Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Valero Energy Corporation (NYSE:VLO)

Q3 2007 Earnings Call

November 6, 200711:00 am ET

Executives

Ashley Smith - Investor Relations

Michael S. Ciskowski - Chief Financial Officer, ExecutiveVice President

Richard J. Marcogliese - Chief Operating Officer, ExecutiveVice President

William R. Klesse - Chairman of the Board, Chief ExecutiveOfficer

Analysts

Doug Terreson - Morgan Stanley

Jeff Dietert - Simmons

Arjun Murti - Goldman Sachs

Doug Leggate - Citigroup

Paul Sankey - Deutsche Bank

Paul Cheng - Lehman Brothers

Chi Chow - Tristone Capital

Mark Gilman - The Benchmark Company

Daniel Vetter - J.P. Morgan

Ari Raivetz - Banc of America

Operator

Good morning. My name is Dennis and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Valero Energy third quarter 2007 earnings conference call. (OperatorInstructions) I will now turn the call over to Mr. Ashley Smith. Please goahead, sir.

Ashley Smith

Thank you, Dennis. Good morning and welcome to Valero EnergyCorporation’s third quarter 2007 earnings conference call. With me today areBill Klesse, our Chairman and CEO; Mike Ciskowski, our CFO; Rich Marcogliese,our Chief Operating Officer; and other members of our executive managementteam.

If you have not received the earnings release and would likea copy, you can find one on our website at Valero.com. There are also tablesattached to the earnings release which provide additional financial informationon our business segments. If you have any questions after reviewing thesetables, please feel free to contact investor relations after the call.

Before we get started, I would like to direct your attentionto the forward-looking statements disclaimer contained in the press release. Insummary, it says that statements in the press release and on this conferencecall that state the company’s or management’s expectations for predictions ofthe future are forward-looking statements intended to be covered by the safeharbor provisions under federal securities laws. There are many factors whichcould cause actual results to differ from our expectations, including those wedescribed in our filings with the SEC.

Now I’ll turn the call over to Mike.

Michael S. Ciskowski

Thanks, Ashley and thank you for joining us today. As notedin the release, our third quarter earnings came in at $1.34 per share fromcontinuing operations and $0.75 per share from discontinued operations.Excluding the effect on diluted earnings per share related to the company’s $94million settlement payment for the accelerated share repurchase program, whichwas $0.16 per share, and a $91 million pretax gain, or $0.10 per share aftertaxes resulting from the repayment of a loan by a foreign subsidiary, the thirdquarter 2007 diluted earnings per share from continuing operations were $1.40.

You should note that the gain on the sale and the operationsof the recently divested Lima, Ohio refinery are classified as discontinued operationsin the financial tables that accompany the earnings release.

Third quarter 2007 operating income was $1.2 billioncompared to $2.3 billion reported in the same period last year. The $1.1billion reduction in operating income was primarily due to lower throughputmargin per barrel of $9.94, which is down $3.23 per barrel versus the thirdquarter of 2006.

The key driver of the lower margin was the higher price forlight sweet crude oils and smaller discounts for sour crude oils and other feedstocks. On average, our feed stocks were approximately $3 per barrel moreexpensive versus WTI and reduced operating income by more than $700 million ascompared to the third quarter of 2006.

Additional factors that negatively affected operating incomeinclude substantially lower throughput margins in the West Coast region, whichreduced operating income by approximately $110 million; lower margins for manyof the company’s other products, such as asphalt, lube oils, and petrochemicalfeed stocks; the impact of Hurricane Humberto on the company’s Port Arthurrefinery; as well as operational issues at the company’s Port Arthur, Aruba,and Ardmore refineries.

Going through some of the key numbers for the third quarter,refinery throughput volumes averaged over to 2.8 million barrels per day, or50,000 barrels per day higher than the second quarter.

Refinery operating expenses, excluding non-cash costs, were$3.96 per barrel. The $0.09 per barrel increase over the second quarter wasprimarily due to an unfavorable adjustment arising from sales tax accruals thatwere charged during the quarter. This was partially offset by lower energycosts and higher throughput volumes.

General and administrative expenses, excluding corporatedepreciation, were $152 million. The $25 million decrease from the secondquarter was mainly due to additional charges incurred in the prior quarter,four charitable contributions, and the cancellation of a services agreementwith New Star Energy.

Total depreciation and amortization expense was $343million. Interest expense net of capitalized interest was $123 million. The $40million increase in net interest expense versus the second quarter wasprimarily due to an increase in average borrowings and an increase in intereston taxes arising from the previously mentioned sales tax accruals.

Our effective tax rate on continuing operations was 28.7% inthe third quarter, which was below the prior quarter due to the use of statetax credits and a greater-than-expected proportion of earnings from our Arubarefinery, which pays no income taxes.

Regarding cash flows for the third quarter, capital spendingwas $619 million, which includes $108 million of turnaround expenditures. For2007, we expect our total capital spending to be around $3 billion.

