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Tesoro (NYSE:TSO)

Q3 2011 Earnings Call

November 03, 2011 8:30 am ET

Executives

Louie Rubiola - Director of Investor Relations

Daniel Robert Romasko - Executive Vice President of Operations

G. Scott Spendlove - Chief Financial Officer and Senior Vice President

Gregory J. Goff - Chief Executive Officer, President and Director

Analysts

Evan Calio - Morgan Stanley, Research Division

Mark Gilman - The Benchmark Company, LLC, Research Division

Edward Westlake - Crédit Suisse AG, Research Division

Paul Sankey - Deutsche Bank AG, Research Division

Jeffrey A. Dietert - Simmons & Company International, Research Division

Ann L. Kohler - CRT Capital Group LLC, Research Division

Jacques H. Rousseau - RBC Capital Markets, LLC, Research Division

Chi Chow - Macquarie Research

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Faisel Khan - Citigroup Inc, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Tesoro Corporation's Earnings Conference Call. My name is Carissa, and I will be your operator 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.

Louie Rubiola

Thank you, Carissa. Good morning, everyone, and welcome to today's conference call to discuss our third 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 and reconciliations for non-GAAP financial measures, should help you in analyzing our results and can be found on our website at tsocorp.com. Please refer to the forward-looking statement and 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 J. 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 details of the results in a moment. But I'm going to start with an overview of some recent highlights.

During the third quarter, we again increased refinery utilization rates, running total crude oil throughput of 609,000 barrels per day or 92% of total capacity, the highest level in 3 years. This allowed us to more fully capture strong crack spreads and advantage discounts on crude oil. We also made good progress on our improvement initiatives to drive EBITDA growth with another quarter of gross margin improvements in excess of the market gains and the lowest manufacturing cost per barrel in 4 years. The combined result is reflected in our very strong third quarter earnings of $2.39 per diluted share, the most profitable quarter for Tesoro since the second quarter of 2007 when the index was $24 per barrel, greater than $10 per barrel higher than in the third quarter of this year. This strong financial performance allowed us to pay down an additional $84 million of debt, taking us to 28% total debt to total capitalization. Our goal is to continue to reduce leverage, and we intend to repurchase the remaining 6.25% senior notes due in 2012.

Additionally, we bought back 4.7 million Tesoro shares in an effort to offset the dilutive effect of our outstanding stock-based compensation awards. During the quarter, we also made progress on our refining and marketing integration strategy, announcing our intention to add about 290 new retail stations to our existing portfolio, an increase of nearly 25%. These sites should add between 30,000 and 35,000 barrels per day of profitable and secure offtake for our refined products starting in 2012. Using year-to-date gasoline production and retail volumes, the addition of these stations increases our refining and marketing integration from about 35% to 47%, a significant improvement to one of our strategic priorities. Our long-term strategy relative to our cash position remains to, one, further strengthen our balance sheet with additional debt reduction; two, invest in business improvements designed to yield high sustainable returns with short payback periods; three, allocate capital through our value-driven growth strategy; and four, to maintain a prudent cash balance to continue to take advantage of commercial opportunities to drive a high capture rate.

Turning to the quarter. The average Tesoro Index gained over $3 per barrel relative to last year. Feedstock cost advantage, particularly in the Mid-Continent, drove the benchmark index higher during the quarter. West Coast benchmark crack spreads were down both sequentially and year-over-year, driven by high refinery utilization rates and lackluster gasoline demand. Incremental U.S. exports of distillates and the continued demand growth in Asia and Latin America provided support to distillate crack spreads during the quarter. Capture rates were very strong, driven by significantly advantaged crude oil costs relative to benchmark grades of crude oil. On the West Coast, we continued to capture wider discounts for heavy crude oil, both domestic and foreign grades, particularly as compared to the West Coast benchmark ANS, which remained expensive during the quarter.

In the Mid-Continent, high levels of domestic inland crude oil inventories increased the discounts for these grades relative to benchmarks, such as Light Louisiana Sweet. In Hawaii, we realized the benefit of falling crude oil prices during the quarter, which benefits the pricing of our fuel oil contracts. On a year-to-date basis, Hawaii has made about $30 million on a fully burdened basis.

For the quarter, our realized gross margin was $18.43 per barrel on a Tesoro Index that averaged $13.33 per barrel. As I stated earlier, throughput rates during the quarter averaged 609,000 barrels per day or 92% of total crude oil capacity. This is up from 578,000 barrels per day or 87% for the second quarter this year. This improvement marks another sequential increase in refinery utilization rates, a key priority for the company.

