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Tesoro Corporation (NYSE:TSO)

Q4 2007 Earnings Conference Call

January 31, 2008, 11:30 AM ET

Executives

Scott Phipps - Manager, IR

Bruce A. Smith - Chairman, President and CEO

Otto C. Schwethelm - VP, CFO

William J. Finnerty - EVP and COO

Lynn Westfall - Sr. VP, External Affairs and Chief Economist

Dan Porter - Sr. VP, Supply and Optimization

Tristone Capital

Paul Sankey

Analysts

Doug Leggate - Citigroup

Doug Terreson - Morgan Stanley

Neil McMahon - Sanford Bernstein

Arjun Murti - Goldman Sachs

Chi Chow

Deutsche Bank

Paul Cheng - Lehman Brothers

Operator

Good morning, ladies and gentlemen and welcome to your Tesoro Corporation 2007 Fourth Quarter Earnings Conference Call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. [Operator Instructions]. At this time, it is my pleasure to turn the call over to Scott Phipps. Scott, the floor is yours.

Scott Phipps - Manager, Investor Relations

Good morning every body. Welcome to today's conference call to discuss our fourth quarter earnings. Joining me for today's call are Bruce Smith, our CEO; Greg Wright, our Chief Administrative Officer; Bill Finnerty, our COO; Otto Schwethelm, our CFO; Lynn Westfall, our Chief Economist; and other members of the senior management team.

A few Safe Harbor comments. If you need a copy of the earnings release we issued this morning or to view the company's supplemental quarterly data, you may obtain it from the Investor Relations section of our website at tsocorp.com.

The earnings release contains additional information in the attached tables on our business. In addition, we have updated the other supplemental financial and operational information on our website that is not included in the release. After reviewing this information, please feel free to contact me with any questions about this material or otherwise following today's call.

I would you like to remind everybody that the statements made during this call are referred to management's expectations and our future predictions are forward-looking statements tends to be covered by Safe Harbor Provisions of the Securities Act and there are many factors will still cause results to differ from our expectations. So with that said, I'll turn the call over to Bruce.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Thanks, Scott. Good morning and thanks to all of you for taking time to participate in our fourth quarter conference call. Before Otto reviews the numbers, I do want to make a few comments about the quarter. Most of you closely monitor market conditions so you probably weren't surprised that our press release attributed a majority of the quarter's disappointing results to very depressed market conditions.

The same factors we witnessed in the third quarter of rapidly increasing crude prices and lagging product prices continued into the fourth quarter and they've continued to impact the business so far in the... in 2008. Lynn is going to review the supply-demand details for the fourth quarter a little later and then importantly, he is going to give us his take on where we are today.

But to summarize the conditions we saw in the fourth quarter, we had rising crude prices that caused pump prices to increase, although not enough to protect margins against economic worries, an inclement December weather on the West Coast. With weak demand, the industry then inflicted more pain as supply rose in California because refineries were operating at high throughput rates, which pushed inventories to five-year highs.

In response to an oversupplied West Coast market, in early January we reduced throughput at several of our facilities, and since then there been other production changes. Looking ahead, the next milestone in the recovery of California margins will be the transition from winter to summer grade gasoline. That transition should cause the industry to reduce its winter inventory position, but seasonal first quarter demand and reduced supply, due to lower industry production rates, turnarounds and unplanned outages will be critical to rebalancing the market.

How long the rebalancing will take is a question. But we do believe it will happen and that increased spring demand will return West Coast crack spreads to the 2004, 2005 range. Today several people will touch on Hawaii's performance, which was impacted by the same macro-economic environment that I described earlier, but Hawaii did have and continues to have other unique challenges.

In the last half of 2007, we saw premiums rise for some of the traditional light sweet crudes we use. That disadvantage created greater problems because several of the long-term commercial contracts in Hawaii priced their products on a prior month or even prior months basis, which prevents us from fully passing along rising crude prices.

Of course the reverse is true and in the past, we have had declining markets which then provide a benefit if crude prices fall. In addition to those market challenges, we had a reliability problem in the fourth quarter when an electrical problem caused unplanned down time at our reformer. In total, we had a pre-tax operating loss of $85 million in Hawaii in the fourth quarter.

In the third quarter, we formed a cross functional team to evaluate the options available us to reverse the trend that we saw in Hawaii's profitability. That team completed an action plan that consists of about 200 initiatives. These are near termed solutions that are designed to return this facility to its former profitability. And yesterday we reviewed that plan with the Board and I am confident that the efforts we are initiating will improve Hawaii's 2008 results. And of course that would make us even profitable as margins return to more historical levels.

Otto, would you take us to the financial results for the quarter and then I would like you to explain some of the one-time impacts, and then you cover first quarter guidance.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Sure Bruce, thanks. As noted in the press release, we recorded a fourth quarter earnings loss of $40 million or $0.29 a share. Our refining segment recorded operating income of $9 million compared to $284 million in the same period last year. The $275 million reduction in operating income was driven primarily by the lower gross margin and higher manufacturing costs. Gross refining margin of $8.28 a barrel was down roughly 35% or $4.50 a barrel versus the fourth quarter of 2006, while refining manufacturing expenses of $5.22 or $1.34 a barrel higher than a year ago.

Although gross margins were down year-over-year against the benchmarks we performed ahead of 2006 in feed stock costs and product sales. Higher manufacturing costs were primarily a result of increased repairs and maintenance, as well as increased energy costs.

Now let me go over the one-time impacts to our quarterly results, so that you can work back to a clean number. Unplanned downtime at our Hawaii refinery lowered earnings by an estimated $30 million because of lost opportunity and additional expense. The lag effect around Hawaii prices that Bruce discussed earlier amounted to approximately $20 million. Expenses at Golden Eagle included an additional accrual of $18 million for certain environmental remediation costs associated with a recent settlement, and finally included in the reported gross margin of $8.28 per barrel is a product inventory bill of $29 million, mainly associated with our business decision of building products ahead of the Golden Eagle turn around.

As you can see in our fourth quarter results, we will now be including the product inventory impact within the gross margin rather than as a specific line item, which is the common practice for our peer group. As such, the supplemental financial tables on our website now reflect this change. Corporate general expenses were $49 million with the $15 million increase from the third quarter mainly due to employee related costs over half of which was the additional expense associated with stock-based compensation.

