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Executives

Gregory Goff - Chief Executive Officer, President and Director

Louie Rubiola - Director of Investor Relations

Daniel Porter -

G. Spendlove - Chief Financial Officer and Senior Vice President

Analysts

Edward Westlake - Crédit Suisse AG

Evan Calio - Morgan Stanley

Mark Gilman - The Benchmark Company, LLC

Jacques Rousseau - RBC Capital Markets, LLC

Paul Cheng

Sam Margolin - Dahlman Rose & Company, LLC

Douglas Leggate - BofA Merrill Lynch

Jeffrey Dietert - Simmons & Company International

Joe Citarrella - Goldman Sachs Group Inc.

Ann Kohler - CRT Capital Group LLC

Chi Chow - Macquarie Research

Paul Sankey - Deutsche Bank AG

Blake Fernandez - Howard Weil Incorporated

Tesoro (TSO) Q1 2011 Earnings Call May 5, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Tesoro Earnings Conference Call. My name is Carissa, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today's call, Mr. Louie Rubiola, Director of Investor Relations. Please proceed.

Louie Rubiola

Thank you, Carissa. Good morning, everyone, and welcome to today's conference call to discuss our first quarter 2011 earnings. Joining me today are Greg Goff, President and CEO; Dan Romasko, Executive Vice President of Operations; 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 www.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.

Gregory Goff

Thanks, Louie. Good morning, and we appreciate everyone taking the time to join us on the call today. You have our earnings release, and Scott will go over some of the details of the results in a moment. But I'm going to start with an overview of some recent highlights.

During the first quarter, we ran at significant higher refinery utilization rates when compared to both the first and fourth quarters of last year, allowing us to more fully capture strong crack spreads and advantaged crude oil discounts.

We also made good progress on our improvement initiatives to drive EBITDA growth. The combined result is reflected in our very strong earnings and positive cash flow for the first quarter. We also announced during the quarter our plans to expand crude oil throughput capacity at our North Dakota refinery by about 17%. This $35 million project, which we expect to complete in the second quarter next year, will allow us to capture more of our advantage crude position in the region.

We also successfully executed the initial public offering of Tesoro Logistics, LP. The launch of this MLP [master limited partnership] is an important step in the execution of our logistics growth strategy. And yesterday, as you probably saw, we redeemed the full $150 million outstanding amount of our junior subordinated notes. With earnings strength and debt reduction, we expect to reduce total debt to total capitalization significantly this year, driving towards our goal of around 30%.

We have made good progress in driving operational efficiency and effectiveness, delivering earnings strength and improvement, exercising financial discipline through debt reduction, and positioning ourselves for strategic growth through the MLP. These results are all evidence of our successful efforts to realize our strategic priorities and drive shareholder value.

Turning to the quarter, industry crack spreads were up year-over-year, and our refining gross margins were up even more. The first quarter average Tesoro Index gained over $5 per barrel, doubling from the same quarter last year. This improvement was driven primarily by diesel crack spreads, which were up nearly 140% over last year. Gasoline crack spreads were also up, gaining 35% over last year. Global demand growth, especially for distillates, remains strong. U.S. refining margins generally have benefited from the growth in Asian demand and increased levels of U.S. exports to Europe and South America. During the quarter, we also saw marginal improvements in U.S. demand. Capture rates were up materially in the quarter, driven by significantly advantaged crude costs relative to benchmark crude prices and a solid operating performance during the quarter. On the West Coast, we continue to capture wider discounts for foreign heavy crude oil relative to domestic alternatives. In the Mid-Continent, supply length of domestic inland crude oil increased the discounts for these grades relative to waterborne benchmarks such as Brent.

For the quarter, our realized gross margin was $14.33 per barrel on a Tesoro Index that averaged $10.54 per barrel. Throughput rates during the quarter averaged 561,000 barrels per day, or more than 84% of total crude oil capacity. This is up from 505,000 barrels per day, or 76% for the fourth quarter last year.

The improvement reflects less unplanned downtime, minimal turnaround activity, and the benefits of Anacortes being back online for a full quarter. Manufacturing cost in the first quarter averaged $5.22 per barrel, a decrease of over $0.50 per barrel from the 2010 fourth quarter, excluding the benefit of $12 million in property damage insurance recoveries accrued last quarter.

Retail marketing margins were down during the quarter, both sequentially and year-over-year. This is typical in a rising crude price environment, where Street prices tend to lag rapid increases in wholesale spot prices. With significantly higher pump prices, we did see a slight reduction in same-store sales. Year-over-year for the quarter, they were down about 1%. However, our total retail fuel sales volumes increased 12% year-over-year, as we completed the previously announced addition of some 300 Shell branded outlets.

As we mentioned in the earnings release, our pretax corporate and unallocated costs for the quarter were $37 million before $3 million in corporate depreciation and $46 million in non-cash, stock-based compensation expense that's primarily related to stock appreciation rights.

Capital expenditures for the first quarter were $42 million. Turnaround spending was $9 million. We continue to plan for 2011 capital spending of $380 million, including our regulatory, maintenance and income projects. We continue to expect about $160 million in turnaround spending for 2011 also. As we look forward, we remain cautiously optimistic about market conditions. From a crack spread perspective, the first quarter exceeded our expectations, and we are pleased with the market conditions so far in the second quarter. Additionally, the steady decline in U.S. light product inventories, combined with strong exports, should continue to provide support to margins.

Putting the market aside, we are capturing 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.

As we progress through 2011, we remain committed to focus on driving operational efficiency and effectiveness through increased reliability and improving process safety, realizing further system improvements, focusing on cost leadership, and investing to drive fundamental improvement in the business.

In all, we've targeted over $225 million in EBITDA growth from these efforts in 2011. Combine that with our increased runs and strong margin capture the first quarter and Anacortes being back online for a full year, and we should be able to deliver significant EBITDA growth in 2011 versus last year.

