all different options. Because of our market position on the West Coast did limit certain things that we could do with our current assets and then – I mean, with that recent announcement by BP, those are things that we’ll just look at as we determine how we move forward. One of our key focus areas is around our Los Angeles refinery to drive significant improvements in that asset.

Evan Calio – Morgan Stanley

Great. Thank you very much, guys.

Everett Lewis

Thanks.

Operator

And your next question comes from the line of Chi Chow of Macquarie Capital. Please proceed.

Chi Chow – Macquarie Capital

Great. Thanks. Good morning. Hey, Greg, you were just talking about LAR. And the guidance for the California plants for the first quarter suggests potentially lowest quarterly OpEx in almost two years. Now, is this time to find that your targeted efficiency or the cost reductions are funneling through? And can we expect this level to be sustained going forward?

Greg Goff

Chi, that’s a good question. Everett has gone into the operations. We’ll let Everett respond to your question.

Everett Lewis

Chi, I think there will be variations quarter-to-quarter on the operating cost. But we are achieving our targets for last year in terms of reducing operating expense there. In some quarters they get masked by other incidents that happen, like the Acki [ph] plant at Golden Eagle. But in general, we’re getting – we are continuing to approve our operating expense across our system, including the West Coast. And I think if you saw the analyst presentation, we have some very aggressive targets on the West Coast for next year and we are on target to achieve those.

Chi Chow – Macquarie Capital

Okay, great. Also, I guess maybe, say, in California I guess on retail in general, your retail fuel sales over the last two quarters suggest that the volumes are returning, at least in your system. Do you feel this trend is representative of overall demand growth in the market or is it just the market share gain on your part?

Everett Lewis

Chi, this is Everett. I think it’s a little bit of both. Our same-store sales are actually relatively flat. We’re seeing increases in retail as we continue to leverage the brand strategies that we have in California and put more and more of our output through our own either brand that are captive retail stations. So I think that more of the volume increase you see in our system is due to the fact that we’ve got more system rather than more same-store sales. But underlying that, we do – we are very cautiously optimistic, I think, about demand growth in California, as we continue to see some signs to strengthen the economy. But it’s cautious yet at this point.

Chi Chow – Macquarie Capital

Okay. Thanks, Everett. And maybe I’ll just ask one more here. Scott, you talked about the inventory you purchased for the Panama system. Can you go into more detail there? Is it crude or products? Is it for your own system or are you moving it for third parties?

Scott Spendlove

It’s crude and we are moving it for third parties.

Chi Chow – Macquarie Capital

And the Panama asset is something that you can contribute to sort of logistics down the road?

Scott Spendlove

No, we will not do that.

Chi Chow – Macquarie Capital

Okay. Thanks. Appreciate it.

Operator

And your next question comes from the line of Blake Fernandez of Howard Weil. Please proceed.

Blake Fernandez – Howard Weil

Good morning, guys. Thanks for taking my question. You referenced a couple of times exports to Europe and South America. And I’m just curious if you could clarify – are you seeing a direct benefit from your portfolio, i.e., the ability to export, or is it really more of an indirect benefit as barrels kind of move the US and you indirectly benefit that way?

Greg Goff

Good morning, Blake. This is Greg Goff. There is no question that the majority of the exports are coming out of the Gulf Coast to the United States to West Coast. We do benefit and participate in the exports too off of the West Coast. I mean, we see that looking pretty good what’s happened in the past and then things that we see going forward look reasonably good. But the order of magnitude is significantly less than what you see from the Gulf Coast.

Blake Fernandez – Howard Weil

Okay. Okay, great. The second question I had for you was on business interruption. The $55 million was pretty well ahead of I guess what we were expecting. Do you have any color or guidance on what we might expect going forward?

Greg Goff

In my statement, like I kind of framed that up for you, the time period that we collected for the insurance was up to about August. And we kind of define the timeframe that we are down as far as when the proceeds kick in to go up until about the end of October. So you can kind of get some idea. We’re to a period now where we need to – we’ve submitted all of the information to the insurance companies. We are very actively trying to bring resolution to that. We said that first half of the year we’d like to it by the first quarter, and it’s just going back in and finalizing everything. But we’re pretty optimistic that all of our documentation and our ability to work with the insurance company is well suited. And so we have a couple more months of proceeds to realize to the extent of what we have to see as we get into the final negotiations of the process.

Blake Fernandez – Howard Weil

Got it. Thanks a lot. Appreciate it.

Operator

And your next question comes from the line of Jacques Rousseau of RBC. Please proceed.

Jacques Rousseau – RBC

Good morning.

Greg Goff

Good morning, Jacques.

Jacques Rousseau – RBC

I wanted to ask about Hawaii and what the status of the utility contract with Hawaii Electric. And then just in general, what has changed in terms of your expectation that caused the write-down? Thanks.

Greg Goff

Jacques, we’ll let Everett. He just came back from Hawaii meeting with the Governor of Hawaii. So we can talk about where that stands. And then we’ll let Scott talk about our methodology on why we took the $10 million goodwill write-down. Everett?