In the third quarter, we continued our stock buy-backprogram by spending $475 million to purchase approximately 7 million shares ofour common stock. So far during the fourth quarter, we have purchased over 1million shares. Year-to-date, we have returned approximately $5 billion to ourstockholders through $205 million in dividends plus $4.8 billion to purchase 70million shares, which represents approximately 11% of our outstanding shares atthe end of 2006.

To reach our $6 billion goal, we intend to purchase anadditional $1.2 billion of our shares by the end of the year.

With respect to our debt position at the end of September,our total debt stood at $6.9 billion, which is unchanged from the end of June,and we ended the quarter with a cash balance of just over $3 billion.

Now, as to the fourth quarter operations for your modelingpurposes, you should expect to see the Gulf Coast refinery throughput ofapproximately 1.6 million barrels per day. Mid-continent throughput should bebetween 435,000 and 445,000 barrels per day. Due to some planned maintenanceactivities, West Cost throughput should average between 240,000 and 250,000barrels per day. And then the Northeast system should average in the range of550,000 to 560,000 barrels per day. Refinery cash operating expenses areexpected to be about $3.90 per barrel.

With respect to some of the other items for the fourthquarter, we anticipate G&A expense to be around $145 million, net interestexpense should be around $95 million, total depreciation and amortizationexpense should be around $350 million, and finally for the fourth quarter, youshould be using a 34% tax rate for your modeling purposes.

Now I’ll turn the call over to Rich.

Richard J.Marcogliese

Thank you, Mike. Before I discuss our growth project in St.Charles, I would like to review some operating highlights from the thirdquarter.

In July, we commissioned a 16,000 barrel per day distillate hydrotreater at our Benicia refinery and in August, a 50,000barrel per day mild hydrocracker at our St. Charles refinery. These projectswere part of our overall plan for making ultra-low sulfur diesel.

Also, we are pleased that our Houstonand Paulsboro refineries were each recertified as VPP star sites under OSHA’svoluntary protection program during the third quarter. In addition, our Ardmorerefinery was recommended for recertification on November 1st. Theserecertifications were made under OSHA’s more rigorous national emphasisprogram.

VPP Star site certification continues tobe an important part of Valero's commitment to occupational and process safety.

Regarding operations in the fourthquarter, we have been executing several major unit turnarounds in ourrefineries. We are just completing a large crude unit turnaround in Paulsboro andare nearing completion of a catcracker turnaround in Texas City.

On the West Coast, Benicia has its fluidcoker down for turnaround and our Wilmington refinery has its catcracker downto support a revamp project on the alkylation unit. As Mike referenced earlier,these turnarounds will impact throughput rates on the West Coast in the fourthquarter.

Also in the fourth quarter, weanticipate the start-up of a new distillate hydrotreater in Corpus Christi inDecember. This is a 55,000 barrel per day unit and essentially completes ourULSD production plans, except for the Northeast.

Turning to projects, we are very pleasedthat our board recently approved a major expansion project for our St. Charlesrefinery. The St. Charles hydrocracker project includes a new 50,000 barrel perday hydrocracker, a 45,000 barrel per day expansion of the crude unit, and a10,000 barrel per day expansion of the Coker.

The project will increase dieselproduction by 49,000 barrels per day and gasoline production by 11,000 barrelsper day as part of our strategy to increase the proportion of ultra-low sulfurdiesel produced in our system. This project is expected to come online in 2010and cost $1.4 billion. This is one of the largest capital projects in Valero'shistory.

Now I will turn it over to Bill.

William R. Klesse

Thanks, Rich. Good morning, everybody. In general, industrygasoline and other product margins have been low so far in the fourth quarter.The seasonal changes in supply and demand and the high crude oil prices havesqueezed gasoline margins to very low levels, thought they have improved acouple of dollars here in November.

Diesel margins have been very good and unlike the thirdquarter, we are seeing wider discounts for medium and heavy sour crude oils thatwe process. For example, the Maya heavy sour crude oil discount to WTI inOctober averaged over $15 per barrel compared to the September. Today, it isover $16 per barrel. And the Mars medium sour crude oil discount is averagingover $11, one of the widest Mars discounts we’ve ever seen. And the Saudidiscounts for the month of December have increased over $4 per barrel.

As many of you know, we recently held our annual strategicplanning meeting with our board and our executive management team. The meeting,from our perspective, went very well and affirmed the strategy we have beenexecuting. Going forward, we will continue to upgrade the quality of ourrefining portfolio by investing in strategic growth projects at our flagshiprefineries that will make them even more competitive. A good example of this isthe project Rich just mentioned, the St. Charles hydrocracker project.

Additionally, we continue to solve our issues or haveprojects in development that will accomplish our goals of a safer, more reliableand more efficient operation.

Another outcome of our strategic planning meeting is that wehave decided to explore strategic alternatives for our Aruba refinery. TheAruba refinery does not make U.S. specification products, nor does it makefinished gasoline. A large capital investment is required to make thiscompetitive in the long run, thus we have decided to look at our strategicalternatives.

