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Sunoco Logistics Partners, L.P. (NYSE:SXL)

Q2 2012 Earnings Call

August 2, 2012, 5:00 p.m. ET

Executives

Brian P. MacDonald – Chairman, President, CEO

Michael J. Hennigan – President, CEO Sunoco Logistics Partners

Michael J. Colavita –CFO

Peter J. Gvazdauskas – VP Finance

Claire McGrory – Manager of Investor Relations

Analysts

Brian Zarahn - Barclays

Brad Olsen – Tudor Pickering

Elvira Scotto – RBC Capital Markets

Operator

Welcome to Sunoco Inc.’s and Sunoco Logistics Q2 2012 Joint Earnings Conference Call. (Operator Instructions)

I would now like to turn the call over to Mr. Brian MacDonald, President and CEO. You may begin.

Brian MacDonald

Thank you and good evening. Welcome to the quarterly conference call for Sunoco and Sunoco Logistics Partners, where we will discuss our second quarter results that were reported earlier today. With me are Mike Hennigan, CEO and President of Sunoco Logistics Partners, Mike Colavita, our Chief Financial Officer, Pete Gvazdauskas, Sunoco Logistics Partners’ VP of Finance and Claire McGrory, Manager of Investor Relations for Sunoco.

As part of today’s call, I will direct you to our website, www.Sunocoinc.com and www.Sunocologistics.com, where we have posted a number of presentation slides which may provide a useful reference as we progress through our remarks.

I would also refer you to the Safe Harbor statement referenced in slide two of the slide package, and as included in this afternoon’s earnings release.

Now I’ll begin by providing an update on the strategic actions of the company, and then we’ll move into the earnings and business updates for both Sunoco Logistics Partners and Sunoco.

As most of you are aware, on April 30th, 2012 Sunoco announced that it had entered into a merger agreement to be acquired by Energy Transfer Partners, L.P. We continue to move forward with this merger process, as seen by ETP’s filing of the first amendment of Form S-4 registration statement last week. We are on track and working towards closing this transaction in the early part of the fourth quarter.

In July, we also announced an agreement to form Philadelphia Energy Solutions, a joint venture with the Carlyle Group, at the Philadelphia refinery. Sunoco will be contributing the Philadelphia refinery assets in exchange for a non-operating minority interest of approximately 33%. Sunoco will receive cash proceeds for the liquidation of working capital related to the refinery. These cash proceeds are in line with expectations when we announced the exit from refining. Sunoco will have no ongoing capital obligations with respect to the refinery. We believe that this structure provides the best opportunity for the success of the Philadelphia refinery, and look forward to closing the transaction with the Carlyle group, which we anticipate should be in September.

Now moving on to the results in the second quarter. As you can see from slide four, Sunoco reported net income before special items of $129 million, or $1.22 per share for the second quarter. I’ll summarize our results in three areas.

Our logistics business continues to deliver strong results and execute on growth opportunities. Sunoco Logistics is progressing well on projects to grow their fee-based earnings and anticipates $350 to 400 million in organic growth projects for 2012. Mike Hennigan will provide an overview of the results of Sunoco Logistics Partners in a few moments.

Our retail business also delivered strong results, as margins expanded related to declining wholesale gasoline prices during the quarter. As we have said before, this business does see quarter-to-quarter volatility, as evidenced in the first half of 2012 performance, but as our trend shows, the business tends to deliver consistent and stable earnings and cash flows year after year.

Lastly, refining and supply delivered strong results this quarter. I want to commend our refinery employees for achieving excellent operating results and capitalizing on strong market conditions during what was a time of considerable uncertainty for everyone at the Philadelphia refinery. As long as we are the operator, we continue to work hard to realize the potential market opportunities to continue strong operations and sharp focus on optimization of the product supply.

At this time, I’m going to turn the call over to Mike Hennigan, who will provide an update on Sunoco Logistics Partners’ strong business results.