Manufacturing costs in the third quarter averaged $4.57 per barrel, down $0.66 sequentially when you exclude the property damage insurance proceeds in the second quarter. We are making progress on lowering our operating cost per barrel, and these results mark the lowest level in 4 years.

Retail fuel sales volumes were up 16% year-over-year, reflecting the addition of some 300 Shell stations in the Mid-Continent earlier this year. Same-store fuel sales during the quarter were up nearly 1% relative to last year. This is a significant improvement compared to what we saw in the second quarter when California retail street prices peaked in May. Since then, street prices have fallen more than $0.40 per gallon, driving a rebound in volumes in the third quarter. Retail marketing margins were down during the quarter, both sequentially and year-over-year. As we mentioned in our earnings release, our pretax corporate and unallocated costs for the quarter were $39 million before $3 million in corporate depreciation and $17 million in non-cash stock-based compensation credits primarily related to stock appreciation rights. This is above the guidance we previously provided due primarily to an additional incentive-based compensation accrual made in the third quarter, which brought our year-to-date employee bonus program better in line with the strong year-to-date financial results.

Capital expenditures for the third quarter were $86 million. Turnaround spending was $17 million. We currently anticipate our 2011 capital spending plan to be about $320 million, including regulatory, maintenance and income projects. This includes spending on our recently announced refinery projects, though most of the spending on these new projects will be in 2012 and beyond. This capital spending guidance is lower than prior guidance by $60 million. This is driven predominantly by our decision to move some West Coast planned maintenance activity from the fourth quarter of this year to 2012, which shifts associated to turnaround linked capital.

Additionally, our efforts to drive more effective and efficient maintenance practices systemwide allowed us to gain effectiveness in our sustaining capital spend. We'll talk more about how these actions impact our 2012 capital spending plans at our Analyst Day event in New York on December 5. We still expect our turnaround spending for 2011 to be about $110 million.

As we look forward, we remain reasonably optimistic about market conditions. From an overall crack spread perspective, this year has clearly exceeded our expectations. Additionally, seasonally typical U.S. light product inventories combined with strong exports should continue to provide support to domestic refining margins. Independent of the favorable market conditions, we are capturing opportunities to drive significant value from our existing asset base. As we've shared with you in the past, we are focused on driving free cash flow, strengthening the competitive position of the company and increasing shareholder value. Our original goal for 2011 targeted over $225 million in year-over-year EBITDA growth. When you look at what we've been able to accomplish so far this year by driving increased refinery runs and capturing more of the available margin, we expect to exceed our goal. In fact, if you look at our reported results year-to-date through September, EBITDA is up over $1.1 billion from the year-to-date results a year ago.

We fully recognize the market has improved. Year-to-date, the Tesoro Index has gained over $3.50 per barrel relative to last year. Using 2010 throughput rates, that would imply an incremental gross margin of about $415 million attributable to the market improvement. Similarly, if we take the year-over-year increase in throughput rates systemwide, 111,000 barrels per day at the 2011 average Tesoro Index, that would imply an incremental gross margin of about $365 million attributable to higher run rates. The remaining $300 million plus incremental year-to-date EBITDA is primarily attributable to the execution of our 2011 improvement initiatives.

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

G. Scott Spendlove

Thanks, Greg. As we reported last night, third quarter net income was $345 million or $2.39 per diluted share. That compares to an unadjusted net income in the third quarter last year of $73 million or $0.51 per diluted share. Special items last year included aftertax expenses of $17 million primarily associated with the Anacortes refinery outage. Our cash G&A expenses before non-cash credits related to stock-based compensation and accruals for incentive-based compensations are coming down as we expected. We ended the quarter with a cash balance of over $1.1 billion. That's up over $500 million from the second quarter of this year. We remained undrawn on the corporate revolver with over $1 billion of additional revolving credit capacity. Tesoro Panama and Tesoro Logistics ended the quarter $20 million and $50 million borrowed on their separate revolving credit facilities, which was down $35 million from the second quarter. As Greg mentioned, after repaying another $84 million of debt, we ended the quarter with total debt to total capitalization of about 28%, down an additional 3 percentage points from the second quarter. The increase in cash for the quarter was $528 million and reflects EBITDA of $694 million plus working capital gains of $190 million less interest and tax payments of $82 million, capital and turnaround spending of $103 million, debt and revolver repayments of $119 million and $52 million in equity purchases primarily associated with the 4.7 million Tesoro shares we recently purchased that Greg mentioned.