Regarding our cash flow, we will continue to take a balancedapproach to investing in our key refineries, as discussed, buying back ourstock, increasing dividends, and maintaining our investment grade rating.

Looking out into 2008, we expect another excellent refiningenvironment of strong product demand, favorable discounts for medium and heavysour crude and feed stocks, a tight refining capacity market as the worldeconomies continue to grow.

With that, we will open it up to Q&A.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question will come from the line ofDoug Terreson with Morgan Stanley.

Doug Terreson -Morgan Stanley

Good morning, guys. Bill, you mentioned just a minute agothat -- and the press release I think suggested that you guys are activelyconsidering strategic alternatives for Aruba and I just have a couple ofquestions on that point. First, would you consider some type of joint ventureupgrading project with another company? If so, would any specific conditionsneed to be met, or are you solely considering outright divestiture.

And the second question is how would you characterize theinterest level towards either type of strategic activity at this time, which ismore kind of a industry, general strategic question?

William R. Klesse

To your first question, we are sincere when we say strategicalternatives, but of course that includes a sale all the way through to someprocessing agreement, even. So we’re in business here for as to maximize ourshareholder value for the long run.

And how would I classify the environment?

Doug Terreson -Morgan Stanley

Well, the interest level toward strategic activity at thistime?

William R. Klesse

I think it’s still very high. I think it’s exampled by therecent announcement in California.

Doug Terreson -Morgan Stanley

Sure. Okay, thanks a lot, guys.

Operator

Your next question will come from the line of Jeff Dietertwith Simmons.

Jeff Dietert -Simmons

Good morning. I was hoping you could give us an update onthe Port Arthur expansion and the Quebec hydrocracker. Those were projects youtalked about in early September that did not go in front of the board, butwhere do those projects stand?

William R. Klesse

Rich is going to go ahead and address that for you.

Richard J.Marcogliese

We are still very active in the development process forthose two projects. For Port Arthur, we envision an identical hydrocracker tobe installed at that refinery. Also related to that project will be theinstallation of a 45,000 barrel a day grass roots coker. Now, that project ison a different timeline from St. Charles and this largely is an outgrowth ofkind of assessing total plant workload.

We have got a plant-wide turnaround scheduled for PortArthur in 2009, which incidentally includes the replacement of all six cokedrums on the existing coker. So taking a look at plant-wide workload betweenturnaround and construction, we’ve pushed back the Port Arthur schedule about ayear and it will be more like a 2011 project compared to a 2010 project for St.Charles.

For the Quebec refinery, we have active development underwayfor a combination project that would include about a 35,000 barrel a dayde-asphalting unit and a 50,000 barrel a day hydrocracker, which would make theQuebec operation more efficient in terms of reduced fuel oil production andmore flexible in terms of the varieties of crudes it can run, and that is alsoenvisioned as more of a 2011 project implementation schedule.

So we are still very active in development on both.

Jeff Dietert -Simmons

Very good. If I could, on a second question, if you couldprovide some color, there’s been a pretty severe change in the crude marketswith the market moving into backwardation. Could you talk about how that’sinfluenced your crude purchases? Has it reduced your purchases, led you toreduce inventories, buy shorter haul crude? Could you provide some color on howthat’s influencing your activity?

UnidentifiedParticipant

Sure, Jeff. This is Joe. All those things you mentioned arethings that we are certainly taking a look at. Obviously it doesn’t pay tocarry crude today, so we are managing the inventories much more aggressivelyand we are keeping an eye on it. As far as the short-haul crudes go, we areabsolutely running them to the extent that we can.

William R. Klesse

It also obviously impacts our mid-continent, probably haschanged our crude costs into our mid-continent refineries, a couple dollars abarrel from the carry to the backward.

Jeff Dietert -Simmons

Thank you.

Operator

Your next question will come from the line of Arjun Murtiwith Goldman Sachs.

Arjun Murti - GoldmanSachs

You allude to wanting to finishing up the $6 billion stockbuy-back goal by the end of this year and that you’d continue to do variouscash returns to shareholders next year. Is the timing of announcing a new stockbuy-back figured tied to whatever you decide to do with Aruba, or simplygetting to year-end and finishing up this programming, you’ll take a fresh lookat where things stand for next year?

William R. Klesse

I would say the latter, Arjun. We will complete -- our planis to complete this program. We still have some authorization that’s left thatcarries into next year, so to be technically correct here, we’ll still have acouple million dollars of authorization. And we’ll see how we see the world aswe get into the first quarter and then as we look to the second. But our planis to continue as we’ve discussed.

Arjun Murti - GoldmanSachs

That’s great. So you’ve obviously already sold Lima. You’venow announced Aruba. You’ve just completed the strategic review with the board.Should we take that to mean -- should we expect there to be continuous highgrading as we get into next year and you are kind of taking it one refinery ata time, or does the conclusion of the review process mean you’ve done Lima,you’re going to do something with Aruba and that’s it in terms of I guessselling or high-grading the existing refinery asset base?

