Valero Energy Corporation (VLO) Q3 2022 Earnings Call Transcript

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Valero Energy Corporation (NYSE:VLO) Q3 2022 Earnings Conference Call October 25, 2022 10:00 AM ET

Company Participants

Homer Bhullar - Vice President-Investor Relations & Finance

Joe Gorder - Chairman & Chief Executive Officer

Lane Riggs - President & Chief Operating Officer

Jason Fraser - Executive Vice President & Chief Financial Officer

Gary Simmons - Executive Vice President & Chief Commercial Officer

Rich Walsh - Senior Vice President, General Counsel & Secretary

Eric Fisher - Senior Vice President-Wholesale Marketing & International Commercial Operations

Conference Call Participants

Doug Leggate - Bank of America

John Royall - JPMorgan

Theresa Chen - Barclays

Sam Margolin - Wolfe Research

Ryan Todd - Piper Sandler

Paul Sankey - Sankey Research

Connor Lynagh - Morgan Stanley

Paul Cheng - Scotiabank

Roger Read - Wells Fargo

Neil Mehta - Goldman Sachs

Jason Gabelman - Cowen

Matthew Blair - Tudor, Pickering, Holt

Operator

Greetings, and welcome to Valero’s Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Homer Bhullar, Vice President, Investor Relations and Finance. Thank you. Please go ahead.

Homer Bhullar

Good morning, everyone, and welcome to Valero Energy Corporation’s third quarter 2022 earnings conference call. With me today are Joe Gorder, our Chairman and CEO; Lane Riggs, our President and COO; Jason Fraser, our Executive Vice President and CFO; Gary Simmons, our Executive Vice President and Chief Commercial Officer 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 investorvalero.com. Also attached to the earnings release are tables that provide additional financial information on our business segments and reconciliations and disclosures for adjusted metrics mentioned on this call. If you have any questions after reviewing these tables, please feel free to contact our Investor Relations team after the call.

I would now 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’ll turn the call over to Joe for opening remarks.

Joe Gorder

Thanks, Homer, and good morning, everyone. We're pleased to report strong financial results for the third quarter, credited to our safe and reliable operational performance and continued strength in refining fundamentals. Refining margins remain supported by strong product demand, low product inventories and continued energy cost advantages for US refineries compared to global competitors. Despite high refinery utilization rates, global product supply remains constrained due to roughly four million barrels per day of global refining capacity being taken permanently off-line since 2020 for a variety of reasons, including unfavorable economics or as part of planned conversions to produce low carbon fuels.

Product demand across our system remains strong, with gasoline and diesel demand higher than pre-pandemic levels, and jet fuel demand steadily approaching 2019 levels. Our refining utilization increased to 95% in the third quarter as we continue to maximize refining throughput. Our refining system also benefited from wider sour crude oil differentials to the Brent light sweet crude oil benchmark. The wider sour crude oil differentials are attributed to increased sour crude oil supply, the impact of the IMO 2020 regulation for lower sulfur marine fuels and high natural gas prices in Europe that incentivize European refiners to process sweet crude oils in lieu of sour crude oils. And we remain on track with our refining growth projects that reduce cost and improve margin capture.

The Port Arthur Coker project, which is expected to increase the refinery's throughput capacity, while also improving turnaround efficiency, is expected to be completed in the first half of 2023.

In our renewable diesel segment, we continue to optimize our operations, setting another sales volume record in the third quarter. The new DGD 3 renewable diesel plant, located next to our Port Arthur refinery, is currently in the start-up process and is expected to be operational in November.

The completion of this 470 million gallons per year plant is expected to increase DGD's total annual capacity to approximately 1.2 billion gallons of renewable diesel and 50 million gallons of renewable naphtha. And for our other low-carbon fuel opportunities, the BlackRock and Navigators carbon sequestration pipeline project is progressing on schedule and is expected to begin start-up activities in late 2024.

We're expecting to be the anchor shipper with eight of our ethanol plants connected to this system, which should provide a lower carbon intensity ethanol product and generate higher product margins. And we continue to evaluate other low-carbon opportunities such as sustainable aviation fuel, renewable hydrogen and additional renewable naphtha and carbon sequestration projects.

On the financial side, our strong balance sheet remains a cornerstone of our capital allocation framework. In the third quarter, we reduced our debt by an additional $1.25 billion, bringing our total debt reduction to approximately $3.6 billion since incurring $4 billion of incremental debt during the height of the pandemic in 2020. And we will continue to further evaluate deleveraging opportunities going forward.

Looking ahead, refining fundamentals remain strong as global product supply remains constrained due to capacity reductions and high natural gas prices in Europe, which are setting a higher floor on margins. In addition, we continue to realize the benefit from discounted sour crude oil and fuel oil feedstocks in our system.

While geopolitical and macroeconomic factors may drive volatility in the market, we remain focused on what we can control, maximizing refinery utilization in a safe, reliable and environmentally responsible manner to provide essential products. We also remain committed to advancing the growth of our low carbon fuels businesses to increase profitability and further strengthen our competitive advantage.

So with that, Homer, I'll hand the call back to you.