Total depreciation and amortization was $102 million, interest expense net of interest income was $16 million. We finished the year with total capital spending of $932 million. Our 2008, our capital guidance still remains about $1.1 billion including turn around. We ended the year with a debt to capitalization ratio of 35%.

Now let me go over our first quarter guidance. Throughput by region; in California, 230,000 to 250,000 barrels per day; Pacific Northwest, 145,000 to 165,000; Mid-Pacific, 65,000 to 75,000; Mid-Continent; 100,000 to 110,000 bringing the total throughput from 540,000 barrels today to about 600,000 barrels per day.

On the OPEX side; in California, $7.55 per barrel; Pacific Northwest, $4.20 per barrel; Mid-Pacific, $2.50 per barrel; Mid-Continent, $3.70 per barrel. For the first quarter, we expect $60 million of corporate G&A, about $20 million for interest expense before interest income, $85 million for D&A and a tax rate to continue at 38%.

Next I'd turn it back to Finn for more detail on our operations.

William J. Finnerty - Executive Vice President and Chief Operating Officer

Thanks, Otto. As Bruce said in his opening comments, despite poor industries spreads during the quarter, we can still point to successes in operations as we continue to work to optimize our assets regardless of the margin environment. Our plans ran safely and reliably during the quarter, expect for unplanned downtime on Hawaii’s reforming unit, which limited throughput rates to 74,000 barrels a day. This compares to 81,000 barrels a day in the third quarter of '07 and 77,000 barrels a day during the fourth quarter a year ago.

And as Otto said, we estimate the impact of the downtime during the quarter to be in the $30 million range of pre-tax operating income including higher repair and maintenance expense. Because the turnarounds in Anacortes, Golden Eagle and Mandan during the fourth quarter of 2006, throughput on a same refinery basis during the fourth quarter of '07 was up 34,000 barrels a day to 535,000 barrels a day, this in spite of the Hawaii outage.

Los Angeles throughput was 104,000 barrels a day bringing total throughput for the fourth quarter up to 639,000 barrels a day. We have programs in place to move to a heavier and more sour slate of crudes and to increase clean product yields. These programs combined with the input and outputs of the Los Angeles refinery have moved the corporation to a more profitable balance of inputs and outputs. We also continue to achieve an excellent endeavor [ph] on Golden Eagle's fluid coker operation, which has allowed us to continue to run heavier crudes at that facility and improve our clean fuels production.

As you recall, when we commenced the Golden Eagle coker modification project, our objective was to maintain operation of the fluid coker until the Coker modification project was completed in order to avoid a turnaround on the fluid coker. The team has done an excellent job in accomplishing this. Our focus remains keeping the problems small and manageable at all of our refineries.

On the pricing side, our realized crude cost and product values during the quarter was stronger relative to market than a year ago. Crude purchases were particularly advantage for Golden Eagle, Anacortes, and Salt Lake City during the fourth quarter. The Amoco work transfer and crude blending project that we completed at Golden Eagle in the latter part of 2007 continues to provide us the opportunity to tailor our crude diet and significantly reduce crude costs. In Anacortes, the start up of the Amine Unit August has allowed us to run more Canadian heavy crudes at significant discounts.

In Salt Lake City, we entered into a new supply contract that should allow us to continue to realize these lower crude costs going forward. For Mandan, we also entered into a long-term supply contract with the mid-continent producer that should maintain a competitive advantage for raw materials into the refinery. The producer will build the pipeline from their fields into our existing crude pipeline, which will enable us to supply 20% to 50% of Mandan's crude requirements.

We were also able to turn up additional supplies for Alaska, Anacortes, and Golden Eagle during the quarter securing for ourselves important feedstocks for these refineries. All of these efforts reflect our continued commitment to reduce our cost, while continuing to optimize runs at our refineries. On the product side, realizations were also strong relative to the market. Much of this reflects the impact of last year's 41-day turnaround at Anacortes. We also saw a significant improvement in Alaska year-over-year. During the fourth quarter of last year, a natural gas shortage in Alaska forced us to use clean products as plant fuel, which significantly reduced our realized values on clean products.

As planned, the start-up of Kenai's DDU in the middle of 2007 positions us as the only producer of ultra low sulfur diesel in Alaska which has greatly improved our product realizations year-over-year. In marketing, for most of the fourth quarter, we did see a drop in wholesale and retail margins as rack and retail prices did not follow surging crude prices. Margins however have improved since Thanksgiving. Same-store sales for the fourth quarter '07 versus fourth quarter '06 were approximately 3% lower, reflecting industry trends. Our integration of the Shell and USA retail assets is complete and we continue the optimization of the assets.

Total operating expenses during the quarter were higher than a year ago on a same refinery basis. Much of the increase reflects the higher cost of energy as crude prices soared during the period. Repairs and maintenance expenses at Golden Eagle and Hawaii were also higher year-over-year. As I mentioned earlier, the increase at Hawaii relates to the upset on the CRU during the quarter and the increase at Golden Eagle reflects cost associated with the extended end-of-run on the fluid coker.

Expenses at Golden Eagle were also impacted by environmental approval, which Otto mentioned earlier. Finally, depreciation expenses were higher on a same plant basis reflecting new capital projects placed into service during the year. As Bruce mentioned, our operations in Hawaii continue to generate losses as finished product prices could not keep pace with dramatically higher crude costs for the second quarter in a row. The unplanned CRU downtime further strained Hawaii's financial performance. Of course, we are deeply concerned about the situation in Hawaii and have an array of initiatives to address every aspect of that operation. While some of these improvements will take time, others are expected to more quickly impact Hawaii's performance.

Market volatility, product contract timing issues, refining, operational flexibility and increased crude flexibility are key focus areas. We reduced run rates at the plant and will continue at the reduced rates until margins improve. Los Angeles continues to run well with throughput of 104,000 barrels a day during the quarter, well above our initial expectations. We continue to meet and exceed our objectives for capturing new synergies associated with this acquisition and for improvements in efficiency. Through December, we achieved nearly $50 million in synergies and are on track to realize our goal of $100 million within the first 12 months of operation.

