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LyondellBasell Industries NV (NYSE:LYB)

Q2 2012 Earnings Call

July 27, 2012 11:00 am ET

Executives

Douglas J. Pike – Investor Relations

Karyn Ovelmen – Executive Vice President and Chief Financial Officer

James L. Gallogly – Chief Executive Officer

Sergey Vasnetsov – Senior Vice President, Strategic Planning and Transactions

Analysts

Jeff Zekauskas – JPMC

David Begleiter – Deutsche Bank

Robert Koort – Goldman Sachs

P.J. Juvekar – Citigroup

Don Carson – Susquehanna Financial

Duffy Fischer – Barclays Capital

Laurence Alexander – Jefferies & Company

Vincent Andrews – Morgan Stanley

Kevin McCarthy – Bank of America/Merrill Lynch

Bill Hoffman – RBC Capital Markets

Nils Wallin – CLSA

Gregg Goodnight – UBS

Operator

Hello, and welcome to the LyondellBasell Teleconference. At the request of LyondellBasell, this conference is being recorded for instant replay purposes. Following today's presentation, we will conduct a question-and-answer session. (Operator Instructions)

I’d now like to turn the call over to your host, Mr. Doug Pike, Vice President, Investor Relations. Sir, you may begin.

Douglas J. Pike

Thank you, Brian. Well, hello and welcome to LyondellBasell’s second quarter 2012 teleconference. I’m joined today by Jim Gallogly, our CEO; Karyn Ovelmen, our CFO; and Sergey Vasnetsov, our Senior Vice President of Strategic Planning and Transactions.

Before we begin the business discussion, I'd like to point out that a slide presentation accompanies today's call, and is available on our website at www.lyondellbasell.com. I'd also like you to note that statements made in this call relating to matters that are not historical facts are forward-looking statements, and these forward-looking statements are based upon assumptions of management, which are believed to be reasonable at the time made, and are subject to significant risks and uncertainties. Actual results could differ materially from those forward-looking statements. And for more detailed information about the factors that could cause our actual results to differ materially, please refer to the cautionary statements in the presentation slides and our financial reports, which are available at www.lyondellbasell.com/investorrelations. A reconciliation of non-GAAP financial measures to GAAP financial measures together with any other applicable disclosures, including the earnings release, are currently available on our website, lyondellbasell.com.

Finally, I'd like to point out that a recording of this call will be available by telephone beginning at 2 pm Eastern Time today until 7 pm Eastern Time on August 27, by calling 866-418-8384 in the United States and 203-369-0754 outside the United States, and the passcode for both numbers is 2378. And during today's call, we'll focus on second quarter 2012 performance, the current environment, and the near-term outlook.

With that being said, I'd now like to turn the call over to Jim.

James J. Gallogly

Thank you for joining our earnings call. As Doug mentioned, a set of presentation slides accompany this call, and are available on our website.

Let’s begin by taking a look at page 4 and reviewing a few financial highlights. Net income was $768 million and EBITDA was $1.77 billion. The quarter included some charges and gains that are not reflective of the underlying business and exclusive of these, net income was $939 million.

Our earnings per share were $1.33 or $1.66 exclusive of the charges and gains that I referenced. Karyn and I will discuss the quarter in detail, but I thought I would quickly summarize a few highlights and trends.

The North American olefins, we benefited from increased ethylene margins. Raw material costs declined as the quarter progressed. European olefins results exceeded expectations as raw material costs declined in advance of product price declines resulting in margin expansion.

All the olefins sales volumes declined reflecting weak economic conditions. Intermediate and derivative results remain strong and were consistent with the first quarter. We’ve restructured our reporting. Oxyfuels are now part of the I&D segment. Karyn will provide more color on this.

Our earnings release also includes an attachment with additional details. Houston refinery spreads increased as the Maya 2-1-1 averaged approximately $23.15 per barrel. However, byproduct values remain weak. Our Berre refinery is now accounted for as a discontinued operation.

During the quarter, we resolved a past insurance claim related to Hurricane Ike, and recognized a gain of $100 million, and we raised our interim dividend by 60% to $0.40 per quarter. The second quarter was challenging for the entire chemical industry in terms of a sluggish economy and volatile energy costs. However, our company met this challenge with highly focused, disciplined, and effective execution, and delivered very strong results. In fact, the second quarter was the all-time record underlying EBITDA quarter for the company.

We also had record quarterly profits for three out of four of our main segments; Americas O&P, EAI, and I&D. However, there are some items, such as the changes in reporting and premiums paid for financing that may create some confusion. Karyn and I will address these during the call.

In addition to continued strong financial results, our environmental health and safety results have been very good. On slide number 5, we've updated our safety data and you can see a continuing trend. I believe that our safety record is very near to best-in-class.

Now, I'd like to turn the call over to Karyn to discuss some key elements of our financial performance.

Karyn F. Ovelmen

Thanks, Jim. Please turn to slide number 6, which charts our first quarter and last 12 months segment EBITDA, the almost $1.8 billion of EBITDA reflects a $550 million increase over the first quarter.

From a segment perspective during the second quarter, O&P Americas EBITDA was $776 million. The Olefins products alone generated approximately $615 million, even while one of our largest plants was in turnaround for a month during the quarter. O&P-EAI produced over $330 million of EBITDA, including $59 million from JV dividends. The Olefins plants benefited as declining naphtha cost outpaced the product price declines.

However, Polyolefin operations were near breakeven and sales volumes declined significantly. Consistent with past quarters differentiated Polyolefin products in our joint ventures performed well.

Intermediates & Derivatives segments results continued to be very good as both the Chemical products and Oxyfuel results were relatively unchanged versus the first quarter. The Refining segment generated approximately $160 million of EBITDA, this only includes the Houston refinery results as the Berre refinery is reported as a discontinued operation and Oxyfuels are now included in the Intermediates & Derivatives segment. These results include $53 million from the Hurricane Ike insurance settlement.

The Technology segment performance was steady with EBITDA of approximately $50 million. The bar chart on the right depicts the last 12 months EBITDA by segment, recast to include the impact of this segment realignment and discontinued operations. Over the period, total EBITDA was approximately $5.6 billion.