Before I turn the call over to Scott, let me comment on the recent IPO [initial public offering] of Tesoro Logistics. I am pleased with the successful launch of Tesoro Logistics, which speaks highly of the quality and strategic value of these assets. The creation of Tesoro Logistics, as we said, is a key element of our value-driven growth strategy, and puts us in a strong position to grow our Logistics business.

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

G. Spendlove

Thanks, Greg. As we reported last night, first quarter net income was $107 million, or $0.74 per diluted share. That compares to an adjusted net loss in the first quarter last year of $136 million or $0.97 per diluted share. Special items last year included after-tax expenses of $12 million related to an impairment charge at our Los Angeles refinery, and $7 million related to the 2010 federal healthcare law.

Our cash G&A expenses, before non-cash charges related stock based compensation expense, are coming down as we expected, and are in line with guidance for the quarter. We ended the quarter with a cash balance of $724 million. This is before the $330 million in total net proceeds from the recent IPO of Tesoro Logistics. We ended the quarter undrawn on the corporate revolver, with nearly $1 billion of additional revolving credit capacity.

During the quarter, we amended and extended the corporate revolving credit facility, extending the term of the facility to 2016, improving some of the credit terms, and lowering the letter of credit and drawn pricing by 50 basis points. We ended the quarter with total debt to total capitalization of 37%. This is before the benefit from the early redemption of the $150 million junior subordinated notes, which we completed yesterday.

The increase in cash for the quarter was $76 million, and reflects EBITDA of $323 million, less working capital, and other uses of $127 million, Tesoro Panama revolver repayments of $70 million, and capital and turnaround spending of $51 million. The use of cash from working capital in the quarter reflects carrying a higher level of crude oil inventory in our system. A portion of this is temporary, and we expect to see the positive cash flow impact from inventory reductions in the coming months.

Turning to our outlook for the second quarter of this year. The second quarter typically sees seasonal increases in PADD V demand for gasoline and distillates compared to the first quarter. Quarter-over-quarter increases of greater than 4% are typical for gasoline and jet, and increases over 7% are typical for diesel. However, high crude oil prices and resulting high product prices are a real challenge to demand growth. Nonetheless, the West Coast 3/2/1 crack spread averaged nearly $20 per barrel in April, up more than 6% per barrel relative to last year.

On the crude side, we continue to see the pricing dislocation for WTI crude oil. Due to logistical constraints in the U.S. mid-continent, inventories have reached record highs, and are putting downward price pressure on this crude. Other crudes that are tied to the same logistical areas such as Canadian, Upper Plains and Rocky Mountain crudes are similarly affected. We expect to continue to recognize an advantaged crude cost for a portion of our refining system in the second quarter.

I'll close with guidance for second quarter modeling purposes. We estimate throughput to be, in thousands per barrels per day, 160,000 to 170,000 in the Pacific Northwest; 65,000 to 75,000 in the Mid-Pacific; 110,000 to 120,000 in the Mid-Continent; and 240,000 to 250,000 barrels per day in the California region. Manufacturing cost guidance for the second quarter in dollars per barrel is as follows: $3.75 in the Pacific Northwest, $3.35 in the Mid-Pacific, $3.50 in the Mid-Continent, and $7.35 in the California region.

You'll notice that our guidance for manufacturing cost per barrel in the California region are up over actual results in the first quarter of this year. The increase coming from our Golden Eagle refinery reflects primarily 2 one-time items: First is additional expense incurred to optimize the planning and execution of planned turnaround activities at the refinery. By deferring planned turnaround work from the first to the second quarter of this year, we were able to run more barrels, and capture the stronger margin environment we saw in the first quarter. Second is additional maintenance spending on mechanical integrity to further improve reliability. So while expenses are up temporarily in the second quarter, we expect overall profitability at the refinery to be improved by these changes. Our depreciation for refining is estimated at $95 million.

Additional second quarter guidance items include estimated corporate expense, including depreciation of $36 million, and interest expense before interest income of $50 million. The higher than usual interest expense is due in part to an estimated $14 million non-cash expense related to the recent redemption of the junior subordinated notes.

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

Gregory Goff

Thanks, Scott. In closing here, we are pleased with the excellent first quarter results and our delivery of higher utilization rates and strong earning and positive cash flow.

For the second quarter, we expect to achieve higher throughput rates, realizing crude capacity utilization of about 90%.

As I said earlier, we are very focused on our strategic priorities, which we expect will generate additional free cash flow, strengthen the competitive position of the company, and increase shareholder value. We look forward to sharing progress updates as we get further into the year, specifically around some of the strategic priorities that we set out at our analyst call. And with that, we'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Jeff Dietert of Simmons.

Jeffrey Dietert - Simmons & Company International

There's been a fair amount of discussion about the Midwest WTI differentials. But I was wondering if you could talk about the West Coast feedstock dynamics. What's happening with the domestic crudes and how you're benefiting from importing foreign crudes?

Gregory Goff

Yes, the differentials, Jeff, in the first quarter, like we said in our release, were favorable for the heavy crude oil, and that is the pricing effect of that [ph]. So the pricing for the crudes on the West Coast continued to be favorable, both for the imports coming out of South America that we bring in, as well as the heavy crudes in California.

Jeffrey Dietert - Simmons & Company International

Could you talk about the impact of the Japanese outages on the West Coast? Did you see any influence there, either lower imports or increased exports?

Gregory Goff

Our view on what happened in Japan and the consequences on the West Coast is that we see the export level activity out of the West Coast has been pretty consistent with what we saw last year, the same levels of both gasoline and distillate imports, which we participate in are there. We saw higher exports coming out of the Gulf Coast that would absorb some of the additional demand there. And we didn't see any exports going into Japan, and maybe a little bit less pressure from any type of Asian imports into the West Coast from Korea that would normally be there. So we did not see a significant impact. Probably the biggest impact that we experienced was really around the pricing for crude oil, sweet crudes, and that impacted us at our Hawaii refinery.