As we said in the third quarter, we are pleased with the operational performance of our newest refinery, and our ability to capture synergies has helped offset the current low margin environment. The fourth quarter had some unique challenges. Going forward we are committed to our objectives to improve safety, operational excellence, reliability and efficient capital project management.

Lynn will now review the market and give his perspective about what he thinks we're going to see in the forward market. Lynn?

Lynn Westfall - Senior Vice President, External Affairs and Chief Economist

Thanks Bill. Well, as you heard from others fourth quarter cracks on the West Coast were very weak, particularly when compared to the same quarter in 2006. Cracks year-over-year were down over $3.80 a barrel. The dynamics of both supply and demand on the West Coast were substantially different between two years. In terms of supply, fourth-quarter 2006 was a record for fourth quarter turnaround activity with over three times the amount of capacity was down from maintenance than the historical average.

By contrast turnaround in the fourth quarter of 2007 were almost 10% less than the prior year. In addition, gasoline demand in the fourth quarter of 2006 grew by six tenth of a percent while the latest data for 2007 through November reports a decline in gasoline demand over 3% in the fourth quarter.

General economy on the West Coast has weakened, the economic growth indicators were [inaudible] which had been above the levels of the rest of the country since 2003, fallen below the U.S. average in the middle of 2007. These factors led to ending December gasoline inventories on the West Coast, which were a five-year record high in 2007, versus a five-year record low in 2006. Looking ahead into the first quarter, West Coast cracks had weakened significantly to $10.40 a barrel versus an '03 to '06 average of $12.94 a barrel and are well below last year's January record setting level of $21.34. Gasoline inventories were 34.2 million barrels or approximately 2 million barrels high than normal for this time of the year. We believe some of the rise in inventory was caused by the flooding rains experienced in much of the West Coast during the first two weeks of the year, which we think lowered demand by 2% to 5%.

In addition, turnaround activity on the West Coast is not expected to begin in earnest till February, when we expect over 7% of this late capacity to be taken offline for repairs. This coupled with the seasonal switch to summer grade gasoline which begins early February in Southern California and seasonal demand increases is expected to draw inventories, strengthen margins back to more normal levels. In addition, with the arbitrage the four markets closed, our normal import volumes for the first quarter of 50,000 barrels a day should slowdown leading to a more rapid decline in the import overhead.

Work on the West Coast is beginning to realize improvements to our condition. The cracks have risen over $12 a barrel from their low point in the middle of January to $16.70 a barrel today. And a forward Contango on gasoline of $0.10 per gallon at the end of February and another $0.12 a gallon at the end of March. While we continue to be concerned about demand growth as a potential for U.S. recession we see no reason at this time the West Coast crack should not return to the historical averages for the reminder of the year. I'll turn now turn the call back over to Bruce.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Thanks Lynn for giving us your view on that. As we highlighted at our Analyst Day in December, we continue to work on ways to generate income above and beyond, whatever the commodity market is going to give us. The recent market volatility confirms our belief that future profitability requires optionality and a competitive cost structure.

Accordingly as we reviewed the principle focus of the discretionary portion of our five year capital program is projects that reduced our cost structure and positioned the company for lower margin environment, such as the one we're currently experiencing. For example we have identified projects that increase crude flexibility giving us the option to process more sour slate which should lower feedstock cost. Second, we want to attack the energy cost. Energy and crude cost are two large expense factors in our industry and our areas, where we believe we have the opportunity to unlock more shareholder value.

Finally we plan to continue to aggressively pursue synergies as Lynn said and use both capital and non-capital projects to further optimize our system. Although crack spreads have been lower longer than anyone expected and as Lynn said we are starting to see some change in that. We have a plan to address the problems of the fourth quarter and believe in the near term supply and demand will rebalance giving us a margin environment that will be similar to 2004, 2005 levels.

And with that, that concludes our comments and we are ready to take questions from investors.

Question and Answer

Operator

[Operator Instructions] Our first question is from Doug Leggate from Citigroup. Go ahead Doug.

Doug Leggate - Citigroup

Hi good morning guys.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Good morning, Doug Leggate.

Doug Leggate – Citigroup

Yes, I guess better every time. Want to try a couple, if [inaudible]. First of all in the inventory move the $29 million, that would be expected to reverse, I guess in the first quarter. Do you have any… give us any indication as what the magnitude of the actual volume decline as in terms of stock impact?

Bruce A. Smith - Chairman, President and Chief Executive Officer

You are talking the West Coast as a whole Dough?

Doug Leggate – Citigroup

Yes.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Yes, if you look at the historical levels almost variably by the end of March the industry gets down to about 30 million barrels. We are 34.2 now, so we have a draw of about $4.2 million barrels now at the end of March.

Doug Leggate – Citigroup

Sorry, I think we are talking about the wrong thing, I am talking about the actual inventory impact on your earnings in the first quarter.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Yes, Doug, end of the year, we built inventory year-on-year about $2.8 million barrels and obviously a big portion of that relates to the LA acquisition, in the other locations we actually drew down inventory and so again as we mentioned in the call the majority of the product inventory increase was a result of anticipation and building of inventories related to Golden Eagle turn around.

So again depending on where you see prices going and how that pans out that's just a kind of the wildcard but, again as usually as the case building inventories in anticipation of the turn around you would see those go down during the course of the quarter.

Doug Leggate – Citigroup

Okay. And I guess the only other one from me is the operating guidance also... the operating cost guidance was a little high, can you kind of dovetail that with what your planed turnaround activity is in the first quarter, so we get an idea of maybe, what your longer term run rate operating costs should look like. In other words is the Q1 guidance still a little high, would do you expect that to fall or what was influencing that?

William J. Finnerty - Executive Vice President and Chief Operating Officer

I think, if you take a look... this is Lynn, Doug. If you take a look at the first quarter, we do have as everybody is well aware the turnaround that will commence in the latter part of the quarter, still working on the exact timing at Golden Eagle as we make the transition from the fluid coker to the delayed coker, plus as you are aware... we had an additional array of units that are going down for normal turnaround. So, obviously that's going to influence things. During this quarter, we also have turnaround activities at Anacortes, which is presently underway, relative to the tag unit so... yes, those and two events will impact, what you're looking at as far as an ongoing rate.

