NuStar Energy LP (NS) 2008 Q2 法說會逐字稿

Good morning. My name is Ashley, and I will be your conference operator today. At this time I would like to welcome everyone to the NuStar Energy L.P. and NuStar GP holdings LLC second quarter 2008 earnings. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) I would now like to turn the conference over to Mark Meador, Director of Investor Relations. Please go ahead, sir.

Thank you, operator. Good morning, and welcome to our conference call to discuss NuStar Energy L.P. and NuStar GP Holding LLC's second quarter 2008 earnings result. If you have not received the earnings releases and would like copies of each, you may obtain them from our website at nustarenergy.com and nustargp.com. Attached to the earnings releases, we have provided additional information for both companies including information on NuStar Energy L.P.'s business segments. In addition, we have posted additional operating highlights and fundamental data for our asphalt business under the investor's portion of the NuStar Energy L.P.'s website. If after reviewing the attached tables and operating highlights you have questions on the information that is presented there, please feel free to contact us after the call. With me today is Curt Anastasio, CEO and President of NuStar Energy L.P. and NuStar GP Holdings LLC, Steve Blank, our CFO and other members of our management team. Before we get started, we would like to remind you that during the course of the call, NuStar management will make certain statements concerning the future performance of NuStar and other statements that will be forward-looking statements as defined by securities laws. These statements reflect our current views with regard to future events and our subject to various risks, uncertainties and assumptions. Actual results may materially different from those discussed in these forward-looking statement and you should refer to the additional information contained at NuStar Energy L.P.'s and NuStar GP Holding LLC's form 10-Ks for the year ended December 31st, 2007 and subsequent filings with the Securities and Exchange Commission. I will now turn the call over to Curt.

Good morning. Thanks for joining us for the second quarter of 2008 earnings conference call. Before I go into the quarterly results, I'd like to say a few words about current market conditions. It has obviously been a challenging year for the stock market and MLPs and the NuStar companies have not been immune. However the fundamentals of our business and the outlook for 2008 have never looked better and I expect NuStar to have its best year ever. We are a well diversified Company, with the majority of our business coming from stable cash flowing pipeline and terminal assets. We have a large geographic footprint in the United States and are one of the few public partnerships with substantial international operations. We own one of the largest independent petroleum pipeline systems in the US. We are the third largest independent liquids terminal operator in the world and we are the third largest asphalt producer in the country, all of which allows us to prosper during times of economic expansion as well as economic slowdowns.

Our pipeline business and the associated terminals continue to perform well, despite unprecedented high fuel prices and refining margins that are lower than in the recent past. In fact, if you compare our pipeline volumes this quarter to a more normalized rate, in other words, correcting for the effect of Valero Energy's McKee refinery fire, which reduced pipeline through-puts the second quarter of last year, we were down on volumes only about 2%. However, increases in transportation tariffs offset the financial impact of those lower volumes as we move forward. Our storage business, which is generally not impacted by high fuels prices, since it is mostly contracted from three to 10 years, had strong results in the second quarter. I see continued good results from this business as projects under our $400 million construction program come online this year, while we develop a sizeable portfolio of new projects for the next few years. Our asphalt and fuels marketing segment is enjoying strong fundamentals, as the former CITGO Asphalt business we acquired on March 20th is already exceeding expectations. Keep in mind that most of the coker projects coming on line over the next few years, will further tighten asphalt supplies that are already tight, resulting in higher margins.

We have a very experienced and dedicated management team and group of employees who are focused on the long-term results of this Company. Our Chairman, Bill Greehey, whose strong track record is well known, believes in the direction of the Company and the management and has recently added to what was already a significant amount of his own money in both NuStar Energy and NuStar GP holdings. Since we have received several inquiries from analysts and investors about the recent liquidity issues, I would like to discuss that briefly. NuStar has no material exposure to the SemGroup companies, with our worst case exposure estimated at approximately $500,000. Going forward, we should not have any material financial exposure to SemGroup and expect to continue to derive a substantial majority of our revenue from a large and diverse set of customers. With regard to our marketing operations, we have as previously reported terminated all hedging associated with the asphalt business. Currently we don't we don't have any near term plans to enter into hedging contracts on that business and we have ample liquidity with our recently upsized $1.25 billion five-year revolving credit facility with about $400 million currently available under that.

Now I will talk about the second quarter results. Despite the negative impact of hedging in the second quarter, we were still able to report better than expected earnings compared to the interim guidance we gave of break-even earnings, which we provided on May 28th. This was mainly due to stronger asphalt margins and higher asphalt sales volumes from the new asphalt business, which continues to exceed all our expectations. NuStar Energy L.P. reported net income applicable to limited markers of $8.2 million or $0.15 per unit for the second quarter and distributable cash flow available to limited of $31.5 million or $0.58 per unit. NuStar GP holdings also reported better than expected earnings of $5.8 million or $0.14 per unit for the second quarter, better than the $0.10 per unit we had guided to. Results for both companies were, of course, lower quarter over quarter primarily due to the $61.3 million our $1.10 loss associated with the crude oil and refined product hedges that we had put on about 30% of our total inventories once we acquired the CITGO Asphalt business. Fortunately, we expect to recover that amount, the amount of the hedging loss, most of this coming in the third quarter as we sell our products at the appreciated prices. Despite the recent drop in crude oil prices, asphalt prices have continued to increase dramatically due to tight supplies and are expected to be even higher in the third quarter compared to the second quarter.

