Valero Energy's (VLO) CEO Joe Gorder on Q4 2016 Results - Earnings Call Transcript

| About: Valero Energy (VLO)
This article is now exclusive for PRO subscribers.

Valero Energy Corporation (NYSE:VLO) Q4 2016 Earnings Conference Call January 31, 2017 10:00 AM ET

Executives

John Locke - Vice President, Investor Relations

Joe Gorder - Chairman, President and Chief Executive Officer

Mike Ciskowski - Executive Vice President and Chief Financial Officer

Lane Riggs - Executive Vice President, Refining Operations and Engineering

Jay Browning - Executive Vice President and General Counsel

Gary Simmons - Senior Vice President, Supply, International Operations and Systems Optimization

Jason Fraser - Vice President, Public Policy & Strategic Planning

Rich Lashway - Vice President, Logistics Operations

Analysts

Brad Heffern - RBC Capital Markets

Phil Gresh - JPMorgan

Neil Mehta - Goldman Sachs

Doug Leggate - Bank of America/Merrill Lynch

Johannes Van Der Tuin - Credit Suisse

Paul Cheng - Barclays

Roger Read - Wells Fargo

Chi Chow - Tudor, Pickering, Holt

Spiro Dounis - UBS Securities

Jeff Dietert - Simmons

Ryan Todd - Deutsche Bank

Blake Fernandez - Howard Weil

Faisel Khan - Citigroup

Craig Shere - Tuohy Brothers

Paul Sankey - Wolfe Research

Operator

Welcome to the Valero Energy Corporation Reports 2016 Fourth Quarter Earnings Results Conference Call. My name is Vanessa and I will be your operator for today’s call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. John Locke, Vice President, Investor Relations. Sir, you may begin.

John Locke

Well, good morning and welcome to Valero Energy Corporation’s fourth quarter 2016 earnings conference call. With me today are Joe Gorder, our Chairman, President and Chief Executive Officer; Mike Ciskowski, our Executive Vice President and CFO; Lane Riggs, our Executive Vice President of Refining Operations and Engineering; Jay Browning, our Executive Vice President and General Counsel; and several other members of Valero’s senior management team.

If you have not received the earnings release and would like a copy, you can find one on our website at valero.com. Also attached to the earnings release are tables that provide additional financial information on our business segments. If you have any questions after reviewing these tables, please feel free to contact our Investor Relations team after the call. I would like to direct your attention to the forward-looking statement disclaimer contained in the press release. In summary, it says that statements in the press release and on this conference call that state the company’s or management’s expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provisions under federal securities laws. There are many factors that could cause actual results to differ from our expectations, including those we’ve described in our filings with the SEC.

Now, I will turn the call over to Joe for a few opening remarks.

Joe Gorder

Thanks, John and good morning everyone. The fourth quarter and the full year 2016 were good for Valero as we achieved our best performance ever in the areas of personnel and process safety, plant reliability, and environmental stewardship. We are very proud of our team’s exceptional execution, which we believe is imperative in our business and critical during the low margin environment like we saw for most of the year.

In the fourth quarter, we continued to see good domestic demand supported by low prices and solid export volumes due primarily to demand strength in Latin America. While we saw seasonal declines in available margin in some regions, margins in the Gulf Coast region remained healthy and distillate margins in all regions were bolstered by a return to more normal weather patterns in North America and Europe. We also saw attractive heavy sour discounts relative to Brent. A persistent headwind again this quarter was the exorbitant price of RINs. We spent $217 million in the fourth quarter to meet our biofuel blending obligations. At this level, this is a significant issue for us so we continue to work it aggressively with regulators. Our efforts are focused on moving the point of obligation because we believe this will level the playing field among refiners and retailers, but more importantly, it will improve the penetration of renewable fuels, lower RIN speculation, and reduce RIN fraud. However, based on current rules, we expect costs in 2017 to be similar to the $750 million amount we incurred last year. Given significance of this cost to our company, this issue continues to have our full attention.

Turning to our refining segment, we initiated turnarounds at our Port Arthur and Ardmore refineries in the third quarter. Both events carried over into and were completed in the fourth quarter. Our employees and contractors worked hard to safely complete these events. We believe distinctive operating performance is highly correlated to capturing more of the margin available in the market. In our ethanol business, we also ran very well and saw strong margins in the fourth quarter due to high gasoline demand in the U.S., strong pull from export markets, and low corn prices.

Also in the fourth quarter, we invested over $600 million to sustain and grow our business. Construction continued on our $450 million Diamond Pipeline project, which we believe is on track for completion at the end of this year, and we continue to work on our $300 million Houston alkylation unit, which we expect to be mechanically complete in the first half of 2019. We also have additional growth investment opportunities under development around octane enhancement, cogeneration, and feedstock flexibility.

And finally, regarding cash return to stockholders, we delivered a payout ratio of 142% of our 2016 adjusted net income, which was 78% higher than our payout ratio for 2015 and well above our target for 2016. Further demonstrating our belief in Valero’s earnings power, last week our Board of Directors approved a 17% increase in the regular quarterly dividend to $0.70 per share or $2.80 annually.

So John, with that, I will hand the call back over to you.

John Locke

Thank you, Joe. For the fourth quarter, net income attributable to Valero stockholders was $367 million or $0.81 per share compared to $298 million or $0.62 per share in the fourth quarter of 2015. Fourth quarter 2015 adjusted net income attributable to Valero stockholders was $862 million or $1.79 per share. For 2016, net income attributable to Valero stockholders was $2.3 billion or $4.94 per share compared to $4 billion or $7.99 per share in 2015. 2016 adjusted net income attributable to Valero stockholders was $1.7 billion or $3.72 per share compared to $4.6 billion or $9.24 per share for 2015.

Please refer to the reconciliations of actual to adjusted amounts as shown on Page 3 of the financial tables that our company released. Operating income for the refining segment in the fourth quarter of 2016 was $715 million compared to $876 million for the fourth quarter of 2015. Adjusted operating income for the fourth quarter of 2015 was $1.5 billion. The decline from the 2015 adjusted amount was primarily due to narrower discounts for most sweet and sour crude oils relative to Brent, weaker gasoline margins in some regions, and higher RINs prices.

