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Tesoro Corp. (NYSE:TSO)

Q3 2007 Earnings Call

November 01, 2007 10:30 am ET

Executives

Scott Phipps - Manager of InvestorRelations

Bruce Smith - Chief Executive Officer

Greg Wright - Chief Administrative Officer

Bill Finnerty - Chief Operating Officer

Otto Schwethelm - Chief Financial Officer

Lynn Westfall - Economist.

Analysts

Doug Terreson - Morgan Stanley

Neil McMahon - Sanford & Bernstein

Doug Leggate - Citigroup

Chi Chow - Tristone Capital

Paul Steinke - Deutsche Bank

Roger Reed - Natexis Bleichroeder

Deepraj Pandey - Siemens & Company

Daniel Vetter - JPMorgan

Operator

Good morning. My name is Meg and I will be your conferenceoperator today. At this time I would like to welcome everyone to the Tesoro ThirdQuarter Earnings Conference Call.

All lines have been placed on mute to prevent any backgroundnoise. After the speakers' remarks, there will be a question and answer session(Operator Instructions).

Thank you, and Mr. Phipps; you may begin your call now.

Scott Phipps

Thank you Meg. Good morning everyone and welcome to today'sconference call to discuss our third quarter earnings. Joining me is BruceSmith, our CEO, Greg Wright, our Chief Administrative Officer, Bill Finnerty,our COO, Otto Schwethelm, our CFO and Lynn Westfall, our Economist.

If you need a copy of the earnings release that we issuedthis morning, will give you the company’s supplemental quarterly data, you mayobtain it from investor relation section of our website at tsocorp.com.

The earnings released contain additional information in theattached tables on our business. In addition, we have updated the othersupplemental financials and operational information on our website that’s notincluded in the press release. After viewing this information please feel freeto contact me with any questions about the material or otherwise followingtodays call.

I would like to remind everybody revenue statements madeduring the call that refer to management's expectations and or futurepredictions are forward-looking statements intend to be covered by Safe Harborprovisions of the Securities Act as there are many factors and which can causeof different from our expectations.

With that set up, I'll turn the call over to Bruce.

Bruce Smith

Okay. Thanks, Scott. And welcome to the third quarterearnings call. I'd like to thank everyone for taking time to participate today.I'm sure that, there are going to be many questions about the third quarterresults and I know that a number of you want to ask about the recentlyannounced tender offer by Tracinda.

We are going to answer any of the normal questions relatedto quarter or other factors that we normally talk about any of our projects,but we are not going to comment about Tracindas analysis tend to acquire 60% ofTesoros outstanding shares.

I want to just take a second here to quick overview of theearnings release. This morning we reported net income for the third quarter of$47 million or $0.34 a share which was significantly lower than earnings a yearago when we earned $247 million or almost $2 a share.

On competitive basis our results were disappointing. Butthey reflected an unusual margin environment. All these conditions affected theentire industry and the real impact on two of our refineries and condition wereslightly worst on the west coast.

Lynn’s going to talk about the margin part later, but if youreduce it to a few words it would be. Power price lagged, rapidly rising crudeprices and operational problems in Gulf Coast caused the west coast premiumover Gulf Coast margins to contract.

Today we are also going to discuss other factors thataffected our financial results and as promised we will report on theperformance of our recent acquisitions. While the third quarter wasoperationally successful, we always look back on our performance to see whatactions we can take to better optimize our system.

This has been particularly insightful this quarter, in partdue to what we believe to be the unusual market condition, but also because weare still learning about the intricacies of our new assets of this system.

Or we don’t believe high crude price and historically, lowtrack spared environment will be the norm in the future, it is important tounderstand what we can do to optimize our system and to maximize products,profits if and when this reoccurs.

I'm going to let Lynn elaborate on some of the profitimprovement opportunities in few minutes. But before he does that I want totake a second and comment on the performance of our recent acquisitions.

After we assumed ownership of the refinery in May, ourshort-term objectives were first to assemble the best leadership talentavailable, form a team that has stabilize operations, proved reliability andsafety and one that would work with our optimization area to capture synergies.

Secondly we assembled routine to begin a process ofreviewing the capital permission will be necessary, to fully optimize ourperformance at southern California over the nest five years. I'm pleased toreport that we have been successful in both of these objectives.

The new leadership team has quickly built trust and teamworkin the workforce that Los Angeles has made great progress in just one quarter.We set a record for throughput at better than expected yields our coststructure in line with expectations, and Los Angeles had a safety record thatwas aligned with the best in our system.

In summary, we're extreme pleased with the operationalperformance of Los Angeles, which we believe is fully meeting our expectations.The question is, how are we doing relative to our financial expectations.

After our acquisition, west coast crack spreads dropped fromthe mid-$30 range to low of $11 followed by an up tick that hovered in the $15to $18 range. We announced three components of our acquisitions and we saidthat the acquisition economics assume the refinery generated, annual operatingincome of $365 million or about $90 million per quarter without seasonaladjustments.

We just reviewed the third quarter performance of the toAngeles refinery with Board and the major variance from our acquisitioneconomics was a margin difference to the 2004, 2006 average we assumed in ouracquisition economics.