If you exclude hedging and certain other items, our results for the second quarter were really outstanding. Earnings for the second quarter would have been significantly higher or $1.25 per unit. In fact, they would have been the highest quarterly earnings every reported by NuStar, which just goes what a strong contributor to our earnings this new asphalt business can be. This is just the first year of operations, well before any of the expected coker projects come online and impact the supply of asphalt further. Distributable cash flow available to limited partners would have been $1.70 per unit before hedging and other items and also far above any previous record. And our coverage ratio would have been a very strong 1.73 times without the hedging and other items. In addition, if you look at the contribution in the second quarter just from their asphalt business, before the impact of hedging, we made nearly $53 million of operating income, which is a substantial contribution from the new business, given that our total operating income would have been $101.7 million. We continue to expect to increase our distribution this year, 2008. For now, our board has declared the quarterly distribution of $0.985 per unit, which equates to $3.94 per unit on an annualized basis. The distribution is payable August 13th to unit holders of record on August 6th and represents an increase of $0.035 a unit or 3.7% over the $0.95 per unit that we paid for the second quarter of 2007. For NuStar GP Holdings the board has declared a quarterly distribution of $0.36 per unit or $1.44 per unit annualized. The distribution is payable August 15th to unit holders of record on August 6th and represents an increase of $0.02 or 5.9% increase over the $0.34 distribution paid in the second quarter of 2007.

Now, looking at how our other businesses performed in the second quarter, I'm very pleased with the results from our storage business as operating income was up over 18% versus last year, mainly due to the impact of our construction program and higher through-puts at some of our terminals. On our transportation business segment, pipeline volumes were significantly higher compared to the second quarter of 2007, primarily as a result of the Valero Energy McKee refinery fire last year and the impact that had on the business. However, if you compare second quarter 2008 volumes to a more normalized rate, crude oil and refined product volumes were down slightly. This can be partially attributable to high fuel prices and the impact they have on demand for refined products. Going forward, we do not expect a material impact to our pipeline volumes from lower demand. And starting July 1st, we have been benefiting from a 5.1% tariff increase on practically all of our pipelines that will offset any lower revenues from lower demand.

Turning to the third and final segment we have, the asphalt and fuels marketing segment. Since we just acquired the former CITGO Asphalt business near the end of the first quarter, quarter-over-quarter comparisons are not relevant. However, our results were obviously impacted negatively by hedging in the second quarter. Including hedging, the asphalt business had an operating loss of $8.5 million while the fuel's marketing condition contributed $1.8 million of operating income, primarily due to the contribution of the bunker business. We had good utilization ranges at both Paulsboro and Savannah. And our product margin per barrel for the entire asphalt business, which is revenues less cost of goods sold divided by total barrels sold, was $1.38 per barrel with the hedging loss but a strong $8.95 per barrel without it.

With that I'll jump down to some of our variance explanations for our expenses. Operating expenses in the second quarter were higher by around $21 million compared to the second quarter of last year. The bulk of the variance or nearly $16 million was due to the acquisition of the asphalt business from CITGO. Higher power costs due to higher natural gas prices and increased volumes in through-puts versus last year due to Valero Energy's Mckee refinery fire also contributed to higher OpEx. G&A increased $2 million compared to last year as we continued to add workers to support the Company's growth. DD&A was up around $7 million, mainly due to the asphalt acquisition and the completion of our growth projects. And interest expense increased by $5.5 million, as we financed the asphalt acquisition and the associated working capital and growth projects with additional debt. Keep in mind that we upsized our revolving credit facility from $600 million to $1.25 billion late last year. And we completed a $350 million senior notes offering in April of this year.

I would now like to briefly update you on the status of our growth projects. I'm pleased to announce that we recently completed another large group of terminal expansion projects under the $400 million construction program. This now brings to date over $105 million of projects completed just this year and we are looking to have another $137 million completed by the end of the third quarter. Phase 1 of our 630,000-barrel tank project at Texas City was put into service on July 1 at a cost of $21 million. This project provides an additional 430,000 barrels of storage capacity for one of our customers who is leasing the tanks for seven years. We expect the project to contribute around $3 million of EBITDA annually. We also just completed two tanks at our St. James, Louisiana, facility for $25 million. That gives an additional 740,000 barrels of storage capacity under a ten-year lease. This project is expected to contribute around $3 million of EBITDA annually and the second phase, which will cost around $25 million, should be complete in September and should add another 747,000 barrels and another $3 million of EBITDA annually. With a small portion of our $400 million construction program left to go, I'm pleased to say that our engineering and procurement department have done a supper job of completing the vast majority of these projects on time and on budget despite higher costs in raw materials.