Doug Leggate – Citigroup

Okay, I'll leave it there. Thanks.

Operator

Our next question is from Doug Terreson from Morgan Stanley. Go ahead Doug with your question.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Good morning Doug.

Doug Terreson - Morgan Stanley

Sure, good morning, guys. Bruce, operating costs on the legacy refining system, meaning exclusive of the Shell acquisition, appeared to have to increased by around 15% in '07, which was pretty similar to the periods I think. And based on Q1 guidance it appears that moderation and cost trends may not be on the horizon. You did talk about some of the synergy and productivity plans in California and Hawaii and so, my question is whether or not there is significant scope for additional application there or elsewhere in the system that is, and also whether you have an internal expedition for cost trends this year, meaning can you keep them to 5% rise, 10% rise, what's on your mind as it relates to cost trend this year?

Bruce A. Smith - Chairman, President and Chief Executive Officer

First, as you look back towards 2007, as we pointed out, we had a record run underway on the fluid coker. In order to facilitate that, we obviously had some additional repair and maintenance costs. And during the fourth quarter we did some additional work on the scrubber section, so that added to our repairs and maintenance costs at that facility. Our focus is as we move forward as Bruce said in 2007, is to generate programs which will reduce our operating costs. Everybody in the industry experienced the variable on energy, but above and beyond that what we are very focused on is programs to drive down lower cost.

We had a team of… including both the refinery managers and our production managers in San Antonio two weeks ago, to address the issues of operating costs and to look at programs that we can implement during the course of the year, that will help drive down costs. Now, obviously at Los Angeles at the time that we acquired the facility and we indicated that we will have some additional expenses associated with bringing that facility up to the standards that we like to see. So I think we're going to continue to see some higher costs associated with that, at least for the next year, but at the rest of the facilities, the clear focus is on trying to bring down expenses.

Doug Terreson - Morgan Stanley

Okay.

William J. Finnerty - Executive Vice President and Chief Operating Officer

I think Doug, the entire focus as we talked in the investor meeting in... at the end of the year for our corporation is really transition from the use of cash for acquisitions to really addressing our cost structure. And we got facilities burning jet fuel for power.

Doug Terreson - Morgan Stanley

Okay.

William J. Finnerty - Executive Vice President and Chief Operating Officer

I mean, we have enormous opportunities, some of those are going to take a little bit of time, but I would tell you that the amount of work that's going into looking at how we can and if you look at our ten year business plan that we presented to the Board, it's all about a long-term reduction of cost.

This year… to answer your questions specifically. I don't recall the exact increase that we budgeted, but it's a modest increase. But some of these repairs and some of the other things that we’ve experienced have affected our cost structure. But our plans for this year are really little bit more modest tempering of that increase.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Doug this is Otto, I might also add, that the guidance on the two regions that actually had increases. Pacific Northwest, we’ve already talked about reducing throughputs, so we've got fixed cost so that the increase there is directly related to the lower throughput. So that's why those cost per barrel actually go up and then in the Mid-Con where we increased to… the guidance of 370, that's primarily driven by higher energy costs. And again as we disused at the earnings call or at the analyst meeting a lot of the initiatives that we have on controlling costs are around reducing operating expenses as Fin mentioned and specifically tailored toward energy cost reduction.

Doug Terreson - Morgan Stanley

Okay, sounds like you are really focused. Thanks a lot.

Operator

Our next question is from Neil McMahon from Sanford Bernstein, go ahead Neil with your question or comment.

Neil McMahon - Sanford Bernstein

Hi, I have few questions, maybe the first one to Lynn. Lynn, maybe you could just go over to the planned downtime number again for yourself and for the industry as well and then I’ve got a follow-up question?

William J. Finnerty - Executive Vice President and Chief Operating Officer

You are talking about the first quarter?

Neil McMahon - Sanford Bernstein

First quarter, yes.

William J. Finnerty - Executive Vice President and Chief Operating Officer

Okay we expect first quarter, this late [ph] in downtime to average somewhere in the 150 to 200 barrels a day range and conversion downtime a little lower than may be 120,000 to 125,000 barrels a day. Those look like they are peaking in February and then there is another peak coming up in April.

Neil McMahon - Sanford Bernstein

Okay great. And secondly, historically it's been the case that building inventories of gasoline has largely been to some degree really restricted by the fact that most of the infrastructure in California, is owned by the refiners themselves, the domestic refiners and therefore imports have been... can be some what controlled. When you look at the situation now where we've got very high inventories in California, what do you put that down to, is it lots of import that have come in or is it being due to this demand weakness at the end of December? What would you describe the current situation and the main drivers?

William J. Finnerty - Executive Vice President and Chief Operating Officer

I think how we got there as an industry was number one. As I've said on the West Coast you really don't get into turn around season until last February whereas rest of the country running at January. So really in the month January we were as the industry building inventories and ready for a turn around. I think on top of that, we saw a severe demand decline in the first two weeks when those horrendous rainstorms hit . We have to make that demand part between 2 and 5%. So to accommodate those two things as well as general shape of the economy on the West Coast, that already gotten us to that high point import now. But if we, with the older projects and importing typical 50,000 barrels a day to get us the turn around and just relying on inventory, we should be able to bring those back down to more normal levels easily by the end of March.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Now Neil, I think that when you look at the inventory situation on the West Coast, imports obviously really depends on the economics that exist in the marketplace. We've seen inventories, we've seen imports as Lynn's reported in the past double the amounts we're talking about and what's normal. But with the market conditions like they are, that will dry up. I think the other factors that we talked about, which are turnarounds, which are also some production cutbacks where people are just responding to the marketplace. You got the independents, I mean doing the smart thing and starting to react to weak margins that takes production out. And so, this rebalancing that we see is a normal response to market conditions and as we… I think we frequently talked about, the highs that you see never last long because the market's going to figure out a way to take advantage of them and the lows don't last a long time because people are going to make the proper economic response and I think we're already starting to see that.