Operator

And your next question comes from the line of Ed Westlake of Credit Suisse.

Edward Westlake - Crédit Suisse AG

Just a very simple one first, what went on in Hawaii in Q1? Obviously, it's going to resolve itself in Q2. A lot of it looked like it was OpEx. But could you just talk us through that?

Gregory Goff

Yes, there -- basically 2 things happened in Hawaii in the first quarter. The first thing was that the way our pricing works in Hawaii with the way we buy crude and then price some of our contracts, there's a lag effect there. So we get hurt in a rising crude environment because of the lag. That's one thing. And that probably accounted for some portion of it. The second thing is, is that we did maintenance work on our cogeneration facility at the Hawaii refinery, and as a result of that, put us in the market to buy both electricity and steam during the quarter, which, as you said, Ed, was the result of a higher operating cost for the second quarter. So those 2 things were the main impact that impacted us in Hawaii, which did not have a good quarter.

Edward Westlake - Crédit Suisse AG

All right. Okay. And then a more general question. Obviously, debt reducing towards your sort of target and probably falling -- well, hopefully falling further in 2012, 2013. But you've still got opportunities to invest in the assets to drive some further EBITDA growth into next year. Can you talk about your latest thoughts another sort of 4 months in, regards to sort of returning some extra cash to shareholders or investing in the core business?

Gregory Goff

Yes, but I think that's a good question. At our outlook, I think we said that we have a pretty strong cash position right now. And as we laid out last year, as I think everyone recalls, we had targeted about -- spending about $110 million in 2011 on what we call small capital, high return projects that fundamentally improve the performance of our assets, but a lot of that directed at our refining business. So we're on target to continue to do that. As we've done further work around all of our assets, we've identified potential opportunities to probably go out and increase some of our capital spending on some pretty attractive projects. For example, we announced a month or so ago the expansion of crude capacity at Mandan for $35 million, and we see a few other projects like that, that as we continue to work the assets and that, that are really attractive and that aren't dependent upon refining margins, because we really want to be able to get sustainability in the capital we spend there. So right now, with the free cash flow that we're generating, our intentions are twofold. One is to continue to pay down some of the debt until we get to a targeted level, like we've said, of around 30% total debt to total cap. And secondly, to be disciplined about capital projects that can really go in and strengthen our asset base and spend that money doing that. And we have a number of those things working that we'll talk about as we go through the year.

Edward Westlake - Crédit Suisse AG

And then so a follow on might be that if you get to pay down debt faster and you spend the money on capital projects, that excess cash, you'd consider returning to shareholders?

Gregory Goff

We'll look at -- at this point in time, we'll look and see how that all prevails. I mean, we're -- as we look at our forecasts for the margin outlook in that, we haven’t tended to be maybe bullish as some people on margins, and so we've been a little bit cautious and focused on what we do in that. So we'll look further as we get through the year, and determine what we do if we get into a position where we have significantly excess cash.

Operator

Your next question comes from the line of Doug Leggate of Merrill Lynch.

Douglas Leggate - BofA Merrill Lynch

Greg, I'm going to try a couple, if I may. Jumping back to the Hawaii refinery, I'm just wondering if you can give us an update on the fuel oil pricing contract. Obviously, it's been going on now for quite a while. And just overall, in the context of Hawaii as a strategic asset for Tesoro, could you maybe just give us a broad discussion around those 2 issues please?

Gregory Goff

Yes. I think no one is more frustrated with the Hawaii fuel oil contract than I am. I can tell you that much. We have spent considerable amounts of time both in negotiations, as we shared with everyone, with our customers to basically get a fair market price for the fuel oil that we supply to the 2 customers, and we did that a long time ago. We went in through the process with the Public Utilities Commission, which -- and advanced that through, and got support from the consumer advocate in Hawaii. Then we got into the elections in Hawaii and changes in the Public Utility Commission, both in leadership and membership as the new governor came into Hawaii. And we've had meetings with the governor himself, as well as continuing discussions. And we've been assured that we will get some answer almost any day now. But quite frankly, it's been a slow painful process. During the second quarter, because of what's happened in Japan and pricing and that, the impact of the old contract has -- we didn't suffer a material impact as the way the fuel oil is priced to the utilities during the second quarter, but we still need to get resolution of that. So we are very hopeful that not only will we get resolution shortly. And then secondly, that we'll get -- have it go back in time to the time that we reached agreement, commercial agreement, with the 2 utilities, and that's still what we're striving to do. The second part of your question, Doug, around Hawaii is, Hawaii, we are looking very, very carefully at Hawaii, and how it -- will perform with the changes you see going on, particularly in Asia, with the way crude is pricing and the high demand for crude oil in Asia and that in Hawaii. It's a tough asset to get it to perform where we need it to. So we need to look very seriously at how -- what things we can do. We laid out some things last year at our analyst presentation that show improvements. One was the contract that you mentioned. The other is some things that we can do. They both contributed about 1/2 to the improvement efforts there. But it doesn't have a lot of upside. Hawaii doesn't have a lot of upside. We need to get it to where we can drive those improvements in the business, and then see how it fits in with what we're trying to do because it doesn't -- it just doesn't have the upside that some of our other assets do.

Douglas Leggate - BofA Merrill Lynch

Got it. The only other one I have is, I think the WTI brand or LLS situation is fairly well understood. But the West Coast, some of your San Joaquin Valley crudes are clearly trading at substantial discounts to ANS, which is your benchmark. Can you just talk a little about what you see as the underlying sustainability of those kind of differentials? Because I think perhaps the advantage that you have on the West Coast is maybe not fully understood at this point. So a little bit of discussion around how sustainable you think that is, and I'll leave it there.