Specifically, the ANS crude benchmark was up by about 50%while the gasoline and diesel benchmarks increased by only 25%. Additionally,this refinery produces a higher amount of coal, and the price of that productreally lagged crude.

Looking at the two retail acquisitions, the acquisitioneconomics assumed that annual operating income contribution of about $85million or about $21 million a quarter. As we reconcile the performance for theboard, it showed that the Shell assets had performed up to our expectations andthat the U.S.A. petroleum assets have been in line with volume and marginexpectations.

U.S.A. is now incurring additional and to some extentunanticipated expenses to improve operating standards and security and otherstore enhancements, which has and will negatively impact quarterly operatingincome by $7 million to $9 million for the next three quarters.

Turning to our capital program, we’ve completed the majorincome improvement projects associated with the 2007 capital budget with theexception of the Golden Eagle coke Mangosteen (ph) project. This is the firstyear we have departed from our buy versus build strategy and that we investedcapital in projects that will have a meaningful impact on our base earnings.

And are assumed 2004-2006margins, these projects areexpected to contribute $100 million of EBITDA. These include the Amorco crude flexibility and expansion projects,which were really two projects that we just completed in June.

In the past, we have talked about how our optimization teamis focused on crude functionality and this project is an excellent example thathow significant it is to be able to fully supply Golden Eagle by water. In thethird quarter this $26 million project contributed EBITDA of $11 million. So onannualized basis this project pays out less than a year.

During the third quarter we completed the sulfur (ph)project Amorcos, which is enabled us to doubleour solid crude throughput. You remember that we canceled a large Coke project Amorco and of course it substituted a couple ofsmaller projects that should capture much of the target benefit of the Coker.

These are the type of low hanging Mangosteen fruit projects,which we think exist elsewhere in our system especially in Los Angeles.(inaudible) should expect the company to exercise the same capital disciplinein the future as we identify solid return projects. I believe this willcontinue to be a key component of building shareholder value going forward.

Bill, will you make a few comments about the operatingresults or highlight some of the improvements you believe we can make?

Bill Finnerty

Thanks Bruce. I'd like to begin by making general statementson operations and then comment on each of our operating regions. We continue tooperate our refining system at the high end of industry standards, which is theresult of the numerous programs we have implemented over the past few years.

Our operating plan is to run reliably and safely with acontinued focus on expenses and feedstocks cost.This is clearly a continuous learning process and we have a solid team to driveoperational results.

On the marketing front, we have commenced the process ofunderstand the new assets we acquired. We are endeavoring to take the bestpractices from across the marketing system to create value and we are excited aboutthe opportunities we are uncovering.

Our supply and optimization team continues to extend itsglobal reach in providing raw materials system, improves logistics capabilityand opening up new markets for product distribution. At the Los Angeles refinery,we are pleased with the third quarter operational performance.

The refinery is operating at near optimal rate consistentwith the current configuration and more focus on reliability and safety andintegration demonstrated by various functions of the refinery, as the refineryachieving throughputs above our early expectations.

We recognize that this is just the beginning and much worklies ahead. With each day we are learning more about the refinery, how itinterfaces with the system, and identifying additional opportunities to drivevalue.

For example, we feel we can improve upon the crude contractsbusiness at the time of transitions. These contracts, which comprise a majorportion of the refinery supply today. We’ll begin to roll off in the first quarterof 2008.

As you know, expanding logistics at our facility to improvecrude flexibility at each of our plants has been a theme we have stronglypursued over the past three years. Similar to what we accomplished at theGolden Eagle Refinery, we plan to phase in throughput enhancements at LosAngeles to increase foreign crude receipts.

We believe that this will facilitate arbitratesopportunities and access to a wider array of crude qualities. We are on trackto achieve the synergies we targeted and are focusing on transportation,operational, turn around, and raw material opportunities.

On the capital front, we have developed a plan, which wewill share with you in December that will provide lower cost, environmentalbenefits and improved product yields.

In the Pacific Northwest region, we were able to capitalizeat the end of the quarter on the sulfur-handlingproject that is now outline. This enabled us to increase our throughputand open up additional blending opportunities.

On the operations side, we did experience unscheduledmaintenance on the boiler units for the FCC and underwent planned maintenanceon two hydrotreating units. In total these reduced the refinery gross margin by$12 million compared to a year ago.

In Hawaii we have three significant market elementsnegatively impacting refinery profitability compared to a year ago. First, lackin product price provisions on certainly product contracts did not offset rapidincreases in crude costs. This is something, which is inherent in the industrypricing for these products and we have shared this with you previously.

Second, the Asian sweet crude realized a higher premium dueto the strong demand for low sulfur fuel oil following the look to our Francecloses to Japan after the earthquake. Third, certain term supplies have higherthan normal market adjustment factors resulting from the change in the marketstructure for WTI and Brent during the quarter.

The confluence of these market conditions took its Toll onHawaii's performance. Some of these quarterly impact would continue into thefourth quarter end 2008. So we are evaluating alternative supply opportunitieshedge options and product channel going forward.

The refining region experienced the highest spreads of ouroperating regions for the quarter and operating at full capacity to capture themarket. Industry unplanned refinery additives and diesel demand supported thegroup three region and specifically the Mandan refinery.