Refining throughput volumes averaged 2.9 million barrels per day, which was in line with the fourth quarter of 2015. Our refineries operated at 95% throughput capacity utilization in the fourth quarter of 2016 with major turnarounds at the Port Arthur and Ardmore refineries completed early in the quarter. Refining cash operating expenses of $3.83 per barrel were $0.36 per barrel higher than the fourth quarter of 2015 primarily due to favorable property tax settlements and adjustments in 2015 and higher energy cost in 2016.

The ethanol segment generated $126 million of operating income in the fourth quarter of 2016 compared to a loss of $13 million in the fourth quarter of 2015. Adjusted operating income for the fourth quarter of 2015 was $37 million. The increase from the 2015 adjusted amount was due primarily to lower corn prices and higher ethanol prices.

For the fourth quarter of 2016, general and administrative expenses, excluding corporate depreciation, were $208 million and net interest expense was $112 million. Net interest expense was lower than guidance due to prepayment penalties associated with the early redemption of the 2017 notes being reflected in other income. Depreciation and amortization expense was $468 million and the effective tax rate was 21% in the fourth quarter of 2016. The effective tax rate was lower than expected due primarily to stronger than projected relative earnings contribution from our international operations that have lower statutory rates and other items as referenced in the release.

With respect to our balance sheet at quarter end, total debt was $8 billion and cash and temporary cash investments were $4.8 billion, of which $71 million was held by VLP. Valero’s debt to capitalization ratio, net of $2 billion in cash, was 23%. We have $5.6 billion of available liquidity, excluding cash, of which $720 million was available for only VLP. We generated $998 million of cash from operating activities in the fourth quarter. With regard to investing activities, we made $628 million of capital investments, of which $244 million was for turnarounds and catalysts. For 2016, we invested $2 billion, which was slightly lower than guidance due to lower turnaround costs and the timing of some growth spending. And of this total, $1.4 billion was for sustaining and $600 million was for growth.

Moving to financing activities, we returned $440 million in cash to our stockholders in the fourth quarter, which included $271 million in dividend payments and $169 million for the purchase of 2.7 million shares of Valero common stock. For 2016, we purchased 23.3 million shares for $1.3 billion and had approximately $2.5 billion of authorization remaining. For 2017, we maintain our guidance of $2.7 billion for capital investments, including turnarounds, catalysts, and joint venture investments. This consists of approximately $1.6 billion for sustaining and $1.1 billion for growth.

For modeling our first quarter operations, we expect throughput volumes to fall within the following ranges; U.S. Gulf Coast at 1.63 million to 1.68 million barrels per day, U.S. Mid-Continent at 415,000 to 435,000 barrels per day, U.S. West Coast at 195,000 to 215,000 barrels per day, which reflects a major turnaround at the Venetia refinery and North Atlantic at 440,000 to 460,000 barrels per day. We expect refining cash operating expenses in the first quarter to be approximately $4.15 per barrel, which reflects projected increased natural gas prices. Our Ethanol segment is expected to produce a total of 3.8 million gallons per day in the first quarter. Operating expenses should average $0.39 per gallon, which includes $0.05 per gallon for non-cash costs such as depreciation and amortization. We expect G&A expenses excluding corporate depreciation for the first quarter to be around $175 million and net interest expense should be about $115 million. Total depreciation and amortization expense should be approximately $485 million and our effective tax rate is expected to be around 30%.

That concludes our opening remarks. Before we open the call to questions, we again respectfully request that callers adhere to our protocol of limiting each turn in the Q&A to two questions each. This will help us ensure other callers have time to ask their questions. If you have more than two questions, please rejoin the queue as time permits.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] We have our first question from Brad Heffern with RBC Capital Markets.

Brad Heffern

Good morning everyone.

Joe Gorder

Good morning Brad.

Brad Heffern

Hey Joe. So I was wondering, obviously a big topic of conversation has been the border adjustment tax in the space, so can you go through your thoughts on how that’s going to affect feedstock costs, your ability to pass it on and maybe the likelihood that you see if that’s actually making it through?

Joe Gorder

Yes, you bet. We will give you a point of view. What I would like to do is let Jason Fraser answer that question. Jason has recently taken the position as the individual responsible for our public policy and strategic planning group, so we brought him back from London to take on this job. And it’s interesting we put the two functions together, strategic planning and public policy, because in our view you really can’t bifurcate the two anymore. They are going to be very intertwined. So Jason, you want to go ahead and share your point of view?

Jason Fraser

Sure. Yes. I will give you a heads-up on where we are with the house tax blueprint. And we have read all of your reports. As you know, there are greatly differing opinions on the blueprints, including the border tax, border adjustment tax aspect, how it affects our industry, and Valero. We are performing our own analysis as well as working through scenarios with AFPM, our trade association. We are also engaged with the legislative process. We are at the very early stages. No legislative tax has been released by the ways and means committee yet, so we are not sure exactly what’s going to be in it. But we are going to continue to work this issue. Regarding the likelihood of passage, you guys know that any kind of major legislative change like this is difficult to pass. If there isn’t bipartisan support, the Republicans may have to use the budget reconciliation process. We also have a new administration which adds another variable. So it’s really hard to handicap at this stage how it’s likely to turn out.

Brad Heffern

Okay. Thanks for that. And then Joe or maybe Gary or Lane, the South Coast AQMD in California has talked about potentially banning the use of hydrofluoric acid, I was curious if you know what the impact will potentially be on Wilmington and maybe the chance of that going through as well?

Lane Riggs

So Brad, this is Lane. So yes, we are engaged in the process and there is obviously a conversation around it. And I can’t really share much more than that than it does impact our operations, so we did have an HF unit [ph] there as long as the operator there in Torrance, and there are technologies out there. Obviously, the most straightforward one is the sulfuric acid, but there is also one of the other technology providers in the space has another solution and – but we are certainly working with them in terms of how long it might take to – if they choose to go down that path and how long that –what the phase-in or at least the requirement would be, but we are very involved.