William R. Klesse

Arjun, it’s a continuing process and so you should assumethat as we go forward, we are constantly looking at these refinery assets. Somereally capitalized on our expertise of basically boiling and coking heavy crudeoils. Some have very unique locations and others might be worth more to otherpeople.

Arjun Murti - GoldmanSachs

That’s great. Thank you very much.

Operator

Your next question will come from the line of Doug Leggatewith Citigroup.

Doug Leggate -Citigroup

Thank you. Good morning, everybody. A couple for me, realquick, I guess; what does the tax rate look like ex Aruba for the rest of theyear, the rest of the firm?

William R. Klesse

What does the CapEx --

Doug Leggate -Citigroup

The tax rate.

William R. Klesse

Tax rate, okay.

Michael S. Ciskowski

It would be probably about 1% or 2% higher, so instead of 34for the fourth quarter, you’d like at 35% to 36%.

Doug Leggate -Citigroup

Okay, great. The second one for me is given what’s going onin Europe right now, there seems to be some pretty incredible diesel cracks.Can you describe how you see the export opportunities over there?

Richard J. Marcogliese

Yeah, the arb is open, clearly, from the U.S. to Europe andwe are taking advantage of it today. I mean, we’ve got cargoes that are inprocess of heading that direction.

Doug Leggate -Citigroup

Okay, so actively taking advantage of that -- have you got atake as to how long you expect that market to remain as strong as it is, giventhe down time you’ve had on a number of venues over there?

William R. Klesse

I don’t think we would know any better than you do. We readthe paper on the down time that’s happened as well as you, so we wouldn’t --the arb is open. Our business is a global business. Products move with the arband so we’ll take, for our company, advantage of the arb while it stays open.

Doug Leggate -Citigroup

Okay. The final one from me is I wonder if you could justbring us up to date with your view on ethanol? There was a lot of discussion,obviously, about the volumetric impact, but at the same time, we are seeingsome pretty incredible discounts. When you take the tax credit into account, abig incentive there for you folks. But could you discuss the financial benefitversus the infrastructure bottlenecks as you see it in terms of whether ethanolis a threat or an opportunity for you as you move into 2008?

William R. Klesse

I’ll give you some general comments and see if I can giveyou some numbers, but today it is advantageous to discretionary blend, evenagainst butane, so where you can, you -- where the logistics are available, theinfrastructure, you would probably be blending.

We are blending because of the economics, as you properlystate, where we can but there is also a lack of infrastructure in many of themarkets, so we can’t take advantage of that. Because with the butane when weblend it, you can ship it in the pipeline for winter spec but here with theethanol, it’s got to be done all locally and so that’s the constraint.

Now, some of the numbers are compelling, as you say. Youhave any --

Richard J.Marcogliese

Well, we’ve got prices that we’re seeing -- $1.80 to $1.90 agallon for ethanol, so it clearly pays to blend it and we are blending about25,000 to 30,000 barrels a day. And we are blending it where we can.

Doug Leggate -Citigroup

Are you getting any octane benefit on the BOB that you areblending it with? Like, for example, an 83 versus an 87 regular?

Richard J.Marcogliese

The effect on the gasoline?

William R. Klesse

It would be true you get the octane, but unless we can sendto some of the terminals a sub-octane, then you don’t get it, okay? Because wedon’t have the -- we have to have the tankage and the logistics. If we areloading at the refinery, we will try to take advantage of it but logistics orinfrastructure here really restricts your ability to fully capitalize on this.But you have to get the sub-octane to the terminal.

But you’re correct; ethanol’s got a great octane and so youtry to take advantage of it.

Doug Leggate -Citigroup

That’s great, gentlemen. Thanks a lot.

Operator

Your next question will come from the line of Paul Sankey withDeutsche Bank.

Paul Sankey -Deutsche Bank

Good morning. A couple of follow-ups for me on Arubafirstly; I guess It’s a bit more complicated as a sale. Do you have a bestguess for the time scale over which it will take to get something done?

William R. Klesse

Well, we are looking at strategic alternatives, so I’m goingto tell you we are going to let the process run. It takes -- most things takemonths.

Paul Sankey -Deutsche Bank

Right, but possibly a bit longer than Lima?

William R. Klesse

I really wouldn’t know.

Paul Sankey -Deutsche Bank

Fair enough. Are there any -- you mentioned the tax rate andthe tax impact, obviously. Are there any other major impact it’s going to haveon your metrics? I’m thinking of op-ex or anything else worth highlighting thatwill change post a potential sale?

Michael S. Ciskowski

Not really. The only -- on the Gulf Coast throughput postthe sale would be down roughly 200 million a day.

William R. Klesse

Two-hundred thousand.

Michael S. Ciskowski

Two-hundred thousand barrels a day.

Richard J.Marcogliese

On op-ex, Aruba is one of our lower refineries on an op-exper barrel basis because it’s a low conversion plant. There’s no catcracking onAruba, for example.