Approximately 45% was generated from O&P Americas, while the recast Intermediates & Derivatives segment generated $1.5 billion. This might be a good time for me to discuss discontinued operations and the segment realignment.

The logic behind moving the Berre refinery into discontinued operations is relatively straightforward and dictated by U.S. accounting rules. We ceased operations in January that mothballed the facility and have been selling inventory during the past months. We are in the final stages of our activities and as a result made the U.S. GAAP criteria for discontinued operations presentation.

During the second quarter, the Berre refinery incurred cost of approximately $20 million and realized a gain of approximately $5 million on the sale of inventory. In an appendix to our earnings release we have recast select financial information back through the second half of 2010. This will enable you to clearly understand the impact of the Berre operations on our historic financials.

We also realigned our Refining and Intermediates & Derivative segments moving Oxyfuels from the former to latter. This is consistent with the change in the internal management of this business following our exit from the European refined products business.

Decisions around this business are closely associated with propylene oxide and TBA chemicals businesses. For example, the raw material for Oxyfuel production is derived from the PO/TBA plants, and the alternative use for this raw material is into the chemical market as isobutylene. In the appendix, we have included selected information, which recast data for this segment realignment.

I also want to point out that the O&P America segment includes a $71 million charge, reflecting a lower of cost or market or LCM adjustments to our inventory. As a LIFO based reporter, the majority of our inventory is held at the cost-basis when the Company formed during the May of 2010. As a result of market price declines, the market value of the inventory pool fell below its book value. This is partially related to the NGL costs. Therefore, we need to adjust the carrying value to the current pricing, an adjustment of this nature occurs because LyondellBasell is a relatively new company and the NGL market has changed considerably over the past two years.

Another item that impacted second quarter earnings was the quarter related to our refinancing. Specifically, the quarter includes $329 million of premiums paid in the write-down of our prior financing costs. These charges reduced our net income by approximately $210 million, and earnings by $0.36 per share. Combining this with the impact of the lower of cost or market and the impact of the insurance claim, our net income was reduced by $191 million or $0.33 per share.

Let’s turn to slide 7 and take a look at the key elements of our cash flow. During the second quarter, cash balances increased by approximately $300 million, closing the quarter near $2 billion. Given our strong earnings, this may fall so much short of your expectations. The key reason for this is that our working capital in the Refining and O&P-EAI businesses increased.

In Refining, we were able to opportunistically secure favorably priced crude oil cargos and this material was in our inventory at the end of the quarter. In EAI, we increased inventory in preparation for third quarter turnaround at our investment side, both increases are temporary and should reverse by year end.

On the right side of this chart, you can see that over the last 12 months our cash balances declined from $4.9 billion to $2 billion. Operations, including working capital generated over $3.1 billion of cash, while usage included approximately $1 billion for CapEx, $1.5 billion of debt repayment, and $3.2 billion in dividends.

While, speaking of cash it is a good opportunity to provide a brief update on our projected capital spending for this year. We ended the year expecting to spend approximately $1.4 billion. We currently believe that spending will be approximately $1.2 billion, the difference results from a combination of more efficient project executions and some changes in spending patterns. There are, however, no major changes in our overall capital plans.

Let’s quickly turn to slide eight and take a look at working capital and some other key metrics. On the left hand chart, you can see the impact of the inventory item that I just mentioned; you can also see that both accounts receivable and payables declined which is consistent with the decline in raw material cost and product prices.

On the right, we have summarizing some key balance sheet and credit statistics. We’ve finished the quarter with $4.35 billion of debt and $2 billion of cash. Our resulting net debt-to-EBITDA ratio remains under 0.5 times.

I'll turn things back to Jim now for a further discussion of our business results.

James L. Gallogly

Thanks, Karyn. Let's discuss segment performance, beginning on slide number 9, with Olefins & Polyolefins America. Second quarter EBITDA was $776 million, an increase of $178 million versus the first quarter. These results include $29 million from the settlement of Hurricane Ike insurance claim, and include the lower of cost or market inventory charge of $71 million.

Underlying Olefins EBITDA was approximately $650 million despite having significant downtime related to the Channelview turnaround, which reduced ethylene production by approximately 150 million pounds during the quarter.

I’d like to discuss a few metrics that put the results in perspective. Relative to the first quarter, our average ethylene price decreased by approximately $0.06 per pound, while the cost of ethylene production metric decreased by approximately $0.13 per pound. The latter decrease was related to the lower cost of both natural gas liquids and naphtha.

Their average ethane cost declined by approximately $0.15 per gallon, propane cracking was competitive with ethane. Naphtha costs declined by approximately $14 per barrel, while in aggregate co-product values were relatively unchanged.

During the quarter, 85% of our ethylene was produced from natural gas liquids with ethane accounting for 66% of ethylene production. Our Midwest Olefins plants were particularly well positioned during the quarter. NGL supply has been very strong in the region, and we have approximately 2.3 billion pounds of Midwest ethylene capacity. At some points during the quarter, raw material prices declined to less than $0.05 a gallon making these plants some of the lowest cost in the world.

Polyolefin results also strengthened versus the first quarter as EBITDA increased by approximately $60 million. Spreads over monomer improved by $0.03 to $0.04 per pound as ethylene and propylene cost declines outpaced polymer price declines.

Polyolefin volumes declined slightly, primarily in polyethylene. However, both domestic and export sales trended upward as the quarter progressed. For example, June polyethylene sales outpaced April by approximately 100 million pounds. Overall, the second quarter was a very good quarter for this segment, and although prices declined as the quarter progressed, the underlying fundamentals that benefitted this segment remain intact. NGL prices have recently increased, but remained low relative to global crude oil prices. July Polyolefin volumes have been somewhat stronger than June.