Brad Heffern

Okay. I will leave it there. Thanks guys.

Operator

Thank you. Our next question comes from Phil Gresh with JPMorgan.

Phil Gresh

Hey, good morning.

Joe Gorder

Hi Phil.

Phil Gresh

I just wanted to start with the return of capital, obviously the year ended up north of 140%, you are guiding to 75%, which is consistent with the guidance you have always said, but there is obviously a big delta between those two numbers, so I guess, I am wondering how you are thinking about that target relative to what you accomplished in 2016 and just taking note of the fact that 4Q did step down a bit from the rest of the year on the buybacks?

Mike Ciskowski

Okay. Phil, this is Mike. We continue to spend our discretionary cash according to our capital allocation framework. When we look at how much we are going to buyback in a particular quarter, we do look at the net income, but we also consider cash flow, and so for the quarter or for 2016, we did have 142% of net income and that equated to 51% of cash flow.

Phil Gresh

It’s okay. So you are suggesting we should consider cash flow as a metric as well?

Mike Ciskowski

Well, not suggesting that as our overall guidance, but in a lower margin environment where net income is hit with our depreciation, we do take that into consideration when we are returning to our shareholders.

Joe Gorder

Phil and we have talked about this before, we set the 75% target because it’s easy to see and cash flow can move around, obviously. And Mike is right, looking at net income in a low-margin environment, we set an expectation and we consider it to be kind of the floor. It’s our commitment to our shareholders to the extent we can do more and it’s the best use for the cash, we will go ahead and continue to buyback shares. I think the move we made with the dividend this quarter clearly reflects our comfort level and our Board’s comfort level with the earnings capability of the company in a down market. And so obviously, if you look at a $2.80 dividend, it’s going to continue to be a more significant component of the 75% payout ratio. We are very comfortable with that. But we will continue to buyback shares and the guys will do it in the way they have done it in the past, to some extent ratably and to some extent opportunistically.

Phil Gresh

Sure. Okay, that makes sense. And if I could maybe push a little bit more on Brad’s question, more from the angle of if something were to happen, maybe just talk through your system, the amount of crude you import, the amount of product you export, you gave some numbers on product exports, but maybe just what changes you think you would potentially make if this were indeed implemented?

Joe Gorder

Yes. I mean it’s – and I will let Gary and Jason and Lane can – we can all speak to this. But obviously, you are going to optimize your crude slate. The big question around this whole border adjustment is how are the markets going to react to it and frankly, we have read everyone of the sell side reports on this and then consulting reports, as Jason mentioned and it’s got a lot of moving parts. Some people look at it on a static basis. Some have looked at it when you take into consideration the markets adjusting and some have taken into consideration the currency adjustment also. So right now, there is a skeleton out there that they are trying to put flesh on and we don’t know exactly what it’s going to look like. But I think it’s fair to say that we are going to continue to optimize our operation. And if you recall, Gary, I don’t remember how long ago, but we are running over 1 million barrels a day of light sweet crude and there has been times when we have run 600,000 or 700,000 barrels a day of light sweet crude. So, Phil, we have got the flexibility in the system. Gary, you want to talk at all about the markets and...

Gary Simmons

Yes. So if you just look really over the last several years, our strategic objectives have been around developing feedstock flexibility and developing export markets. And so we believe that puts us in a really good position to be able to handle whatever the border tax may throw our way.

Phil Gresh

Okay, got it. Thank you.

Operator

Thank you. Our next question comes from Neil Mehta with Goldman Sachs.

Neil Mehta

Good morning, guys.

Joe Gorder

Hi, Neil.

Neil Mehta

Joe, I want to start off on the product markets here. We have seen couple of weeks of gasoline inventory builds. I want to just get your sense of what you think is going on there? Is there an issue with underlying gasoline demand? And how do you see it playing out from here?

Joe Gorder

Yes, it’s a great question, Neil. Gary, you want to share your thoughts?

Gary Simmons

Yes. Neil, I guess to me when you look at the DOE numbers, it’s always difficult this early in the year to tell a lot from the numbers. But certainly, when you look at gasoline demand, we were trending below last year’s level. Last week stat showed gasoline demand really at the lower end of the 5-year range. The part to me, though, when you look at implied demand, which includes the exports, implied demand is actually tracking above last year’s level, which is a little confusing. It’s certainly confusing to us when we look at our operations, because what we have seen in our operations in the Gulf is we have had a number of weather impacts in the Gulf, primarily fog, which has hindered our visibility to really load ships, which hinders our ability to do the exports. So at least, in our minds, the exports in the DOEs are probably overstated, which would in turn tell you that domestic demand is understated. And so I think you will see a revision in the stats to where exports will be lowered and the domestic demand raise, but we will have to see how that plays out. Really, when you look regionally, we don’t see any indication to believe that domestic demand is down. You have a few locations. We had high levels of rain on the West Coast, which hindered our demand there. You had some instances in the Upper Midwest with some ice storms, but none of that is abnormal. So I don’t think we see anything that tells us demand this year is going to be dramatically different than what we saw last year.

Neil Mehta

And then so Gary, what do you make of the inventory builds, is that just a function of fog and having some issues getting the product out or the refining industry running too hard in response to the strong crack to end the year last year?

Gary Simmons

Yes. So I would say PADD III is definitely is a result of fog. And weather clears and you will start to see the PADD III market clear. Obviously, the concern is the PADD I market. And our hope certainly was, with less carry in the market, you would see less of an incentive to put barrels into New York harbor and store them for summer. And really, we have been on a similar trajectory is what we were last year. I think the only thing that we see that’s different in the market we don’t have a lot of line of sight to the barrels people are putting into tanks, but it does look to us like a lot more of the inventory this year is a winter grade gasoline which if that’s true you should see play out is before RVP transition, people will have to liquidate those barrels and the market will get a little soft, but then you should see inventory cleanup before you get to gasoline season. To your comment, I do think part of this is obviously the utilization rates are just too high and we are producing more diesel and gasoline than the market can absorb. When you look at the Northwest Europe crack, it looks like this week we have gone below a level where we generally start to see some run cuts in Northwest Europe. I also believe regionally, the Rocky Mountain region, the Upper Midwest Chicago market, those markets are long and you will see some run cuts there. So, you combine that with turnaround activity and I think you will start to see inventories come back in line.