Homer Bhullar

Thanks, Joe. For the third quarter of 2022, net income attributable to Valero stockholders was $2.8 billion or $7.19 per share, compared to $463 million or $1.13 per share for the third quarter of 2021. Adjusted net income attributable to Valero stockholders was $2.8 billion or $7.14 per share for the third quarter of 2022, compared to $545 million or $1.33 per share for the third quarter of 2021. For reconciliations to adjusted amounts, please refer to the earnings release and the accompanying financial tables.

The refining segment reported $3.8 billion of operating income for the third quarter of 2022 compared to $835 million for the third quarter of 2021. Adjusted operating income for the third quarter of 2021 was $911 million.

Refining throughput volumes in the third quarter of 2022 averaged 3 million barrels per day, which was 141,000 barrels per day higher than the third quarter of 2021. Throughput capacity utilization was 95% in the third quarter of 2022, compared to 91% in the third quarter of 2021.

Refining cash operating expenses of $5.48 per barrel in the third quarter of 2022 were $0.95 per barrel higher than the third quarter of 2021, primarily attributed to higher natural gas prices. Renewable diesel segment operating income was $212 million for the third quarter of 2022, compared to $108 million for the third quarter of 2021. Renewable diesel sales volumes averaged 2.2 million gallons per day in the third quarter of 2022, which was 1.6 million gallons per day higher than the third quarter of 2021. The higher sales volumes were due to DGD 1 downtime in the third quarter of 2021, resulting from Hurricane Ida, and the impact of additional volumes from DGD 2, which started up in the fourth quarter of 2021.

The ethanol segment reported $1 million of operating income for the third quarter of 2022, compared to a $44 million operating loss for the third quarter of 2021. Adjusted operating income for the third quarter of 2021 was $4 million. Ethanol production volumes averaged 3.5 million gallons per day in the third quarter of 2022.

For the third quarter of 2022, G&A expenses were $214 million and net interest expense was $138 million. Depreciation and amortization expense was $632 million and income tax expense was $816 million for the third quarter of 2022. The effective tax rate was 22%. Net cash provided by operating activities was $2 billion in the third quarter of 2022. Excluding the unfavorable change in working capital of $1.5 billion, which was primarily due to our third quarter estimated tax payment and the other joint venture member share of DGD's net cash provided by operating activities, excluding changes in DGD's working capital, adjusted net cash provided by operating activities was $3.4 billion.

With regard to investing activities, we made $602 million of capital investments in the third quarter of 2022, of which $185 million was for sustaining the business, including costs for turnarounds, catalysts and regulatory compliance and $417 million was for growing the business.

Excluding capital investments attributable to the other joint venture members share of DGD and those related to other variable interest entities, capital investments attributable to Valero were $479 million in the third quarter of 2022.

Moving to financing activities. Year-to-date, we have returned 40% of adjusted net cash provided by operating activities to our stockholders through dividends and stock buybacks, which is consistent with our guidance to be at the low end of our annual 40% to 50% target payout ratio, while focusing on deleveraging our balance sheet.

With respect to our balance sheet, we completed another debt reduction transaction in the third quarter that reduced Valero's debt by $1.25 billion. As Joe noted earlier, this transaction, combined with a series of debt reduction and refinancing transactions since the second half of 2021, have collectively reduced Valero's debt by approximately $3.6 billion. We ended the quarter with $9.6 billion of total debt, $1.9 billion of finance lease obligations and $4 billion of cash and cash equivalents. The debt-to-capitalization ratio, net of cash and cash equivalents, was approximately 24%, down from the pandemic high of 40% at the end of March 2021, which was largely the result of the debt incurred during the height of the COVID-19 pandemic. And we ended the quarter well capitalized with $4.9 billion of available liquidity, excluding cash.

Turning to guidance. We expect capital investments attributable to Valero for 2022 to be approximately $2 billion, which includes expenditures for turnarounds, catalysts and joint venture investments. About 60% of that amount is allocated to sustaining the business and 40% to growth. About half of the growth capital in 2022 is allocated to expanding our low carbon fuels businesses.

For modeling our fourth quarter operations, we expect refining throughput volumes to fall within the following ranges: Gulf Coast at 1.73 million to 1.78 million barrels per day; Mid-Continent at 460,000 to 480,000 barrels per day; West Coast at 250,000 to 270,000 barrels per day; and North Atlantic at 440,000 to 460,000 barrels per day.

We expect refining cash operating expenses in the fourth quarter to be approximately $5.10 per barrel. With respect to the renewable diesel segment, we expect sales volumes to be approximately 750 million gallons in 2022 with the anticipated start-up of DGD 3 in November. Operating expenses in 2022 should be $0.45 per gallon, which includes $0.15 per gallon for non-cash costs such as depreciation and amortization.

Our ethanol segment is expected to produce 4.1 million gallons per day in the fourth quarter. Operating expenses should average $0.50 per gallon, which includes $0. 05 per gallon for non-cash costs such as depreciation and amortization. For the fourth quarter, net interest expense should be about $140 million and total depreciation and amortization expense should be approximately $640 million. For 2022, we expect G&A expenses, excluding corporate depreciation, to be approximately $870 million.

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

Question-and-Answer Session

Operator

Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] The first question is coming from Doug Leggate of Bank of America. Please go ahead.