The Salt Lake City ref margins did not follow the samestrength as in the group three benchmark. On the feedstock side, we continue tosee favorable economics for the regional high quality crude production, whichas you note is a trading at a discount to WTI.

Going into the fourth quarter we continue to see high productdemand, especially on the diesel side coupled with advantage free stockopportunities. Golden Eagle's operating income in this quarter was lower thanlast year as a result of the reduced tax price that ranged $6 a barrel.

Operationally, we experienced a temporary slowdown in thefluid coker and a few other downstream units. This reduced our throughput formerely guidance. The project modification project, part of this year's $900million capital program is still scheduled to come online during the first partof 2008.

I'll now turn it over to Lynn for an update on marketfundamentals.

Lynn Westfall

Thanks Bill. Margins in the third quarter weredisappointing. While, the Gulf Coast crack year-over-year for the quarter wasactually up by $0.74 a barrel. West coast crack, were down by almost $8 abarrel. With this in mind, I have concentrated my analysis and my comments on aparticular weakness of the West coast early quarter.

While, few of you must saw an update as we entered into fullanalysis on this decline. It appeared good been due to both the demand andsupply factors. The latest estimates for July against meet demand on west coastfor year-over-year decline of about 60,000 barrels a day. Used decline wasabout 35,000 barrels a day.

We believe these are reactions to the steep retail priceincreases for the first half of the year. We saw gasoline prices rise by morethan $0.70 per gallon. Retail prices reached an all time in high California$3.50 per gallon May of this year.

Recently release sale for August are, shows a slightincrease in demand on year-over-year basis to recovery may be underway. On thesupply side, crude price increases on the West Coast exceeded those on the GulfCoast, with ANS up over $7.50 per barrel year-over-year versus WTI increase ofjust over $5 a barrel. We believe this is due to higher weakness on the NorthSlope which reduced crude production by about 8%.

In terms of product supply, California refinery grandsuccessfully well in the quarter. We produced 3% more gasoline than in the sameperiod of 2006. And July, August represented the two highest production monthsof the year so far. There is also excess product of the market from aninventory draw on the West Coast during the quarter of $3.2 million barrels. Arecord high third quarter inventory decline.

This contrasts to the same period last year when there isinventory build of 600,000 barrels. So the incremental supply year-over-yearwas of 41,000 barrels a year higher in higher port. This excessive draw wasbrought about by a second month accreditation on the future market was tripledfrom over $0.04 per gallon in June to $0.125 per gallon in July. Thus providinglarge incentive to reduce inventory levels.

In a market its typically only short about 50 to 60,000barrels a day during this part of the year. combination of demand line increaseproduction and large inventory draw had the effect on margins you would expectto see.

Looking forward, we see the fundamentals improving duringthe fourth quarter. The average West Coast crack for October now stands at$17.56 a barrel slightly above the same month last year has increased about$3.70 from September levels.

While the average WTI crude price for the month hasincreased by $5.29 barrel from September, ANS crude prices above the by $4.52 abarrel or about $0.77 barrel. The date for the month of October, Californiarefineries are producing about 130,000 barrels a day less gasoline than inOctober 2006.

Also turn around activity in pipeline for the quarter is expectedto be heavier than normal removing about 160,000 barrels a day for thiscapacity about a 100,000 barrel a day for converted capacity home production.

I'll now turn it over to Otto for fourth quarter guidance.

Otto Schwethelm

Thanks, Lynn. As mentioned earlier, total system throughputwas 654,000 barrels a day which was at the high end of our third quarterguidance. I think the overall fourth quarter throughput guidance at theCalifornia region we expect throughput to average between 260 to 275,000barrels per day.

Pacific Northwest 175 to 180, Mid Pacific 80 to 85, and Midcontinent 105 to 110 bringing total system throughput somewhere between 620 to650,000 barrels per day. Operating expenses were in line with guidance, exceptfor Los Angeles where expenses were lower than we had forecast.

The variance was mainly due to a lag and the ramping up inexpenses associated with the execution of our capital program. We expectexpenses at Los Angeles to increase in the next few quarters as we match theexpense needs with the capital program.

Other regions are expected to be in line with the thirdquarter. By region we expect California during the fourth quarter to average$6.60 per barrel, Pacific Northwest $2.75. Mid-Pacific $1.85, and Mid-Continent$2.80. Depreciation and amortization for refining is expected to be around $85million while DNA for the retail system is now expected to be around $8 millionfor the fourth quarter.

Our corporate and unallocated expense is expected to beroughly $45 million in the fourth quarter. Interest expense before interestincome is estimated to be around $25 million and we expect our tax rate tocontinue around 38%.

On a special note for those of you who have a model aroundour refinery we are currently reviewing our guidance around used of SanFrancisco crack spread for modeling LA and the appropriate capture rate. Weexpect report on this after we get a few more quarters under our belt. And withthat I'll turn it over to you, Bruce.

Bruce Smith

Okay. Thanks Otto. Clearly the third quarter had some uniquechallenges, but we continue to believe that new incremental whole demand wassupport a long-term margin outlook exceed the historical five year average andthey will better track the cost of crude.