Before we move to the other segments, let’s spend a few minutes considering the trends that have occurred within the Olefins raw material environment. In the upper left of slide number 10, we applied a benchmark pricing of NGLs and Brent crude oil. Since most of the world’s ethylene production is based on naphtha, the pricing tide to crude oil, while our U.S. production is primarily NGL based, this chart provides a high level indication of the growing advantage enjoyed by our U.S. crackers. It is certainly notable that ethane prices declined by approximately 50%, since beginning of the year.

In the upper right, we have plotted IHS’s estimated cost of ethylene production, both for Asia and the U.S. This very, clearly demonstrates the advantage enjoyed by U.S. producers and the impact of falling raw material cost. This impact was a key driver of our second quarter results. You can also see that the preferred feedstock universe expanded in the U.S. as propane cracking economics rivaled ethane.

On the bottom of the page, we have plotted IHS ethylene margin estimates, which have been very strong. So, our lower NGL price is sustainable, were only related to the first half of the year industry maintenance activity. Undoubtedly, the latter has contributed, but we believe that NGL balances are fundamentally long.

On chart number 11, we have plotted ethane and propane production and inventory statistics. During the final months of 2011 and throughout early 2012, both production and inventory data have been at or near peak levels. The situation has been and continues to be favorable for U.S. ethylene producers. We believe that it will stay this way over the foreseeable future, although we will likely see periods of volatility.

Let's shift our focus to slide number 12 in the Olefins & Polyolefins, Europe, Asia and International segment. Second quarter EBITDA was $335 million, a $234 million improvement over the first quarter. The improvement was generated principally through increased European olefins margins and $59 million from joint venture dividends.

Our differentiated products such as polypropylene compounds and Catalloy resins continued to perform well, generating results consistent with prior quarters. Even though June polyolefin volumes were approximately 70 million pounds higher than April, underlying business conditions within Europe were quite weak. This was seen in an approximate 13% reduction in our polyolefin sales volumes and continued weak polyolefin margins versus the first quarter 2012.

Resulting second quarter polyolefin results were only marginally positive, relatively unchanged versus the first quarter. However, olefin results improved substantially. Our EBITDA per pound of ethylene produced increased by approximately $0.19 per pound versus the first quarter when we operated near breakeven. This margin increase was primarily attributed to declining raw material cost as the quarter progressed.

On average, second quarter olefin sales prices exceeded first quarter prices by several cents per pound. However, the pricing trend within the quarter was downward. Ethylene and propylene prices finished the quarter approximately $0.10 per pound below March pricing.

Within Europe, the environment for Olefins & Polyolefins remains difficult and olefin prices declined further in July. As the third quarter progresses, we expect that olefin results will be a more reflective of the weak economic conditions and uncertainties within Europe.

We expect that our differentiated product positions will continue to perform much as they have over the past quarters. We will have a turnaround at one of our German ethylene plants. As previously mentioned, we have prepared for this and anticipate that it will only have a minor impact on our financial results.

Now, please turn to slide number 13 for a discussion of the Intermediates & Derivatives segment. First quarter EBITDA was $455 million, an increase of $37million from the prior quarter. Included in these results is $18 million related to the Hurricane Ike insurance settlement. Additionally, the results include $14 million of joint venture dividends as we received our first annual dividend from our Chinese propylene oxide joint venture.

Within the segment, underlying results for the propylene oxide and derivatives products, as well as intermediate chemicals were relatively unchanged. You might notice that we have added a graph of the spread between propylene and propylene glycol prices. Although this industry data only captures a subset of the propylene oxide industry, I think that it will help convey trends within the market. You can see that spreads have been relatively steady across the quarters.

As we previously mentioned, the segment now includes our Oxyfuels business, which also generated results consistent with the first quarter. MTBE raw material margins remained strong near $1.25 per gallon. Thus far during the third quarter, underlying business trends are largely unchanged in the second quarter. We have a turnaround at one of our U.S. propylene oxide plants that starts mid-September. We do not expect a significant impact on third quarter EBITDA results from this turnaround.

Let’s move to slide number 14 for a discussion of the Refining segment. Second quarter EBITDA was $161 million, this includes $53 million from the Hurricane Ike insurance settlement. Of course, under our new segment reporting results only include the Houston refinery. Underlying EBITDA improved by approximately $60 million. Throughput at the refinery was near capacity at 267,000 barrels per day and the benchmark Maya 2-1-1 spread increased by approximately $3 per barrel to average $23.16 per barrel.

Refinery continued to realize a lower than historic yield on the benchmark as the value of byproducts such as petroleum coke remained at crest versus the price of crude oil. We estimate that lower byproduct values impacted our margin by approximately $2 to $3 per barrel versus historic yields.

Looking to the third quarter, July operations have been steady and the Maya 2-1-1 has averaged approximately $25 per barrel. We continue to pursue opportunities to optimize our crude slate. This includes actions such as the opportunistic crude purchases that we made late in the second quarter. We also sometimes lighten our crude mix to take advantage of mid-continent pricing.

Let's step back from the details and summarize the business environment on Slide 15. Our adjusted second quarter results were our best ever, despite a challenging environment. The U.S. business continue to benefit from shale gas opportunities. The magnitude and scope of this drilling and completion technology shift is becoming increasingly evident.

In our O&P-EAI segment, the second quarter benefited from the timing of raw material cost declines. We took advantage of the opportunity, but clearly can't rely on this to be repeated under the uncertain economic situations in Europe. Despite this and other macro uncertainties, the differentiated products within this segment continue their trend of steady performance as did the I&D segment. The Houston refinery ran well, and we continue to develop opportunities to exploit the quality of this asset.

The third quarter started with similar drivers across most of our business areas, but as I said Olefins & Polyolefin prices have declined. We believe that this will manifest itself in weaker European Olefins margins while U.S. margins will continue to benefit from low cost NGLs. Before I take your questions, I want to discuss progress and opportunities reviewed at our Investor Day last year.

First, the operational and financial improvement projects have proceeded as planned. Our refinancing has been completed. The Berre refinery has ceased operations and our European restructuring is proceeding. Our capital projects are also progressing. Today, I'll briefly review the ethane flexibility; methanol restart, European butadiene and La Porte ethylene debottleneck projects.

