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Western Refining, Inc. (NYSE:WNR)

Q2 2012 Results Earnings Call

August 2, 2012 11:00 AM ET

Executives

Jeff Beyersdorfer – Treasurer and Director, Investor Relations

Jeff Stevens – President and CEO

Gary Dalke – Chief Financial Officer

Mark Smith – President, Refining and Marketing

Analysts

Chi Chow – Macquarie

Jeff Dietert – Simmons

Ed Westlake – Credit Suisse

Arjun Murti – Goldman Sachs

Evan Calio – Morgan Stanley

Paul Sankey – Deutsche Bank

Roger Read – Wells Fargo

Cory Garcia – Raymond James

Operator

Good morning. And welcome to the Second Quarter 2012 Western Refining Earnings Conference Call. After the speakers’ opening remarks, there will be a question-and-answer period. (Operator Instructions)

As a reminder, ladies and gentlemen, this conference call is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time.

Thank you. I would now like to turn the call over to Mr. Jeff Beyersdorfer, Treasurer and Director of Investor Relations of Western Refining. Mr. Beyersdorfer, please go ahead, sir.

Jeff Beyersdorfer

Thanks, Susan, and good morning. I would like to thank you for taking the time to listen in today and for your continued interest in Western Refining. Again, my name is Jeff Beyersdorfer. I’m the company’s Treasurer and Director of Investor Relations.

Joining me for today’s call are Jeff Stevens, President and CEO; Gary Dalke, CFO; Mark Smith, President, Refining and Marketing, and other members of our senior management team.

We will be referencing our earning call slides throughout the call this morning. The slide presentation, in addition to our earnings release can be found in the Investor Relations section of our website at wnr.com.

Before we proceed, I would like to make the following Safe Harbor statement. Today’s presentation will contain forward-looking statements and I refer you to the Forward-Looking Statements section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release, which is posted on the IR section of our website.

I’ll now turn the call over to Jeff.

Jeff Stevens

Thanks, Jeff. Welcome to everyone on the call. Today, we will discuss our second quarter performance. After my opening remarks, Gary will review our earnings in more detail and provide operating guidance for Q3 2012 and then we will open up the call for your questions.

The second quarter was one of the most profitable in Western’s history and continues several quarters of strong performance. Over the past year, we have discussed our plans to continue to focus on safe and reliable operations, improve the balance sheet, implement crack spread hedging and reinvest in the business, and I’m pleased to report we are executing very well on this plan.

In the second quarter, total refining throughput was approximately 158,000 barrels per day, which is near full capacity and both refineries are currently operating at planned rates.

I’m very proud of our employees and their dedication in running our facilities in a safe and reliable manner, which allows the company to continue to capture the current strong margins.

We reached a significant milestone in the second quarter in terms of balance sheet improvement. During the quarter, we prepaid and retired our term loan and over the last 12 months we have reduced total debt by $566 million, a reduction of more than 50%.

This debt reduction will lower our cash interest expense by approximately $54 million annually, compared to a year ago. We are pleased with the debt reduction we’ve achieved and we believe the improvements we have made in the balance sheet have made Western a much stronger company.

Another key component of our plan is our crack spread hedging activity. Given the strong forward margin environment during the quarter we added to our 2013 and 2014 crack spread hedges, and also put on crack spread hedges for 2015. A summary of our hedge positions as of June 30th can be found on slide five.

We also continue to invest in our business with approximately 40% of our 2012 capital budget dedicated to discretionary projects. Our major initiatives, which include the Delaware Basin Logistic projects and refinery expansions continue to progress on time and on budget.

In addition, we continue to evaluate other projects that will enable us to capitalize on the growing crude production in our region, allowing us to further enhance the value of our assets.

For the second quarter, we generated $365.9 million in adjusted EBITDA. This performance was due to our excellent operations and continued strong refining margins. These margins continue to be driven by the wide Brent/WTI spreads and strong refined product values in our region.