As Lynn said, fourth quarter fundamentals have improved andthe average West Coast spread crack 7th of October was slightly higher than thesame month last year. But, still in line with the third quarter. The averageANS retrieves an increased in another $8.

So while West Coast premium as improved relationship betweencrude and products -- consequentially, plus we see a rapid throughout marketconditions is going to be difficult for the company to improve on the thirdquarter results of fourth.

But the return of more rational markets we expectcombination of income improvement projects and Golden Eagle coker project andthe recent acquisitions that they will make a meaningful contribution to ourshareholders.

When we acquired these Southern California assets, weexpected both systems synergies and new investment opportunities. We are ontrack to capture the expected synergies and it's been said we are reviewing thecapital projects that we initially identified as part of Los Angeles refineryacquisition.

We have in place a very talented team, one that's deliveringbetter than expected operating performance and I'd like to congratulate thatentire team today on this call. There's uncertainty in today's marketplace webelieve our system has solid value and certainly it has an excellent historicalearning power.

Nevertheless we realize a successful organization must adaptto the changing market conditions. As then said we are and will be making somenear term changes to lower crude costs and better optimize our system.

Operator, I believe at this time we're finished with ourcomments and we're prepared to take questions.

Question-and-Answer Session

Operator

Okay. Your first question comes from Doug Terreson MorganStanley.

Bruce Smith

Hi, Doug

Doug Terreson - Morgan Stanley

Good morning, Bruce and team.

Bruce Smith

How are you?

Doug Terreson - Morgan Stanley

I'm doing fine.

Bruce Smith

Good.

Doug Terreson - Morgan Stanley

I think Dan talked about the differentials with thebenchmark refining margin in Pacific refineries in Hawaii implements being weakand been weak and, my question regards the composition of that differential inthe period.

And specifically how the weakness might have been segmentedbetween crude, but I think you spend time on and products which relatebenchmark. Do you guys have additional insight into how that benchmark traveledduring the period? Or tracked rather?

Bruce Smith

Relative to the, benchmark relative to obviously versuscapture rate what was put out. We had a much lower capture rate at Hawaii. Ithink the key thing gets back to what Bruce was mentioning before. And that wasjust the changes that we saw on the crude structure for that particular facility.

Doug Terreson - Morgan Stanley

Okay.

Bruce Smith

And those unusual events that we did witness in the thirdquarter, just as a reference if you take a look at typical patterns, yourraging supply into the U.S. is typically a lower price and what you see intoEurope and into Asia, but because of the various changes in the market, theunusual changes in the marketplace, that actually flipped during the thirdquarter.

Doug Terreson - Morgan Stanley

Okay. So, it's mostly on the crude side its sounds like...?

Bruce Smith

It's predominantly the crude side, yes.

Doug Terreson - Morgan Stanley

Okay. And also just quick update is it reasonable to assumethat the Golden Eagle cocker (ph) is a Q2 '08 item? And Anacortes is a hydrogenation unit is Q3?

Bill Finnerty

Is that the unit coming on line of latter part of the firstquarter so that would be a correct assumption.

Bruce Smith

That is so economic impact I think the bulk of that would besecond quarter next the operational in March. But it’s by the time we got itironed out significantly contributing in the third quarter.

Doug Terreson - Morgan Stanley

Okay. Thanks a lot, guys.

Bill Finnerty

Okay, Doug.

Operator

Your next question comes from Neil McMahon Sanford &Bernstein. Your line is open.

Neil McMahon - Sanford & Bernstein

Hi. Neil McMahon, Sanford & Bernstein. Just a fewquestions. First of all, could you tell us what potential you have to fasttrack the port plans at long beach to get greater flexibility into the L.A.refinery? You think there's the possibility of doing this.

Given the fact that you're crude contracts are running offat the refinery, but how soon can we expect anything to happen there? Especiallyafter Shell was unsuccessful was doing at anything in that area.

Bill Finnerty

The plan that we have in place Neil addresses the secondhalf of 2008 for the first phase of increments and the complete project won'tbe done until the latter part of 2009.

Bruce Smith

I think it would be fair to say that Shell wasn't reallymotivated early on to make investments at all, we’re certainly not to makeinvestments here relative to the crude. That wasn't where they were focused.And so, again I'm not sure that was really a part of their strategy and when weinherited these contracts, we needed to have them for transition purposes, butits certainly when we look at how we would supply it relative to thosecontracts, we do filling in this market we would have done a better job.

Bill Finnerty

Clearly we'll have a higher utilization through the top evenunder current capacity just because of the profile of materials that we goinginto our system as a whole. And then we'll have the incremental adjustmentsonce the capital projects are completed and as I indicated we've got two phasesto that.

Neil McMahon - Sanford & Bernstein

Maybe just a quick follow-up. Would you benefit at all fromthe rolling off of these contracts over the next quarter at all in terms ofwriting even near term contracts before any port developments take place orpretty much we have to wait for the second half of '08 for any more flexibilityat L.A.?