Doug Leggate

Thanks. Good morning, everybody. Joe, I wonder if I could take the opportunity to ask just your views on a couple of big picture macro issues. I mean, in the quarter, your operational performance speaks for itself. I'm obviously delighted to see the cash returns back with the buyback. But my question, I guess, is your visit to the White House recently and your thoughts on the possibility of an export ban, product export ban that seems to be still rumbling on the table. So any color you are comfortable sharing there would be my first comment.

And then my second question, if I may, maybe it's for Lane or one of the guys. But you did make a comment in your results about a higher floor on margins. I'm just wondering, I think you know our view on this, I'm wondering if you could elaborate on what you're trying to imply from that commentary? And I'll leave it there. Thank you.

Joe Gorder

No, Doug, that's great. Both good questions. So on the visit to the White House, Lane and I went in and of course, there were seven companies, I think, represented there. We ended up meeting with Secretary Granholm. And I would say that it was a constructive conversation. She was looking for things that the industry might suggest that would try to bring down the cost of fuels. And so we did, we provided her with several suggestions, which would have an effect on increasing the supply of fuel into the marketplace.

Thus far, I don't believe any of those have been embraced, but at least it was put on the table for her to give it some consideration to. And so the team that we have involved in the process continues to work with her team. So the dialogue has continued. I know that our DC office has spent quite a bit of time continuing to work with them. And then, of course, the supply folks back here also have been involved in those conversations.

So the dialogue continues, and I think they're looking for just additional opportunities that they might have to reduce the fuel price. So Rich, is there anything you would add to that, you or Lane?

Rich Walsh

No, I don't think so. I mean, I think they understand the consequences of trying to disrupt market flows. And I think they realized that would probably be more harmful than helpful. And so I think that understanding is there. So I know they're looking at a lot of options, but I think that's the understanding they have from the industry at least.

Joe Gorder

Yeah. So that's as it relates to the potential ban on exports, Doug. I mean, I do think they understand the consequences of that. And I think the general consensus is, it wouldn't have the effect that they're trying to achieve. And then you want to take the second question?

Lane Riggs

Yeah, sure. Doug, it's Lane. From a work process, we define the mid-cycle as being the average margin of a few tweaks that we think are market anomalies that go through the entire business cycle. So we're not through the next business cycle yet, but we do believe structurally, you've had interperiod where we've had refinery closures through the pandemic. You're going to have probably not as much investment in the fossil fuel industry, in particular, refining going forward at the time when everybody is trying to understand exactly how the balances are going to work. But our view is will be a higher call on refining capacity. So we don't -- we're not prepared to quantify that, but we do believe the next mid-cycle will be higher than the last mid-cycle.

Doug Leggate

Guys, forgive me for the quick follow-up, but there's a lot of concern, I guess, of Chinese exports hitting the market, and obviously new capacity expansion, Lane. So I just wonder if you could throw that into your consideration. Is that a concern for you guys in that definition of mid-cycle? And I will leave it there. Thank you.

Lane Riggs

There has been a talk about -- we've seen some increases with respect to -- at least, on the prompt that the Chinese are picking up purchases, but I don't know that we've really seen them in the market on products that much. I'm looking at Gary, by the way.

Gary Simmons

No. I think our traders believe most of the Chinese exports are going to stay in the region. And then, even if you kind of assume some of it comes into the North Atlantic Basin, in the short term, the French refinery strikes are really offsetting any of that. And longer term, it looks like, to us, any incremental volume coming out of China will be offset by further reductions in exports from Russia as the sanctions are ramped up.

Lane Riggs

And then on a longer-term basis, just whether Europeans and North America and everyone else is sort of under ESG pressure aren't really trying to increase refining capacity. So if there is a region of the world that's going to raise refining capacity, that will probably be India and China.

Doug Leggate

Thank you, guys. Appreciate the answers.

Operator

Thank you. The next question is coming from John Royall of JPMorgan. Please go ahead.

John Royall

Hey, good morning, guys. Thanks for taking my question. So you talked about bulletproofing your balance sheet in the prior quarter, and you mentioned evaluating further reductions in your prepared remarks. How much lower would you like to get on your leverage before you kind of get to that bulletproof level where you can move off the low end of the 40% to 50% returns, or do you think you're already there?

Joe Gorder

John, that's a good question. We'll let Jason take a swack at it here.

Jason Fraser

Yes, yes. As we've been talking about, we're still working on paying down our COVID debt. We have about $432 million left to have paid off the full $4 billion after accounting for the tender offer we did in this third quarter.

So we're working our debt down with -- and let's see on the cash side, we're at a $4 billion cash balance, we talked about how, going forward, we like to hold more cash at $3 billion to $4 billion probably on the base level. But if you're looking at potentially higher flat price levels or economic downturn, you maybe want to hold a little bit more. So we bias to the upper end of that. So we're close to a good spot on both of those.

On a long-term debt to cap -- net debt to cap, we have a 20% to 30% range that we target. We're at 24.5% now at the end of the third quarter, down from 40% at the highest point toward COVID. So we've been working in the right direction. I'd like to be even lower, you'd like to be at the 20% range to give you more financial flexibility going forward. So that's kind of an overview.

Joe Gorder

So we're getting close.

Jason Fraser

Yes.

Joe Gorder

To the point where, I mean, the low end of the range wouldn't necessarily be the target anymore.

John Royall

Okay. That's helpful. Thank you. And then, maybe you could talk about refining captures and how they're looking so far in 4Q. I know we have, at least in October, a rising price environment, but also you're seeing some tailwinds from heavy dips. So any color there just generally would be helpful.