Neil Mehta

That’s great. And my follow-up here is for Cisco, there are lot of puts and takes in the quarter. Do you mind walking through the tax rate, which was a little bit lower, the interest expense guidance, which was a little bit different and some funkiness in other income?

Mike Ciskowski

Okay. Yes, Neil, I can do that. Okay. First, on our tax rate for the quarter, we were 21% versus our guidance of 31%. We had a couple of things going on there. First, we had higher income than previously projected with most of this being in Canada and the UK, which has the lower statutory tax rate. So that was worth about 3% on the tax rate. Next on a few of our tax audits, the statute of limitations expired, therefore, we reversed reserves associated with these audits and those reversals, along with a few other small adjustments was about 7% on our tax rate. Okay. We had a few items that we did -- we chose not to identify them as special items for this earnings call, but I will walk through those. First and you talked about one already, the debt prepayment penalty. We inadvertently on our last call included that penalty in interest expense. It actually flowed through other income. That was a charge of about $42 million. Offsetting that, however, was kind of a unique item. It’s the Canadian commercial paper recovery. Back in 2009, we wrote off that investment. Part of the deal, we exchanged our commercial paper for some notes. And in the fourth quarter, we received payment on those notes and that was about $50 million. So, those two kind of offset each other in other income. And then lastly, we had in the fourth quarter a LIFO charge. We had a decrement and we had a LIFO charge of about $55 million. So we chose not to identify any of these four items as a special, but I did want to go over that. So in summary, we had two expense items, the debt prepayment and the LIFO charge. We had one income item, commercial paper recovery and then we had the lower tax rates. So when you net those four items together, that was $0.02 per share on our earnings.

Neil Mehta

That’s great. Thanks a lot.

Mike Ciskowski

You bet.

Operator

Thank you. Our next question comes from Doug Leggate with Bank of America/Merrill Lynch.

Doug Leggate

Thanks. Good morning, everybody. Joe, one of the other, I guess, policy moving parts that has emerged in the last week or so is Keystone. Of course, OPEC, the newswires should suggest it’s heavy barrels that are getting cut. So, I am just wondering what can you share with us about the dynamics of what you are seeing on the Gulf Coast specifically as it relates to how you expect the heavy differential at this kind to evolve over the next uncertain periods, I guess, that we have?

Gary Simmons

You bet. Hey, Doug, this is Gary. What we have seen is we have certainly seen some impact to the OPEC cuts. Our crude allocations have been cut a little bit primarily from Saudi Arabia and Kuwait. But we have seen minimal impact to our system from the cuts. We continue to see good availability of grades from Latin America, Canada and U.S. sources to replace the volumes that have been lost from OPEC. Thus far, the impact from the cuts has really been offset by lower refinery demand due to refinery turnarounds. So it will probably be April, May before the full impact if any cuts are seen. Directionally, we really didn’t see the meetings to how our discounts react at all to the OPEC cuts. When the cuts were announced, you saw an increase in flat price but the discounts really didn’t change. Here over the last week, the medium sour discounts have come in a little bit, but we have actually seen heavy sour discounts move wider. PMI adjusted their K factor to make [indiscernible] a little more – the discount a little wider, and I think they had to do that to compete with the Canadians. So we have seen heavy discounts actually move wider. We always look at 3% fuel oil as kind of a leading indicator of where the discounts are going. And 3% fuel oil has actually moved from 85% of Brent last week to 82% of Brent. You see fuel inventories at Singapore that are above the 5-year high. The ARB to ship fuel to Singapore is closed, so that would kind of indicate that the discounts will actually move wider.

Doug Leggate

Okay. Just on the Keystone issue, I guess, I don’t want to push the point too much, because I realized how much uncertainty there is, but I seem to recall in the past that you guys had – maybe I have got this wrong with talking about becoming an anchor shipper with an option to even acquire interest on that. Have I got that wrong or is that back in the table?

Gary Simmons

Well, so we are a shipper. We are still a strong supporter of Keystone. We don’t have the ability to actually be an owner in the line. So, we are working with TransCanada as they try to better understand the executive order and drum up customer support. Our belief is that the direct connection from the Western Canadian production to the U.S. Gulf Coast is a good thing, because we have the most efficient capacity to really process those growing areas of production. Our intent, again, will be to process those barrels in our system, not to export the barrels.

Doug Leggate

Okay, I appreciate that. If I could just squeeze in a last one because that was kind of a follow-up, I guess, but Joe, you have put it down in – but I realized you addressed there earlier, but I just want to ask you a question about that very quickly, it’s become the MO, I guess of your tenure as CEO, the return to shareholders, what are you thinking now in terms of the dividend yield, because you are not sitting, if not the highest, pretty close to the highest yield in the sector, is that kind of – do you have a target in mind, do you have an idea of how that dividend growth can evolve relative to buybacks, just what are you thinking in terms of the overall balance of one versus the other, I leave it there? Thanks.

Joe Gorder

Thanks Doug. The yield obviously is a function of the stock price. And we can’t control the stock price. What we can control is how we reward the shareholders of the company and how confident we feel about our ability to produce cash flows, free cash flows within the company, that we try to manage, right and we do it through a capital allocation framework that Mike mentioned earlier. The dividend and our maintenance CapEx is non-discretionary in our minds and it will continue to be. So making commitments to our shareholder returns through the dividend is something that we don’t take lightly and we modeled extensively. The buybacks and the growth projects, organic capital projects and acquisitions are areas that we consider to be competing for the use of free cash flow. And we look at the timing on our project development activities. We look at the return on our projects that Lane and his team are developing and that Rich and Martin have and we compared it to the value of buying back shares. And so we make the decisions accordingly to provide the highest returns for the shareholder. I would tell you, I wouldn’t – I would be lying to you if I told you that we look at the absolute yield and say that is what determines our decision around the dividend policy. It’s more how do we feel about the cash flows that we can produce within the system.

Doug Leggate

I appreciate the answer Joe. And I guess we will see you in a couple of weeks. Thanks.

Joe Gorder

Doug thanks.

Operator

Thank you. Our next question comes from Ed Westlake with Credit Suisse.

Johannes Van Der Tuin

Hi. Thanks for taking the call. It’s Johannes here. I have to pinch hit today unfortunately for you all, but fortunate for me. Thank you for taking the call.

Joe Gorder

Glad to hear.

Johannes Van Der Tuin

The first question, I guess has to do with the other big policy that’s not border adjustment taxes, but it’s being pushed aside for the moment, but still probably later important to you and that’s RINs, you mentioned it earlier up in the call, and what’s your progress are you seeing in terms of trying to move the point of obligation or engaging with the EPA as there has been a transition, I know that Scott Pruitt is not in his seat yet, but nonetheless, if you have got any sort of color on that. And then would you expect the RIN market to move before any sort of policy change once there is some sort of color clarity on which direction it’s going or are you modeling out for 2017 with the higher RIN expense because you don’t think the market is going to move?

Joe Gorder

Okay, fair enough. Jason, you want to take the crack in our RIN?

Jason Fraser

Sure. Yes. To talk about the point of obligation effort meant maybe somebody else can speak to the RIN price. The comment on our petition to change the point of obligation is February 22, so that period is still open and there is till comments being generated. We firmly believe that once all the evidence is reviewed, the EPA is going to agree to the change the point of obligation. Regarding the introduction of the process, the Attorney General Pruitt as EPA Administrator, which has been there is some discussion about that is whether that will change the dynamic. In his confirmation hearing, he said he would administer the RFS in accordance with Congress’ statutory objectives and he would make a decision based on the evidence and their administrative record. And it all sounds great to us, that’s all we would ever ask for. So we think that after hearing all the arguments and reviewing the facts and what’s in the record and consulting with the staff that they are going to agree that it should be moved. So we don’t really see anything changed due to this changeover of administrators.

Johannes Van Der Tuin

And then on the actual RIN price and the trading price?

Gary Simmons

Yes. So again, our view is certainly you would see a reaction in the market if this gets done. And you would see RINs come off, we have seen some market reaction already. It’s difficult for us to model because of all the uncertainty around it, so.

Joe Gorder

But yes, I guess Gary, we started the year like $0.95 per RIN and now it’s like at $0.50.

Gary Simmons

Right.

Joe Gorder

So we have made the point all along that this is a market that we believe is right for manipulation and the fact that you have had this movement in it, it sure is based on fundamentals.

Johannes Van Der Tuin

It sounds good. So hopefully, there will be some movement. The other question I have I guess just had to do with the California margin weakness, clearly, the margin environment in California has come off quite a bit over the last six months, do you see an underlying reason for that, what the big driver is, is there a difference in the way the market clearing, is it just the Torrance has come back online, is there some sort of dynamic whether it would be weather or something else in terms of EMT that you would like to say, king of just curious as to what’s going on out there for you rise on an operational basis?

Joe Gorder

Well, I certainly think Torrance coming back online has impacted the market here in the prompt market. As I mentioned, we saw some weaker demand with RIN on the West Coast. But overall, LA is moving to summer grade expect today, which you pull butane out of the pool, which directionally tightens it [ph], next month, the bay will go to summer grade gasoline. So all of those things should directionally help demand and bring supply and demand back into balance.

Johannes Van Der Tuin

Okay. So you don’t see any sort of a grinding issue there?

Gary Simmons

No.

Johannes Van Der Tuin

Okay, perfect. Thank you very much for taking the call.

Operator

And thank you. Our next question comes from Paul Cheng with Barclays.

Paul Cheng

Hi guys, good morning.

Joe Gorder

Good Paul.

Paul Cheng

I have to apologize first. I joined late, so my question, you already addressed, just let me know, I will take it offline. Two questions, if I may. First, if I am looking at the Contango curve, their current structure seems to suggest that you want to build inventory because that May and June, the margin was very high for gasoline, on the other hand, the stock is high right now, so just curious that internally for Valero, how you guys contemplate on those diverging forces and when you plan one, how you go with the process?

Gary Simmons

Yes. Paul for us, most of our tankage is more operational in nature, so we don’t do a lot of storage plays to take advantage of the market structure. We do some of it especially on the crude side, but it’s more related to buying opportunistic barrels that we believe have wide discounts and then you can also take advantage of the markets structure. But overall, we don’t do a lot of that.

Paul Cheng

But I mean with inventory, at that high today Gary, is that influencing your decision that you may want to slowdown your run, even if the physical asset availability is there or that you don’t really do that just because you are off the game favorably, that if you slow other people it is going to take up the slack anyway, so you are just going to max out your production even though you may build inventory yourself?

Gary Simmons

Yes. I think to me, the key on the inventory build is that what we are seeing out in the market is a lot of winter grade gasoline. And so our view is that those barrels are going to have to clear before we have our VP transition. And as those barrels clear, it will bring the market down and you will see economic run cuts and lower utilization while those barrels clear before we actually going to summer driving season.

Joe Gorder

Yes. But Gary, you are not suggesting that its Valero, it’s going to make the run cut?

Gary Simmons

No, that’s right.

Joe Gorder

I mean Paul, we are the lowest cash operating cost guys in the business and we don’t have any strong interest in balancing the market ourselves.

Paul Cheng

Very good. If I may the second question is that, maybe this is either for Lane or for Gary also. I am looking at the margin capture RIN, system-wide in the fourth quarter, it’s about 56%, 57%, which is 6% lower than the third quarter and 21% lower from the year ago level and if you are looking at your last 5- year average, it’s about 65%, 66% and this year, it’s about 60%, just curious that is that just a – because of the rising oil price or what – is there anything that you can see structurally, what then you will see in your system or that in the market new condition to make you believe that this year, the 60% margin capture weight is what the future may look like or that this is really more of an one-off certain items impacting that?