Based on our outlook for projects to be completed by the end of the year, we expect our construction program will add another $26 million of EBITDA in 2008 over 2007 or, as we mentioned in the press release, about $20 million more in operating income. Looking at what we have left, we have storage expansion and pipeline projects at Amsterdam in the Netherlands, St. James, Louisiana, Jacksonville, Florida, Texas City, Texas and Linden, New Jersey, with most of these expected to be complete by the end of the third quarter. A couple of projects, including expansion phases in Amsterdam and Texas City, are now expected to be completed early 2009. I am very excited about the next phase of growth we are planning. We are currently in discussions and are evaluating several major terminal expansion projects, both in the U.S. and internationally, including grassroots tank projects. We are also evaluating other projects at existing facilities in the U.S. and we continue to push forward on the $35 million in projects relating to the asphalt business. These products should drive the partnership's growth for the next few years. We expect to have more information on these and other projects once we present our strategic plan to our board in late October.

Looking forward to the third quarter of this year, we continue to believe third quarter earnings will be very strong, primarily due to the contribution from our asphalt business. Very tight supply conditions have resulted in a significant increase in the margins for the asphalt and the intermediate products we produce. While asphalt prices in the initial part of the paving season lagged a rapid run up in crude oil prices, price increases have now accelerated resulting in attractive margins. For example, asphalt prices averaged around $450 per short ton for the second quarter, but we are seeing prices as much as $700 per short ton. As a result, we expect to see margins for our asphalt business in the range of $10 to $15 per barrel in the third quarter, which compares very favorably to the $8.95 per barrel we achieved in the second quarter exclusive of the hedging impact. Some of the factors that have contributed to the current tight supply conditions include lower than normal asphalt inventories on the U.S. east coast, weaker gasoline cracks that have persisted through the third quarter resulting in production run cuts at fuels refineries that have also reduced the production of asphalt as a byproduct, strong asphalt pricing in certainly international markets that have attracted asphalt to those countries rather than the US. and some of our competitors getting out of the asphalt manufacturing business altogether and also lower asphalt imports to the US compared to the past.

And while demand volumes for asphalt are expected to be somewhat lower than last year, due to rising construction costs costs and higher commodity prices the reduction in supply more than offsets the demand. The cost supply is so constrained, we believe the markets will continue to be tight this asphalt season even with lower demand. In fact, we are taking actions to increase our refinery run rate to maximize our production to help our customers meet their demand requirements. With respect to our other businesses, while we expect refined product and crude pipeline volumes to decline slightly in the third quarter, increases in tariffs will offset the impact of lower volumes as we move forward. And we continue to expect to see good results on our storage business, as most of the business is contracted and more expansion projects come online. Looking at some of the expense estimates for the third quarter, total operating expenses are expected to be in the range of $115 million to $125 million, G&A expense in the range of $18 million to $19 million, DD&A expense around $34 million to $35 million, interest expense of $25 million to $26 million and income tax expense of around $3 million to $5 million. Reliability CapEx for the full year of 2008 is expected to be lower than our previous guidance at between $55 million to $60 million for 2008, while strategic capital is expected to be slightly higher in the range of $185 million to $190 million and includes CapEx for some of the projects discussed previously relating to the asphalt business. So in summary, despite the challenges facing many companies in the marketplace right now, we remain very bullish on the outlook for NuStar and the opportunities we have to continue to grow our business. So at this time, I will open it up for Q&A. Operator?

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Gabe Moreen with Merrill Lynch.

Good morning, everyone. Getting back to SemGroup. I guess two questions there. One is in terms of real-time whether you are seeing any beneficial impact, given SemGroup's issues in terms of Sem Materials not being able to I guess service their customers and whether that's got some sort of impact or implications for you. And number two, I guess longer term, just trying to gauge I guess your appetite for the assets at Sem Materials, whether that might be something you would be potentially interested in.

Well, obviously SemGroup's is a supplier in the marketplace and we do see the market very, very tight. I looked at one set of data this morning with some of our guys, which indicated that asphalt inventories might be at something like an 18-year low in the country right now. So all things being equal, to the extent that SemGroups is stressed and their product distribution group is stressed. That's another bullish factor. Probably not a major one, because we were already seeing tight supply conditions anyway. So I wouldn't attribute too much to that. With regard to opportunities, we are monitoring SemGroup and seeing what, if any, opportunities there might be for NuStar there. But beyond that, we just have to wait and see how it unfolds. But we are absolutely monitoring it and very interested in seeing if we can help ourselves by doing a transaction with the SemGroup folks.

Okay. That's fair. And staying on asphalt in terms of -- two questions. One is in terms of what you've presold and you certainly sound very confident in terms of what you'll make for the third quarter. Does that mean you've presold some of your production here in the third quarter and to what you are exposed to spot pricing right now and also in terms of where I guess you expect to end up at the end of the third quarter in terms of inventory.

Right. Let me -- I'm going to refer the question here to -- I have Paul Brattlof here and also [Mike Stoner] asphalt marketer with regard to our sales. But I do want to reiterate we are quite bullish on the third quarter. Here we are in late July. So as each day and each week rolls by, we get more and more confident and bullish about the quarter will look like. But Paul and Mike you want to comment on the sales question.

Sales, I think what we are seeing is the supply is tight everywhere like Curt said but I think we are seeing demand pick up. Actually, last month we even had to allocate some customers and now we are opening that back up. So we fully -- we are seeing a lot of demand right now shift over to our racks. Mike, anything?

In addition to that. You mentioned presold. I'm not sure that -- what you're referring to there as preselling but we are typically selling data shipment, which means that as crude does fall up or fall down or move up we do have the flexible to move with that. So we are not held to fixed pricing going forward.

Okay. Thanks.

Our next question comes from the line of Darren Horowitz with Raymond James.

Good morning. Thank you. Curt, my first question for you is in regards to something that you mentioned. When you talk about taking actions to increase the refinery run rate in order to enhance production, can you quantify the incremental capacity and then of course any associates with that.

I'll tell you what we're trying to do. To the extent we can get more Venezuelan crude, great. If not we do have the opportunity to combine our feedstock with other feedstocks. And I have Rick Bluntzer here, Head of Operations can talk on that. But you might want to put a little qualification around that.

What we did is added some capacity to be able to control other feedstocks that we can introduce to the processing of equipment through what we call single component blend system. Obviously, this is something new to us and we have taken a very conservative approach upfront. But we have been pleased with the results of what we have been able to process with supplemental crude.

But you brought in a supplemental cargo of (inaudible). How much was that? How much was that cargo?

It was 500,000.

500,000 barrels. So that gives you some quantification around it. That's a 500,000 additional that we otherwise would not have run. So the point is to move up the feedstock, inputs into these plants at a time when the market is so strong the way it is, which is what Rick just described. So we were able to find additional feedstock on top of our normal crude contract supply commitments to the tune of 500,000 to try to capture more of this favorable margin that we are seeing.

Sure. No, that's helpful. I appreciate it. Switching over to refined petroleum products for a minute. Obviously, as you mentioned, you're going to get that tariff increase here and that's going to offset the volume degradation in the third quarter. But can you give us a little more color as to the magnitude of that volume shortfall. And more importantly, your thoughts on any sort of carryover effect into the fourth quarter volumetrically.

It's more -- it's complex when you talk about volume decline, because our different systems -- there are so many different demand drivers, like central east the product pipeline tends to be more agricultural driven. And some others are more gasoline transportation driven, but overall we were coming up with a number, like physical volumes might be down around 2%. It is a lot of puts and takes to this. But we just had a 5.1% tariff increase go into effect on nearly all of our pipelines July 1. And when you quantify it, the revenue from the tariff increase at least offsets if not more -- at least offsets the anticipated volume declines. Mary, do you want to say anything more about that?

I think Curt mentioned again, we do have some advantages in our central east pipeline system being agricultural driven, even though there was a bit of a wet spring season, the planting was still better than what people had expected. So again, we have had absolutely no decline in our volumes on our north system in the central east region. And so again, we continue to see our pipelines performing very much as they have in the past. 2007 was not a representative year for us at all, but if you look at them compared to 2006, our volumes are basically right where they were.

I don't see this as a major factor in our results going forward. Let me try to put it that way.

Okay. So safe to say given the geographic distribution of your pipeline footprint then you guys might not see the volume metric decline. Even into the back half of this year, more importantly into next year that I think other folks perceive to you have.

That's right. And even if you see some physical through-put decline, we are going to make it up on the revenue side on the pipelines anyway. So I don't see this as a major risk factor to our financial outlook.

Okay. Thanks, Curt. I appreciate the color.

Our next question comes from the line of Michael Blum with Wachovia.

Good morning, everyone.

Good morning.

A few questions. In the past you've said in terms of asphalt's contribution this year that you thought you would still be able to hit the low end of your previous guidance. I guess given the strength in that market, is there any chance you may do better than that this year?

We are not changing the guidance for now that we issued previously but, yes, there is a chance that we can do better. For now I would like to leave it at that. But we have put out the guidance of I think $80 million to $120 million as the range of the EBITDA for the nine months that we owned the former CITGO business. We are keeping it there. But I think we are feeling better about that than we had when we put out the range.

Okay. That's helpful. I guess maybe the same question but as it relates to distribution growth. Again, you said in the past that you thought that you saw your base business, if you will, could generate 7% type of annual distribution growth and that asphalt would be additive. So maybe you can comment where you see distribution growth for '08 now given all the factors in your business.

Do you want to comment on it.

Well, I think we just need to get through the third quarter. It is shaping up really strong as we've said but we haven't even closed the books for the first month of the quarter. But things are looking pretty good. And there's other issues. I mean, we do have $61 million more of debt than we thought because of the hedging loss. And need to take that into consideration.

We have to consider that because we do want -- we are going to make a lot of money. We do want to look at the state of our balance sheet, which Steve does every day, and decides what we should do with the money. We also told you we'd keep a bigger cushion relating to cargo, and this former CITGO Asphalt business than we do in the rest of the our business. So rather than pay all that out, we wanted to reserve a cushion because of the higher level of volatility in that business segment compared to the very stable other two business segments. So all of this will come into play on a distribution decision, but it is becoming clear that financially the Company is going to generate more profit and be healthier that even we thought when we made the decision to pull the trigger on this acquisition.

I was just going to add that much is going to depend on where we are in our debt to EBITDA ratio. The way that's calculated under our bank, you don't get to back out what I would consider non-recurring hedge loss that we incurred in the second quarter. So with that imbedded in the trailing EBITDA, that debt to EBITDA is within our financial covenant in our bank debt but still higher than we would like. It comes down very sharply in the third quarter and fourth quarter, as we forecast these very good results particularly in the third quarter. So too early to say I would say, yes, there is certainly some upside on the distribution above what we have guided on the base business, but we want to close the books first.

Okay, that's fair. Very helpful. Last question. On your refinery tour, I guess the question was asked, in terms of your strategy going forward on the asphalt business from a hedging perspective, what you thought you may do if you would just not hedge that going forward or hedge it differently or take some other strategy? And at the time you said you were still evaluating your options. Do you have any update in terms of how you are thinking about that, maybe not for this asphalt season but for the following year?

Well, as is implied by your question, near term we don't have any plan to put on hedges. We have got the physical inventory. It has appreciated the way we were saying it would, even when we were guiding to the hedge loss back in May. So we are telling this appreciated inventory at high prices and at high margins right now. The thing we got to do, which we look at every single day is watch the physical inventories. So the way we're managing inventory risk at the moment is not by putting on (inaudible) positions or other types of hedges, but by selling the physical and managing our inventories down as you head toward the end of the season and that's -- we're managing inventory risk that way at the moment. So no near term decision about changing that. Now, if things -- if we come to a different decision as we go along, then we will look at hedging again. But right now that is not -- it's not in the cards.

Okay. Thank you very much.

Our next question comes from the line of [Brian Zarong] with Lehman Brothers.

Thanks. Can you discuss the potential impact of cost inflation on your '09 and out expansion projects? You previously described a $500 million estimate. Is that still what you're looking at?

Yes. Well, you know, we look at things at a financial rate of return. So if our costs are up, then our revenues have to compensate us for that. So we are not going to do a project whether it has a good rate of return. We think -- we are confident that the marketplace for our assets is strong because we have good assets in good places and the new ones that we are focused on are also good assets in good places. In other words, they are places where our customers want to be long-term. So as a result of that they are willing to pay for that. And as the energy infrastructure, all of it has gone up. We are one piece of a big energy supply chain, moving and storing and blending products. But the cost of everything has gone up and, relatively speaking, our cost is a small part of that overall supply chain. So if we can command higher rates for our assets and services, which we believe we can, we are going to have good projects and we are going to do them even though they cost more to build. Maybe it a little long winded but I -- answer to your question -- but as right of now I don't think that higher costs will impinge our ability to do those next phase of projects because I anticipate getting a good financial return on those with higher rates.

I'm not sure if I missed this earlier, but is the -- looking out to next year, the pressure on state and local governments on their balance sheets, is that going to impact some end market demand?

I will let Mike answer it in a second. But there is some demand impact just this year. Asphalt prices have doubled like everything else and so that does ultimately impact demand, although I have to say our sales volumes have been great, so we don't -- we haven't seen that in the short term but we are being reasonable and saying higher prices will impact demand. But the supply store is what you've got to focus on. The supply is not there. And at some point you have to maintain and repair the infrastructure of these states and of this country. That's why just yesterday, congress decided -- house representatives first decided yesterday to transfer $8 billion more from the U.S. treasury into the national highway trust fund, because the highway funding they recognized needed to be plugged. Even though they are running budget deficits and everything else, this is an urgent need. That ultimately is what this business is. It is an urgent need. You can have short term fluctuations in demand, but longer term you can put things off for only so long and if you listened to CSPAN yesterday, that's what every congressman who stood up was saying. But Mike, you want to talk -- I guess the question was a little bit of what's going to happen next year on the demand side?

Demand is -- we said this year it's been down about 20, 25%, but as you said the key has been the shift in demand because of the supply situation in the marketplace. With the crack -- gasoline crack spreads not being there for the conversion refineries, they are not producing the asphalt so therefore that reduction in supply is offsetting -- more than offsetting demand. But just to touch base on your infrastructure, I think you're right. Curt hit the nail on the head. That it has to be maintained in the country and that's going to be the biggest challenge for this congress coming up and passing Highway Bill 4 for the 2009 for the six-year period.

This is one of the few areas, though, infrastructure investment, that actually has bipartisan support. The term bipartisan is thrown around a lot, but this is one where democrats and republicans sing off the same sheet of music.

That's helpful. Thanks.

Yes.

Our next question comes from the line of Louis Shamie with Zimmer Lucas Partners.

Good morning, everyone. This was an excellent quarter. Congratulations.

Thank you.

I would like to get a sense of if you're just to look at the asphalt EBITDA year-to-date, how is that running just on the basis of the 80 to 120 guidance? What does that look like before the hedge impact and before the marketing segment?

Well -- go ahead.

Just in the second quarter alone we would have had $57 million or so -- or $53 million of operating income. That's, of course, exclusive of the hedging loss. Obviously we didn't have the business for many days in the first quarter. But we expect the third quarter is going to be stronger still. Considerably stronger still. So we are looking pretty good. But we still want to reserve this sort of 80 to 120 range after the hedging loss is sort of the guidance we have given. But the third quarter is going to go a long way to firming up that bad range. We expect it to be very strong.

And then if we look at the sales volumes in the second quarter compared to what you're expecting to sell in the third quarter, can you give an estimate of that?

Are you talking about asphalt now?

Yes, for asphalt and the associated products.

Okay. That segment. Do you guys have that handy?

Yes. It is up quite strongly. It's up about not quite --

July and August is the -- it is the paving season. So we expect them to be much, considerably higher.

July, August and September are your three peak paving seasons. So that's --

Do you have let's say a million barrels -- a millions of barrels estimate? Or tons? Or anything like that?

I think we are shying away from doing that on this call, but it is going to be significantly higher. To the extent you can maybe call Mark later to get a little bit more detail around it, that would be appreciated. But it is strong.

Okay. So basically you're expecting to see $2 to $7 in additional barrel and about 2 million more barrels.

That's just the asphalt side. I mean, that margin that we are talking about is across the light products as well. But on the asphalt side, as Paul mentioned, we are kind of currently forecasting 2 million barrels more of sales of asphalt in the third quarter versus second but, again, we don't want to go too specific on this stuff. We have got competitors in the market that don't need to signal what our sales estimates are going to be.

And then in terms of your base business. Can you guys give a little bit of a description as to how the Valero refineries you're connected to, how they stack up competitively, in other words of the rest of the refining sector.

Yes, the Valero refineries we are tied to are excellent refineries. If you take the Mckee system, which really sort of dominates the legacy business that we IPOed off of, they have one of the lowest operating costs in the Solomon Survey, so they are very competitive. Just to give you sort of an illustration of how competitive. I remember we used to get a whole bunch of questions about the Longhorn pipeline and how the Longhorn pipeline was going to wipe out Valero's ability to sell in El Paso. Guess what. They are moving more to El Paso probably than they ever have. And we always said that would happen, because they have an excellent landing cost in El Paso. It's just one example of what I'm saying about the cost competitiveness of their refinery. Some of the others that we are tied to are really flagship refineries for Valero. You're talking about Corpus Christi, a large refining complex on the U.S. Gulf coast, Bonicia, one of the best refineries on the U.S. West Coast, Texas City another strong Gulf Coast contributor to Valero's project. They have got a huge coker there they put in only a couple of years ago that they made a huge investment in because of the ongoing sustainability and profitability of Texas City. So it is really a question properly answered by Valero, but I feel great about the refineries that we are connected to.

That's really positive to hear.

Another point of confirmation on that would be, to the extent there has been chatter about refineries, Valero has slated for sale or that has sold in the recent past, none of the ones I've just mentioned are on that list.

Great. And then when it comes to the potential $500 million worth of projects that you guys are evaluating can you give an estimate of what kind of returns you are expecting on those projects?

Same sort of return that we had on the 400. In other words, IRRs in the range of 15 to 20%. EBITDA multiples of six to seven times.

Probably on average, the ones we are looking at now are probably coming about at 20%.

They have been a little higher.

They have been a little higher. The multiples are very good.

Closer to six than seven lately.

And on the 400, as we've said, we've really brought those in pretty much on time and on budget. The only one that's been delayed is Amsterdam. And that's over budget only because the Euro has strengthened so much against the U.S. dollar. But the revenues on that project are all in Euros as well. So in the multiples on these are really great, really low and very competitive certainly against what you can buy things on Wall Street for.

Great. And if you're looking forward to 2009, do you expect the asphalt market or at least the supply demand balance there to kind of hold up?

Yes, I think we do. Everybody around the table is nodding yes too. Some of the same factors that we have been talking about are already evident on the tightness of the supply and after '09, as you get to '10 and '11, which is the story we have been telling previously as significant segments of these coker projects come online, it gets that much tighter. So yes, we think it will continue to be good.

Great. Good luck. Thanks for answering my questions.

Thank you. Our next question comes from the line of [Steven Erico] with [Locuswood Capital].

How are you?

Good, thanks.

Good, again congratulations on a good quarter. I want to clarify a couple things. Your guidance for the asphalt business on the low end is roughly $80 million of EBITDA for the year. So basically that would -- if you take it through the second quarter, that's inclusive of the loss that you have on the hedge. So basically if I say in Q2, you basically had a wash, that means we are looking for roughly $70 million to $80 million of EBITDA in the third and fourth quarter of this year to get to your guidance. Is that an accurate statement?

Well, that's the guidance on the low end of the range, yes.

Okay.

that would be a conservative estimate I would say.

Great. Also, this business, does it -- it is seasonal. Do you generate -- is your expectation to generate positive EBITDA in both the fourth and first quarters or is the fourth quarter typically a break even quarter?

Fourth quarter we really don't expect much of anything positive in the fourth quarter and that's when we are -- they tend to do maintenance on the refineries. Now part of our -- I'll say this. That's the near term answer. Part of our strategic direction is to run these refineries harder and make more money in the fourth and first quarters during the off-season for asphalt, essentially by expanding more into the fuel oil business and making modifications to these plants in order to do that. So that is in our plan. You won't see that this winter, the first winter we have owned it, but going forward that's our plan to do that.

And then secondly, just in clarifying the distribution. Respecting Steve's conservativism, but basically what you're saying is without this acquisition, we are looking for 5 to 7% distribution growth this year. And basically what you're saying is you're saying, should I look at that as a floor and maybe we will do better, maybe we won? It depends on what the asphalt EBITDA does on the back half of the last year?

Yes, I think that's fair.

Let me just say about Steve, you want your CFO to be conservative.

I do. I respect it very much. I have got no problems with that.

-- another type of CFO, a lot of them aren't around any more.

No, I agree. That was a compliment.

I was kidding.

And Steve, there's competing audiences too. We've got a rating agency that has put a negative outlook on us because of the acquisition of a more volatile business and we have incurred $61 million more of debt because of that loss on the hedging side in the second quarter. So we will be talking with the agencies here as we go through the order. As you can imagine, the agencies right now are very focused on the energy space in light of the SemGroup situation. So we will be doing a lot of handholding with the agencies walking them through the forecast and getting them more comfortable I think with the asphalt story.

It would be my thought with the cash flow you generate in the third quarter you can kind of think about that you'll pay back the $60 million that you had on your debt lines I assume.

That's about right. We will be leveraging quite a bit in getting this back into the range that we expect it to be in and really it is just the unfortunate nature of the product lag compared to the hedging loss. If you could have married that loss up with the physical sales in the third quarter, it would have smoothed everything out and things would have looked terrific. But that unfortunately was not what happened. We had to book the loss and now we are getting the physical in the third quarter.

Can you remind me what the relationship is on the dividend growth at the LP versus the GP. Is the GP about 1.5 times or is it 1.25 time?

It is a little higher. It is 1.7 multiplier.

Great. Guys, congratulations. Thanks for taking my questions.

Good questions. Thanks.

Your next question comes from the line of Mark Easterbrook with RBC Capital Markets.

Good morning, everyone. Really a lot of my questions have been answered. But just one quick one. Any scheduled down time for the refineries that you are tied to in the third quarter or if you look into the fourth quarter as well.

I don't think so. No.

No. In the fourth quarter we will take a scheduled outage for turn around. At our facilities.

At our facilities.

There is nothing at the refinery being served.

Okay. So just on the refinery product side and crude oil side, there is no refineries planning any down time for right now?

Correct.

Thanks, guys. Great quarter.

Our next question comes from the line of [Andrew Dunnlodge] with ASC.

Good morning. I just wanted to ask something on the debt. Where do you expect your total consolidated debt to be, either at the end of the third quarter or at end of the year? I guess -- sorry, just more specifically, if you're 5-to-1 debt coverage ratio is what the banks have on your facility, if I'm not mistaken, would you say that the rating edge conservativism today in order to maintain your development status continues to be at that 5-to-1 level?

No. Well, right now at the end of the second quarter we were 4.8 times versus a covenant of 5.5. The covenant is at 5.5 for two quarters after an acquisition of more than $100 million. So at the end of the third quarter, the covenant is at 5 times and we expect to be way below that because of the result. The 4.8 will drop into the 3s because of the deleveraging that you get just seasonally in the business, but more importantly because of the strength in the earnings in the third quarter. And what we feel is appropriate, given the addition of this more volatile business, is at peak inventory levels, a debt to EBITDA of around 4 times but on average around 3.5 times. And if you backed out the hedging loss that's where we would have been. Okay. Pretty close to that in the second quarter. And that's pretty much what we have shared with the agencies, that we would expect that you need to run a higher coverage ratio. And we would discuss we would hold back half of the distributable cash flow coming from the asphalt market business and that, given the season and volatility of 20% of that -- 20% of our business coming from the asphalt side, that the debt to EBITDA should be in around the mid 3 range. And that's pretty much where we would be on average for the year. Again, backing out the hedging loss.

I see. And if you deliver on what you've said to the rating agencies, will they take you off watch by the end of the year do you think?

I can't speak for them. I don't know. We are certainly going to be pitching that pretty hard. It's not something that hopefully is hard to fix. You can always lay out more equity and solve the problem. I would rather not do that, to dilute existing holders, but that's not something that's too difficult to accomplish, I think, just by simply shoring up the balance sheet. But again, we would rather not do that, we would rather just prove the business case through the generation of the earnings and the deleveraging and we will probably delever by somewhere in the range of $50 million to $100 million by the end of the year but again, that will depend upon other opportunities. If we do something that falls out of the SemGroup and buy some terminals there or whatever, then obviously there is a financing need. But traditionally we finance everything, as you know, at least from a theoretical point of view, 50/50 when we run our economics and then when the need gets big enough we will look at raising equity. So the question of equity is really just when, not if. Obviously we want to aggressively grow the company and we will need to tap the capital markets.

Okay. Can I just ask one other big picture question on the financial players in the oil trading and logistics business. You would expect that the SemGroup volumes will be taken up by other financial or strategic players I assume and I'm just curious if you're worried at all about the financial players being customers not necessarily of you but of other pipeline terminal storage blending facilities, such that it might impact flows and pricing and things like that through the business?

Well, we have looked at that and particularly on our central east pipeline system. Again, SemGroup has not -- they are not a physical supplier. They buy and they sell at supply end markets. Obviously, Magellan is our competitor so we have taken a look at that. We feel very confident that while we could possibly lose small volumes at particular loading ramps, they would not be material whatsoever. The railroad is one of our largest customers. They have taken on there becoming their own shipper and we think other shippers will step into the shoes to supply the terminals on our system.

Great. Thank you so much.

Our next question comes from the line of John Tysseland with Citi.

Thanks for the detail on the call. Real quick question, kind of has to do with that last question, but I believe SemGroup does have -- and correct me if I'm wrong, do they have allocations on your current product pipelines? And I also wanted to know, do you see them utilizing that capacity now and is that creating any kind of dislocations in basis on product prices that you see so far?

Again, our central east where they're our customer has not been on allocation and we don't expect it to be on any sort of allocation, so we don't expect any sort of disruption in the physical supply to the terminals that we move our products to.

Now, does taking a player like SemGroup out of the market, who is a very large marketer not only in refined products but also crude oil and across really the chain. Does that provide in your mind an opportunity for your marketing group at this point or is it just, I think, or is it something that is a little bit too early to tell?

I would say it is a possibility since they are really kind of a middle man. They don't have any end user type retail demand, and so it's our production, so it would create a small opportunity for us. But I think they have scaled back that business from what I have heard over the last few months so I think it is an opportunity but I don't think it's a real big one for us right now.

All right. That's it. Thanks a lot. Appreciate the call.

Our next question comes from the line of Mark Reichman with Sanders Morris Harris.

Good morning. I'm looking at this asphalt operational data that was posted to your website and I was looking at the adjusted product margin per barrel. I think it was $8.95 for this last quarter. What is the adjusted product margin per barrel for Paulsboro and what is it for Savannah? Is there a material difference between the two refineries?

We will probably have to get back to you on that if you don't mind after the call. We will have an answer. We don't have it broken out right this instant. They are very similar.

You would think so, you would think they're very close.

So I'm understanding what I'm looking at, is that adjusted product margin per barrel, does that reflect like an average across a variety of products ranging from hot mix asphalt to say the polymer modified asphalts?

It is absolutely. It is just your sales. Cost of goods sold and cost of manufacturing all the way through to the rack divided by your sales volume.

So if I remember from the refinery tour, the higher value added product like polymer modified asphalt, those were really responsible for a disproportionate share of the margin, so do you see these margins improving as perhaps you are able to grow the volumes of the higher value added asphalts relative to the overall mix?

Yes, that's part of our strategy to make more of the polymer modified for that reason. Volumes are relatively small in the scheme of things, but the profit margin is better. Mike, do you want to talk about that.

Polymer consists of about 3% of our total sales on asphalt. And we are targeting anywhere from 10 to 15%.

Right. What percentage of the margin was it responsible for?

I would have to get back to you on that.

So 3% is going to be more than 3% of the margin. So we will get you the exact number.

Okay. It was just kind of interesting, because it would be kind of nice to get kind of the detail on the different products just because some are higher margin. If you're able to grow those volumes, that would have real positive implications for that business. Thank you very much.

Thank you.

Our next question comes from the line Ben Segal with Aurora Capital.

Good morning. Just a quick question and that is you have a plethora of capital projects in front of you and you've done a great job getting a pretty high return on the projects. How do you see the dynamics between the cost of capital rising in this environment versus the backlog of potential projects moving forward over the next, I don't know, year or more? Well, we have been demanding a higher return.

Steve was mentioning, when I throw out this 15 to 20% range, that our recent projects are closer to 20% because we are a little more demanding, there is a higher cost of capital, we're a little more demanding on what that return needs to be. Steve, do you want to comment further?

No, I think that's pretty much it. So far in what we have examined, we do not feel we are going to be capital constrained. But there is no denying the market's a lot tougher and more expensive today than it was a year ago. I don't need to tell you guys things have changed quite a lot. So we are very selective and we do, from time to time, knock out a couple of projects that we are reviewing. Yesterday was a perfect example. We brought some projects to the board, and a couple of them, although they had decent returns, were less attractive than a couple of the others and we are standing down on those opportunities.

The good news is you take some in, you take some out, but we have also been able to put some in. So we have been able to keep that portfolio full so we can still talk about an estimated $500 million or so. But we are upgrading the portfolio. Let's put it that way.

It's also a balancing act between, you don't want too many construction projects, where you're spending $500 million for two, two and a half years without seeing any EBITDA. So there is that issue as well.

Thanks, guys.

Thank you.

(OPERATOR INSTRUCTIONS) And I am showing there are no further questions at this time, sir. Do you have any closing remarks?

Yes, thank you, Operator. If you have any further questions please call NuStar. Thank you.

This concludes today's conference call. You may now disconnect.