The question as I said in my comments is really how quick do all the combination of those factors and the fact that we have to liquidate winter grade gasoline curve and we are talking about, I think more than anything else in one month. And there have been some weaker demand, the recessionary worries, there been a lot of factors that are a little bit more normal, but at the end, the market will adjust and our feeling is that you can start to see that in the trends that if you look backwards, it's awful, but if you look forward it's looking very good.

Neil McMahon - Sanford Bernstein

Maybe just one last quick question that touches on those comments. When you look specifically at peak travel periods during the day and work week from your newly expanded retail stations in California, have you noticed the drop off there or is it more discretionary travel that potentially is being impacted?

Bruce A. Smith - Chairman, President and Chief Executive Officer

I think if you look at 2007, we did see the unemployment rate in California go up and that did have an impact on your daily commute and I think that was probably the most significant contribution to same-store sales drop that we witnessed. However, as we pointed out earlier, you get into the latter part of December and in particular a good part of January, we saw just torrential rains in California, which dampened both elements of driving.

Neil McMahon - Sanford Bernstein

Great, thanks.

Operator

Our next question is from Arjun Murti from Goldman Sachs, go ahead.

Arjun Murti - Goldman Sachs

Thanks. Bruce, when we look at your refining system, you've got obviously a good position on the West Coast with Golden Eagle generally doing well, Anacortes, you seem to be getting your arms around Wilmington now. The Mid-Continent outlook much improves the Mandan and Salt Lake makes sense. Can you talk about the long-term viability of Hawaii and I don't mean this to be just a reaction to the fourth quarter loss. Over long periods of time, it's never been your most profitable asset, margins have always been a narrow bend out there. Does it really make sense to spend the management time and effort fixing and improving Hawaii? How does that really fit into your long-term plans of the company?

Bruce A. Smith - Chairman, President and Chief Executive Officer

That's a great question Arjun and I will tell you, we… as a part of our continued planning process, which you would expect we would have done, we went through to look at what's it going to take in capital, what are going to be… what's the net present value, what future cash flows are and Hawaii has always been underperforming as you look at our portfolio. It's at the bottom end of the returns. It's had… in the last years, it's had 15% type return on capital employed, but that's the low end of what is... what our bracket has been.

And so as we went through the ten-year plan, the natural thought process was to look at our entire portfolio and… it was a natural force to begin with. The question is does it make sense in the longer term. We did the same thing when we started this... early in the third period when we had Dan Porter lead this team to look at. My question was, geez should we be shutting this facility down, what's it going to take in capital to correct it, are we on track for looking at the capital investment that the ten year plan that we were looking at to make corrections relative to the book value and our expectation. So, we've done a pretty complete analysis of this facility, in particular we did with all facilities, but obviously with the current state when you loose as much money as we've lost, you have to look to all the different options that exist.

We reviewed those with the Board yesterday, which you would have expected us to do. And I think the answer is... to the question is that we have to make some changes, the marketplace here has changed, it's always a difficult marketplace, these marketing contracts, the commercial contracts that have prior month pricing have always been an issue for us, I mean anybody that's listened to our conference call, we've talked about this forever and we have been successful in transitioning a large percentage of our contracts to a more current month pricing basis. We have a few legacy ones that we've got to do some work on. But the net of it is that when we look at it, I think that we still think that this facility obviously can do a lot better then it has done. We think it'll return, if you look at the net for the year and take out the extraordinary items that really goes down to a couple of things. It goes down to... for the year about $100 million of losses that it could be attributed either to the crude side or to the marketing side.

In a stable market, we believe that the… obviously the marketing in fact goes away, that then correct the long-term problem, but it goes away and we're really working, this team has developed a good feel for what can do to change the crudes. So we think substantially, we are going to improve the profitability. And I think that what we see still is that this potentially fits into more of our activity as you look at some of our strategic goals relative to Asia, but that doesn't mean that we aren't reviewing this situation... actively reviewing the situation about what to do, but I think first foremost goal is to execute our plan with these initiatives to get it back to profitability. Then you have a little different situation relative to what your options are.

Arjun Murti - Goldman Sachs

Bruce, I appreciate that. Is it the marketing contracts, why you have to run it even at such a big loss in the fourth quarter?

Otto C. Schwethelm - Vice President, Chief Financial Officer

Well you know, Arjun I think it was a combination [ph], it was clearly the rapid rising crude prices and the fact that some of these contracts have a lag in their pricing structure that can be one to two months, and you saw how crude increased so rapidly during the 4Q. So, when you take a look that, that's obviously a big part of it. But the other part was as Bruce said in the Asian market, the traditional crudes that we were bringing in such as Tapas [ph] and other low sweet crudes, those crudes had high premiums within… the ability to get other grades to run with propane [ph] with such as the heavy sweet story which we think our… and AXL which are good crude's to continue to bring into that facility. I think those two factors there are the ones that hit us hard in the 4Q.

Arjun Murti - Goldman Sachs

I'm now with you. If you going to run Tapas and some of the Asian crude's with the lagged pricing effects that is going to be tuff for the quarter.

Bruce A. Smith - Chairman, President and Chief Executive Officer

You just got slaughtered with the combination and I think that Dan Porter who led this team, who run supply and optimization for us. Every month we took a look at whether we were going to be better off one way or the other to meet the contraction where we were and obviously with our crude purchases and when you make crude purchase. You're sort of there, for entrants here in the first quarter, I think we are already talking about the pricing it for about the end of February and so we're almost cooked in our pricing structure for the first quarter.

We appreciate, this is one of the biggest concerns that we have as a corporation and it is not lost on us and it has been... its actively discussed what we should do but I think that the end result of the planning that’s done and Dan Porter is on this phone call because it was an enormous effort to try to figure out how to go through the change measure. How do you change the crudes, for… we're not looking at the five-year investment plans here. And Dan's team has found some modest ways that we think we can make some changes to crude. We're trying some different crudes in February for the first time that we think we could alter what we're doing and I think based on that and when we take profitability, I'm not sure what the end result is but the level of profitability that is to say. But then, we have to... we have to make some long-term decisions about okay the next level of investments that are here are other factors. But our first focus has got to be on just generating cash at this facility.