First, the core of the ethane flexibility project was completed during the Channelview turnaround and this quarter, we are in position to increase ethane feed at the site. The methanol plant restart project is progressing as planned. We have completed our discovery work, contracted the detail engineering and ordered long lead items.

Although we have not received environmental permits, the process is progressing as we had envisioned. We expect to be in a position to restart this 780,000 ton facility during the second half of 2013 at a capital cost of approximately $150 million. At current natural gas and methanol prices, the benefit from the project would be approximately $200 million annually.

The butadiene debottleneck project at Wesseling is the only significant growth project that we're pursuing in Europe. This is a 40% debottleneck of our German facility and the finished product has been contracted, ensuring a good economic return. Construction has begun and we plan to have the expansion online in mid-2013. The La Porte ethylene debottleneck project is in a similar position to the methanol project. We have not yet received our permits, but the process is proceeding. Detailed engineering is in process and we have ordered long lead items.

We anticipate completion of this 800 million pound plus expansion during the second quarter of 2014 in conjunction with the olefin plant turnaround schedule. If ethane cracking margins remain at current levels, this project will add more than $200 million to our annual EBITDA. We’ve had an excellent quarter in a tough environment. Our back-to-basics strategy, now coupled with disciplined growth is working. We are well positioned for a bright future.

We’re now please to take questions, Brad.

Question-and-Answer Session

Operator

(Operator instructions) Our first question of the day will come from Jeff Zekauskas of JPMC. Your line is open

Jeff Zekauskas – JPMC

Hi, good morning. I have a question for Sergey Vasnetsov. So Sergey, you've been Head of Strategic Planning at LyondellBasell now for almost two years. How has your view of Lyondell's strategy changed since you first took the position compared to how you see it now?

Sergey Vasnetsov

Jeff, when I joined the company, I didn't have a view and a strategy, so I think my view has developed for this past couple of years in discussions with our managements and with our Board. Clearly, the strategy must be based on realization, what kind of company we are, and so that’s perception both internally and externally. We’ve also developed, as you can see us in a stronger opposition than we were two years ago. I think in terms of our deployment of cash and variety of different place, the basic premises hasn’t changed for the past two years. We identified some specific opportunities that I did know about two years ago, such as the debottlenecks and restarts as Jim had mentioned. But I think there are underlying disciplines, the approach to viewing the world and trying to strike for the best really hasn’t changed. So hopefully this will continue to evolve over the next two years, and so along there and so you’ll see the results of it.

Jeff Zekauskas – JPMC

Okay. And for my follow-up, natural gas liquids prices have down-stopped since the end of June. Do you read in anything into that, and do you have ideas of where natural gas liquids prices will be for the remainder of 2012?

James L. Gallogly

Well, Jeff, it’s always difficult to forecast NGL prices. You’re right that they have come up recently, some in the Midwest, some in the Gulf Coast, but if you look at ethane and propane inventories you’re going to see that they’re extremely high at this point in time, NGL prices have tracked up a little bit with gas prices and crude oil prices, but there is still, so strongly advantage in the United States that we’re quite optimistic about the future. We’ll see short-term volatility, but ethane price is still under $0.40 in the Gulf Coast and around $0.15 in the Midwest, so we’re in a good position.

Jeff Zekauskas – JPMC

Okay. Thank you very much.

Operator

Our next question will come from David Begleiter of Deutsche Bank. Your line is open.

David Begleiter – Deutsche Bank

Thank you Jim, just on the Midwest Conway advantage, is there a new spread we’d be think about between Conway and Mont Belvieu going forward given the constrains still shipping ethane down?

James L. Gallogly

Well, I think next year you’ll see some product moving south, but I think there still will be an advantage in the Midwest. It won’t be as great as we see today. At this moment in time there is such an abundance of supply that the pricing has been as low as $0.02 a gallon. That price has moved up, as I mentioned, but there still is ethane rejection taking place. So that shows you just how long the market is.

David Begleiter – Deutsche Bank

And Jim, just on the June, July PE strain, is this mainly restocking in a view and is it coming to an end from your perspective?

James L. Gallogly

Well, there is a couple of things that happened when the overall complex of oil prices and gas prices start to increase again. People say, okay, we’ve hit that floor. It’s time to go and buy again, but the other thing that’s going on as we see a bit more export in a little bit by ourselves and quite a bit more by our competitors according to industry data. The U.S. is advantaged enough that we can move our product efficiently in other markets.

LyondellBasell exported about 15%. Most of that was South versus to Asia. We had a very, very modest volume to Asia or Africa, just a couple percent. So, the good news is that the pricing advantage that we have here allows us to be an export platform and so we expect rates to remain pretty high in the U.S.

David Begleiter – Deutsche Bank

Thank you.

Operator

Our next question will come from Bob Koort of Goldman Sachs. Your line is open.

Robert Koort – Goldman Sachs

Thank you. Good morning.

James L. Gallogly

Good morning, Bob.

Robert Koort – Goldman Sachs

Jim, I guess it’s pretty clear how you guys get an advantage on your costs. I’m little bit uncertain. How do you get an advantage on your price? I know it’s your ethylene price that you guys realized it was better than the market price or at least the change in price was?

James L. Gallogly

Well, we're just working hard, Bob. I don't know what to say. I think some of that has to do, we always watch our pennies and nickels and how we contract or lawn on ethylene. If you look at who we sell the excess volumes still a lot of that goes spot and so that may be spot has been above contract a fair amount and so that maybe part of that answer.

Robert Koort – Goldman Sachs

Okay. And then, if I might follow-up in the spring there seem to be quite a bit of anxiety about this great wave of ethylene production rates that all the plants are going to come back on and it was going to squash this nice holiday in ethane prices, but that hasn’t seem to happen even though the global economy is kind of choppy. So, I guess people were surprised in being too concerned this spring. What do you think people to get wrong and maybe it would go the other way as we go into next year? What could cause a problem in feedstock cost?