Bruce Smith

No. I clearly will benefit from writing off contracts we'vealready got a team that are addressing alternate supplies on a domestic basis.So, we see a benefit there. But as we talked so many times, the ability as wehave at Golden Eagle now both on the domestic and the foreign side is theultimate game and that will have two phases to achieve. But we will havebenefits in the first half.

Neil McMahon - Sanford & Bernstein

I've just got two more quick ones. When you look at Hawaiiand Anacortes, you mentioned that a number ofissues, especially associated with the situation. I think you said one was itin Asia, was there anything to do with the logistical program between thoserefineries in the Pacific Northwest and Hawaii that may have resulted in thelow margins? And just a second quick question. What the outlook for theblending component coming into the West Coast over the next six months?

Bruce Smith

Well, as far as the logistics go, Neil, I did not have anythe activities that we are during the course as you know we’ve got U.S. Fuel(ph) Tonnage fleet that we operate to service our needs there. And on theexport of fuel oil if you look at what was happening in Asia on fuel oil, thefuel oil prices were about where they were the previous year. So, there isnothing from a logistics perspective that hindered us. What did you refer goingto you final question?

Neil McMahon - Sanford & Bernstein

The second question was just really to look at, as you lookforward going into the start of next year, in terms of gasoline and blendingcomponents import into the west coast, what are you looking at in terms of, howtight the Californian market is likely to be?

Lynn Westfall

This is Lynn Westfall. I’ll try that one. I think we see areturn some time soon or certainly by next year to normal levels of coast. Thisyear they were extraordinarily high with reformulated import bugs 70,000barrels a day. Total import over 100,000 barrels a day particularly because ofthe maintenance of both planned and unplanned in the first half of the year.

Because of the huge inventory draw we saw the third quarterof this year, import were down to the lowest level that’s going to do and bringin inventory you have to back our imports. I think, August was down only 7000barrels a day. But taking those two events and assuming that neither one ofthem repeat next year we'd still expect to see reformulated imports in theCalifornia in the 30 to 35,000-barrel a day range.

Neil McMahon - Sanford & Bernstein

Great. Thank you.

Operator

Your next question comes from Doug Leggate with Citigroup.Your line is open.

Doug Leggate - Citigroup

Thanks, good morning. Hi, everybody.

Bruce Smith

Good Morning, Doug.

Doug Leggate - Citigroup

Couple of things from me. Just give some clarity on this $28million hedging and by that’s included in the reported numbers right on themid-Pacific.

Bruce Smith

We show that as a combined adjustment on the financials andDoug what it is. It's the program that we have on long haul crude and it'stracking the crude price only. It's looking at the crude at time of purchaseand marrying it up with prices at the time of delivery and processing so thatwe can capture what we've talked about in the past as far as refining margin.

And when you look at our portfolio the amount of crude thatwe actually hedged is a relatively small percentage. But the dollar value wasup because of the rapid rise that you have in crude oil market. Remember,that's just on the crude side.

Doug Leggate - Citigroup

Okay. So it's not all included in the realized margin?

Bruce Smith

That's correct. It spread and is recognized as you look atthe margin for each of the refineries in the supplemental to the -- as well asthe information we post on the website. If in the realized margin for thoserefining region they were impacted so that would be everybody with theexception of the Mid-Continents.

Doug Leggate - Citigroup

Right. So $28 million I guess, what I'm trying to figure outis should I be really stripping out to get an idea what your underlying capturelooks like in those assets it's kind of a nonrecurring item?

Bruce Smith

It's part of an ongoing program. It's hard to strip it outand add it back in. I mean, it is what it is Doug and we've been working on ourhedging for a while to really recognize they have refinery margin. And so wedon't have any plans to change that at this time, so I mean, you couldcertainly take it out if you want but it's going to be part of a recurringprogram.

Doug Leggate - Citigroup

Okay. And declining oil price environment you probably get abenefit ends up here to say (inaudible).

Bruce Smith

That's what you saw in the third quarter of last year. Asprices come down, that becomes a gain and you have an increasing market thatthe paper portion of it is a loss. I look at that in total.

Doug Leggate - Citigroup

We can't forecast that so I tend to treat it as a bit of anonrecurring. Then everything I’ve is a I want to go back to one of the things,Neil is maybe referring to. You guys don't normally do too well in the back endof the year.

One of the things evident over the last couple of years istightness in the high Octane will be the pressure market in the early parts of theyear, when summer blending kicks in again. Is there a something I guess is itdirected to Lynn any obstacles as to why that should not reoccur again in 2008?In other words, pay all market margin premiums lifting second quarter is that areasonable outlook from here?

Bruce Smith

I at this point can't change to that law, I would expectthat to reoccur just like it does every year.

Doug Leggate - Citigroup

Is some what exacerbated since ethanol came in there after?

Bruce Smith

Well, I mean, ethanol has been in California for many yearsnow.

Doug Leggate - Citigroup

Sure.

Bruce Smith

Year-over-year there should be no retain. The only thing towatch for coming up in the first quarter of next year, we probably will nothave the scheduled turn around that we had in the first quarter of '07. As maybe little bit up.

Doug Leggate - Citigroup

Right.

Bruce Smith

So the quantity of imports may change but the quality willremain unchanged.

Doug Leggate - Citigroup

That's it for me, gentlemen.