Arjun Murti - Goldman Sachs

Right. Bruce, separate from Hawaii, you mentioned in the past lot of the cash and balance sheet had gone towards acquisitions, now you've got the organic program. Can you make any comments that there are a number of assets on the market at least three by Valero and potentially few others to follow Sunoco, Tulsa. Either generally or specifically can you characterize your interest in any of those facilities?

Bruce A. Smith - Chairman, President and Chief Executive Officer

We have never done that. I'll tell you we're not actively doing anything right now but focusing on our business. The package that’s out there, we've looked at... we continue to look at almost every package on the teaser at least. Just to look at what is going on in the marketplace, we tried and then set in our own mind whether we want to do something or what we think the value would be but we are not actively involved in today in looking at anything in the asset... in an asset way that doesn't mean tomorrow that we may not do that but the focus... the entire focus for the team has really been about trying to correct the cash, the cash drain that we've had on Hawaii looking at, are we on track and we haven't talked lot of about Wilmington. But with Wilmington we are about to start facing out as a bad crude contract. Wilmington, that whole process stars to unwind and so our focus is trying to get what we do and get it to a higher level right now and have that impact us in 2008.

Arjun Murti - Goldman Sachs

That's really helpful. Thank you very much.

Bruce A. Smith - Chairman, President and Chief Executive Officer

You are welcome.

Operator

Our next question is from Chi Chow from Tristone Capital. Go ahead with your question.

Chi Chow

- Tristone Capital

Good morning.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Good morning Chi.

Chi Chow

- Tristone Capital

Back on these operating costs. Bruce, could you go into a little bit more specific detail, when you talk about the issues with your energy cost, what exactly are the issues, you mentioned burning jet fuel and is it natural gas pricing. What other issues are there and what specific actions are you taking to improve that situation?

William J. Finnerty - Executive Vice President and Chief Operating Officer

Chi this is Fin, a little background, as you know the assets that we acquired overtime, we're going to have to spend some capital, bring them up to standards that will provide the lower operating cost we're looking for. Energy efficiency is one of those areas that, over the past five years we have not spend a lot of money on. So the bright side is that we move forward, there are significant projects that we'll be looking at in our ten-year plan that going to provide the benefits to those projects.

Just to give you an idea of the process that we go through, we are going through a detailed review at every facility to come up with the energy projects, then we'll look at that on a system-wide basis and then allocate capital appropriately. But you can go from facility to facility and there is clearly room for improvement. What Bruce was talking about, with the jet fuel is we run jet fuel to operate cogen at Hawaii, at these prices here, that's a burden that we can't afford to continue to have. So we are looking at alternatives there.

As you go on to look at some of the other facilities, obviously we've got a lot of room at Los Angeles, that's embedded in our capital program. At Golden Eagle, we've talked in the past that once the coker modification project is complete, that in essence is a platform for a host of energy efficiency projects which we have embedded in our plan. So we have a lot of opportunities out there, we are very focused on prioritizing those, and those are the type of things that we'll be moving forward with.

Bruce A. Smith - Chairman, President and Chief Executive Officer

I think we talked a little bit, Fin, talked about the disadvantage that we have... had in Alaska. There are some markets where it is just clear they aren't the normal type of energy markets. And so what we've done is, just put this in perspective. What we've done is focus, first of all and we talked about this for a long time, we've used the term crude flexibility, people return [ph] crude optionality. But the biggest lever that you call is in reducing crude cost. And so our projects have been taking the bigger, faster hits for how do we alter crude. We are still doing that now in some of the programs that we talked about for Hawaii, which Dan and his team on the supply side have been working on to try to figure out how can we do this is without investing a lot more money.

The energy side has been, we've had a few projects but it's, again highlighted here in Hawaii because there isn’t any natural gas in Hawaii. So power and when you look at the competitive cost structure here, and it is not competitive cost structure, just the Chevron's refinery next door. Obviously it's competitive to whatever you have in the way of import purity [ph] because that's what we price against in the island going back to what Arjun’s questions was.

And so we understand that the world in the global market has become more competitive and our cost structure has to reflect not… in particularly were those markets exist, were you have to drive your cost structure down or look at alternately what you're going to do. So our cost structure is important going back to energy but it's just one component. It's looking at everything that we do, and if there is good news in the story, it is that we're doing some of it now and we believe there is a lot more to do.

Chi Chow

- Tristone Capital

And so, is the timing on these improvements you think as we protracted out ways then, it sounds like you're in the process reviewing all these issues?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Actually in the ten year plan, we've identified a number of key projects, but these type of projects, they are going to be rolled out, so you won't really realize the benefits installed at the tail end of this year and then we'll continue roll in on a fairly ratable basis over the rest of the plan period. These are the things that don't happen overnight, but the contrary to that Chi, is that we continue to focus on our

operating processes and reliability to try and improve upon that stature also.

Otto C. Schwethelm - Vice President, Chief Financial Officer

In the investor program we gave you if you look at it, the majority of the improvements that we're looking at for 8 and 9 are really around crude. There are a small amount of energy. We focused on that, that's where we spend our money. I would say we are much more serious about defining the long-term and certainly Lynn [ph] has highlighted that one of the things that Dan's team pointed to was how disadvantaged we are around our cost structure here because it's changed so quickly, when you have to burn high price jet fuel for your cogen. So I think that some of them are going to be more immediate but a smaller portion on the energy side I think that’s sort of the next several years I think that the crude side is we have a few things that will continue on the next several years also but the ones we have talked about which are on the website from the... I think it is still in the website from the investor meeting, were all about crude flexibility and lowering our crude costs.

Chi Chow

- Tristone Capital

Let me ask you one more question on that point. In the Pacific Northwest you are starting to run more heavy Canadian crudes at Anacortes. What sort of volumes are you running right now and it doesn't seem like we're seeing that necessarily in the realized margins yet and when you see it... when you expect to see the impacts there?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Well actually you should be seeing it in the 4Q, but it is a big project that the latest step change that we had up there Chi was the main unit that went online. So that came online in the third quarter. That has enabled us to increase the heavy crude runs up there and to maximize our ability at the plant we have also talked in past about the tankage that we ahead of pipe and that’s going to provide us the ability to blend at the [inaudible] and batch just the right specs down to make sure we are meeting the maximum capability at the facility. So I think if you look at Anacortes we are very pleased with the results of that particular project and we did run some additional heavy crude at Anacortes during the fourth quarter because of that.