In addition, El Paso refinery benefited from the WTI Midland/Cushing differential, which averaged $4.48 per barrel during the quarter, compared to $0.40 per barrel in Q2 2011.

Our wholesale business performed well in the quarter with significantly higher operating income driven by increased fuel margins, and improved fuel and loop volumes compared to Q2 2011.

In our Retail business we added 11 locations during the quarter by leasing an existing network of stores in Northern New Mexico bringing our total count to 222 stores. This addition is consistent with our strategy to opportunistically grow retail in order to secure a long term outlet for our refinery production.

Operating income for retail was improved significantly during the quarter due to strong fuel margins and increased sales from acquisitions.

Turning to the third quarter, the Brent/WTI spread in July averaged a strong $15.09 per barrel. The WTI Midland/Cushing spread is down from the highs that we saw earlier this year, but is still elevated above historic average.

Also preparations are going very well for the September turnaround and expansion at the Gallup refinery. In July our Board approved a $200 million share repurchase plan. Our intent is to use the shares we purchased to partially offset the potential dilutive effect of our convertible bonds.

In addition, we announced that we’ve increased our dividend to $0.08 per share for the third quarter, which will be paid to shareholders in mid-August. These actions further demonstrate our confidence in Western’s ability to produce strong future financial results.

In closing, it was an outstanding quarter for Western. We are proud of our employees for doing the things necessary to capitalize on these market conditions and the investments we’re making will enable us to further enhance our crude advantage and refining productivity.

Now, I will turn the call over to Gary who will go through our second quarter financials in more detail.

Gary Dalke

Thank you, Jeff. On a GAAP basis the company reported net income in the quarter of $238.5 million, or $2.19 per diluted share, which compares to a Q2 2011 net income of $100.1 million, or $0.94 per diluted share. A summary of second quarter highlights and key financials can be found on slide three.

Excluding special items, the company had net income of $205 million, or $1.89 per diluted share in Q2 2012, which compares to $102.9 million, or $0.97 per diluted share in Q2 2011. A reconciliation of our net earnings to earnings excluding special items is included in our press release.

As shown on slide five -- on slide four, our refineries demonstrated gross margin improvement during the quarter with El Paso up by 29% and Gallup up by 9%, compared to Q2 2011.

Direct operating expenses at our refineries were $5.33 per barrel for the quarter, which compares to $6.18 per barrel in Q2 2011. This reduction was driven by improved throughputs and lower natural gas catalyst and chemical costs.

Total company SG&A was $27.3 million for the quarter, compared to $24.8 million in Q2 2011. SG&A expenses were up primarily due to an incentive compensation accrual which is tied to profitability.

As Jeff mentioned, adjusted EBITDA for the quarter was $365.9 million, which compares to adjusted EBITDA of $233 million for Q2 2011. As a reminder, we now include an adjustment for non-cash unrealized mark-to-market hedging gains and losses in our adjusted EBITDA calculation.

Depreciation and amortization expense for the quarter was $22.8 million, a decrease of $11.5 million, compared to Q2 2011 due to the Yorktown sale.

Interest expense was $21.8 million, an $11.7 million decrease compared to Q2 2011, primarily results of reduced debt and interest rate levels associated with our refinancing and debt reduction efforts.

Cash and cash equivalents stood at $346.1 million at the end of the quarter, a bridge from Q1 2012 to Q2 2012 ending cash position can be found on slide six. Cash flow from operations for the quarter was $306 million, which compares to $165.8 million in Q2 2011.

Total capital expenditures for the quarter were $37.2 million. As of June 30th, total debt stood at $491.8 million and net debt was $145.7 million. A summary of our capital structure is available on slide seven.

Our total debt to LTM adjusted EBITDA leverage ratio has improved significantly, decreasing from 2.2 times to 0.5 times over the last year. Liquidity, which we define as cash and availability under our revolver was approximately $770 million at the end of the quarter, and has averaged approximately $835 million thus far in the third quarter.