Gregory Goff

Yes, I think, Doug, we, I mean we see pretty good support for the differentials where they're trading around $8 a barrel right now. So I think it's, like everywhere else, particularly with what's happening in the crude dynamics on the inland crudes in that, we think it's reasonably sustainable going into the foreseeable future here.

Douglas Leggate - BofA Merrill Lynch

And the mechanics behind it? Well, obviously, there's a glut around Cushing, but there's no glut around Alaska. So what do you see as the underlying cause?

Gregory Goff

Now just the ability to bring the other foreign crudes into the market, in California, that are attractively priced for not only ourselves, but other people that put the support for the differential. It's a competition of crudes.

Operator

Your next question comes from the line of Chi Chow of Macquarie.

Chi Chow - Macquarie Research

Greg, I want to go back to the analyst day presentation back in December, and you identified integrating refining and marketing systems as a weakness in each of your regions. I was wondering, can give us an update on any initiatives that you've taken to address this?

Gregory Goff

Yes, we've actually been pretty active addressing that in the markets the last little bit here. So we are doing 2 or 3 things. One, we've actually, which we'll probably -- I don't have the numbers with me, but we've actually been pretty successful in the last little bit of contractually extending both some existing customers with higher volumes for longer periods of time, as well as some new customers with volumes, which adds about 30,000 barrels a day in total with 20,000 barrels a day of it being new volumes, which are unlike 3-year contract terms. So that's one part of what we've been able to do in the first part of this year, which will support our integration, as you talked about there. The second thing is, we are out looking for opportunities to drive further integration, and considering a bunch of different alternatives that are smaller things, but in total, they really support some of the areas where we're weak, like the Pacific Northwest. We need to grow our integration around Mandan, with the expansion of the crude and that. So we're seeing pretty good success in the market to capture additional marketing support, which will allow us to drive higher integration.

Chi Chow - Macquarie Research

And Greg, in the PNW, I think you mentioned increasing exports to the Pacific Rim. Has there been progress on this to date?

Gregory Goff

We are actively looking at things, Chi, that we are -- have been for the last few months. So we're in a good place of going about that. But I can't talk about those commercial discussions. But we are -- the idea that we have there, we are actively pursuing that.

Chi Chow - Macquarie Research

Okay. Have you been exporting ratably out of the West Coast to foreign markets, South America and/or Asia?

Gregory Goff

We have contracts in place that allow us to export out of the West Coast both gasoline and distillate, yes.

Chi Chow - Macquarie Research

Okay. Great, and any update on utilizing the Panama assets further here?

Gregory Goff

Actually in the first quarter, we actually had a reasonably good quarter with -- using the Panama assets. As you recall, we basically said the value of those assets are really fourfold. One was to take advantage of transportation logistics, where we could move crude across the Panama Canal, either for ourselves or some of other commercial customers. The second thing is there were some opportunities during the quarter that allow us to play the contango in the crude market, which provided opportunities. We've also been able to look at some distressed cargoes that allow us to position them for our systems. So the activity level around Panama in the first quarter had actually worked out pretty well for us. And we continue to actively work that, not only for our own system, but in some commercial relationships that we're trying to develop. So it got off to a good start actually.

Chi Chow - Macquarie Research

Okay. And is that an asset that you can contribute into the -- to Tesoro Logistics at some point down the road?

Gregory Goff

Chi, our involvement with Panama is really just a contract for both capacity on the pipeline, as well as storage. That's not something that we would ever contribute into the MLP. We have no intention to do that.

Operator

Your next question comes from the line of Ann Kohler of CRT Capital Group.

Ann Kohler - CRT Capital Group LLC

A couple of questions. First, a follow-up in regards to potentially looking at returning cash to shareholders. Certainly, there are 2 options there, a dividend or repurchasing stock. Do you have currently existing, anything outstanding, an outstanding share repurchase program, or would that be something that the board would have to authorize?

Gregory Goff

Ann, we do not have anything from the share repurchase program. We do not have anything at all there. I think just to be clear on our cash position, we see the opportunity to pay down some debt, and also a fair number of good opportunities that create a lot of value for the company that we're in early stages of evaluating, but we'll share those as we go through the year. So that's really where we stand from with our free cash flow right now.

Ann Kohler - CRT Capital Group LLC

No, I perfectly understand that. I just wanted to just get details on that one little area. But no, I clearly recognize that debt reduction and spending on your businesses is the key priority at the moment. The other question that I had, in regards to the additional volumes, the 30,000 barrels a day volumes, are those located in any one particular market?

Gregory Goff

They're actually spread across most of our markets in both -- they're in California, around our Salt Lake City refinery, and a little bit around the Pacific Northwest. So it's actually pretty good coverage. We're actually very pleased with the progress we made there. Because it's also both gasoline and diesel. So it's a very good step in the first quarter.

Ann Kohler - CRT Capital Group LLC

Great. Wonderful. And then my last question, you certainly noted that you did have a reduction in your costs by about $0.50 a barrel. What exactly was that attributable to, and is it sustainable?

Gregory Goff

I mean it's attributable to 2 things. One is higher run rate, because it's on a per unit basis. So to be clear, we ran at higher run rate. And as you know, we had targeted some cost reductions for calendar year 2011 that we're continuing to work on. So it's just been discipline around our operating cost spending. We're very focused on continuing to drive improvements in our mechanical integrity of our assets, but at the same time, be very disciplined in our spending, so those are the 2 things.

Operator

And your next question comes from the line of Sam Margolin of Dahlman Rose.

Sam Margolin - Dahlman Rose & Company, LLC

I also want to circle back to the analyst day in December. You guys mentioned yield enhancements were an important part of the improvement program. It seems like that, of all these initiatives, could really move the needle, especially in California. But they're also -- they'd also be quite expensive as capital projects. And I was just looking for an update there to see what direction you're going in from that standpoint? And sort of on a related note, what does bottom of the barrel recovery look like in this kind of crude market up here? Is there a different way we should look at capture rates as far as some residuals in asphalt and things like that go?

Gregory Goff

Let me turn the question over, and let Dan answer your question.

Daniel Porter

Yes, sure. Regarding yields improvements, you're right. The structural improvements needed at the refineries to accomplish significant yield change do require capital. The good news there is we've got several capital projects in the hopper that we're reviewing, and do expect to make some significant improvement there. The other way that we can capture yield improvement is by optimizing the way that we align our turnarounds and shutdowns of the units to eliminate the redundancy of loss throughput. That allows us to run more third-party feedstock, and convert it all into products. And that's what you saw occur in the first quarter. Regarding bottom of the barrel investment, there are a few projects that we're looking at that aren't quite ready for discussion at this moment or at this time. But they do take a look at grabbing more of the bottom of the barrel, and turning it into gasoline and diesel largely on the West Coast.

Sam Margolin - Dahlman Rose & Company, LLC

Okay. And as far as pricing goes for that material now, is there a wider loss, or can you recover costs better than maybe some people could expect in this current crude market?

Gregory Goff

Yes, the things that we're looking at, Sam, the price differentials and that are supportive of what we're trying to do, maybe by changing some of the types of crudes to produce less bottoms, and get the upgrading of both gasoline and diesel like Dan talked about there. So there's light-heavy spreads in that, where they are supportive of what we're trying to do.

Operator

And your next question comes from the line of Evan Calio of Morgan Stanley.

Evan Calio - Morgan Stanley

It's good to see Anacortes up for the full quarter and profitable. Maybe to follow up on some of Greg's comments on other capital projects relating to Anacortes. And maybe it's too early, but as you think about better crude sourcing options or opportunities in conjunction with Tesoro Logistics, do you see an opportunity to get Bakken crudes into Anacortes, and if you could potentially, to mention that potential opportunity, the kind of scope, scale, cost maybe?

Gregory Goff

Yes, I mean, there's no question, Evan, that we are looking -- we look at every opportunity to take some things where we can gain advantage in crude. One of the things that we think is the strength of what we have is we talk a lot about our advantage position, and so places where we can take either Bakken crude or black wax crude in Salt Lake, which we've talked about trying to run more of that, and also look at something like moving Bakken to the Pacific Northwest. Those are definitely all the things that we are actually seriously, seriously looking at. We see some opportunities.

Evan Calio - Morgan Stanley

Well, via rail would be the primary potential there right?

Gregory Goff

I mean that -- yes, to get to Anacortes, the only way you could get there economically is by rail. But I think we need to be clear. I mean, we're driven more by the opportunity to capture the refining value. That's what we're really driven by. So we're looking at all types of different crudes in that because -- to gain those advantages.

Evan Calio - Morgan Stanley

Sure, now, of course. I mean, on the other side, and I know you touched on it a little bit earlier, but I just didn't if you could -- you clearly had some early success, Greg, but could you give us an update on your program here for $300 million of kind of EBITDA operational improvements, how's that trending 5 months in, and did you see -- do you see some upside on the operations side in the kind of capital project side?

Gregory Goff

I think what we see, as you recall, there were about 5 major initiatives that we were undertaking. And at this point in time, particularly through the first quarter, we feel like we're on track to deliver everything that we said we have. To me, the encouraging thing is that both Dan and myself alluded here is that as we've got more into it and looked at things for different opportunities, what we're seeing is some other opportunities to do enhancements to the assets that will add value that haven't been built into those plans. We won't realize those in 2011, but it's encouraging, some of the things that our people are identifying that are probably a little bit bigger than some of the small capital improvement projects, but can be implemented and add a lot of value that, like I said earlier, aren’t driven by refining margins, but maybe more by gaining crude advantages or other things. So to me, that's pretty positive. And we'll progress those through the year and when it's appropriate, share what we are looking at.

Operator

Your next question comes from the line of Jacques Rousseau of RBC.

Jacques Rousseau - RBC Capital Markets, LLC

Just wanted to check on the guidance for the second quarter. What jumped out at me was the big move up in the Pacific Northwest volumes. I'm assuming that's mostly Anacortes. And I'd just like to get your view if demand stays somewhat constant, how should we see those volumes moving forward?

Gregory Goff

Yes, for the second quarter, I mean, you're right, Anacortes is projected to have strong run rates there in the region. There's some refinery downtime in that that's allowing us to capture -- other companies have some downtime that allows us to capture a favorable environment. So we're running strong at Anacortes during the second quarter, and we'll just -- it's actually worked well since we brought the refinery back up in that, and we'll continue to monitor that. We're really focused on being able to find homes for the products that we run there. So that's a continuing focus of what we're trying to do there. So it looks encouraging.

Jacques Rousseau - RBC Capital Markets, LLC

So do you think the subsequent quarters will be at this level, or as you said, some of this is due to other downtime?

Gregory Goff

Yes, I don't know if it'll be as high as what we're doing in the second quarter, we'll see as we get there. But it will -- according to our plans and that, it will be at a pretty reasonable level in the third and fourth quarter.

Jacques Rousseau - RBC Capital Markets, LLC

Great. One more question for you. You mentioned that retail same-store sales were down, I believe, you said 1% in the first quarter.

Gregory Goff

That’s correct.

Jacques Rousseau - RBC Capital Markets, LLC

And I just wanted to see how they were trending in April?

Gregory Goff

Yes, they're under pressure after the end of the first quarter. So they're down a little bit more than that, going into the second quarter with – as prices have gone up in that.

Operator

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

Blake Fernandez - Howard Weil Incorporated

Greg, question for you on Mandan. The economics there look pretty attractive as far as $35 million for 10,000 barrels per day. Is the constraint on the facility as far as constraint meaning going over and above that, or is it really on the distribution through the shale network?