James L. Gallogly

Well, there is a few things. I think if you look at the demand side of the equation, because of the turnaround it was light in the first quarter, but in the second quarter most of the turnarounds were done most people were operating reasonably well. There is a couple of plants down at the moment; one in turnaround, one was an operational difficulty associated with the pipeline. But the volumes of demand are slightly down from where people would expect. Bu one of the big positives has been, propane has come into the mix in a big way and it's a comparable crack to ethane at this point in time. So with that going on, you're seeing very substantial builds in ethane and propane inventories which have held prices down. What could go wrong? Well, I'm feeling pretty good about it near-term, and it's a bit hard to forecast this stuff. As you know, ethane prices dropped, our NGL prices about 50%; since the end of last year pretty amazing, so with that kind of movement it's very unpredictable, there is a lot of chop, but when you look at the fundamentals it looks good through the rest of the year.

Robert Koort – Goldman Sachs

Terrific thank you.

Operator

Our next question will come from P.J. Juvekar of Citi. Your line is open.

P.J. Juvekar – Citigroup

Yes, good morning Jim.

James L. Gallogly

Good morning P.J.

P.J. Juvekar – Citigroup

Jim you had talked about a condo cracker in the past. Now there are several other parties that are also interested in a similar cracker or partnering with somebody else. So, are the discussions happening or is the structuring of the deal taking longer, because the longer you wait more crackers are likely to start ahead of you, and so, any thoughts on that?

James L. Gallogly

Yeah, we're still thinking about it, P.J., but our basic strategy has been to get debottlenecks that are significant down early. La Porte is a $800 million plus expansion. We talked about the timing of that. I hope to have that one paid for before that first new cracker is built by any of the third party. We're also looking at some debottlenecks adding furnaces at other locations, and that's been our emphasis.

The way we're thinking about it, is if we can bring on these debottlenecks and the $0.45 in annual pound range versus $0.75 plus annual pound range for new builds and get them into the market a year or two earlier than another folks, we're going to have better than the equivalent of a new grassroots cracker when you look at the economic impact. So, we think our strategy makes sense. We're starting supply-demand NGL balances later in the period and trying to decide whether it makes sense for us to join the fray with a new build. There are certainly a lot of people who have come to us and said, you're good operators and we like to partner with you. But we have not reached a conclusion yet on whether that makes sense and would be the kind of return that we would want for our investors. I really believe that some of these crackers are going to come later and be more expensive than people are talking about at this point in time, and so our emphasis is debottleneck and get it done.

P.J. Juvekar – Citigroup

Thank you. And secondly, can you describe your propylene oxide demand sort of regionally; Europe versus Asia and North America? And the reason I'm asking that is one of your larger competitors saw weakness in polyurethanes and thermosets, and I'm wondering if you're seeing that in propylene oxide or are you likely to see that?

James L. Gallogly

Yeah, the propylene oxide demand is been a little bit weaker in Asia and there has been a new plant on board and they've been trying to put volume into that market, which has affected pricing. Europe’s been okay, the United States has been okay. Feels a little weaker, but it’s a pretty steady performer and we've got some very sound customers with some pretty solid demand and we’ve been okay.

Operator

Our next question will come from Don Carson of Susquehanna Financial. Your line is open.

Don Carson – Susquehanna Financial

Thank you. Jim, couple of question on some of your initiatives that you outlined last year and thinking specifically on Europe, you talked about a restructuring potential that could deliver up to $200 million in annual cost savings and efficiencies, just wondering where you are on that, have you seen any bottom line benefit and if not what do you think the timing is?

And on a couple of projects you mentioned that you haven't gotten environmental permits yet, is permitting becoming increasingly difficult because I thought on methanol for example one of your advantages was that it was a restart of an existing facility and that you’d be grandfathered on your permit?

James L. Gallogly

Yeah. Let me first talk about Europe, we said that we would take about $200 million out of the cost structure, and that’s on plan. We’ve had a pretty big reorganization. Now having said that, given that the tough environment over there, we’re increasing our initiatives to take costs out, it takes longer in Europe we have works councils to deal with, but we are reinvigorated on that, but more to come.

I didn’t mention that Mike VanDerSnick is taking over our European Manufacturing Operations, and I’ve asked him to look very hard at all of our costs, and see if there is any room for us to further improve.

As you know, Europe is a fairly high cost environment in general, and while we’re very competitive, our goal is to be the top competitor, and so we’ll be looking at everything in the way that we operate, and the money that we spend there.

In terms of environmental permits, I think a few things have been missed in the U.S. expansions. First, it does take a fair amount of time in any event to get an environmental permit. I think if you look at who’s filed permit requests on these new crackers and some other things you’ll find that, a lot of the announced projects are not even at the stage where they have filed for a permit. For seconds and all in line and couple of others have now filed for permits, but we think there is an advantage to being early, and so that was a key component of our strategy. We’re not behind at this stage. These permits take time. We have no reason to believe that we’re going to be late in getting permits, but I’ll just say it’s always a bit complex to do so. We are in non-attainment areas and we have to make sure that were bringing the best available controlled technologies to the table.

We have some credits, but we’re very actively engaged in it, and hope that we’ll be one of the first to get our permits. But again, if you look at who’s filed and all there is quite a few people who have nice capacity, and yet to file their first permit application.

Don Carson – Susquehanna Financial

Thank you.

Operator

Our next question will come from Duffy Fischer of Barclays. Your line is open.

Duffy Fischer – Barclays Capital

Good morning, and congrats on a wonderful quarter. Jim, a question for you around the change with Oxyfuels going into I&D, when you think of Oxyfuels and compare that to I&D, I&D has been a pretty stable business, I wouldn’t argue it should be a higher multiple business. How does that change the volatility, I guess moving Oxyfuels into that business, and then does that change any of the decision-making now being rung out of I&D, as far as which of the byproducts the isobutylene or the MTBE you end up making?

James L. Gallogly

No Duffy, it won't change our decision making. Whenever we make a call on that, we actually compare our isobutylene margins or MTBE, ETBE margins. We stack up the profitability by market segment, by customer, and make conscious decisions. Even when that business was part of Refining & Oxyfuels, before it moved to I&D, we still did that analysis.