I would also like to note that cash balance has averaged approximately $440 million during July.

Lastly, you can find our third quarter operating guidance on slide eight. As Jeff mentioned, we will be performing our Gallup turnaround and expansion during the third quarter. We estimate that the turnaround costs will be approximately $25 million and as a reminder, we recognized turnaround expenses as they occur.

Also we have a planned reformer regeneration scheduled at El Paso. The impact of this planned maintenance is reflected in the throughput volumes and per barrel costs in our guidance for the quarter.

Susan, we will now open up the call for questions.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) Your first question comes from the line of Chi Chow with Macquarie.

Chi Chow – Macquarie

On the great results. Can you give us an update on the crude logistics projects in the Delaware Basin and kind of a status of progress there?

Jeff Stevens

Sure, Chi. As you know it’s kind of a three phase project, we’re in the midst of building some tank each and a truck loading rack facility. We believe that will be up running here in the fourth quarter of this year.

Along with that, we’re building about 40 miles of pipeline, we believe that will be up in the first quarter of 2013. So it’s kind of a staged in project. But as far as all the permits, everything we need to stay on time looks good.

Chi Chow – Macquarie

And can you walk us through the expected upside on crude pricing once these projects get online? I understand you’re priced 100% off Midland right now at El Paso and how does that change going forward with the new logistics system?

Jeff Stevens

Well, there is really two parts to that Chi. There is, obviously, we’ve talked a lot about the quality of this crude that we’ll be bringing into El Paso and the yield pattern is definitely better than what we’ve historically run. And then there’s some location differentials and so forth. But when you combine the two it’s somewhere around a $1, $1.50 on these initial barrels.

Chi Chow – Macquarie

And that’s going to be 40-day, is that correct, one say, once you get going?

Jeff Stevens

Well, the initial with the truck rack is closer to 25 a day. But once the pipeline is fully up and running it will be about 40, maybe a little bit more than 40 a day.

Chi Chow – Macquarie

Okay. Great. And can you give us any more thoughts on the additional projects you may be considering, and maybe anything going on up in the Mancos right now?

Jeff Stevens

Well, the two areas that we are focused on right now is this Permian Basin and I would tell you that it’s kind of changing week to week. It’s pretty exciting with all the activity out there.

And we have a lot of different opportunities to continue to enhance the system that we’re building and kind of bolt-on other systems that will add value to that. So we’re in the process of negotiating the long-term deals and I think, you’ll hear us make more announcements in the next quarter relative to the Permian Basin.

As far as the Mancos goes, we are still at an early stage there in the Mancos. But the results that we are hearing are good. We are receiving some of that new crude now and as they start to ramp up, it’s just going to give us a lot more flexibility on the types of crudes we can run into the Four Corners.

And as you know, we’re currently have the capability of railing crude out of Gallup. So we’ll continue to buy all the crude up into that region and then we have the flexibility putting it on the rail and going east or west with it.

Chi Chow – Macquarie

Right. Okay. Great. Thanks, Jeff. I appreciate it.

Jeff Stevens

Thanks, Chi.

Operator

Your next question comes from the line of Jeff Dietert with Simmons.

Jeff Dietert – Simmons

Good morning.

Jeff Stevens

Good morning, Jeff.

Jeff Dietert – Simmons

Following up on Chi’s question, you talked about better crude quality. Can you talk about API gravity, sulfur content kind of gasoline yield, distil yield, how that compares with what you’re currently running and as you see more shale crudes coming into your system. Do you expect to run more light sweet less WTS? And maybe finally, how does that factor into your expansion plans at El Paso?

Jeff Stevens

Yeah. The gravity we’re seeing right now is about a 42. The sulfur is 0.1. Historically, the crude -- the Midland common stream is a 0.5. So you can see a significant decrease in the sulfur content.

And Jeff, what this really does is it just gives us a lot of flexibility. We are going to be building some tank each at El Paso to segregate our crude, so we can keep the shale or the super sweet isolated, depending on where solid differentials come out, we maybe better off to blend more solid and having the lower sulfur sweet crude will give us more flexibility. So it just depends upon differentials.