Gary Simmons

Yes. Paul, this is Gary. I will take it. Mike started the call with some comments that we took a LIFO charge in the fourth quarter of ‘16 and really, that LIFO charge explains the third quarter to fourth quarter variants that you talked about. It also explains a portion of the fourth quarter ‘15 versus fourth quarter ‘16 results. In addition to that, we had a couple other items. There is really nothing operational that I see, but the other big things that affect the year-over-year results. In ‘15, the blenders tax credit was enacted in December of ‘15 and so all of the credit was booked in the fourth quarter of ‘15, whereas in ‘16, that blenders tax credit was kind of spread out through the year so that had an impact on the capture rates. And the other big thing that we are looking at in terms of the capture rates is just the cost of the RINs. So in the fourth quarter of ‘15, RINs were around $0.49, whereas the fourth quarter of ‘16, they were $0.96. And so that delta in the cost of RINs also impacts our capture rates and that really is the bulk of it.

Paul Cheng

Gary, I mean, this certainly explains for the quarter. And for the year, RIN probably is part of the explanation. But for the full year of 60% capture rate also seems quite low comparing to the last several years what you have been able to achieve?

Gary Simmons

Yes, we can dive it into it more with John, I would suggest. But those are really the big items that we see. We don’t really see anything operational, Paul.

Paul Cheng

Okay, thank you.

Operator

And our next question comes from Roger Read with Wells Fargo.

Roger Read

Yes. Hey, thanks. Good morning, guys.

Joe Gorder

Good morning, Roger.

Roger Read

I will leave some of the policy to decide for now, but I guess specific question for you. Exports have been a huge part on the product side, 2016 story looks like a good start to ‘17. Pemex is out saying they intend to run a lot better in ‘17 than ‘16. That’s their forecast. I mean, we will see what turns out to be true, but could you characterize maybe the incremental growth in exports for you as to where that’s gone and if Pemex were to run better in ‘17, is that a risk we need be concerned about or are there enough other growth areas internationally?

Gary Simmons

Yes, Roger. It’s hard to tell. As Lane can tell you, it takes a long time to improve refinery mechanical availability, so we will see what happens there. But I think, one of the things that we are looking at and we export to Mexico and to South America and certainly when you look at a lot of the consultant views where Brazil has had negative demand growth over the last couple of years that are forecasting some decent demand growth in Brazil, so even if we are to lose some volume into Mexico, I think you could be absorbed in other locations in South America.

Roger Read

Okay. And then second question, M&A, I know with some of the policy uncertainty, maybe sellers don’t want to sell and buyers want to be a little questionable. But I was wondering, Joe, as you kind of think about the longer plan here, Lyondell pulled their unit off the market, but maybe some of the other opportunities that exist there right now?

Joe Gorder

Mike, you want to speak to this?

Mike Ciskowski

Well, yes, Lyondell did pull their refinery back for now. Other than a few things on the West Coast, there are no opportunities really for the refining space presently.

Roger Read

Well, that was brief. And I heard that Lane was a miracle worker, so maybe we could get him to work for Pemex that will fix them?

Joe Gorder

No, we don’t want to do that. But Roger, you are right, I mean, what Mike said is exactly right and it was characterized earlier. The Lyondell refinery is a nice opportunity, but they chose not to sell it. And we are just not seeing a lot of refining assets that are for sale that would add any value to Valero’s portfolio. So from an acquisition perspective, what do you focus on? You focus on the opportunities in logistics and other areas where you could improve the earnings capability of the company by improving your logistics, your feeds in, your products out, and then potentially upgrading your stream. So we are not in a position – we don’t believe we are in a position where we have got to go do a deal to balance on our portfolio. We will look at this a little differently and then we continue to seek ways to try to improve the quality of the portfolio we have got in place.

Roger Read

Okay, great. Thank you.

Operator

[Operator Instructions] And our next question comes from Chi Chow with Tudor, Pickering, Holt.

Chi Chow

Thanks. Good morning.

Joe Gorder

Hi, Chi.

Chi Chow

Hi. Mike, do you have the cash balance held by the company’s international subsidiaries as of year end ‘16? We have noticed that balance has been steadily growing over the last couple of years. I was just wondering if you could also talk about whether, one, that cash is available for use for domestic CapEx and capital returns to shareholders. Two, what are their – are there any repatriation inefficiencies in the current tax structure? And then third, how do some of the tax policy changes proposed under the new administration impact repatriation of that cash going forward?

Mike Ciskowski

Okay. Roughly at the end of the year, we had about $2 billion of cash that was in the UK and in Canada. So presently – okay, our current structure that we have today would allow us to move most of the cash back to the U.S. without incurring a significant tax penalty. We haven’t needed to do that presently given where our U.S. cash balance is as well.

Joe Gorder

That was an incredibly clever way to ask three questions.

Chi Chow

That’s all related, right.

Joe Gorder

That was good.

Chi Chow

Well, do you feel the need, any urgency to get that cash back given the potential changes in the repatriation policies going forward here?

Joe Gorder

The need to get it back, I don’t think we have a sense of need to get it back. Would it be nice to have access to it? And Jason and the team are looking at the repatriation implications of the border tax adjustment. You always want to have your cash totally accessible to you. So, it will be great to get it back. But I would tell you that this – let’s just assume that we are able to bring it back and bring it back in good shape. The question is that what do you do with it? You reinvest it in the business? I don’t see us changing our approach to capital if we had the cash back, okay. I mean, I don’t think Lane is going to say gee whiz, now I can do a whole bunch more, because we are not holding back on things that we are doing today. So it will be wonderful to have access to it without paying any tax on it. That’s not likely. But I don’t think it changes anything we are doing, Chi.

Chi Chow

Great. I will leave it there. Thanks, Joe. Appreciate it.

Operator

And thank you. Our next question comes from Spiro Dounis with UBS Securities.

Spiro Dounis

Hey, good morning everyone. Thanks for squeezing us in here. Just wanted to follow up on the RFS. Without getting into what does it look like and then when does it change, just thinking about, I mean, I guess, an environment where the point of obligation has actually moved away from the refiners, just curious in terms of the reaction or just change in behavior on your part, maybe the refining industry in general, what are some of the things you think happens, I guess, on day 1 without the point of obligation? I think one thing we think about maybe is that exports actually go down, because of course, that’s a good way to avoid the RIN. Just curious if you are thinking about anything else in terms of changes in product mix?