Bruce Smith

Thanks, Doug.

Operator

Your next question comes from Chi Chow with TristoneCapital. Your line is open.

Chi Chow - Tristone Capital

Good morning, gentleman.

Bruce Smith

Good morning, Chi.

Chi Chow - Tristone Capital

Got a couple of questions, back on Wilmington. When I lookat our yields year-over-year things haven't switched that much. You'reproducing jet now obviously. But in the heavy oil/RESID component and how hasthe mix changed year-over-year?

Bruce Smith

We see year-over-year….

Chi Chow - Tristone Capital

3Q '07 versus 3Q '06.

Bruce Smith

Compared to shell.

Chi Chow - Tristone Capital

Or you're showing 54,000 barrels a day of heavy oil residecategory of 3Q '07 versus 31on yield percent -- it's percentage basis it'sright around 17% to 19% of total yield. But how has the mix changed within thatcategory?

Bruce Smith

You said Wilmington, you mean in the California in general.

Chi Chow - Tristone Capital

Yes. Sorry, California in general.

Bruce Smith

Okay. We were starting with the Wilmington part of it.

Chi Chow - Tristone Capital

Yes.

Bruce Smith

That’s all, I think just under third quarter, you can lookat two things that would alter the structure of that. One is, we not made notethat we had work underway for the fluid coker. So, obviously we had changeslater in part of fluid coker operations.

And then, the second is that we ran higher fluids at LosAngeles, which would directly mean that your yield pattern on the incrementalbarrels is less. You got clean product yield.

Chi Chow - Tristone Capital

Okay. How much coke are you producing? I'm assuming coke fallsinto that 54,000 barrels a day category.

Bruce Smith

Yeah. I don't know, if we've shared that number, wedirectionally anywhere between the two facilities are about 20,000 barrels aday of coke, 18 to 20. It’s and I think again, the fact is that we've got LosAngeles on its yield pattern it's got a little larger percentage of coke andthat certainly in a high margin environment coke prices are not moving isreally going to hurt that facility.

Chi Chow - Tristone Capital

Yeah. I mean it seems like you've got an outside coker, atthat plant 40,000 barrels a day. First, for the hundred thousand barrel a dayfacility. I mean is this going to be an ongoing problem at high crude pricesgoing forward?

Bruce Smith

I don't know, but I think what it speaks to is that if youcan't source your crudes in the right way, where there's a big enough discountaround what really got there with heavy sulfur crudes.

Yeah. You've got a little bit of an issue and that reallycompounds what we've got today. We guess, we start with some other crudes thatwe can't maximize carefully optimize that facility.

Chi Chow - Tristone Capital

Okay. So, this is a problem with your current crudecontracts really?

Bruce Smith

Well, Chi, I think you have to take a look at the structureof the market on coke pricing relative to other pricing structures and coketypically doesn't follow your pricing structures as rapidly as other products.

Exacerbated in the third quarter because of the huge surgein crude prices. So, it's going to take a while for that gap to narrow.

Chi Chow - Tristone Capital

The combination I think is really the right way to look atthat.

Bruce Smith

But it is a factor and what goes on there, and I wouldn'tsay that we've got an oversized coker. I think, we have an under-optimizedcrude slate and then some of the same things product price problem right now,which is really imbedded in gasoline and diesel and everything else.

Chi Chow - Tristone Capital

Well, crude is obviously continue to surge in for queue (ph)so.

Bruce Smith

And that's why we point that out. Unless coke prices jumpup, it's going to hurt that facility has those crude price…

Chi Chow - Tristone Capital

And what should we be using for a coke price? Do you haveany guidance on that?

Bruce Smith

Chi, we'll work on that with guidance as we go forward.

Chi Chow - Tristone Capital

Okay.

Bruce Smith

We don't have any (inaudible) on that.

Chi Chow - Tristone Capital

Okay. And then, one final question. Bruce in your openingcomments you mentioned that operating problems in the Gulf Coast impacted westcoast margins during the quarter. Can you explain that dynamic?

Bruce Smith

I think he was addressing the differential.

Chi Chow - Tristone Capital

Right.

Bruce Smith

Between the Gulf Coast and the west coast squeezed in. Thecombination of oversupply on the west coast and some operating problems thatreduced supplies in the Gulf Coast.

Bill Finnerty

Yes. That's what I was trying to say, sorry, I was trying todeal with the differential. As we edited this we decided it wasn't clearenough. It would have been better to talk about the differentials.

Chi Chow - Tristone Capital

Okay. Thanks a lot.

Bruce Smith

You're welcome.

Operator

Your next question comes from Paul Steinke of Deutsche Bank.Your line is open.

Bruce Smith

Paul?

Paul Steinke - Deutsche Bank

Yes, hi, sorry guys. I was asking a question on mute there.

Bruce Smith

Did you get an answer?

Paul Steinke - Deutsche Bank

Easy to answer that one. You've provided a tremendous amountof (inaudible) here in, in terms of operations, but when all is said and donewhat you're saying if the current market conditions persist you're going tomake about the same amount in Q4 as you made in Q3 all things being equal. Isthat a fair statement?

Bruce Smith

I think that's a fair statement.