William R. Klesse

So I guess to answer you, our operating costs in the GulfCoast would move up but if you deal in a complexity barrel, it wouldn’t be thatway.

Paul Sankey -Deutsche Bank

Sure, I got you. Just going back to the -- another follow-upfrom me, the contango backwardation issue. I think it was an earnings impacteffectively, this quarter and I guess it will continue to be that as long as weremain in backwardation. Is that a fair statement and can you quantify how muchthe impact was?

William R. Klesse

It is a fair statement certainly for the mid-continentrefineries. It gets very complicated because Louisianagrade crudes tend to price the roll into them when at WTI, we have the rollvery visible. But to give you -- because it is significant. It comes up everytime we have the -- from contango to backward, it’s in the -- between thesecond quarter and the third quarter, if you include our estimate for Louisianaon the roll, it’s probably about a $58 million hit in our crude costs.

Paul Sankey -Deutsche Bank

Okay, so that was -- that’s the trailing and I guess wewould expect that just to continue as long as the situation continues with the--

William R. Klesse

I was trying to give you a comparison but clearly you canlook at the roll and you can look where the contango was in our mid-continentvolumes and you can figure out that it raised our crude costs that much.

But yes, those numbers I gave you were second quarter tothird quarter.

Paul Sankey -Deutsche Bank

I’ve got you. Okay, thanks. Just a last one for me, I guessto roll up what you said about the change in the environment, you mentionedgasoline weaker, diesel better, differentials helpful. On balance, are youexpecting a better quarter this quarter than we saw in Q3 on an ongoing basis,obviously? Worse or -- you know, how are we panning out quarter to date forearnings? Thanks.

William R. Klesse

We usually don’t give you any guidance on this but I willtell you, you can look at the industry cracks. Obviously October was a weakmonth and the cracks are strengthening. If you look at where we are today, it’sgoing to be a weak fourth quarter but it is strengthening. Some of the marketsare recovering. As I said, gasoline is a couple dollars better, the Saudidiscounts are wider, the Maya, Mars is absolutely almost a record. I can’tremember $11.

So the quarter is improving. It’s hard for me to tell you atthis point in time whether it’s going to be better or worse than the thirdquarter, and I’ll also tell you it’s this time of year. Gasoline season for usis generally over, even though we have good demand still, and distillates,we’re like everybody -- winter’s coming.

Paul Sankey -Deutsche Bank

Yeah, and I guess that’s the basis for you being positive on’08 as well, is that despite -- I mean, you seem to be saying that demand isstrong. Could you just address that one a little bit? I guess some of the DOEdata is looking a bit weak.

William R. Klesse

Well, the DOE data is all over the place but it’s easy -- ifwe go back and look at the monthly data, gasoline is up year-to-date. However,we would not argue that the recent gasoline data is probably pretty darn flatwith last year. It’s hard to articulate whether it’s just prices or whetherit’s housing, confidence in the economy, or whatever. But we would say it’s --gasoline right now is pretty flat with last year, so your assessment iscorrect.

However, when we look into next year, lots of changes,refining is still tight, our product is still economic -- I mean, compared towhere it was, obviously not but it is still a very viable, economic product --and the dollar weakness is also impacting all of this.

But we are still very optimistic that the refining supplyand demand balance remains tight.

Paul Sankey -Deutsche Bank

I think I’ve had my fair share. Thanks for that.

Operator

Your next question will come from the line of Paul Chengwith Lehman Brothers.

Paul Cheng - LehmanBrothers

Good morning, guys. I think this is for Mike or maybe forBill; I think previously that we were talking about 2008 capital spending, $4.7billion to $5 billion, and at the time I think the timelines for Port Arthurand Quebec upgrading project is 2010, so with those two projects, the delay,are we looking differently on that CapEx range?

Michael S. Ciskowski

For 2008, we are still looking at right around $5 billion ora little bit under.

Paul Cheng - LehmanBrothers

So we are still at $5 billion?

Michael S. Ciskowski

Yes, Paul.

Paul Cheng - LehmanBrothers

And then Mike, for 2007, I think the original budget is 3.5and then later on, that turned into 3.2 and now I think, if I’m not mistaken,you are talking about $3 billion. Is there any project being delayed or thatyou guys just do far more effectively?

Michael S. Ciskowski

There is only really one project that we consciously delayedand that was the crude oil expansion at the Quebec refinery, which we rolledfrom year-end 2007 to mid 2008. Beyond that specific deferral, the capitalexpenditures are just following the normal progression of our capital projectdevelopment, and in some cases things are moving along just a little bit slowerthan we anticipated.

William R. Klesse

But you heard the numbers correctly, Paul. We would expectto be around this $3 billion or slightly less for 2007.

Paul Cheng - LehmanBrothers

I see. And I think this is for Rich; in the third quarter,we have a little bit of the operating upset in I think Port Arthur this year,some of the facility. Can you quantify that? I mean, how much is the actual andopportunity costs associated with those?