Lane Riggs

This is Lane. The heavy dips are baked into our margin indicators to some degree. So those will move with it. I think, and all things being equal, when you compare the third quarter to the fourth quarter, and this is really in any given year, you'll see a blending of butane benefit.

So if you hold all the other things constant, our capture rates are a bit marginally improved because of -- we're going to be on more butane in the fourth quarter than we did in the third quarter. And, obviously, if flat price moves up or down, byproducts have enough to effect. So those are all still intact.

But your biggest contribution to margin capture really is gasoline and diesel. So we'll just see. But the main thing to always keep in mind going from third quarter to fourth quarter is blending and butane.

John Royall

Great. Thanks very much.

Operator

Thank you. The next question is coming from Theresa Chen of Barclays. Please, go ahead.

Theresa Chen

Good morning, everyone. I wanted to ask about your comments related to demand across your footprint first. Your wholesale volumes being very strong through last quarter, and currently, when you talk about demand surpassing 2019 levels for gasoline and diesel, is that primarily driven by strengthening your export channels? Is domestic demand in your areas of service equally strong? I'd like to get a sense of what's happening there.

Gary Simmons

Hi, Theresa, this is Gary. Really, it's the domestic markets and our wholesale volumes have trended considerably higher. We set a wholesale volume record in August. We beat that in September, and we're on pace to beat it again in October. So wholesale volumes continue to trend higher.

If you look at the pump market through our wholesale channels of trade, gasoline is trending about 8% above where we were pre-pandemic levels. Diesel volumes are trending about 32% above where we were pre-pandemic levels. So seeing really strong domestic demand through our wholesale channels of trade.

Theresa Chen

Got it. Thank you. And in relation to the high European natural gas prices supporting higher margins. Given the recent decline in TTF and our natural gas storage over 93% full, lowering that Henry Hub to TTF spread. Do you see any risk for a pullback of margins as a result over the near term, while longer term, I imagine just depends on the pace of liquefaction build-out.

Lane Riggs

But I'll try, I'll take a shot at it, and I've seen Gary, again, in sort of my comments. We still need to reinventory the Atlantic Basin with diesel. By and large, we're still -- when you look at stocks, they're slow. Most of what's happening in Europe when you have all these LNG ships that are sort of floating down, you still are limited on the regasification of everything. So we'll just have to see how it plays out. But certainly in the last couple of weeks, at least for our Pembroke refinery, natural gas prices have fallen.

Theresa Chen

Got it. Thank you.

Operator

Thank you. The next question is coming from Sam Margolin of Wolfe Research. Please, go ahead.

Sam Margolin

Good morning, everybody.

Joe Gorder

Good morning, Sam.

Sam Margolin

So we definitely see evidence, everybody does, of this structurally higher margin environment. But more than just kind of through cycle margins being higher, the market is also sort of characterized by anomalies like a very high frequency of sort of regional blowouts or single commodity events within the stream.

And I was wondering if you could just maybe speak broadly to that, not to ask too open ended of a question, but just is that -- are things like this a function of kind of capacity coming down globally, or just a very tight market on an underlying basis, or is it is really just a coincidence where we've had kind of a bunch of one-off things happen in sequence and that might not necessarily be a go-forward trend?

Gary Simmons

Yes. So I think some of it is structural. I think, as Joe alluded to in his opening, we had a lot of refinery rationalization, refining capacity converted to produce low carbon fuels. And so, much tighter supply-demand balances, which structurally means a stronger market.

Some of the things you talked about on market dislocation could be more transient in nature. A lot of that is just a function of very, very low product inventories, especially in the domestic markets.

I think we feel like through the winter period of time, you could see some restocking of gasoline, which could prevent some of those market dislocations from happening, at least in the short term. Diesel, on the other hand, looks to us to be -- remain very, very tight, and I think you'll continue to see volatility in the markets due to very low inventory.

Sam Margolin

Okay. Thanks for that. And then just a follow-up on DGD and the start up timing. You know, in the past, when you guys start up a DGD unit, we can see feedstock prices or the veg oil complex, sort of, respond. And this year, I don't know if it's a timing issue where it hasn't really started yet in earnest or if the market has just adjusted to that demand ahead of time. But it seems like the feedstock environment has tolerated new starting capacity a little bit better than in the past, if you have any thoughts about just DGD 3 into the feedstock background that would be helpful?

Eric Fisher

Yes, this is Eric. I think, what your observations are correct. We are not seeing the increase in feedstock prices like we did with DGD 2 this time last year. Thinking about some cases of that, I think some of it is given refining margins, the conversion projects that had been announced, I think, have largely been deferred or delayed. And with the drop in LCFS prices, I think a lot of the projects have been deferred and delayed. So if you look, we just not -- we have not seen the increase in feedstock prices like we did last year with DGD 3 starting up. And we have bought feedstock for the start-up in this quarter.

Sam Margolin

Okay. Thank you so much. Have a great day.

Eric Fisher

Sam.

Operator

Thank you. The next question is coming from Ryan Todd of Piper Sandler. Please go ahead.

Ryan Todd

Thanks. Maybe one follow-up immediately on Diamond Green Diesel. You've been in a pretty rapid expansion mode at DGD over the last couple of years. With the start-up of DGD 3, will you take a pause here to, kind of, digest and evaluate for market conditions for a bit, or how do you think about the strategic direction of Diamond Green Diesel unit over the next five years in terms of priorities there?

Lane Riggs

Yes. I think, like we've talked about this quarter and last quarter, LCFS prices continue to drop. And I think that is taking a lot of the fun away in this space. And so as you look across the industry, a lot of projects are getting deferred and delayed.

And given the high energy prices across the world, everyone is kind of rethinking a lot of their policies. So we have to, especially, in Europe you have to step back and see, are they going to continue the path and pace that they have been on historically? So I think after DGD 3, we've said, we will pause, reassess the market. I think SAF is becoming a lot more interesting. But overall, I think there will be a pause after DGD 3.

Ryan Todd

Yeah. Thanks. And then maybe you mentioned it briefly in passing earlier, and I know it's a little speculative, but any thoughts on how you think trade routes and supply chains get impacted if you expand on Russian product imports goes into effect early next year? Is there a logical home for some of that Russian product to make its way to someplace else, South America or Africa, et cetera, or do you think those Russian barrels just kind of go away and refining utilization falls dramatically there?

Lane Riggs

Our view is that you will see a reduction in Russian exports of primarily diesel. They export a little bit of naphtha, not much gasoline. But on the diesel side, you will see a reduction in exports. You do have the potential for some of those barrels to find homes in South America and Africa, as you mentioned. But we, kind of, believe diplomatic pressures from the US and from Europe will, kind of, keep a lot of that from happening, and you will see a reduction in exports from Russia.

Ryan Todd

Okay. Thank you.

Operator

Thank you. The next question is coming from Paul Sankey of Sankey Research. Please go ahead.

Paul Sankey

Hi, guys. Can you hear me okay?

Joe Gorder

Morning Paul.

Paul Sankey

Can you hear me, Joe?

Joe Gorder

Yes, sir, we can.

Paul Sankey

Cool. Can you talk a little bit about the strategic petroleum reserve release? Joe, you mentioned a few things that made SPR crude discounts wider, but my understanding was a lot of the drawdown in the SPR was crude. I was just wondering how much the SPR has affected you, I guess, operationally and from a profit point of view and what your outlook is for the coming months. I would assume that you're anticipating that we taper and even start reducing the crude. Thanks.

Lane Riggs

Yes. So really, what we saw is with each of the SPR options, we have good logistics at our Gulf Coast assets to be able to receive the barrels. A lot of people really don't have the logistics in place to be able to take those barrels. So, certainly, early on, they were more sour barrels, and we took a good volume of the SPR volume as it transition to more sweeter. We still saw value in our system to take those barrels and we would expect that to continue moving forward as long as they're offering the barrels.

Paul Sankey

I know you're anticipating continuing drawdowns through, let's say, 2023, or do you think they will have to start convention?

Lane Riggs

I think you'll continue to see drawdowns at least through this year and then start to see some restocking happen next year.

Paul Sankey

Great. Thanks a lot. I'll leave it there. Thank you.

Joe Gorder

Thanks Paul.

Operator

Thank you. The next question is coming from Connor Lynagh of Morgan Stanley. Please go ahead.

Connor Lynagh

Yes, thanks. I wanted to return to a topic that you mentioned briefly earlier, which is the suggestion that you made to the administration on potential pathways for reducing fuel costs. I'm curious if you could just provide a little color on the things that the industry suggested.

Joe Gorder

Well, Lane and I were both there. So, do you want to talk about it first?

Lane Riggs

Sure. I think -- yes, this is Lane. So I think the -- there's two main ones, which was one was increasing or relaxing the sulfur spec on fuels. Many of the US refiners didn't necessarily invest, and it looks like either making ultra-low sulfur diesel as much as maybe some others or Tier 3 gasoline. So, consequently, they're in a posture of having to export some of those -- some gasoline and some diesel to markets around the world that can handle the sulfur.

So, that was really, I think, the two big ones. I mean, obviously, a part of that meeting was meant to see if there was any possibility if somebody could start a refinery up and we discuss -- the industry discuss the difficulty in doing that and that was really the main coming ones.

Joe Gorder

I mean, yes, waving specs really on products was what we talked about. The one interesting thing, Connor, that came out of it, too, was there was consideration for the ability to restart refining capacity that had been shut down. And I think the general sentiment was that, that wasn't going to happen.

Of course, we're not in that boat. But I mean, people had very good reasons for making the decisions that they made, and they weren't in a position to unwind those decisions. So, the solution is going to probably have to come from some waving of regulation or just reduction in demand, which we just haven't seen to-date.

Connor Lynagh

Makes sense. Semi-related policy question, just given that the Inflation Reduction Act is maybe had a bit of time to be digested by the market or players out there that you talk to. What types of opportunities are you seeing as more likely or more in the money with the incentives in that bill?

Rich Walsh

This is Rich Walsh. I'll take just a high-level effort on it and then, kind of, give you an idea. I mean, we're really -- we're focusing on a number of things. One is that they have clean energy tax credits in there that are enacted, that are really an extension of the BTC, the Blender's Tax Credit, which is helpful to us.

There's also tax credits there for sustainable aviation fuel. And I think Eric had mentioned earlier, that makes it more interesting for us to look at. And, additionally, there's additions for the 45Q tax credit, which we think strongly supports carbon sequestration, and we think you're going to see more opportunities to develop around that.

Connor Lynagh

Okay. Got it. I’ll turn it back here. Thank you.

Joe Gorder

Thank you.

Operator

Thank you. The next question is coming from Paul Cheng of Scotiabank. Please, go ahead.

Paul Cheng

Hey, guys. Good morning.

Joe Gorder

Hi, Paul.

Paul Cheng

Two questions, hopefully, short. First one is for Lane. I think, back in the first quarter conference call, you gave a number of $8 in the diesel crack advantage for US refiner versus Europe, because of the natural gas price gap. And at the time, you're using, say, you need is $25 gap.

Since then, we have seen the European refiner essentially cut their natural gas consumption by half. So curious that, is there an updated number you can share? And is it -- we need that cut from $8 to $4 just linear or that we can't really do in that way? Secondly, that -- and also that, if you can give us what is your natural gas exposure by operating region for you guys?

The second question is on DGD. I think that the joint venture so forward on the diesel contract as a part of the hedge operation. So in a backwardation curve you had heard -- in the third quarter, I think the backwardation curve is substantially less than second quarter. So we were surprised your margin capture didn't improve comparing you to your benchmark indicator. Is there anything going on we should be aware that lead to that or anything -- any insight you can provide? Thank you.

Lane Riggs

Hey, Paul. So, that was -- yes, I'll try to come back to that first question a little bit. But you're accurate in what I had stated in the first quarter. Today, what we're seeing, at least in our Pembroke refineries, natural gas prices have fallen. But I think what you're seeing in the Atlantic Basin, you're seeing in the diesel crack, is the advantage is lower, but you still have a wide diesel crack. And that's because a lot of the refineries that are having, that sort of reinventory the Atlantic Basin, are looking to running a lot of sweeter crudes, because they can't meet the fuel oil spec, right?

So they end up bidding up in the industry, or at least the marginal guy out there is bidding up the sort of the low sulfur crude price to try to meet the demand in the Atlantic Basin. So -- and you're seeing that in discount, you're seeing medium sour getting cheaper, you're seeing heavy sour getting cheaper.

Part of that is also a function of redirection of all the Russian trade flow. So that's really in terms of a prompt basis, what's driving the heat crack. I don't know that Europe solved this natural gas problem. We're just going to see. There's a lot of tankers sitting offshore trying to regas. And so we'll just see how that goes. Eric, do you want to...

Paul Cheng

Lane, before you go on that one. I'm just curious that, I mean, is the advantage US refiner versus Europe on the natural gas price gap, does it impact that advantage when the European refiner cut their natural gas consumption, or that doesn't really -- that's not how it should be calculated or be in?

Joe Gorder

What I'm saying is versus the fourth quarter first quarter really up until about three weeks ago, there was an advantage that you could see they were paying higher cost of fuel. We could also see, when we use our Pembroke Refinery as a proxy, we were through that, right? In other words, even though now we eliminated all of our natural gas purchases, but what we could see was the profitability or at least your ability to -- it was setting the marginal capacity out there in the Atlantic Basin. It's not so much around natural gas, I don't think today.

I think what it is, is people are having to buy a very low sulfur crude oil to try to meet the low sulfur diesel spec and trying to avoid making a higher fuel oil spec. So in a simple term, some of it is being driven by IMO 2020 and the ability of some of these simple refiners can't deal with the crude oils that are available to them to restock the Atlantic Basin.

Paul Cheng

I see. So you actually don't think that the natural gas is driving the advantage at all?

Joe Gorder

Well, what I'm trying -- this is just a three-week phenomena, Paul. I'm not sure I would jump out there and try to make it an annualized thing. I'm just saying, I think most of the -- for the last quarter, a lot of is just being driven by the marginal economics of a simple refiner trying to buy -- having to buy low sulfur crudes to meet the Atlantic Basin diesel requirements.

Paul Cheng

Okay. Thank you.

Joe Gorder

All right, Eric, you're ready?

Eric Fisher

Yes. So on DGD, what you said is correct, that backwardation was less severe in the third quarter than the second quarter. So the margin capture issue in the third quarter was more related to the feedstock slate that we ran. And as before, where we said we haven't seen an increase in feedstock prices we did see, and this is a little bit of a function of the margin indicator. We saw – see by [ph] soybean prices drop $0.05 to $0.15 a pound below all of the waste oil feedstocks.

And when you look at that through the third quarter, that was about 80% of the impact on the margin capture. So it's really related to what we're seeing is veg oils pricing at or below waste oil feedstocks. And so the only thing I would say going forward to be aware of, we are increasing the amount of veg oil that we are running in the DGD complex, not because waste oils are not available, just because we see flat prices of veg oils coming down to a point where the LCFS advantages are not as strong versus what we see in waste oils. So we are implementing veg oil into DGD because we see those prices are attractive.

Paul Cheng

Eric, do you have a percentage? How much is the vegetable oil you're going to run in the DGD 3?

Eric Fisher

Yes. We're not going to give out that level of detail. What I'll say is, up until the fourth quarter, we ran essentially zero veg oil. So we're incrementing veg oil into the units because of this attractive price.

Paul Cheng

Okay. Eric, Thank you.

Eric Fisher

Thank you, Paul.

Operator

Thank you. The next question is coming from Roger Read of Wells Fargo. Please go ahead.

Roger Read

Hey. Hello, everybody. Good morning.

Eric Fisher

Hi, Roger.

Roger Read

Maybe just to come back to the cash returns to shareholders question. We're getting a lot of interest on not just the 40% to 60% return, but how are you thinking about the split between those? And when should we think about potential to raise the dividend? Is it as simple as you get rid of the $4 billion that came with COVID?

Or is there a step beyond that you want to see? And I think the question is growing more acute because as you look at the overall crack spread environment, right, it's one that says you're earning above a typical mid-cycle, so kind of an expectation, I think, here of greater than mid-cycle cash returns to shareholders is pushing on us. I'm just curious how you're thinking about it.

Jason Fraser

This is Jason. I think, Joe answered it pretty well. I'll ran through our cash. We were up to $4 billion now, which is getting to where we'd like to be. The debt is getting to a good level at 24.5%. We still like to do a little bit more. We have 430 left just to have paid-off the COVID and prefer to be at the lower end of that 20% to 30% range. But, yes, we're getting in a good shape, but I would say we're not declaring victory yet.

Joe Gorder

Roger, it's -- and Jason answered correctly. We don't know the economic climate is going to be like going into next year. It's probably premature to certainly to make a commitment right now on anything that we're going to use the balance sheet to defend. And I think everyone clearly could see that we had stated in the past that we were going to defend the dividend with the balance sheet, and we did that. And we will do that in the future.

And so we just want to be sure that we don't need your care and then we've got a line of sight that we get a position where we want to be positioned. And then we have line of sight to the way things look going into next year before we would make that decision. But I do think we've got the flywheel of the buybacks, and we talked about maybe not moving up above. And by the way, it's 40% to 50%, okay? You took us up to 60%. I didn't notice that, okay? But it's 40% to 50%. And we'll see. We'll use that flywheel to drive the returns.

Roger Read

Hey, got to try something here and there, and you know that's right. All right, well, let me try something else more on the kind of the operational side. You brought it up as there is obviously a risk of a slowing economic cycle out there. What level would you think about a typical recession impact in terms of fuel demand, recognizing gasoline is already well below what we would call, kind of, a normal environment. So let's maybe think about diesel since that's the real strong part.

When you think about industrial demand weakness, transportation-related weakness, right, whether it's just typical trucking, et cetera, how does that factor in? Like what, kind of, would you expect to see a couple of hundred thousand barrels go away? Is it a 10% sort of, cut top to bottom? I'm just wondering how you think about the typical magnitude impact of a recession on fuel demand.

Gary Simmons

Hey, Roger, this is Gary. I guess as the guys have, kind of, gone back and looked at recessionary period in the past, they see their product demand has hit about two times GDP. So whatever GDP assumption you're going to have, you would take twice that on the impact of fuel demand. And as you mentioned, more of that is going to be diesel, less on gasoline.

I think there are some unique situations as we head into next year. One, jet demand hasn't fully recovered. And so you'll have a good increase in jet demand as we would anticipate, and then Chinese oil demand has been down 20%. At some point in time, they will come out of the pandemic, and you would expect to see Chinese demand recover. So the combination of both those things is that we would expect, even with the typical recessionary period, you may see year-over-year global oil demand growth.

Roger Read

All right. Thank you. Appreciate it.

Operator

Thank you. The next question is coming from Neil Mehta of Goldman Sachs. Please go ahead.

Neil Mehta

Good morning team. First question is just around the high sulfur fuel oil market, and we're seeing these big heavy discounts showing up in the market. I love your perspective on, what do you think is driving it? How much of that really is the later impacts of IMO versus other dynamics in the market? And are you changing your configuration in refining at all to run some of that high sulfur fuel oil into the cokers? Are you doing it more through WCS and so forth?

Gary Simmons

Yeah. So this is Gary. As Joe touched on a few of these things, but there's a number of factors that have been really driving the heavy sour discounts. First, the sanctions put on Russia have caused some rebalancing. A lot of the Indian and Chinese refiners are running euros. It's backed up Mars and heavy Canadian into the Gulf, which are driving those discounts wider, which we talked about the higher prices of natural gas around the world caused the operating expenses running heavy and medium sours to be higher. So that causes the discounts to be wider.

There's a higher naphtha content in heavy Canadian crude. Naphtha has been discounted, so that drives the discounts wider. We've seen some unplanned maintenance in the US, which has also contributed.

But overall, I think we continue to see weakness in high sulfur fuel oil, combined with higher refinery utilization, putting more product on the market. So some of that, what we expected in IMO 2020, we're finally starting to see in the market. The lack of Chinese demand is certainly also contributing to that.

So for us, when we look at the market going forward, seasonal maintenance in Western Canada is coming to an end. You'll see higher diluent volumes as we head into winter. So all of that's putting more heavy Canadian on the market. We expect to see even more rebalancing occur as sanctions are ramped up in Russia. And so we expect this market to continue. We're certainly maximizing heavy Canadian in our system today and seeing a lot of opportunity to buy those high sulfur fuel in stocks, as you mentioned that we're putting to our cokers.