And so, I saw a comparison in a review earlier this week, and the thing that I’m excited about is that, we've been able to move up a lot of the value equation in the Oxyfuels. Some of that goes into a very, very long Japanese contract. It's a decent margin. And so, I think that business has been well run, and the decision-making is very economic-based.

Duffy Fischer – Barclays Capital

Great. And then a couple of questions for Karyn. It looks like about a $750 million working capital use that you talked a little bit about the plant turnaround in Germany, and then buying some distressed crude. But that seems like a pretty big chunk; three quarters of $1 billion. Can you break that out a little bit more? And then just the second one is, what effect did Channelview have on profitability when it was down first turnaround, had that not been down in Q2?

Karyn Ovelmen

Yeah, from a working capital perspective, the Houston refinery built about 4 million barrels of crude, 3 million barrels of which were advantaged crude opportunities. And then, the build for EAI was approximately 200 million. The rest really is related to timing. So when you see the drop in feedstock costs, it’s faster than the increase in pricing, we’ve got the accounts payable declining without that corresponding rate of change in accounts receivable. So this is a short-term impact and should stabilize our level out.

Douglas J. Pike

Duffy, this is Doug. Regarding the olefins turnaround, as Jim mentioned, there is about 150 million pounds of production that we didn’t, so that's an opportunity that we really didn't have available to us in the quarter. So if you think of that, you think of the quarterly margins, that’s why you need to think how the impacts from the turnaround.

Duffy Fischer – Barclays Capital

Great. thank you guys.

Operator

Our next question will come from Laurence Alexander of Jefferies. Your line is open.

Laurence Alexander – Jefferies & Company

Good morning. Just to follow-on the question of the 3 million barrels of advantaged crude in the inventory. How do you look at the frequency of being able to capture the opportunity crudes going forward? Should we expect that to flow out or will that be replaced by a similar opportunity later in the quarter or next quarter? I mean how should we think about the oscillations quarter-to-quarter?

James L. Gallogly

Laurence, that’s been something that's been very hard to predict. You know that there has been a WTI advantage compared to Brent. That continued has been better than most people expected and that’s why we’ve been starting to crack a little of the Midwest crudes. Some of the other crudes on a comparison to Maya, whereas last year there were Maya minus, this year they’ve been Maya plus. Some of the distressed cargos that we had last year have been less available earlier in the first and second quarter, but we did find a nice batch of crude at a very nice pricing, that very few other refineries can take. We’re able to and we build inventory to take advantage of that, and hedged the way the basis risk.

It’s very difficult to see how much of that will be available. There is one positive though, and that’s that one of our competitors have had significant operating problems and that was one of the reasons that some of these cargos are less available, because there is more heavy crude being sought because of additional capacity in the Gulf Coast, that capacity is now off-line and we’re seeing some of those cargos show up again. And so, we’ll be opportunistic and try to put some money in the bank.

Laurence Alexander – Jefferies & Company

And then if you’re thinking longer-term, the frequency or the availability of the distressed cargos, is it more a function of your relative balance sheet strength compared to competitors or is it a function of just industry utilization rates?

James L. Gallogly

Well, we run our refinery very hard. You’ll see that we’re running basically at capacities, some days over the nameplate, and that has been a positive trend. That was not the case with our refinery a couple of years ago as you’ll remember. We’ve now been very, very reliable. So, it’s being able to take advantage knowing we’ll probably be running. We worked that part very hard.

But we also just have a different buying philosophy than we did a couple of years ago. We’ve changed out a lot of the team members in refining, and we’re just a lot smarter in our crude sourcing. Now going forward longer-term, I’m looking forward to crude coming from Canada, whether it’s sin bed or dual bed, I think that’s going to be very, very powerful for certain Gulf Coast refineries like ours that can take that crude and process it efficiently, we’re very optimistic about that when it comes down in larger volumes.

Laurence Alexander – Jefferies & Company

Thank you.

Operator

Our next question will come from Vincent Andrews of Morgan Stanley. Your line is open.

Vincent Andrews – Morgan Stanley

Thank you and hello everyone. Just a question, if we think about propane, and go out a couple of years and think about the potential source for propane exports, leave aside whether that’s going to happen or not, but if it does happen, your European operations, what would have to happen for you to be able to use that propane, and how much possible do you think that is?

James L. Gallogly

Yeah, Vincent, I think that there will be more propane exports going forward. At this point in time the U.S. industry is logistically constrained to move a lot more volume. There is a pricing reason to try to move the volume, but like many things as people solve the problems on logistics, there will be more propane export should start to closer to a world price. Our European operations can track some of it. Generally, we have naphtha-based crude fee there, but we’re starting to run more condensates. We’ll start to run more propanes and that should help us a bit.

Vincent Andrews – Morgan Stanley

But where would the opportunity to increase propane those operations could accept or is there not one?

James L. Gallogly

We can take some. We have not been able to quantify that specifically. A lot of times you have to go in and run push tests and just see how things run and go from there.

Vincent Andrews – Morgan Stanley

Okay, can I just ask a quick question? As the NGLs came down during the quarter, and then picked back up. What is your capability, can you remind us just sort op?

James L. Gallogly

Well, I didn't hear the remainder of that question, I'm sorry.

Douglas J. Pike

Well, Brad I believe Vincent just has lost his line.

Operator

Yes, one moment sir.

Douglas J. Pike

The line available to others?

Operator

Mr. Andrews, your line is open again.

Vincent Andrews – Morgan Stanley

I'll just pass it on, it's fine.

Douglas J. Pike

Thanks.

Operator

Our next question will come from (inaudible) Pentwater. Your line is open.

Unidentified Analyst

I just have a question – if you have a target leverage ratio on mind, given how under leveraged your balance sheet is today?

Karyn F. Ovelmen

Yeah, I mean there is no change to our existing policy. We’re currently looking at monitoring and reviewing our capital structure in the context of potential capital redeployment, overall market conditions, our working capital needs, and our free cash flow profile. But today, we have an appropriate overall leverage and liquidity policy. So we continue to look at it for review and assess our balance sheet position and capital structure, but as we continue to optimize our earnings potential with our existing assets balance with how the overall market evolves. But today there has been no change to our policy in regards to overall leverage.

Unidentified Analyst

Well, given that commentary and how much cash you mentioned you'd be generating, and the fact that you won’t able to buyback shares until next year given the tax implications, are you still thinking about returning share – returning cash to shareholders through another dividend a large one?

Karyn F. Ovelmen

Right. Again, in terms of our redeployment of excess cash, no change to our policy. We'll continue to assess the environment and for the most leveraging use of our excess cash. But assuming there is no near-term executable investment opportunities, but beyond what we've already outlined, and under the presumption of a sustainable outlook, our free cash flow profile, maintaining our credit metrics, we would look to supplement our current regular dividend with the potential of returning excess cash. This has been our policy. We’ve illustrated our commitment to returning value via the special dividend that we did in 2011, and as I indicated on the call earlier, we have paid $3.2 billion in dividends over the last 12 months.

Of course, today, I won’t comment on timing or levels, but as you indicated, when it comes to share buyback versus special dividend options, we do have tax implications in 2012 as it relates to share buybacks. But also as it relates to share buybacks, we do need to continue to consider our current PE ownership position and the consideration to not further concentrate our ownership profile and the overhanging of our shares. There are no changes we look forward in our approach or expectations on continuing to potentially return excess cash directly to our shareholders.

Unidentified Analyst

Thank you. One last question on the inventory distressed cargo purchases you did at the end of the second quarter. Can you give an indication of what kind of spread benefit that would be given what today’s prices are?

James L. Gallogly

Well, that’s very much competitive data

Unidentified Analyst

Okay

James L. Gallogly

So we don’t provide that level of detail, but we should be running that crude here in the third quarter.

Unidentified Analyst

Great. Thank you.

Operator

Our next question will come from Kevin McCarthy of Merrill Lynch. Your line is open.

Kevin McCarthy – Bank of America/Merrill Lynch

Yes, good morning. Thank you. A couple of questions, Jim, on Oxyfuels. First off, can you comment on your outlook for MTBE margins? I think there was a competitive outage earlier this year. It looks like margins have actually strengthened in recent months. Is that all butane, cost-linked, and where you think the back half of the year looks like in that product line?

James L. Gallogly

Kevin, octane has been pretty valuable. We've had some butane pricing advantage, natural gas pricing advantage. So, we had unseasonably strong first quarter that carried over into the second quarter. Margins are holding a very, very nicely at this point in time. So Oxyfuels is looking pretty good. It always gets down to price of octane and relative natural gas butane prices; so far so good.

Kevin McCarthy – Bank of America/Merrill Lynch

And I guess just a clarification if I may with regard to your shift of Oxyfuels into Intermediates & Derivatives. It makes sense to me, given your TBA co-product generation, but is that shift a matter of convenience if you will or is there an anticipated economic benefit associated with that shift and if so how large might it be?

James L. Gallogly

Well, I think, there is some modest personnel changes, but it doesn’t really move the needle, it just every day we look for further efficiencies and this gave us an opportunity to achieve a bit of synergy, but having said that there is such a good connection between our PO/TBA, and Oxyfuels now, and since we're no longer running the Berre refinery and don’t have all the people associated with marketing those products, remember that a lot of our Oxyfuel products go into Europe, and so a lot of the marketing took place there. And so it just makes more sense for us to do what we’re doing today and we’ll look at it that way from the management perspective.

Kevin McCarthy – Bank of America/Merrill Lynch

Okay. And then, final question if I may, can you review for us any significant maintenance turnaround activity that you would have planned for the third quarter?

James L. Gallogly

Yeah, we have two items Bayport PO/TBA and Wesseling one of our crackers in Germany is coming up for turnaround in the third quarter. As we mentioned in the call, we don't expect those to be significant financial implications because we’ve built some inventory and thought through well in advance to be prepared for those.

Kevin McCarthy – Bank of America/Merrill Lynch

Thank you.

Operator

Our next question will come from Bill Hoffman of RBC Capital Markets. Your line is open.

Bill Hoffman – RBC Capital Markets

Thanks. Good morning. Jim, you seem to be pretty constructive on the outlook on the demand side here in North America as well as globally. I wonder if you could just talk a little bit about like how you’re looking at the back half of the year and whether you think that we’ll have a significant inventory cycle as we get towards the end of the year given all the uncertainties here, especially North America.

James L. Gallogly

Yeah, I have to talk regionally and I think what I was saying is that Asia remains pretty weak. Whenever there is price firming, volumes improvement, we saw that at the end of the quarter, we’ll have to see what happens in Asia, there is some stimulus planned and we’ll see how that affects volumes into the second half of the year. Europe remains very weak. It was weak in both quarters so far this year kind of breakeven type. Olefins change margins, except when feedstock prices fell so rapidly. We’re able to capture some value, particularly in Olefins.

In the United States, there has been some firming of demand again, maybe in part because of restocking as prices start to turn in the other direction. There are price increases on the table, which we expect to be implemented. NGL prices remain low and that gives us the ability to export. And so of the United States, we’ve been able to run our plants very hard and move the volumes, but it’s generally pretty tough economic times in the rest of the world, but as a company we have a good customer slate. We try to deliver value to our customers and we move our products pretty efficiently.

Bill Hoffman – RBC Capital Markets

Thanks, that’s helpful. And just if you're going to address the questions at the year-end inventory, do you have any sense to what inventories are like downstream in the Polyolefins?

James L. Gallogly

And at the end of the year?

Bill Hoffman – RBC Capital Markets

Well, yeah, towards the end of the year, right.

James L. Gallogly

Yeah, we try to stay in certain ranges and really look at that on an extremely regular basis. Every now and then we'll let our inventory build like we did for the turnaround in Germany, like we did to opportunistically purchase crude oils for the refinery, but generally we stay in a pretty tight range on inventories. And if we start to build some inventory, we'll start to cut back rates. But we'll just watch the economic conditions and go from there. I think Karyn mentioned that we should see that inventory build decline here into the third quarter and see that cash back up on the balance sheet.