Turning to the fourth quarter. The fourth quarter is seasonally a weak demand period with PADD V gasoline demand typically falling about 4% relative to the third quarter. Reductions in supply, however, from planned and unplanned refinery maintenance have supported crack spreads quarter-to-date, which were up sequentially and year-over-year. In the Mid-Continent, gasoline and diesel crack spreads remained strong, up significantly relative to last year, driven by a significant feedstock cost advantage.

So far in the fourth quarter, the average discount of WTI to LLS remains above $20 per barrel and is slightly up relative to the third quarter. I'll close with guidance for the fourth quarter for your modeling purposes. We estimate throughput to be in thousands of barrels per day: 135 to 145 at the Pacific Northwest, 70 to 80 in the Mid-Pacific, 110 to 120 in the Mid-Continent and 240 to 250 in the California region. Manufacturing cost guidance for the fourth quarter in dollars per barrel is as follows: $4.25 in the Pacific Northwest, $2.90 in the Mid-Pacific, $3.40 in the Mid-Continent and $6.50 in the California region.

Throughputs in California will be affected by planned turnaround activity at our Los Angeles refinery. Similarly, we expect throughputs to be down sequentially in the Pacific Northwest due to seasonally lower rates in Alaska and maintenance at our Anacortes refinery. Our depreciation for refining is estimated at $90 million. Additional fourth quarter guidance items include estimated corporate expense excluding depreciation of $35 million and interest expense before interest income of $36 million.

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

Gregory J. Goff

Thanks, Scott. We're very pleased with our third quarter and year-to-date results. This marks another quarter where we delivered on our plan to significantly improve the business, guided by the strategic priorities as we laid out in December of last year. We look forward to sharing more details around our 2011 achievements and our plans for 2012 at our upcoming Analyst and Investor Day event on December 5 at the New York Stock Exchange. We hope you'll join us then. With that, we'll now take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Edward Westlake of Crédit Suisse.

Edward Westlake - Crédit Suisse AG, Research Division

Just one of the drivers of getting unit OpEx down is obviously higher utilization. You've given us guidance for 2011, but as you've done these sort of improvement plans, trying to improve reliability, I mean, absent market conditions, can you give us a sort of a flavor for how much further you think you can drive utilization up through reliability next year?

Daniel Robert Romasko

Yes, this is Dan. Reliability based utilization for next year should continue to be strong, although we're not really in a position to provide guidance on production yet for next year.

Edward Westlake - Crédit Suisse AG, Research Division

Okay. And then just on Hawaii, there was obviously another beat there, and obviously, there's been shifts in the contract. But is Q3 a good base in terms of the sort of capture rate? Or were there any funnies that you saw there?

Gregory J. Goff

I think, Ed, the timing of the -- with the fallen prices and that made Hawaii a little bit unusual compared to what we expect, and that's why we kind of reflected on a year-to-date basis that show the changes during the year. But I think Hawaii third quarter would be a little bit unusual, the price environment and that. We have made some improvements -- I think, last year, we described that we were driving improvements in Hawaii, and we are making some improvements in the business.

Edward Westlake - Crédit Suisse AG, Research Division

Okay. And then, my final question is just on crude discounts. Obviously, we've seen ANS Kern differentials narrow since 3Q, but you can still capture some international crudes coming into the market as well. So could you talk a little bit about the market environment for the sort of cheaper, heavier non-benchmark crudes in the region?

Daniel Robert Romasko

Yes, this is Dan. Again, the -- obviously, you're aware that the ANS premium is coming off, so our ability to improve relative to that benchmark will dwindle a little bit. But you're also right that there are optimistic crudes, foreign and other, that we'll take advantage of. And it probably wouldn't be appropriate to provide more guidance than that.

Operator

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

Chi Chow - Macquarie Research

Scott, what tranche of debt was repurchased in the third quarter?

G. Scott Spendlove

The 2012s, primarily.

Chi Chow - Macquarie Research

Was that the senior notes or the junior subs?

G. Scott Spendlove

The junior subs, we retired in the second quarter, and it was the senior unsecured 2012s.

Chi Chow - Macquarie Research

Okay. And then you're going to retire the balance of those next year, you mentioned?

G. Scott Spendlove

Yes, right.