Everett Lewis

Hi. I was just in Hawaii to talk to the Governor there. As you know, or you may know, there has been a change in administration in Hawaii, and there has been some turnover in the utilities commission there that has to rule on it. Our amended contracts have been agreed between ourselves and our customer for some time and they have been before the PUC as a pending item for some time in Hawaii. We don’t have a schedule or a date from the PUC when they will consider those rulings. We expected them to be done by year-end. They have obviously taken longer than that. And I met with the Governor. He was sympathetic with our position and indicated that he would do what he could to get the commission to act as quickly as possible on those outstanding agreements.

Scott Spendlove

Jacques, this is Scott. As far as the goodwill write-off, the accounting literature has us look at different valuation methods, one of which is to look at our future expectations of cash flows and present value of those. Our margin outlook for that market is not as robust as it was going into 2010 and really it’s a marginal difference, but it has led us to have to take the write-off of the $10 million of goodwill. It’s not an impairment charge. It’s just the write-off of the remaining goodwill for the Hawaii system.

Jacques Rousseau – RBC

What in particular changed your margin outlook?

Greg Goff

When we put our forecast together, we took a more conservative look at the outlook on margins. Like Scott said on what was there, it’s not significantly different; it’s just enough to following the procedures that Scott talked about. We wrote off the $10 million of goodwill. I mean – and I think it’s important to restate it wasn’t an impairment on the assets at all.

Jacques Rousseau – RBC

Great. Thank you.

Greg Goff

Yes.

Operator

And your next question comes from the line of Doug Leggate of Bank of America Merrill Lynch. Please proceed.

Doug Leggate – Bank of America Merrill Lynch

Thank you. Good morning, fellas. Couple of things from me. Very quick follow-up on Jacques’ question. Scott, when you did the impairment, did you assume that the fuel oil contract had been renegotiated and embedded in those future margins? I’ve got a couple of quick follow-ups.

Scott Spendlove

Yes, that was part of it.

Doug Leggate – Bank of America Merrill Lynch

(inaudible) that was a positive though?

Scott Spendlove

It is a positive, but there are other offsets in the overall margin outlook.

Doug Leggate – Bank of America Merrill Lynch

Okay. That’s fine. Thank you. On the working capital, can you just give us a little bit more color? I assume there was some year-end inventory money going on here. If that’s not the case, maybe you could elaborate. But if you could give us some idea, can you help quantify how much of that you might receive in terms of working capital in the first quarter?

Scott Spendlove

Yes. There was no management of inventory at year-end. It really was collecting receivables three times faster than we made payments towards the end of the year. On January 20, when we settled our crude purchases, we made a significant outlay of cash to settle those purchases based on that higher crude price environment. As we’ve seen a retraction of some of that crude, but – I mean, some of that cash, but currently we aren’t positioned to tell you where we are right now. But it has come in.

Doug Leggate – Bank of America Merrill Lynch

Okay. I guess, if I may ask a follow-up on that. The inventory management generally takes up quite a lot of cash obviously and at a $100 oil. One has to margin the LOEs, and for some investment grade kind of companies, it starts to become more costly again. So, is there any consideration now or in the future that you might consider changing the way you manage that? By that, what I mean is, having it financed by potentially a third-party and incurring an additional operating cost, but at the benefit of reducing your – obviously releasing inventory and free up some cash and obviously improving return on capital. Is that something you’ve considered? If not, why it would not be tried?

Scott Spendlove

Well, we actually look at the balance between the cost of LCs and those kinds of arrangements occasionally, and our LC structure is appropriate, the cost is appropriate. We have significant excess capacity on the revolver at this time. And even when crude was $120 a barrel or more, the higher crude prices, this revolving credit facility was sufficient for our needs. And we are very comfortable with where we are right now.

Greg Goff

Our focus, Doug, really is to run a very lean system on how we acquire the crude and move it throughout our distribution system, and we very actively and aggressively manage our working capital to take advantage of it, but to take other steps that you suggest isn’t something that we are doing. We are actually – we think that through our optimization process, we manage that whole cash flow to the system very well.

Doug Leggate – Bank of America Merrill Lynch

So the LC issue, I guess, is – I saw one of your competitors do something similar. But a final one from me is, could you give us an update on your crude slates? I seem to recall, Greg, probably about a year or so ago there were some organizational changes put in place to allow the company to have a better organization around the world. And I’m just curious in light of what’s going on with the global benchmarks and domestic rates, what’s happening in terms of your crude flexibility? And I’ll leave it there. Thanks.

Greg Goff

Yes. I’ll let Everett talk specifically around what’s happening, what’s the different crudes we’re taking into the system.

Everett Lewis

There’s sort of several different questions embedded there. It is interesting and it makes it difficult to track. We’ve given the disconnect that’s going on with WTI. What we are generally finding with the WTI discounts in our crudes are that the deltas that the pricing contained to WTI are changing in tandem with the changes in the WTI such that the margins were realizing on those crudes, even though there are apparent deltas to WTI are changing, are not really changing that much. So we are not having to do a lot of creative things around that situation. We continue to be very, I think, creative around what we’re doing with our crude sourcing. We ran almost 35 different crudes in the fourth quarter. And we’ve – you can see by our capture rates that we’ve done a great job of picking up crudes that are advantaged relative to our official indexes or the market crudes in our indexes. I think that’s probably one of the best measures of the effectiveness of our crude buying. And we continue to improve that.