Joe Gorder

Gary, you want to?

Gary Simmons

Yes, I don’t know that to some degree, the export market has over time recognized the RIN, so I don’t really know that it really changes the dynamics of the export markets that much if the point of obligation moves.

Joe Gorder

Yes, I mean we have all adjusted to this. Really, the frustrating thing from our perspective is the negative effect it has by shifting the value of doing business from us to the guidance capturing the RIN. And so obviously, it would be beneficial to Valero if the point of obligation moved, which would reduce our burden. And frankly, we believe it would take a lot of the speculation and the manipulation opportunities out of that RIN market and it should lower the price of RINs. Now, the RVOs will have a factor on that and so on. But from a refiner, from an independent refiner’s perspective, it will be positive.

Spiro Dounis

Appreciate the color. Thanks, everyone.

Operator

And thank you. Our next question is from Jeff Dietert with Simmons.

Jeff Dietert

Good morning.

Joe Gorder

Hi, Jeff.

Jeff Dietert

I am sitting here in Houston looking out my back window and the fog has cleared in the Houston ship channel, so hopefully, that’s good news.

Joe Gorder

It is good news. Yes, do you see our ships loading, Jeff?

Jeff Dietert

They are going out one right after another. I had a question on your pace of the MLP drops and there are a few things going on, one of your peers accelerating, there is also the potential for lower corporate and individual tax rates under the Trump administration, potential for higher interest rates, how do these things impact your thinking on MLP valuations and the attractiveness of dropdowns?

Joe Gorder

Rich, you want to?

Rich Lashway

Yes. I will take a crack at our peers accelerating. So we have been pretty consistent in the execution of our strategy from the IPO that we are going to take a very measured pace. We believe that that’s more of prudent to have a measured pace on our dropdowns. Valero’s exceeded their targeted total payout ratio for the past 2 years. VLP doesn’t really need to do any acquisitions or dropdowns to meet our distribution growth. There is not a need for the cash as we have kind of talked about, the cash balance at Valero. So we are just going to stick to our measured approach of growing, focusing on growing the distributions. We have been clear that we are growing distributions in ‘17 at 25% and at least 20% in ‘18. So it’s really the focus is on the distribution growth at VLP. And we have got the coverage to achieve this and without doing anything drops.

Joe Gorder

And then Jeff, the tail on that was tax rate changes.

Mike Ciskowski

I mean the lower corporate tax rate, if that’s what gets put in place, obviously would make the corporation a little more attractive. However, the MLP will still have the tax advantages structure versus the corporation.

Joe Gorder

In interest rates, I mean it just – it provides an investor different option, right. But you still have the benefits of everything that you have today with an MLP ownership position.

Jeff Dietert

Thanks for taking the questions.

Joe Gorder

You bet.

Operator

Thank you. Our next question is from Ryan Todd with Deutsche Bank.

Ryan Todd

Hi. Thank you. You may have touched on parts of this over the course of the call and I apologize if I missed some of that. But can you talk through what you see as some of the similarities and differences as we look at the macro environment versus last year at this time margins are a little bit better, but we have seen some pretty significant inventory builds over the last four weeks again, I mean what are some of the lingering challenges that are maybe similar to last year and what’s different this year that gives you confidence that we won’t just repeat the 2016 environment again?

Gary Simmons

Yes. This is Gary. I think the similarities, we continue to see the industry running at high utilization rates and so the production of gasoline and distillate is exceeding demand in the marketplace, which isn’t good, causing inventories to build. The difference we see is it looks like on the gasoline side a lot of what’s being put into inventory is winter grade. So again, our view is this will have to clear before RVP transitions could bring inventories down before gasoline season starts, which would make this year look different than what we saw last year and should lead to better gasoline cracks. On the distillate side, not too much different I think the things that we are seeing on the distillate side is slightly better demand. So year-over-year, we will have a little colder weather here in the U.S. and also in Northwest Europe, which may distillate demand. And then as we see some resurgence in the upstream, the drilling activity, it also leads to a little better incremental diesel demand. So those are kind of the key factors we are looking at in the market.

Joe Gorder

And you are right, we don’t know enough yet about the infrastructure projects that are being talked about, at the Federal level right now, what the implications of those are. But any time you get projects like this taking place, they tend to drive distillate demand, of course it would drive gasoline demands also. But – then there is the other things, petrochemical feeds, asphalt, things like that. So we are actually encouraged by the outlook and by the focus on the infrastructure within the U.S. So we will just see how it all plays out.

Ryan Todd

So I guess at a high level, it’s safe to say you have just – is your view on ‘17, but it’s still a little bit better that ‘16, but we will wait and see, is that...?

Gary Simmons

Yes. I think definitely, we will see the gasoline market being similar to ‘16, but a slightly better diesel market than ‘16.

Ryan Todd

Okay, thank you.

Operator

Thank you. Our next question comes from Blake Fernandez with Howard Weil.

Blake Fernandez

Gents, good morning. I am not sure I’m as good as, but I am going to do my best at least two in for one here. The question is on pipelines, I know you talked about Keystone, but I am curious for one, do you have a sense of what the current transport cost is in the market and where that might go to once the pipe is in the ground. And then secondly on dapple, can you think of any direct maybe indirect positive impacts that you may have, whether it’s just additional crude, light sweet on the Gulf Coast? Thanks.

Gary Simmons

Yes, that’s some of the things that we are working with TransCanada on, so we don’t really have guidance on where the Keystone itself tariff is going to be and that’s certainly something that we are working with them on. In terms of dapple, yes I think you kind of hit on it, it’s definitely will be bringing more light sweet to the Gulf Coast, which should be good for us.

Blake Fernandez

Good deal. Thank you.

Operator

And thank you. Our next question comes from Faisel Khan with Citigroup.

Faisel Khan

Hi, good morning. It’s Faisel. Thanks for squeezing me in here. Just going back to Excel for a second and back to I think Doug’s question, have you guys talked to them about taking an equity interest in the pipeline, I mean now that you have the sort of the MLP up and running, it might make sense for them to have an equity partner with their anchor shipper?