Richard J.Marcogliese

What we’ve associated with the third quarter was about a$300 million impact, which is favorable to the second quarter but it’s a bignumber nonetheless. The issues we had, just to give you a sense, we had thecatcracker outage in Ardmore in July. We had issues with the Port Arthur crudeunits also in July, which was separate from the hurricane impact that MikeCiskowski mentioned. We also difficulty with the coke handling system at our Port Arthur refinery.

We had crude throughput issues in our Aruba plant, whichwere related to typing and metallurgical issues, so we had a number of thingsgoing on across the system. Additionally, we also had a catalyst change on theTexas City gas oil hydrotreater. We don’t generally define that as a major unitturnaround, but that also had its impact in the third quarter.

Paul Cheng - LehmanBrothers

Rich, since I’ve got you, is there a preliminary firstquarter turnaround schedule you can share?

Richard J.Marcogliese

Well, I’ll just mention a couple of things for first quarter’08. In February of next year, we plan to take the St. Charles millisecondcatcracker down for about a 21-day turnaround, and then also in Quebec, we’regoing to take one of the crude units down. This is a crude unit that’s going tobe revamped for the expansion project. That will come down in the March/Apriltimeframe for about 42 days. Those are the most significant.

Paul Cheng - LehmanBrothers

And [money] for Aruba, I believe the tax holiday is comingup for extension or expiration. Is it 2010 or 2011?

William R. Klesse

It is for 2010, the end of 2010.

Paul Cheng - LehmanBrothers

The end of 2010, so whatever is the selling price of thatproperty -- if we decide to sell, that probably we’ll need to take intoconsideration.

William R. Klesse

Well, I think so. You got it.

Paul Cheng - LehmanBrothers

Okay, excellent. Thank you.

Operator

Your next question will come from the line of Chi Chow withTristone Capital.

Chi Chow - TristoneCapital

Thanks. I was wondering if you could provide us with anupdate on McKee and what the status is there?

UnidentifiedParticipant

Sure, I can do that. Currently we are in the sameconfiguration in McKee, which is the total plant is up ex the propanede-asphalting unit. Construction continues on the revamp and rebuild of thatunit. We expect mechanical completion some time late November, early December,with start-up of the PDA either just before the end of the year or in earlyJanuary.

Today, the plant is running at a throughput of about 140,000barrels a day with the PDA out of service.

Chi Chow - TristoneCapital

And are you running more sweet crude as a result now?

UnidentifiedParticipant

We have adjusted the crude mix at McKee to try to minimizethe [volumes] production. That is the constraint on the refinery operationbecause we are shipping fuel all out by rail, so very recently we’ve made someattempts to lighten the crude slate a little.

Chi Chow - TristoneCapital

How big of an impact do you think McKee and also BP's Whitingplant, downtime at both those plants is having on Cushing inventories? And asthose plants get back up, do you see the backwardation easing at all and do yousee sour crude discounts narrowing going forward?

UnidentifiedParticipant

Chi, you know it had a significant impact back in the secondand probably the early part of the third quarter. I think we saw thedislocation of TI to the other sweet crudes as a result of that, where it wassignificantly discounted. I think that largely, that’s behind us.

As far as the effect going forward and the heavy sourdiscounts coming in, with these high prices like we are experiencing today, Ithink we are going to continue to see strong discounts. We have Maya discountstoday that are over $16. We have other heavy sours that are in the market thatare trading at $20 plus discount, so I would say that if we were to look at it,we would expect the heavy sour discounts to maintain.

William R. Klesse

I think the other piece you asked in there was what ouroutlook would be on the backwardation. I would say if inventories continue tokeep drawing, the backwardation is going to continue, okay? So if you areasking how we plan our business here, we are looking at these overallinventories and trying to assess where we really think they are going to go.And if they keep coming down, the front is going to stay a little tightrelative to the out months. We’re going to see the backwardation continue.

It’s very difficult for us to comment, as Joe skipped aroundthere, that we can’t comment on BP. At McKee though, we are running prettyclose to our crude charge. BP's situation at Whiting, we wouldn’t know about.

Chi Chow - TristoneCapital

What type of crude do you think is sitting in Cushing rightnow, in storage? Is it primarily sour grades?

UnidentifiedParticipant

I don’t know for certain but we would -- we know that thereis a lot of Canadian crude in Cushing today.

William R. Klesse

I guess we’ll give you one other piece of info; we also knowasphalt markets are very weak and when you know asphalt markets are very weak,you don’t want to run the WTS, and so you tend to -- so your idea or approachhere may be right, Chi, but we don’t have any per se data.

Chi Chow - TristoneCapital

Okay, then one more question on Aruba; have you seen thereliability, in particular the power supply, improve over the years sinceyou’ve had that plant?

Richard J.Marcogliese

Let me comment. Let me say that we have put a lot into itand we even have more investments planned, but we did have a total powerdisruption on Aruba about a month ago, which was related to a transformer andbreaker failure, which we had anticipated replacing within the next year or so,so I would say we’ve put quite a bit of effort and investment into theupgrading. But the difficulty is we still have a lot of 1930s and 1940s vintageinfrastructure that is in the process of being upgraded and we’re not completewith the program.

