瓦萊羅能源 (VLO) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Valero Energy Q2 2004 earnings conference call.

My name is Carlo, and I will be your coordinator for today.

At this time all participants are in a listen-only mode and we'll be facilitating a question-and-answer session towards the end of this presentation.

If at any time during the call you require assistance, feel free to press star followed by 0 and a coordinator will be happy to assist you.

I would now like to turn the presentation over to your host for today's call, Mr. Eric Fisher, Vice President of Investor Relations.

Please proceed, sir.

Thanks, Carlo.

Good afternoon.

Welcome to Valero Energy Corporation second quarter 2004 earnings conference call.

I'm Eric Fisher, with Valero's Investor Relations department.

With me today is Bill Greehey, Chairman and Chief Executive Officer and other members of our senior management team.

If you've not received the earnings release and would like a copy you may obtain one off our website at Valero.com.

There are also tables attached to the earnings release which provide additional financial information on our business segments.

If after reviewing the tables you have questions on the information that's presented there, please feel free to contact us after the call.

Before I turn it over to Bill, though, I'd like to direct your attention to the forward-looking statement disclaimer contained in the press release.

In summary, it says the statements in the press release and on this conference call that state the Company's or management's expectations, or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor Provisions under the federal securities laws.

There are many factors which could cause our results to differ from expectations including those we've described in our filings with the SEC.

With that I'll turn it over to Bill.

Thank you, Eric.

As all of you know for the last seven years Lee Bailey has introduced our earnings call while serving as Vice President of Investor Relations.

Lee has now taken over as Vice President of Internal Audit.

I think all of you would agree Lee has done an outstanding job in Investor Relations.

And certainly made my job easier and he's been fun to work with.

We hate to see him leave the position but Lee has a great future with Valero, and this is part of his development plan.

Eric Fisher who has been working with Lee for the last 5 years has been promoted to Vice President of Investor Relations.

And I know that Lee and Eric both will do a great job in their new roles.

Now, turning to the quarter's results - - and I think everyone who's been following the company knows that this was going to be a great quarter for Valero, and it has been.

We set a new record with the best total net income per share earnings for any quarter in Valero's history with net income of 632.7 million, or 4.56 per share.

This compares to the last year's second quarter of 128.4 million, or 1.08 per share.

You know, to put this in perspective we made more net income in the second quarter than we made in the full year of 2003, and 2003 was a record year.

I think the continued strong margin environment clearly demonstrates that the changes in refining are fundamental, they're not cyclical, and that we have truly entered a new era in refining margins that will be higher than historical averages.

Our balance sheet is also in the best shape since the UDS acquisition.

Our debt to cap now is 38.6% at the end of the quarter.

And for the first time in our history our refineries generated over a billion dollars in quarterly operating income.

Obviously the biggest factors in achieving these records were our increased throughputs, continued record refined product margins, and strong sour crude discounts throughout the quarter.

In fact, throughput volumes were up over 470,000 barrels per day versus last year's levels.

Our refineries ran well, no major turn arounds or down time.

This reflects significant investments that we've made in improving the reliability of our refining system.

The improvement is particularly noteworthy because we've only owned the St. Charles and Aruba refineries for a short time.

Both of these plants ran well during the second quarter.

We expect continued improvement because of the significant strategic investments that we have planned for next year.

As we mentioned in the press release, over half of our operating income came just from 4 refineries, but all of our refineries did well.

Let me quickly highlight some of the top contributing refineries this quarter.

Corpus Christi had the biggest contribution, 206 million in operating income, followed by Benicia at 149 million.

Texas City contributed 110 million, obviously the addition of the Coker has made a big impact on the refinery's profitability due to the heavier feed stock slate now runs.

The Coker alone is expected to contribute 125 million to operating income this year.

Our Quebec refinery also had another great quarter contributing 100 million.

Both the St. Charles and Aruba refineries made significant contributions to operating income in the second quarter.

St. Charles earned around 80 million and Aruba 56 million.

Both refineries are on track to exceed our original acquisition economics.

In fact, we estimated that St. Charles would be 40 cents a share accretive when we acquired it.

We now expect it to be more than a dollar per share accretive to 2004 earnings using the current First Call estimate for this year.

We'd estimated the Aruba would add about 37 cents to our 2004 earnings and our current projections indicate it will be over 70 cents accretive to the First Call estimate for this year.

It also looks like St. Charles will actually pay out in less than 2 years based upon our acquisition costs of about 400 million.

In looking ahead to the third quarter operations, total throughput is projected to be around 2.3 million barrels per day, which would be more than 50,000 barrels a day higher than the second quarter, and another record for the company.

For the full year we expect our throughput volumes to be up about 20%, or 240,000 barrels per day more than the last year.

Now I'd like to briefly touch on retail.

Retail earnings in both the U.S. and Canadian systems were good this quarter despite the fact that retail fuel margins were negatively impacted by the higher crude prices for much of the quarter.

In early June, as WTI prices declined, margins improved significantly and the two systems contributed total of more than 50 million in operating income for the quarter.

And our wholesale business continues to add new sites as part of our ongoing growth strategy.

Year to date we've added a net 270 new Valero distributor sites, primarily along the East Coast, bringing our total distribution network to 2600 sites.