Joe Gorder

Faisel, you should never ask us that question when you got a guy who is responsible for the MLP in the room. But to answer your question, honestly, no, we haven’t talked about an equity stake in Keystone.

Faisel Khan

Only because it might make sense for them to syndicate out some of that risk, given how large the pipeline is, but I’m not sure if that’s?

Joe Gorder

That maybe true, but that does not mean that we would be the guy.

Faisel Khan

Along with the price.

Joe Gorder

That’s right.

Faisel Khan

Okay. Thanks guys.

Joe Gorder

You bet.

Operator

And thank you. Our next question comes from Craig Shere with Tuohy Brothers.

Craig Shere

Good morning. Thanks for squeezing me in.

Joe Gorder

Sure Craig.

Craig Shere

Quick follow-up on Phil and Doug’s questions about capital deployment and buyback questions, it seems that the buybacks were kind of turbocharged little bit in ‘16 when shares were more in the mid-$50 area versus in the $60-plus area, as you think about flexing buyback metrics from earnings to cash flow in a low margin environment, how does the share price itself factor into your analysis?

Joe Gorder

Mike, you want to?

Mike Ciskowski

Well, I mean we don’t have specific seasonal targets for our buybacks. It’s on an annual basis, at least 75% of net income. And our program does consist of both somewhat ratable purchases, but also opportunistic purchases, too. So we just evaluate when we want to accelerate that depending on the stock price.

Craig Shere

Is it fair to say that the mid-$50 area is kind of turbocharged area for you?

Joe Gorder

We couldn’t answer that question. But – and I think Mike answered it properly. It’s – we sure don’t want to signal our timing on our buying, but we look at what we view to be the earnings capability of this company. And if the returns on the buybacks are better than the returns on the growth CapEx project, then we are going to buyback shares. We said for years that we are not going to hoard cash, to the extent that we produce free cash flow. We will continue to look at the buybacks.

Craig Shere

Fair enough. Thank you.

Operator

And thank you. Our next question comes from Paul Sankey with Wolfe Research.

Paul Sankey

Hi guys. Good morning. Forgive me if this has been asked….

Joe Gorder

Paul, where have you been?

Paul Sankey

On the Exxon – let’s be honest, that it may be way – further to an earlier comment about the Houston ship and all the good news for you from New York is that it’s snowing very heavily here, so there should be a bit more gas flow demand, I guess. Guys, I am sorry if you asked this – answered this already, but what’s the latency on the border adjusted tax and what are you doing, I guess you have to some level plan for the potential for that to happen, what would you do if it did occur, so I guess the question is what’s your understanding of the likelihood of that happens and what would be your response to if it did? Thanks.

Joe Gorder

Okay. Jason did talk to that earlier. Just want to give him the likelihood and then we can talk, Gary or we can talk about the other components of that question.

Jason Fraser

Yes. We really at this stage, we haven’t put a handicap on the likelihood yet. It’s so early, we don’t even have any draft on legislative tax floating around the committee, so we don’t feel it’s proper for us to try to guesstimate that now.

Joe Gorder

And then Gary as far as well – Paul, it comes down to how are the markets going to react to this, right. And we have read all of the reports and we have read the consultants reports. Something is going to be good for refining, something that may not be as good for refining. And we talked earlier about the fact that we can adjust for the crude slate. But Gary, the markets are going to react.

Gary Simmons

Yes. So everything we have been doing is to increase de-stock flexibility and also be able to grow these export markets and both those things aligned well with this and we can optimize the system around border tax.

Paul Sankey

I guess the punch line kind of goes back to 2010 to ‘14 when we were trying to maximize usage of U.S. light sweets, where did you end up on all that, how much more could you use at the end of the process and do you have any numbers to illustrate the flexibility?

Gary Simmons

Yes. So if you look in our IR presentation, I think its Slide 9, it does a pretty good job of going through how we can swing our system between individual grades. We got to where we were processing over 1 million barrels a day of domestic light sweet crude, I guess that was pretty tougher, so we have added some additional capacity since that time as well so.

Joe Gorder

The interesting thing was, I guess at Port Arthur, you were able to increase overall run rates, throughput rates, because we were running the lighter slate. So Paul, we will be able to flex the system to deal with it. I guess the question is how to – how do the global crude markets respond to the duty, do they price to continue to push their barrels into the market or do they find a different home. And I think Gary has made the comment in several of the meetings that we have had that the natural home for a lot of the heavy sour crudes tends to be in the U.S. Gulf Coast refining system. So I don’t know if that changes in any material way.

Paul Sankey

Absolutely and I guess, the other question is we would assume the gasoline prices at the pump would go up pretty much by the amount of the tax in the short-term?

Joe Gorder

Look that is certainly what we have read also, okay. And I think your friends at Goldman did a report here recently that I have gotten to study, but I thought okay, maybe they moved up and then they move back down, something rise, the market suggest to it. So Paul, the interesting thing is because this is kind of a topic du jour, right. But none of us – they got the skeleton out there and the House seems very committed to this today. But they don’t have the flesh on the bones. There is lots of conversations that are taking place around do you have carve-outs, don’t you have carve-outs and so on. I think what I have encouraged our investor base to do is just let’s be patient, not over-reactive and let’s just see how it shakes out. We will adjust to maximize the value to the company, but I don’t think anybody knows enough yet to really understand what the full implications are. And then when we have seen changes like this, the markets tend to respond. So here again, we don’t have a great deal of concern and consternation around us right now. We are just trying to understand it better.

Paul Sankey

Yes. I totally understand. Thank you very much.

Joe Gorder

You bet.

Operator

And thank you. This concludes the question-and-answer session. I will now turn the call back over to Mr. John Locke for closing remarks.

John Locke

Okay. Well, thanks everybody. And we appreciate you joining us today. Please contact me after the call if you have any additional questions. Thanks.

Operator

And thank you. Ladies and gentlemen, this concludes today’s conference. We thank you for participating. And you may now disconnect.

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

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

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