Gregory Goff

Let me -- I'll let Dan answer that question, Blake.

Daniel Porter

Yes, Blake, what we've done in the Mandan from the capital expansion is expand the crude end or the -- a crude unit at the front end of the unit all the way up to the limits of the secondary processing units, and got a little creative on the back end there to make that happen. Additional capacity at Mandan requires significant capital investment well beyond the crude unit. So that's what makes this project so attractive and low cost is it's a small investment in just the front end of the processing.

Blake Fernandez - Howard Weil Incorporated

Okay, so it sounds like to go over and above, it's not really something you're looking at, at this time?

Daniel Porter

That's correct.

Blake Fernandez - Howard Weil Incorporated

Okay. And then secondly, with regard to the debt-to-cap, I know you're at about 37% at the end of the quarter, a few moving pieces with the MLP, and then paying off the note due in '12, I'm just curious if you happen to have a current net debt-to-cap with the debt paid down, and then the removal of some equity for the MLP?

Daniel Porter

I'll let Scott respond to that question, Blake.

G. Spendlove

Yes. It's going to reduce our total debt to total cap by a couple percentage points, given what we've just done in paying down the junior subs. I don't have it on a net debt-to-cap basis in front of me. But on a net debt-to-cap basis, it's probably in the low 30% range at this point.

Blake Fernandez - Howard Weil Incorporated

Okay. So you're already working your way pretty close to the 30%, or at least in that direction still?

G. Spendlove

Yes, the 30% is a total debt to total cap target.

Operator

[Operator Instructions] And your next question comes from the line of Paul Cheng of Barclays.

Paul Cheng

I have a number of question, maybe start out with some balance sheet items. Can you tell me what is the market value of inventory in excess of the working capital in long-term debt?

G. Spendlove

It's about $1.9 billion.

Paul Cheng

Okay. Just in excess of both. How about working capital?

G. Spendlove

Working capital is about $661 million.

Paul Cheng

Okay. The long-term debt component of the total debt?

G. Spendlove

$1.82 billion.

Paul Cheng

$1.82 billion, 1-0-8-2, right?

G. Spendlove

No, 1-8. Just call it $1.8 billion, Paul.

Paul Cheng

Okay. All right. And Scott, on the second quarter guidance on the $14 million related to the early debt redemption, are you guys going to treat it as a special item when you report it?

G. Spendlove

Yes, it'll be in our interest expense charge and I mean, we can pull it out.

Paul Cheng

No, but I mean, it doesn't matter. I just want to see what is the -- what you guys are going to do, so that we do correspondingly in our estimates, so are you going to include it as normal operation or are you going to...

G. Spendlove

No, we'll treat it as a special item.

Paul Cheng

You're going to treat it as a special item? Okay.

G. Spendlove

Yes.

Paul Cheng

And from a reporting standpoint with Tesoro Logistics, are you going to report it as a separate -- as a Tesoro Logistics, and then pull out the corresponding revenue or operating profit from the Mid-Continent refining system? Or how exactly the reporting going to look like going forward?

G. Spendlove

It will be consolidated. There will be significant additional disclosure in the 10-Q around that in terms of the balance sheet impact, minority interest, those kinds of things.

Paul Cheng

But in terms of the actual reporting format, you are not going to change from the current method? So in other words, you're not going to have a separate line called Tesoro Logistics or a Logistics segment?

G. Spendlove

Well, for Tesoro Corp., again, it will be consolidated. Of course, Tesoro Logistics will have their own financial statements.

Paul Cheng

Right, I fully understand. My question is that in the Tesoro Inc., are you going to, when you report it now that you report refining retail in the segment earning, will you be reporting refining, and then retail and Logistic in that way?

G. Spendlove

No.

Paul Cheng

You're not. Okay. And Greg, I hear what you say about the use of cash and the CapEx. And in addition to Mandan, if we're looking at Salt Lake City, is there any opportunity there to expand that? Or the crude capacity is already pretty match up with the conversion unit, and so that to really expand it is going to be too costly?

Gregory Goff

I will let Dan respond to your question here.

Daniel Porter

You're probably right on the additional crude capacity. But we do have projects that allow us to run more black wax. And we're actually looking at those projects right now. They look relatively interesting. At the moment, we're not quite ready to say that they're a sure go.

Paul Cheng

Dan, what kind of the magnitude that we may be talking about here? Is it running another 5,000 barrels per day, 10,000, any kind of rough number that you can share?

Daniel Porter

Sure. The range we're that we're at right now is, let's say, about 10,000 barrels a day. And the opportunities we're looking at could increase that in the range of, let's say, 50%.

Paul Cheng

Okay. So it's another 5,000 barrels. Okay. And Dan or Greg, that in addition to that project, is there any other more meaningful cap expanding project that is currently on the table being evaluated?

Gregory Goff

I'm sorry. Can you just repeat the question, Paul?

Paul Cheng

No, in addition to in Salt Lake, talking about the increased use of the crude there, is there any other, maybe a little bit more substantial CapEx spending projects that is currently on the table being evaluated by the company?

Gregory Goff

Across our system, we have a few projects, a handful of projects, less than $100 million each, that we're looking at, at the refinery. So there's probably 4 or 5 other projects, which are not big projects, but probably some from $50 million to some up to $100 million that are refineries that we're looking at, which will as we go through and further work those, they're in certain stages of engineering that impact the refineries, both in California, Salt Lake, stuff in Mandan, so across our system, we're really looking at everything there, Paul. I think it's encouraging that the things that we're looking at are really driven to either provide additional crude advantage or other advantages. But they're not really driven by -- they're not dependent upon the margin.

Paul Cheng

That's great. Greg, are you at the stage that you can share some of that with us now, or would you rather wait?

Gregory Goff

No, but we will. We will be, and relatively soon, in the next little bit here. Some of the projects, we'll come out and make those aware, once we get the engineering done and the cost estimates to a point where we understand the economics. So we're progressing well on those projects.

Paul Cheng

And, Greg, in terms of using cash, of course, I mean, talking about returning to the shareholder, but the other component is that in addition to the organic, could be in the inorganic through acquisition. Can you talk about your view how acquisition play in the overall strategy of the company over the next, say, 3 to 4 years, and what kind of criteria that you will put before you would consider a particular acquisition?

Gregory Goff

I think, Paul, we, as part of all of our strategic work that we did last year, is we have looked at the entire market place for opportunities that make sense. And we see some possible opportunities. The criteria that we are really driven by are projects that may fit in strategically with what we do. So that means that they really stay in our market area, where we can gain advantages through our system through either the crude supply that we can take advantage of, or the distribution into the markets to really increase our presence in the markets we're in. So we've been very clear to say that we don't look -- we're not looking at anything on the East Coast or Gulf Coast of the United States. So you kind of draw the area that we target there. So the criteria are that they have to be very strategic, and fit in with our business model. They have to be very value-accretive. And we also like things that are more integrated, where it's not just a refinery, but where it is a total refining, marketing and transportation assets.

Paul Cheng

And Greg, what kind of debt-to-capital ratio that you will tolerate in the short term when you do an acquisition?

Gregory Goff

We have to look at the individual opportunities and -- as we model them and see what they would be, because there are different ways to do the things we're looking at, Paul. I don't think it's -- it's probably a little bit premature to comment on that specific question.

Paul Cheng

Okay. That's fine. And one final one, Scott, on the Tesoro Logistics, is there any kind of information you can share with us in the first quarter? What is the -- on a pro forma basis, what is the operating profit or revenue from that business?

G. Spendlove

No, Paul, I can't really comment beyond what's in the prospectus on that. We will be filing first quarter 10-Q here later in the month.

Paul Cheng

And in the 10-Q, when you file it, are you going to have additional information on the Tesoro Logistics?

G. Spendlove

Yes, I mean, there will be a separate 10-Q filed for Tesoro Logistics later this month.

Operator

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

Paul Sankey - Deutsche Bank AG

On the disposal side, I was wondering how aggressive the interest has been in buying some of your assets, and even whether you've had interest in an overall company takeover from others?

Gregory Goff

No, we're not aware of any interest.

Paul Sankey - Deutsche Bank AG

And what about, I guess, the individual assets, you must have some pretty aggressive interest?

Gregory Goff

We have had no inquiries.

Paul Sankey - Deutsche Bank AG

Oh really? Okay. What was the assumption for the discounts? I mean, I guess it was a very easy decision to expand Mandan, but I was wondering what your assumptions are. You've talked a lot about how you're not relying on the market to help you out. But I guess you just -- you have to make some sort of assumptions. And what I'm really thinking is that with you expanding, with you talking about rail, with the producers talking about rail, with the pipelines coming in, how do you see those discounts developing going forward?

Gregory Goff

What we see, Paul, specifically around the Bakken play, is that one of the advantages we have in addition to having the refinery there is that we have the crude gathering and pipeline system, so that being able to collect by the crude at the well head is a big advantage. And that we see that over time, if you look at the market for Mandan crude, being the Gulf Coast, United States, we see about an $8 differential over time that would -- which reflects the transportation costs to get the crude to the Gulf Coast. That's the kind of differential we see at the well head.

Paul Sankey - Deutsche Bank AG

Yes, that’s been my idea is that regardless of the short-term infrastructure issues, the simple fact is the transportation distance cost advantage that you've got?

Gregory Goff

Right.

Paul Sankey - Deutsche Bank AG

No more complicated than that, right, and you think that's about $8?

Gregory Goff

Around there, yes.

Paul Sankey - Deutsche Bank AG

Great. On the demand side, people have talked about weather; you mentioned some weakness in California. Could you just do the usual runaround of how things are developing? And I just wondered, because I think the weather has been a pretty dramatic impact here on some of the demand numbers we've been seeing, particularly for gasoline?

Gregory Goff

Yes. I think not in our particular market areas, the weather hasn't had an impact around our system from a demand standpoint. So we have not been impacted by that. So California, like you mentioned, Paul, is not improving. We haven't seen substantial weaknesses worse than that. But with the unemployment rate staying above 12% now, we haven't seen big changes in California, except for now as prices started to come up, we are seeing some of our retail sales go down a little bit, but we were not impacted by weather.

Paul Sankey - Deutsche Bank AG

Sounds like the price impact hasn't been that dramatic for you. I mean it doesn't sound great, but it hasn't been a disaster.

Gregory Goff

In the first quarter, it definitely wasn’t. It was around slightly less than 1% and then probably getting a little bit more impact in April and May. But it hasn't been that painful yet.

Operator

Your next question comes from the line of Joe Citarrella of Goldman Sachs.

Joe Citarrella - Goldman Sachs Group Inc.

Just a couple of quick ones, following up on the last one in demand. Could you quantify what it's been in April maybe, and where you see it heading in terms of demand? And then just to be able to give us a sense of your participation in the export markets during the quarter, and maybe where commercial agreements could take you, even if it's just a rough order of magnitude kind of estimate at this point?

Gregory Goff

Yes, Joe, your first question on demand, I mean, so far, it's probably been a little bit greater than 1% on our system. I don't have that with me right now. We've had pretty good growth in our marketing demand because of what we're trying to do, total. But on the same -- on a comparable basis, year-over-year, it's greater than 1%. But I don't have that with me to know what the exact percent is. It's a little bit higher than that. And then the second, our export activity is actually, off the West Coast has stayed pretty constant. We think the industry takes about 40,000 barrels a day of gasoline and about 50,000 barrels a day of diesel off of the West Coast, and we have contracts that we participate in both products going south. It's been pretty...