Bill Hoffman – RBC Capital Markets

Right. Thanks, and then just a question for Karyn. On the capital spend, cutting this year to building intuitive, is that sort of push it into next year or closer to $1.6 billion, is that because obviously the projects are still on track?

Karyn Ovelmen

Yeah. No, some of that's timing, but in terms of – with increased efficiencies and the capital program that we had were outlined for 2012.

Bill Hoffman – RBC Capital Markets

Okay. Thank you.

James L. Gallogly

Yeah, I think, in the given time, I think, we just feel to take questions from just two more people.

Operator

Our next question will come from Nils Wallin of CLSA. Your line is open.

Nils Wallin – CLSA

Yeah, good morning, and thanks for taking my question. One of the things people have talked a lot about, of course, is the spread between Conway and Mont Belvieu. But there was also significant spread between Mont Belvieu ethane propane mix and Mont Belvieu ethane. So, I was wondering if you would be able to talk about how much you were able to enjoy or exploit that spread and where do you think that might go over the next two quarters?

James L. Gallogly

Yeah, you're right. There has been some benefit to that. We do have some fractionation capability and we've done some work on the furnaces to be able to separate streams and optimize around unique furnaces as part of turnaround programs. So, we're better equipped to take advantage of that mix than we were, say a year ago. It has given us a little bit of a boost, but those market swings come and go within days. I would tell you though that we optimize our feed slate basically every hour. We're always looking to see where the market is going and what we ought to be running and switching our furnaces around. We think that agility is part of the reason we have some pretty good margins. We work that extremely hard and pay attention of those market dynamics at any moment in time.

Nils Wallin – CLSA

Got it. Thanks and then you mentioned also on the chance for heavy seller from Canada to come down to the U.S., and I would assume to U.S. Gulf Coast. How long do you think that will take and then will that ultimately push out Brent coming into the Gulf Coast?

James L. Gallogly

Well, right now we really don't have Brent in our crack in the Gulf Coast and you don't see it a whole lot. You see some of the LLS’s and things in the Gulf Coast. But in terms of what comes down from Canada, a lot of that has been moving into the Midwest because of the pipeline availability. You've seen so much in the news about the keystone pipeline and we really would like to see that build. We have been finding other ways to get certain amount of crude down to us. You had seaway get reversed. There is a few things we can do to get some barrels, but we certainly would like to see a lot more. And frankly for the good of our country, we'd like to see that investment made. 2014 you'll see a little more of that crude showing up I expect, but few things have to happen politically to get that done.

Nils Wallin – CLSA

Great, thank you so much.

Operator

Our next question will come from Gregg Goodnight of UBS. Your line is open.

Gregg Goodnight – UBS

Hello gentlemen.

James L. Gallogly

Hello, Gregg.

Gregg Goodnight – UBS

During the Investor Day you mentioned that Clinton and Nomura, she might be able to squeeze about 100 million pounds of additional capacity out of these two crackers. I know you might have a turnaround in the third quarter for more, could you talk about the timing of these potential debottlenecks?

James L. Gallogly

Yeah, actually more is due to big turnaround last year, and we – as a result of that turnaround, you've seen the volume show up a little bit better. We're kind of limited sometimes on the backside by derivatives and the ability to use it all. So, some slight increment – we're looking at about $2.3 billion between Clinton and Morris. Clinton has turnaround next year. So, we don't have a turnaround in third quarter of either of those two crackers.

Gregg Goodnight – UBS

Okay, very good. The second question; the Channelview, the $150 million, I assume that's designed by (Inaudible) you had a chance yet to demonstrate the additional capacity?

Douglas J. Pike

Gregg this is Doug. No, the $150 million that I referred to was the downtime of one of the olefin plants for the turnaround.

Gregg Goodnight – UBS

Okay.

Douglas J. Pike

That was the loss opportunity because we had that facility in turnaround really throughout April.

Gregg Goodnight – UBS

Okay.

Douglas J. Pike

That's what that is. What we did in the turnaround, of course, is we've had a project to increase our ethane consumption at Channelview, and in each of the turnarounds last year, first olefins plant, this year the second olefins plant, we've made changes so we can swing our mix and increase by about 500 million pounds of equivalent ethylene from what would have been naphtha over to ethane.

Gregg Goodnight – UBS

Okay. Well, thanks for that clarity. The last question I had if I could is, what is your view or your favorite consultants' view in terms of Refining margins longer-term, say, the next two to three years?

James L. Gallogly

Well, various people have different views. I'd just tell you that I'm a little more optimistic than some on crude cracks. If some of the capacity that's been taken out stays out, that should speak favorably to U.S. refining dynamics. We'll see how that happens. We have been able to export. The industry overall is competitive enough for various reasons that we've been able to export, even a little bit of gasoline has moved by some of our competitors over to Europe.

So that's kind of an unusual trend. The crude oil from Canada can be a powerful thing for refineries that have the ability to crack synbit or dilbit like we have the ability to do, and so longer-term, I think that asset will see an increased advantage. Near term, refinery cracks and all are somewhat dependent on oil pricing, volatility, variety of things like that and the ability to pick up distressed cargos in the meantime. So, might have we just okay right now. Coke product prices, not very good at all. So, this is a very tough one to predict, but I think longer-term the trend is positive.

Gregg Goodnight – UBS Financial

Okay. Well, thanks for taking a stab at that anyway.

James L. Gallogly

All right. So let me make a few final comments. As I mentioned, this is the best quarter we ever had on an adjusted basis, and a very tough economic environment. We ran safely. We ran reliably. We managed our cost. We took advantage of market opportunities that presented themselves. We’re progressing a very nice slate of growth projects. We are trying to get those to the market early and take advantage of the conditions that we see, particularly in the United States. I think we continue to be on the path of becoming the world’s top commodity petrochemical company and that’s been our goal. We’re starting to be really good at this business. We have some room to get better, and it’s our job to accomplish that every day. Thank you for your attention.

Operator

Thank you for your participation in the conference call today. At this time, all parties may disconnect.

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