Chi Chow - Macquarie Research

Any timing on that?

G. Scott Spendlove

We’re looking at that, but we have nothing to announce at this point.

Chi Chow - Macquarie Research

Okay. Can you give us some updates on how your projects are coming along, demand and expansion, the Bakken crudes, Anacortes, distillation unit down in Wilmington, any updates on that end?

Gregory J. Goff

Chi, those -- actually those projects are all -- all of them are progressing extremely well as we go through the permitting process and the work that we have in place. And at this time, based upon the prior guidance, everything is actually on schedule.

Chi Chow - Macquarie Research

Okay. And then the final one, it looks like California has adopted its cap and trade rigs. Any thoughts there long term on how you're going to manage that program and any concerns on what you see in the rigs?

Daniel Robert Romasko

This is Dan. You were aware of the recent announcements on the regulatory issues in California, but I think it's too early for us to provide indication on the impacts, so we're still in an evaluation mode.

Chi Chow - Macquarie Research

Did it -- the finalization of the rig give you any increased concerns over what you thought before?

Daniel Robert Romasko

Probably too early to say. We're still evaluating what the impact will be.

Gregory J. Goff

Chi, some of those are still -- they're moving -- they're still moving around. And so as we formulate plans, we'll be able to share them at a later date, but it's just too early with what's happening with the regulations to come out definitively and state the impact.

Operator

Your next question comes from the line of Jeff Dietert of Simmons.

Jeffrey A. Dietert - Simmons & Company International, Research Division

I was hoping you could talk a little bit about how much ANS crude as a percent of total feedstock you're using on the West Coast generally. And I know you wouldn't want to talk specific refineries, and how much potential there is to continue to whittle that down if ANS stays at a premium to alternatives?

Gregory J. Goff

Jeff, ANS is a relatively small part of our crude oil supply on the West Coast. And I think one of the ways that we intend to lessen the amount of ANS we run is the project to move Anacortes crude -- I mean, Bakken crude, excuse me, to Anacortes. And as we've said in the past, that has a potential to lessen the amount of ANS and other form of crudes that we run at Anacortes.

Jeffrey A. Dietert - Simmons & Company International, Research Division

With the Bakken rail project, you talked about yield advantages and better transportation costs versus the Gulf Coast. Are you working to lock in the economics of those -- of that project either through long-term purchases of crude or financial hedging to lock in the economics there?

Gregory J. Goff

No, we are able to -- with our crude purchasing strategy and our logistical system that we have in North Dakota and that, we're able to use those to put us in a good position to secure the crude for Anacortes, and we do not intend to hedge it.

Jeffrey A. Dietert - Simmons & Company International, Research Division

Is there any concern that at some point in the future if pipeline projects come into play that, that discount might narrow? Or you feel like it's going to be sustained for a longer period of time?

Gregory J. Goff

I think over time, I mean, our view is over periods of time, as the logistical systems are put in place to move the crude, that the incremental cost to get Bakken crude to the Gulf Coast will be based on the cost of rail. And we’ve said previously that the cost of rail to the Gulf Coast versus the cost of rail to Anacortes that we have an advantage from a cost standpoint. So I mean, yes, we expect it to weaken out over time when those changes are put in place, but we still have a good position.

Operator

And your next question comes of the line of Mark Gilman of The Benchmark Company.

Mark Gilman - The Benchmark Company, LLC, Research Division

A couple of things if I could, please? Can you say anything about 2012 capital at this point?

Gregory J. Goff

Regarding 2012, Mark, last year at the Analyst Meeting when you were there, we kind of laid out plans for 2012 capital and turnaround, and it's too early. I mean, our Analyst Day is only a month away, and we'll share details of what we plan to do. But you can recall that it was higher than 2011, and we've come out and said that we've had several projects that we're going to do in 2012. So we'll share more of those details, but that kind of gives you an indication of what's in store.

Mark Gilman - The Benchmark Company, LLC, Research Division

Greg, where do you stand on reinstating a dividend?

Gregory J. Goff

I think in the past, Mark, we've talked about how we return -- look at ways to return cash to shareholders. And as we look at where we stand today and our plans, one, we are very focused on continuing to delever. Like we said, we fully intend to pay out the remaining 2012 debt. The second thing is that with the additional projects that we've been working on and that we've talked about, those are going to require more cash that we'll fund a lot in 2012, maybe a little bit rolls into 2013, and we'll share more details on that. We do intend to carry more cash on the balance sheet because with the opportunities we see in the marketplace to take advantage of supply for the refineries and that, it gives us that flexibility to do that. And so that's what our plans are today. So we -- at this point in time, we do not have any intention of instituting a dividend.

Mark Gilman - The Benchmark Company, LLC, Research Division

Okay. Just 2 more quick ones for me, Greg, if I could. The Albertsons station acquisition with the stations in Southern California, how much gasoline out of Wilmington are you moving on a spot basis currently?

Gregory J. Goff

In Southern California, we're fairly well integrated. That is, as you look at our retail system, you can see that, that is our strongest retail position in the overall Tesoro system. So we're highly integrated in Southern California out of the refinery into our marketing system.

Mark Gilman - The Benchmark Company, LLC, Research Division

Does that include the Albertsons -- the Thrifty stations, excuse me, or excluding them?

Gregory J. Goff

No, it does not include the Thrifty stations to date. The Thrifty stations come online in 2012, and that will further extend the amount of -- our volume will exceed our production with the Thrifty stations in Southern California.

Mark Gilman - The Benchmark Company, LLC, Research Division

Okay. Final one for me. Greg, can you say anything about the performance at Panama in the quarter, plus, minus and where it's reflected in the statements?

Gregory J. Goff

Well, in the statements [ph], like we’ve said in the past, it flows into the California region, and it's not a material impact, Mark, on the results. It's the -- the market conditions were frayed and that have been pretty tough. We've gained advantages that show up in our crude advantage that allow us to source South American crudes there but it's not -- from a Panama asset standpoint, it's not a material impact.

Operator

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

Evan Calio - Morgan Stanley, Research Division

On my estimates, I think once you get Bakken crude railed into Anacortes, you run up to 30%, 33%, TI linked crudes. I guess, more nuanced, once you get those Bakken crudes into Anacortes, how -- how do those -- how does that impact the amount of runs of discounted WCS that you guys are picking up versus trans-mountain? And I presume that'll go up and help with the realizations, but any sizing there the way we can think about that mix shift?

Gregory J. Goff

I mean, that the numbers you have on a percent of TI are pretty in the ballpark. And I mean, our favorite crude is Canadian crude into Anacortes, which is constrained because of the pipeline, so that we expect to stay basically how it is until there are changes in the pipeline capacity into the Pacific Northwest.

Evan Calio - Morgan Stanley, Research Division

Okay. So that wouldn't go up until, I guess, 2016? You couldn't run more heavies -- you couldn't run more heavies versus lights on that line?

Gregory J. Goff

On the line, it's -- you mean...

Evan Calio - Morgan Stanley, Research Division

I mean, at the refiner.

Gregory J. Goff

I'm sorry?

Evan Calio - Morgan Stanley, Research Division

You didn't run more heavies versus lights at the refiner by blending it with the Bakken that you're going to rail in?

Gregory J. Goff

No, no, we're not going to do that.

Evan Calio - Morgan Stanley, Research Division

Okay, is the -- what's the symmetry in terms of the Bakken transloader? I think it's already built versus the Anacortes transloader. And is there any ability to use the built transloader or rail to either trade around that physical offload position?

Gregory J. Goff

For us, the projects, I mean, there are 2 parts to it. The loading facility in the state of North Dakota is with a contract we have with a third-party. And you're right. It is under construction and due to come online in the early part of 2012. The unloading facility, which we will be building at the refinery, is the project that we talked about that is going through the permitting process and will come online in the latter part of 2012. And so, we are today moving just single manifest cars over to Anacortes, but the volume is inconsequential. It just allows us to get it there. So we'll use the facility to do other things because we'll have the rail cars and the loading capability prior to being able to take crude oil to Anacortes next year.

Evan Calio - Morgan Stanley, Research Division

So it’ll enable you to move crude elsewhere to…

Gregory J. Goff

We could, yes.

Evan Calio - Morgan Stanley, Research Division

Okay. I guess, lastly, any update on Salt Lake with regard to black wax offtake increase from Newfield and how they talked about shifting capital and raising production to their -- are there any update on current talks with them to either offtake or potential expansion of Salt Lake?

Gregory J. Goff

Evan, we're doing work at the refinery to see what we can do to optimize the crude supply and that, and we're not -- we haven't finished that work yet but we will shortly. So it looks encouraging. We're just -- we haven't completed the engineering work on that to comment on that so that we'd feel certain what we can do with the refinery.

Operator

Your next question comes of the line of Doug Leggate of Bank of America.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Couple of questions, I guess, a follow-up on Evan, first of all, on Salt Lake. Greg, when you look at Salt Lake in terms of its location and the opportunity that might be there to follow similar path demand on, can you kind of lay out how you see Salt Lake strategically as maybe you’ve been able to take advantage of more of the ramp-up in light crude, and I've got a couple of follow-ups, if that's okay.

Gregory J. Goff

Doug, I think the best thing to do around Salt Lake is just give us time to finish our work that we're doing on the engineering and that, and we can lay out plans fairly shortly on we want to do with Salt Lake and then be just more open about what we think we can do because it's -- there are things that we’re working. We're just not -- they're not complete yet.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Got it. We hear about that in December, possibly?

Gregory J. Goff

Yes, possibly so.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Okay. Moving to Hawaii, obviously a phenomenal quarter there. Can you help us quantify the impact of the crude benefit, if you like, the delta quarter-end to quarter-end in terms of the contribution match [ph] we made. In other words, what would the underlying earnings have been for the facility outside of the crude dynamics?

Gregory J. Goff

In Hawaii, we've -- one of the things that I stated was that we kind of looked to the variability because of the lag effect on the fuel oil contracts, and pricing of how we price long-haul crudes because we take long-haul crudes into Hawaii. It moves around a lot because of timing of how crudes are priced, and that's -- Hawaii's third quarter definitely was stronger than one would normally expect. There's no question about that. And that's why we kind of put it into perspective and look back over the 9 months of this year and said that when we look at Hawaii and we burdened it with our overheads and that like we do everything else, it stands at about $30 million of profit. It's -- that's kind of where it stands right now.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

So $30 million would be the, sorry, the underlying?

Gregory J. Goff

Yes, underlying, fully burdened for January through September because it bounced around, it's bounced around each of the quarters.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Yes. I'm going to take it offline and go into a bit more detail with Louie. Just 2 final quick ones, Scott, on the debt paydown, just help us rather than do the arithmetic ourselves, what's left of the 2012 seniors to be paid down next year?

G. Scott Spendlove

$239 million.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Okay. And with the higher CapEx...

G. Scott Spendlove

I'm sorry, I apologize, $299 million.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Right. With higher CapEx points next year, you still reckon you can get that done?

G. Scott Spendlove

Yes.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

Okay. And the final one for me is just a refresher please on what exactly your West Coast crude slate looks like currently? And I'll leave it at that.

Daniel Robert Romasko

This is Dan. We run obviously lot of domestic California, the rest of it is largely foreign-oriented, and that’s dependent upon what the relative pricing of those crudes are.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

The domestic California, if you look at the realizations from the likes of Occidental, is that a good gauge because it seems to have been tracking world prices more than TI, I guess, to some extent?

Daniel Robert Romasko

For the percentage of the barrels that we run, that's correct.

Douglas George Blyth Leggate - BofA Merrill Lynch, Research Division

What is that percentage?

Daniel Robert Romasko

I don't know that we provided that guidance previously.

Operator

And your next question comes from the line of Ann Kohler of CRT Capital.

Ann L. Kohler - CRT Capital Group LLC, Research Division

Greg, is there a number that you've given in terms of the level of retail integration that you'd like to see for the company?

Gregory J. Goff

I'm sorry, can you ask the question again, Ann? I didn't pick -- oh, retail?

Ann L. Kohler - CRT Capital Group LLC, Research Division

Oh, sure. Retail, yes, retail integration.

Gregory J. Goff

We have -- that's work we've just completed. We definitely -- it's something we do on a regional basis because of the nature of the markets we're in, and we look at it each on a regional basis. But it's probably in excess of 2/3, 60-some percent is where we'd like to get to that gives us some flexibility and positions the assets because of the different markets. So we have a ways to go from where we are today.

Ann L. Kohler - CRT Capital Group LLC, Research Division

Great, and would you say that -- I know that when you -- when they made the L.A. acquisition, there were a couple of independent station packages that were a part of that transaction or simultaneous to that transaction. To go from 47% to the 66%, is the bulk of that within California or outside of California?

Gregory J. Goff

It's really spread around everywhere. The big impact in California is next year when we bring Thrifty online from integration, and then we go into all of the different regions, so the bulk of it would be outside after Thrifty.

Operator

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

Jacques H. Rousseau - RBC Capital Markets, LLC, Research Division

Great quarter. Just wanted to, and most of my questions have been answered, but just a few things. When you look at your operating cost improvement, which has been pretty significant, how much of that do you attribute to external factors, lower power costs, et cetera, or internal factors of optimization?

Daniel Robert Romasko

This is Dan. The external factors like fuel gas price, et cetera, have essentially been canceled out by the incremental volume run, so the vast majority of it we're seeing on improvement there is actually improvement in operating efficiency and then fixed cost spread across additional barrels because of increased utilization.

Jacques H. Rousseau - RBC Capital Markets, LLC, Research Division

Okay, great. And one more, if I could. In prior slide decks that you've provided, there's been some commentary about hedging gains in the quarter. Were there any in 3Q?

G. Scott Spendlove

Yes, Jacques. This is Scott. You'll see in our 10-Q when we filed it that we had $112 million of hedging gains in the quarter. And again, those really reflect derivative activities that we put in place to manage inventory builds or draws. There's physical offsets that balance those gains. Most of those gains were realized in the quarter as well.

Jacques H. Rousseau - RBC Capital Markets, LLC, Research Division

Could you give a breakout of regions for that?

G. Scott Spendlove

No, we don't provide that.

Operator

[Operator Instructions] And your next question comes from the line of Paul Sankey of Deutsche Bank.

Paul Sankey - Deutsche Bank AG, Research Division

Greg, really from the moment you took over, and I guess for about at least 1 year after that, you were always very clear in stating that you didn't expect any help from the market, I think was the approximate wording you used.

Gregory J. Goff

Right.

Paul Sankey - Deutsche Bank AG, Research Division

If I heard you right, and you kind of slipped it in, in your commentary today, you were saying words to the effect that you expect the current strength in the market to be sustainable. Could you expound on that a little bit more?

Gregory J. Goff

Yes, I mean, one, let me comment, we -- all of our plans were to really drive improvement in the business without any help from the market. And like I said, the market, to be honest, was stronger in 2011 than we thought it would be when we sat back in 2010, and we've actually used that -- the advantage of that to really strengthen our financial position, so that's been the big benefit there. As we look out from a market standpoint, we think some of the fundamental drivers in the market going forward, are relatively supportive to the margin environment data. We think that the export activity out of the United States is a fundamental driver. I think you have made comments to that yourself, and we see that continuing to happen. So bottom line is we think that there is still pretty good support for margins on a go-forward basis.

Paul Sankey - Deutsche Bank AG, Research Division

So is there more to it than just the export story? And obviously, I mean, we're also highlighting the availability of domestic...

Gregory J. Goff

Absolutely. The availability of domestic crude is another factor, and depending on some of the recent announcements on some potential refinery closures, whatever happens there, that could lend some additional support if that materializes.

Paul Sankey - Deutsche Bank AG, Research Division

Yes, and I guess you kind of started by saying this, but my follow-up was going to be the extent to which your strategy has changed or been altered as a function of that shift in view and of the extra financial firepower that you've sort of benefited from over the past 1.5 years.

Gregory J. Goff

I mean, our strategy remains absolutely solid and focused on what we're trying to do, and we've been able to accelerate particularly improving our balance sheet and that because of market conditions. That's been the biggest thing. And the second thing that's really helped us on our further development as we've got into the assets more. One of the really positive things is the announcements of the projects like the Mandan expansion, the work in Los Angeles, the ability to move the Bakken crude over to Anacortes, the work that we're doing in Salt Lake that we can't share with you. But we have -- what's encouraging, we have a lot of those other types of work going on that weren't part of the plans that we shared with everyone last year that we'll talk more about when we meet in December.

Paul Sankey - Deutsche Bank AG, Research Division

Sure. And then a slightly obscure follow-up. I thought the kind of conventional wisdom was when you have retail stations, it was better to own them? I noticed that you signed quite a big lease here. Is there anything to say about that?

Gregory J. Goff

From our standpoint, I mean, as a company, we're very driven trying to get a high return on capital employed. And because of the nature of the market and we look at the integration on a regional basis partly because of the Mandan, Salt Lake, the inland nature of our -- to some of those refineries and that, so we look at integration there, and the opportunities to drive the integration that we're trying to achieve is different in different regions. And our preference would be to have wholesale agreements where we don't tie up a lot of capital but we -- we're taking a portfolio approach to give us the diversification in the marketplace to reach out into the customers either through some retail stations that we acquire, the leasing of the stations was one of the options and growing our wholesale business like we did with Shell is another option. So it's a diversified approach but at the end of the day, we're trying not to tie up a lot of capital in it.