But, of course, the big story is refining.

Let's take a quick look at the reasons why refining margins were so outstanding this quarter and the positive outlook we see going forward.

The strong fundamentals that we've been discussing throughout the year and on our recent road show remain firmly in place.

Refined product supplies are tight and sour crude discounts are excellent.

This is the perfect combination for Valero, and one that we have been predicting for sometime now.

Gasoline inventories remain relatively low in the U.S. especially now that we're in the peak summer demand period.

On a days supply basis in particular, we continue to be at the low end of the historical range,and August has historically been a month of large inventory draws.

With the market as tight as it is, any unplanned outages are likely to have a big impact on margins.

And with refineries running full out, as they have been this year, there's an increased likelihood of higher than normal unplanned outages.

Also the hurricane season will soon be here which can have a significant impact on production.

And since the U.S. requires about 1 million barrels per day of imports just to meet the summertime demand, margins will need to stay high in order to track the necessary imports, particularly given that gasoline prices in other parts of the world are also very strong.

Currently the yard from Europe is closed, which highlights how strong margins are in both Europe and the United States.

And with the recent outages in Europe we expect to see gasoline imports decline over the next few weeks.

And as we see nearly all summer gasoline demand is at record levels despite the higher pump prices.

In fact, year to date gasoline demand is up about 2% over last year.

Another factor affecting the gasoline market is the continued rise in petrochemical prices.

Benzene prices are exceptionally strong, $4 a gallon.

Toluene is currently selling at 80 cents per gallon over gasoline blend value, and xylene is selling at 45 cents over blend value.

That compares to 10 cents per gallon over blend value for each in the second quarter.

This keeps these blending components out of the gasoline pool, thereby tightening supply and supporting stronger gasoline margins.

Propaline margins have also been very strong this year.

Compared to last year we should generate an incremental 200 million in income this year from our petrochemical production.

Distillate margins have also been surprisingly strong since the middle of June.

For example, the Gulf Coast distillate margins for second quarter averaged $1.61 per barrel, but are currently around $4 per barrel.

In the northeast they averaged $2.73 per barrel for second quarter but are now at 5.10 per barrel.

This is significant because typically we don't see the distillate margins moving up like this until later in the fall.

There are several reasons why distillate margins have risen so sharply.

First, foreign demand for distillates is increasing, particularly in South America, Asia, and Europe, which has tightened the global markets for distillates.

In fact, the latest data shows that the European distillate stocks are well below average levels for this time of year.

U.S. demand for on-road diesel is also up more than 6% due to the stronger economy, and demand for off-road diesel for agriculture and construction use is up over 25%, and in addition jet fuel demand in the U.S. is up nearly 7% year to date as travel activity throughout the world has picked up.

Now turning to feed stocks, our sour crude fundamentals remain outstanding for the same reasons we've mentioned in the past.

The tier 2 sulfur specs are leading to creased demand for sweet crudes.

The high gasoline cracks and poor net-backs on the bottom of the barrel are also causing many refiners to favor the sweet crudes over the sour crudes due to their higher gasoline content which further increases the price for sweeter crudes and widens the sour crude discount.

At the same time heavy sour crude oil discounts are widening due to the increased supply as the sour crude from OPEC and ample supplies of resid on the market.

As the foreign refineries have been ramping up production, in their less efficient crude units, more and more resid has been generated that has to be dumped on the world market which widens the heavy sour crude discounts.

In fact, resid discounts are currently over $16 per barrel, and the Maya discounts are currently over 10.50 per barrel.

And as OPEC and other producers bring incremental crude oil to the market they are the lower quality heavy sour crudes.

Just to remind you how big an impact these discounts are on Valero, based upon current volumes for every dollar improvement in the discount our per share earnings increase by about $2.

For the year we think sour crude discounts should average 35% higher than they did last year, which would add over 450 million in incremental operating income for 2004.

Taking all these positive factors together we expect sour crude discounts to remain very favorable for the foreseeable future.

In fact, for our September Saudi sour crude deliveries, we expect the discount to widen by another 25 to 40 cents per barrel.

Finally something you should also note is that PYRA and other industry consultants are predicting that the industry will be entering a high level of turn around activity beginning in September.

Industry sources are indicating that about 500,000 barrels per day of crude capacity will be down in September and about 1.4 million barrels will be down in October.

The heavy activity is partially due to tier 2 related work.

Since we completed the bulk of our turn arounds in the first quarter, we only have one major turn around during the second half of the year, and that's at Benicia where we'll have a plant wide turn around in October that will last about 30 days.

So, given that the refined product margins remain very strong and the fact that our sour crude discounts for July and August are just as good as they were in the second quarter, and obviously September should be as good, if not better, I can't understand why the First Call consensus number for the third quarter is only at $2.14 per share, which is less than half of what we earned in the second quarter.

In fact, while we haven't closed the books yet we expect to earn about $1.25 per share in July alone.

The forward curve for the Gulf Coast gasoline margin for the third quarter is currently about $10 a barrel, which would be a new third quarter record.

Including the forward curve for the remainder of the year the gas crack would average about 9.50 per barrel, which is $4 per barrel better than last year's average.

The forward curve for distillate on the Gulf Coast for the third quarter is nearly a record at $4.70 per barrel.

On the sour crude discounts our posted Saudi sour crude discount for July and August deliveries is averaging $4.83 per barrel and the Maya discounts have actually widened to 10.50 per barrel compared to second quarter average of 8.71 per barrel.

And as I mentioned earlier, with all of our plants in full operation our throughput is projected to be up 50,000 barrels per day over the second quarter.

So based on all these fundamentals we expect to earn well over $3 a share in the third quarter.

It's also just as clear that the full-year numbers for Valero are substantially understated.

If you just take the $6.41 per share we've earned year to date and assume we make the $3 in the third quarter, then the nine-month number is still more than the current 9.38 consensus number for the full year.

And the fourth quarter is setting up to be outstanding, with fourth quarter gas cracks on the forward curve at about $7 a barrel on the Gulf Coast, heat cracks over 6.50 per barrel.

If the forward curve plays out, that would set a new fourth quarter and full-year record for both of these products.

Looking ahead to 2005, we're also disappointed with the First Call projections which are way below the 2004 estimates.

We're confident that next year should be a continuation of the same trends that we've seen this year resulting in another record year of earnings.

Because we are so confident in our great outlook, we just announced that later this year we'll be splitting our stock two for one, and increasing our dividend for the second time this year.

Our stockholder meeting to approve the increase in number of authorized shares will be held September 13th, and the dividend will be paid on October 7th.

With all the positive fundamentals of our business and tremendous advantage that our refining system has over others in the industry, it's disappointing that earnings estimates for Valero do not reflect earnings power and that our valuation does not reflect the improved era for refining that we're enjoying and will continue to enjoy.

The industry continues to face further reductions in sulfur content for gasoline over the next two years.

By the beginning of 2006 the maximum sulfur content in gasoline will have dropped to 30 parts per million, which should further constrain supply.

Most people haven't even begun to consider the impact of the sulfur reduction in our on-road diesel which goes to 15 parts per million in 2006.

Refined product demand is projected to continue to grow fueled by positive economic trends while our feed stock costs, while benefiting from increased production of the heavy sour crudes relative to the sweet crudes.

As we predicted for sometime we've entered a new era for refined product margins.

With the tighter supply-demand balance the highs are going to remain higher than they have been historically.

The lows aren't going to be as low, and will be shorter in duration.

This is exactly what's happening and we don't expect it to the change anytime soon.

Most economists are projecting the global economy will remain healthy in 2005, so demand should stay strong next year.

Historically gasoline demand has increased at an annual rate of about 1.2 to 1.5%.

After reviewing the capacity additions coming on line in 2005, we expect capacity growth for 2005 to be less than 1%.

So even if demand growth is just at the historical growth rate next year, supply and demand balance should get even tighter.

Plus our 2005 throughput volumes should be higher than 2004 levels because we'll have the benefit of the Aruba operations for the full year, and we expect the strategic projects that we completed in 2004 and 2005 to add around 185 million of incremental operating income in 2005.

I don't think I can make it any more clear than what I've said today.

Estimates for our earnings in the third quarter for 2004 and 2005 are all way too low.

Our stock remains undervalued.

We believe that the refining industry has entered a period of sustained higher product margins and as a result of our strategy of purchasing assets at deeply discounted prices, investing them to process the heavier sour feed stock, no refiner is better positioned to benefit from the improved earnings environment than we are at Valero.

Today we have the most complex refining system in the U.S. with the greatest geographic diversity.

And as you can see from everything I've outlined today, as good as it has been, I still believe the best is yet to come.

So with that we'll open it up for questions.

Thank you, sir.

Ladies and gentlemen at this time if you wish to ask a question. please press star followed by 1 on your touch-tone telephone.

If your question has been answered or you wish to withdraw your question, press star 2.

We will take questions in the order they are received.

Once again star 1 for any questions at this time.

Sir, your first question is from Fred Leuffer with Bear Stearns.

Good afternoon, Bill.

Hey, Fred.

How many shares did you buy back in the second quarter?

Mike.

Yeah.

We bought back about three and a half million shares in the quarter.

At --.

The average price was a little over - - about $61.

And how much remains on the share authorization?

I think it's, what --.

It's 300 remaining on that plan, and we have authorization for benefit plan purposes.

There was a jump in the corporate and administrative expense, I guess due to performance bonuses.

My question is, is there a formula we can apply related to earnings or some other metric to forecast changes in the events going forward?

Well, Fred, our bonus calculation is based on three different metrics.

It's based on earnings per share versus a target established at the beginning of the year, total shareholder return versus a target established at the beginning of the year, then our ROI versus the peer group.

Clearly with, you know, the strong earnings and what the stock has done this year ,we're doing exceptionally well on those two metrics and we're also doing very well thus far on the ROI metric versus the peer group.

Right.

But is there - - just trying to figure out as we're modeling going forward is there some rule of thumb or some way we can gauge what - -?

I think at this point, you know, for modeling purposes, you should be modeling that bonuses would be - - total corporation, roughly in the range of $100 million, of which probably about 40% of that flows through G&A expenses, the rest flows through operating expenses at the refineries.