Chi Chow

- Tristone Capital

What is the volume on the Canadian right now?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Dan, do you know?

Dan Porter - Senior Vice President, Supply and Optimization

We essentially have doubled the level of Canadian that we are… heavy Canadian that we are processing at Anacortes from what we have done prior to the investment. Typically that's somewhere in the 15,000 to 20,000 barrels a day range, is what we are able to do.

Chi Chow

- Tristone Capital

Thanks a lot.

Operator

Our next question is from Paul Sankey from Deutsche Bank. Go ahead Paul.

Paul Sankey - Deutsche Bank

Hi guys. Just keeping on with this cost thing quickly. I think it is understandable given what you said about the crude cost and the energy cost that would have a jump in Q4 given what happened with energy prices. What I was wondering is why is that continuing into Q1 given at crude price is more less than stabilized that the average levels that we saw for Q4. Could you just talk about the step change ops that we have got and what is driving that between the guidance… what happened in Q4 and the guidance for Q1? Thanks.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Well, I think we have had a bit of softening on the crude prices but if you look at the average that we have it is still been hovering around $90. So we still have very high crude cost as we move into the first quarter. The other thing, the only abnormal thing that we have in the first quarter are some of the repairs that are underway. As I said there is more maintenance associated with the fluid coker as we get towards the end of the run at the end of the quarter. Outside of that, the cost at LA, I mean we've talked before about we will have higher maintenance cost at LA through out the course of the year because of the numerous projects that we are trying to do to improve the reliability there. Outside of that for the rest of the facilities we are in pretty good shape.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Obviously… relatively flat... our plan directionally is to say, have programs in place that will keep the operating expenses flat and try and work off any inflation.

Bruce A. Smith - Chairman, President and Chief Executive Officer

One of the things... I don't have that number with me as to exactly when you look at the composition of CapEx, I'm sorry, but I really believe that probably it's little flatter than may be... than may be your comments suggested, if we've led anybody to believe that its... these OpEx changed due to energy, I'm not sure that that's really true. I don't... is there anybody on phone that could comment on that one-way or the other?

Scott Phipps - Manager, Investor Relations

Total increase in OpEx to the guidance, majority of it the $23 million out at the $32 million [inaudible] on the coker atleast on least on the safety expenses.

Paul Sankey - Deutsche Bank

That's helpful Scott thanks. On the share count, a positive surprise is the lower number. Could you just talk a little bit about share count for the year, as I said below what we thought it would be and what the outlook is there, perhaps you mentioned as well in your comments dilution, any guidance you could give would be helpful, thanks?

Otto C. Schwethelm - Vice President, Chief Financial Officer

I'm not sure from the standpoint of the expectation... really there's nothing significant that we are aware of.

Paul Sankey - Deutsche Bank

So that mean we just assume that it holds the 136 a year… right for the year or do we expect it to rise on the 36 million shares?

Otto C. Schwethelm - Vice President, Chief Financial Officer

Basically it is just the result of exercise of options and things of that nature, so I don't think... that is not going to change significantly. So I think we use the current trend for the expectations going forward.

Paul Sankey - Deutsche Bank

Great thanks and just finally Lynn on distillate inventories, those seem to be at record highs on the West Cost. Can you just talk about distillate markets and what you are seeing on that side of the ledger and I will leave it there. Thanks.

Lynn Westfall - Senior Vice President, External Affairs and Chief Economist

Yeah, I think we are really [inaudible] because the first turnarounds we are going to have are primarily on distillation. So they’ll have... they build those in [inaudible] in core components for those like [inaudible] we are also seeing some pretty good exports opportunities, I think moving off the West Cost down into primarily South America, there is a really good arm there. So between those things that will probably take care of distillate inventories.

Paul Sankey - Deutsche Bank

Great thanks.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Paul this is Otto, just a quick follow-up. I think what you are doing is referring to the share count for the quarter, which because we have a loss, there is no dilution, so you don't have the impact of the conversion and the diluted. So if you look at the year-end count you are still at 1395 versus 1398 compared to last year.

Paul Sankey - Deutsche Bank

I have got you. Thanks Otto, I appreciate that.

Operator

Our next question is from Paul Cheng from Lehman Brothers. Go ahead Paul.

Paul Cheng - Lehman Brothers

Hi, good morning guys.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Hi Paul.

Paul Cheng - Lehman Brothers

I think that I have the numbers of very short. I have to apologize, I think I missed those numbers from Otto, Otto can you repeat what is the DD&A and also the Golden Eagle environmental settlements provision in the fourth quarter, and the DD&A for the first quarter 2008?

Otto C. Schwethelm - Vice President, Chief Financial Officer

Let me make sure I have got it. I’ve got guidance for first quarter 2008 DD&A is $85 million.

Paul Cheng - Lehman Brothers

Okay. And that you're saying that the Golden Eagle environmental provision in the fourth quarter I believe.

Otto C. Schwethelm - Vice President, Chief Financial Officer

That's correct that was a additional accrual of $18 million.

Paul Cheng - Lehman Brothers

18, is it pre-tax or after-tax?

Otto C. Schwethelm - Vice President, Chief Financial Officer

18.

Paul Cheng - Lehman Brothers

18, but is it pre-tax or after-tax?

Otto C. Schwethelm - Vice President, Chief Financial Officer

That's pre-tax.

Paul Cheng - Lehman Brothers

Pre-tax.

Otto C. Schwethelm - Vice President, Chief Financial Officer

All of these are operating income pre-tax numbers.

Paul Cheng - Lehman Brothers

And you have mentioned that the inventory loss in the quarter, for fourth quarter is $29 million. I think that is an after-tax.

Otto C. Schwethelm - Vice President, Chief Financial Officer

All of those would be pre-tax Paul.

Paul Cheng - Lehman Brothers

That is a pre-tax number also.

Otto C. Schwethelm - Vice President, Chief Financial Officer

That is correct.

Paul Cheng - Lehman Brothers

So that the number that you say before, say the $20 million time lag in Hawaii is $20 million in reduced earnings, $30 million those is all pre-tax number.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Right. It's correct.

Paul Cheng - Lehman Brothers

I see. Okay. And I'm wondering Bruce if Hawaii order unit the reformer problem is now that back to normal in January?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Yes, it came back online in December.

Paul Cheng - Lehman Brothers

In December, so for the full months we should not see that problem. And...

Bruce A. Smith - Chairman, President and Chief Executive Officer

The other thing that we are working on which is, which is a very important project. This is second time we've had an electrical problem and... I guess it maybe in certainly at 18 months, 14 months. We are about to complete an upgrade to the electrical system there, which will be completed in March. Is that Fin?

William J. Finnerty - Executive Vice President and Chief Operating Officer

Yes.

Bruce A. Smith - Chairman, President and Chief Executive Officer

So in the next couple of months, we won’t be as exposed to this particular issues we have been for the past year.

Paul Cheng - Lehman Brothers

Okay. Thank you, Bruce. And Otto, if we assume that oil price stay where we are today for the remaining of the quarter, presumably that in Hawaii the lacking the effect, and we see some of the reversal. Can you quantify that how biggest that reversal may be? What are benefits that we may see if commodity price stay where we are and not moving for the remaining of the quarter?

Otto C. Schwethelm - Vice President, Chief Financial Officer

I think directionally, you won't see the impact that we had if the market stays relatively flat. You know there are so many different elements, timing of the contracts when the market was up or down, you still have volatility in the market. It's not just as severe it was before. By directionally, we should be softening that impact.

Paul Cheng - Lehman Brothers

So you can't give us a quantified number at this point.

Otto C. Schwethelm - Vice President, Chief Financial Officer

You can tell me what the market--.

Paul Cheng - Lehman Brothers

No. That's what I'm saying. That if, if the price stay where we are and not moving at all for the remaining of the quarter.

Otto C. Schwethelm - Vice President, Chief Financial Officer

Maybe historically, let me look at it in another way. What we saw in the year, we saw it go crude go from, I don't know what the number was, we went from 60 to 90, fairly sustained rise. And that cost us over… for the course of the year over $40 million. So if it bends over the other way and the same slope going backwards it will be about $40 million benefit. If we look traditionally in the stable markets, that we've seen that number probably is more in the $4 million to $5 million range.

So if you believe you’ve got some type of stability, and that doesn't mean that the price is right on and when we are talking about the stable markets of the past, it probably is even what we would characterize is more stable than what a stable market is today. That is to say a 10% swing today is more than obviously, than the aggregate than it was it's a $60. So, it's still meaningful money, but it's nothing like what we've seen in the... in this particular market in the past year.

Paul Cheng - Lehman Brothers

Okay. That's great. Fin the coke plant, now they are at the very tail end of their life, in terms of their performance, if the run rate or the ability to run heavy oil have any impact or does this continue, incur more cost, but run rate is about the same?

William J. Finnerty - Executive Vice President and Chief Operating Officer

Actually we have been very pleased with the run rate. The team out in Golden Eagle has done a fantastic job and they've maintained higher rates on the fluid coker throughout this time period. But, as we said, there have been some additional expenses in order to stay there. We did not expect when we planned for the turnaround that we would be at these levels that we're at today. We thought with this type of unit, we'd see a gradual decline in coker rate. But, because of the good work that they've done out there, we've been able to maintain fairly high levels.

Bruce A. Smith - Chairman, President and Chief Executive Officer

But, I think it's also a result of the investment we made, roughly $50 million investment we made in the Distributed Control Systems there, which gives us great belief that going forward as we get even the new system on that we're going to see even better results.

Paul Cheng - Lehman Brothers

And Otto, on a different subject, With the Hawaii, the reformer problem, presume you guys have business interruption in the instrument. I'm wondering if that big enough to trigger that and to have some future payments for you guys?

Otto C. Schwethelm - Vice President, Chief Financial Officer

Did not, It did not meet the time or the deductible on either.

Bruce A. Smith - Chairman, President and Chief Executive Officer

It is more catastrophic in nature than an incident like this. And one of the real advantages that we have and as a company, I mean we paid for it, but obviously if there is something that's catastrophic that happens, we do have that kick in. And of course, the other benefit we've always said and we've talked to the rating agencies about this, not only do we have that, but it's based whatever the current market does and you would think that if we take a refinery down substantial amount, that the whole market floats up. So, the value of the loss production is even higher. So, but that... but it didn't meet the threshold under the BI.

Paul Cheng - Lehman Brothers

Okay. A final one, Bruce, if the margin for whatever reasons stay similar to the current level pretty depressed and how, how much is the flexibility on your 2008 capital spending program, will you be able to cut back or you would decide that to fund it by borrowing some money?

Bruce A. Smith - Chairman, President and Chief Executive Officer

Well, I think that we obviously have done sensitivities around what the margin environment would be, we'll make the decisions. We're starting to look at what we could differ in the current year to better match our cash outflows with a lower margin environment. I think we're prepared to do that. We're actually making some baby steps right now. We don't want to do that too early as we look at the market, it seems to be going the other direction. March is the critical month, as you look at where demand shifts and as the inventories change. But, in a prudent way, we've already prepared for a more adverse market environment from a cash perspective and looking at how we would adjust our capital program.

Paul Cheng - Lehman Brothers

And Bruce under the worse environment, that how much of the program that you'll be able to shift along? Is it, $200 million or $300 million any comp number you can share?

Bruce A. Smith - Chairman, President and Chief Executive Officer

No. I'm not going to share that number right now. I think that it's too premature to start down the path of what we would do. But, I would tell you that we are prepared to make those decisions earlier rather than later because, obviously once you start to comment, it gets to be a lot more difficult to reverse them.

Paul Cheng - Lehman Brothers

Thank you.

Operator

There appear to be no further questions at this time.

Bruce A. Smith - Chairman, President and Chief Executive Officer

Well again it's... I appreciate, it's been a little over an hour for this conference call. I know the surprise of the quarter, made it a longer call. But, I do appreciate that good questions we had today, the interest that you have in what we're doing and the time that you committed. We'll look forward to reviewing the first quarter activity with you. And if there are follow-up questions, please feel free to give Scott a telephone call. Thanks again.

Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. And have a great day.

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