Chi Chow - TristoneCapital

Okay, thanks, Rich. Appreciate that.

Operator

(Operator Instructions) Your next question will come fromthe line of Mark Gilman with The Benchmark Company.

Mark Gilman - TheBenchmark Company

Good morning. I had a couple of things. I wanted to go backto this mid-continent effect. Bill, I think you said a $58 million impact onthe third quarter. My guess is that it was probably something closer tomultiples of that, just going from the average contango in the second to theaverage backwardation in the third. Also, if you could clarify -- it’s myunderstanding that this is an effect really only during the time when youswitch from contango to backwardation and not if the market structure remainsthe same going forward.

William R. Klesse

I can only tell you the numbers that people give me, and thenumber I gave you is the number they gave me, okay?

As far as to your question as to -- I guess what you areasking is when it changes, it’s the impact? Well, it was contango in the secondand the contango reduced, and so I was giving you the impact of the drop in orthe reduction of the contango, of the roll.

So as it’s continued to roll and comes down to the questionthat we were asked earlier, if you compare fourth quarter to second quarter, itis going to have two times or something the number I gave you for the third tothe second. If you are comparing the fourth to the third, it’s gotten worse soit is going to be to that magnitude.

But you know this roll like I know the roll and you know thebackwardation. I’m giving you the number that we calculate.

Mark Gilman - TheBenchmark Company

-- we’re on the same page. Let me try something else, if Icould; it just appears to me that as it relates to your Texas and Gulf Coastplants in particular, that a pretty good fraction of the reliability in unplanneddowntime issues relate to power and I was wondering whether in response tothis, if you share my conclusion, whether co-gen type investments on a broaderscale would make a lot of sense.

Richard J.Marcogliese

I might take a crack at that. I would not characterize ourGulf Coast system as having a generalized power issue. If you went back a fewyears, there were issues of that nature in Texas City that we’ve sincecorrected. Where we’re having most of our reliability issues are in the PortArthur refinery, but that is primarily related to the operation of the delayedcoker.

Now, I would also say that from a co-gen infrastructurepoint of view, Port Arthur is one of the most highly integrated plants in termsof internal power generation. And a good example of that, there was this recentpipeline fire in the Port Arthur area. It took out both 230,000 volt feeders tothe refinery. We were able to [islandize] the plant and run off power generatedfrom our relationship with Air Products to product hydrogen.

I mean, just to summarize again, I would not say that wehave a power reliability issue in the Gulf Coast. Where we are seeing areliability issues, they are associated with the process units.

William R. Klesse

In Aruba, we’ve made a lot of improvements but we generateall our power there. It basically starts with fuel oil to stay into the power,and so the improvements we have made have helped but power in Aruba is achallenge.

Mark Gilman - TheBenchmark Company

Thanks, guys. Let me try one more if I could, regardingAruba specifically; Aruba has a number of the characteristics that you wouldotherwise look at I think as being desirable in terms of both size as well ascoastal location, ability to receive VLCC type cargoes. Is there a message thatperhaps you are sending the government regarding the expiration of the taxholiday with this announcement, and therefore might this strategic alternativeassessment potentially wind up in no action at all?

William R. Klesse

Well, I guess potentially I would say yes, but we aresincere in looking at our strategic alternatives. I think that you are veryfamiliar with the refinery. In a high crude cost environment, when you have acoking refinery that doesn’t do any upgrading, it is a different competitiveplant than a -- for instance, for us, our St. Charles refinery that does cokingand upgrades.

Another thing, remember Aruba does not make any gasoline. Itmakes very limited ULSD, so as we do our assessment of the future, it requiresus to invest heavily in this refinery to be competitive. And so you, as aperson who recommends our stock and as the people that own our stock wouldexpect us to do, we would -- we are looking at our alternatives. So that’s whatwe’re doing, Mark.

Hey, listen, on your contango question and backwardquestion, when the market contango in the mid-continent, we capture the roll,so --

Mark Gilman - TheBenchmark Company

I understand that. It’s the loss of that and going tobackwardation where there is a significant loss, if you will --

William R. Klesse

That’s right, so --

Mark Gilman - TheBenchmark Company

-- this is a number that in the third quarter looks to melike it’s more like $200 million.

William R. Klesse

Well, we didn’t calculate it that high but if you went backto the second quarter and went all the way to the fourth quarter, where youhave a dollar backward versus over a dollar contango, it’s a big number. Iagree.

Mark Gilman - TheBenchmark Company

Thanks, guys.

Operator

Your next question will come from the line of Daniel Vetterwith J.P. Morgan.

Daniel Vetter - J.P.Morgan

Can you comment on your progress to date towards meetingyour $1 billion operating improvement target?

Richard J.Marcogliese

Sure, and just to -- just to define that, we’ve got a $1billion competitive gap closure objective defined over a five-year period. Wehave a rigorous reporting and stewardship process towards those objectives.