Okay.

Now, in the second quarter, just to make sure you understand, is that we caught up a bit.

We were not accruing at 200% in the first quarter, but, you know, based upon, you know, the realization of earnings and how the stock's done, we've adjusted now to accrue at that 200% level going forward.

So there was a bit of a catch up in the second quarter.

So going forward, like in the third and fourth quarter we would not expect G&A expenses to be at this $92 million type level.

It will be more in the mid 80 range.

And the bonuses are capped at 200%.

You have a normal bonus, then based upon performance you can get up to twice.

Alright.

Probably be an okay year anyway, right, Bill?

It's going to be a great year.

You need to look at your third quarter assessment.

I'm going to come to you for a loan, Mr. Greehey.

You told me you were going to reevaluate your position on refining, Fred.

We'll talk about that later, let me just get two more in, if I may.

How much incremental static crude do you expect to run in July and August versus what you ran in June?

I don't know the exact number.

It's up some just because we've got more volume.

As they've increased production they've made more available to the customers.

I don't have the exact number, but we're getting a little more.

5 to 7% ,Gene?

That's kind of what I'm hearing.

Is that in the ballpark?

That's probably in the ballpark.

But you know it's just one sour grade versus another right now.

And the sour grade (INAUDIBLE) whether it comes from Saudi Arabia, Iraq, Mars, I mean all of it is very cheap.

Maybe just lastly, I know you cited macro numbers on gasoline demand.

Couple of your competitors have indicated that they have a little bit of a slowdown in same-store gasoline sales as they went through second quarter and in the month of July.

What was your experience on that?

Same-store gasoline sales.

Yeah, we were actually up, Fred, for the quarter, 1.9% against the same quarter year ago.

With fewer stores.

That's an average per store number.

As compared to 6% for the first quarter.

So we still were up 3.9% for the year, for the first 6 months.

And if you look at July, the month of July, against last July, we're flat, maybe up about a quarter of 1% against last July.

So we have certainly seen some decline since earlier in the year.

But the numbers still look pretty good against a year ago.

I appreciate it.

Bill, I never ever say this to any company, but good quarter.

Now, having said that, that gives me the right, when things don't go well to say "Bad quarter," right?

I will readily admit that, but I don't think it will happen anytime soon.

Thanks for your help.

Your next question is from Mark Flannery with Credit Suisse First Boston.

Hi, Bill.

Hey, Mark.

Before my question I would certainly advise you not to lend money to any Wall Street analysts.

Historically been a bad performing loan. [ LAUGHTER ]

We're making progress.

You're starting to admit it.

I'd like to talk about the balance sheet and what happens to the free cash flow.

At what point do you relax about the balance sheet and say, okay, here's - - I'm comfortable with the leverage, I'm comfortable with my position, and start to divert the free cash flow into more strategic projects or whatever you want to call them?

You know, small pieces within your existing system which will upgrade capacity either on the front end or in the middle?

Where is that point?

You know, we're working - - obviously, this is one that we have to work with closely with the rating agencies.

But when we feel like we've got a really strong investment-grade rating, then - - whether it's, you know, 30, 31%, whatever it is, then we'll start freeing up more for capital projects and not paying down debt.

We have a big backlog of great strategic projects that have great rates of return that we'd like to put in the system as quickly as we can.

And I really think that that will start happening next year.

Right.

So you think it's an '05 event?

Right.

Now, '05 is still big, you know, for environmental and maintenance and '06 is where we really start having more available for strategic.

But again, with the earnings we're experiencing and the outlook for next year, I think it's going to happen sooner.

Great.

Okay.

Thank you very much.

Sir, your next question is from Wayne R. Cooperman with Cobalt Capital.

Hey Bill, how are you?

Hey.

I don't have a lot to add to what you said.

Couple questions.

How nervous are you about gas prices up here?

When do you get worried?

And second question is, how much of the forward spread have you guys hedged, you know, for the rest of the year and even next year?

Gene, you want to talk about what we've got hedged?

Yes, sir.

Right now we have about 50% of our distillate hedged for the balance of the year because it's just so extremely strong.

Next year we've got about 19% of our heating oil cracks hedged.

So when you're giving estimates for Q3 and Q4 based on the forward curve you've actually realized - - I mean you're kind of sold it already.

Right.

We factor that into our estimates.

Gotcha.

And then we do have a little bit of gasoline hedged in the fourth quarter as well but we really haven't hedged any gasoline in the second or third quarters, when the suppliers are much tighter and demand is high (INAUDIBLE).

Incidentally we hedge distillate almost every year.

I mean we watch the forward curve.

When we see exceptionally strong margins we'll sell into that.

Gasoline we rarely ever sell forward, and if we do it is a very, very small amount.

Right.

Conceptually, on high gas prices, would you get nervous at all?

You're talking about gasoline prices?

Yes.

It hasn't affected demand a lot this year.

I know, that's a little surprising.

I think it's strictly driven on the economy.

If the economy continues to stay strong, I think people are willing to pay more for the gasoline.

Right.

Seems that way.

All right.

Thanks a lot.

I appreciate it.

Great job.

Thank you.

Sir, your next question is from Doug Teracen with Morgan Stanley.

Congratulations on your record results, guys.

Hey, Doug.

I have a couple of questions today.

First, while margins were obviously very strong in the quarter your differentials on both the mid continent and Gulf Coast have been widening a little bit in relation to the benchmark during the past couple of quarter, and that may be explained entirely by mix factors.

But either way I wanted to see if could you provide some color on these trends and any insights as to the level that these differentials may be at in the future in these two regions as well?

Doug, I assume you're comparing us against the WTI benchmark.

We are.

And the items such as (INAUDIBLE) sulfur, propane, they are a - - that differential has widened significantly.

Give you a good example.

In the northeast for Canadian operation, which you didn't mention but we make about 13% funker out of Canada, and that funker price relative to New York has been excellent, but the differential against Brent has widened significantly.

So when you actually look at our spread, our crack, for that operation, you'll see that the industry index was up significantly, but our overall income wasn't up as much, and that's the main reason.

That's a high quality problem.

And second, from a strategic standpoint, I wanted to see if Bill or Mike would provide an update, get assessment on the refinery acquisition market in the United States?

Specifically with the rise in margins that we've seen which a lot of folks believe is structural, it may reason that sellers may be fewer in the future, has been in the case, but it may not.

With your size, it may be issues, too.

If you guys could provide your current assessment of the landscape in the United States it would be appreciated.

Hey, Doug.

First of all with regard to FTC I don't think we would have a problem other than in California, acquiring additional refineries.

Okay.

And what is available on the landscape, I mean, we're not looking at anything right now.

I'm sure that if a refinery became available, you know, we're not going to be able to buy the refinery for what we did two years ago.

Yeah.

That's obvious.

But I think there's going to be opportunities.

We continue to evaluate refineries and hopefully we'll be able to acquire some, but we don't have anything specific right now.

I think it's safe to say you have a lot to work with internally in the meantime.

Thanks a lot guys and congratulations again.

Thank you.

Your next question is from Jennifer Roland with J.P. Morgan.

Good afternoon.

I just had two questions.

First, I was wondering if could you comment on what you're seeing for retail margins in July?

Gary Arthur, Jr.: Yeah, Jennifer, this is Gary.

Our margins are right about 13 and a half cents for the month of July.

Is that in the U.S. and Canada as well?

Gary Arthur, Jr.: That's just the U.S.

And what about in your northeast operations in Canada?

Gary Arthur, Jr.: In Canada our margins, which include, and we don't have much at this point, but it would be about 21 cents a gallon.

21 cents.

Great.

And then lastly, I think you said you didn't have any hedges on in the quarter, I just wanted to verify whether or not you had any impact from hedges in the 2 Q numbers?

We did. (SPEAKER TOO FAR FROM MIC - MOSTLY INAUDIBLE) Yeah, the 2 Q numbers gas and - - we didn't hedge gas itself, mainly heating oil, loss of about $8.5 million, first quarter gain of 3.7 so it's been pretty minor year to date, loss of $7 million.

Very strong market --.

Okay.

Great, thank you. (INAUDIBLE) Thanks.

Sir, your next question is from Christopher Eades with Solomon Brothers.

Good afternoon, and thank you.

Over the last month we've seen gasoline inventories increase to the point where they're now above year-ago levels.

Distillate inventories are still above year ago levels.

And by my math, gasoline demand cover is now above where it was a year ago, and demand growth appears to have lost some of the steam that we saw back in the spring months.

And behind that backdrop we've seen refining margins drop by $4 or $5 over the last three or four weeks depending on what benchmark you want to use.

I was wondering if that fundamental landscape concerns you, and if it doesn't I'd like to hear why?

Well I think the big thing on gasoline, when we gas crack in the second quarter at $13 a barrel, I mean obviously, every refinery that could gasoline and every imported barrel in the world to make it here came to our market, I think that's why you saw inventories start to catch up a little bit.

I think going forward you know, we see there's - - the arbitrage is closed in Europe, like Bill was saying before, there's at least three refineries we know that have significant operating problems in Europe right now, one in Germany, one in Wales and one in Turkey.

So we think import is going to subside although bit, and you know, we really haven't hit the peak demand.

Even if you hit last year's demand in August which was around 9.4 and you know, and import fall off any at all we're going to be pretty heavily back on stocks during the - - over that 5 or 6 weeks..

The other thing, you know, U.S. production is down year on year.

A lot of the reports you see people show balloon stocks included and say gasoline production is up, but if you back out the balloon stocks and just show what the refineries themselves are making, this week we only made right at 8 million, maybe 8.1 million barrels a day which is a lot less than last year.

Heck, the last 6 weeks on a percentage basis, gasoline yield has been less than last year.

So I think it the's just the magnet we had in the second quarter caused inventories to renormalize, but it going to take margins at least this strong to keep the arbitrage open to bring the million barrels a day or so we're going to require to meet demand.

Even though margins have fallen back I mean the margins we're looking at right now are darn good margins.

We'd be happy.

And we'd be happy with forward curve.

End of the third quarter is falling off.

It's currently just under $10 a barrel.

Last year's third quarter was only seven and a quarter.

I agree with that.

It strikes me that the directional movement and the fundamental seems to have turned course here over the last three our four weeks.

Margins are now reflecting that.

I guess my concern as an investor here is that we swing from one pendulum to the next quickly as this market typically has in cycles past.

The problem is, you look at this stuff from week to week you go crazy chasing it.

There's always corrections in it and I think what you have to to is look on a trend base.

We do have a business that's volatile on a day to day, week to week, but directionally supply is tight and margins are going to continue to improve over time.

Thank you.

Sir, your next question is from Mark Gilman with the Benchmark Company.

Bill and guys, good afternoon.

I had a couple of things I wanted to go over if I could.

The interest expense in the quarter looked a bit higher than I thought it was going to be.

Any particular reason, Mike?

Yeah, it's due to an increase in our average borrowings.

We issued right there at the end of the first quarter about 600 million of term debt and we brought the leases back on, too, and our oil prices on our inventories.

Okay.

The refining DD&A went up more than I had expected it was going to.

Anything change in terms of the way that's being computed?

Not in the way it's being computed.

We had an increase due to capital projects being completed and coming on line.

We also had the full quarter effect of St. Charles and Aruba which was not in last year's second quarter, and then the turn around amortization increased also.

Okay.

I wonder if you could update me, I'm focusing on the retail segment for just a sec.

How the regional sales break down look right now, perhaps amongst pads in rough ballpark terms?

You mean Mark, relative to when you say how they break down, you mean relative to last year or --.

Oh, no, not on a relative basis but absolute.

I mean X% in pad 1, Y% in pad 2, et cetera, et cetera.

Well we don't have anything in pad 1 or 2.

We're basically a three, four, five marketer.

And I would tell you that our sales have been really consistent, the numbers that you see on an overall basis are fairly representative of the mix.

We actually are maybe down just a little bit, particularly in the month of June, in the Texas market which would be pad three, of course, because of - - largely because of weather.

We had the third wetest month on record in Houston.

One of the wetest months on record in the Dallas / Fort Worth market which is two market where we've got a fairly significant concentration of stores.

So that had some impact.

What does that split look like?

Mark, we don't have those numbers right now.

And we'll give you a call after the conference call we don't have it.

That would be great.

Gene, could you tell us what level that hedge is at for the second half on the distillate crack?

How many barrels?

Not how many barrels, what price level?

They were just just on average just under $5 a barrel.

So the market is a little higher than that right now.

On a mark to market basis we have a loss right now on the hedge itself, but remember we've got twice as many physical barrels as we've got hedged.

Net-net we're still well ahead of a really strong number that we locked in.

Okay, guys.

Thanks very much.

Sir, your next question is from Paul Cheng with Lehman Brothers.

Hey guys.

Several quick questions.

I think Eric may be able to help.

Eric, do you have a breakdown of the throughput (INAUDIBLE) for the third quarter by system?

Sure For the third quarter I'd expect the Gulf Coast, we'd be at about 1.3 million barrels.

The west coast, some where 300 to 310.

In the mid continent, probably 290 to 300.

In the northeast, you know, 365, 370, something like that.

And should we assume that the third quarter and the second quarter, the unit cost will be similar and we should not have any significant change?

That's right, Paul.

Okay.

And that maybe this is for Mike.

If we assume you're going to earn about $3 in the third quarter what will be the corp expense may look like?

Which expense?

Corporate.

It will be about - - the administer there will be about 87 million a quarter for the last two, third and fourth quarter.

Even if we assume that you're going to make it $3 per share in the third quarter?

That's correct.

Okay.

And how about the interest expense, $17 million reasonable run rate going forward?

Going forward, net interest expense will be about 68 million a quarter.

Okay.

Two final questions.

I think this is for Bill.

Bill, given your optimistic view on the U.S. refining margin, you didn't even make any sales if we look at that time European - - some of the refinery and perhaps that you can purchase it at adeep discount and convert that into exported facility, and back in and putting the product back to U.S., is that a reasonable strategy, or you - -

No, I think it is a reasonable strategy.

I think it is something that we will be looking at but, you know, again our first priority would be to continue to buy refineries in the U.S.

Yeah, because I presume --.

that does make

The European refinery.

Looking at it right now.

Because I just think it's going to be cheaper that you get it in Europe than you get it in U.S. today.

If I do one you'll be happy?

Well, it depends on the price, right?

[ LAUGHTER ]

Okay, Paul.

Last question, Bill.

On the Aruba and O'Ryan, when that you may decide, for example, Aruba, to make the investment to convert that into a gasoline refinery?

You know, we're going to be preliminary evaluation work now.

We're probably at least six months away from making any kind of a decision.

And, again, it would be way out.

I mean, you know, we're looking four or five years out.

Uh-huh.

It would be a large expenditure.

Probably talking about in the 7 or 800 million dollars?

I would think at least.

Okay.

Very good.

Thank you.

Congratulations.

Thank you.

Your next question is from Jay Saunders with Deutsche Bank.

Thank you.

Just a couple of quick ones.

I was wondering if you could give us an update on Aruba, the operating rate there and the money you're investing in that plant?

Is it more or less than you said when you bought it?

Sure.

I can give you an update on that.

Aruba operations have been generally good.

Crude rates have been typically in the 220,000 barrel a day to 240,000 barrel a day level with full Coker(ph) operations about 67 - 68,000 barrels a day.

Okay.

Great.

And kind of a market question, on the west coast I guess Gene might be able to answer this one.

Just looking at DOE numbers looks like total product imports are down in to the west coast but you got more gasoline imports so the mix is changing into blending components rather than finished gasoline.

How does that impact - - how does that impact, kind of, the fundamentals out there?

Does that impact your yield?

Does it lower your yield, I guess, for that - - for the pad?

And are you seeing that?

Is China keeping more at home, I guess?

Just look at the year on year data, you make a good point.

It's all the (INAUDIBLE) that comes in that's classified as a blend stock rather than the finished gasoline, so year on year it kind of looks different, but inventories are still about a million and a half barrels less than last year.

We do see some turn arounds upcoming in the next couple of month.

So the market has come up a little bit, too, but we still have pretty good margins around $16 a barrel.

I think the latest crack in San Francisco is probably 50 cents higher now than LA right now.

Still a lot of - - there's a lot of blend stock that need to come in.

We're taking output and wrapping it out there every month to help meet our blending requirements in Wilmington. (INAUDIBLE) It's inner pad movement. (INAUDIBLE) The base production in California really dropped off without these imports coming in.

Right.

Okay.

Any ideas about distillate demand beyond just the economy?

Is there any kind of fuel efficiency declines there that are increasing the demand?

Diesel, I guess?

We see trucking activity at all-time high levels, so we think that's a lot of what's causing the on route demand, strong economy, more big trucks on the road, whether they be commercial or private trucks.

And the off-road is agriculture, you said.

Agriculture and construction.

Okay.

Thanks, guys.

Sir, your next question is from Andrew Fairbanks with Merrill Lynch.

Hey, good afternoon.

Bill, Eric, I'll offer congratulations to you all.

My question was regarding any additional capacity or margin augmentation projects.

If you guys do 125 million in the Coker at Texas City this year it could well be a three-year payout project.

Are there any other Coker opportunities or any other major unit opportunities that are out there through the system?

You mentioned BTX, I seem to recall you had a moth-balled BTX unit at Three Rivers for a while.

Is that still the case?

Rich has the schedule of the strategic project that we have planned for next year.

And you know, it's pretty similar to what we presented to you in the road show.

You remember those projects for 4 and 5?

That would be great.

Let me cover those quickly.

Before the year is done we will start up a new CCR re-forming unit in the Quebec, that way we have about 32,000 barrels a day of re-forming capacity and have income of about $30 million EBITDA.

When we get to 2005, earlier in the year we bring on two sour-up projects, one at our Ardmore refinery and one at our Three Rivers refinery.

So those will increase sour capacity versus sweet.

Together they will add about $45 million in annual EBITDA.

Significant upgrade at our St. Charles refinery will happen in the first and second quarter.

We will be upgrading the MSCC operation.

We'll expand throughput from about 85,000 barrels a day up to about 100.

There's also going to be a companion project where we expand out (INAUDIBLE) capacity by another 5,000 barrels a day.

The cat expansion will let about $45 million of EBITDA.

Later in the year in the third quarter we'll expand Coking capacity in Aruba.

We'll be able to take unit rates up by about 16,000 barrels a day, which will increase income by about 30 million.

And then, in the third quarter also we anticipate reactivating the (INAUDIBLE) breaker on Aruba which will add about 34,000 barrels a day of emergency conversion capacity for another $30 million a year of income.

And do you have any further updates on the Wilmington CDU?

Potential expansion there?

The Wilmington crude capacity?

Yes.

You know, it runs about 85,000 barrels a day now.

We do have in our strategic outlook looking at bringing capacity up over 100,000 barrels a day.

With Aruba in the mix, we've got more opportunity to run crude and bring feed stocks to the west coast so we haven't locked in on a final strategy on crude rate on Wilmington yet but it's being looked at.

We have been doing that lately, actually taking gas off to the west coast from Aruba.

Excellent.

Thanks.

Your next question is from Daniel Berk with Johnson Rice.

Good afternoon.

Was hoping to get an update on the Cameron Highway project, specifically what the benefit to the bottom line could be in 2005 either from a cost basis or I guess a net income basis as well.

Cameron highway project is about $460 million project.

We expect it to the overrun around $15 million.

So it's close but we did after slight overrun.

If needed 2 billion of barrels of crude for its economic.

We now have committed 1.2 billion barrels, and that's over a 20-year project life.

The first oil is expected to actually be delivered on November 15th, and line fill will begin in September.

I don't have the bottom line.

Perhaps I could follow up on that.

One other question.

You mentioned earlier an estimate of increase in aggregate domestic motor gasoline supply capacity in2005.

You provided, you know, throughput rates for 2005 and I guess I could back into this number if I knew your (ph) yield headed into 2005.

Curious if I could just get specifically how muchly Valero's motor gasoline output would be up in 2005 versus 2004?

Our yield just in general runs about 48% or so. 48 - 50% of gasoline.

Having Aruba come in there.

Other than that you just to have run the numbers.

Does it look like 2 - 3% year-over-year for you guys?

I'm not sure the percentage will go up.

Our volume will be up, as Rich said, for a couple of the projects.

But we will also run more crude at Aruba where we're But we did -- I think you need to let us run our model and we can get that you answer.

Okay.

Thank you, guys.

Sir, your next question is from Chee Chow with Petrie Parkman.

Eric, congratulations.

Promotion is very well deserved.

Where are you seeing gasoline imports coming from these days?

Really just about what we said last year.

We said imports would be down, primarily Latin America, Venezuela.

We only have real data through April for the DOE.

Place by place.

But I believe that South America is down about 45,000 barrels a day and would really being replaced mainly by European barrels that have come in because of the stronger arbitrage we've had the first half of this year to bring barrels down.

Ir net year on year increase.

Are you seeing any evidence of Venezuela being able to export meaningful and sustained volumes of gasoline?

The, in connection with I keep hearing, 27,000 barrels a day, remember couple years ago they were exporting 80, 0,000 barrels a day.

So they're still do you know historically.

Bill, with crude at $40 plus now, probably demand hasn't seen the (INAUDIBLE) at all.

At what price do you think we'll start to see any degradation in demand?

I don't know.

I think receiving tied (INAUDIBLE) the DME.

As long as the economy stays strong it seems to be absorbing these higher prices but it scares me that prices crude where they are for any prolonged period of time.

It's having a big impact on transportation companies and airlines and so - - you know, I don't know what price it is but it's not good at $40.

Thanks a lot.

Your next question is from Walter Lovato with Pass Worth Capital.

Quick question on the turnaround.

Are those numbers that you mentioned for September and October, those are just U.S.?

That's right, Walter.

Those are U.S. numbers.

What's a normal sort of fall turnaround level?

I don't have the exact number but this is above the normal level that's projected by PYRO right now.

Mainly in October is when their peek turn arounds.

Some people comment in the turn arounds weren't very heavy.

Well, they're never very heavy then.

July and August are your big gasoline months so most are focused in the October time frame.

The (INAUDIBLE0 we've seen from are what's typical you would have in the month of October.

Do you have any sense of whether the turn arounds might be higher than normal elsewhere in the world, in Asia and Europe, given- - they must be running at full capacity as well right now.

I haven't seen any official numbers out of there.

Okay.

Thank you very much.

Your next question is from Daniel Volte with Barkley's Capital .

I'd like to ask a question about your '05 capital spending.

How much of that I believe it's 1.8 billion.

Can any of that be deferred should refining margins not be as supportive as you feel?

I'm trying to get a sense for how confident you are you can internally fund your capital spending?

The strategic capital of, that 1.8, 325 of that is strategic.

So some of that could be did he period the margins weren't there.

Okay.

Thank you very much.

Next, Mark Gilman with the Benchmark Company.

Bill, I'm looking at some of the product yield statistics in the earnings release and it seems that gasoline distillate combination slipped a little bit, you know, in this period relative to both first and year-ago and there's an increase in the other product side.

I know Aruba is going to skew these numbers a little bit but is there anything else going on that might be responsible for this shift which in turn might contribute to the widening of the differential in terms of margin performance versus benchmarks?

The only other thing that would be going on is that we are, like most people, to run as much heavy because the differential exceeds the lots of product value but otherwise there's nothing else going on.

Okay.

Thanks, Bill.

Thanks, Mark.

Ladies and gentlemen, as a reminder press star 1 at this time if you would like to ask a question.

We have a question from Al Silver with Brean Murray.

Hi, Bill.

Congratulations.

Big change from the old days.

Bill, in your wholesale business, could you give us an idea if that is still expanding and also are you still supplying products to Exxon and Mobile on a tolling basis out of Benicia or Paulsboro or has that all gone away by now?

The Mobile contract that we had at Paulsboro is ongoing, Gene, you want to comment on wholesale?

Yeah.

Over the year we've added 267 net new sites we brought more than that on but we've add few - - on some of the contracts on some of the smaller stores that we didn't really want to rebrand again.

But we had rights to the Exxon brands out in the west coast, or not really Exxons any more (INAUDIBLE)but we supply them under a branded deal.

Do you still see growth in that sector going forward?

Yeah, we're actively looking at adding more site, particularly on the eastern seaboard, all the way northern New England all the way down to Florida.

There's a lot of interest still in our brand.

And what sort of margin trend are you looking at in that business?

Right now we've got an average about 2 cents a gallon unbranded.

Nice is you take it out of the spot market and you have it on a firm basis also.

So it helps both sides.

There's no future potential in sort of converting some tolling runs into sort of market runs.

I don't know what that means.

Let's say you're running throughput for Mobile.

Is that on a fixed margin basis and can that go away and give you some opportunity?

No, those barrels are - - they're sold to the Exxon jobbers are really sold on a market-related formula.

So with the refining margin we keep all that.

Okay.

Thank you.

Gentlemen, we have no further questions.

Mr. Fisher, back over to you for closing remarks.

Thank y'all for joining us today.

If anybody has any follow-ups, feel free to give us a call.

Thanks.

Ladies and gentlemen, we thank you for your participation in today's conference.

This concludes your presentation and you may now disconnect.