Doug Leggate – Bank of America Merrill Lynch

So I guess the logical question then for us would be, how can we get some transparency on that? I mean, as we look forward on your average [ph] capture rates, if it’s not coming from efficiencies and cost improvements in the actual system that’s coming from better crude management, we need to change our slate in terms of our assumptions as we go forward. So what guidance can you give us on how permanent that change actually is?

Greg Goff

Well, I think what we do – and Louie can correct me if I’m wrong here, but I think we tried to give you some guidance on capture rates and indexes going forward. So we gave you the index, and I think we give you some help at least directionally on where we see those capture rates going. And I think that was the purpose in putting our index is that was to help you with that. It is difficult to do though. The other – in addition to that, the WTI change has helped us out in the Mid-Con as it has helped others out. As we see the WTI plays going down, that is also reflected in some of the Bakken prices and some of the Canadian prices, which is also helping our capture rates.

Doug Leggate – Bank of America Merrill Lynch

All right. I’ll take it offline with Louie. Thanks a lot.

Greg Goff

Okay.

Operator

And your next question comes from the line of Edward Westlake of Credit Suisse. Please proceed.

Edward Westlake – Credit Suisse

Yes. Good morning, and well done on some of the capture rates that we’re seeing. Just a small question on – again following on from Doug’s on the crude side, the Panama inventory is with third parties, when should we start to see some EBITDA contribution from Panama? And what do you think the impact is going to be on crude differentials from the extra crude coming into your region and maybe from Canada and from other parts of Pacific?

Greg Goff

Ed, you asked a couple different questions there. The contributions from Panama are billed into our refining results. And if you recall back in December, we’re really building our capability around our supply and trading activity. And that’s going to – I think we were pretty clear that that’s going to take us a little bit of time. And we kind of set our targets for EBITDA contributions for 2011 somewhere in the order of $35 million plus or minus a little bit. And so we really – as we’re starting to build that up, that amount will flow into our refining results. But we expect to improve that as we build up that capability over time and have better results in 2012. So – I mean, it’s not a lot actually for this year, but it helps us and gives us more flexibility to really meet our system requirements as we source crudes out of South America into the West Coast system. And your second question was, I think, a follow-on. Can you ask that question again?

Edward Westlake – Credit Suisse

The second question was just following on from Doug’s is, are you seeing more crude availability, not just the amount of grades you process, but the actual volumes coming into the West Coast? And do you think that will have an impact on differentials?

Greg Goff

Everett, do you want to comment on that?

Everett Lewis

We are starting to see the beginnings of that trend. We are starting to see things like 40 showing up in the Pacific Basin again. I don’t think it’s driven as much by the West Coast as it is by the growth in Asia and the increased crude demand in Asia. But if that crude demand goes up, I think we’re going to see additional tightness in the Pacific Basin crude. And I think that’s going to start pulling some crude more from the Atlantic Basin and probably will increase the traffic across Panama. That movement is not large today, but we’re starting to see the beginnings of it and I would expect it to increase. I think it doesn’t so much impact the pricing of Pacific Basin crudes as it does the marginal crude price into the Pacific Basin from other places.

Edward Westlake – Credit Suisse

Thanks.

Operator

And your next question comes from the line of Jeff Dietert of Simmons. Please proceed.

Jeff Dietert – Simmons

Good morning. Perhaps it’s a little early to get too much information from this, but you’ve incorporated the 300 Shell stations into the Midwest. And I was just wondering if you’re seeing any incremental value as you pull that into your value chain in the Midwest and how that’s proceeding.

Greg Goff

Good morning, Jeff. The transition over to the Shell stations in our network is actually progressing very, very well. Everyone is doing a good job. We’re on schedule by about the middle of February. That transition will be almost 100% complete. And as we talked about before and Everett mentioned it in response to an earlier question, that supply then fits into our system well, and I think that was about 13,000 barrels a day of additional supply in that. So, the answer to your question is yes, it’s working extremely well. That’s going to be a very positive thing for the company, particularly in that market area around the Salt Lake and Mandan refineries.

Jeff Dietert – Simmons

Very well. One of the things you highlighted was the cost of biodiesel and RIN values were rising rapidly in the fall. Have they stabilized? Is there any change in your expectations for the incremental costs in 2011 relative to ’10?

Greg Goff

You’re right, Jeff. At the Analyst presentation in December, we singled out as a potential pretty significant cost to our system the RINS. And we talk specifically about the biodiesel requirements. And that was the result from our plan, which was before the government implemented the changes that basically reduced the cost. So we think in that number that we presented, I don’t remember what it was, around $50 million to $60 million, I think, back in December, we’ll probably be something more than – less than half of that amount now.

Jeff Dietert – Simmons

Thank you very much.

Operator

Ladies and gentlemen, that concludes today’s conference. We thank you for your participation. You may now disconnect. Have a great day.

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