What I would say generally first is the progress on thatkind of by design is more heavily weighted to the back end, because there aresome large capital projects that we need to implement to create some of thisgap closure.

Examples I would use, you know, I’ve described problems withthe coker in Port Arthur. We’ve got a premature drum cracking issue there.We’re going to replace all six coke drums in 2009. We are also going to dolikewise at our St. Charles plant and replace four coke drums there.

So certain of the refinery reliability boost and improvementthat we are anticipating isn’t really captured until 2009. Now, we do have anumber of non-capital improvement initiatives, maintenance efficiency, energyconservation, that are underway but we’re really early in the program at thispoint.

So I would say our program is on track but it is lightlyloaded on the front end and kind of heavily loaded mid to the back end.

Daniel Vetter - J.P.Morgan

Okay, and one more, if I may; I noticed that the estimatedcost of the St. Charles project, or I guess it’s actually a handful ofprojects, is up a bit from your prior estimate. Can you comment on the -- orupdate us on the expected EBITDA contribution of that project, or the expectedreturns of that handful of projects? Thank you.

William R. Klesse

The capital is up from when I was in New York in September,as we finalized the project to scope for our board, so that was the number wecame up with. We are looking here to find the EBITDA number, but the projecthas a return that’s in the -- slightly higher than the mid-teens and we expectit to, at this order of magnitude project, using our forecast in the future, itadds significant -- and that’s an [inaudible] return -- significant shareholdervalue.

If we can’t find the EBITDA, you’ll need to call AshleySmith here.

Michael S. Ciskowski

It was on the slide I think I used in New York. We haven’t-- I’ll get you an updated number for that slightly higher cost estimate now.

Daniel Vetter - J.P.Morgan

Okay, and the mid-teens return assumes what kind of a marginenvironment?

William R. Klesse

It’s our strategic plan forecasting and we do our ownforecast on this and so that -- I mean, that’s what it is.

Daniel Vetter - J.P.Morgan

Okay. All right. Thank you.

Operator

Your next question will come from the line of Ari Raivetzwith Banc of America.

Ari Raivetz - Banc ofAmerica

Just a quick follow-up on the ethanol; you had said 25,000to 30,000 a dayof blending. I’m just wondering how much of that is discretionary versus statemandated.

William R. Klesse

I don’t think we’re going to have a good answer for you onthat.

Richard J.Marcogliese

If I look at the numbers, I would tell you it looks likeprobably 12,000 or probably half of it is mandatory and the other half isdiscretionary.

Ari Raivetz - Banc ofAmerica

Okay, great. Thank you.

Operator

(Operator Instructions) Your next question will come fromthe line of Paul Cheng with Lehman Brothers.

Paul Cheng - LehmanBrothers

Just two quick follow-ups; Mike, for 2008, your CapEx is $5billion. Given the three major upgrades in Port Arthur, Quebec and St. Charles,should we assume that is roughly about in the $5 billion from 2009 to 2011also? Or that the number will be lower?

William R. Klesse

The 2008, we’re not going to spend a lot of money on PortArthur or Quebec just because of timing, so in all our numbers, we’ve said --it just really doesn’t have that big an impact.

But yes, to your question, you can look at this range ofcapital here for ’08 and ’09 and then ’10 really depends on how much was spenton these jobs in ’09, quite frankly -- ’09 is a large turnaround year for usalso. So if I add that, it could be slightly higher than in ’08. If you look atour turnaround scheduled extended, ’09, as Rich said, we have Port Arthur, we have the St. Charles,both cokers, we have the millisecond complete revamp at the end of ’09 -- bigprojects for us.

Paul Cheng - LehmanBrothers

So that means ’09 may be over five and the ’10 and ’11 maybe somewhat below five?

William R. Klesse

I think that’s a fair assessment for right now.

Paul Cheng - LehmanBrothers

And if I looked at the presentation you have this[inaudible] back in September, quickly calculate the sustainable capital isabout in the $2.6 billion, $2.7 billion for 2008. Is that also a reasonableproxy going forward, based on your current configuration, assuming we don’t doanything with Aruba?

William R. Klesse

I would say it’s in the $2 billion-ish, so 2.2, 2.3 I thinkis fair.

Paul Cheng - LehmanBrothers

Okay. A final question; Mike, for 2008, is there a numberyou can share for anti-dilution, that how much stock you have to buy back in2008? I mean, is it 10 million shares, 5 million shares? What kind of a numbershould we assume?

Michael S. Ciskowski

The number that -- I mean, a lot of that depends on theexercise of stock options and the like, but I would guesstimate about 10million to 12 million shares.

Paul Cheng - LehmanBrothers

Perfect. Thank you.

Operator

And at this time, this does conclude the Q&A session.Please continue with any closing comments.

Ashley Smith

I just want to thank everyone for listening to our calltoday and if you need more information, please contact our investor relationsdepartment. Thank you.

Operator

Ladies and gentlemen, this does conclude the Valero Energythird quarter 2007 earnings conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Valero Energy Q3 2007 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts