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Operator
Ladies and gentlemen, thank you standing by.
Welcome to the Valero Energy Corporation Second Quarter Earnings Conference Call.
At this time all participants are in a listen-only mode.
My name is Edie and I will be your conference coordinator.
If at any time during the conference you require assistance, press star 0 and a coordinator will be happy to assist you.
As a reminder, this conference call is being recorded.
I will now like to introduce the host for the call, Mr. Lee Bailey, Vice President of Investor Relations.
Please proceed.
- Vice President of Investor Relations
Thank you Edie.
Good morning and welcome to Valero Energy Corporation Second Quarter Conference Call.
With me today is Bill Greehey and other members of the Senior Management Team.
If you haven't received the earnings release and would like to get a copy, you may get one from the website at valero.com.
The table attached to the release has some additional financial information on the various business segments.
After reviewing the tables, if you have questions on the information that's on the various business segments, please feel free contact myself or Eric Fisher.
We have also posted some additional statistical information on gasoline and distillate crude oil fundamentals that are on the Investor Relations portion of our website that may be helpful for you.
Before I turn it over to Bill, I would like to direct your attention to the forward-looking statement disclaimer contained in the press release that says statements in the press release and conference call that state that the company's or management's expectations or predictions of the future and forward-looking statements and are intended to be covered by the Safe Harbor Provisions under the Federal Securities laws.
There are many factors which could cause actual results to differ including those we described in the filings with the SEC.
I'll turn it over to Bill at this time.
Thanks.
- Chairman & CEO
Thank you Lee.
For the second quarter we reported earnings of $1.08 per share which was a big improvement over the 10 cents per share that we earned last year, second quarter.
Refining fundamentals have been much better this year than last year when refined product inventories were high and (inaudible) crude discounts were narrow.
Having said that, the quarter did end on somewhat of a disappointing note as we pointed out in our earnings guidance news release on June 20th.
The second quarter started off very strong with continuation of the good refining margins that we experienced in the first quarter.
However, in May gasoline and distillate margins began to climb as inventories built.
Distillate margins in particular weakened late in the quarter.
The Gulf Coast heat crack averaged only 23 cents per barrel in June, down from $1.25 in May and (inaudible).
The (inaudible) crude discounts also narrowed substantially in June as a result of the Iraqi crude being come completely out of the market.
For April and May the average sour crude discounts for the benchmark Saudi crudes was 443 per barrel but fell sharply to 280 per barrel in June.
In addition, natural gas costs remained high in the second quarter averaging 560 per million BTU which had a negative impact on our hydrogen and (inaudible) costs.
We had several unplanned outages at the refineries which I'll talk about more in detail later on.
But before I do, let me quickly give you more detail on the numbers for the quarter.
Net income for the second quarter was $128.4 million, or $1.08 per share.
That compares to a net income of $11.3 million, or 10 cents per share, in the second quarter of last year.
When you add the $170.4 million, or the $1.51 per share, we earned in the first quarter our net income for the first half of this year is $298.8 million, or $2.59 per share.
The operating income was $274.4 million, up from $100.1 million in the second quarter of 2002.
Refining operations contributed $279.2 million to total operating income before administrative expenses.
Over $89 million of this came from the Quebec Refinery which had another excellent quarter.
Our retail operations contributed a record $74.4 million. $53 million of the retail contribution was earned in the U.S. retail system which has an average fuel margin of nearly 18 cents per gallon, which interestingly, is that we have achieved this record level of earnings with nearly 200 fewer retail sites than we had at this time last year.
This reflects the success we have had in upgrading the quality and profitability of the U.S. retail system.
The Canadian retail also had a good quarterer contributing $21.3 million with an average fuel margin of just over 21 cents per gallon.
If you combine the Canadian refining and retail contribution this quarter it equates to over 30% of the total operating income before administrative expenses.
I would also like to add that the efforts to grow the wholesale business is going well.
Year to date we have added over 300 sites and we've increased wholesale fuel volume sales by approximately 20,000 barrels per day.
In fact, many of you in the Northeast will be seeing more and more Valero branded sites as we have begun to sign up new jobbers in the market.
The big advantage to growing this part of our business is that we get a few cents per gallon uplift over spot sales alternatives at a very low incremental investment.
We're also working to grow the unbranded rack volumes throughout the system which also provides a small uplift over spot sales.
The increase in unbranded sales this year equates to additional 50,000 barrels per day.
Going through some of the income statement items.
Interest expense declined to $63 million from over $72 million in the second quarter of last year and roughly $75 million in the first quarter of this year.
The $12 million decline in interest expense from the first quarter of this year is due primarily to termination of the capital lease for the former El Paso/Corpus Christi Refinery we acquired in 2001.
Lower average borrowings and the full quarter impact of the deconsolidation of Valero LP from our balance sheet.
We also had a total of about $750 million of interest rate swaps in place which lowered our second quarter interest expense versus the first quarter by over $4 million.
Our debt portfolio is now about 75% fixed to 25% floating rate.
Again, that is after the effect of the interest rate swaps.
Also during the quarter we issued $300 million of 10 year 4 and 3/4% debt and used the proceeds to buy back the $200 million of 8.32% toppers and $100 million of 8% debentures that were outstanding.
These were both securities that UDS informally issued.
On a present value basis, this will save us approximately $70 million in interest costs over the next 10 years.
The total debt at the end of the quarter was approximately $4 and a half billion dollars leaving the debt-to-capitalization ratio at 42.6% net of the $697.5 million of cash on the balance sheet.
Also note that we currently have over $1 billion of available capacity under the revolving credit facilities.
The weighted average shares outstanding for the second quarter were $118.7 million on a fully diluted basis.
This is up from $112.8 million shares in the first quarter due to the overnight equity offering we completed in late March.
On August 18th an additional 4.9 million common shares will be issued pursuant to the terms of the mandatory redeemable preferred securities that we issued as part of the (inaudible) acquisition.
And for the third quarter, fully diluted shares outstanding will also increase by another 6.7 million shares with the inclusion of the convertible preferred securities we issued to the Orion owners.
Let me discuss the unplanned refining outages that we experienced recently experienced and what we are doing to address the issue.
We now have 14 refineries in our system. 16 if you count the 2 asphalt refineries in California.
So it the inevitable that we will have outages and the outages get more media coverage than any other refinery outages.
This is because Valero, like -- unlike other energy companies is very open to all of its communications with the media including operational issues.
This strategy has served us well over the years and helped to foster very positive media relations for the company.
Of course, on the down side to open communications process is that the media reports every hiccup in the system with the ten's of thousands of moving parts in the many complex operating units in 16 refineries we are always going to have some unit shut down for something, somewhere.
A good example of how minor outages get blown out of proportion is the recent rotor replacement we completed for our heavy oil cracker in Corpus Christi.
This was a case where the operation folks noticed higher than normal vibrations, took the unit down and found an imbalanced rotor and replaced it with a spare rotor and brought the unit back, all in less than 4 days.
This is a good example to solid preventive maintenance and good operational decision making, but it was reported as if it was a major unplanned outage.
However, with that being said, we are disappointed with the number of outages we have had this year.
We estimate the downtime in the second quarter resulted in lower operating income of roughly $60 million.
However, the vast majority of this, approximately $45 million, was related to three major outages in and two of these were related to planned outages at our Texas City and Ardmore Refineries.
It is important to remember that 90% of the refineries problems occur during shutdown or startup procedures.
Ardmore was our only refinery that was scheduled for a major turnaround this year and the startup was delayed by a week because of a defective rooter in the gas compressor of the plant's hydrotreater.
Then shortly after startup, tornado activities in the area resulted in the total plant power outage.
The abrupt plant shut down resulted in damage to the steam generator in the plant's sulfer recovery unit.
Because we only have a single sulfer drain at the Ardmore refinery, this single repair required a complete shut down for 10 days.
The turnaround delay sulfer plant outage cost us almost $10 million in lost operating income.
The good news is we are acting a second unit in Ardmore in March of 2005.
This will not only eliminate the need for a total plant shut down if a problem develops in one of the sulfur recovery units in the future and enable the refinery to process lower cost speed stocks and improve the refinery's net margin by more than 50 cents a barrel.
In Texas City we also had a planned outage or a catalyst change and to make some minor modifications to prepare for the new 45,000 barrel a day coker which is coming on line November of this year.
Texas City also experienced problems with the resid finders during the startup which cost us almost $7 million in lost operating income at the end of the second quarter.
Unfortunately, these problems have carried over into July and are expected to have a $14 million impact on July operating income.
In Benicia we also planned a brief hydrocracker outage in June for a partial catalyst change.
We accelerated that change in May when it became clear that we needed to replace the gas turbine that drives the recycled gas compressor.
This extended our planned outage by 9 days.
Then in June we had a pump seal failure which caused a hydrocarbon leak resulting in a brief localized fire in the FCC fractionater.
This damaged some instrumentation cables and resulted in a 16 day outage.
The total impact of these outages at Benicia was approximately $28 million for the second quarter.
Then in July we discovered a crack in the piping of the hydrocracker which required us to take the unit down to make the needed repairs.
It was also decided to make a planned to repair to the unit's recycled gas compressor while the unit was down.
Unfortunately, Benicia experienced problems with the unit startup which is expected to reduce the operating income by about $20 million.
I want to assure you that we do not take these operational reliability incidents lightly.
Currently we have targeted Benicia, Texas City and Paulsboro for in depth and reliability assessments.
In fact, we already have teams on the ground at these facilities that are making good progress in identifying and correcting the causes of these outages.
Now, I would like to give you an update and the recent acquisition of the Orion Refinery which we have renamed the St. Charles Refinery.
Valero took over operations July 1st .
We've replaced most of the management team with top people from across our refining system.
The new Plant Manager is Jonathan Stewart, is formally the Plant Manager at Houston Refinery, and we also have Lee Rolls at Corpus Christi and Benicia.
The new Complex Manager for the catalytic cracker at St. Charles is from Corpus and the Maintenance Manager is from Benicia.
We're happy and pleased with quality and motivation of the St. Charles employees.
They are happy to be part of Valero and they are anxious to improve the operations at the plant.
Since we took over, we have been able to make several improvements through renegotiating contracts for things such as industrial gases and chemicals and maintenance services we have lowered the annual operating expenses by about $9.5 million dollars.
We have also improved the operating economics of the cat cracker and the CCR reformer by increasing catalyst circulation and optimizing the unit operations.
In addition, we are in the process of improving the operation of the two sulfur units in order to provide a reliable base for processing the higher sulfur feedstocks.
The initial transition to Valero has gone well.
We are excited about the long-term prospects for the refinery.
Before we open up for questions I will make a few comments on the current industry fundamentals.
Thus far in July we have seen an improvement in refined product margins as compared to June with the exception of the carb gasoline margins.
For example, the Gulf Coast gasoline crack has averaged $6.52 per barrel in July, as compared to $4.09 per barrel in June.
The Gulf Coast heat crack is average $l.20 dollars in July, compared to 23 cents in June.
The carb gasoline margins on the other hand have weakened average $12.10 in July compared to $19.27 in June.
If terms of demand gasoline, demand is trending around 9.1 billion barrels per day which is a little better than where demand was at this time last year.
Gasoline imports have begun to moderate as the European refining market has strengthened.
Distillate inventories are at the very low end of the historical range.
For the last 10 weeks distillate inventories have remained 17-23 million barrels below last year's level.
And with refiners continuing to focus on gasoline production, it is going to be difficult to meaningful to build distillate inventories before winter.
On the feedstock side as I mentioned, the lack of Iraqi crude negatively affected sour crude discounts in June and July.
The good news is that we are starting to see some real signs of improvement.
For August, deliveries of Saudi crude discounts has widened to 320 per barrel.
We'll be notified regarding September deliveries in the next week and do expect the discounts to widen further.
As world events stablize, more sour crude oil should return to the market and discounts should continue to widen.
We're seeing more and more crude oils from Russian on the market and it appears that crude oil is finally beginning to flow out of southern Iraq.
In fact, we entered into a term contract with (inaudible) for two million barrels per month and expect to take our first deliveries in mid-August.
We're also beginning to see lower prices on the bottom of the barrel feedstock such as high sulfur fuel oil.
The lower prices partially due to the fact that European power generators required to switch to the lower sulfur alternatives and Japanese nuclear power plants are coming back on line, causing demand to fall.
Because the high sulfur feedstocks compete with certain sour crude oil as refinery feedstocks, this should also put additional downward pressure on sour crude prices.
In fact, we are currently seeing spot sour crude discounts widen for the second quarter levels.
On the operating expense side, we are also benefitting from the lower natural gas costs which are currently under $5 per (inaudible) BTUs.
Given that we can save about 260 million - or thousand million - BTUs per day in natural gas.
In summary, refined products inventories remain low.
Demand is good.
Sour crude fundamentals are improving, which should translate into above average margins for the back half of the year.
With that, we'll open this up for questions.
Operator
Ladies and gentlemen, if you would like to ask a question at this time, please press Star followed by 1 on the telephone.
If your question has been answered or you wish to withdraw your question key Star 2.
Our first question is from are Art Morty of Goldman Sachs.
Please proceed.
Just a couple questions.
Do you have an estimated throughput level for the Saint Charles Refinery in 3Q and 4Q, what you are looking for, and then any update on Cap Ex plans still on track for $1.1 billion I believe for '03 and '04?
The updated throughput levels for St. Charles after we repair the sulfur plants is about 210,000 barrels a day.
That includes crude, plus purchase interim.
And what with will that level start?
In September.
September, great.
- Chairman & CEO
On the Cap Ex side we're still at the 1.1 billion level that excludes Camron Highway and some other things. 2004 by about a billion 3 but also includes now the Saint Charles Refinery.
And then do you have the second quarter cut backs?
- Chairman & CEO
About $220 million.
220, that's great.
Thank you very much .
Operator
The next question is from Mark Flannery of Credit Suisse First Boston.
Please proceed.
A couple of questions.
First, we heard some comments, and I apologize if I missed this at the beginning, some comments on the other refiners of backward dated crude markets on their income.
Could you comment on what you are seeing there, if anything?
And the second question is can you give us an update and what is going on with Cameron Highway and remind us of that project there.
- Chairman & CEO
Gene.
First of all, the back ward all the domestic crudes were bought where you have to buy them in month in advance before you receive them so the backward market you're effectively paying a higher price for the crude that you're getting next month.
It averaged right at a dollar a barrel and we buy about 8 million-barrels a month of domestic crude so you do the math it cost us probably around $24, $25 million for the quarter on the backward side of the market.
- Chairman & CEO
Cameron Highway is scheduled to be completed next summer probably mid-year.
Okay.
Great.
Thanks a lot.
Operator
Our next question is from Paul Tinge of UBS.
Please proceed.
Good morning, I have two questions, please.
One is on the operating highlights refining throughput at 1.76 million barrels per day in the second quarter.
I wonder whether that reflected any kind of a voluntarily 1 cuts and what is your planned run rate for the third quarter.
And the second question deals with the Midwest refining margin, indicator looks kind of different from the industry indicator.
Your Midwest show it decline of margin in the second quarter versus prior year.
Does that reflect down time hedging or can you explain that to us, please?
I guess I'll comment on the up theres in the second quarter as bill mentioned we have some unscheduled down time.
We with respect weren't planning any run cuts in the second quarter and that is what impacted the throughputs.
Going forward, we plan the estimated throughput from August to the end of the year is 1.92 to 1.93 million barrels per day a 7-8% reduction from capacity mostly related to a declining asphalt cracks in the later half of the year.
- Chairman & CEO
And, Paul, I'll give you a breakdown on the gree graphicly third quarter we would expect Gulf Coast to be at about 950 a day and west coast at about 320.
Mid continent at about 275.
And these are all, you know, rough estimations.
Sure.
In the northeast. 365 so that gets you to right at 1910 a day as John was alluding to.
- Vice President of Investor Relations
In looking at the indicator margin in the mid county intercept, a lot of it has to do with the Ardmore Refinery.
Our turnaround at Ardmore went 15 days into April and as Bill mentioned a sulfur plant go down which was a 10 day outage.
And if you look at when the margins were very good in the mid continent we were actually down in Ardmore during some of that period.
So that affected us.
The second piece is asphalt prices which are a key component of our mid continent refining in Ardmore and they have fallen significantly in the second quarter.
That is very helpful, thank you very much.
Operator
Our next question is from Darren Tearson of Morgan Stanley.
Please proceed, sir.
Good morning, guys.
How are you all doing?
Hey, Darren.
I had a question go hedging specifically whether or not there were any meaningful positions at this time and in what products for the rest of this year and also 2004?
Okay.
We're fairly hesitant on the distillate side.
We actually made $11.9 million in the second quarter but still down $5.2 million year to date bus of the first quarter lost when heat cracks really blew out.
We also forward about 24% of the third quarter volume and 27% of the fourth quarter volume which represents at this time about 26 million barrels of shorts we have on.
The our current market on that is a gain of 16.9 million in third quarter and about $4 million in the fourth quarter to net we're positive on the distillate hedge nor the year.
Gasoline we lost $11 million the second quarter and a lot of this is because the way we put them on -- a flat price for the entire year.
Second quarter will be the highest quarter, you know, we had a loss that period.
We're down $16 million, year to date. $16.9 million.
We don't have any third quarter hedges on this point but we do have 5% on the 4th quarter and we have a mark to market gain for the balance of the year of $19 million.
Which is $5.6 million in third quarter and $13.4 million in the fourth quarter so again on gasoline we are positive for the hedge on the year to date that the mark to market.
Do you have anything for 2004?
We have some of the disllate hedged in '04 represents -- one second.
Only about 4 or 5%.
Okay.
Production for next year.
Also, on shares outstanding I couldn't keep up with Bill.
Did you say 5 million additional shares led to the (inaudible) and 6.7 for the former O'Ryan owners.
- Chairman & CEO
935 on the (inaudible).
Okay.
- Chairman & CEO
And Orion is 6.7 million.
Great, thanks a lot, guys.
Operator
The next question from Fred Loafer of Bear Stearns.
Go ahead, sir.
Good morning.
Hi, Fred.
At today's margins what contribution to earnings would you expect in the second half from St. Charles?
You know, we don't have that number right now.
It is -- right now, they have done some major repairs on one sulfur unit.
They will be doing the other one probably as we speak.
So we're not able to process the heavy sour crude as we would like.
After that we will be able to -- I just don't have that number.
Okay.
Can you give us an idea what balance sheet looks like now after the acquisition?
Cash debt, shareholder equity.
We had cash at the end of the second quarter of $697 million.
We did the issuance of the preferred.
We gave them $305 million of cash and $250 million of preferred so we just don't even have the June balance sheet much less the July balance sheet, Fred, unfortunately.
All right is, but we start by subtracting $305 from the just under $700 in cash.
Yes, you could.
And then the preferred.
Those should be the only two changes, right, Danny?
Bill, I this weekend visited a brand new Valero station in eastern Long Island.
It looks spectacular!
- Chairman & CEO
Terrific.
That part of the business is doing well.
Thank you.
Operator
Our next question from John Meloy of Simons and Company.
Please proceed, sir.
Hi, guys.
Could you comment on -- Mark talked about the backwardation effect for the second quarter.
Could you talk about what you have seen in July and into August.
Backwardation has subsided some.
It is currently about 40 cents a barrel so it has come in as crude prices have come off.
So 40 cents in August and July combined?
July is probably higher than that because is really was established in the previous month.
Probably in the same dollar range but for August 40 cents and depends on what the market does between now and then as you get into September.
If the market comes off should go flat.
Okay.
Okay.
What was the cost of the Ardmore sulfur recovery problems?
Well, the (inaudible) failure that had on the sulfur train was about a $5 million incident.
Okay.
And then lastly, running through the math here, you are going to be about 130 million shares for the third quarter?
Sounds right. 128, John, to be exact, because the(inaudible) will only be outstanding --common units -- for a portion of the quarter.
When we get into the 4s and out to the full quarter about 130.
130 for the 4th.
Okay.
Okay.
And then lastly, hearing some commentary from some of your peers about what they are burning as for as for fuel as the refineries.
Are you burning natural gas or still back to products as distillate cracks have softened up in the last few week?
Natural gas at all locations with the exception of Benicia and Denver and we're burning about 4,000-barrel a day total of butane.
Is the heavy discounted and the West Coast and its currently at market value, below fuel value.
Thank you very much guys.
Operator
Next question from Mark Gilman of First Albany Corporation.
Please proceed.
Good morning, a couple things.
Can you give a comment on how the MTBE Facility did in the quarter and you reach any definitive plans as to what to do with that unit?
Mark, I'll tell clue we are planning to do on our MTBE unit, the small unit, we're planning to convert those to (inaudible).
The cost to convert the small unit is in the $3-$5 million range.
Our timing is yet to be decided.
We're reviewing technologies now.
On the larger unit, we still have plans to produce quite a bit of RSG and Mexican carb gasoline in the strategic plan years so right now, we're continuing to operate the large MTBE complex in Corpus Christi.
And as far as income in the second quarter, do you remember that Gene?
Averaged some where in the 10-15 cents range for both of the quarters.
Cash flow positive because of lower operating costs but probably didn't make a lot.
Compared to a factor last year in the second quarter of about 30 cents.
I wonder if I could ask a balance sheet cash flow question.
As I look at the June 30th cash and debt numbers, they're both off of what we're expecting by quite a bit implying that something else of a fund slow related in nature might have been going on in the period.
Were there significant working capital effects, Danny, or other items that affected the 630 cash and debt positions?
Yes, there's several things going on.
Obviously with the build an inventory between March and June and the other thing that is affecting debt we redeemed the toppers so you've got 200 million coming out of preferred and going into debt.
And, again, you've the building inventories and the increased -- the other thing we did in the quarter a we bought back the synthetic leases. $240 million.
We increased the AR program. $350 million.
So there is a lot of changes that you will see when you get the 10-Q of the numbers going both ways.
Danny, the AR program the accounts receivable is that what you you are referring to?
The account receivable sales program.
That should have been a source of funds, right?
Yes, it was.
Okay.
I guess I'm good.
Thanks very much, guys.
Operator
Next question from Chi Chow, Pietry Partners.
Go ahead, please.
Good morning.
Have you seen recently any fuel swishing back to natural gas and if so, what sort of implications do you think that has on the prospects of building those inventories back up prior to winter?
Well, natural gas has gotten cheaper than distillate so we don't see the hard evidence but we suspect everybody is like even the plant we are burning distillate early in the year and swished that back over to natural gas and I think it indicates (inaudible) the industry is doing right now as natural gas prices come off.
Okay.
Have you seen any slackening in distillate demand further recently.
Well, distillate demand for the year is still up 7% mainly because of the first quarter during the time when we thought there was fuel switching going on it looked like there was 100, 150,000-barrels a day of distillate demand over and above last year but with the 4 week later average we're flat with last year. (inaudible)
Okay.
Do you see any impacts on product imports with the upcoming tightening the of of the (inaudible) specks starting next year.
Have I haven't seen it yet but less out of Europe right now primarily because their inventories are low on gasoline and distillate and we are not seeing as much gasoline coming in now as we we early in the second quarter we had a lot of material come in right at that time.
They average (inaudible) closed off some and you'll always get some barrels in but we have seen a little lower levels than we saw earlier.
Right, but starting next year do you think over all less imports because of the tightening?
A lot of you have to meet -- there is a lot barrels that come in right now that are out of areas that aren't really prepared to meet the specks and we see some moderation in imports from those areas next year.
Thanks a lot.
Operator
Next question from Jacques Rouse, Friedman Billings Ramsey.
Please go ahead.
Most of my questions have been answered, but just a question on the retail segment.
I've noticed you guys have had a great quarter and was just curious if we should expect to see the selling expenses decline in the coming periods after you get through rebranding and get your store count where you want it to be?
This is Gary.
We will, I think, see that.
What really impacted us this quarter was we're about 20-25 stores ahead of the plan in terms of divesting or shutting down stores and that sort of skews it on a per-store basis.
But we made good progress on lowering our payroll and the rent expense which directly tied to the store count itself.
And that was offset a little bit this quarter by increases in our maintenance on the stores that we do have in the network and some higher credit card fees that we pay because of higher fuel prices to credit card processors.
So when should by start modeling in kind of the range you had been in the last couple of year is on a cents-per-gallon type basis?
We're still moving quickly throughout network.
I would hope next quarter we start too see some stabilizing but we still have 77 stores to close that we have identified this year.
So it may be next quarter or may not be until later in the year because we're continuing to look at the net network and weed od the stores that we don't think will be long-term competitive.
Great, thanks.
Operator
The next question from Fadel Gheit of (inaudible) and company.
Go ahead, please.
I have tow questions.
The first one on the frequency of the refinery accidents.
This question is for Bill.
Bill, is that a symptom of the company growing too fast, or capital spending is being curtailed, or it is a personnel problem, because it seems to be that the frequency is getting more frequent.
And although the industry is going through the same thing, but it seems to me that you are picking your fair share of incidents.
- Chairman & CEO
Well, first of all, it is not because of lack of capital spending o lack of maintenance or lack of a priority on safety.
Again, the problems that we are having are mostly mechanical and we're looking into the root causes of them to determine exactly why we're having the problems that we are having.
You know, obviously we have had an outstanding record in the past and we're just going through (inaudible) now.
Okay.
- Chairman & CEO
We're not happy.
I mean obviously.
We had everyone in here yesterday and (inaudible) and them are looking at all the root causes to see why this happened and what could have been done differently.
And I might add an example.
One of the problems that we had in Benicia was associated with a gas turbine operation and we had a rotor failure on the machine.
It was within its normal inspection and overhaul intervals and we are investigating the cause now but that would be unrelated to any organizational or capital issues.
You know, but at this point we are probing for what the cause was.
But, that doesn't have anything to do with like not in depth due diligence before you bought the facility there are things that probably might have over looked or anything like that?
No, as a matter of fact, on that particular machine operated under the maintenance guidelines that existed under Exxon is and we had always thought that those were adequate.
Now the second question on the (inaudible) contract.
Could you please expand upon it a little bit?
I didn't hear exactly what you said.
Could you discuss the pricing in terms of the contract and what would be the frequency of the sale?
The term is for 2 million barrels a month which is a VOBC per month at the Iraqi OST, official selling price, which for August listings is 495 per barrel.
And by the time you laid some of the other costs in, it would lay in to us probably about 50 cents cheaper than our air medium contract for August deliveries.
Now, granted this comes in September and we do think that the other contracts will reduce by about the same amount, 50 to 60 cents.
So it is a better market than what we are seeing for the month of July and August so we are seeing the benefit of widening cracks for September going forward.
In fact, Mars is now trading you out to 365 where last month it was right at about 310.
So we continue to see the sour crudes widen out because it is really the sour crudes from Iraq getting back in the market where we haven't had them for awhile.
And since you said that you are going to get the crude at a discount, could you have purchased more?
I think they're divvying it up where all the smaller refining companies are getting a cargo a month I think there was five companies announced or maybe more nan five now.
So you know, I think that is all they have available right now.
We will look to take more as they increase the volumes further.
- Chairman & CEO
But that's going to have a big impact on Saudi crude when they price it.
They will be similar prices in the long run but I think the extra crude in the market widens the discount on all the barrels.
Okay.
Thank you.
Operator
The next question from Paul Cheng, Lehman Brothers.
Please go ahead.
Hi, guys.
A real quick question.
Maybe Gene, when you talk about a hedging profit, you say $11.9 million for the second quarter?
Is there a net number or the (inaudible) gasoline?
We were up $11.9 million the second quarter and last year we were down $11.1 million in the second quarter so to net just a small gain.
So the number 11.9 is not a net number, just for the distillate part.
Just for the distillate om only and then only for the second quarter, right.
Okay.
And that wondering if you guys can give us some rough estimate of how is the retail margin for the July month to date comparing to the second quarter?
Are we down, say, 4 or 5 cents, 3 or 4 cents or any number?
Yeah, Paul, the second quarter current -- well, the current margin this month is down just about 3 cents from what we averaged in the second quarter.
Okay.
And that -- maybe that this is the stupid.
On the LP you are no longer consolidating.
Before you deconsolidate, where is the LP, I presume it is under the refining, it this being sewn up -- show up in your gross margin.
That means you have a higher gross margin or under what we call the long refinery (inaudible) profit?
Paul, the LP shows up in the equity and earnings line.
No, right now it is, but previously before you deconsolidate when your before deconsolidate I presume that it was under the refining operation, is it?
Operating expenses.
I mean all you were doing is operating the tanks and terminals?
But I mean the LP make money, right?
Previously you had before the consolidate where you record the earning from the LP you deconsolidate?
It was in revenues and cost of sales.
I mean it was in all the line items when we had it consolidate.
But I'm saying when you breakdown the divisional earning and refining U.S. retail and then North and then Northeast retail is the LP earning previously being recorded in the segment of refining?
Yes, it was in the refining segment.
Okay.
When they previously recall it the refining segment, do they record it in the profit as we call it as a gross op in the refining margin?
I'm trying to look at from the first quarter to the second quarter without a change when we no longer consolidated LP with sour.
What is in the refining is the gross margin we see a higher sequential decline because of that or that is all in the other refining operation?
We recorded everything gross.
So you got things in sales and in cost of sales and in operating expenses in the refining segment.
Okay.
You know what, don't worry about it.
I would take it off mine (inaudible).
Okay.
Thank you.
Thanks, Paul.
Operator
Next question is from Andrew Fairbanks of Merrill Lynch.
Please proceed.
Good morning, guys.
I wondered if you had and update on the coker project at Texas City and then any larger self-help factors that impacted the quarter.
Update the coker.
Okay, the coker is is actually ahead of schedule planned on mechanical completion in really late October and we should be proceeding with startup shortly after.
That probably be about a month.
I guess on the self-help or the synergy update we're on track to capture over 100 million of recurring synergies this year and year to date over 60 million captured in primary areas of accomplishments and procurement and energy savings of about 29 million and operating synergies of about 26 million.
A lot of progress on operating synergies on the West Coast.
That's great.
And then as you look at -- we have seen a lot of companies revisit dividend policies this quarter.
Do you have any update for us on the thinking there given the tax changes.
- Chairman & CEO
You know, we talked to the Board at the last meeting and basically the dividend policy will be that we will review it for 4th quarter dividend and as the company increased earnings we will we'll increase recommend an increase in the dividend and though in looking at the 4th quarter you know it has ban long time since we have increased the dividend and been 10 cents for how long, Danny?
Unidentified
So we'll be looking at a recommended increase to the board.
That's great.
Thanks, Bill.
Operator
The next question is from Ted Isaac of Lehman Brothers.
Please proceed.
Hello.
I have two questions.
One, is can we assume that the cash balances on the balance sheet will be used for debt reduction and, number two, I have all questioned on acquisitions we noted that you have the $1 billion line of credit and all this crash What is your your current viewpoint around further acquisitions here going forward?
Thanks.
You know, on future acquisitions what we have indicated is that we would have an interest in looking at the Aruba Refinery which fits well with our refining network.
They process heavy sour crudes and a lot of intermediates and we're a big buyer at the intermediates.
First Boston will be selling that for El Paso.
This is something that probably when it gets done, won't get done until late in the year or early next year.
So we would be looking at that.
That is the only major acquisition that we are looking at.
As far as the quarterback being used to bay down debt, it is just being used for general corporate purposes generally.
Okay thank you.
Operator
The next question is from John Meloy of Simons and Company.
Please proceed.
Mr. Meloy?
Yes, follow up question.
Do you expect any write downs associated with the conversion of the MTBE plant size of octane?
No.
No.
Thank you.
Operator
Next question from Mark Gilman of First Albany Corporation.
Please proceed.
Just a follow up for clarification because I think it was John that was fading.
Did you say you were going to maintain the corporate MTBE unit running as it is presently with no modification?
Did I hear you right?
Currently to satisfy the RFC demand in the gulf and meet can CARB gasoline contract we need about 14,000 barrels of day a day of ether so we currently plan to continue to continue to make that ether in Corpus Christi.
Until MTBE is phased out nationwide we continue to run that (inaudible).
Okay, Gene, thank you.
Operator
Gentlemen, we have no further questions in the cue.
- Vice President of Investor Relations
Well, in closing I would like to say thank you all for joining us today and if you have any follow up questions, call myself or Eric Fisher.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today's conference call.
This concludes the program.
You may now disconnect.
Have a good day.