Neil Mehta

Yeah. That makes a lot of sense. And the other question is you guys have really built a wonderful business here through organically. Really haven't done much M&A in the better part of the last decade. And just your perspective on whether, as you look forward, are there bolt-on M&A opportunities as we are seeing some A&D in the downstream markets and in low carbon markets, or do you want to continue to build the business on an organic basis?

Joe Gorder

Neil, we're very comfortable with the approach we've taken to building the business. I mean, we went through the period, of course, where we grew the business. And frankly, bolted on a lot of stuff to the portfolio, which we now have largely operating to a level that we're comfortable with. And so we're very comfortable with the refining portfolio that we have in place today.

We always look at opportunities that are out there, and we'll continue to do that. But the strategy that we've employed with really directing a significant part of the capital budget to the renewables businesses has made sense to us. We believe that they're very durable as is refining. But we're very comfortable with that approach, and we are comfortable with the way we've gone about doing it, which is certainly in the renewable diesel business from the ground up. So I think you should expect that we're not going to jump into the market for any kind of significant transaction. And we'll continue to do what we're doing.

Neil Mehta

Makes tone of sense. Thanks, Joe.

Operator

Thank you. The next question is coming from Jason Gabelman of Cowen. Please go ahead.

Jason Gabelman

Hey, thanks for taking my questions. I have two. The first one kind of on near-term dynamics. Just thinking into 4Q, I was hoping you could discuss a couple of things. One, impacts to capture with the start-up of DGD 3, the ability to capture strong West Coast cracks in October, gasoline margins were over $100 a barrel. And then any impacts from the Mississippi River drought that you saw in your footprint that could be ongoing? And I have a follow-up. Thanks.

Gary Simmons

You want to start with DGD 3? Okay. On DGD 3, margin capture, I think, will be challenged. One of the details of this business is when you first start up a brand-new unit, we have to start up on temporary pathways that are somewhat generic to renewable diesel units.

You got to run like that for the first several months until you gather the data to get your actual carbon intensity numbers. So margin capture on DGD 3 will be lower initially as we start up because you have to line out, get in, like I said, get the data to then cement your actual CI numbers. So I think that will be one of the main issues as we started DGD 3. So we'll certainly get volume, we'll certainly get more overall income. But if you look at it through the margin indicator or on a dollar per gallon basis on temporary CIs for the first several months, it will be lower. But that will line out in the back half of 2023 as we submit our data and get responses from all the different jurisdictions that you have to submit your CI numbers, too.

Lane Riggs

This is Lane. On California, we have been executing a turnaround at our Benicia refinery, some of which the turnaround was in the third quarter, and we'll be wrapping up here in the fourth quarter. So to the extent we still maximize gasoline, even to the extent we could, based on the operating posture we had for this turnaround, and we'll make the brand at full rate. So that's really -- so we'll just see how the fourth quarter wraps up with respect to the gasoline crack in the West Coast.

Gary Simmons

I guess, the final one around Memphis, the river levels have been impacting us at our Memphis refinery, both the ability to clear the refinery and supply the river terminals. As of this morning, both northbound and southbound traffic out on the river is wide open, expected to be there for the next couple of weeks and we expect the situation to improve.

Jason Gabelman

Great. Thanks. That colors are really helpful to think about 4Q. And then the other one just on low carbon opportunities within your portfolio. In addition to the DGD venture, you also have an ethanol business, and it seems like with the carbon capture project that you're installing there and the Inflation Reduction Act, maybe ethanol to jet is a technology that makes sense, particularly given weaker ethanol margins. Is that something that you're looking at either to complement any SAF growth you would pursue within DGD or as an alternative investment instead of pursuing SAF near-term within DGD? Thanks.

Jason Fraser

Yeah. So that's definitely something on the radar for us. As you said, ethanol carbon, carbon captured ethanol will be eligible to get into SAF. And given our footprint and our Navigator project, it will be in – SAF is a possibility with that ethanol product post-sequestration. So it's definitely sort of a somebody on the radar to look at sort of post 2025 when Navigator comes online.

Jason Gabelman

Thanks.

Operator

Thank you. Ladies and gentlemen, we're showing time for a final question. The final question today is coming from Matthew Blair of Tudor, Pickering Holt. Please go ahead.

Matthew Blair

Hey, good morning. Thanks for squeezing me in here. I just had one question on the DGD guidance. If I heard it correctly, it was still $750 million for the year, which I believe implies that Q4 volumes to be lower quarter-over-quarter despite starting up a new plant in November. Could you help us understand that? Is that just being a little conservative around the start-up, or is there a turnaround at the DGD 1 or DGD 2 that we should be keeping in mind?

Jason Fraser

It's a little conservative. We are in start of the DGD 3. The plan is to ramp to full rates in November. So if you added that volume in, it will come in higher than the $750 million. But we're still lining the unit out and have yet to put feed into the Echo finer. So we won't know that detail until mid-November or so. So from a guidance standpoint, we decided to keep the guidance at $750 million. It's proven that we see that rate.

Matthew Blair

That sounds good. Thank you very much.

Operator

Thank you. At this time, I'd like to turn the floor back over for closing comments.

End of Q&A

Homer Bhullar

Great. Thank you, Donna. We appreciate everyone joining us today. Obviously, feel free to contact the IR team if you have any additional questions. Thank you, everyone, and have a great week.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time, and enjoy the rest of your day.

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