Paul Sankey - Deutsche Bank AG, Research Division

Yes, what are the main differences in the integration potential between, I don't know, Mid-Continent, West Coast or whatever you're thinking of?

Gregory J. Goff

Well, the West Coast has been easier because of the California market. I mean, there's no question we’re -- we look at California from a total integration standpoint between the 2 refineries, and we have a far stronger position there. The opportunities in the other areas take a little bit more time, and the growth will be -- well, it will just take a little bit more time for that to materialize, but they're all kind of different. The Shell deal was an excellent opportunity for the company because, as we've talked numerous times, it gave us 13,000 to 15,000 barrels a day plus a platform to grow into, especially around the Salt Lake and Mandan refineries. So we just need to look at them in each of the areas.

Operator

Your next question comes from the line of Faisel Khan of Citigroup.

Faisel Khan - Citigroup Inc, Research Division

It's Faisel from Citi. On the Anacortes rail project, what are the major permits that you guys need to start construction of that facility?

Daniel Robert Romasko

Yes, Faisel, this is Dan. There are actually just a lot of permits necessary, and I don't think I can give it justice in a short comment. But the U.S. Corps of Engineers is probably the critical path permit for us. And right now, we're still optimistic that we’ll have that in time to secure construction for Q4 completion of next year.

Faisel Khan - Citigroup Inc, Research Division

Okay, understood. And just right now, how much light -- Western Canadian light are you bringing into Anacortes right now?

Daniel Robert Romasko

We don't provide that level of guidance.

Faisel Khan - Citigroup Inc, Research Division

Okay, understood. And can you discuss a little bit on the West Coast, how you guys shifted production to a higher sort of product yield geared towards diesel? It looks like you guys increased diesel production by at least 14,000 barrels a day. Can you just talk a little bit about what happened there year-over-year in the third quarter?

Daniel Robert Romasko

Yes, we have the capability to swing in the -- or remain 2% to 10% volume between gasoline and diesel and the economics were there off and on for us to do that in Q3, so we took advantage of it.

Faisel Khan - Citigroup Inc, Research Division

Okay, understood. And then, I was wondering if you could comment a little bit about last night, there was a transaction for a refinery, I guess, in the Mid-Continent. Are you -- would you guys look at assets like that? Or what's your kind of focus right now in terms of -- where do you put sort of acquisitions or sort of assets like this when they come up for sale in your kind of priority?

Gregory J. Goff

We've -- I think, in the past, what we’ve said is that we really did a lot of strategic work last year, and we looked in our market area and understand assets that would fit in well with the company if they were available. And we would -- so we understand what we would like to be able to do, and if things were to become available, we would definitely look at those opportunities. There hasn't been anything on the market available that would be a fit for the company based upon the quality of the asset and the location that would fit into our system.

Operator

And your next question comes from the line of Mark Gilman of The Benchmark Company.

Mark Gilman - The Benchmark Company, LLC, Research Division

Greg, any update on the Anacortes litigation you can share with us?

Gregory J. Goff

Mark, I think that everything is kind of moving forward. There's nothing of any significance that's changed on either the work that we're doing with the outside authorities or the litigation that's going on. It's kind of just going through the due process, really. There's no significant changes.

Mark Gilman - The Benchmark Company, LLC, Research Division

Any significant dates we should pay attention to?

Gregory J. Goff

We don't have any -- we do not have any concrete dates on any of that stuff. It is work in process. It has taken a long time, and there aren't any concrete dates, Mark.

Operator

Your next question comes from the line of Edward Westlake of Crédit Suisse.

Edward Westlake - Crédit Suisse AG, Research Division

I was waiting for someone to ask you about the acquisition, and thanks, Faisel, for that. But the multiples would have been accretive to Tesoro if you look at the, I don't know if you've seen the math. So I take it from your comments, Greg, that it's more around strategic fit with your interest with your existing assets rather than just, say, sort of a Mid-Con focus?

Gregory J. Goff

That's absolutely correct.

Operator

And there are no further questions at this time. I'd like to turn the call back over to Greg Goff for closing remarks.

Gregory J. Goff

We appreciate all the questions, and we look forward to seeing everyone if you can make it to our Analyst Day meeting at the beginning of December. Thanks very much.

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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