Paul Steinke - Deutsche Bank

Great. Okay. That’s fine, thanks. You seem to open the doora little bit in your opening comments through the choosing the question so,I'll run it by you. What are the major considerations that you are taking tothe Board regarding the offer? Thanks.

Bruce Smith

I didn’t think I opened the door at all, but the Boardyesterday and obviously the Board by what we're required to do has got anobligation to respond after the tender offer is filed.

The Board is duly considered at this point. The informationthat is, its got hand to selecting some information and waiting for the offerto be formalized and filed, which to my knowledge has not occurred yet.

So there's not much more we can say about it at this point.The Board will in fact once it filed will consider it and it will respondappropriately.

Paul Steinke - Deutsche Bank

And that's obviously within the frame that you've outlinedwithin your own news release on the subject.

Bruce Smith

At this the (inaudible) regulations required that we respondwithin 10 days of the tender offer, which has been made and of course we'll dothat.

Bill Finnerty

There's a very strict guideline for what we need to do andwe'll follow the guidelines and we'll provide appropriate information and it is10 business days. And so once that's filed we'll within that 10-day periodwe’ll make an appropriate announcement.

Paul Steinke - Deutsche Bank

Okay. Great and finally from would you had direct contactwith (inaudible) guys

Bruce Smith

I'm not going to comment on any of the other aspects of it.I just can't do that, Paul.

Bill Finnerty

I understand Bruce. Thanks a lot.

Bruce Smith

Thank you.

Operator

Your next question comes from Roger Reed of NatexisBleichroeder. Your line is open.

Bruce Smith

Hi, Roger.

Roger Reed - Natexis Bleichroeder

Good morning. That is a tough name it is Bleichroeder but…

Bruce Smith

That is a tough name. You pronounced it very well.

Roger Reed - Natexis Bleichroeder

Well, I've had several years of practice now. I guess onethe question here for you could you walk back through the west coast volumeissues and in doing so on a year-over-year comparison. Do you believe this wasdue to just a different maintenance schedule?

Have we seen legitimate expansion of capacity on the westcoast? Are we getting as an industry if not just inside solo better aboutoperating in this clean fuel environment? Could you kind of help me out understandingthat a little bit?

Bruce Smith

Yes, It's hard to say with two months of refineryutilizations in the quarter are here to stay. They were higher for this year,but they were not historical highs or July and August. So, certainly the productionlevels of California refineries didn't hit historical highs, which me tobelieve that they shouldn't deviate from that norm over a longer period oftime.

So, I don't think there's been substantive changes in howwell or poorly refineries operate on the west coast. As I said, I think theprimary thing that defined the poor margins on the west coast, was that newgulf reporting of. Here in market total is shows 60,000 barrels a day, 40,000barrels a day progress our order 20,000 barrels a day from inventory that hasan effect that I would expect to see is poor margins. But I don't think you cansee that kind of a record inventory draw often.

Roger Reed - Natexis Bleichroeder

Okay. And I know it's tough to separate a lot of theseitems. But if you were to see crude prices go from where they are now to backto where they were let say at the start of the second quarter or so a $20 plusis $25 reversal.

What would be the sort of stand-alone impact on your resultsand we are assuming your product prices remain I mean do you get the reversalof most of what we saw in the fourth quarter? Do you get a better situationwhen crude prices are going down and product prices hold or worse?

Bruce Smith

I think if your follow historical patterns there are acouple of things that happen. Part prices particularly the farther you get downthe distribution change what we saw the wholesale to retail only always reactwith a time delay.

Either up ward tick or downward tick. So rather the plainmarket I think you can certainly expect the retail margins improve. Wholesalemargin is improved whether the stock margins improve or not they're fairlyreactive.

But the certainly thing that those two margin will improvedramatically and then as Bruce pin pointed we’re pointing out rapidly decliningcrude prices and your coke prices stay where they are you'll gain back over todollar for crude oil on that amount of your production. Those would be the twoprimary of that (inaudible).

Bill Finnerty

And certainly why is one facility for benefits in theenvironment more additional portion leads to that pipeline and on the thin mixwe have few contracts and why do we have to built in time line here. Loss overa benefit from a drop like that.

Roger Reed - Natexis Bleichroeder

Okay. So not much difference in an up market versus downmarket all things otherwise being equal on that approach.

Bruce Smith

We get back in a down market what we lose in an up market Iguess is the short answer.

Roger Reed - Natexis Bleichroeder

That’s what I tried to figure out. All right thank you.

Bruce Smith

Thank you.

Operator

Your next question comes from Deepraj Pandey of Siemens& Company (ph). Your line is open.

Bruce Smith

Hi Debra.

Deepraj Pandey - Siemens & Company

Hey guys its Deepraj actually from Siemens.

Bruce Smith

Hi.

Deepraj Pandey - Siemens & Company

So, two quick questions and I apologize if you cover this. Ihad to step out for a second. Could you talk about your crude slate in 3Q andgoing to into 4Q we are able to reduce and as an run alternative crude.

And the second question could you give an update on thestatus of the dock project have you further fall permit one will you and howlong will it take to get it done after filing? Thanks.