But certainly, we haven’t had this flexibility in the past. So it will be modeled out every quarter, every month and depending on where differentials are, we’ll make the appropriate blend.

Jeff Dietert – Simmons

Do you have a good feel for what the gasoline and diesel yields look like for the Delaware Basin crudes, the new crudes coming in and how do they compare to your Midland crudes?

Jeff Stevens

Well, it’s pretty much, it will be the same diesel. What it will be is, obviously, there is lower bottoms and less resid. So it will help kind of equally out as far as the pattern goes. But it will also depend upon how much solid we decide that we’re going to blend with it.

But the key to it is, is that we’re going to keep all the crudes sacred and as we run the different crudes and look at the different patterns, we’ll be able to fine-tuner and really understand the value that it brings to the refinery.

Jeff Dietert – Simmons

Very well. Thank you.

Jeff Stevens

Thanks, Jeff.

Operator

Your next question comes from the line of Ed Westlake with Credit Suisse.

Ed Westlake – Credit Suisse

Hi. Good morning everyone and congratulations on the buyback and the results.

Jeff Stevens

Thanks, Ed.

Ed Westlake – Credit Suisse

Just a quick one on the actual results, obviously, you saw a decent wholesale contribution in the quarter. Is that just pricing or is something else going on there?

Jeff Stevens

It’s kind of two things, Ed. Wholesale now is combined the Southwest and the East Coast and when you look at the wholesale business, when you look at the type of drop in price that we saw in crude and products throughout the quarter, just in general, wholesale typically has higher margins than normal, and that was part of it.

The other thing is on the East Coast. We continue to see wider spreads relative to the harbor and the markets that we market. As you recall, we’re bringing the majority of our product up from the Gulf Coast on Colonial and supply in those markets.

So we’ve seen good up downs relative to that and I think the other thing wholesale benefited from in the quarter was we had fairly wide ethanol gasoline margins, we’re pretty strong. So I think that all contributed to it.

Ed Westlake – Credit Suisse

Right. Okay. On the issue of growing logistics assets and with the shales that are emerging as Chi mentioned not just in the Permian, what opportunities are there to grow logistics faster and then feed that into sort an MLP and a funding question?

Jeff Stevens

Well. Certainly, the logistics projects that we’re doing right now obviously are being done to benefit the refineries and just the overall asset portfolio. But obviously, as we continue to build out more logistics, it’s going to give us more flexibility to look at opportunities to really get the value out of the logistic assets.

So we believe that we have some very good logistics assets today but we believe we can grow that pretty significantly over the next couple of years. And then, I think, we’ll be in a position to figure out a way to really capture the value out of those assets.

Ed Westlake – Credit Suisse

Right. So more at the moment are using corporate cash to grow that out and then build up sufficient scale, am I hearing that correctly?

Jeff Stevens

Yeah. That’s the key component and the other key component is in a lot of these assets, Western is the primary user of these assets and of course, as Western’s balance sheet continues to get stronger, the value of these assets just keeps going up.

Ed Westlake – Credit Suisse

Great. And then maybe a final question. We do have new pipeline export capacity in your slides obviously and everyone is aware of that, going from the Permian down to the Gulf, I guess in early 2013?

What are your thoughts in terms of speaking to the local producers in terms of whether there’ll be enough off-take capacity relative to the growth that we’re seeing out of West Texas?

Jeff Stevens

Well, I mean obviously today the off-take has hit a level of strength and we’ve seen that in the differentials and there are pipeline projects that have been proposed to be built. But if you look at the estimates and the estimates in the Permian Basin are for total crude of anywhere from $1.6 million up to $2.1 million barrels per day.

If it’s closer to that $1.6 million then I think the takeaway will probably be able to meet that demand. If we get up into the higher ranges of production then I think we’re going to have -- continue to have takeaway issues.

So, it’s going to be interesting, we’re at the early stage in the Permian Basin. But as I remind people in the Bakken, they’ve had to revise their production numbers up quite a bit and so if the Permian any indication of what we saw in the Bakken or even the Eagle Ford we might see higher production than what is first being forecast.

But the bottom line is we sit right in the middle of it and we’re going to be a major beneficiary of this, and we’re doing things necessary to capture as much as we can of this through price and quality of crude.

Ed Westlake – Credit Suisse

Congrats. And thanks for your time this morning.

Jeff Stevens

Thanks, Ed.

Operator

Your next question comes from the line of Arjun Murti with Goldman Sachs.

Arjun Murti – Goldman Sachs

Thanks, Jeff. Just somewhat following up on the last question and then also your balance sheet comments, obviously the balance sheet is much improved and you have announced a buyback and I think the initiation and now increase in dividend. You mentioned the logistics projects to improve your crude discounts? When companies have challenged balance sheets typically there are other capital projects that get put aside?

Do you -- with your now better balance sheet, do you have a backlog of projects at the refinery level that you might be looking to pursue over the next few years or is the emphasis going to be primarily on the logistics and crude sourcing advantages coupled with the dividends and stock buyback? Thank you.

Jeff Stevens

We believe there are projects within the refinery. We have the expansion going on that coincides with the turnaround in Gallup. We’ve talked about an expansion in El Paso, that we’re moving forward, we’re in our second phase of engineering on that, probably the biggest issue on that will be permitting. But that will add about 25,000, 30,000 barrels a day of capacity potentially to coincide with a turnaround in 2014.

But there are a number of things, because we’ve been capital constrained the last several years that the refineries are looking at that will have long-term benefit. So, I think, you’ll see over time more projects being announced here and with very high returns.

Arjun Murti – Goldman Sachs

Jeff, when might you be able to give an update on the potential capital costs and moving forward the El Paso expansion?

Jeff Stevens

I think by the end of the year we’ll be prepared to move forward, we’re also understanding the timing on the permit too.

Arjun Murti – Goldman Sachs

Yeah. And then just lastly, the current stock buyback, I think that matches the dilution that would come from the converts. Can we think about you all as just trying to accomplish that or being willing to engage in an ongoing stock buyback, above and beyond just eliminating that dilution?

Jeff Stevens

Well, I think, obviously, the first is to help potentially take out that dilution or as much as we can. But I think what you’ll see Arjun is kind of a balanced approach. I think you’ll see us continue to look at, our first priority is going to be these high return capital projects and then we’ll look at where we’re at on our dividend, and where we’re on -- at on our share repurchase.

I think it’s a good start, but I believe, like I said I’m very confident in the business. I think our best days are ahead of us right now. So I think that you’ll see us continue kind of a balanced approach in those three areas.

Arjun Murti – Goldman Sachs

That’s helpful. Thank you so much.

Jeff Stevens

Thanks, Arjun.

Operator

Your next question comes from the line of Evan Calio with Morgan Stanley.

Evan Calio – Morgan Stanley

Hey. Good afternoon, guys. Very good quarter.

Jeff Stevens

Hey, Evan.

Evan Calio – Morgan Stanley

We covered a lot of ground here already, but just a question, I mean, I know you put on more hedges on the quarter, but as you deliver the much better balance sheet, improving on a very rapid rate. Do you see less inclination or less need to hedge cracks to the same levels before on a go forward basis there? How you are approaching that as your fiscal situation improves?

Jeff Stevens

Well, I mean obviously, the hedging program was really important when the debt structure that we had needed to be improved. But we simply look at the hedges that we’re putting on today as opportunistic.

So what you’re seeing is as Brent TI widens out, you’ll see us opportunistically essentially selling forward some of our production at very, very high levels. But it isn’t something we have to do. It’s more of an opportunistic thing.

I think you’ll see us still stay kind of at a third of our production or less. But when we’ve got margins clear out to 2015 of approximately $25 a barrel on distillate. I think it’s prudent of us to go ahead and sell a little bit of our production and just go ahead and take that off the table.

So I think you’ll continue to see us it’s an opportunistic move and just making sure we capture some of the higher margin.

Evan Calio – Morgan Stanley

That’s great. And secondly, for me I know you have focused a lot -- refocused a lot on returning cash to shareholders and deleveraging. I mean should we assume refining acquisitions are something that are not within your current plans and how you think about things?

Jeff Stevens

Well, what our plans are today is to grow the logistics, take advantage of this crude that we’re going to have access to and make sure that we capitalize on that. And we continue to look at assets that either fit our system that would add value to our existing asset base and we look at assets that would add value to the shareholders.

But I would just tell you, our priority right now is to continue to focus in on these logistic assets because these are long-term assets that help make the company very profitable for a very long time.

Evan Calio – Morgan Stanley

Understood. Appreciate it, guys.

Jeff Stevens

Thank you.

Operator

Your next question comes from the line of Paul Sankey with Deutsche Bank.

Paul Sankey – Deutsche Bank

Hi.

Jeff Stevens

Good morning, Paul.

Paul Sankey – Deutsche Bank

I think mine are all, all very much follow up to the earlier questions, to ask an immediate follow-up to Evan. When you IPO the company it was about growth and obviously you have been constrained by the debt issue. I guess and so far as it a follow-up to what you just said?

But when you step back and look at the strategy, the speed of the debt pay down that you’ve got here must have you thinking about, if you like a re-launch of how you see the world over the next five and 10 years.

Can you just talk a little bit more about how that has changed and whether you would revert to more of a growth oriented, more aggressive strategy once you’re less constrained? Thanks.

Jeff Stevens

Yeah. Paul, you’re exactly right. It is a different day for Western than it was just even a year ago, relative to our balance sheet and where we’ve come in. We certainly, like I said before, we like our assets, we like where we’re positioned.

If there are assets out there that complement or make sense for us, we certainly are in a position to date to look at them. We are a young company that does want to grow. But we just need to look at it and make sure that we find the right opportunities that make sense for us. That’s really all I can say.

Paul Sankey – Deutsche Bank

Yeah. I mean I think we frankly would prefer more of the just now right cash return strategy as the primary aim. But I guess, it will be interesting to hear, how you address that as things go so well. I mean, I guess, this is a luxurious problem to have right?

Jeff Stevens

Oh! Yeah. And Paul, the original founders still own about 35% of the stock and so, I think we have the same interests that the existing shareholders have.

Paul Sankey – Deutsche Bank

Yeah. That is a very sad point. Follow-up as well to earlier, I think it just might be me being a bit dumb. But can you, just sorry to do this to you, can you go over the Midland discount again, maybe I don’t know, walk through it kind of as you see it on a quarterly basis developing, because there is so much movement in terms of the infrastructure additions.

If again, keeping it simple for me. Is what you’re saying that you continue to expect the growth of Permian production to exceed the available capacity that gets developed in pipelines for I don’t know, next two years or how is it, you’re thinking about that?

Jeff Stevens

Well, what I think the way to think about it is that the system is now strained and so with the new production that’s come on and the existing production and you look at the existing takeaways in the market.

Whenever, you see either a pipeline or a local refinery disruption, I think we’ll see spikes in the differentials between Midland and Cushing, and it’s simply just being able to get the barrels out of the market.

I think as if the price of crude stays elevated $90 to $100, I think, you’re going to continue to see more and more production coming online. The question is how fast will the production come on versus pipelines either expanded or new pipelines being built?

And I just -- the only way to look at it is that what we’ve seen in the Bakken and Eagle Ford, the crude typically comes on first. And so it’s our belief that we’ll continue to have opportunities with wider differentials between Midland and Cushing than we’ve historically seen.

And I think the way to think about it is, I think, they will be similar to the Brent-TI differentials where they move in and out based on speculation of new pipelines being built or pipelines being expanded. And so I think that it will be volatile but when a -- when one of the major players either has a problem or goes on a turnaround, the system is going to be taxed as far as getting the barrels out of the market.

Paul Sankey – Deutsche Bank

Yeah. Thanks. That’s kind of exactly our view and thanks for slowing down your speech there a little bit for me. I appreciate that. The hedging -- what is the basis differential risk on that? Can you remind me the extent to which you can really capture a true hedge for yourself?

Jeff Stevens

Yeah. The way we approach our crack spread hedges is we enter into an agreement that simply defines the crack. And so it’s a Gulf Coast low sulfur diesel crack or a gasoline crack tied to the Gulf Coast. And so we don’t have any risk relative to spreads or anything else. It’s just a pure Gulf Coast gas and diesel crack.

And then on our end, we have customers that we sell product to on a Gulf Coast monthly average. So really, there isn’t any basis risk the way we approach it.

Paul Sankey – Deutsche Bank

Okay. And I know you’ve got a lot of exposure to the trains. The rail system and general demand trends obviously must be fairly healthy for these margins. But anything to add on demand trends that you’re seeing in your specific markets. Particularly, I’d like to look year-over-year and to the extent that you can normalize that. Thanks.

Jeff Stevens

Right. I would say diesel remained strong. I think overall particularly rail and mining is up year-over-year. The trucking may be flat and then the gasoline I’d call flat, maybe down 1%, 2%. But no real move on gasoline but diesel remains strong and it’s reflected in the margins we’re seeing.

Paul Sankey – Deutsche Bank

And what’s the percentage year-over-year that you’d call that for the diesel is strong?

Jeff Stevens

Well, like I said, it depends upon the segment and we’re very weighted towards mining and railroad. But I’d say it’s 5% to 7%.

Paul Sankey – Deutsche Bank

Brilliant. Guys, I’ve asked you plenty of questions. Thanks a lot.

Jeff Stevens

Thanks, Paul.

Operator

Your next question comes from the line of Roger Read with Wells Fargo.

Roger Read – Wells Fargo

Hey, good morning.

Jeff Stevens

Good morning, Roger.

Roger Read – Wells Fargo

I guess, since a lot of the stuff on the refining side certainly has been covered, if we could talk a little bit maybe about these negotiations to the extent you can on the sourcing the crude there in the far west part of the Permian. How should we think of those contracts being -- established from a pricing standpoint? Is there an index, maybe if you could help us out to understand what that index would be.

Jeff Stevens

Well, I mean, the premise is they’re all -- all the contracts we’re doing are Midland based contracts. So the way to think in terms of -- they’re tied to the Midland on the calendar month average. And then depending on the quality of the crude and depending upon the location of the crude, there’s some discounts that are negotiated that we work out with the producers. So, each, individually one is negotiated and it’s simply a location and quality discussion.

Roger Read – Wells Fargo

And then whatever the transportation cost is I assume.

Jeff Stevens

Correct.

Roger Read – Wells Fargo

Okay. And then my only other question on the retail side obviously pretty good results there. Following on with some of the questions the others have asked now that you have greater financial flexibility, should we expect meaningful potential growth in the retail side or are you pretty comfortable with where you are there?

Jeff Stevens

We’ve made a pretty dramatic increase in our retail just over the last 12 months. What we’ve done is, we’ve opportunistically done some deals with long-term leases. So we haven’t had to outlay a lot of capital. I think you’ll see us continue to follow that approach. I think we have other and better uses for our capital.

But if there’s opportunities in our region that fit into our network, we’ll continue to opportunistically look at these similar type retail facilities in the future. They need to fit our retail group and they need to fit within the refineries and make sense as far as the supply destination is concerned.

Roger Read – Wells Fargo

Okay. Thank you.

Jeff Stevens

Thanks, Roger.

Operator

Your next question comes from the line of Cory Garcia with Raymond James.

Cory Garcia – Raymond James

Congrats on the quarter. Just wanted to circle back to Gallup, I’m sorry to belabor this point but I was, sort of, curious on how you guys are thinking about the crude optionality ahead of, sort of, the development in the Mancos and the San Juan. Clearly that’s going to be the most cost effective method for sourcing the crude but I’m just wondering what sort of other opportunities, possibly the reversal of the Tex-New Mex has been put out before but other options that could sort of accentuate that in the near term into Gallup.

Jeff Stevens

Well, obviously in that region, we really have a pretty extensive gathering system today with trucks and pipes and tanks and as you mentioned the Tex-New Mex line and what we’ll do is, we continue -- what we’ll do, our first priority will be sourcing crude for the refinery.

So we’ll look at the different qualities of crude and make sure we find the right mix to maximize Gallup’s production. And then what we’ll do is we’ll continue to buy the crude and gather it, ship it through our lines. We have the flexibility today.

We invested money about six months ago into increasing our rail siding and rail loading at Gallup. So we can load railcars for the crude that doesn’t meet our needs and we can push that crude either to the West Coast or push it East and make a profit on it and continue to be able to pick and choose the crudes.

If the crude continues to go up and like a lot of people feel that the crude is going to significantly increase in that area, we always have the flexibility of putting the pipeline back in service and pushing the barrels down into the Midland area. And we actually have options to potentially get the crude into our pipeline and feed it to El Paso if that’s what makes sense.

So we have a lot of flexibility. We’re a little ways away from that. It will depend upon how fast the crude comes online. But the bottom line is I believe we’re sitting in a great position to take advantage of this.

Cory Garcia – Raymond James

Sure. Clearly a ton of opportunity. I appreciate the color. Thanks, guys.

Jeff Stevens

Thank you.

Operator

Your next question comes from the line of Ed Westlake with Credit Suisse.

Ed Westlake – Credit Suisse

Hey. Very interesting. Just a follow-up on the Mancos and I see the Sundance Bear Lodge as the best place to stay there according to TripAdvisor. Just on the quality of crude that’s coming out of the Mancos, is it light enough that you could process in Gallup without having to do much changes to the way that operates?

Jeff Stevens

What we’re seeing today is actually a perfect fit. It’s ideal. It’s actually -- could be conceived as a better crude than we’ve historically run at the facility. So we’re very excited about that project and getting more and more of that crude to see how it runs. But we’re confident it will run well in Gallup.

Ed Westlake – Credit Suisse

And so then I mean obviously if it’s light and sweet enough, a CDU and associated units are cheaper than upgrading. But I mean I guess it has to compete with the prices of just railing the crude out of there and the local market. I mean, is that sort of in the thinking?

Jeff Stevens

Yeah. Like I said before, I think that we’re positioned well with our assets to help the crude find its way into the marketplace. And I think that we’ll have kind of our choice on which crudes we want to run and which crude that we’ll deliver to other markets.

Ed Westlake – Credit Suisse

And just one final thing. The train loading facility, do you have a capacity for that at Gallup.

Jeff Stevens

It’s some where -- we haven’t gotten up to that level but it’s somewhere around 5,000 or 6,000 barrels a day.

Ed Westlake – Credit Suisse

Okay. And there’s land for a unit train facility if required?

Jeff Stevens

That would take some capital. But I think before we did that, I think we’d have better options. We have a pipeline in the area that we could reverse that could more than handle the production up there if we needed to do that.

Ed Westlake – Credit Suisse

Great. Thank you for your time this morning.

Jeff Stevens

Thanks, Ed.

Operator

Thank you. At this time, there are no further questions. I would now like to return the call over to Mr. Jeff Stevens for any closing remarks.

Jeff Stevens

Thanks Susan. Thank you for your participation in today’s call and your continued interest in Western.

Operator

Thank you. That does conclude today’s second quarter 2012 Western Refining earnings conference call. You may now disconnect your lines at this time and have a wonderful day.

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