Joe Citarrella - Goldman Sachs Group Inc.

Any idea where of this will range, commercial agreements could take you?

Gregory Goff

Not into Mexico or South America, not additional things, unless you have some disruption that causes increased demand. We don't think there's a lot of upside there.

Operator

Your next question comes from the line of Mark Gilman of Benchmark.

Mark Gilman - The Benchmark Company, LLC

I had a couple things. Greg, it would appear just based on the capital outlook, that there's a fairly significant second-half turnaround schedule, and thus lower operating rates than certainly, we have seen, first quarter, second quarter? Could you comment on that at all?

Gregory Goff

I mean, you're right, Mark. Our turnaround spending was relatively low in the first quarter, partly because we were able to take and move Golden Eagle turnaround out of the first quarter and capture the higher margins. And so we have higher turnaround spending in the -- just going out into the second half of the year. But we also continue to look at that, and try to optimize that turnaround spending. So from our planning standpoint right now, our forecasts are kind of what we shared with everyone. But we are trying really trying to optimize that based upon how we can capture some advantages there.

Joe Citarrella - Goldman Sachs Group Inc.

Any guess as to what a second half operating rate might look like, Greg?

Gregory Goff

I haven't looked at it that closely getting out to the second half right now. Like I told you, the second quarter, we see running at about 90% crude utilization. But we'll have to just look and see what it looks like for the second half of the year. I don't have that with me, Mark.

Mark Gilman - The Benchmark Company, LLC

Okay. Different subject, Greg, I'm a little bit puzzled by this issue of crude discounts and advantages on the West Coast. I guess, basically, because in our tracking, it looks to me as if some of the imported heavies, the Napo, for example and even Kern, in terms of the San Joaquin Valley, these crudes seemed to have disconnected from WTI, and I guess I haven't really seen any significant changes in the relationship versus ANS. Can you discuss this just a little bit or is my perception or characterization just completely off the mark?

Gregory Goff

I'll let Louie respond to your question.

Louie Rubiola

Mark, it's Louie. Those discounts specifically for the South Americans, have widened out both year-over-year and sequentially. I think it's at least $2 is kind of what we're seeing. So I mean, that's kind of identifying the South America portion. Was there -- were you talking about another crude as well?

Mark Gilman - The Benchmark Company, LLC

Well, I thought that in Greg's remarks, he mentioned San Joaquin as well?

Louie Rubiola

Definitely. If you look at -- it did disconnect from WTI, the San Joaquin Valleys did. However, as you compare those relative to ANS, they have widened out. I think we're looking at around $8 or so discount to ANS, which is the appropriate benchmark on the West Coast. So I mean that was -- and that's more attractive than it has been recently in past quarters. So we did see an advantage.

Mark Gilman - The Benchmark Company, LLC

Did you make any changes in the California crude slate as a result of these pricing relationships?

Louie Rubiola

No, we have not. We've been running pretty comparable crudes.

Mark Gilman - The Benchmark Company, LLC

Okay. Final one for me relates to the Logistics partnership. I guess I'm curious a little bit as to how you settled on 48% being the right amount to sell, and what the longer-term intent, Greg, might be in terms of the retention of the remaining interest?

Gregory Goff

The intent there, Mark, was to really go up and have that same with the general partner owning 2%, and then our ownership, and then the public interest is kind of almost a kind of a traditional MLP approach is what we took when we put that together there. So there's nothing more complicated to it than that. We felt like that was the right ownership percentages. And our intent over time is to keep that relationship the same, the ownership percentages the same. We're very much focused -- our focus really is to be able to take our logistics assets, and use that as a platform to grow the business to really support our refining and marketing.

Mark Gilman - The Benchmark Company, LLC

So there wouldn't be any intent to divest your interest down further?

Gregory Goff

We don't have any intent to do that at this point in time.

Mark Gilman - The Benchmark Company, LLC

Was I incorrect in assuming that the time you announced you were going to proceed in this direction that you had contemplated a much lower public interest, or is that just my failing memory?

Gregory Goff

I don't know where you got that from. We never talked about that at all actually.

Operator

Your next question comes from the line of Doug Leggate of Merrill Lynch.

Douglas Leggate - BofA Merrill Lynch

I just wanted to circle back on the operating cost real quick. I know you don't typically give a lot of guidance on that. But given the Tesoro Logistics is obviously not out there, can you just give us a little bit of color as to how the unit operating costs and maybe the total operating costs should trend from the second quarter, or maybe a sequential comparison would be most useful?

G. Spendlove

Doug, if you're asking about the impact of the Logistics business on our expenses, there shouldn't be any impact at all.

Douglas Leggate - BofA Merrill Lynch

It shouldn't be material? What about overall generally in terms of your progress in reducing costs from a self-help standpoint? I'm thinking more about your breakeven level. You're targeting a breakeven margin by 2013, of about $1.50 below where it is right now, so maybe an update on that. I'll leave it there.

Gregory Goff

We're still focused, like I mentioned earlier, on one of the other questions, Doug, on driving those areas that we've targeted, to drive improvements, we're still very focused on being able to do that. We don't see any changes at this point in time to where our targets are.

Douglas Leggate - BofA Merrill Lynch

Is there a progress report, Greg, into what you've achieved so far?

Gregory Goff

What we're going to do, Doug, it's the first quarter, it's early in the year. But our full intent is as that we get into the next quarter and further on, with those things 5 areas that we targeted, we'll be very clear about the progress we're making on those areas. We just wanted more history behind us.

Douglas Leggate - BofA Merrill Lynch

I understand. I know it's a big deal for your intel on management performance, so I guess you're monitoring it pretty closely.

Gregory Goff

Thank you.

Operator

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

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