Bruce Smith

Well, I guess you mean by the dock that we are roaming toproject and said Deepraj.

Deepraj Pandey - Siemens & Company

Yes.

Bruce Smith

Okay. We have relative to the footprint for the dockextension that's moving forward smoothly. Or relative to the portfolio of greatthat we had coming in now we talked a little bit about this. We continue on thepath of diversifying.

We added two new grades, one from Angola and one from Brazilto the portfolio during the third quarter some of the other grades that weintroduce to the system in prior quarters as we've now spread out to otherplants.

The issue that we had that we eluded to was basicallyassociated with unique market conditions that existed in Asia and there's aresponse time for any of these types of activities and you already have stuffin play when these type of events come up.

So, we had a short term hit relative to some of thoseevents. As we move forward we feel confident that the programs that we had inplay are going to be able to provide value into the system.

Deepraj Pandey - Siemens & Company

Thanks, guys.

Bruce Smith

And the next question comes from Daniel Vetter of JPMorgan.Your line is open.

Daniel Vetter - JPMorgan

Good morning.

Bruce Smith

Good morning Dan.

Daniel Vetter - JPMorgan

You mentioned in your opening remarks that operatingexpenses at the LA refinery might start to catch up a little bit in the comingquarters. My question is that guidance for the fourth quarter for theCalifornia region 660 per barrel is that going to creep higher in the comingquarters?

Bruce Smith

I think the guidance that we provided for that region takesinto account the initial expenses we're anticipating as we proceed with thingsthat we've identified earlier. The work that we need to do at the facility.

Daniel Vetter - JPMorgan

So I should use that as sort of a run rate for that region.

Bruce Smith

Yes I think if we can say with a little bit of exact but Imean we say the best I mean the best that we can you right now I think we’veonly got one full quarter at this point and so the best of our knowledge rightnow based on the facts that we've got we think that looks like a pretty goodrun rate.

Daniel Vetter - JPMorgan

Okay. My second question is with regards to the Los Angelesrefinery, the five-year capital plan that you've talked about $1.1 billion overI suppose five years.

Can you give us a sense of the time allocation of thatspending? Or you going to have more details in that regard at your upcomingannual update?

Bruce Smith

We'll have more detail and there's going to be an update ingeneral in the Q, the numbers not surprisingly are up a little bit. But we’llthe update the guidance on those ranges that we gave you from everything, frommaintenance to the regulatory spending, to the income projects.

What we want to do is try to sit down and put that incontext with everything else in December. That there will be in the Q and so wewant to give the ranges now. I mean it will be public information shortly onthe reports.

I'm going to ask to take a look at the Q because that Ithink I remember what the numbers are but I don't have them right in front ofme and I don't want to misquote them. I think, we had in the maintenance areawe had it at 80 originally in our guidance and I think we’ve got 90 to 100 nowis where we think the maintenance spending is going to be over the period of time.

Our regulatory, I think was down from that was 375.

Bill Finnerty

No 550 to 650.

Bruce Smith

550 to 650.

Bill Finnerty

550 to 650 and in the area of reliability throughput andproduction of clean products, 400 to 450.

Bruce Smith

Again, we're going to try to put that in context becausewe're reshaping a number of other things that again focusing on cost it's beensaid and that both our energy and our crude costs we really, I think that theprimary focus continues to be crude costs particularly in this environment wesee going forward where you're going to have this type of volatility.

We want to have as much optionality, so we're going to focuson energy and crude costs in our capital program. There will be something inLos Angeles that we talk about. We feel pretty good.

We're really, as we did at the sulfur plant with the certainchanges in the end of quarters, we're focusing on how to get maximum value forminimum dollars. But we will review those with everyone in December.

We have not fully approved the budget. We had some otherissues that we needed to talk about in the higher board meeting. So we will beable to get the budget approved by the board and then we’ll come back anddiscuss those in December.

Daniel Vetter - JPMorgan

So for now, until we receive more guidance at the analysts'meeting, is it reasonable to just spread out that depending over the next fiveyears?

Bruce Smith

I think that's probably a reasonable assumption and I say thatwithout looking at the detail right in front of me but I think that'sreasonable. I don't think it's disproportionate in any one year just becausemost of those capital plans take pre-made indicate prime good to the plan.

And so I think, it's going to be somewhat equal over theyear. So probably not as much in '08, as we might like to see, but some of theprograms are already in place from what Shell had to do on the regulatory side.

So I still think it's on balance just going to be closer tospreading over the five-year period.

Daniel Vetter - JPMorgan

All right. Thank you.

Bruce Smith

You're welcome.

Operator

At this time, there are no further questions in the queue.

Bruce Smith

Well, I'd like to thank everybody for participating today,some excellent questions. I hope, we've done a good job of trying to providesome better detail and clearly around the different elements we continue tolearn a lot about California as I said earlier.

We are very excited about it and we'll look forward toreviewing that capital program with everyone in December and then relative tothe other announcement, which I do appreciate everybody's courtesy inrestraining from asking questions so that I couldn't answer.

But as soon as we're in a position to do that we’ll beproviding more information and we’ll look forward to see people in December.Thanks very much.

Operator

This concludes today's conference call and you may nowdisconnect.

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