Mike Hennigan

Thank you, Brian. Sunoco Logistics continues its momentum with another strong performance in the second quarter of 2012. We had record distributable cash flow of $166 million, compared to 106 million in 2011. All the areas that are part of our strategic focus are delivering results. The main driver of results continues to be our crude oil business. Demand for West Texas Crude continues to be at a very high level, translating into tremendous demand for our transportation services, including our proprietary pipelines, our West Texas Gulf and Mid-Valley pipeline joint ventures and our trucking services.

The expansion of our West Texas system continues on track to meet the market needs, and is expected to start up in the first quarter of 2013. We’ve completed three successful open seasons, which will deliver 110,000 barrels to the market.

We also announced our fourth West Texas open season, called Permian Express, a new project to transport West Texas crude oil to Gulf Coast markets. Phase I of the project will have a capacity of approximately 150,000 barrels per day, and Permian Express can be expanded to at least 350,000 barrels per day. For Permian Express phase I, we are offering approximately 150,000 barrels a day of crude oil service from Wichita Falls, Texas to the Nederland Beaumont Texas markets. We will reverse our [inaudible] to Wichita Falls pipeline to create continuous pipeline service from Wichita Falls to Nederland, including utilizing excess capacity on the southern leg of the West Texas Gulf pipeline system. Permian Express phase I offers customers speed to market, as it will be operational within six to nine months, with an initial capacity of 90,000 barrels per day. Full capacity of 150,000 barrels per day is expected within 12 to 18 months.

In addition, commitment terms of three, five or seven years are available to offer customers flexibility. The open season for phase I launched on June 25th, and is expected to close on August 7th. Permian Express phase II would increase the takeaway capacity at Colorado City by an additional 200,000 barrels per day, and provide further market access east of the Nederland area.

We also continue to look for other opportunities to complement these projects, as crude production outlook remains robust. In addition, our crude oil acquisition and marketing business continues to deliver excellent results. In the second quarter, market conditions continued to be favorable for our business, with the WTI-LLS spread widened considerably in April and May from levels seen in the first quarter. However, they have come in tighter for July and August business.

On the refined products side of our business, we’ve been pleased with the acquisition of the controlling interest in the inland pipeline system in Ohio. This system serves multiple Ohio refineries, providing gasoline and diesel to many markets, and is synergistic with our existing pipeline system. As a complement to this acquisition, we’ve launched an open season on July 19th for a project called Allegheny Access. Midwest refinery expansions and strong economics have been driven by low cost crude from the Shale [inaudible]. This has created a surplus of refined product, and an opportunity to broaden our refined product pipeline network to be able to move Midwest barrels into the Eastern Ohio and Western Pennsylvania markets. This project is designed for 85,000 barrels per day, expandable to 110,000 barrels per day. We’re encouraged by the early response to this open season. Engineering is underway with an expected start-up in the first half of 2014.

In our NGL business, our Mariner West project, the first ethane pipeline solution in the Marcellus area that will deliver ethane to the [inaudible] marketplace, is on schedule for a mid-2013 startup. We also remain excited about the potential conversion of our eastern pipeline related to the growing development of the Marcellus and Utica Shale areas. Our Mariner East project could initially move approximately 65,000 barrels a day of ethane and propane to the U.S. east coast, with the ability to scale capacity higher as needed. We’re confident that this project meets a growing market need to export natural gas liquids.

On our distributions, we’ve announced an increase to $1.88 per common unit on an annualized basis, which is a 10% increase quarter-over-quarter and a 16% increase year-over-year. The quarterly distribution of $.47 per common unit will be paid on August 14th to unit holders of record as of August 8th. This represents our 29th consecutive quarterly distribution increase. We are pleased with the open season success, and commitments on our first set of West Texas projects, our Mariner West project and the overall growth of our ratable earnings, as we’re executing $350 to 400 million of organic growth capital this year.

These significant accomplishments are enabling us to make a step change in our distribution for our unit holders. In addition, we continue to have tremendous balance sheet capacity to fund our ongoing expansion capital program. We finished June with a debt-to-EBITDA of 2.3 times. As we continue to implement our plans, we remain committed to sustainable, competitive distribution growth. We’re confident our strategy is on track and we’re committed to growing our cash flows over the near and long term.

I also want to mention that we expect to have a new general partner in the near future, and we at Sunoco Logistics are excited to be part of the energy transfer family of partnerships. I will turn the discussion over to Mike Colavita, who will continue the update on Sunoco business results and financials.

Mike Colavita

Thanks, Mike. As Brian noted earlier, for the second quarter, Sunoco reported net income of $129 million attributable to Sunoco shareholders, excluding special items. Pretax income from special items totaled $207 million, including a $213 million [inaudible] inventory gain. Regarding Q2 pretax [inaudible] results attributable to Sunoco shareholders, I direct you to slide 10.

SXL reported earnings of $152 million during the quarter, and our retail marketing business reported pretax income of $73 million. Sunoco’s share of SXL earnings, driven by our GP ownership and LP holdings, are reported to our Logistics segment, which earned $82 million during the quarter. As Mike Hennigan outlined, SXL continues to deliver strong results, execute on its gross strategy and also maintain financial flexibility and a strong balance sheet.

Retail marketing reported second quarter income of $73 million, as wholesale gasoline prices were declining through the quarter, providing holistic gasoline margins which averaged $.125 per gallon for the quarter. However, across the industry, gasoline demand was weak in the second quarter, reflecting the continuing challenges in the economy.

Refining and supply reported income of $87 million pretax for the second quarter of 2012. Realized margins expanded from the first quarter averaging over $7 per barrel, as benchmark barges were supported by sharply declining crude oil prices. The refinery performed well, capitalizing on the market opportunities.

As shown on slide 11, at June 30th we had approximately $1.9 billion of cash on Sunoco’s balance sheet. In the second quarter, we saw a net reduction in cash of $76 billion at the Sunoco parent level. Cash use during the quarter was driven by refining exit costs, including a contract penalty payment of approximately $130 million related to the [inaudible] refinery closure, as well as $50 million in share repurchases made in April.

I’ll now turn the call back to Brian for final comments.

Brian MacDonald

Thanks, Mike. In closing, we are pleased with the strategic actions that are underway at Sunoco, and the value that has been returned to shareholders through a number of actions over recent years. We now have two strong, high return businesses in logistics and retail. We continue to focus on ensuring these businesses are positioned to deliver strong results and to execute on their respective growth opportunities. In regards to the Philadelphia Energy Solutions joint venture, as we have said before, we believe this is the best possible outcome for the Philadelphia refinery and all of its stakeholders. We are working towards a closing of this transaction in September. For the company, we are very excited to join forces with ETP; as we move towards closing and thereafter, we will be working hard to ensure smooth integration and to capture synergies through the combination.

With that, I’ll ask the moderator to open the line for questions, for any questions you have.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Brian Zarahn with Barclays Capital. Your line is open, sir.

Brian Zarahn - Barclays

Good afternoon.

Michael Hennigan

Hey, Brian.

Brian Zarahn - Barclays

Congratulations on a strong quarter. On the distribution, obviously, you said is a big step change, can you give a little more color on your thought process around the distribution and any thoughts on talking about updating your sustainable growth rate on the distribution?

Michael Hennigan

Yeah, Brian, I would tell you that, you know, that several factors came into our thinking. The main ones of which were, you know, we were just recently successful with reopen seasons in West Texas. As you know, we’ve also been successful on Mariner West and we’re looking to implement it. And our organic program, you know, we’ve updated the guidance there up to 350 to 400 million and at the end of the quarter, we have a balance sheet that’s got a 2.3 times debt to EBITDA. So we’re very confident in what we’ve achieved so far, the major points I’ve mentioned and we thought it was a good opportunity to return cash to the unit holders.

Brian Zarahn - Barclays

And in terms of the – your assumptions on sort of future sustainable EBITDA, any assumptions embedded on sort of crude oil price differentials within that? Do you think they’ll continue to remain wide or is that not – doesn’t impact your assumptions regarding DCS?

Michael Hennigan

I don’t think that comes into our thinking at all, Brian. I mean, at the end of the day, we’re very confident our growth prospects and our balance sheet is very strong so you know, we’ll be in a position to increase our distribution at a very competitive levels and we’ve made a, you know, step in that direction today. So I think that’s the thing that’s driving us more, the projects that we have in the Q that we believe will be successful and the strength of our balance sheet.

Brian Zarahn - Barclays

Appreciate the update to 2012 expansion CapEx given there’s a backlog of projects. Any preliminary thoughts on 2013 expansion CapEx?

Michael Hennigan

No, we usually talk about that a little later in the year. We’ve had the same theme that we’ve been working on, Brian, you know, we have obviously a large focus in West Texas, our Mariner projects are active, we continue to expand our butane business, our Nederland terminal continues to expand. We’ve mentioned previously that we put some effort in at Eagle Point in the Philadelphia Harbor. So you know, all those factors come together as we’ve been trying to deploy the strategy that we’ve been talking about over the last couple quarters.

Brian Zarahn - Barclays

Okay, last one for me. We’re seeing a pickup in propane export activity out in the Gulf Coast. Can you talk about anything that – opportunities for you on the East Coast?

Michael Hennigan

Yeah, we’re still very encouraged that we’re going to get Mariner East to the finish line. We don’t have anything to report at this point but as we mentioned to you previously, we have morphed a project from an ethane only to an ethane and propane solution. We’re kind of working through some more details along those lines. There’s definitely interest in the market for both ethane and propane and that’s kind of morphed the project a little bit for us and again, we’re hoping to give you some more color on that very shortly. But we are confident in the project, we think the market needs it and we’re just – we’re looking forward to coming out a little more firm.

Brian Zarahn - Barclays

Thanks, Mike.

Michael Hennigan

You’re welcome, Brian.

Operator

Your next question comes from Brad Olsen with Tudor Pickering.

Brad Olsen – Tudor Pickering

Hey, good afternoon, Mike.

Michael Hennigan

Hi, Brand.

Brad Olsen – Tudor Pickering

Just a couple questions on – I guess starting out with your terminals business, it looks like you kind of experienced a step change in EBITDA in that business. Is that associated with getting the Eagle Point asset more thoroughly contracted or are there other kind of – are there other moving pieces there?

Michael Hennigan

Yeah, Brad, that was one piece of the puzzle. In that segment we reported out our butane business, which has had a very healthy run here in 2012. Eagle Point, as you mentioned, East Boston, we also made that acquisition, Nederland continues to expand and then the one anomaly is we reversed a $10 million write-down that we had taken previously related to some [inaudible] cleaning that the Philadelphia Refinery did not run. And as Brian mentioned, you know, we’re now looking forward to Philadelphia being serviced by Sunoco Logistics and so we reverse that $10 million issue. So that was a one-time event but the others we believe are just showing the strength of our terminal segment.

Brad Olsen – Tudor Pickering

Okay, great. And on the acquisition marketing business, have you seen kind of improving performance from Tex on that? That’s another business that, you know, no matter how high it goes, it seems like each quarter you set a new record in that business. And so, I guess I’m trying to understand, you know, is the demand for the West Texas crude coming more from the Midwestern end of Mid Valley or is it coming from the Gulf Coast refiners or is there, you know, more of the Texon marketing volumes driving that business?

Michael Hennigan

I think it’s a little bit of all the above. First off, we are very happy with the Texon acquisition. We’re very happy to have those employees on our team and it’s going very, very well. That gave us some more geographic diversity compared to what we had previously. But even our existing system, I think we’re just in a good position as each of these shale places continue to grow, our exposure in West Texas has been helpful, Eagleford, Bakken, you know, each of these areas, I think has been good for us and as you’ve seen in the results, we’ve been increasing our margin and our volume in that segment of our business.

Brad Olsen – Tudor Pickering

Great. And just one last one if I may. The inland Allegheny access project that you announced, obviously you guys having kind of – with your refining heritage, are you know, very familiar with what a kind of game changing development it would be if a crude pipeline were built from the Midwest out to the East Coast to service PAD 1 refineries. As you kind of evaluate the prospects for Allegheny, is it – have ou given any consideration to using some of your legacy pipeline assets that extend from the Midwest all the way out to the East Coast and converting any of those to move crude?

Michael Hennigan

We’ve looked at it, Brad, a little bit, but at least our first priority has been on NGLs and that’s why you saw Mariner West and East develop as projects on our existing assets. On our Inland acquisition when we made that acquisition we were hopeful but we weren’t sure that they had a section of pipe in Ohio that it was out of service, that we were hopeful that we could bring that back to service and put it in another source and at least in the short term, we still think the best opportunity is in refined products for that and that’s what developed Allegheny access. We’re very bullish that Midwest margins will continue to be good crude pricing, it will be such that those Midwest refiners will continue to run hard and we thought it was a good opportunity to expand our system into Pennsylvania from the Ohio spot. Now, with that said, we still continue to look at crude growth in those areas. We’re very aware. As you know, we still have some existing assets and a lot of right-of-way capability in the areas. So we’re continuing to look at it but our first focus was on NGLs and then Allegheny access became our second focus. So at this point, we don’t have anything to report on crude, although we continue to look at that possibility.

Brad Olsen – Tudor Pickering

All right, great. Thanks a lot for the color.

Michael Hennigan

You’re welcome.

Operator

Thank you. Our next question comes from Elvira Scotto with RBC Capital Markets.

Elvira Scotto – RBC Capital Markets

Hi, good afternoon. Just on the – going back to the terminal segment, so if we back out the $10 million that you mentioned as the reversal of the tank cleaning, and you know, we kind of get to that 50-kind-of-million dollar run rate. How much of the terminal’s operating income is ratable versus maybe some of the shipping market dynamics or you know, market opportunities?

Michael Hennigan

Elvira, yeah, what I would say, there’s a couple things at the terminal segment. Like you say, once you remove the one-time thing, probably the most important thing to keep in your mind as you’re thinking about it is the seasonality of the butane business. You know, we’ve talked in the past about that being more of a fall and winter-spring type of business so in the summer, you’re not going to see the ratability from that segment. But all the other segments, I would tell you – I would think are pretty ratable. You know, our Nederland terminal’s very consistent with it’s flows, although the market has been changing down in that area. Same type of thing we’ve seen on all of our product terminals, pretty ratable business overall when you step back. Now, there might be a little variability quarter to quarter with the normal seasonality that you see with gasoline and diesel but as a general rule, you know, I’d say very ratable overall when you step back and then you kind of have to put the seasonality of butane on top of that.

Elvira Scotto – RBC Capital Markets

Okay, thanks for that. And then I guess just the follow up on the Mariner East project, what needs to get done to get this to the finish line? I mean, it seems like the project that makes a lot of sense. What’s been the holdup I guess?

Michael Hennigan

Yeah, Elvira, I’ve mentioned previously, I mean, we’re really still very excited about it and we’re very, very close in our mind, but what makes it always difficult is there’s multiple parties that are involved expressing interest and in our mind we just want to make sure that we’re providing exactly what the market needs. Early on, as you know, we started off with a ethane project and it’s now morphed into an ethane and propane and we’re just trying to put some, what I would call the final touches on how that project will how itself from an ethane versus propane standpoint, but we’re hoping to be very, very close to getting the closure on being able to move forward with that.

Elvira Scotto – RBC Capital Markets

Okay, thank you.

Michael Hennigan

You’re welcome.

Operator

Thank you. At this time I am showing no further questions.

Michael Hennigan

Thank you for joining us this evening. Pete and Claire will be available for follow up questions tonight and tomorrow. Thank you.

Operator

Thank you. That concludes today’s conference, you may disconnect at this time.

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